Who knew Quick Draw would turn into Slo-Mo?
Regular readers of this blog may remember the Quick Draw (as I dubbed it) buy-sell agreement in the Mintz v Pazer case decided by Brooklyn Commercial Division Justice David Schmidt. The provision at issue — found in a shareholders’ agreement between two, 50/50 factions of a family owned business whose sole asset is a shopping center allegedly worth over $50 million — authorized either faction to give the other an irrevocable purchase notice within 10 days after the failure to resolve deadlock, with the purchase price to be determined by a subsequent multiple-appraiser process. Litigation erupted after each of the Mintz and Pazer factions sent the other a purchase notice within the 10-day period. Justice Schmidt eventually declared the Mintz faction the purchaser because its notice preceded the Pazer faction’s notice by several days.
The dueling purchase notices were given in September 2012. Justice Schmidt declared the Mintz faction the purchaser in December 2013. It’s now sixteen months later and still no sale has occurred while the two factions continue to battle it out in court. What went wrong?
Naturally the two sides offer different answers. The Mintz faction chiefly contends that the shopping center appraisals cannot be completed pending environmental testing, sign offs by the regulatory agencies, and remediation of contamination from a former tenant’s dry cleaning business. The Pazer faction contends that the appraisals needn’t be delayed and accuse the Mintzes of using the environmental issue to stall the purchase until the shopping center’s mortgage comes due in April 2015 to avoid a $1.5 million penalty if they have to pre-pay the mortgage to finance the purchase.
If you ask me, the root cause of the problem is the absence of a fixed valuation date in the buy-sell agreement.
The appraisal impasse resulted in a flurry of motions and a pair of recent decisions by Justice Schmidt designed to put the purchase back on track. In a decision last November (read here), Justice Schmidt agreed with the Pazer faction that the required appraisals need not await quantification of the costs of the environmental remediation required by the regulatory authorities. Then, in a decision last February (read here), Justice Schmidt ruled that the valuation date is to be contemporaneous with the date on which the parties exchange their appraisals.
The November 2014 Decision
In the first of the two decisions, Justice Schmidt found that the “unambiguous terms” of the Shareholders’ Agreement mandated that the appraisers determine fair market value based on the liquidation value of the company’s assets (“as if its assets were being sold on the open market”) less all liabilities, without any discounts for lack of control or marketability. Under the fair market value standard, he continued, “the assessor may consider whether the factor of environmental contamination would depress the Shopping Center’s value and whether a buyer of the property on the open market would have demanded an abatement in the purchase price to account for the contamination.”
Justice Schmidt rejected the Mintz faction’s contention, that the mandated asset value appraisal requires a final determination of the shopping center’s environmental liabilities, explaining as follows:
While the Mintzes contend that since the purchase price must be determined “less all of [the Company’s] liabilities” and after payment of all liabilities, they must await a final determination of any liability for remediation before an appraiser can determine the purchase price, this contention is devoid of merit. The potential of future liability based upon potential contamination is not a present liability of the Company which is due and payable, but rather it is merely “contingent, possible and in futuro” (Matter of Northville Indus. Corp. v State of New York, 14 AD3d 817,818 [3d Dept 2005]).
“[U]ncertainty concerning future events should not bar attempts to assign value to an asset” (Burns v Burns, 84 NY2d 369, 375 ). The potential environmental contamination is simply one of the factors, along with other factors such as the rent roll, the state of the real estate market, and comparable sales and rentals, that the appraisers must consider in determining the appropriate value of the Company. An appraiser may make an appropriate adjustment to account for any risk of a negative effect on market value based upon the possibility of a diminution in value of the property at issue by reason of the need for future claimed cleanup and remediation costs. Rendering such an appraisal now, rather than waiting an indefinite time period for a future determination by governmental regulators regarding the possibility of required remediation and any potential liability for cleanup costs, comports with precedent, appraisal practices and common sense. [Footnote omitted.]
