A prominent business litigation attorney (okay, it was Mike Mahoney) recently told me the story of two young men fighting over grandma’s apple pie. They could not agree on how to split up the pie. Each wanted to cut the pie their own way leaving the smaller slice to the other. But it was grandma that made the peace: one young man was given the knife for slicing the pie, and the other young man was given the option to decide which half of the pie to take. The young man slicing the pie had the incentive to fairly and equally slice the pie. The other young man had the ultimate decision on which half of the pie to keep. Everyone was able to enjoy a fair slice of pie.
This is what we often call a “bid auction” during a mediation of a shareholder dispute in closely held corporations. Under Minnesota law, there is a statutory process when shareholders of a closely held company need to go their separate ways. In those circumstances, one shareholder argues that the others are acting unfairly and harming the value of the shares. The shareholders cannot continue working together and legal action follows. The dispute is generally governed under Minnesota Statute Section 302A.751: https://www.revisor.mn.gov/statutes/?id=302A.751
In essence, this statute allows the court to force the company to buy out one member’s ownership in the company. The parties retain lawyers, cast accusations at each other, and hire experts to value the shares in the company. Sooner or later, the parties are ordered to participate in a mediation.
These type of disputes are often compared to a family law disputes. All of the shareholders value the company. The minority shareholder may want to keep ownership in the company just as much as the majority shareholder wants to own the company. There is likely strong economic reasons justifying the position but there also might be an emotional attachment to the company. Regardless of the reason, these can be difficult disputes to find a resolution.
The bid auction process is often used to help the parties negotiate the separation. Under this process, the parties negotiate the terms of the redemption of the shares. For example, the terms that need to be agreed to include the cash down payment, the length of time for any payment terms, interest rate, and any restrictive covenants arising from an employment agreement. These terms will govern regardless of which party is “slicing the pie.”
Once these terms have been negotiated, the mediator starts a confidential process in which a price is proposed to both parties separately. If both parties say “no” to the price proposed, then the mediator raises or lowers the price. Neither party is told the other’s position; only the mediator know. Each party is given an opportunity without knowing the other’s position to decide whether the price is right to be bought out.
At some point during the bid auction, the mediator will get an affirmative response from one of the parties. A settlement is reached at that point when the party willing to accept the proposal thereby agrees to buy out the other party. This is the same as allowing one party to slice the pie and the other to pick the half of pie.
The bid auction process follows the wisdom that the grandmother used in dividing the pie. Both parties are given an opportunity to control their decision without having to resort to a final court decision.