Shawnee Telecom Res., Inc. v. Brown

• Decision Date: 27 October 2011
• Docket Number: No. 2009–SC–000574–DG.,2009–SC–000574–DG.
• Citation: 354 S.W.3d 542
• Parties: SHAWNEE TELECOM RESOURCES, INC., Successor by Merger to Shawnee Technology, Inc., Appellant, v. Kathy BROWN, Appellee.
• Court: United States State Supreme Court — District of Kentucky

354 S.W.3d 542

SHAWNEE TELECOM RESOURCES, INC., Successor by Merger to Shawnee Technology, Inc., Appellant,

v.Kathy BROWN, Appellee.

No. 2009–SC–000574–DG.

Supreme Court of Kentucky.

Oct. 27, 2011.

Derise Duane Cook, Georgetown, KY, Counsel for Appellant.

Clark Philip Case, Case & Case, LLP, Jessica K. Case, Getty & Childers, PLLC, Lexington, KY, Counsel for Appellee.

Janet Jakubowicz, Brent Robert Baughman, Greenbaum, Doll & McDonald, Louisville, KY, Counsel for Amicus Curiae, The Kentucky Chamber of Commerce.Opinion of the Court by Justice ABRAMSON.

Subtitle 13 of the Kentucky Business Corporation Act, Kentucky Revised Statutes (KRS) Chapter 271B, gives shareholders the right to dissent from certain significant corporate actions and to obtain “fair value” from the corporation for their shares. This Court has never addressed “fair value” in a dissenters' rights action, leaving that issue to be governed for many years by the Court of Appeals decision in Ford v. Courier–Journal Job Printing Co., 639 S.W.2d 553 (Ky.App.1982), a dissenters' rights action under a predecessor statute. Recently, in Brooks v. Brooks Furniture Mfgrs., Inc., 325 S.W.3d 904 (Ky.App.2010), the Court of Appeals, en banc, explicitly overruled Ford, in part, rejecting the use of a marketability discount in assessing the fair value of a dissenter's stock in a closely held corporation except in exceptional circumstances. The case before us presents squarely the broad issue of “fair value” and the more specific issues of the continuing viability of a marketability discount in a dissenters' rights appraisal action and the appropriateness of valuing closely held corporate stock under the net asset method. Having thoroughly considered the statute and its underlying purpose, we conclude that “fair value” is the shareholder's proportionate interest in the value of the company as a whole and as a going concern. Any valuation method generally recognized in the business appraisal field, including the net asset and capitalization of earnings methods employed in this case, can be appropriate in valuing a given business and thus the Court of Appeals erred in categorically rejecting the net asset method. As for applying a marketability discount when valuing the dissenter's shares, we join the majority of jurisdictions which, as a matter of law, reject this shareholder-level discount because it is premised on fair market value principles which overlook the primary purpose of the dissenters' appraisal right—the right to receive the value of their stock in the company as a going concern, not its value in a hypothetical sale to a corporate outsider. However, generally recognized entity-level discounts, where justified by the evidence are appropriate because these are factors that affect the intrinsic value of the corporate entity as a whole. Although our reasoning is not entirely in accord with that of the Court of Appeals in this case, we agree that the fair value standard applied in this case was erroneous and that the matter must be remanded for reconsideration under the proper standard.

RELEVANT FACTS

In December 2003, Shawnee Technology, Inc. (Shawnee Tech), a Kentucky corporation headquartered and doing business in Lexington, merged into Appellant Shawnee Telecom Resources, Inc. (Shawnee Tel),¹ also a Kentucky corporation. The merger plan provided that one of Shawnee Tech's shareholders, Appellee Kathy Brown, would receive cash for her shares instead of shares in the new company, a so-called cash-out merger authorized by KRS 271B.11–010. The announcement of the merger triggered Brown's rights under KRS 271B.13–020, and she duly demanded from Shawnee Tech what she asserted was “fair value” for her shares. Disputing the amount of Brown's entitlement, Shawnee Tech, pursuant to KRS 271B.13–300, brought the present action in the Fayette Circuit Court for an appraisal of Brown's interest in the company. To understand fully the events that led to the cash-out merger and judicial appraisal litigation, it is necessary to step back a few years.

