Every Day Is Cyber Monday When An LLC Dissolves

November 29, 2021 |

Sale special offer advertise display in shopping department store. Shopping sale sign 30- 50% sale at adepartment.

As shoppers around the country begin to queue for deep discounts on nearly everything under the sun, the California Court of Appeals wants you to know that those discounts can sometimes apply to the sale of minority interests in an LLC, too. When company interest holders decide that their best path forward is dissolution, they likely expect to receive the fair value of their interests in the entire company. However, this may not be in line with what the law requires. Depending on the organizational structure of the company and the interests being purchased, some owners may only get a fraction of the fair value of their interest. On the other hand, majority owners may be able to buy out other interest holders at a steep discount. It is important for owners to appreciate on what side of this equation they stand before moving forward in a dissolution action.

In Cheng v. Coastal L.B. Associates, LLC, a sibling of an equally owned limited liability company, whose sole asset was a single-story industrial warehouse, filed an action for involuntary dissolution against her three other siblings. Two of the siblings elected to purchase the shares of the other two siblings’ 25% shares pursuant to Corp. Code section 17707.03, which allows members to avoid dissolution of an LLC by purchasing the membership interest of those seeking dissolution at fair market value.

The trial court appointed three appraisers to determine the fair market value of each of the two siblings’ 25% interest. The appraisers submitted a joint final report and unanimously agreed on a net asset value of $831,973 for each 25% interest share in the LLC. Critically, a majority of the appraisers also agreed that the fair market value standard required consideration of a 27% discount applicable to a minority interest in the LLC, which resulted in a valuation of $623,979 for each 25% interest in the LLC. The trial court agreed with this discounted valuation and ordered an additional deduction of $2,025 for reimbursement of appraisal fees and set a final buyout price of $621,954 for each 25% interest share.

The minority interest holders appealed the discounted valuation. The Second District Court of Appeal agreed with the majority appraisers and emphasized that “[t]he 27 percent discount applied by a majority of the appraisers and confirmed by the trial court is consistent with commonly understood fair market valuation principles stipulated to by the parties.” It rejected the argument that the valuation standards proscribed for shareholder buyouts of a closely-held corporation should apply to LLCs. Such standards would not allow a discount when determining the fair value of a minority shareholder interest because a corporation’s fair value is determined by considering the liquidation value of the entire business and “’does not consider market-related factors that could affect value in the particular hands of a specific owner . . . and only considers the proportional interest in a going concern.’”

The Court of Appeal focused on the different standards used to purchase interests in LLCs versus closely-held corporations: fair market value versus fair value, respectively. The Court of Appeal defined fair market value as “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, and both parties have reasonable knowledge of the relevant facts.” The Court of Appeal indicated that such a definition includes “discounts reflected in the market” and cited a case that would also include premiums in this definition.

The Court of Appeal reasoned that because “the difference in the statutory language evidences a difference in legislative intent . . . the inference is that the Legislature intended a difference in meaning.” Since the Legislature could have used the same language, but chose not to, the standard used in closely-held corporations did not apply to LLCs.

In Cheng, and in other cases like Goles v. Sawhney, courts have found that similar discounts on minority interests do not apply to corporations. Other cases, like Ronald v. 4-C’s Electronic Packaging, Inc. and Brown v. Allied Corrugated Box Co., raise the question of whether a premium should be added when purchasing a corporation’s controlling shares, both cases reaching conflicting opinions. Majority interest holders of LLCs will likely argue for similar premiums when selling their shares.

Knowing how much your interest in a company is worth at its inception and at its dissolution is crucial when making business decisions. Regardless of the current stage of your company’s life or the amount of interest you hold in the company, you should seek legal advice when the value of your interest is an important consideration.