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BUSINESS LAW these terms may have similar meanings in other contexts, the difference is quite ‘Fair Value’ and Discounting in N.J. noteworthy here. FV seeks to adequate- ly compensate shareholders for their in- terest, while fair market value (“FMV”) Shareholder Oppression Case is the market’s judgment of : the price that would be paid “between a Amorphous standard that has proved to be fertile ground willing buyer and a willing seller when the former is not under any compul- By Michael L. Rich gets interesting. What is FV? Does FV sion to buy and the latter is not under encompass a minority or marketability any compulsion to sell.” The two values he New Jersey Oppressed Share- discount? Faced with these questions, are rarely equivalent. Until the adoption holder Statute (the “Act”), in 1999 the N.J. Supreme Court in Bal- of the New Jersey Corporation Act in N.J.S.A. 14A:12-7(1)(c), allows samides v. Protameen Chemicals, Inc., 1968, FMV was the metric utilized in Tan oppressed minority shareholder in a 160 N.J. 352 (1999), and Lawson Mar- dissenting shareholder valuation. The closely held corporation having 25 or don Wheaton, Inc. v. Smith, 160 N.J. 383 Act jettisoned FMV in favor of FV to fewer shareholders to bring suit in the (1999), responded that it was not possi- permit judges to have more flexibility in N.J. Superior Court. Once oppression ble to pronounce a consistent rule. Rath- valuation. Be careful what you wish for: has been established, the Act allows er, each decision depends on the specific this flexibility has opened the floodgates a judge to, inter alia, order dissolution facts of the case, and also should reflect for debate and litigation in oppressed of the corporation or sale of its . the purpose served by the law in that shareholder cases. If sale of the stock is the remedy, the context. Hence, despite a progeny of New Jersey is not alone in its Act allows judicial discretion to struc- cases brought under the Act, we are left struggle to define FV. Nationally, inter- ture the sale in a manner “fair and eq- with a case-by-case resolution, which is pretation is split between the FMV (hy- uitable” to all parties, given the circum- an amorphous standard that has proven pothetical transaction) approach and that stances. Typically the court will order to be fertile ground for dispute between of . The N.J. Legislature the oppressor-majority shareholder to valuation experts. has apparently opted for something dif- buy out the shares of the oppressed-mi- The Supreme Court, in Bals- ferent than FMV with its marked redefi- nority. Where there is to be a sale, the amides, addressed the meaning of FV nition in the New Jersey Corporation Act requires the judge to price the op- with limited success. Courts in states Act. The enterprise value approach sees pressed-minority’s ownership interest at with similar oppression statutes often the oppressed shareholder as an investor a “fair value” (“FV”). This is where it look to that state’s dissenting share- with no choice but to cash out his owner- holder appraisal statute in defining FV. ship interest. It assumes that, were it not Rich is a Principal at Porzio New Jersey is no exception. As the Bal- for the adverse conduct by the oppres- Bromberg & Newman in Morristown and samides Court stated, “there is no rea- sor, the oppressed would have retained handles complex commercial litigation son to believe that ‘fair value’ means ownership and continued to enjoy ben- matters. The author would like to thank something different when addressed to efits commensurate with his or her share Justin G. Craig, a summer associate of the dissenting shareholders than it does in of the company. Rather than conjuring firm attending the University of Pennsyl- the context of oppressed shareholders.” up a fairy-tale romance between a fic- vania Law School, for his many contribu- Notice that the Act uses the term “fair tional buyer and seller of a minority in- tions to this article. value,” not “fair market value.” While terest in a closely-held corporation, the

