I recently had the privilege of presenting at the FAE 2022 Business Valuation/Litigation Services Conference on recent case law developments of interest to business appraisers, primarily involving statutory fair value appraisal proceedings but also involving contract-based damages and buyout disputes litigated in the courts of New York, Delaware, and several other states. For those who were unable to attend, this article covers much of the same discussed at the conference. 

New York Cases

A. Fair Value Appraisals

Two recent New York fair-value appraisal cases offer lessons for business appraisers. The first, Magarik v Kraus USA, Inc., Index No. 606128-15 (Sup. Ct. Nassau County Apr. 10, 2020), highlights the risk of relying on client-driven projections and value estimates. The case involved an eight-year-old Internet-based “marketeer” business importing and selling plumbing fixtures primarily to distributors and retailers. The three shareholders applied for and obtained a $10 million bank credit facility. The application included the CFO’s cash flow projections forecasting a 40% increase in sales the following year, along with the shareholders’ personal net worth statements each valuing the company at $30 million.

Three months later, one of the three shareholders claiming oppression sued for judicial dissolution. The other shareholders elected to purchase the petitioner’s shares for fair value to be determined by the court. The petitioner’s expert appraiser concluded a company value of $30 million (coincidentally or not the same as the net worth statements provided to the bank) by averaging his discounted cash flow (DCF) income approach ($21.4 million) using the CFO’s aggressive cash-flow forecast with his widely disparate guideline public company market approach ($38.8 million) with no marketability discount. Respondents’ expert used capitalization of earnings and cash flow for his income approach and a merged and acquired company method arriving at consistent values approximately $6 million, to which he applied a 25% marketability discount.

Other than the 25% discount that the court reduced to 5% without elaboration, the court fully adopted the respondents’ experts’ appraisal, which the court found was “supported by credible evidence which demonstrated a successful and growing business that was not especially liquid.” The court criticized the petitioner’s expert’s appraisal as “based on income projections that were unrealistic and optimistic and not based on comparable businesses.” It also found that the expert’s “incredibly disparate” income and market valuations underscored “mistaken premises and assumptions.”

The second case, Matter of Gurney’s Inn Resort & Spa, Ltd., 188 A.D.3d 531 (1st Dept. 2020), cautions against the use of overly aggressive normalization of historical income. The case involved an iconic Montauk, Long Island oceanside time share/coop resort that was de-cooped and sold to new investors via merger and tender offer based on an $84 million appraisal. A small number of unit owners dissented and demanded a fair value appraisal. In the appraisal proceeding that followed, the opposing experts both used a 10-year DCF income approach with fairly close discount and terminal cap rates. The main driver of difference with the dissenters’ expert’s $115 million appraisal was projected earnings before interest, taxes, depreciation, and amortization (EBITDA), featuring widely disparate base year figures generated in large part by the dissenters’ expert use of a significantly higher Average Daily Rate than the current rate for rental units. 

The trial court adopted the dissenters’ expert’s $115 million conclusion of value, but rejected any additional value for trademarks, brand, and net operating loss (NOL) carryforward tax benefits. Both sides appealed the decision. The appellate court reversed and remanded for a corrected award, finding that the dissenter’s appraiser’s “calculation of the potential average daily room rate resulted in a highly inflated valuation and that the trial court’s rejection of the company’s expert’s $84 million appraisal or $95/sh. was not supported by the record.” Sadly, for the dissenters, the court’s fair value determination was $65 less per share than they had been offered pre-trial, which they rejected.

B. Damages

Quattro Parent LLC v Rakib, 2022 NY Slip Op 30190(U) (Sup. Ct. N.Y. County Jan. 14, 2022), is the rare dispute between co-owners in which, not only did the court award the plaintiff company damages based on the parties’ paper submissions without holding an evidentiary hearing; it featured an unusual match-up between an accredited, accomplished business appraiser as expert witness for the defendant, versus one of the company’s board members who had a background in finance and private equity, but had no appraisal credentials and was not offered as an expert witness. The non-expert carried the day, with a big assist from the defendant’s own admissions concerning the company’s lack of value.

