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VALUING CLOSELY HELD CORPORATIONS IN NORTH
CAROLINA: ROYALS V. PIEDMONT ELECTRIC REPAIR CO. AND
PRACTICAL CONSIDERATIONS
Harrison Hall
May 11, 2001
Law and Valuation – Spring 2001
Professor Alan R. Palmiter
Wake Forest University School of Law
DESCRIPTION
This paper discusses the method North Carolina courts use to value closely held
corporations upon dissolution proceedings brought by complaining shareholders.
Specifically it will analyze the impact of “practical considerations” on those valuations.
It concludes that PERCO, the only North Carolina case to reduce an award of fair value
for “practical considerations,” was decided wrongly. In an attempt to protect minority
shareholders, it inadvertently deprived them rights to which they are entitled.
ABSTRACT
The North Carolina legislature and courts have long recognized the need for fair
adjudication of problems that arise in closely held corporations. North Carolina has
become a leader in the field of minority shareholder rights and remedies within closely
held corporations. However, North Carolina’s valuation of minority interests and its
determination of fair value has become distorted and actually takes away rights to which
minority shareholders are entitled.
The first case decided after Meiselman, and thus after the revocation of 55-125 and
promulgation of 55-14-30, was Royals v. Piedmont Electric Repair Co. v. Royals,
decided by the North Carolina Business Court. This case is of Seminole importance
because of its thorough discussion of the pertinent valuation issues. Most notably, its
discussion of the various applicable discounts is of interest and raises an important issue.
The determining factor for the court was the price it thought Buck and/or PERCO could
pay without having dissolve PERCO. The court was wary of effectively ordering
liquidation of PERCO. If dissolution had resulted, the court believed the minority would
have gotten much less than they actually received. The court reduced the independent
valuators determination of fair value from $846 per share to $635 per share. The just
remedy would have been for the court to award the minority shareholder her full fair
value, $846 per share. Under 55-14-30 and 31, she is entitled to $846. Just because the
court does not believe that she will be able to collect the full amount for her shares does
not mean that to what see is legally entitled should be reduced.
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The court in PERCO overstepped its bounds. By failing to consider the practical
outcome of its decision, the court denied the minority shareholder a right to which she
was entitled.
TEXT
I. Introduction
North Carolina is home to many small, often family owned, textile, furniture, and retail
companies. Many of these businesses are organized as closely held corporations.
Because these businesses form the backbone of the local economy, their well-being is
vital to North Carolina. The North Carolina legislature and courts have long recognized
the need for fair adjudication of problems that arise in closely held corporations.1
Therefore, North Carolina has become a leader in the field of minority shareholder rights
and remedies within closely held corporations. As a result, North Carolina’s corporate
dissolution statute allows for liberal relief from a majority’s frustration of minority
expectations.2 However, North Carolina’s valuation of minority interests and its
determination of fair value has become distorted and actually takes away rights to which
minority shareholders are entitled.3
This paper will discuss the method North Carolina courts use to value closely held
corporations upon dissolution proceedings brought by complaining shareholders.
Specifically it will analyze the impact of “practical considerations” on those valuations.4
First, it will set a foundation for its analysis by detailing the basis for relief for minority
shareholders who feel their reasonable expectations are frustrated by the majority.
Second, it will discuss the valuation methods employed by North Carolina courts and the
applicability of minority and marketability discounts used to reach “fair value.”5 Finally,
the paper will analyze the use of “practical considerations” in the determination of fair
value for complaining minority shareholders.
II. North Carolina Valuation
To properly understand the impact of practical considerations on business valuations, one
must first understand the dissolution procedures used by North Carolina courts and the
methods that valuators use to reach a minority interest’s “fair value.” This section will
broadly define the basis and methods used by North Carolina courts to determine the “fair
value” of a minority interest in a closely held corporation.
A. Basis for Relief
North Carolina General Statute 55-14-30 (2000) details the remedies complaining
minority shareholders may seek and when relief is available.6 The sole remedy allowed
is dissolution, and it is available when “liquidation is reasonably necessary for the
protection of the rights or interests of the complaining shareholder.”7
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Before the enactment of 55-14-30, courts were given plenary power to frame any relief
they saw fit to protect the rights of complaining shareholders.8 While dissolution was
available, it was such an extreme remedy that more targeted remedies were preferred.9
Because the legislature feared an opening of the litigation “flood gates,” 55-14-30
changed the procedures for relief and the remedies available.10 The resulting changes in
55-14-30 revoked the flexibility previously available to trial courts to fashion individual
remedies and created a substantial bar for relief.
