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Shareholder and Partnership Disputes -- California Corporations Code Section 2000

Thursday, October 22, 2015

Shareholder and partner disputes arise frequently in business for a multitude of reasons.  Examples include a shareholder mishandling corporate information, a partner acting inappropriately or a personality conflict among shareholders.

 

In situations where the shareholders or partners agree, it is beneficial to have a business valuation performed to determine the fair market value of the ownership interests in the company.  This is the simplest and most cost effective way to determine the value of the interests and decide if one will buy out the other owner’s interest in the business.

 

However, these disputes may rise to a more serious category including disputes that may include “dissenting shareholder actions” or “minority oppression actions”. 

 

Dissenting shareholder actions address the valuation rights that minority shareholders possess which give them the opportunity to dissent from corporate actions that will adversely impact their minority interests.  State statutes and case law govern the valuation rights of dissenting shareholders.  These rights may be triggered by differing actions such as a merger between companies, a new board of directors in a company or an exchange of shares between companies to name a few. 

 

Minority oppression actions arise from corporate dissolution statutes.  The statutes enable minority shareholders or partners who believe they’ve been “oppressed” to file for judicial dissolution of a company and cover acts by majority shareholders or directors that are adverse to the success of the company. 

 

California Corporations Code Section 2000

 

California Corporations Code Section 2000 provides majority shareholders with a manner for determining “fair value” to buy the shares of a dissenting minority shareholder who seeks dissolution of a corporation. 

 

The statute defines the applicable standard of value as:

 

“The fair value shall be determined on the basis of liquidation value as of the valuation date but taking into account the possibility, if any, of sale of the entire business as a going concern in a liquidation.” Section 2000 (a) of the California Corporations Code.

 

The definition of fair value under Section 2000 addresses a business that is subject to a dissolution proceeding by a minority shareholder.

 

Section 2000 was created for majority shareholders to avoid the dissolution of the company and appoint a receiver by having a court supervised valuation determine how much a minority shareholder would receive if the dissolution proceeding concluded and the proceeds were distributed.  The majority shareholder does not initiate the buy out but instead the minority shareholder seeks to dissolve the company according to California law.

 

Differences Between Fair Market Value and Fair Value Standards

 

It is important to note that this definition of fair value is different from that of the typical valuation standards applied. 

 

Revenue Ruling 59-60 defines “fair market value as the price at which property would change hands between a hypothetical willing buyer and a hypothetical willing seller, acting at arms-length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.” 

“Fair Value” – The pro rata Fair Market Value of the entire company without the application of discounts for lack of control and/or lack of marketability.  It is based upon the premise that the value of a minority interest is what would be obtained if the entire business was sold at liquidation.

A number of elements in Revenue Ruling 59-60 are not included in Section 2000.  They include:

 

  1. A willing seller is not involved.  The seller in Section 2000 is involved in a dissolution proceeding.
  2. Neither party is under compulsion to buy or sell.  The seller in Section 2000 is under compulsion to sell pending a dissolution proceeding.  Additionally, the buyer is aware of the seller’s weakened position because the sale must be completed before the completion of the pending dissolution.
  3. Parties are acting in an open and unrestricted market.  This is not present in Section 2000 where the seller has to take a cash offer because the sale must be completed by the time the dissolution proceeding concludes.

 

Dissolution Proceeding

 

In a dissolution proceeding, there are two ways to dissolve a company.  First is to liquidate the assets in the business on a piecemeal basis.  Second is to find a buyer willing to buy the business for cash before the completion of the dissolution proceeding. 

 

In a Section 2000 valuation matter, fair value is comprised of determining two values.  The first approach to value is a liquidation value of the assets in the business.  The second approach to value is to value the business “As If” there is a possibility of a sale during the dissolution proceeding.  In this situation, the valuator has to determine whether the following events could possibly occur:

 

  • A potential buyer could be found who is interested in purchasing the entire business;
  • The buyer is willing to make an all cash offer;
  • The transaction can be completed within the time frame of the dissolution proceeding.
  • The value must include a discount for lack of marketability because it is a closely held business without an available market.
  • The costs of hiring an investment bank and/or legal and accounting advisors to assist with the transaction are considered.

 

If the valuator determines that a sale of the entire business could occur during the dissolution proceeding, this would comprise the fair value above the piecemeal liquidation value of the assets.  Fair value consists of the liquidation value of the piecemeal assets plus the incremental value from the sale of the business in the liquidation proceeding.

If the valuator determines that a potential buyer could not possibly be found then valuing the business as a “going concern” is not an option and the business is valued using only the liquidation value of the piecemeal assets in the business.

 

Additional Considerations

 

In a dissolution proceeding, the directors are required to provide written notice of the involuntary winding up of the business to the shareholders, creditors and any others entitled to notice.  The valuation must consider the negative impact of giving notice of the liquidation and consider such factors as:

 

  • Impact on key employees who may leave due to the liquidation.
  • Customers may terminate their relationship with the company.
  • Loan obligations may be accelerated.
  • New sales opportunities may be lost to more stable competitors.
  • Collection of accounts receivables may become arduous.

 

The costs incurred to liquidate the assets of the business will need to be considered.  Such factors to be considered include:

 

  • Legal fees for negotiation and liquidation notices and filings.
  • Brokerage fees on the sale of the business assets.
  • Auctioneer fees in liquidating the assets.
  • Accounting and legal fees for winding up the business.
  • Costs to continue operating the business.
  • Legal fees to resolve outstanding contingent liabilities.
  • Termination fees for employees.
  • Costs to pay off the debts.

 

A piecemeal liquidation of assets may take a few months to a couple of years to complete.  The time value of money will need to be considered because the proceeds when distributed to shareholders may be worth less than as of the current time.

 

 

Conclusion

 

It is important to determine what category the shareholder or partner falls into.  If you can settle the dispute by agreement to have an independent valuation performed that is the most cost effective way to settle the matter.  However, if the parties are not getting along and there isn’t a chance of reconciliation, then a Section 2000 valuation proceeding may be the best available option for the parties involved.  Seek advise from your trusted advisors before proceeding.