Minority Shareholder Rights: The Challenge to Selling Shares and Solutions to Receiving Fair Value

 
While close corporations begin as friendly ventures, the balance of power often lends itself to oppression of those shareholders who do not control the corporation and usually own only a small percentage of shares, i.e. the minority shareholders.

When minority shareholders in a large publicly traded corporation become dissatisfied with corporate operations, they can sell their shares and thus discontinue their involvement with the corporation. Minority shareholders in the closely held corporation, on the other hand, often cannot easily sell their shares.

Although Minority shareholders in any corporation are in a difficult position due to their lack of control, the Revised Model Business Corporation Act – adopted by every state – allows shareholders who dissent from certain fundamental corporate transactions to compel the corporation to purchase their shares. These transactions include mergers, consolidations, or asset transfers.

The dissenters remedy, “dissenters shareholders appraisal right”, is a method a minority shareholder may use to mitigate an injustice caused by a fundamental corporate change. This statutory remedy provides shareholders with the right to dissent from certain corporate activity and to obtain payment for their shares directly from the corporation.

When the corporation receives a demand from the dissenting shareholder, the corporation must pay the dissenter shareholder the amount the corporation considers to be the fair value of the shares as soon as the shareholder surrenders their shares. The corporation is required to provide the shareholder the financial statements and an explanation of how the corporation ascertained the fair value.

If the dissenting shareholder is dissatisfied with the corporations’ computation of fair value, a judicial proceeding commences (“judicial appraisal”) to determine the fair value of the shares. The courts generally appoint a qualified appraiser to ascertain the fair value.

The dissenting shareholder has the best of both worlds – they get their money immediately and if they insist on a judicial appraisal, the cost is borne by the corporation.

Additionally, case law works in the favor of the shareholder
Most states define fair value available in appraisal to exclude any appreciation or depreciation attributable to the transaction. This definition makes sense when you consider that the majority wants to change the direction of the business, the minority objects and corporate law provides the dissenter with a chance to exit. If the minority chooses not to go with the new enterprise in the new direction, the minority has no claim to value brought by the transaction.

Most states have looked to Delaware Courts for guidance is defining “fair value”. The Delaware Supreme court defined fair value as “the amount the stockholder is entitled to be paid for that which has been taken from him, viz., his proportionate interest in a going concern.”

In the appraisal context, a clear majority of courts have ruled that it would be inappropriate to apply a minority discount. Modern courts recognize that only by excluding a minority interest discount can minority shareholders be assured of receiving their proportionate fair value.

FWIW - Summer 2003

FWIW is intended to inform readers of developments in the field of valuation. The articles written may, or may not, reflect the opinion of the authors. Please note, any advice contained in this publication was not intended, or written, to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. This publication is distributed with the understanding that the publisher and distributor are not providing legal, accounting or other professional advice and assume no liability whatsoever in conjunction with the information contained within this publication.