Courts determine the value of equity interests in closely held firms in a variety of settings, including (among others) dissenting shareholder proceedings triggered by mergers; elective stock buy-outs triggered by minority shareholder dissolution petitions; partnership buy-outs triggered by death or dissolution; disputes over contractual buy-outs contained in agreements among the co-owners; and damages claims arising from buy-outs tainted by fraud or wrongful nondisclosure.
The central feature of a valuation contest is the battle of the opposing appraisal experts. Nothing is more critical to the success of a litigant’s valuation case than putting on the testimony of a qualified, independent, experienced, credible, well-prepared, articulate appraiser who, using his or her written appraisal report as a springboard, can both educate and persuade the judge (or jury in certain types of cases) who has ultimate responsibility for determining the value of the equity interest under the applicable standard of value.
In most valuation proceedings, the parties either are required to, or voluntarily agree to, disclose certain information concerning their intended expert witnesses in advance of the valuation hearing. I say in most cases because the governing rules can vary depending whether the case is brought in court or as an arbitration and, if in court, as a plenary action versus a special proceeding, or in the court’s Commercial Division versus in a general civil part. Disclosure practices also can vary from judge to judge.
In my experience, even in special proceedings where pretrial disclosure requires the court’s consent, judges usually will permit or even encourage the parties to exchange expert disclosure in advance of a valuation hearing. Pretrial expert disclosure, especially when it includes a written appraisal report, is tremendously helpful in streamlining the issues for trial and allowing the opposing experts and counsel to present more effectively their offensive and rebuttal cases. It also can facilitate settlement.
The basic New York rule governing pretrial expert disclosure requires a relatively modest amount of information — many would argue too modest. Section 3101(d) of the Civil Practice Law and Rules states that, upon request, a party must identify each expert witness at trial and disclose “in reasonable detail”:
- the subject matter on which each expert is expected to testify;
- the substance of the facts and opinions on which each expert is expected to testify;
- the qualifications of each expert witness; and
- a summary of the grounds for each expert’s opinion.
The “reasonable detail” standard for each disclosure category as applied by the courts is only moderately helpful in assessing the meat of the opposing side’s valuation case including methodology used, the data relied upon, and the appraiser’s conclusion of value. The rule’s utility is further weakened by its lack of a hard deadline for expert disclosure. Also notice that, unlike the counterpart Federal Rule of Civil Procedure 26(a)(2), there’s no required disclosure of the expert’s written report.
The good news is that, by order of the Chief Administrative Judge in September 2013, implementing a recommendation made by a blue-ribbon task force on commercial litigation practices, an amended Commercial Division Rule 13 now imposes a pretrial expert disclosure regimen substantially similar to the federal rule, including the exchange of written reports and depositions of experts within four months after the completion of fact discovery. The amended rule, which only applies to cases assigned to the Commercial Division, also states that expert disclosure provided after the due dates “without good cause” will be precluded from use at trial.
The Cost of Noncompliance
Litigants who fail to comply with expert disclosure requirements in valuation cases generally fall into three categories: those who don’t give adequate disclosure, those who don’t give timely disclosure, and those who don’t give any disclosure.
The first category — inadequate disclosure — usually prompts an objection by the receiving party followed by a motion to preclude the expert from testifying absent further disclosure. Take, for example, Sieger v Zak in which each side challenged the adequacy of the other’s expert disclosure in a case involving damages claims arising from a shareholder buy-out.
In round one, the plaintiffs moved to preclude testimony by the defendants’ expert appraiser based on a disclosure statement (sans written report) that identified the appraiser, and stated that he would testify as to the “business value” of the subject company pursuant to “standard valuation methods and procedures.” In an October 2010 decision by Nassau County Commercial Division Justice Stephen A. Bucaria (read here), the court found the disclosure statement inadequate under CPLR § 3101(d) but denied preclusion based on lack of evidence of “willful failure to disclose on defendants’ part or any showing of prejudice on the part of the plaintiffs.” Justice Bucaria instead ordered the defendants to serve an amended expert disclosure statement providing “the method or methods by which [the expert] will estimate the value of [the company].”
