Valuation of Minority Shareholder Interests In Oppression, Fiduciary Duty, And Contract Cases

Yesterday afternoon, the defendants in my trial dumped a twenty-one page brief on me, requesting the Court preclude our business valuation expert from testifying, arguing that we had “a bogus valuation expert” whose “report is a sham” describing a “topsy-turvy world” in support of “Plaintiff’s belief that he can obtain a windfall through a whimsical and inflated valuation of this business” — and that was all just in the introduction.

It seems somebody needs to read #4 on my advice for litigators.

Naturally, within less than a day I filed a detailed response, explaining why our expert was fine, and why the appropriate valuation of a minority shareholder interest in a company where the shares aren’t regularly traded is “the shareholder’s proportionate interest in the company as a whole valued as a going concern according to accepted business practices.” As a service to any other plaintiff’s lawyers out there in a similar case, I leave you with an edited excerpt from my brief.

In Pennsylvania, business damages ‘need not be proved with mathematical certainty, but only with reasonable certainty, and evidence of damages may consist of probabilities and inferences.’ Hawthorne v. Dravo Corp., Keystone Division, 352 Pa. Super. 359, 376, 508 A.2d 298, 307 (1986), appeal denied, 514 Pa. 617, 521 A.2d 932 (1987); Delahanty v. First Pennsylvania Bank N.A., 318 Pa. Super. 90, 119, 464 A.2d 1243, 1257 (1983). ‘Thus, the law does not demand that the estimation of damages be completely free of all elements of speculation[,]‘ Delahanty, 318 Pa. Super. at 118, 464 A.2d at 1257, and the fact-finder ‘may use a measure of speculation in estimating damages.’ Penn Electric Supply Co. Inc. v. Billows Electric Supply Co. Inc., 364 Pa. Super. 544, 549, 528 A.2d 643, 645 (1987). Any doubt or uncertainty as to the precise amount of damages is construed against the breaching party or wrongdoer. Atacs Corp. v. Trans World Communications Inc., 155 F.3d 659, 669 (3d Cir. 1998) (citing Delahanty and applying Pennsylvania law).

Pennsylvania law plainly provides that shareholders forced or frozen out of their interests are entitled to that “fair value” of their interests. This “fair value” approach is consistent with breach of fiduciary duty precedent (i.e., Viener v. Jacobs, 2003 PA Super 324, 834 A.2d 546 (Pa. Super. Ct. 2003)) and with the dissenters’ rights provisions of the Pennsylvania Business Corporations Law (“BCL”) that plainly entitles dissenting shareholders to “payment the fair value of [their] shares.” 15 Pa.C.S. § 1571–1580. The BCL includes similar provisions for limited partnerships and for LLCs.

Across the United States, the overwhelming majority rule regarding the “fair value” of minority interests in private companies derives from this analysis by the Delaware Supreme Court: 

 [T]he [trial court’s] task here was to value what has been taken from the shareholder: viz. his proportionate interest in a going concern. To this end the company must be first valued as an operating entity by application of traditional value factors, weighted as required, but without regard to post-merger events or other possible business combinations. The dissenting shareholder’s proportionate interest is determined only after the company as an entity has been valued. In that determination 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.

The application of a discount to a minority shareholder is contrary to the requirement that the company be viewed as a ‘going concern.‘ Cavalier’s argument, that the only way Harnett would have received value for his 1.5% stock interest was to sell his stock, subject to market treatment of its minority status, misperceives the nature of the appraisal remedy. Where there is no objective market data available, the 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 Oil Corp. v. Harnett, 564 A.2d 1137, 1144–1145 (Del. 1989)(citations omitted, emphasis added). Since Cavalier Oil, “the vast majority of states to consider the appraisal remedy for ousted minority shareholders have likewise held that ‘fair value’ in this context means the shareholder’s proportionate interest in the company as a whole valued as a going concern according to accepted business practices.Shawnee Telecom Res., Inc. v. Brown, 354 S.W.3d 542, 555 (Ky. 2011). In this case, such an analysis would be quite simple: Plaintiff is entitled to one-third of the value of the business as a going concern. The jury should be given testimony on the ongoing value of the business as a whole and then be asked to provide that number in their verdict, with the instruction that Plaintiff’s damages will be one-third of that amount.

Further, the value of the company of a whole obviously includes no discounts for “minority” interests, and so, “Since Cavalier Oil, the split in authority has narrowed, with most courts following this seminal case. The vast majority of courts have determined that a minority discount should not be applied to determine fair value of a minority shareholder’s interest.” Brown v. Arp & Hammond Hardware Co., 2006 WY 107, 141 P.3d 673, 8 (Wyo. 2006).

No Pennsylvania court has directly opined on Cavalier Oil, although prior to Cavalier Oil Pennsylvania appellate courts had frequently relied on the “Supreme Court of Delaware, known for its expertise in these matters.” In re Glosser Bros., 382 Pa. Super. 177, 186, 555 A.2d 129, 134 (1989). In the past the Pennsylvania Superior Court has expressly looked first to the Delaware Supreme Court where they “[did] not find any Pennsylvania cases addressing this situation” in corporate law. Barter v. Diodoardo, 2001 PA Super 105, 771 A.2d 835 (Pa. Super. Ct. 2001); but see First Union Nat’l Bank v. Quality Carriers Inc., 48 Pa. D. & C.4th 1  (Philadelphia 2000)(Sheppard, J., “it is important to note that no Pennsylvania case specifically states that Delaware corporate law is accorded special weight.”).

Lacking any precedent one way or the other in Pennsylvania, Plaintiff urges this Court to look to Delaware for this issue of corporate law and to look to New Jersey, which is also in accord. Lawson Mardon Wheaton v. Smith, 160 N.J. 383, 402, 734 A.2d 738, 749 (1999)(“We find most persuasive those cases holding that marketability discounts should not be applied in determining the ‘fair value’ of a dissenting shareholder’s share in an appraisal action.”). Legal scholars, too, have concluded that the Cavalier Oil approach is the appropriate approach for valuing minority shareholder interests. See, e.g., Moll, Douglas K., Shareholder Oppression & ‘Fair Value’: Of Discounts, Dates, and Dastardly Deeds in the Close Corporation, 54 Duke L.J. 293 (“This Article builds a case for defining fair value as enterprise value in the shareholder oppression context. The Article argues, in other words, that the buyout remedy should provide an oppressed minority investor with his pro rata share of the company’s overall value, with no reductions (or ‘discounts’) for the lack of control or liquidity associated with the minority’s shares.”)

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  • RichNewsome

    Nothing worse than getting blindsided with a massive brief during the middle of trial on a core issue in the case like damages… With a 21 page memo you know damn well they were waiting in the weeds with this. No surprise, but sounds like you came back at them with soundly briefed argument.

    Best of luck with the trial Max, hope you get a great verdict for your client!