An Ill-Fated Solution to an Ill-Fated Buy-Sell Agreement
Let's face it: If you have a close corporation shareholders' agreement or LLC operating agreement including a buy-sell provision with a fixed share price that's supposed to be updated periodically, there's a good chance you (or your estate) are in for a nasty fight when the buy-out is triggered by the death, disability or retirement of one of the owners. Why so? Because more often than not the owners never update the agreed share price, so that when a buy-out is triggered many years later, the last agreed value no longer reflects a fair value for the ownership interest due to the growth (or decline) of the business in the interim, e.g., the Nimkoff case about which I wrote here.
Many such buy-sell agreements include an alternative valuation method when the agreed price -- often memorialized in a so-called Certificate of Value appended to the shareholders' agreement -- is not updated within a stated number of years before the trigger event, such as using an appraiser to perform a current evaluation. Such alternatives are no panacea, however, especially when the agreement fails to specify valuation parameters including the standard of value (e.g., fair market value, fair value, book value) and level of value (e.g., controlling, marketable minority, nonmarketable minority). The Sassower case, about which I wrote here and here, is a textbook illustration of the litigation woes that can follow when the buy-sell fails to articulate relevant valuation parameters.
If there's anything worse than failing to specify standards for the alternative valuation, it's providing no alternative, as when the buy-sell mandates use of the stale fixed price, which brings us to this week's featured case, DeMatteo v. DeMatteo Salvage Co., 2011 NY Slip Op 09586 (2d Dept Dec. 27, 2011).
DeMatteo is a poster child for all that can go wrong with a poorly designed buy-sell agreement. DeMatteo Salvage Co. is a Long Island based, family-owned business since the 1920's, designing and installing machinery and equipment for scrap paper and solid waste customers. In 1966, siblings Domenick, Edward, Carmine and Joseph DeMatteo entered into mirror image buy-sell agreements for DeMatteo Salvage and a second company they owned called E&J Holding Corp. The agreement requires the estate of a deceased shareholder to sell, and the companies to buy, the decedent's shares at a fixed price. The agreement does not require that the agreed value be updated periodically. Rather, it merely provides that the agreed price "may be redetermined at any time by mutual agreement of the Corporation and the Stockholders" and then goes on to specify that the failure to redetermine value for however long does not disable the last, agreed value:
The last value established preceding the death of a Stockholder shall be the value of his stock for purposes of this agreement. This provision shall not be altered by the fact that the Corporation and the Stockholders for any reason have failed to redetermine such value at any time or from time to time. All redeterminations of value shall be endorsed upon Schedule A hereof, dated and signed by the Corporation and the Stockholders.
Fifteen years later, in 1981, Schedule A was formally endorsed with new values of $7,500 per DeMatteo Salvage share and $10,000 per E&J share. Although Schedule A thereafter never was amended, on several occasions in 1984-86 there were shareholder meetings whose minutes reflected redetermined values, the last of which set per-share prices of $20,000 for DeMatteo Salvage and $37,500 for E&J.
Further muddying the issue, minutes of a shareholder meeting in March 1992 reflect a resolution to "table" the re-evaluation of the shares until October 1992, and to keep the previously set values of $66,197 per DeMatteo Salvage share and $66,666 per E&J share. (The court decisions don't reveal when those share values were set or how they were recorded.)
It appears that all of these share re-evaluations were done by the shareholders themselves without the assistance of an appraisal professional.
The eldest brother, Joseph, died sometime before 2000, which sparked the first buy-out litigation culminating with a settlement that forced the surviving three siblings to borrow funds to pay the estate. In April 2000, apparently hoping to avoid a repeat, the three surviving shareholders adopted a formal resolution stating "that the values for the shares of stock in both corporations [are] voluntarily canceled at their present value" and that "Paul Iadanza at the office of Delle Fave & Tarasco, has been retained to value both corporations."
Edward DeMatteo died two years later, in June 2002. In the interim, for reasons never made clear to the court, the designated company accountant, Mr. Iadanza, did not perform the evaluations authorized by the April 2000 resolution.
Thus began an 8-year litigation saga, commencing in 2003 when Edward's widow, Gloria, as executrix, sued DeMatteo Salvage and E&J to enforce a buy-out of the Estate's shares based on what she claimed was the last validly determined value of approximately $66,000 per share for each company based on the March 1992 resolution.
In 2004, Gloria moved for summary judgment on her buy-out claim at $66,000 per share. The companies, now owned by the two surviving siblings, cross moved for summary judgment based on what they claimed were the last valid determinations of value, namely, the 1981 endorsements on Schedule A at $7,500 per DeMatteo Salvage share and $10,000 per E&J share.
In a decision and order dated February 8, 2005, Suffolk County Commercial Division Justice Elizabeth Hazlitt Emerson concluded there were factual issues precluding a summary determination of the buy-out price. In so ruling, she found that the 1992 resolution was not binding because Dominick DeMatteo was not present at the meeting and because the values were not endorsed on Schedule A. She also found that the 1984-86 re-evaluations evidenced the siblings' intent to redetermine the value of their stock after the 1981 valuation, but that they were not conclusive as to "whether [the shareholders] took all steps necessary to redetermine the value in accordance with the buy/sell agreements."
At some point during the litigation, Mr. Iadanza prepared current appraisals of both companies, reporting values not disclosed in the court's decisions other than mentioning that they were less than the values adopted in the 1981 endorsements to Schedule A. The surviving siblings thereupon sought to enforce a buy-out based on Mr. Iadanza's valuation. In June 2009, Suffolk County Commercial Division Justice Emily Pines held a framed-issue hearing at which the surviving siblings testified that their deceased brother, Edward, drafted the April 2000 resolution and specifically chose Mr. Iadanza to perform new valuations, and that all the siblings agreed to accept Mr. Iadanza's valuations in lieu of the prior valuations over which there had been years of litigation following Joseph's death.
In her decision dated July 2, 2009, Justice Pines credited the surviving siblings' testimony and granted them summary judgment to the extent of finding that they and Edward agreed in April 2000 to scrap the prior valuations and to be bound by new valuations as of that date to be performed by Mr. Iadanza. As Justice Pines further explained:
While [Gloria's] counsel has suggested that the Iadanza evaluation that was in fact performed should not be accepted as it was lower than the one set forth by the shareholders themselves in 1981, clearly that was part of their purpose in enacting the 2000 resolution; i.e., for the valuation to reflect a number which would not place the corporations in extremis when the estate of the next shareholder was entitled to payment. They made the decision consciously with the imprimatur of [Edward] who chose the evaluator.
However, since the valuations prepared by Mr. Iadanza valued the companies as of a date some years after April 2000, Justice Pines also ordered him to prepare new valuations as of April 2000.
Approximately one year later, in August 2010, Justice Pines entered judgment based on Mr. Iadanza's new valuation reports, awarding Edward's estate the sum of approximately $500,000 for his combined interests in both companies based on an aggregate valuation of both companies of approximately $1.3 million.
