Judicial dissolution of a closely held corporation, the "corporate divorce," is one of the most acrimonious, expensive, and, by almost all accounts, unpopular of legal remedies available in business litigation. Modern corporate statutes tend to reflect this widely held aversion by providing courts and litigants with a variety of alternatives to ending a business's existence. The buyout election, for example, a sort of call option patterned after common law remedies and American Bar Association ("ABA") model legislation, provides one means by which shareholders and corporations can avoid the extreme remedy of corporate dissolution by forcing complaining shareholders to sell their stock to them. But when can these electing shareholders or corporations change their minds about the decision to buy out their adversaries? Many statutes deem the buyout election "irrevocable"--but then allow a court to set it aside if it would be equitable to do so. Such a fluid notion of irrevocability presents challenges.
An electing purchaser might have second thoughts about buying a greater stake in a company for any number of reasons: a precipitous decline in business, the defection of key employees, an unexplained loss (or defalcation) of assets, an owner's death; all of which will arise in something of a no-man's-land between formal civil proceedings and private negotiations found in most statutory buyout procedures. With nothing more than the invocation of equity, courts must somehow divine whether a party ought to be allowed to withdraw an irrevocable election to purchase in a shifting landscape of evolving business conditions and competing interests. Not surprisingly, the reported rulings emanating from these disputes defy cohesive analysis. Some further clarity would be invaluable. This article explores a proposed method to hone the broad conception of equity these statutory provisions utilize into something more manageable and easier to grasp, a limitation premised on the commonly understood business term of transactional due diligence.
INTRODUCTION II. DEVELOPMENT OF THE MODEL STATUTORY BUYOUT ELECTION A. Common Law Origins B. The Model Act Buyout Elections III. SEARCHING FOR A STANDARD IN BUYOUT REVOCATION A. Survey of the Reported Rulings B. The Dilemma of Uncertainty IV. SHAPING t DUE DILIGENCE STANDARD FROM EQUITY A. Fundamentals of Equitable Limitations B. Components of the Vigilance Limitation 1. Awareness 2. Diligence C. Due Diligence in Commercial Transactions V. INCORPORATING A DUE DILIGENCE STANDARD INTO STATUTORY BUYOUT REVOCATIONS A. The Proposed Standard B. Reexamining the Rulings Under the Proposed Standard VI. CONCLUSION I. INTRODUCTION
Few areas in business litigation derive more acrimony than a lawsuit to dissolve a closely held corporation. Close corporations are often formed among family members or longtime friends and business partners, the kind of intimate relations that all too frequently carry simmering jealousies, sibling rivalries, personal grievances, real or imagined, all of which invariably become bound in subtle (or not so subtle) ways within the business's day-to-day operations and governance. (1) Bitter personality clashes between individuals can transform into heated commercial disagreements and corporate deadlock. The need to untangle these business relations may indeed be stark, but the separation itself is often freighted with ill will. As the Delaware Court of Chancery once observed, "[e]motions run high, feelings are frayed, and former friends and colleagues find themselves at odds." (2) Judicial dissolution petitions have been likened to a "corporate divorce," and not without justification. (3)
But because terminating a corporation's existence necessarily carries a profound impact on anyone connected to its business--the shareholders, employees, customers, vendors, and suppliers may all have considerable stakes, if not their entire livelihoods, invested in its viability (4)--there has arisen over time a prevailing view that, regardless of contention among the owners, involuntary dissolution of a corporate entity ought to be avoided if at all possible and reserved as a mechanism of last resort. (5) One alternative in particular that has gained a wide level of acceptance is a statutory right to purchase a complaining party's shares in lieu of dissolving the business. (6) In 1990 the ABA approved section 14.34 of the Model Business Corporations Act ("Model Act") to codify, as an alternative to dissolution from owner deadlock or shareholder oppression, a statutory framework to facilitate a shareholder's buyout. (7) To date, twenty-nine states have enacted some form of an elective purchase remedy within their respective corporate statutes, of which sixteen are patterned directly after the Model Act's section 14.34. (8)
