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Litigation Services Bulletin: Q3 2019

Posted 12:00 PM by

In This Issue:

In Gatekeeper Role, Court Trains Attention on Expert Methodology, Not Conclusions

Acosta v. Wilmington Trust, N.A., 2019 U.S. Dist. LEXIS 9246 (Jan. 18, 2019)

In this ESOP litigation, both parties tried to exclude the opposing side’s valuation expert testimony under Rule 702 and Daubert. The court noted that, at this stage in the proceedings, its focus was on whether the experts applied reliable principles and methods, not on the experts’ conclusions. This case serves as an important reminder to attorneys and experts that the role of the court as gatekeeper is different from its role as evaluator of the sufficiency of the evidence (as the court in another case, Washington v. Kellwood Co., explained so well). Put differently, simply because the expert opinion is admissible does not mean it will hold up in terms of the ultimate outcome of the case.

Questioning ESOP valuation. The U.S. Department of Labor (DOL) sued the defendant trustee (and others) alleging the trustee violated its duties under ERISA by causing an employee stock ownership plan (ESOP) to purchase the outstanding stock in a graphite processing company (Graphite Sales Inc.). According to the DOL, the purchase was for greater than fair market value, which meant the trustee caused the ESOP to overpay by approximately $6 million. At the time of the transaction, an independent valuation firm appraised the company. As part of the transaction, the sellers received stock warrants that amounted to an 18% equity stake in the company. Also, two officers received stock appreciation rights, representing a 10% equity interest. Further, an investor received rights to a 7% equity stake in the company.

The crux of the case was the valuation of the company. The DOL offered expert testimony that called into question the ESOP valuator’s contemporaneous appraisal. The defendant trustee presented its own trial expert to testify and rebut the opinion of the DOL’s expert. Both parties challenged the opposing testimony under Rule 702 of the federal rules of evidence and under Daubert and its progeny. Further, the DOL argued the opposing expert opinion was inadmissible under Rule 403, which provides for exclusion of relevant evidence on various grounds (unfair prejudice, confusing the issues, misleading the jury, etc.). The court’s discussion focused on Rule 702 and Daubert.

In a nutshell, Rule 702 and Daubert provide for testimony by a qualified expert whose “scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue.” The testimony must be based on sufficient facts and data and must be “the product of reliable principles and methods.” In assessing the testimony, a court considers whether the testimony “has been tested, is the subject of peer review and publication, has a permissible error rate, follows established standards, and receives ‘general acceptance’ within a ‘relevant scientific community.’”

“At this gatekeeping stage,” the court in the instant case said, the court’s focus is “on principles and methodology, not the conclusions that they generated.”

Objections to DOL expert testimony. In trying to exclude the DOL’s expert, the defense broadly claimed the expert’s value opinion was nothing more than ipse dixit, or “I say so.” This argument, the court found, was based on the expert’s statement during his deposition that he “could not speak for the entire industry.” In other words, he suggested different valuation experts might interpret certain facts differently.

“Of course, [the expert’s] concession … does not mean that his own interpretation is made up,” the court said, dismissing the defendant’s argument.

The defendant also attacked the expert’s methodology on specifics. For example, it took issue with the DOL expert’s statement that the ESOP appraiser should have used multiples of revenue and EBITDA, not multiples of EBIT and EBITDA, in valuing the company. The defense claimed the DOL expert’s view conflicted with a cited treatise that said the expert’s proposed approach was applied most frequently to startups and service businesses, neither of which the subject company was.

“The defendant is wrong,” the court said. It noted the treatise “explicitly contemplates” use of the expert’s approach “in circumstances other than start-ups and service companies.”

Secondly, the defendant objected to the DOL expert’s claim that the ESOP appraiser erred by using the exit multiple method rather than the Gordon growth model for its discounted cash flow analysis. The defendant said the expert’s critique was wrong because treatises permit the use of either method.

“Even if true,” the court said, the defense argument does not affect admissibility because it simply contests the DOL’s expert choice among accepted valuation methodologies.

Thirdly, the defendant claimed it was improper for the expert to consider the stock warrants and appreciation rights when valuing the company. The defendant noted that the expert, in deposition testimony, “admitted” that the warrants could be considered part of financing the transaction.

The court noted that, in the same testimony, the expert pointed to another “motivation” for the warrants: They were “a form of contingent consideration” and should have been added to the purchase price, he said.

The court said that the defendant would have a chance to probe this issue at trial. However, in terms of admissibility, the defendant failed to show the expert’s view was based on insufficient facts or conflicted with accepted principles and methodologies.

Moreover, the defendant raised questions related to the DOL expert’s application of the principles and method to the facts of the case. For example, the expert criticized the ESOP appraiser’s projections. The defendant, in turn, claimed the expert failed to give proper consideration to the management projections and ignored various other pieces of financial evidence.

The court noted that none of “these purported errors” showed the DOL expert “made up” his revenue projections or used unsound methods. The defendant failed to show that accepted valuation principles compelled the expert to weigh the evidence differently or consider certain evidence, the court said.

Another defense objection was to the expert’s criticism of the ESOP appraiser’s selection of guideline companies and the latter’s choices related to the application of the guideline company method. The defense claimed the expert’s criticism contradicted the expert’s own analysis on other topics. The defendant said there was no reason to use the expert’s preferred method.

According to the court, the defendant’s objection went toward the weight of the opposing opinion, but it did not “even remotely suggest” the opposing expert’s opinion was based on an unsound methodology.

Similarly, the DOL’s expert criticized the ESOP appraiser’s use of a 10% control premium to the guideline companies’ stock. The defendant suggested that the DOL expert’s analysis of control was wrong and made his calculation wrong.

The court disagreed again, noting that this type of application error “would not show that [the expert’s] views are inadmissible.

Objection to defense expert testimony. The court quickly dismissed the DOL’s claim that the defense expert’s testimony was inadmissible because he improperly proposed a damages methodology when doing so was the role of the court.

The court noted the defense expert’s approach—comparing what the ESOP paid for the stock with the fair market value of the stock on the date of the transaction—was the same approach the DOL expert used. Further, this analysis was a legally approved methodology.

In general, the court suggested that the parties mostly quarreled over the opposing expert’s conclusions but failed to show the conclusions were unscientific—the requisite inquiry for purposes of determining admissibility of expert testimony.

Both expert testimonies were admissible in their entirety, the court found.

Editor’s Note: A digest of the above-mentioned case, Washington v. Kellwood Co., 2016 U.S. Dist. LEXIS 92309 (July 15, 2016), and the court’s opinion are available at BVLaw.

 

Economic Damages Culminate Suit Over War Journalist's Extrajudicial Killing

Colvin v. Syrian Arab Republic, 2019 U.S. Dist. LEXIS 14641 (Jan. 30, 2019)

A civil suit arising out of the “deliberated” killing of a well-respected American war correspondent illustrates that valuation and damages issues play a critical role in most litigation. The loss of income analysis in this case will be of particular interest to appraisers specializing in personal injury cases.

Marie Colvin was an acclaimed American war journalist who worked for over 25 years for the British paper, The Sunday Times. In February 2012, Colvin, who was a special target of the Syrian government, was killed in a concerted artillery attack in the Syrian city of Homs. Afterwards, members of the Syrian military and intelligence celebrated. Based on evidence, they said: “Marie Colvin was a dog and now she’s dead. Let the Americans help her now.”

Colvin’s youngest sister, Cathleen, and Colvin’s niece and nephew sued the Syrian government under the Foreign Sovereign Immunities Act (FSIA), alleging the reporter’s death was an extrajudicial killing. The plaintiffs sought damages under two legal theories: wrongful death and emotional distress. The court found there was copious evidence (almost 1,000 pages of exhibits, detailed affidavits, declarations, and expert reports) to support a finding that Colvin was the victim of a “deliberated killing” by the Syrian government.

Under the wrongful death theory, all plaintiffs were entitled to monetary damages for the loss of prospective income, benefits, and retirement pay as shown by a reasonable estimate from an expert that was based on well-founded assumptions. The plaintiffs’ damages expert was highly qualified, the court noted. She held a Ph.D. in economics and had worked in valuation for over 10 years, participating in “hundreds of valuation-related projects around the world.” The testimony met the requirements of federal rule of evidence 702, the court found.

To calculate the economic loss resulting from the reporter’s premature death, the expert decided to take a conservative view. In determining the expected income, the expert did not include professional earnings beyond Colvin’s employment with The Sunday Times, believing “it was not possible” to quantify with “a reasonable degree of certainty” any future book deals or film contracts that Marie Colvin could have received.

The expert also adjusted the total amount of lost wages for the risk inherent in the journalist’s job (“probability of survival”) and the time value of money and found the economic loss was $2.37 million. The court credited the expert’s opinion but said that, under the relevant case law, the calculation had to be adjusted for consumption costs. Therefore, the court asked for an updated expert report before making a final determination as to the exact amount of loss of income.

The court also awarded Colvin’s sister $2.5 million to compensate for the pain and suffering resulting from the journalist’s death, and it awarded punitive damages of $300 million. However, this is a default judgment against the Syrian government. How much of the award the plaintiffs will ever see remains unclear.

Extra: A well-received movie based on Marie Colvin’s life came out in 2018. It’s called A Private War.

 

Divorce Court Finds No Personal Goodwill Value in Single-Owner Business

Stephanos v. Stephanos (In re Marriage of Stephanos), Case No. 502013DR007061XXXXSB, Circuit Court of the Fifteenth Judicial Circuit, Palm Beach County, Florida, J. Samantha Schosberg Feuer, Final Judgment (Dec. 28, 2018)

A Florida divorce case is noteworthy for its multifaceted goodwill analysis, which included an examination by the court of which party had the burden of establishing that goodwill was either enterprise or personal in character and was either a marital asset or not. The nub of the problem was that the husband, who held sole title to the contested company, had a damaged business reputation but still claimed any goodwill existing in the business should be attributed to him. The wife, through expert and lay testimony, was able to show all of the goodwill was enterprise goodwill. The husband was not vital to the company’s continuing existence and success. Further, the court found a noncompete analysis (or “real world transaction”) would not change the goodwill attribution.

Owner’s problems with the law. The parties first filed for divorce in 2003. They then reconciled and dropped their divorce petitions. Ten years later, in June 2013, the husband filed another petition for divorce, which, in November 2013, prompted a counterpetition from the wife. The husband was active in the hormone replacement industry. At one point, he and a business partner equally owned a company, Palm Beach Rejuvenation (PBR). However, in 2007, during the reconciliation period with the wife, the husband and his brother became targets of a federal investigation and were indicted by the state of New York. PBR was raided. The events were on the cover of Sports Illustrated in 2007.

The husband pled guilty to a third-degree felony in the state case and was found guilty, placed on probation, and prohibited from ever providing human growth hormone services to anyone in New York state. The wife gave financial support for the husband’s defense and also provided funds for the creation of a separate entity, Nationwide Synergy Inc. (NSI), which operated in the hormone replacement industry but was not a professional practice. The valuation of NSI was a flashpoint during the divorce proceedings.

The parties also argued over whether PBR morphed into NSI or essentially stopped functioning because of the husband’s legal problems. The trial court ruled that NSI was mostly a separate entity, even though the businesses shared similarities and the husband had bought PBR’s assets and opened NSI in an effort to rebrand. Besides those two entities, between 2007 and 2013, the spouses, and the husband’s brother, also created other businesses involved in hormone replacement therapy.

Importantly, the NSI stock was in the husband’s name alone. The court noted the reason for this arrangement was strategic, to protect the wife from potential legal exposure in light of the husband’s past problems regarding PBR.

The husband was CEO, and the wife served as the CFO of NSI. The evidence showed she made an initial contribution of approximately $850,000 of her nonmarital assets and dealt with the company’s financial activities. She also supervised employees and assisted in creating an important database, and she worked on developing a reputation for NSI and the other entities.

In the company’s beginning, the husband recruited salespersons and put in place people who were key to generating cash. But, once the company grew, other employees became key persons, including the spouses’ son and another employee. The latter two developed a network of physicians who performed clinical valuations of potential customers who wanted to buy the company’s products over the internet. This medical assessment became federal law in 2008. NSI’s key employees established the necessary protocol at the company.

Between 2007 and 2016 (the valuation date), the value of the company went from about zero to $5.3 million and $5.7 million, according to the valuations the parties’ highly qualified experts offered at trial.

Equitable distribution principles. The overriding issue was for the court to determine whether NSI was a marital asset that was subject to equitable distribution.

The applicable statute (Fla. Stat. § 61.075) provides for a three-step process. In essence, the court first has to classify the assets and liabilities as marital or nonmarital. Next, the court has to value the “significant” marital assets based on “competent, substantial evidence.” Under case law, a court must not simply “split the difference” between the values the parties proposed but has to “cite to specific evidence or lack thereof in the record to arrive at its conclusions.” Finally, the court must distribute the assets and liabilities under a presumption in favor of equal distribution, “unless there is a justification for an unequal distribution based on all relevant factors.” Also, under the statute, all assets a couple acquires after the date of marriage that are not specifically established as nonmarital assets are presumed to be marital assets and liabilities. This presumption may be overcome by showing that the assets are nonmarital assets.

Residual method. The court’s inquiry focused on whether there was goodwill value in the company. The question was how to calculate the goodwill value and how to determine whether it was personal or enterprise goodwill.

The applicable statutory provision (Fla. Stat. § 61.075(3)(b)) and case law require a valuation based on the fair market value standard of value.

The clearest method would be the fair market value approach, which is best described as what would a willing buyer pay, and what would a willing seller accept, neither acting under duress for a sale of the business. The excess over assets would represent goodwill. See Thompson v. Thompson, 576 So. 2d 267 (Fla. 1991) (available at BVLaw).

The court explained that Thompson was the controlling case on the issue of business goodwill in the divorce context. Thompson says that enterprise goodwill is value attributable to the company/entity as opposed to value related to the reputation or continued presence of a particular person (“the marital litigant”). In Florida, enterprise goodwill is a marital asset, whereas personal goodwill is not.

The court noted that, when it came to the overall valuation of NSI, the parties’ experts achieved a fair market value determination that was remarkably close. The difference was less than $250,000. The wife’s expert found the company was worth $5.3 million, and the husband’s expert determined it was worth $5.7 million.

The more contentious issue was the goodwill calculation. The court noted the husband’s expert suggested he was unable to extrapolate any goodwill value from the fair market value. Although it respected the expert’s opinion, the court found the claim somewhat “dubious” given the expert’s “extensive expertise and knowledge in the area of business valuation and goodwill.”

In contrast, the wife’s expert used the residual method to determine the value of goodwill, which the husband’s expert allowed was a proper approach. By subtracting the net asset value from the entity’s FMV, the expert achieved a residual value (goodwill) of $2.2 million.

Burden of proof issue. The court noted that it found no reported cases that addressed which party had the burden of establishing the value of enterprise goodwill. Here, the husband claimed that all of the goodwill at the company was personal, whereas the wife claimed personal goodwill in the company was nonexistent or negligible. Accordingly, the husband contended the wife should have the burden of showing all of the goodwill was enterprise goodwill, while the wife argued the burden was on the husband to show he was entitled to the goodwill value as he claimed it was personal to him. Both parties cited cases to support their positions. The court concluded that, since the wife claimed there was goodwill, it was appropriate that she had the burden of showing that enterprise goodwill existed—”through competent and substantial evidence”—and that, therefore, the goodwill was a marital asset.