Both sides thereafter appealed to the Appellate Division, Second Department which in its December 27, 2011 order, reduced the award to Edward's estate by approximately $100,000. The appellate court found that Justice Pines should not have disregarded minority and marketability discounts applied by Mr. Iadanza to the value of one of the company's shares (the decision does not specify which company), thereby reducing the per-share value for that company by a combined 30% discount, from $12,379 to $8,665. By the way, the fact that the parties litigated the applicability of discounts tends to confirm the fact that the April 2000 resolution authorizing an appraisal by Mr. Iadanza was silent concerning standards and levels of value.
Gloria's appeal argued that, pursuant to the April 2000 resolution, the shareholders did not intend to be bound by Mr. Iadanza's new report, but the appellate court declined to reach the issue on procedural grounds based on that court's dismissal of Gloria's previous appeal from Justice Pines' July 2009 decision for failure to prosecute.
[Note: The buy-sell agreements provided for the companies to procure insurance policies on the lives of the shareholders for the purchase of their shares. In September 2006, Gloria won a prior appeal to the Second Department which ordered the companies to pay Edward's estate approximately $440,000 in life insurance proceeds (read here). It's not clear if that amount is in addition to, or is applicable in satisfaction of, the lesser sum awarded in the recently decided appeal.]
Between the first buy-out litigation following the eldest brother Joseph's death, and the second lawsuit started by Gloria after Edward's death, the DeMatteo family has been warring in the courts over the value of the companies' shares for more than a decade. Whatever one thinks of the outcome, what's absolutely clear is that the buy-sell agreement failed miserably, both in its design and its implementation, in its intended purpose to ensure family control of the businesses while providing the shareholders' heirs with a measure of financial security based on a consensual, non-litigated, fair valuation of the companies' equity.
- It was a mistake to design the buy-sell agreement without requiring periodic updates.
- It was a mistake to design the buy-sell agreement without providing an alternative valuation method when a buy-out event occurs more than a year or two after the last agreed valuation.
- It was a mistake for the shareholders to come up with their own valuations over the years without seeking the guidance of a professional appraiser.
- It was a mistake for the shareholders to agree to rescind the prior valuations in favor of obtaining a professional appraisal, and then not following through by having the professional perform the appraisal until long after the death of a shareholder, when the financial interests of the surviving shareholders and the deceased shareholder's estate became antagonistic.
Business appraiser and author Z. Christopher Mercer, a leading authority on buy-sell agreements, has described fixed pricing in a buy-sell agreement as a "ticking time bomb". The DeMatteo case is a powerful demonstration of the accuracy of Chris's warning.
Update January 14, 2012: Chris Mercer has written a post on the DeMatteo case on his highly informative blog, ValuationSpeak.
The Rise and Fall and Rise of Blue Chip: Fiduciary Duty Trumps Waiver in Latest First Department Decision
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Toward the close of its 2010-11 term, the New York Court of Appeals (the state's highest court) issued a pair of decisions in the Centro and Arfa cases that cast a dark cloud over a line of precedent established by the Manhattan-based Appellate Division, First Department, that had refused to enforce releases or fiduciary waivers given by sellers of interests in closely held businesses who later brought suit against the purchasers/controlling owners for concealing material information affecting the buy-out price, such as an impending deal to sell the company assets to a third party at a much higher valuation.
The best known of the First Department cases, Blue Chip Emerald v. Allied Partners, 299 AD2d 278 (2002), and its progeny including Littman v. Magee, 54 AD3d 14 (2008), broadly suggested that a fiduciary can never contractually relieve itself of its duty of full disclosure by withholding material information the non-controlling owner needs in making its decision to enter into the buy-out agreement. In Centro and Arfa, however, the Court of Appeals expressly disagreed with the First Department cases insofar as they would preclude a sophisticated party from giving a release or waiver in favor of its fiduciary as part of a transaction where the party understands that the fiduciary is acting in its own self-interest and the release or waiver is knowingly entered into. (Read here my post on the Centro and Arfa decisions.)
Anyone who thought Blue Chip was down for the count would be mistaken. Last week, over a vigorous two-judge dissent, a three-judge majority in Pappas v. Tzolis, 2011 NY Slip Op 06455 (1st Dept Sept. 15, 2011), unabashedly wielded Blue Chip to salvage a lawsuit brought by two owners of a realty company who, after selling their LLC membership interests to the third member under an agreement containing a fiduciary waiver, brought suit claiming the buyer intentionally concealed from them an impending deal to sell the company's sole asset to an outside buyer at a spectactularly higher valuation.
The Lower Court's Ruling
My March 2010 post about the trial court's decision in Pappas throwing out the complaint gives a full recital of the underlying facts. In brief, the three parties formed a member-managed Delaware LLC to hold a long-term net lease on a Manhattan commercial property, which they then subleased to one of the members, Tzolis, who subsequently stopped paying rent and then proposed that he acquire the other two members' interests. The deal was made for $1.5 million. Six months later, Tzolis as sole LLC member transfered the lease to a developer for $17.5 million. The two former members then brought suit against Tzolis for breach of fiduciary duty, fraud and other claims based on his alleged nondisclosure at the time of the buy-out of his concurrent negotiations with the developer who acquired the lease.
The trial court dismissed the complaint based primarily on the "Other Activities" provision in the LLC's operating agreement that authorized any member to "engage in business ventures and investments of any nature whatsoever, whether or not in competition with the LLC, without obligation of any kind to the LLC or to the other Members." The judge held that the provision eliminated Tzolis's alleged fiduciary duty of disclosure, as authorized under Section 18-1101(c) of Delaware's LLC Act as well as under New York law to the extent made applicable under the LLC agreement's choice-of-law provision. (Read here Professor Larry Ribstein's analysis of the choice-of-law issue in Pappas.)
The judge also accepted Tzolis's argument that the parties' intent to eliminate fiduciary duty under this provision was re-affirmed by a "Certificate" signed by the selling members as part of the buy-out agreement, stating that the sellers had performed their own due diligence, had engaged their own legal counsel, were not relying on any representation by Tzolis outside those made in the agreement, and that "each of the undersigned sellers agrees that Steve Tzolis has no fiduciary duty to the undersigned sellers in connection with [the sales of their interests]."
The Majority Opinion
Last week's appellate decision reversed the lower court and reinstated the complaint's central claims for fiduciary breach and fraud. (It's interesting to note that two of the three judges in the majority, Justices Saxe and Acosta, were on the panel that decided the Littman v. Magee case that, along with Blue Chip, came under attack in Centro and Arfa.)
