CHAPTER 3

Fair Value in Shareholder Dissent and Oppression

Gilbert E. Matthews and Michelle Patterson

FAIR VALUE AS THE STANDARD OF VALUE IN DISSENT, OPPRESSION, AND ENTIRE FAIRNESS CASES

State courts employ fair value as the predominant standard to determine the value of minority shares in both appraisal (also known as dissent)1 and oppression cases. When the courts determine the minority's share price in an appraisal or order the buy out of an oppressed minority shareholder, the price of the award or buyout is critical for both parties and sets the “fair value” of the minority's shares.2 Although appraisal and oppression statutes in most states expressly or effectively stipulate that the minority's shares are to be valued at “fair value,” there remains considerable confusion about what “fair value” means. To understand fair value as a standard of measurement, it must be considered in contrast to the standards of value called fair market value and third-party sale value, as will be discussed in this Chapter.

Both appraisal and oppression cases are governed by state law. That state law includes corporate law statutes, the judicial interpretations of those statutes, and the courts' holdings under their equitable authority, even when the state lacks corresponding statutes.3 Although fair value is now the state-mandated or accepted standard for judicial appraisal and oppression valuations in almost all states, there are differing interpretations of its meaning and measurement that have evolved through legislative changes and judicial interpretation.

The model statutes proposed by the American Bar Association (ABA) and the American Law Institute (ALI), together with Delaware appraisal law, have greatly influenced a majority of state statutes. The ABA and the ALI have developed definitions of fair value that are set forth in the ABA's Revised Model Business Corporation Act (RMBCA)4 and the ALI's Principles of Corporate Governance.5 Although statutes and legal organizations have contributed to the development of the fair value standard, the Delaware courts' decisions are central to its definition.

Delaware's appraisal statute explicitly mandates fair value as the measure of value, and the Delaware Supreme Court clarified its meaning in Tri-Continental v. Battye6 in 1950. Fair value was defined as the value that had been taken from the dissenting shareholder:

The basic concept of value under the appraisal statute is that the stockholder is entitled to be paid for that which has been taken from him, viz., his proportionate interest in a going concern. By value of the stockholder's proportionate interest in the corporate enterprise is meant the true or intrinsic value of his stock which has been taken by the merger. In determining what figure represents this true or intrinsic value, the appraiser and the courts must take into consideration all factors and elements which reasonably might enter into fixing the value.7

This concept of value has since been cited in numerous appraisal and oppression cases as the basic standard. In recent years, most (but not all) jurisdictions have accepted the position that what has been taken from the shareholder is a pro rata share of the value of the company as a whole.

It is helpful to understand the different legal actions of appraisal, oppression, and breach fiduciary duty in which fair value is used as the standard of valuation. The appraisal action is a “limited legislative remedy which is intended to provide minority shareholders who dissent from a merger asserting the inadequacy of the [consideration], with an independent judicial determination of the fair value of their shares.”8 Dissenting minority shareholders may petition for appraisal under a state statute, commonly known as appraisal or dissenters' rights. Shareholders customarily have appraisal rights when they are involuntarily cashed out in a merger or consolidation, but some states also permit dissenters to seek appraisal in other circumstances, such as a sale of assets, recapitalization, stock-for-stock mergers, amendments to articles of incorporation, or other major changes to the nature of their investment. In an appraisal action, the exclusive remedy is cash.

Although appraisal or dissenters' rights commonly apply to close corporations, public companies may be subject to appraisal actions under some of the above circumstances. A common misperception exists that publicly held shares are not entitled to appraisal rights because of the existence in many states' appraisal statutes of a provision called the “market exception.” This is discussed below in the section entitled “Appraisal Rights in Publicly Traded Corporations: The Market Exception.”

Oppression actions arise from shareholders of close corporations who assert that they have been treated unfairly or prejudicially by those in control and seek dissolution of the company or a buyout of their shares. Oppression remedies are available to these shareholders when they establish that the majority has excluded them from their proper share of the benefits accruing from the enterprise.9 Oppression often involves egregious majority action targeting individual minority shareholders. It can include termination of compensation, employment, or dividends, and/or a siphoning of corporate assets for the benefit of the majority at the expense of the minority.

Oppression actions, like appraisal actions, are primarily based on state statutes. All but nine states have enacted oppression-triggered dissolution statutes under which shareholders may petition for involuntary dissolution. Over time, alternative remedies to involuntary dissolution have arisen, and involuntary dissolution has come to be much less frequent. In fact, “‘oppression' has evolved from a statutory ground for involuntary dissolution to a statutory ground for a wide variety of relief.”10

In many states lacking oppression-triggered dissolution statutes, the courts have created another way for oppressed minority shareholders to seek redress. These courts have emphasized that a fiduciary duty of good faith and loyalty exists between the majority and the minority shareholders; other courts have even extended fiduciary duty obligations to exist between one shareholder and another. By so doing, these courts have permitted the “oppressed” shareholder to sue, asserting breach of fiduciary duty. The failure of the control shareholders to fulfill their fiduciary duties to the minority can be deemed to be oppression.

In breach of fiduciary duty cases, the courts grant many of the same remedies, such as dissolution and compulsory buyouts, which are provided for in the state oppresion statutes. The court employs the same fair value standard used in oppression and appraisal actions to make its judicial determination of minority share value. Professor Douglas Moll writes:

The development of the statutory and fiduciary duty actions reflect[s] “the same underlying concerns for the position of minority shareholders, particularly in close corporations after harmony no longer reigns.” Because of the similarities between the two remedial schemes, it has been suggested that “it makes sense to think of them as two manifestations of a minority shareholder's cause of action for oppression.” In the close corporation context, therefore, it is sensible to view the parallel development of the statutory action and the fiduciary duty action as two sides of the same coin—i.e., the shareholder's cause of action for oppression.11

Delaware provides an example of courts acting under their own equitable authority in states where there is no specific oppression statute.12 In Delaware, when the court believes there is a conflict of interest or oppressive behavior, it will allow a breach of fiduciary duty case for the minority shareholder. If the case is designated as one of “entire fairness,” the Delaware courts will use the same standard of fairness, fair value, which its uses in Delaware appraisal cases to set the price for the minority's shares.

Importantly, defining fair value as a proportionate share of a company's value, as Delaware did in Tri-Continental, differentiates it from the other two standards of value—fair market value and third-party sale value.13 It has been argued that the courts have made the best choice by selecting fair value as the appropriate standard and by rejecting fair market value and third-party sale value.14 When fair market value is used in tax cases, for example, substantial discounts for the minority's lack of control and lack of marketability are often applied to the value of the minority shares. Courts have noted that a fair market value valuation based on such discounts would be less than the value of the minority shareholders' proportionate interest in the company. With a fair market valuation, the controller (or majority) would reap a windfall at the expense of the minority. Consequently, judicial interpretations and statutes in many states now reject minority or marketability discounts in the determination of fair value. However, a few states still allow the discounts either by precedent, at a court's discretion, or in special circumstances.15

On the other hand, if the courts used the standard of third-party sale value, those shares would receive a value, a premium, that would be higher than fair value. An augmented value would result because the third-party sale price could include additional elements of value resulting from the transaction, such as financial control and synergistic values. Minority shareholders would not be entitled to those additional values. Most appraisal statutes expressly instruct the judiciary to exclude from their determination of fair value the increases in value that resulted from the synergies accomplished by the transaction.

In order to further understand the issues and complexity surrounding fair value in appraisal and oppression cases, we will examine what elements of value are addressed by the courts in their determination of fair value. We look, as well, at how various courts address current valuation concepts and techniques.

THE APPRAISAL REMEDY FOR DISSENTING SHAREHOLDERS

History and Overview of the Appraisal Remedy

In the early nineteenth century, common law held that extraordinary corporate decisions were to be made unanimously, meaning 100% shareholder approval was required. The prevailing perspective on business was that the investment made by the minority shareholder contractually connected the corporation to the shareholder, and that shareholders should not be required to comply with fundamental changes they did not support. Therefore, any single shareholder could utilize his or her common law veto in order to prevent corporate action.16

This perspective could have a paralyzing effect on the decision-making process in a corporation. A minority shareholder could impulsively or arbitrarily threaten to reject a corporate action solely to collect a premium on an initial investment.17 The advancing industrial revolution brought about an increasingly complex economy based on the nation's growing institutions and infrastructure, including the development of the transcontinental railroads. With these changes in commerce and finance, the corporations and the courts came to realize that a unanimity requirement was not efficient for forward movement and growth.18

In 1892, the Illinois Supreme Court turned away from the unanimity view of corporate management and affirmed majority rule and the role of the minority shareholder in Wheeler v. Pullman Iron & Steel Co.19 The court decided that the fundamental law of corporations should be that the majority should control policy. It revised the concept of the minority shareholder's investment to mean that the minority shareholder, by investing in the corporation, agrees to abide by the decisions sanctioned by the majority or the board of directors elected by the majority of the shareholders.20

Following the Wheeler decision, other state courts, recognizing the paralyzing effect of unanimity, generally became more sympathetic toward majority rule. Initially, majority rule was in place only in cases of insolvency, but later it was considered controlling in mergers, asset sales, and similar transactions, as long as the majority's decision was in the best interests of the corporation.21 As a result, minority shareholders who disagreed with the actions of the majority were left without the power to challenge such corporate decisions or, if the shares were not publicly traded, the ability to exit the corporation. This in turn led to the development of appraisal rights for such minority shareholders.

