Appraisers should assume reasonable terms in the sale of Company as a going concern in liquidation.
This 2002 case out of the First Appellate District (San Francisco) speaks to the assumptions applied by business appraisers in a Corp. Code §2000 valuation, and clarifies the proper role of the trial Court in setting the price to be paid by the controlling shareholders to the unhappy minority shareholders.
Pursuant to the election by the majority shareholder to have the corporate stock appraised under the provisions of Corp. Code §2000, the panel of three appraisers considered the value of the corporation in a piecemeal liquidation of its assets, but concluded that this method did not apply because the company was a profitable going concern, and more likely to be sold under the scenario of a going concern sold in liquidation. In developing their unanimous opinion of value, the appraisers adopted methods that relied on the income stream of the company as the best indicator of its value.
This resulted in a value of $5.6 million, as compared with the value of $1.48 million if the assets were sold piecemeal in liquidation. In applying this going-concern methodology, the appraisers relied on the assumption that a willing seller would give the willing buyer a covenant not to compete at the time of the hypothetical sale. The trial Court adopted the lower value on the basis that no such covenant not to compete was in place at the date of valuation, so the appraisers’ reliance on it was improper. Minority shareholder appealed hoping that the appellate Court would find the appraisers’ assumptions proper and force the controlling shareholder to pay the higher price for minority shareholders’ stock.
On appeal, the Court clearly differentiated between the covenant not to compete that may or may not issue as between the parties to the litigation, and the hypothetical covenant not to compete that a willing seller would freely give to a willing buyer as the result of the negotiation of reasonable terms of the sale. In most appraisals, appraisers usually assume such an agreement will issue since it circumscribes the substance being sold to the buyer: if the seller takes the goodwill with him, the buyer has bought nothing.
The Court held that the appraisers properly applied Corp. Code §2000 by assuming that a hypothetical willing seller would execute a covenant not to compete with the corporation, after the sale; even though the actual parties may not have done so. The Court embraced the notion that the standard of value, here Fair Value, requires the appraisers to contemplate a hypothetical sale scenario; a sale of the entire corporation, in a liquidation setting, on the date of valuation.
This is consistent with California case law: in Abrams, the Court held that appraisers who conducted a Corp. Code §2000 fair value determination acted properly by assuming that the owners of the corporation would have agreed not to compete with the corporation after it was sold as a going concern in liquidation. [Abrams v. Abrams-Rubaloff & Associates (1980) 114 Cal.App.3d 240]. Under the statute, the appraisers are not only entitled, but required to consider the manner in which the [hypothetical] parties to such a hypothetical sale are most likely to maximize their return. [Id. at 249]. Thus the question posed by the statute is whether the entire corporation could have been sold as a going concern in liquidation. The appraisers answered the question by considering hypothetical reasonable buyers and seller in a hypothetical forced-sale environment.
The Appellate Court found that the trial Court misinterpreted §2000 in requiring that the appraisers give weight to the fact that the parties might not have granted the covenant not to compete. Interestingly the Court went on to conclude that the statute contains a procedure for establishing a fair value price for the minority shareholders’ stock. However, the statute does not govern or even address covenants not to compete or any other term of the sale pursuant to which the buying party can buy-out the minority shares. Nor does it authorize the trial court to dictate any of the terms of that sale other than the sale price. Section 2000 doesn't give the trial court authority to require a party to execute a covenant not to compete or to evaluate the validity of such a covenant. The Court held that the trial court should not have gotten involved in negotiations pertaining to that sales term.