One error in an extensive economic analysis does not automatically call into question the entire expert opinion, the 2nd Circuit Court of Appeals recently said in the context of a securities fraud lawsuit involving the drug giant Pfizer. With this pronouncement, the appeals court resuscitated a class action that had died after the district court excluded the plaintiffs’ loss causation and damages expert under Daubert based on errors in the expert’s event study. Deprived of the testimony, the plaintiffs were unable to prove two critical elements of their claim.
Shareholders in Pfizer sued the company alleging it made fraudulent misrepresentations about the safety of its Celebrex and Bextra drugs—nonsteroidal anti-inflammatory drugs to treat chronic pain and inflammation. According to the plaintiffs, even though Pfizer and the prior owners of the drugs knew about the drugs’ dangerous side effects as early as 1998, they kept touting the drugs’ safety to keep the public’s misperception going and cash in on the drugs’ commercial success.
The plaintiffs hired one of the most reputed experts working in the field to prove the fraud actually caused losses and compute the extent of the loss to shareholders. He performed an event study to determine whether and to what degree Pfizer’s stock price changed when investors discovered the risks associated with the two drugs.
Pfizer offered rebuttal testimony only. Its expert “overall” did not have “any major criticism” of the event study the plaintiffs’ expert developed. However, Pfizer’s expert objected to certain assumptions the plaintiffs’ expert made about certain corrective disclosures. Almost a decade into the litigation, the district court found the plaintiff expert opinion had two irremediable flaws and declared the entire testimony inadmissible under Daubert.
The 2nd Circuit Court of Appeals firmly disagreed. In taking such a drastic step, the district court “went astray,” the appeals court said. It pointed out that “parsing” expert testimony and excising the unreliable part(s) from the reliable testimony accords with the “liberal admissibility standards” of Daubert and Federal Rule of Evidence 702.
Read more about the appeals court’s ruling here.
In re Cole, 2016 Bankr. LEXIS 932 (March 24, 2016)
How meaningful is a valuation that was prepared for one type of case in another context? This was the key issue in a combined divorce and bankruptcy case centering on the husband’s minority interest in a dental practice.
Following the divorce, the husband filed for Chapter 13 bankruptcy and asked for confirmation of his plan. The issue was whether the plan could meet the liquidation test applicable under the Bankruptcy Code’s section 1325(a)(4). In essence, the test requires that creditors in a Chapter 13 bankruptcy receive present value payments that are at least equal to the amount the creditors would receive in a Chapter 7 case.
The Bankruptcy Court said its decision depended on the value of the husband’s share in the practice, which, in turn, depended on whether the court was required to adopt, or could simply adopt, the valuation prevailing in the divorce case, or whether it had to find a reliable indicator of value elsewhere.
The wife, who was the primary unsecured creditor, claimed that the divorce court’s valuation was controlling. If it was used in a Chapter 7 liquidation analysis, the plan did not qualify for confirmation, she said. At divorce, the principal valuation the wife’s expert presented was based on the going concern of the dental practice as a whole, of which the expert then took 25% of the total value. He concluded the husband’s share was worth $212,000. The divorce court adopted the valuation.
In contrast, the husband’s expert maintained the interest was worth about $15,800. He declined to assign any value to the patient records or the goodwill of the practice.
In the bankruptcy proceedings, the husband contended that he was not precluded from revisiting the issue since the valuation the divorce court adopted was based on the intrinsic value of the business. This was not the standard of value applicable under Section 1325(a)(4), the husband claimed. Relying on expert testimony, the husband emphasized the impediments a Chapter 7 trustee would encounter when trying to market this minority interest in a personal services corporation. It showed that the interest had no value in the open market, the husband contended.
The Bankruptcy Court agreed and disagreed with both sides on different arguments. Find out more about the court’s analysis here.
Moore v. Moore, 2016 Ark. LEXIS 82 (March 10, 2016)
Too activist? In a controversial move involving the valuation of nonmarital property, a majority of the Arkansas Supreme Court recently decided to overturn precedent even though neither of the parties, in petitioning for review, asked for a change in case law. The dissenting judges thought the majority’s dramatic about-face was inappropriate under the circumstances.
