Opinion ID: 2630535
Heading Depth: 2
Heading Rank: 3

Heading: Fair Value Means the Shareholder's Proportionate Ownership Interest in the Corporation

Text: We hold that the proper interpretation of fair value is the shareholder's proportionate ownership interest in the value of the corporation, without discounting for lack of marketability. This view is consistent with the underlying purpose of the dissenters' rights statute and the strong national trend against applying discounts.
Historically, the dissenters' rights statutes were intended to compensate minority shareholders for the loss of their veto power and to provide liquidity for dissenting shareholders who found themselves trapped in an involuntarily altered investment. See Barry M. Wertheimer, The Purpose of the Shareholders' Appraisal Remedy, 65 Tenn. L.Rev. 661 (1998); Mary Siegel, Back to the Future: Appraisal Rights in the Twenty-First Century, 32 Harv. J. on Legis. 79, 93-97 (1995). In recent years, the purpose of modern dissenters' rights statutes has been vigorously debated by commentators. [7] The consensus that has developed among courts and commentators is that the modern dissenters' rights statute exists to protect minority shareholders from oppressive conduct by the majority. See Wertheimer, supra, at 689 (The case law suggests [the appraisal remedy] does serve several functions, although each involves an overriding goal of minority shareholder protection.); Thompson, 84 Geo. L.J. at 4 (Now the remedy serves as a check against opportunism by a majority shareholder in mergers and other transactions in which the majority forces minority shareholders out of the business and requires them to accept cash for their shares.); M Life, 40 P.3d at 13 (citing Breniman v. Agric. Consultants, Inc., 829 P.2d 493, 496 (Colo. App.1992)) (the purpose of the dissenters' rights statute is to protect the property rights of dissenting shareholders from actions by majority shareholders which alter the character of their investment.). The necessity of a dissenters' rights statute for protection of minority shareholders is illustrated by examining the situations in which the remedy is typically used today. The original concern of the appraisal remedy was for shareholders who were trapped in a post-merger investment that did not resemble their original investment. Wertheimer, supra, at 667. Today, financial practice and legal environments have changed such that mergers are often used solely to cash-out minority shareholders. See Thompson, supra, at 25-28 (conducting a survey of appraisal cases over the course of the prior decade and noting that over eighty percent of those cases involved some form of a cash-out merger). In a typical cash-out merger, a corporation creates a shell company which is owned by the corporation's majority shareholders. The original corporation and the shell company merge and only the majority shareholders continue as shareholders of the surviving company; the minority shareholders are involuntarily cashed out of their investment. [8] The dissenters' rights statute serves as the primary assurance that minority shareholders will be properly compensated for the involuntary loss of their investment. The remedy protects the minority shareholders ex ante, by deterring majority shareholders from engaging in wrongful transactions, and ex post, by providing adequate compensation to minority shareholders. Wertheimer, supra, at 680. In this case, the sole purpose of the merger between Holding Company and Merger Corp. was to cash out minority shareholders, such as Lindoe, who did not qualify to hold stock in an S corporation. [9] The time and price at which Lindoe was cashed out was determined entirely by Holding Company. The purpose of the dissenters' rights statute would best be fulfilled through an interpretation of fair value which ensures minority shareholders are compensated for what they have lost, that is, their proportionate ownership interest in a going concern. A marketability discount is inconsistent with this interpretation; it injects unnecessary speculation into the appraisal process and substantially increases the possibility that a dissenting shareholder will be under-compensated for his ownership interest. An interpretation of fair value that gives minority shareholders less than their proportionate share of the whole firm's fair value would produce a transfer of wealth from the minority shareholders to the shareholders in control. Such a rule would inevitably encourage corporate squeeze-outs. In re Valuation of Common Stock of McLoon Oil Co., 565 A.2d 997 (Me.1989).
The interpretation of fair value which we adopt today is the clear majority view. It has been adopted by most courts that have considered the issue, the authors of the Model Business Corporation Act, and the American Law Institute.
