A recent case from the California Court of Appeal offers instruction in how to conduct the valuation of a minority shareholder’s interest under California’s statutory buyout process in a corporate dissolution lawsuit.

On November 22, 2016, in Goles v. Sawhney, 2d Civil Case No. B268990, the Court of Appeal, Second Appellate District, Division 6 reversed the Ventura Superior Court’s ruling that “confirmed” three disparate court-ordered appraisals of plaintiff minority shareholders’ interests in a privately held company and averaged them to determine the fair value of the company.  The appellate court ordered the trial court on remand to either: (1) adopt a majority fair value appraisal that takes into account the plaintiffs’ derivative claims and does not use a lack-of-control discount, or, alternatively, (2) hear evidence on the derivative claims and make a de novo determination of the fair value of the plaintiffs’ shareholder interest, consistent with California Corporations Code section 2000.


Plaintiffs-appellants were minority shareholders of Katana Software, Inc. (Katana) a closely held corporation, with a 36.7% interest in the company.  Plaintiffs were founders of Katana and employed by it in key positions.  In 2013, the company and other shareholders terminated plaintiffs’ employment after plaintiffs solicited a company executive to take Katana’s intellectual property and client lists for a new start-up company.  Plaintiffs sued for the involuntary dissolution of Katana and sought an accounting, injunctive relief, and damages for breach of fiduciary duty.  To avoid dissolution, defendants-respondents brought a motion to appraise the fair value of the company and buy out plaintiffs’ interest under Corporations Code section 2000.  Defendants also requested a stay of the dissolution action and the claims for breach of fiduciary duty.

The trial court stayed the proceedings and appointed three disinterested appraisers to ascertain the fair value of Katana and the plaintiffs’ shares.  The court’s order stated: “There shall be no direct or indirect contact or communication between any appraiser, on the one hand, and any party or their counsel, on the other hand, without a showing of good cause and prior order of the Court.”  The court instructed the appraisers to base the appraisals on the company’s “liquidated value as of December 20, 2013, but taking into account the possibility, if any, of the sale of the entire business as a going concern in liquidation.”

The appraisers submitted reports valuing plaintiffs’ shares at $69,000, $150,000, and $200,000 respectively.  Defendants requested a hearing to finalize the valuation and shareholder buyout.  Plaintiffs questioned the appraisals and requested that the trial court set a briefing schedule.  The trial court denied plaintiffs’ request and found that the fair value of their buyout interest in Katana was $139,666.67, which sum the court calculated by simply averaging the three appraisal report valuations.  Defendants tendered full payment for the buyout.  Plaintiffs deposited the funds in a trust account and then appealed.  The trial court denied a motion to stay the judgment pending the appeal and ordered plaintiffs to deliver their Katana stock certificates to defendants under Corporations Code section 2000(d).  Plaintiffs did so.

Plaintiffs appealed the trial court’s order pursuant to Section 2000(c).  Because the statutory buyout provision is a “special proceeding,” the Court of Appeal construed the order as an alternative decree, which is appealable under Section 2000(c).  Plaintiffs argued on appeal that the trial court undervalued their shares and its judgment was reversible error.

Shareholder Buyouts Under California Law

A Section 2000 shareholder buyout is a special proceeding that supplants an action for involuntary dissolution of a corporation.  Section 2000(a) states that when a shareholder sues for involuntary dissolution, the corporation, or the holders of 50% or more of the voting power of the corporation, may avoid dissolution by paying cash for the shares owned by plaintiffs at their “fair value.”  The statute defines “fair value” as the “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.”  Under Section 2000(c), if the parties cannot agree on a valuation, the trial court shall order the appointment of three disinterested appraisers to appraise the fair value of the shares.  “The order shall prescribe the time and manner of producing evidence, if evidence is required.  The award of the appraisers or of a majority of them, when confirmed by the [trial] court, shall be final and conclusive upon all parties.”

In Goles, the appraisers could not reach a consensus on the fair value of the company or plaintiffs’ shares.  The trial court nonetheless “confirmed” the separate appraisal reports, averaged the three appraisals, and found that the fair value of plaintiffs’ interest was $139,666.67.

