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Damages in a Direct Shareholder Claim

Assuming the absence of a "buy-sell" or shareholder agreement that includes a price for purchase or valuation method, there is no hard and fast determination as to the “value” afforded shareholders in a direct action. The damages to a minority shareholder “squeezed out” or “oppressed” could be the amount of money wrongfully withheld by the majority shareholders. Or the trial court could potentially “force” a purchase of the minority shareholder’s interest. See, e.g., Fulton v. Callahan, 621 So.2d 1235, 1238 (Ala. 1993). But what is the value of the minority shareholder’s stock if the trial court requires a purchase? How is the value of the minority owner’s interest calculated? Among the many methods of “valuation” of a business, there are two types of “value” which are most likely to be applied - fair value” and “fair market value.” Which applies and what does each mean?

In one case, heard by both the Court of Civil Appeals and the Alabama Supreme Court, the Alabama appellate courts clarified what the terms “fair value” and “fair market value” mean and which might apply. See Ex parte Baron Services, Inc., 874 So. 2d 545 (Ala. 2003) and Offenbecher v. Baron Services, Inc., 874 So. 2d 532 (Ala. Civ. App. 2002). In the Baron Services cases, the minority shareholder, Offenbecher, was granted 130 shares of stock in Baron Services for services to the corporation. Baron Services, 874 So. 2d at 547. The board of directors of Baron Services voted to merge Baron Services into a Delaware corporation of the same name, and to “cash-out” any shareholders holding less than 150 shares of stock. Id. Offenbecher objected to the plan of merger adopted by the board of directors, based upon the valuation chosen by the majority, and notified Baron Services of his “dissent” pursuant to § 10-2B-13.02(a) of the Alabama Code [now Ala. Code § 10A-2-13.02]. Id. The “shareholder dissent” statute permits a minority shareholder “‘to dissent from, and obtain payment of the fair value of his or her shares in the event of’ certain corporate actions, including mergers such as that undertaken by Baron Services.” Offenbecher, 874 So. 2d at 535 (emphasis added by Court of Civil Appeals). This “statutory right to receive the ‘fair value’ of one’s shareholder interest provides a remedy for actual threatened oppression of minority shareholders.” Id.

The Court of Civil Appeals asked (and answered) “[w]hat is the ‘fair value’ of a dissenting stockholder’s shares?” Alabama Code § 10-2B-13.01(4) [now Ala. Code § 10A-2-13.01] defines “fair value” as “the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.” Id. at 536. The Court of Civil Appeals expressly notes that “‘fair value’ and ‘fair market value’ are two different things.” Id. “Fair value” is “the market value of a company as measured by its stock price and the intrinsic value of the company.” Id. “Fair market value,” on the other hand, is “the sum arrived at by fair negotiation between an owner willing to sell and a purchaser willing to buy, neither being under pressure to do so.” Barron Services, 874 So. 2d at 550. The Alabama Supreme Court also noted that “fair value” and “fair market value” are not the same:

“Fair value” is not the same, or short-hand for, “fair market value.” “Fair value” carries with it the statutory purpose that shareholders be fairly compensated, which may or may not equate with the market’s judgment about the stock’s value. This is particularly appropriate in the close corporate setting where there is no ready market for the shares and consequently no fair market value.

Id. at 549.

The trial court determined the fair value of Offenbecher’s shares using a 50% “marketability discount.” “A marketability discount is an adjustment applied to a valuation of stock, intended to reflect the decreased worth of stock in a closely held corporation for which there is no readily available market.” Id. at 542 (Thompson, J., concurrence in part and dissent in part) (citing Balsamides v. Protameen Chems., Inc., 160 N.J. 352, 734 A.2d 721 (1999)). Other discounts which may be applied in calculating the value of a minority interest include a discount for the lack of control a minority shareholder may exert over a corporation (a “minority discount”). A marketability discount may be applied to even controlling interests in a closely-held corporation, while a minority discount would apply only to a minority interest. Offenbecher, 874 So. 2d at 542 (quoting Balsamides, 160 N.J. at 373, 734 A.2d at 733).

