Valuation Decision Finds LLC “Worthless, Worthless, Worthless”
February 14, 2022
The chorus to one of Neil Young’s most sublime songs is “Helpless, helpless, helpless.”
If composed in song, the chorus to a recent valuation decision by Manhattan Commercial Division Justice Andrea J. Masley would be “Worthless, worthless, worthless.”
Justice Masley’s valuation decision in Quattro Parent LLC v Rakib, 2022 NY Slip Op 30190(U) [Sup Ct, NY County Jan. 14, 2022] is noteworthy for two reasons.
First, it is an extraordinarily rare example of a business valuation performed by a court solely on paper submissions without a trial.
Second, it is a rare example of a valuation case pitting a veteran appraisal expert on one side against a fact witness with no expert on the other. Sound lopsided? Let’s see who prevailed in this unorthodox battle of valuation expert versus layperson.
The Business Venture
Plaintiff Quattro Parent LLC (“Quattro”) was a closely-held Delaware LLC comprised of a handful of investment funds, including one affiliated with George Soros (“Soros”), which invested in a startup venture to build a wireless broadband network in São Paulo, Brazil.
Between 2011 and 2014, Quattro’s primary members invested almost $150 million into the capital-intensive effort to build a broadband network in a foreign country. By 2015, Quattro was foundering, operating expenses far exceeding revenues. Quattro’s board, including Defendant Zaki Rakib (“Rakib”), who was also a minority investor, attempted to raise capital through a sale of membership interests but was unable to entice any potential investors.
The Contract to Purchase a Majority Stake
The origin of the lawsuit was a Quattro board meeting in June 2015, at which Quattro’s CEO expressed the grim view that an infusion of tens of millions of dollars was essential to keep the company afloat. After the meeting, Rakib made an offer the board quickly accepted to acquire a majority interest in Quattro for $7.5 million, documented in two writings: a Transaction Agreement and Third Amended and Restated Operating Agreement. Both documents were conditioned upon approval of the Brazilian government, requiring Rakib to tender payment for his membership interest within five days of the approval. A little less than a month after Rakib signed the contracts, the Brazilian government approved the transactions, but Rakib refused to proceed, claiming he was defrauded, misled, or mistaken about Quattro’s true value when he made his offer.
Summary Judgment on Liability
Quattro sued Rakib alleging a single cause of action for breach of contract. Rakib counterclaimed to rescind the transaction.
In a Decision and Order, Justice Masley granted Quattro summary judgment on liability for breach of contract and dismissed Rakib’s counterclaims, holding that (i) Rakib failed to perform under the agreement, (ii) “nothing in the record” demonstrates “a misrepresentation of present fact” to Rakib about Quattro’s value, and (iii) any alleged reliance by Rakib upon “projections of returns of investment” would have been unreasonable as a matter of law. At the conclusion of her decision, Justice Masley directed “an immediate trial on the issue of damages.” The Appellate Division affirmed in all respects in Quattro Parent LLC v Rakib, 181 AD3d 518 [1st Dept 2020].
The Trial Interrupted by COVID
When COVID struck, the parties were gearing up for a damages trial limited to one main issue: the value of the interest Rakib agreed to purchase in Quattro as of the date of breach. As the Court noted in its final decision, a trial on this issue was needed because “[t]he measure of damages here is the difference between the price defendant promised to pay for 100 million shares, $7.5 million, or 59% [of Quattro], and the value of those shares at the time of breach” (citing Emposimato v CICF Acquisition Corp., 89 AD3d 418 [1st Dept 2011] [“In the case of a breach of a contract to sell securities, expectation damages are calculated as the difference between the agreed price of the shares and the fair market value at the time of the breach”]).
Summary Judgment on Damages
A few months after COVID struck, as courts were still learning how to advance cases without in-person appearances, Quattro moved for summary judgment on damages. Quattro’s decision was a gamble, undoubtedly motivated by the fact that trials were unlikely to occur anytime soon. Business valuation almost always involves conflicting testimony and credibility assessments of expert appraisers. “Fair value, therefore, is a question of fact” (Zelouf Intern. Corp. v Zelouf, 45 Misc 3d 1205(A) [Sup Ct, NY County 2014]), almost never appropriate for resolution on papers alone.
Quattro’s Position on Value
In its memorandum of law, Quattro argued that no trial was required because all of the evidence showed, and Rakib previously admitted, that Quattro’s equity was worthless without an additional cash infusion of tens of millions of dollars.
The cornerstone of Quattro’s motion was a trial affidavit in lieu of live testimony filed months prior to the summary judgment motion by one of its former board members, Joshua Ho-Walker (“Ho-Walker”). Though Ho-Walker had an impressive pedigree – a degree in finance and economics from the Stern School of Business at New York University and 15 years of experience in investment banking and private equity – he was not an accredited business appraiser, nor an expert. But, according to his affidavit, Ho-Walker’s “role” as principal of one of the primary investors in Quattro was to “manage, value, and make recommendations concerning [the Soros fund’s] investment in Quattro.”
