Exit remedies for minority shareholders in close companies (IVOR nr. 82) 2011/3.4.5.1:3.4.5.1 Approach and guidance

Exit remedies for minority shareholders in close companies (IVOR nr. 82) 2011/3.4.5.1

3.4.5.1 Approach and guidance

Documentgegevens:

dr. Q. Wang, datum 02-05-2011

Datum: 02-05-2011
Auteur: dr. Q. Wang
JCDI: JCDI:ADS405259:1
Vakgebied(en): Ondernemingsrecht (V)

The fact that the most common relief sought by the minority shareholders in this remedy is a court ordered buyout underlines the importance of the valuation issue in this remedy.1 However, the Model Act and most of the statutes do not define fair value. Some statutes simply mention the reference to value as an ongoing concern.2

In the practice, courts and commentators view the corporate valuation methods in the oppression remedy as similar to those in the appraisal remedy because both these remedies aim to calculate the value of the corporation and attempt to ensure that the dissenting or dissatisfied shareholders can leave the corporation with the fair value of their shares.3 Consequently, methods used in the appraisal proceedings are applicable to the oppression remedy as wel1.4 Because the value of the corporation is distorted by the wrongdoing, and considering the small business scale of most close corporations, such a distortion can be disproportionately devastating and severe to corporate value. In the valuation process, therefore, the decrease in value due to the impact of the wrongdoing is added back, such as a decrease resulting from transactions at undervalue, hidden distribution, excessive remuneration, exorbitant management fees, waste of assets, self-dealing, intentional and negligent misrepresentation and so on. One example given here is the extra salaries paid to shareholder officers. In the Hendley case, when the earning ability of the corporation was assessed, the excess or non-functional income drawn by the majority was added back, and after the adjustment, the value of a corporation doubled.5 Thus, courts give aggrieved shareholders the opportunity to recover damages in the oppression litigation.6

The scope of the appraisal action is limited to the value of the dissenting stockholder's stock,7 and any inquiry into claims of wrongdoing is not involved.8 The restricted valuation scope in an appraisal proceeding can be justified. Judgments on the fiduciary duty claims invariably take more time, and time is essentially valuable in a business transaction. It is therefore to exclude equitable claims from an appraisal proceeding. As ruled in Rabkin, claims based on breaches of the duties of loyalty and care, raise "issues which an appraisal cannot address".9

However, a conflict is produced by such a standing when there is breach of fiduciary duties in an appraisal occasion. Take mergers for example, there are a number of situations where a merger is carried out with breach of fiduciary duties, and the interests of minority shareholders are consequently affected. For instance:

1): inadequate disclosure of information or misrepresentation. In this case, compensation for damages is appropriate since the stockholders have been deprived of the opportunity to make an informed decision on the corporate action. In Smith v. Shell Petroleum. Inc., an employee of Shell miscalculated the value of the company's oil and gas reserve by failing to account for around 300 million barrel equivalents of proved oil and gas reserves; 10
2): breach of due of care, such as the board approving the merger within two hours and without adequate information and inquiry. There is a high risk that the corporation could possibly be sold at undervalue;11
3): breach of the duty of loyalty, the board deliberately times the transaction at a historically low price and so on. 12 If claims of breach of duties are allowed to be considered in an appraisal proceeding, as mentioned above, such a practice prolongs the litigation process and destroys the expedient nature of an appraisal proceeding. If not allowed, the wrongdoing damages the interests of the minority shareholders, and the appraisal suit alone cannot ensure they are fully compensated. The current way adopted by the Delaware courts is to permit the plaintiffs to apply both remedies and to allow the aggrieved shareholders to seek an award of damages for all losses resulting from defendants' wrongdoing in excess of the court appraised corporate value in an appraisal, provided the specific misconduct can be proved.13 As the court reasoned in Ryan: "(Where directors) have been adjudicated in breach of their duty of loyalty, the damages award will not be limited to what would be recoverable in statutory appraisal.... Rather, the Court will exercise its discretion to craft from the "panoply of equitable remedies" a damage award that approximates a price the board would have approved absent a breach of duty."14

In sum, if a shareholder brings an appraisal and an oppression suit at the same time, the court usually first carries out valuation in the appraisal suit and lets the petitioner show that he should receive more beyond the fair value assessed in the appraisal suit. If the only claim is an oppressive action, courts can adjust figures in the calculation equation, such as by increasing the earning ability of the corporation. Again, as in the appraisal remedy, calculation of the fair value here is not an exact science. There is no right answer.15

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Thompson, ibid, pp. 699-700, 705-709, 1993.

