Shareholders who own a minority interest in a business may not always agree with key decisions made by controlling shareholders. For instance, a minority shareholder might object to a stock-for-stock or “squeeze-out” merger. Or, if a proposed transaction will reduce a minority shareholder’s compensation or divert corporate assets, that individual may file an oppression suit. In such cases, courts will often apply a “fair value” remedy.
What is fair value?
Most states have adopted the Model Business Corporation Act (MBCA), which entitles dissenting or oppressed minority shareholders to receive fair value for their interests. Under the MBCA, fair value is the value of the shares immediately before the corporate action to which the dissenter objects. It generally excludes any change in value in anticipation of the corporate action unless exclusion would be inequitable.
Appraisal rights provisions protect investors — who may not be “willing” sellers — from being shortchanged in minority shareholder squeeze-outs, going-private transactions and leveraged buyouts, especially when a deal involves related parties. A fundamental question in appraisal rights litigation is: Does the price paid in the transaction represent fair value?
In numerous cases, courts have ruled that the transaction price isn’t equitable. When that happens, judges may turn to other valuation techniques, such as the discounted cash flow and the guideline public stock methods, to estimate fair value.
Do valuation discounts apply?
Most jurisdictions entitle a dissenting or oppressed minority shareholder to receive his or her proportionate share of the company’s entire value on a controlling, marketable basis. In other words, most courts interpret fair value to exclude discounts for lack of marketability or control (or, conversely, to include a premium for control).
The interpretation assumes that a discounted purchase price would provide a windfall to shareholders who already control the business. And court-ordered buyouts provide ready markets for minority interests.
When it comes to the issue of valuation discounts, it’s important to understand the relevant standard of value that applies under state law and/or the terms of any contractual agreements between the parties. However, legal precedent on applying valuation discounts in dissension and oppression cases often conflicts — even within the same jurisdiction.
In fact, some states discourage rigid rules barring valuation discounts. Instead, a court might permit discounting after all relevant factors are considered on a case-by-case basis.
To further complicate matters, judges may reference cases outside their jurisdictions. This may be especially likely to occur when little or no relevant precedent exists in a judge’s own jurisdiction.
We can help
Successful appraisal right claims by dissenting or oppressed shareholders may result in court-ordered buyouts of the minority owners’ interests. Courts are typically granted significant leeway when deciding on the appropriate buyout price in compulsory buyouts. Contact us for more information. Our business valuation pros can help you better understand how the laws and legal precedent in your jurisdiction may apply in your situation.
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