What's Fair?

In Della Ratta v. Larkin, 382 Md. 553 (2004), the Maryland Court of Appeals held that four limited partners had the ability to withdraw from the limited partnership and to recieve the "fair value" of their partnership interest. The case was remanded to the Circuit Court for Anne Arundel County for a determination of what constituted fair value. In March, the Circuit Court rendered its opinion in the case. (The opinion is found on the website of the Maryland Business and Technology Case Management Program.)

The limited partnership had but one asset, a shopping center. The Court first determined the value of that asset. While several points of the Court's discussion of the appraisal issue are of some interest (particularly the Court's rejection of the use of the assessment used to determine property tax), the importance of the case for me is in its discussion of the meaning of term "fair value."

The Court held that the purpose of the statutory provision calling for withdrawing partners to be paid fair value for their interests "is to indemnify the withdrawing partners for the interests that they are giving up upon withdrawal, in the same proportion as the partner[s] would participate in distributions from the partnership." The Court then concluded "that fair value is a legal concept which differs from fair market value." (Emphasis by the Court.) To determine fair value, "the valuation must be viewed from the perspective of the withdrawing partners who are surrendering their interests back to the partnership."

Since there was no direct Maryland precedent with respect to the meaning of the term, the Court looked to the dissenters' rights provisions of the Maryland corporate statute, Section 3-202, et seq. of the Maryland Corps. & Ass'ns Article. The Court quoted Warren v. Baltimore Transit Co., 220 Md. 478, 483 (1959) to the effect that:

the real objective [of the dissenters' rights provision] is to ascertain the actual worth of that which the dissenter loses because of his unwillingness to go along with the controlling stockholders, that is, to indemnify him. The textwriters and cases agree generally that this is to be determined by assuming that the corporation will continue as a going concern – not that it is being liquidated – and on this assumption by appraising all material factors and elements that affect value, giving to each the weight indicated by the circumstances, including the nature of the business and its operations, its assets and liabilities, its earning capacity, the investment value of its stock, the market value of its stock, the price of stocks of like character, the size of the surplus, the amount and regularity of dividends, future prospects of any industry and of the company, and good will, if any.

Most significantly, the Court rejected the use of a minority or marketability discount applied to the partnership interests of the withdrawing partners to determine the purchase price. This is consonant with the theory that the buyout represents a division of the business entity, not merely a purchase of the departing partners' interest in the entity. Thus, the Court found that this case was a

statutory redemption intended to make the withdrawing partners whole by allowing them to "cash out" their interests. If discounts were applied, the remaining partners would end up acquiring the interests of the withdrawing partners for less than they were worth if those interests had remained in the hands of the withdrawing partners . . . [and that] under the circumstances of this case, it is not appropriate to apply such discounts in order to determine the value of the interests of the withdrawing partners.

(Emphasis by the Court.)

The opinion seems to be correct. However, it should also serve as yet another warning that proper drafting of an agreement can control the outcome of a business dispute. Here, the parties had not addressed the possibility of a business dispute in their operative formation documents and, as a consequence, were left with a statutorily mandated result.