The Application of Marketability or Minority Discounts in a Minority Shareholder Buyout, 0915 SCBJ, SC Lawyer, September 2015, #17

• Author: Marcus A. Manos and Manton Grier Jr., J.

The Application of Marketability or Minority Discounts in a Minority Shareholder Buyout

Vol. 27 Issue 2 Pg. 17

South Carolina BAR Journal

September, 2015

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0 Marcus A. Manos and Manton Grier Jr., J.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0A minority shareholder in a closely held corporation owns the stock subject to the will of the majority. If the majority shareholders do not wish to sell shares or issue dividends or distributions, minority shareholders may be left with little recourse. Because majority rule is the norm in corporate governance, courts typically will not interfere with the majority's exercise of good faith and reasonable business judgment, even if the minority disagrees with the majority's actions.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0However, the court will address certain actions by the majority that may constitute oppression or mistreatment of the minority. The controlling shareholders, for example, may provide well-paying jobs in the corporation to favored shareholders while excluding minority shareholders from similar employment. If the majority then declines to issue dividends or distributions, the minority shareholder is excluded from the benefits of his or her stock. The stock may have value on paper, but without the provision of jobs, or without dividends or distributions, the stock is valuable only to the extent that it may be sold. Without a publicly traded market, the shareholder may not be able to sell the shares. In such a scenario, the shares are said to be "imprisoned" by the majority.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Courts and legislatures nationally recognize the market limitations on minority owners of closely held businesses.¹ When faced with an unreasonable majority, minority shareholders may have no choice but to file an oppression or breach of fiduciary duty lawsuit.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The courts continue to define oppression. It can include, but is not limited to, conduct otherwise illegal or fraudulent.² Oppressive conduct by the majority may include:

• Failure to pay dividends when cash is available to do so.

• Paying excessive or unfair compensation to majority shareholders.

• Paying compensation to majority shareholders that is, in effect, a dividend excluding the minority.

• Engaging in a freeze-out of the minority.

• Failing to provide the minority with documents and information necessary to evaluate the value of the shares and performance of the corporation.

• Using corporate funds to pay personal expenses of majority shareholders and related persons.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Fortunately for the minority shareholder, the South Carolina Corporate Code allows him or her to petition the court in cases of shareholder oppression.³ If the shareholder proves oppression, the court may then order the corporation or its shareholders to buy out the minority shareholder's shares at their "fair value."⁴ Both corporate dissolution actions and minority oppression actions fall in the equity jurisdiction of the court.⁵The court hears the cases without a jury and seeks fundamental fairness to the parties.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The Supreme Court of South Carolina recognized the flexibility of the statutory remedy for oppressed minority shareholders in Kirakides v. Atlas Food Systems & Services, Inc.⁶In that case, the court warned trial courts not to use a rigid test for what is unfair or oppressive, but to be flexible in order to prevent abuse of the minority⁷To obtain relief, the minority does not need to prove fraud, but instead must show that the majority has taken "oppressive" or "unfairly prejudicial" action, and then craft a remedy for this conduct.⁸

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0When the majority's oppressive and unfairly prejudicial conduct deprives the minority of the benefits of ownership, a buyout is an appropriate remedy⁹ Refusing to pay dividends when funds are available, diluting the minorities' shares or preventing the minority from having corporate employment may all be factors that deprive a minority of ownership benefits.¹⁰

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0However, because a closely held corporation is not publicly traded and lacks a ready market on which to sell its shares, the question becomes whether the court should apply a "marketability or minority discount" reflecting the shares' lack of marketability and the fact that minority interests are less valuable than majority interests. Thus, the question is whether a court should apply a marketability or minority discount when arriving at the "fair value" of the shares in a forced buyout.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0South Carolina cases recognize that a judicial valuation of stock differs from the "market value" used by professionals. Therefore, the term "fair value" or "fair market value" means something different to the courts than an economic calculation of "market value."¹¹ No individual case has attempted to draw all the distinctions, however, leaving the differences to be determined on a case-by-case basis.¹²

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0What is a marketability or minority discount?

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Fair market value is generally defined as what a willing seller will pay a willing buyer for an asset. For publicly traded stocks, reaching a fair-market value is easy because the stock price reflects what buyers are willing to pay.

...