Although Meiselman v. Meiselman interpreted the earlier dissolution statute, North
Carolina continues to use its test to determine when relief is proper.11 Under the
Meiselman test relief is reasonably necessary to protect the complaining shareholder
plaintiff where:
(1)
The shareholder has shown that she had substantial reasonable expectations
that were known or assumed by the other shareholders.12
(2)
The shareholder’s reasonable expectations have been frustrated.13
(3)
The shareholder has shown that the frustration was without his fault and was
beyond his control.14
(4)
And, the shareholder has shown that “under all of the circumstances… [she] is
entitled to some form of equitable relief.15
An important caveat to the sole remedy of dissolution allowed by § 55-14-30 is that § 5514-31 allows the target corporation, if the court determines that dissolution is appropriate,
to purchase the complaining stockholders shares at their fair value.16 This alternative
allows the corporation to avoid dissolution while still providing the complaining
shareholder with fair value for her shares.17
B. Commercial Valuation Methods
After the complaining shareholder has satisfied the four-part Meiselman test, assuming
the corporation elects to purchase the complaining shareholder’s shares, the court must
determine the “fair value” of those shares.18 The statute gives no guidance as to the
meaning of “fair value.”19 Instead it leaves the task to the sole discretion of the court. In
fact the only guidance available to determine fair value is case law, and in North Carolina
there is very little case law explaining the methods used to reach fair value of a minority
interest.20
For the past fifteen years, Delaware courts have consistently endorsed and employed the
Discounted Cash Flow (DCF) method.21 However, Delaware is also careful to note that
“any techniques or methods which are generally considered acceptable in the financial
community” are available for courts to use.22 For instance, the Delaware Block Method,23
the Market Comparables approach,24 Net Asset Value approach,25 valuations based on
Book Value or earnings,26 and combinations of these methods are all accepted and
employed methods.27
Nevertheless, the DCF has remained the outstanding method. Essentially, it consists of
three basic components. First, a valuator must estimate a growth rate for the company for
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a period of years into the future.28 The growth rate is based on historical earnings and
existing and predicted company conditions. Second, a terminal value must be established
to compensate for all earnings past the projected period.29 Last, the cost of capital must
be determined with which the projected earnings and terminal value are discounted to
present value.30 Although this method has been the prominent method used, it still
involves a large degree of guess-work and discretion on the part of the valuator.31 For
this reason the North Carolina Business Court favors appointing an independent valuator
to perform a single valuation for the company.32
C. Minority Discounts
Because publicly traded shares trade at a natural discount due to their lack of control, a
question arises as to whether the court should apply a minority discount to reflect the
shareholder’s lack of control over company proceedings. Minority discounts are not an
issue in publicly traded companies where no shareholder has a controlling interest, but in
closely held corporations there is generally a shareholder or group of shareholders that
have such a large block of stock that they are able to control the business. If fair value
was solely based on fair market value, then a minority discount would be applicable to
closely held stock. Just as shares of publicly held corporations trade at a discount that
reflects their lack of control, so too would shares of closely held corporations if they were
sold in an open market.33 However, if shares are purchased by someone who is either
purchasing control or already has control of the corporation, then applying a minority
discount is inappropriate because the purchaser will be able to sell the shares as part of a
majority block (without a minority discount).34 Therefore, whether a minority discount
will be applied and how great that discount should be is generally a hotly contested issue
in North Carolina Courts.
An argument for applying a minority discount is that if the corporation were dissolved, as
directed by statute, shareholders would receive only the liquidation value of their shares.
For most businesses, liquidation value (the value of their tangible assets) is much less
than the value of the company as a going concern. Since the majority would only receive
liquidation value upon dissolution there is a great incentive for the majority shareholder
to elect to purchase the minorities shares. The argument is that the minority shareholder
should not benefit from forcing the majority to elect to purchase her shares rather than
dissolve the company.
