Achieving the Proper Remedy for a Dissenting Shareholder in Todays Economy: Yuspeh v. Koch

• Author: Stephen J. Paine
• Position: J.D./B.C.L., May 2005, Paul M. Hebert Law Center, Louisiana State University
• Pages: 911-939

J.D./B.C.L., May 2005, Paul M. Hebert Law Center, Louisiana State University. The author wishes to thank his wife Emily for her patience and support during the three arduous years of law school, but especially while writing this casenote. Also, the author wishes to thank his mother and father for teaching him to always shoot for the stars and to never settle for second best. Finally, the author would like to thank Professor Glenn G. Morris for his guidance during the many earlier drafts of this casenote. Without all their help, this paper would not have been possible.

Page 911

Introduction

Louisiana Revised Statutes 12:131 provides rights to a shareholder dissenting from certain corporate actions including mergers, consolidations, share exchanges, and sales of assets to which the corporation is a party. These rights, known as dissenters' or appraisal rights, give the dissenting shareholder the right to demand payment from the corporate issuer of his shares at their "fair cash value."¹ Since the general rule in Louisiana is that corporations have no responsibility to repurchase the shares of an investor who wishes to recede from the firm, intuition tells one that dissenters' rights are therefore valuable assets to all dissenting shareholders.² However, these appraisal rights may provide inadequate compensation to the shareholders who are being forced or "freezed-out" of a corporation.³ Freeze-out mergers, which began to arise in the early 1970s, are corporate transactions in which the majority expels the minority stockholders from the company and requires them to accept cash, notes, or other property for their shares.⁴ The question has been raised whether the dissenting shareholders of a corporate action are limited to the rights dictated by Louisiana Revised Statutes 12:131, or instead, may they pursue other legal remedies?⁵ Though unresolved in Louisiana before Yuspeh v. Koch,⁶ other states have held, both jurisprudentially and statutorily, that dissenting shareholders can maintain a breach of fiduciary duty suit in lieu of the statutory dissenters' rights action.⁷

This casenote analyzes the decision of Yuspeh v. Koch in which the Louisiana Fifth Circuit Court of Appeal declared, first, that Louisiana's dissenters' rights were not exclusive and, second, that aPage 912 minority shareholder's interests were properly valued as a proportionate part of the corporation. The court's decision allowed the dissenting shareholders to receive equitable monetary recovery for their shares of stock and demonstrated that Louisiana courts understand the serious inequities of dissenters' rights in freeze-out transactions. The court did not hold that freeze-out transactions are necessarily an evil way of doing business. In fact, the court supports freeze-out transactions as long as the minority shareholders receive a fair and evenhanded valuation for their shares of stock.

Part I of this casenote explains the factual and procedural background of the Yuspeh case and details the court opinion. Part II describes the pertinent history of dissenters' rights in American corporate law, in order to ascertain the original purposes of the statute. This description also explains how the dissenters' rights statute is now being used for purposes that it was never designed to accomplish.⁸ This second section includes a description of the two main problems with dissenters' rights today: complicated and demanding procedural rules, and share valuation problems that undervalue the dissenters' shares. These particular troubles have led many courts, including the court in Yuspeh, to allow minority shareholders to pursue other causes of action outside dissenters' rights.

