Valuing Noncontrolling Shares of Private Corporations; Hartman v. BigInch Fabricators & Construction Holding Co., Inc.

People often disagree about how to run a business, and sometimes those disagreements can be so fundamental that the parties decide to split ways. This can cause problems with how to value the relative shares of the owners, and that problem is particularly acute if the person leaving is a minority shareholder in a closely held corporation. In this case, the Court addresses how those shares should be valued under Indiana law.

Hartman was an officer, director, and shareholder in BigInch. The shareholders were bound by a buyback clause. That clause required BigInch to repurchase a shareholder’s interest if the company involuntarily terminates the shareholder as an officer or director. And the clause further provided that the company must pay the shares’ “appraised market value” as determined by a third-party valuation company in accordance with generally accepted accounting principles.

Hartman was terminated in 2018, and BigInch hired an appraiser to value Hartman’s interest. The appraiser discounted the shares for their lack of marketability and Hartman’s lack of control and arrived at a valuation.

Hartman sued BigInch, arguing that the appraiser should not have applied those discounts. After the parties filed cross-motions for summary judgment, the trial court agreed with BigInch. Hartman appealed, and the Court of Appeals agreed with him. The Indiana Supreme Court then granted transfer.

When deciding the issue, the Court acknowledged that Indiana cases have previously held that these discounts were against public policy in some situations. But it found that line of cases inapplicable here because of the buyback clause. Rather, this was an issue of contract interpretation, and the buyback clause specified that the price would be “the appraised market value,” but did not define that phrase. The Court concluded that “market value” includes the discounts.

First, the agreement’s language explicitly sets the “price per Share” at its “appraised market value.” Thus, the valuation standard refers to the “market value” of the terminated member’s individual interest in the company— not the value of the company as a whole.

Second, “market value” plainly and unambiguously refers to the shares’ “fair market value.” Black’s Law Dictionary … defines those terms identically as “the price that a seller is willing to accept and a buyer is willing to pay on the open market and in an arm’s-length transaction.” We, too, on multiple occasions have used the two terms interchangeably.

And, third, we agree with the trial court that the term “appraised” merely describes how to determine the shares’ market value. Black’s Law Dictionary does not define this term, but the plain and ordinary meaning of the word “appraise” is “to set a value on” or “to judge and analyze the worth, significance or status of.” And, as used in the buyback clause, “appraised” is an adjective modifying “market value,” which is then followed by the method to be used, namely, “in accordance with generally accepted accounting principles by a third party valuation company.”

Simply said, the use of the term “market value” meant the value that the shares would have on the open market, which means that the discounts were both appropriate and proper.

Thus, while it may be against public policy to discount the shares of a minority shareholder in many contexts, when a contract requires that the shares be priced at a market value, these discounts should be applied.

Lessons:
1. Freedom of contract principles override public policy concerns when shareholders have agreed by contract to a compulsory buyback of shares of a minority shareholder.
2. Determinations of “market value” and “fair market value” are based on determining the value of shares as if they were sold on the open market even when a closed market sale by compulsory buyback is at issue.
3. Fair market value may be determined by applying minority and marketability discounts for the sale of stock by a noncontrolling shareholder in a close corporation.
4. If a buyback provision speaks of an “appraised fair market value” by a “third party valuation company”, a minority shareholder should get its own appraisal.

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