The court rejected the husband’s position that it was impossible to extract the value of personal goodwill from the residual value. Instead, the court relied on testimony from the wife’s expert as to the purchase price allocation approach and on other testimony and factors to come to the conclusion that there was no personal goodwill attributable to the husband.

The court specifically noted that the husband was a convicted felon who was “unable to compete in certain markets”; his reputation was blemished. He could not point to any customers his efforts brought in. He had no role in developing the database or sales force, both of which were critical parts of the business. He had no relationships with the company’s physician affiliates. Further, all employees of NSI had signed noncompetes and, therefore, were precluded from aligning themselves with the husband in a similar business. In addition, members in the physician affiliate network were bound by noncompetes and confidentiality agreements to protect NSI’s intellectual property. The physicians in the network had relationships with the two key employees, not the husband. The company’s advertising did not mention the husband because the company specifically determined that, if his affiliation with the company were known, it could hurt the business. Most of the company’s revenue stream was generated by website sales; the website in turn was managed by another employee, not the husband. Any web domains and phone numbers belonged to the company and would transfer in the event of a sale.

Company employees spoke of the husband’s limited role and said they did not know what he actually did there. One key employee said that, if the husband were to leave for a year, the company would continue to function as it always had. Also, as of 2016, the husband had limited his role in the company. He was rarely in the office and only communicated sporadically via email.

There was no credible evidence that showed the husband was key to the company, the court found. It decided that the entire residual value was enterprise goodwill. This amount was a marital asset, subject to equitable distribution.

Noncompete goodwill theory. That said, the court also considered the husband’s alternate theory in support of his position that the goodwill was personal to him. He and his expert contended that, in the real world (i.e., in an actual, as opposed to a hypothetical, transaction), a buyer would only be willing to purchase NSI’s stock if the husband executed a noncompete agreement.

The court noted, however, that the ASA’s business valuation standards do not require consideration of a noncompete when calculating fair market value. The court also noted it was not aware of any precedent “from any substantive authority in this State wherein the specificities regarding value and methodology address the criteria to value a covenant not to compete in a ‘real world’ situation.” In other words, there was no specific appellate opinion addressing the valuation of a noncompete.

The wife’s expert proposed looking to Internal Revenue Service guidelines for the purpose of valuing a noncompete. The nine factors included:

  1. The seller’s ability to compete;
  1. The seller’s intent to compete;
  1. The seller’s economic resources;
  1. The potential damage to the buyer the seller’s competition posed;
  1. The seller’s business expertise in the industry;
  1. The seller’s contacts and relationships with customers, suppliers, and others in the business;
  1. The buyer’s interest in eliminating competition;
  1. The duration and economic scope of the covenant; and
  1. The seller’s intention to remain in the same geographic area. See Langdon v. Commissioner, 59 Fed. Appx. 168 (8th Cir. 2003) (citing Lorvic Holdings, Inc. v. Commissioner, 1998 Tax Ct. Memo 283 (1998).

The court said it would rely on the analysis of the wife’s expert for the calculation of value (assuming there was any) of a noncompete. Several case-specific facts were critical, including the fact that all 16 sales force members of the company had executed noncompete, nonsolicitation, and confidentiality agreements, as did the 14 “non-sales force” employees.

Further, all 32 physicians in the company’s physician affiliate network were bound by noncompetes. The company had established a proprietary database related to customers. And there was an established relationship between the entity and the patients/customers the company served.

Considering all the restrictions in place, the court found a real-world transaction analysis that centered on the existence or nonexistence of the husband’s noncompete also would not change the outcome as to personal goodwill. Under either continued presence or noncompete analysis, the goodwill value personal to the husband was nonexistent or negligible, the court concluded.

In the final analysis, the court awarded the company to the husband. For equitable distribution purposes, the court adopted the $5.3 million valuation the wife’s expert had proposed as well as this expert’s determination that goodwill in the company was about $2.2 million and was enterprise goodwill that was subject to marital distribution.

Editor’s note: Hat tip to Josh Shilts (Villela & Shilts LLC) for alerting us to this important goodwill decision.

 

Court Chooses DCF to Determine Fair Value in ‘Straightforward’ Appraisal Case

Kendall Hoyd & Silver v. Trussway Holdings, 2019 Del. Ch. LEXIS 72, 2019 WL 994048 (Feb. 28, 2019)

Several standard valuation methods were in play in a statutory appraisal case arising out of the minority shareholder’s petition to the Delaware Court of Chancery for a fair value determination. Neither the aborted sales process nor the market approach produced reliable indicators of fair value, the court found. Instead, it relied on a discounted cash flow (DCF) analysis and, in so doing, discussed and resolved disagreements between the parties’ experts over various inputs, including management projections, beta, and residual value. As the subject company was not a public company, the Delaware Supreme Court’s Dell and DFC Global decisions did not guide the Court of Chancery’s analysis.

Nine-year projections. The dispute related to the conversion of a corporation into a limited liability company. Trussway Holdings Inc. (Trussway) had a wholly owned subsidiary, Trussway Industries Inc. (TII), that was the leading manufacturer of prefabricated trusses and other components for the multifamily housing market. TII was the company whose value was in dispute. It had six manufacturing facilities in the U.S. and approximately 930 employees.

In mid-2016, TII contemplated a sale and hired an investment firm to develop a valuation of the company. The financial adviser came up with a value range of $202 million to $298 million. It contacted over 75 parties. At the end of 2016, TII made presentations to seven interested parties. The focal point was nine-year projections (2017 to 2025). The projections envisioned revenue for 2016 to be $218.2 million, increasing in 2017 to $235.9 million. Afterward, revenue was expected to grow from 2.2% to 14.9% annually through 2025. These numbers were very optimistic compared to the numbers appearing in internal management projections for 2015 and 2016. For example, the 2015 projections anticipated an increase from $196 million in 2015 to $204 million in 2016 and an annual decline thereafter, to $132.76 in 2019. The record showed one board member foresaw declines in multifamily housing starts. Internal five-year projections for 2016 also anticipated a decline in revenue through 2020.

A company representative said in his deposition that the nine-year projections were adjusted downward during the sales process “because the business wasn’t performing as was anticipated.”

Importantly, the nine-year projections added to the base case projected costs, revenue, and EBITDA related to four strategic initiatives. The effect was an increase in revenue and EBITDA. By 2025, the initiatives accounted for 39% of revenue and 43% of EBITDA in the nine-year projections.

In December 2016, Trussway’s board of directors approved a merger that transformed Trussway and its subsidiaries, including TII, into LLCs. The transaction was driven by one majority shareholder that owned about 95% of the company’s stock. Two minority shareholders held roughly 5% of the company’s stock and did not vote on or consent to the merger. Instead, the minority shareholders filed for statutory appraisal under section 262 of the Delaware appraisal statute.

While the merger went forward, the negotiations over the sale of TII were ongoing. In February 2017, one offer emerged. The bidder offered $170 million. It later withdrew the offer, and the sale went nowhere.

The parties agreed to the value of the corporate assets and liabilities but did not agree on the value of TII. Ultimately, one minority shareholder settled in principle with Trussway (the respondent). The other shareholder’s petition went to trial in the Delaware Court of Chancery.

Both the petitioner and the respondent offered expert valuation testimony.

Applicable law. Section 262 of the Delaware appraisal statute entitles dissenting shareholders to petition the Delaware Court of Chancery for a determination of the fair value (intrinsic value) of their shares as of the merger date. The fair value determination must exclude “any element of value arising from the accomplishment or expectation of the merger.” The court “should first envisage the entire pre-merger company as a ‘going concern,’ as a standalone entity and assess its value as such.” Under the statute, the court must undertake a case-by-case analysis that considers “all relevant factors.” Both parties have the burden of proving their valuation positions.

Court rejects market approach. In a nutshell, the petitioner’s expert determined the petitioner’s interest in Trussway was $387.82 per share, which was made up of the value of TII, plus the agreed-upon value of the corporate assets, minus the agreed-upon amount of liabilities.

The company’s expert (respondent’s expert) arrived at a fair value of $225.92 per share.

The petitioner’s expert performed a DCF analysis to which he assigned 60% of the weight, a comparable companies analysis that he weighted at 30%, and a precedent transactions analysis that he weighted at 10%.

The company’s expert relied on the results of two DCF analyses. One analysis was based on the nine-year management projections. In a second analysis, the expert modified the nine-year projections to become five-year projections. He assigned a 25% weight to the DCF using the nine-year projections and a 75% weight to the DCF based on the five-year projections.

Neither party claimed that the unsuccessful sales process revealed a value that represented fair value. The court said the one bid emerging during the sales process, $170 million, and other indications of interest, at best, served as “a very rough reasonable check.”

The court agreed with the company’s expert that the petitioner expert’s comparable companies analysis did not generate a meaningful value indicator because the companies used as comparables were insufficiently similar to the subject company in regard to size, public status, and products. The company further contended that the court should disregard the result of the opposing expert’s precedent transaction analysis since that analysis was based on only one reliable transaction. The court agreed and used the DCF for its determination of fair value.

DCF disagreements. Here, the experts used a similar methodology to perform their DCFs but had consequential disagreements over a few key inputs, the court noted.

Projections. The issue was how reliable the nine-year management projections were. The petitioner’s expert used them in their entirety, finding they were based on “the best currently available estimates and judgments of the management of the company.”

The company argued that a valuation should use only the base projections, thus ignoring the strategic initiatives. Alternatively, if the strategic initiatives were part of the analysis, the valuation should assign greater weight to the first five years of company projections, as the company’s expert had done.

In discussing the reliability of the nine-year projections, the court noted the company “routinely” created projections. The projections were done in the course of business and, in this instance, the company intended to use them in the context of a sales, the court observed. Sales considerations generated optimistic projections, the court noted. It also found the projections were longer than the common five-year projections. One explanation for the extended period was that the multifamily housing industry was cyclical. The longer projections aimed to correct “cyclic distortion,” the petitioner argued.

The court agreed that the projections were “the best predictor” of the subsidiary’s performance. Moreover, it found that the strategic initiatives were part of TII’s “operative reality” and should be considered in valuing the company as a going concern. “TII had the unilateral choice to pursue the initiatives, and projected that they would do so,” the court noted.

The court acknowledged there was “a degree of huckster’s optimism in these predictions” and noted that the petitioner’s expert seemed to acknowledge as much by adding a 1% risk premium to account for the uncertainty surrounding the forecasts. However, there was no basis for the 1% risk premium adjustment, the court found. It adopted a modified version of the approach the company’s expert took regarding the projections. The court weighted the results of the two DCF-generated values equally. One value resulted from using the nine-year projections and the other from using the same projections but beginning the terminal period after five years. The court said its analyses applied the calculation the company’s expert made from the nine-year projections of management’s projected annual cash flows and expected debt and equity levels.

WACC and beta. Although the experts largely agreed on how to calculate WACC, they disagreed over beta. The petitioner’s expert used adjusted beta, assigning two-thirds of the weight to raw beta and one-third weight to a mean beta of 1.0. The company’s expert used historic beta.

Further, the petitioner’s expert used the Hamada method to unlever and relever beta. In contrast, the company’s expert used the Harris-Pringle method. The methodologies differ in their treatment of debt, which can result in “notably disparate beta calculations,” the court noted.

The petitioner’s expert obtained a WACC of 13.4%, whereas the company’s expert calculated a WACC of 15.4%.

The court disfavored the use of an adjusted beta “for this small, private corporation.” It also said that any error in using a historic beta would be minimized because the court assigned a 50% weight to a DCF that used the nine-year projections with very optimistic growth forecasts.

Also, since the court leaned heavily on the DCF analysis of the company’s expert, it accepted his use of the Harris-Pringle model. The difference in the approaches was de minimus, the court said. The court’s beta was 1.74, and its WACC was 15.4%.

Residual value. To calculate the terminal value, both experts used the Gordon growth model. However, the plaintiff’s expert also used the exit multiples approach, which the opposing expert said doing so improperly increased the residual value. The company’s expert used a 2.3% growth rate, which the petitioner claimed was too low.

The court said use of the exit multiples approach with its high-growth-rate assumptions was inappropriate considering the court already used the optimistic nine-year forecast. Therefore, the court decided to use the Gordon growth model and a 2.3% growth rate.

The court’s inputs generated two values. A DCF analysis based on the nine-year forecast resulted in a value for TII of $197,800. A DCF analysis based on the first five years of the projections resulted in a valuation of $168,800. Weighting each result equally, the value of the company was about $183,300. Adding the other agreed-upon values for assets and liabilities and dividing the result by the shares outstanding, the court obtained a per-share value for Trussway Holdings of $236.52—thus a value close to the fair value calculated by the company’s expert.

Based on its DCF analysis, the court decided the fair value of the company as of the merger date was $236.52 per share.

About Ron
Ron Lenz is the partner-in-charge of KSM’s Litigation Services Group.  He advises clients and attorneys in matters of financial litigation and often challenges assumptions to help clients obtain the best possible litigation outcome. Connect with him on LinkedIn.
 

About Jay
Jay Cunningham is a director in KSM’s Litigation Services Group. Jay counsels clients faced with litigation or other disputes through forensics and commercial damage analyses, often serving as an expert witness. Connect with him on LinkedIn.

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Valuation Services Bulletin: Q3 2019

Posted 12:00 PM by

In This Issue:

Tricks of the Trade in Detecting Rigged Valuations

Did you ever read a business valuation report where you knew the valuation was rigged to obtain a higher or lower value? Unfortunately, some valuation analysts manipulate the process in order to please their client and/or win at all costs. This can often happen in contentious divorce engagements.

Where to look: One place to look for evidence of rigging is in the discount rate, which has several inputs susceptible to manipulation. The size premium is one input that appears to be a good candidate for abuse. However, the size premium differs depending on the data breakdown you use and the historical time frame of the data, which can explain the difference. But where the discount rate can be manipulated the most is in the company-specific risk adjustment, which is based purely on the judgment of the expert. This is a prime area where opponents will try to detect valuation bias and try to discredit the analysis.

 

In Gatekeeper Role, Court Trains Attention on Expert Methodology, Not Conclusions

Acosta v. Wilmington Trust, N.A., 2019 U.S. Dist. LEXIS 9246 (Jan. 18, 2019)

In this ESOP litigation, both parties tried to exclude the opposing side’s valuation expert testimony under Rule 702 and Daubert. The court noted that, at this stage in the proceedings, its focus was on whether the experts applied reliable principles and methods, not on the experts’ conclusions. This case serves as an important reminder to attorneys and experts that the role of the court as gatekeeper is different from its role as evaluator of the sufficiency of the evidence (as the court in another case, Washington v. Kellwood Co., explained so well). Put differently, simply because the expert opinion is admissible does not mean it will hold up in terms of the ultimate outcome of the case.

Questioning ESOP valuation. The U.S. Department of Labor (DOL) sued the defendant trustee (and others) alleging the trustee violated its duties under ERISA by causing an employee stock ownership plan (ESOP) to purchase the outstanding stock in a graphite processing company (Graphite Sales Inc.). According to the DOL, the purchase was for greater than fair market value, which meant the trustee caused the ESOP to overpay by approximately $6 million. At the time of the transaction, an independent valuation firm appraised the company. As part of the transaction, the sellers received stock warrants that amounted to an 18% equity stake in the company. Also, two officers received stock appreciation rights, representing a 10% equity interest. Further, an investor received rights to a 7% equity stake in the company.