Part III outlines: (A) why dissenters' rights should not be the exclusive remedy with freeze-out mergers; (B) Delaware's approach to the issue of exclusivity of dissenters' rights; and (C) that Louisiana followed the correct approach with the Yuspeh decision. This section establishes that dissenters' rights are incapable of providing an equitable remedy to a minority shareholder. Therefore, it is nonsensical to relegate these former shareholders to this ill-equipped remedy. Part IV describes the court's valuation of an exiting minority shareholder in a freeze-out transaction as a proportionate part of the whole company. This valuation methodology was a break from the precedent set in Shopf v. Marina Del Ray Partnership,⁹ but remains the correct decision. However, the court made certain assumptions that allowed it to avoid discussing this adverse precedent. Though the decision to avoid precedent provided a correct result for the plaintiffs in Yuspeh, it has left the jurisprudence muddled. Finally, part V argues that Louisiana should amend its current dissenters' rights statute to deal with the problems that freeze-out mergers have caused under the present structure of the appraisal remedy. This amendment can be properly achieved byPage 913 following the American Law Institute's guidance. Specifically the American Law Institute (ALI) recommends removing minority and marketability discounts when shares are being sold between shareholders in a closely-held corporation,¹⁰ simplifying the complicated appraisal remedy procedures,¹¹ and specifying exactly when dissenters' rights should be applied exclusively.¹²

I Yuspeh v. Koch

A Factual and Procedural Background

Charles Yuspeh, Wallace Murphy, and Michael Ditcharo founded Certified Security Systems, Incorporated (CSS) in 1983.¹³ Yuspeh effectively owned seventy percent of the common stock of CSS.¹⁴ Of this ownership percentage, eighteen percent represented the shares of stock that were held in his two daughters' names.¹⁵ Murphy owned exactly twenty-five percent of CSS and Ditcharo owned the remaining five percent interest.¹⁶ In 1990, Yuspeh attracted two new investors, Hansen and David Koch, to invest $1.5 million in secured notes and $500,000 in 500 shares of preferred stock in CSS.

Eventually in 1993, the Kochs' loan to CSS became overdue. The loan was subsequently restructured, through which the Kochs lent additional money to CSS and the 500 shares of preferred stock were exchanged for new common shares worth fifty-one percent of CSS's issued and outstanding common stock.¹⁷ Consequently, the Kochs began to control the corporation by a majority vote. This transaction left Yuspeh, Murphy, and Ditcharo with 34.3%, 12.25%, and 2.5% ownership interests respectively. Also, the shareholders of CSS amended the articles of incorporation to require a 60% vote of the shareholders to reorganize the company.¹⁸ The corporate articles had previously required 67% of the shareholders to agree to reorganization.

CSS struggled with profitability, upsetting the Kochs, the new majority owners. In 1994, Hansen Koch fired the president, Yuspeh,Page 914 for falsifying the corporation's true financial condition and subsequently promoted himself as the President and Chief Operation Officer of CSS. Murphy, head of the sales department, eventually quit CSS in 1996 because he was dissatisfied with his employment terms.¹⁹

The Kochs later attempted to purchase Murphy's new 12.5% ownership of common stock for $50,000, which Murphy declined to accept.²⁰ Subsequently, in December of 1997 the Kochs, who now controlled the corporation with a majority ownership interest, caused the board of directors to issue them thirty-four authorized, but previously unissued shares of common stock from CSS for $50 per share.²¹ The plaintiffs, consisting of Yuspeh and other minority shareholders, were never notified of the Kochs purchase of these thirty-four shares of stock. This transaction raised the Kochs ownership percentage to approximately 67.6%, giving them the sixty percent ownership interest necessary to reorganize CSS.

The Kochs reorganized, over objections by Yuspeh and the other minority shareholders, and created a new corporation wholly owned by them. The Kochs merged CSS into this new company, leaving them with a 100% ownership interest in the new firm, and requiring Yuspeh and the other minority shareholders to relinquish their CSS shares for $50 a share.²²

The plaintiffs believed that the merger did not set their stock at fair market value. The $50 per share price set by the plan of merger was much lower than the $2000 per share value the Kochs had earlier offered Murphy for his 12.25% ownership interest. The plaintiffs would have been entitled to exercise appraisal rights, had they complied with the statutorily prescribed procedures.²³ Instead, they filed a suit alleging that the majority shareholders committed fraud and a breach of fiduciary duty by purchasing the thirty-four unissued shares and abusing the leverage those thirty-four shares gave them by forcing the minority shareholders out of the corporation in a freeze-out merger.²⁴

The district...