IS YOUR EXPERT RIGHT? Fair Market Value or Fair Value?

Most recently we were working on a high profile litigated case and the Plaintiff (one of four shareholders in a New Jersey C-Corporation) was suing for a breach of fiduciary duty and shareholder oppression.  We were working for the Defendant and assisting in rebutting the Plaintiff’s expert.  Upon receipt of the Plaintiff’s expert report, we quickly observed that the Plaintiff’s expert was applying a discount for lack of marketability, a discount for lack of control, a discount for key-man risk and additional discounts for client concentration risk.  The overall discount was just shy of 47% and this discount was applied to the Plaintiff’s shareholder interest.  Upon receipt of the report, it became clear to us that the Plaintiff’s expert was unaware of the New Jersey rules related to the calculation of value in fiduciary duty and shareholder oppression cases.  When the Defendant received the valuation report from the Plaintiff, and noticed the substantial discount, she was pleased with the number but continued to push for an additional 15% reduction in price and the case settled.  To all Parties this seemed like a great outcome.  However, what the Plaintiff’s expert missed here is that in New Jersey (and most other states) the court does not ‘typically’ allow for discounts like marketability and control.  Considering this, it is my opinion that the Plaintiff received a value probably about 40% lower than it should have been.  For all my attorney friends and colleagues taking on fiduciary duty cases, shareholder oppression, or matrimonial cases – PLEASE MAKE SURE YOUR EXPERT HAS THE RIGHT STANDARD OF VALUE OR YOUR CLIENT CAN BE MATERIALLY IMPACTED.  I provide below some thoughts and observations about the standard that you should be aware of.

Fair Value versus Fair Market Value

Fair Value (FV) is the Standard of Value in cases of dissenting and oppressed shareholders and marital dissolution valuation. In 1972, the New Jersey Legislature amended N.J.S.A. 14A:12-7 to enable minority shareholders to protect themselves from oppressive majority shareholders in closely-held corporations. The statute, amended again in 1988, provides for substantial relief beyond dissolution and the courts have interpreted the statute since then liberally and expanded the remedies available.[1]

The question that valuation experts face is the difference between Fair Market Value (FMV) and FV. FMV is defined by the IRS in Revenue Ruling 59-60 as,

The price at which the property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.

The integral component of FMV is that it is the market’s determination of value which is in contrast to FV. It is our view that there is a substantial difference in calculating FV (in cases of dissent, oppression, and marital dissolution) and FMV. It is our position here to define and illustrate these differences.

In most states, FV is the statutory Standard of Value applicable in cases of dissenting and oppressed shareholders’ appraisal rights. In these states, such as New Jersey, if a corporation merges, sells out, or takes certain other major actions and the minority shareholder believes that it is being forced to receive less than adequate consideration for its stock, it has the right to have her shares appraised and to receive FV. There is no clearly recognized consensus about the definition of FV in this context; but precedents established in the courts of most states certainly have not equated it to FMV.[2] The New Jersey Oppressed Shareholder Statute specifies FV, (N.J.S.A. 14A:12-7 et seq.)

Provides equitable relief in the form of buy-out punitive damages; attorney fees’, and sometimes dissolution. In addition it states that the purchase price of any shares so sold shall be their fair value as of the date of the commencement of the action or such earlier or later date deemed equitable by the court, plus or minus any adjustments deemed equitable by the court.[3]

In determination of FV, selling shareholders may indeed receive more than the FV of its shares. N.J.S.A. 14A:12-7(8)(f) expressly provides that selling shareholders are entitled to receive the FV of their shares as well as whatever other amounts may be awarded by the Court. A court of equity therefore may uphold other contractual arrangements between the shareholders or between the selling shareholder and the corporation. Marketability and minority discounts generally should not be applied when determining the FV of a dissenter’s shares in an appraisal action. There are certain exceptions which as per the American Law Institutes’ (ALI) 1992 definition of FV can be explained,

The value of the eligible holder’s proportionate interest in the corporation, without any discount for minority status or, absent extraordinary circumstances, lack of marketability.[4]

Extraordinary circumstances exist when a court finds that a dissenting or oppressed shareholder is trying to exploit a transaction to divert value that could not be made available proportionately to other shareholders. The Lawson and the Balsamides cases (described below) are defined by the guiding principle that a marketability discount cannot be used unfairly by the controlling or oppressing shareholders to the detriment of the minority or oppressed shareholders. Equitable considerations generally state that minority discounts should not be applied in determining the FV of a minority shareholder’s stock when the corporation or the majority stockholders elect or are compelled to purchase the minority interests. This is based upon the rationale that when a party already in control purchases a minority’s shares, it is irrelevant that the shares represent a noncontrolling interest. [5]

