Attorneys for Appellant Attorney for Appellee
J. Richard Ransel Leonard E.
Eilbacher
Jacob S. Frost Fort Wayne, Indiana
Elkhart, Indiana
________________________________________________________________________
In the
Indiana Supreme Court
_________________________________
No. 76S03-0209-CV-491
F.B.I. Farms, Inc., Ivan Burger,
Freddy L. Burger, Susan Burger
Eash, and Linda Moore,
Appellants (Defendants below),
v.
Birchell Moore,
Appellee (Plaintiff below).
_________________________________
Appeal from the Steuben Circuit Court, No. 76C01-0110-CP-836
The Honorable Allen N. Wheat, Judge
_________________________________
On Petition To Transfer from the Indiana Court of Appeals, No. 76A03-0201-
CV-24
_________________________________
November 13, 2003
BOEHM, Justice.
We hold that as a general proposition, restrictions on corporate
share transfers may require approval of the transfer by the corporation’s
Board of Directors, at least in a family-owned corporation. Although
generally valid against purchasers with notice of them, such restrictions
may not prevent a creditor from foreclosing a lien on the shares, but a
purchaser who buys at a foreclosure sale with notice of the restrictions
acquires the shares subject to the restrictions. We also hold that if
shares are subject to a right of first refusal, and the holder of the right
has notice of the foreclosure, the holder cannot exercise the right against
a purchaser at a foreclosure sale after the purchaser has taken title to
the shares without objection from the holder of the rights.
Factual and Procedural Background
F.B.I. Farms, Inc., was formed in 1976 by Ivan and Thelma Burger,
their children, Linda and Freddy, and the children’s spouses. Each of the
three couples transferred a farm and related machinery to the corporation
in exchange for common stock in the corporation. At the time, Birchell
Moore was married to Linda. Linda and Moore deeded a jointly-owned 180-
acre farm to F.B.I., and 2,507 shares were issued to Moore and one to
Linda. These 2,508 shares represented approximately fourteen percent of
the capitalization of F.B.I.
In 1977, the Board of Directors of F.B.I. consisted of Moore, Ivan,
Freddy and Linda. The minutes of a 1977 meeting of the Board recite that
the following restrictions on the transfer of shares were “adopted”:
1) No stock of said corporation shall be transferred, assigned
and/or exchanged or divided, unless or until approved by the
Directors thereof;
2) That if any stock be offered for sale, assigned and/or
transferred, the corporation should have the first opportunity
of purchasing the same at no more than the book value thereof;
3) Should said corporation be not interested, and could not
economically offer to purchase said stock, any stockholder of
record should be given the next opportunity to purchase said
stock, at a price not to exceed the book value thereof;
4) That if the corporation was not interested in the stock, and
any stockholders were not interested therein, then the same
could be sold to any blood member of the family. Should they be
desirous of purchasing the same, then at not more than the book
value thereof.
Linda’s marriage to Moore was dissolved in 1982. As part of the
dissolution proceedings, Linda was awarded all of the F.B.I. shares and
Moore was awarded a monetary judgment in the amount of $155,889.80, secured
by a lien on Linda’s shares.
F.B.I. filed for bankruptcy protection in 1989 and emerged from
Chapter 11 Bankruptcy in 1991. Moore’s judgment against Linda remained
unsatisfied, and in April 1998 he sought a writ of execution of his lien.
The corporation, through its counsel, responded with a letter to Moore’s
counsel demanding payment of the $250,700 subscription price for the 2,507
shares that were initially issued to Moore but had since been transferred
to Linda. Moore obtained the writ of execution in June 1999, and in
October 1999 the corporation, again through counsel, sent a letter to Moore
purporting to cancel the 2,507 shares for failure to pay the subscription
price. A sheriff’s sale went forward and in February 2000 Moore purchased
all 2,924 shares owned by Linda at the time for $290,450.67.
