In Re: Shares of Lee Madden, No. 185-4-01 Wmcv (Carroll, J., May 16, 2005)
[The text of this Vermont trial court opinion is unofficial. It has been reformatted from the original. The accuracy of the text and the accompanying data included in the Vermont trial court opinion database is not guaranteed.]
STATE OF VERMONT WINDHAM SUPERIOR COURT WINDHAM COUNTY, SS. DOCKET NO. 185-4-01Wmcv
IN RE SHARES OF LEE MADDEN, CAROLYN FULFORD and REBECCA TRUMBULL
FINDINGS OF FACT, CONCLUSIONS OF LAW AND ORDER
The Court held a hearing over four days, beginning on November 8, 2004, under the
Dissenters’ Rights provisions of 11A V.S.A., Chapter 13. At all times, Chroma Technology
Corporation was represented by Attorney Robert Rachlin. The dissenters were represented by
Attorney Potter Stewart. Based upon the evidence presented to the Court, the Court makes the
following findings of fact:
The Corporation
1. Chroma Technology Corporation was founded in Brattleboro in 1991. All founding
members were previously employed by Omega Opticals, one of Chroma’s competitors. Both are
in the business of manufacturing and distributing optical filters. These filters are used to control
wavelengths of light and are used principally by biologists and those in the medical field in
various instruments. Therefore, Chroma’s customer base is primarily manufacturers of
instruments which use the filters. Although Omega has been Chroma’s chief competitor,
companies in Europe and Japan have also been competitors. 2. Paul Millman is the Vice-President of Chroma. The corporation was originally owned
by its founders, previous employees and present employees, but as of October 2000, the
corporation was wholly employee owned. Chroma’s culture is to reward hard work by allowing
each of its employees to become an owner of the corporation. The management style at Chroma
is atypical. Meetings are informal and those with greater knowledge in a given area generally
were responsible for making decisions in that area. Other decisions were made in a “Town
Meeting” type atmosphere. Chroma has no hierarchical management structure.
3. Chroma’s wage structure is equally unique. When the corporation was started, the
founders decided that $30,000 was the minimum amount a family needed to live on reasonably at
that time. Everyone received this salary. When a new employee started work with Chroma, he
or she received wages of $10.00 per hour for a three month probationary period. After about
three years, Chroma noted that it had extra money from profits which it decided to distribute as a
“retroactive wage.” The funds were distributed equally to those who had been working at
Chroma for at least six months and in smaller shares to those who had worked at Chroma for less
than six months. This “retroactive wage distribution” (RWD) was done twice a year and all of
Chroma’s profits were distributed in this fashion. In the beginning of Chroma’s sixth year, the
corporation decided to reward longevity and the base salary was raised to $35,000 or $52,5000,
if one had worked at Chroma for at least five years. Except for those still in the probationary
period, every employee at Chroma is paid the same base wage, with the added RWD twice a year
(usually in a range of $26,000 to $29,000 per distribution). In addition, a one time bonus was
paid to founders ($50,000) and those who joined Chroma in either year one ($40,000) or year
two ($30,000). In fact, a shipper at Chroma was paid $97,000.00 one year. 4. Another component of the compensation program at Chroma involved the distribution
of shares. This distribution was not dependent upon one’s job nor value to the corporation. The
original founders each bought $1,000 shares at $1.00 per share. Later, Chroma distributed a total
of 4,000 shares per annum to those who had worked at Chroma for at least a year. The amount
of shares was divided by the number of eligible employees. After an initial five year period,
Chroma decided to issue a certain amount of shares per person, per annum equally to all
employees (unless one had not yet completed the probationary period). This program continued
through October 2000.
5. The unorthodox and loose management structure led to problems and disagreements at
Chroma. Lee Madden came to Chroma, at the founders’ request, in September 1991, having also
previously worked at Omega. The last three founders had arrived at Chroma in August 1991.
Lee Madden became the employee who principally oversaw the financial, personnel, and legal
aspects of Chroma. Soon after his arrival, the cordiality and mutual respect among employees
dissipated. There were major disagreements about finances, although the product continued to
be manufactured and distributed successfully. When the employee number reached almost 50 by
April 2000, some chose to not make the regular distribution of shares to those who had been
employed at Chroma for the requisite period of time for fear that continued distribution of shares
was diluting the value of the shares already distributed. Lee Madden objected to this proposal,
arguing that some employees had come to Chroma with the understanding that the shares would
be distributed in the manner they always had been. At least one Chroma employee left the
corporation because of this action.
6. Problems also surfaced regarding the unavailability of understandable financial
3 statements, the fact that the financial committees were not meeting regularly, and the lack of a
protocol to buy out those leaving Chroma. The corporation was ill prepared to address the buy-
out of a departing employee. Because of this, Madden met with an accountant and decided that a
departing employee would be paid 1.3 times book value. This was later modified to 1.25 times
book value upon the suggestion of the accountant.
