| Asset Protection: A Buy-Sell Agreement in Action Talk about a case where the blood is obviously in the water, this is it. A doctor decided to get a divorce. Let the bleeding begin. As part of that process, both Doctor husband and Soon-to-be-Ex-spouse Wife listed the assets of the community that had to be split between them, and they valued those assets so the Court could divide them “appropriately.” Doctor was a stockholder in Medical Practice Group. Doctor also owned part of Medical Equipment Business. Medical Equipment Business owned facilities and medical equipment it leased to Medical Practice Group. Both Medical Practice Group and Medical Equipment Business had buy-sell agreements signed by each owner and each owner’s spouse, including Doctor and Doctor’s wife. Both Doctor and Doctor’s wife listed the ownership of these entities as community property. No dispute there. But Doctor’s spouse listed their fair market value at $775,484. Doctor listed their value as $75,000. That’s a huge difference, and the parties couldn’t resolve it among themselves, so off to court they went. The difference in the valuations was simply this: Doctor’s values of the interests were figured based on the valuation formulas in the buy-sell agreements, where as Doctor’s Wife’s wasn’t, being instead a value of the businesses as ongoing concerns. As Ali might say: In Round
1, The buy-sell agreement of the Medical Practice Group said, in relevant part:
The buy-sell agreement for the Medical Equipment Business said, in relevant part:
Both buy-sell agreements defined “operative event” as the attempted sale, transfer, gift, mortgage (which this divorce was not), or pledge of ownership without the business’s consent (which this divorce was not), termination of an owner’s employment (again, which the divorce was not), and termination of an owner’s marriage by death or divorce if the owner does not succeed to his or her spouse’s community interest in the ownership. Maybe this last provision applied. Doctor husband figured it did, Wife didn’t. The rationale in the Court’s opinion is somewhat hard to follow and apply, mostly because it said “we know the parties think the issue is whether ‘commercial goodwill’ should be included n the value of these businesses, but that’s not really the issue at all.” The Court then completely restated the issue much more broadly as whether a buy-sell agreement limits the value of the business ownership for purposes of valuation in a divorce action. And it held that it did. Since all parties agreed there had been a transfer of ownership in the Medical Practice Group in the fifteen months prior to the divorce, the Medical Practice Group value was determined by the purchase price paid by the new owner. For the Medical Equipment Business, the value was limited to simply the amount of Doctor’s initial investment. So, we now have a Texas opinion that holds, in a very broad ruling, that business ownership subject to a buy-sell agreement is valued pursuant to the terms of the buy-sell agreement. It is not valued as a going concern, which would in nearly all instances be higher. It appears to me that this rule will apply across the board, against judgment creditors in any turnover action, as well as ex-spouses. Usually the way these things play out, practically, is that either the business or the person who triggered the buy-sell agreement (i.e. “caused” a transfer by getting hit with a judgment or divorce), pays the ex-spouse half of the value, or pays the judgment creditor all of the value, to basically keep the interest away from them. In this instance, a buy-sell agreement protected an asset worth over $775,000 in fair market value, by reducing that value to less than one-tenth of its value, $75,000. Buy-sell agreements also typically have payout provisions, so that the business or owner buying the interest has a decent length of time to make installments to buy the interest, at an interest rate that is usually at or below market rates. In other words, the transfer of ownership to a non-owner involuntarily, is very costly to the non-owner. This is how these sorts of agreements provide asset protection most often in the real world. Buy-sell agreements covering stock are generally not as strong a form of asset protection from judgment creditors as putting business operations in limited partnerships or limited liability companies, in part because they rely on court decisions such as this one for strength, with a court that could have gone either way, whereas the protection afforded by limited partnerships and limited liability companies is a matter of statute. As long as the court follows the statutes, owners are protected. But, as shown by this case where the Medical Equipment Business was a limited partnership, even limited partnerships and limited liability companies may need a buy-sell agreement in addition to their other governance documents. If you have a corporation, or if you own a business with others, a buy-sell agreement can help protect you from the sorts of financial setbacks discussed in this article, as well as protect one owner from another owner’s woes. If you are interested in a buy-sell agreement, it is critical to involve your CPA as you design the formulas to be used to value the business in certain circumstances. We have an entire booklet on our website explaining the basics of buy-sell agreements, at www.mctexlaw.com/comcenter.asp, under “Booklets.” If we can help you in this matter, please give us a call. R.V.K. v. L.L.K., Case No. 04-01-00345-CV, Texas Court of Appeals, San Antonio, February 28, 2003. Close
Window |