In December 2000 Moore instituted this suit against F.B.I., its
shareholders, and Linda seeking a declaratory judgment that the attempted
cancellation of the shares by the defendants was invalid, that Moore
properly retained ownership of the shares, and that the shares were
unencumbered by restrictions and were freely transferable. Moore also
sought dissolution of the corporation, injunctive relief against alleged
fraudulent practices by the defendants, and monetary damages. The trial
court granted Moore’s motion for partial summary judgment, finding (1) the
shares were not “lawfully cancelled”; (2) Moore was the “lawful owner” of
the disputed stock; (3) the restriction in paragraph one of the agreement
requiring approval by F.B.I.’s directors for a share transfer was
“manifestly unreasonable”; and, (4) the provision in paragraph four of the
agreement giving “blood members” the option to purchase after the
corporation and shareholders was “manifestly unreasonable” and
unenforceable. The trial court’s findings included those rendering the
order appealable as a final judgment pursuant to Indiana Trial Rule 54(B).
On appeal, the Court of Appeals held that the transfer restrictions
barred only voluntary transfers. F.B.I. Farms, Inc. v. Moore, 769 N.E.2d
688, 696 (Ind. Ct. App. 2002). Because the sheriff’s sale effectuated an
involuntary transfer of Linda’s shares, Moore, as the purchaser of the
shares, acquired the shares. Id. at 692. Although the court found that
future transfers of stock would be subject to the restrictions in Moore’s
hands, it also affirmed the trial court’s finding that the two disputed
restrictions were manifestly unreasonable. Id. at 695-96. The court
reasoned that the several tumultuous years of dispute between the parties
rendered the restriction requiring director approval before transfer
unreasonable, and the reference to “blood members” of the family was
sufficiently ambiguous that that restriction was unenforceable. Id. at 694-
96. We granted transfer.
Standard of Review
To support an order granting a motion for summary judgment, the
designated evidence must show that there is no genuine issue as to any
material fact and that the moving party is entitled to a judgment as a
matter of law. Ind. Trial Rule 56(C). On appeal, the standard of review
of a grant or denial of a motion for summary judgment is the same as that
used in the trial court. Bemenderfer v. Williams, 745 N.E.2d 212, 215
(Ind. 2001).
I. Transfer Restrictions
A. General Principles
Most of the issues in this case are resolved by the Indiana statute
governing share transfer restrictions. Indiana Code section 23-1-26-8
essentially mirrors Model Business Corporation Act § 6.27, which authorizes
restrictions on the transfer of shares. The Indiana statute reads as
follows:
(a) The articles of incorporation, bylaws, an agreement among
shareholders, or an agreement between shareholders and the
corporation may impose restrictions on the transfer or
registration of transfer of shares of any class or series of
shares of the corporation. A restriction does not affect shares
issued before the restriction was adopted unless the holders of
the shares are parties to the restriction agreement or voted in
favor of the restriction.
(b) A restriction on the transfer or registration of transfer of
shares is valid and enforceable against the holder or a
transferee of the holder if the restriction is authorized by
this section and its existence is noted conspicuously on the
front or back of the certificate or is contained in the
information statement required by section 7(b) [Ind.Code 23-1-26-
7(b)] of this chapter. Unless so noted, a restriction is not
enforceable against a person without knowledge of the
restriction.
(c) A restriction on the transfer or registration of transfer of
shares is authorized:
(1) to maintain the corporation’s status when it is
dependent on the number or identity of its shareholders;
(2) to preserve exemptions under federal or state
securities law; or
(3) for any other reasonable purpose.
(d) A restriction on the transfer or registration of transfer of
shares may, among other things:
(1) obligate the shareholder first to offer the corporation
or other persons (separately, consecutively, or
simultaneously) an opportunity to acquire the restricted
shares;
(2) obligate the corporation or other persons (separately,
consecutively, or simultaneously) to acquire the restricted
shares;
(3) require the corporation, the holders of any class of
its shares, or another person to approve the transfer of
the restricted shares, if the requirement is not manifestly
unreasonable; or
(4) prohibit the transfer of the restricted shares to
designated persons or classes of persons, if the
prohibition is not manifestly unreasonable. . . .
Corporate shares are personal property. At common law, any
restriction on the power to alienate personal property was impermissible.
