A general principle of business valuation is that courts may consider “known or knowable” events as of the “valuation date” – the date as of which the court values the entity – but not post-valuation date events or financial performance.
In Matter of Murphy v U.S. Dredging Corp. (74 AD3d 815 [2d Dept 2010]), a valuation proceeding resulting from a judicial-dissolution-provoked buyout election under Section 1118 of the Business Corporation Law (the “BCL”), the Court reversed a trial court for considering a multi-million-dollar pension liability substantially diminishing the entity’s value because the liability arose shortly after the valuation date, even though the liability was contemplated pre-valuation date.
The Murphy Court wrote, “Contrary to the Corporation’s contention, notwithstanding that the pension obligation . . . was discussed prior to the valuation date, it did not constitute a future event which was known or susceptible of proof as of the valuation date” (id. [quotations omitted]).
In Miller Bros. Indus., Inc. v Lazy Riv. Inv. Co. (272 AD2d 166 [1st Dept 2000]), a valuation proceeding under BCL § 623 resulting from a merger from which shareholders dissented, the Court affirmed a trial court’s rejection of the shareholders’ attempt to rely upon the entity’s actual financial performance in the immediate aftermath of the valuation date.
The Miller Court wrote, “We reject the dissenting shareholders’ argument that investment value as of the valuation date may be computed retrospectively based on the corporation’s reported actual earnings for the fiscal year ending eleven months after the valuation date, since fair value may include elements of future value only if known or susceptible of proof as of the date of the merger” (id. [quotations omitted]).
Notwithstanding these authorities, litigants hoping to either increase or decrease an entity’s valuation often ask courts to consider post-valuation date events or financial performance as affirmatory or disaffirmatory of financial projections or assumptions made before or as of the valuation date. And sometimes, litigants succeed in that endeavor.
Earlier this month, the same court which in Murphy forbade courts from considering post-valuation date events in BCL § 1118 appraisal proceedings issued Magarik v Kraus USA, Inc. (___ AD3d ___, 2024 NY Slip Op 04964 [2d Dept Oct. 9, 2024]).
In Magarik, contrarily to Murphy, the Court rejected a dissenting shareholder’s challenge to a trial court’s consideration of the corporation’s actual financial performance post-valuation date as a basis to completely reject his expert’s would-be reliance upon pre-valuation date financial projections prepared by the entity itself and submitted to a lender as part of a $10 million loan application.
The Dissolution Proceeding and the Buyout Election
Magarik started as business valuations proceedings often do — with a petition for judicial dissolution under BCL § 1104-a. Sergio Magarik (“Magarik”) alleged that he owned 24% of the stock of the well-known, high-end kitchen and bathroom fixture company, Kraus USA Inc. (“Kraus”). According to Magarik, his two co-shareholders, Michael Rukhlin (“Rukhlin”) and Russell Levi (“Levi”), diverted assets to other companies and engaged in a scheme to “devalue” Magarik’s equity by saddling the company with millions of dollars of debt. Ironically, Kraus’s application for one of those debts became the cornerstone of Magarik’s appraisal case.
At the start, Magarik alleged a mix of claims for judicial dissolution and money damages, but after his co-shareholders exercised a BCL § 1118 buyout election, Magarik withdrew his damages claims, proceeding to trial solely on valuation.
The Hearing and Post-Trial Submissions
After a seven-day hearing before Nassau County Commercial Division Justice Vito M. DeStefano, each side submitted a post-trial memorandum of law and proposed findings of fact and conclusions of law. You can read Magarik’s here and here and read Rukhlin and Levi’s here and here.
Magarik and his expert, Randall Paulikens, asked the Court to disregard the company’s “historical numbers,” and to rely instead upon “management projections” Kraus’s chief financial officer prepared and submitted to a lender less than four months before the valuation date, projecting rapid growth and valuing the company at slightly more than $30 million.
Predominantly based upon the projections Kraus submitted to its lender, Magarik and his expert asked the Court to award Magarik $7.2 million for his 24% stake with no discount for lack of marketability (“DLOM”).
Rukhlin, Levi, and their expert, Paul Marquez, argued that Kraus’s financial projections were “wishful thinking,” “overly optimistic,” based on “unreasonable assumptions,” and Kraus’s actual post-valuation date financial performance proved them to be inaccurate.
Rukhlin, Levi, and their expert asked the Court to value the company at slightly more than $6 million, apply a 25% DLOM, and value Magarik’s 24% stake at slightly more than $1 million.