7. No employee at Chroma has an employment contract. Employees are not required to
sign a non-compete agreement nor a confidentiality agreement. Despite this, Chroma
acknowledges that if certain key employees left Chroma, its status in the scientific community
would be greatly affected. In addition, if one of these employees began to work for a competitor,
it would seriously affect Chroma’s future success.
8. In October 1996, Omega Optical filed a lawsuit against Chroma and certain key
employees who previously worked for Omega, claiming, among other things, use of trade
secrets. (See Omega Optical v. Chroma Technology Corp., et al., Docket No. 370-10-96Wmc,
Decision and Order, Grussing, J., November 24, 1999). After more than three weeks of hearing,
the Court entered judgment for all defendants on all of plaintiff’s claims. However, Omega
appealed Judge Grussing’s order and the appeal was still pending before the Vermont Supreme
Court on October 25, 2000. Chroma incurred legal expenses of approximately $2.5 million and
an adverse decision by the Supreme Court could have resulted in Chroma’s key employees being
prohibited from working in the optical lens field in the future and utilizing knowledge gained
while they worked at Omega. This could have resulted in the demise of the corporation.1
1 Judge Grussing’s decision was affirmed by the Supreme Court on April 12, 2002 in Omega Optical, Inc., v. Chroma Technology Corporation, Richard Stewart, et al., 174 Vt. 10
4 However, Chroma never put any money in reserve in the event the appeal was not decided in its
favor. In addition, notes to financial statements, of April 30, 1999 refer to the Omega litigation
and indicate that “The Company believes that the plaintiff’s case is without merit.” (See
Defendant’s Exhibit G, Note J)
9. In either 1995 or 1996, Lee Madden was diagnosed with a serious illness requiring
lengthy treatment and decreased ability to perform his responsibilities at Chroma.
The Vote and Determination of Value
10. On October 25, 2000, a majority of Chroma shareholders voted to amend the Articles
of Incorporation which, in effect, created two classes of stock and required those leaving employ
at Chroma to sell their shares back to Chroma for pro-rata book value of the shares plus
exchange for Class B shares which decreased in value over a period of time. Pursuant to the
amendment, the original founders of Chroma were awarded Class A shares which allowed them
to retain their proportionate interest in the corporation in perpetuity. Lee Madden, Carolyn
Fulford, and Rebecca Trumbull each voted their shares against the proposed action and
demanded payment of fair value for their shares. Previous to this action, departing employees
wishing to sell their shares back to Chroma were paid book value for the shares. In October
2000, Madden was working part-time and Fulford and Trumbull were no longer employed at
Chroma but retained their shares. At the time of the vote, there were 38,073 outstanding shares
of Chroma common stock. The Dissenters owned 10.866% of the shares as follows: Madden
(2,492); Fulford (1,526); and Trumbull (119).
11. Chroma decided to pay and did pay $64.69 per share to the Dissenters which
(2002). This is not relevant to this case, however, because the Court is required to focus on the
5 represented an accountant’s computation as to book value. On February 17, 2001, the Dissenters
notified Chroma via letter that they were dissatisfied with this calculation. Madden proposed
$13,177,933 as the fair value of Chroma , relying in part on an expression of interest from an
outside corporation which was interested in purchasing Chroma after assessing Chroma’s
financials and projected future earnings.
12. On September 15, 1999, Paul Millman sent an e-mail to other Chroma employees in
response to an e-mail from Becky Trumbull regarding pending issues at Chroma. In the e-mail,
Millman states that, at the time, $25,000,000.00 would not be “an impossible number” as a
selling price for Chroma.
13. During December 1999, then President Dick Stewart received an expression of
interest in purchasing Chroma from a company known as Cybron. Stewart considered the
interest serious and in good faith. Cybron was a company traded on the New York Stock
Exchange. The company inquired about a sale of Chroma for $12 to $15 million. Chroma
terminated any discussion prior to a site visit by Cybron representatives. Even after this point,
Cybron continued to be interested in an acquisition of Chroma. Stewart told Cybron that
Chroma was not interested and Chroma would let Cybron know if things changed. During
Chroma’s discussions with Cybron, Stewart informed Cybron representatives of the pending
litigation with Omega and that Chroma was optimistic about its outcome.
14. On February 1, 2001, at a Board of Directors meeting, those present discussed what
amount to offer the Dissenters per share. Millman motioned that the three dissenters be paid
consistent with a January 31, 2001 letter from John Simard (who had taken over Lee Madden’s
status of the litigation on October 25, 2000.