Under Arkansas statutory law, the increase in the value of nonmarital property is nonmarital property. But, in a line of decisions going back nearly 30 years, the Arkansas Supreme Court created an exception to the statutory rule by way of the active appreciation doctrine, which says that if the growth in value is the result of the owner spouse’s efforts, the appreciation is subject to marital distribution.
This was the law until a recent divorce case came along. The husband owned a business that was separate property. The trial court, following Supreme Court precedent, decided to award half of the $556,000 appreciation in the business’s value to the wife, finding the increase was the result of the husband’s significant efforts and the wife’s contribution during the marriage.
The case eventually found its way to the state Supreme Court. In contesting the trial court’s ruling on appreciation, the husband argued that, under the applicable state statute (Ark. Code Ann. § 9-12-315(b)(5)), any increase in the value of a nonmarital business remained nonmarital property. But he also acknowledged the Supreme Court cases that applied the active appreciation rule. The husband, rather than arguing the controlling cases were wrong as a matter of law, contended the active appreciation exception was inapplicable to the facts of this case.
A majority of the state Supreme Court decided an altogether different analysis was in order—one that nixed the active appreciation rule and returned to the plain language of the statute.
Find out more about the court’s analysis here.
Curran v. Curran, 2016 Conn. Super. LEXIS 77 (Jan. 12, 2016)
A contract is a contract. That’s the conclusion a court recently reached in the context of a share buyback, after one party to a valuation agreement belatedly attacked the appraiser’s use of a minority discount and the resulting drop in share price.
The plaintiff owned a 30% interest in a VW dealership. Initially, he asked for a dissolution of the company, but the company obtained permission from the court to buy back his shares. The court urged the parties to take charge of the valuation process in order to avoid “the needless expense of a ‘battle of appraisers'” or a judicial proceeding.
The parties eventually retained a sole appraiser, whom both sides knew from past appraisals he had done of the company. Prior to formally engaging the appraiser, in a court hearing, the parties broached the issue of whether it was appropriate to apply a minority discount in valuing the plaintiff’s shares. The court declined to weigh in on the subject, but it told the parties the minority discount issue should form “part of the discussion” they needed to have over the valuation methodology.
Ultimately, the parties stipulated that the appraiser’s value determination “shall be final and binding, with no right of appeal for any party.”
Regardless of the parties’ commitment to the agreement, the plaintiff subsequently challenged the appraiser’s decision to apply a 25% minority discount—which lowered the value of his interest by about $100,000—in court.
The court was not obliging. To find out more about the court’s reaction, click here.
Witt-Bahls v. Bahls, 2016 Fla. App. LEXIS 1451 (Feb. 3, 2016)
In this age of entrepreneurship, valuators working on divorce cases often run into the issue of active and passive appreciation. But the issue not only comes up in the context of one spouse’s ownership of a business that qualifies as separate property, as a recent Florida appeals court ruling shows.
Prior to the marriage, the husband acquired a substantial amount of stock, by way of a bank loan, in the company for which he worked in some managerial capacity. He was never a top executive. During the marriage, when he was terminated, his stock was liquidated and sold for substantially more than the outstanding balance on the loan used to pay for the shares.
At divorce, the trial court determined the shares were separate property and the appreciation was passive. The increase in value, therefore, also was the husband’s separate property.
The wife appealed the ruling. According to the appeals court opinion, she asked the court for a rule “that all appreciation of the stock of a company for which a spouse works is a marital asset.” It’s not clear from the opinion whether the wife asked for a rule that would shift the burden to the stock-owning spouse to show the appreciation was passive in nature and, therefore, not part of the marital estate or whether she wanted a rule that all appreciation in value during the marriage was marital property as a matter of law.
Either way, the appeals court rejected the wife’s request, suggesting that such an expansion of the concept of marital assets was the province of the legislature. Instead, the court affirmed the existing analytical framework.
To find out more about the court’s discussion, click here.