There are many arguments against applying a minority discount. First, upon dissolution a
minority shareholder is entitled to the percentage value of the company as represented by
her shares.35 Under this circumstance, no weight is given to the fact that the minority
shareholder does not carry a controlling interest.36 The argument is that when a minority
shareholder brings an action for dissolution, she should not receive less value for her
shares simply because the majority shareholder elects to purchase the shares.37 Second,
courts do not want to unfairly advantage majority shareholders. If courts allowed
majority shareholders to purchase minority shares at a discount, then they could later sell
those same shares as part of a majority block without a minority discount. In this way,
majority shareholders would benefit from their own wrongful conduct.38 This argument
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is often cited as the basis for denying a minority discount.39 Last, as a policy argument,
statutes such as 55-14-30 were enacted to protect minority shareholders. Therefore, to
apply a minority discount to the value of their shares is arguably against legislative
intent.40
D. Marketability Discounts
The very nature of a closely held corporation means there is little or no market for the
business’ shares. Because of this absence of a market, an issue arises as to whether
shares be discounted for their lack of marketability. North Carolina Courts generally do
not favor a marketability discount.41 The reason for this decision is that a lack of
marketability is one of the same justifications for applying a minority discount.42
Discounting for marketability after applying a minority discount would double discount
the shares. Further, the minority shareholder is not selling her shares on the market but is
forced to sell them to the majority, if the majority elects to purchase the shares.43 In
essence, the valuation assumes that the minority shareholder is willing to maintain her
investment position had the majority not frustrated her reasonable expectations.44
III.
PERCO
The first case decided after Meiselman, and thus after the revocation of 55-125 and
promulgation of 55-14-30, was Royals v. Piedmont Electric Repair Co. v. Royals,
decided by the North Carolina Business Court. This case is of Seminole importance
because of its thorough discussion of the pertinent valuation issues. Most notably, its
discussion of the various applicable discounts is of interest and raises an important
valuation issue.
A. Facts
Piedmont Electric Repair Co. (PERCO) was a closely held corporation, operating since
1937, that had 990 outstanding shares in 1999.45 The family or estate of A.G. Draughn,
“the backbone of PERCO” from 1938 until 1994, owned all but 49 shares of the
company.46 Buck, Draughan’s son, and Short, Draughan’s nephew, began work at
PERCO in 1951.47 Draughan and Short’s father each owned fifty percent of PERCO.48
In 1958, Short’s father retired, selling his fifty-percent interest to Short.49 Short funded
his retirement through the sale of his shares.50 In 1989, Draughan, Buck and Short were
the only holders of PERCO stock, and in that year they signed an agreement which
imposed a right of first refusal by the corporation and shareholders before any of
PERCO’s stock could be sold.51
In 1992, it became apparent that Draughan had engaged in what might constitute sexual
harassment.52 Due to his conduct, Buck, as president of PERCO requested Draughan
withdraw from PERCO’s group health insurance program.53 In 1993, due to his
activities, Buck and Short barred Draughan from portions of PERCO’s premises.54 Later
in 1993, Draughan was barred from PERCO’s premises completely.55 That same year
Draughan’s salary was reduced to $15,000 from a past average of $42,000. As a result,
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Draughan changed his will, which had originally provided for Buck to receive all of his
shares in PERCO for a fraction of their value, to leave his shares to his wife and
daughters.56 Later in 1993, Draughan and Buck, Short, and PERCO entered into
negotiations for the purchase of Draughan’s shares.57 Per the 1989 agreement, Draughan
was required to offer his shares to Buck, Short, and PERCO first before seeking outside
buyers.58 Draughan made it well known that he needed the money from the sale of his
shares to fund his retirement and testamentary trust, just as Short had done in 1958.59
In 1994, Short sold all but 100 of his shares to Buck.60 This sale was in violation of the
1989 agreement because he did not first offer the shares to Draughan or PERCO and did
not disclose the sale until after it was final.61 This sale gave Buck a fifty-one percent
interest and control of PERCO.62 Relations between the parties deteriorated further when
Buck and Short elected themselves to two-person executive committee, effectively
excluding Draughan’s shares from representation.63 The executive committee then
offered to purchase Draughan’s remaining thirty-nine percent interest for less than half
their book value.64 After Draughan refused the committee’s offer, PERCO terminated his