Cal Corp Code § 2000, Wis Stat § 180.1833.

Melvin Aron Eisenberg, op cit., p. 1070; see also, Principles of Corporate Govemance: Analysis and Recommendations, American Law Institute, 1994, part VII, Chapter 4, The Appraisal Remedy. p. 312 ('In administering [the] oppression remedy, the court might properly look to the procedures and standards specified in this chapter for the determination of fair value.'); In Delaware, it is recognized that the approach to valuation was the same as that in an appraisal proceeding, only the scope was different.

Dissolution of Funplex, Inc., 252 A.D.2d 923, 676 N.Y.S.2d 321, 322 (3d Dept 1998) (Discounted cash flows in determining valuation of a closely held corporation is considered in a dissolution case); Matter of Cohen, 168 Misc. 2d 91, 636 N.Y.S.2d 994, 998 (Sup 1995), order aff'd, 240 A.D. 2d 225, 659 N.Y.S.2d 735 (lst Dept 1997) Friedman v. Beway Realty Corp., 87 N.Y.2d 161, 638 N.Y.S. 2d 399, 661 N.E.2d 972 (1995) (In discussing how value of corporation is determined for purposes of dissolution, these courts said that 'Investment value can be ascertained through a capitalization of earning.')

Hendley v. Lee, 676 F. Supp. 1317, D.S.C. 1987.

The Delaware courts have treated the extent of damages in a faimess/breach of fiduciary duty case as greater than in an appraisal case, which includes elements of 'rescissory damages.' See John J. ANDALORO, et al. v. PFPC WORLDWIDE, INC., et al No. Civ.A. 20336, Civ.A. 20289. Court of Chancery of Delaware. 2005; Cede & Co. v. Technicolor, Inc., 542 A. 2d 1182, 1187-88 (Del. 1988); Rabkin v. Philip A. Hunt Chem. Corp., 498 A. 2d 1099, 1107 (Del. 1985); Weinberger, 457 A. 2d at 714.

Kaye v. Pantone Inc., Del.Ch., 395 A. 2d 369, 374-75 (1978).

See Felder v. Anderson, Clayton & Co., Del.Ch., 159 A. 2d 278 (1960);

Rabkin, 498 A. 2d at 1106, Del. 1985.

10.

606 A. 2d 112 Del. 1992.

11.

Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).

12.

Eisenberg v. Chicago Milwaukee Corp., 537 A. 2d. 1051, Del. Ch. 1987 (Tender offer 33 premium over the last reported sale price, but that price was 5 years lowest. The court issued an injunction until adequate disclosure was made and the coercion was eliminated.); Rabkin, 498 A.2d at 1106, Del 1985 (in Rabkin, when shareholders alleged that their directors manipulated the timing of the transaction so as to deprive shareholders of a contractual right to receive a fixed price if the transaction closed within a certain timeframe and the fixed price was arguably more than the stock fair value, the oppression remedy rather than the appraisal remedy would compensate shareholders for the loss.)

13.

Cede & Co. v. Technicolor, Inc. 542 A. 2d 1182, 57 USLW 2017 Del. 1988. (On remand, the Court of Chancery addressed the appraisal issue first and valued Technicolor. In this case, the breach of duty of care was not remedied. Although the Technicolor board was not sufficiently informed when it approved the merger, but the 23m dollars per share was possibly the best price available); John J. ANDALORO, et al. v. PFPC WORLDWIDE, INC., et al, No. Civ. A. 20336, Civ. A. 20289. Del. Ch. 2005. (the plaintiffs, if they were to later prove a breach of fiduciary duty, would be entitled to an award of damages to compensate them for any gap between the value of what was taken from them in the Merger, i.e., their PFPC stock, and what was received by as consideration for the Merger.)

14.

Ryan v. Tad's Enterprises, Inc., 709 A. 2d 682, 699 (Del. Ch. 1996).

15.

Balsamides v. Protameen Chemicals, Inc., 160 N.J. 352, 734 A. 2d 721, 729-730 (1999).