The Value Question

In politics, it is often all about the economy (stupid).  In Business Divorce disputes between majority owners and minority investors in private companies, it is often all about the valuation of the minority held interest.

When a minority shareholder establishes at trial that he has been subject to oppression by the majority owner, the question becomes, what standard of value should be applied to the minority ownership interest.  More simply stated, should the minority owner’s shares be valued based on “fair value” or “fair market value.”[1]

In Texas, the trial court decides as a matter of law BOTH whether the minority shareholder has been oppressed AND the equitable remedy to be applied to cure the majority shareholder’s oppressive conduct.  After oppression has been found, the parties’ valuation battle centers on the extent to which the trial court will apply discounts to the value of the minority shareholder’s stock based on its lack of marketability and the lack of control the minority is able to exert in the business.  The fundamental distinction is between “fair value” or “enterprise value” where no discounts apply to the minority interest and “fair market value” where these discounts apply in full force. Fair market value is “the price at which property would change hands between a willing buyer and a willing seller when neither party is under an obligation to act.”[2] A fair market value usually substantially discounts the minority interest for lack of marketability and lack of control.[3]

Before the Dallas Court of Appeals’ Rupe opinion in March 2011, many Texas courts declined to include a lack of control discount when ordering a buyout of the minority interest, because it would “deprive minority shareholders of their proportionate interest in a going concern,”[4] and would undermine the remedial goal of protecting “minority shareholders from being forced to sell at unfair values imposed by those dominating the corporation while allowing the majority to proceed with its desired corporate action.”[5]  The lack of marketability discount, however, has been viewed as more debatable and courts consider adjusting the valuation to reflect the fact that shares in a close corporation lack liquidity.[6]  Thus, majority shareholders argue for discounts and use of the fair market value standard.  By contrast, minority shareholders seek buyouts of their interest at fair value, a valuation with no discounts.[7]

In Rupe, the appellate court held that minority (or fair market value) discounts must be applied by the jury when the minority stockholder complains that the majority shareholders blocked the sales of the minority’s stock to a third party.  The appellate court also favorably cited commentary by Professor Doug Moll, who has written extensively regarding minority shareholder oppression claims.[8]  Prof. Moll expressed the view that trial courts should adopt a flexible approach in construing minority shareholder oppression claims and fashioning remedies for oppressed minority shareholders.[9]

The Rupe decision is the first reported Texas case to require fair market discounts to be applied to the value of the minority shareholder’s stock interest.  Rupe upheld the trial court’s finding that the minority shareholder had been oppressed by the majority shareholders, but the court overturned a buyout awarded to the minority shareholder of more than $7 million – as determined by the jury.  On remand, Rupe required the jury, on retrial, to consider application of discounts for lack of control and lack of marketability in valuing the minority’s stock interest.  Rupe was orally argued to the Texas Supreme Court in February 2013 and a decision is expected soon.

As an alternative to a court-imposed equitable buyout award, some states offer the majority shareholder the option to buy the minority owner’s shares.  For example, California permits the corporation or the shareholder with more than 50% to avoid dissolution by buying the dissenter’s stock for “fair value.”[10]  If the parties cannot agree on fair value, the court can order that evidence of value submitted to a panel of three disinterested appraisers selected by the Court.  The Court then enters a decree based on its review of and affirmation of the valuation of the appraisers.  The decree gives the corporation, or, if it declines, the majority shareholder, the right to avoid dissolution by purchasing the minority’s shares for the price stated in the decree.[11]

[1] See generally Douglas K. Moll, Shareholder Oppression and “Fair Value”: Of Discounts, Dates, and Dastardly Deeds in the Close Corporation, 54 Duke L.J. 293 (Nov. 2004); Balsamides v. Protameen Chems., Inc., 734 A.2d 721, 734-35 (N.J. 1999).

[2] Pueblo Bancorporation v. Lindoe, Inc., 63 P.3d 353, 362 (Colo. 2003).

[3] See Douglas K. Moll & Robert A. Ragazzo, The Law of Closely Held Corporations § 8.02[B][3] (2009).

[4] In re Friedman, 661 N.E.2d 972, 976-77 (N.Y. 1995).

[5] Id.; see also Balsamides, 734 A.2d at 734-35.

[6] Pueblo Bancorporation, 63 P.3d at 357 n.2; Advanced Commc’n Design, Inc. v. Follett, 615 N.W.2d 285, 291 (Minn. 2000).

[7] See generally Douglas K. Moll, Shareholder Oppression and “Fair Value”: Of Discounts, Dates, and Dastardly Deeds in the Close Corporation, 54 Duke L.J. 293 (Nov. 2004).

[8] Id. at 291 nn. 24-25, 27-29, 299 n. 42 (citing Moll publications).

[9] See, e.g., Douglas Moll, Majority Rule Isn’t What It Used It Used To Be:  Shareholder Oppression In Texas Close Corporations, 63 Tex. B.J. 434 (2000).

[10] Cal. Corp. Code § 2000 (West 2010).

[11] Id.