Oppression & 'Fair Value': Of Discounts, Dates,
and Dastardly Deeds in the Close Corporation"
Duke Law Journal, 2005
BY: DOUGLAS MOLL
University of Houston Law Center
The task of measuring value is a task of great
importance in corporate law. Indeed, the need
to determine the fair value of close corporation
stock has arisen frequently in recent years. This
frequency has coincided with the rise of the shareholder
oppression doctrine - a doctrine that seeks to
safeguard the close corporation minority investor
from the improper exercise of majority control.
Over the past few decades, a number of jurisdictions
have authorized, either by statute or judicial
decision, a buyout of an oppressed close corporation
investor's stock at the fair value of the shares.
When a minority investor establishes shareholder
oppression, in other words, the question of fair
value often takes center stage, as the remedy
for oppression typically involves a court-ordered
buyout of the minority's holdings at a judicially-determined
fair value. For shareholders seeking to exit an
oppressive situation, therefore, fair value is
a concept of considerable significance.
But what does fair value mean? The question affects
the lives of countless close corporation investors.
Two conflicting approaches to the meaning of fair
value have developed. The first approach equates
fair value with fair market value. Under this
position, a court values an oppressed minority's
shares by considering what a hypothetical purchaser
would pay for them.
Because minority shares, by definition, lack control,
a hypothetical purchaser is likely to pay less
for minority shares than it would for shares that
possess control (the minority discount). Moreover,
because close corporation shares lack a ready
market and are, as a consequence, difficult to
liquidate, a hypothetical purchaser is likely
to pay less for close corporation shares than
it would for readily-traded public corporation
shares (the marketability discount). Under the
fair market value interpretation of fair value,
therefore, minority and marketability discounts
are appropriate. The second approach to the meaning
of fair value defines fair value simply as a pro
rata share of the company's overall value. Under
this enterprise value approach, further discounting
for the shares' lack of control and lack of liquidity
is inappropriate. Because the combined effect
of minority and marketability discounts can reduce
the value of a pro rata stake in a company by
50% or more, the propriety of discounts and the
related debate over the
meaning of fair value are issues of critical importance
to close corporation investors.
Just as oppressed investors are affected by the
meaning of fair value in a buyout proceeding,
so too are they affected by the choice of the
valuation date. As mentioned, the remedy for shareholder
oppression typically involves a buyout of the
aggrieved investor's holdings at the fair value
of the shares, but fair value as of when? The
date of the oppressive conduct?
The date of the filing of the oppression lawsuit?
The date of trial? The date of judgment? In the
age of Enron and internet ventures, it hardly
needs to be said that a company's value can change
dramatically in a relatively short period of time.
Given how quickly a company's fortunes can change,
the question of when to measure fair value is
a critical inquiry in and of itself, as the choice
of date can have a significant impact on the ultimate
fair value conclusion.
This article grapples with the difficult valuation
issues surrounding discounts and dates in the
shareholder oppression context. The article methodically
builds a case against discounts by using both
conventional and novel arguments to support an
enterprise value approach to fair value. In the
course of constructing that case, the article
challenges some of the traditional arguments that
courts and commentators have routinely relied
on (and still rely on) to reject discounts. By
analyzing the shortcomings of those arguments,
the article addresses the weaknesses of the case
against discounts as well as the strengths. In
addition, by discussing the importance of the
valuation date and various factors that should
affect its designation, this article adds to the
fair value literature.
PERCO - NC Business Court