An 1875 Ohio case was earlier evidence of the emergence of appraisal rights. In its decision, the Ohio Supreme Court stated:

[O]ur legislature has seen proper to provide that stockholders in a railroad corporation shall not be carried into a new or consolidated company against their consent. From this provision it is plain that a stockholder not only can not be compelled to become a member of the consolidated corporation, but the consolidation can not proceed until he is paid the fair value of his stock. It is impossible to force upon him the liabilities and responsibilities attaching to the new corporation; it is impossible to change the character of the enterprise in which he agreed to embark his money, until he has been paid the fair value of his investment.22

Before the appearance of appraisal statutes, minority shareholders had to petition the courts to stop the corporation from pursuing a course of action until their desire to exit was satisfied. They had to sue for injunctive relief and for the cash value of their shares. The courts would award the fair value in cash to enable shareholders to escape forced membership in a new corporation.23 Legislatures began to enact appraisal rights statutes that allowed the minority to dissent from a corporate transaction and receive a judicial determination of the fair value of their shares in the original corporation in cash.24 The statutes prevented expensive and drawn-out injunction procedures and allowed corporations, during the dispute, to continue conducting business as usual.

The U.S. Supreme Court clarified the purpose of dissenters' rights statutes in its 1941 Voeller decision.25 Justice Black cited a Securities and Exchange Commission (SEC) report describing the history and necessity of establishing majority rule and a remedy for minority shareholders:

At common law, unanimous shareholder consent was a prerequisite to fundamental changes in the corporation. This made it possible for an arbitrary minority to establish a nuisance value for its shares by refusing to cooperate. To address this situation, legislatures authorized corporations to make changes by a majority vote. This, however, opened the door to victimization of the minority. To solve the dilemma, statutes permitting a dissenting minority to recover the appraised value of its shares were widely adopted.26

In 1927, the Uniform Business Corporation Act was introduced by the Commissioners for Uniform State Laws.27 It was adopted only by Louisiana, Washington, and Kentucky, likely because most states were not comfortable with the implied inflexibility of uniform laws and wanted to reserve their own legislative rights.28 Over the course of the first half of the twentieth century, nearly all states adopted an appraisal statute.29

Appraisal Rights Today

Currently, the ABA and the ALI recognize various events that can trigger dissenters' rights. States have adopted triggering events in their statutes, and these may have developed differently from those of the RMBCA and the Principles of Corporate Governance because of each state's corporate law history. Some common triggers contained in the RMBCA and the state statutes include:

• Merger
• Share exchange
• Disposition of assets
• Amendment to the articles of incorporation that creates fractional shares
• Any other amendment to the articles from which shareholders may dissent
• Change of state of incorporation
• Conversion to a flow-through, unincorporated or non-profit entity

In practice, a substantial majority of appraisal cases today arise when control shareholders squeeze out minority shareholders for cash.

In fact, it has been convincingly argued by Professor Robert Thompson that the “conventional explanation [which] describes appraisal rights as part of a tradeoff implemented at the turn of the century to facilitate the growth of American business” provides an inadequate and incorrect understanding of the role of appraisal rights today.30 This traditional view, set forth by Justice Black in Voeller and discussed by us above, explains that when appraisal rights were first granted, they were the tradeoff for the removal of the unanimity decision-making requirement. Thompson notes:

Legislatures . . . passed statutes authorizing fundamental changes by a supermajority vote, and often included appraisal rights permitting the minority to exit from these changed enterprises. The focus was on facilitating desirable corporate changes while providing liquidity to those who chose not to continue in a business fundamentally different from the one in which they had originally invested.31

Thompson's argument, however, is that the original liquidity purpose of the appraisal remedy has almost completely disappeared. Instead, the remedy now “serves an entirely different purpose” of acting as a check against opportunism. He points out that “the overwhelming majority of appraisal cases …reflect this cash-out context” and ‘‘less than one in ten of …litigated cases illustrate the liquidity/fundamental change concern of the classic appraisal remedy.”32 Thompson states:

Now the remedy serves as a check against opportunism by a majority shareholder in mergers and other transactions in which the majority forces minority shareholders out of the business and requires them to accept cash for their shares. In earlier times, policing transactions in which those who controlled the corporation had a conflict of interest was left to the courts through the use of fiduciary duty or statues that limited corporate powers. Today, that function is left for appraisal in many cases.33

Thompson makes the case that several statutory appraisal provisions which were deemed appropriate for liquidity purposes work counter to providing fairness in the modern opportunism context:

• excluding from the fair value calculation any appreciation or depreciation attributable to the merger transaction;
• requiring minority shareholders seeking appraisal to take four or more separate legal steps to perfect the remedy (and withdrawing relief if the actions are not perfect);
• excluding appraisal when shares are traded on a public market;34 and
• making appraisal an exclusive remedy even when the valuation remedy does not include loss from breaches of fiduciary duty.35

Dissenters are required to follow precisely the complex timing and other requirements of state law in a process referred to as perfecting dissenters' rights. The process and timetable of these events vary from state to state, but in most cases are strictly enforced. A company's board of directors is required to give notice (commonly in a proxy or information statement) of a contemplated corporate action from which shareholders may dissent. Dissenters must then decline the consideration and demand payment of their shares in a notice to the board prior to the action. This dissent triggers an appraisal. Upon notice of dissent, dissenters relinquish all rights except the right to receive payment of the fair value of their shares, and will receive no payment until the conclusion or settlement of litigation. In some states, however, the company must put into escrow the amount that it contends to be fair value. Furthermore, dissenters become unsecured creditors of the company or its successor, which often is a highly leveraged entity.

Some modifications were suggested in 1978 when the Model Business Corporation Act (MBCA) provided that dissenting shareholders should be given notice of events from which they could dissent, and instituted guidelines as to how to dissent. Even with the MBCA's new procedural aids, there remain strict and onerous rules and procedures that dissenters must follow to perfect their rights.

Appraisal Rights in Publicly Traded Corporations: The Market Exception

There is a common misperception that publicly held shares are not entitled to appraisal rights because of a provision in many states' appraisal statutes called the market exception. The market exception denies appraisal rights in many circumstances for shareholders of companies whose shares are listed on a national market, or, in most states, have more than 2,000 shareholders.

Although it is true that shareholders of public companies, in contrast to shareholders of privately held companies, are often restricted in their ability to avail themselves of the appraisal remedy, there are conditions under which they may do so. Fifteen states permit appraisal rights to shareholders whether publicly traded or not while 35 states deny or materially limit the appraisal rights of publicly traded companies' shareholders under their market exceptions.36 For example, the Arizona statute states:

Unless the articles of incorporation of the corporation provide otherwise, this [appraisal] section does not apply to the holders of shares of a class or series if the shares of the class or series were registered on a national securities exchange, were listed on the national market systems of the national association of securities dealers automated quotation system or were held of record by at least two thousand shareholders on the date fixed to determine the shareholders entitled to vote on the proposed corporate action.37

Although the 1969 MBCA included the market exception, the 1984 RMBCA deleted it because opponents argued that even when a liquid market existed, the market price might not reflect all relevant information. In addition, the market price is capped by the transaction price and “market value and fair value are not necessarily synonymous under all circumstances.”38 The 1999 RMBCA committee weighed these arguments and decided that it would again recommend a market exception provided that appraisals be available in conflict-of-interest transactions.39

Restrictions on appraisal rights break down as follows:

Eight states (including Delaware) provide that shareholders of public companies have appraisal rights when the shareholder receives in consideration anything other marketable shares.40 Delaware's statute states:

Notwithstanding paragraph (b)(1) of this section [the market exception], appraisal rights under this section shall be available for the shares of any class or series of stock of a constituent corporation if the holders thereof are required . . . to accept for such stock anything except:

a. Shares of stock of the corporation surviving or resulting from such merger or consolidation, or depository receipts in respect thereof;

b. Shares of stock of any other corporation, or depository receipts in respect thereof, which shares of stock (or depository receipts in respect thereof) or depository receipts at the effective date of the merger or consolidation will be either listed on a national securities exchange or held of record by more than 2,000 holders.41

Fourteen states provide that the market exception is inapplicable and appraisal is permitted when the consideration includes anything other than cash and/or listed shares.42 For example, the Florida statute provides:

Paragraph (a) [the market exception] shall not be applicable and appraisal rights shall be available pursuant to subsection (1) for the holders of any class or series of shares who are required by the terms of the corporate action requiring appraisal rights to accept for such shares anything other than cash or shares of any class or any series of shares of any corporation, or any other proprietary interest of any other entity, that satisfies the standards [of being publicly traded] set forth in paragraph (a) at the time the corporate action becomes effective.43

Two major states permit appraisals only in special circumstances. California allows dissent by holders of shares either when those shares are subject to transfer restrictions or when 5% of the outstanding shares of a class request appraisal.44 Pennsylvania permits shareholders in a class other than common stock to dissent if the transaction does not require a majority vote of the class.45

Exhibit 3.1 (on page 103) shows which jurisdictions apply the market exception, and gives an overview of those situations in which the shareholders of public companies will have appraisal rights and the exception does not apply.46

EXHIBIT 3.1 The Market Exception and When Appraisal Is Permitted Despite the Market Exception

Fair Value Can Be Less Than Arms'-Length Price

Dissenting shareholders seek appraisal when they believe that the fair value of their shares is greater than the consideration that they were offered in the transaction. Dissenters have sometimes been awarded far more than the price they were originally offered, but this rarely happens when the buyer was a third party. When considering fair value, courts give substantial weight to a price negotiated in an arm's-length transaction:

This fact that major shareholders . . . who had the greatest insight into the value of the company, sold their stock to [the third-party buyer] at the same price paid to the remaining shareholders also powerfully implies that the price received was fair.47