employment and the payment of his $15,000 salary.65
From 1994 all management decisions of PERCO were conducted exclusively by the
executive committee consisting of Buck and Short.66 In 1996, Draughan died.67 The
owners of his shares brought suit claiming Draughan’s shares would never be sold at their
fair market value and without such a sale, no value for those shares would ever be
realized.68 The complaining shareholders sought dissolution of PERCO under 55-1430.69 The court agreed with the minority shareholders that their reasonable expectations
were known to the defendants and had been frustrated by the majority shareholders.70
After the court determined that the Meiselman test had been satisfied and dissolution was
reasonably necessary to protect the interests of the minority shareholders, the court
attempted to determine the fair value of their shares under 55-14-31(d).71
B. PERCO Valuation
The parties agreed to have an independent and objective business appraiser prepare a
valuation of PERCO.72 The court relied heavily on this valuation.73 The report was
prepared in accordance with the Business Valuation Standards of the American Society
of Appraisers and the Uniform Standards of Professional Appraisal Practice.74 While
the court did not divulge the details of the PERCO valuation, it stated that Hawkins
estimated the fair market value of PERCO’s shares as a going concern both with and
without a minority discount and marketability discount.75 This led to a high valuation of
$846.61 per share and a low valuation of $462.27 per share.76 The court found that it
would be inequitable, after determining that dissolution was appropriate, to value the
minority shares at less than the full value they would have had if the company were sold
and they received their pro rata share of the total sales price.77 The court wanted to avoid
allowing the majority to buy at a discounted price when they could resell those shares at
full price.78 To do otherwise would provide an incentive for the majority to oppress
minority shareholders and force them to seek relief under 55-14-30 and 31.79 Therefore
the court rejected both a minority and marketability discount.80
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Rather than accepting the Banister valuation, the court included “equitable factors which
were not appropriate for the Banister Valuation.”81 In reaching fair value the court
heavily considered market value but did not base its finding upon market value.82 If it
had then it would have awarded the minority shareholders $846.61 per share. The court
divided the equitable factors into three categories: (1) changes in condition, (2) equitable
considerations, (3) practical considerations. Under the changes in condition subheading,
the court applied a “key man” discount. Because Buck was president and had been for a
long time, there was no succession plan in place, and PERCO’s business was essentially a
personal services business, the court discounted the company’s value due to the risk of
losing key management.83 Additionally, there was the risk that Buck would dissolve the
company upon retirement.84 The court did not make clear the exact impact this
consideration had on the valuation. Under the equitable considerations subheading, the
court recognized that Buck was not solely responsible for the failure of the Draughan’s
expectations.85 The court even went so far as to say that Draughan precipitated the
crisis.86 So while the minority shareholders should not have their shares held hostage by
the majority to coerce a bargain buyout, their expectation could have been nothing more
than a return on their equity or a buyout at a fair price.87 The court did not make it clear
to what degree this consideration impacted the valuation. Under the practical
considerations subheading, the court reduced its determination of fair value in light of the
burden placed on PERCO and/or Buck in having to fund the purchase of Draughan’s
shares.88 The court held a fair price is not a price that automatically results in
dissolution.89 The court took into account the possibility that its valuation could make
purchase of the shares impractical or impossible.90 The reason for this consideration was
that if the court effectively forced dissolution by its valuation, then the “minority
shareholders would receive less in liquidation than they would at a price less than ‘market
valuation…’ [and] their interests may be better served by the fair value price which is
greater than the liquidation price.”91 In addition, the court noted that Short had the same
expectations that Draughan had; to have his shares bought by PERCO or Buck to fund his
retirement.92 As Short was near retirement age, the majority was likely going to be
forced to make a similar purchase of Short’s shares in the near future.93 This additional
purchase would add even greater stress to PERCO and/or Draughan. Taking these
equitable factors into account, the court determined that the “fair value” of the minority
shares under 55-12-31(d) was $635 per share.94
IV. Analysis of Practical Considerations
Unfortunately the court was not mathematically explicit in its determination of fair value.