Our interpretation of fair value is consistent with the interpretation adopted by most courts that have considered the issue. The interpretation of other states is especially persuasive for two reasons. First, the language of the Colorado statute, because it was based on the Model Act, is nearly identical to the language of dissenters' rights statutes around the country. [10] Forty-five states and the District of Columbia currently have dissenters' rights statutes which, like Colorado, require that a dissenting shareholder be paid fair value for his shares. [11] Of these forty-six jurisdictions, five have adopted the definition of fair value found in the 1999 amendments to the MBCA and another twenty-seven, including Colorado, have a definition that is identical or nearly identical to that found in the 1984 MBCA. [12] Second, we believe that one of the purposes of the MBCA was to facilitate a degree of national uniformity among state corporate law. Because the General Assembly enacted Colorado's corporate code based largely on the Model Act, we presume that it intended, to some degree, to place Colorado's corporate law in step with the law of other states. Holding Company's interpretation of fair value conflicts with the interpretation adopted by most courts that have already considered the issue. In the leading case regarding discounts, Cavalier Oil Corp. v. Harnett, 564 A.2d 1137 (Del.1989), the Delaware Supreme Court held that discounts should not be used in determining the fair value of a dissenters' shares. In that case, the majority shareholders of a closely-held Delaware corporation, in order to consolidate ownership of the company, approved a short-form merger. [13] The dissenting shareholder, who owned just 1.5 percent of the company's outstanding shares, exercised his dissenters' rights. In determining the fair value of his shares, the Delaware Court of Chancery refused to apply a discount at the shareholder level. The supreme court affirmed: [T]he 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. 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. Cavalier, 564 A.2d at 1145. Since Cavalier, courts across the country have considered the issue of marketability discounts and have generally followed Delaware's lead. Of the jurisdictions with fair value statutes, courts in fifteen states have held that a marketability discount should not be applied in determining fair value. [14] See Offenbecher v. Baron Serv., Inc., No. 2000025, ___ So.2d ___, 2002 WL 959833 (Ala.Civ.App. May 10, 2002); Devivo v. Devivo, No. CV980581020, 2001 WL 577072 (Conn.Super.Ct. May 8, 2001) (interpreting fair value standard of statute authorizing a buy-out of minority shareholder who has petitioned the court for dissolution of the corporation); Blitch v. Peoples Bank, 246 Ga.App. 453, 540 S.E.2d 667 (2000); In re Valuation of Common Stock of McLoon Oil Co., 565 A.2d 997 (Me.1989); Advanced Communication Design, Inc. v. Follett, 615 N.W.2d 285 (Minn.2000) (interpreting the fair value standard of statute authorizing a buy-out of a minority shareholder who has petitioned for corporate dissolution); Swope v. Siegel-Robert, Inc., 243 F.3d 486 (8th Cir.2001) (interpreting Missouri law); Rigel Corp. v. Cutchall, 245 Neb. 118, 511 N.W.2d 519 (1994); Lawson Mardon Wheaton, Inc. v. Smith, 160 N.J. 383, 734 A.2d 738 (1999); Woolf v. Universal Fid. Life Ins. Co., 849 P.2d 1093 (Okla. Ct.App.1992) (expressing approval of the Delaware position of prohibiting all discounts at the shareholder level); Charland v. Country View Golf Club, Inc., 588 A.2d 609 (R.I.1991) (interpreting the fair value standard of statute authorizing a buy-out of a minority shareholder who has petitioned for corporate dissolution); Morrow v. Martschink, 922 F.Supp. 1093 (D.S.C.1995) (same); First Western Bank Wall v. Olsen, 621 N.W.2d 611 (S.D.2001); Hogle v. Zinetics Medical, Inc., No. 20000470, 2002 UT 121, 63 P.3d 80 (2002); U.S . Inspect Inc. v. McGreevy, No160966, 2000 WL 33232337 (Va. Cir. Ct. Nov.27, 2000); Matthew G. Norton Co. v. Smyth, 112 Wash.App. 