The Unfairness of Applying Lack of Marketability Discounts to Determine Fair Value in Dissenters' Rights Cases

By Hollis, Bobbie J., II | Journal of Corporation Law, Fall 1999 | Go to article overview

The Unfairness of Applying Lack of Marketability Discounts to Determine Fair Value in Dissenters' Rights Cases


Hollis, Bobbie J., II, Journal of Corporation Law


1. INTRODUCTION

The closely held corporation seems ideal when contemplated by the everyday entrepreneur. Incorporating presents a way to keep the reins of the corporation tightly in one's grip while at the same time eliminating personal liability. The management of the corporation stays small and direct, while the opportunity to expand the number of owners with greater or lesser voices is available.1 Unfortunately, a downside can emerge if the company decides to merge or to be taken over. The minority shareowners cannot prevent the transaction per se, but they can assert dissenters' rights and seek "fair value" of their shares if they feel the compensation of the deal is inadequate.2

This search for "fair value" in closely held corporations is difficult and draining, both for the courts and the corporations, because there is no easily observable market to look to for a readily available price.3 Instead, the court must attempt to recreate a market and give the dissenter what he or she is giving up.4 In this search, some courts and corporations have applied a "lack of marketability discount"5 to reflect the fact that no ready market for the shares is available. This Note will explain why this discount should not be applied when the court is attempting to create a ready market for shares being given up as a result of an event promulgated by the corporation.

This Note elaborates on the reasoning behind disallowing the lack of marketability discounts. The first part of the Note looks generally at the development of dissenters' rights as an alternative to the historic notion of requiring unanimous approval for significant corporate changes.6 The second part gives an overview of what exactly is meant by the term "lack of marketability discount.,7 The third section of the Note looks at the distinction that exists between the terms "fair value" and "fair market value" as they are used in appraisal statutes.8 The fourth part of the Note looks at the decisions of individual states regarding the issue of lack of marketability discounts.9 In particular, the decisions of Delaware,10 New Jersey,11 New York,12 and Illinois13 are discussed in greater detail to illustrate the different viewpoints throughout the nation. The fifth part of the Note looks at the approach adopted by the American Law Institute ("ALI") in its Principles of Corporate Governance.14 In particular, this section looks at the possible difficulties that may arise with the exception allowed by the ALI's rule. In its entirety, this Note seeks to shed light on how lack of marketability discounts have been regarded in the past and why they should be disregarded in the future.

II. DEVELOPMENT OF DISSENTERS' RIGHTS

The notion of providing some kind of dissenting rights to minority shareholders who choose not to assent to a fundamental corporate change is not a startling idea in the arena of American corporate law. In fact, it is a natural evolution for a nation founded on principles of democracy and fairness in all facets of life to extend those same ideas into the field of business. 15 Dissenting rights fill the compromise zone, the transition point between the ancient notion of requiring unanimous approval for significant corporate changes to more manageable alternatives such as a simple majority16 or whatever fraction is deemed by the legislature or corporation to be an acceptable alternative.17 Unfortunately, this lessened requirement left a dissenting minority of shareholders unsatisfied, so these dissenters were given the option to exit from the changed corporation with fair compensation.18 This decreased the possibility of dictatorial leadership by a small number of people who owned a large stake of the corporation with a voiceless minority unable to fight for their economic rights, and increased the possibility that all parties would leave the table at least with proper compensation, if not completely satisfied. 19

Dissenters' rights, or appraisal rights as they are sometimes called, is the phrase coined for the compromise that legislatures reached in their attempts to allow for less than unanimous merger approval, while still preventing shareholders with smaller ownership stakes from being taken advantage of or financially mistreated. …

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