Delaware Block Method of Valuation of Stock Approved in TN

Tennessee business valuation law case summary from the Tennessee Court of Appeals.

Genesco v. Scolaro, 871 S.W.2d 487 (Tenn. Ct. App. 1993).

The primary question raised in Genesco v. Scolaro is whether the Delaware Block method of corporate share valuation is appropriate to use when determining the value of preferred stock. In 1975, as a result of serious financial problems, Genesco, Inc., a shoe and apparel manufacturer based in Nashville, suspended dividend payments and redemptions on all of its subordinated serial preferred stock. Under the charter, the Series 1 and Series 2 preferred stock ranked equally and no payments could be made on any junior series until all arrearages were paid to all senior series.  However, in February 1988, Genesco amended its charter and had the right to redeem the Series 2 preferred stock for $119.41 per share and to redeem the Series 3 preferred stock for $161.75 per share.  The 1988 amendments gave the preferred shareholders the right to dissent and to demand the fair value of their shares.  Stockholder Jacob Landis owned 573 shares of Series 2 preferred stock, 1,530 of Series 3 preferred stock, and exercised his right to dissent, demanding payment of the fair value of the shares. When Mr. Landis and Genesco were unable to come to an agreement regarding the fair value of the stock, Genesco filed an action to get a judicial appraisal.

At that point, the parties disagreed about which method of valuation to use, with Genesco wanting to use what it called the Discounted Cash Flow method, and Mr. Landis wanting to apply the Delaware Block method used in prior Tennessee cases. After Genesco filed an action for judicial appraisal, the chancellor sided with Mr. Landis holding that the Tennessee Supreme Court had adopted the Delaware Block approach as the appropriate method for valuing dissenter shares, and then referred the case to a special master to recommend to the court findings of fact and law regarding fair value of the Genesco preferred stock.

Before the special master, Mr. Landis’ expert appraiser who had previously testified in Tennessee cases using the Delaware Block method, concluded that neither Series 2 nor Series 3 preferred stock had a trading history, so a market value could not be assigned. According to Genesco’s January 31, 1988, balance sheet, the actual going concern net asset value of Series 2 shares was $695.80, and $1,091.07 for Series 3 shares.  However, recognizing the restrictions placed on the shares, the appraiser reduced the values to $119.41 for Series 2 shares $161.75 for Series 3 shares based on the amounts which would be payable upon dissolution or winding up of the corporation. Based on the appraiser’s estimation of the corporations’ strong cash position, he applied a weight of 80%.  To determine the earnings component of the Delaware Block calculation, the appraiser found in the eight most recent Genesco reports, the Series 2 shares earned an average of $28.50 and Series 3 shares earned an average of $50.73. By utilizing three different capitalization rates and assigning a weight of 20% the resulting earnings, Mr. Landis’ appraiser arrived at a range of values which he then averaged to come up with a final opinion that the Series 2 shares had a value of $131.32 each and the Series 3 shares a value of $193.11 each.  Subsequently, the special master accepted the appraiser’s findings regarding the values of the Series 2 and 3 preferred shares.  The chancellor then confirmed the report and entered a final judgment on the issue of the value assigned to the Series 2 and 3 preferred shares.

Genesco appealed the decision contending that the chancellor erred in holding that the Delaware Block method was the only method to be used in finding the fair value of the preferred stock, believing the Delaware Block method to be per se unacceptable in finding the value of preferred stock.  Genesco’s position was that the special master and the chancellor both erred by not applying the Discounted Cash Flow method when determining the “fair market value” of the dissenter’s shares.  This method would calculate the price at which the stock could be sold if both a willing seller and a willing buyer existed.

The Appellate Court disagreed and did not believe the application of the Delaware Block method to calculate the fair value of preferred stocks was per se unacceptable.  While the Court noted that the only reported cases in Tennessee which have applied the Delaware Block method have involved common stock, there are many reported cases from other jurisdictions where the Delaware Block method has been used to find the value of preferred stock.  The Appellate Court also noted the distinction between “fair value” and “fair market value.”  In circumstances where there is no reliable market, as was the case with Genesco stocks since they were not traded and had no trading history, the market price is not considered at all.

Sept. 1, 1993, Court of Appeals of Tennessee, Middle Section at Nashville, 871 S.W.2d 487.

See original opinion for exact language. Legal citations omitted.

To learn more about Tennessee business valuation law, see Business Valuation in Tennessee Divorce Law. To learn more about the division and valuation of professional practices in divorce, see When Professionals Divorce in Tennessee: Valuing Professional Practices.

Miles Mason, Sr. JD, CPA handles complex divorce matters including business valuations and forensic accounting issues. View his professional biography listing books and articles published on business valuation and forensic accounting, seminars presented to lawyers, judges, business valuation experts, and forensic accountants. Miles Mason, Sr. authored The Forensic Accounting Deskbook: A Practical Guide to Financial Investigation and Analysis for Family Lawyers, published by the American Bar Association. The Miles Mason Family Law Group, PLC’s offices are located in Memphis, Tennessee and serves West Tennessee and Nashville, Tennessee.