In my book, Buy-Sell Agreements for Closely Held and Family Business Owners, I wrote the following:

I often use the term “words on the page.”  Appraisers retained pursuant to the operation of buy-sell agreements are normally bound to prepare their calculations in accordance with the kind of value described or defined with the agreements.  In other words, the “words on the page” will determine the kind of value to be developed in the appraisal…

The Indiana Supreme Court affirmed the importance of the “words on the pages” of buy-sell agreements pertaining to the kind of value called for by the parties to those agreements.  The decision was filed on January 28, 2021, so Blake B. Hartman v. BigInch Fabricators & Construction Holding Company, Inc. is hot off the press. We will use ‘Hartman” (appellant) and “BigInch” or “the Company” (appellee) to denote the parties.

Brief Background

Hartman is a former officer of BigInch and was involuntarily terminated in 2018.  This termination triggered the buyout provision of the Company’s shareholder agreement, which had been signed by all the shareholders in 2006.  Pursuant to the shareholder agreement, BigInch hired an independent appraisal firm to determine the “appraised market value” of Hartman’s shares. BigInch retained Paul Wonch of Wonch Valuation Advisors to appraise Hartman’s interest.  In performing the appraisal, Wonch applied the fair market value standard of value and discounted the shares for lack of marketability and lack of control.

Hartman sued BigInch arguing that in a forced buyout, valuation discounts should not apply. The trial court ruled in BigInch’s favor, determining that “market value” as called for in the agreement and “fair market value” were synonymous terms, and that both were consistent with the appraiser’s approach to the appraisal.

Hartman appealed.  The Court of Appeals reversed the trial court, concluding that valuation discounts could not apply in a closed-market sale.

BigInch petitioned to be heard by the Indiana Supreme Court.  The case was argued on December 20, 2020 and decided January 28, 2021, so it was on a fast track.

The Decision was Clear at the Beginning

Chief Justice Rush wrote the opinion, which began with three short paragraphs that signaled the Supreme Court’s decision:

The value of corporate shares may not correspond proportionally to the company’s overall value. Shares are usually valued less if they represent a non-controlling interest or if they are not publicly traded. When valuing such shares, an appraiser will often account for this reality by applying “minority” and “marketability” discounts.

Here, when tasked with valuing shares, an appraiser applied these discounts, even though the shares would be sold in a compulsory, closed-market sale. The selling shareholder takes issue with the valuation, arguing that minority and marketability discounts are open-market concepts inapplicable to the buyback provision of his shareholder agreement with the company.

While we recognize the public policy rationale underlying the shareholder’s position, we hold that the parties’ freedom to contract may permit these discounts, even for shares in a closed-market transaction. And under the plain language of this shareholder agreement—which calls for the “appraised market value” of the shares—the discounts apply.

Hartman attempted to argue, effectively, that the fair value standard of value should apply in the event of forced buy-outs and that valuation discounts should not apply.  The Court’s decision made a clear distinction between cases that interpret a statute, as in the cited fair value cases, and those that interpret a contract.  The shareholder agreement clearly called for the valuation of Hartman’s shares to be their “appraised market value,” and not their “fair value.”

The Court cited an Indiana Court of Appeals decision, indicating that when parties “stipulate to a valuation method in a purchase agreement,” a court “will not rewrite an explicit agreement.”

The “Words on the Page”

The shareholder agreement specified that the “price per share” for the mandatory buyout

“…shall be the appraised market value on the last day of the year preceding the valuation, determined in accordance with generally accepted accounting principles by a third party valuation company within the twenty-four months immediately preceding the transfer of shares.” (emphasis added)

Cutting to the chase, the Court concluded that the buyback clause through its plain language called for a standard identical to “fair market value,” which, in turn, contemplates consideration of relevant valuation discounts.  The Court interpreted the language to refer specifically to Hartman’s individual interest and not to the value of the business as a whole. This issue, by the way, of unclear language regarding the valuation of a company or an interest in it, is one of the most frequent causes of valuation disputes with buy-sell agreements.

While the actual valuation was not discussed in the decision, the Court’s opinion made it clear that Wonch’s interpretation of the fair market value standard was deemed reasonable.

Implications for Shareholder Agreements

As I have said for years, it is important for owners of businesses who enter into shareholder agreements (or operating agreements or limited partnership agreements) understand the implication of their buy-sell provisions.

I’ve been saying this for years in my writing and speaking.  The Indiana Supreme Court’s decision in Hartman v. BigInch just adds an exclamation mark to that advice.

That same advice applies to the many thousands of existing shareholder agreements.  Like in Hartman, most of the time, the parties do not know what their agreements say until a trigger event occurs.  And then it is too late to change things. My suggestion to all business owners is that they retain the services of their corporate attorney and a qualified independent appraiser to review, at a minimum, the buy-sell provisions of their agreements.  If there are issues, they can be addressed before a trigger event occurs.

Our  Buy-Sell Agreement Review Checklist (complimentary) will help in such reviews.

As will Buy-Sell Agreements for Closely Held and Family Business Owners, which is available for purchase.

Until next time, be safe and be well!

Chris