The crux of the case was the valuation of the company. The DOL offered expert testimony that called into question the ESOP valuator’s contemporaneous appraisal. The defendant trustee presented its own trial expert to testify and rebut the opinion of the DOL’s expert. Both parties challenged the opposing testimony under Rule 702 of the federal rules of evidence and under Daubert and its progeny. Further, the DOL argued the opposing expert opinion was inadmissible under Rule 403, which provides for exclusion of relevant evidence on various grounds (unfair prejudice, confusing the issues, misleading the jury, etc.). The court’s discussion focused on Rule 702 and Daubert.

In a nutshell, Rule 702 and Daubert provide for testimony by a qualified expert whose “scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue.” The testimony must be based on sufficient facts and data and must be “the product of reliable principles and methods.” In assessing the testimony, a court considers whether the testimony “has been tested, is the subject of peer review and publication, has a permissible error rate, follows established standards, and receives ‘general acceptance’ within a ‘relevant scientific community.’”

“At this gatekeeping stage,” the court in the instant case said, the court’s focus is “on principles and methodology, not the conclusions that they generated.”

Objections to DOL expert testimony. In trying to exclude the DOL’s expert, the defense broadly claimed the expert’s value opinion was nothing more than ipse dixit, or “I say so.” This argument, the court found, was based on the expert’s statement during his deposition that he “could not speak for the entire industry.” In other words, he suggested different valuation experts might interpret certain facts differently.

“Of course, [the expert’s] concession … does not mean that his own interpretation is made up,” the court said, dismissing the defendant’s argument.

The defendant also attacked the expert’s methodology on specifics. For example, it took issue with the DOL expert’s statement that the ESOP appraiser should have used multiples of revenue and EBITDA, not multiples of EBIT and EBITDA, in valuing the company. The defense claimed the DOL expert’s view conflicted with a cited treatise that said the expert’s proposed approach was applied most frequently to startups and service businesses, neither of which the subject company was.

“The defendant is wrong,” the court said. It noted the treatise “explicitly contemplates” use of the expert’s approach “in circumstances other than start-ups and service companies.”

Secondly, the defendant objected to the DOL expert’s claim that the ESOP appraiser erred by using the exit multiple method rather than the Gordon growth model for its discounted cash flow analysis. The defendant said the expert’s critique was wrong because treatises permit the use of either method.

“Even if true,” the court said, the defense argument does not affect admissibility because it simply contests the DOL’s expert choice among accepted valuation methodologies.

Thirdly, the defendant claimed it was improper for the expert to consider the stock warrants and appreciation rights when valuing the company. The defendant noted that the expert, in deposition testimony, “admitted” that the warrants could be considered part of financing the transaction.

The court noted that, in the same testimony, the expert pointed to another “motivation” for the warrants: They were “a form of contingent consideration” and should have been added to the purchase price, he said.

The court said that the defendant would have a chance to probe this issue at trial. However, in terms of admissibility, the defendant failed to show the expert’s view was based on insufficient facts or conflicted with accepted principles and methodologies.

Moreover, the defendant raised questions related to the DOL expert’s application of the principles and method to the facts of the case. For example, the expert criticized the ESOP appraiser’s projections. The defendant, in turn, claimed the expert failed to give proper consideration to the management projections and ignored various other pieces of financial evidence.

The court noted that none of “these purported errors” showed the DOL expert “made up” his revenue projections or used unsound methods. The defendant failed to show that accepted valuation principles compelled the expert to weigh the evidence differently or consider certain evidence, the court said.

Another defense objection was to the expert’s criticism of the ESOP appraiser’s selection of guideline companies and the latter’s choices related to the application of the guideline company method. The defense claimed the expert’s criticism contradicted the expert’s own analysis on other topics. The defendant said there was no reason to use the expert’s preferred method.

According to the court, the defendant’s objection went toward the weight of the opposing opinion, but it did not “even remotely suggest” the opposing expert’s opinion was based on an unsound methodology.

Similarly, the DOL’s expert criticized the ESOP appraiser’s use of a 10% control premium to the guideline companies’ stock. The defendant suggested that the DOL expert’s analysis of control was wrong and made his calculation wrong.

The court disagreed again, noting that this type of application error “would not show that [the expert’s] views are inadmissible.

Objection to defense expert testimony. The court quickly dismissed the DOL’s claim that the defense expert’s testimony was inadmissible because he improperly proposed a damages methodology when doing so was the role of the court.

The court noted the defense expert’s approach—comparing what the ESOP paid for the stock with the fair market value of the stock on the date of the transaction—was the same approach the DOL expert used. Further, this analysis was a legally approved methodology.

In general, the court suggested that the parties mostly quarreled over the opposing expert’s conclusions but failed to show the conclusions were unscientific—the requisite inquiry for purposes of determining admissibility of expert testimony.

Both expert testimonies were admissible in their entirety, the court found.

Editor’s Note: A digest of the above-mentioned case, Washington v. Kellwood Co., 2016 U.S. Dist. LEXIS 92309 (July 15, 2016), and the court’s opinion are available at BVLaw.

 

Divorce Court Finds No Personal Goodwill Value in Single-Owner Business

Stephanos v. Stephanos (In re Marriage of Stephanos), Case No. 502013DR007061XXXXSB, Circuit Court of the Fifteenth Judicial Circuit, Palm Beach County, Florida, J. Samantha Schosberg Feuer, Final Judgment (Dec. 28, 2018)

A Florida divorce case is noteworthy for its multifaceted goodwill analysis, which included an examination by the court of which party had the burden of establishing that goodwill was either enterprise or personal in character and was either a marital asset or not. The nub of the problem was that the husband, who held sole title to the contested company, had a damaged business reputation but still claimed any goodwill existing in the business should be attributed to him. The wife, through expert and lay testimony, was able to show all of the goodwill was enterprise goodwill. The husband was not vital to the company’s continuing existence and success. Further, the court found a noncompete analysis (or “real world transaction”) would not change the goodwill attribution.

Owner’s problems with the law. The parties first filed for divorce in 2003. They then reconciled and dropped their divorce petitions. Ten years later, in June 2013, the husband filed another petition for divorce, which, in November 2013, prompted a counterpetition from the wife. The husband was active in the hormone replacement industry. At one point, he and a business partner equally owned a company, Palm Beach Rejuvenation (PBR). However, in 2007, during the reconciliation period with the wife, the husband and his brother became targets of a federal investigation and were indicted by the state of New York. PBR was raided. The events were on the cover of Sports Illustrated in 2007.

The husband pled guilty to a third-degree felony in the state case and was found guilty, placed on probation, and prohibited from ever providing human growth hormone services to anyone in New York state. The wife gave financial support for the husband’s defense and also provided funds for the creation of a separate entity, Nationwide Synergy Inc. (NSI), which operated in the hormone replacement industry but was not a professional practice. The valuation of NSI was a flashpoint during the divorce proceedings.

The parties also argued over whether PBR morphed into NSI or essentially stopped functioning because of the husband’s legal problems. The trial court ruled that NSI was mostly a separate entity, even though the businesses shared similarities and the husband had bought PBR’s assets and opened NSI in an effort to rebrand. Besides those two entities, between 2007 and 2013, the spouses, and the husband’s brother, also created other businesses involved in hormone replacement therapy.

Importantly, the NSI stock was in the husband’s name alone. The court noted the reason for this arrangement was strategic, to protect the wife from potential legal exposure in light of the husband’s past problems regarding PBR.

The husband was CEO, and the wife served as the CFO of NSI. The evidence showed she made an initial contribution of approximately $850,000 of her nonmarital assets and dealt with the company’s financial activities. She also supervised employees and assisted in creating an important database, and she worked on developing a reputation for NSI and the other entities.

In the company’s beginning, the husband recruited salespersons and put in place people who were key to generating cash. But, once the company grew, other employees became key persons, including the spouses’ son and another employee. The latter two developed a network of physicians who performed clinical valuations of potential customers who wanted to buy the company’s products over the internet. This medical assessment became federal law in 2008. NSI’s key employees established the necessary protocol at the company.

Between 2007 and 2016 (the valuation date), the value of the company went from about zero to $5.3 million and $5.7 million, according to the valuations the parties’ highly qualified experts offered at trial.

Equitable distribution principles. The overriding issue was for the court to determine whether NSI was a marital asset that was subject to equitable distribution.

The applicable statute (Fla. Stat. § 61.075) provides for a three-step process. In essence, the court first has to classify the assets and liabilities as marital or nonmarital. Next, the court has to value the “significant” marital assets based on “competent, substantial evidence.” Under case law, a court must not simply “split the difference” between the values the parties proposed but has to “cite to specific evidence or lack thereof in the record to arrive at its conclusions.” Finally, the court must distribute the assets and liabilities under a presumption in favor of equal distribution, “unless there is a justification for an unequal distribution based on all relevant factors.” Also, under the statute, all assets a couple acquires after the date of marriage that are not specifically established as nonmarital assets are presumed to be marital assets and liabilities. This presumption may be overcome by showing that the assets are nonmarital assets.

Residual method. The court’s inquiry focused on whether there was goodwill value in the company. The question was how to calculate the goodwill value and how to determine whether it was personal or enterprise goodwill.

The applicable statutory provision (Fla. Stat. § 61.075(3)(b)) and case law require a valuation based on the fair market value standard of value.

The clearest method would be the fair market value approach, which is best described as what would a willing buyer pay, and what would a willing seller accept, neither acting under duress for a sale of the business. The excess over assets would represent goodwill. See Thompson v. Thompson, 576 So. 2d 267 (Fla. 1991) (available at BVLaw).

The court explained that Thompson was the controlling case on the issue of business goodwill in the divorce context. Thompson says that enterprise goodwill is value attributable to the company/entity as opposed to value related to the reputation or continued presence of a particular person (“the marital litigant”). In Florida, enterprise goodwill is a marital asset, whereas personal goodwill is not.

The court noted that, when it came to the overall valuation of NSI, the parties’ experts achieved a fair market value determination that was remarkably close. The difference was less than $250,000. The wife’s expert found the company was worth $5.3 million, and the husband’s expert determined it was worth $5.7 million.

The more contentious issue was the goodwill calculation. The court noted the husband’s expert suggested he was unable to extrapolate any goodwill value from the fair market value. Although it respected the expert’s opinion, the court found the claim somewhat “dubious” given the expert’s “extensive expertise and knowledge in the area of business valuation and goodwill.”

In contrast, the wife’s expert used the residual method to determine the value of goodwill, which the husband’s expert allowed was a proper approach. By subtracting the net asset value from the entity’s FMV, the expert achieved a residual value (goodwill) of $2.2 million.

Burden of proof issue. The court noted that it found no reported cases that addressed which party had the burden of establishing the value of enterprise goodwill. Here, the husband claimed that all of the goodwill at the company was personal, whereas the wife claimed personal goodwill in the company was nonexistent or negligible. Accordingly, the husband contended the wife should have the burden of showing all of the goodwill was enterprise goodwill, while the wife argued the burden was on the husband to show he was entitled to the goodwill value as he claimed it was personal to him. Both parties cited cases to support their positions. The court concluded that, since the wife claimed there was goodwill, it was appropriate that she had the burden of showing that enterprise goodwill existed—”through competent and substantial evidence”—and that, therefore, the goodwill was a marital asset.

The court rejected the husband’s position that it was impossible to extract the value of personal goodwill from the residual value. Instead, the court relied on testimony from the wife’s expert as to the purchase price allocation approach and on other testimony and factors to come to the conclusion that there was no personal goodwill attributable to the husband.

The court specifically noted that the husband was a convicted felon who was “unable to compete in certain markets”; his reputation was blemished. He could not point to any customers his efforts brought in. He had no role in developing the database or sales force, both of which were critical parts of the business. He had no relationships with the company’s physician affiliates. Further, all employees of NSI had signed noncompetes and, therefore, were precluded from aligning themselves with the husband in a similar business. In addition, members in the physician affiliate network were bound by noncompetes and confidentiality agreements to protect NSI’s intellectual property. The physicians in the network had relationships with the two key employees, not the husband. The company’s advertising did not mention the husband because the company specifically determined that, if his affiliation with the company were known, it could hurt the business. Most of the company’s revenue stream was generated by website sales; the website in turn was managed by another employee, not the husband. Any web domains and phone numbers belonged to the company and would transfer in the event of a sale.

Company employees spoke of the husband’s limited role and said they did not know what he actually did there. One key employee said that, if the husband were to leave for a year, the company would continue to function as it always had. Also, as of 2016, the husband had limited his role in the company. He was rarely in the office and only communicated sporadically via email.

There was no credible evidence that showed the husband was key to the company, the court found. It decided that the entire residual value was enterprise goodwill. This amount was a marital asset, subject to equitable distribution.

Noncompete goodwill theory. That said, the court also considered the husband’s alternate theory in support of his position that the goodwill was personal to him. He and his expert contended that, in the real world (i.e., in an actual, as opposed to a hypothetical, transaction), a buyer would only be willing to purchase NSI’s stock if the husband executed a noncompete agreement.

The court noted, however, that the ASA’s business valuation standards do not require consideration of a noncompete when calculating fair market value. The court also noted it was not aware of any precedent “from any substantive authority in this State wherein the specificities regarding value and methodology address the criteria to value a covenant not to compete in a ‘real world’ situation.” In other words, there was no specific appellate opinion addressing the valuation of a noncompete.

The wife’s expert proposed looking to Internal Revenue Service guidelines for the purpose of valuing a noncompete. The nine factors included:

  1. The seller’s ability to compete;
  1. The seller’s intent to compete;
  1. The seller’s economic resources;
  1. The potential damage to the buyer the seller’s competition posed;
  1. The seller’s business expertise in the industry;
  1. The seller’s contacts and relationships with customers, suppliers, and others in the business;
  1. The buyer’s interest in eliminating competition;
  1. The duration and economic scope of the covenant; and
  1. The seller’s intention to remain in the same geographic area. See Langdon v. Commissioner, 59 Fed. Appx. 168 (8th Cir. 2003) (citing Lorvic Holdings, Inc. v. Commissioner, 1998 Tax Ct. Memo 283 (1998).

The court said it would rely on the analysis of the wife’s expert for the calculation of value (assuming there was any) of a noncompete. Several case-specific facts were critical, including the fact that all 16 sales force members of the company had executed noncompete, nonsolicitation, and confidentiality agreements, as did the 14 “non-sales force” employees.

Further, all 32 physicians in the company’s physician affiliate network were bound by noncompetes. The company had established a proprietary database related to customers. And there was an established relationship between the entity and the patients/customers the company served.

Considering all the restrictions in place, the court found a real-world transaction analysis that centered on the existence or nonexistence of the husband’s noncompete also would not change the outcome as to personal goodwill. Under either continued presence or noncompete analysis, the goodwill value personal to the husband was nonexistent or negligible, the court concluded.

In the final analysis, the court awarded the company to the husband. For equitable distribution purposes, the court adopted the $5.3 million valuation the wife’s expert had proposed as well as this expert’s determination that goodwill in the company was about $2.2 million and was enterprise goodwill that was subject to marital distribution.

Editor’s note: Hat tip to Josh Shilts (Villela & Shilts LLC) for alerting us to this important goodwill decision.

 

Pratt's Stats/DealStats Analysis Holds Up in Divorce Litigation

Hultz v. Kuhn, 2019 Md. App. LEXIS 151, 2019 WL 852109 (Feb. 21, 2019)

A Maryland divorce case illustrates the difficulties an appraiser charged with valuing a small company in the divorce context may face and how he or she may prevail in court.

The wife was the sole shareholder in a tree services business. The issue at divorce was the size of the monetary award to the husband. Initially, neither spouse offered much valuation evidence. The trial court performed a value determination based on a recent tax return that an en banc panel overturned. At the remand hearing, both parties presented expert testimony from CPAs who had valuation credentials.