The majority starts its analysis stating that, as the party seeking dismissal, Tzolis had the procedural burden of "clearly" establishing that the Other Activities provision "eliminated the particular fiduciary duty that plaintiffs contend he breached." The majority readily finds that, while the provision may have permitted Tzolis to pursue for his own benefit a competitive business opportunity unrelated to the LLC,
the provision does not "clearly" permit Tzolis to engage in behavior such as that alleged here, which was to surreptitiously engineer the lucrative sale of the sole asset owned by [the LLC], without informing his fellow owners of that entity.
The majority reaches the same conclusion under substantive Delaware law holding that "'unless the LLC agreement in a manager-managed LLC explicity . . . restricts or eliminates traditional fiduciary duties, managers owe those duties to . . . [the LLC's] members'" (quoting Kelly v. Blum, 2010 WL 629850, *10 (Del Ch 2010).
The majority devotes the greater part of its analysis to the effect of the Certificate's statements disclaiming plaintiffs' reliance on any representations by Tzolis and that Tzolis owed them no fiduciary duty. Stating that "[t]his Court addressed that very issue in Blue Chip . . . a case with very similar facts," the majority concludes that "we are compelled to act with the same uncompromising rigidity here as in Blue Chip." Notwithstanding the Certificate's disclaimers, Tzolis "had an overriding duty to disclose his dealings with [the developer] to plaintiffs before they assigned their interests in [the LLC] to him."
Arguably the most critical part of the majority's opininon is its treatment of the Court of Appeals' recent Centro and Arfa decisions in which, as noted above, the higher court seemingly gutted Blue Chip. Here's how the majority distinguishes the cases and narrows their import as regards the effect of the Certificate:
. . . Centro is distinguishable. In that case, the plaintiffs alleged that the defendants, their co-fiduciaries, induced them to sell their interest in a telecommunications company by misrepresenting the value of the enterprise. The Court of Appeals, in affirming the dismissal of the plaintiffs' fraud claim, noted that the "plaintiffs knew that defendants had not supplied them with the financial information necessary to properly value [their interest], and that they were entitled to that information . . . In short, this is an instance where plaintiffs have been so lax in protecting themselves that they cannot fairly ask for the law's protection'" (2011 Slip Op at *7, quoting DDJ Mgt., LLC v Rhone Group L.L.C., 15 NY3d 147, 154 [2010]). The Court further noted that the plaintiff "ha[d] actual knowledge that its fiduciary [was] not being entirely forthright" (id.). In contrast, defendants here have made no showing that plaintiffs had any reason to suspect Tzolis of deceit or that they had the independent ability to discover facts that would have deterred them from selling their interests in [the LLC] to him.
The majority dismisses as "irrelevant" Centro's and Arfa's disagreement with Blue Chip. In both of those cases, the majority says, prior to entering into the agreements including releases, the relationships between the co-owners had deteriorated to the point that, in Centro's words, "the fiduciary relationship is no longer one of unquestioning trust." The majority contrasts the facts in Pappas, where there is
no evidence that plaintiffs and Tzolis were not still in a relationship of unquestioning trust at the time of the transaction at issue, other than employing the circular logic that they must not have had such a relationship given that plaintiffs were willing to execute the certificate.
Finally, the majority also distinguishes the "exceedingly broad" releases given in Centro and Arfa that, unlike the language used in the Certificate, extinguished the defendants' liability "in all manner of actions . . . whatsoever . . . whether past, present or future . . . resulting from the ownership of membership interests in the entity . . .."
The Dissent
The first sentence of the dissent, written by Justice Helen Freedman and joined by Justice David Friedman, plainly states its thesis: "I would affirm the dismissal of the complaint in its entirety, because contractual disclaimers by plaintiffs preclude the causes of action that the majority has reinstated." (It's again interesting to note that Justice David Friedman wrote both of the First Department opinions upheld by the Court of Appeals in Centro and Arfa, while Justice Helen Freedman voted with the majority in Centro.)
It's unclear the extent to which the dissenters rest their position on the Other Activities provision in the LLC's operating agreement. All they say is that the provision "anticipated competing interests among the LLC members"; that it "afforded Tzolis latitude to pursue his individual business interests for his own gain regardless if his co-members' interests"; and that the restriction or elimination of fiduciary duty is permitted under Delaware law. The dissent does not directly lock horns with the majority's distinction between competitive activities involving business opportunities outside the LLC versus those involving the LLC's sole asset, and thus whether the provision standing alone eliminated the fiduciary duty of disclosure allegedly breached by Tzolis.
What is clear is the dissenters' reliance on the Certificate as an insuperable, contractual barrier to the plaintiffs' claims. Justice Freedman writes:
In this case, plaintiffs were business partners of Tzolis who affirmed at the closing and in connection with the assignments that they were represented by counsel and had performed their own due diligence in connection with the transaction. Their acknowledgment in the closing certificate that Tzolis was not acting as their fiduciary and that they were not relying on any representations by him beyond those contained in the closing documents, constituted fair notice that plaintiffs were engaging in an arm's-length business transaction with Tzolis, that they should not place their "unquestioning trust" in him, and that in exchange for their immediate and certain twentyfold return on their investment, they were forgoing the possibility of future greater profit.
The dissent calls "unpersuasive" the majority's attempt to distinguish Centro. Here's what Justice Freedman says:
It is immaterial that instead of signing a general release plaintiffs executed a certificate disclaiming Tzolis's fiduciary duty and his earlier representations. The disclaimer was tantamount to a release from all claims against Tzolis in connection with the assignment that were premised on his fiduciary duty to plaintiffs.
Lastly, Justice Freedman also challenges the majority's contention that Tzolis made no showing that plaintiffs lacked "unquestioning trust" in him, writing as follows:
The face of the closing certificate, however, indicates otherwise. In consideration of Tzolis's purchase, plaintiffs were presented with, and with the advice of counsel signed, an explicit acknowledgment that Tzolis was not their fiduciary and that they should not rely on his earlier representations. Even if plaintiffs had the right to place their trust in Tzolis before they signed the certificate, that right necessarily ended when they executed it. Accordingly, the breach of fiduciary duty claim is barred.
Next Stop, Court of Appeals?
Under New York appellate rules, since the decision reinstating claims does not finally determine the action, it does not appear that Tzolis has a right of appeal to the Court of Appeals based on the two-judge dissent under CPLR 5601[a]. Nonetheless, I would think there's a more than decent likelihood that the Appellate Division or Court of Appeals would grant permission to appeal. We bystanders can only hope Tzolis pursues and is granted such leave.
The wavering fortunes of Blue Chip reflect a fascinating tug-of-war between two schools of thought. On the one hand, there are what I'll call the judicial interventionists who believe it is the purpose and duty of the courts to use their powers of equity to enforce common law norms of behavior among business partners who owe each other, as Judge Cardozo put it in Meinhard v. Salmon, the "punctilio of an honor the most sensitive." On the other hand there are the contractarians who posit that the parties by and large are free to order their business relations as they see fit and that judicial policing should not extend beyond enforcement of the parties' agreements. The Delaware LLC Act, with its express invocation of the freedom-of-contract principle and its express authorization to eliminate fiduciary duty, creates an optimal vehicle for the latter school.