It made clear that neither minority nor marketability discounts were applied and that its
three categories of equitable factors were considered, but it made no attempt to make
clear the exact impact these factors had on its determination of fair value. Other than
knowing that the Banister valuation was completed according to Business Valuation
Standards and Uniform Standards of Professional Appraiser Practice, all other
information regarding the valuation was not revealed.95
Although little information regarding the valuation was given, by analyzing the court’s
language, one can surmise how the court arrived at its value of $635 per share. First,
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because the court did not apply marketability or minority discounts, it is reasonable to
assume that Hawkins’ valuation that included minority and marketability discounts bore
little weight in the final valuation.96 Additionally, the court appears to have accepted
Hawkins’ other valuation number of $846 per share as a base from which fair value was
determined.97 The court recognized that fair value was not market value, $846 per share,
and then began reducing its award from market value to reach fair value.98 Although it is
clear the equitable factors used by the court reduced the valuation, it is not clear the exact
impact that each factor had on the valuation. However, it appears that the court’s
practical considerations played the largest role in discounting market value.
At first appearance the court looks to have discounted market value in one of two ways:
(1) splitting the difference between market value without minority or marketability
discounts and market value with both discounts (i.e. the difference between $846 per
share and $462 per share) or (2) applying a 25% discount to the market value of $846 per
share.99 However, neither of these assumptions is correct. The determining factor for the
court was the price it thought Buck and/or PERCO could pay without having dissolve
PERCO.100 The court was wary of effectively ordering liquidation of PERCO.101 If
dissolution had resulted, the court believed the minority would have gotten much less
than they actually received.102 This conclusion is supported by the fact that the court
structured the terms of the buyout so that the majority had the right to purchase the
minority’s shares over three to four years with a secured note.103 In essence, the court set
fair value at as a high a value as it thought it could without forcing the majority to
dissolve the business.
Allowing these practical considerations to affect the determination of fair value creates a
problem. On the one hand, fair value should not be based on what the corporation can
afford while avoiding dissolution. There is a strong argument that since the court
accepted Hawkins’ valuation as reasonable and fair, it should have accepted one of the
two values suggested by him. Doing otherwise creates a degree of unpredictability and
inconsistency. Minority shareholders can longer be sure that they will receive their true
mathematically fair value. Instead the economic well-being of the company and the
majority shareholder will color the minority shareholder’s award. For instance a minority
shareholder attacking a company that is cash rich with a majority shareholder who is
wealthy will likely not have its determination of fair value reduced by practical
considerations, but a minority shareholder in a company that is cash poor or highly
leveraged and with a majority shareholder who is not wealthy will likely have its award
of fair value impacted. It does not seem fair to disadvantage a minority shareholder for
the poor financial management of a company over which it had little or no control.
There is further unpredictability in the court’s failure to explain exactly what impact the
practical considerations had on the determination of fair value. While one may surmise
that these considerations impacted the valuation to the point of reducing fair value to a
level payable by the company, there is no explanation of how this point was determined.
The court merely stated that it believed its adjusted value would be low enough to keep
PERCO from dissolving.104
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On the other hand, should the award for a minority shareholder be effectively minimized
by a determination of fair value well above what the company could possibly pay?
Because the corporation has the choice of dissolving and granting the minority
shareholder her pro rata share, an amount much smaller than an award of fair value
adjusted for practical considerations, the court cannot force the majority shareholder or
the corporation to purchase the minorities shares.105 Upon determination of fair value,
the corporation and majority shareholder have a period of time in which to decide
whether it will elect to purchase the minority’s shares under it 55-14-31(d) rights or
dissolve pursuant to 55-14-30. This situation spawns a simple mathematical decision in
which the corporation will dissolve if it determines that financially it cannot pay the
minority shareholder fair value or the corporation and/or majority shareholder will elect
to pay the minority its fair value if that amount is not so great as to destroy the company.
This issue was the determinative concern in PERCO.106 The court believed it was
maximizing the minority shareholder’s value by providing them with a legal right to an
award greater than their pro rata value under dissolution but less than a value that would
force the majority to seek dissolution.
V. Conclusion
The court was correct in concluding that the well-being of the shareholder and her value
maximization is paramount, but the court failed to protect that interest. In attempting to
fashion a “practical” remedy, the court inadvertently deprived the minority shareholder of
rights the court implicitly agreed were hers. To explain, the court essentially agreed that
Hawkins’ value of $846 per share was the value to which the minority was entitled,
minus the practical considerations.107 After the court determined that PERCO / the
majority could not afford to purchase the minority’s shares at the value determined by
Hawkins, the court reduced the minority’s award to a level sustainable by PERCO / the
majority.108 Therefore, although the court agreed that the minority’s rights were to
Hawkins’ value of $846 per share, it reduced that right to only $635 per share solely
because this was the highest sustainable purchase price for PERCO / the majority. While
the justification for this right, as discussed above, was to maximize the award for the
minority shareholder, by protecting the right of the shareholder to receive a buyout price
(any buyout price), the court essentially prevented the minority from seeking fair value.
