War over Workable Stock Appraisal Method

In nearly 40 years of banking and litigation support work we have reviewed hundreds of buy/sell agreements, many referencing the establishment of annual valuations. But it is extremely rare that owners actually establish that annual value. This New York case illustrates a worst case scenario when owners ignore their agreement to establish annual value.

Ten years of litigation over a shareholder buy-sell agreement between parties that never agreed on the value for the shares of a closely held corporation have taken the litigants through four rounds of appeal but not close to an answer as to the appropriate valuation method.

The plaintiff served as the defendant’s director of sales for the operation of a ski resort. In 1986, the parties made an agreement that promised him an 18% equity interest in the defendant’s closely held corporation if he remained employed until year-end 1991. Under a contemporaneous buy-sell agreement, the defendant had the option to buy back the plaintiff’s stock if, among other things, the employment ended.

The purchase price was to be “an amount agreed upon annually by the Stockholders as set forth on the attached Schedule A.” If the parties failed to establish an annual value, “the value shall be the last agreed upon value except that if no such agreed upon value is established for period of two years, the value shall be the last agreed upon value in- creased or decreased by reference … the company’s book value.” The agreement listed the plaintiff as a “stockholder.”

No Schedule A exists. In 2003, the plaintiff sued in state court (Supreme Court, Monroe County, which is a trial court) for specific performance of the stock issuance. Moreover, he requested an order that, once the stock was issued, the defendant had an obligation to repurchase it and a determination of the parties’ rights and duties under the buy- sell agreement. The trial court directed the defendant to issue 18% of its shares of stock to the plain- tiff, which the defendant subsequently did. The court also ordered the parties to execute the buy- sell agreement and fixed a price for the purchase.

Specifically, it valued the buy-back interest at an amount that aligned with a prior buy-out involving a different shareholder. Both sides appealed.

Volley of appeals. In 2005, the defendant sought dismissal of the complaint, arguing it was time- barred. The appellate court declined. At the same time, it granted the plaintiff’s request to overturn the lower court’s setting a price for the purchase of his shares.

In 2006, the trial court directed the defendant to repurchase the stock for approximately $110,000, based on the defendant’s claim that the method to value the stock was by prorating the value of its parent corporation among that company’s three subsidiaries. The plaintiff appealed, contending that the agreement required that the two stockholders of the defendant determine the value of the stock, not the owners of the parent corporation. He also provided a letter he had received from the defendant’s attorney in 1999 that specified a different valuation method. The appellate court ruled for the plaintiff.

In 2009, the trial court denied the plaintiff’s request for a determination that his shares “be valued on the basis of his percentage interest in the Defendant’s assets” in the event that the defendant exercised its option to buy back the shares. He advocated for the use of a net asset approach that  the state’s highest court had approved in a case about the buyout of a law firm partner pursuant to an agreement that provided for a future agreement among partners that never came into existence.

The plaintiff appealed, contending the agreement’s purchase price provision was unenforceable. The defendant presented other stock valuations. The appellate court said the plaintiff showed “as a matter of law that the stockholders have never agreed upon a value of the stock.”

Accordingly, there was no way to ascertain his share price in accordance with the terms of the buy-sell agreement. Evidence of stock valuations from other transactions was of no consequence because the plaintiff was not a party to them.

No uniform rule for valuing stock. In 2011, the trial court denied the defendant’s motion to set the stock purchase price at approximately $184,000 based on its expert’s calculation. The expert had used the same formula the plaintiff proposed in 2009.

The appellate court affirmed the denial. Its 2010 ruling notwithstanding, it stated it did not then require  a  net  asset  valuation,  a  method  the  High Court approved but did not mandate. The court clarified that its earlier decision established that the plaintiff’s shares had to be valued “on the basis of his percentage interest.” However, issues of fact as to what the appropriate method for valuing the defendants’ assets remained.

The court rejected the defendant’s claim that the buy-sell agreement’s reference to book value dictated its use to determine the price for the plaintiff’s shares. The parties never agreed on the value of the shares, and there was no adjustment to be made. “Book value does not come into play.” In this vein, it also noted that, even though, under pro- visions of the business corporation law, the plain- tiff had no right to the “fair value” of the stock, “it does not follow … that the plaintiff is entitled only to book value.”

There was “no uniform rule for valuing stock in closely held corporations,” the appellate court stated. A court must tailor the valuation method to a particular case, based on the evidence at trial.

The appellate court, however, agreed with the defendant that the trial court had erred in finding the defendant had exercised its option to buy back the shares. The plaintiff earlier had raised the issue in an inappropriate manner. A resolution of this question could wait until the defendant actually refused to buy the shares at the price the lower court set after a trial on the value of the shares, the appellate court concluded.