The Delaware Supreme Court reiterated this view in 1999, when it wrote that “a merger price resulting from arms-length negotiations where there are no claims of collusion is a very strong indication of fair value.”48 However, if the court determines that a third-party transaction was not arm's-length due to conflict of interest and/or improper actions by the buyer, the merger price is not credible evidence of fair value.49 Because of synergies, as well as a buyer's ability to make changes in the operations and financial structure of a company, fair value is often less than third-party value.50

Importantly, dissenting shareholders have been awarded amounts lower than an arm's-length transaction price when the court determined that the transaction price included synergies and/or a control premium that should not have been included in fair value under Delaware law. A 2005 case concluded that the fair value of a company was $2.74 per share, even though the minority shares had been acquired for $3.31 in stock.51 A 2003 decision awarded the petitioner “the value of the Merger Price net of synergies,”52 which gave the dissenters only 86% of the merger price. In 2012, a company acquired by a competitor was also appraised at 86% of the purchase price, thus resulting in a minority shareholder value less than what the dissenters would have received in the transaction price.53

THE OPPRESSION REMEDY

Development of the Oppression Remedy

A remedy for oppressed shareholders emerged for reasons similar to the origin of dissenters' rights. As the courts moved to majority rule, which based decisions on the best interests of the corporation rather than the shareholders, minority shareholders could be frozen out or otherwise harmed without the intervention of the courts. Shareholders would have to bring suit for an injunction or to dissolve the corporation in order to recover their interest.

Illinois was the first state to codify oppression as a trigger for dissolution in the 1933 Illinois Business Corporation Act. The ABA later modeled the MBCA's dissolution statute after Illinois' example.54 The 1953 MBCA stated that a shareholder could call for dissolution if “the acts of the directors or those in control of management are illegal, oppressive, or fraudulent.”55

As oppression became more widely recognized over the course of the twentieth century, the courts needed to find ways to identify whether oppression had actually occurred. Some viewed oppression as akin to fraudulent or illegal acts. The Illinois court's 1957 decision in Central Standard Life Insurance56 applied the term oppression more broadly than fraudulent or illegal activity despite finding in favor of the corporation. The term has come to include conduct by the majority that breaches fiduciary duty, denies the minority shareholder his or her reasonable expectations in acquiring shares and entering into a shareholder agreement, or is burdensome, harsh, and wrongful to minority shareholder interests. Oppressive acts by the majority can be very damaging to a minority shareholder; for example, a majority decision may eliminate a minority shareholder's ability to receive dividends or other types of benefits from a corporation.

Shareholder oppression now is seen to occur when the majority shareholders or the board of directors act in a manner that is detrimental to minority shareholders. New York's highest court described oppression in a 1984 decision:

A shareholder who reasonably expected that ownership in the corporation would entitle him or her to a job, a share of corporate earnings, a place in corporate management, or some other form of security, would be oppressed in a very real sense when others in the corporation seek to defeat those expectations and there exists no effective means of salvaging the investment.57

Context of Oppression Remedy

Although dissent and oppression cases are sometimes grouped together, their nature is very different. Oppression is generally more personal. It often involves the loss of employment, exclusion from a close corporation that the stockholder may have helped build, or fallout between family members or business associates that results in the breaking up of a corporation. In contrast, dissent is generally less personal because it arises primarily from a financial decision in a corporation. Also dissenters' rights proceedings usually involve shareholders with small interests in a corporation.

There are some similarities between dissent and oppression cases. The primary similarity is that in most states they both use the fair value standard. Many courts understand the fair value definitions in the dissenters' rights statutes to carry over to the oppression statutes. Although the ALI asserts that fair value can be viewed differently for oppression and dissent, many courts disagree. For example, New Jersey's Supreme Court in Balsamides58 agreed with Washington's Supreme Court in Robblee59 that fair value in the oppressed shareholder context has the same meaning as in the dissenting shareholder context. In addition, many oppression and dissent cases cite each other for guidelines on how to deal with various elements of valuation.

Both oppression and dissent statutes and case law were developed to protect minority shareholders from being excluded or abused by the majority. In states where the oppression remedy is unavailable, oppressed shareholders may be entitled to exercise dissenters' rights. For example, reverse stock splits are often used to cash out minority shareholders by reducing the number of shares in a corporation so that certain members end up holding less than one share and are forced to sell it back to the corporation. The U.S. District Court for the Northern District of Illinois decided in Connector Service Corp. v. Briggs that the Delaware language governing reverse split cash-outs was similar to the language governing cash-out mergers and ordered the fair value of the oppressed shareholder's stock to be determined using the same criteria as in a cash-out merger.60 This conclusion is consistent with the Delaware decision in Metropolitan Life v. Aramark, which granted a quasi-appraisal remedy in a reverse split.61

Closely held corporations present an unusual situation requiring departures from the corporate norm. Shareholders in large publicly held corporations necessarily relinquish their control over daily activities to the board of directors, and only function to elect the board and vote on fundamental transactions. Shareholders who disagree with corporate management may elect a new board or they may sell their shares in the open market. In contrast, in a closely held corporation, shareholders often serve as directors and officers of the corporation and minority shareholders do not have the alternative of selling their shares on the open market. Thus, shareholder agreements that set out the transfer of shares, voting rights, and election of directors are necessary safeguards for investors in close corporations. In addition, as a result of their small size, many close corporations operate without all of the strict formalities normally required in the operation of public corporations. In fact, the close corporation in many ways resembles a partnership.

One characteristic of a closely held corporation is that its shareholders often are also employees. Minority shareholders frequently invest with the expectation of receiving a salary from employment and of participating in the profits of the corporation. When an employee is frozen out of a corporation, it means that although he or she remains a shareholder, management eliminates that shareholder's job. Additionally, the majority may elect to eliminate the payment of dividends when applicable. Although the minority shareholder's ownership interest remains intact, that shareholder no longer receives the benefits he or she has received historically and expects as part of his or her investment.

Furthermore, there is no necessity for the company to buy out the minority shareholder, as it costs the company little to keep the shareholder locked in.62 Alternatively, the minority shareholder may be compelled to accept an unfavorable price to gain liquidity.63 If, however, the control shareholders do use their majority votes to force a squeeze-out merger, the minority shareholders will then have the option to exercise their dissenters' rights and seek appraisal.

Freeze-Outs and Squeeze-Outs64

For public companies, freeze-outs are transactions in which minority shareholders are compelled to take cash for their shares, either in a cash merger or through a tender offer followed by a shortform merger. For private companies, the term freeze-outs covers compulsory buyouts as well as a broader range of actions by the controller. As Professor Moll wrote:

Through this control of the board, the majority shareholder has the ability to take actions that are harmful to the minority shareholder's interests. Such actions are often referred to as “freeze-out” or “squeeze-out” techniques that “oppress” the close corporation minority shareholder. Standard freeze-out techniques include the refusal to declare dividends, the termination of a minority shareholder's employment, the removal of a minority shareholder from a position of management, and the siphoning off of corporate earnings through high compensation to the majority shareholder. Quite often, these tactics are used in combination. . . . Once the minority shareholder is faced with this “indefinite future with no return on the capital he or she contributed to the enterprise,” the majority often proposes to purchase the shares of the minority shareholder at an unfairly low price.65

Dissolution as a Remedy for Oppression

Presently, certain events trigger the right to call for judicial dissolution of a corporation.66 Generally they fall under the categories of mismanagement, waste, fraud, or illegal acts by management and the board of directors. However, majority behavior does not necessarily have to be illegal or fraudulent to be unfair to a minority shareholder.

The shareholder oppression statutes are part of corporate dissolution statutes, which are the laws in place to provide guidelines for dissolving corporations. Dissolution statutes exist to provide procedures by which businesses may wrap up their business affairs and end their existence. Although, as noted above, most states use a combination of similar triggering events, the statutes are generally unique to each state.

Many states allow shareholder oppression as a triggering event for dissolution or a buyout of a claimant's shares.67 Most states allow the oppressed minority shareholder to file for judicial dissolution; in those that do not, the oppressed shareholder must seek relief in other ways, such as a suit for breach of fiduciary duty.68 Delaware does not include shareholder oppression in its dissolution statute.

Shareholder Buyouts as an Alternative Remedy

As long as dissolution was the primary remedy for oppressed minority shareholders, the courts were hesitant to find in favor of the minority shareholder. Oppressive conduct had to be egregious—a waste of assets or gross fraud or illegality. Dissolution is drastic because it results in the liquidation of the company and adversely affects employees, suppliers, and clients. An Alaska Supreme Court decision notes the problem:

Liquidation is an extreme remedy. In a sense, forced dissolution allows minority shareholders to exercise retaliatory oppression against the majority. Absent compelling circumstances, courts often are reluctant to order involuntary dissolution. . . . As a result, courts have recognized alternative remedies based upon their inherent equitable powers.69

Dissolution remained the statutory remedy until the states began to institute buyout provisions for the shares of oppressed shareholders.70 In 1941, California was the first state to institute a buyout provision; its statute71 provided an option for a corporation to offer petitioning minority shareholders the fair cash value for their shares in lieu of dissolution.72

In 1973, the Oregon Supreme Court ruled that “for ‘oppressive' conduct consisting of a ‘squeeze out' or ‘freeze out' in a ‘close' corporation the courts are not limited to the remedy of dissolution, but may, as an alternative, consider other appropriate equitable relief.”73 The expressly permitted alternative is “[t]he ordering of affirmative relief by the entry of an order requiring the corporation or a majority of its stockholders to purchase the stock of the minority stockholders at a price to be determined according to a specified formula or at a price determined by the court to be a fair and reasonable price.”74 The decision proved highly influential, as many other states accepted the reasoning of the Oregon court and permitted buyouts as an alternative to dissolution.75 A 1991 revision to the RMBCA introduced the compulsory buyout for shareholders filing for dissolution. By that time, the fair value buyout as an alternative remedy was already in use in some states, such as New York.

