Quick Read: Lessons from a Recent Arbitration
A highly regarded arbitrator recently released his decision regarding the valuation of a minority interest in an insurance brokerage firm.
?In this matter, there were two shareholders ("Majority Shareholder" with 53% and "Minority Shareholder" with 47%).?The Minority Shareholder was dismissed from his employment at the company in December 2019.?
?Pursuant to the company's shareholders' agreement, the Majority Shareholder attempted to purchase the Minority Shareholder's shares based on a valuation prepared by the company's accountant.
?The parties disagreed about various issues, including:
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1.?The Valuation Date
The parties disputed the appropriate valuation date in this matter. The Majority Shareholder claimed it was the date the Minority Shareholder was terminated.
?The Minority Shareholder believed the valuation date should be a current date, essentially a moving target until the resolution of this matter based on the premise that the Minority Shareholder is still a shareholder until his shares are sold.
?The arbitrator decided as follows:
"I find that the fair date of valuation of his shares, which are still owned by him, is the date of my Award, using the best evidence before me."
??The arbitrator found that the shareholders' agreement did not adequately address this issue and therefore a "current date" would be fair and appropriate. This finding, in our view, is consistent with non-litigious share transactions that occur every day (including the public stock markets). Neither buyer nor seller would normally agree on a share price that did not reflect all events and issues existing as at the actual date of the share transaction.
?Having determined the valuation date should be current, the arbitrator was faced with the challenge that the most recent valuation evidence before him was effective five months prior to the Award Date and therefore any "stub period" changes would need to be accounted for in the Award.
?The arbitrator decided the following:
"The claimants [Minority Shareholder] further claim an extra amount for the additional amount in redundant cash of $173,000 that has accumulated in the company [edited to maintain confidentiality] since October 31, 2021 as shown on the December 31, 2021 balance sheet. Their 43% proportionate share is $74,000. The claimants are entitled to this amount plus any further additional amount in redundant cash that has accumulated since December 31, 2021 to the date of this Award."
This finding is significant because it suggests that valuation reports prepared for share acquisition purposes may need to be updated or amended prior to the hearing and/or the judgment date.
In some cases, any stub period changes since the date of the valuation could be estimated on a "per diem" basis (similar to pre-judgment interest) using the company's most recent earnings. A more sophisticated analysis may be required in some cases where significant differences occurred between the valuation report date and the hearing and/or judgment date.
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?2.?Independence of the Valuator
In Ontario, experts are required to provide, amongst other things, Form 20.1 (Family Law matters) or Form 53 (other litigation matters) confirming their acknowledgment of their duty to provide opinion evidence that is fair, objective and non-partisan.
Additionally, the Canadian Institute of Chartered Business Valuators ("CICBV") provides practice standards to Canadian business valuators that require the business valuation report to include a statement of independence.* For example, Practice Standard 110 (valuation reports) states:
?"The valuation report shall have an introduction that includes… a statement that the Valuation Report was prepared by the Valuator acting independently and objectively;"
??In determining the admissibility of the Majority Shareholder's valuation report, the arbitrator considered the case "White Burgess Langille Inman v. Abbot and Haliburton Co." (2015 SCC 23) and commented the following:
"if a party can show realistic concern that the expert's evidence should not be received because the expert is unable to comply with the duty of independence and impartiality, the burden to establish on a balance of probabilities that the expert can fulfill his obligations to be impartial and fulfill his primary duty to the court to be fair, objective and non-partisan falls on the party calling the expert as a witness."
?The arbitrator concluded the following in this matter:
"…I found the valuator's [edited to maintain confidentiality] evidence to be less than objective and non-partisan. I cannot find on a balance of probabilities that the report should be admitted."
This finding reminds us of the importance of independence in providing expert reports for purposes of litigation and/or arbitrations. Compliance with provincial rules and professional standards is always necessary.
3.?Other Valuation Issues
In addition to the above challenges, the arbitrator was provided with two very different valuation reports and had to make determinations with respect to significant other valuation issues including:
?These issues were canvased in detail and the arbitrator's findings will be very helpful to us in preparing expert reports in the future.
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We are grateful for being retained to assist in this very interesting arbitration.?If you or your colleagues require assistance in any financial analysis in the areas of business valuation, damages quantification or family law matters, it would be our pleasure to assist you.
?For more information, please do not hesitate to contact Wayne B. Rudson, CPA, CA·IFA/CBV, ASA, CFE ([email protected]) or Vincent Lam, CBV, MAcc ([email protected]) at 416-598-4500.
* The exception to this requirement is Advisory Reports which generally are not used to assist in share transaction negotiations. These reports do not require the independence of the valuator.