In this article, we address theory and application of fair value in judicial matters regarding shareholders who dissent from a corporate action and those who avail themselves of the buy-out provision in dissolution statutes under situations of deadlock and oppression. The term fair value used here is not the same as that referred to in accounting literature. In dissenter’s rights and oppression cases, fair value is a legislatively and judicially mandated concept. Moreover, as dissenters’ and oppressed shareholder’s rights evolved in the courts, those who chose to use this term did so to distinguish the concept from fair market value.
Because dissent and oppression matters deal with corporate actions, they are governed by statutes on a state-by-state basis. Fair value in this context is a legal term used in the vast majority of dissenter’s rights and oppressed shareholders statutes, but only broadly defined. Accordingly, the term has been left to judicial interpretation.
There can be as many interpretations of fair value as there are states. In fact, in some instances, there are differing interpretations within a state. Because the interpretation of this standard of value is left to the courts, it is helpful to consider the different contexts in which the term is used.
Our analysis includes the development of dissenting shareholders’ rights (sometimes called appraisal rights). We also address the development of a minority shareholder’s right to petition for dissolution of a company, specifically in situations where oppression has occurred, and receive the fair value of his or her shares through a buy-out or a judicially directed dissolution of the corporation. We then examine the evolution of the standard and definition of fair value. To understand fair value as a standard of value in the context of dissenter’s rights and oppression cases, we examine how various courts address current valuation concepts and techniques, especially the application of shareholder level discounts for lack of control and lack of marketability and the application of control premiums.
A minority shareholder is any owner of shares who lacks a sufficient number of shares of a corporation to control its policies. Generally, in a fair market value context, minority shares are not worth as much as their pro rata share of the value of the enterprise. One primary factor in valuing a minority interest is the degree to which minority shares lack the prerogatives of control. The prerogatives of control can be valuable benefits accruing to a majority shareholder and not necessarily shared by a corresponding minority shareholder. Controlling shareholders may also engage in activities that are harmful to the interests of the minority shareholders. They may:
These particular actions may result in a dissenter’s rights or shareholder oppression action. Dissenter’s rights proceedings generally involve a minority shareholder who disagrees with the direction the board of directors is taking the company. A disagreement will generally involve a merger, sale of assets, or other major change to the nature of the investment, such that the shareholder is no longer involved in the company.
Oppression cases often include more egregious actions than do dissent cases. Oppressed shareholders are those who have been treated unfairly or prejudicially by the majority shareholders or the board of directors. Those cases often involve shareholder employees. Oppression cases can involve termination of dividends, compensation, or employment, or a siphoning of corporate assets for the benefit of the majority at the expense of the minority. In some states, shareholders may petition to dissolve the corporation in order to regain what was taken from them. The corporation may elect to buy their shares at fair value, or the courts may order the buy-out, if provided for by the individual state’s statute.
Because of the relative lack of control and the lack of liquidity faced by many minority shareholders, in a valuation to determine fair market value, appraisers often apply discounts for lack of control and a lack of marketability to the pro rata share of the value of the enterprise. In proceedings that seek to determine fair value, however, the controversy over the past decades has been whether the application of one or both discounts is appropriate to oppressed or dissenting shareholders in a judicial proceeding.
Fair value is the standard of value used to determine the cash price dissenting and oppressed shareholders will receive in exchange for their shares of stock. Currently, this much-debated standard of value is widely understood to mean the proportionate value of the company as a whole. Today, this understanding is essentially correct in many jurisdictions, as the courts increasingly have interpreted fair value to be a pro rata share of the entity-level value rather than the value of the individual minority shares themselves. While the general trend in many states is not to allow or to limit the use of minority and marketability discounts by statute or case law, some states still allow the discounts either by precedent, a court’s discretion, or special circumstances.
In 1950, the Delaware Supreme Court defined fair value in Tri-Continental Corp. v. Battye as the value which had been taken from the shareholder. To the present, the debate continues as to the nature of what has been taken and whether the value should relate to subject interest of the shareholder or a percentage of the company as a whole.
Two influential legal associations, the American Bar Association (ABA) and the American Law Institute (ALI), have each created their own definitions of fair value. By considering relevant case law from past decades, these organizations have influenced legislative and judicial understanding of fair value by publishing definitions in the Model Business Corporation Act (MBCA, from the ABA) and the Principles of Corporate Governance (from the ALI).
