Archive for December, 2014
Management of Dissenters’ Rights Case
This post discusses the management of dissenters’ rights cases involving privately held corporations. These may be S corps, C corps, or LLC’s. They may be family owned or simply closely held. The common characteristic is a dispute between the majority in management and the minority.
Typically, the dispute arises because the minority shareholders consider that the majority in control of management of the company has in some way acted to prejudice the minority. The minority shareholders may claim breach of fiduciary duty, self-dealing, or fraud by the directors and sue for remedies under the common law. Or, the majority may use statutory procedures that enable them to “squeeze-out” the minority but obligate the company to pay “fair value” for the minority’s shares. The ensuing litigation may therefore involve both common law and statutory claims.
The term, “dissenters’ rights,” actually derives from the minority’s right to dissent from the majority’s statutory proceeding (typically a merger of the original corporation into a new corporation owned by the majority shareholders only). This right includes the entitlement to “fair value” for the dissenter.
1. Principal legal and factual issues
Some dissenters’ rights statutes expressly state that their fair value remedy is exclusive, typically with exceptions for fraud in the process. Most states, following either the Model Business Corporation Code or Delaware law, have incorporated some degree of exclusivity with exceptions into their case law. So, the first principal issue is whether the minority shareholder’s lawsuit is limited to a statutory fair value claim. Usually, a plaintiff can assert both common law claims and the statutory remedy if fraud or some form of self-dealing by the directors is present.
The legal and factual issues associated with common law claims are routine in the sense that they are similar to such claims outside of the dissenters’ rights context. They obviously may overlap with the issues in the statutory claims.
The issues in a statutory proceeding are different because (a) the judge is usually the trier of fact and (b) the statute, case law, or standards usually provide that “fair value” is measured at a date just before the statutory transaction, generally independent of the effects of the transaction. These two characteristics of a dissenters’ rights case lead to significant evidentiary issues, such as what facts are relevant to a valuation just before the transaction date.
The accepted standard is what was “known or knowable” at the valuation date, but that standard can provoke controversy as the judge decides what he may consider in valuing the plaintiff’s shares. So, there is considerable motivation by the party controlling the information (usually the majority in management) to limit or somehow modify the disclosure of information that might tend to increase the value of the dissenter’s shares. This motivation obviously leads to discovery issues and subsequently credibility issues.
2. What is the real source of the dispute?
On the surface, the answer to this question is easy. The dispute is about the value of the dissenting shareholder’s shares. The majority in management wants the amount to be low, and the dissenter wants the value to be high.
But, a disagreement about value usually has its roots in something more fundamental. Identifying that fundamental problem can assist not only in managing the case but also in resolving it. At worst, the fundamental problem may be that the shareholders have simply had a personal falling out (always potential in a closely held, even family, corporations), now have personal animosity, and cannot act rationally with respect to each other. At best, they have simply disagreed about the value. Understanding real source of the dispute is necessary to dealing with discovery issues and managing expectations.
3. How to maximize (or minimize) the “fair value?”
Developing the best strategy in a dissenters’ rights case means addressing several factors:
a. The party in control of the information (usually the majority in management) probably has a motivation and the ability to control and modify the information.
b. The dissenting shareholder may have had no involvement in management and may have little or no understanding of the business, its operation, or its records.
c. The judge as trier of fact may have insufficient time or inclination to understand the sometimes complex accounting issues required to value a business.
Each of these factors leads to challenges in discovery and proof of facts. The managing majority may resist any discovery, even alter records, and misstate the facts to suit its position on value. This potential increases when the plaintiff has no experience and so limited ability to recognize what is wrong. The plaintiff may have difficulty finding and presenting a “fact” witness, forcing reliance on expert testimony and cross-examination. Finally, a trial to the court may take an exceedingly long time, during which the presentation of evidence can become repetitive, the process expensive, and the judge can lose the ability to make difficult factual determinations. All of these factors can combine to make the whole experience emotionally difficult for the parties.
4. What are the challenges to the strategy?
Put differently, what are the unexpected pitfalls that can disrupt any well-planned strategy with mistakes? There are many, but they fall into a few categories:
a. Given the risk that a court may find the dissenters’ rights statutory remedy exclusive, the initial pleadings – even those premised on “notice” – are important. If the dissenting minority shareholder has a common law right of action, he must plead it carefully to come within the statutory or case law exceptions to exclusivity for fraud, breach of fiduciary duty etc knowing that the defendant will argue that the claim is simply about the price of the shares.
b. Given the control over the facts that the majority in management has, discovery must assume and counter efforts to limit and modify the truth. While good practice may assume this in any case, it is paramount in representing the minority, non-management shareholder. So, discovery can become more time consuming and expensive to achieve the necessary level of information.
c. If, as the plaintiff, the minority shareholder lacks personal information about the business and its operation, then the plaintiff needs to substitute another credible source of facts to preempt and counter the “story” from the defendant. The documents can help; cross-examination can help, and an expert can help. Whatever the approach, it is best to get the facts pinned down in deposition testimony ahead of trial to avoid time consuming, costly adjustments during trial. While trial lawyers often like to opt against detailed depositions before trial (for good reasons of cost, disclosure of approach etc), preemption of factual surprises may argue against that option in the dissenters’ rights case.
d. More than most cases, dissenters’ rights cases probably should be settled to save costs, avoid delays, and minimize the risk that the parties’ dislike for each other will color the proceeding. This means more attention to planning a settlement and working with counsel for the other side to carry it out.