Understanding the “Economic Value” of Being Employed When Stock is About to be Purchased By a Co-Shareholder

HNWBusiness and Corporate Legal Services, Shareholder Rights Litigation

  • Shareholders are often employees of their company
  • If they sell their stock they may lose their job
  • The value of being employed should be factored into the value and purchase price of a Shareholder’s Stock ownership

If you are a shareholder of a small corporation interested in selling your shares to a co-shareholder, one aspect of value is your employment status. Let me explain this further by reference to a recent published decision by a New Jersey Court.

Facts of the Case

A plaintiff brought suit based on an alleged violation of the Oppressed Shareholder Statute, N.J.S.A. 14A:12-7 (“Statute”), alleging that the defendants oppressed the plaintiff in his capacity as a director, officer and employee of a New Jersey corporation.

In setting forth a remedy, the Judge ordered that the plaintiff a minority shareholder buyout the other minority shareholders.

The Judge further ordered that the purchase price of the co-shareholder shares be set either by agreement, or by a joint appraisal determining their fair market value as of a specified date.

Losing Your Job in a Shareholder Buyout

As a result of the remedy imposed by the Judge, the defendant shareholders will lose their jobs and their expectation of continued employment. Employment and the opportunity to earn a salary are judicially recognized as incidental benefits of ownership in a small corporation. In this case, these shareholders asked the court to include the fair net value of their lost wages and reduction of their employment compensation as factors in determining the value of the shares being purchased by the plaintiff. Here was their legal argument.

The Net Present Value of an Employment Interest Should Be Added to the Appraised Value of Stock to Arrive at “Fair Value” of Those Stocks

Recall that the court ordered the plaintiff to purchase the shares of the co-owners at “fair value.”  The defendants argued that the value of their employment wages and compensation should be added to the overall value of the shares plaintiff is purchasing.

N.J.S.A 14A:12-7 states in pertinent part:

(1) The Superior Court, in an action brought under this section, may appoint a custodian, appoint a provisional director, order a sale of the corporation’s stock as provided below, or enter a judgment dissolving the corporation, upon proof that…

(c) In the case of a corporation having 25 or less shareholders, the directors or those in control have acted fraudulently or illegally, mismanaged the corporation, or abused their authority as officers or directors or have acted oppressively or unfairly toward one or more minority shareholders in their capacities as shareholders, directors, officers, or employees

That section also provides:

(8) Upon motion of the corporation or any shareholder who is a party to the proceeding, the court may order the sale of all shares of the corporation’s stock held by any other shareholder who is a party to the proceeding to either the corporation or the moving shareholder or shareholders, whichever is specified in the motion, if the court determines in its discretion that such an order would be fair and equitable to all parties under all of the circumstances of the case.

(a) The purchase price of any shares so sold shall be their fair value as of the date of the commencement of the action or such earlier or later date deemed equitable by the court, plus or minus any adjustments deemed equitable by the court if the action was brought in whole or in part under paragraph 14A:12-7(1)©.

In fashioning a remedy of buy-out, a court of equity must ensure that the shareholders being bought out are fairly compensated overall, and fairly compensated for the “fair value” of their shares. This also means that the courts retain a “wide variety of equitable remedies available to them” in shareholder oppression cases, whether the minority shareholders buy-out the majority, or whether the majority shareholders buy-out the minority.

The New Jersey Supreme Court has held that given the nature of close corporations, a minority shareholder’s “reasonable expectations” include reasonable employment and wages as a natural benefit of ownership. Muellenberg v. Bikon, 143 N.J. at 180-81. In this case the Court held that a buyout should include “a fair price for [the transferor’s] stake in the corporation including compensating [the transferor] for the loss of a contract of employment.

Therefore, compensating a shareholder being bought out “for both their employment and ownership interest is consistent with N.J.S.A. 14A:12-7(8)(a)” as a matter of equity and fairness. Kaplan and Tonrey, “Protecting the Employment Interests Of Oppressed Minority Shareholders,” New Jersey Law Journal, June 26, 2000.  According to Kaplan and Tonrey, the reason that loss of employment should be compensated rests on a line of cases which hold that a minority shareholder’s reasonable expectation of continued employment in the corporation may be the most valuable aspect of his or her interest.

The authors conclude that under N.J.S.A. 14A:12-7(1)(c) lost income due to a buy-out is appropriate.  Moreover, Kaplan and Tonrey note that valuation experts typically exclude the shareholders’ employment compensation from the calculation of fair value of the stock. In order to provide the shareholder “with the full ‘fair value’ (N.J.S.A. 14A:12-7(8)(a)) of his or her shareholder interests in the corporation – which includes their ‘capacities as shareholders, directors, officers or employees’ – one should include” the fair value of the compensation package. This value is customarily and necessarily excluded in determining the value of the stock ownership interest.

To discuss your NJ shareholder matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com.  Please ask us about our video conferencing consultations if you are unable to come to our office.

By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, NJ Shareholder Attorney

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