The February 2015 Decision
The November 2014 Decision left unresolved the critical question of the valuation date. The Mintz faction relied on an email exchange between counsel in November 2012 agreeing to a valuation date of October 31, 2012. The Pazer faction acknowledged the prior agreement but argued that it had been severely prejudiced by the subsequent delay and that the court should align the valuation date with the exchange date of the appraisals.
Justice Schmidt again sided with the Pazer faction, finding that “[a]t the time that the October 31, 2012 valuation date was set, the parties contemplated that the exchange of appraisals would occur at a time contemporaneous with that date” which also preceded by more than a year the court’s determination of the dispute over the dueling purchase notices. As Justice Schmidt further explained:
Here, upon reading the Shareholders’ Agreement as a whole, and giving practical interpretation to the language employed and the parties’ reasonable expectations, the court finds that it requires that a current valuation be used. In this regard, it is noted that the parties acknowledged, in sections 4.8 and 8.2 of the Shareholders’ Agreement, that the Company cannot effectively function in the event of a deadlock. Significantly, the Shareholders’ Agreement set forth short time frames regarding the purchase of shares in section 8.2, as well as a time is of the essence provision in section 11.12, which indicate an intent to expeditiously move forward with an appraisal and sale. Indeed, the very purpose of the Shareholders’ Agreement was to avoid a lengthy dissolution process. The use of the October 31, 2012 valuation date, as urged by the Mintzes, would vitiate the Shareholders’ Agreement, whereas setting the valuation date for a time reasonably contemporaneous with the exchange date, as sought by Shelley, is consistent with the purpose of the Shareholders’ Agreement and ensures that the purchase price reflects the fair market value of the Company.
. . . In any event, the fact remains that there has been a substantial delay from the time of the November 2012 e-mails, resulting in a misalignment of over two years between the October 31, 2012 valuation date and the exchange date which shall now take place. Such misalignment would result in a skewed and inaccurate approximation of the fair market value when the Company shares are actually sold in contravention of the language and intent of the Shareholders’ Agreement.
Justice Schmidt’s decision accordingly ordered that the valuation date “shall be the date of this decision and order, and the exchange of appraisals shall proceed, in accordance with the provisions of the Shareholders’ Agreement, 10 days after notice of entry of this decision and order.”
Important to Include Valuation Date in Buy-Sell Agreement
Chris Mercer, one of the leading experts on buy-sell agreements, writes this about the valuation date, which he identifies as one of six defining valuation elements of a process-based buy-sell agreement:
Every appraisal is grounded at a point in time. That time, referred to as the “valuation date” or “effective date” or the “as of” date, provides the perspective, whether current or historical, from which the appraisal is prepared. Unfortunately, some buy-sell agreements are not clear about the date as of which the valuation(s) should be determined by appraisers. This can be extremely important, particularly in corporate partnerships and joint ventures when trigger events establish the valuation date. Because value changes over time, it is essential that the “as of” date be specified.
As Chris notes, the passage of time can be a friend or an enemy to parties involved in a buy-out where the price depends on a contractually agreed appraisal process. Perceived rising or falling market values for company assets, or changes in the firm’s profitability outlook, create incentives and disincentives to complete the appraisal and sale process in a timely manner. Financing and liability concerns likewise can influence the process for the better or worse when there’s uncertainty surrounding the valuation date.
The buy-sell provision in the Mintz-Pazer Shareholders’ Agreement laid out an appraisal process to follow a deadlock-triggered purchase notice, and even included a general time-of-the-essence clause, but it did not fix a valuation date binding upon the appraisers. Had it done so, there’s a good chance the buy-out transaction would have proceeded with far less contentiousness and delay.
Update July 27, 2017: The Appellate Division, Second Department, yesterday issued a decision on Mintz’s appeal in which it agreed with Justice Schmidt’s February 2015 ruling and analysis setting the valuation date as contemporaneous with the exchange of appraisal reports (read here).