Dissenters' Rights: the Colorado Supreme Court Finally Speaks

• Publication year: 2005
• Pages: 53

34 Colo.Law. 53 Colorado Bar Journal 2005.

2005, April, Pg. 53. Dissenters' Rights: The Colorado Supreme Court Finally Speaks

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53

Vol. 34, No. 4, Pg. 53

The Colorado Lawyer
April 2005
Vol. 34, No. 4 [Page 53]

Specialty Law Columns
Business Law Newsletter
Dissenters' Rights: The Colorado Supreme Court Finally Speaks
by E. Lee Reichert, John R. Chadd

This column is sponsored by the CBA Criminal Law Section. It features articles written by prosecutors, defense lawyers and judges to provide information about case law legislation, and advocacy affecting the prosecution, defense and administration of criminal cases in Colorado state and federal courts.

Column Editors:

Leonard Frieling, a criminal defense attorney in private practice, Boulder - (303) 666-4064, lfrieling@lfrieling. com; and Morris Hoffman, a judge for the Second Judicial District Court, Denver

E. Lee Reichert

John R. Chadd

About The Author:

This month's article was written by Barrett T. Weisz, Denver, an attorney with Richilano and Ridley, P.C., practicing in criminal defense and civil litigation - (303) 893-8000, BWeisz@randrlaw.net.

This article reviews the process and requirements for obtaining an indictment from a state grand jury in Colorado. It also discusses potential attacks on the indictment and discovery necessary to pursue such attacks.

Over the past decade, "dissenters' rights"1 issues have received significant attention from academics and courts in numerous jurisdictions.2 In particular, Delaware courts, which have developed considerable expertise in dealing with corporate legal issues, have issued a number of opinions addressing appraisal rights for dissenting stockholders under the Delaware General Corporation Law ("DGCL").3

The Colorado Business Corporation Act ("CBCA")4 became effective July 1, 1994. In many respects, including dissenters' rights, the CBCA represented major changes from prior Colorado corporate law. Nonetheless, until the last two years, the Colorado Supreme Court had not issued any opinions regarding dissenters' rights.

The Court's recent decisions in Pueblo Bancorporation v. Lindoe, Inc. and Szaloczi v. John R. Behrmann Revocable Trust5 reflected a willingness of the Court to break its silence in this often controversial area. These opinions are important for Colorado business law practitioners to review, not only because of their holdings on specific dissenters' rights issues, but also because the decisions provide some guidance as to how the Colorado Supreme Court may later address a variety of matters arising under the CBCA.

As discussed in this article, the Court tackled some complex issues in Lindoe and Szaloczi. This article reviews how the cases addressed: (1) the definition of "fair value" under the CBCA and whether a marketability discount should apply in determining fair value; and (2) the scope of the exclusivity remedy contained in Colorado's dissenters' rights provisions. This article also analyzes unresolved areas pertaining to dissenters' rights provisions of the CBCA and provides some insight into how Colorado courts eventually may address other corporate matters relating to the CBCA.

Lindoe Case:
Fair Value Issues

The Colorado Supreme Court initially entered the dissenters' rights arena in 2003 in Lindoe6 to resolve a Court of Appeals conflict over whether a "marketability discount" may be applied in determining fair value. A marketability discount adjusts for a lack of liquidity in a shareholder's ownership interest in an entity, on the theory that there is a limited supply of potential buyers for stock in a closely held corporation.7 The CBCA, like the statutory provisions of most states, does not expressly address the question of discounts in the statutory definition of fair value. Instead, CBCA § 7-113-101(4) simply states that fair value means "the value of the shares before the effective date of the corporate action to which the dissenter objects."

A frequent question involving fair value is whether common minority and marketability discounts should apply to the valuation of a dissenting party's shares.8 Courts that have addressed this matter have produced conflicting decisions with myriad rationales. In Lindoe, the minority discount issue was decided at the appeals court level and was not appealed to the Supreme Court. Regarding a marketability discount, the Supreme Court held that it should not apply as a matter of law.9

Underlying Facts

Lindoe, Inc. ("Lindoe"), was a shareholder in Pueblo Bancorporation ("Holding Company"). Lindoe was a Subchapter C corporation under the Internal Revenue Code ("Code"). Holding Company, which itself also was a Subchapter C corporation, instead desired to make a Subchapter S election under the Code. However, to qualify as an S corporation, a corporation cannot have any C corporations as shareholders.

