The German Federal Court of Justice (FCJ) recently decided (case number II ZB 12/21) that the stock exchange price of shares of a German stock corporation can be, in the context of a corporate appraisal proceeding, the legal basis for the court’s determination of the adequate compensation for outside shareholders as well as the guaranteed dividend. This decision increases the relevance of the stock exchange price of shares of a German stock corporation for corporate restructurings.
The calculatory basis shall be the volume-weighted average stock exchange price within a reference period of three months before the date of the announcement of the respective corporate restructuring.
Stock exchange prices will be held to be inappropriate if
In German law, an appraisal proceeding is intended as a court proceeding in which minority shareholders can have reviewed in court the amount of compensation or compensation payments in the case of structural measures under stock corporation law or transformation law.
Legislation stipulates that compensation or compensation payments must be “adequate.” The courts have interpreted this brief legal requirement to mean shareholders are entitled to a “full” compensation or compensation payment. This is only the case if the compensation or compensation payment corresponds to the “real” or “true” value of the working company, including the hidden reserves and the intrinsic business value, so that a shareholder can leave the company without disadvantage.
In the appraisal proceeding, the court must enforce this statutory evaluation objective by selecting an adequate evaluation method in the context of its estimation of the company value.
Stock market value is becoming increasingly important in the case law related to appraisal proceedings. The German Federal Constitutional Court ruled in 1999 that the full compensation for shareholders of listed companies may not be set regardless of the stock market price as the lower limit for the compensation, and indicated in later decisions that the stock market price can also be considered as the basis for estimation because no specific method of company valuation is prescribed by law.
While complex valuation issues of the “discounted earnings” method commonly used to determine compensation and compensation payments are among the reasons why appraisal proceedings often take many years, courts have been reluctant to estimate the amount of compensation or compensation payments solely based on the market value of a company until the first Higher Regional Courts did so in 2021. According to the FCJ, this method used by the court in the individual case discussed here stands up to legal scrutiny.
The appraisal proceeding concerned the adequate compensation of outside shareholders, as well as the guaranteed dividend, under a domination agreement entered into in 2017 by a bidder and a target company after a takeover offer for the acquisition of the shares in the target company (Target Shares) in exchange for shares of the bidder (Bidder Shares).
The offer consideration of four Bidder Shares for every 23 Target Shares included the statutory minimum consideration under the German Securities Acquisition and Takeover Act (based on the volume-weighted average stock price during the three months prior to the publication of the decision to launch the takeover offer), plus a premium.
For the evaluation of the adequacy of the compensation and guaranteed dividend to be offered under the domination agreement, the contracting parties used a neutral expert to determine the earnings values of the companies per share in accordance with the IDW S1 standard “Principles for the Performance of Business Valuations.”
The expert calculated the equity value per Target Share and derived from such value, applying a reasonable annuity interest rate, the guaranteed dividend. Based on the equity values per share, the boards of the contracting parties set the exchange ratio to four Bidder Shares for every 23 Target Shares.
In the appraisal proceeding, the court of first instance based its findings that the compensation and guaranteed dividend were adequate on the market value of the companies, not on a business valuation. Since the appeal court confirmed these findings as well as the court’s use of the market value of the companies as the basis for its determination, the applicants appealed to the FCJ, which found that the appeal court’s decision stands up to legal scrutiny.
The FCJ found that, in the case of compensation in shares under German stock corporation law, the value relationship between the participating companies can be determined based on their stock exchange prices. The respective average stock exchange price within a reference period of three months before the reference date of the announcement of the structural measure will be relevant in these cases.
In the FCJ’s view, the prerequisite for determining the value of a shareholding based on the market value is not that the capital market is strictly allocation- and information-efficient with regard to the shares (i.e., there is a state of perfect competition and all public and nonpublic information that is accessible in principle is correctly processed in the prices). The share value can be determined using the stock market price unless in a specific case it cannot be assumed that the market participants can effectively evaluate the information.
The FCJ pointed out that it is a legal question whether a valuation method chosen by the judge of fact (or a calculation method chosen within the valuation method) contradicts the statutory valuation objectives. The choice of which of the several methods of calculation permitted in a specific case is best suited for depicting the enterprise value is the responsibility of the judge of fact as part of the determination of the facts.
Because every valuation is associated with forecasts, estimates, and methodological individual decisions—which cannot be checked in court for correctness, only for reasonableness—no valuation method will be able to calculate the value of the company participation exactly.
Rather, each method can only provide mathematical results that form the basis and point of reference for the court’s estimate. The FCJ noted that valuation methods are not legal norms and do not resemble them, and as such the court is not bound by them. This applies all the more to methods of calculation developed by economics or auditing practices, even if they are recorded in writing as “valuation standards.”
