The Kochs and Cato

Charles and David Koch have sued the Cato Insitute and its president, Ed Crane in state court in Kansas, where Cato was organized, claiming violation of the non-profit's shareholder agreement. Prior to October 2011, there were four shareholders - the Koch brothers, Crane, and William Niskanen. Niskanen died in October 2011, leaving a great deal of uncertainty as to what will happen to his 25% interest.

Many non-profit corporations are organized and operated as non-shareholder entities. It is relatively unusual for a non-profit that has qualified as a 501(c)(3) entity to be owned by shareholders. Clearly the assets of the corporation cannot inure to the benefit of its shareholders, even if it is dissolved.

The value of the shares is not monetary. Their value lies in the ability of shareholders to nominate new members to the Board.

The shareholder agreement, which was first signed in 1977 and then updated in 1985, was attached as an exhibit to the Complaint. It was poorly drafted in several respects. Its essential provisons were:

• Each shareholder has 16 shares, with a value of $1 per share. (In 1977, there were five shareholders, each owning 12 shares.)
• Any shareholder who wishes to transfer his shares to any other person must first offer them to the corporation, which has a 30-day option to purchase them for the price paid for them - i.e., the $16.  
• The agreement does not say what happens if the corporation does not exercise the option. The conclusion would be that the shareholder is then free to transfer the shares to another person. 
• The complaint asserts that the remaining shareholders may exercise the option if the corporation does not do so. I do not see that in the agreement. 
• A majority of the shareholders may buy out a shareholder involuntarily. (Effectively, with four shareholders, all of the other three would have to agree to buy out the fourth.) 

The complaint alleges that Niskanen's wife has not tendered his shares to the corporation. But if she is the executor of his estate, she has a period of several months while the estate is being administered before having to make any distribution of property. So the lawsuit may well be premature. If the widow wants to distribute the shares to any beneficiary of the estate as successor, she would have to make the resale offer to Cato before she did so.

The wife, Kathryn Washburn, is herself a member of the Cato board, and would certainly want to move cautiously.

Since the lawsuit is essentially aimed at forcing the executor to comply with the agreement, it is likely that it should have been filed in the probate court in D.C. where the estate was presumably opened.  (The Last Will and Testament of Niskanen was attached as an exhibit to the complaint, which means an estate has been opened and the will has been filed.)

The will provides for a cash bequest to Niskanen's children, and then the residuary estate is to be divided among his wife, the Cato Institute, and the Institute for Justice. It does not mention or direct the disposition of the Cato shares. Thus, if the executor makes the offer and Cato does not act on it, the 16 shares could have to be divided equally, or as close to equally as possible, among those three recipients. Thus the Cato Institute itself would succeed to the ownership of five or six shares.

The shareholder agreement does not even mention the death of a shareholder, which was a major omission. It should have provided for automatic redemption of the shares on the death of a shareholder. Then there would be no need to wait for the executor to do anything, and no need for the corporation to make any decision.

This situation leaves Ed Crane and the board in a quandary. If the shares are in fact absorbed by the company, this would leave the Kochs as two of the three remaining shareholders, amplifying their ability to continue their current course of adding members of their choosing to Cato's Board of Directors. If the Board declines to repurchase the shares, then the executor would be free to sell or transfer the shares to a person of her choice, assuming that she could get approval of the probate court or consent of the residuary legatees - one of which is the Cato Institute itself - to do so.

Theoretically, as this situation replays itself - and it will, as the current shareholders age - the number of shareholders could shrink until only one person is left. The last one alive would then have full control of the board of the organization.