6 position) which bases the buy out price on “book value.” On the same day, Simard sent Madden
a letter advising him of rights of dissenters under state law, a copy of the statute, a copy of the
corporate balance sheet, a letter from the accountant calculating book value, and a check payable
to Madden. (Defendant’s Exhibit V). Although Simard’s letter references a calculation as to
“fair value,” his previous letter to the Board references the calculation of “book value” and the
letter sent by the accountant, which was relied upon by Chroma at the February 1 meeting,
clearly stated the calculation represented “book value.” The accountant determined that, at the
time of the vote to amend the Articles of Incorporation, Chroma’s book value was
$2,897,784.66. By this time, and until the time of hearing, Chroma had never directed Simard
nor its accountant to try to arrive at the corporation’s “fair value.” Simard knew about the
Cybron expression of interest at $12 million to $15 million at the time he relied on the book
value calculated by the accountant at just under $3 million. In addition, Simard recalls Chroma
shareholders discussing the potential reversal on appeal as depreciating the value of the
company. However, at the time he authored the January 31, 2001 letters he was also aware of a
letter written by Lee Madden which indicated that Chroma and its attorneys were confident that
the trial court decision would be affirmed. Simard was also aware that sales projections were
increasing, that Chroma was hiring new employees, and that the corporation was expanding to
new facilities due to increased business. Prior to the actual vote on October 25, 2000, Simard
had already decided that if any shareholder dissented, he or she would be paid his or her share of
book value and that this was equivalent to the fair value of Chroma.
15. At all times, Chroma intended to pay the dissenters their share of the “book value” of
the corporation. In fact, Chroma never considered the concept of paying the dissenters their
7 share of the corporation’s “fair value” until the remaining members consulted with their
attorneys. However, in a September 9, 1999 memo from Millman to “everyone,” he concludes
that buying out departing employees based upon Chroma’s book value was “low priced” and
“unfair.” He further states “I believe that we are all guilty of not finding a better method for
valuing our shares.”
16. On October 25, 2000, Chroma was planning on expanding its field of employees, its
customer list was increasing, and Chroma expected to ship $13 million in that fiscal year. In
addition, Chroma was building a new site in Westminster. The building and some of the new
equipment would be financed by debt. Written notes by Paul Toomey, the first accountant hired
by the Dissenters to value the corporation pursuant to this litigation, indicate that management
intended to finance equipment with debt and that some equipment already purchased had been
financed via debt. Records indicate that Chroma had incurred debt through both Chittenden
Trust Company and Vermont Economic Development Authority. Historically, Chroma used to
debt to finance new equipment and the equipment was used as collateral.
The Experts
17. Howard Gordon was hired by Chroma to perform a business valuation and arrive at
Chroma’s fair value as of October 25, 2000.2 Fair value is described as what a reasonable and
willing buyer would pay a willing seller, while knowing all the facts and while under no
compulsion to act. In deciding this, Gordon’s primary area of concern was the pending litigation
between Chroma and Omega. Gordon opines that a knowledgeable and willing buyer would
2 The Court will not make extensive findings as to the credentials of the experts called. The Court is confident based upon the evidence presented that each of the experts who testified
8 realize that if Chroma did not prevail on appeal, the end result would prohibit Chroma from
producing and selling a majority of it products and put Chroma out of business. According to
Gordon, a buyer would not even consider the likelihood of the outcome of the litigation being
favorable or unfavorable to Chroma; the mere fact that the litigation was pending would be
enough for a buyer to refuse to purchase the company and to not assume the risk.
18. Other factors which Gordon considered in arriving at fair value included the fact that
there were no employment contracts with key employees; employees were not required to sign
non-compete agreements; and there existed no prohibition against the distribution of trade secrets
by employees. According to Gordon, any willing buyer would take issue with this failure to
protect intellectual property. Gordon also believes that buyers would be uncomfortable with the
untraditional and socialistic management structure and the unconventional pay structure at
Chroma so much so that the corporation would be unmarketable.
19. Based upon the concerns expressed above, Gordon believes that the fair value per
share of Chroma on October 25, 2000, while considering the pending Omega litigation, was
equal to its book value per share, or $64.00. If one were not to consider the pending litigation in
determining fair value, the value per share would be $140.00.
20. There are three general methods of determining fair value of a closely-held business:
the market method, the income approach, and the cost or asset approach. Both valuation experts
in this litigation utilized the income-based approach, specifically a discounted cash flow
approach. This method of analysis is appropriate when the business at issue expects future cash
flows which are substantially different than the current cash flow. In this case, Chroma projected
possesses the education, skill, and experience necessary to arrive at his opinions.
9 substantial growth, making the discounted cash flow approach applicable. In determining fair
value, one would measure the earning capacity of the business and then capitalize that earning
capacity by an appropriate multiple. (See Defendant’s Exhibit A, Valuation Report of Edward
Gallagher, C.P.A., C.V.A. at p. 19).
21. Using the income approach, one considers the investor’s required rate of return;
generally, the higher the risk, the higher the rate of return. Investors will pay less for riskier
companies but will usually reap the benefits of a higher rate of return.
