Appraisal Rights in South Africa - Part 1

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Introduction

This article explores appraisal rights in South Africa, with a primary focus on the pertinent principles of share valuation. This article further makes proposals for a faster and more efficient appraisal process for both companies and dissenting shareholders. This is Part 1 of a 3-part series.

Background

The appraisal rights in section 164 of the Companies Act 71 of 2008 ('the Act') came about through the wholesale revision of South African Company Law from 2003 to 2011 and was, at the time of promulgation, completely new to the South African corporate environment.
The appraisal right has been a feature of USA corporate law for over a century and was recently adopted in Canada and New Zealand.
Interestingly, the UK and Australia have not adopted the regime.

So, what is an appraisal right?

The appraisal right is effectively a statutory put option in the hands of a shareholder ('dissenting shareholder' or 'dissenter), who, after objecting to a special resolution, may require a company to acquire the holder's shares at fair value.

Four actions that trigger the right

    As per the Act:

  1. Fundamental transactions whereby the company:
    • disposes of all or the greater part of its assets or undertaking;
    • enters an amalgamation or merger; or
    • implements a scheme of arrangement.
  2. Significant alterations to the memorandum of incorporation (MOI) that materially affect shareholder class rights.

    3. South African legal precedents:

  3. Where a subsidiary of a holding company disposes of all or a greater part of its assets, a shareholder in the holding company can dissent1.
  4. A shareholder can also dissent where the company acquires 5% or more of its issued shares2.

What is the purpose of S164?

The Act and foreign corporate legislation are largely based on the principle of majority rule. S164 is one of the sections in the Act that enhances minority shareholder protection.
Appraisal rights are particularly relevant in smaller countries such as South Africa, where there are fewer listed entities and large capitalisation companies, compared to more mature jurisdictions (and substantially larger capital markets), such as the USA.
Local mergers and acquisitions activity rarely involves multiple bidders, the result of which is an imperfect or undesirable open market for such transactions.
Minorities require the protection that S164 offers.

Procedures to dissent

Commentators have claimed that the dissent procedures are onerous and complex. This can be mitigated by advice and guidance from experienced legal and financial advisers.
The dissenter must comply with all the procedural requirements of S164. Essentially, the dissenter must indicate dissent by written notice of objection, vote against the special resolution at the shareholders' meeting and then demand the company acquires the dissenting shares for fair value.
The board of the company must offer the dissenters what it considers to be fair value for the dissenting shares, accompanied by a statement showing how they arrived at the value.
Should the dissenter consider the offer as inadequate, he may apply to the court for a determination of fair value.
The court must determine the fair value, or it may exercise its discretion to appoint an expert to assist it to determine the fair value.
It is important to note that the dissenter's rights are suspended when he makes a demand for payment of fair value. He is only entitled to receive fair value. That said, he may withdraw his demand and all his rights as a shareholder are reinstated, and any dividends declared in the interim ought to be paid to him3.

Notable points of South African legal precedents

There have been several S164 cases in recent years, features being:

  • Most demands were paid without the need to commence formal proceedings.
  • Some companies have tried to frustrate the progress of formal proceedings, escalating legal costs. It should be noted that the USA judicial system has substantial legal precedents regarding oppressive behaviour in dissenting shareholder cases where directors have been held liable, and S163 of the Act provides similar relief.
  • Companies typically benchmark fair value to the trading price of the shares at the time of the triggering event (market value). In the case of listed companies, this approach renders the remedy redundant, for the dissenter would simply sell the shares on the market. This approach ignores the distinction between fair value and market value.
  • South African courts have yet to establish jurisprudence on the correct approach to determine statutory fair value.

What is (statutory) Fair Value based on foreign legal precedents?

Since (statutory) Fair Value is not defined in the Act and South African cases are not definitive, foreign legal precedents are valuable guides to the approach a local court would take.
With over a century of appraisal rights case law, the USA jurisprudence offers extensive guidance, particularly from the Court of Chancery4, a specialized court with a specialist bench, experienced in share valuation methodology.
Whilst the Act provides four triggering events, the only trigger event for appraisal in Delaware is a merger. In a survey of Delaware mergers, it is evident that most transactions are concluded at values that exceed the prevailing share price. In many instances, dissenters succeeded in obtaining a fair value determination that also exceeded the merger price.

FAIR VALUE IS NOT:

  • the same as fair value for financial reporting purposes (IFRS 13)
    The net asset value (equity value) in the annual financial statements is not the fair value of the equity for appraisal purposes. As an example, auditors audit the management's estimation of fair value of assets recorded in the annual financial statements and test for impairment of goodwill. Goodwill is not written up (increased) where the business acquired in a historical reporting period is deemed to be worth more than the value recorded at acquisition but is written down when the deemed fair value of the business acquired has declined.
  • equal to the "market value" or "fair market value" of the dissenting shares (securities exchange price)5
    While various states interpret fair value differently from one another, with variations in interpretation even within the same state under differing facts and circumstances, they consistently do not strictly equate fair value with fair market value.
    This point is illustrated well by a New York court's rejection of an expert's valuation report based on fair market value in a dissenting shareholder case. The court stated:

    Because the petitioner's expert... in its valuation report (on title page) and on 15 occasions refers to its valuation to be based on Fair Market Value, and the Business Corporation Law only uses the term Fair Value.

