Dissenters Rights Pt. 2 – Valuation
Last week, I covered the first part of the complex process of dissenters’ rights: learning what they are and who has them. This week covers the second part of the process: valuing an interest once an owner has dissented.
Procedure to Exercise Dissenter’s Rights
After a member of an LLC or shareholder of a corporation goes through the process of dissenting from a proposed merger (or other enumerated corporate action—see RCW 23B.13.020(1)(a)-(g)), the “Dissenter” becomes entitled to obtain payment for the “fair value” of their interest. RCW 25.15.471; RCW 23B.13.020(1). The Dissenter and the entity must then jump through certain statutory hoops to determine, and pay, fair value to the Dissenter.
If the parties cannot agree and the valuation dispute ends up in court, it is the court’s responsibility to determine the fair value of the Dissenter’s interest.
Fair Value vs. Fair Market Value
The language in dissenters’ rights statutes calling for a determination of fair value is significant in this area of law, but nevertheless is widely misunderstood by practitioners. Many practitioners take “fair value” to equate to “fair market value.” However, fair value and fair market value are two very different things.
The IRS defines fair market value as “[T]he 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.” IRS Revenue Ruling 59-60. This seems to comport with our general understanding of fair market value.
However, “fair market value” is not “fair value” in the context of a dissenter’s rights proceeding. Fair value in this context, means the value of an interest immediately before the effectuation of the merger (or other relevant corporate action) to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the merger unless exclusion would be inequitable. RCW 25.15.466(2); RCW 23B.13.010(3). Significantly, this definition omits any discussion of “market” language. However, it still does not tell us how to go about finding fair value.
In determining fair value, one thing is certain: a “minority” or “marketability” discount is not applied. Such discounts refer to the fact that an interest in an entity may be inherently worth less to a third party because the interest being sold is a minority interest, and therefore not a controlling interest. Minority interest holders may legally be “owners” of a business, but it does not mean the majority interest holders must listen to you. Washington courts have wholly rejected any attempt to consider such discounts in a determination of fair value for purposes of valuing a Dissenter’s interest. See generally Matthew G. Norton Co. v. Smyth, 112 Wn. App. 865, 51 P.3d 159 (2002).
The understanding that Washington courts reject minority discounts for purposes of valuing Dissenters’ interests is important within the context of figuring how to arrive at fair value. The Norton court discusses how fair value “is the proportionate share of the value of 100 percent of the equity in the company, without any discount for minority status, or, absent extraordinary circumstances, lack of marketability.” Id. at 877. This was made within the context of analyzing other case law from other jurisdictions, like Delaware and the Federal Court for the 8th Circuit.
Takeaways
Speaking as someone who deals with these issues on a regular basis, it is so easy to get “lost in the weeds.” Practitioners ought to always refer back to the statute to ensure they are following the road map required to successfully handle these issues, especially the procedural notice issues.
Furthermore, understanding the difference between “fair value” and “fair market value” is crucial to successfully handling matters involving dissenting interest holders. Practitioners must be able to adequately convey the circumstances to their clients, but a lack of understanding in this essential issue may severely inhibit a practitioner’s ability to provide sound counsel.
Not surprisingly, courts nation-wide regularly deal with the issues of fair value and fair market value. Being informed as to these opinions can significantly bolster practitioners’ understandings of this area of law. I highly recommend this post by Peter Mahler where he reviews several national opinions discussing these concepts.
For more Washington business entity law considerations, refer to this blog every Wednesday at 12 PM, noon.