By design, the model statute provides a straightforward mechanism to effectuate the buyout during litigation. "In a proceeding under section 14.30(a)(2) to dissolve a corporation" that has no shares listed on a national securities exchange or regularly traded in a market maintained by one or more members of a national or affiliated securities association, "the corporation may elect or, if it fails to elect, one or more shareholders may elect to purchase all shares owned by the petitioning shareholder at the fair value of the shares." (9)
Filing such an election (10) carries a number of concomitant responsibilities on the part of the electing party, the corporation, the remaining shareholders, and the court overseeing the case, which are described in both substantive and temporal terms within the statute. (11) Indeed, the entire process--including prescribed notice procedures, deadlines, a mandatory negotiation period, and the availability of a judicial valuation hearing--would appear almost mechanical in structure and operation. (12)
Yet, within this framework the drafters of the model legislation set aside a significant role for a trial court to exercise a range of equity powers. (13) Particularly noteworthy is how the buyout election, the triggering event for the entire process, is characterized in subsection (a): "An election pursuant to this section shall be irrevocable unless the court determines that it is equitable to set aside or modify the election." (14) Which raises the question, when might it be equitable to allow a party to withdraw such an offer?
It is an issue located at a dynamic intersection between statutory directives, corporate dispute resolution, and ancient common law principles of equitable jurisprudence. The relatively few reported decisions to construe this grant of authority have applied it in the broadest ways conceivable, relying on a seemingly unfettered grant of equitable powers within the legislation, but seldom have the courts offered definitive pronouncements about the contours of that authority or guidance for future tribunals to apply when faced with a shareholder recanting a buyout election. (15) Given the necessarily fluid nature of dissolution proceedings and the correspondingly flexible architecture dissolution statutes employ, this should hardly come as a surprise. Amidst the throng of offers, counter-offers, shifting interests and alliances, and competitive positioning within the litigation, the court becomes something of a bridge between a facilitator of corporate negotiations and an equitable arbiter should those negotiations fail. (16) Still, is it possible to discern some boundaries, some guiding limits, even in a field as wide as equity, for deciding when a shareholder may permissibly revoke his or her election to purchase? Can one find any constraints within the Model Act or the case law interpreting corporate dissolution statutes?
I believe, through the use of a modest legal fiction, it is eminently feasible to do so. Exercising the statutory election to purchase, like an arm's length transaction to acquire a stake in a business, ought to impose some level of "due diligence," as that term is commonly understood, on the part of the electing shareholder or corporation, absent which the decision should remain irrevocable. This article will examine how such a concept could yield some needed clarity in this area of the law and aid decision-makers confronted with a request to revoke what would otherwise be an irrevocable election. This article begins in Part II by briefly examining the development and more notable features of the statutory election to purchase mechanism, paying particular attention to the purposes underlying the seemingly contradictory notion of a potentially revocable irrevocable notice. Part III continues with an exposition of the case precedents surrounding election to purchase revocations, while highlighting points of tension that may have arisen among the reported decisions. Part IV explores the historic development of equity and the concept of due diligence in the law. Finally, Part V concludes by attempting to draw together all of these strands into a workable due diligence standard when a party seeks to revoke an election to purchase.
DEVELOPMENT OF THE MODEL STATUTORY BUYOUT ELECTION
From its beginning in 1950, the ABA's Model Act has steadily evolved both in its scope and in its level of acceptance. (17) Modifications to the Model Act frequently arose from developments found in reported case decisions or in academic writings, but just as often, changes would germinate when practitioners identified an unresolved problem that they perceived could be remedied by uniform legislation. (18) Not unlike the process of administrative rulemaking, the ABA Corporation, Banking, and Business Law Section's Committee on Corporate Laws (essentially, the entity charged with overseeing the Model Act) now publishes proposed amendments to the Model Act in The Business Lawyer, inviting comments for a period of time, which it then considers before adopting any proposed changes. (19) The buyout...