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 15 states over the last 30 years. I speak as a business appraiser and a business man. I have no legal opinions. (I do hope the ones I have are not illegal.)
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, unfortunately, between business appraisers. Because fair value is ultimately a legal concept, appraisers should consult with counsel regarding their legal interpretation of fair value in each jurisdiction.
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 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 effected shareholders. Appraisers would need further guidance from counsel in order to assure that they 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.
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.
Fair market value is a willing buyer, willing seller concept.
The standard of fair market value is mentioned here because it is referenced (albeit indirectly) in the statutory definition of fair value in Delaware. 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 effect minority owners. Fair value is also the statutory standard of value in cases of shareholder oppression in many states.
But 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 value in such situations is a willing buyer, unwilling seller concept.
Fair market value is an objective standard. Fair value, on the other hand, is an equitable standard. Equitable is defined in YourDictionary.com as: “Fair, under widely held moral principles, often embodied in court precedents; or referring to a remedy available in a court of equity.”
A “court of equity” is defined in Wikipedia.com (footnotes omitted) as:
… a court that is authorized to apply principles of equity, as opposed to law, to cases brought before it.
These 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.”
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.
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.
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, can be confusing when viewed through the objective lenses of fair market value and valuation and finance theory. This observation is more or less true in the majority of states.
We begin a journey to talk about statutory fair value. Before we talk about any cases, in Delaware or elsewhere, it is critical to follow this introduction with a discussion of key valuation concepts that underlie both fair market value and fair value.
In our next post on the topic, we will begin our valuation and finance introduction with a discussion of the Discounted Cash Flow Model, or the discounted cash flow method, or simply, DCF. There is a reason for beginning here. As we will see, the DCF method is of primary importance in fair value determinations in Delaware.