Opinion ID: 772475
Heading Depth: 2
Heading Rank: 1

Heading: Application of Marketability Discount

Text: 11 The Company argues that the district court failed to consider all relevant facts and circumstances when it refused to consider the lack of liquidity of the stock, and that the district court erroneously failed to discount the stock for lack of marketability. We disagree. 12 The fair value appraisal statute, Mo. Rev. Stat. 351.455, was enacted in response to the legislature's decision to change the requirements for shareholder approval of major corporate transactions by allowing majority rather than unanimous shareholder approval. In exchange, the legislature created appraisal rights to protect minority shareholders from being deprived of their ownership interests by majority shareholders. Hunter v. Mitek Indus., 721 F. Supp. 1102, 1106-07 (E.D. Mo. 1989) (Hunter) (concluding that the purpose of the fair value statute is to substitute for the control power or value the minority relinquished); Flarsheim v. Twenty Five Thirty Two Broadway Corp., 432 S.W.2d 245, 253 (Mo. 1968) (Flarsheim) (remarking that the appraisal statute is the bargained exchange for the abolition of the requirement of unanimous consent to approve a transfer of the assets of a corporation); see also HMO-W, Inc. v. SSM Health Care System, 611 N.W.2d 250, 254 (Wis. 2000) (HMO-W, Inc.) (noting that the appraisal remedy has its roots in equity and serves as a quid pro quo: minority shareholders may dissent and receive a fair value for their shares in exchange for relinquishing their veto power). 13 The appraisal statute provides an equitable remedy, compensating minority shareholders for their lack of control and ensuring that they retain the same proportionate value of their stock regardless of undesired changes dictated by majority vote. Dreiseszun, 577 S.W.2d at 907 (the underlying purpose [of the appraisal statute] is to assure such dissenting minority shareholders an equitable, just, and 'fair value' for their stock); Lawson Mardon Wheaton, Inc. v. Smith, 734 A.2d 738, 748 (N.J. 1999) (Lawson Mardon Wheaton) ([t]he very nature of the term 'fair value' suggests that courts must take fairness and equity into account in deciding whether to apply a discount to the value of the dissenting shareholders' stock in an appraisal action). Therefore, the proper valuation of minority stock must calculate the value of the corporation as a whole and award a pro-rata share of that value to the dissenting shareholders. See Hunter, 721 F. Supp. at 1106 (declaring that [f]air value means on-going business value, and a dissenting shareholder is entitled to his proportional or pro-rata share of the company's on-going value); Dreiseszun, 577 S.W.2d at 908 (a share of common stock is evidence of unit ownership of the whole, each unit being of equal value such that the sum equals the value of the whole. (citing 18 C.J.S. Corporations 515, p. 1194)); see also Cavalier Oil Corp. v. Harnett, 564 A.2d 1137, 1145 (Del. 1989) (Cavalier Oil) (holding that a minority shareholder is entitled to a proportionate interest in the corporation appraised as an entity); In re Valuation of Common Stock of McLoon Oil Co., 565 A.2d 997, 1004 (Me. 1989) (McLoon) ([i]n the statutory appraisal proceeding, the involuntary change of ownership caused by a merger requires as a matter of fairness that a dissenting shareholder be compensated for the loss of his proportionate interest in the business as an entity). This valuation reflects the shareholder's actual interest in the company prior to the corporate change, independent of market variables or influences, and dictates that the fair value of a dissenter's minority share should remain equal to the value of the majority shares. See Dreiseszun, 577 S.W.2d at 906 (holding that the classification of stock as minority or majority shares must not affect actual value). 14 The American Law Institute explicitly confirms the interpretation of fair value as the proportionate share of the value of 100 percent of the equity, by entitling a dissenting shareholder to a proportionate interest in the corporation, without any discount for minority status or, absent extraordinary circumstances, lack of marketability. American Law Institute, Standards for Determining Fair Value, Principles of Corporate Governance: Analysis and Recommendations (ALI) 7.22(a) (1994). See also Business Valuation Selected Advanced Topics, Model 2.5 Dissenting Shareholder Actions and Fair Value, American Society of Appraisers (1997) (declaring a trend towards defining fair value as a pro-rata share of the value of 100 percent of the equity). Comment e to 7.22 explains that in an appraisal proceeding, absent extraordinary circumstances, the corporation should be valued as a whole and allocated proportionately. ALI 7.22 cmt. e. 15 Contrary to the Company's contention, fair value in minority stock appraisal cases is not equivalent to fair market value. Dissenting shareholders, by nature, do not replicate the willing and ready buyers of the open market. Rather, they are unwilling sellers with no bargaining power. See Harry J. Haynsworth, Valuation of Business Interests, 33 Mercer L. Rev. 457, 459 (1982) (explaining that fair market value attempts to reflect the context of a hypothetical sale between a willing seller and buyer, a situation that does not exist in the dissenting shareholder situation); see also Joseph W. Anthony & Karlyn V. Boraas, Betrayed, Belittled ... But Triumphant: Claims of Shareholders in Closely Held Corporations, 22 Wm. Mitchell L. Rev. 1173, 1186 (1996) (contending that, particularly in the close corporation setting where there is no ready market for the shares and consequently no fair market value, '[f]air value' is not the same as, or short-hand for, 'fair market value.' 