The court would not disagree that the mathematical fair value of the minority’s shares
was $846 per share. However, by reducing the judicial remedy to $635 per share, the
court prevented the minority shareholder from seeking that fair value.
The just remedy would have been for the court to award the minority shareholder her full
fair value, $846 per share. Under 55-14-30 and 31, she is entitled to $846. Just because
the court does not believe that she will be able to collect the full amount for her shares
does not mean that to what see is legally entitled should be reduced. By reducing the
minority shareholder’s award, the court prevented exactly what it set out to do: protect
the minority shareholder’s interest in the fair value of her shares. Without a judicial right
to the $846 per share value, there is certainly no chance she will receive full value for her
shares. However, with a legal right to the full fair value, the shareholder at least has the
legal right and a chance to collect to that amount.
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In spite of the court’s argument that awarding fair value above what is sustainable would
force the company into dissolution, this is assuredly not the case. If the court recognized
that the minority shareholder would not be able to squeeze its full fair value from the
company, then surely both parties recognized that as well. Therefore, the most likely
outcome of awarding fair value above the sustainable price would be settlement. Just as
the court implicitly argued that fair value should be adjusted for practical considerations
because all parties would be better off under a buyout remedy rather than dissolution,
both parties would have tangible incentive to settle after an award of fair value had been
determined and was above a level sustainable by the corporation or majority. The
minority shareholder would be forced to settle because she understands that if she presses
for the full fair value award, the company would dissolve and she would be left with only
her pro rata share upon dissolution. The majority would be forced to settle because if it
was faced with paying full fair value it would have to dissolve. Therefore, had the court
awarded the full fair value of $846 per share, not only would the parties have settled but
the minority shareholder would have had a legal entitlement to her full fair value as
contemplated by 55-14-31(d).
The court in PERCO overstepped its bounds. By failing to consider the practical
outcome of its decision, the court denied the minority shareholder a right to which she
was entitled. The inclusion of the court’s “practical considerations” destroyed the right
of the minority shareholder to the full fair value of her shares. Although there may not
have been a great chance that the minority shareholder would have received her full fair
value, under the courts ruling there is absolutely no chance that will happen.
Additionally, because Royals was a case of first impression in North Carolina any case to
arise from this point will have to reconcile itself with Royals’ determination that practical
considerations are valid factors. Minority shareholders in North Carolina should be wary
that their rights upon an action for dissolution under 55-14-30 are subject to what the
court believes the corporation can sustain. In an attempt to protect the rights and value of
minority shareholders, North Carolina has stripped its minority shareholders of rights to
which they are justly entitled.
1
See Generally, Robert McLean, Survey of Developments in North Carolina Law: Corporate Law:
Minority Shareholders' Rights in the Close Corporation Under the New North Carolina Business
Corporation Act, 68 N.C.L. Rev. 1109 (1990); Meiselman v. Meiselman, 58 N.C. App. 758, 295 S.E.2d
249 (1982), modified and aff’d, 309 N.C. 279, 307 S.E.2d 551 (1983), interpreting 55-14-30’s predecessor,
N.C. Gen. Stat. § 55-125.
2
Compare N.C. Gen. Stat. § 55-14-30 and its predecessor, N.C. Gen. Stat. § 55-125, with, Del. Code Ann.
Tit. 8, § 262(a)-(d) (2000); N.Y. Bus. Corp. Law § 1104 (2000).
3
See Generally, Royals v. Piedmont Electric Repair Co., 97 CVS 720 (N.C. Superior Ct. 1999), affirmed,
137 N.C. App. 700, 529 S.E.2d 515 (2000).
4
Royals, 97 CVS 720, affirmed, 137 N.C. App. 700, 529 S.E.2d 515.
5
Id. at ¶ 54. Fair value is not defined by the statute that provides for it nor is any specific guidance given
with respect to the factors determine fair value. While hypothetical market value will be a heavily weighed
component in determining fair value, there are other factors which upon the final determination.
