Buy-Sell value stands after expert is discredited in shareholder buy-out case
In re White, 2010 WL 786292 (Bkrptcy. S.D. Tex.)(March 4, 2010)
The federal bankruptcy court first found that $4.9 million in executive bonuses paid by a profitable construction equipment company over a span of two years (2006 and 2007) were in fact disguised dividends. “Uncontroverted” testimony at trial established that the company paid shareholder-employee bonuses to avoid double taxation, first as corporate profits and then as individual income to the recipients.
Further, with the exception of the CEO and the oppressed shareholder, the company paid the bonuses in proportion to each employee-shareholder’s ownership interest, based on the company’s performance. If the company had paid its combined tax burden on the disguised dividends, which the court estimated at 40%, then the $4.9 million dividend pool would have declined to $2,940,000. The oppressed shareholder owned an 8% interest; thus his share of the disguised dividends amounted to $235,200.
Shareholder wants a forced buy-out, too. In reviewing the shareholder’s request for a statutory buy-out under Texas law, the bankruptcy court concluded that it had three options to value his 8% interest: 1) the shareholder’s expert valuation; 2) book value; or 3) the buy-sell provision in the company’s shareholders’ agreement.
The shareholder’s expert used a capitalization of income approach and the company’s annual EBITDA of $9 million. Based on a number of factors—including then-current market conditions and a prior sale using a 5.17 multiplier—he applied a 6.0 multiple and arrived at a gross value of $54 million. After subtracting $22 million in liabilities and applying discounts for lack of control and marketability, the expert valued the minority shareholder’s interest at $1.23 million. (The court opinion does not detail the combined discounts, but by extrapolating from the expert’s conclusion, they total roughly 30%.)
Cross-examination by the company’s attorney dealt a “devastating” blow to the expert, according to the court. First, his March valuation report forecast annual revenues of $120 million, when actual revenues were only $77 million. More importantly, the company’s fiscal year ended in June. “Therefore, the expert’s forecast was only for a three month period of time,” the court said, “yet his forecast erred by $43 million.”
The expert suffered a second blow when he said that he’d never been excluded from a case—yet evidence revealed that at least one prior court had rejected his testimony. And finally, when the expert testified on his choice of earnings multiples, “he gave completely different testimony in court from that given in his deposition,” the court said. “[He] testified as to facts and conclusions that were convenient at the time,” and the court refused to credit any of his testimony or conclusions in this case.
The company offered a valuation expert only to critique the shareholder’s expert, leaving the court with little guidance regarding the validity of applying book value to the particulars of the case. Moreover, no witness testified how to apply the minority’s 8% interest to book value. “Would there be a discount?” the court asked, and “if so, how much?” Due to lack of answers or evidence, it declined to apply book value.
Buy-sell value by default. The shareholders’ agreement established a simple formula for determining the buy-out price for a departing owner’s shares: the difference between total fixed assets and total long-term liabilities. The parties disputed whether fixed assets should be calculated before or after depreciation; in a footnote, the court decided that the final value should be net of depreciation. The buy-sell agreement did not provide any discounts for lack of marketability or control, and the company was allowed to purchase the interest over 25 months, interest-free.
The court acknowledged “substantial pitfalls” in the formula. For example, if the company converted 100% of its assets to cash and paid off all of its debts, a departing shareholder would receive nothing. At the same time, the agreement was negotiated at arm’s length and without coercion. The formula excluded both short-term assets and short-term debt and allowed for the extended payment period. Both elements could implicitly recognize or build in a discount, the court observed.
In any event, the court saw “little reason to substitute [its] own judgment as to the fair terms of a buy-out.” In applying the formula to the company’s most recent balance sheet, it found total fixed assets of about $53 million, minus $15.3 million in deprecation, leaving net fixed assets of $38.6 million. Long-term liabilities were about $29.4 million, resulting in a total value for the company of $9.2 million. The minority shareholder’s interest was worth just over $739,000. The company would pay the shareholder that amount, plus the disguised dividend award. Or, in the alternative and pursuant to an equitable remedy available in Texas, it could pay the shareholder dividends according to a court-issued injunction, outlined in the remainder of the opinion. “In these difficult economic times,” the court said, it was “loathe to mandate a particular dividend policy for the company.” Its sole purpose in issuing the injunction, in addition to complying with applicable law, was “to protect [the shareholder’s] future expectations that have thus far been frustrated by [the company’s] conduct,” and it gave the company one month to elect its option.