Derivative Claims Must Be Considered as a Component of “Fair Value”

Plaintiffs’ complaint also included derivative claims on behalf of the corporation for breach of fiduciary duty.  Plaintiffs alleged that defendants “looted” Katana by taking unauthorized loans, employing family members, using corporate funds to pay personal expenses, and purposefully neglecting corporate governance matters.

The appellate court found that the trial court erred in determining the fair value of Katana without taking into consideration the value of the derivative claims, which belonged to the corporation.  The Goles court reiterated the rule that where a minority shareholder claims his or her shares were undervalued because of self-dealing and misconduct by corporate directors and officers, the court should afford the shareholder an opportunity to demonstrate that the alleged misconduct occurred.  Moreover, Section 2000 requires an assessment of the value, if any, of pending derivative claims and their effect on the fair value of the minority shareholder’s interest in the entire corporation.

A Trial Court’s Conduct of a De Novo Determination of Fair Value Must Conform to Corporations Code section 2000

While a trial court is not bound by appraisals and it may examine the valuations de novo to establish what it believes is the correct value of a minority shareholder’s interest, the Goles court found that the trial failed to do so.  Instead, the trial court “confirmed” the appraisal reports “in their entirety” and found that the fair value of the plaintiffs’ interest in the corporation could be calculated by averaging the sum of the three appraisal report valuations.  As the appellate court noted, however, “[t]here is no provision in the Corporations Code for this averaging methodology.”

Section 2000(c) may state that “[t]he award of the appraisers or of a majority of them, when confirmed by the court, shall be final and conclusive upon all parties.”  But, such an award requires that at least two of the three appraisals agree on the fair value.  The trial court mistakenly confirmed all three appraisal reports even though there was no consensus.  If the trial court intended to determine fair value de novo, it could not do so by “confirming” the appraisals and taking the mathematical average of defective appraisals that use a lack-of-control discount and fail to consider the value of the derivative claims.

The Goles court held that a trial court may not select among conflicting appraisals or decide a corporate valuation de novo, unless 1) the court considers plaintiff’s derivative claims, and 2) appraisers of the corporate valuation remove all “lack of control” discounts from their consideration.

The Court’s Questionable Opinion That It Is Error to Discount Minority Shares for Lack of Control

Two of the three appraisers discounted the fair value of plaintiffs’ shareholder interest by 20% and 15% respectively for lack of control.  The Court of Appeal held, however, that the trial court erroneously ignored Section 2000 when it averaged the three appraisals, two of which the appellate court believed had incorrectly used lack-of-control discounts.  Notwithstanding the Court of Appeal’s rejection of the use of lack-of-control discounts, doing so is a common technique by business valuators when dealing with small, privately held corporations.  After all, minority shareholders cannot control the corporation, so their shares are naturally less valuable than the controlling shares.

Nevertheless, the Court of Appeal determined that Section 2000 does not permit a lack-of-control discount when determining the fair value of a minority shareholder interest.  The court cited three authorities for its holding: Ronald v. 4–C’s Elec. Packaging, Inc. (1985) 168 Cal.App.3d 290, 298; Brown v. Allied Corrugated Box Co. (1979) 91 Cal.App.3d 477, 486; and Friedman et al., Cal. Practice Guide: Corporations (The Rutter Group 2016), ¶ 8:876, p. 8-178.  According to the Goles court, “[t]he rule justifying the devaluation of minority shares in closely held corporations for their lack of control has little validity when the shares are to be purchased by someone who is already in control of the corporation.  In such a situation, it can hardly be said that the shares are worth less to the purchaser because they are noncontrolling.”  (Quoting Brown, supra, 91 Cal.App.3d at 486.)

However, that belief may be misguided.  Shouldn’t minority shares be discounted because they lack control?  Acquiring minority shares does not provide a majority shareholder with any control that he or she does not already have.  Thus, there would be no control premium for anyone with minority shares, whether that person is the minority holder, future holder, or anyone else.  How can a court expect a buyer at arm’s length to pay, or any reasonable seller to sell, minority shares for the same price as majority shares?  It appears the Goles court just granted minority shareholders of California corporations a boon in the form of extra money that those shareholders could not expect to receive in the real world.  Expect this issue to be further litigated at the appeals level.