Summer Shorts: Partnership Appraisal and Other Recent Decisions of Interest

August 13, 2018

The dog days of August are upon us, a perfect time as I do each year to offer vacationing readers some lighter fare consisting of summaries of a few recent decisions of interest involving disputes between business co-owners.

This year’s summaries include a partnership appraisal case from Nebraska in which the usual “battle of the experts” turned into a romp for one side, a New York case in which one side insisted that a written “Shareholder Agreement” was not really a shareholder agreement, and a federal court decision from Illinois in which the court rejected the argument that it should abstain from hearing a statutory dissolution claim.

A Train Wreck of a Valuation Case

If you want a lesson in how not to litigate an appraisal proceeding, look no further than Fredericks Peebles & Morgan LLP v Assam, 300 Neb. 670 [Sup Ct Aug. 3, 2018], in which the Nebraska Supreme Court recently affirmed the appraisal court’s determination, pursuant to the buy-out provisions of a law firm partnership agreement, of the $590,000 fair market value of a withdrawn partner’s 23.25% partnership interest.

The trial pitted a single, well-qualified expert witness for the law firm who had extensive experience consulting for and valuing law practices, against four experts for the withdrawn partner: a CPA with no valuation credentials who previously valued only one other law firm; another CPA accredited in business valuation who also previously had valued only one other law firm; a non-accredited witness with law and MBA degrees with no prior experience valuing law firms; and the plaintiff himself.

The law firm’s expert, who spent over 100 hours preparing a 48-page appraisal report, used an income approach employing a build-up discount rate resulting in a $590,000 value for the withdrawn partner’s interest after applying combined 60% marketability and minority discounts.

It was mayhem on the other side, culminating with the testimony of the withdrawn partner, acting as his own expert witness, in which he valued his 23.25% interest at approximately $4.8 million and, in the words of the Supreme Court’s opinion, “encouraged the court to reject his [own] experts’ valuations” that arrived at substantially lower values. Among other oddities:

Notwithstanding the contractually required fair market value standard, one of the withdrawn partner’s experts admitted that his valuation assumed that the law firm “should be understood as the specific hypothetical buyer” of the 23.25% interest as the basis for his application of de minimis marketability and minority discounts.
Another of his experts testified that the withdrawn partner advised him that the reference to fair market value in the partnership agreement should equate to fair value, i.e., should exclude marketability and minority discounts. The trial court found that the withdrawn partner attempted to “influence in an upward manner” his hired experts’ valuation.
The withdrawn partner’s experts merely prepared a “calculation of value” report instead of the more rigorous conclusion of value.
Their report included a pass-through premium that they admitted at trial had not been accepted by the U.S. Tax Court. It also indicated that $9 million of the firm’s $10 million in accounts receivable included in the withdrawn partner’s own valuation report “was likely uncollectible.”
The withdrawn partner prepared his own appraisal report which one of his other experts testified was “ridiculous.”
That same expert, who admitted that the law firm’s expert was more experienced in the field of law firm valuation, included $2.5 million of goodwill value which, according to the court based on the evidence, was “attributable to personal goodwill of the remaining partners.”

In real estate, it’s location, location, location. In business appraisal, it’s experience, experience, experience.

Extrinsic Evidence Not Permitted to Recast Shareholder Agreement as Profit-Sharing Agreement

In World Ambulette Transportation, Inc. v Lee, 161 AD3d 1028, 2018 NY Slip Op 03560 [2d Dept May 16, 2018], the plaintiff corporation sued a former employee for alleged misuse of corporate funds for personal expenses. The defendant countersued for wrongful termination and breach of contract based on a written agreement entitled “Shareholder Agreement” providing that the founding shareholder and the defendant owned 102 and 98 shares, respectively. At a nonjury trial, the parties gave conflicting testimony as to their understanding of the agreement, with the founding shareholder testifying that the agreement was intended merely as a profit-sharing arrangement in which he promised to pay the defendant 49% of the corporation’s earnings.

The trial court dismissed the defendant’s counterclaim for breach of contract, crediting the plaintiff’s extrinsic evidence of the parties’ intent and concluding that they had “entered into nothing more than a profit sharing agreement, despite the wording of the agreement.”

On appeal, the Second Department reversed that portion of the judgment, finding that the plain and unambiguous terms of the written Shareholder Agreement precluded the admission of extrinsic evidence to vary its terms. Wrote the court:

Contrary to the court’s conclusion, the written agreement was not ambiguous such that it could be construed as a profit-sharing agreement. The written agreement is entitled “Shareholder Agreement,” and it contains numerous provisions setting forth the rights and obligations of shareholders. In addition, the written agreement provides in paragraph 5, under the section entitled “Warranties,” that Chang owns 102 Class “A” shares and that the defendant owns 98 Class “A” shares. Accordingly, the plain language of the written agreement unambiguously demonstrates that the defendant was a shareholder.

Based on this finding, the court reinstated and entered judgment for defendant on his counterclaim for an accounting. On the other hand, it sustained the dismissal of his counterclaims for breach of contract and wrongful termination, holding that the Shareholder Agreement neither assured defendant the right to receive dividends nor entitled him to any employment position within the company or to any salary.

Federal Court Sustains Jurisdiction Over Dissolution Action

Previous posts on this blog have addressed federal court decisions applying the Burford abstention doctrine to dismiss diversity actions in which shareholders sought judicial dissolution of corporations under state law (see here and here). Under that doctrine, a federal court will abstain from hearing a case over which it otherwise has jurisdiction to avoid “needless disruption” of a state’s strong interest in the uniform development and interpretation of a comprehensive statutory scheme, such as state laws governing dissolution of state-created entities.

The last time I checked (admittedly a while ago), federal appellate and district courts in the First, Second and Sixth Circuits had issued rulings dismissing dissolution cases under Burford. I hadn’t noticed any decisions in dissolution cases from other U.S. circuits (which doesn’t mean there aren’t any) until yesterday, when I happened upon a very recent decision by a U.S. District Judge for the Central District of Illinois, in Hausman v Green, No. 3:18-CV-03013 [July 20, 2018].

Hausman involves a shareholder dispute which arose after the plaintiff sold 80% of the corporation’s shares to the defendants and also gave one of the defendants an option to purchase the real estate housing the corporation’s business. The option holder initially sued the plaintiff in state court for specific performance of the purchase option, prompting plaintiff’s counterclaim for breach of shareholders agreement and demanding access to books and records.

Almost two years later, the state court granted the option holder’s motion to voluntarily dismiss without prejudice the state court case, following which the plaintiff filed suit in federal court asserting state law claims for judicial dissolution and also to compel defendants to produce books and records. The defendants reacted by moving to dismiss the federal action, not under Burford but under its cousin, known as the Colorado River abstention doctrine, based on the plaintiff’s pending state court counterclaims seeking the same or similar relief.

The District Judge, ruling on objections to a Magistrate’s Report and Recommendation, held that Colorado River abstention did not apply, and that the dissolution case therefore could proceed in federal court, because the record in the state court proceedings showed that “the state court judge closed the case and ordered the cause struck [and] [n]o further action has occurred in the state court case since that action.”

The decision does not mention Burford abstention or otherwise indicate if the defendants argued Burford abstention as an alternative basis for dismissal. I did not find any decisions in the Seventh Circuit, which includes Illinois District Courts, addressing Burford abstention in the context of corporate dissolution cases. If any readers know of such cases from that or any other circuit yet to weigh in, please drop me a line.