22. In order to perform this valuation, the accountant must first project future net income
and convert this to cash flow. This would include a consideration of depreciation, future capital
expenditures, working capital requirements, repaying debt, and future financing with debt. This
exercise takes into account the future growth rate. Finally, a discount rate is applied to discount
the projected cash flow to its present value at a rate which reflects the risk of investment in the
company. In this analysis, both parties’ experts relied on the same numbers for projected
operating income through the year 2006. However, the projected cash flow differed after the
experts considered future expenditures and debt. Both experts applied the same approximate rate
of growth. While adjusting the projected cash flow, Gordon assumed that all future equipment
purchases at Chroma would be paid for using existing capital, thus decreasing projected cash
flow. The Dissenters’ expert assumed that debt would be used to finance future equipment
purchases.
23. There is more than one approach that may be used in determining the appropriate
discount rate: the build-up method and the capital asset pricing method (CapM). Using the
build- up method, one would look at the risk free rate, usually defined as the yield on long-term
10 government bonds, then add increments of risk premiums for considerations such as, for
example, the size of the company. In addition, other subjective judgments are made. The CapM
method is similar but one would factor in more industry-specific information including the
volatility of pricing in certain industries. For this method, these industry specific risks have
already been calculated as BETA scores. Chroma’s expert arrived at a fair value of Chroma
stock using each approach. The Dissenters’ expert utilized only the build-up method, finding it
most appropriate due to the difficulty in locating guideline companies similar to Chroma which
would be required under the CapM method.
24. In considering the build-up method, Gordon utilized the figure of 6% as the average
yield on long term government bonds. He then added an equity premium of 7.8%, relying on the
2001 Ibbotson’s Stocks, Bonds, Bills and Inflation Yearbook, a source commonly relied up by
experts in this field to reflect the more risky nature of equity securities. Again, relying on
Ibbotson, Gordon then added a micro-capitalization premium, or small stock premium, of 5.4%,
which is applied to “publicly traded companies with total capitalization of less than
approximately $192 million.” (See Defendant’s Exhibit D, Chroma Technology Corp. Valuation
Study by Howard J. Gordon, C.F.A., at p. 31). Ibbotson, however, suggests that this small stock
premium figure should be adjusted with beta information if available. The beta adjusted number,
according to Ibbotson, is 2.6%. Gordon thus arrived at 19.2% as of the total cost of equity for
small public companies.
25. When Gordon performed a similar analysis under the CapM method, he again began
with 6.0% as the risk free rate and applied it to the CapM equation. Next, Gordon set out to
determine an appropriate beta using the generally accepted principal that a company with a beta
11 of less than 1.0 is less risky relative to the overall market than a company with a beta of more
than 1.0 which presents a higher risk. Since beta is calculated only for publicly held companies,
Gordon attempted to determine a beta for Chroma by selecting an appropriate substitute in the
area of the optical instruments and lens industry. The beta selected is 1.26 which was also
applied to the equation along with the previously discussed historical equity premium of 7.8%.
Finally, Gordon used a beta adjusted small stock premium, mentioned above at 5.4%, of 2.6%.
Utilizing the equation, the cost of equity is 18.4% according to Gordon. He then averaged the
figures arrived at under both the build-up and CapM methods and arrived at an average cost of
equity of 18.8%.
26. After performing the above calculations, Chroma’s expert then adjusted this 18.8%
by adding a company specific risk factor of 3.0%. This was done, according to Gordon, to
reflect that the cost of equity is based upon returns of companies “with up to approximately $192
million in total capital,” Id. at 33, and based upon the fact that he believes Chroma is
significantly smaller than these companies. Adding this 3.0% to the 18.8%, Gordon concluded
that the total cost of equity for Chroma equals 21.8%.
27. Using this figure, Gordon used the projected cash flow numbers and discounted them
to present value. This resulted in a present value of Chroma on October 25, 2000 of $2,057,000,
resulting in price per share of $140.00 based upon 38,073 shares outstanding.
28. Gordon considered but refused to apply a control premium to his valuation.
Although he recognized that a controlling interest in a company is more valuable than a minority
interest, and that a premium is sometimes appropriate in determining the value of a controlling
interest, Gordon did not apply one because he determined that his valuation method already
12 considered the elements of control and that the controlling interest was outweighed in this case
by a lack of marketability due to the unusual compensation and management policies at
Chroma.3
29. Gordon played an integral part in the previously reported valuation case of In re
75,629 Shares of Common Stock of Trapp Family Lodge, Inc., 169 Vt. 82 (1999). While
performing a valuation for the dissenters in that case, Gordon utilized a small stock premium of
4.0%, rather than the 5.4% used in this case. The difference of 1.4% represents an increase of
35% and if Gordon had used the small stock premium of 4.0% in this case as well, it would have
had the effect of decreasing the discount rate and increasing the value of Chroma on the
valuation date. In addition, under the CapM method, in this case, Gordon added a “small
company stock premium” to his calculation when, in Trapp, he did not do so. Once again, this
has the effect of increasing the discount rate and lower Chroma’s value as of the valuation date.