Doss v. Yingling, 95 Ind. App. 494, 500, 172 N.E. 801, 803 (1930). Despite
this doctrine, Indiana, like virtually all jurisdictions, allows
corporations and their shareholders to impose restrictions on transfers of
shares. The basic theory of these statutes is to permit owners of a
corporation to control its ownership and management and prevent outsiders
from inserting themselves into the operations of the corporation. Id. at
502-03; 12 William Meade Fletcher et al, Fletcher Cyclopedia of the Law of
Private Corporations, § 5454 (1996). Chief Justice Holmes stated the
matter succinctly a century ago: “Stock in a corporation is not merely
property. It also creates a personal relation analogous otherwise than
technically to a partnership. . . . [T]here seems to be no greater
objection to retaining the right of choosing one’s associates in a
corporation than in a firm.” Barrett v. King, 63 N.E. 934, 935 (Mass.
1902). As applied to a family-owned corporation, this remains valid today.
Transfer restrictions are treated as contracts either between
shareholders or between shareholders and the corporation.[1] Doss, 95 Ind.
App. at 502, 172 N.E. at 803; Butner v. United States, 440 U.S. 48, 55
(1979) (the validity and enforcement of restrictions are governed by state
law just like any other contract); Boston Safe Deposit & Trust Co., et al.
v. North Attleborough Chapter of the Am. Red Cross, et al., 111 N.E.2d 447,
449 (Mass. 1953) (restrictions in the articles of organization are binding
on a shareholder by reason of the contract made with the corporation when
she accepted the certificates of stock containing the printed
restrictions). Apart from any statutory requirements, restrictions on
transfer are to be read, like any other contract, to further the manifest
intention of the parties. Because they are restrictions on alienation and
therefore disfavored, the terms in the restrictions are not to be expanded
beyond their plain and ordinary meaning. 12 Fletcher § 5455 (1996).
For a party to be bound by share transfer restrictions, that party
must have notice of the restrictions. I.C. § 23-1-26-8(b) (1998). Here,
the restrictions on transfer of F.B.I. shares were neither “noted
conspicuously” on the certificates nor contained in the information
statement referred to in Indiana Code 23-1-26-8(b), but there is no doubt
that Moore, the buyer at the sheriff’s sale, had notice of the
restrictions. He was therefore bound by them. State ex rel. Hudelson v.
Clarks Hill Tel. Co., 139 Ind. App. 507, 510, 218 N.E.2d 154, 156 (1966).
Finally, a closely held corporation is a “corporation in which all of
the outstanding stock is held by just a few individuals, or by a small
group of persons belonging to a single family.” J.R. Kemper, Validity of
“Consent Restraint” on Transfer of Shares of Close Corporation, 69 A.L.R.3d
1327, 1328 (1976). In 1977, F.B.I. plainly fell within that description;
it was owned by six individuals, all members of a single family. Closely
held corporations have a viable interest in remaining the organization they
envision at incorporation and transfer restrictions are an appropriate
means of maintaining the status quo.
B. Rights of First Refusal
Paragraphs (2) and (3) of the restrictions created rights of first
refusal in F.B.I. and its shareholders. A transfer in violation of
restrictions is voidable at the insistence of the corporation. Groves v.
Prickett, 420 F.2d 1119, 1122 (9th Cir. 1970). F.B.I. and its shareholders
argue that Moore should have been obliged to offer the shares to the
corporation or a shareholder pursuant to those provisions. Moore responds,
and the Court of Appeals agreed, that he was not a shareholder until he
purchased the shares at the sheriff’s sale. He contends he therefore had
no power to offer the shares. This misses the point that before Linda
could transfer her shares, she was obliged to offer them to F.B.I. and the
other shareholders. Moore was on notice of that requirement. Moore, as
the buyer, had the right to demand that Linda initiate the process to
exercise or waive the right to first refusal.
Thus, if the corporation had insisted on its right of first refusal,
Linda would have been obliged to sell to F.B.I. (or its shareholders). And
Moore, as a buyer on notice of the restrictions, had the right to insist
that that process go forward. But the corporation and its shareholders
were aware of the sheriff’s sale and did nothing to assert the right of
first refusal. They cannot sit back and let the sale go forward, await
future events, then claim a right to purchase on the same terms as Moore.
