In a knotty ESOP case, the 5th Circuit Court of Appeals recently largely upheld the district court’s findings that the plan’s trustees violated their fiduciary duties and engaged in a prohibited transaction. An appraiser’s dodgy doing enabled the improper conduct, which resulted in the ESOP’s overpaying for the company stock, the district court found.
The transactions were the brainchild of the owner of a closely held corporation that installed and serviced satellite TV equipment for Direct TV and his lawyer. The owner decided to divest himself of the company by selling 100% of the company’s shares to its employees by way of an employee stock ownership plan and by using a family limited liability company that held the company stock. The undertaking, rife with conflicts of interest, prompted separate suits from the Department of Labor and two individual plaintiffs alleging essentially the same thing: that the plan’s three trustees (the owner was one of them) caused the ESOP to buy the shares above its fair market value. The district court consolidated the actions.
In deciding the case, the district court said “this is not a normal case” considering the “enormous” record and many factual and legal disputes. The key questions were whether the appraiser and the trustees were truly independent and looking out for the interests of the ESOP and whether it was reasonable for the trustees to rely on the appraiser’s valuations. The court’s answer was no. The court also noted that the remedy questions were harder to resolve than the liability questions, and it suggested its valuation-related findings might be “vulnerable” on appeal.
The district court’s determination of overpayment was a function of the contract price and the stock’s fair market value on each of three transaction dates. For its FMV determination, the court considered the testimony of three noted valuation experts retained by the plaintiffs, the DOL, and the defendants, respectively. It found all equally credible. Different experts used different methods, different assumptions, different estimates, and they reached different conclusions. But they all used multiple approaches to produce several FMV estimates on the transaction dates. To arrive at a final value determination, or range of values, they all averaged or weighted the results.
The district approved of the averaging method and adopted it. It weighted the results the defendants’ expert achieved at 50% and the much lower valuations the DOL’s expert and the individual plaintiffs’ expert proposed at 25% each. It entirely disregarded the appraiser’s valuations made at the time of the transactions. Based on its overpayment calculation, the district court awarded $4.5 million in equitable restitution.
The defendants appealed the liability and remedy findings of the district court, and the DOL cross-appealed on the remedy.
The 5th Circuit Court of Appeals performed an extensive review. To find out more about its findings, click here.
There is no absolute requirement to develop a reasonable royalty based on the Georgia-Pacific framework. That’s the takeaway from a Daubert ruling in which the court denied the defendant’s motion to preclude the testimony of the opposing damages expert, who determined a reasonable royalty based on market data instead of the customary Georgia–Pacific factors.
The issue arose in a patent infringement case in which the plaintiff alleged the defendants violated two of its patents covering a healthcare provider reimbursement system. The plaintiff’s expert called the Georgia-Pacific factors “outmoded” and not suited to the case. Instead, he offered a market-based analysis.
The defendants’ expert criticized the opposing expert’s unusual approach, and the defendants argued the refusal to perform a Georgia-Pacific analysis disqualified the plaintiff’s expert from offering opinions or conclusions regarding Georgia-Pacific.
The court rejected the defendants’ Daubert challenge.
Find out more about the court’s decision here.
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.