"Valuation is an art, not an exact science. Mathematical certainty is not demanded, nor indeed is it possible."

Justice Simon in Gold Coast (1948)

Determining the proper price of an item of property has bedevilled lawyers and courts since time immemorial.

Just as lawyers often look at members of other professions, such as accountants, with awe in their mastery of mathematical matters so, too, must accountants look upon lawyers who seek to apply law to valuation or vice versa, with not just awe but also apprehension. One judge wrote:

"The task of enterprise valuation, even for a finance expert, is fraught with uncertainty. For a lay person, even one who wears judicial robes, it is even more so. No formula exists that can invest with scientific precision a process that is inherently judgmental."1

However, valuation, appraisal or assessment - call it what you will - remains an essential topic in the law with which any person in business must be aware.

That the law would squirm when immersed in valuation principles was apparent in these words of Justice Wendell Holmes of the United States Supreme Court in Itheca Trust:

"(A)ll values, as the word is used by the law, ... depends largely on more or less certain prophecies of the future, and the value is no less real at that time if later the prophecy turns out false than when it comes out true."

In Brant, Justice Anderson of the Ontario High Court of Justice had to decide the value of shares in a corporation. He wrote:

"(V)aluation is not an exact science....

"While due application of the methodical approaches adopted by the experts is useful, it is dependent upon factors which are entirely a matter of judgment and the end result is an opinion, not a precise solution arrived at by precise methods utilizing only known and constant factors....

"(T)his is the nature of valuation.... "

judicial valuationOften, corporations, partners or participants in joint ventures establish valuation principles in a constitutive contract. For example, a shareholders agreement or a partnership agreement typically provides, in whole or in part, assistance in determining the valuation of a participant's share or shares in that the participant is leaving the business.

Valuation can depend on the purpose of the valuation. For income tax purposes, the conservative approach may be preferred, as is typically the case for any valuation prepared for disclosure purposes.

In litigation, where a contract sets out the necessary elements of a valuation, the court will bow to the principle of freedom of contract. They will not reinvent the wheel but, instead, will leave the parties to their bargain, for better or for worse.

In the absence of contractual process, most jurisdictions provide statutory formulas for dividing assets but rarely, if ever, as to the valuation of those assets, which is a condition precedent to any division. At best, there may be a baker's dozen of references in statute as noted by Justice Greenberg of the Quebec Superior Court in Domglas:

"Various corporation statutes have in such provisions employed, as the basis for the appraisal, such varied terms as value, market value, fair market value, full market value, real value, fair cash value, fair price and finally fair value."

But these cases often go to court because there is no agreement as to valuation. In Black v Black, Justice Walsh of Ontario  was busy splitting family assets as part of a divorce case. The husband, Conrad Black's brother, had shares in five different private companies: The Warspite Corporation, Trachrannont Limited, J.E. Black Investments Ltd., Great Thunder Holdings Limited and Farmcal Holdings Inc. To help one or the other of the parties, the poor judge had before him four different expert reports on the value of the shares ranging from $9 to $34-million!

Compounding valuation for the purposes of the law is that the law concerns itself with justice whereas, arguably, there is no room for the errant paths of judicial discretion in the valuation of an item of property: it is what it is. Thus, in law, valuation often spoken of in terms of fair value, as distinct from, for example, fair market value.

Trepidation has not and will not stop a judge from doing his or her job. In Dinham, Justice Lindley wrote:

"... where persons enter into partnership on certain terms, one of which is that on a dissolution one partner shall take the share of another at a valuation, the court will ... enforce such a stipulation and if necessary itself ascertain the value of the share."

Thus, lesson #1: provide for valuation in a constitutive contract or, in the event of a dispute, look first to the contract.

Many a lawyer or accountant will share with you horror stories of some former criminal law lawyer turned-judge called upon to exercise judicial discretion and value some item of property.

In a situation where a corporation is being sold, where valuation is always a primary issue, the competing interests not only of buyer versus seller, but a desire on the purchaser to buy the assets of a corporation, and the vendor's preference to sell the shares, all must be weighed against the financial and tax consequences to four different parties and which has the potential of substantially impacting upon any agreed valuation: the buyer, the seller, the business and the tax department Sometimes, but not always, the interests of the first three can be married on terms advantageous to both and, to the extent possible, avoiding taxes.