McCroden v. Case, 602 N.W.2d 736, 743-44 (S.D. 1999) (transfer restriction
is waived by stockholder’s failure to exercise “first option” preemptive
rights); Calton v. Calton, 456 S.E.2d 520, 523 (N.C. Ct. App. 1995) (no
justiciable controversy existed where no shareholder exercised the right to
purchase stock, intended to exercise the right, or was even financially
able to do so at the time the action was filed; shareholders waived any
right to object to the transfers where they had knowledge of both the
testator’s death and the restrictions contained on the stock certificates,
no shareholder asked to purchase any of the stock, and shareholders waited
eighteen months to file an action); Puro v. Puro, 337 N.Y.S.2d 586, 587
(N.Y. App. Div. 1972) (transfer restrictions are not self-executing). In
sum, F.B.I. and its shareholders had rights of first refusal, but failed to
exercise them. As a result, the sale to Moore proceeded as if the shares
had been offered and the corporation refused the opportunity. To hold
otherwise would be to give F.B.I. and its shareholders a perpetual option
to purchase but no obligation to do so. Having failed to demand their
right to buy at the time of the sale, the rights of first refusal gave them
no ability to upset the sale conducted by the sheriff.
C. Restrictions on Transfer with Board Approval
The restrictions “adopted” in paragraphs (1) and (4) are more
problematic. Indiana’s statute, reflecting the common law, requires that
restrictions on share transfers be reasonable. I.C. § 23-1-26-8(c)(3),
(d)(3), and (d)(4). The general common law doctrine surrounding evaluation
of the reasonableness of restrictions is well established. A restriction
is reasonable if it is designed to serve a legitimate purpose of the party
imposing the restraint and the restraint is not an absolute restriction on
the recipient’s right of alienability. Bernard F. Cataldo, Stock Transfer
Restrictions and the Closed Corporation, 37 Va. L. Rev. 229, 232-33 (1951).
The Indiana statute is somewhat more generous in allowing restrictions on
classes of buyers unless “manifestly unreasonable.” I.C. 23-1-26-8(d)(4).
Several factors are relevant in determining the reasonableness of any
transfer restriction, including the size of the corporation, the degree of
restraint upon alienation; the time the restriction was to continue in
effect, the method to be used in determining the transfer price of shares,
the likelihood of the restriction’s contributing to the attainment of
corporate objectives, the possibility that a hostile stockholder might
injure the corporation, and the probability of the restriction’s promoting
the best interests of the corporation. 18A Am. Jur. 2d Corporations § 683
(1985). At one extreme, a restriction that merely prescribes procedures
that must be observed before stock may be transferred is not unreasonable.
State ex rel. Howland v. Olympia Veneer Co., 244 P. 261 (Wash. 1926). At
the other end of the spectrum, restrictions that are fraudulent,
oppressive, unconscionable, Tourtelott v. Chestnuts Salon, No. 00-5496 2001
R.I. Super. LEXIS 19 at *6 (R.I. Sup. Ct. Jan. 17, 2001), or the result of
a breach of the fiduciary duty that shareholders in a close corporation owe
to one another, will not be upheld. Cressy v. Shannon Cont’l Corp., 378
N.E.2d 941, 945 (Ind. Ct. App. 1978); 12 Fletcher § 5455 (1996). The
restrictions on F.B.I.’s shares, like most, are somewhere in the middle.
They impose substantive limitations on transfer, but are not alleged to be
the result of fraud or breach of fiduciary duty.
The trial court, in its order granting partial summary judgment,
concluded that the restriction precluding transfer without Board approval
was reasonable at the time that it was adopted, but the lengthy and
difficult history between the parties had rendered the restriction
unreasonable. Under basic contract law principles, the reasonableness of a
term of a contract is evaluated at the time of its adoption. First Fed.
Sav. Bank v. Key Mkts., 559 N.E.2d 600, 603 (Ind. 1990). The same is true
of share transfer restrictions. As a result, evaluating the reasonableness
of the restrictions in light of subsequent developments is inappropriate.