The wife’s expert found the company had a value of zero. The husband’s expert explained in detail the numerous obstacles he encountered to performing a valuation. The company did not provide all of the requested financial information and the company’s tax preparer and management did not answer most of the questions the expert had asked. The company only made available four years of tax returns and a QuickBooks file, which did not “match up” from an accounting point of view. The expert also said that, from other “tax work,” he was able to see there were accounting problems. He noted “some troubling trends regarding … revenues to operating costs … as time passed.” Sales were declining, but expenses were increasing, he noted.

The expert considered all three valuation approaches but concluded here the market approach generated the only reliable indicator of value. He made it clear that he normally would prefer to do an income analysis, but he didn’t have the necessary information and the information he received was problematic. For the market approach, he used Pratt’s Stats (now DealStats) and attained a value of about $408,000, which he decided was too high for this kind of company. In light of the company’s poor performance, he applied a “very heavy discount for lack of marketability,” i.e., 50%. He recognized the significant payroll tax liability, which would make it less likely that someone would buy the business. The DLOM reduced the fair market value to $204,000.

The trial court found it difficult to reconcile the zero value with the company’s employing 11 people, paying the employee who took over the husband’s job a $65,000 annual salary, allowing the wife to pay herself $40,000 and $50,000 in 2014 and 2015, respectively, and other factors. The court credited the opinion of the husband’s expert, noting his credentials and the detailed explanation he gave of the various valuation methods and the obstacles he faced in doing the valuation.

The state Court of Special Appeals upheld the trial court’s findings.

Takeaway: Courts may be sympathetic to an expert whose work is stymied by the other side’s lack of cooperation. Therefore, talk about it!

 

Important Utah Goodwill Ruling Concerning One-Person Business

Marroquin v. Marroquin, 2019 UT App 38 (March 14, 2019)

The Utah Court of Appeals examined the nature of goodwill in a one-person business and, in so doing, expanded on the state’s goodwill jurisprudence. The appeals court upheld the trial court’s finding that there was no institutional (enterprise) goodwill in a business that entirely depended on the owner-spouse’s efforts and reputation for competency.

Personal relationships: At issue was the value of a vending machine business that operated throughout Salt Lake City. The husband owned 99% of the business (someone else owned the remaining 1%) and was the only employee. He developed and maintained the relationships with the property owners where the vending machines and kiosks were located. Most of the contracts were month-to-month, making it easy for a property owner to replace one vendor with another.

The company was a marital asset subject to division. But the parties disagreed over the nature of goodwill related to the business. Under Utah law, enterprise goodwill is a marital asset, subject to division, but personal goodwill is not.

The trial court credited the husband’s expert, a CPA and experienced business valuator, who valued the company under the net asset approach and who determined the company had no “institutional goodwill.” The expert noted that, “without the relationships that exist for the places where the vending machines are located, there is no potential for goodwill. There’s no income earning capacity that would be in excess of the value of the assets.”

“[T]he goodwill of [the company] is solely attributable to [the husband’s] work, his efforts, and his reputation for competency,” the trial court said. The goodwill was based on the husband’s “being the face of the business” and his personal relationships with the property owners that allowed him to continue to conduct business on their property on a month-to-month basis.

The wife unsuccessfully challenged this finding in a post-judgment motion and then on appeal. The Court of Appeals agreed with the trial court that the business was essentially a kind of sole proprietorship in which the wife had minimal involvement. The husband was the one who remained in contact with the entities that enabled the business to continue operating, the appeals court noted. While the wife claimed that “anybody could step into [the husband’s] shoes and carry on with the business under its name and with its assets,” she offered no evidence to support this assertion, the court said.

The appeals court found the trial court did not abuse its discretion in finding there was no institutional goodwill to be included in the company’s valuation.

Hat tip to Daniel Rondeau (Sage Forensic Accounting Inc.) for alerting us to this important decision.

About Dan
Dan Rosio is the partner-in-charge of Katz, Sapper & Miller's Valuation Services Group. Dan advises clients on valuation, succession planning, and transaction matters, often serving as an expert witness and helping find solutions to unique challenges. Connect with him on LinkedIn

 

About Andy
Andy Manchir is a director in Katz, Sapper & Miller's Valuation and ESOP Services Groups. Andy helps clients understand the value of their business and advises them on succession planning options, including ESOP, third-party sales, or family transitions. Connect with him on LinkedIn.

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Litigation Services Bulletin: Q2 2019

Posted 2:01 PM by

In This Issue:

 

Court Says Daubert’s ‘Gatekeeper’ Role Favors Inclusion, Not Exclusion

Ferraro v. Convercent, Inc., 2018 U.S. Dist. LEXIS 209530 (Dec. 12, 2018)

This Daubert case illustrates how courts may interpret the role of “gatekeeper” differently. The dispute featured a company that provided software-based services. The defendants claimed the plaintiff’s expert was unqualified because he lacked the necessary experience valuing that type of company, but the court found the law did not require this degree of specialized knowledge. In contrast, in Weinman v. Crowley, a bankruptcy case turning on insolvency, the court, on its own accord, found the trustee’s expert, who had extensive background in international finance and some accounting experience, lacked the necessary solvency experience. The court suggested that it would have excluded the expert on this basis had the defendant argued for it. Courts also diverge on reliability when it comes to calculating damages. Here, the court said some degree of speculation is common in expert testimony. In contrast, in a recent Texas case, Cargotec v. Logan Industries, an appeals court majority found damages testimony was not admissible because the expert relied on management projections that were based on some unfounded assumptions, notwithstanding the expert’s extensive independent work on the case.

Backstory. In 1994, the plaintiff founded a company, Group Dynamics, that specialized in complex workplace investigations. The company later changed its name to Business Controls and eventually became Convercent, the named defendant. As the company developed, it expanded the services it provided. They included the traditional web-based whistleblower services as well as investigative, consulting, and training services. In 2012, Convercent was worth approximately $6 million to $8 million. The plaintiff began to look for outside investors. The company’s then-president introduced the plaintiff to the leader of a consulting company, Nebbiolo, suggesting Nebbiolo could increase Convercent’s value.

At that time, the plaintiff did not know that Nebbiolo had only just been formed and that Convercent’s president had a personal stake in it. In 2012, the plaintiff and Nebbiolo entered into a professional services agreement (PSA) under which Nebbiolo would provide services for a fee and the ability to buy equity in Convercent. As Nebbiolo lacked the funds to buy the stock outright, it persuaded the plaintiff to accept a four-year note for $1.95 million. Nebbiolo convinced the plaintiff to surrender his role as CEO of Convercent, giving verbal assurances that he could continue to work for Convercent as long as he wished. After the plaintiff’s three-year employment contract was up, Convercent declined to renew it.

In March 2017, the plaintiff sued Convercent, Nebbiolo, and two persons who he claimed had conspired against him. The claims included wrongful discharge, breach of the employment agreement, civil conspiracy, and violations of the Colorado Organized Crime Control Act (COCCA). In an earlier ruling, the court dismissed some claims but allowed others to go forward.

The defendants then filed several pretrial motions, including a Rule 702/Daubert challenge to the plaintiff’s damages expert. The court granted the defendants’ summary judgment motion as to the plaintiff’s claim for breach of the duty of good faith and fair dealing against Convercent. But the court found that there were triable issues as to the other claims.

The court also denied the defendants’ motion to exclude the plaintiff’s expert testimony.

Applicable law. Rule 702 of the Federal Rules of Evidence provides for expert testimony if the expert’s specialized knowledge assists the trier of fact and the expert’s opinions are based on sufficient facts and reliable methods properly applied to the facts. Under Daubert, the evidence must be relevant and reliable. The party offering the expert testimony has the burden of showing the testimony is admissible. The trial court serves as “gatekeeper,” assessing the expert’s reasoning and methodology and determining whether the expert opinion is scientifically valid and applicable to the facts of the case. Here, in explaining the applicable legal principles, the court noted that, being the gatekeeper “is not a role that emphasizes exclusion of expert testimony.”

Expert testimony. The plaintiff’s expert had advanced degrees in economics and professional experience working in that field. He was retained to provide a damages calculation, which included a valuation of the plaintiff’s shares in Convercent as of the end of 2017, the year in which the plaintiff filed suit.

The defendants claimed the testimony failed all the requirements of Rule 702 and Daubert: qualification, relevance, and reliability.

Qualification. According to the defendants, the expert lacked the specialized knowledge to testify to Convercent’s value because he had never valued a software-as-a-service company.

The court disagreed, finding the expert had multiple economics degrees and had been teaching and working in the field of economics for years. He also had prepared business valuations for a cannabis company and for a medical devices company. “Defendants have not stated why a business valuation of a software-as-a-service company is any different than valuing a company in the cannabis and medical devices industry,” the court said. It further noted that, under case law, an expert’s lack of specialized knowledge goes toward the weight of the testimony but does not affect admissibility.

Relevance. The defendants contended the expert testimony was not relevant because it was incongruous with the remedy available to the plaintiff. The plaintiff could only recover the projected value of the company’s shares today before the plaintiff entered into the PSA with Nebbiolo—thus, before March 2012 (when the company did business as Business Controls). The defendants argued this remedy was mandated by the plaintiff’s claim that he would not have made the PSA agreement had he known the facts about Nebbiolo.

In the alternative, the defendants said the expert should have valued the company (then doing business as Convercent) as of 2015, not 2017.

The court rejected this argument, noting that, relative to expert testimony, “relevance” meant the testimony would have to assist the jury in its damages determination. Broadly speaking, the testimony here was helpful because the average juror was unlikely to have the knowledge necessary to value a company based on market indicators, the court observed. It also found the testimony was relevant to the damages issue in the instant case.

The court noted that, under the controlling law, the court could not require the plaintiff to pursue one remedy over another. Rather, a plaintiff alleging fraudulent inducement of a contract could request rescission of the contract to restore the conditions as they existed before the parties entered into the contract or affirm the contract and claim the difference between the actual value of the benefits received and the value of the benefits the defendant had promised.

Therefore, the plaintiff here was entitled “to affirm the PSA and seek the value of his current Convercent shares,” the court said. The expert’s testimony on this point was relevant, the court found, adding it ultimately was the jury’s decision what the appropriate measure of damages here was.

Reliability. The defendants claimed the expert opinion was not reliable because the opposing expert lacked the necessary qualifications (an objection the court rejected) and also because the expert failed to consider mitigation and other pertinent facts. Therefore, his opinion was speculative.

The court dismissed these objections as well. It noted that the defendants would have a chance to challenge the data on which the plaintiff’s expert based his calculation. The plaintiff’s expert appeared to use similar facts and data as the defendants’ expert, the court pointed out. The court said it would not preclude the plaintiff’s expert from testifying “simply because the two experts have reached a different result. This is almost always the case with opposing experts.” Disagreeing with an expert’s approach or his or her reliance on certain data “does not necessarily mean an expert’s opinion is not reliable under Rule 702,” the court said.

Finally, the court noted that there was “some degree of speculation” in the plaintiff expert’s report. However, the court also observed that “there is typically some degree of speculation in expert testimony.” Performing the role of gatekeeper here, the court said its task was to ensure the expert used a reliable methodology. The expert did so by using a market-based approach, the court found.

In sum, the court found there were no grounds under Rule 702 or Daubert to exclude the plaintiff’s damages expert.

Editor’s note: Digests of Weinman v. Crowley and Cargotec v. Logan Industries, as well as the respective court opinions, are available at BVLaw.

 

Expert’s Use of Wrong Damages Methodology Results in ‘Grossly Inflated’ Damages

Zayo Group v. Latisys Holdings, LLC, 2018 Del. Ch. LEXIS 540 (Nov. 26, 2018)

A Delaware case turned on the interpretation of key provisions in the parties’ sales purchase agreement. But the case includes a damages analysis from the court that deserves attention. The plaintiff claimed the contract required the defendant to make certain disclosures that the latter did not make. The Court of Chancery found the contract was ambiguous; however, based on extrinsic evidence, the court ruled in favor of the defendant. Although the court could have ended its discussion there, it decided to analyze in detail the damages evidence the plaintiff offered. The court noted the plaintiff’s expert lacked experience in valuing going-concern businesses. This shortcoming, the court said, showed when the expert chose a methodology for calculating expectancy damages that did not fit the facts of the case, resulting in a “grossly inflated final damages number.” According to the court, even if the plaintiff had prevailed on the liability issue, it would have lost on damages for failure to present a persuasive damages analysis.

Failure to prove liability. The plaintiff, Zayo Group (Zayo), provided high-tech infrastructure, including fiber and bandwidth connectivity, colocation, and cloud services. Colocation refers to data center facilities in which businesses can rent space to operate their software and hardware. This computing real estate usually includes physical space, cooling, power, bandwidth, and physical security for the customer’s servers and other hardware. At the time of the litigation, Zayo had acquired over 40 fiber and data center companies.

The defendant, Latisys Holdings LLC (Latisys), also offered IT infrastructure services, including data center colocation. In January 2015, Zayo and Latisys executed a sales and purchase agreement (SPA) pursuant to which Zayo bought Latisys for $675 million. The transaction closed on Feb. 23, 2015. The parties later disagreed on the meaning of certain terms in the SPA.

Latisys had two kinds of contracts with its customers: master services agreements (MSAs) and service order forms (SOFs). The SOFs drove the customer relationships; they specified the services a customer bought, including rates, recurring charges, and renewal periods. Customers often had more than one SOF to cover all the services they required. The average term of an SOF was three years. When a contract expired, Latisys would provide services on a month-to-month basis. When a customer relationship had reached the “month-to-month” phase, the customer could terminate its services with Latisys within 30 days of written notice. Thirty percent of Latisys’ revenue was guaranteed only for 30 days.

The average period of Latisys’ SOFs was about four and a half years. Typically, as time went on, customers relied less on Latisys’ services and required less storage space. In negotiating a renewal for an expiring SOF, customers often were successful in extracting concessions from Latisys.

In November 2014, Zayo submitted a letter of interest to acquire Latisys, proposing “a total value in the range of $625M - $655M in cash (approximately 11 – 11.5x Q4 2014E LQA Adjusted EBITDA of $56.8M) on a cash-free, debt-free basis.” For purposes of due diligence, Latisys sent Zayo a spreadsheet that listed each customer (but not by name), the contract with the customer, expiration dates, and recurring revenue by location and product. The spreadsheet included information regarding bookings and loss from turnover (churn) for 2013 and 2014. Zayo received all the MSAs and SOFs for Latisys’ top 30 customers by monthly recurring revenue (MRR).

A Zayo’s financial analyst working on the deal developed a financial model that calculated how many months of revenue were left on the contract for each of the customers and how much revenue was guaranteed for the customers. The eventual dispute centered on five customers. Latisys initially identified them by code name but provided a key to the names in early January 2015.

Around Christmas 2014, Zayo sent a letter of intent in which it proposed a base acquisition for $655 million. Among other things, Zayo wanted to change one of the SPA provisions to include the following sentence: “No Latisys Company has received any written notice that any party to Material Contract intends to cancel, terminate, materially modify, refuse to perform or refuse to renew such Material Contract.” (emphasis added)

Latisys accepted all of the proposed language but struck the phrase “or refuse to renew” from Zayo’s draft. Zayo returned the redline to Latisys, accepting Latisys’ change. Zayo then performed a number of calculations, including a synergies analysis, which indicated significant cost saving as a result of the deal. Zayo also undertook a comparable analysis that indicated “recent comparable transactions” at “13.6 X Avg Reported LQA EBITDA Mult.” Moreover, Zayo’s financial analyst performed a 30-year discounted cash flow analysis, a net present value sensitivity analysis, and an internal rate of return analysis.

