When a minority shareholder petitions for dissolution of a corporation on the grounds of oppressive or illegal conduct (see BCL 1104-a), Section 1118 of New York’s Business Corporation Law allows the corporation or any other shareholder to elect to purchase the petitioning shareholder’s shares “at their fair value and upon such terms and conditions as may be approved by the court.”
Several years ago, Peter Mahler explored the BCL 1118 election in the aptly-titled post, A Deep Dive into the Election to Purchase in Dissolution Proceedings. That post borrows its description of the section 1118 election from the Court of Appeals in Matter of Pace Photographers, Ltd., which calls the election “a defensive mechanism for the other shareholders and the corporation, giving them an absolute right to avoid the dissolution proceedings and any possibility of the company’s liquidation by electing to purchase petitioner’s shares at their fair value and upon terms and conditions approved by the court.”
New York is not alone in providing such a defensive mechanism for corporations and shareholders facing dissolution. Many other states, including California, Nebraska, Illinois, and Florida, have similar statutes. This week’s post takes a look at several recent decisions concerning buyout elections across the country. While each case features different statutory language, our New York readers would be wise to note the persuasive power of these cases on the sometimes thin body of New York caselaw concerning section 1118 elections.
Nebraska – Payment Terms are Subject to the Discretion of the Court
In January 2022, Nebraska’s highest court conducted an extensive analysis of its “fair value” standard. It held that a court’s calculation of the fair value of a petitioning shareholder’s interest under Nebraska’s election to purchase statute (Neb. Rev. Stat. § 21-2,201) precluded the application of either a discount for lack of marketability (“DLOM”) or a minority discount (Bohac v Benes Serv. Co., 310 Neb 722, 735 ).
More recently, the Bohac case took a second trip to the Nebraska Supreme Court, this time to consider the payment terms under which the defendant corporation would buy out the petitioning shareholder (Bohac v Benes Service Co., 313 Neb 409 ).
Bohac concerns a petition for dissolution of Benes Service Co., filed by the estate of its co-founder, Marlene Benes, who at the time of her death held a 14.84% interest in the corporation. The corporation elected to purchase the Estate’s shares, and a trial was held to determine their fair value. During the trial, the corporation’s president testified that he would “prefer” to pay for the Estate’s shares in installments. He testified that the corporation “did not have that kind of money laying around every day,” and that without an installment plan, the corporation would need to borrow money or liquidate assets.
The trial court fixed the value of the Estate’s shares at approximately $2.8 million, which included a substantial DLOM and minority discount. The trial court allowed a five-year payment plan: the corporation must pay at least $575,000 each year, and the judgment must be paid in fully by March 1, 2026.
In January 2022, the Nebraska Supreme Court rejected application of a DLOM and minority discount, and remanded the case to the trial court to recalculate the value of the Estate’s shares. On remand, the trial court fixed the value of the Estate’s shares at $4.1 million, but gave different terms: this time, the corporation was only required to pay $250,000 in the first year of the judgment, with annual payments of $825,000 in subsequent years.
The Estate took another trip to the Supreme Court, insisting that the trial court abused its discretion in setting the new terms, since the post-remand buyout terms actually lowered the amount due in the first year, from $575,000 to $250,000. The Nebraska Supreme Court deferred to the trial court’s broad discretion to fix the terms of the sale: “we are not persuaded, however, that the district court’s post-remand installment plan was an abuse of discretion.”
New York Takeaway: Like the Nebraska statute at issue in Bohac, BCL 1118 specifically allows the court to fix the terms of the sale of the petitioning shareholder’s stock (“Upon such terms and conditions as may be just”). But New York courts rarely take a deep dive into appropriate terms. The best my research could uncover were:
- Matter of Taines v Gene Barry One Hour Photo Process, Inc., where the court refused to grant the purchasing shareholders lenient payment terms based on their oppressive conduct (123 Misc 2d 529, 539 [Sup Ct, NY County 1983]);
- Matter of Elniski v Niagara Falls Coach Lines, Inc., which allowed installment payments (101 AD3d 1722, 1722 [4th Dept 2012]); and
- In re Rapid Recovery Enterprises, Inc., which encourages courts to consider any restrictive covenants in the shareholders agreement in fixing buyout terms (No. 02-8512 [Sup Ct, Suffolk County Oct. 23, 2004]).
New York shareholders angling for favorable buyout terms—specifically, to avoid borrowing money or liquidating assets—might consider the persuasive authority of the corporation-friendly terms offered in Bohac.
North Carolina – Election as an Affirmative Defense, Applicability of Discounts Cannot Be Decided on Summary Judgment
Summary judgment motions generally are rare birds in valuation cases, since there is almost always conflicting testimony from fact and expert witnesses on core valuation issues.
But where the only dispute is the applicability of discounts (a DLOM and a minority discount), is summary judgment appropriate? Not according to a recent case out of North Carolina, Mason v Mason 2022 NCBC 24 (May 13, 2022).
