Let’s say you are a minority shareholder in a closely held business, where you own a bit more than a third of the shares, and the other two shareholders each own just under a third. There’s a major squabble, and you just want out. What happens to your shares, and as a minority interest in a closely held company, what are they worth?

That was the issue just decided by the California Court of Appeal, 2nd Appellate District, in Goles v. Sawhney. The decision is important to anyone who owns a non-controlling interest in a non-public company.

Mark and Karen Goles (for convenience here, “Goles”) owned 36.7% of a software development company where they both held senior technology posts. The company’s president and its chief financial officer each owned 31.6%.

Their business relationship blew up over allegations of wrongdoing on both sides, including a claim that the two senior executives had used company funds for personal expenses.

Goles sued for an involuntary dissolution of the company, recovery of $53,000 due the company for unauthorized use of its funds by the two officers, and other relief.

To avoid having to dissolve the company, the other two shareholders asked the court to appraise the fair market value of the Goles shares and compel a buyout under California Corporations Code section 2000.

As the existence of section 2000 suggests, a falling-out among shareholders of a closely held business is hardly uncommon.

What makes Goles v. Sawhney interesting is what happened first at the trial court level, and then on appeal.

Following usual practice, the trial judge had three independent experts appraise the value of the Goles' share of the company. The appraisals came in at $69,000, $150,000 and $200,000. The judge simply averaged the three figures and said the Goles' shares were worth $139,666.67.

Any fourth grader could have done the math, right? Well, according to the Court of Appeal, this simple math is wrong. It noted that there is no provision in the Corporations Code for this “averaging methodology.” Instead, the trial judge should have obtained at least two appraisals that reflected a consensus on the firm’s value.

The appellate court said the trial judge also made other errors.

First, all three appraisers failed to include in their valuations the $53,000 “derivative claim” by Goles, aimed at recovering on behalf of the company money allegedly spent by the other executives without authorization. That claim is an asset of the company, and should have been included in the appraisals, the appellate court said.

Second, and of broadest interest to other minority shareholders, the appellate court noted that two of the three appraisals reflected a “minority discount,” but should not have done so.

It is common to discount the value of a minority ownership interest in a closely held company in a sale to a third party. That’s because the purchaser understands that he or she will not have decision-making power; that will be held by the majority shareholder(s).

But it is incorrect to devalue minority shares of a closely held company when those shares are being acquired by those who already hold the majority, the appellate court said.

In fact, it noted, Corporations Code section 2000 does not permit a lack-of-control “minority discount” in appraising a plaintiff’s minority shares in judicial dissolution actions.

The rationale behind this “no discount rule” is that when the controlling shareholders buy the minority shareholder’s interest in the company, this boosts the buyer’s control and, therefore, there is no reason to discount the minority interest.

“The rule justifying the devaluation of minority shares in closely held corporations for their lack of control has little validity when the shares are to be purchased by someone who is already in control of the corporation,” the appellate court ruled.

“In such a situation, it can hardly be said that the shares are worth less to the purchaser because they are noncontrolling,” it said, citing earlier cases that had reached a similar conclusion.

These “no discount” cases suggest that under appropriate circumstances, a minority shareholder seeking a judicial dissolution may get a better price for his or her shares than by going through the non-judicial buy-out process that is likely included in the company’s operating agreement.

However, the judicial dissolution process will be costly, and it may not be available if your operating agreement contains a strong arbitration clause.

Just like matrimonial divorces, corporate divorces cost money – and keep us lawyers busy.