865, 51 P.3d 159 (2002). In addition, five state legislatures have already adopted the 1999 amendments to the MBCA's fair value definition which explicitly prohibit minority and marketability discounts. See 2001 Conn. Acts 01-199 (Reg. Sess.) (amending Conn. Gen.Stat. § 33-855 (2001)); 2002 Iowa Legis. Serv. 1154 (West)(effective Jan. 1, 2003) (amending Iowa Code § 490.1301 (1999)); 2001 Me. Legis. Serv. 640 (West) (effective July 1, 2003) (adding Me.Rev.Stat. Ann. tit. 13-C, § 1301(4) (West 1981)); 2000 Miss. Laws ch. 469, § 28 (amending Miss.Code Ann. § 79-4-13.01(4) (1999)); 2002 W. Va. Acts ch. 25 (adding W. Va.Code § 31D-13-1301 (2002)). Finally, several other states, while not specifically addressing the issue of marketability discounts, have expressed the view that the proper interpretation of fair value is the shareholder's proportionate interest of the corporation as a going concern, not the specific stock valued as a commodity. See Hansen v. 75 Ranch Co., 288 Mont. 310, 957 P.2d 32 (1998) (holding, where marketability discount was not the precise issue, that a minority discount may not be applied because the proper measure of value is the shareholder's proportionate share of the corporation's fair value); In re 75,629 Shares of Common Stock of Trapp Family Lodge, Inc., 169 Vt. 82, 725 A.2d 927, 931 (1999) (holding, where discounts were not specifically in issue, that a dissenting shareholder is entitled to be paid his proportionate interest in a going concern); HMO-W, Inc. v. SSM Health Care System, 234 Wis.2d 707, 611 N.W.2d 250, 256 (2000) (prohibiting minority discounts and noting that the focus of fair valuation is not the stock as a commodity but rather the stock only as it represents a proportionate part of the enterprise as a whole.); see also Arnaud v. Stockgrowers State Bank, 268 Kan. 163, 992 P.2d 216 (1999) (interpreting the fair value standard of the statute dealing with payment for fractional shares and holding that no marketability discount should be applied); McKesson Corp. v. Islamic Republic of Iran, 116 F.Supp.2d 13 (D.D.C. 2000) (citing the approval by the overwhelming majority of state courts in refusing to apply a marketability discount to determine value of a minority ownership interest which was expropriated by a foreign nation). In contrast, only six states with fair value statutes have clearly concluded that fair value may include marketability discounts. [15] See Munshower v. Kolbenheyer, 732 So.2d 385, 386 (Fla.Dist.Ct.App.1999) (interpreting fair value in the context of a buy-out of a shareholder who petitioned for corporate dissolution); Weigel Broadcasting Co. v. Smith, 289 Ill.App.3d 602, 225 Ill.Dec. 1, 682 N.E.2d 745 (1996) (holding that the decision of whether to apply a marketability discount is within the trial court's discretion); Ford v. Courier-Journal Job Printing Co., 639 S.W.2d 553 (Ky.Ct.App.1982); McDonough v. Alpha Const. Eng'g Corp., No. 12757, 1994 WL 1031191 (Va. Cir. Ct. May 19, 1994) (trial court, interpreting Maryland law, applied marketability discount in buy-out proceeding); In re Dissolution of Gift Pax, Inc., 123 Misc.2d 830, 475 N.Y.S.2d 324 (N.Y.Sup.Ct. 1984) (interpreting fair value in context of statute authorizing buy-out of shareholder who petitioned for corporate dissolution); Columbia Mgmt. Co. v. Wyss, 94 Or.App. 195, 765 P.2d 207 (1988). The clear majority trend is to interpret fair value as the shareholder's proportionate ownership of a going concern and not to apply discounts at the shareholder level. The interpretation urged by Holding Company would position Colorado among a shrinking minority of jurisdictions in the country. We decline to do so. Although corporate law varies widely among the states, we believe there is some benefit to a consistent interpretation of the same statutory language from one jurisdiction to the next. See In Interest of R.L.H., 942 P.2d 1386 (Colo.App.1997) (holding that Colorado statute, which was adopted from a uniform law, should be construed in conformity with other state's interpretations).
