Rarely will you see a buy-sell agreement that requires the approval of the holders of a certain class of shares or another person in order for shares to be sold. Rarer still are outright prohibitions on the transfer of shares to certain persons or a class of persons. All such restrictions or prohibitions are permitted under Iowa law so long as the restriction or the prohibition is not “manifestly unreasonable.” This means the consent of your shareholders or the president of the company could be required in order for a shareholder to sell his or her stock. It also means that the shareholders could agree that the stock will never be sold to a competitor. Business owners should consider revising or creating buy-sell agreements with these straightforward requirements instead of the traditional right-of-first-refusal language found in most buy-sell agreements. For one thing, the issue of how to value the option to buy disappears. If a shareholder wants to sell, but can only do so with the consent of the other shareholders, that is the time the price is negotiated.

If you go this route, the challenge, of course, is interpreting the meaning of “manifestly unreasonable.” Neither the Iowa Legislature nor the courts have provided much guidance. In judging whether contemplated restrictions or prohibitions are permissible under the “manifestly unreasonable” standard commentators have suggested that it means not “obviously unfair” and somewhere between “unreasonable and unconscionable” or “passing beyond the outer limits of permissiveness.”[1]

The courts, in interpreting the meaning of “manifestly unreasonable” have also suggested that a restriction needs to serve a legitimate purpose of the company or the shareholders or further the interests of the corporation and not be an absolute restriction on the transfer of shares. Other factors that may be considered are the relative bargaining power of the shareholders involved. One court observed that a restriction will not be manifestly unreasonable if it “ensures that the management and control of the business remain[ed] in the group of investors or with people well-known to them.”

Taken together these observations and interpretations of “manifestly unreasonable” provide a great deal of latitude for shareholders to craft restrictions and outright prohibitions on the transfer of stock that meet their needs. Short of an outright prohibition on all transfers anything that furthered the interests of the parties at the time the agreement is signed should pass muster.

Although not found in typical buy-sell agreements, you should also consider whether drag-along rights (the right of the majority to compel the minority to sell), tag-along rights (the right of the minority to sell along with the majority) and Texas Shoot-Out provisions (the ability to force an intra-shareholder purchase or sale of the business) make sense for your business.

Rights-of-first refusal are very common restrictions on the transferability of stock. But they are also very cumbersome to put into effect and the valuation of the option can be difficult and often unsatisfactory. Simple restrictions and prohibitions on transfer may meet your needs more effectively.

[1] I am indebted to Professor Daniel Kleinberger of the William Mitchell Law School and his research assistant, Maggie Tatton for the research on this topic.