Three recent court decisions from three different states — New York, Pennsylvania, and Alabama — add to the rogue’s gallery of valuation cases stemming from poorly conceived and/or poorly implemented buy-sell agreements among shareholders or LLC members.

Each one, in its own way, teaches a valuable lesson for lawyers charged with drafting such agreements, and also highlights the wisdom of consulting with appraisal experts at the time of drafting.

New York: The Nimkoff Case

The Nimkoff case is an old friend of this blog, and I do mean old. I first wrote about the case in its infancy, in 2010 (read here). Eight years later, following discovery and a dozen or so motions, the case has yet to be tried.

Nimkoff is a fight over the value of a 3.6% membership interest in a single-asset realty holding LLC owned by a group of medical doctors. The plaintiff is the wife-executrix of one of the doctors, whose death in 2004 triggered the LLC’s obligation to purchase the deceased member’s interest for a “Stated Value” in accordance with the operating agreement which also required that the Stated Value be updated annually. Continue Reading Lessons From a Trio of Dysfunctional Buy-Sell Agreements

The next time someone tells me they’re preparing a shareholder buy-sell agreement using a fixed price memorialized in a so-called Certificate of Value, I’m going to tell them to rename it a Certificate of Legal Fees, and I’m going to tell them to read the court’s opinion in Sullivan v. Troser Management, Inc., 2013 NY Slip Op 01634 (4th Dept Mar. 15, 2013).

When intelligently prepared and implemented, buy-sell agreements among co-owners of closely-held businesses are extremely useful and effective devices to preserve business continuity and financial stability while providing a fair exit mechanism for withdrawing owners and fair compensation for the estates of deceased owners, often funded by cross-purchase plan life insurance policies.

The pricing aspect of a buy-sell agreement is perhaps its most critical feature. There are three pricing methods in general use: (1) fixed price, that is, a dollar amount usually found in an appended Certificate of Value or Schedule; (2) formula price, which can take any one of many forms based on the company’s financial metrics and/or the withdrawing owner’s historic compensation; and (3) a process-based approach involving one or more appraisers who will value the selling owner’s interest in the company as of the date of the triggering event (death, notice of withdrawal, etc.). Continue Reading Missing Certificate of Value Spawns Decade-Long Lawsuit Over 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).

Continue Reading An Ill-Fated Solution to an Ill-Fated Buy-Sell Agreement

Buy-sell provisions in shareholder agreements utilize various pricing mechanisms, such as book value or an earnings-based formula.  Another popular method is agreed value, whereby the shareholders assign up front a fixed dollar amount per share to be paid in redemption upon the retirement, disability or death of a shareholder.  The agreed-value method usually entails appending to the shareholders agreement a so-called “certificate of value” which states the price per share.  The buy-sell provision also usually requires that the certificate of value be updated annually or on some other periodic basis to reflect changes in the value of the business with the passage of time.

I’ve always found the certificate-of-value method more appealing in theory than in reality, for the simple reason that the shareholders more often than not never get around to updating the share price.  A well written buy-sell agreement will include a back-up valuation method when the certificate price is not updated within a defined period prior to the redemption event, usually 2 or 3 years, such as a formula adjustment to the last stated value based on current book value or earnings, or an appraisal by the company accountant or by one or more independent appraisers.

But what happens when the buy-sell agreement has no back-up valuation method, and a redemption event occurs many years later when the shares intrinsically are worth far in excess of the value stated in the original certificate?  Is the redeeming shareholder, or his or her estate, stuck with a grossly undervalued price, or can the controlling shareholders of the corporation be held liable for failing to update the certificate?

According to a decision last month by Nassau County Commercial Division Justice Stephen A. Bucaria, in Nimkoff v. Central Park Plaza Associates, LLC, 2010 NY Slip Op 31374(U) (Sup Ct Nassau County May 25, 2010), at least under certain circumstances the controlling shareholders may be liable for breach of fiduciary duty.

Continue Reading The Stakes Just Went Up for Failing to Update Certificate of Value