Reprinted with permission from the NOVEMBER 3, 2008, edition of the New Jersey Law Journal. © 2008 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited. For information, call 973.854.2923 or [email protected]. ALM is now Incisive Media, www.incisivemedia.com 2 NEW JERSEY LAW JOURNAL, NOVEMBER 5, 2008 194 N.J.L.J. 510 enterprise valuation claims to run paral- A minority discount recognizes under “extraordinary circumstances.” lel to reality. In this light, the enterprise that , and the likelihood Citing to the ALI Principles of Corpo- approach values the company as a whole of that interest to control the actions of a rate Governance, the court explained and then apportions its pro rata value to corporation, is factored into the valuation that this exception applies only when each shareholder. Excess earnings, dis- of a given share. Data suggests that the the dissenting shareholder attempts to counted cash flow, the formula method, difference — the discount — between exploit the transaction and gain value or some combination thereof may be uti- valuation of a minority and majority that would not have been made avail- lized in calculating FV. share, averages between 29 and 33 per- able proportionately to the dissenter’s Several scholars have proffered cent. fellow shareholders. The Lawson Court that marketability and minority discounts The conditions of a court-or- made clear that a mere “family feud,” are, by definition, inapplicable to the dered are not, however, condu- as was the case there, was anything but enterprise value approach. New Jersey cive to a minority discount. The crux of extraordinary. courts have acknowledged the poten- the minority discount is that it reflects the A theme of fairness and equity tially perverse results of these discounts lack of control the buyer will have in the can be deduced from these two cases. in court-ordered , and generally corporation. In oppression buyouts, the Generally, neither a minority nor mar- have precluded them in all but “extraor- oppressor is usually ordered to buy out ketability discount should be applied dinary circumstances.” the oppressed. The oppressor, owning an in either the oppressed or dissenting A marketability discount ac- even greater portion of the company post- shareholder contexts absent extraordi- knowledges the small pool of potential buyout, will have increased control over nary circumstances, nor should a dis- buyers for shares in a closely held cor- the “bottom line” of the business. Thus, count be exploited by the controlling or poration. Thus, compared with a publicly to allow an oppressing buyer to receive oppressing shareholder to benefit him- traded corporation, a sale will demand a discount, despite greater control, would self or herself to the detriment of the increased time and expenditure. These seem contrary to the reasoning behind a minority or oppressed. discounts generally range from 30 to 40 minority discount in most instances. While ambiguities remain in percent. While some erroneously equate Perhaps this logic explains the the definition of FV and the status of minority and marketability discounts as increasing hesitation of judges to apply minority and marketability discounts synonymous, the two are quite distinct. these discounts. Notwithstanding a small vis-à-vis the Act, several observations Even a majority or controlling share in a body of case law, marketability and mi- can be made with some certainty. First, closely held corporation may be subject nority discounts have apparently entered FV, as used in the Act, is not synony- to a marketability discount: the size of a period of dormancy in New Jersey. In mous with FMV. Second, marketabil- the interest being sold does not necessar- Balsamides, the Supreme Court applied a ity and minority discounts are now the ily affect its liquidity. marketability discount when an oppressed exception rather than the norm. While The problem with marketability shareholder was ordered to buy out his they may be more applicable when the discounts in the oppression setting, it is oppressor (an unusual result), as the op- oppressed buys out the oppressor, as in argued, is that there is no lack of liquid- pressed would suffer the full effects of illi- Balsamides, that is not the typical sce- ity in a court-ordered buyout. The buyer quidity when he eventually sold the com- nario. Third, the court generally will and seller have no choice but to accept pany. The court left unresolved the tough not permit the oppressor or party with the judge’s terms. The seller need not question: the applicability of the market- “unclean hands” to exploit these dis- expend time or money in search of a po- ability discount when the oppressor buys counts to his or her advantage. There tential buyer. This has been labeled the out the oppressed. That issue remains un- is ample scholarship arguing inherent “sale misnomer.” See Douglas K. Moll, decided. In contrast, in Lawson Mardon contradiction between these discounts “Shareholder Oppression and ‘Fair Val- Wheaton, supra, decided the same day as and court-ordered buyouts. Perhaps ue’: of Discounts, Dates, and Dastardly Balsamides, the Supreme Court held that their decreasing application evinces the Deeds in the Close Corporation,” 54 marketability discounts should only be courts’ tacit acceptance of these argu- Duke L.J. 293, 319 (2004). applied in dissenting shareholder actions ments. ■