Shareholder Oppression & 'Fair Value': Of Discounts, Dates, and Dastardly Deeds in the Close Corporation

Abstract

The task of measuring value is a task of great importance in corporate law. Indeed, the need to determine the fair value of close corporation stock has arisen frequently in recent years. This frequency has coincided with the rise of the shareholder oppression doctrine - a doctrine that seeks to safeguard the close corporation minority investor from the improper exercise of majority control. Over the past few decades, a number of jurisdictions have authorized, either by statute or judicial decision, a buyout of an oppressed close corporation investor's stock at the fair value of the shares. When a minority investor establishes shareholder oppression, in other words, the question of fair value often takes center stage, as the remedy for oppression typically involves a court-ordered buyout of the minority's holdings at a judicially-determined fair value. For shareholders seeking to exit an oppressive situation, therefore, fair value is a concept of considerable significance.

But what does fair value mean? The question affects the lives of countless close corporation investors. Two conflicting approaches to the meaning of fair value have developed. The first approach equates fair value with fair market value. Under this position, a court values an oppressed minority's shares by considering what a hypothetical purchaser would pay for them. Because minority shares, by definition, lack control, a hypothetical purchaser is likely to pay less for minority shares than it would for shares that possess control (the minority discount). Moreover, because close corporation shares lack a ready market and are, as a consequence, difficult to liquidate, a hypothetical purchaser is likely to pay less for close corporation shares than it would for readily-traded public corporation shares (the marketability discount). Under the fair market value interpretation of fair value, therefore, minority and marketability discounts are appropriate. The second approach to the meaning of fair value defines fair value simply as a pro rata share of the company's overall value. Under this enterprise value approach, further discounting for the shares' lack of control and lack of liquidity is inappropriate. Because the combined effect of minority and marketability discounts can reduce the value of a pro rata stake in a company by 50% or more, the propriety of discounts and the related debate over the meaning of fair value are issues of critical importance to close corporation investors.

Just as oppressed investors are affected by the meaning of fair value in a buyout proceeding, so too are they affected by the choice of the valuation date. As mentioned, the remedy for shareholder oppression typically involves a buyout of the aggrieved investor's holdings at the fair value of the shares, but fair value as of when? The date of the oppressive conduct? The date of the filing of the oppression lawsuit? The date of trial? The date of judgment? In the age of Enron and internet ventures, it hardly needs to be said that a company's value can change dramatically in a relatively short period of time. Given how quickly a company's fortunes can change, the question of when to measure fair value is a critical inquiry in and of itself, as the choice of date can have a significant impact on the ultimate fair value conclusion.

This article grapples with the difficult valuation issues surrounding discounts and dates in the shareholder oppression context. The article methodically builds a case against discounts by using both conventional and novel arguments to support an enterprise value approach to fair value. In the course of constructing that case, the article challenges some of the traditional arguments that courts and commentators have routinely relied on (and still rely on) to reject discounts. By analyzing the shortcomings of those arguments, the article addresses the weaknesses of the case against discounts as well as the strengths. In addition, by discussing the importance of the valuation date and various factors that should affect its designation, this article adds to the fair value literature.

Keywords: Shareholder oppression, discount, minority discount, marketability discount, fair value, valuation date

JEL Classification: K22