Of course, the New York Court of Appeals is not a debating society and, should the Pappas case come before it, it is likely to examine closely the facts alleged in the complaint and the precise language used in the parties' agreements to fashion a ruling that resolves the particular dispute on the narrowest possible grounds. As I see it, that narrow issue will be whether, under the analysis advanced in Centro and Arfa, Tzolis's reliance on the Certificate as a fiduciary waiver must be accompanied by extrinsic evidence of an already deteriorated relationship and loss of trust between the bargaining business partners, or whether the "mere" presence in the Certificate of disclaimers and a fiduciary waiver itself evidences the selling members' actual or constructive knowledge and acceptance of the risk that Tzolis was withholding material information concerning the value of the LLC's asset.
Professor Ribstein on last week's decision: Read here his lively take on the Pappas decision, in which he suggests among other things that neither New York nor Delaware law offers an adequate legal framework for contracting parties in such circumstances to clarify their intentions and fend for themselves in determining at what price to liquidate their ownership interests.
Failure to Define Terms in Buyout Agreements Leads to Litigation Woes
Time and again this blog has highlighted cases stemming from dysfunctional buyout agreements among partners, LLC members and close corporation shareholders in which the parties fail to define with adequate clarity the price determination process or parameters for the interest being transferred. One can't ignore the irony of agreements intended to avoid uncertainty and costly litigation, doing exactly the opposite.
Three recent cases join the ever-growing catalog of buyout agreements gone awry. Two of the cases, decided by New York courts, involve a law firm partnership agreement and a settlement agreement in an underlying shareholder derivative action. The third case, decided by the Wisconsin Supreme Court, involves a disability buyout provision in a shareholders agreement.
Costello v. Costello, Shea & Gaffney, LLP, 2010 NY Slip Op 33058(U) (Sup Ct Nassau County Oct. 22, 2010): Dispute over the term "capital interest" in law firm partnership agreement
In Costello v. Costello, Shea & Gaffney, LLP (read here), the executors of the estate of Joseph Costello sued for an accounting and payment for his capital account in a dissolved law firm. The 1993 partnership agreement included a provision dealing with the retirement or death of Mr. Costello and another senior partner. Here's the relevant portion:
Should [Costello] elect retirement, it is agreed that the partnership shall use its best efforts to pay [him] the sum of $100,000 annually, such payment to include first the return of his capital for a period up to and including December 31, 1999, and thereafter the sum of $50,000 until his demise. . . . Upon the retirement or death of [Costello], he or his estate shall surrender his entire capital interest in the firm to the firm which shall then revert to the remaining members of the executive committee for distribution to any member or members thereof in its sole discretion, without regard to any other proposition. [Emphases added.]
Costello never retired and was a member of the firm when he died in 2007, at which time his capital account exceeded $130,000. The surviving partners took the position that, under the second sentence in the above-quoted provision, Costello agreed to forfeit his capital account if he failed to retire before his death. Costello's executors argued that "capital interest" as used in the second sentence is different from "capital account," otherwise the provision for "return of his capital" in the first sentence would be rendered meaningless. They also argued that the called-for surrender of Costello's "capital interest" referred to the termination of his voting participation in the management of the firm.
The court's decision, by Nassau County Commercial Division Justice Ira B. Warshawsky, agreed with the executors that, in order to give effect to all portions of the provision, the terms "capital account" and "capital interest" must have different meanings. As Justice Warshawsky explained:
If, on retirement, [Costello] relinquished [his] interest in [his] capital account, to be distributed by the executive committee to any member or members in their sole discretion, it would be impossible to pay [him] $100,000 per year, going first to the repayment of the capital account, because [Costello] would have none.
Justice Warshawsky also notes that the agreement "is actually silent on the distribution of the capital account upon death" and that the "surrender upon death or retirement can only refer to voting rights in the operation of the law firm." He also highlights the fact that, following Costello's death, the firm paid his estate $8,250 representing the increase in Costello's capital account in the year 2007. "Defendants' treatment of the payment of the $8,250 increase for 2007," Justice Warshawsky writes, "is inconsistent with their claim that decedent's claim to his capital account terminated upon his death. If it did, he would not have been entitled to any payment from the account." The court accordingly granted summary judgment in favor of the executors on the claim to recover the balance of Costello's capital account.
Bell v. White, 2010 NY Slip Op 07648 (3d Dept Oct. 28, 2010): Dispute over application of minority discount under agreement calling for "fair market value" appraisal
Bell v. White (read here) involves not so much a drafting error or inconsistency as it does a failure to understand appraisal terminology. In 2005, plaintiff John Bell and defendant David White settled a shareholder derivative lawsuit brought by Bell as a 20% shareholder of Norpco Restaurant, Inc. and a second company. The stipulation of settlement provided that Bell and White were to each select an appraiser to assess the "fair market value" of Bell's Norpco shares and, if the appraisers failed to agree on value, a third appraiser would be selected to perform a binding appraisal. The party-selected appraisers failed to reach agreement following which the third appraiser valued Bell's shares at $150,000. Bell then went back to court to have the appraisal set aside on the ground that the appraiser improperly appraised the shares according to their fair market value (FMV), rather than fair value (FV), and erroneously applied a minority discount.
The trial court rejected Bell's argument. Bell appealed to the Appellate Division, Third Department, which likewise enforced the stipulated use of the FMV standard, writing:
With respect to Mellen's [the third appraiser] use of fair market value in appraising the shares, the stipulation plainly states that, in the event that the parties' respective appraisers are unable to agree on the "fair market value" of plaintiff's shares, they would agree upon a third appraiser to determine the "fair market value" of such shares. Indeed, Mellen explicitly stated in his report that, "[i]n accordance with the Stipulation, the applicable standard of value . . . is fair market value," and then went on to define the term pursuant to applicable regulations. Although plaintiff argues that it is "readily apparent" that the parties were contemplating a "fair value" standard since that standard is traditionally utilized in determining the value of shares of a closely-held corporation, "our sole function here is to interpret the stipulation of settlement and glean the intent of the parties from the plain language of the stipulation" (Mayefsky v Mayefsky, 184 AD2d at 955). As the stipulation unambiguously calls for a determination of the fair market value of plaintiff's shares, plaintiff's contrary interpretation of the parties' intent must be rejected.
As I've written before (see here and here), under New York case law the main difference between FMV and FV is the latter's exclusion of any discount for lack of control a/k/a minority discount. The decision in Bell does not indicate the size of the minority discount applied by the third appraiser, but generally such discounts can range up to thirty or forty percent. The cases cited by Bell on his appeal all arose in the context of dissenting shareholder or oppressed shareholder buyouts under the Business Corporation Law in which the governing statutes expressly require use of the FV standard rather than FMV. The appellate court found these cases inapplicable based on the stipulated use of the FMV standard. It also rejected Bell's attack on the appraiser's use of a minority discount based on Norpco's preincorporation agreement requiring unanimous shareholder approval for all corporate decisions. While this feature gave Bell "some level of control, i.e., the ability to veto important corporate decisions," the court explained, "a minority shareholder under these circumstances nonetheless still lacks the power to unilaterally direct and compel corporate activity."