Several judicial remedies for the oppressed shareholder have emerged. If the court finds oppression, it can order a wide variety of remedies, including an equitable distribution of the proceeds of a court-ordered liquidation or a compulsory buyout of the oppressed shareholder(s) shares at a court-determined fair value.76 When the court orders a buyout, the price to be paid for the minority shares is judicially determined under the fair value standard.

If there is a chance the corporation will be found to have committed acts of oppression, fraud, mismanagement, abuse, or if the corporation anticipates dissolution being the outcome of the court proceeding, or if the corporation wants to avoid the court proceeding altogether, it may elect to purchase the petitioner's shares at their fair value within the statutory time frame.77 In this case, the dissolution proceeding will be put on hold (but not terminated) until an equitable settlement has been negotiated. One New York court pointed out that “once the corporation has elected to buy the petitioning stockholders' shares at fair value, the issue of majority wrongdoing is superfluous.”78 In addition, if the corporation elects the buyout, it may avoid the “equitable adjustments” the court might make in a case where wrongdoing is found, as well as other costs associated with a court proceeding.

In the buyout remedy, the company may elect to buy out the shareholder at fair value before a proceeding occurs, or the court can go forward with the proceeding. This leaves four scenarios when oppression is alleged:

As we have noted, in states with an election, if the election process does not succeed in reaching a value for the minority shares that is acceptable to both sides, the court may order a compulsory buyout of the minority shares. As Professor Moll describes it:

Election provisions are designed to serve as a counterbalance to the dissolution-for-oppression statutes. Although an aggrieved investor is entitled to petition for dissolution of a company on the ground of oppressive conduct, shareholders who wish to continue the business may elect to buy out the petitioner's ownership stake to avoid any risk of dissolution. Thus, the purpose of the election provisions is to provide the remaining shareholders with a mechanism for continuing the business and, relatedly, to safeguard against the risk of dissolution. In operation, an election usually circumvents any liability inquiry and converts an oppression lawsuit into a mere valuation proceeding. Indeed, because an election often occurs before a court has made a finding of oppression, the election statutes, in most instances, effectively create a no-fault “divorce” procedure. The company at issue continues as a going concern under the control of the majority shareholder, the allegedly aggrieved investor is cashed out of the business, and no finding of wrongdoing is made by the court.79

In cases of appraisal pursuant to a dissent action, an individual should receive the undiscounted proportionate value of the company as a going concern. In an oppression action, there are many other considerations caused by the degree of oppression and misconduct by the majority.

Exhibit 3.2 lists the states that have a buyout option in oppression cases and those that do not.

EXHIBIT 3.2 Availability of Buyout Remedy in Judicial Dissolution of Close Corporations by State

The generic terms closely held corporation or close corporation refer to privately held corporations formed under a state's regular business corporation statutes. A company is not a statutory close corporation unless it elects that status. As shown in Exhibit 3.2, the buyout option is offered only to statutory close corporations in some states, whereas in other states such an option is additionally available to all close corporations.

Statutory close corporations share the attributes of almost all close corporations: they are privately held, cannot make public offerings of stock, and shares are most often held by the owners/managers of the business and their families.80 In addition, when shareholders die or wish to liquidate their interests, remaining shareholders or the company itself usually will purchase the shares.

Statutory close corporations are not heavily utilized, but the relevant statutes contain provisions that relate to the standard of value,81 and they may differ from other closely held corporations both in those standards and in the remedies they provide. Only certain states provide statutory close corporation shareholders with dissolution as a remedy for oppressive or illegal conduct; others provide them with a buyout election in lieu of dissolution. Valuators involved in oppression cases need to work closely with counsel in the appropriate jurisdiction to understand the legal status of the entity in which they are valuing shares and to know what standard of value is applicable.

Examples of Oppression

Reasonable Expectations

More than 20 states use a “reasonable expectations” standard for oppression.82 A breach of reasonable expectations was established as a fundamental determination of oppression based on the 1980 New York case Topper v. Park Sheraton Pharmacy,83 one of the earliest cases in which the court ordered a buyout as an alternative remedy. In this case, the court found that the plaintiff's reasonable expectations were violated by an intentional freeze-out and ordered the buyout of his shares.

In a Connecticut case, the plaintiff sought to dissolve a corporation as tensions became high among the doctors in the corporation.85 The plaintiff claimed she was entitled to a fair value of $338,000 as her share, but the shareholders' agreement stated that she was entitled to the net book value of the assets she had contributed to the corporation, a little over $13,000. No oppression was found by the court, and the court found it was not inequitable or unfair under the circumstances to look to the stockholders' agreement for a determination of value. This case indicates that maintenance of and adherence to a shareholders' agreement provides a certain amount of clarity as to shareholder expectations, as long as a particularly egregious breach of the agreement has not occurred.

Breach of Fiduciary Duty

The failure of the control shareholders to fulfill their fiduciary duties to the minority can be deemed to be oppression. According to Matheson and Maler, “twelve states have adopted a fiduciary duty approach that, for the most part, is expansive and could be employed to reach the same result as the reasonable expectations standard.”86 A landmark Massachusetts case offering relief to oppressed shareholders, Donahue v. Rodd Electrotype,87 established that a breach of fiduciary duty (the obligation owed to minority shareholders by the majority) may determine whether shareholder oppression has occurred.88

Heavy-Handed, Arbitrary, or Overbearing Conduct

Illinois uses the standard of heavy-handed and arbitrary or overbearing conduct to determine whether oppression has occurred. This definition leaves great discretion to the court's judgment on oppressive conduct. The standard was established by a 1972 Illinois case, Compton v. Paul K. Harding Realty Co.89

FAIR VALUE IS THE STANDARD OF VALUE IN APPRAISAL AND OPPRESSION IN ALMOST ALL STATES

Fair Value as Defined by Various Authorities and Statutes

Professors Lawrence Hamermesh and Michael Wachter write that in Delaware “the measure of ‘fair value' in share valuation proceedings is superior, in both fairness and efficiency, to its two main competitors, [fair] market value and third-party sale value.”91 They posit that the fair value standard is fairer to opposing parties in a dispute than either fair market value or third-party sale value because fair value attempts to balance the dangers that lie in either direction: on one side, that of awarding a windfall to an opportunistic controller who has forced out the minority shareholders; on the other side, incentivizing litigation by minority shareholders attempting to capture value from controllers whose energies and abilities have resulted in increased company value through a synergistic transaction. These writers suggest that fair value strikes the best balance in the attempt to value what was taken from the minority by awarding them the pro rata share of the existing company's going-concern value. Going-concern value is the present value of the cash flows to be generated from the corporation's existing assets plus its reinvestment opportunities.92

Fair value is the standard of value for appraisal in 47 states and the District of Columbia.93 State statutes vary, but most draw inspiration from the MCBA (1969) and the later RMBCAs (1984 and 1999). In order to address the fair value standard, we look at the definitions in the various iterations. The 1969 MBCA set out that “fair value” was to be the measure by which the minority shareholder was to be paid for his or her shares, but it provided no details on fair value's definition. It stated that:

[S]uch corporation shall pay to such shareholder, upon surrender of the certificate or certificates representing such shares, the fair value thereof as of the day prior to the date on which the vote was taken approving the proposed corporate action, excluding any appreciation or depreciation in anticipation of such corporate action.94

In 1984, the ABA issued the RMBCA, which added important additional concepts to the definition of fair value. It excluded from the value of minority shares the synergy value of the objected-to transaction “unless exclusion would be inequitable.” It reads:

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 [added language in italics].95

The 1984 definition provides a guideline, however nonspecific, by which fair value should be determined. The company should be valued on the day before the corporate action occurs without any of the effects of the action unless their exclusion would be unfair. The passage does not give instructions on what method or valuation technique should be utilized to determine the fair value, nor does it define inequitable. Twenty-one states96 currently use this exact definition of fair value. The intentional ambiguity in this definition allows for wide interpretation of the assumptions that underlie this standard of value. Comments published by the ABA explain that this definition leaves the matter to the courts to determine “the details by which fair value is to be determined within the broad outlines of the definition.”97

While insuring that the courts have wide discretion, this ambiguity can create confusion on the part of appraisers and appraisal users. Valuation professionals are well advised to discuss this with counsel so as to come to an understanding of the specific interpretation relevant to their state or appropriate jurisdiction.

Although most state statutes use the RMBCA's definition of fair value, six states have utilized the ALI's concept of fair value in case law.98 In the Principles of Corporate Governance, published in 1992, the ALI defined fair value as:

. . . the value of the eligible holder's proportionate interest in the corporation, without any discount for minority status or, absent extraordinary circumstances, lack of marketability. Fair value should be determined using the customary valuation concepts and techniques generally employed in the relevant securities and financial markets for similar businesses in the context of the transaction giving rise to appraisal.99

In 1999, following the development of substantial case law on dissent and oppression, as well as the publication of the ALI's Principles of Corporate Governance, the RMBCA was revised so that the definition of fair value reads:

The value of the shares immediately before the effectuation of the corporate action to which the shareholder objects using customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal, and without discounting for lack of marketability or minority status except, if appropriate, for amendments to the certificate of incorporation [added language in italics].100

The 1999 RMBCA definition mirrors the ALI's Principles of Corporate Governance in that it adds two important concepts to the framework: the use of customary and current valuation techniques, and the rejection of the use of marketability and minority discounts except, “if appropriate, for amendments to the certificate of incorporation pursuant to section 13.02(a)(5).”101 (The exception permitting discounts for amendments to the certificate of incorporation is minor in impact.) The dissenters' rights statutes of 11 jurisdictions currently follow this definition.102

Other states, including Delaware, have developed their own definitions of fair value or have used different standards of value in their statutes. For example, although New Jersey has used fair value as its statutory standard for appraisal since 1968,103 its oppression statute includes a clause that allows for “equitable adjustments.”