In the end, the parties settled on a price of $675 million. Latisys also agreed to indemnify Zayo for losses stemming from various breaches, assuming cumulative aggregate damages exceeded $3.375 million (the basket). The final SPA did not make representations or include warranties as to churn, churn rates, revenue, or expected revenue.

In late 2016, Zayo sued Latisys in the Delaware Court of Chancery, demanding indemnification for damages resulting from breaches of representations, warranties, and covenants included in the SPA.

Zayo claimed that Latisys failed to disclose that five customers had notified Latisys of their intent not to renew their contracts or renew the contract under different terms. Zayo contended Latisys had an obligation under the SPA to disclose this information. According to Zayo, nonrenewal of certain contracts was captured by the terms “terminate” or “cancel,” which appeared in the SPA. Latisys responded that, under the specific language of the SPA, it had no obligation to disclose the nonrenewals to Zayo.

In ruling on the liability issue, the court found the SPA was ambiguous in that both parties’ interpretations of the contractual language were reasonable. To resolve the dispute, the court then considered extrinsic evidence, including the drafting history of the SPA, the sales negotiations between the parties, and trial testimony as to the parties’ understanding of what representation Latisys would or would not have agreed to when negotiating with Zayo. A Latisys representative testified the phrase “refuse to renew” suggested an allocation of risk between the buyer and the seller. This language would make the seller liable to the buyer for undisclosed upcoming churn. According to the witness, Latisys purposefully did not include this language in the contract because it would impose on the company an unreasonable obligation to isolate and disclose potential nonrenewals. The court concluded extrinsic evidence supported Latisys’ interpretation of the SPA. Latisys did not commit a breach of contract as to any of the five customers. There was no liability.

Benefit-of-the-bargain method. The court’s liability conclusion meant the end of the plaintiff’s case. However, “for the sake of completeness,” the court also considered whether the plaintiff would have been able to prove recoverable damages.

The court explained that the standard was high: The plaintiff had to prove damages by a preponderance of the evidence. “Contract damages are not like some works of abstract art; the plaintiff cannot simply throw its proof against the canvas and hope that something recognizable as damages emerges,” the court said. It added that this case, in particular, required precise calculations because the contested SPA had an indemnification provision. Zayo would only qualify for damages exceeding the basket, i.e., the cumulative aggregate amount of $3.375 million.

The court said the plaintiff’s expert was “certainly qualified to calculate damages in the ordinary course.” However, the expert acknowledged that she had never valued a business. This lack of valuation experience “proved a disadvantage to her and ultimately rendered her opinions in this case unpersuasive,” the court said. It pointed out that the defense expert had “significant experience in benefit-of-the-bargain damages and business valuations,” including experience serving as an expert in post-transaction disputes related to representations and warranties made in sales and purchase agreements. The defense expert testified that, “to the extent the damage is derived by an alleged change in the value of what the deal should have been, then, of course, the valuation experience is pretty critical.”

The plaintiff’s expert based her expectancy damages on a multiple (14.1) of EBITDA, but this methodology was inappropriate under the facts of the case, the court said.

Expectancy (or “benefit-of-the-bargain”) damages seek to capture the difference between the as-represented value of the purchase price and the value the buyer actually received, the court explained. “The actual value the purchaser received, in turn, must assume, and account for, a diminution of the company’s earnings into perpetuity,” the court said. It further noted that the benefit-of-the-bargain methodology is only appropriate if the alleged breach causes a permanent diminution in the value of the business (lost revenues into perpetuity) and the business has been permanently impaired.

The court noted that, in deposition testimony, the plaintiff’s expert acknowledged as much. She said that this method was only appropriate where there was a loss of monthly recurring revenue “into the foreseeable future.” She defined “foreseeable future” as “one year.” At trial, she admitted that all the contested contracts expired in less than one year. She recognized that, if Zayo knew that a contested contract was in the month-to-month phase, the maximum amount a customer would be liable for would be 30 days of revenue.

The court noted that Zayo made no attempt to prove diminution of value into perpetuity; nor did its expert, by her own admission, perform a post-closing valuation of Latisys. In contrast, the opposing expert reviewed the plaintiff’s internal calculations of value and found the plaintiff, in effect, believed the value of Latisys actually increased after the deal closed. In other words, the acquisition resulted in positive returns on the plaintiff’s investment.

The court also noted there was no support in the record for the plaintiff expert’s testimony that Zayo would not have paid $675 million for Latisys had Zayo known about the renewal situation.

The court said it could “appreciate why Zayo may have avoided taking on the challenge of proving that Latisys was worth less ($22 million less to be precise) after Closing.” Zayo knew it was buying a business based on short-term contracts, with customer loyalty somewhere between four and five years, the court observed. The contested contracts expired in less than a year from the time Zayo was considering an acquisition of Latisys. If the contracts were near expiration or in the month-to-month phase at the closing of the deal, Zayo was not in a position to claim expectancy damages beyond one month of monthly recurring revenue, the court pointed out.

Additionally, the court noted that there was no evidence that Zayo based its purchase price on a multiple of EBITDA, as Zayo’s damages expert did for her calculation. Therefore, “it is difficult to understand why [the expert] would choose an EBITDA multiple as the most accurate and comprehensive metric for valuing damages.” A Zayo executive in testimony explained that the sales price was based on a number of different factors. The court said it was unsurprising that the plaintiff’s expert later struggled to explain why she selected 14.1 as the EBITDA multiple in her calculation. The damages calculation lacked any foundation in the evidence, the court found.

On the other hand, the court found the defendant’s expert proposed several damages scenarios that were credible. All the calculations showed that, under the SPA’s indemnification clause, the realized damages would not exceed the $3.375 million base amount. The court said it found most persuasive an out-of-pocket cost analysis for lost revenue through the remaining contract term of each of the contested contracts for the five customers. This defense calculation was based on the assumption that the customers would renegotiate contracts after the expiration of the existing contract based on the state of the market. The calculation achieved a total damages amount of $2.1 million, below the required $3.375 million.

The court observed that a calculation that considered damages for a period longer than the remaining terms of the contested contracts produced a total damage amount of $3.4 million, a number that was only slightly above the indemnification threshold. “[A] damages calculation that assumes Zayo would have realized revenue beyond the bargained-for SOF does not comport with the evidence of record,” the court said, pointing to market reality and the need for service companies often to offer significant price concessions to customers.

In a last-ditch effort to advocate for benefit-of-the-bargain damages, the plaintiff claimed that the AICPA Practice Aid considered those damages appropriate where “a buyer’s subjective expectation has been materially affected.”

Not so, the court said. Defense expert testimony as well as the AICPA Practice Aid confirmed that a multiples methodology for calculating damages was only appropriate “where there is a permanent impairment to the value of the business and the value the buyer receives is less than the value for which the buyer bargained.”

The Court of Chancery found that, even if the plaintiff had met its burden of proving liability, it would have been unable to prove damages. The defendant’s expert provided the only credible damages evidence, and it showed that the plaintiff had not suffered damages above the amount to which the parties had stipulated in their indemnification agreement, the court concluded.

 

Court Concludes Plaintiff Cannot Satisfy Three-Part New York Lost Profits Test

MY Imagination v. M.Z. Berger & Co., 2018 U.S. Dist. LEXIS 184346 (Oct. 29, 2018)

A contract case that was subject to New York law provides a helpful review of the test a plaintiff must meet to qualify for lost profits. Here, the plaintiff’s case was poorly litigated and ultimately made it impossible for the plaintiff to advocate for lost profits. On the record, the plaintiff initially conceded that it was a new business with no track record and that lost profits or lost opportunities damages would be speculative. Later efforts to walk back these statements were unsuccessful. The court also found flawed the plaintiff expert’s methodology for calculating lost profits. The expert seemed unaware of key facts and relied blindly on statements from the plaintiff as to possible sales and profit margins, the court noted. This case illustrates how a damages case falls apart when it lacks a consistent damages theory, the participants are not on the same page, and the expert is not fully informed of the facts and the record.

Litigation history. The plaintiff, MY Imagination, was a new stationary company that wanted to enter the school supply market. For this purpose, it bought the assets of the defendant, M.Z. Berger, a well-established consumer-goods wholesaler. The defendant had a number of valuable license agreements including ones with LEGO, Universal Studios (Universal), and One Direction, a very successful English-Irish pop boy band.

The plaintiff claimed that, under the parties’ asset purchase agreement, which was governed by New York law, the defendant had agreed to make “commercially reasonable” efforts to help the plaintiff in transferring those licenses. Also, the plaintiff said, the defendant had promised to leave the stationary industry.

After the sale, the parties’ relationship broke down. The plaintiff obtained the LEGO license, the most lucrative license, but not the others. The record showed that there was a dispute between the plaintiff’s principals as to whether to pursue other licenses. For example, the plaintiff twice turned down a licensing agreement with Nickelodeon. A Universal representative later testified that Universal decided on its own not to transfer the stationary license from the defendant to the plaintiff.

In suing the defendant, the plaintiff brought contract and tort claims, alleging the defendant breached the asset purchase agreement. The federal district court adjudicating the case granted the defendant’s summary judgment motion as to all claims. Regarding the contract claims, the court found the plaintiff failed to prove actual damages.

The plaintiff appealed the findings with the 6th Circuit Court of Appeals, which affirmed the dismissal of the tort claims but reinstated the contract claims. The appeals court found there were genuine issues of fact as to: (1) whether the defendant made “commercially reasonable” efforts on behalf of the plaintiff; and (2) whether the defendant, after selling its goodwill, solicited former retail customers on behalf of Universal’s new product line.

In addition, the 6th Circuit noted “the [district] court’s emphasis on actual damages was misplaced. In New York, nominal damages are ‘always available for breach of contract.’” It sent the case back to the district court.

Inconsistent damages theory. In deposition testimony, the plaintiff’s two principals admitted that it was difficult to predict how much profit the plaintiff would reap from a particular license. Importantly, in a court brief, the plaintiff conceded:

Here, Plaintiff was a new business with no established history and approval of specific license transfers would be difficult to establish. Under these circumstances, due to the admittedly speculative nature of Plaintiff’s damages relative to lost profits or lost business opportunities, rescissory damages are an available, appropriate and proper measure of damages for Breach of Contract.

On remand to the district court, the plaintiff suddenly asked for lost profits and presented expert testimony to support its position. In response, the defendant filed another summary judgment motion, arguing the plaintiff was unable to meet the legal requirements for lost profits and asking the court to limit the remedy to nominal damages.

The court found the expert testimony unreliable and ruled for the defendant.

Applicable law. The court explained that, under the applicable New York case law, the party seeking lost profits has to satisfy a three-part test. See Kenford Co. v. County of Erie, 67 N.Y.2d 257 (1986) (available at BVLaw).

Causation. In the controlling Kenford case, the New York high court said the plaintiff first has to show causation. Put differently, the plaintiff has to establish a causal connection between the alleged wrongdoing and the alleged harm to the plaintiff.

Here, the court explained the plaintiff had to show on a license-by-license basis that, “but for” the defendant’s alleged failure to make “commercially reasonable efforts” to transfer the individual licenses, the plaintiff would have obtained them. The court noted the defendant never guaranteed the licenses would be transferred.

In addition, the plaintiff had to show that the defendant’s alleged solicitation of former retail customers directly caused the plaintiff to lose business.

The court observed that the plaintiff failed to take discovery from any licensor other than Universal. The plaintiff could not point to any statement that, “if [the defendant] had done X, then Licensor A would have transferred the license to [the plaintiff],” the court said. As regards Universal, at deposition, the plaintiff never asked the witness what impact the defendant’s “commercially reasonable efforts” at the relevant time might have had on Universal’s decision, the court added.

Based on the record of the case, the court said to conclude that a license would have transferred, but for the defendant’s conduct, and that the plaintiff would have accepted a particular license, was nothing more than speculation. The plaintiff failed to meet the causation requirement.

Reasonable certainty. Secondly, the plaintiff had to show lost profits with “reasonable certainty.” This requirement has particular importance when the plaintiff is a new business, the court pointed out. The bar in effect is higher because there is no “reasonable basis of experience upon which to estimate lost profits with the requisite degree of reasonable certainty,” the court explained (citing Cramer v Grand Rapids Show Case Co., 223 N.Y. 63 (1918)).

The court further noted that expert testimony was necessary to establish that lost profits damages were “capable of measurement based upon known reliable factors without undue speculation” (citing Schonfeld v. Hilliard, 218 F.3d 164 (2d Cir. 2000) (available at BVLaw).

The court found the plaintiff’s expert was unable to do so. He did not offer an “advanced and sophisticated method for predicting the probable results of contemplated projects,” the court said (citing Kenford). Instead, the expert relied on the plaintiff’s projections and interviews with the principals, ignoring the fact that those principals on the record had admitted that lost profits would be speculative.

Further, the expert used the defendant’s 2013 sales data but applied a profit margin from the plaintiff’s 2014 projection of sales. He also failed to consider that not every license would be transferred. In doing so, he contradicted the record, which showed that Universal, on its own, had declined to transfer its license to the plaintiff and that the plaintiff, on its own, twice had declined a license with Nickelodeon, the court said.

New York courts have found that relying on what the plaintiff thinks “might” have happened fails to meet the applicable test, the court noted. Here, the expert assumed a profit margin based on the plaintiff’s representations that it would have sales of $25 million in 2014 and its profit margin would increase over that of the defendant. The expert also seemed unaware of actual sales data as to the important LEGO license, the court noted. Ultimately, his calculation assumed a series of transactions—all hypothetical—would occur. This approach “constitutes precisely the sort of conjecture that the reasonable certainty standard prohibits,” the court said.

The court also rejected the expert’s alternate, more conservative, calculation that was based solely on the Universal license. The court said the plaintiff never asked for actual sales figures from any licensee, including Universal, or any customer (such as Target or Walmart).

In a footnote, the court dismissed the plaintiff’s late claim that it was not a new business because its principals were “experienced business men with extensive familiarity with product licensing.” The court pointed out that the plaintiff’s expert in his report said the plaintiff was a “new business.” Further, the 6th Circuit earlier also found the plaintiff was a “new stationary company.”

Parties’ contemplation. Thirdly, the applicable test required the plaintiff to show that the parties contemplated lost profits as a remedy for breach of contract. Here, the parties disagreed over whether the asset purchase agreement provided lost profits.

For its current ruling, the court said it did not have to resolve this issue because the plaintiff failed to meet the other two requirements for lost profits.

Nominal damages. The court noted that, under New York law, the plaintiff was limited to nominal damages assuming it could show liability, i.e., the defendant breached its obligations under the controlling agreement.

Futile course change. The court noted, and dismissed, the plaintiff’s efforts to “down play the statements in the record in which it conceded that lost profits are not a viable damage theory and statements indicating that [the plaintiff] was a new business entity.”

The court pointed out that in those very statements the plaintiff admitted that it was: (1) a new business; (2) had no history of sales; (3) could not establish which, if any, of the licenses would transfer; and, most importantly, (4) conceded that any lost profits were speculative.

The court also rejected the plaintiff’s claim that the defendant failed to address the plaintiff expert’s theory for loss of business value. In actuality, the court said, the expert did not present a loss of business value calculation. Instead, the expert said that, under the circumstances, “a short horizon lost profits calculation is more appropriate than a calculation of business value based on long-term projections.”

For all of these reasons, the court granted the defendant’s summary judgment motion, finding that lost profits were not a remedy available to the plaintiff.

