Shareholders of privately-held corporations usually execute buy-sell agreements to assure continuity in ownership and to provide a mechanism to buy each other’s shares upon specified events such as death or disability. Specification of an acceptable purchase pricing mechanism is essential and the absence of one may have dire consequences, as reflected in the recent case of Ehlinger v. Hauser, et. al.
Ehlinger involved a dispute between Jon Hauser (“Hauser”) and William Ehlinger (“Ehlinger”), each of whom owned fifty percent of the outstanding shares of Evald Moulding Company (“Evald”), a picture frame manufacturing company. Each served as an officer of Evald.
In 1992, Ehlinger and Hauser executed a buy-sell agreement (“Agreement”). The Agreement provided, among other things, that in the event of a shareholder’s death or disability the shareholder’s shares could be purchased by the other at a price of “$350,000.00 or Book Value[,] whichever is greater, except if the Shareholders have determined by unanimous resolution passed subsequent to the date of this agreement that the purchase price shall be other than $350,000.00, then the most recent such resolution shall determine the purchase price. For transfers of all of a Shareholder’s stock on threat of involuntary transfer, the purchase price of a Shareholder’s shares of stock shall be the Book Value of said shares as of the end of the last fiscal year.”
Ehlinger was later diagnosed with Parkinson’s disease. In June 2001, Hauser invoked the disability buyout provisions of the Agreement and offered to purchase Ehlinger’s shares for $431,400, an amount Hauser claimed was based on Evald’s “Book Value.” Ehlinger requested an audit to confirm the Book Value calculation. Hauser refused. Ehlinger filed suit against Hauser and Evald seeking, among other things, a judicial dissolution of Evald and a declaratory judgment that the buyout provisions in the Agreement were unenforceable for lack of essential terms, including the term “Book Value,” which the Agreement neither defined nor specified a method of calculating.
The trial court ruled in Ehlinger’s favor. Hauser then appealed. The Appellate Court stated that a “contract must be definite and certain as to its basic terms and requirements to be enforceable” and that indefiniteness regarding a basic term prevents the formation of an enforceable contract. It concluded that while use of the term “Book Value” did not render the Agreement so vague as to be indefinite, it created an ambiguity in how the term “Book Value” would be calculated.
The ambiguity could not be resolved through extrinsic evidence such as the parties’ historical practices relating to the preparation of Evald’s financial statement. The Court cited prior rulings that in the absence of a specific definition in a written agreement, “Book Value” is an ambiguous term. It acknowledged that a reasonable construction might imply use of generally accepted accounting principles (“GAAP”) to calculate Book Value, but concluded that the absence of information necessary to complete a GAAP analysis rendered the Agreement unenforceable. The Court affirmed Ehlinger’s motion to dissolve Evald.
Ehlinger highlights the need for careful preparation of buy-sell and other corporate agreements to ensure that all essential and basic terms are identified, included, and defined. Any failure to do so may render an agreement unenforceable and result in unexpected consequences with substantial or disastrous effect.