In my business divorce travels occasionally I encounter instances in which shareholder distributions are made in the period between the valuation date for an elective buyout of a minority shareholder who sued for dissolution and the consummation of the buyout following a contested fair value appraisal proceeding.
With that setup, there are two questions you might ask yourself:
- Why would the controllers of a closely held corporation voluntarily make shareholder distributions benefitting the soon-to-be-removed minority shareholder whose petition accuses them of oppression, looting, or other misdeeds?
- Since the petitioner’s shares are to be valued based essentially on the risk-adjusted value of future cash flows, do such post-valuation date distributions constitute double dipping and thus should they be credited against the fair value award?
There’s no single answer to the first question. It can happen where the company’s owners for whatever reasons historically have distributed substantially all profits as dividends rather than as salary or bonus, and feel compelled to continue the practice out of economic necessity. It also can happen where a company with a longstanding dividend policy has a number of non-petitioning minority shareholders who likely would object loudly if their dividends were suspended indefinitely by reason of a dissolution and valuation proceeding brought by another shareholder.
As for the second question, I’ve not seen any appraisal literature that addresses the double-dipping issue. Nor does the sparse case authority provide a clear answer.
New York Cases
I know of only three New York cases involving fair value appraisals that touch upon the issue at hand.
In Hall v King, the referee who conducted the valuation hearing accepted the net asset approach utilized by the defendant’s expert in valuing a firm dealing in high quality reproduction antique furniture and accessories. The referee took no position and left to the court whether two distributions of $180,000 each made to the plaintiff after the valuation date should be deducted from the referee’s recommended fair value award.
In the subsequent confirmation proceedings before the judge, the defendant relied on his expert’s testimony that the post-valuation date distributions would have to be deducted from the value of the plaintiff’s shares because they necessarily impact on the value of the corporation measured by the net asset method. The plaintiff countered that the distributions were lawfully made, at a time when he was still an officer and shareholder of the corporation, so that he is entitled to retain them in addition to the full award for the value of his shares.
The court decided the issue not as a matter of appraisal doctrine or methodology, and without any discussion of the double-dipping issue. Instead, the court focused solely on whether the distributions were approved or ratified by the board of directors. Finding that only one of the two $180,000 distributions had been so authorized, the court deducted the other $180,000 from the referee’s recommended fair value determination.
The second case, Murphy v U.S Dredging Corp., which I previously wrote about here and here, likewise involved a fair value appraisal following an election to purchase the shares of a minority shareholder who sued for judicial dissolution. All we know from that case, as recorded in the court’s decision, is that it was “agreed that the cash dividend paid to the Petitioners in January 2007, paid after the valuation date, will be considered a credit to the purchase price.”
The third case, McCully v Jersey Partners, Inc., which I previously wrote about here, addresses the issue in the unusual setting of a separate lawsuit decided after the conclusion of a dissenting shareholder fair value appraisal proceeding, in which the now-former shareholder sought to recover tax dividend distributions for the two years preceding the merger pursuant to the provisions of a pre-merger shareholders agreement.
In dismissing the suit, the lower court found that the pre-merger company owed no tax distributions for the first year and that post-merger the plaintiff as a non-shareholder lost any right to receive distributions for the second year.
Of greater relevance to the double-dipping issue, the court wrote:
Moreover, if McCully were permitted to recover herein the amount of a dividend paid on his shares after [the merger/valuation date], such a recovery would be duplicative of his recovery of the fair value of those shares in the Appraisal Proceeding, since that fair value presumably encompassed the value of the right to receive future dividends that would be paid on the shares.
Dicta? Perhaps. A persuasive rationale in the context of a fair value appraisal proceeding such as Hall v King in which distributions are made post-valuation date and pre-buyout? You decide.
The Puklich Case
A very recent decision by the North Dakota Supreme Court in Puklich v Puklich, 2019 ND 154, 920 N.W.2d 593 , affirmed the lower court’s refusal to deduct from its award the distributions made in the course of statutory buyout appraisal proceedings involving interests in a partnership and a corporate affiliate.
The central question for the court, as framed by the appellant’s argument, was whether the lower court properly found that the other owner whose interests were being bought out continued to own the interests during the pendency of the proceedings. That argument was entangled with the lower court’s selection of the valuation date which, at least as to the corporation, under North Dakota law (unlike New York law) can be any date the court deems “equitable.”
In a nutshell, the Supreme Court concluded that whether or not the lower court’s valuation date was correct, it had the power and discretion to order the continuation of distributions to the other owner until the consummation of the buyouts, without offsetting the valuation award. The opinion does not reveal whether the appellant argued double-dipping much less does it address the issue through the lens of appraisal methodology or doctrine.
Uncertainty Begets Caution
The sparse case precedent and lack of authoritative appraisal literature leaves uncertain the answer to the question posed by this post.
If you control the board of directors of a closely held corporation and you’re under no contractual compulsion or economic necessity to make distributions, then the safest bet is not to make distributions once a petition for judicial dissolution is filed and for so long as you are considering exercising, or have already exercised, an election to purchase leading to an appraisal proceeding.
Another option is to reach an upfront agreement with the shareholder whose stock is being purchased, that any discretionary distributions made before the consummation of the buyout will be credited against the fair value award. Perhaps that is what happened in the above-mentioned Murphy case.
Yet another option, for those in the mood to make new law, is to ask the court for an advance ruling that distributions shall be credited toward the eventual award.
If it’s too late, and you’ve already made distributions in the interim between the valuation date and the conclusion of appraisal proceedings, then consult with your expert business evaluator about his or her possible testimony supportive of the double-dipping argument.
Addendum: Business appraiser Chris Mercer emailed me the following comment:
Peter, This is an interesting question. Let me make a few observations: 1. If the “fair value” date is set and time passes before the valuation and the buyout, symmetry suggests that either the selling owner should receive distributions or interest from the valuation date until the actual purchase. That was the case in the AriZona matter in which I testified. Otherwise, the Company gets a free ride and the seller has no investment return for that period. 2. Certainly, the selling owner should receive distributions for taxes he may be responsible for paying personally. Otherwise, the “fair value” he ultimately receives would not be “fair.” Take this same concept to the arena of buy-sell agreements. One of the things I suggest should be agreed upon in buy-sell agreements is the answer to this question: What happens to a seller’s ownership interest following the trigger event? Does the seller remain an owner, subject to the risks of ownership and to receive distributions? Does the interest convert into a right to receive the buy-sell agreement price, together with interest between the trigger event and the actual transaction? If these issues are not addressed, they will become major points of contention when trigger events occur. Chris