La Verghetta v. Lawlor, Index No. 5934/2014, N.Y. Sup. Ct. [County of Westchester] (March 9, 2016)
A recent statutory fair value ruling from a New York trial court is must read for appraisers. The case featured experts whose professional backgrounds and valuation approaches could hardly be more dissimilar. Their value determinations were light-years apart. In trying to make sense of the conflicting testimony and achieve a plausible and fair result, the court decided it could not totally trust either valuation. Although it adopted the defense expert’s valuation, it made two consequential changes to it. One was getting rid of the expert’s admittedly high and insufficiently explained discount for lack of marketability.
The case revolved around two entities that served as holding companies for Planet Fitness franchises. The owners were three partners who roughly owned equal interests. The companies’ function was to manage the existing health clubs in New York and to develop new ones in New York and California pursuant to development agreements with the franchisor. The contracts favored the franchisor. They included strict requirements as to the number of clubs the franchisees had to open per year and severely limited what the franchisees could do to generate income.
When the partners fell out, the plaintiff minority shareholder sued the defendants and initially asked for the dissolution of the enterprise. The parties subsequently agreed to a fair value determination of the two companies by the court to enable a buyout of the plaintiff’s interest.
The plaintiff’s expert was a tax lawyer with no formal valuation training or certification, whereas the defendants’ expert was one of the founding fathers of the valuation profession. The former valued the two corporations at over $162 million and the plaintiff’s interest at over $53 million. The latter determined one of the entities was worth over $6.2 million and the other $208,000. Accordingly, the plaintiff’s one-third interest was worth approximately $2.2 million.
The court discredited the valuation the plaintiff’s expert offered. At the same time, it decided a number of aspects of the defense expert’s valuation required a correction.
Read more about the court’s analysis here.
Healthcare v. Orr, 2016 Cal. App. Unpub. LEXIS 440 (Jan. 20, 2016)
Goodwill has its price. That’s the message the California Court of Appeal recently sent to a medical entity that sought to affect a noncompete/nonsolicitation agreement following the purchase of a doctor’s practice. The decision also sends a note of caution to appraisers who work on asset valuations in similar transactions.
When a solo independent practitioner expressed interest in selling her medical practice, a large medical provider offered a generous price for the building in which the practice was housed (also owned by the doctor) but told the doctor the practice itself had no monetary or goodwill value. The doctor responded she was not “comfortable” with the proposition that the business had no value, but negotiations continued.
Ultimately, the parties reached a deal that included the sale of the building and the sale of the assets of the practice, as well as an employment contract for the doctor. The asset purchase agreement said the assets being sold included all of the practice’s goodwill. At the same time, it allocated 100% of the purchase price to tangible assets: furniture, fixtures, equipment, and supplies. The agreement also included noncompete and nonsolicitation clauses.
The price allocation came to haunt the buyer later when it tried to enforce the restraints against the doctor.
Noncompetes and nonsolicitation clauses are generally unenforceable under California law. An exception applies only when the sale of a business includes the sale of the business’s goodwill and there is a clear indication that the parties valued goodwill as part of the sales price. The “clear indication” requirement is where the buyer’s arrangement ran into trouble.
To find out why the appeals court invalidated the noncompete/nonsolicitation clauses, click here.
In re Trulia Stockholder Litig., 2016 Del. Ch. LEXIS 8 (Jan. 22, 2016)
When it comes to disclosure settlements, more information does not necessarily equate to more value to the recipient. That’s according to the Chancellor of the Delaware Court of Chancery in a shareholder class action suit arising out of the acquisition of Trulia, an online provider of information on homes for purchase or rent, by the real estate site Zillow.
The plaintiffs, shareholders of Trulia, alleged Trulia’s board of directors breached its fiduciary duty when it approved the merger. But only four months after the transaction occurred, the plaintiffs and the defendants had worked out an agreement-in-principle to settle the case. The settlement envisioned a broad release of claims from the class of plaintiffs in return for some additional disclosures related to the various financial analyses Trulia’s financial advisor had performed prior to the transaction.
