Move over New York and New Jersey! By issuing a precedent-setting decision on the use of discounts in fair value proceedings, the Idaho Supreme Court has shifted the attention of the valuation community from the east to the west. The issue, which was a matter of first impression in Idaho, was whether minority and marketability discounts should be mandatory when determining fair value.
Nonprofessional appraisal wins: The case revolved around a closely held family farming business whose assets included a mill, land, lake property, and homes. Since 1998, the shareholders of the corporation had tried unsuccessfully to effect a split under Section 355 of the Internal Revenue Code. In 2012, they obtained an appraisal that valued the corporation’s net assets at $1.61 million under the cost approach. Shortly thereafter, they hired an attorney to assist with crafting the split. He developed a proposal that assigned a value of about $3.3 million to the corporation as an ongoing business—$3,344 for each of the company’s 1,000 shares. He valued the mill at $1.7 million. His valuation was based on the 2012 appraisal and financial statements from the company’s accountant. Some of financial information turned out to be wrong.
Ultimately, the majority gave up on the 355 split, shut down the mill, and liquidated its assets. This prompted the minority to sue for dissolution of the company. Subsequently, the parties stipulated to a buyout based on the court’s determination of the fair value of the corporation’s shares. The minority’s expert had extensive experience appraising agricultural processing facilities. He used many of the same documents the attorney had used but caught and corrected the errors. He arrived at a value of $3,399 per share. The majority’s expert, who was not a CPA, valued the company in the neighborhood of $1,500 per share. He applied minority and majority discounts.
The trial court adopted the valuation of the attorney notwithstanding his lack of appraisal experience and the problematic financial data underlying his calculation. The court noted that the credited value was “very close” to the value the minority’s expert had proposed. The court rejected the use of discounts.
The majority challenged the decision on a number of grounds with the state Supreme Court. The crux was that there should be a bright-line requirement to apply minority and marketability discounts in fair value proceedings. For support, the majority looked to a comment in the Model Business Corporation Act (MBCA), which is identical to the applicable Idaho statute, and which says that “‘fair value’ should be determined with reference to what the petitioner would likely receive in a voluntary sale of shares to a third party, taking into account his minority status.” The appellant also cited case law from other jurisdictions, including New York, in which courts have sanctioned the use of discounts.
Discounts ‘just another fact’: The Supreme Court was not swayed. The comments to the MBCA, which are at not controlling authority in Idaho, simply say that “minority discounts may be considered,” the high court emphasized. And, the majority “does not cite a case that supports its assertion that minority and lack of marketability discounts must be applied as a matter of law.” In short, the discounts are “just another fact that a court may consider in determining fair value,” the Supreme Court said. It “expressly” rejected the proposition to require their use as a matter of law.
What’s more, the court awarded attorney fees to the minority shareholders, calling the appeal “frivolous, unreasonable, and without foundation,” because the majority failed to identify a jurisdiction that mandates the use of discounts.
Takeaway: The Idaho Supreme Court says minority or marketability discounts may factor into the determination of fair value, but they are not mandatory.
Find an extended discussion of Wagner v. Wagner, 2016 Ida. LEXIS 128 (April 27, 2016) in the July issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.
A shout-out to Keith Pinkerton (Coles Reinstein) for alerting us to this crucial opinion.