Why You Should Revisit Your Buy-Sell Agreement – A Cautionary Tale

When drawing up a buyout clause it is critical to specify, in no uncertain terms, the value to be applied to an owner’s share. The case of the Estate of Cohen v. Booth Computers, July 13, 2011, is a good illustration of what can happen when the terms of a buy-sell agreement are not updated to reflect the current value of a company. 

Claudia Cohen and her brother James were partners of Booth Computers, a family partnership set up by their father. A buyout provision was included in the partnership agreement, stating that upon the death of one of the partners the remaining partners could buy back the share at book value plus $50,000.  One of the assets owned by the partnership was an oceanfront estate in Palm Beach Florida that had increased in value from its original cost of $760,000 in 1976 to $45 million in 2007.  The partnership paid Claudia’s estate just over $177,800 based on the “net book value” of the 50% interest as shown on the most recent balance sheet. 

The executor of the estate appealed that the buyout was “unconscionable” based on the gross disparity between fair market value and net book value.  The court determined that there was nothing “inherently offensive” in the buyout formula.  Book value may be artificial but it is easily ascertainable.  The estate appealed but the appellate court concluded that the language of the partnership agreement was plain and unambiguous.  When a buy-sell provision is clear, the disparity between book value and fair market value alone is not sufficient to “shock the judicial conscious”.  The appeals court held and affirmed the buyout at book value. 

The estate of Claudia L. Cohen is a “cautionary tale” for every business owner who has a buy-sell agreement with a formula or fixed price pricing mechanism.  Formulas and fixed prices are not good pricing mechanisms for most buy-sell agreements as they may not reflect the current value of a company.  To assure that the pricing mechanism in your buy-sell agreement will work as intended contact appropriate legal counsel and a business appraiser who is experienced valuing buy-sell agreements.