In regards to the valuation of a corporation, the Supreme Court of Delaware, Chancery Division wrote in Cede:

"Valuation decisions are impossible to make with anything approaching complete confidence. Valuing an entity is a difficult intellectual exercise, especially when business and financial experts are able to organize data in support of widely divergent valuations for the same entity.... (A corporation's) value is not a point on the line, but a range of reasonable values, and the judge's task is to assign one particular value within this range as the most reasonable value ... based on considerations of fairness."

Some Guidance in Law

But the Courts like to beat and tread upon beaten paths and therefore, statements of law were inevitable in this area. In Domglas, the Quebec Court adopted these words:

"Valuation means the procedure and technique of estimating the value of specific property at a stated time and place. In a derived sense, it refers also to the estimated value itself.

"Generally accepted and recognized valuation principles and theory have postulated four approaches to the valuation of corporate shares. They are the quoted market price on the stock exchange: the market value approach; the valuation of the net assets of the company at fair market value (the assets approach), the capitalization of maintainable earnings (the earnings or investment value approach) (and) some combination of the preceding three approaches."

moneySimilarly, in Kelvin Energy, Justice Forsthy of the Alberta Court of Queen's Bench wrote:

"The term fair value has been subject to judicial interpretation and comment concerning the method of arriving at what is the fair value of a particular share. It is clear from the authorities that there are four generally accepted methods of valuation which can be used in arriving at the fair market value of Kelvin shares from which the fair value of the dissenting shares may be determined .... These are ... market price; net assets approach; earnings or investment value approach (or) a combination of the foregoing."

There are many factors that play upon valuation of a share in a business:

  • Goodwill;
  • Cash flow;
  • Assets, real property and other including vehicles and equipment or furnishings;
  • Financial assets including "money in the bank";
  • Accounts receivable;
  • Debts;
  • Market value of shares, in the case of a corporation;
  • Potential growth in value of the assets; and
  • Financial or in-lieu-of contributions by partners, in the case of a partnership.

For this reason, in Re Libby, the Court noted that:

"... there is no definite rule for determining fair value, but that the proper results in each case will depend upon the particular circumstances of the (business) involved."

Conclusions

When valuation issues arise in law, as they so very often do, the best approach is to consider an agreed expert valuer or appraiser.

An honest valuation by a disinterested, competent evaluator is better than an honest valuation by a disinterested but incompetent evaluator, aka a judge.

REFERENCES:

  • Banks, R., Lindley & Banks on Partnership, 7th Ed. (London: Sweet & Maxwell, 1995)
  • Black v Black 66 O.R. (2d) 643 (1988); also at 18 R.F.L. (3d) 303, 31 E.T.R. 188 and 1988 CarswellOnt 323
  • Brant Investments Ltd. v. KeepRite Inc. 37 B.L.R. 65, 60 O.R. (2d) 737, 42 D.L.R. (4th) 15 and 1987 CarswellOnt 135
  • Campbell, I., The Valuation & Pricing of Privately-Held Business Interests (Toronto: Canadian Institute of Chartered Accountants, 1990)
  • Cede & Co. v Technicolor Inc. 2003 Del. Ch. Lexis 146
  • Dinham v Bradford 1869 Ch. App. 519
  • Domglas Inc. v. Jarislowsky, Fraser & Co. 13 B.L.R. 135, [1980] C.S. 925, J.E. 80-851 and 1980 CarswellQue 51
  • Gold Coast Selection Trust Ltd. v. Humphrey, [1948] A.C. 459 and at [1948] 2 All E.R. 379
  • Ithaca Trust Co. v. United States 279 U.S. 151 (1929)
  • Kelvin Energy Ltd. v. Bahan 52 Alta. L.R. (2d) 71, 79 A.R. 259 and at 1987 CarswellAlta 99
  • McGuiness, K., Canadian Business Corporations Law, 2d ed. (Toronto: LexisNexis, 2007), pages 1418-1430
  • Owen, D., editor, Buying and Selling a Business (Vancouver: Continuing Legal Education Society of British Columbia, 2009)
  • Prescott Group Small Cap v Coleman Co. 2004 Del. Ch. Lexis 131 (note 1)
  • Re Libby, McNeill & Libby 406 A. 2d 54 (Maine, 1979)