In KOVACS-WHALEY v. WELLNESS SOLUTIONS, INC. ET AL., No. M2011-00089-COA-R3-CV decided March 16, 2012, the Tennessee Court of Appeals held that Defendants were not entitled to summary judgment on a breach of contract claim because a jury could ultimately decide that Plaintiff's objection to the stock appraiser chosen by Defendants was reasonable. This case highlights the perils of including provisions of mutuality and reasonableness in Shareholders' Agreements, or as we like to say, "no good deed goes unpunished."
Plaintiff, a former employee, shareholder and director of Defendant Company, filed an action against the Defendant and its shareholders following the termination of Plaintiff's employment. Thereafter, the Company exercised a call option contained within the Shareholders' Agreement and purchased Plaintiff's stock. Plaintiff then amended her complaint to include a claim for breach of contract based upon the call option exercise and valuation of Plaintiff's stock over her objection to the appraiser.
The Shareholders' Agreement provided that the stock value would be determined in an appraisal obtained by the Company "performed by an appraiser reasonably acceptable to the Company and such Shareholder" (Emphasis added). The dispositive issue was whether the appraiser was reasonably acceptable to Plaintiff. At issue was not that Plaintiff complained about the competency of the appraiser; rather, that the Company had obtained an informal valuation from the appraiser before he performed a full valuation. The Court took umbrage with the Company's "show me your cards first" approach, and held that Plaintiff's objection to such appraiser under the circumstances was an issue of fact for the jury.
The lesson to learn is that extreme care should be taken in drafting Shareholders' Agreements. This valuation provision was fairly typical, and may have been negotiated by the parties, but it suffered from a double whammy of allowing a veto to a disgruntled former employee, and based such veto on a standard of reasonableness. As reasonableness is an issue of fact, this language unnecessarily opened the door to summary judgment. One could argue that the drafter attempted to avoid conflict by requiring reasonableness as a safeguard, as opposed to giving the Plaintiff an outright veto. And clearly what bothered the Court was the Company's obtaining a sneak peak at the value of the stock before hiring the appraiser. But the Agreement apparently failed to contain a methodology for appraisal in the absence of agreement of the parties. Thus, it appears that different or additional language in this situation may have prevented further litigation.
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