Moral of the story: know the difference between FMV and FV if you use one or the other valuation standard in any form of buyout agreement.
Ehlinger v. Hauser, 2010 WI 54, 785 N.W.2d 328 (2010): Dispute over term "book value" in shareholder buyout agreement
The third case, Ehlinger v. Hauser (read here), hails from Wisconsin and involves the disability buyout provisions of a shareholders agreement between two 50-50 shareholders of a picture frame manufacturing company. The agreement specified a purchase price of the greater of $350,000 or "book value" but did not define book value or set forth any process for its determination. Ehlinger subsequently became disabled and Hauser elected to purchase his shares based on his book value calculation of approximately $430,000, which Ehlinger rejected. Ehlinger sought to have the company's books audited for the purpose of determining book value; Hauser refused. Ehlinger then sued for judicial dissolution of the company on the grounds of deadlock and also sought a declaratory judgment that the buyout agreement was unenforceable for lack of essential terms including the definition and means of determining book value.
Both parties agreed that book value is defined as "assets minus liabilities" but could not agree on how to determine which assets and liabilities should be computed in the calculation and what degree of verification was needed. Hauser argued for determination of book value based on the company's unaudited year-end financial statements. Ehlinger countered that the statements were calculated for tax purposes, did not represent the true worth of the company's assets, and were not adequately documented. The trial judge appointed a CPA as special magistrate to assess whether book value as reflected in the statements deviated from generally accepted accounting principles (GAAP), but the magistrate eventually reported his inability to validate 76% of the company's assets and 90% of its liabilities because of missing or otherwise deficient supporting records. The trial judge ruled that the term "book value" was indefinite, precluding the enforceability of the buyout agreement, and therefore granted Ehlinger's petition to dissolve the company.
Hauser appealed unsuccessfully to the intermediate appellate court, which opined that book value as used in the agreement was "ambiguous" (as opposed to indefinite) and that supporting documentation is a necessary component of a GAAP computation (read its 2008 decision here). Hauser next appealed to Wisconsin's Supreme Court, again meeting defeat. The Supreme Court ruled that it mattered not whether "book value" was indefinite or ambiguous because, even in the latter event, which would normally allow the court to hear extrinsic evidence of the parties' intent to use one or another basis for arriving at book value, the absence of supporting documentation rendered impossible the validation of book value on any basis.
I have seen many buy-sell agreements that fix purchase price based on book value. In most instances, the agreements expressly require computation in accordance with GAAP (which typically will entail substantial adjustments to the company's financial statements used for tax purposes) and/or provide for binding determination by the company's regular outside accounting firm or other designated CPA.
Sassower Case Illustrates Anew the Price of Poorly Drafted Buy-Sell Agreement
The case of Sassower v. 975 Stewart Avenue Associates, LLC is fast approaching poster-child status as an illustration of the headaches that can follow from poorly drafted valuation criteria in the buy-sell provision of a shareholders' or operating agreement.
The case involves a medical practice known as Cardiovascular Medical Associates, P.C. ("CMA"), whose seven doctors also owned the building housing the practice through a separate limited liability company named 975 Stewart Avenue Associates, LLC ("975 Stewart"). Dr. Sassower resigned from CMA in late 2007, triggering his obligation to offer his interest in 975 Stewart to the remaining doctors.
The CMA shareholders' agreement set forth an appraisal procedure for fixing the purchase price, whereby the exiting member and the company each hire an appraiser followed by an exchange of appraisal reports within 30 days. If the appraisals fall within 10% of each other, the purchase price is the average of the two; if more than 10%, the two appraisers select a third appraiser whose valuation opinion determines the price.
Nothing unusual about this arrangement. Rather, the problem is seeded in the provision's vague and inarticulate language purporting to establish either a standard or method of valuation. Specifically, the operative Section 8.5(c) of the agreement states that the two, party-appointed appraisers must use "the market value approach appraisal methodology" while further providing that the opinion of the third, neutral appraiser "shall establish the fair market value" of the offered interest.
In August 2008 the two sides exchanged appraisal reports based on an enterprise "market value" of $7.8 million (Dr. Sassower) versus $6.8 million (the company) and a purchase price for Dr. Sassower's 12.5% interest of $962,500 (Dr. Sassower) versus $850,000 (the company). Being more than 10% apart, the parties were required under Section 8.5(c) to engage a third appraiser.
Before that happened, however, the company's appraiser issued an amendment to its report stating as follows:
It is the understanding of this appraiser that there is an outstanding mortgage balance on the property in the amount of $2,668,750.00. At the request of the client, we have deducted the mortgage balance from the final value to arrive at an equity position value.
The deduction reduced the purchase price to about $512,000. (The amendment also newly applied a 20% discount, further reducing the purchase price to about $350,000, but the discount subsequently was withdrawn.)
The amendment ignited litigation which is about to enter its third year without resolution and in which, I hazard to guess, the parties are destined to incur attorney and expert fees rivaling if not surpassing the difference between their competing valuation figures.
Dr. Sassower struck first with a lawsuit seeking a declaratory judgment that the purchase price should not be reduced by the mortgage balance on the property. The company moved to dismiss the complaint based on documentary evidence, arguing that the agreement requires determination of the "equity" in the building net of the mortgage balance. In December 2008, in the first of several substantive decisions in the case, Nassau County Commercial Division Justice Ira B. Warshawsky denied the motion on the ground that the term "market value approach methodology" used in Section 8.5(c) is ambiguous. (Read decision here.)
In March 2009, the remaining doctors voted to voluntarily dissolve and liquidate 975 Stewart, which they contended mooted Dr. Sassower's buy-out. This led to a second written opinion by Justice Warshawsky in which he ordered the company to proceed with the buy-out, observing that the company "cannot opt to buy out the Plaintiff, then, when unhappy with the outcome of that decision, choose to dissolve the entity." (Read decision here.)
In that same decision, which I previously reported on here, Justice Warshawsky offered some future guidance for the unresolved valuation dispute, stating that "the sought after number is fair market value" and that the phrase "market value approach methodology"
is not an appraisal methodology, but a defined value to be arrived at by one of the three traditional appraisal approaches, namely, direct sales comparison, income capitalization, or replacement cost. For a building of the type owned by 975 Stewart, the most appropriate approach is the direct income capitalization approach, upon which both appraisers apparently relied. . . . The deduction of the outstanding mortgage on the property from the estimate of fair market value does not produce market value, but rather equity position value.
