The fair value and fair market value appraisal standards applicable in contested buyout and dissenting shareholder valuations cut across state lines, which is one of the main reasons I occasionally highlight significant court decisions in valuation cases from outside New York.
As in other areas of the law concerning the internal affairs of business entities, the courts of Delaware play an outsized role in setting standards for assessing competing valuations in contested appraisal proceedings involving both privately and publicly owned companies. In this post, I’m putting Delaware aside in favor of four recent cases that reached the Supreme Courts of four different states — Nebraska, Iowa, Indiana, and North Carolina — involving a number of frequently litigated issues in valuation cases, including discounts.
Nebraska Supreme Court Overturns Application of Discounts In Fair-Value Buyout
Bohac v Benes Service Co., 310 Neb. 722 [Neb. Sup. Ct. 2022]. The Nebraska Supreme Court’s Bohac opinion involves a family-owned farming business in which a sibling schism followed the parents’ death, leading to a dissolution petition, leading to the other siblings’ election to purchase the petitioners’ 14.84% interest under the statutory fair value standard. The trial court valued the shares at approximately $2.9 million after applying discounts for lack of control (DLOC) and marketability (DLOM). On appeal, the petitioners primarily challenged the discounts, the trial court’s non-award of their litigation costs and fees, and payment terms of the award. The respondents’ cross-appeal challenged the trial court’s application of the asset-based approach over the income-based approach.
The Supreme Court’s opinion offers a detailed analysis of the legislative history of the Nebraska Model Business Corporation Act (NMBCA) and commentary supporting its interpretation of the undefined term “fair value” in the elective buyout statute as excluding both DLOC and DLOM, in sync with the explicit exclusion of those discounts in Nebraska’s dissenting shareholder appraisal statute. The Court also takes issue with the trial court’s stated rationale for imposing discounts based on the lack of evidence of oppression by the majority shareholders, noting that once the majority elected to purchase the petitioners’ shares, the issue of oppression dropped out of the case.
On some of the other, core valuation issues, the Court found:
- The trial court properly applied the asset-based approach over the income-based approach.
- The trial court properly valued the business using the going-concern premise of value and not, as argued by the majority’s expert, as if in liquidation.
- The trial court properly adopted the petitioner’s expert’s 10-year deferred gains tax on the sale of the C corporation’s fixed assets over the majority’s expert’s 100% discount for built-in gains.
The Court also upheld the trial court’s denial of petitioners’ request to recover their legal fees, finding that the NMBCA did not authorize their recovery and, upon remand for recalculation of the award without discounts, directing the trial court to reconsider and possibly change the award’s terms and conditions — a 5-year payout with no interest — “based on the needs and abilities of both parties.”
Iowa Supreme Court Upholds Non-Deduction for Built-In Gains Tax But Faults Net Asset Valuation for Excluding Liquidation Costs
Guge v Kassel Enterprises, Inc., 962 N.W.2d 764 [Iowa Sup. Ct. 2021]. The contrast between the Nebraska Supreme Court’s Bohac decision, affirming a deduction for built-in capital gains tax, and the Iowa Supreme Court’s Guge decision, affirming non-deduction for built-in capital gains tax, underscores the nationwide lack of consensus in fair-value proceedings involving subchapter C corporations. The lack of consistency exists even among New York courts, as I’ve written here, here, here and here.
Guge, like Bohac, involves an appraisal contest between siblings who inherited the family farm from their deceased parents. Two sisters holding a minority interest sought judicial dissolution alleging oppressive conduct by their majority-shareholder brother who, in turn, elected to purchase his sisters’ 47.5% interest for fair value. At trial, both experts agreed, and the trial judge adopted, a top-line net asset valuation of approximately $5.8 million. The court rejected the brother’s expert deduction of about $1.45 million for built-in gains tax, finding no evidence that the brother planned to sell the farming operation. It also rejected any deduction for the transaction costs of a hypothetical asset sale even though both experts, while disagreeing on the amount, included a cost deduction in their evaluations.
On appeal, the Supreme Court affirmed the trial court’s determination not to discount for built-in gains tax, citing the lack of evidence of any “contemplated liquidation of assets associated with [the brother’s] election to purchase [the sisters’] shares in lieu of dissolution that would create any tax consequences impacting the corporation’s value as a going concern.” Otherwise, the court reasoned, “the oppressive shareholder [could] reap the benefit of the buyout at a 30% discount while retaining all the corporate assets and never paying the tax himself” [italics in original] which “would create a perverse incentive for the controlling shareholder and provide payment far short of ‘fair value’ for the oppressed shareholder’s shares.”
