Opinion ID: 1860529
Heading Depth: 1
Heading Rank: 4

Heading: The Meaning of Fair Value

Text: Fair value, with respect to a dissenter's shares, is defined at § 10-2B-13.01(4), Ala.Code 1975, as follows: `Fair Value,' with respect to a dissenter's shares, means the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable. The statute is silent on the application of a marketability discount. [5] Therefore, we are forced to look outside the language of the statute to determine what the Legislature intended. Baron Services urges this Court to adopt a definition of fair value that would permit the application of marketability discounts in the case of shares of a closely held corporation. A marketability discount adjusts for a lack of liquidity in one's shares on the theory that there is a limited supply of potential buyers for stock in a closely held corporation. Thus, the interpretation of fair value advanced by Baron Services takes into account the limited market available for sale of the shares. Under its interpretation of fair value, Baron Services essentially equates fair value with fair market value. Under a fair market value standard a marketability discount should be applied because the court is, by definition, determining the price at which a specific allotment of shares would change hands between a willing buyer and a willing seller. Pueblo Bancorporation v. Lindoe, Inc., 63 P.3d 353, 361 (Colo.2003). There is, however, a fundamental difference between fair value and fair market value when those terms are used in the appraisal context: `Fair 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. This is particularly appropriate in the close corporation setting where there is no ready market for the shares and consequently no fair market value. ... When appraising shares of a close corporation, fair value cannot be fairly equated with the company's fair market value. Close corporations by their nature have less value to outsiders, but at the same time their value may be even greater to other shareholders who want to keep the business in the form of a close corporation. [Marketability] [d]iscounts would call for speculation by a court as to whether a market exists by requiring the judge to determine a value, deduct a variable percentage, decide how unmarketable a stock is, and so forth.... Furthermore, applying a lack of marketability discount would allow the majority who approved the transaction to later buy out with a net gain what the minority dissenters have lost, granting the majority an unfair windfall. Bobbie J. Hollis II, The Unfairness of Applying Lack of Marketability Discounts to Determine Fair Value in Dissenters' Rights Cases, 25 J. Corp. L. 137, 141-42 (1999) (footnotes omitted). We have recognized fair market value as ` the sum arrived at by fair negotiation between an owner willing to sell and a purchaser willing to buy, neither being under pressure to do so.'  Mt. Carmel Estates, Inc. v. Regions Bank, 853 So.2d 160, 166 (Ala.2002) (quoting Barnard v. First Nat'l Bank of Okaloosa County, 482 So.2d 534, 536 (Fla.Dist.Ct.App.1986), quoting in turn Flagship Bank of Orlando v. Bryan, 384 So.2d 1323 (Fla.Dist.Ct.App.1980)). [6] In the context of a cash-out merger, a minority shareholder is not a willing seller; instead, the minority shareholder is selling his or her shares under the compulsion of the majority shareholders who approved the merger. We cannot conclude that the Legislature intended by fair value to mean fair market value. The Delaware courts define the fair value of a dissenting shareholder's shares as the value of what has been taken from the shareholder: `viz. his proportionate interest in [the company as] a going concern.' Cavalier Oil Corp. v. Harnett, 564 A.2d 1137, 1144 (Del.1989) (quoting Tri-Continental Corp. v. Battye, 74 A.2d 71, 72 (Del.1950)). [7] In determining the dissenting shareholder's proportionate interest, the [trial court] is not required to apply further weighting factors at the shareholder level, such as discounts to minority shares for asserted lack of marketability. 564 A.2d at 1144. In reaching this conclusion, the Delaware court reasoned: The application of a discount to a minority shareholder is contrary to the requirement that the company be viewed as a `going concern.' ... Where there is no objective market data available, the appraisal process is not intended to construct a pro forma sale but to assume that the shareholder was willing to maintain his investment position, however slight, had the merger not occurred. Discounting individual share holdings injects into the appraisal process speculation on the various factors which may dictate the marketability of minority shareholdings. More important, to fail to accord to a minority shareholder the full proportionate value of his shares imposes a penalty for lack of control, and unfairly enriches the majority shareholders who may reap a windfall from the appraisal process by cashing out a dissenting shareholder, a clearly undesirable result. Id. at 1145. We hereby adopt the Delaware fair-value standard insofar as it prohibits discounting for lack of marketability, or otherwise, at the shareholder level. [8] Baron Services argues that Saliba in fact applied the marketability discount in this case at the company level, not at the shareholder level, and that, therefore, the discount was permissible under the fair-value standard. See Onti, Inc. v. Integra Bank, 751 A.2d 904, 912 (Del.Ch.1999) (applying discount to market value of shares because shareholders were restricted in their ability to sell shares under Securities and Exchange Commission Rule 144). In Onti, the court calculated the value of the subject company, and, in turn, the fair value of the dissenting shareholder's shares, by weighing the values of the company using a stock-market-value approach and a discounted-cash-flow approach. In determining the value of the company under the stock-market-value approach, the court applied a 31.31% discount to the market value of the successor company's publicly traded stock. This discount reflected the fact that the stock the dissenting shareholders would have received in the successor company but for the cash-out merger would have been unregistered stock. [9] However, the discounted-cash-flow value assigned to the business did not reflect a further marketability discount to take into account the fact that the shares could not be freely traded. Saliba's valuation, unlike the court's valuation in Onti, was not calculated, in whole or in part, on the stock-market value of a publicly traded company. Further, it was not calculated based on a comparative market analysis, which, by its nature, requires that a marketability discount be applied to the figures of the company being used for comparison. The direct-valuation approaches used in Saliba's valuation are not based on market-comparable values; therefore, we find no reason to apply a marketability discount in this case. Nonetheless, Baron Services argues, the marketability discount was necessary to account for the cost of capital differences between it and public companies. In this regard, Saliba testified: If I had not made that [marketability] adjustment, I would have raised my cost of capital numbers and I would have increased the public offering discount and I would have included a liquidity premium for that shareholder.... In deriving appropriate discount and capitalization rates for use in his valuation models, Saliba did account for the fact that Baron Services was a small closely held company that presented a higher degree of investment risk than a larger publicly traded company. Saliba included in the discount rate a micro-capitalization risk premium of 3.5% and a company size premium of 4.35%. He describes his rationale for adding those premiums as follows: 3. Micro-Capitalization Risk Premium The typical small company has a higher degree of investment risk than a similar, but larger company.... Therefore, smaller companies must offer a higher expected rate of return than similar larger companies.... . . . . 5. Equity Risk related to Size Differential ... Since a small, closely-held company is usually restricted to narrower markets than publicly-traded companies, an additional small company premium is warranted.... By including the above premiums in the discount rate, Saliba directly accounted for the market differences between Baron Services and larger public companies. Based on the justifications given by Saliba for including in his valuation the micro-capitalization risk premium and the company size premium, permitting a marketability discount would amount to double counting the market premiums included in the discount rate. The need for a public-offering discount is not apparent from the facts of this case. In his valuation report, Saliba states: Given the size of the Subject Company, its corporate organization and the number of shareholders, the likelihood of a public offering is considered implausible. Moreover, a liquidity premium for [Offenbecher] would not be permissible under the fair-value standard because it would apply to Offenbecher's shares only. See Cavalier Oil, 564 A.2d at 1144. Therefore, we are not convinced by Baron Services' argument that as a matter of financial analysis a marketability discount was reasonable and necessary in this case.