Finally, in Trapp, Gordon did not add a company specific premium and he agrees this is a
subjective decision. In this case, Gordon added a 3% company specific premium, citing in part
the small size of Chroma. However, in Trapp, the annual sales were approximately one-half of
those in this case.
30. With regard to the control premium which Gordon did not apply in Chroma’s
valuation, Gordon did utilize the control premium in Trapp. A control premium adjustment is
appropriate when the discount rate has been derived from data based upon publicly traded stocks
3 The Court will not discuss the “marketability discount” at great length. Gordon’s report indicates that while he did not apply a control premium, it may be offset by a lack of marketability discount. However, Gordon did not discuss a specific discount in either his report or in his testimony and did not apply one in is valuation. Thus, the Court will not consider one.
13 (reflecting a minority position) and when projected cash flows have not been adjusted to reflect
specific and predictable improvements in cash flow. In this case, despite the fact that Gordon
arrived at his discount rate using data from publicly held companies and did not adjust the
projected cash flow to reflect projected improvements, he did not utilize a control premium. In
Trapp, Gordon not only adjusted cash flow to reflect expected improvements, but he used a
control premium as well. On the one hand, Gordon believes that it is not appropriate to adjust
future cash flow to reflect improvements, but on the other hand, Gordon applied in this case a
3% company specific rate to account for poor management and the unusual wage structure which
is, in essence, “double dipping” by considering these issues in four different areas of his
valuation.
31. The Dissenters hired Gallagher, Flynn & Company to perform a valuation on
Chroma for purposes of this litigation. This valuation was originally done by Paul A Toomey,
but after his untimely death, Edward Gallagher, CPA, CVA, took the case over. He produced a
report dated may 6, 2004.
32. Gallagher did not use the CapM method in developing a discount rate for the
valuation of Chroma because he did not believe he could locate publicly traded companies which
were similar enough to Chroma so that the beta selected would not be a valid one. In
considering the build-up method, Gallagher utilized the same risk free rate as Gordon, or 6.04%,
and the same equity risk for large stocks of 7.8%. Thereafter the analysis changed. In the size
premium category, where Gordon used 5.4%, Gallagher adjusted this as suggested by Ibbotson,
so as not to double count the risk, and arrived at a figure of 2.6%. Gallagher then added a
company specific risk factor of 2% concluding with an overall discount rate of 18.5%. As stated
14 above, Gordon had arrived at a similar number, but then adjusted it with a 3% specific company
risk rate resulting in a lower overall discount rate.
33. In the area of determining future cash flow, Gallagher used much information
obtained from Chroma by Gordon, as Gordon had superior access to management at Chroma. In
considering future capital expenditures, Gallagher relied on information given to his predecessor
Paul Toomey by Chroma management, that future acquisitions would be financed, totaling
financing of at least $900,000 in 2001, $1,000,000 the next year, and $500.000 in the following
years.
34. Gallagher applied a control premium to his valuation. Although Paul Toomey did
not add a control premium, Toomey did adjust cash flows by normalizing the unusual wage
structure at Chroma. When the Superior Court ruled that the wage structure could not be
normalized for purposes of valuation4, Gallagher applied a control premium in its place. This
substitution actually benefits Chroma in this litigation by lowering the company’s value by
approximately $12 million. Gallagher used a control premium so that a controlling interest
would be represented upon a hypothetical sale of Chroma; otherwise, only a minority interest
would be represented. Gallagher utilized the control premium, rather than adjusting future cash
flow in a manner to reflect what a controlling buyer would likely do.
35. Gallagher did not consider, when performing his valuation, the Omega litigation
which was pending on October 25, 2000. Gallagher believes that a potential buyer would
consult with attorneys, prior to making a decision to purchase, in an effort to decide the likely
4 See Opinion and Order on Chroma’s Motion for Partial Summary Judgment and to Exclude, Wesley, J, Docket No. 185-4-01Wmcv, September 23, 2003.
15 outcome of the litigation and whether it would affect the future viability of Chroma.
36. Neither Gordon nor Gallagher could advise the Court how one would take the
pending litigation into account when conducting a valuation. There is no accepted method for
doing so.
37. Gene Laber is a consulting economist and a Professor Emeritus at U.V.M.. Laber
has a PhD in Economics. He was asked by the Dissenters to look at the valuation reports of
Gordon, Toomey and Gallagher and to express an opinion as to the issues discussed above.
Initially, Laber disagrees with Gordon’s assumption that Chroma would not, in the future, use
debt to fund purchases. There are many advantages to use of debt and judicious use of debt is
quite beneficial.
38. Laber also agrees with Gallagher’s use of a beta adjusted small stock premium,
which Gordon did not utilize. Laber also takes exception with Gordon’s use of the 2.6 percent
beta adjusted small stock premium under the CapM method because Gordon had already
captured the risk of this company with a beta coefficient. Gordon did not use a similar procedure
in the Trapp case where he was hired by the Dissenters. Finally, Laber disagrees with Gordon’s
decision to add a 3% company specific premium in this valuation. He believes this decision is
too speculative and is not appropriate. There is no basis for this documented in the literature and
studies. Laber also disagrees with Gallagher’s use of 2%.
