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.
