Effective January 1, 2007, Public Act 94-0889 will bring clarification and new meaning to minority shareholder rights by defining fair value for purposes of valuing stock and ownership interests in Illinois corporations and limited liability companies.
On June 20, the Illinois legislature enacted Public Act 94-0889, which will statutorily define fair value for cashouts of fractional shares in a closely held corporation. Beginning in January, the Business Corporation Act and the Limited Liability Company Act will require that a shareholder whose shares are being eliminated in a reverse stock split or whose shares are being surrendered due to their dissent to a corporate action must be paid the fair value of his shares shares.
Prior to the enactment of Public Act 94-0889, minority shareholders could understandably contend the Illinois courts’ interpretation of fair value was anything but fair. Historically, there was extensive litigation in Illinois regarding the definition of fair value for those shares held by dissenters or minority shareholders involved in forced buyouts. Fair value was a question of fact determined by a judge or jury, and both sides argued heavily as to which concept—fair value or fair market value—applied. Minority shareholders argued that the fair value of their stock was equivalent to the proportionate amount of the shareholder’s ownership in the corporation. On the other hand, the corporation believed the fair value of a minority shareholder’s stock was only that stock’s fair market value. Experts for the corporations testified that lack of control of a minority shareholder position, as well as the lack of marketability of a minority position, constituted separate discounts in the stock’s purchase price, thus greatly decreasing the overall value of the shareholder’s interest.
According to the fair market value theory, a discount of approximately 10 to 45 percent should be taken for minority status, along with another discount of 15 percent for lack of marketability. Conceivably, as was most often the case, the amount of return actually received by the minority shareholder for her shares was far less than the equity held in the company. For example, if the corporation was worth $1 million, a shareholder with a 25 percent ownership would believe that the fair value of his stock was worth $250,000. Unfortunately, the fair market value of these shares may be as low as $130,000 after discounts for minority status and lack of marketability were deducted from the value of the shares.
Many states, including Illinois, are beginning to recognize the fair value of a minority shareholder’s shares should be more proportionate to the amount of ownership in the entire company. Public Act 94-0889 eliminates the discount for minority status and provides that the discount for lack of marketability is not to be applied except in extraordinary circumstances. Therefore, if the amendments contained in Public Act 94-0889 applied to the previous example, the fair value of the minority shareholder’s share would be the proportionate share of equity. In other words, a 25 percent interest in a $1 million corporation would be closer to $250,000.
Perhaps the Illinois legislature felt the need to address a sense of injustice, or perhaps it was a desire to follow national trends of not recognizing the fair market value reduction that prompted it to step in and change the way minority stock values are determined in Illinois. Whatever the reason, there’s little doubt that Public Act 94-0889 will significantly change the way fair value of valuing stock and ownership interests in closely held corporations and limited liability companies is determined in Illinois. IBI