The FCJ held that the judge of fact, who is responsible for choosing the valuation method in the appraisal proceedings, is not bound by the valuation method used by the party liable for compensation. Neither the party liable for compensation nor the shareholders may justifiably trust that the court in the appraisal proceedings will retain the method on which the compensation offer was based.
Those entitled to compensation are protected from negative consequences of selecting a different valuation method because the court cannot determine any compensation below that which was offered by the party liable for compensation.
The German Stock Corporation Act stipulates that the guaranteed dividend for the outside shareholders is to be calculated based on the company’s previous earnings situation and its future earnings prospects, taking into account appropriate depreciation and value adjustments but without the formation of other revenue reserves.
It is disputed which methodological specifications for the calculation result from this statutory provision. The FCJ assessed the opposing views and found that the market value of a company can be suitable for adequately reflecting both its previous earnings situation and its future earnings prospects in the individual case and can therefore be the basis for determining the adequate guaranteed dividend pursuant to the German Stock Corporation Act.
According to the FCJ, the wording of the relevant provision does not prevent recourse to the stock market value of a company to determine the adequate guaranteed dividend. It is not stipulated that the amount would have to be determined solely using the discounted earnings method. The provision does not prescribe the basis on which to forecast future earnings prospects and the amount that could likely be allocated to each share.
It cannot be inferred from the provision that it would be impossible for the judge of fact to proceed from the forecasts of the market, which are expressed in the respective stock exchange price, when choosing the method. This is so because the consideration of the stock market value is based on the assumption that the market participants, on the basis of the information and information possibilities made available to them, have correctly assessed the earning power of the concerned company and the market valuation is reflected in the stock market price of the shares.
In the view of the FCJ, the goal formulated by the legislator of giving the outside shareholders an appropriate replacement for the dividends withdrawn is also achieved if the stock market value of the company is used instead of the discounted earnings method. The FCJ noted that the future earnings prospects of a company (as part of its earnings power) are in a functioning capital market correctly assessed by a large number of market participants through their real transactions. Thus, the participation of a shareholder in the company is valued through this interplay of supply and demand.
Accordingly, an effective information evaluation by the market participants is a prerequisite for the meaningfulness of the stock market value for the valuation of a company. In this respect, an effective evaluation by the market not only includes the past earnings situation of the company, but also its future earnings prospects.
The system of the relevant provision also does not prevent the judge of fact from resorting to assessing the stock market value methodically. The FCJ reminded that the determination based on the company’s stock market value can be a suitable method for determining the adequate compensation pursuant to the German Stock Corporation Act. A synchronization of the available methods can therefore not only be achieved if both the determination of the guaranteed dividend and the compensation are based solely on the discounted earnings method.
It is equally possible, with regard to the common reason for the valuation, to synchronize the methods in such a way that the valuation methods recognized for the determination of the adequate compensation can also be used for the determination of the adequate guaranteed dividend because both provisions are intended to ensure, in accordance with the constitutional guarantee of property pursuant to Article 14 of the German Federal Constitution, that the outside shareholder is fully compensated economically.
Recourse to stock market prices is ruled out when determining the guaranteed dividend, as well as when determining the compensation of outside shareholders, if there is no functioning capital market, e.g., if there has been practically no trading in the company’s shares over a longer period of time or if there is a tight market.
For the FCJ, indications of a tight market can be low trading volumes, trading on only a few trading days, or a low free float of the shares. Stock market prices are also not sufficiently meaningful if there are inexplicable price fluctuations or price manipulations, or if capital market disclosure requirements have not been complied with.
Furthermore, the FCJ noted that the choice of the appropriate method for determining an adequate annuity rate for deriving the guaranteed dividend in the individual case is, as with the question of the appropriate valuation method for determining the value of an investment in a company, a factual finding incumbent on the judge of fact.
The FCJ continues its case-law holding that choosing which of the several methods of calculation permitted in a specific case is best suited for depicting the enterprise value is the responsibility of the judge of fact as part of the determination of the facts.
The decision should significantly increase the relevance of the stock exchange price of a listed company’s shares as the basis for the determination of the adequate compensation, or the guaranteed dividend, by the court in the context of an appraisal proceeding.
However, since the FCJ highlights the relevance of the circumstances in the individual case, a business valuation using, for example, the discounted earnings method may continue to be a reliable basis for determining the adequate compensation of outside shareholders and the guaranteed dividend.
It may not be clear from the outset whether the court will use the market value as the basis for its estimation in an appraisal proceeding. Parties considering initiating structural measures under stock corporation law or transformation law should analyze in advance how likely an estimate by the court based on the market value in the appraisal proceeding might be.
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