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Stock Purchase Agreement is somewhat confusing

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oohlalaw

Member
I have some questions about a California Stock Purchase Agreement. The main thing we wonder is if the contract is typical/standard, or if my cousin Tim should request a few changes in the language/content. Apologies in advance if some of the questions seem silly or if our assumptions are wrong.

Background: The consideration for the sale and purchase of the Shares is “the services previously rendered by the Purchaser to the Company” (a small mom-and-pop S Corp in a small town). Total value of the shares is $7,500. If Tim wants to sell his shares or if certain “Termination Events” happen, the company has the option to repurchase all or any portion of the shares at the Issue Price. This is repeated several times for different situations. No problem there.

First question: In the “Purchase Price” section, it states, “If the Purchase Price includes consideration other than cash, the cash equivalent value of the non-cash consideration shall be determined by the Board of Directors in good faith.” Is this a standard clause, and does it mean that the Board can change the value of the Shares from the Issue Price since the proposed consideration is a non-cash consideration? In short, if Tim sells his Shares back to the Company, will he be paid $7,500 for them, or could the price change?

Next, the contract states that “the Company will make timely distributions of cash to the Purchaser in amounts agreed by the Board to cover her state and federal income tax obligations arising by virtue of the allocation of the Company’s net income to her as shown on the applicable K1 statements.” We assume the “timely distributions of cash” are dividends or equivalent; is this correct? If so, should Tim request a specification for distributions of cash, such as on a quarterly basis, or is the clause fine as is?

Third, a few of the “Termination Events” are confusing. The first is “death or permanent disability of the Purchaser.” He wonders about rights, if any, his family/heirs might have. In “Exception for Certain Family Transfers” it states “anything to the contrary contained in this Section notwithstanding, the transfer of any or all of the Shares during the Purchaser’s lifetime or on the Purchaser’s death by will or intestacy to adult members of the Purchaser’s Immediate Family .... shall be exempt from the provisions of this Section.” So it sounds like it is possible for his family to inherit the stock if certain conditions are met. Is this correct? . . .

. . . This seems to be confirmed later in “Successors and Assigns,” where it states, “Subject to the restrictions on transfer herein set forth, this Agreement shall bind and inure to the benefit of the successors, permitted assigns, personal representatives, heirs and legatees to the respective parties.”

One of the“Termination Events” is confusing, and we wonder if it was part of an older document that may have been edited to suit the current use: “the dissolution of a Purchaser’s marriage or legal separation of the Purchaser and her spouse unless, as a condition thereof, the Purchaser acquires ownership of all of the Shares as his separate property.” Does this sound like it belongs here, or should Tim ask to have it removed or edited? For example, it refers to “a Purchaser” (so could be the owners or Tim) and “her spouse.” Is the intent that if Tim divorces or separates, all his Shares stay with him? That makes sense, but the language doesn’t seem clear if that is the meaning.

Thanks for any clarifications.
 


Zigner

Senior Member, Non-Attorney
Contract review is beyond the scope of this forum. You (meaning the actual legally involved person) should consult with an attorney.
 

LdiJ

Senior Member
I have some questions about a California Stock Purchase Agreement. The main thing we wonder is if the contract is typical/standard, or if my cousin Tim should request a few changes in the language/content. Apologies in advance if some of the questions seem silly or if our assumptions are wrong.
I agree with the response that the other poster gave you to consult an attorney, but I am still going to comment. It might help you know what to ask the attorney.

Background: The consideration for the sale and purchase of the Shares is “the services previously rendered by the Purchaser to the Company” (a small mom-and-pop S Corp in a small town). Total value of the shares is $7,500. If Tim wants to sell his shares or if certain “Termination Events” happen, the company has the option to repurchase all or any portion of the shares at the Issue Price. This is repeated several times for different situations. No problem there.
Seems pretty normal/standard.

First question: In the “Purchase Price” section, it states, “If the Purchase Price includes consideration other than cash, the cash equivalent value of the non-cash consideration shall be determined by the Board of Directors in good faith.” Is this a standard clause, and does it mean that the Board can change the value of the Shares from the Issue Price since the proposed consideration is a non-cash consideration? In short, if Tim sells his Shares back to the Company, will he be paid $7,500 for them, or could the price change?
This is definitely one that you need to run by an attorney because the language does leave room for interpretation.

