California is among the states that allows for a kind of shareholder “divorce” when a corporation is hopelessly deadlocked due to shareholder disagreement. As long as the minority can assemble a coalition of at least one-third of the outstanding corporate shares, that minority can sue for an involuntary dissolution of the company.
In turn, however, the holders of 50 percent or more of the voting stock of the company have the statutory right to avoid the dissolution by purchasing for cash the shares owned by those seeking the involuntary dissolution at their “fair value” [see Cal. Corp. Code § 2000]. The statute defines “fair value” as the liquidation value as of the valuation date but taking into account the possibility, if any, of sale of the entire business as a going concern in a liquidation [§ 2000(a)].
A recent California Court of Appeals decision [Goles v. Sawhney, 2016 Cal. App. LEXIS 1010 (Nov. 22, 2016)] provides new guidance in determining the “fair value” of the minority’s interest. The Appeals Court for the Second Appellate District indicated:
• The determination of “fair value” should include an assessment of the value, if any, of any pending derivative claims. These can be quite common where one block of shareholders blocks the actions of another.
• § 2000 does not permit a “lack of control discount” in determining “fair value.”
• Where a trial court appoints three appraisers and then proceeds to determine “fair value,” it should not simply average those appraisals in determining the correct value.
“Fair Value” Versus “Fair Market Value”
Minority shareholders are often disappointed in learning that within the context of an involuntary dissolution, the concept of “fair value” is not the same as “fair market value.” Had the legislature intended the court to determine “fair market value,” it would have said so. And so, in determining the value of the minority’s interest, the Court need not make the evaluation on the basis of a going concern. True, the Court can consider a firm’s going value, but need not do so. It may alternatively consider what a piecemeal sale of the firm’s assets might bring.
Lack of Control Discount
The Court of Appeals clearly indicated the minority’s interest should not be discounted by the fact that the minority, by definition, lacks any effective control of the corporation. This is an incredibly important point. Consider the following hypothetical:
Assume a corporation has two shareholders, one with a 51 percent interest, and another with a 49 percent interest, that it is valued at $1 million. If the value of the minority owner’s interest were determined as the value of his or her proportionate interest in the corporation, the minority owner would receive $490,000. Many valuation experts say, however, that the minority interest should be discounted for lack of control at as much as 33 percent. Were that to be applied, it would result in a final evaluation of the minority’s shares factored in, and the value of the minority owner’s shares could conceivably be reduced by 33 percent, to $323,400. That’s a difference of $166,600.
Averaging the Appraisers’ Valuations
Equally important is the Court’s indication that a trial judge should not merely average the evaluations offered by the three appraisers.
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