I won't say the guidance was all for naught, but based on yet another, recent decision by Justice Warshawsky, it's hard to discern any real evolution over the last year in the parties' diametrically opposed, all-or-nothing approaches.
The latest decision dated June 29, 2010 (read here) denied cross motions for summary judgment on the same, bedeviling question whether the mortgage balance must be deducted from the market value of the realty. Justice Warshawsky reframes the issue as follows, with a finishing hint of exasperation:
The Court concludes that the role of the Appraisers retained by the parties, or the Appraiser selected by the original two appraisers, is, at a starting point, to determine the market value of the subject property. This however, does not conclude their responsibility, because the Agreement calls upon them to establish the "purchase price of the Offered Interests". It appears that the question which should have been asked of the appraisers is "What would a typical buyer pay for an investment of a 12.5% interest in a building with a continuing first mortgage of what was $2,668,750 at the time of valuation?" This question has never been asked of them.
Justice Warshawsky then offers a series of observations explaining why summary judgment is inappropriate and, again, offering the parties future guidance on the path toward determination of the contractual purchase price.
First, he notes that the third appraisal was completed and that the parties agreed to accept $7.1 million as the fair market value of the realty on an unencumbered basis.
Second, he finds that the statements and deposition testimony of the doctors, offering their recollections of discussions (or lack thereof) and beliefs surrounding the mortgage deduction question, do not provide "adequate clarification to avoid the conclusion that there remains a question of fact as to what the parties intended."
Third, and perhaps most importantly, he offers a nuanced view of how an appraiser should approach the mortgage question, writing:
This may or may not involve simply deducting the mortgage principal from the estimated fair value. The value estimate may, for example, treat the mortgage interest payment as an additional expense in valuing the property under the Income Capitalization Approach, which the appraisals to date have not done. It may also consider whether or not the mortgage interest rate is above or below market, which could impact on the valuation process. This involves consideration as to whether a reasonably prudent investor would refinance so as to reduce interest payments if the existing rate is significantly above the currently available rates.
In the concluding portion of his opinion, Justice Warshawsky acknowledges the illogic of ignoring the mortgage, stating that it is "mathematically clear that distributing a proportionate share of full market value to a departing member will result in a depletion of the equity before the departure of the last members," and that this "unlikely" was the parties' intent. "But neither is it clear," he continues, "that the simplistic solution of deducting the mortgage from market value was unquestionably the intention of the parties."
I said it in my prior post on this case, and I'll say it again: the proper time to carefully consider and specify valuation parameters is when the company co-owners and their counsel sit down to draft the buy-sell provisions of the shareholders' or operating agreement. When parties fail to do so or, as in Sassower, employ confusing terminology, the temptation to adopt extreme valuation positions on both ends can take over, generating employment opportunity for lawyers and great expense to business owners.
Case Illustrates Importance of Clear Valuation Parameters in Buy-Sell Agreement Among Owners of Closely Held Business
When properly designed, buy-sell provisions in shareholders' agreements of closely held corporations, or in operating agreements of limited liability companies, can avoid disruptive and costly litigation triggered by the voluntary or involuntary dissociation of a shareholder or member. The key elements of a workable buy-sell agreement for lifetime dispositions are (1) defining the circumstances under which a shareholder or member can leave voluntarily or be forced out, (2) setting the valuation date, (3) fixing the value of, or a mechanism to value, the interest of the departing shareholder or member, and (4) setting forth the terms of payment.
Sassower v. 975 Stewart Avenue Associates, LLC, 2009 NY Slip Op 31901(U) (Sup Ct Nassau County Aug. 14, 2009), recently decided by Nassau County Commercial Division Justice Ira B. Warshawsky, illustrates the mayhem that can result when the buy-sell agreement renders uncertain the basis for valuing the departing owner's interest in the entity.
Cardiologist Michael Sassower was one of seven physician-shareholders of a Long Island cardiology practice organized as a professional corporation. He and his fellow shareholders also were members of a real estate holding company called 975 Stewart Avenue Associates, LLC (the "Company") that owned the premises housing the medical practice. In December 2007, Sassower gave six-months notice of his resignation from the medical practice. The Company's operating agreement provided that, upon his departure from the practice, Sassower was required to offer his 12.5% membership interest to the Company and the other members. Section 8.5(c) of the operating agreement described the following process to determine the price to be paid for his interest:
The Company and the Offering Member/New Member shall have ten (10) days to appoint a Qualified Appraiser. Upon appointment, both Qualified Appraisers shall each establish the purchase price of the Offered Interests, using the market value approach appraisal methodology, in a written opinion to the Company each such opinion to be delivered within thirty (30) days of the appointment of the latter of appraisers. If the difference between the two (2) appraisals is less than ten (10%) percent, then the valuation of the Offered Interests shall be the average of the appraisals. However, if the difference between the two (2) appraisals is more than ten (10%) percent, then the Qualified Appraisers shall mutually appoint a third Qualified Appraiser whose sole written opinion shall establish the fair market value of the Offered Interests. [Emphasis added.]
The Company and Sassower each retained an appraiser. The Company's appraiser valued Sassower's 12.5% interest at $850,000 versus Sassower's appraiser's valuation of $962,500 based on "market values" of $6.8 million and $7.8 million, respectively, for the entirety. The difference being more than 10%, the parties were required by Section 8.5(c) to secure a third, decisive appraisal.
The appraisals were exchanged in August 2008. Things started to go haywire when the Company sent Sassower an amendment to its appraiser's report, noting that the Company's property carried an outstanding mortgage balance of approximately $2.7 million and stating that, "at the request of the client [i.e., the Company]," it was reducing the value of the Company's equity by the amount of the mortgage, to a little over $4.1 million, which reduced the value of Sassower's 12.5% interest to about $350,000.
Sassower commenced a lawsuit the following month, seeking a declaration that the mortgage balance should not be deducted from the appraised market value in determining the price for his interest. Justice Warshawsky denied the Company's initial pre-answer motion to dismiss the complaint in a Short Form Order dated December 3, 2008, finding that the meaning of "market value approach methodology" as used in Section 8.5(c) was "not clear on its face" and could not be determined without further proceedings.
A month later, in January 2009, the Company's counsel wrote to the court contending that both appraisers had erroneously failed to deduct from their estimate of value the principal balance of the existing mortgage. The Company further contended that both appraisers had used overstated figures for the property's net operating income, and that utilizing the actual figures based on the existing net lease held by the medical practice would bring the two appraisals within 10% of each other and therefore obviate the third appraisal.
Two months after that, in March 2009, the remaining members of the Company voted to dissolve and liquidate the Company voluntarily, by virtue of which they sought anew to dismiss as moot Sassower's complaint to enforce the buy-out. Sassower countered with his own motion to enforce a September 2008 stipulation whereby the two sides had agreed to go forward with the third appraisal.
