Originally published by Ladd Hirsch.
Minority investors who purchase an ownership interest in a private Texas company are advised to secure an exit strategy confirmed in a Buy/Sell Agreement at the time they make their investment. But investors who look closely at the specific terms of their Agreement may find that the contract contains an unwelcome surprise if it includes “good faith” obligations that have been accepted by the majority owner or by the company. While good faith may sound attractive on paper, a recent Texas Supreme Court decision holds that a promise to act in good faith does not reflect a binding commitment and is not enforceable. See Dallas Forth Worth International Airport Board v. Vizant Technologies, LLC, 2019 WL 2147262 (Tex. May 17, 2019).
The specific terms of Buy/Sell Agreements between owners and investors in private Texas companies are of critical importance, and this post reviews how the Supreme Court’s decision in the Vizant case earlier this year may impact the rights of owners/investors.
The Vizant Case Holding
The Vizant case did not involve a dispute between business co-owners, but the Court’s decision is nevertheless significant to contracts between business partners. In the lawsuit, Vizant Technologies sued the D/FW Airport Board (the “Board”) contending that the Board had failed to follow through on a good faith promise in a consulting agreement, which potentially provided additional compensation for Vizant. In the contract, Vizant agreed to provide consulting services related to credit-card processing for a capped fee of $50,000, but the terms of the contract also included a “good faith” promise. Specifically, the Board had agreed to make a good faith effort to increase the amount of the fees to be paid to Vizant if the consulting services that it provided under the contract exceeded the amount of the fee cap.
After Vizant provided services that exceeded the fee cap and the Board declined to pay more than the $50,000 capped amount, Vizant sued for breach of the good faith promise in the contract. In its opinion, the Supreme Court noted that it had previously held that agreements to negotiate a future contract are not enforceable, and that the contract at issue did not constitute a legally enforceable agreement. In fact, the Court indicated it would be a drastic step to change Texas law to make agreements to agree enforceable provisions. Id.
Good Faith Obligations in Buy/Sell Agreements
The Vizant holding should sound as a warning note for private company owners/investors who enter into Buy/Sell Agreements. As discussed above, promises to act in good faith in these agreements will not be viewed as enforceable, and this type of good faith obligation may arise in the following terms of the Agreement.
Buy/Sell Agreements include the following terms that might call for the majority owner to exercise good faith in dealing with the minority investor:
- Typically, the Buy/Sell Agreement permits the minority investor to trigger a buyout by issuing a written notice, but the Agreement could permit the buyout to be triggered on some type of good faith basis rather than on a defined timetable. In other words, the investor’s right to secure a buyout of the investor’s stake in the business could be based on the good faith “permission” of the majority owner
- The terms for the buyout of the minority investor’s interest in the company are usually detailed in the Buy/Sell Agreement, but those terms or the specific amount to be paid may be subject to some type of a good faith obligation by the majority owner
- The length of the payment period for the buyout of the minority investor’s interest in the business is an important point that should be confirmed in the Agreement, but again, the timeframe for payment could be subject to a good faith obligation by the majority owner
In light of the Vizant decision, all of the foregoing terms in the Buy/Sell Agreement become suspect to the extent they rely on the majority owner’s good faith. These good faith provisions in the Buy/Sell Agreement may later be invalidated by a court and held to be unenforceable. The minority owner who permits good faith to be the lynchpin of the Buy/Sell Agreement is therefore at significant risk if the majority owner declines to permit a buyout to take place or if the owner varies the terms of the buyout based on the owner’s subjective view of what good faith requires.
Conclusion
The Supreme Court’s recent decision in Vizant makes it clear that the adage about getting agreements in writing is not enough. In addition to getting the terms of the Buy/Sell Agreement in writing, the minority investor will want to make sure that any specific commitments made by the majority owner in the Agreement are not based on the owner’s mere promise to exercise good faith. In Halloween parlance, good faith is a trick not a treat. To avoid having the entirety of the Buy/Sell Agreement or a critical term of the buyout rejected by a court as unenforceable, any obligations made by the majority owner in the Agreement must be set forth as a requirement and not based on the owner’s good faith or an agreement to use best efforts.
Curated by Texas Bar Today. Follow us on Twitter @texasbartoday.
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