In a recent decision of the Tennessee Court of Appeals in a breach of shareholders agreement lawsuit appealed from the Chancery Court of Davidson County, Tennessee, the appeals court decided that the Davidson County trial court should not have dismissed the shareholder’s claim that the call option provisions of the shareholders’ agreement had been breached. Here are the facts:
• The Plaintiff in the case was an employee, officer, director, and minority shareholder of the corporation (“Corporation”) which was closely held
• The Plaintiff was asked to sign an employment agreement which contained non-compete and non-disclosure provisions
• The Plaintiff refused to sign the employment agreement until she was told what her salary would be under that agreement
• The information requested by the Plaintiff was not provided, and she did not sign the employment agreement
• Thereafter, the board of directors terminated the employment of the Plaintiff
• The Plaintiff filed a lawsuit in Davidson County Chancery Court against the Corporation and the two remaining shareholders
• After the lawsuit was filed, the Plaintiff was notified that the Corporation was exercising its rights under the call option in the shareholders agreement to buy Plaintiff’s stock in the Corporation
• The shareholders agreement provided that Plaintiff was entitled to be paid the “appraised fair market value” of her shares “as set forth in an appraisal obtained by” the Corporation
• The appraisal of the stock was to be performed by “an appraiser reasonably acceptable” to the Corporation and to the Plaintiff according to the terms of the shareholders agreement
• A remaining shareholder and director called an accountant, Mr. Price, to have an informal discussion with him about the value of the Plaintiff’s stock, and obtained an informal valuation of the Plaintiff’s stock from Mr. Price
• After the informal evaluation was obtained, the Corporation notified the Plaintiff that it was retaining Mr. Price to appraise Plaintiff’s stock
• The Plaintiff believed that the preliminary, informal conversations involving Mr. Price made him potentially biased and subject to undue influence
• The Plaintiff objected to the Corporation using Mr. Price to value Plaintiff’s stock
• Notwithstanding the Plaintiff’s objection, the Corporation used Mr. Price’s appraisal to determine the value of Plaintiff’s stock
The Plaintiff’s claim related to the use of Mr. Price to value her shares was a breach of contract claim based on the breach of the terms of the shareholders agreement. The trial judge ruled that no reasonable jury could conclude that Plaintiff’s objection to the use of Mr. Price to appraise her stock was reasonable. Consequently, the trial court dismissed Plaintiff’s breach of contract claim.
The Tennessee Court of Appeals disagreed with that decision of the trial court, and reversed it. The court of appeals believed that the concerns on the part of the Plaintiff regarding Mr. Price’s potential bias were such that a jury could conclude that her objection to Mr. Price as the appraiser was reasonable.
The Plaintiff had also alleged, in her lawsuit, that the remaining shareholders had breached their fiduciary duties and duties of good faith by terminating her employment. The Tennessee Court of Appeals affirmed the decision of the trial judge dismissing those claims based on the business judgment rule. The business judgment rule provides protection to corporate directors (not to mention LLC members) by, generally, preventing a court from second guessing the decisions of directors who have acted in good faith, honestly and on an informed basis. The business judgment rule is meant to allow directors to exercise “broad management discretion” without incurring liability.
Based on the language of the shareholders agreement in this case, the director was “playing with fire” by having an informal conversation with the accountant, and by obtaining an informal evaluation. The Plaintiff, on the other hand, based on the facts set forth in the opinion of the Tennessee Court of Appeals, should have known that her breach of fiduciary duty claims were almost certain to fail because of the formidability of the business judgment rule defense.