For that reason, we do not agree that the restriction requiring director
approval became unreasonable based upon events and disputes within the
family that occurred after the restrictions had been adopted. To be sure,
the parties find themselves in a difficult dispute as is sometimes the case
in a family business following a dissolution. But when F.B.I. was formed
and the family farms were effectively pooled, the shareholders agreed that
the Board would be permitted to restrict access to the shares. To the
extent that restriction devalues the shares in the hands of any individual
shareholder by reason of lack of transferability, it is the result of the
bargain they struck. The policy behind enforcement of these restrictions
is to encourage entering into formal partnerships by permitting all parties
to have confidence they will not involuntarily end up with an undesired co-
venturer. Presumably for that reason, the statute permits a restriction
that requires a transferee to be approved by the Board of Directors, and to
that extent may severely limit transferability.
A “consent restriction” such as this has been considered unreasonable
by some courts. 2 Cox, Hazen, O’Neal Corporations § 14.10 (2002); Harry G.
Henn & John R. Alexander, Laws of Corporations, § 281 (1983). However, the
General Assembly has allowed precisely this type of restriction in Indiana
Code section 23-1-26-8(d)(3). That section provides that transfer
restrictions may require the approval of “the corporation, the holders of
any class of its shares, or another person” before the shares may be
transferred. Board approval is one permissible way of implementing
approval by “the Corporation” under this section. See also Wright v.
Iredell Telephone Co., 108 S.E. 744, 747 (N.C. 1921) (upholding a
restriction requiring the approval of the corporation’s directors).
D. Restrictions on Transfer Except to “Blood Members of the Family”
We also find the “blood-member” restriction to be enforceable as
protecting a viable interest. Mathews v. United States, 226 F. Supp. 1003,
1009 (E.D.N.Y. 1964) (recognized “intact family ownership” as an interest
worth protecting by a restriction). These are family farmers in corporate
form. It is apparent from the nature of the corporation that the Burger
family had an interest in maintaining ownership and operation of F.B.I. in
the hands of family members. Although one may quibble with the
terminology, and there may be some individuals where status as blood
members is debatable, we think it plain enough that all parties to this
dispute either are or are not blood members of the Burger family. All are
either direct descendants of Ivan or spouses of Ivan or of one of his
children.
II. Attempted Cancellation of the Shares
F.B.I. took the position that the subscription price for Linda’s
shares had not been paid and therefore the shares were cancelled. The
trial court rejected the claim that the shares had been cancelled. We
agree that F.B.I.’s effort in 1989 to cancel the shares in the face of the
impending sheriff’s sale has little merit. The shares were issued in 1977
in exchange for the 180-acre farm Linda and Moore contributed to F.B.I.
That is surely sufficiently substantial consideration to eliminate any
claim that there was no consideration for the shares, and its initial
valuation was a matter of wide discretion for the Board. I.C. § 23-1-26-
2(c).
III. Restrictions as Applied to Involuntary Transfers
The Court of Appeals held that the restrictions on Linda’s shares did
not apply by their terms to the sheriff’s sale and, as a result, did not
bar the sheriff’s sale to Moore. We agree that Moore acquired the shares
at the sheriff’s sale, but not because the restrictions were inapplicable
by their terms.
The Court of Appeals relied on cases stating that involuntary
transfers fall within the terms of a restriction only if the language of
the restrictions specifically identifies them. F.B.I. Farms, 769 N.E.2d at
692. This doctrine has been developed largely in cases involving intestate
transfers by a decedent, Stern v. Stern, 146 F.2d 870, 870 (D.C. Cir.
1945), and in marriage dissolution proceedings where a transfer is made to
a spouse. Castonguay v. Castonguay, 306 N.W.2d 143, 146 (Minn. 1981).
