Valuator, watch your back! A recent case involving a major valuation firm shows how willing parties are to use financial experts as pawns in litigating value disputes. Lucky for the appraiser, it performed flawlessly and the court saw right through the gamesmanship.
Voluntary commitment: The defendants were related companies that owned preferred units of PECO Logistics, the plaintiff. In the context of a merger involving the PECO companies, the parties agreed that the plaintiff would purchase all of the defendants’ units within three years of the agreement, following notice that the defendants wanted to sell. The contract required the plaintiff to retain a nationally recognized valuation firm to determine the fair market value of the put units based on a specified valuation formula. Critically, the parties agreed to be bound by the appraiser’s calculation. The contract did not provide for judicial or any other form of review of the value determination.
Following receipt of the defendants’ put notice, the plaintiff hired one of the most notable BV firms in the country. Displeased with the valuation, the defendants refused to transfer their units to the plaintiff, which prompted the latter to ask the Delaware Court of Chancery for a declaration that it had complied with the agreement and that the defendants were bound by the valuation. The defendants, in turn, attacked the valuation based on alleged problematic judgment calls by the appraiser and claimed the plaintiff violated the covenant of good faith and fair dealing.
According to the defendants, whenever there was ambiguity in the agreement as to what to do, the appraiser took a position that benefited the plaintiff rather than them. For example, the appraiser picked a valuation date that added an additional $14 million in debt to the liabilities and, therefore, decreased the valuation. But the court noted the defendants failed to point to any provision in the agreement that mandated the use of their preferred valuation date. The defendants in fact admitted that the valuator’s choice of date was reasonable but tried to argue it was “the lesser of the two reasonable explanations.” The court found the other objections were equally unconvincing.
No meddling in valuation: “When parties to a contract agree to be bound by a contractually established valuation methodology, this Court will respect their right to order their affairs as they wish and refrain from second-guessing the substantive determination of value,” the Chancellor said. Had the agreement provided for judicial review, the court might have entertained questions as to the reasonableness of the valuator’s assumptions or decisions. But, since no such provision existed, “the Court will not take mere allegations of ambiguity about the valuation methodology as an invitation to circumvent the structure of the deal to substitute its own judgment for that of the valuation firm.”
No trial ensued. Based on the parties’ motions alone, the Chancery ruled in favor of the plaintiff. The defendants were bound by the appraiser’s determination of value.
Takeaway: In the face of the parties’ voluntary agreement, which provided no review mechanism in valuation disputes, and, in the absence of any challenge to the appraiser’s independence, the Chancery upheld the contested valuation.
Find an extended discussion of PECO Logistics, LLC v. Walnut Inv. Partners, L.P., 2015 Del. Ch. LEXIS 311 (Dec. 30, 2015), in the February edition of Business Valuation Update; a copy of the court’s opinion will appear soon at BVLaw.