We also find the recent amendments to the Model Business Corporation Act to be persuasive. In 1999, the MBCA amended its definition of fair value to reflect the national trend against discounts in fair value appraisals. Fair value, according to the amended definition: means the value of the corporation's shares determined: . . . (iii) without discounting for lack of marketability or minority status except, if appropriate, for amendments to the articles pursuant to section 13.02(a)(5). Model Bus. Corp. Act 3d § 13.01(4)(iii) (1984) (amended 1999). The commentary to the 1999 amendments makes clear that the change was an adoption of the more modern view that appraisal should generally award a shareholder his or her proportional interest in the corporation after valuing the corporation as a whole, rather than the value of the shareholder's shares when valued alone. MBCA § 13.01 official cmt. 2. The MBCA has long been the source of Colorado's corporate law, including the dissenters' rights statute. Colorado's first dissenters' rights statute was enacted in 1941 and has undergone numerous revisions since that time. Ch. 109, sec. 5, Ch. 41, § 57(5), 1941 Colo. Sess. Laws 344, 347. Since 1958, when Colorado adopted the first Model Business Corporation Act, the corporate code of this state has been largely modeled after the amendments and revisions to the Model Act. See Nancy A. Clodfelter et. al., An Overview of the New Colorado Business Corporation Act, 22 Colo. Law. 2337 (1993) (noting that Colorado has been a Model Act state since the enactment of the first Model act by the General Assembly in 1958). [16] In 1984, the Revised Model Business Corporation Act was published. The General Assembly followed suit in 1993 by repealing the entire Corporate Code and enacting, in large part, the 1984 Act. See Ch. 191, § 7-101-101 to § 7-117-105, 1993 Colo. Sess. Laws 732-853. The current version of Colorado's dissenters' rights statute, although amended in 1996, remains substantially the same as the 1984 Model Act. The most important part of the statute for the purpose of this case, the definition of fair value, is nearly identical to the definition found in the 1984 Model Act. Holding Company argues that because the General Assembly has not adopted the 1999 MBCA amendments we should infer that it has rejected them. We are not persuaded. It has been less than four years since the MBCA was amended, too short a period of time to infer intent from legislative inaction. [17] Because the legislature has consistently relied on the MBCA when fashioning the corporate laws of this state we find the views of the MBCA on this issue to be persuasive. See Offenbecher, ___ So.2d at ___, 2002 WL 959833 at ; Blitch, 540 S.E.2d at 670; Matthew G. Norton Co., 51 P.3d at 164 (in each of these cases, although the dissenters' rights statute was based on the 1984 MBCA and the state legislature had not yet adopted the 1999 amendments to the MBCA, the court nonetheless considered the 1999 MBCA amendments persuasive on the issue of whether to allow discounts in determining fair value); see also Copper Mountain Inc. v. Poma of America, Inc., 890 P.2d 100 (Colo.1995) (noting that the intent of the authors of a model act which has been adopted in Colorado will be presumed to be the same as the intent of the General Assembly).
Finally, we are persuaded by the recommendations of the American Law Institute regarding the interpretation of fair value. The ALI has endorsed the national trend of interpreting fair value as the proportionate share of a going concern without any discount for minority status or, absent extraordinary circumstances, lack of marketability. A.L.I., Principles of Corporate Governance: Analysis and Recommendations § 7.22(a) (1994). To determine fair value, the trial court must determine the aggregate value for the firm as an entity, and then simply allocate that value pro rata in accordance with the shareholders' percentage ownership. A.L.I. § 7.22 cmt. d. The court of appeals explicitly adopted the ALI's definition of fair value, including the exception for extraordinary circumstances. The extraordinary circumstances exception is very limited and is intended to apply only when the trial court finds that the dissenting shareholder has held out in order to exploit the transaction giving rise to appraisal so as to divert value to itself that could not be made available proportionately to other shareholders. A.L.I. § 7.22 cmt. e. In effect, the exception is intended to leave room for trial courts to exercise their equitable powers in certain extraordinary circumstances to ensure that a fair and just result is reached. The court of appeals concluded, as a matter of law, that the facts of this case did not constitute an extraordinary circumstance. We believe the court of appeals erred in explicitly adopting the ALI interpretation of fair value. The precise issue for our review is whether a marketability discount may be applied in ascertaining fair value. We hold that fair value, for the purpose of the dissenters' rights statute, means the shareholder's proportionate ownership interest in the value of the corporation and therefore, it is inappropriate to apply a marketability discount at the shareholder level. Because the issue is not squarely before us, we do not decide the question of whether there may be an equitable exception to this rule, such as the ALI extraordinary circumstance exception, which would allow a trial court to apply a marketability discount under certain circumstances. [18]