The case pitted the plaintiff holding company for a Brazilian telecommunications business that foundered and was unable to attract new investors, against the minority investor in the company who also sat on the board. After the CEO announced that the company needed tens of millions of dollars to stay afloat, the defendant offered to buy a majority stake for $7.5 million. The company accepted the offer and formal agreements were entered into, but the defendant subsequently refused to close the deal, prompting the company’s lawsuit seeking to recover the $7.5 million as damages. In opposition, the defendant urged the court to find that the company suffered no damages based on his business appraisal expert’s report that employed asset and income approaches to value the company at approximately $15 million. 

The court, after granting the company summary judgment on liability for breach of contract, awarded the company the full measure of its claimed damages. The court credited the submission of the non-expert board member attesting to the company’s negative net revenues, its inability to raise the $75 million needed to break even, and its zero value, over that of the defendant’s expert’s $15 million valuation. The court also relied on the defendant’s own sworn statements that the shares were “worthless” unless the company obtained an additional $75 million in financing which he conceded would never happen.

C. Certificate of Value

The use of the so-called “certificate of value” (CoV) to establish fixed pricing in buy-sell agreements among company owners has received many a bad rap by lawyers and business appraisers alike. Even if the original CoV is based on a professionally prepared appraisal, quite often the co-owners fail to undertake periodic updates to reflect changes in the company’s value over the ensuing years. Yet, the CoV device continues to be used and continues to generate litigation when there’s a trigger event for the buy-sell and, more often than not, the seller or seller’s estate contends the pricing is woefully outdated and inadequate.

Estate of Collins v Tabs Motors Corp., 73 Misc. 3d 1225(A), 156 N.Y.S.3d 711 (N.Y. Sup. Ct. 2021), is one of those cases. It involved a family-owned realty holding company with a buy-sell provision in the 2012 shareholders agreement triggered, among other events, by the bringing of a dissolution petition and requiring the petitioner to sell for $5,250/sh. per the CoV that was never updated. The agreement expressly provided that the “last certificate shall be conclusive.”

In response to a dissolution petition by two of the four shareholders, the company counter-sued for specific performance of the buy-sell. The petitioners argued that the price was “unconscionable” and that the company’s president breached fiduciary duty by failing to update the CoV in the intervening years. The court rejected the petitioners’ arguments and ordered compliance with the buy-sell agreement, finding that the agreement was “fundamentally fair,” that it applied equally to all shareholders, and also noting that the CoV’s $5,250/sh. value assigned in 2012 was double the appraisal obtained at the time. 
 
Cases from Other States 

Disagreement over the applicability of minority (DLOC) and marketability (DLOM) discounts continues to claim an outsized share of attention in fair value and fair market value appraisal controversies, as reflected in a quartet of recent appellate decisions from across the country.

In two fair value appraisal cases, Raley v Brinkman, 621 S.W.3d 208 (Tenn. Ct. App. 2020), and Bohac v Benes Service Co., 310 Neb. 722, 969 N.W.2d 103 (2022), the former involving an LLC that operates a restaurant business and the latter a family-owned farming operation, the courts interpreted their fair value statutes as excluding both DLOC and DLOM. 

In Raley, the Tennessee appellate court affirmed the trial court’s rejection of DLOC and DLOM, reasoning that the statutory appraisal process does not seek to reconstruct a pro forma sale, “but to assume that the shareholder was willing to maintain his investment position," that “[b]ecause discounts for lack of control and marketability are premised on a theoretical sale to a third party, they are contrary to the foregoing principles,” and that “these discounts have the undesired effect of merely transferring, without compensation, a portion of the member's interest to the company.” 

In Bohac, Nebraska’s high court reversed the trial court’s application of DLOC and DLOM to an asset approach as a going concern, holding that the statute’s use of the term fair value instead of fair market value suggests “disapproval of a fair market value approach and the discounting that would accompany it” and that to find otherwise “would encourage majority oppression and would double-penalize minority interest holders . . ..”

Unlike their fair value counterparts, Hartman v BigInch Fabricators Co., 161 N.E.3d 1218 (Ind. 2021), and Patel v Siddhi Hospitality, LLC, 312 Or. App. 347 (2021), involved disputed discounts under contractual buyout provisions, with mixed results. 

In Hartman, the shareholders’ agreement required the company to purchase the plaintiff’s shares at “appraised market value” which, agreeing with the trial court, Indiana’s high court interpreted as fair market value including application of DLOC and DLOM. 