The sheriff’s sale where Moore purchased Linda’s shares was an
involuntary transfer. Transfers ordered incident to marriage dissolutions
and transfers under intestate law may also be deemed involuntary. We think
the governing principle is not the same for all forms of “involuntary”
transfers. The language of the restrictions in this case does not
specifically refer to involuntary transfers of any kind. Rather, it seems
to contemplate restricting all transfers, voluntary and involuntary, by
providing that no stock of the corporation should be “transferred,
assigned, exchanged, divided, or sold” without complying with the
restrictions. The intent of the parties is thus rather plain: to restrict
ownership to the designated group, and to preclude transfer by any means.
The question is whether that intent should be permitted to prevail in the
face of countervailing policies.
Transfer by intestacy is in some sense involuntary, but it may also be
viewed as a voluntary act of the decedent who had the option to leave a
will. If a transfer could not be made by gift during lifetime, for
example, to an offspring regarded by other shareholders as an undesirable
partner, we see no reason to permit it at death by the decedent’s choice to
die intestate. There are, however, forms of involuntary transfers that a
private agreement may not prevent because the agreement would unreasonably
interfere with the rights of third parties. In a dissolution, the
interests of the spouse require permitting transfer over the stated intent
of the parties. Similarly, creditors of the shareholder cannot be stymied
by a private agreement that renders foreclosure of a lien impossible. For
that reason, we agree with the trial court that the sheriff’s sale
transferred the shares to Moore despite the restrictions. Transfer
restrictions cannot preclude transfer in a foreclosure sale and thereby
leave creditors without recourse. This does not turn on a doctrine of
construction. Rather we hold that requiring an explicit bar specifically
naming transfer by intestacy or by testamentary disposition should not be
necessary. If the language purports to bar all transfers, and by its terms
would apply to intestacy, devise or any other means of transfer, it should
be given effect unless the restriction violates some policy.
Although we agree with Moore that he could purchase the shares at the
sale, it is also the case that he purchased the shares with knowledge of
the restrictions. We conclude that he could not acquire more property
rights than were possessed by Linda as his seller. U.C.C. § 8-302 (1994)
(the purchaser of an investment security acquires the rights in the
security his transferor had or had actual authority to convey). The shares
in Linda’s hands were valued with restrictions in place, and therefore it
is not unfair to her creditors that a purchaser at a foreclosure sale
acquire the disputed shares subject to the same restrictions, and with
whatever lessened value that produces. To be sure, the effect of such a
restriction may be to make the shares unmarketable to any buyer. But the
creditor retains the option to bid at the sale and, if successful, succeed
to the shareholders’ interest. The creditor then gets the assets the
debtor used to secure the underlying obligation. If the creditor wants
collateral free of restrictions, the creditor must negotiate for that at
the outset of the arrangement.
Conclusion
We affirm the trial court’s ruling that F.B.I. Farms did not cancel
the shares prior to the sheriff’s sale where Moore reacquired them. We
also uphold the trial court’s finding that the transfer restrictions did
not prevent the sheriff’s sale, and that the transfer restrictions remain
applicable to the shares in Moore’s hands. We reverse the trial court’s
ruling that the two disputed transfer restrictions are unreasonable and
therefore unenforceable, and find that the director-approval and blood-
member restrictions are reasonable and enforceable. The case is remanded
for further proceedings consistent with this opinion.
SHEPARD, C.J., and DICKSON and SULLIVAN, JJ., concur.
RUCKER, J., concurs in result without opinion.
-----------------------
[1] The Indiana statute provides that restrictions are valid if included in
the articles, the bylaws, an agreement among shareholders or an agreement
between the corporation and shareholders. I.C. § 23-1-26-8(a) (1998).
None of these was done here. However, no one challenges the restrictions
as defective in their initial adoption. At least as to Moore, who approved
them as a director and had actual knowledge of them, under these
circumstances, the restrictions constitute a contract as to all of those
shareholders who approved the adoption of the restrictions. Shortridge v.
Platis, 458 N.E.2d 301, 304 (Ind. Ct. App. 1984) (a buy-sell restriction is
analyzed by the court as a contract); 18A Am. Jur.2d Corporations § 687
(1985) (courts sustain a restriction whether valid as a bylaw or not, on
the ground that it constitutes a valid agreement between the stockholders
and the corporation, particularly as applied to stockholders who assent to,
or participate in, the adoption of the bylaw).