Company X is a closely held corporation, incorporated in a state that has adopted the Model Business Corporation Act (MBCA). The company has three shareholders: Mr. A, Mr. B., and Ms. C. None enjoy preferential dissolution rights. When X was incorporated, the three shareholders agreed to, and did, include a share-transfer restriction in the bylaws. The restriction reads:
Company X’s shareholders enjoy a close working relationship, and they intend to preserve that relationship. Consequently, any shareholder wishing to sell his or her shares in Company X must (i) notify the board of directors of that intention by filing with the board a notice of intent to sell and (ii) grant the company a 30-day period during which only the company may purchase the shares. This period cannot be extended for any reason. The company’s purchase price for each share will equal the per-share price established by the board at the previous board meeting.
All three founding shareholders signed an agreement acknowledging the share-transfer restriction to be valid to the extent allowed by applicable law. However, the restriction was not noted on any of the company’s share certificates.
After two years, Ms. C decides to sell all her worldly possessions and move to India. To that end, she works with a local investment banker, who finds a buyer interested in purchasing all her outstanding Company X shares at a significant premium over the per-share price that the board set at its most recent meeting.
When Ms. C informs Mr. A and Mr. B of her intentions, both remind her of the share-transfer restriction. Further, Company X is suffering financial distress: it is currently balance-sheet insolvent, which means that its liabilities exceed its assets. But the company should become solvent within the next 30 to 60 days. To help matters, Mr. A and Mr. B both want Company X to purchase Ms. C’s outstanding shares for the price per share that the board set at its last meeting, and then sell the shares to an outside investor at a premium price.
Ms. C does not want to sell her shares to Company X at the lower price, so she wants to find some way to prevent the company from exercising the purchase option. Ms. C would have the right to sell her shares to a party of her choosing, should the company prove unable to exercise its option within the 30-day window established in the bylaws.
- Under the MBCA, what four criteria would Company X need to demonstrate, to establish that the share-transfer restriction is enforceable, and can the company satisfy these criteria? Explain.
- If the share-transfer restriction is enforceable, what is the most effective argument that Ms. C can make, under the MBCA, to prevent Company X from exercising its purchase option? Explain, keeping in mind that a share repurchase is a company distribution.