 

Daubert Ruling on How to Satisfy Apportionment When Using Benchmark Licenses

Bio Rad Labs. v. 10X Genomics, Inc., 2018 U.S. Dist. LEXIS 187897 (Nov. 2, 2018); Bio Rad Labs. v. 10X Genomics, Inc., 2018 U.S. Dist. LEXIS 167104 (Sept. 28, 2018)

A short but insightful Daubert opinion sheds light on how a damages expert may meet the apportionment requirement where the expert uses benchmark license agreements to develop a reasonable royalty. For purposes of admissibility, the issue in this case was whether the plaintiffs’ expert could assume the prior licenses apportioned for patented and unpatented features, as the plaintiff initially claimed or, as the defendant would have it, whether the expert had to quantify the value of the patented features to the licensed product in the benchmark licenses and show the apportionment was comparable to the value assigned to the patented features in the accused product. The court here found a middle ground.

Background. The plaintiffs alleged that the defendant’s “10X Genomics platform” had violated a number of their patents having to do with “methods for conducting an auto catalytic reaction in a microfluidic system.”

Both parties raised Rule 702 and Daubert challenges to the opposing expert’s damages testimony. The accused products had patented and unpatented features.

The court, in its earlier opinion, admitted the defense expert’s reasonable royalty analysis, but it rejected the plaintiff expert’s lost profits calculation, assuming a two-supplier market. The court found the expert had failed to support his analysis with economic or financial data but had relied on qualitative evidence only.

The plaintiffs’ expert also calculated a reasonable royalty. He relied on three benchmark licenses to determine a royalty rate the parties would agree on in a hypothetical negotiation. The court found the expert made a “showing of baseline comparability between the licenses.”

At the same time, the court found the analysis failed the apportionment requirement. Specifically, the court objected to the expert’s superficial analysis, which asserted, without more, that the benchmark licenses had apportionment “built in,” such that the parties making the agreements would have apportioned for the contribution of the patented feature to the protected products. Therefore, the expert suggested, no further apportionment analysis was necessary.

In its earlier ruling, the court noted that, even assuming the parties to the benchmark agreements dealt with the apportionment requirement in calculating a reasonable royalty, did not show the same royalty rates applied in the instant case. By way of example, one comparable agreement might use a 15% reasonable royalty in a situation in which the patented technology accounted for 50% of the product. Another comparable agreement might use a 3% royalty where the patented technology accounted for 10% of a different product. While there was no doubt that the agreements incorporated apportionment, further analysis was necessary to show that either rate was apportioned in a comparable way to the value of the patented technology to the accused product(s), the court said. See Bio Rad Labs. v. 10X Genomics, Inc., 2018 U.S. Dist. LEXIS 167104 (Sept. 28, 2018).

Although the court rejected the expert’s reasonable royalty calculation, it allowed the plaintiffs to supplement the expert report.

Subsequently, the issue was whether the expert’s supplemental report adequately addressed the apportionment issue for admissibility purposes. The court found it did.

Applicable legal principles. The court explained that Rule 702 imposed a trilogy of requirements: qualification, reliability, and relevance (fit). Under the qualification prong, the witness must qualify as an expert by way of “a broad range of knowledge, skills, and training.” Reliability requires the expert testimony to be based on the “methods and procedures of science” rather than “subjective belief or unsupported speculation.” Relevance or fit means the testimony has to be helpful to the trier of fact when deciding the issues in the case.

Apportionment is a cornerstone of patent infringement cases. It seeks to ensure the patent holder is compensated for the infringement that can be attributed to the patented feature, and not more.

‘Approximation and uncertainty.’ In the supplemental report, the plaintiffs’ expert compared the unpatented features of the accused products with what he considered to be the unlicensed features of the products at issue in the benchmark licenses. He determined that there were unlicensed features analogous to the unpatented features. He also found the relative value of the licensed technology to the licensed products was comparable to the relative value of the patented technology to the accused product. He concluded that the royalty rates in the comparable licenses were apportioned in a comparable fashion to the royalty rate in the hypothetical license.

The defendant argued the opposing expert relied on qualitative rather than quantitative analyses and therefore did not satisfy the apportionment requirement.

The court disagreed, noting the defendant’s argument conflicted with a general principle that “any reasonable royalty analysis necessarily involves an element of approximation and uncertainty.” Also, the court said, “it may be impossible to quantitatively determine the exact percentage of a royalty rate that corresponds to each component of a licensed product.”

The court said it found the following commentary accurate:

The challenge is that apportionment is inherently imprecise. There’s never going to be a perfect basis to apportion … Licensors and licensees are not doing [rigorous scientific analyses] to decide the royalty rate. They negotiate based on their perception of the value being contributed—based on a lot of qualitative information typically … To require that sort of level of scientific discipline, (a) increases the cost of every case, and (b) divorces us from real life.

The court concluded that the plaintiff expert’s supplemental report filled the analytic gap in his initial report, “at least to the extent necessary to make his reasonable royalty opinion admissible.” The court allowed the reasonable royalty testimony into evidence.

 

Court Rejects Expert’s Reliance on Other Celebrity Royalty Agreements to Develop Damages Analysis

Olive v. General Nutrition Centers, 2018 Cal. App. LEXIS 998 (Nov. 2, 2018)

In a California intellectual property case, a model/actor/professional athlete sued General Nutrition Centers (GNC) over the unauthorized use of his likeness. The plaintiff retained three damages experts, including an expert in branding, licensing, and valuing intellectual property and an expert for quantifying damages. The trial court found both of these experts’ opinions inadmissible, saying the analysis was “nearly data free and methodologically primitive.” The appeals court agreed. Among other flaws, the court found the expert opinions were based on “speculative assumptions,” including an unsubstantiated assumption that a causal connection existed between the company’s revenue increase and the unauthorized use of the model’s image.

Limited use of image. The plaintiff was Jason Olive. His modeling career peaked in the mid-1990s, when he earned up to $25,000 per day working on campaigns for Ralph Lauren, Versace, Armani, and other brands and magazines. Olive later turned to acting. He also was a professional volleyball player.

The defendant was GNC, a retailer and manufacturer of vitamins and nutritional products with roughly 8,000 retail stores. In 2010, GNC undertook a “Live Well” advertising campaign for which it wanted models who were, among other things, “everyday relatable people.” The plaintiff and about 15 other people were hired for a one-day photo shoot. The plaintiff executed a “Photograph and Likeness Release” that gave GNC the right to use and reuse his “image and likeness and photograph to be taken at the photoshoot scheduled for September 24, 2010.” The plaintiff was paid $4,000 for the three-hour shoot and also received an $800 agent fee. The release was for one year from GNC’s first use in print media. GNC had the unilateral right to agree to a one-year renewal for the same amount of compensation. GNC’s right to use the plaintiff’s likeness expired sometime in late 2011 or early 2012.

Later, in November 2010, the plaintiff executed a second release that allowed the defendant to use his image and likeness on print media displayed on any company trucks and other vehicles in North America. The plaintiff received $8,000 in compensation. The contract was valid through Dec. 31, 2021.

GNC used the plaintiff’s image sometime in January 2011 in various settings: outdoor billboards, bus shelters, kiosks, social media websites, direct mail advertising, in-store posters, and signage. The plaintiff said he believed he had agreed to a “very small job” given the small fee he obtained and that he was “shocked” and “angered” over the far-reaching use of his image.

Later, GNC failed to keep track of the expiration of the model release agreements. While it eventually negotiated extensions with every model that participated in the September 2010 campaign (paying between $7,500 and $32,000 for five-year extensions), it failed to obtain a release extension from the plaintiff. Sometime in late 2012, GNC offered the plaintiff $150,000 for such an extension, which he rejected. Instead, he sued. GNC removed his image from any marketing materials at the end of 2012, incurring about $350,000 in take-down expenses.

In his lawsuit, the plaintiff alleged common law and statutory misappropriation of likeness (Cal. Civ. Code § 3344.1). He also claimed unjust enrichment and sought disgorgement of any profits GNC had made from the unauthorized use of his image. He asked for over $23.5 million in damages. Before trial started, GNC admitted liability; it recommended damages of $4,800.

Expert testimony wants data and science. In a pretrial motion, GNC asked the trial court to exclude the testimony of two of the three experts the plaintiff designated to testify to GNC’s profits attributable to the misappropriation.

Expert 1 was to testify to actual damages and to apportionment—how much of the defendant’s profits was attributable to GNC’s misappropriation of the plaintiff’s likeness. Expert 2 was to calculate the defendant’s revenue, expenses, and profits. He also was to perform an apportionment analysis and give an opinion on whether the defendant had committed fraud or intentional misconduct. (The plaintiff initially proposed testimony by a third expert, but it’s not clear from the court’s opinion what the purpose of this testimony was. Ultimately, the plaintiff did not call this witness.)

In challenging Expert 1’s testimony, GNC argued the opinion was speculative and lacked a foundation and an objective methodology. Expert 2’s testimony was inadmissible because it relied on Expert 1’s defective analysis, GNC contended.

Expert 1. In the relevant year, 2012, GNC’s revenue was approximately $2.4 billion. Expert 1 claimed that 1% to 3% of the revenue was attributable to the infringement. He said his conclusion was based on a review of royalty agreements for various other celebrities, including, for example, George Foreman, Kathy Ireland, Barry Bonds, Michael Jordan, Alex Rodriguez, and Tyra Banks. He also claimed GNC’s president and CEO had admitted in his deposition that at least 1% of the company’s revenue resulted from in-store advertising. Further, Expert 1 said GNC’s revenue increased during the subject period. He noted that the median compensation for a celebrity endorsement was 5% but believed a more conservative figure was appropriate in this case.

Expert 1 also determined that actual damages for the plaintiff were between $500,000 and $1 million for 2012 and $1 million for 2013. He based these figures on a statement from the plaintiff that he would not work for any less compensation as well as on testimony from the plaintiff’s agent that the minimum fee acceptable for the plaintiff would have been in the “high six figures.” Further, Expert 1 considered a list of earnings of top male models that appeared in Forbes magazine.

Expert 2. Expert 2’s quantification of damages relied on Expert 1’s opinion that 1% to 3% of the defendant’s profits were attributable to the misappropriation. Expert 2 acknowledged that he did not perform an independent calculation, noting that Expert 1 had “a long track record” as well as a reputation as an expert in branding, licensing, and intellectual property valuation. Expert 2 said he had met Expert 1 and reviewed the work Expert 1 had done, “so I would feel comfortable with it.”

The trial court rejected both expert opinions, saying they were based on “mere wishful thinking” rather than science and data. Expert 2’s opinion was “directly tethered” to Expert 1’s inadmissible determination opinion; therefore, Expert 2’s opinion was inadmissible. Further the issue of fraud and intentional misuse of the plaintiff’s image was not the proper subject of expert testimony. Therefore, Expert 2 was not able to testify on this point.

A jury ultimately awarded the plaintiff about $1.1 million in damages, including $213,000 in actual damages and $910,000 for emotional distress. The jury found the plaintiff had not proven that any of GNC’s profits were attributable to the unauthorized use of his image. Also, the jury found GNC had not acted with malice or committed fraud.

The trial court itself ruled for GNC on the unjust enrichment claim. But the court denied GNC’s post-trial motions for a new trial and judgment notwithstanding the verdict on the emotional distress award.

Analytical gap ‘too great.’ The plaintiff appealed the verdict on various grounds. It argued the trial court improperly applied the germane statute. Moreover, the trial court’s exclusion of the damages experts was an abuse of discretion.

Regarding the first argument, the plaintiff said the trial court erred by failing to instruct the jury correctly on the burden each party had in determining damages related to the defendant’s profits resulting from the misappropriation of the plaintiff’s likeness. According to the plaintiff, the defendant had the burden of proving the amount of its gross revenue that was not attributable to the use of the plaintiff’s likeness. The trial court failed to provide the jury with an instruction to this effect.

The California Court of Appeal disagreed, noting the statutory language was “clear and unambiguous,” requiring the plaintiff (“injured party”) to prove the gross revenue attributable to the defendant’s unauthorized use of the plaintiff’s likeness and requiring the defendant to prove his or her expenses. The appeals court said the approach the plaintiff proposed would turn “that statutory language on its head,” in that it would require the defendant first to prove total gross revenue to determine what portion was not attributable to the infringement. What’s more, this approach “would create the absurd result of effectively placing on each party the burden to prove the same disputed fact [revenue attributable to infringement].”

Regarding the admissibility of expert testimony, the Court of Appeal explained that, under the applicable California law, the trial court, as the gatekeeper, may exclude expert testimony if the court determines that the expert opinion is based on the type of matter on which an expert may not reasonably rely; the expert opinion is based on reasons that are not supported by the material on which the expert relies; or the expert opinion is based on speculation or conjecture. See Sargon Enterprises, Inc. v. University of Southern California, 55 Cal. 4th 747 (2012). Further, the trial court may conclude that the analytical gap between the expert’s data and his or her opinion “is simply too great” and may exclude the opinion as speculative or irrelevant. Ibid. In general, the trial court “must simply determine whether the matter relied on can provide a reasonable basis for the opinion or whether that opinion is based on a leap of logic or conjecture.” Ibid.

The Court of Appeal found none of the reasons Expert 1 gave for attributing 1% to 3% of the defendant’s revenue to the infringement were persuasive. The celebrity royalty agreements Expert 1 relied on to support his opinion were not comparable, the court said, noting the plaintiff did not share “anywhere near the same degree of celebrity as those included in [the expert’s] sample.”

Also, the plaintiff’s agreement with the defendant was nothing like the referenced celebrity agreements, the court found. The expert compared the limited use of the plaintiff’s image from one photo shoot to much more extensive licensing agreements that included the celebrity’s name, signature, voice, initials, endorsement, and copyright. The appeals court dismissed the expert’s claim that the plaintiff became the spokesperson for the company—the “face of the brand” that “finally resonated with everyone.” The court emphasized that the plaintiff “was not the company spokesperson, and the use of images taken from a photo shoot with 15 other models is in no way analogous to a comprehensive celebrity endorsement arrangement.” It is not proper for an expert to base his or her opinion “upon a comparison of matters that are not reasonably comparable,” the Court of Appeal said.

The appeals court also found that, in order to support his claim that 1% of revenue stemmed from the misappropriation, Expert 1 “mischaracterized a statement from GNC’s President and CEO.” The executive, when asked what drove sales, said that in-store marketing had “the least amount of value of anything I’ve told you in regards to whether a consumer buys a product.” When pressed for a percentage, he said it was very little—”I’ll go zero to one.” Also, the executive never apportioned revenue between the Live Well campaign for which the plaintiff’s image was used or other in-store marketing efforts, and he did not apportion between the plaintiff and other models used in the Live Well campaign, the Court of Appeal pointed out.

In addition, the court noted the expert asserted a causal connection between the company’s annual sales increase and the infringement but did not identify “any reliable evidence linking the two, such as data from a focus group.” The court said he did not consider “the macroeconomic conditions” that prevailed during the relevant period, such as the company’s pricing promotions, general sales in the vitamin and supplement industry, other marketing efforts, and “the impact of professional athletic ‘ambassadors’ used by GNC.” The court found the analysis was “conclusory” and as such speculative. The testimony was inadmissible as it would not have reasonably assisted the jury. The trial court did not err in finding the analytical gap between the data the expert used and the opinion he submitted was “simply too great,” the Court of Appeal concluded.

‘No independent evidentiary value.’ In appealing the exclusion of Expert 2’s testimony, the plaintiff seemed to argue the trial court failed to perform an independent review of the expert’s testimony and as such erred.

