In Hartman v. BigInch Fabricators & Construction Holding Company, Inc., 2020 WL 2121471 (Ind. Ct. App. 2020), the Indiana Court of Appeals held that open market discounts like lack of control and lack of marketability do not apply as a matter of law to forced sales by minority shareholders in closely held entities. This is consistent with the majority of states that have confronted the issue.
BigInch was a closely-held Indiana corporation that had ten shareholders, none of whom held a majority interest. Hartman was one of the founders of the company and its former president. In March 2018, Hartman was involuntary terminated from his position as a director and officer of the company. At the time, Hartman owned 17.77% of the company. The Shareholder Agreement required BigInch to purchase the shares of any shareholder who, like Hartmann, was involuntarily terminated.
After his termination, BigInch retained a valuation firm to appraise the value of Hartman’s shares. The shares were valued at $3,526,060, but the valuation discounted this amount for Hartman’s lack of controlling interest in the company (because he was a minority shareholder) and the lack of marketability of his shares (because there was no market in which Hartman could sell his shares). After these discounts, the valuation firm determined that the “fair market value” of Hartman’s shares was $2,398,000.
Hartman filed suit, seeking a declaration as to the value of his shares and alleging that the company improperly applied the lack of control and marketability discounts to the mandatory sale. BigInch counterclaimed for declaratory judgment, and the trial court found for the company on summary judgment, concluding that the discounts were proper. Hartman appealed.
On appeal, the Court of Appeals of Indiana reversed. Close corporations generally have no market for their shares, and accordingly, it is difficult and speculative to value their shares. Therefore, shareholder agreements that include repurchase obligations often include a valuation method to determine the value of the closely-held shares. The BigInch Shareholder Agreement provided that “appraised market value” would be used. The Company’s valuation equated this phrase to “fair market value” through the use of discounts.
The appellate court explained that “fair market value” and the discounts applied were open market concepts, but this was not an open market purchase. The appellate court noted that a “substantial majority” of courts in other jurisdictions have rejected discounts for lack of control and marketability where a majority shareholder or corporation is required to purchase the stock. Where a majority shareholder purchases minority shares, it increases its control, so applying a minority discount would result in a windfall to the majority shareholder. In short, lack of control discounts have no application in compelled transactions to a controlling party. Likewise, where there is a “ready-made market” for shares through a mandatory purchase agreement, discounts for marketability are not appropriate, and would, again, result in a windfall to the purchasing majority shareholder. The Shareholder Agreement indicated that these “fair market value” concepts should not be applied by adopting the “appraised market value” standard.
BigInch is another reminder of the unique issues posed by valuations in the closely-held context. Free market discounts generally have no place there, where shares will not be purchased on the free market, but instead often in a forced minority/majority context.