To accomplish its corporate objectives, Holding Company agreed to merge into a newly created S corporation. Only those shareholders that could legally own shares in an S corporation were eligible to remain shareholders of the surviving corporation. Shareholders such as Lindoe, which were ineligible to receive shares of the surviving S corporation entity because they were C corporations (or otherwise were ineligible S corporation shareholders), instead received a cash payout in exchange for shares of Holding Company stock.

Lindoe chose to dissent from the $341 per share cash-out price established by Holding Company. Instead, Lindoe exercised its right under the CBCA to have a court determine the fair value of its shares. The trial court first concluded that the pro rata value of the outstanding shares in Holding Company was $666.16 per share. The trial court then applied both a minority discount and a marketability discount to arrive at a fair value determination of $362.03 per share.10 Lindoe appealed the trial court's decision to apply the two separate discounts.

Court of Appeals Decision

In addressing the minority discount, the Court of Appeals cited a recently issued Colorado Court of Appeals case, M Life Insurance Co. v. Sapers & Wallack Insurance Agency, Inc.11 In M Life, the Court of Appeals had determined that the application of a minority discount:

1) deprives minority shareholders of their proportionate interest in a going concern;

2) values minority shares below majority shares, resulting in unequal treatment of the same class of shares;

3) undermines the primary goal of a dissenters' rights statute (protecting minority shareholders from being forced to sell at unfairly low values while allowing the majority shareholders to proceed as they desire); and

4) encourages oppressive conduct by the majority shareholders.

Agreeing with the M Life court's analysis, the Court of Appeals in Lindoe concluded that the trial court should not have applied a minority discount. Holding Company did not appeal this portion of the opinion.

In Lindoe, the Court of Appeals addressed the trial court's use of a marketability discount by first reviewing and analyzing numerous considerations for and against a marketability discount. In determining that the arguments against the application of a marketability discount were more persuasive than those in its favor, the Court of Appeals relied heavily on several sources. These sources were: (1) the rationale set forth in the Model Business Corporation Act ("Model Act"), on which the CBCA was based; (2) the Delaware decision in Cavalier Oil Corp. v. Harnett;12 and (3) Principles of Corporate Governance promulgated by the American Law Institute ("ALI").13 Each of these authorities supported the position that dissenting shareholders should be awarded the proportional value in the corporation valued as a whole and not their individual shares valued standing alone.

Ultimately, the Court of Appeals in Lindoe held that the trial court should not have applied a marketability discount. This result was in direct opposition to prior cases decided by the Colorado Court of Appeals, including the 2001 M Life decision, which had permitted the application of a marketability discount.14 Holding Company appealed this aspect of the opinion to the Colorado Supreme Court.

Supreme Court Decision

On appeal, in a 4-3 decision, the Colorado Supreme Court held in Lindoe that the question of whether to apply a marketability discount is a question of law, not a question of fact for trial courts to determine. In doing so, the Court rejected the determination of fair value on a case-by-case basis and overruled a number of prior Colorado Court of Appeals decisions.15

The Supreme Court stated that the Colorado legislature intentionally used the phrase "fair value" in the dissenters' rights statute and that the term represented a different standard than "fair market value," again abrogating prior Court of Appeals decisions.16 After determining what fair value did not mean, the Lindoe Court concluded that fair value was the shareholder's pro rata share of the corporation without any marketability discount.

The Court examined the purpose of the dissenters' rights statute and found the statute was intended to compensate the shareholder for what it has lost: its proportionate interest in a going concern. The Court concluded that a marketability discount would inject unnecessary speculation into the appraisal process. After reviewing the Model Act's influence on the relevant provision, the Court looked to cases from other jurisdictions for further support, including what it termed the leading case on the issue, Cavalier Oil.17

The Court relied on the Delaware Cavalier Oil decision, the fact that a number...