Next, the contract states that “the Company will make timely distributions of cash to the Purchaser in amounts agreed by the Board to cover her state and federal income tax obligations arising by virtue of the allocation of the Company’s net income to her as shown on the applicable K1 statements.” We assume the “timely distributions of cash” are dividends or equivalent; is this correct? If so, should Tim request a specification for distributions of cash, such as on a quarterly basis, or is the clause fine as is?
No, the distribution of cash would not be a dividend. In an S-corp, the S-corp does not pay taxes on its profits. Instead the profits are divided between the shareholders via a Schedule K1 and the individual shareholders pay taxes on the profits. The profits often remain in the S-Corp and can later be taken or given to the shareholders as tax free distributions, because they would have already paid tax on the profits.

It is not uncommon for an S-corp to distribute to their shareholders, enough money to cover the taxes, if they are not distributing the full profits.

Third, a few of the “Termination Events” are confusing. The first is “death or permanent disability of the Purchaser.” He wonders about rights, if any, his family/heirs might have. In “Exception for Certain Family Transfers” it states “anything to the contrary contained in this Section notwithstanding, the transfer of any or all of the Shares during the Purchaser’s lifetime or on the Purchaser’s death by will or intestacy to adult members of the Purchaser’s Immediate Family .... shall be exempt from the provisions of this Section.” So it sounds like it is possible for his family to inherit the stock if certain conditions are met. Is this correct? . . .

. . . This seems to be confirmed later in “Successors and Assigns,” where it states, “Subject to the restrictions on transfer herein set forth, this Agreement shall bind and inure to the benefit of the successors, permitted assigns, personal representatives, heirs and legatees to the respective parties.”
these provisions not uncommon in an S-corp. They don't want the shares being sold off to strangers. So clauses are written in to ensure that the corp gets first shot at buying the shares when a termination event happens. However, its also common if the shares would be going to close family, that the provision is waived.

One of the“Termination Events” is confusing, and we wonder if it was part of an older document that may have been edited to suit the current use: “the dissolution of a Purchaser’s marriage or legal separation of the Purchaser and her spouse unless, as a condition thereof, the Purchaser acquires ownership of all of the Shares as his separate property.” Does this sound like it belongs here, or should Tim ask to have it removed or edited? For example, it refers to “a Purchaser” (so could be the owners or Tim) and “her spouse.” Is the intent that if Tim divorces or separates, all his Shares stay with him? That makes sense, but the language doesn’t seem clear if that is the meaning.

Thanks for any clarifications.
That last one's language is poor. You definitely want the attorney to make suggestions on whether or not its even enforceable, as well as cleaning up the language if it is.
 

oohlalaw

Member
I agree with the response that the other poster gave you to consult an attorney, but I am still going to comment. It might help you know what to ask the attorney.
. . .
That last one's language is poor. You definitely want the attorney to make suggestions on whether or not its even enforceable, as well as cleaning up the language if it is.
Thanks very much. Appreciate your helpful reply. You are right, it will help us know what to ask about.
 

Taxing Matters

Overtaxed Member
Background: The consideration for the sale and purchase of the Shares is “the services previously rendered by the Purchaser to the Company” (a small mom-and-pop S Corp in a small town). Total value of the shares is $7,500. If Tim wants to sell his shares or if certain “Termination Events” happen, the company has the option to repurchase all or any portion of the shares at the Issue Price. This is repeated several times for different situations. No problem there.
Pretty common.

First question: In the “Purchase Price” section, it states, “If the Purchase Price includes consideration other than cash, the cash equivalent value of the non-cash consideration shall be determined by the Board of Directors in good faith.” Is this a standard clause, and does it mean that the Board can change the value of the Shares from the Issue Price since the proposed consideration is a non-cash consideration? In short, if Tim sells his Shares back to the Company, will he be paid $7,500 for them, or could the price change?

