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Buyout provisions can have unexpected consequences

Many businesses have a buyout agreement that says that if one owner retires or resigns, the others can buy out his or her interest at a certain price.

These agreements are a smart idea for retaining control of a company. But you should keep in mind that they can sometimes be used in ways you wouldn’t expect.

For instance, Irvin Gordon was a member of a professional firm in New Hampshire. His agreement said that if he died or resigned, the other owners would buy out his interest according to a fixed formula. Gordon was not allowed to sell his interest to anyone other than the firm.

Sometime later, Gordon got divorced. So the question was how to value his membership interest (so that his wife could get her fair share of the couple’s assets).

Gordon argued that his interest was worth about $25,000 – which was what a third party could be expected to pay for the right to receive his buyout payment at his expected retirement date.

But his wife Priscilla claimed his interest was worth about $180,000 – the amount he’d receive if he retired immediately.

The New Hampshire Supreme Court sided with Priscilla. It said using the $180,000 figure was more reasonable than a figure based on a speculative retirement date and a hypothetical sale to a third party that was prohibited by the agreement.

It’s not clear if a different buyout agreement would have led to a different result – but if you’re signing one, it’s worth speaking to an attorney about any possible unintended consequences.

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