The Supreme Court, however, disagreed with the trial court’s non-deduction of transaction costs and remanded the case to the lower court to determine and apply the appropriate deduction of transaction costs from the fair value award. The court stated that it was “[p]ersuaded . . . by the parties’ experts, both of whom included transaction costs in their valuations under a net asset approach,” and that the lower court “stopped short of making any finding about the deduction that we’ve now determined must be applied.”
Indiana Supreme Court Upholds DLOC and DLOM for Contractual Buyback at “Appraised Market Value”
Hartman v BigInch Fabricators & Construction Holding Co., 161 N.E.3d 1218 [Ind. Sup. Ct. 2021]. Unlike the other cases featured in this post, Hartman is not a statutory fair-value appraisal case. Rather, it involves a contested buyout under an agreement requiring the defendant company to purchase the plaintiff’s shares for their “appraised market value” upon his termination as an officer and director. The trial court agreed with the company that “appraised market value” means fair market value, thereby justifying the application of discounts for lack of control and marketability. The intermediate appellate court reversed the trial court (read here), holding that Indiana case precedent disallows DLOC and DLOM in compelled buyouts by the controlling party.
The company appealed to the Indiana Supreme Court which reversed the intermediate appellate court’s ruling, agreeing with the trial court that the “plain and unambiguous language of the shareholder agreement calls for BigInch to pay Hartman the fair market value of his shares” and that “[t]here is no blanket rule prohibiting agreements that call for open-market concepts to apply to compulsory, closed-market transactions.” The Court also observed that the agreement explicitly sets the “price per Share” at its “appraised market value” and “[t]hus, the valuation standard refers to the ‘market value’ of the terminated member’s individual interest in the company — not the value of the company as a whole.”
North Carolina Supreme Court Holds Dissenters to Deal Price in Big Tobacco Merger
Reynolds American Inc. v Third Motion Equities Master Fund Ltd., 2021-NCSC-162 [N. Car. Sup. Ct. 2021]. At the top of this post I said this case roundup intentionally excludes recent Delaware appraisal cases. True, but the North Carolina Supreme Court’s opinion in the Reynolds case, affirming the Business Court’s deal-price valuation in a dissenting shareholder appraisal case following British American Tobacco’s $49 billion acquisition of a majority stake in Reynolds American, might as well be a Delaware case, at least based on the prodigious number of Delaware case authorities cited in the opinion. Which is no surprise given that the case not only involves valuation of a publicly traded company — routine fodder for the Delaware Chancery Court — but Reynolds also is the North Carolina Supreme Court’s first ever appeal from a Business Court judgment determining the fair value of a dissenting shareholder’s shares under the state’s dissenting shareholder appraisal statute.
The statute requires North Carolina courts to determine fair value “using customary and current valuation concepts and techniques generally employed for similar business[es] in the context of the transaction requiring appraisal.” The dissenting shareholders’ primary contention on appeal was that the trial court ignored the statute and instead simply deferred to the deal price negotiated by Reynolds and BAT (which pre-merger held a large minority stake in Reynolds). The dissenters also argued that, even if consideration of deal price is permissible, the deal was executed without a robust market check. The dissenters’ valuation expert arrived at a valuation of $92.17 per share using a DCF approach that effectively doubled the $49 billion deal price.
The Court’s lengthy opinion offers a thorough analysis of the competing appraisals at trial, ultimately finding that the Business Court did not abuse its discretion by rejecting the dissenters’ expert’s DCF valuation primarily for its use of an “unreasonable and unreliable” perpetuity growth rate resulting in what the Business Court described as “the largest mispricing ever identified in an appraisal case in North Carolina, Delaware, or elsewhere, by far.” The Court ultimately concluded that the Business Court did not err in choosing to credit the results of Reynolds’ expert’s adjusted unaffected stock price analysis which generated a price range within which the deal price landed.
I encourage those interested to read the opinion front to back for the full flavor of the Court’s appraisal analysis which, among other interesting features, endorses in principle the court’s consideration of deal price “as evidence of fair value when warranted by the circumstances of a particular transaction” even in the absence of a market check, and, while not disturbing the Business Court’s rejection of a control premium, declines to impose a “universal legal presumption that any given market-based valuation methodology does or does not reflect an implicit minority discount.”