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




                                         26