While much of the focus has been surrounding corporations, partnerships in New Jersey also adhere to the FV standard in buyouts. Buyouts occur when a partner is disassociated from a partnership and the entity remains operating. Disassociation may occur for a variety of reasons, such as breach of fiduciary duties, other members of the partnership voted out unanimously the leaving partner, or if it is unlawful to continue the partnership with a particular partner. As of the date of the partner’s withdrawal, the buyout price is the FV based on the right to share in distributions from the partnership unless the operating agreement contains a formula for the price. If economic damages are awarded for wrongful dissociation, the award is offset against the buyout price. With that said, for partnerships, as contrasted with corporations, in many states the buyout provision applies not only for matters akin to dissent and oppression, but for retirement or any other reason a partner may dissociate from the partnership.[6]

The 2013 New Jersey Revised Statutes (Title 42, Partnerships and Partnership Associations) clearly equates buyout price with FV,

Except as otherwise provided in the partnership agreement, the partnership shall cause the dissociated partner’s interest in the partnership to be purchased for a buyout price as determined pursuant to… buyout price means the fair value as of the date of withdrawal based upon the right to share in the distributions from the partnership unless the partnership agreement provides for another fair value formula.[7

By following the FV standard in New Jersey for valuations, the courts dissuade actions such as controlling shareholders pushing out non-controlling shareholders, or non-controlling shareholders from filing lawsuits against controlling shareholders to get an increase in value for their minority (and non-marketable for private companies) interests. In addition, by following the ALI’s definition, New Jersey courts are able to permit marketability and or control discounts if uncommon facts persist. The extraordinary circumstance exception to the FV standard in shareholder oppression cases is the direct result of two (2) New Jersey Supreme Court’s rulings in 1999.

While we do not attempt to practice law, the following are a handful of cases in which New Jersey courts awarded or did not award appraisal discounts:

Balsamides v. Protameen Chemicals, Inc. – In this case the oppressed Emanuel Balsamides, Sr. (Balsamides) and oppressor Leonard M. Pearle (Perle), each owned 50.0% ownership in Protameen Chemicals, Inc. (Protameen) and had been in business together for twenty five (25) years. A series of spiteful and abusive actions by Perle against Balsamides led the oppressed to petition the court for dissolution of Protameen, pursuant to N.J.S.A. 14A: 12-7. The court ordered Perle to sell his shares to Balsamides, and deemed there were unusual circumstances surrounding the case because the oppressed was purchasing the oppressor’s shares. Accordingly, to the disadvantage of Perle and to the benefit of Balsamides a marketability discount was applied. Since Perle was the oppressor, had the FV standard been permitted, Balsamides would have paid more for Perle’s interest, which the court ruled was unfair.[8]

Lawson Mardon Wheaton, Inc. v. Smith – On the exact same day the New Jersey Supreme Court ruled on Balsamides v. Protameen Chemicals, Inc., it also ruled on the dissenting shareholder case, Lawson Mardon Wheaton, Inc. v. Smith. In this case the family owned multinational was attempting a corporate restructuring by creating a dual-class stock arrangement. To do this, the outstanding Company shares were to be purchased at FV. However the Company’s valuation expert applied a 25.0% marketability discount to the dissenting shareholders’ shares. 15.0% of Wheaton’s shareholders dissented by rejecting the value offered for their shares by its board of directors. The Supreme Court made its ruling, citing the ALI Principles of Corporate Governance, that only under uncommon times may marketability or control discounts be applied. Given the circumstances it was ruled that a corporate restructuring was in fact common, and not extraordinary, for businesses and therefore neither marketability nor control discounts were warranted for their interests.[9]

Wisniewski v. Walsh – Most recently in New Jersey a shareholder oppression case ongoing for nearly twenty (20) years epitomized the extraordinary circumstance whereby the Superior Court allowed a marketability discount. In Wisniewski v. Walsh, three (3) siblings owned equal shares in a family trucking business. One (1) of the shareholders filed suit against the other two (2), claiming shareholder oppression, but the trial court found the plaintiff to actually be the oppressor. Using its equitable authority, the trial court forced the oppressor to sell his interest at FV. The trial and appeals courts both determined that that the circumstances were uncommon because the selling, minority, and oppressing shareholder was forcing the buyout, and therefore it should not benefit at the expense of the oppressed by receiving a undiscounted valuation. The use of a marketability discount was consequently permitted. In addition, the Discounted Cash Flow analysis that was complete already yielded a control value and so no premium was further added[10]