39. Laber agrees with Gallagher that a control premium was necessary in this case
because Gallagher had not adjusted cash flow based upon what a controlling purchaser would do.
Control of the company must be taken into account and use of the control premium was
important and appropriate.
16 40. Laber believes that Gordon’s consideration of the effect of the pending litigation was
also misplaced. Litigation is a widespread phenomenon and securities of companies involved in
litigation are routinely traded and purchased. In fact, creditors were allowing Chroma to finance
through debt at the prime rate while the Omega litigation was pending indicating a confidence in
the future of Chroma despite the pending litigation.
CONCLUSIONS OF LAW
Vermont Dissenters’ Rights Statute is found at 11A V.S.A. Chapter 13. There is no
question that Lee Madden, Carolyn Fulford, and Rebecca Trumbull are “dissenters” within the
meaning of the statute. (See 11A V.S.A. §13.01(2)( “Dissenter means a shareholder who is
entitled to dissent from corporate action under 13.02 of this title and who exercises that right
when and in the manner required by sections 13.20 through 13.28 of this title.”). The statute
provides for specific procedures to occur in order for dissenters to be paid the fair value of their
shares. Because the effect of these provisions is not in dispute in this case, the Court will not
discuss them. The important provision in this case is:
§13.02 Right to dissent (a) A shareholder is entitled to dissent from, and obtain payment of the fair value of his or her shares in the event of, any of the following corporate actions:......(4) Amendment to articles....” (Italics added).
This Court is required to enter judgment for the dissenters “(1) for the amount, if any, by which
the court finds the fair value of his or her shares, plus interest, exceeds the amount paid by the
corporation; or (2) for the faire value, plus accrued interest, of his or her after-acquired shares for
which the corporation elected to withhold payment under section 13.27 of this title.” 11A V.S.A.
§13.30(e).
“Fair Value” is defined under the statute as “the value of the shares immediately before
17 the effectuation of the corporate action to which the dissenter objects, excluding any appreciation
or depreciation in anticipation of the corporate action unless exclusion would be inequitable.”
11A V.S.A. §13.01(3). The date of the corporate action in this case is October 25, 2000.
The Vermont Supreme Court has defined “fair value” as follows:
The basic concept of fair value under a dissenters’ rights statute is that the stockholder is entitled to be paid for his or her proportionate interest in a going concern. The focus of the valuation is not the stock as a commodity, but rather the stock as it represents a proportionate part of the enterprise as a whole. Thus, to find fair value, the trial court must determine the best price a single buyer could reasonably be expected to pay for the corporation as an entirety and prorate this value equally among all shares of its common stock. Under this method, all shares of the corporation have the same value. (Internal citations omitted)
In re 75,629 Shares of Common Stock of Trapp Family Lodge, Inc., 169 Vt. 82, 85-86 (1999).
In arriving at a determination of fair value, this Court must consider all of the evidence presented
by the corporation and the dissenters via a “fact-specific process.” Id. at 86.
In this case, there are four major issues which the Court will address: (1) whether to
consider the pending Omega litigation in the valuation; (2) whether the experts’ consideration of
the acquisition of assets through debt was proper in arriving at future cash flow; (3) whether the
experts applied the appropriate discount rate; and (4) whether the application of a control
premium was appropriate.
I. The Effect of Pending Litigation
Chroma argues that the Court should consider the fact that litigation with Omega was
pending on October 25, 2000 and that, because of the possibility that the litigation result would
not be favorable to Chroma, it would seriously affect the fair value of Chroma on that date.
As of the valuation date, Chroma was defendant in a lawsuit brought by Omega, the
company Chroma’s founders and other employees previously worked for, for misappropriation
18 of trade secrets. After a lengthy bench trial, the trial court had already found in Chroma’s favor
in a 110 page order; but, Omega had appealed, and the appeal was still pending on the valuation
date. This Court has reviewed the trial court’s order, as a legal advisor to a potential,
reasonable buyer would have done. The trial court’s decision rested on two key factual findings:
(1) that although process information the former Omega employees learned at Omega and later
used at Chroma could have been protected as a trade secret, it was not, because Omega, at the
time the former Omega employees learned this process information, did nothing to indicate to
employees that the process information was confidential (and in fact downplayed
confidentiality);5 and (2) that, in any case, Omega had failed to prove damages. These factual
determinations would be given great deference on appeal. See V.R.C.P. 52(a)(2)(trial court’s
findings of fact shall not be set aside unless clearly erroneous). And both would have to be set
aside as clearly erroneous to produce a negative outcome for Chroma. Though such an
occurrence was possible, it cannot be said to have been reasonably probable. Thus, the Court
finds that a negative outcome to the litigation was not reasonably probable.