The Court of Appeal disagreed. It noted that expert testimony may rely on information from others as “long as the information is of a type reasonably relied upon by professionals in the relevant field.” But this expert testimony is only of value if the source is reliable, the court explained.

Here, Expert 2’s opinion hinged on Expert 1’s speculative assumptions. Expert 2 did not perform any investigation to ensure Expert 1’s information was reliable. For example, Expert 2 did not know how Expert 1 chose his sample of royalty agreements. Expert 2 did not independently determine whether the sample was appropriate. He did not ask Expert 1 how the latter ruled out other persons in the sample, and he did not ask Expert 1 “about the parameters for his sample database.” At the same time, Expert 2 said he was “very comfortable” with the way in which Expert 1 performed his analysis, the appeals court observed. Expert 2 also did not offer “compelling evidence” that the misappropriation of the plaintiff’s likeness directly caused an increase in company sales, the appeals court said. In sum, Expert 2’s opinions had “no independent evidentiary value” and therefore were properly excluded.

The Court of Appeals did, however, find the trial court erred when it decided neither party prevailed (noting that both sides were visibly unhappy with the jury verdict) and denied the plaintiff’s motion for attorney fees. The court noted that, even though the plaintiff recovered less than 10% of the maximum damages he sought, the award to the plaintiff was much higher than the defendant’s proposed $4,800. The plaintiff prevailed on a “practical level,” the court said. Therefore, he was entitled to attorney fees under the applicable statute, the Court of Appeal ruled.

About Ron
Ron Lenz is the partner-in-charge of KSM’s Litigation Services Group.  He advises clients and attorneys in matters of financial litigation and often challenges assumptions to help clients obtain the best possible litigation outcome. Connect with him on LinkedIn.
 

About Jay
Jay Cunningham is a director in KSM’s Litigation Services Group. Jay counsels clients faced with litigation or other disputes through forensics and commercial damage analyses, often serving as an expert witness. Connect with him on LinkedIn.

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Valuation Services Bulletin: Q2 2019

Posted 1:39 PM by

In This Issue:

Simplified MUM Approach Weathers Attacks in Illinois Divorce Case

In re Marriage of Preston, 2018 Ill. App. Unpub. LEXIS 1281 (Aug. 1, 2018)

One of the key questions in an Illinois divorce case was how to allocate goodwill between enterprise and personal goodwill. One expert used the “with-and-without” method; the other used the MUM approach in a simplified version. The latter prevailed. Although the appellate court’s opinion is unpublished, valuators should take note because the court’s discussion of the dispute over the validity of MUM reflects an ongoing debate in the valuation community.

At issue was the value of a company offering design assistance and engineering services as well as machining and molding assembly. The husband was the sole shareholder and, by the wife’s admission, the “key guy” at the company. Both sides retained seasoned, credentialed business appraisers who used a similar methodology to value the company, weighting the results of the income and market approach. But the analyses diverged in a number of respects, including the approach for determining the value of goodwill attributable to the husband—a value that was not marital property and therefore excludable from the company’s overall value.

The wife’s expert used the “with-and-without method,” comparing the company’s projected cash flow over five years under two scenarios: if the husband left the company having signed a noncompete and if he left without signing a noncompete agreement. The expert valued personal goodwill at nearly $1.1 million.

The husband’s expert used the multiattribute utility model (MUM) for which he selected 10 attributes that he scored in a binary manner, i.e., the attribute either existed or did not exist. (The traditional MUM method uses an elaborate scoring system, but the expert used a simplified version.) He determined that two-thirds of the total goodwill value, $2.1 million, represented personal goodwill and one-third was enterprise goodwill.

The wife’s expert acknowledged that MUM was an accepted goodwill allocation method but criticized it for being “subjective” in terms of selecting the attributes and the binary scoring. The “with-and-without” methodology was able to eliminate subjectivity, the wife’s expert said.

The trial court adopted the value determination the husband’s expert proposed, awarding the wife half of it. In appealing the trial court’s valuation decision, the wife attacked the opposing expert’s personal goodwill determination as “far too subjective, and far too suspect, to be accepted by the court.” MUM, the wife argued, allowed for “cherry-picking” and for skewing the results. The appellate court was not persuaded. It found the trial court faced conflicting valuation testimony, considered the weakness in each expert’s opinion, and noted that both goodwill methods were accepted in the profession. Under the applicable standard of review, the appellate court said it was required to give deference to the trial court as fact finder.

Extra: Goodwill is just one of the many topics on the agenda of the upcoming AAML/BVR National Divorce Conference, which will take place in Las Vegas, May 8-10. In addition, the conference offers attendees a great opportunity to explore a host of other legal and valuation-related topics and interact with peers.

 

‘Mixed-Purpose’ Valuation Is Discoverable, New York Court Rules

Noven Pharmaceuticals v Novartis Pharmaceuticals, 2018 N.Y. Mis. LEXIS 5133 (Nov. 9, 2018)

When it comes to document discovery, the “why and “when” matter greatly, as a recent New York ruling centering on a valuation report makes clear. The issue was whether a valuation the defendant had commissioned months before the plaintiff filed suit was privileged or protected by the work-product doctrine.

No protection: In 2012, two pharmaceutical companies made an agreement to end a joint venture. Years later, they were still at odds as to whether the agreement required a valuation of noncash assets to effect the distribution of capital contributions. The plaintiff believed a fair market valuation of products was necessary, whereas the defendant initially disagreed. In spring 2015, the defendant changed course and began to pursue its own valuation, which, it then said, the parties “could use as a starting point.” Contemporaneous communication between the parties showed that, at the time, the parties were in negotiations.

In fall 2015, the defendant’s in-house counsel decided the plaintiff’s position as to the valuation was “antithetical” to the agreement. The disagreement, he believed, “could lead to litigation.” At the same time, in the ongoing discussions with the plaintiff, the defendant did not mention anything about a valuation. The defendant eventually hired a law firm that formally retained an appraiser, saying an estimate of the value of the products would help the firm “assess the case.” The appraiser’s final report from February 2016 said it was “privileged and confidential.” The valuation was assisting with “the provision of services for corporate planning purposes.” The appraiser’s services were solely for internal use “to assist with … litigation due diligence.”

In March 2016, the parties again met to settle their dispute. The defendant used the valuation to prepare for the meeting. The parties did not achieve a resolution, and, six months later, the plaintiff sued.

The plaintiff asked for the defendant’s valuation. The court found it was discoverable. When the defendant continued to refuse producing the report, the plaintiff filed a motion to compel, which the court granted.

The court’s concise opinion pays close attention to the purpose of the valuation and the timing. The court found the attorney-client privilege did not apply because the valuation was not prepared by an attorney “acting as such,” and it did not reflect an attorney’s thinking and professional skills. The work-product doctrine did not apply because the valuation was not “created solely and exclusively in anticipation of litigation.” The court noted that, before the defendant contemplated litigation, its business people chose an appraiser to prepare the valuation for business purposes. Even if the defendant shortly afterwards contemplated the possibility of litigation, the defendant could not show that “the actual scope or nature of the retention changed in any material way.” After the valuation was completed, the parties were still in business discussions to resolve their disagreement. “Under the circumstances, a mixed purpose cannot be ruled out,” the court said.

 

Mix of Real Estate and Business Assets Poses Valuation Challenges for Courts

Persaud v. Goad, 2018 Md. App. LEXIS 1076 (Nov. 19, 2018) (unreported opinion)

This Maryland divorce case, which features a combination of real estate and business assets, raised several noteworthy valuation questions. One concerned the trial court’s decision to assign a negative value to one company where case law says marital property cannot have a negative value. The appeals court sought to affirm this principle while also upholding the trial court’s overall analysis. A second issue was the valuation of the spouses’ catering company that operated out of a space the spouses’ real estate company owned. The parties’ experts relied on different sets of financials—one was based on cash-basis accounting, and the other on accrual-basis accounting. Moreover, one expert argued that the catering business formed a single unit with the real estate holding company, which meant both companies had to be valued as one business. The opposing expert rejected this proposition, as did the trial court. Ultimately, the trial court declined to adopt either expert’s opinion and came up with its own valuation. The appeals court, noting the trial court’s discretion, affirmed.

A mix of marital assets. The spouses acquired real estate (residential and nonresidential) and a catering business in a “unique and historic building” in Baltimore that used to be a luxury hotel but was converted into a condominium with commercial and residential units. At the time of divorce, the spouses owned about 45% of the building’s square footage and a majority of seats on the board of the condominium association. The board had the authority to impose use restrictions and “special assessments.” However, in their proposed valuations, the parties’ experts did not quantify the value of control over the board, the appeals court later observed.

Because the husband had a judgment against him, the wife came to hold title to the companies. At the time of divorce, she managed the real estate holdings and operated the catering business.

Valuation issues dominated the divorce proceedings, prompting the trial court to comment that, even though “this is a divorce case … effectively, this is a business dissolution matter.” The parties’ expert appraisals were $5 million apart. In a nutshell, the husband’s expert claimed the holding company for the nonresidential properties was worth slightly over $1.9 million and the operating company for the catering business was worth slightly less than $1.2 million. In contrast, the wife’s expert contended both of those entities should be considered a single entity worth -$1.76 million.

The trial court found the total value of the marital property that was in the wife’s name (the real estate and business holdings) was about $2.8 million. The property to which the husband held title was worth about $750,000 (his retirement assets). The court awarded the businesses to the wife, and it awarded the husband half of the total value of the wife’s property, offset by half of the total value of the husband’s property in the form of a monetary award.

Initially, the trial court decided that it was important to account for the cost of selling the assets. If the wife were to sell her real estate, she “most likely would incur sales costs,” including a 7% realtor fee and a 1% fee to cover closing costs, the court found. Therefore, in calculating the monetary award to the husband, the court included 46% of the value of the wife’s real property and business holdings and 50% of the value of the wife’s other holdings. The husband objected to this and other findings and asked the court for an amended order. In response, the trial court took away the deduction for costs of sale, which increased the monetary award to the husband from $650,000 to approximately $760,000.

Negative value controversy. The husband unsuccessfully raised other challenges in a post-judgment motion and later made the same arguments on appeal with the state Court of Appeals.

A major point of contention was the valuation of one business entity, Truffles LLC. Truffles owned two units (R1 and R2) in the building, both of which were underground. The R1 unit used to be a “bottle club” where people held parties fueled by alcohol that frequently resulted in fights and police presence, as well as unfavorable coverage in the local paper. The husband said he had bought this space to shut down the operation because it had negative effects on the catering business in the building. R2 was a space that was unusable because of water damage. The husband said owning both of these spaces did increase voting power on the condominium board,

The husband’s real estate expert said the value of the two units was zero. “Any value attributed to these spaces would be offset by the liability of the cost to correct the space, the condominium fees and taxes,” the expert explained. The wife’s real estate expert also arrived at a zero value. He said R1 and R2 were “in poor condition and could not be rented.” At the same time, the units “still incur the fixed condominium fees” of almost $78,300 as well as “combined real estate taxes” of over $19,600. Therefore, the annual expenses related to the two spaces were almost $97,900.

The wife’s business valuation expert said Truffles, as the holding company for R1 and R2, had a value of -$118,200. He pointed out the units were vacant and did not generate any income, while leaving the owner with sizable yearly expenses in condo fees and taxes.

The trial court noted there was “uncontroverted testimony” that the units had “little or no commercial use or value to the food service businesses, but were purchased so [t]he [p]arties could strengthen their position on … [the] condominium board.” The court also found that, given “the unusually high carrying costs … and the fact that they do not generate income,” valuing them at zero () “undercuts the negative impact they have on the total value of the other units.” The court said it was difficult to see how one could sell the “valuable” commercial properties in the building “while keeping units with $97,000 in annual … carrying costs with no income.” Accordingly, the trial court decided Truffles, as the owner of the units, had a value of -$118,200, crediting the wife’s expert. As a consequence, the trial court reduced the husband’s monetary award by half of that amount.

In his post-judgment motion, the husband argued that, under the applicable law, it was error to assign a negative value to Truffles. The wife conceded that “in most cases the court cannot attribute a negative value to marital property in granting a marital award.” At the same time, the wife maintained it was appropriate for the court to consider the “financial drain” resulting from the units. She requested that the trial court “adjust the overall marital award” to account for this negative effect on the marital property held in the building.

The trial court let stand its finding, emphasizing it had decided the units “negatively impact[ed] the value of all of the marital property associated with [the building].” According to the trial court, it was of “no moment” that the court had “expressed this impact as a negative value” in its original opinion.

Focus on fairness. In reviewing the trial court’s ruling, the appeals court explained that, pursuant to Maryland law, the trial court must follow a three-step process in making an equitable distribution of property. Step 1 is to determine which property is marital property. Step 2 requires determining the value of all marital property. Step 3 asks the court to “evaluate whether ‘the division of marital property according to title will be unfair; if so, the court may make an award to rectify the inequality.’” If the trial court decides in favor of a monetary award, it must consider the factors set forth in the applicable statute (FL § 8-205(b)) to calculate the amount of the award.

The appeals court agreed with the husband that the trial court, in its original order, erred. But the reviewing court found a reason to uphold the trial court’s findings. The Court of Appeals acknowledged that the controlling case law requires the court to value each item of marital property separately. “There is no authority for the deduction of the loss incurred by a spouse in a bad investment from the value of the other marital property titled in his name.” The value of the bad investment would be zero. See Green v. Green, 64 Md. App. 122 (1985).

However, the Court of Appeals explained that, under case law, a trial court need not “ignore economic reality where the liabilities associated with a marital asset greatly exceed whatever money an owner could hope to extract from the asset.” See Randolph v. Randolph, 67 Md. App. 577 (1986). For example, in Randolph, the court allowed that debt associated with the husband’s partnership interests was “a factor to be considered in granting a monetary award but not in determining the value of any marital property other than” that asset.

The Court of Appeals found that the trial court, in its amended opinion, had “re-characterized” its arguably improper original decision to make it clear the reduction of the monetary award to the husband was based on the negative impact that asset had on all of the marital property. The trial court “unmistakably signaled” it was concerned about “fairness and not simply about finances” when it emphasized that it would be “inequitable for [the husband] to receive the benefit of the ‘good’ property, but not receive a portion of the burden of the ‘bad’ property,” the appeals court said.

And, considering the trial court’s later reasoning, requiring that court to revisit this issue would be unreasonable. Further, the trial court’s valuation of Truffles was not prejudicial because the error ultimately did not affect the outcome. The trial court would have made this deduction anyway, whether it did so when valuing the various marital assets or when considering the parties’ economic circumstances, the Court of Appeals found.

Disputed catering business valuation. The husband also attacked the trial court’s zero valuation of the catering business, which the husband’s expert had valued at $1.2 million. The record “constrained the court to assign a positive value” to the catering business, the husband contended.

In 2009, when the husband bought the catering business as part of a larger transaction, he paid almost $4.3 million for the real estate in the building but a mere $10,000 for the food-service businesses. The husband later admitted that he and the seller had not obtained an appraisal but had “picked a number of $10,000.” The catering businesses at that time had liabilities of several hundred thousand dollars.

Trial testimony showed the business model for the catering business was unusual in that the business operated inside the building and did not offer off-site catering. Sales were tied to events taking place inside the building’s other spaces. Because the spouses owned the real estate, they did not charge the catering company market rent but only charged enough to cover costs.

The catering business required customers to pay upfront (usually one year in advance) 25% of the price for catering an event. The customer would pay the remainder in 25% increments before the event. When the husband managed the companies, he would redirect funds from the catering business’s account to other investments in the building.

