I’m always disappointed by appellate opinions that decide novel or unsettled issues in business divorce cases with little or no analysis. It seems like a lost opportunity to provide guidance in future cases. The Appellate Division, Second Department’s opinion last week in PFT Technology, LLC v Wieser, 2020 NY Slip Op 01942 [2d Dept Mar. 18, 2020], is one of those.
PFT is a case I’ve previously featured on this blog three times over it’s eight-year life span, addressing Nassau County Commercial Division Justice Stephen A. Bucaria’s novel rulings in an LLC dissolution case:
- ordering the LLC to advance all parties’ legal fees to “level the playing field” (read here);
- fixing the valuation date for a buyout of the defendant 25% member’s interest on the day before the LLC filed suit in July 2012 (read here); and
- rejecting the LLC’s subsequent request to withdraw its dissolution claim in connection with its unsuccessful bid to enjoin the minority member from operating a competing business (read here).
The trial of the case yielded rulings on a number of important issues concerning fair value appraisals generally, one of which was the subject of my recent article entitled Post-Valuation Date Distributions: Should They Be Credited Against Fair Value Awards? The article summarized the few and arguably conflicting lower court cases addressing whether an award to the exiting shareholder of his or her pro rata share of post-valuation date distributions made during the proceeding’s pendency, i.e., prior to consummation of the buyout, constitutes “double dipping.”
Having already written extensively on the case background and the court’s pretrial rulings in my prior posts, I won’t do it again here. If you’re not inclined to read the prior posts, what you need to know is:
- The subject LLC, in the business of detecting gas and fluid leaks in power networks for public utilities, had four 25% members.
- In 2011, either three of the members froze out the fourth or the fourth “abandoned” the business, depending which side’s story you accept.
- In 2012, the three members brought suit in the name and right of the LLC asserting claims against the fourth and also seeking the LLC’s dissolution or “reconstitution” without the fourth.
- The fourth counter-sued for a buyout of his 25% interest.
- Notwithstanding the absence of any buyout authorization in the LLC Law’s provisions governing judicial dissolution, the court ordered a fair value appraisal and “equitable” buyout of the fourth’s interest, apparently without objection by the other three members.
One other tidbit for those who don’t read the prior posts: If you’re wondering why the LLC’s three members holding an aggregate 75% membership interest had to seek judicial dissolution as opposed to dissolving voluntarily, the answer lies in the LLC’s operating agreement which required a super-majority in excess of 75%, i.e., unanimity, to dissolve voluntarily.
Justice Bucaria’s Post-Trial Decision
In September 2016, Justice Bucaria conducted a bench trial of all remaining issues including valuation of the minority member Robert Wieser’s interest. Justice Bucaria’s November 2016 post-trial decision (read here) recounted the case background and procedural history before making the following rulings:
- The court rejected Wieser’s claim, based on his continued membership in the LLC throughout the litigation, for his pro rata share of the LLC’s distributions made after the July 2012 valuation date. Wieser calculated his share of those distributions at over $3.25 million. As Justice Bucaria wrote, “To grant Wieser a buy out as of July 2012, and his share of income distributions for subsequent years, would result in ‘double dipping'” regardless whether “he abandoned PFT or was forced out by the other members in 2011.”
- Justice Bucaria valued Wieser’s 25% interest at $1.25 million based on a company valuation of $5 million, the latter figure being roughly halfway between Wieser’s expert’s $5.95 million valuation and the company’s expert’s $4 million valuation. The decision noted that the company’s expert applied a 25% discount for lack of marketability (DLOM) and a 10% company specific risk premium based on customer concentration, whereas Wieser’s expert applied no DLOM but did account for “the risk factor through size and industry premiums.”
- In arriving at his $5 million valuation, Justice Bucaria took into account, on the one hand, that “the risk factor is relatively slight” because “despite its limited customer base, business seems likely to continue” and, on the other hand, “the decreased profitability of the company after dissension ensued and Wieser left the business.”
- The $1.25 million valuation, the court wrote, also took into consideration “all of the parties’ various claims, including unpaid distributions and reimbursement for attorney’s fees,” adding that the $250,000 previously granted to Wieser for legal fees advanced by the LLC “was generally in proportion to plaintiff’s legal fees, given the members’ respective equity interests in the company.”
- The court awarded Wieser pre-judgment interest on the valuation award from July 2012 at the rate of 5% “in view of the [LLC’s] delay in prosecuting this case.”
