July 10, 2020

Buy Out at Fair Value

Current Issues in Closely Held Businesses Series: Part 5
Holland & Knight Shareholder Rights Blog
Michael J. Zdeb
Shareholder Rights Blog

The prior discussion, Determining a Remedy After Oppression or Breach of Fiduciary Duty (Part 4), presented a listing of the potential remedies on a finding of a breach of duty and oppression. Frequently, the animosity among the parties will lead the court to order a buyout of the complaining parties' interest. It does not seem useful to order other alternative remedies, which would leave the minority in place with the potential for further disputes and an interest that otherwise may be worthless. Also, alternative remedies would likely leave open the potential for further disputes and absorption of the resources of the court in supervision.

The buyout of the minority by those in control is the usual order. However, a forced sale by the breaching party has happened in the past. Once the court has determined that a buyout is the appropriate remedy, an appraisal proceeding will take place to establish the value of the interest to be purchased.

This is where it gets interesting. The standard of value used to establish the purchase price is "fair value" (or in some instances, "fair price"). It is not the familiar "fair market value" standard. Understanding the distinction between the two is critical.

It has been said in numerous opinions that fair market value is "the price which property will bring when it is offered for sale by an owner who is willing but under no compulsion to sell and is bought by a buyer who is willing or desires to purchase but is not compelled to do so." At least one court referred to it "as a phrase without ambiguity in the law" and considered it as a "hypothetical metric" that seeks the price an informed buyer would pay to an informed seller.

"Fair value," on the other hand, is not a financial or appraisal hypothetical metric. It is an equitable concept, one frequently stated to not be "susceptible of determination by any precise mathematical computation and no one formula or figure is binding or conclusive." As the Delaware Chancery has noted, it is infused with equitable considerations.

Fair value does not involve any hypothetical seller or buyer; there may be unequal access to information, and the "willingness" is replaced by compulsion between the known parties.

Often fair value is thought of as an adjusted "fair market value" amount. The usual adjustments refer to the lack of control and lack of a market discount inherent in fair market value standard not being allowed in the determination. In a sense, fair value is then closer to a value based on the proportional interest in the entire enterprise itself.

However, fair value is really something other than just fair market value but without discounts for minority position and lack of a market. It is the court taking into consideration all relevant information and evidence, and determining what is fair. The other nonfinancial considerations may have an effect. It is value in the context of the matter.

A further discussion of the equitable aspect will be discussed in a future post of this series.

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