Only three states—Louisiana, Ohio, and California—do not explicitly use the phrase fair value for dissenters' rights. Louisiana and Ohio use fair cash value, but with different meanings. Ohio's appraisal standard is unfavorable to dissenters, as discussed later in this chapter under “Ohio's Unique and Unfavorable Standard of Value in Appraisals.” In contrast, the Louisiana statute's wording is favorable: “‘[F]air cash value' means a value not less than the highest price paid per share by the acquiring person in the control share acquisition [emphasis added].”104 Thus, a Louisiana court may determine that the value is higher than the transaction price, but the dissenter cannot receive less.

California uses the term “fair market value” in dissent (but not in oppression). Its dissent statute states:

The fair market value shall be determined as of the day before the first announcement of the terms of the proposed reorganization or short-form merger, excluding any appreciation or depreciation in consequence of the proposed action, but adjusted for any stock split, reverse stock split, or share dividend which becomes effective thereafter.105

The dissolution statutes in California and Alaska permit payment of fair value in lieu of dissolution, and both state:

The fair value shall be determined on the basis of the liquidation value as of the valuation date but taking into account the possibility, if any, of sale of the entire business as a going concern in liquidation.106

The term fair value in liquidation, as used in California and Alaska, is unusual since most states attempt to determine fair value in oppression circumstances under the assumption that the business will continue to operate as a going concern.

The diversity among states in their definitions of fair value combined with the complexity of each state's statutes compels valuation experts to consult with counsel for guidance before undertaking their fairness assessment.

As noted earlier, the majority of states use all or part of the RMBCA's definition of fair value. This definition involves several components, and in order to understand the requirements of the definition, it is important to break it down and understand each component separately.

THE VALUATION DATE—BEFORE THE EFFECTUATION OF THE CORPORATE ACTION TO WHICH THE SHAREHOLDER OBJECTS

In both appraisal and oppression cases, the valuation date is a critical component that can significantly affect a court's ultimate fair value assessment. This portion of the definition suggests a time frame for the valuation: it instructs the court to set a valuation date immediately prior to the corporate action from which the shareholder dissents. Most states follow the RMBCA and say that valuation should reflect the value on the day before the corporate action occurred or was voted on to which the shareholder dissents. This indicates that the shareholder should not suffer or benefit from the proceeds or effects of the transaction from which he or she dissented.

Valuation Date in Appraisal Cases

In appraisal cases, state statutes instruct the court as to the appropriate valuation date. Most states define the valuation date as the day of, or the day before, the effectuation of the corporate action from which the shareholder dissents. However, some states define the valuation date as the day of or the day before the shareholder vote.107 California is an anomaly: it uses day before the transaction was announced as the valuation date.

Although the date of effectuation of the corporate action is the valuation date in appraisal cases, what may be considered in the determination of fair value is often at issue. The general rule is that all information that is known or knowable as of the valuation date is generally to be considered. The Tri-Continental case, more than 60 years ago, stated that “facts which were known or which could be ascertained as of the date of merger” must be considered, as these are essential in determining value.108

In a few cases, events occurring after the valuation date have been used as a “sanity test” to check the validity of the corporate transaction valuation date fairness calculation. For example, in Lane v. Cancer Treatment Centers, the court allowed postvaluation date discovery for a year after the action to test the assumptions underlying a pre-merger discounted cash flow (DCF) calculation.109

In Lawson Mardon Wheaton, the lower courts refused to consider a post-event acquisition price.110 The New Jersey Supreme Court, recognizing that Delaware had allowed the use in appraisal of certain post-merger information in order to better determine fair value at the time of merger,111 decided to permit the consideration of certain post-event information.112 The dissenter's assertion was that the trial court's fair value of $41.50 per share in 1991 was questionable because, in 1996, an acquisition price of $63 per share was offered. The court reasoned that the value of $41.50 per share in 1991, when the company was doing well, should be questioned in light of an actual sale in 1996 at $63 per share when the company's performance was poorer.

Valuation Date in Oppression Cases

In oppression, similarly as in appraisal, the valuation date is crucial to the fair value determination.

“The [court's] determination of fair value [in oppression cases] is also critically influenced by the choice of the valuation date. . . . The question is of enormous consequence to the relevant parties, as a company's value is affected by internal and external factors that can materially change over a short period of time. The designation of the valuation date therefore is an important inquiry in and of itself, as the choice of date can significantly affect a court's ultimate fair value conclusion.”113

The issues concerning the valuation date differ, but are equally important to the relief or the remedies for the oppressed shareholder. The valuation date for fair value will be the same when (a) the state statute or court permits the company or its majority shareholders to attempt to avoid trial by electing to purchase the dissenter's shares, or (b) no such election is made (or statutorily permitted) and the court finds oppression and orders a compulsory buyout as a remedy.

The RMBCA suggests that the court should “determine the fair value of the petitioner's shares as of the day before the date on which the [dissolution] petition . . . was filed or as of such other date as the court deems appropriate under the circumstances.”114 Three types of valuation dates may be used, and there are debates as to which is appropriate and under what circumstances. The date used in a substantial majority of fair value determinations is the date of filing (or the preceding day).115 This date not only has the virtue of clarity and simplicity––it also embodies the notion that the minority shareholder has kept his shareholder status in the company as long as he chose to do so before feeling compelled to exit because of oppressive majority behavior.

The second most frequently used valuation date is the date of oppression, which may be much more difficult to determine. Since oppressive conduct usually occurs not on a single date but over a period of time, the court may have to assess when the most severe acts of oppression occurred in order to select a valuation date. Although this complicates the date of oppression, Moll posits that courts are competent to evaluate the evidence and to choose a date when the most damaging oppressive conduct occurred.116

The third alternative is a post filing valuation date (i.e., the trial date, the judgment date, or the date a buyback order is issued). Moll points out the flaws in using a post-filing valuation date:

A presumptive post filing valuation date is problematic, however, because the parties' actions will be influenced by the litigation context. In addition, . . . if the valuation period extends through (and potentially beyond) the date of trial, experts may be unable to draw final conclusions about a company's value by the time their reports are due, by the time their deposition testimony is required, and perhaps even by the time their trial testimony is needed.117

The arguments among these different valuation dates differ depending on whether election is permitted in the state in which the oppression occurred. When the company or majority is permitted to elect to buy out dissenters' shares, the argument for the use of the date of filing is strong. As Moll explains:

[S]hareholders who wish to continue the business may elect to buy out the petitioner's ownership stake to avoid any risk of dissolution. . . . [B]ecause an election often occurs before a court has made a finding of oppression, the election statutes, in most instances, effectively create a no-fault “divorce” procedure. . . . [T]he allegedly aggrieved investor is cashed out of the business, and no finding of wrongdoing is made by the court.118

In nonelection cases, the arguments on balance are more persuasive for using the date of oppression. Since the majority has frustrated the oppressed shareholder's reasonable expectations and forced him or her into a non participatory role, it can be argued that adverse changes in the company's value post-freeze-out (or other oppressive act) should not be borne by the oppressed shareholder. Moll writes:

The logical consequence of this argument is that a court should set the valuation date as close as possible to when the oppressive exclusion from management occurred, as that date signifies when the majority decided that the minority's participation would cease.119

In a variation of setting the valuation date as the date of oppression, some courts view the date of a specific act of oppression as the appropriate valuation date. When this has been done, it has depended on the specific facts and circumstances of the case. For example, a Washington court ruled that “‘fair value' means the shares' value at the moment just before the majority committed misconduct.”120A federal court concluded, “In cases of minority stockholder oppression, the date of ouster seems appropriately used.”121

However, in nonelection cases, Moll argues that the use of the filing date can be justified as a means of allowing an oppressed shareholder the ability to benefit from increases in the value of the business:

[T]he date of filing is defensible as the presumptive valuation date to the extent that it is deemed to reflect the “unofficial” end of a plaintiff's shareholder status. Up until that point, the oppressed investor was entitled, as a shareholder, to participate in any changes in the company's value. It is important to note that this rationale can work both for and against a plaintiff shareholder, as changes in the company's value from the date of oppression to the date of filing can encompass losses as well as gains.122

[However,] no one will ever know with certainty what would have happened because the majority oppressively denied the minority an opportunity to participate. Because this uncertainty stems from the majority's conduct, it is appropriate to resolve the uncertainty against the majority's interests. If a company experienced post oppression losses, a court could legitimately presume that the minority's managerial participation would have prevented the decline. On this basis, a court could decide that the minority does not have to share in the losses.123

Although valuation dates vary not only among states but sometimes within states where the courts may use their discretion, “the date of filing of the oppression action is usually designated as the presumptive valuation date.”124

CUSTOMARY AND CURRENT VALUATION TECHNIQUES

As a result of numerous fair value cases, a considerable body of law suggesting various methodologies to arrive at fair value emerged in the twentieth century. One such well-known methodology is the Delaware block method. Midway through the twentieth century, the Delaware block method was often used for determining value in the context of appraisal rights,125 and was relied on almost exclusively by the Delaware courts until 1983. This method was also adopted in several other states that tended to rely on Delaware cases related to corporate law.