When a corporation is involved in litigation with the potential to seriously affect its
value, the potential impact of a negative outcome should be considered in a fair value
determination if a negative outcome is “reasonably probable,” but not if a negative outcome is
merely possible. MT Properties, Inc. v. CMC Real Estate Corp., 481 N.W.2d 383, 389-90 (Mn.
Ct. App. 1992), citing Olson v. United States, 292 U.S. 246, 257 (1934) (“Elements affecting
5 Essentially, this was a finding that the former Omega employees who started or joined Chroma had no duty of confidentiality with respect to this information – i.e., they did not know or have reason to know that the information was confidential. And as the Vermont Supreme Court noted in its subsequent opinion, “whether a duty of confidence attached is a factual
19 value that depend upon events or combinations of occurrences which, while within the realm of
possibility, are not fairly shown to be reasonably probable should be excluded from
consideration for that would be to allow mere speculation and conjecture to become a guide for
the ascertainment of value – a thing to be condemned in business transactions as well as in
judicial ascertainment of truth.”)
In this case, based on its review of the trial court opinion which was on appeal on the
valuation date, the Court has found that a negative outcome on appeal was not reasonably
probable. The essence of the lower court decision was a determination that Omega had simply
failed to prove its claim that Chroma had misappropriated trade secrets. This determination was
based on two key factual findings by the court, both of which could only be set aside if clearly
erroneous, and both of which would have to be set aside to produce a negative outcome for
Chroma.
Despite the persuasive authority of MT Properties, the Court has considered the
possibility of some sort of discount or reduction which would reflect the possibility of potential
liability short of a reasonable probability. There is no precedent for such an approach, however;
and even when asked by the Court, no expert could suggest a reasonable manner in which this
could be done. The Court recognizes that it has discretion in determining value, but in the
absence of any accepted methodology for considering a possibility that is less than a reasonable
probability, it cannot fashion its own methodology for doing so.
Thus, having found that there was no reasonable probability that the pending litigation
would result in a negative outcome for Chroma, the Court concludes that the litigation should not
inquiry.” Omega v. Chroma, 174 Vt 10, 14 (2002).
20 be considered in determining fair value.
II. Consideration of Future Debt
Chroma’s expert, in arriving at projected cash flow, did not take into consideration debt
financing of future equipment; rather, he assumed that all equipment would be purchased with
cash. The Dissenters’ expert, Mr. Gallagher, disagreed and assumed that debt would be used to
finance future equipment purchases. The Court finds that Gallagher’s position is more credible.
Utilizing debt judiciously may and usually does result in favorable financial
consequences. One may assume that Chroma would aim to benefit from these favorable
conditions. In addition, Chroma had assumed some debt in the past to finance equipment and
when the Dissenters’ first valuation expert, Paul Toomey, discussed future cash flow with
Chroma management, it was made clear to him that the company intended to finance equipment
purchases with debt in the future. Gordon flat out rejected any adjustment to future cash flow via
debt financing and therefore did not assess the appropriateness of the numbers utilized by
Gallagher.
The Court finds that the Dissenters’ position on this issue is more credible based upon the
evidence. Debt had been used historically and members of the corporation had indicated their
intent to do so in the future. To completely reject this consideration in determining projected
cash flow would be to ignore a pattern of behavior and the expressed intentions of management.
Because no evidence was presented to contest the numbers used by Gallagher regarding future
debt financing, the Court finds them credible.
III. The Discount Rate
In general, the Court is skeptical of Gordon’s valuation, especially in the area of
21 determining the appropriate discount rate. Gordon played a major role in the Trapp case, acting
as the expert for the dissenters. One can conclude that a higher fair value in that case would
have been beneficial to the dissenters and that a lower fair value in the instant case benefits
Gordon’s current client, Chroma. Gordon’s work in both cases was inconsistent, which resulted
in benefits to his clients in both cases. For this reason, the Court accepts the valuation performed
by Gallagher, the Dissenters’ expert, as more credible, supported by the evidence, and based
upon the procedures experts in the valuation field rely on.
First, Gordon applied a small stock premium of 5.4% to his analysis of the appropriate
discount rate. Although Gordon frequently relies on Ibbotson while arriving at these discount
rates, he ignored the fact that the literature suggests that this small stock premium should be
adjusted with beta information. Gallagher did so and utilized a different figure.
Next, Gordon utilized a company specific risk factor of 3% where Gordon used a number
of 2%. Although Gene Laber contends this should not be considered, the Court will find that the
2% used by Gallagher is appropriate because both of the valuation experts in the case applied the
company specific risk factor. However, Gordon did not use one in performing his valuation in
Trapp. Finding that the higher the number used the more beneficial it is to Gordon’s client, the
Court is more skeptical about his position and more confident in accepting the number
suggested by Gallagher, especially considering Laber’s suggestion that it is not a requirement to
use one at all.
