Pay "Fair" Value For Minority Shares Or Risk Dissolution


Since 1955, North Carolina courts have had the statutory power to dissolve a corporation when it is "reasonably necessary for the protection of the rights or interests of a complaining shareholder." In 1973, the legislature expanded those powers, authorizing the courts to grant virtually any relief, other than dissolution, that the courts deemed appropriate. In 1983, the N. C. Supreme Court decided Meiselman v. Meiselman, which involved two brothers, Michael and Ira, whose deceased father had owned several corporations. Through the father's lifetime gifts of stock, Ira controlled the businesses. Both brothers were employed by the companies until Ira fired Michael and excluded him from all benefits or participation. The Supreme Court held that a minority shareholder's "rights or interests" in a close corporation include realization of his "reasonable expectations." For expectations to be "reasonable," they must be known or assumed by the other shareholders. A plaintiff is entitled to relief under this "reasonable expectations" rule if he can show that (1) he had one or more substantial or reasonable expectations known or assumed by the other participants, (2) the expectations have been frustrated, (3) he (the plaintiff) is without fault, and (4) under the circumstances he is entitled to some form of relief. In a later case, the Court of Appeals said that the rights and interests of a shareholder include secure employment, fringe benefits, and meaningful participation in management.

Buy Out At "Fair Value" Or Risk Dissolution

In 1989, when our "new" Business Corporations Act was enacted, the drafters brought forward the provision allowing the court to liquidate a corporation when "reasonably necessary for the protection of the rights or interests" of a shareholder, but placed strict limits on the remedies the court could grant. The court can no longer dissolve the corporation or grant "such relief, other than dissolution," as it deems appropriate. Now the court must order dissolution unless the corporation elects to purchase shares of the complaining shareholder at "fair value" as determined by the court.

Determining "Fair Value"

The statute does not define the term "fair value." There were no reported decisions in North Carolina on how a court is to determine "fair value" until March, 1999, when the North Carolina Business Court decided Royals v. Piedmont Electric Repair Company. After ruling that the plaintiff minority shareholders were entitled to relief under the "reasonably necessary for the protection of interests" standard based on their unrealized expectations of continuing income, fringe benefits, and participation in management, the Court turned to the "fair value" question.

The parties agreed to employ an appraiser to value the company. The appraisal expert valued the shares at $846.61 per share undiscounted, or $462.27 if discounted for minority interest and lack of marketability. The Court accepted the valuation report as establishing "market value," but held that "fair value" and "market value" are not synonymous and that factors in addition to "market value" must be considered in determining "fair value." The additional factors considered by the Court in determining "fair value" were: (1) the company had no succession plan; (2) the President was approaching retirement age, and there was a risk that he would run the business until his retirement and then dissolve it; (3) the founder of the company, from whom the plaintiffs inherited their stock, had engaged in activities which exposed the company to substantial liability; and (4) he had received significant financial benefits at times when he did not perform any significant services, while the minority shareholders had received no financial benefits. The Court held that no discount should be taken for minority interest, as frequently happens in other valuation contexts. To discount the shares because they represented a minority interest would be inequitable, in effect rewarding the majority shareholders for the very exclusion of the minority shareholders that gave rise to the lawsuit. The Court also declined to apply a discount for lack of marketability. The Court concluded that the "fair value" of the stock was $635.00 per share and ordered the company dissolved unless the company elected to buy the minority shares at that amount. The Court allowed the company to do so by paying 25% down and executing a note for the balance, payable over three years, bearing interest at 8%, and secured by fixed assets worth at least two times the principal amount, with the principal balance becoming immediately due on a "change in control" or a sale of a majority of the company's assets. The Royals case has been appealed to the North Carolina Court of Appeals.