Opinion ID: 516903
Heading Depth: 1
Heading Rank: 1

Heading: u.s. news's exercises of its purchase option

Text: 11 A 1962 reorganization of U.S. News created two classes of shares, Common and Class A. All shares of both classes had equal voting rights. The only difference was that Class A shares had a non-cumulative dividend preference of $2.00 per share per year and could be held only by the U.S. News Profit-Sharing Plan. III J.A. 936. Class A shares were designed to convert automatically to Common if they were acquired by anyone other than the Plan. U.S. News Certificate of Incorporation, Article Fourth (d)(ii). 12 As part of the 1962 reorganization, those employees who owned shares in the predecessor corporation were issued a total of 108,000 shares in the new company. About two-thirds of the shares in the predecessor company had belonged to the company's founder, David Lawrence, and to his family; the company purchased these shares for cash and for notes that it repaid by 1967. 13 After the reorganization, employees could acquire additional direct ownership of shares only through U.S. News's stock bonus plan. All employees were eligible to participate. I J.A. 168. U.S. News gave bonus shares to employees in the fifth year of their employment, and every five years thereafter. It calculated the dollar value of the shares to be awarded according to a consistent formula: the longer an employee's length of service, and the greater his salary, the larger the dollar value of the quinquennial bonus. U.S. News then divided this dollar figure by the current appraised value of a share to arrive at the number of bonus shares it would award the employee that year. 14 In order to keep the beneficial ownership of the company lodged among its active employees, Article Fifth of the U.S. News Certificate of Incorporation required employees to offer to sell their shares back to the company if the employee left for any reason, including retirement. The option price was to be established by an independent appraiser, according to a procedure spelled out in Article Fifth, paragraph (e): 15 (e) Option Price. The option price of stock shall be its fair market value as of the date of exercise of the option.... 16 Fair market value as of any date shall be the fair market value agreed upon by the parties, or in the absence of such agreement, determined as follows: The board of directors of the corporation shall select each year a qualified appraiser of national standing, who shall, as soon after the close of each fiscal year of the corporation as complete financial statements are available, determine the fair market value of the stock of the corporation as of the close of such fiscal year. Such fair market value shall be determined without regard to the restrictions on transfer of stock contained in this Article. In making such appraisal the appraiser shall use methods and standards recognized by the regulations of the United States Internal Revenue Service as appropriate for determining fair market value of corporate stock.... The market value per share so determined shall be the option price ... 17 Article Fifth (e), III J.A. 918-19 (emphasis added). Article Fifth (e) also included a procedure by which aggrieved employees could contest the appraisal, but the parties agree that no employee invoked it during the period over which plaintiffs retired. Appellants' Joint Br. at 8, Appellees' Joint Br. at 25. Between 1962 and the retirement of the last retiring plaintiff, U.S. News always exercised its Article Fifth (e) purchase option. 663 F.Supp. at 1500-01. 18 Although plaintiffs make a game try, it seems quite plain that U.S. News acted properly in adopting a minority valuation for the small lots of bonus stock that it purchased from employees. Article Fifth (e) gives the appraiser two instructions on the subject. The appraiser is to assume that the stock could trade freely (i.e., ignore the fact that the Certificate of Incorporation limited stockholders' power of alienation), and to use methods and standards recognized by the regulations of the United States Internal Revenue Service as appropriate for determining fair market value of corporate stock. Neither point provides any basis for valuing on a majority basis lots that were obviously minority. 19 The parties and the trial court all agreed that whatever enlightenment is available from the IRS was embodied in Rev.Rul. 59-60, 1959-1 Cum.Bul. 237, and in the cases interpreting this pronouncement on the valuation of stock for estate tax purposes. We shall revisit Rev.Rul. 59-60 and those cases shortly, but for present purposes it is enough to say that no one here even argues that it could require assignment of a control premium to non-control stock. 20 Plaintiffs argue that because Article Fifth (a) defines stock as comprising both Class A and Common stock, it follows that the phrase stock of the corporation, as used in Article Fifth (e), must refer to all the company's stock and that the entirety of its stock would necessarily entail control. Support for the notion that the valuation is to encompass all of the company's stock lies in the fact that Class A stock could be held only by the Plan, not by an individual, so that the phrase in Article Fifth (e) seems to encompass stock that in the nature of things would never be directly covered by the purchase option. We think the reading very strained. Plaintiffs suggest no reason whatsoever why the framers of the clause could possibly want minority shares valued on a majority basis. 21 Other circumstances also cut against such a reading. It is clear from the Certificate of Incorporation and is conceded by plaintiffs that the framers of the arrangement sought to perpetuate employee ownership and control. Valuation on a majority basis would be inconsistent with the implicit assumption that the company would not be sold, as a control premium is in the nature of things realized only at the moment of sale. In addition, the liquidity problems that plaintiffs' reading might engender for the company could imperil continued employee ownership. 22 Rejecting plaintiffs' strained reading of Article Fifth, we conclude that U.S. News quite properly valued the stock bonus shares on a minority basis. 23 The plaintiffs further argue that even if valuation of the shares on a minority basis was proper, the huge discount that American Appraisal applied to the potential value of U.S. News's West End real estate was unreasonable. After reviewing the testimony of the expert witnesses, the district court found that American Appraisal's decision to give some, but very limited, weight to the value of the real estate adequately took account of the Company's underlying assets. 663 F.Supp. at 1531. We find no error here. In view of U.S. News's often-stated unwillingness to develop the West End real estate, a purchaser of a minority interest in the company would likely have drastically discounted the possibility of a change of mind. And only a decision to develop the real estate in the fairly near future would enable it to contribute very substantially to the discounted present value of the expected returns on a minority share of U.S. News stock. See Citizens Bank & Trust Co. v. Commissioner of Internal Revenue, 839 F.2d 1249, 1251, 1254 (7th Cir.1988) (discussing propensity of investors to heavily discount future returns, especially those beyond their control). Cf. Estate of Watts v. Commissioner of IRS, 823 F.2d 483 (11th Cir.1987) (arms-length transaction would value interest in partnership at going concern value not higher liquidation value when liquidation was unlikely and interest transferred did not carry power to force liquidation). 24