No, what it means is that if the purchase is made using something other than cash, the board will in good faith value the property being used for the purchase. He still gets $7,500 for the stock, the problem being that if the purchase is made in part by giving him, say, a car owned by the corporation the board has to value the car to determine what he's getting. If the car is valued at $6,000 then they'd still need to come up with cash or other stuff worth $1,500 to make up the difference. This is not all that unusual either, though of course you could have provisions that require other ways to value the property. If the stock were worth a whole lot more than $7,500 I might want some outside party or independent method to determine the value of the property given, but of course doing that often costs money, too.

Next, the contract states that “the Company will make timely distributions of cash to the Purchaser in amounts agreed by the Board to cover her state and federal income tax obligations arising by virtue of the allocation of the Company’s net income to her as shown on the applicable K1 statements.” We assume the “timely distributions of cash” are dividends or equivalent; is this correct? If so, should Tim request a specification for distributions of cash, such as on a quarterly basis, or is the clause fine as is?

This is not a provision the company would need to include and many corporations do not provide it as it limits their ability to retain earnings to invest in future growth. It is favorable to Tim in the sense that he gets cash to help pay the income tax that will result from his share of the S-corporation income that will hit his income tax return. Requiring the company to make payments out quarterly is, IMO, overly restrictive on the company and in any event is difficult to do because the K-1 won't be prepared until after the close of the tax year. Basically the company is committing to pay out at least once year an amount to help pay the tax the shareholder will have as a result of his share of the company's income being included on his tax return.

Third, a few of the “Termination Events” are confusing. The first is “death or permanent disability of the Purchaser.” He wonders about rights, if any, his family/heirs might have. In “Exception for Certain Family Transfers” it states “anything to the contrary contained in this Section notwithstanding, the transfer of any or all of the Shares during the Purchaser’s lifetime or on the Purchaser’s death by will or intestacy to adult members of the Purchaser’s Immediate Family .... shall be exempt from the provisions of this Section.” So it sounds like it is possible for his family to inherit the stock if certain conditions are met. Is this correct? . . .

No way to comment on that without reading the entire agreement relating to restrictions on transfers. It is always important to read all of the applicable provisions before advising on how they work.

One of the“Termination Events” is confusing, and we wonder if it was part of an older document that may have been edited to suit the current use: “the dissolution of a Purchaser’s marriage or legal separation of the Purchaser and her spouse unless, as a condition thereof, the Purchaser acquires ownership of all of the Shares as his separate property.” Does this sound like it belongs here, or should Tim ask to have it removed or edited? For example, it refers to “a Purchaser” (so could be the owners or Tim) and “her spouse.” Is the intent that if Tim divorces or separates, all his Shares stay with him? That makes sense, but the language doesn’t seem clear if that is the meaning.

Same thing here. It is important to read all the transfer provisions together. I will note, however, that it sounds like it is a common provision that allows the company to buy back the shares that would go to Tim's spouse in the event of a divorce. In a closely held company this is an extremely common provision. The other owners do NOT want end up with someone else they do not know as an owner of the company, and especially end up in a situation where they now have two owners of the company who may hate each other and cause all kinds of trouble in the company as a result of it.

Tim should take the agreement to a corporate law attorney to make sure that there are no provisions in it that may be troubling and to ensure he understand what the terms of the agreement are.
 

Taxing Matters

Overtaxed Member
That last one's language is poor. You definitely want the attorney to make suggestions on whether or not its even enforceable, as well as cleaning up the language if it is.
I disagree. The problem is that the OP did not include all the provision but only a part of it. That is what is perhaps making it confusing. I can pretty well bet what the likely wording is of the parts he did not include, and the provision would make perfect sense if that was included. If I am right it is a pretty common provision and one that is indeed enforceable.
 

quincy

Senior Member
Contract review is beyond the scope of this forum. You (meaning the actual legally involved person) should consult with an attorney.
I agree. Contracts need to be personally reviewed in their entirety by a professional.

Contract review and analysis exceeds the scope of this forum.
 

