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By: Patrick B Mathis

Most buy-sell agreements include a restriction on the sale or transfer of shares by a shareholder to any third party without first giving the corporation and/or the other shareholders the option to buy the shares prior to transfer to the third party.

This right of first refusal may contain certain exceptions such as a proposed transfer to other current shareholders, a spouse or descendants of any shareholder, a trust or trusts created for the benefit of the shareholder or his spouse or descendants, to a corporation or other entity controlled by the shareholder, or similar carve outs. In those situations, the shareholders may agree that they wish to allow for the free transfer of shares within a family group but restrict the free transferability of shares to an outside party. (If transfers are to be allowed to a spouse, the definition may be limited to the spouse of a descendant of a common ancestor so that a “family shareholder” might freely transfer his or her shares to his or her spouse, but if that spouse remarried to an individual who is not a descendant of the initial ancestor, the shares could not be transferred to this “outsider” similar terms may limit “descendants” to those of a “family ancestor”.)

This right of first refusal would typically require that the selling shareholder give notice to the company and/or the other shareholders of the proposed transfer, the proposed transferee, the anticipated sale price and terms of sale and other salient information.

The company under a stock redemption agreement would then be given the right for a period of time to elect to exercise the right to purchase the shares. The decision on behalf of the corporation may be made by the board of directors or other shareholders, with the selling shareholder abstaining from voting on such decision and the majority vote of the non-selling shareholders treated as the decision of the corporation regarding the election to purchase.

If the corporation elects not to purchase the offered shares or to purchase less than all of the offered shares, a secondary option may then pass to the non-selling shareholders to elect to purchase the remaining offered shares based upon their prorata holdings as non-selling shareholders. The agreement may also contain a third tier option for the initial electing shareholders to purchase any remaining unpurchased shares.

Reasonable time lines should be included in this provision which would allow the corporation and the non-selling shareholders to review and decide upon exercise of the option to purchase.

This provision may allow the corporation and non-selling shareholders to purchase only a portion, but not necessarily all, of the offered shares, or provide that the option rights are void unless all of the offered shares are purchased by the corporation by non-selling shareholders.

The right of first refusal may require that the corporation and purchasing shareholders match the terms and conditions of the third party offer. Alternatively, this provision may provide that the option price is set by the valuation terms contained in the agreement (as discussed below) and/or that the purchase price may be paid over a period of time regardless of the offered terms.

If the corporation and non-selling shareholders do not purchase the shares, the selling shareholder may then proceed with a sale to the identified third party buyer upon the same terms and conditions as outlined. However, if the potential purchaser or the terms are in any way modified, or the third party sale fails to close within a specified period of time, this provision will generally require that the selling shareholder go through another offering to the corporation and non-selling shareholders prior to completing any sale.

Professional Services Disclaimer: Please note that the information presented here is as an educational service, and while it contains information about legal issues, it is not legal advice. No warranty is made regarding the applicability of the information presented to a particular client situation, and the information set forth is not a substitute for original legal research, analysis and drafting for a particular client situation.