The individual states’ statutes have largely drawn from these institutions to establish their definitions of fair value, whose meanings are later reinterpreted by the courts in subsequent decisions. The nature of this process has led the states to interpret fair value in light of decisions in other jurisdictions as well as changes in valuation theory. Determining the purpose for which the statutes were enacted helps us better understand how fair value should be applied in these cases. In doing so, we must address the development of the modern definitions of fair value and how they have been interpreted by the courts.
The fair value standard has been loosely defined in dissenter’s rights statutes, which have been widely affected by the standards recommended by the MBCA. However, the courts’ decisions in dissent and oppression cases have had the most profound effect on defining fair value. The related case law, legal institutions, and statutes have all contributed to the development of the concept of fair value.
Although nearly ubiquitous in dissent and oppression statutes, fair value is never specifically defined. Over the course of the nineteenth century, fair value was used to reference a variety of commodities: an interest in a sailing vessel while a group was heading to California for the gold rush, an interest in the ownership of slaves, the value of rolling stock, and so on.
Why is the concept so indefinite? The use of the term fair value, rather than fair market value, suggests that the willing buyer–willing seller test inherent in fair market value may not apply. Many cases explicitly recognize that fair value and fair market value do not mean the same thing.9 The most important differentiating factor is that in dissent and oppression cases, one of the parties is not considered willing. Either the corporation is being forced to buy, or the shareholder is being forced to sell or compelled to remain. Also, unlike common applications of fair market value, the use of a less-well-defined term allows the court to interpret value based on circumstances of each individual case.
In order to address this standard of value for the purposes of minority shareholder cases, let us address definitions offered by the American Bar Association’s Model Business Corporation Act. Statutes vary, but most draw inspiration from the MBCA or the later published Revised Model Business Corporation Act (RMBCA).
The 1969 Model Business Corporation Act, the first in which the ABA explicitly defined fair value, contains the following definition:
In 1984, the ABA issued the Revised Model Business Corporation Act, which added the phrase: “unless exclusion would be inequitable.” Accordingly, many states use the definition established by the 1984 RMBCA. The definition of fair value in this treatise reads:
The value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.
The 1984 definition provides a guideline, however nonspecific, by which fair value should be determined. The company should be valued on the day before the corporate action occurs, and without any of the effects of the action unless their exclusion would be unfair. The passage does not give instructions on what method or valuation technique should be utilized to determine the fair value, nor does it define “inequitable.” Twenty-one states currently use this exact definition of fair value. In our view, the intentional ambiguity in this definition allows for wide interpretation of the assumptions that underlie this standard of value. Comments published by the ABA explain that this definition leaves the matter to the courts to determine “the details by which fair value is to be determined within the broad outlines of the definition.”
While insuring that the courts have wide discretion, the ambiguity can create confusion on the part of appraisers and appraisal users. Valuation professionals are well advised to discuss this with their attorney so as to come to an understanding of the specific interpretation relevant to the jurisdiction. Although state statutes more often use the RMBCA’s definition of fair value, six states have utilized the American Law Institute’s concept of fair value in case law. In the Principles of Corporate Governance, published in 1992, the ALI defined fair value as:
In 1999, following the development of substantial case law on dissent and oppression, as well as the publication of the Principles of Corporate Governance, the RMBCA was revised so that the definition of fair value reads:
Although still not outlining a specific method of calculating value, the 1999 RMBCA definition mirrors the ALI’s Principles of Corporate Governance, in that it adds two important concepts to the framework: the use of customary and current valuation techniques, and the rejection of the use of marketability and minority discounts except, “if appropriate, for amendments to the certificate of incorporation pursuant to section 13.02(a)(5).” The dissenters’ rights statutes of nine states currently follow this definition.
Other states have developed their own definitions of fair value or have used different standards of value in their statutes. For example, New Jersey has used fair value as its statutory standard since 1968. In the dissolution statute, the explanation of fair value makes allowances for “equitable adjustments” in conjunction with oppression proceedings.
Ohio and Louisiana use fair cash value in their statutes. Ohio uses the willing buyer/willing seller definition in its statute along with the term fair cash value. Decisions in Ohio involving closely held businesses have largely utilized significant discounts in valuing minority shares. Additionally, when the stock of a company is publicly traded, the Ohio court usually relies on that value as opposed to a hypothetical sale price for the entire corporation as indicated in Armstrong v. Marathon Oil.
California uses a fair market value in dissent and the term fair value in liquidation in oppression. Its dissolution (oppression) statute states:
California’s dissent statute states:
The term fair value in liquidation as used in California’s oppression statute is unique. Most states look to determine fair value in these circumstances under the assumption that the business will continue to operate as a going concern.