The Delaware block method weights a company's investment value (based on earnings and dividends), market value (usually based on its public trading price, guideline public company information, or guideline transaction information), and asset value (usually the net asset value based on current value of the underlying assets). These individual values are determined and then assigned a weight selected by the valuator to compute the fair value.126 Many viewed the Delaware block method as mechanistic and not reflective of the techniques regularly employed by those in the financial community.

In 1983, the Delaware Supreme Court's landmark Weinberger decision127 enunciated the concept that a company could be valued using alternative methods customarily employed by the financial community, rather than relying on the long-established Delaware block method.

Weinberger did not immediately do away with the use of the Delaware block method, but it is now rarely used in practice either in Delaware or elsewhere. Weinberger allowed widely accepted alternative valuation procedures to be used, as well as industry-appropriate valuation techniques. The appropriate valuation method is not the same in every case. It is likely that a court will use the most relevant evidence presented to it to determine value. As customary techniques have evolved, so has the case law. The Delaware block method looked only at historical data, and the courts now prefer forward-looking approaches in determining fair value. As a result, the discounted cash flow method is widely used in dissenting shareholder cases.

The ALI's Principles of Corporate Governance and the ABA's model statutes recommend that fair value be determined using the customary valuation concepts and techniques generally employed for similar businesses in financial markets. As corporations have different underlying assets, no universal technique of measurement can cover all industries. Therefore, it is necessary to allow flexibility in valuation so that the valuation professional and the courts can use their best judgment to find equitable outcomes.131

Exhibit 3.3 addresses the statutory guidance provided for determining fair value (or other standard of value) in states whose statutes include the use of customary and current valuation concepts and techniques, all relevant factors, or other guidance relating to the method of valuation.

EXHIBIT 3.3 Guidance Provided by Statutory Language with Respect to Valuation Techniques

The Weinberger court's directive that all methods typically used by the financial community be considered in these matters resulted in courts permitting the use of a number of methodologies recognized by the financial community. The primary methods that have been considered include:

• Discounted cash flow (DCF)—the income approach. Weinberger used the discounted cash flow method in its departure from the standard Delaware block method. The DCF methodology is widely used in the determination of fair value, especially in Delaware. In the 1995 Kleinwort Benson decision, the Delaware court concluded that DCF was a better way of determining the value of a corporation than a market-based approach, and it stated that the DCF method should have greater weight because it values the corporation as a going concern, rather than comparing it to other companies.132 In Grimes v. Vitalink, the Court of Chancery stated that the “discounted cash flow model [is] increasingly the model of choice for valuations in this Court,”133 and in Gholl v. eMachines, Inc., it pointed out that DCF “is widely accepted in the financial community and has frequently been relied upon by this Court in appraisal actions.”134
• Guideline methods—the market approach. These methods involve valuing a privately held company based on multiples generated from the market prices of guideline public companies' traded shares (the guideline or comparable company method) or from guideline transactions involving both public and private companies (the guideline or comparable transaction method).135 Those values can vary greatly depending on the selection of companies and on their similarity to the subject company. Although courts often rely more heavily on DCF, the market approach continues to be widely used.
• Asset value. Asset value is seldom used in appraisals. Paskill prohibited using a net asset value method alone for purposes of an appraisal of a going concern in Delaware because a going concern's liquidation value cannot be considered in appraisal.136 However, asset value may be given an appropriate weight in limited circumstances. For example, a real estate company was valued primarily on its asset value in Ng v. Heng Sang Realty Corp.137
• Excess earnings method. The excess earnings method has rarely been employed in fair value cases. In Balsamides, however, the excess earnings method was used by the plaintiff's expert, who stated that the defendants would not provide the information needed to employ any other method.138 The excess earnings method has not been addressed in Delaware.
• Rules of thumb. Rules of thumb are seldom accepted by courts as a valuation method. There are rare exceptions: For example, in a Delaware case, the court accepted value per recoverable ton of coal reserves as a valuation method;139 a Louisiana court valued an alarm company at a multiple of its monthly revenues.140

It is common for courts to consider more than one method. In the U.S. District Court's Steiner decision (applying Nevada law),141 the court weighted various methods in order to find a fair value of the stock. First, it looked to find enterprise value, weighting a DCF valuation 30% and what it called a mergers-and-acquisitions method 70%. To find market value, the guideline company method was considered. Then enterprise value and market value were weighted 75% and 25%, respectively.

The Delaware Court of Chancery has explicitly used weighting in some cases as well. For example, the court in Andaloro weighted DCF at 75% and comparable companies at 25%.142 In U.S. Cellular, the weighting was 70% DCF, 30% comparable acquisitions.143 In Dobler, the court gave a 30% weight to DCF, 5% to comparable companies, and 65% to comparable acquisitions.144

Courts tend to prefer analyses that use more than one valuation approach. A valuation supported by several independent indicia of value is considered more reliable than one by an expert who “does not even attempt to perform reasonableness checks upon his valuation.”145 In Hanover Direct, the court criticized an expert who used only DCF and stated, “If a discounted cash flow analysis reveals a valuation similar to a comparable companies or comparable transactions analysis, I have more confidence that both analyses are accurately valuing a company.”146

Courts have often used the guideline company method when DCF could not be utilized because of the unavailability of adequate projections. In Borruso, the court was limited to using a multiple of comparable companies' revenues, as there was insufficient information to adequately apply any other multiple or method.147 In Doft, the court rejected both experts' DCF analyses because the projections were unreliable148 and relied on the EBITDA multiples and P/E ratios of comparable companies.149 The U.S. District Court, applying Delaware law in Connector Service, noted that a multiple of EBITDA was a better method than DCF because the EBITDA multiple was based on the multiples used by the subject company itself in two prior acquisitions.150

The MBCA excludes “any appreciation or depreciation in anticipation of the corporate action.”151 Delaware prescribes that fair value excludes “any element of value arising from the accomplishment or expectation of the merger or consolidation.”152 This requires valuing the company as if the corporate action had not taken place.

FAIR VALUE IN DELAWARE

Delaware Fair Value Standards

Fair value for both appraisal and entire fairness in Delaware is a pro rata portion of the value of the company as a going concern. The Delaware Supreme Court developed the standards for valuations in appraisal and entire fairness cases in four seminal cases: Tri-Continental (1950),153 Sterling v. Mayflower (1952),154 Weinberger (1983),155 and Cavalier Oil Corp. v. Harnett (1989).156

• Tri-Continental described fair value as that which has been taken from the shareholder and stated that fair value should be determined based on facts known or knowable at the valuation date.
• Sterling v. Mayflower stated that the proper test of fairness was whether the “minority stockholder will receive the substantial equivalent in value of the shares he held [emphasis added].”157
• Weinberger permitted the use of valuation techniques customarily accepted in the financial community and endorsed forward-looking valuation approaches.
• Cavalier confirmed that discounts for lack of marketability or minority interest should not be applied in calculating fair value.

Subsequent case law is based on these principles. Numerous decisions interpreting Delaware's appraisal statute158 have further clarified how fair value is to be determined and have explained which factors should be considered and excluded. We discuss these developments in this section.

Entire Fairness in Delaware

When a minority shareholder believes that he/she has been treated unfairly and/or that there is a conflict of interest, such as in a freezeout conducted by an opportunistic controller, the minority shareholder may file a breach of fiduciary duty “entire fairness” action against the majority (the controlling shareholder(s)). Simply put, entire fairness cases are transactions in which the controllers have breached their fiduciary duties to shareholders, often in squeeze-out mergers. Hamermesh and Wachter point out that “the ‘fair price' component of the ‘entire fairness' standard mirrors the definition of ‘fair value' as articulated in the appraisal cases” and that the Delaware courts generally use the same valuation analysis for evaluating entire fairness that they use for appraisals.159

Delaware does not have a shareholder oppression statute, but the failure of control shareholders to fulfill their fiduciary duties to the minority is, in many ways, analogous to oppression. Thus, in Delaware, the legal action is not governed by an oppression statute but is addressed by the courts in fairness cases. If the Delaware Court finds that the controlling shareholder breached his fiduciary duties by being conflicted and obtaining benefits for himself that were not shared with the minority shareholders, such as being on both sides of a deal or negotiating a special price for himself or some group, the court will impose a very strict scrutiny review in its consideration of whether the transaction was fair to the minority shareholders. This standard is called the entire fairness standard (“entire fairness”) and is “Delaware's most onerous standard.”160

The court will proceed to examine the transaction by looking at how the majority treated the minority in regard to two prongs of fairness: fair price and fair dealing. Entire fairness thereby encompasses not only “‘fair price' but also ‘fair dealing'—the timing and structure of negotiations and the method of approval of the transaction.”161 Weinberger states:

The concept of [entire] fairness has two basic aspects: fair dealing and fair price. The former embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained. The latter aspect of fairness [fair price] relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock.162

When the Court is asking whether the majority engaged in “fair dealing,” it is focusing on procedural fairness. The Court of Chancery, in deciding whether the majority has acted with procedural fairness and can thereby satisfy the “fair dealing” prong of an entire fairness review, assesses whether it meets three requirements:

(a) a disinterested and independent special committee, which has sufficient authority and opportunity to hire its own independent advisors and to bargain on behalf of the minority stockholders, must recommend the transaction, and

(b) the transaction must be subject to a non-waivable condition of approval by a majority of the minority stockholders based on disclosure that contains no material misstatements or omissions, and

(c) the controlling stockholder must not have engaged in threats, coercion, or fraud.163

A judicial determination of lack of entire fairness means that the controllers and/or directors have violated the duty they owed to the shareholders. If the shareholders establish that the board has violated the duty of fairness, the consequences are that the Delaware courts may decide whether to include adjustments or damage claims along with their determination of fair value. In such cases, the measure of damages may exceed the determination of fair value.164 The Weinberger court looked at the case of damages in fair value through the perspective of the appraisal statutory requirement of “all relevant factors.”165 It stated:

When the trial court deems it appropriate, fair value also includes any damages, resulting from the taking, which the stockholders sustain as a class. If that was not the case, then the obligation to consider “all relevant factors” in the valuation process would be eroded.166

Weinberger points out that the key difference between the appraisal remedy and the remedy in a fairness case is that an appraisal award must be in cash, while the Court of Chancery may award “any form of equitable and monetary relief as may be appropriate” in a fairness case.167 It may, as damages or equitable remedies, order (or permit) payment in stock, grant rescission, or provide other forms of equitable compensation and relief.