6
N.C. Gen. Stat. § 55-14-30 (2000).
7
§ 55-14-30(2)(ii).
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Meiselman v. Meiselman, 58 N.C. App. 758, 295 S.E.2d 249 (1982), modified and aff’d, 309 N.C. 279,
307 S.E.2d 551 (1983), interpreting 55-14-30’s predecessor, N.C. Gen. Stat. § 55-125.
9
N.C. Gen. Stat. § 55-125(a)(4) and 55-125.1 See also Meiselman at 300, 307 S.E.2d at 564.
10
55-14-30 comment 2(b).
11
Royals at ¶ 39.
12
Meiselman at 301, 307 S.E.2d at 564. Also the shareholders reasonable expectations may be express or
implied and must have been accepted by the other shareholders.
13
Id.
14
Id.
15
Id.
16
N.C. Gen. Stat. § 55-14-31(d) (2000).
17
55-14-31(d).
18
Corporations normally elect to purchase the complaining shareholder’s interest per 55-14-31(d). See
generally, Royals v. Piedmont Electric Co., 97 CVS 720 (N.C. Superior Ct. 1999), aff’d, 137 N.C. App.
700, 529 S.E.2d 515 (2000); Meiselman v. Meiselman, 58 N.C. App. 758, 295 S.E.2d 249 (1982), modified
and aff’d, 309 N.C. 279, 307 S.E.2d 551 (1983).
19
55-14-31(d) simply states that fair value should be “determined in accordance with such procedures as
the court may provide.”
20
Case law detailing and debating valuation methods from jurisdictions other than Delaware are sparse.
Therefore, the discussion of the DCF and other valuation methods will refer mostly to Delaware case law.
North Carolina valuation methods generally fall in line with Delaware methods. See generally Royals, 97
CVS 720; Meiselman, 58 N.C. App. 758, 29 S.E.2d 249.
21
Barry M. Wertheimer, The Shareholders’ Appraisal Remedy and How Courts Determine Fair Value, 47
Duke L.J. 613, 627 (1998).
22
Id. citing Weinberger v. UOP, Inc., 457 A.2d 701, 713 (Del. 1983).
23
Id. at 628 citing Rosenblatt v. Getty Oil Co., 493 A.2d 929, 940 (Del. 1985); Gonsalves v. Straight
Arrow Publishers, Inc., No. CIV.A.8474, 1996 WL 696936, at *4-8 (Del. Ch. Nov. 27, 1996).
24
Id. citing See Rapid-American Corp. v. Harris, 603 A.2d 796, 800-01 (Del. 1992); Hodas v. Spectrum
Tech., Inc., No. CIV.A.11265, 1992 Del. Ch. LEXIS 252, at *4-5, *10 (Dec. 7, 1992).
25
Id. at 629 citing Kahn v. Household Acquisition Corp., 591 A.2d 166, 175 (Del. 1991) (quasi-appraisal
proceeding); Campbell v. Caravel Academy, Inc., No. CIV.A.7830, 1988 Del. Ch. LEXIS 86, at *14-16
(June 16, 1988), aff'd, 553 A.2d 638 (Del. 1988).
26
Id. citing Pinson v. Campbell-Taggart, Inc., No. CIV.A.7499, 1989 Del. Ch. LEXIS 50, at *48-50 (Nov.
8, 1989).
27
Id. citing Kleinwort Benson Ltd. v. Silgan Corp., No. CIV.A.11107, 1995 WL 376911, at *10 (Del. Ch.
June 15, 1995) (assigning a percentage weight to the DCF model and a percentage weight to a comparable
company approach).
28
Id. at 628.
29
Id.
30
Id. The discount rate is typically determined using either the CAPM method or the WACC method. See
Alan R. Palmiter, Law and Valuation § 4.4 (2001) <http://www.law.wfu.edu/courses/Law&ValuePalmiter/04/4.html>.
31
The more predictable the company’s earnings are the more accurate the DCF method is.
32
Cite to Corporate Governance Notes.
33
Wertheimer at 640.
34
Id.
35
Christopher Vaeth, Propriety of Applying Minority Discount Value of Shares Purchased by aCorporation
or Its Shareolders from Minority Shareholders, 13 A.L.R. 5th 840 (1993).
36
Id.
37
Id.
38
Id.
39
Royals at ¶ 57.
