Disclosure of Estate Tax Stock Appraisals in Shareholder Disputes
April 01, 2019
The discoverability of materials in civil litigation in general resists any hard and fast rules, other than that the scope of discovery is broadly defined and liberally applied under the rules of civil procedure in both state and federal cases, and that judges are afforded broad discretion in deciding what’s “material and necessary” (NY CPLR 3101 (a)) or “relevant” (Fed.R.Civ.P. 26 (b) (1)) based on the specific facts and issues in each case.
In contested stock valuations triggered by elections to purchase in statutory dissolution or dissenting shareholder cases, it’s only natural that purchaser and seller both are motivated to obtain discovery from the other for possible use at trial of any pre-litigation appraisals of the corporation’s equity, whether or not obtained in contemplation of litigation, in the hope that the appraisal will undermine the valuation performed by the other’s expert witness at trial.
Business and real estate appraisals may be secured in the ordinary course for a host of different reasons having nothing to do with shareholder disputes. The probative value of the appraisal in any subsequent litigation over stock value may depend on its proximity in time to the valuation date in the case, its purpose, the standard and premise of value employed, and other variables.
Occasionally, a stock valuation contest is triggered by the death of a shareholder under the terms of a shareholder agreement requiring a buy-out of the estate’s shares, or involves a statutory buy-out of shares owned by a living shareholder who acquired the shares by inheritance from a former, deceased shareholder. In such cases, the purchaser may seek discovery of any stock appraisal done for purposes of reporting the stock’s value on the Form 706 tax return that must be filed on behalf of the deceased shareholder’s estate.
Depending on the size of the estate, its taxability, and other factors, there may or may not be an incentive to appraise the stock and to report its value on the Form 706 at its lowest supportable value — hence the purchasing side’s attraction to getting their hands on a copy of the appraisal for use at the valuation hearing.
Vick v Albert
There has been very little guidance in New York case law bearing on the relevance and discoverability of such appraisals in stock valuation proceedings. (Obviously I’m not referring to Tax Court proceedings over the estate’s value.)
One of the only notable valuation rulings I’ve encountered is Vick v Albert, 47 AD2d 482 [1st Dept 2008], a case I previously wrote about here. Vick was an appeal from the valuation of a deceased partner’s interest in a realty holding partnership in which the appellate panel upheld the trial judge’s refusal to hold binding against the estate “the discounted values set forth in the estate tax return.” The court reasoned that “since the purposes of estate tax valuation and partnership interest valuation differ, there is no basis here for deeming the representation in the estate tax return an admission as to value with regard to the partnership interest.”
The value of the partnership interest in Vick was based on fair market value. Whether the Vick court’s reasoning would be any stronger, weaker, or the same in regard to a statutory valuation proceeding applying the fair value standard is an open question I’ve not seen addressed by any New York court.
The appellate decision in Vick did not arise from a lower court’s discovery ruling. Whether the estate’s tax return and appraisal in that case was produced voluntarily or under compulsion I can’t say. The court’s reasoning nonetheless could be cited as precedent for the non-discoverability of the return and appraisal in some other case involving disconsonant valuation purposes and standards.
The Galasso Case
While not involving a stock appraisal contest, the discoverability in a shareholder dispute of an appraisal prepared for an estate tax return was front and center in the Appellate Division, Third Department’s recent decision in Galasso v Cobleskill Stone Products, Inc., 169 AD3d 1344 [3d Dept 2019].
Galasso involves a suit brought by the administrator of the estate of a deceased minority shareholder of a highway construction and paving materials business in upstate New York. The plaintiff sued for injunctive relief and damages, accusing the controller of wasting corporate assets and engaging in self-dealing. The defendant demanded disclosure of a report valuing the deceased’s shares, prepared by a professional business valuation and advisory firm. The report was prepared prior to litigation for the purpose of declaring the shares’ value on the estate tax return. The plaintiff declined to provide the report on the grounds, first, it was not relevant and, second, that it was protected by attorney-client privilege.
The lower court disagreed on both counts and compelled production of the report. The plaintiff appealed to the Third Department, to no avail.
As to the report’s relevancy, the court noted that the appraiser
was retained by plaintiff for the appraisal of plaintiff’s assets, specifically stocks in defendant, for estate tax filing purposes. . . . According to plaintiff, after its appraisal, [the appraiser] raised “serious and substantial concerns” that prompted plaintiff to commence this action against defendant. As a result, the valuation report is relevant to this action because it played a role in the commencement of the action, and it may be probative as to why plaintiff believes that defendant is guilty of gross malfeasance Also, as correctly determined by Supreme Court, the valuation report, which values decedent’s stock in defendant, provides a benchmark “by which to . . . evaluate plaintiff’s damages” [citations omitted].
The court likewise was unpersuaded by the plaintiff’s argument based on the attorney-client privilege, writing as follows:
Although [the appraiser] was hired by plaintiff’s counsel and the agreement between [the appraiser] and plaintiff’s counsel states that its communications would be confidential, the primary purpose for which [the appraiser] was hired was to appraise plaintiff’s stocks in defendant for estate tax filing purposes. In fact, the instant action was not commenced until after [the appraiser] expressed “serious and substantial concerns” upon completion of its appraisal. Therefore, the mere fact that [the appraiser’s] report now supports plaintiff’s legal action does not eliminate the fact that the report was not initially done for legal purposes. In fact, during a court conference, plaintiff confirmed that the valuation report did not include any legal information, nor did it disclose plaintiff’s confidences. Thus, given that the primary purpose of [the appraiser’s] valuation report was for estate tax purposes and is not “of a legal character,” Supreme Court properly held that it was not protected by the attorney-client privilege.
The court also rejected the plaintiff’s assertion that the so-called “Kovel privilege” (United States v Kovel, 296 F2d 918 [2d Cir 1961]) attaches to the valuation report “because the purpose of the report was not to facilitate or clarify communications between plaintiff and his attorneys.”
The Takeaway. The plaintiff in the Galasso case seemingly placed at issue the stock appraisal report prepared for the estate tax return by citing it as a basis for commencing the lawsuit, thus opening the door to its discovery by the defendant. It may have been discoverable even had the plaintiff not done so based on the nature of the plaintiff’s damages claims. Does Galasso support a demand for discovery of an appraisal prepared in connection with an estate tax return in a stock appraisal proceeding? It may be a harder sell, but I can envision arguments on both sides so, for now, we’ll just have to wait and see if and when the issue presents itself in some future case.
P.S. Chris Mercer today posted a very informative article building on mine with the sellf-explanatory title, Should Pre-Litigation Appraisals be Admitted in Current Litigations? It is Likely Best to Assume That They Will be Admitted. Read it here.