RKS thanks Daniel Kalansky, Partner at Loria e Kalansky Advogados and Professor in the LLM program at Insper University for this guest post.  Professor Kalansky holds a PHD in Corporate Law from the University of São Paulo – USP and is the Former president of the Brazilian Institute of Business Law – IBRADEMP.   To contact the author: dkalansky@lklaw.com.br

*** RKS does not practice in the Federative Republic of Brazil and takes no position on Brazilian law or changes to it. ***


Appraisal Rights and Fair Value as Investor Protection: A Needed Brazilian Reform

It was in Professor Joshua Mitts’ class, based on his article “Asking the right question: The Statutory Right of Appraisal and Efficient Markets”, co-authored with Professor Jonathan Macey, that made me reflect on the share value for appraisal rights in Brazilian law and subsequently formed the basis of my thesis to achieve my PHD in Brazil, which later was published as a book prefaced by Judge Karen Valihura of the Supreme Court of Delaware.

My thesis focuses on the following questions: what would be the best valuation method to determine the value of the shares of a company in an appraisal process? Should a mandatory legal criterion be predetermined, or should the law allow for the corporation itself determine such criteria in the bylaws? Is calculating the reimbursement model adopted in Brazilian legislation the most adequate to produce the desired effects of the appraisal rights in publicly held corporations?

The current Brazilian Corporation Law (Law nº 6.404 of 1976) sets book value as the standard method to define the share value, even in the case of a listed company. Companies may adopt a different approach in their corporate by-laws; however, few have done so. This method does not reflect the company’s inherent value, which results in shareholder’s not being offered a fair value.

Appraisal rights are unlikely to be effective in Brazil, since the valuation criterion used, the book value (in the omission of the bylaws), does not consider the goodwill, or the profitability of the company, and, consequently, produce smaller measures of fair value. Thus, the disparity in the application of such is evident because: (i) the impact on the company’s management is minimal, since the chances of a shareholder requesting appraisal rights are small; (ii) the minority shareholder is provided with the misconception of choice between staying in the company and enduring an ownership environment that could potentially be non-beneficial to them or leave and receive only a fraction of the value of what the investment represents; (iii) the company provides for reimbursement at a value well below that of the market and, from this perspective, retains unjust enrichment.

In Brazil, appraisal rights do not effectively manage to boost investor protection, because the valuation method leaves most of the company value out of the equation, since the valuation method provided for in the Law, whenever the bylaws do not provide for one, is the book value of the company, regardless of any particularities of the company.

In the State of Delaware, United States of America, Section §262 of the Delaware General Corporations Law, dissenting shareholders shall receive the fair value of their shares. This means that, for each case, the Court must seek the best method for meeting the company’s fair value. In Italy, the reimbursement must be calculated using the six-month running average of closing prices on the stock exchange, for listed companies.

Considering such a theoretical framework used in Unites States of America or in Italy, it is evident to observe flaws in the Brazilian Corporation Law, which regulates appraisal right in Brazil. It is fair to conclude that, when the law determines that the appraisal right must be calculated according to the book value, the value for the shares would be below fair value, as the law would stipulate that the shareholder buy the shares based on profitability however receive the company’s book value when requesting appraisal rights.

The setting of an appraisal right amount in the bylaws is at the company’s discretion; the Brazilian Corporation Law does not require companies to provide for this, but they are allowed to, if they wish to do so.

However, based on the assumption that almost all listed companies do not adopt an assessment criterion in their bylaws, the appraisal rights operating scenario is not practical to provide adequate protection to the minority shareholder, in view of the prevailing notion that, in the absence of not being listed in the bylaws, book value is applied.

This results in the minority shareholder being left with an illusion of choice between leaving the company and receiving reimbursement or remaining and accepting the new shareholder environment. This is a choice between suffering the decision they disagree with or paying to leave the company.

Thus, the Brazilian Corporation Law should take it upon itself to determine the calculation of the value of the shares for the purpose of reimbursement, expressly establishing the valuation criteria, and not leaving this to the freedom of varied interested parties.

In my opinion there are rights that should not be bargained against contractual freedom, that is, they should be non-negotiable and exposed to pricing, as they represent “public order laws” that cannot be waived by the will of the parties.

Appraisal rights are a legal remedy to protect the minority shareholder against the decision-making power of the controlling shareholders. The current wording of the appraisal right calculation allows for parties to choose the calculation criterion for a right that is essential, whose function should be to “cure” a problem.

It is safe to conclude that the reimbursement value should be provided for as public law and be non-negotiable. It is also understood that the criterion adopted by Section 45 of the Brazilian Corporation Law obscures the intention of the law. While creating a necessary right, it allows for compensation to be minimal. In this scenario, the dissenting shareholder is unlikely to be effectively reimbursed for his investment.

If the amount the shareholder will receive does not result in a material difference to the company, the right will be considered virtually useless, who “wins, however does not gain the spoils”. Thus, it is unacceptable, for the legislator to grant an ineffective right.

However, despite this legislative drama, one case judged by the Brazilian Superior Court of Justice, contrary to the prevailing doctrine, understood that, in the case of omission of the bylaws, the criterion of book value should not be applied, as the value calculated for the appraisal right harmed the minority shareholder. (BRASIL. STJ. RE No. 1.572.648).

It can be said that the Superior Court introduced the use of the “fair value” thesis in Brazil. The existence of this decision confirms the premise that the Brazilian Corporation Law is controversial in relation to the valuation method in the absence of the bylaws and that there is room for interpretation of what price effectively corresponds to the share value mentioned in the caput of art. 45 of the Brazilian Corporation Law.

My conclusion was that an amendment in our Brazilian Corporation Law is required to establish the fair value as a mandatory rule to obtain the payment for the dissenting shareholder to protect the minority shareholders and foster the capital market.