Each side appealed from different aspects of Justice Bucaria’s post-trial decision and its implementing judgment:
- Wieser, from the court’s $1.25 million valuation of his interest, its denial of additional attorney’s fees, and from the Court’s July 2012 valuation date and denial of Wieser’s share of post-valuation date income distributions;
- the LLC, from the court’s failure to award it a credit for damages allegedly arising from a pretrial order of attachment and from the award of prejudgment interest.
The Second Department’s decision last week, affirming and modifying the judgment in part “on the law, on the facts, and in the exercise of discretion,” represents a mixed outcome for both sides.
Valuation Date. The appellate court affirmed Justice Bucaria’s exercise of discretion in fixing a July 2012 valuation date, writing:
The court should set the valuation date for the minority member’s interest by reference to the equities of the case (see Matter of Superior Vending, LLC [Tal—Plotkin], 71 AD3d at 1154). Under the circumstances of this case, the record supports the court’s conclusion that the most equitable method of resolving the dispute among the principals of PFT was to permit the majority members to buy out Wieser’s interest and to set the valuation date for that interest as July 9, 2012—the day prior to the commencement of the action (see generally Matter of Superior Vending, LLC [Tal—Plotkin], 71 AD3d at 1154).
“Double Dipping.” The opinion references Justice Bucaria’s pretrial determination denying Wieser “unpaid distributions after the valuation date, stating that such would constitute ‘double dipping.'” The court agreed without further analysis, simply stating that, “contrary to Wieser’s contention, the court properly determined that he was not entitled to recover damages related to unpaid distributions made after the valuation date.”
Valuation. The appellate court’s remaining rulings made up a bit of the ground lost by Wieser on the post-valuation date distributions calculated by him over $3.25 million, starting with its conclusion that the lower court “erred in applying certain adjustments to reduce the value of PFT as calculated by Wieser’s expert.” Without further analysis, the court adopted PFT’s expert’s $5.95 million company valuation, stating that it “comports with the evidence in the record” and that Wieser’s proportionate share of PFT accordingly “should have been valued at $1,489,000, rather than at $1,250,000 found by the court.”
Attorney’s Fees. Next, the appellate ruling sided with Wieser on his claim for about $1.5 million additional legal fees under the indemnification provision in Section 7.02(b) of PFT’s operating agreement, writing:
We agree with Wieser that the Supreme Court improvidently exercised its discretion in declining to award him additional attorney’s fees pursuant to his counterclaim for contractual indemnification. Rather, the record, including the language of the operating agreement and the billing records submitted by Wieser’s counsel, established that Wieser was entitled to recover all of the reasonable attorney’s fees he incurred in connection with this action, totaling $1,758,318, less the $250,000 that he had already been awarded for that purpose, for a net total sum of $1,508,318, without interest.
Prejudgment Interest. Finally, Wieser also prevailed on the issue of prejudgment interest. The appellate court shed little light on the subject in finding that the lower court “providently exercised its discretion in imposing prejudgment interest at the rate of five percent per annum on the award for Wieser’s interest in PFT, as there was evidence in the record to support the court’s finding of delay in the prosecution of the action.”
I Wish the Court Had Said More
The appeal in PFT presented an opportunity for the Second Department to address several unsettled questions in valuation cases:
- Is it always impermissible “double dipping” to award post-valuation date distributions to the owner whose interest is being bought out, or just some of the time as some lower court decisions suggest? I wish the court had said more.
- Why was the 10% company specific risk premium disallowed in valuing a small company with the large majority of its sales concentrated in two customers? Was it because the record included evidence of significant sales growth in the post-valuation date years and, if so, was there evidence that such growth was known or reasonably knowable as of the valuation date? I wish the court had said more.
- Why was DLOM treated as an impermissible adjustment? There are only a handful of fair value appraisal decisions in New York in which courts have not applied DLOM. What made this case out of the ordinary? From my cursory look at some of the expert testimony in the trial transcript, it appears that both sides approached the application of DLOM purely as a legal issue based on court precedent — an approach frowned upon by the IRS in its DLOM Job Aid. I wish the court had said more.
- The LLC’s initial suit against Wieser included claims against him personally that plausibly triggered his right to indemnification and advancement under the operating agreement. Did that right include Wieser’s litigation expenses even after the case pivoted to a fair value appraisal, to the tune of $1.75 million? I wish the court had said more.
- An award of prejudgment interest is statutorily authorized in fair value appraisals for buyouts of oppressed minority shareholders and for dissenters in cash out mergers. There is no buyout statute in LLC dissolution cases. There’s a general provision for prejudgment interest in certain cases, including for equitable claims, in the Civil Practice Law and Rules, but that carries with it a statutory interest rate of 9%. Where did the 5% come from? I wish the court had said more.