The following two cases, Seagraves v. Urstadt Property168and Bomarko v. International Telecharge,169 deal with decisions based on the corporation's lack of entire fairness to minority shareholders.

Components of Fair Value in Delaware

Fair Value Is Proportionate Share of Equity Value

The Delaware appraisal statute states:

[T]he Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation. . . . In determining such fair value, the Court shall take into account all relevant factors.172

Interpreting the statute, the Delaware Court of Chancery ruled in 1988 that a dissenting shareholder was entitled to a pro rata share of the equity value of the company:

Under §262 [of the Delaware General Corporation Law], the dissenting shareholder is entitled to his proportionate interest in the overall fair value of the corporation, appraised as a going concern. The amount of the holdings of a particular dissenting stockholder is not relevant, except insofar as they represent that shareholder's proportionate interest in the corporation's overall “fair value.” That a particular dissenting stockholde`r's ownership represents only a minority stock interest in a corporation is, therefore, legally immaterial in determining the corporation's “fair value.”173

The Delaware Supreme Court upheld the lower court's Cavalier decision in 1989, pointing out that if minority shareholders were not to receive “the full proportionate value,” the majority shareholders would “reap a windfall.”174

[T]o fail to accord to a minority shareholder the full proportionate value of his shares imposes a penalty for lack of control, and unfairly enriches the majority shareholders who may reap a windfall from the appraisal process by chasing out a dissenting shareholder, a clearly undesirable result.175

The two Cavalier decisions support the pro rata share concept that in an appraisal the minority shareholder should not receive a lesser price for his shares because he does not share in the exercise of control of the corporation. Giving proportionate value to minority shareholders means that the controller cannot benefit disproportionately from forcing out the minority at a diminished price. This thinking explains Delaware's position that fair value permits neither a discount for lack of marketability nor a minority discount.

Fair Value Is Going-Concern Value

The Delaware courts have consistently held that the best measure of fair value is going-concern value.176 In Delaware, the concept of going-concern value is based on earnings from existing assets plus the value of anticipated reinvestment opportunities.

[G]oing concern value must include not only the discounted free cash flow to be generated by the corporation's current assets, but also the discounted free cash flow to be generated by the reinvestment opportunities anticipated by the corporation.177

A Delaware company is appraised as it exists at the transaction date, inclusive of its anticipated reinvestments. This concept of going-concern value is often referred to as operative reality. Recently, in Just Care (2012), the court wrote:

A company “must be valued as a going concern based upon the ‘operative reality' of the company as of the time of the merger.” In an appraisal proceeding, “the corporation must be valued as a going concern based upon the ‘operative reality' of the company as of the time of the merger.”178

Going-Concern Value Is Based on How the Company Is Being Managed Prior to Merger

An important part of operative reality is how the company is being managed at the time of the transaction. A company being appraised is valued “as is” under its current management, not as it might be run by a different party:

The company, with all of its warts and diamonds, is valued in terms of the discounted free cash flow generated by the company's assets and reinvestment opportunities. In measuring the value of the warts and diamonds, the warts are valued as warts and the diamonds as diamonds. The minority shareholders cannot claim that if the company was run differently, or if a third party owned it, the warts would become diamonds. That may be correct as a factual matter, but it is irrelevant to the valuation issue. The minority's claim is equal to the value of the shares into the future, and that value is a mix of the existing warts and diamonds.179

However, it is important to note that some “warts” can be disregarded as discussed later in this section in “Fair Value Includes Changes Contemplated by Management” ahead.

Management's plans, not those of an independent acquirer, are a company's operative reality. When a third-party buyer projected a higher growth rate for the target than did the target's management, the court determined that the appropriate input for the court's DCF calculation in an appraisal was the growth rate expected by the target's CEO and principal shareholder, not the buyer's expectation.180 Similarly, a company should be valued on its existing capital structure rather than on an optimal capital structure or the buyer's plans.181

Actions planned by existing management prior to a squeeze-out merger are part of operative reality. Although Delaware normally excludes actions planned by a third-party acquirer before it acquires control, there is an important exception. If control actually changes hands before a second-stage merger (a merger that squeezes out any minority shareholders whose shares were not acquired in an initial tender or exchange offer), the new control party's plans may be taken into account. In the long-running Technicolor case, the Supreme Court ruled in 1996 that dissenting shareholders were entitled to benefit from changes being made or planned by a new management that had assumed control prior to the valuation date.182 The non-tendering shareholders were bought out in the second-stage merger at the same price that had been paid for the bulk of the shares in November 1982 pursuant to a friendly tender offer by MacAndrews & Forbes. By the time the squeeze-out merger was consummated in January 1983, MacAndrews & Forbes had taken operating control. The Supreme Court ruled that MacAndrews & Forbes's plan, which involved disposing of certain unprofitable operations and increasing profit margins, was the operative reality and that the projections based on that plan should be the basis for the valuation.

The Court of Chancery relied on the 1996 Technicolor decision in Delaware Open MRI, writing, “The expansion plans for Delaware III were clearly part of the operative reality of Delaware Radiology as of the merger date and under Technicolor and its progeny must be valued in the appraisal.”183 It ruled:

The decision of [the control group] to cash out the [dissenters] at a price that did not afford it any of the value of the gains expected from [the additional MRI Centers] clearly bears on the fairness of the merger. Not only that, if the concept of opening [them] was part of the business plans of Delaware Radiology as of the merger date, then the value of those expansion plans must be taken into account in valuing Delaware Radiology as a going concern.184

The court added that “when a business has opened a couple of facilities and has plans to replicate those facilities as of the merger date, the value of its expansion plans must be considered in the determining fair value.”185

The court may, however, reject the projected benefits of a planned expansion if it deems the project to be too speculative. In a case appraising a company that operated a prison health-care facility in South Carolina, the financial projections included renovating a Georgia prison as a medical detention facility. The Court of Chancery distinguished this expansion from Delaware Open MRI and rejected the portion of the projection that related to the Georgia facility:

I find that the Georgia Case was too speculative to be included in the valuation of the Company as of the merger date. . . .[E]ven if the new facility was successful, there was a risk that Georgia would move its prisoners currently housed at the Columbia Center back to Georgia, thereby reducing the value of the Columbia Center.186

Just Care could not undertake the expansion unilaterally without a decision by Georgia to move forward. The fact that the Company was focused on expanding into Georgia and had taken actions in furtherance of that goal is insufficient to make the Georgia Case part of Just Care's operative reality.187

The court did accept Just Care's planned expansion of its existing South Carolina facility but probability-weighted the calculated DCF value because of the uncertainty as to whether the state's Department of Correction would proceed with the project. To risk-adjust the planned expansion, the court deducted 33.3% from the calculated value.188

Fair Value Excludes Synergies Resulting from the Transaction but Includes Synergies Obtainable by Current Controller

In Delaware, the fair value standard does not permit the benefits of synergies resulting from a transaction to be included in a going-concern valuation:

[S]ynergies dependent on the consummation of an arm's-length acquisition or combination may not contribute to “fair value” in appraisal proceedings. Similarly, we conclude that operating efficiencies that arise from the acquirer's new business plans are not properly included in determining “fair value,” as long as they are not operationally implemented before the merger, even though they derive solely from the enterprise's own assets.189

The Delaware Supreme Court has stressed that the value of synergies imbedded in a third-party purchase price should be excluded:

In performing its valuation, the Court of Chancery is free to consider the price actually derived from the sale of the company being valued, but only after the synergistic elements of value are excluded from that price [emphasis added].190

Under the going-concern “operative reality” concept, the court did not include the benefits to a near-bankrupt airline of the transaction's cancellation of preferred stock, a debt restructuring, and a planned capital infusion. The court declined to credit the existing shareholders for benefits that could not have been achieved without the transaction. The acquirer's future plans and projections assumed the closing of the merger, which was conditioned on concessions from creditors and the infusion of new capital. The court followed the practice of excluding from fair value any gains that would not occur but for the transaction. The court noted:

[T]he Concessions were not being implemented—and thus were not an “operative reality”—as of the merger date. On that date the only “operative reality” was that the parties had entered into a contract which provided that the Concessions would become operative if and when the merger closed.191

Another example of a situation where the dissenter could not benefit from the consequences of the transaction was when shareholders of a real estate corporation were squeezed out in order to convert a C corporation into an S corporation. The prospective tax benefits from the conversion were excluded from fair value because they could not have been achieved without the transaction:

Heng Sang's conversion to an S corporation cannot be considered for valuation purposes, because without Ng's consent it was not possible for Heng Sang to convert to subchapter S status before the merger, and Ng never granted his consent.192

In contrast, if the controller can achieve the benefits without the transaction, the court may include the present value of those benefits in fair value. In the 2004 Emerging Communications decision, the court concluded that the substantial post-transaction benefits that defendants attributed to the merger were in fact contemplated and achievable before the transaction. It ruled that the control shareholder could have achieved the benefits without the merger by other means, such as entering into a contract between his wholly owned private company and the public company he controlled:

The cost savings attributed to the consolidation were properly includable in the June projections, because they were contemplated well before the going private merger and could have been achieved without it. Prosser had identified potential consolidation savings before the Privatization occurred. Because Prosser controlled both ECM and ICC, he had the power to accomplish those savings without a business combination, such as by intercompany contractual arrangements [emphasis added]. To put it differently, the value achieved by Prosser's existing pre-merger ability to effect those cost savings was an asset of ECM at the time of the Privatization merger.193

The court decided that the fact that the controller's ability to accomplish the cost savings before the merger was an asset of the public company at the merger date and that all shareholders were entitled to share pro rata in that benefit.