Justice Warshawsky's decision earlier this month denied the Company's motion to dismiss and granted Sassower's motion to enforce the stipulation. As to the former, the operating agreement specified that the remaining members' right to elect to dissolve in lieu of purchasing the departing member's interest was time-limited by the operating agreement's express terms. The purported voluntary dissolution in March 2009 therefore was too late, particularly given the remaining members' interim election to purchase and the exchange of appraisals. "In the opinion of the Court," Justice Warshawsky commented pointedly, "the Defendant cannot opt to buy out the Plaintiff, then, when unhappy with the outcome of that decision, choose to dissolve the entity."
The court's decision to enforce the stipulation also appears to provide some guidance for the third appraiser as to the underlying valuation dispute. Justice Warshawsky notes that, while the language in the operating agreement "is less than crystal clear," in his opinion "the sought after number is fair market value." The phrase "market value approach methodology," he concludes,
is not an appraisal methodology, but a defined value to be arrived at by one of the three traditional appraisal approaches, namely, direct sales comparison, income capitalization, or replacement cost. For a building of the type owned by 975 Stewart, the most appropriate approach is the direct income capitalization approach, upon which both appraisers apparently relied. . . . The deduction of the outstanding mortgage on the property from the estimate of fair market value does not produce market value, but rather equity position value.
It appears that in applying the income capitalization approach, both party-retained appraisers constructed a market rate rather than using the existing net lease between the Company and the medical practice -- presumably at a below-market rate -- prompting Justice Warshawsky to observe:
It would be inappropriate to rely upon this lease to determine market value. There is a good practical reason for not considering it. Certainly, if CMA decided to relocate and sell the property to a third party, they would sell free and clear of the existing lease and the arm's length purchaser would be free to impose market rent on his prospective tenants.
I frequently see buy-sell provisions in shareholder and operating agreements that leave it entirely to the appraisers how to arrive at their appraisal. I also see many agreements containing very specific appraisal parameters, e.g., dictating use of book value, specifically excluding or including good will or other identified assets and liabilities, and specifically including or excluding minority and marketability discounts. Counsel drafting such agreements must carefully consider the nature of the business, its tangible and intangible assets, and its actual and potential liabilities. Better yet, counsel not adequately familiar with appraisal methodology should consult with the company's outside accountant or a business appraiser before the agreement is signed.
It's impossible to know from the language used in Sassower whether the drafter and/or the doctors who signed the agreement thought the words "market value" meant the sale value of the unencumbered real estate less the mortgage balance, or, as Justice Warshawsky construed it, an income-based valuation. What's clear is that the ambiguous buy-sell provision in Sassower failed its essential purpose to provide a certain, speedy and litigation-free procedure for valuing a departing member's interest.
Court Grants Specific Performance of LLC Members' Buy-Sell Agreement
On its surface, the case of Berle v. Buckley discussed below is about routine contract law, the question being whether an exchange of letters between two parties constituted a binding agreement or merely an unenforceable expression of intent. What makes it compelling reading is its wrenching setting -- the breakup of a family as well as a business -- and the undeniable, unpredictable human element at play as the two parties, one with a lawyer and the other without, made important decisions with known or unknown legal consequences in a tightly compressed time frame.
The Facts:
Beatrice Berle and Abdon Buckley never married, but for 13 years they lived and worked together on a 500-acre farm in upstate New York, producing organic goat cheese, straw and hay. They also produced two children. At some point, things went wrong for Berle and Buckley, very wrong. Berle accused Buckley of physical, sexual, verbal and mental abuse. In 2007, Berle petitioned the court for sole custody of the children and obtained a protective order banning Buckley from entering the farm property.
The farm business was owned through a limited liability company called Berle Farm, LLC, of which Berle held a two-thirds membership interest and Buckley held the other third. Wishing to sever her business ties with Buckley, Berle forwarded to him a letter addressed to her from her own lawyer, dated September 10, 2007 (the "September 10 Offer"), outlining how Buckley's interest could be purchased by Berle as well as the procedures for judicial dissolution of the LLC if Buckley refused to sell. The September 10 Offer proposed to purchase Buckley's interest for $268,666 based on the appraised value of the farm plus the fair market value of the LLC's assets and other equipment, net of a loan balance due Berle. It also proposed a lump sum payment subject to specified terms and conditions including a requirement that Buckley not enter into any farming operation or reside within 20 miles of the farm.
Buckley didn't have a lawyer. On September 12, 2007, Buckley and Berle's lawyer had a telephone conversation which the lawyer then confirmed in a letter sent by fax the same day to Buckley, advising him to retain counsel; confirming Buckley's agreement to the terms of the September 10 Offer except that Buckley wanted to farm and/or reside on family property in Cambridge, NY; advising Buckley that his latter proposal was acceptable if all other terms of Berle's offer were acceptable to Buckley; and informing Buckley that the purchase price needed to be adjusted to reflect Buckley's removal of "several thousand dollars of cash from the safe located at the Berle Farm property". The letter closes by requesting Buckley to "signify his consent to the foregoing terms by signing this letter in the space below" and returning it before the close of business on September 13, 2007, and that, otherwise, Berle will "commence legal proceedings for the dissolution of Berle Farm, LLC".
Buckley did not countersign the letter. Instead, on September 13, 2007, Buckley prepared and sent Berle's lawyer a form of agreement (the "Buy-Sell Agreement") bearing Buckley's notarized signature. The Buy-Sell Agreement reiterated much of the September 10 Offer including the purchase price and timing of the payment. It also reflected certain modifications including Buckley's agreement to reduce the purchase price by $1,100 for the cash he removed from the safe, and a proviso allowing him to farm and/or reside on his family property. The Buy-Sell Agreement closed by stating that Buckley "believes this agreement is a faithful representation of all matters formerly addressed, and affixes his signature below to affirm his acceptance of this agreement". Buckley's cover letter to Berle's lawyer stated:
In an attempt to meet the deadline specified by your office in your fax of September 12, 2007, I am preparing an agreement to sign and fax. This agreement I believe will meet your original specifications, with the inclusion of the additional information addressed in the faxes. They are indicated by [numbered] notes on page 3 of this agreement. I appreciate your reiterated advice to acquire legal representation, and have been working towards that end, but have been unsuccessful within the stated time constraints.
After receiving the Buy-Sell Agreement, on September 14, 2007, Berle's lawyer wrote to Buckley as follows:
I have received your memorandum of September 12 and your letter of yesterday and since it appears that, subject to confirming with Ms. Berle the amount of cash taken from the Berle Farm safe, there is general agreement regarding the terms of the purchase of your interest in Berle Farms, LLC, we are turning our attention to the drafting of a formal agreement which will contain the typical provisions regarding the purchase as well as the specific provisions that have been addressed in our communications. I expect that I will be able to send you the draft agreement for review next week. It would certainly be beneficial for you to retain counsel to review the contract.