The settlement required the approval of the court. The plaintiffs, now aligned with the defendants, advocated in favor of the agreement.
Asked to probe the value of the disclosures, and by extension the fairness of the settlement, to the absent class members, the Chancellor used the occasion to detail the problems related to disclosure settlements. He noted the Chancery’s historical practice of approving such settlements even though they frequently were of marginal value to the plaintiffs. He considered this past attitude of the court one of the causes for the explosion of deal litigation “beyond the realm of reason.” And he noted: “It is all too common for a plaintiff to identify and obtain supplemental disclosure of a laundry list of minutiae in a financial advisor’s board presentation that does not appear in the summary of the advisor’s analysis in the proxy materials.” But the extra information seldom was material and helpful to the plaintiffs, the Chancellor observed.
Read more about the court’s analysis of the additional valuation information and the outcome of the instant case here.
Wisniewski v. Walsh , 2015 N.J. Super. Unpub. LEXIS 3001 (Dec. 24, 2015)
Just when attorneys and valuators working on dissenting shareholder suits in New York courts have become increasingly vocal about their objection to the imposition of a marketability discount in that jurisdiction, in comes a piquant New Jersey ruling in which the appeals court upheld a 25% DLOM.
The New Jersey case, Wisniewski v. Walsh, in many ways is sui generis. It is decades old and involves feuding family members (which may explain its length and intensity). The litigation has resulted in three appeals, and it has featured valuators of the highest caliber. Along the way, the trial court found, and the appeals court agreed, that the plaintiff, who positioned himself as the oppressed shareholder, actually was the oppressor and should be bought out by the two remaining shareholders. Even though a marketability discount was usually only applicable in “extraordinary circumstances” in forced buyout suits, the trial and appeals courts found the circumstances of the case justified the application of a DLOM.
The DLOM was not the only discount in play, however.
The parties’ most recent fight focused on whether the prevailing expert’s DCF analysis embedded a marketability discount to account for illiquidity. If not, the trial court had to decide what the appropriate DLOM rate was. The plaintiff-selling shareholder argued in favor of a zero marketability discount, and the defendants-buying shareholders presented an expert valuation that specified a 35% DLOM, based on the expert’s use of a market approach.
To read more about the most recent 2015 ruling in the case, click here
To read about an insider’s take on the outcome of the case and the NY DLOM debate, click here
Investors in a company committed themselves to having a nationally recognized valuation firm determine the value of their units in accordance with a specified formula. But, dissatisfied with the resulting price, they challenged the value determination. The court refused to meddle with the parties’ contractual arrangement.
The plaintiff owned an equity interest in a company that rented pallets to manufacturers for the shipping of groceries and consumer goods. The defendants owned preferred units of the plaintiff. The parties agreed the plaintiff would purchase all of the defendants’ units following notice that the defendants wanted to exercise their put rights. The contract required the plaintiff to retain a reputable appraiser that would determine the fair market value of the defendants’ preferred units.
In terms of valuation methodology, the agreement provided that “there shall be no minority or non-marketability discount applied.” Also, “fair market value” meant an arm’s-length sale to an unrelated third party. And, for purposes of calculating the “total equity value,” the value of the assets would be subject to an EBITDA collar to ensure that the value of the assets was at least 6.5x but no more than 7.5x the company’s “EBITDA less maintenance capex” for year-end 2013. The resulting number was to be reduced by the company’s obligations and liabilities. Most important in terms of the ensuing litigation, the parties agreed to be bound by the appraiser’s calculation of the price of the put units. The contract did not allow for judicial or any other form of review of the appraiser’s valuation.
The plaintiff followed the script, but the defendants refused to transfer their units to the plaintiff. Consequently, the plaintiff asked the Delaware Court of Chancery for a declaration that it had complied with the agreement’s valuation provisions and that the defendants were bound by the value determination. The defendants, in turn, attacked certain decisions—judgment calls—the appraiser made to arrive at the fair market value.
The Delaware Court of Chancery (Chancellor Bouchard) saw no reason to “second-guess” the valuator’s work product.
To find out more about the court’s ruling on the case, click here.