[Ed. note: The following article was written by Mack Sperling before his unplanned leave. Although releasing it today is less timely than is Mack’s custom, the issues involved in the case are still of interest to businesses and business lawyers. Any errors or shortcomings in the article are attributable to your substitute bloggers.]
On February 16, in Lynn v. Lynn, the Court of Appeals interpreted provisions of a Shareholders Agreement requiring the corporation to repurchase a shareholder’s "restricted shares" upon his death, with the purchase to be funded by the proceeds of a life insurance policy on the shareholder.
The trial court had found the Agreement to be ambiguous, and had considered a variety of extrinsic evidence in determining the ownership of the shares in question. The Court of Appeals found no ambiguity, ruled that it had been error to consider the extrinsic evidence, but it nevertheless reached the same result as to ownership.
A father (James) and his two sons (Greg and Kenneth) formed a corporation, James Lynn & Sons, Inc. Eventually, the father owned 51% and the sons each owned 24.5% of the company’s stock.
In 1993, the shareholders and their wives entered into a shareholders’ agreement requiring that upon death, each shareholder would sell his "restricted" shares back to the corporation for an amount equivalent to the face amount of a life insurance policy on his life, with the face amount to be adjusted annually. The corporation was to own the policies.
The sons kept life insurance in place, paid for by the company, which increased over time from $75,000 to $375,000. The corporation paid the premiums, though the brothers had the policies issued in their names as opposed to them being owned by the corporation. They named their wives as beneficiaries of the policies. The father didn’t maintain insurance, due to expense, but upon his death in 1997 his executor sold his shares to the sons in a transaction referencing the Shareholders Agreement.
Later, the sons adjusted their ownership interests with Kenneth becoming the 55% majority owner and Greg holding a 45% interest.
Then it got interesting. Greg and his wife got divorced, and were involved in heated litigation over the equitable distribution of their property. Greg’s wife sued Kenneth, as majority shareholder, to establish that the shares of the company were subject to equitable distribution.
Kenneth then died unexpectedly. His shares went to his estate. The insurance proceeds went to his wife. Greg’s ex-wife said that 100% of the shares were now subject to her equitable distribution claim. Greg pretty much agreed with his ex-wife, and said that upon the payment of the life insurance proceeds to Kenneth’s wife, he held 100% of the shares.
Kenneth’s widow had a different point of view. She said that the Shareholders Agreement only applied to "restricted shares," and that the shares held by her late husband did not fit that definition. She also said that the corporation hadn’t complied with the life insurance provision given that it did not own the policies. She said she was entitled to both the insurance proceeds and the shares.
Continue Reading NC Court of Appeals Interprets the “Purchase on Death” Provisions of a Shareholders Agreement