Brown v. Brown – In marital dissolution cases New Jersey courts using the FV standard have also applied the extraordinary circumstance condition to value a minority business interest. A husband owned 47.5% in his family’s wholesale florist business, and was facing a divorce from his wife. The husband’s valuation expert applied minority and marketability discounts, while the wife’s valuation expert applied neither. Since the divorce and its proceedings were neither unique nor unusual, the appellate court held that discounts should not be applied to the husband’s interest in the floral business. The court in its ruling states,

Given the purpose of equitable distribution to fairly divide the accumulated wealth of a marital partnership, and that the purpose of valuing the shareholder spouse’s interest is to determine the non-owner spouse’s fair share of other marital assets; where the shareholder will retain his shares and the divorce will not trigger a sale of those shares, lack of liquidity does not affect the fair value of the minority interest. Neither discount is appropriate.[11]

Casey v. Amboy Bancorporation – In Casey v. Amboy Bancorporation, the New Jersey court found no evidence of an extraordinary case. In this case, dissenting shareholders sought a judicial valuation for their shares when the company was attempting to convert from a C to an S corporation. Marketability and control discounts were not utilized, as the court deemed that the circumstances surrounding this case (a restructuring) were normal.[12]

In Balsamides, the oppressor was ordered to sell his share to the oppressed shareholder. The New Jersey Supreme Court found that marketability and control discounts applied, because when the oppressed shareholder eventually sold all the shares of the corporation, it would suffer the full effect of any marketing difficulties.

The Supreme Court decisions in Balsamides and Lawson Mardon Wheaton, Inc. v. Smith leave the question of whether there is universal application of a marketability and control discount open ended. In the Lawson case, the Supreme Court found that there were no extraordinary circumstances warranting the application of a marketability discount. With respect to the Brown case, the Court cites with approval, the ALI’s analysis of the FV concept stating,

“The ALI’s rationale for the fair value, no discount rule, a rationale adopted in Lawson and Balsamides, is that neither the dissenting (minority) shareholder, nor the oppressive (majority) shareholder, nor a veto-welding (50%) shareholder, can be allowed to exploit the very situation that triggered the right to an appraisal, thereby capturing more than a proportionate share of the corporation’s value and depriving other shareholders to their fair share.”[13]

In conclusion, we believe that the Standard of Value in the state of New Jersey is FV with respect to partner, shareholder oppression dissolution/dissociation, and marital dissolution. The calculation of FV should be applied without any discounts for marketability and control except in “extraordinary circumstances.”  While ambiguities remain in the definition of FV, we can with certainty define FV as not synonymous with FMV. In addition, marketability and minority discounts are more of an exception than a norm. The court generally will not permit the oppressor to exploit any discounts to his or her advantage.

[1] SOURCE – “New Jersey Business Litigation,” Paul A. Rowe, 2006, pp. 57-80.

[2] SOURCE – “The Opinion of the College on Defining Standards of Value,” Shannon P. Pratt, FASA June 1989, pp. 7-8.

[3] SOURCE – NJ Rev Stat § 14A:12-7 (2013).

[4] SOURCE – American Law Institute, Principles of Corporate Governance, at § 7.22

[5] SOURCE – “New Jersey Business Litigation,” Paul A. Rowe, 2006, pp. 70-81.

[6] SOURCE – “Standards of Value for Partnership and Limited Liability Company Buyouts,” Jay E. Fishman, Shannon P. Pratt, and William J. Morrison, October 15, 2015, pp. 195 – 230.

[7] SOURCE – New Jersey, § 42:1A-34

[8] SOURCE – Balsamides v. Protameen Chemicals, Inc., 160 N.J. 352, 734 A.2d 721 (N.J. 1999).

[9] SOURCE – Rich, Michael L. (2008). “Fair Value’ and Discounting in N.J. Shareholder Oppression Case,” New Jersey Law Journal.

[10] SOURCE – “Wisniewski v. Walsh,” (http://www.meislik.com/cases/wisniewski_v_walsh/), March 23, 2004.

[11] SOURCE -Brown v. Brown, 348 N.J. Super. 466, 792 A.2d 463 (2002).

[12] SOURCE – “Understanding the Court’s Treatment of Synergistic Value Arising from Transactional Disputes,” July/August 2013, Kevin P.Carey, CFA, (http://www.willamette.com/pubs/presentations2/carey_synergistic_value_article.pdf).

[13] SOURCE – “Standards of Value for Partnership and Limited Liability Company Buyouts,” Jay E. Fishman, Shannon P. Pratt, and William J. Morrison, October 15, 2015, p. 79.