Valuation Contests In Private Bank Mergers
By: EMILY E. DUKE
October 1999
Bank reorganizations, including "phantom mergers," may give rise to dissenters' rights for minority shareholders under both the state and federal banking systems. If minority shareholders feel they haven't been treated fairly, they can sue the bank for more money.
State-chartered banks that merge or consolidate should not underestimate minority shareholders and their ability to throw the bank into what could be lengthy litigation over the adequacy of the purchase price paid for their shares. The statutory scheme, spelled out in Minn. Stat. §49.41, has not yet been tested by Minnesota's appellate courts. Under the statute, within 20 days after the shareholder meeting at which the merger/consolidation is approved, any shareholder who voted against the corporate action may object and demand payment for their stock. Then, within 60 days after the merger/consolidation becomes effective, the shareholder may apply to a Minnesota District Court for the appointment of three appraisers who will determine the "value" of the stock. The appraisers then prepare a written estimate of the value of the stock "at the time of the appraisal." Once the bank pays the appraised amount, the dissenters cease to be shareholders. The cost of the appraisers is split 50-50 between the bank and the dissenters.
"This apparently straight-forward procedure is complicated by the lack of definitions - statutory or in the courts - of "time of the appraisal" and "value." Therefore, it is unclear when the valuation date will be frozen and what the appraisers may or may not consider in estimating the value of the stock. Furthermore, it is unclear whether the Court will or should give the appraisers any guidance on what factors to consider and what, if any, discounts to apply when calculating the "value" of the dissenters' stock.
In addition to the uncertainty about valuation methodology, there is procedural uncertainty. As discussed above, dissenters' rights cases do not proceed to trial before the Court. Rather, the Court appoints three persons to perform an appraisal. It is likely that such proceedings are less formal than a Chapter 302A business valuation trial, which occurs before a Judge of District Court. Issues that must be addressed early on will include the parties' ability to conduct discovery and present evidence to the appraisers. Furthermore, the parties may seek to have input to the court regarding appropriate persons or professionals to be appointed to the appraisal panel.
State-chartered banks that merge with, consolidate with, or convert into national banks may also run into the uncharted water of Minnesota's statutory valuation scheme. According to Minn. Stat. § 49.43, shareholders who vote against the conversion to, merger with or consolidation with a national banking association, may either follow the state remedy provided in Minn. Stat. § 49.43 or "any rights given by applicable law of the United States."
The Federal scheme, depending on the speed with which the OCC can respond, could take as long as any state-court action. However, the federal scheme has the benefit of more certainty because the OCC has a well-established procedure and methodology for determining "value." The process is governed by 12 U.S.C. §§215 and 215a. Under these statutes, if minority shareholders disagree with the bank's offered price, the dissenters and the surviving entity each select an appraiser. The two appraisers then select a third. The resulting three-person panel then determines the "value" of the dissenter's shares by majority vote. If the dissenter disagrees with the panel's appraisal, or if either party fails to appoint an appraiser to participate in the appraisal committee, the dissenters may request that the OCC re-appraise (or appraise as a first instance) the value of the shares. The OCC appraisal is "final and binding."
The OCC has broad discretion in determining "value" since the term is not defined in the statute. The OCC has developed a basic formula that it applies to each case, which has been upheld by courts across the country. This formula is essentially a weighted average of three valuation methods, minus a discount for lack of marketability of the stock in appropriate cases. The three methods evaluated are: market value (if stock is publicly traded), investment value, and book value. For the investment value, the OCC picks a peer group of banks with readily available earnings data, develops an earnings multiple and applies the multiple to the bank stock in question. This method receives a 75% weight. For the book value method, the OCC analyzes the market price to book value ratio for the peer group banks, develops a multiple and applies the multiple to the book value for the bank stock in question. This method receives a 25% weight. Finally, the OCC typically applies a 5-15% lack of marketability discount in cases where no transactions in the stock have occurred for approximately three years. Some recent appraisals ordered payment to dissenters in excess of two times book value.
The statutes do not explicitly provide for court review of OCC valuations, but courts have unanimously concluded that review is available in U.S. District Courts under the Administrative Procedure Act. Although the OCC appraisal is appealable, the chances of overturning an undesirable appraisal appear slim, as the standard of review is "arbitrary and capricious."
In general, banks considering a reorganization that will squeeze out minority shareholders should consider obtaining a fairness opinion prior to the proposed merger. This opinion will not only provide a justification for the price offered from a litigation standpoint, but it may hedge off shareholder dissatisfaction that could lead to litigation. If minority shareholders feel they have not been treated fairly, the bank and potential dissenters should be prepared for lengthy delays and high litigation costs if the dissatisfaction cannot be resolved. Both sides may need to obtain expensive expert opinions as to "value." For the potential dissenter, an additional consideration is the fact that the bank will not have to pay a dime until the appraisal is decided. The statutes do not provide for interest pending the dissenters' rights proceedings, and the stream of dividend income received prior to the squeeze-out merger will be gone.