Buy-sell provisions in shareholder agreements are good. Arbitration provisions in shareholder agreements are good. Inconsistent buy-sell and arbitration provisions in shareholder agreements are bad.
That pretty much sums up the lesson to be learned from an appellate opinion handed down last month in Matter of Grande’ Vie, LLC, 2012 NY Slip Op 02190 (4th Dept Mar. 23, 2012), in which a majority of the court, with one judge dissenting, ordered arbitration over an appraisal for the buy-out of a deceased LLC member’s interest notwithstanding language in the buy-sell provision stating that the appraisal “shall be binding.”
The case involves two real estate holding companies organized as LLCs owned equally by three members, one of whom died in 2008. The operating agreement included buy-sell provisions triggered, inter alia, by the death of a member whose estate was entitled to be paid a purchase price determined by appraisal. The agreement also included a broad arbitration clause. Litigation broke out in 2010 after the estate sought arbitration of the value of the decedent’s membership interest, while the surviving members sought to compel a sale at a value set forth in a written appraisal rendered by an appraiser selected by the surviving members after the appraisers specifically named in the agreement declined the assignment.
In April 2011, the Monroe County trial court denied the estate’s application to compel arbitration and granted the surviving members’ application to enforce the buy-out at the appraised value. The estate appealed.
The appeal naturally focused on the language of the buy-sell and arbitration provisions. The former identified by name the appraiser to determine the “Fair Value” of the membership interest, named a second appraiser in case the first appraiser was not available, and permitted the purchasing members to select any MAI-qualified appraiser if the neither of the two named appraisers was available. In the quoted excerpt of the provision that follows, for reasons that will become clear below, pay special attention to the use of the defined terms “Appraiser” and “Successor Appraiser”:
For purposes of this Agreement, within ten (10) days after the expiration of the thirty (30) day period set forth in Section 8.2 (a) (ii) above, the selling Member (either the selling Member or the legal representative of the Deceased Member, as the case may be) and the purchasing Members shall notify Richard Bellows (the ‘Appraiser’), to calculate the Fair Value of the Company. In the event the Appraiser or its successor in interest is no longer in business then the purchasing member shall notify Bob Pogel or if he is no longer in business, any MAI appraiser (the ‘Successor Appraiser’). The Fair Value of the Membership Interest being purchased shall be determined by the Appraiser, in accordance with such valuation techniques and appropriate methodologies as the Appraiser deems appropriate, all in accordance with Generally Accepted Accounting Principles, and the policies and rules of MAI (Member Appraisal Institute). In all cases, the Appraiser’s final determination shall be binding on the selling Member and the purchasing Member(s). The Appraiser shall deliver a written report of its determination of Fair Value to all interested parties, and the cost of such appraisal shall be borne equally Fifty Percent (50%) by said selling Member and Fifty Percent (50%) by the Purchasing Member(s). [Emphasis added.]
The operating agreement also included a broad arbitration clause requiring arbitration of any “controversy or claim arising out of or relating to” the agreement. The appeal focused on the following, additional proviso in the arbitration clause dealing with arbitrator qualifications:
[I]f the matter submitted to arbitration shall involve a dispute as to the value of a Membership Interest, one of the arbitrators shall be a certified public accountant and shall have no prior affiliation with any Member or the Company.
If you’ve been reading closely, you already see the problem: the buy-sell provision uses the defined term “Appraiser” in the underscored sentence purporting to make the appraisal “binding” on the members. Was it the members’ intent that only an appraisal performed by the first-named appraiser (the “Appraiser”) be binding, and that an appraisal performed by the second-named appraiser or the back-up MAI-qualified appraiser (the “Successor Appraiser”) not be binding? And how does the arbitration clause’s explicit reference to a dispute ”as to the value of a Membership interest” fit with the stated intent, however broadly or narrowly construed, to make the ”Appraiser’s final determination” binding on the members?
The appeal was heard by four judges of the Rochester-based Appellate Division, Fourth Department. The three-judge majority opinion reversed the trial court’s order and granted the estate’s bid to compel arbitration, basically finding that the use of the defined term ”Appraiser” in the sentence making the “Appraiser’s” determination binding clearly did not apply to the appraisal rendered by the “Successor Appraiser” selected by the surviving members. Here’s what the majority wrote:
By the plain wording of the appraisal clause, the MAI appraiser was the “Successor Appraiser,” but only the “Appraiser’s” determination would be final and binding on the parties. We therefore conclude that the parties intended that, where the “Appraiser” was not available to value the companies and the member’s interest, the matter should be submitted to arbitration.
The dissenting justice, who would have upheld the lower court’s order enforcing the buy-out at the appraised value, disagreed that the term “Appraiser” as used in the sentence making the “Appraiser’s” determination binding applied only to the first-named appraiser. He drew support for this conclusion from two other sentences in the buy-sell provision — one giving instructions as to how the Fair Value of the membership interest is to be valued, the other directing that a written report of the appraisal be delivered to all parties — that use the term “Appraiser.” As the dissent further explains:
Thus, if the appraisal clause is interpreted as respondent suggests (so as to distinguish between the Appraiser and the Successor Appraiser), the Successor Appraiser would play no role in the appraisal process upon being “notif[ied]” by the purchasing member. In other words, to construe the appraisal clause as giving binding effect to an appraisal submitted by only Bellows [the first-named appraiser] would render meaningless the provisions for selecting another appraiser in the event that Bellows declines to perform an appraisal. That construction of the appraisal clause is contrary to the well-established rule that courts should “avoid an interpretation that would leave contractual clauses meaningless.” (Two Guys from Harrison-N.Y. v S.F.R. Realty Assoc., 63 NY2d 396, 403). As the Court of Appeals has advised, “[i]t is a cardinal rule of construction that a court should not adopt an interpretation which will operate to leave a provision of a contract . . . without force and effect” (Corhill Corp. v S.D. Plants, Inc., 9 NY2d 595, 599 [internal quotation marks omitted]; see Muzak Corp. v Hotel Taft Corp., 1 NY2d 42, 46-47).
The dissenting justice also found that the arbitration clause’s reference to a valuation dispute “does not compel a finding that the parties’ dispute over the value of the decedent’s membership interest must be arbitrated.” He gives three reasons:
- The reference to a valuation dispute in the arbitration clause does not differentiate between appraisals submitted by an Appraiser — which the parties agree would be binding and therefore non-arbitrable — or a Successor Appraiser.
- The provision of the appraisal clause “directing the Appraiser or Successor Appraiser definitively to determine the value of a membership interest removed that subject from the purview of the arbitrator.”
- Under the rule of contract construction that specific provisions control over general provisions, “the appraisal clause is far more specific than the arbitration clause, which is contained in a section of the agreements entitled ‘General Provisions.’”
I’ve seen many shareholder and operating agreements that provide for a binding valuation process when a buy-out event is triggered by death, disability or other specified disposition of an ownership interest. The whole idea is to avoid the burden, expense and delay associated with litigation in favor of a reasonably prompt and orderly determination by one or more qualified appraisers of the value of the interest being purchased. The appraisal provision in Grande’ Vie failed its purpose because the drafter did not state with sufficient precision the intent of the parties to be bound by the appraisal under the different scenarios for selection of the appraiser. I would go one step further by pointing out that, in my view, it’s always a bad idea to give either the buyer or the seller the power unilaterally to select the appraiser because, regardless of the selected appraiser’s qualifications, it almost always gives rise to mistrust and accusations of manipulation by the non-selecting party.