Ho-Walker valued Quattro using an income approach based on a discounted future cash flow analysis considering “Quattro’s long-term forecasts to project the company’s future operating cash flows.” According to Ho-Walker, by June 2015, he “no longer believed that Quattro’s business was viable” and he “did not see how this could change based on the company’s trajectory.” Quattro was consistently reporting negative net revenues and, according to Ho-Walker, it “would need another $75 million” cash to even “approach breakeven.” Ho-Walker explained that in September 2015, more than a month before Rakib’s breach, the Soros fund he managed “marked the value of the investment to zero.” Ho-Walker summarized: “My conclusion in November 2015 was that Quattro had no value for its shareholder. I held that view in 2015 and that remains my view today.”
Rakib’s Position on Value
In his memorandum of law in opposition, Rakib argued that there were multiple issues of fact – “a very real dispute” – about the “actual value of the membership interest in November 2015.” Rakib also argued that “neither Quattro nor the Court have cited to a single authority for even the existence of a procedure resembling a ‘trial on the papers.’”
The cornerstone of Rakib’s opposition was an expert affidavit from business appraiser Michael Garibaldi (“Garibaldi”). Garibaldi valued Quattro using an asset approach based upon its “book value” as stated in its financial statement and tax return for the period ended December 31, 2015. Garibaldi opined that “the value of the membership interest was in excess of USD $7,500,000 at the time of the alleged breach” because Quattro’s audited financial statements allegedly recited a book value of $16 million and its tax return for the same period recited a book value of $15 million. As a fallback, using a discounted future cash flow analysis, Garibaldi concluded that Quattro’s discounted future earnings would be $14 million. Under either approach, what this meant was that Quattro, in his view, suffered no actual damage from Rakib’s breach because the value of the 59% membership interest it retained exceeded what Rakib promised to pay for it.
The Damages Decision
In its Decision and Order, the Court carefully considered the competing views of Ho-Walker and Garibaldi, but ultimately relied predominantly upon the admissions of Rakib himself. The Court wrote, “Defendant has repeatedly stated under oath to this court that plaintiff’s shares were ‘worthless’ unless the company obtained an additional $75 million in financing, which he conceded would never happen.” The Court concluded that Rakib’s summary judgment submissions attempting to retract his prior admissions of Quattro’s lack of worth created a mere “feigned issue of fact,” which was “insufficient to defeat a properly supported motion for summary judgment.”
The Court wrote:
[T]he court credits defendant’s evaluation of the shares as ‘worthless.’ Indeed, the court credits defendant’s statements more than any other evidence. Defendant co-founded plaintiff’s predecessor, successfully attracted significant investments from Soros and others of $150 million, and was an active board member throughout–no one knew plaintiff’s value, or the lack thereof, better.
Ultimately, though, the Court found that the majority interest at most had a measly $100 value by looking to a transaction that occurred a little more than one year after the breach.
The court finds that the best indication of market price is the price that was paid to the shareholders who sold 1.1 million shares in December 2016 for $.01, not per share, but per 1.1 million shares. Defendant does not challenge this transaction. There is no evidence that these shareholders are interested or conflicted in any way. Based on Ho-Walker’s testimony, the court finds that the shares were no more valuable than $.01/1 million shares in November 15, 2015. The court credits Ho-Walker’s analysis as it was contemporaneous and factual. Most significant is Soros’s decision to mark the value of its investment to zero on September 30, 2015, 45 days before the November 15, 2015 closing date.
As a result, the Court subtracted $100 from the gross price of the breached contract, awarding Quattro damages of $7,499,900.
Thoughts on Quattro
One might question the Court’s consideration of post-breach events as supporting the value of Quattro’s majority interest. The justification for the Quattro Court’s decision to do so lies in the nature of the proceeding itself. Under statutory “fair value” proceedings, such as those under Sections 623 and 1118 of the Business Corporation Law, courts are generally prohibited from considering post-valuation date events in arriving at fair value unless pre-valuation date evidence confirms those events were “known or knowable” as of the valuation date (read our articles, for example, on Estate of Mandelbaum and Matter of Murphy). Quattro was not a “fair value” proceeding. Rather, it involved a common-law claim for breach of contract with no statutory rules for considering pre- or post-valuation date evidence, hence the Court’s freedom to look to post-breach events.
More interesting, perhaps, is the Court’s decision to essentially hold a valuation trial on papers alone. If any of our readers have ever seen a court do that before, I encourage you to please email me and let me know. I have not. Reading Quattro, the Court essentially made a series of fact findings and credibility determinations (i.e., “The court finds that the best indication of market price . . .”; “the court finds that the shares were no more valuable . . .”; “The court credits Ho-Walker’s analysis . . .”; “The court credits Garibaldi’s data and analysis but disagrees that . . .”; “the court rejects Garibaldi’s reliance on . . .”; etc.). This language is reminiscent of post-trial findings of fact and conclusions of law, which Quattro decidedly was not.
Less than a week after the decision, Rakib took an appeal, stating that he “challenges the procedure employed by the Lower Court” in granting Quattro judgment on damages “without trial” and “before defendant was permitted to cross-examine plaintiff’s witnesses or submit rebuttal evidence.” It will be interesting to see if the Appellate Division takes issue with the unconventional procedure of the Quattro Court.