Some quick concepts.
1. Tennessee Code Annotated 48-16-208 authorizes corporations and their shareholders to agree to restrictions on the transfer or sale of the corporation's stock.
2. Banks and other lenders often include in their loan agreements covenants that restrict the sale of transfer of the corporation's stock.
3. Lawyers are paid to figure out how to avoid all of these restrictions.
With that background, here is the story.
In 1992, Mr. and Mrs. Baugh decide they want to be owners and not employees. They approach the owner of the company, and he agrees to sell the company's assets to a new company formed by the Baughs for that purpose. In short, the transaction is pretty typical.
Like many people, they did not have the cash in their pockets to pay to the owner the full purchase price. The owner agreed to finance the purchase price. In turn, the Baughs pledged the stock in the new company to the owner, now lender, to secure the payment of the loan. In addition, the Baughs agreed in a loan agreement that they would not transfer the stock of the new company without the owner/lender's consent. Again, all of this is pretty standard.
Three years later, the Baughs decided that they wanted to add a partner. They found two very willing partners in their neighbors -- the Novaks.
The Baughs asked the owner/lender to consent to the sale of 50% of the company's stock. The owner/lender requested financial statements and other information about the Novaks, and that information was provided. For reasons unknown, the owner/lender never granted its consent.
Not to be delayed, the Baughs instructed their attorney to draft a stock purchase agreement that did not require the consent of the owner/lender. This agreement included an agreement by the Novaks to indemnify the Baughs from 50% of all of the company's debts and 50% of the balance remaining on the original purchase price of the stock. There is no question that the Novaks knew about the loan restrictions and decided to go forth with the purchase.
As with all partnerships, life was good until the money ran out. Apparently, the company lost one of its key customers and was never able to recover financially. Ultimately, the parties agreed to close the company. Unfortunately, there was not enough money to pay all of the debts, including the debt to the seller/lender. The Baughs paid those debts and then, remembering the indemnity agreement, asked the Novaks for their portion of the debt. At this point, the friendship ended.
The trial court found the indemnity agreement enforcable and granted a judgment to the Baughs. So, why is this case even worthy of mention. Well, the court of appeals reversed the judgment holding that the stock purchase agreement was intended to avoid the transfer restrictions (and admittedly it was). As Tennessee Code Annotated 48-16-208 authorizes restrictions of this type, the court concluded that the stock purchase agreement violated public policy and therefore was unenforceable.
The Tennessee Supreme Court in a very lengthy opinion concluded that the agreement did not violate public policy and reversed the court of appeals' decision. Essentially, the Court held that Tennessee Code Annotated section 48-16-208 merely authorizes restrictions. It does not contain the type of provisions designed to protect the general public as a whole, the buyer or the seller that make a breach of those restrictions an offense against the public. In short, the transfer of stock in violation of a stock restriction may be a breach of contract, but it is not void.
Like all supreme court decisions, the real "holding" of the case is not quite so apparent. Those holdings are:
1. The right to contract is an inherent right of liberty and property -- a fool with a pen is exercising his constitutional rights.
2. Tennessee courts should interpret all contracts in a manner that makes the subject matter legal, if possible.
3. If a contract cannot be interpreted so as to be legal, then the court should use a scalpel and not a sledgehammer to remove the offending provisions.
4. Finally, if you buy stock knowing that the transfer is restricted, you become subject to those same restrictions.
This is actually a classic case of who was harmed? The purchasers received all of the benefits of the deal -- it just was not as beneficial as they wanted. The owner/lender was not harmed because he still had his security interest in the stock. The public was not harmed because the public has no interest in this type of private transaction.
See Baugh, et al. v. Novak, et al.
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