In Patel, an appraisal proceeding involving a compelled buyout following the plaintiff’s expulsion from an LLC, the appellate court disagreed with the trial court’s application of DLOC and DLOM under the operating agreement’s provision stating that “the value of the affected member’s interest shall be determined by multiplying the member’s percentage ownership interest by the fair market value of all LLC assets.”

Discount for Built-in Gains

There are decisions in New York and other states in statutory fair value appraisal cases involving subchapter C corporations in which the courts apply a discount for built-in gains tax based on the present value of deferred taxes over a holding period. A trio of recent decisions by appellate courts in Nebraska, Iowa, and Louisiana reminds us that, at least on a nationwide basis, there is no uniform approach to the issue.

In Guge v Kassel Enterprises, Inc., 962 N.W.2d 764 (Iowa 2021), an oppression case in which the company elected to purchase the minority shareholders’ 47.5% stock interest in a family farming business, the Iowa Supreme Court affirmed the trial court’s rejection of the company’s expert’s proposed $1.46 million deduction for built-in gains tax, citing lack of evidence that the controlling shareholder had any plans to sell the business and stressing the “perverse incentive” the discount would create for the “oppressive shareholder.” 

The Louisiana Court of Appeals in Shop Rite, Inc. v Gardiner, 2021 WL 1413949 (La. App. 3 Cir. Apr. 14, 2021), applied essentially the same rationale in reversing the lower court’s $7 million deduction for built-in gains tax, adding, “if the claimed tax consequence is a future one that will arise upon the occurrence of some unknown future event, the future tax consequence . . . should not be considered in determining” fair value. 

In contrast, in Bohac v Benes Service Co., 310 Neb. 722 (2022), in which the company elected to purchase an estate’s 14.84% stock interest in response to a dissolution petition, in addition to reversing the trial court’s application of DLOC and DLOM as mentioned above, the Nebraska Supreme Court upheld the trial court’s adoption of the estate’s expert’s 10-year deferred gains tax on the sale of the corporation’s fixed assets as opposed to the corporation’s expert’s 100% deduction.

Cases Impacting Appraisal Opportunities

A pair of recent New York and Delaware cases may impact future opportunities for business appraisers – one for the better, one for the worse.

For the better, there’s Farro v Schochet, 190 A.D.3d 689 (2d Dept. 2021), a first impression, appellate ruling in which the court resolved conflicting lower court decisions by construing Section 1002(g) of New York’s LLC Law as precluding legal challenge by a minority member to a freeze-out merger on grounds of fraud or other illegality. In contrast, such challenges are expressly permitted by the Business Corporation Law’s counterpart provision applicable to cashed-out minority shareholders. The court’s ruling stressed the absence of a similar exception in the LLC statute. The Farro court also held that the LLC Law’s default rule, generally permitting member action by majority written consent, trumps the 20-day notice and meeting requirement in the LLC Law’s merger article. The combination of an exclusive appraisal remedy for cashed-out LLC members and the controller’s ability to give notice of a merger as fait accompli by utilizing written-consent authorization, makes the cash-out merger a far more attractive option for LLC controllers as a means of dissociating minority members with whom they are at odds. That, in turn, is already translating into more frequent dissenting member appraisal proceedings and concomitant opportunities for expert engagements for business appraisers. 

For the worse, there’s Manti Holdings, LLC v Authentix Acquisition Co., 261 A.3d 1199 (Del. 2021), in which the Delaware Supreme Court affirmed Chancery Court’s dismissal of an appraisal petition by a group of common stockholders following a merger in which they received little or no consideration under the waterfall provision in the stockholders’ agreement. The agreement, entered into in connection with a merger years earlier, included an express waiver of the right to seek appraisal in the event of a future sale of the company. The common stockholders argued that Section 262 of the Delaware General Corporation Law is mandatory and prohibits a Delaware corporation from enforcing an advance waiver of appraisal rights against its own stockholders. The court disagreed, holding that the statute’s language does not preclude waiver and that public policy concerns do not prohibit sophisticated and informed stockholders – the plaintiffs in the case were both – from waiving their appraisal rights in exchange for valuable consideration. It can be anticipated that the Manti decision will motivate more Delaware closely held corporations to include waivers of appraisal rights in their stockholder agreements, with a concomitant reduction in the volume of engagement opportunities for expert business appraisers.

Several cases mentioned in this piece are featured on the author’s New York Business Divorce blog (www.NYBusinessDivorce.com).