40
See Generally 55-14-30.
41
Royals at ¶ 57.
8
Law and Valuation
42
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May 11, 2001
Id.
Id.
44
Cavalier Oil Corp. v. Harnett, 564 A.2d 1137, 1145 (Del. 1989).
45
Royals at ¶ 9, 12
46
Id. at ¶ 12.
47
Id.
48
Id.
49
Id.
50
Id.
51
Id. at ¶ 13.
52
Id. at ¶ 14. Apparently, Draughan had an affinity for asking female secretaries if they liked the various
Victoria Secret Catalog pictures he frequently showed them.
53
Id. at ¶ 15.
54
Id. at ¶ 16.
55
Id. at ¶ 17.
56
Id.
57
Id. at ¶ 18.
58
Id. at ¶ 13.
59
Id. at ¶ 19.
60
Id. at ¶ 20.
61
Id.
62
Id.
63
Id. at ¶ 21.
64
Id.
65
Id.
66
Id. at ¶ 23.
67
Id. at ¶ 31.
68
Id. at ¶ 33.
69
Id. at ¶ 35. The frustrated reasonable expectations were (1) meaningful participation in the management
of PERCO, (2) mutual respect and trust between the majority and minority, (3) purchase of Draughan’s
shares by PERCO upon his retirement, (4) a reasonable opportunity to realize some return upon the value
of their equity in PERCO either by distribution of profits or by sale at fair market value, and (5) the shares
would not be held captive and subject to coercion of bargain sale.
70
Id. Specifically, it was clear that Draughan like Short and Short’s father before him expected to use the
sale of his shares to fund his retirement.
71
Id.
72
Id. at ¶ 51. George Hawkins, ASA, CFA of Banister Financial, Inc. prepared a valuation dated August
26, 1998.
73
Id.
74
Id. at ¶ 55.
75
Id. at ¶ 56.
76
Id. Hawkins applied a 40% discount for marketability which the court accepted as a fair discount if it
were to apply a marketability discount.
77
Id. at ¶ 57.
78
Id.
79
Id.
80
Id.
81
Id. at ¶ 51.
82
Id. at ¶ 54. The court noted that market value was a factor but also noted that had the legislature intended
fair value to be market value it would have said market value rather than fair value. Meiselman was the
first North Carolina case to recognize that fair value for shares of a closely held corporation could differ
significantly from market value.
83
Id. at ¶ 59(a)
84
Id.
85
Id. at ¶ 59(b).
43
Law and Valuation
86
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May 11, 2001
Id.
Id.
88
Id. at ¶ 59(c).
89
Id.
90
Id.
91
Id.
92
Id.
93
Id.
94
Id. at ¶ 60. Interestingly, this value is nearly the difference between Hawkin’s high value of $846 per
share and $462 per share. A true split of the difference would yield $654 per share. This similarity may be
just a coincidence, but the court did not explain mathematically how it arrived at the $635 per share price.
95
Id. at ¶ 55. We do know that Hawkins used a capitalization of earning approach to value the minority
shares, but that method was used to determine the shares with a minority and marketability discount. As it
does not appear that the court gave this valuation much weight, this particular valuation is of dubious
significance.
96
Id. at ¶ 57.
97
Id. at ¶ 59.
98
Although this was not explicitly stated, the court accepted the $846 per share valuation as market value
and then began its discussion of the various equitable factors with which it arrived at the $635 per share
final figure.
99
In scenario one this leads to a per share value of $654, and in scenario two this leads to a per share value
of $634.5, an exact match to the court’s final determination of fair value.
100
Judge Ben F. Tennille, Address at Wake Forest University School of Law Corporate Governance Class
#8, Meiselman, PERCO, Nash Farms and the Governance of Small Business (February 27, 2001).
Although this was alluded to in ¶ 59(c), the judge made it very clear that PERCO’s “breaking point” was
the determining factor in the valuation.
101
Id.
102
Id.
103
Id. Judge Tennille recognizes that the structured settlement may be outside the court’s authority, but
argues that to bar the court from structuring awards would be too rigid a solution and would minimize the
value minority shareholders could receive in 55-14-31(d) actions.
104
Royals at ¶ 59(c).
105
Id. at ¶ 63.
106
Id. at ¶ 59(c).
107
Id.
108
Id.
87