Hartman v. BigInch Fabricators & Construction Holding Co., Inc

In 2020, the Indiana Court of Appeals overturned the trial court and found for the selling shareholder when it decided discounts were inappropriate in any compulsory, closed-market sale. The court did not think it mattered that a shareholder agreement specified a buyout based on specific valuation terms, which a third-party appraiser interpreted as fair market value. In a recent decision, the state Supreme Court vacated the appeals court’s decision. Finding a blanket rule disallowing minority and marketability discounts in closed-market transactions regardless of the shareholder agreement would violate the freedom to contract principle. Here, the agreement unambiguously allowed for bargains, the high court said.

‘Appraised market value.’

The plaintiff was one of the founders of a closely held company. He also had a minority interest in the company. In 2006, all the shareholders agreed to a contract that included a buyback clause. Under the clause, the company was required to buy back a shareholder’s interest if the company involuntarily terminated him or her. The buyback clause specified the company would buy out the shareholder at “appraised market value” as determined by a third-party valuation company following generally accepted accounting principles.

 In 2018, the plaintiff was terminated without cause. To determine the value of his interest, the company retained an outside valuation firm. The appraiser applied the fair market value standard of value and discounted the plaintiff’s shares for lack of control and marketability.

The plaintiff asked the trial court for a declaratory judgment that discounts were inapplicable because the shareholder agreement here did not “contemplate a fair market value standard.” Ruling on the parties’ motions for summary judgment, the trial essentially found that the term “market value” as used in the agreement was synonymous with fair market value. According to the trial court, the word “appraised” is an adjective modifying“market value.” The trial court ruled for the company.

The Court of Appeals reversed, finding that discounts were inappropriate under controlling case law because the transaction involved a compulsory sale. Discounts could not apply to any closed-market sales, the appeals court decided. The Court of Appeals agreed with the terminated shareholder that one case, in particular, Wenzel v. Hopper &Galliher, P.C., was controlling.

Among other things, the court inWenzeldescribed minority and marketability discounts as “open market concepts.” A minority discount adjusts for lack of control over the corporation because a minority interest does not have the same value to a third party as a majority holding. A marketability discount adjusts for lack of liquidity as to the stock because of a limited number of purchasers.

The Wenzel court said applying a minority discount was inappropriate in a compulsory buyout because “a sale to a majority shareholder of the corporation simply consolidates or increases the interest of those already in control.” The discount “would result in a windfall to the transferee.” A marketability discount was inappropriate because there was a ready-made market for the shares.

In the instant case, the Court of Appeals found cases following Wenzel have affirmed that discounts do not apply to a controlling party in compelled transactions. Further, the court rejected the company’s argument that Wenzel and related cases did not apply to this case because they involved a fair value determination under the statute. In contrast, the instant case necessitated a value determination per the shareholder agreement.

Parties’ freedom to contract.

The company petitioned for the transfer of the case to the state Supreme Court. The petition was granted, and the Court of Appeals decision was vacated.

The direction of the Supreme Court’s opinion becomes apparent in the opening paragraphs. The court said, notwithstanding policy concerns that may preclude the use of discounts in certain circumstances, “We hold that the parties’ freedom to contract may permit these discounts, even for shares in a closed-market transaction.” The court went on to say that “under the plain language of this shareholder agreement—which calls for the ‘appraised market value’ of the shares—the discounts apply.”

The Supreme Court agreed with the company that Wenzel was distinguishable from the instant case because it concerned the interpretation of a statute, not a contract. TheWenzelcourt performed a statutory interpretation to determine the meaning of the term“fair value,” the high court noted. The statutory purpose was to ensure the shareholders would be compensated fairly. In contrast, the high court pointed out, here, the valuation term comes from a contract that requires the determination of the shares’ “appraised market value,” not “fair value.”

The agreement’s valuation term “unambiguously allows the discounts to apply,” theSupreme Court said. It noted that the operative term was“appraised market value,” a term the agreement did not define. However, the company, throughout the litigation, argued: “market value” was synonymous with “fair market value,” and the term “appraised” indicated who would value the stock.

In contrast, the selling shareholder (plaintiff) argued “appraised market value” and “fair market value” were not synonymous terms; the trial court improperly “injected” the fair market value standard into the agreement.

The high court disagreed with the plaintiff, finding the term “‘market value’ plainly and unambiguously refers to the shares’ ‘fair market value.’” Further, the term “‘appraised’ value merely describes how to determine the shares’ market value,” the Supreme Court concluded.

The court went on to say that, while the parties agreed to a compulsory, closed-market sale, not an arms-length transaction, the agreement’s “plain and unambiguous language” also provides the shares be valued “as if they were sold on the open market.”

No court applying Indiana law has held that discounts are always inapplicable to a closed-market sale, “only that the discounts cannot be applied in certain situations,” the high court noted.

Here, the Supreme Court said, even if the valuation term “were somehow ambiguous, we would find ‘fair market value’ to be the appropriate standard.”

“[W]e must honor the parties’ freedom to contract and look to the terms they chose to govern the buyback of [the plaintiff’s] shares,” the court said. It noted the company does not receive a windfall from the use of discounts “because, by definition, a windfall is unexpected.” In contrast, the parties to the company’s shareholder agreement years ago agreed to be bound by the terms of the agreement.

The high court further noted that the selling shareholder benefited from the agreement. There was a ready market for his shares as the company was obligated to buy them. Additionally, under generally accepted accounting principles, the use of discounts is accepted practice when determining the shares’ fair market value. The plaintiff had a right under the contract to obtain an additional appraisal from a third-party appraiser but did not do so; the state Supreme Court pointed out.

The court affirmed the trial court’s granting summary judgment for the company; there was no blanket rule against applying discounts in a compulsory, closed-end transaction. Here, under the parties’ shareholder agreement, discounts were applicable in determining the fair market value of the plaintiff’s minority interest.