Berle's lawyer subsequently prepared and sent to Buckley a proposed final Membership Interest Purchase Agreement ("MIPA"). At this point, Buckley retained a lawyer to review the MIPA. The lawyer advised Buckley not to sign the MIPA without further modifications which the lawyer then tried to negotiate with Berle's lawyer. The negotiations proved unsuccessful.
The Claims:
On December 7, 2007, Berle petitioned the Supreme Court, Rensselaer County, for an order granting her specific performance of the Buy-Sell Agreement and compelling Buckley to transfer his one-third membership interest in the LLC. Alternatively, Berle sought an order dissolving the LLC pursuant to Section 702 of the LLC Law. Buckley cross-petitioned for an order of dissolution, the appointment of a liquidating receiver and an accounting.
Buckley contended that Berle's claims of abuse were fabricated as part of an effort to force him out of the LLC. Berle countered with a non-party affidavit stating that she witnessed the bruising on Berle's body resulting from Buckley's abuse. Buckley argued that he never intended the Buy-Sell Agreement to be a final and complete contract; that he merely expressed his interest in Berle's proposal and his willingness to engage in continued negotiations relative to her buyout offer; that he did not have sufficient time to consult with an attorney prior to Berle's deadline; and that he did not understand how the threatened judicial dissolution of the LLC would affect his interest. Berle argued that the Buy-Sell Agreement constituted a binding acceptance of her offers embodied in her attorney's September 10 Offer and September 12 letter.
The Decision:
The task fell to Supreme Court Justice Richard M. Platkin to determine whether the parties' dealings coalesced into a binding agreement, or were simply a non-binding agreement to agree. Read his decision here.
His legal analysis begins with a summary of the governing principles. First, the existence of a binding contract does not turn on the parties' subjective intent but, rather, on the objective manifestations of the parties' intent as expressed in their words and deeds which are to be viewed in their totality. Second, where it is clear that parties intended to bind themselves to future performance, the fact that some terms may be left open does not necessarily render the agreement unenforceable.
Applying these principles, Justice Platkin concludes that Buckley entered into a binding contract to sell his one-third membership interest in the LLC to Berle for $267,566, subject to the other terms in the Buy-Sell Agreement. Justice Platkin notes that Buckley did not dispute that the September 10 Offer and September 12 letter from Berle's lawyer constituted a valid offer. Justice Platkin then addresses as follows the decisive issue, whether Buckley's Buy-Sell Agreement constitutes an acceptance of Berle's offer:
The issue then becomes whether defendant's transmittal of the Buy-Sell Agreement to plaintiff's counsel constituted an acceptance of the offer. The Court concludes that it does. The Buy-Sell Agreement, signed by defendant in the presence of a notary, recites the essential terms of the transaction, including the amount to be paid to defendant for his one-third membership interest and the timing of such payment. It also addresses the two minor issues left outstanding following transmittal of the September 12 letter: (1) the precise amount by which the purchase price must be reduced to reflect defendant's removal of cash from the LLC's safe; and (2) the exact location of the family property upon which defendant seeks to farm and/or reside. Indeed, the Buy-Sell Agreement prepared by defendant contains an express acknowledgment that it represents a written memorialization of the parties' meeting of the minds: defendant acknowledges that such "agreement is a faithful representation of all matters formerly addressed, and affixes his signature below to affirm his acceptance of this agreement."
Buckley, the judge further comments, "prepared and transmitted the Buy-Sell Agreement to accept [Berle's] buy-out proposal prior to the deadline for the purpose of avoiding litigation". As to the September 14 letter from Berle's lawyer, advising Buckley that he would be sending him a formal agreement and recommending that Buckley engage counsel to review it, Justice Platkin finds no inconsistency with the existence of a binding agreement. Here's what he wrote:
The fact that the parties' written agreement on the essential terms of the buy-out transaction were subject to the preparation of a definitive "formal agreement" that would include "typical provisions" regarding the purchase of an LLC membership interest (in addition to the specific terms negotiated by defendant and plaintiff's counsel) did not "leave the transaction incomplete and without binding force in the absence of a positive agreement that it should not be binding until so reduced to writing and formally executed" (Municipal Consultants & Publs., Inc. v. Town of Ramapo, 47 NY2d 144, 149 [1979]).
This last point perhaps is the most important take-away from this case for anyone involved in contract negotiations, be they lawyer or layperson. If you want to ensure that the writings being exchanged are a non-binding expression of intent, then say so. All it takes is one sentence at the bottom of the term sheet or in a cover letter, something like, "It is understood that this is not a binding agreement and that the obligations and rights of the parties shall be set forth in the definitive agreement to be executed by the parties". In this case, it seemed pretty clear that Buckley took seriously and therefore sought to allay Berle's lawyer's threat of a dissolution proceeding by giving him written assurance that he intended to be bound by his agreement. By then, it was too late to bring in counsel to re-negotiate the deal.
The Aftermath:
Subsequent proceedings in Berle also offer a little something for civil procedure buffs. Buckley filed a notice of appeal from the order which required him formally to transfer his membership interest to Berle within 30 days. In an attempt to stay enforcement of the lower court's order pending his appeal, Buckley filed with the County Clerk a Bill of Sale and Assignment of his membership interest along with an Affidavit of Lost Membership Certificate. Buckley then refused to proceed with the transfer, asserting that the filings entitled him to an automatic stay of enforcement under Section 5519(a)(5) of the Civil Procedure Law and Rules (CPLR). Under that provision, the lower court's order automatically is stayed upon filing a notice of appeal where "the judgment or order directs the execution of any instrument, and the instrument is executed and deposited in the office where the original judgment or order is entered to abide the direction of the court to which the appeal is taken". Berle disagreed and asked the court to hold Buckley in contempt of court.
Justice Platkin didn't hold Buckley in contempt, but he also didn't agree that Buckley was entitled to an automatic stay, and he gave him an additional two weeks to transfer his interest (read decision here). The judge held that subsection (a)(4) of CPLR 5519 also applies, and that Buckley had not complied with it. The automatic stay under (a)(4) applies where "the judgment or order directs the assignment or delivery of personal property and the property is placed in the custody of an officer designated by the court of original instance to abide the direction of the court to which the appeal is taken . . .." In this case, ruled Justice Platkin, Buckley's membership interest constitutes personal property (see Section 601 of the LLC Law), and the court's order "implicitly required the parties to execute a written instrument binding them to the negotiated terms and conditions of the Buy-Sell Agreement, to which such transfer was subject". Buckley's bare Bill of Sale and Assignment did not do the trick.
UPDATE (12/29/08): Buckley appealed the order granting specific performance. In a decision dated December 24, 2008, the Appellate Division, Third Department, reversed the lower court's order on the purely procedural ground that the lower court had acted prematurely in making a summary determination of the issue. Although the lower court could have made a summary determination regarding dissolution, the claim for specific performance was not part of the dissolution relief. The case therefore goes back down to the lower court for further proceedings.