In sum, the Court is giving more weight to the discount rate arrived at by Gallagher,
given Gordon’s inconsistency in arriving at a discount rate in the cases in which he has been
involved. In addition Gallagher’s work has been accepted as appropriate by another expert in the
22 field in almost all respects.
IV. The Control Premium
The Court is confident that a control premium should be applied in this case. Most
experts who testified agree that a valuation must take into account the effect of the purchase of a
controlling interest in a corporation. Only Gordon disagreed with this concept, after having
already applied a control premium while working for the dissenters in the Trapp case.
Because the valuation done in this case reflects publicly traded minority interests, it is
appropriate to account for the value of control in owning the corporation as a whole. Trapp, 169
Vt. at 93. A control premium is appropriate for this reason and because the projected cash flow
arrived at by Gallagher was not adjusted to reflect decisions by a controlling purchaser. Because
Chroma rejected the use of a control premium, but did not contest the validity of the actual
number used by Gallagher, 40%, the Court finds it appropriate.
In conclusion, for the above reasons, the Court will accept the valuation conducted by
Mr. Gallagher in all respects. The Court finds that his methods and conclusions have been
supported by other evidence in the case and that the procedures he used are those commonly
recognized by experts in the field of business valuation. It should be noted that Gallagher’s
determination of fair value is supported by Cybron’s expression of interest at a higher price and
Millman’s indication in the past that the corporation could be worth $25,000,000. Gallagher’s
fair value is less than both of these numbers.
V. Costs, Expenses and Attorney’s Fees
In considering the award of costs and expenses in this type of case, the statute provides
that “[t]he court shall assess the costs against the corporation, except that the court may assess
23 costs against all or some of the dissenters, in amounts the court finds equitable, to the extent the
court finds the dissenters acted arbitrarily, vexatiously, or not in good faith in demanding
payment under section 13.28 of this title.” 11A V.S.A. §13.31(a). There has been absolutely no
evidence presented from which the Court can find that the Dissenters acted arbitrarily,
vexatiously, or not in good faith in demanding payment. The findings and conclusions noted
above support the position of the Dissenters to go forward and litigate this matter rather than
accept the value of Chroma proposed by management. The Dissenters are awarded their costs.
Regarding legal fees and costs of experts, these may be awarded by the Court if the Court
finds that either Chroma did not substantially comply with the requirements of the Dissenters’
Rights Statute or one party acted arbitrarily, vexatiously, or not in good faith with respect to the
rights provided by the statute. 11A V.S.A. §13.31(b)(1) and (2). The Court finds that Chroma
did substantially comply with the requirements of the statute. There was evidence presented that
Chroma management did notify the Dissenters of all of their rights under the statute. There is no
evidence that management failed to take action when the Dissenters demanded payment.
Although Chroma management was not well-versed in the requirement that “fair value” and not
“book value” be determined, there is no indication that this was based on bad faith. Rather, the
evidence suggests that Chroma management had previously always relied on book value in
buying out departing employees and that management learned of its responsibilities in
determining fair value after meeting with its attorneys. Ignorance of the law does not equate
with bad faith. Chroma substantially complied with the requirements of the Dissenters’ Rights
Statute. Therefore, there will be no award for either party for expert or attorney’s fees.
VI. Interest
24 The Dissenters are entitled to interest on the difference in the amount paid by the
corporation and the appropriate amount based upon the fair value determined by the Court. 11A
V.S.A. §13.30(e). The appropriate interest is “from the effective date of the corporate action
until the date of payment, at the average rate currently paid by the corporation on its principal
bank loans or, if none, at a rate that is fair and equitable under all the circumstances.” 11A
V.S.A. §13.01(4).
The Dissenters, in their memorandum of law filed with the Court, put the interest rate at
8%. However, the Court does not believe it has enough information before it at this time to
determine the “rate currently paid by the corporation on its principal bank loans” or a “fair and
equitable rate.” In its order, the Court will require further filings on this issue.
ORDER
1. The Court finds that the fair value of Chroma Technology Corporation is $10,900,000 as of October 25, 2000 or $287.00 per share based upon the 38,073 shares issued and outstanding at the time.
2. The Dissenters are awarded judgment as follows (with interest yet to be determined):
Lee Madden: 2,492 shares @ $287 per share = $715,204.00 minus book value paid @ $64.69 per share = $553,996.52
Carolyn Fulford: 1,526 shares @ $287 per share = $437,962.00 minus book value paid @ $64.69 per share = $339,245.06
Rebecca Trumbull: 119 shares @ $287 per share = $34,153.00 minus book value paid @ $64.69 per share = $26,454.89
3. The parties are directed to consult with one another about the appropriate interest rate to be utilized by the Court. In the event the parties cannot agree, each party shall file any information and/or memorandum with the Court regarding this
25 issue within 30 days and the Court will make an order regarding the appropriate interest rate.
4. Also within 30 days, the Dissenters’ shall file an affidavit with the Court detailing their costs as awarded above.
Dated:
________________________ Karen R. Carroll Presiding Judge