Standard of value in ‘reverse stock split’ cases?

BVWireIssue #103-1
April 6, 2011

In two recent cases, majority shareholders in private enterprises used a reverse stock split to “squeeze out” the minority. When the minority shareholders sue for the “fair value” of their shares, what standard of value applies?

The issue was one of first impression in both cases—and in both, the answer sounds all-too familiar: It depends…on the controlling statute. In Reis v. Hazelett Strip-Casting Corp., 2011 WL 303207 (Del. Ch.)(Jan. 21, 2011), the Delaware Chancery Court found—after an extensive discussion of the remedies available in an entire fairness case versus a statutory appraisal proceeding—that “the fair value standard is . . . economically efficient and should be applied consistently to freeze-outs, regardless of form.” The same policies that “animate using a fair value standard” to evaluate a squeeze-out merger “calls for its use when the freeze-out is implemented by a reverse split,” the court held.

Compare Rolfe State Bank v. Gunderson, 2011 WL 480685 (Iowa)(Feb. 11, 2011), in which a bank claimed that the controlling provision of the state banking code (which permitted discounts under an FMV standard) applied not only to bank mergers but to any bank transaction, including its own reverse stock split (notwithstanding the FV standard available generally to minority shareholders under the state’s appraisal proceedings). The court found the banking statute ambiguous, and—after a lengthy discussion of its legislative history—concluded that it extended the FMV standard in a reverse stock split to the valuation of a bank holding company, but not to a bank, thereby precluding discounts in the valuation of the minority’s shares.

The lesson is also familiar: It’s critical to know the applicable law in any particular case. Read the complete digests of both decisions in the May 2011 Business Valuation Update; the court’s decisions will be posted soon at BVLaw.

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