    ...The Court considers it a threshold question as to whether Fair Value and Fair Market Value are synonymous. The Standard upon which the company's expert's valuation was based was Market Value... the statutory standard is much broader... The Court may give no weight to market value if the facts of the case so require6

That court ultimately rejected the report based on the fair market value of $52 per share and awarded the dissenters fair value of $99 per share.

In Le Beau vs M.G. Bancorp, the investment banker issued a fairness opinion on a squeeze-out merger based on fair market value rather than on fair value. The Court of Chancery stated that this was legally flawed as evidence to determine fair value.
In Pueblo Bancorporation vs Lindoe, following an extensive review of legal precedents from various jurisdictions, the Colorado Supreme Court concluded that, "We are convinced that fair value does not mean fair market value."
The New Jersey Supreme Court has expressed a similar sentiment7, as have most other courts.

FAIR VALUE DEFINITION: USA COURTS:

That which has been taken - a proportionate interest in a going concern postulating a theoretical buyer of the whole business

Fair value, in an appraisal context measures "that which has been taken from [the shareholder], viz., his proportionate interest in a going concern." 8

Going concern value is the amount that could be obtained by selling the business as a whole, assuming that it will continue to operate and generate cash flow in the future. This emphasizes that going concern as opposed to a liquidation assumption is appropriate.
In 1986, the Supreme Judicial Court of Massachusetts ruled:
As a going concern, the value of an enterprise such as the Old Patriots is the price a knowledgeable buyer would pay for the entire corporation, including the National Football League (NFL) franchise, the stadium lease, various contracts, goodwill, and other assets and liabilities.

The High Court of Maine concluded in the McLoon case:

Especially in fixing the appraisal remedy in a closely held corporation9, the relevant inquiry is what is the highest price a single buyer would reasonably pay for the whole enterprise, not what a willing buyer and a willing seller would bargain out as the sales price of a dissenting shareholder's share in a hypothetical market transaction.

In Trapp Family Lodge, the Vermont Supreme Court ruled:

To find fair value, the trial court must determine the best price a single buyer could reasonably be expected to pay for the corporation as an entirety and prorate this value equally among all shares of its common stock.

New York similarly defines fair value as the amount that would be paid by an arm's length nonsynergistic buyer10 (ie, acquisition value):

In fixing fair value, courts should determine the minority shareholder's proportionate interest in the going-concern value of the corporation, that is, 'what a willing purchaser, in an arm's length transaction, would offer for the corporation as an operating business.'

Other states have cited McLoon and valued companies at the presumed acquisition value.

Should consider all relevant factors

In a landmark case11 of the Court of Chancery, adjudicated that, "all relevant factors" should be considered when determining fair value. The court specifically made the point that projections of future earnings were available and should be considered. Most states have embraced this notion.

The court has significant discretion to use valuation methods it deems appropriate

In another Delaware decision12, the court noted that:
"...in using 'all relevant factors' to determine fair value, the court has significant discretion to use the valuation methods it deems appropriate, including the parties' proposed valuation frameworks, or one of the court's own making."

Part 2

 

 

1 Cilliers vs La Concorde Holdings (2018) and Contemporary Company Law, 3rd ed, chapter 16
2 Rozendal vs Capital Appreciation (2019, ongoing) - high court and appeals court in favour of Rozendal
3 Contemporary Company Law 3rd ed P1109 "It thus seems that upon a judicial appraisal of fair value, each dissenting shareholder has a choice to either accept the court's determination of fair value or, alternatively, to withdraw its demand and be reinstated as a shareholder of the (now restructured) company"
4 Contemporary Company Law 3rd ed at P1114 "A resort to Delaware jurisprudence would be in a similar vain to other jurisdictions that have adopted the appraisal right such as New Zealand and Canada"
5Pratt Valuing a Business, 6th ed
6 Slant/Fin. Corp. v. Chicago Corp. (N.Y. Supr. Ct. Oct. 5, 1995), aff'd 236 A.D.2d 547 (N.Y. App. 1997).
7 See, e.g., Swope v. Seigel-Robert, Inc., 243 F.3d 486, 493 (8th Cir. 2001); Wenzel v. Hopper & Galliher, P.C., 779 N.E.2d 30, 38 (Ind. App. 2002); First Western Bank Wall v. Olsen, 621 N.W.2d 611, 617 (S.D. 2001); Matthew G. Norton Co. v. Smyth, 51 P.3d 159, 165 (Wash. App. 2002); HMO-W, Inc. v. SSM Health Care Sys., 611 N.W.2d 250, 255 (Wis. 2000).
8Tri-Continental Corp. v. Battye Del. Supr. 74 A.2d 71, 72 (1950)
9Applicable to both a small cap / illiquid listed share and a private company
10 Synergies from the acquisition or merger should be excluded. In practice, it is difficult to quantify any synergies
11 Weinberger v. UOP
12 Appraisal of DFC Global, C.A. No. 10107-CB (Del. Ch. July 8, 2016)