Plaintiff, a 39% shareholder, petitioned for dissolution of Multiflora Greenhouses, Inc. Her ex-husband, another 39% shareholder, interposed an affirmative defense to the dissolution petition stating that dissolution is not an appropriate remedy because he is willing to purchase the Plaintiff’s shares at their fair value. In a subsequent stipulation, the parties agreed that the sole issue submitted to the Court was the fair value of the Plaintiff’s interest for purposes of the agreed-upon buyout.
Defendant presented an expert valuation report concluding that the total value of the corporation as of the valuation date was $960,000. The expert then applied a 30% DLOM and a 20% minority discount, concluding that the fair value of Plaintiff’s interest was $213,000.
Without submitting her own expert report, Plaintiff moved for summary judgment seeking $380,640, which she argued was the calculation prepared by Defendant’s expert, but without application of the DLOM or the minority discount.
Plaintiff’s motion put an interesting question before the Court: by focusing only on the applicability of the DLOM and minority discount, did Plaintiff convert a typically fact-intensive inquiry into a pure legal question that could be decided on summary judgment? The Court did not bite, holding that “Plaintiff has not carried her burden of proving, for purposes of a summary judgment motion, that the Court should disregard the minority and lack of marketability discounts employed by Defendant’s expert.”
New York Takeaways: First, summary judgment continues to be elusive in valuation cases, and Mason is at least persuasive authority for the proposition that the applicability of a DLOM is not a pure question of law that can be determined on summary judgment. Second, I’m intrigued about how the buyout election in Mason came about. Rather than rely on statutory authority, the purchasing shareholder creatively interposed a buyout election as an affirmative defense. I wonder if that maneuver would work in a New York LLC dissolution case, to which BCL 1118 does not apply.
California – A Three-Appraiser Process and Prejudgment Interest
While New York’s section 1118 provides for the Court to determine the “fair value” of the petitioner’s shares, the Golden State puts the question in the hands of the experts. Cal Corp. Code 2000 provides that in the event a corporation elects to forestall dissolution by purchasing the petitioner’s shares, “the court shall appoint three disinterested appraisers to appraise the fair value of the shares owned by the moving parties, and shall make an order referring the matter to the appraisers so appointed for the purpose of ascertaining the value.” The award of at least two of the three appraisers, when confirmed by the court, “shall be final and conclusive upon all parties.”
Is the petitioning shareholder entitled to interest for the time between the valuation date (in California, the day of the filing of the petition) and the confirmed award? Not according to a recent decision from the California Appellate Courts, Crane v R. R. Crane Inv. Corp., 82 Cal App 5th 748, 759 (Cal Ct App 2022).
Crane concerns a petition for dissolution filed by Brian Crane, a 50% shareholder of R. R. Crane Investment Corp. When the remaining 50% shareholder, Brian’s brother, elected to avoid dissolution by purchasing Brian’s interest at fair value, the trial court appointed three appraisers to value his 50% interest as of the date of his dissolution petition. Due to various holdups and slowdowns, that process took almost three years.
While he did not contest the valuation, Brian argued on appeal that the trial court erred by failing to award him prejudgment interest between the valuation date and the date he received payment for his shares. Brian cited the time value of the money owed to him as of the valuation date, the investment opportunities he lost as a result of the three-year delay, and the fact that in the years since his petition, the corporation had performed exceedingly well.
The Court of Appeal held that Brian was not entitled to prejudgment interest. The buyout election statute (Cal Corp. Code 2000) does not itself provide for an award of interest, and the Court first held that California’s general statute providing for prejudgment interest on damages was not applicable, since a corporation’s exercise of its buyout rights—and the payments pursuant thereto—were not “damages.”
The Court then declined to impose prejudgment interest as an equitable remedy, noting that the California Code provided a mechanism for Brian to seek a deferred valuation date. Had he done so, the Court reasoned, he would have captured in the valuation the performance of the corporation over the years. An equitable award of prejudgment interest, the Court held, could not remedy Brian’s failure to seek an alternate date.
New York Takeaways: Most New York Courts that consider the issue require that interest be paid on a purchase after a BCL 1118 election (see Matter of Blake, 107 AD2d 139 [2d Dept 1985]), unless it is determined that the petitioner acted in bad faith. But there’s some appealing logic to Crane: if the idea behind BCL 1118 is to take “fault” out of the equation and substitute it for a neutral determination of fair value, does that counsel for a lower interest award than might ordinarily be applicable to claims for actual “damages”? You decide.
In my view, Crane is more interesting as a demonstration of California’s three-appraiser process at work. Those shareholders that find it appealing to put valuation questions directly into the hands of the valuation experts might consider agreeing ex ante to California’s approach or a similar three-appraiser process (like the one in Walsh v. White House Post Productions, LLC, C.A. No. 2019-0419-KSJM [Del Ch Mar 25, 2020]) in a buy-sell agreement.