Shawnee Tech was the successor of Shawnee Installation Services, LLC, a company organized in June 1998 by Jim Clark, Brown, Andrea Simmons, and Gina Thomas. The company incorporated as Shawnee Tech, a Subchapter S corporation, in 1999. Ownership was divided 49% to Clark, 24% each to Brown and Simmons, and 3% to Thomas. According to Shawnee, the foursome hoped to build on Clark's experience installing communications devices and his contacts with telecommunications companies, by providing a sort of employment agency for the local telecommunications industry. Telecommunication companies, including MCI and Quest, which installed switches and other devices necessary for the provision of such services as dial-up internet access would engage Shawnee to provide temporary installation workers. Clark provided technological expertise, while Brown and Simmons, it appears, attempted to recruit both customers and installation workers and also to coordinate the assembling of installation crews in response to installation requests.

One of Shawnee's principal customers was a local branch of the global engineering and consulting company Siemens, Inc. For several years, Siemens had employed Clark, and his company Shawnee Communications, Inc., to provide installation services to its customers. Over the years, Clark developed a close working relationship with a couple of Siemens's managers. Until January 2000, apparently, Clark made some effort to divide the work for Siemens between Shawnee Communications and Shawnee Tech, but at that time he allowed Shawnee Communications to be subsumed by the newer company.

Shawnee Tech's early years coincided with a boom in the telecommunications industry, and the company fared well. Its adjusted operating income in 1999 was in excess of $650,000, and in 2000 in excess of $2,000,000. The industry suffered a sharp retraction in 2001, however, and several of Shawnee Tech's customers ceased to expand or went out of business altogether. The company operated at a loss that year, but managed to survive in large part due to Siemens, which became for a time virtually Shawnee's only customer. In 2002 and 2003, Shawnee again profited, generating adjusted operating income in excess of $500,000 and $750,000, respectively, but Siemens remained by far the dominant source of that income.

In the summer of 2001, Brown informed her colleagues that she wished to withdraw from the company in order to return to school. Withdrawal from the company was apparently provided for by a buy-sell provision of Shawnee Tech's Shareholders Agreement, and it appears that initially Brown's withdrawal did not raise any objection. The company ceased to pay her as an employee in October of that year, but she remained a shareholder and agreed to defer payment for her shares until the company had adjusted to her departure and could make the payment without unduly disrupting its operations. Acrimony developed, however, as the parties could not agree upon a buy-out price, and a dispute arose over the meaning of the buy-sell provision. Rather than pursuing that dispute, however, Shawnee Tech opted instead to extinguish Brown's shares via the cash-out merger into Shawnee Tel, and pursuant to the merger tendered to Brown $168,840.00 or about $703.50 per share. Claiming that the fair value of her shares was $2190.00 per share, Brown demanded an additional $356,000.00, whereupon Shawnee sought appraisal by the Fayette Circuit Court.

Shawnee filed its complaint on December 9, 2003, and completed the merger on December 31. That date became, therefore, the date as of which Shawnee Tech was to be appraised. The trial court referred the appraisal to the Master Commissioner, who heard evidence over several days in late May and June of 2006 and rendered his report on about June 5. In the meantime, the contentious litigation did nothing to ease the parties' hard feelings. In April 2005, Brown filed a counterclaim, alleging, among other things, that Shawnee and/or its directors had improperly withheld and deprived her of dividends during the whole of 2003. Clark, who was named by Brown as a counterclaim defendant, and Shawnee then responded with claims against Brown alleging, for the first time, that Brown's withdrawal from the enterprise breached a contract with Clark and that her lackadaisical job performance throughout her tenure with the company breached her contractual obligations as an employee and her fiduciary obligations as a director. The trial court severed these collateral matters from the appraisal proceeding and referred to the Commissioner the appraisal alone.

Before the Commissioner, both parties presented expert testimony concerning the value of the business as of December 31, 2003, and the value of Brown's shares. James Roller, an accountant with the firm of Hisle & Company and a certified business appraiser, testified for Shawnee. He noted that standard techniques of business evaluation include market-based approaches, approaches based on the company's assets, and approaches based on the company's income. Because he had been unable to find information regarding actual sales of companies comparable to Shawnee, he did not employ any market-based techniques.

As an assets-based approach, Mr. Roller employed a simplified version of the adjusted net assets method. He analyzed Shawnee's books and attempted to establish from them the market value of the company's assets, primarily cash, and its liabilities. He then deducted the latter from the former and adjusted that net amount for what he claimed would be the effect of income taxes. He arrived at an after tax value of $1,249,600. He noted, however, that a major limitation of this simplified approach was its inability to identify and value intangible assets, which his analysis made no attempt to do.

Mr. Roller employed the capitalization of earnings method as his income-based...