Oppressed Shareholders' Rights Can Affect Estate and Gift Tax Valuation

By Greene, Martin; Schnapp, Douglas | The CPA Journal, February 2001 | Go to article overview

Oppressed Shareholders' Rights Can Affect Estate and Gift Tax Valuation


Greene, Martin, Schnapp, Douglas, The CPA Journal


By Martin Greene, CVA, CPA Greene Valuation Consulting Inc., and Douglas Schnapp, Esq., CPA

Minority shareholders are provided statutory rights frequently overlooked in estate and gift tax valuations. Although designed to protect minority shareholders from oppressive controlling shareholders, these rights should be carefully considered during business valuations in other settings, such as estate and gift taxation. The potential for the legal exercise of special minority shareholder rights could affect the discounts assigned to the minority interest.

Professionals that perform business valuations (or draft or review shareholder agreements and corporate bylaws) in the context of estate and gift tax matters would normally look to the rights of the shareholder to affect the value of the interest being appraised. One area frequently not considered in valuation reports for such interests is "frozen out," or oppressed, shareholder interests. Oppressed shareholders are restricted by controlling shareholders' policies from participation in management, whereas dissenting shareholders oppose a transaction initiated by the controlling shareholders.

Summary of New York State Low

In 1979, the New York State Legislature enacted sections 1104-a and 1118 of the Business Corporation Law (BCL) to ameliorate the problem of minority shareholders being frozen out of corporate management. Section 1104-a gave the holders of 20% or more of the outstanding shares of a corporation the right, when the other shareholders or directors engaged in oppressive conduct, to petition the court for dissolution. The counterweight to that right is provided in section 1118, which permits the other shareholders or the corporation to buy such shares at fair value.

The statute failed to provide guidelines to determine fair value, leaving the courts to play a significant role in the development of principles. Matter of Tames [Taines v. Gene Barry One Hour Photo Express, 123 Misc. 2d 529 (Sup. Ct, XY Co. 1983)] stated that, in fair value proceedings of closely held corporations, the court is free to adopt its own method of valuation so long as it is based on recognized criteria and the facts of the case.

On February 25, 1985, the Appellate Division Second Department rendered two decisions. In one, Matter of Fleischer [Fleischer 107 AD 2d 97 (2d Dept 1985)], the court applied a 25% lack of marketability or liquidity discount based on multiplying various components of the corporation's income by an average price to earnings ratio of comparable publicly traded companies. It added the resulting figure to the adjusted net assets and marketable securities of the company.

In Matter of Blake [Blake v. Blake Agency 107 AD 2d 139 (2d Dept 1985)], the same court stated that three factors should be considered in arriving at fair value-market value, investment value, and net asset value-and that the weight accorded to each depends upon the circumstances of each case. It set the overriding rule that the value of a corporation should be determined on the basis of what a willing purchaser, in an arm'slength transaction, would offer for an operating business, rather than for a business being liquidated.

The Blake court contended that market value in a closely held company is of little or no significance because the shares of stock are not traded on any public market and that, other than bona fide offers to acquire all the shares, the sale of stock of a closely held corporation does not usually qualify as an arm's-length transaction because the sale usually involves corporate officers, employees, or family mem bers. The court further stated that net asset value is generally the standard applicable in evaluating manufacturing corporations or real estate and investment holding companies and is the appropriate standard for the case. Finally, the court indi cated that investment value was appropriate in this case. Furthermore, investment value is usually a function of the earning power of a corporation that should be calculated by a "discounted income approach," the capitalization of dividends, or a comparative appraisal approach. …

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Oppressed Shareholders' Rights Can Affect Estate and Gift Tax Valuation
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