Obtaining Fair Value for Buyouts in Close Corporations
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Minority shareholders in a closely held corporation can find themselves in a difficult position if the majority shareholder engages in oppressive, fraudulent, or illegal conduct. (See Charles Jimerson’s blog post on how majority shareholders and close corporations can avoid shareholder oppression claims.) Alternatively, minority shareholders can face challenges when the directors are deadlocked, or when the corporation’s assets are being wasted. Without a controlling block of shares or a market to sell its investment, the minority shareholder may be stuck unless it dissolves the corporation. However, in these circumstances, the minority shareholder need not dissolve the corporation to extricate its investment. This blog post discusses the buyout remedy in the context of dissolution and how courts determine the fair value of a minority shareholder’s interest in a closely held corporation.
The Buyout Remedy
After a court determines that those in control have oppressed a shareholder or otherwise acted improperly, the attention shifts to the remedy. Many states—including those that follow the Model Business Corporation Act—give minority shareholders in a close corporation the statutory right to petition to dissolve the corporation. See Model Bus. Corp. Act § 14.30 (Am. Law. Inst. 2006); see also Fla. Stat. § 607.1430(2) (2017). However, there is an alternative to dissolution. The most common remedial measure for oppression claims is a compulsory or voluntary buyout of the oppressed investor’s shares.
The operation of the buyout remedy varies by jurisdiction. Some jurisdictions have statutes that allow a court to order the buyout of the minority shareholder’s shares by either the corporation or the majority shareholder. See, e.g., Ariz. Rev. Stat. Ann. § 10-1816 (West 2017); S.C. Code Ann. § 33-14-310(d)(4) (2017). Alternatively, some jurisdictions—including Florida—have statutes that allow a corporation or other shareholders to avoid dissolution by purchasing the shares of the minority shareholder who initiated the dissolution proceeding. See Fla. Stat. §§ 607.1434; 607.1436(1) (2017); N.Y. Bus. Corp. Law §§ 1104-a, 1118 (McKinney 2015); see also Model Bus. Corp. Act § 14.34 (Am. Law. Inst. 2006). In other words, “election-to-purchase statute[s]” require buyouts be voluntary. See Fla. Stat. § 607.1434(1), (3); Cox Enters., Inc. v. Pension Benefit Guar. Co., 666 F.3d 697, 699 (11th Cir. 2012).
Regardless of whether the corporation or majority shareholder is a forced buyer, the buyout remedy has pros and cons. On the one hand, a buyout allows the majority shareholder to operate the corporation as it sees fit, while the minority shareholder receives the fair value of its investment. On the other hand, a buyout may be costly for the corporation or majority shareholder, or conversely, may have the minority shareholder lose a significant portion of its investment.
Who decides the value of the shares?
If the corporation or the majority shareholder elects (or is ordered) to buy out the shares of the minority shareholder, the parties may agree on the value of the shares. See, e.g., Fla. Stat. § 607.1436(3). Not surprisingly, this does not always pan out. As a result, if the parties cannot agree on a value, then the court must determine the “fair value” of the minority shareholder’s interest. See Fla. Stat. § 607.1436(4); Model Bus. Corp. Act § 14.34(a).
Determining “Fair Value”
Unfortunately, “fair value” for dissolution statutes is rarely defined and many disagree about what it means. Some courts equate fair value with “fair market value,” which is determined by asking what a willing buyer would voluntarily pay for the minority shareholder’s shares. See Pueblo Bancorporation v. Lindoe, Inc., 63 P.3d 353, 362 (Colo. 2003). Further, under this approach, the value of the minority shareholder’s interest is decreased by discounts, such as lack of control and marketability. Alternatively, other courts equate fair value with “enterprise value,” which is determined by valuing the corporation as a whole and pro rating each share based on the overall enterprise value. See HMO-W, Inc. v. SSM Health Care Sys., 611 N.W.2d 250, 256 (Wis. 2000). Unlike the fair market value approach, this approach does not consider discounts.
Florida courts have the discretion to determine the appropriate valuation method by which to arrive at “fair value.” See G&G Fashion Design, Inc. v. Garcia, 870 So.2d 870, 873 (Fla. 3d DCA 2004). Specifically, in Florida, the “fair value” of a minority shareholder’s interest “rests on determining what a willing purchaser in an arm’s length transaction would offer for an interest in the subject business.” Id. This price should be determined based on the value of the corporation as a going concern, id. at 872, and should consider “net asset values, market price, earnings, and the like” as proof of value, see Boettcher v. IMC Mortg. Co., 871 So.2d 1047, 1053 n.6 (Fla. 2d DCA 2004) (internal quotation and citation marks omitted). Additionally, Florida courts may even consider discounts, such as a lack of marketability when valuing the minority shareholder’s interest. See Munshower v. Kolbenheyer, 732 So. 2d 385, 386 (Fla. 3d DCA 1999).
At first glance, this seems like the fair market value approach; however, Florida’s approach is slightly more nuanced. Unlike the fair market value approach, “the valuation process under § 607.1436 must exclude both positive and negative effects of any” impending corporate actions, such as a merger or acquisition. Cox Enters., Inc. v. News-Journal Corp., 510 F.3d 1350, 1357 (11th Cir. 2007) (citing Boettcher, 871 So.2d at 1052). Nonetheless, the use of fair market value can be used to estimate “fair value” when a potentially distorting corporate action, such as a merger or acquisition, is not at issue. See, e.g., G&G Fashion Design, Inc., 870 So.2d at 872-73. Additionally, Florida courts have also stated that “fair value” must take into account any effect upon the corporation from corporate asset waste or other harm caused by mismanagement. News-Journal Corp., 510 F.3d at 1359.
Minority shareholders in a closely held corporation are in a difficult position if those in control act oppressively, fraudulently, illegally, or otherwise improperly. However, forcing a corporation into dissolution is not always necessary. Either by court order or voluntary agreement, the minority shareholder may extract its interest through the buyout remedy. Nonetheless, it is imperative for both the minority and majority shareholders in a close corporation to understand how courts determine the “fair value” of the minority shareholder’s interest.