The Delaware Supreme Court recently considered whether the directors of a closely held corporation had a duty under common law fiduciary principles to repurchase a minority shareholder’s shares. The court also considered whether the covenant of good faith and fair dealing created such a duty within a shareholder’s purchase agreement. The court found no such duties in either instance, re-affirmed Delaware precedent on the issue and highlighted the importance of having an agreed-upon exit strategy for minority shareholders or members of closely held entities. The court’s decision in Blaustein v. Lord Baltimore Capital Corp., No. 272, 2013 (Del. Jan. 21, 2014), can be viewed here.

In 1999, Susan Blaustein (Blaustein), individually and as trustee of several trusts, became a minority shareholder in the Lord Baltimore Capital Corporation (Baltimore), a closely held Delaware corporation. Paragraph 7(d) of the Baltimore Shareholder’s Agreement, which Blaustein executed, addressed the repurchase of stock from minority shareholders. It provides:

Notwithstanding any other provision of this Agreement, the Company may repurchase Shares upon terms and conditions agreeable to the Company and the Shareholder who owns the Shares to be repurchased provided that the repurchase is approved either (i) by a majority, being at least four, of all of the Directors of the Company then authorized (regardless of the number attending the meeting of the Board of Directors) at a duly called meeting of the Board of Directors or (ii) in writing by Shareholders who, in the aggregate, own of record or beneficially 70 percent or more of all Shares then issued and outstanding.

Despite the existence of this provision, Blaustein claimed that she purchased shares in Baltimore on the understanding that after ten years, she would have the opportunity to sell the stock back to Baltimore for full value. Blaustein’s understanding was based upon an alleged oral promise made to her by Louis B. Thalheimer, the Chief Executive Officer of Baltimore and Chairman of its board of directors.

After the expiration of ten years, Blaustein asked Baltimore to buy-out her shares at full value. In response, Baltimore’s board offered to purchase Blaustein’s shares at a 52 percent discount from the net asset value of her shares. Blaustein’s subsequent attempts to negotiate a higher repurchase price were rejected.

Blaustein filed suit in the Delaware Court of Chancery, alleging promissory estoppel, breach of fiduciary duty and breach of the implied covenant of good faith and fair dealing. The Court of Chancery dismissed Blaustein’s complaint with the exception of the claim for breach of the covenant of good faith and fair dealing and allowed her to amend her complaint to add a new breach of fiduciary duty claim and a new implied covenant claim. Later, the Court of Chancery granted summary judgment in favor of Baltimore on all of Blaustein’s remaining claims and denied her request to amend her complaint yet again. Blaustein appealed her breach of fiduciary duty and implied covenant of good faith claims. She did not appeal the dismissal of her other claims.

On appeal, Blaustein argued that Baltimore’s directors acted out of self-interest as majority shareholders when they failed to offer anything higher than a 52 percent discount on a share repurchase. Blaustein also claimed that she was entitled to a “non-conflicted corporate decision” on whether the shares would be repurchased and at what price. Blaustein argued that the board’s failure to offer anything higher than a 52 percent discount constituted a breach of the board’s fiduciary duties towards a minority shareholder. Blaustein also argued that Paragraph 7(d) of the Baltimore Shareholder’s Agreement contained an implied contractual right to good faith negotiation of stockholder redemption offers. The failure of the board of directors to offer anything more than 52 percent of net asset value constituted a breach of the covenant of good faith and fair dealing, Blaustein claimed.

In rejecting Blaustein’s arguments as to her remaining claims, the Delaware Supreme Court affirmed two established legal principals under Delaware law. First, the directors of a closely held corporation have no general fiduciary duty to repurchase the stock of a minority stockholder. Second, an investor must rely upon contractual protections if liquidity is a matter of concern when investing in closely held entities. The court then looked to the plainly written terms of Paragraph 7(d) of the Baltimore Shareholder’s Agreement. The court found that Paragraph 7(d) “gives the stockholder and the company discretion as to whether to engage in a transaction, and as to the price. It does not impose any affirmative duty on either party to consider or negotiate any repurchase proposal.” Because there is no general fiduciary duty at common law to repurchase the stock of a minority stockholder, and the Baltimore Shareholder’s Agreement does not create a duty to do so, there was no breach of fiduciary duty by the directors of Baltimore towards Blaustein. Similarly, the court noted that the “implied covenant of good faith and fair dealing cannot be employed to impose new contract terms that could have been bargained for but were not. Rather, the implied covenant is used in limited circumstances to include what the parties would have agreed to themselves had they considered the issue in their original bargaining positions at the time of contracting.” In this case, the parties had obviously considered the issue of whether, and on what terms, Baltimore minority shareholders might have their stock repurchased by the company. That consideration found its final expression in Paragraph 7(d) of the Shareholder’s Agreement. Thus, there was no breach of the covenant of good faith and fair dealing in this instance. Finally, the court noted that the factual allegations by Blaustein with regard to Louis B. Thalheimer’s offer to buy back Blaustein’s shares after ten years “suggest a claim for fraud in the inducement.” However, the court pointed out that Blaustein never pled fraud in any of her complaints. Therefore, the court declined to consider whether relief was available to Blaustein under a theory of fraud in the inducement.

Blaustein v. Lord Baltimore Capital Corp. is useful to closely held businesses, minority investors in such businesses, and lawyers. For closely held businesses, Blaustein reaffirms that, that under Delaware law, the duties of directors towards minority shareholders or members will be squarely governed by the shareholder or operating agreement. For minority investors in closely held businesses, Blaustein illustrates that an exit strategy and formula to value shares or member interest should be created before investing, and memorialized in whatever agreement governs the relationship between the business entity and its investors. Oral promises that contradict those agreements are unlikely to be enforced. Finally, for lawyers, Blaustein is a cold reminder of the importance of sometimes pleading all possible causes of action that the facts support.