Statutory fair value appraisal proceedings in New York come in two flavors. First, there’s the buy-out appraisal under Business Corporation Law § 1118 triggered by a minority shareholder’s petition for judicial dissolution. Second, there’s the appraisal proceeding under BCL § 623 triggered by a shareholder’s, LLC member’s, or limited partner’s dissent from a merger, consolidation, or sale of all or substantially all the firm’s assets.
There are commonalities and differences between the two types of appraisal proceedings. The basic approach to the determination of fair value is the same:
While neither statute defines “fair value,” almost 30 years ago New York’s highest court, in Friedman v Beway Realty, declared “there is no difference in analysis between stock fair value determinations under Business Corporation Law § 623, and fair value determinations under Business Corporation Law § 1118.”
As summed up in the landmark Blake v Blake Agency case, in both types of proceedings fair value “should be determined on the basis of what a willing purchaser, in an arm’s length transaction, would offer for the corporation as an operating business, rather than as a business in the process of liquidation.” In both types of appraisal proceedings, the three major elements of fair value are net asset value, investment value and market value, without consideration of any minority discount for lack of control but permitting consideration of a discount for lack of marketability.
The differences between the two types of appraisal proceedings include:
BCL § 623(h)(4) requires the court to consider “the nature of the transaction giving rise to the shareholder’s right to receive payment for shares and its effects on the corporation and its shareholders, the concepts and methods then customary in the relevant securities and financial markets for determining fair value of shares of a corporation engaging in a similar transaction under comparable circumstances and all other relevant factors” — language not found in BCL § 1118 that can make a meaningful difference as highlighted by New York’s Court of Appeals in Matter of Cawley v SCM Corp.
In proceedings under § 623 involving corporations (but not LLCs and limited partnerships), simultaneous with the required offer to the dissenting shareholder the company must tender 80% of the offered price. Section 1118 has no such requirement. The different rules make sense since a dissenting shareholder loses shareholder status immediately upon consummation of the corporate transaction whereas the petitioning minority shareholder in a dissolution proceeding remains a shareholder even after the buyout election until the buyout is consummated by means of a settlement or following the court’s fair value award.
Interest on Fair Value Awards: The Statutes
Here’s another important difference: Under § 1118(b), “the court, in its discretion, may award interest from the date the petition is filed to the date of payment for the petitioner’s share at an equitable rate” (italics added). That’s all the statute says on the subject.
Now compare the judicial discretion granted in § 1118 with the mandatory language in § 623(h)(6) addressing (1) allowance of interest, (2) rate of interest, and (3) disallowance of interest:
The final order shall include an allowance for interest at such rate as the court finds to be equitable, from the date the corporate action was consummated to the date of payment. In determining the rate of interest, the court shall consider all relevant factors, including the rate of interest which the corporation would have had to pay to borrow money during the pendency of the proceeding. If the court finds that the refusal of any shareholder to accept the corporate offer of payment for his shares was arbitrary, vexatious or otherwise not in good faith, no interest shall be allowed to him. [Italics added.]
Most But Not All Section 1118 Cases Default to 9%
Courts routinely allow interest on § 1118 awards absent some showing of bad faith. In the majority of published decisions I’ve seen in § 1118 cases, the courts order interest at the 9% statutory rate under CPLR 5004 which has remained static since 1981 despite dramatic fluctuations in market interest rates over the last four decades. The great majority of decisions I’ve seen awarding 9% interest don’t even pay lip service to whether the statutory rate is “equitable” and/or they expressly rely on CPLR 5004 as authority for selecting 9% although the rule provides that “Interest shall be at the rate of nine per centum per annum, except where otherwise provided by statute [italics added].”
A recent example of the latter is Igbara v Abuzahrieh in which the Appellate Division, First Department, simply wrote that the trial court “did not abuse its discretion in awarding nine percent interest, as such award is within the court’s discretion in an action under [BCL] § 1118,” citing CPLR 5004.
The memorable AriZona Iced Tea case is one of the few § 1118 cases in which the court’s decision offered meaningful analysis before landing on a 9% interest award, no doubt occasioned by the 10-figure valuation at issue. The court noted that under case precedent interest is to be awarded absent bad faith or delay on the part of the petitioner being bought out, while also noting that the court “is not required, however, to award the statutory rate of nine percent for prejudgment interest set forth in CPLR § 5004.” In nonetheless fixing 9% as an “equitable” rate, the court relied on evidence that the company pays 10% interest on loans made to it by the purchasing owner.
There are several § 623 appraisal decisions such as Matter of Carolina Gardens, Inc. in which appellate panels have remanded the cases for calculation of interest after the trial courts declined to award any interest in the absence of any finding of bad faith, delay, or other inequitable conduct by the dissenting shareholder. Those decisions, however, shed no light on the determination of an equitable interest rate.
I know of four reported § 623 cases in which the courts set an interest rate. The earliest one is Matter of Endicott Johnson Corp.decided in 1974 by the Appellate Division, Third Department and later affirmed by the Court of Appeals. There the court upheld the trial court’s 6% interest award, rejecting the appellant’s argument that 6% was too low. The decision does not relate the trial court’s reasons for selecting 6% but it’s possible if not likely that the court simply applied CPLR 5004’s then-statutory rate of 6%.
The other three cases post-date CPLR 5004’s amendment to 9%. In Matter of Jamaica Acquisition, Inc. v Shea, the Nassau County Commercial Division rejected the dissenters’ request for 9% interest and instead awarded 6.5% interest comparable to the rate payable under the company’s line of credit from the time of the merger to the date of payment.
In Matter of Gurney’s Inn Resort & Spa, Ltd. the Manhattan Commercial Division awarded 6% interest on its fair value award which, the court wrote, “approximates the rate which Gurney’s must pay for capital.” On appeal the First Department reduced the principal amount of the award but it does not appear the interest rate on the award was contested by either side on appeal.
In Zelouf Int’l Corp. v Zelouf, best known and most often cited for applying a 0% marketability discount in its fair value determination, is the most interesting of the three cases that decided the interest rate. Initially the suit was commenced as a derivative action but then “converted” to a § 623 appraisal proceeding after the company implemented a cash-out merger on the eve of trial. Following trial the Manhattan Commercial Division applied a blanket 9% interest rate both on the derivative damages award and the appraisal award. On subsequent reargument it vacated and deferred its interest determination pending the report and recommendation of a referee on other issues, acknowledging that under § 623(h)(6) the court “should apply an ‘equitable’ interest rate.” Following the referee’s report, the court allowed 4% interest on the fair value award based on evidence of the company’s borrowing rate, taking “judicial notice that current interest rates are far less than 9%,” and finding that “[i]n the current interest rate environment, 4% is fair.”
Litigating a fair value case can and often does take years, making interest on the fair value award an important factor. Whether it’s a § 1118 or § 623 fair value proceeding, as I see it based on case precedent, not to mention the steady increase in market interest rates over the last five years, a 9% interest award is not a given but certainly the wind is at the back of the party divesting their equity interest, unless during trial the company or other acquiring party offers probative evidence of a lower, equitable rate.
That was the strategy that worked in the three above-mentioned, post-Endicott § 623 cases where the companies based their arguments on their own borrowing rate as expressly allowed by the statute. Even though § 1118 doesn’t have the same reference to the company’s borrowing rate, there’s no reason it can’t be equally effective in that setting.
In the end, whether you’re advocating an interest rate higher, lower, or the same as the statutory interest rate, the objective should be to convince the court that the advocated rate is one that adequately compensates the seller for the time or investment value of the funds without unjustly enriching either side.