'Fair value' carries with it the statutory purpose that shareholders be fairly compensated, which may or may not equate with the market's judgment about the stock's value.); Barry M. Wertheimer, The Shareholders Appraisal Remedy and How Courts Determine Fair Value, Duke L.J. 613, 636-37 (1998) (Wertheimer) (discussing the unreliability of market price due to its dramatic fluctuations and susceptibility to manipulation by insiders or majority shareholders). 16 The purpose of a marketability discount is to adjust for a lack of liquidity in one's interest in an entity, on the theory that there is a limited supply of potential buyers for stock in a closely-held corporation. Lawson Mardon Wheaton, 734 A.2d at 747. Because fair market value is irrelevant to the determination of fair value, market forces, such as the availability of buyers for the stock, do not affect the ultimate assessment of fair value in an appraisal proceeding. The American Law Institute interprets fair value as not including any discount, absent extraordinary circumstances, for lack of marketability. ALI 7.22(a). Comment e to 7.22 further clarifies that extraordinary circumstances must consist of more than an absence of a trading market in the shares. Id. at cmt. e. See also Advanced Communication Design, Inc. v. Follett, 615 N.W.2d 285, 292 (Minn. 2000) (Follett) (allowing a marketability discount only in an extraordinary circumstance where an unfair wealth transfer occurred from the remaining shareholders to the dissenting shareholder). 17 The marketability discount is incompatible with the purpose of the appraisal right, which provides dissenting shareholders with a forum for recapturing their complete investment in the corporation after they are unwillingly subjected to substantial corporate changes beyond their control. See Hunter, 721 F. Supp. at 1107 (the purpose of the appraisal statute is to award the dissenter the value of what he owned before a significant corporate change); see also Cavalier Oil, 564 A.2d at 1145 (the appraisal process is not intended to reconstruct a pro forma sale but to assume that the shareholder was willing to maintain his investment position, however slight, had the merger not occurred). A discount for lack of marketability is inappropriate because the minority shareholders are not willing sellers. See First Western Bank Wall v. Olsen, 621 N.W.2d 611 (S.D.2001) (First Western Bank) (observing that a marketability discount is especially inapplicable in a dissenters' rights context, as a ready market does exist for the dissenters' shares, namely the majority shareholder or the corporation itself); Columbia Management Co. v. Wyss, 765 P.2d 207, 213 (Or. Ct. App. 1988) (noting that because a dissenting shareholder is exercising a right designed for his or her protection, and because the purchaser of the shares will be the corporation, not an outsider, this recognition of decreased market value may not be appropriate). Imposing a marketability discount would benefit the majority shareholders at the expense of the minority shareholders, in direct conflict with the purpose of the statute. See Follett, 615 N.W.2d at 292 (noting that marketability discounts might create [a] result that allows majority shareholders to reap a windfall by buying out or that encourages corporate squeeze-outs, which is contrary to the statutory purpose to provide a remedy to minority shareholders). 18 In fact, no Missouri court has ever applied a discount for lack of marketability in a dissenting shareholders' appraisal action. On the contrary, most courts have refused to apply a marketability discount in fair value cases. See Cavalier Oil, 564 A.2d at 1144-45 (rejecting under Delaware law application of a marketability discount as contrary to the requirement that the company be valued as a going concern); Arnaud v. Stockgrowers State Bank, 992 P.2d 216, 217 (Kan. 1999) (holding that under Kansas law neither minority nor marketability discounts are appropriate when the purchaser of the stock is either the majority shareholder or the corporations, because the sale results in a windfall to those already in control); Lawson Mardon Wheaton, 716 A.2d at 563 (New Jersey) ([t]he history and policies behind dissenters' rights and appraisal statutes lead us to conclude that marketability discounts generally should not be applied when determining the 'fair value' of dissenters' shares in a statutory appraisal action); First Western Bank, 621 N.W.2d 611 (South Dakota) (deciding that a non-marketability discount may not be applied to the valuation of shares in an appraised proceeding). 19 We conclude that the market for minority stock in a dissenting shareholders' appraisal proceeding, absent extraordinary circumstances, is not a relevant fact or circumstance to consider when determining fair value. We hold that the facts of the present case do not constitute extraordinary circumstances warranting a discount for lack of marketability in the determination of the fair value of the stock. Rather, the illiquid nature of the stock is precisely the type of minority stock held in a close corporation which Missouri's appraisal statute is designed to protect. To remain consistent with this purpose of compensating the dissenting shareholders for the full proportionate value of their stock, we affirm the decision of the district court to refrain from discounting the minority stock for lack of marketability.