The Court of Civil Appeals determined that the application of this apparently neutral “marketability” discount “has made possible a squeeze-out merger” in which the minority shareholder was forced to sell his shares at an extremely discounted price and was thereby squeezed-out of sharing in large corporate profits thereafter. Id. at 538. The Court of Civil Appeals held that the application of the discount when calculating the “fair value” under the dissenting shareholder statute was incorrect as a matter of law. Id. at 539.

Judge Thompson’s concurrence in part and dissent in part disagreed with the majority opinion’s determination that a “marketability discount” was inappropriate as a matter of law. Relying upon the commentary to Alabama Code § 10-2B-13.01 [now Ala. Code § 10A-2-13.01], which provided that Delaware law was persuasive in determining the fair value of a dissenting shareholder’s stock, Judge Thompson concluded that the Delaware Supreme Court “distinguished between a permissible corporate-level discounting [such as a marketability discount] and an impermissible stockholder-level discounting [such as a minority discount].” Id. at 543, 545 (Thompson, J., concurring in part and dissenting in part).

In Baron Services, the Alabama Supreme Court accepted certiorari review of, and then affirmed, the decision by the Court of Civil Appeals. Baron Services, 874 So. 2d at 546. The Supreme Court determined that “[t]he direct-valuation approaches used [by Baron Services]’s valuation are not based on market-comparable values; therefore, we find no reason to apply a marketability discount in this case.” Id. at 551.

The Baron Services cases dealt with the Alabama dissenter’s rights statute, which expressly called for “fair value” to be used as the measure of value for the dissenting shareholder’s stock. However, the rationale of the two decisions may be helpful in determining whether “fair value” or “fair market value” is the appropriate measure of damages for a forced buyout of a minority shareholder’s interest in a direct squeeze-out or oppression claim. No Alabama court has addressed this precise issue, but in a related arena, the Alabama appellate courts have determined that “fair value” is the appropriate measure in a marital divorce:

This court has explained that a trial court valuing a closely held business in the context of a divorce is not to determine the “fair market value” of the entity but, instead, is to determine the “fair value” of the entity. Grelier v. Grelier, 44 So. 3d 1092, 1097 (Ala. Civ. App. 2009). We have determined that a trial court valuing a business for divorce purposes cannot use discounts that artificially deflate the value of the company because such an approach is inequitable. Grelier, 44 So. 3d at 1097. As we explained:

“Alabama law has not adopted a ‘fair market value’ standard for assessing marital property. Rather, under Alabama law, a trial court must determine the value of property with the only limitation being that the value must be equitable under the circumstances of the particular case. See generally Yohey v. Yohey, 890 So. 2d 160 (Ala. Civ. App. 2004). That standard implies that the valuation must be fair to all parties concerned. See generally Black’s Law Dictionary 578 (8th ed.2004) (defining ‘equitable distribution’ as the ‘fair ... allocation’ of marital property). In cases in which a divorce court does not contemplate the sale of a business in which one of the spouses holds a minority interest but, instead, intends that the business shall remain a going concern, it makes little sense to determine fair value by the measuring stick of a hypothetical sales price. That methodology would artificially reduce the value of the marital asset in almost every case, which would be unfair, i.e., inequitable, to the party receiving only a portion of the reduced value or the property equivalent to that reduced value but would be advantageous to the party retaining the business interest, including its actual value to him or her as the holder.”

Wilson v. Wilson, 93 So. 3d 122, 127-28 (Ala. Civ. App. 2011) (quoting Grelier v. Grelier, 44 So. 3d 1092, 1097 (Ala. Civ. App. 2009)) (emphasis added by Wilson court).

As described by the Court of Civil Appeals, in divorce actions, where a shareholder is involuntarily forced to sell his or her shares, the appropriate valuation is “fair value,” and not “fair market value,” because to force a sale at fair market value would encourage negative behavior by the majority. A good argument can be made that this same rationale applies with equal force to the appropriate measure of damages in a squeeze-out or oppression claim, where the minority shareholder is similarly claiming to be “forced” or “squeezed” out of the corporate benefits.

However, the initial examination of the valuation issue starts with any existing buy-sell or shareholder agreements. Using a contractual buyout price or valuation formula for establishing value is a compelling argument against the court setting a value, using either fair value or fair market value, in contravention to the parties’ contractual agreement.