In round two it was the defendants’ turn to object to the adequacy of the plaintiffs’ expert disclosure statement (also sans written report) which identified their expert appraiser and stated that his testimony at trial:
- will utilize an income approach, modeling anticipated future returns of the company and discounting cash flows to present value;
- will utilize a market approach, examining the trading prices and “benchmarks” of publicly traded companies;
- will utilize a cost approach, and
- will utilize a “SWOT analysis,” considering strengths, weaknesses, opportunities, and threats to the company.
In an April 2012 decision (read here), Justice Bucaria again concluded that the statement did not disclose in sufficient detail the methodology used to evaluate the company so as to enable the defendants “to engage in adequate and thorough trial preparation.” Instead of ordering a supplemental disclosure statement, however, this time Justice Bucaria ordered the plaintiffs to produce their expert for deposition, at defendants’ cost.
A more extreme – nightmarish may be a better word – example of the costs of noncompliance with expert disclosure surfaced recently, of all places, in a legal malpractice case, Roberts v Corwin, brought against a lawyer who represented an unsuccessful claimant in an arbitration. The underlying arbitration concerned the breakup and reconstitution of a law firm partnership in which the claimant, Roberts, sought to recover his pro rata share of the dissolved law firm’s assets and going concern value allegedly transferred to his former partners’ new firm for inadequate consideration.
Prior to the hearing, the arbitrators issued an interim order requiring the parties to “disclose immediately if expert testimony on any subject is contemplated, or confirm that none shall be offered and that only fact witnesses shall testify.” The response prepared by Roberts’ lawyer, Corwin, did not disclose their previously-retained valuation expert. At the subsequent hearing, when the expert was called to testify, the arbitrators upheld the respondents’ objection and precluded the expert from giving any expert testimony concerning accounting and valuation issues.
The arbitrators thereafter made an award dismissing the claims and requiring Roberts to reimburse respondents’ attorney’s fees. The award noted the absence of expert testimony on Roberts’ behalf due to noncompliance with the interim disclosure order, and found that Roberts failed to show any damages resulting from the former law firm’s dissolution. A Manhattan Supreme Court Justice subsequently denied Roberts’ petition to vacate the arbitration award, and granted the respondents’ motion to confirm the award (read here).
Next came Roberts’ malpractice suit against Corwin and his firm, centering on his alleged failure to provide expert disclosure resulting in the preclusion of critical expert testimony needed to establish the value of the dissolved law firm and the damages suffered by Roberts (read complaint here). In a decision last November by Manhattan Commercial Division Justice Marcy Friedman (read here), the court denied Corwin’s summary judgment motion seeking dismissal of the complaint.
Specifically, the court rejected Corwin’s argument, that Roberts cannot prove that he would have prevailed in the arbitration “but for” Corwin’s alleged negligence in failing to designate an expert on the valuation of the partnership interest. Here’s the key passage from Justice Friedman’s decision:
[T]he panel’s holding that Mr. Roberts failed to prove liability on these causes of action was based on his failure to prove damages — i.e., the amount by which his partnership interest was undervalued. Triable issues of fact thus remain as to whether the failure to designate an expert witness on valuation was a but for cause of Mr. Roberts’ loss.
Next it’ll be up to a jury to decide if the lawyer will have to pay for the arbitration loss.
For various reasons, including the newly amended Commercial Division Rule 13 mentioned above, it’s less likely that a dispute over expert witness disclosure in a valuation proceeding in New York Supreme Court (or federal court) would replicate the harsh outcome in the Roberts arbitration. The case nonetheless stands as a reminder of the critical importance of expert testimony in valuation proceedings, and of the equal importance of full and timely compliance with expert disclosure mandates.