LdiJ

Senior Member
I disagree. The problem is that the OP did not include all the provision but only a part of it. That is what is perhaps making it confusing. I can pretty well bet what the likely wording is of the parts he did not include, and the provision would make perfect sense if that was included. If I am right it is a pretty common provision and one that is indeed enforceable.
Which is why I said he needs to have an attorney review it.
 

oohlalaw

Member
Thanks very much for your interesting and insightful reply!

Aha, we hadn't considered this: " what it means is that if the purchase is made using something other than cash, the board will in good faith value the property being used for the purchase. He still gets $7,500 for the stock, the problem being that if the purchase is made in part by giving him, say, a car owned by the corporation the board has to value the car to determine what he's getting. If the car is valued at $6,000 then they'd still need to come up with cash or other stuff worth $1,500 to make up the difference."

We were wrong to think dividends would be involved ("my bad"), as pointed out by LdiJ. In this light, this makes perfect sense: "Requiring the company to make payments out quarterly is, IMO, overly restrictive on the company and in any event is difficult to do because the K-1 won't be prepared until after the close of the tax year."

Sorry I didn't include all the Termination Events; we didn't have issues with any except found the language odd in the one I mentioned. I've included the whole section below just FYI.

. . . It is important to read all the transfer provisions together. I will note, however, that it sounds like it is a common provision that allows the company to buy back the shares that would go to Tim's spouse in the event of a divorce. In a closely held company this is an extremely common provision. The other owners do NOT want end up with someone else they do not know as an owner of the company, and especially end up in a situation where they now have two owners of the company who may hate each other and cause all kinds of trouble in the company as a result of it.
2.2 Termination Events.
(a) Each of the following shall constitute a "Termination Event" for the purposes of this Agreement:
(i) death or permanent disability of the Purchaser;
(ii) the termination of any employment, consulting, or independent contractor agreement between the Company and the Purchaser (or any entity affiliated with the Purchaser) (with or without cause);
(iii) any bankruptcy or receivership applicable to the Purchaser or if any of the assets of the Purchaser become subject to any legal process, order or action;
(iv) if the Purchaser attempts to transfer, sell, assign, pledge or hypothecate any of the Shares (or any interest thereon) otherwise than in accordance with the terms of this Agreement; or
(v) the dissolution of a Purchaser's marriage or legal separation of the Purchaser and her spouse unless, as a condition thereof, the Purchaser acquires ownership of all of the Shares as his separate property.
(b) For the purposes of this Agreement, the "Termination Date" shall be the date of the occurrence specified in Section 2.2(a) above.

Finally, the last part of the "Termination upon a Liquidity Event" section (in blue, below) appears to be a double negative, so has us stumped as to the meaning:
2.4 Termination upon a Liquidity Event. In the event of a Liquidity Event, the Repurchase Option shall automatically terminate with respect to all of the Shares to the extent that a Termination Event has not occurred prior to the effective date of the Liquidity Event (whether or not the Repurchase Option has been exercised by that date). For these purposes, "Liquidity Event" means any of the following, whether in a single transaction or through a series of related transactions: (a) a liquidation, dissolution or winding up of the Company; (b) the sale of all or substantially all of the Company's assets; (c) the acquisition of the Company by another entity (other than a reincorporation for the purpose of changing the Company's domicile) by means of merger or other form of corporate reorganization in which the outstanding shares of the Company are exchanged for securities or other consideration issued by or on behalf of the acquiring entity as a result of which the shareholders of the Company immediately prior to such transaction hold less than fifty percent (50%) of the voting power of the surviving or resulting corporation; and (d) the transfer to a person or group of affiliated persons (other than an underwriter of the Company's securities), of the Company's securities if, as a result, the shareholders of the Company immediately prior to such transaction hold less than fifty percent (50%) of the voting power of the Company; provided, however, that in no event shall an equity financing transaction in which the Company is the surviving entity shall not be considered a Liquidity Event.

Seems like it should say or mean "in no event shall an equity financing transaction in which the Company is the surviving entity be considered a Liquidity Event."

-- Tim should take the agreement to a corporate law attorney to make sure that there are no provisions in it that may be troubling and to ensure he understand what the terms of the agreement are. --

He is going to do this. Reading replies here has clarified several things and will help him prepare questions for the attorney.

Thanks again!

 

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