Fair Value Includes Changes Contemplated by Management

If management is contemplating changes in the company at the time the relevant transaction is completed, or if new management has begun implementing its plans prior to a squeeze-out merger, the Court of Chancery will deem these changes to be operative reality. Professors Hamermesh and Wachter explain certain adjustments that Delaware will recognize in an appraisal:

[I]n appropriate circumstances in which a controlling shareholder is acquiring the minority shares, the courts have interpreted “fair value” to include elements of value that arise from assets or plans that were not in place operationally at the time of the merger. Those three areas . . . involve:

(1) pro forma inclusion of assets not formally owned by the corporation at the time of the merger, but constructively attributed to the corporation because they had represented a corporate opportunity wrongfully usurped prior to the merger;

(2) projections of post-merger returns in which actual costs are disregarded and excluded because they represent improper benefits to the controlling shareholder; and

(3) operating improvements that the controlling shareholder implements following the merger but that do not depend causally upon the consummation of the merger.194

This section discusses the three categories listed by Hamermesh and Wachter. We then discuss examples of adjustments rejected by the court as unacceptable under the fair value standard in Delaware appraisals, even though they might be considered by a financial buyer under the third-party sale value standard. Then we will discuss cases where plans in place at the merger date were considered.

Usurped Corporate Opportunities

If a corporate opportunity is wrongfully usurped prior to the transaction, the court will constructively attribute the corporate opportunity to the corporation and adjust fair value to reflect this misconduct. Misappropriation of a corporate opportunity by a control shareholder has been addressed in appraisal cases when the misconduct was not known to the dissenters until after the transaction that triggered the appraisal.

In its seminal 1989 Cavalier decision, the Supreme Court discussed a diversion of assets to a related company and stated:

The . . . corporate opportunity claim, if considered on its derivative merits, would inure almost entirely to the benefit of the alleged wrongdoers, an inequitable result at variance with the fair value quest of the appraisal proceeding. . . . [T]he Vice Chancellor found that [petitioner] did not have knowledge of the basis for the corporate opportunity claim prior to the institution of the appraisal proceeding and that, as a matter of credibility, those claims were based on misrepresentations by the principal shareholders. We conclude that, under the unusual configuration of facts present here, the corporate opportunity claim was assertable in the [appraisal] proceeding.195

ONTI v. Integra Bank also involved an abuse of corporate opportunity. Within days of closing the squeeze-out cash merger, the control shareholder merged his company with a publicly traded company. Plaintiffs asked that the appraisal valuation take into consideration their pro rata portion of the market value of shares that the defendant received in the later merger. The court ruled in favor of the plaintiffs, stating, “I think it is clear that it is ‘not the product of speculation' that the [subsequent] Transaction was effectively in place at the time of the Cash-Out Mergers.”196

Improper Benefits to Control Shareholders

The court may make adjustments to eliminate the agency costs of improper actions by a control party that were not known to shareholders before the transaction and that affect current and future cash flow. For example, in ONTI, the court adjusted the projection underlying the DCF calculation by doubling the fees receivable from an affiliate of the controller, which had been paying less than the contractual rate.197

In another case, the court accepted adjustments to eliminate the adverse consequences of “excessive management fees, an unexplained inter-company loan, an unexplained corporate allocation, and an overcharge by a vendor”198 as well as “the sale and leaseback of Montgomery's cell sites and towers,” which “was clearly an inappropriate exaction by [the control party] due to its corporate control.”199

The court may also make adjustments when it can be shown that payments to shareholders were not for services rendered. In 1991, the court accepted a DCF analysis in which officers' salaries were adjusted to exclude a portion which, because compensation was proportional to equity ownership, was deemed to be a return on equity.200 That decision was cited in a recent case where the court pointed out that “Delaware law on fair value . . . empower[s] a court to make normalizing adjustments to account for expenses that reflect controller self-dealing when the plaintiff/petitioner provides an adequate evidentiary basis for the adjustment.” 201

Claims relating to the control shareholder's improper conduct that were known prior to a squeeze-out—and thus could have been challenged prior to the squeeze-out—have been excluded from consideration in Delaware appraisals. For example, in two cases where the petitioners claimed that improperly issued shares had diluted their interests, the court determined that it could not address these claims in an appraisal context.202

Improvements Not Dependent on Merger

The court considers future events that were not speculative as part of going-concern value under the fair value standard. The court decided in a 2005 appraisal of a cellular telephone company that it was not speculative to consider the prospective conversion of its network to higher future industry standards, so that the requisite capital expenditures were part of the company's operative reality. It ruled that the expert “should have incorporated the effects of this expected capital improvement in his projections.”203

Hamermesh and Wachter summarize this concept:

In fact, we believe that both finance theory and Delaware case law are consistent with our view that minority shareholders have a right to “fair value” that incorporates not only current assets but also future reinvestment opportunities, so long as those reinvestment opportunities reflect pre-merger plans or policies of the corporation and its controlling shareholder [emphasis added]. . . . These reinvestment opportunities will not have been taken at the time of the merger, because they are to be funded with future free cash flow. Consequently, the assets purchased as part of the reinvestment opportunities will not exist at the time of the merger. However, these assets are as much a part of the present value of the corporation as are the value of the existing assets.204

Consistent with this view and with customary valuation practice, income should be normalized so that nonrecurring items should be excluded from valuation calculations.205 The Court of Chancery has faulted an expert for not normalizing earnings data, pointing out, “The earnings figures used to derive the earnings base should be adjusted to eliminate non-recurring gains and losses.”206

Pro Forma Adjustments Rejected by the Court

In 1997, the Delaware Supreme Court rejected petitioner's claim that earnings and projections should be adjusted because the control shareholder had been and continued to be materially overpaid. It noted that there was no plan prior to the merger to adjust that compensation. The court ruled that “in the absence of a derivative claim attacking excessive compensation, the underlying issue of whether such costs may be adjusted may not be considered in an appraisal proceeding.”207 It concluded that “going business value of the corporation at the moment before the merger . . . does not include the capitalized value of possible changes which may be made by new management [emphasis added].”208

A recent decision rejected an adjustment to earnings premised on the assertion that that the company was overspending on research. The Court of Chancery ruled, “Because a reduction in R&D expense only could be made by a new controller of Hazelett Strip-Casting, adjustments to reflect those changes would generate a third-party sale value, not going concern value.”209 The court stated that its conclusion was based on “the well-established principle of Delaware law that minority shareholders have no legal right to demand that the controlling shareholder achieve—and that they be paid—the value that might be obtained in a hypothetical third-party sale.”210

Taxes Are Considered Only If They Are “Operative Reality”

The operative reality concept has also been used to justify the exclusion of deferred taxes on investment assets that management does not currently intend to sell. In Paskill, the Supreme Court ruled:

The record reflects that a sale of its appreciated investment assets was not part of Okeechobee's operative reality on the date of the merger. Therefore, the Court of Chancery should have excluded any deduction for the speculative future tax liabilities that were attributed by Alcoma to those uncontemplated sales.211

This differs from the Supreme Court's ruling that accepted deferred taxes in Technicolor because Technicolor's management had already decided to sell the relevant assets. The expected gain on that asset sale was the operative reality on the date of the merger.212

In a 2006 decision, the Court of Chancery used the operative reality concept when it accepted taxes and other expenses paid as a result of an asset sale directly related to a merger. Carter-Wallace sold the assets of its consumer products business simultaneously with the merger into MedPointe Healthcare of its health-care business. Each transaction was contingent on the other. The asset sale resulted in substantial capital gains taxes and expenses. The petitioner unsuccessfully argued that the taxes and expenses should not be deducted in determining appraisal value because the asset sale was not completed prior to the date of the merger. The court said, “There is no principled distinction between an asset sale occurring a few hours before the merger and a sale on the day before the merger,” and based its appraisal of Carter-Wallace on the company's value after the asset sale, giving effect to all related expenses including taxes on the asset sales.213

A 2011 decision rejected the deduction of potential taxes and selling expenses and “add[ed] the full appraised value of the non-operating real estate” that the company had no current intent to sell.214 Moreover, since the company expected to utilize its net operating losses, the Court of Chancery also added the potential tax benefit of the carry forward:

Hazelett Strip-Casting has a history of generating taxable earnings, and the capitalized earnings valuation anticipates that it will continuing doing so in a manner that will enable the Hazelett family to take advantage of the NOL. I therefore add $258,000, representing the full value of the NOL.215