February, 1997
Repurchase of Stock From Employees Upon Termination of Employment
Two recent state court decisions show that courts will closely scrutinize and may limit the ability of employers to repurchase employee owned stock for less than fair market value or book value upon termination of employment, even if the employee agreed in advance to those terms.
In Man O War Restaurants, Inc. v. Martin, 932 S.W. 2d 366 (Ky. 1996), the Supreme Court of Kentucky held that a buy-back provision which required a terminated employee to sell his stock back to his employer for the amount the employee paid for the stock was unenforceable. The court noted that the contract provision "made no reference to any concept of value. . . . One who may be compelled to surrender property to another for a sum which bears no relationship to the value of the property can hardly be said to be an owner." The court did recognize that parties can mutually agree to an initial fixed value, but found that they must adjust their prior agreement at defined intervals. "If the parties cannot agree on these future valuations, than another recognized method must be utilized."
Conversely, in Contractors Heating & Cooling, Inc. v. Devine, 1996 Tenn. App. LEXIS 744 (Tenn. App. 1996), a Tennessee appellate court agreed to enforce a buy-sell provision between an employer and employee which set a repurchase value for the employer's stock less than either fair market value or book value at the time the employee was terminated fourteen years later. The agreement provided that the company could repurchase its shares that the employee owned upon termination of employment. The repurchase price was the value of the stock which was to be adjusted each year by the mutual agreement of the stockholders, and, where no adjustments were made, the value would be the last value agreed upon. The court concluded that the agreement was valid and enforceable, even though no adjustments were made during the fourteen year period between the establishment of the initial value and the termination of employment. The court stated that it "is not the function of this court to rewrite a contract in order to relieve a party of the hardship of an improvident bargain."
Companies which have entered into agreements to purchase or sell stock upon the termination of a stockholder's employment should review these agreements periodically to ensure that the provisions which establish the price to be paid for the stock comply with relevant state laws. Buy-back provisions which specify book value or fair market value are less likely to be challenged as they provide for a current valuation of the stock.
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