Statutory “fair value” is the standard of value for valuation in the dissenters’ rights and shareholder oppression statutes of the majority of states. I have testified on the fair value of equity interests at deposition and/or trial in about 15 states over the last 30-plus years. I speak as a business appraiser and a business man. I have no legal opinions.
While I testify as a business appraiser, it is necessary for appraisers to have some knowledge of relevant statutory fair value case law if working on an assignment in a particular jurisdiction.
At the outset of this series of posts on statutory fair value, let me be clear: I am agnostic with respect to what fair value should be in any particular state. That is a matter of statutory decision-making and judicial interpretation. As a business appraiser, what I hope is that the collective (statutory and judicial) definitions of fair value are clear and able to be expressed in the context of valuation theory and practice.
In my experience, disagreements over the applicability (or not) of certain valuation premiums or discounts provide the source of significant differences of opinion between counsel for dissenting shareholders and companies and, unfortunately, between business appraisers. Because fair value is ultimately a legal concept, appraisers should consult with counsel regarding their counsel’s interpretation of fair value in each jurisdiction.
Statutory Fair Value Defined in Delaware
About half of all public companies in the United States are domiciled in Delaware — in large part because of favorable corporation laws and the responsiveness of the Delaware Court of Chancery. As we begin our discussion of fair value, we look at the statutory definition in Delaware. Fair value is defined in Delaware Code Annotated Section 262(h) as (with parenthetical numbers and emphasis added):
After the Court determines the stockholders entitled to an appraisal, the appraisal proceeding shall be conducted in accordance with the rules of the Court of Chancery, including any rules specifically governing appraisal proceedings. Through such proceeding (1) the Court shall determine the fair value of the shares (2) exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation, together with interest, if any, to be paid upon the amount determined to be the fair value. (3) In determining such fair value, the Court shall take into account all relevant factors…
From this statutory definition, we know that the Court of Chancery in Delaware will determine fair value according to its rules. We know that fair value shall be determined “exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation.” Finally, we know that “the Court shall take into account all relevant factors” in fair value determinations in Delaware.
As a business appraiser, the first thing I see is that fair value in Delaware is a concept that does not give benefit to potential value arising from statutory mergers or combinations for affected shareholders. Appraisers would need further guidance from counsel in order to assure that their fair value determinations meet the requirements of fair value as defined.
The next thing to note is that the Court will consider “all relevant factors.” In business appraisal, we typically consider “all relevant factors” that influence a valuation situation. The language is familiar. Revenue Ruling 59-60 at Section 4.01 states (emphasis added):
It is advisable to emphasize that in the valuation of the stock of closely held corporations or the stock of corporations where market quotations are either lacking or too scarce to be recognized, all available financial data, as well as all relevant factors affecting the fair market value, should be considered. The following factors, although not all-inclusive are fundamental and require careful analysis in each case:
Section 4.01 goes on to list eight well-known factors that should be considered in fair market value determinations, including the nature of the business, its history and outlook, and its earning capacity.
There is a difference, however, in the words “all relevant factors” in the Delaware definition of fair value and the same words in the definition of fair market value. In the context of fair market value, all of the relevant factors pertain to the valuation subject and its industry and the entire valuation context. In the Delaware definition, “all relevant factors” can include factors not pertaining to the valuation itself, like concepts of fairness and equity.
This fact, and the fact that courts in other states that adjudicate statutory fair value matters are also courts of equity, can create sometimes confusing issues for counsel for dissenting shareholders, for counsel for companies, and for the various courts themselves. We will discuss this issue in more depth below.
Fair Market Value is a Willing Buyer and Willing Seller Concept
Fair market value is an objective, arms’ length standard of value and is defined in Section 2.02 of Revenue Ruling 59-50. The parties are hypothetical, willingly negotiate, are independent of each other, have reasonable knowledge of the facts of an investment, are under no compulsion to transact, and have the financial capacity to engage in hypothetical transactions.
The emphasis in the definition of fair market value is on hypothetical willing buyers and willing sellers. These hypothetical parties negotiate in good faith with their own best interests at heart. Both parties are at least reasonably informed about the facts regarding the company being valued, and neither is under any compulsion to engage in a transaction. Nevertheless, the parties do engage in hypothetical negotiations in light of the facts and circumstances, until their interests intersect in a hypothetical price, at which a hypothetical transaction occurs.
Buyers are interested in buying at a price that reasonably recognizes the facts of the situation, and sellers are interested in selling in the hypothetical world of fair market value.
The standard of fair market value is mentioned here because it is referenced (albeit indirectly) in the statutory definition of fair value in Delaware. It is also the most widely used and best-understood standard of value employed by business appraisers.
Fair Value is a Willing Buyer and Unwilling Seller Concept
The statutory right to dissent arises in a number of situations involving sales, consolidations, recapitalizations or other actions on the part of controllers of corporations that affect minority owners. Fair value is also the statutory standard of value in cases of shareholder oppression in many states.
Take the fairly common cases of a squeeze-out merger or a reverse stock split. The effect of either transaction is to attempt to force minority shareholders to receive the consideration offered by the controllers. If the right to dissent is triggered, affected owners can dissent to the transaction and petition the courts in their states to determine the fair value of their shares.
Fair market value is an objective standard of value. Fair value, on the other hand, is an equitable standard. “Equitable” is defined in (Black’s on-line) Law Dictionary as:
Just; conformable to the principles of natural justice and right. Just, fair, and right, in consideration of the facts and circumstances of the individual case. Existing in equity; available or sustainable only in equity, or only upon the rules and principles of equity.
Equity courts began with petitions to the Lord Chancellor of England. Equity courts “handled lawsuits and petitions requesting remedies other than damages, such as writs, injunctions, and specific performance.” Most were eventually “merged with courts of law.” (dictionary.law.com | “Court of Equity” definition)
United States bankruptcy courts are the one example of federal courts which operate as courts of equity. Some common law jurisdictions–such as the U.S. states of Delaware, Mississippi, New Jersey, South Carolina, and Tennessee–preserve the distinctions between law and equity and between courts of law and courts of equity.
Fair Market Value, Equity Value, and Equity Courts
The point of this seeming diversion to talk about fair market value, equity and courts of equity is to illustrate that there is potential tension between objective valuation standards and the standard of fair value as it might be interpreted based on equitable considerations by a court in a particular jurisdiction.
As a business appraiser, I can provide objective valuation evidence to a court in a fair value proceeding.
As a business appraiser, I cannot consider equitable issues in providing valuation evidence unless instructed by a court.
We will see that fair value is intertwined with concepts of fair market value and equity, which can be highly confusing for participants in fair value proceedings and for business appraisers as well.
As a business appraisal expert, Delaware’s statutory definition of fair value provides little effective guidance as to what kind of value fair value should be. Delaware is a state with a rich history of cases involving fair value determinations. Delaware’s judicial guidance, as we will see later in this series, can be somewhat confusing when viewed through the objective lenses of fair market value and valuation and finance theory. This observation can be true in many states.
Statutory fair value is a fascinating subject to me. It has many different nuances in the various states across our nation. Based on my experiences testifying in statutory fair value matters beginning in 1981 and continuing to the present, the subject is almost always controversial from the perspective of valuation.
This series will continue for some time as we delve into the meaning of statutory fair value in general and under the laws and judicial guidance of a number of states – all written from my perspective as a business appraiser and a businessman.
Please do comment here or contact me directly.
In the meantime, be well!