The Post-Trial Decision
In a Decision and Order After Trial, Justice DeStefano discredited entirely Magarik and his expert’s valuation position. The Court wrote Magarik’s expert’s valuation “exceeded the true value of the business” because it was “based on income projections that were unrealistic and optimistic” and rooted in “mistaken premises and assumptions.”
The Court elaborated:
Much of the petitioner’s valuation depended upon projected earnings prepared by Kraus . . . in connection with a loan application to Bank Hapoalim B.B. (“BHI”). These projections were, put mildly, ambitious, and, in fact, were overstated. In the loan application to BHI, the parties valued Kraus at more than $30 million. In reality, the value of the business was never $30 million and the projections contained in the loan application were never realized.
The Court held that Rukhlin and Levi’s expert provided a more “sound” and “realistic” assessment of Kraus’s value “consistent with the credible evidence presented regarding Kraus’s successful business model as well as its debt and cash flow issues.”
Unlike many appraisal courts, Justice DeStefano rejected the dissenting shareholder’s request to arrive at a valuation somewhere in the middle of the two appraisers’ extremes, writing, “The Petitioner’s request that the court average the two incredibly disparate valuations is rejected.”
Though Justice DeStefano rejected Magarik’s request to average the two sides’ numbers, he more closely sided with Magarik on the DLOM debate, imposing a 5% DLOM in lieu of the 25% Rukhlin, Levi, and their expert requested.
With pre-judgment interest, Magarik’s final judgment came in at slightly less than $2 million.
The Appellate Arguments
Magarik appealed, relying in his appellant’s brief predominantly upon the Murphy and Miller decisions, writing that the court-appointed special referee forbade any pre-trial disclosure of Kraus’s “post-valuation date finances,” the income projections upon which Magarik’s expert relied were “realistic as of the valuation date,” and the trial court committed “reversible error” by “consider[ing] future events retrospectively when assessing a corporation’s value.” Magarik warned:
[I]f the lower court’s decision is allowed to stand, it will completely change the law in New York. Instead of valuing a company as of the valuation date, the new test will be to value the company with the benefit of hindsight, to see how the facts eventually turned out – years down the road – and then base the valuation on what is known now, as opposed to what was known on the valuation date. That would be new law and a terrible precedent.
In their respondent’s brief, Rukhlin and Levi argued that Magarik relied upon a “tortured” reading of Murphy and Miller, and that neither case “mandates” a trial court to “accept an internal company forecast as a proper measure of future growth no matter how unreasonable.”
“Neither Murphy nor Miller, nor any other case anywhere,” wrote Rukhlin and Levi, “compel” a trial court “to treat internal company forecasts as gospel when performing a BCL § 1118 valuation.”
A Missed Opportunity
With these arguments, the parties squarely raised an important appellate issue about whether, or to what extent, courts may rely upon actual financial performance post-valuation date to depart from pre-valuation date financial projections.
But after years of litigation, rather than reach the important question of whether the trial court’s decision was inconsistent with Murphy or Miller, the Court affirmed, but with virtually no analysis, under upon the generic rule of law that a valuation decision “will not be disturbed on appeal” where the trial court’s decision was “within the range of the testimony presented.”
The Court concluded, “Here, contrary to the contention of the petitioner, the Supreme Court’s determination as to the fair value of the petitioner’s shares of stock in Kraus is supported by the evidence.”
What Lessons?
In some ways, the appeals court’s decision in Magarik may be more a lesson about the frustrations of appellate practice than about the law of business valuation. Sometimes, we spend years litigating what we think are perfectly teed-up appellate issues, only for the court to sidestep them entirely.
What a missed opportunity.
Magarik does offer a valuable lesson in another respect about the importance of avoiding rigid reliance upon pie-in-the-sky financial projections, even those prepared by the entity itself. Peter Sluka described this phenomenon in a recent article as “Garbage In; Garbage Out.”
From time to time, entities, their owners, professionals they hire, or counterparties to a deal will prepare income projections for some sort of corporate transaction, like a loan, merger, purchase, or sale. Sometimes, these numbers are absolutely unattainable.
Dissenting owners should be wary of dogmatic adherence in valuation proceedings to financial projections that at the time arguably did not, and in hindsight, do not, resemble reality. The further pre-valuation date projections stray from post-valuation date reality, the harder it may be for the court to avoid the siren-like allure of considering post-valuation date metrics, even sub silentio when not technically permitted to do so.
Of course, this is all just one guy’s take on Magarik. Those interested can read Peter Mahler’s perspective on the trial court decision in his article from four years ago.