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Articles From Brisbane Consulting Group

Hartman v. BigInch Fabricators & Construction Holding Company, Inc. – Court Allows Valuation Discounts Under Shareholder Agreement

The Indiana Supreme Court recently held that the language of a shareholder agreement controlled the application of valuation discounts under its mandatory buyback provision. The agreement called for the buyback price for an ownership interest to be based on the interest’s “appraised market value” as determined by a third-party valuation firm.

Background

The plaintiff, an officer and minority shareholder, was terminated for cause, triggering the company’s obligation to buy back his shares. The company hired a business valuation professional who valued the interest at roughly $2.4 million.

This estimate included discounts for lack of control and marketability. The undiscounted value of the interest was approximately $3.5 million. So, the combined discount was roughly 31%.

Legal Saga

The minority shareholder sued the company, arguing that discounts were inappropriate because the agreement didn’t “contemplate a fair market value standard.” The trial court upheld the application of valuation discounts. However, the court of appeals reversed this decision. It found that marketability and control discounts “have no application in compelled transactions to a controlling party.”

Ultimately, the state supreme court reversed this ruling, reinstating the discounts. It rejected the shareholder’s argument that, as a matter of law, minority and marketability discounts don’t apply when selling shares to a controlling interest in a closed-market sale. The court reasoned that the discounts “improperly punish minority shareholders and create a windfall for majority shareholders.”

The case law cited to support this proposition involved a company’s purchase of a minority shareholder’s stock in a compulsory statutory buyout. The court distinguished contractual buyouts, such as the one involved in this case. It explained that a “blanket rule” that disallows valuation discounts in closed-market transactions, irrespective of an agreement’s terms, is “incompatible with basic contract-law principles.”

The supreme court recognized the parties’ freedom to contract according to whatever terms they see fit. It held that the state legislature didn’t control the valuation method for selling a former officer or director’s shares to the company. In addition, the court found that the plain language of the agreement — which priced the shares at their “appraised market value” — contemplated a fair market value standard, under which discounts for lack of control and marketability were appropriate.

The Last Straw

The state supreme court also observed that the minority shareholder failed to exercise his contractual rights to obtain an additional third-party appraisal or to offer evidence to challenge the valuation obtained by the company. This finding underscores the importance of obtaining an independent second opinion, rather than leveraging the expert witness hired by the opposing side. The cost of hiring your own expert is usually money well spent.

Hartman v. BigInch Fabricators & Construction Holding Company, Inc. – Court Allows Valuation Discounts Under Shareholder Agreement

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Doug is a Partner with Brisbane Consulting Group, LLC providing business valuation, forensic accounting, and litigation support services. He has extensive valuation experience and has served as a financial consultant and expert to attorneys in the economic aspects of matrimonial dissolution. Doug has experience consulting with publicly traded entities and valuing a variety of closely held companies in connection with mergers, acquisition and divestitures, business combinations, estate and gift tax planning, ESOPs, and purchase allocations.

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