Under the husband’s management, beginning in 2013, the company’s accountant was ordered to switch from accrual-basis accounting to cash-basis accounting. The husband later claimed this method gave a more accurate picture of the company’s profits. The wife, in contrast, argued this approach allowed the husband to show higher profits than there actually were, in an effort to impress lenders.

When the wife took over management and operations, she hired another accountant who returned to accrual-basis accounting for 2015 and the first three quarters of 2016. Testifying at trial, this accountant said cash-basis accounting was “very misleading” where the company collected deposits long in advance of events. Cash-basis financials “would overstate the net worth” of the company as this information “underestimated liabilities.” By way of example, at the end of 2015, the company had $850,000 in “deferred revenue” but only $173,000 in cash. By mid-2016, it had $1.6 million in “deferred revenue” against $427,000 in the bank. The deficiency at the end of 2016 was even greater, the accountant testified. He characterized the catering company as “definitely insolvent.”

The husband’s business valuation expert, valuing the company at $1.2 million as of December 2015 (the agreed-upon valuation date was June 2016), relied on the former accountant’s financial records prepared under the cash-basis accounting method. The expert did not consider the data the testifying account had prepared.

The wife’s expert argued the holding companies for the nonresidential real estate and the catering company should be valued as a single entity. They were “wholly dependent” on each other. He noted that customers signed up for the catering and the use of the event space simultaneously. In a hypothetical transaction, a willing buyer and a willing seller would only agree to a transaction involving both companies at the same time, the expert said. Relying on data from the testifying accountant that was based on accrual-basis accounting, this expert concluded the fair market value of the catering business and the real estate holding company together, as of June 2016, was -$1.76 million.

The husband’s expert objected to the single valuation, noting a “real estate appraisal is different from the appraisal of an operating entity.” Moreover, it was conceivable that the catering company would allow other caterers to service events and charge those companies a facility fee, the expert claimed.

The trial court found that all of the real estate was worth about $4.6 million, but it had encumbrances of $3.7 million. Therefore, the net value of the properties was about $930,000. Concerning the catering company valuation, the trial court found the “accrual-basis accounting system more accurately reflects the finances of the business.” But the court rejected the proposition by the wife’s expert to treat the companies as a single entity. Doing so “masks the true value of each LLC,” the trial court said. It assigned this asset a value of zero “[g]iven its dependence on [the real estate holding company] for rent ‘at cost.’”

The court noted that, if a third party demanded market rent from the catering business, the latter would cease to exist, “given the competitive market for catering services.” The court noted the $10,000 sales price, which “considered the lack of working capital in [the company’s] possession.” In fact, at the time of sale, the business had collected nearly $330,000 in customer deposits that required performance at future events, but the company did not have the cash to put on the events. The seller agreed to credit the husband dollar for dollar when purchasing the real estate if the husband agreed to take the catering business off the seller’s hands.

The trial court affirmed its finding in its amended order, saying the catering business “has no value absent ownership of the real estate.” The value of the catering business was “inextricably tied to the value of the real estate used by it,” the court said, adding the original sale made this obvious.

The Court of Appeals noted the husband failed to cite to case law that required the trial court to adopt the valuation the husband’s expert proposed. The trial court had given specific reasons why it discounted that expert’s opinion, including the expert’s use of the wrong valuation date and his reliance on cash-basis accounting data. Although the expert explained his use of that data, there was countervailing expert testimony, the appeals court found.

Further, the husband’s attack on the opposing expert was “immaterial” because the trial court had not adopted the opposing expert’s opinion. There also was no merit to the argument that assigning the catering business zero value “simply defies logic.” There was testimony, including from an accountant for the company, that said redirecting customer deposits into illiquid real estate investments for other entities had a “negative impact on [the catering company’s] ability to meet its obligations as they become due,” the appeals court said. It noted the husband’s expert agreed that a third-party buyer would lower the sales price to account for the company’s working capital deficiency,” even though the expert did not think the reduction would be dollar for dollar.

The husband’s various arguments against the trial court’s valuation “cannot overcome the deferential standard of review,” the Court of Appeals said. While a different fact-finder might have come to a different conclusion than the trial court, the latter’s valuation was not clearly erroneous, the appeals court concluded.

“The [trial] court here was even-handed in its decisions and transparent in its reasoning,” the Court of Appeals said. It upheld the trial court’s value determinations and the amount of the monetary award to the husband.

 

Appellate Court Upholds Use of Risk Discount in Fair Value Determination

Saltzer v. Rolka, 2018 Pa. Super. Unpub. LEXIS 4044 (Oct. 30, 2018)

Although unpublished, this Pennsylvania appellate ruling in a buyout dispute merits attention as it shows how the trial court tried to reconcile the contrasting expert valuations in determining fair value. Here, as is often the case, the members of a company executed an operating agreement but did not include a buyout provision for valuing a departing member’s shares. This omission later became a liability when two members tried to force the third member out by devising their own buyback formula. Litigation ensued, leading to a trial and ultimately to an appeal because neither side was satisfied with the trial court’s value determination. The court’s valuation was substantially higher than the proposed buyout price, but the court, agreeing with the defendants’ expert, found it was appropriate to apply a company-specific risk discount. The treatment of goodwill became another sticking point.

Forced sale. Three members created a closely held limited liability company that offered consulting services to state public utility commissions and the federal government. The company’s main source of income was one contract that was structured as five contracts generating about $300,000 in profits per year. All three members worked for the company, receiving regular salaries. One served as the company’s president and manager, and the other worked on the consulting side of the business. The third member, the plaintiff, was the specialist in information technology and served as VP of operations. As owners of the company, the members also periodically received profit disbursements in proportion to the size of their interests.

In April 2007, the members made an operating agreement under which the defendants (remaining members) each owned 400 units of the company and the plaintiff (departing member) owned 200 units. The operating agreement did not address a member’s departure (by death or otherwise). In the next few years, the members talked about amending the agreement to include a buyout provision, but they took no action.

In May 2013, the defendant members fired the plaintiff. But the latter remained an owner and as such continued to share in the company’s profits.

In June 2014, the defendant members decided to force the plaintiff out. As they together owned a majority interest in the company, they decided they could amend the operating agreement by devising a formula for determining the buyout price. The record later showed that the defendants arrived at the purchase price ($63,400) by “arbitrarily plugging numbers into their self-created formula.” The appellate court later noted that the defendants “had no factual basis for the valuation.”

To add insult to injury, the defendants gave the plaintiff a check for only 20% of the purchase price and two promissory notes for the remaining obligation. As the appellate court noted, in essence, the defendants made the forced-out member finance the buyback of his ownership interest. The plaintiff sued.

At trial, the parties presented valuation expert testimony. (However, the appellate court does not discuss the testimony in great detail.) The defendants’ expert said that it was appropriate to discount the value of the company by 24% to account for the uncertainty around the valuation date as to whether the key contract would be renewed. The final (fifth year) portion of the contract was to expire in June 2016. However, by the time this case went to trial, the contract had been extended to December 2016. The defense expert also argued in favor of excluding the value of personal goodwill attributable to the two remaining members from the valuation.

In contrast, the plaintiff’s expert rejected a personal goodwill deduction as well as a risk-based discount related to the company’s largest customer because the contract in fact continued into the following years.

Date of valuation matters. The trial court found the remaining members had breached their fiduciary duty to the plaintiff and had acted in an oppressive manner when they forced a sale on their terms. The court said the plaintiff’s expert was more credible and adopted her valuation. Therefore, the court did not deduct the value of personal goodwill from the company valuation.

However, the court agreed with the defense expert that a risk discount was appropriate under the facts of the case. Fair value was “the value on the date of dissociation,” i.e., the value in 2014 when a renewal of the contract was not a certainty. The trial court valued the plaintiff’s share in the company at $294,000. It declined to award the plaintiff punitive damages even though it recognized that the defendants’ conduct vis-à-vis the plaintiff was close to outrageous conduct, as defined by law.

Both parties appealed the trial court’s findings with the Superior Court of Pennsylvania (appellate court). The plaintiff challenged the application of risk discount, and the defendants attacked the trial court’s decision not to allow a personal goodwill deduction. In addition, the plaintiff claimed it was entitled to punitive damages, considering the defendants’ “recklessly indifferent” conduct.

The Superior Court affirmed. It agreed with the trial court that the existing operating agreement did not allow for an amendment by a majority of votes. Under the applicable state Limited Liability Company Act (LLCA), which governed here, the modification of the operating agreement required the unanimous vote of all members, not simply a majority of votes, the reviewing court found.

The appellate court rejected the plaintiff’s argument that no evidence at trial “even remotely suggested that the stream of income from the … contract would end,” obviating the need for a risk-based discount. The valuation date was the date of dissociation, the appellate court affirmed. The plaintiff’s expert improperly relied on information after the plaintiff had been made to leave. Also, the appellate court noted, the valuation findings were credibility determinations that were “well” within the trial court’s discretion and with which the appellate court could not interfere. Likewise, the trial court, in balancing the circumstances accompanying the forced buyout, did not abuse its discretion in finding that punitive damages were not appropriate in the instant case.

The appellate court upheld the $294,000 valuation of the plaintiff’s ownership interest.

About Dan
Dan Rosio is the partner-in-charge of Katz, Sapper & Miller's Valuation Services Group. Dan advises clients on valuation, succession planning, and transaction matters, often serving as an expert witness and helping find solutions to unique challenges. Connect with him on LinkedIn

 

About Andy
Andy Manchir is a director in Katz, Sapper & Miller's Valuation and ESOP Services Groups. Andy helps clients understand the value of their business and advises them on succession planning options, including ESOP, third-party sales, or family transitions. Connect with him on LinkedIn.

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State & Local Tax Update - 8/7/15

Posted 12:45 PM by

KSM Location Advisors 

Whether your company is just starting up, looking for the best location to build a new headquarters, or you have been in the business for many years and are looking to expand, KSM Location Advisors can provide a high-level and/or in-depth location analysis, which includes information important to your company’s location decisions. For more information about how your business may benefit from this service, please contact Katie Culp at kculp@ksmlocationadvisors.com

 
 

Arizona Provides Sales and Use (TPT) Guidance on Changes to Prime Contracting Classification

TPN 15-1 has been issued to provide guidance on questions arising from recent legislative changes to the prime contracting classification, including new exemptions for the gross income derived from the maintenance, repair, replacement or alteration (MRRA) activities affecting real estate when the activities are performed directly for the property owner or authorized party. Note that modifications remain taxable.

Kansas Issues Guidance on Effective Date of Change Taxing Guaranteed Payments

The Kansas Department of Revenue has issued Public Notice 15-11, indicating the exclusion of guaranteed payments as an acceptable deduction to Kansas AGI is effective July 1, 2015, and not retroactively. 

Maryland Issues Guidance on 2015 Amnesty Program

The Maryland comptroller has issued information on the upcoming 2015 Tax Amnesty Program. The program runs from Sept. 1 through Oct. 30, 2015, and waives all civil penalties and one-half of the interest for delinquent taxpayers who apply and are approved. The tax amnesty application, tax amnesty calculator, and Tax Amnesty BillPay will be available by Aug. 28, 2015. Tax amnesty applications will be accepted beginning Sept. 1, 2015. See Maryland 2015 Amnesty for additional information on the program. 

New Jersey Rules on Residency of Telecommuters

In Gundecha v. Board of Review and DB Services New Jersey, the New Jersey Superior Court, Appellate Division, has ruled a telecommuter working in North Carolina for her employer in New Jersey was considered to be working in North Carolina and was not eligible for unemployment compensation benefits in New Jersey. Although the case dealt with unemployment compensation, some parallels from this case may be applied in the income tax context. 

New York Rules Buyer Responsible for Seller Sales Tax Liability

The taxpayer was liable for sales tax related to the bulk purchase of the business assets of a New York-based kitchen and bath company. The transfer at issue was clearly a bulk sale as a transfer to the taxpayer of the entire business assets of the seller outside the ordinary course of business.

At the time of the bulk sale transfer, the seller owed sales tax. The taxpayer, as the purchaser, was obligated to notify the Division of the transaction and withhold from the seller the transfer of any consideration on the purchase until payment of that liability was made.

Failure to comply with the notification requirements resulted in the taxpayer becoming personally liable for the payment of any New York state sales and use taxes determined to be due from the seller. For more details, see In the Matter of the Petition of GB&K/DCS LLC.

Tennessee Issues Notice on Taxability of Remotely Accessed Software

Important Notice 15-14 has been issued to reflect recent legislative changes with regard to the taxability of certain software products. Effective July 1, 2015, the taxable use of computer software in Tennessee includes the access and use of software that remains in possession of the seller and is remotely accessed by a customer for use in Tennessee. The notice outlines the reason for the change and related issues, including multiple points of use.

Tennessee Amends Definition of Nexus for Franchise, Excise and Business Taxes

Effective for tax years beginning on or after Jan. 1, 2016, taxpayers are subject to the franchise and excise tax if they are doing business in Tennessee and have substantial nexus with Tennessee. Substantial nexus is created if:

  1. The taxpayer is organized or commercially domiciled in Tennessee;
  2. The taxpayer owns or uses capital in Tennessee;
  3. The taxpayer has systematic and continuous business activity in Tennessee that has produced gross receipts attributable to customers in Tennessee (often referred to as economic nexus);
  4. The taxpayer licenses intangible property for use by another party in Tennessee and derives income from the use of that intangible property; or
  5. The taxpayer has bright-line presence* in Tennessee.

*The taxpayer has bright-line presence in Tennessee if any of the following applies:

  1. The taxpayer's receipts in Tennessee exceed either $500,000 or 25% of the taxpayer's total receipts everywhere;
  2. The average value of the taxpayer's real and tangible property owned or rented and used in Tennessee during the tax period exceeds $50,000 or 25% of the taxpayer's total real and tangible property; or
  3. The taxpayer paid compensation in Tennessee that exceeded more than $50,000 or 25% of the total compensation paid by that taxpayer. For more information, see HB0644

Tennessee Amends Apportionment Sourcing and Factor Weighting

Effective for tax years beginning on or after July 1, 2016, receipts from sales, other than sales of tangible personal property, are in Tennessee if the taxpayer's market for the sale is in Tennessee. In the case of the sale, rental, lease or license of real or tangible property, the market for the sale is in Tennessee to the extent that the property is located in Tennessee.

In the case of sale of a service, the sale will be sourced to Tennessee to the extent that the service is delivered to a location in Tennessee. In the case of intangible property that is rented, leased or licensed, the sale will be sourced to Tennessee to the extent that the intangible property is used in Tennessee.

Additionally, the weight of the sales factor increases so that it makes up 60% of the apportionment factor rather than 50% of the apportionment factor. For more information, see HB0644.

Washington Rules Captive Paymaster Subject to Business and Occupation (B&O) Tax

By failing to establish it had no liability to pay the employer obligations except as an agent of its affiliates, failing to establish it was a Form 2678 Agent for its clients, and failing to notify employees of the client’s status as employer liable for all employer obligations, a taxpayer was subject to B&O tax on all gross income received from related parties for the provision of payroll and benefits services, accounting services and administrative services. For more information, see  WA Tax Determination 14-0175.

About the Author
Donna Niesen is a partner in Katz, Sapper & Miller’s State and Local Tax Group. Donna helps keep clients up-to-date on the multitude of tax rules and requirements in all 50 states. She guides them in the right direction as they address the complex issues that emerge on both the state and local levels. Connect with her on LinkedIn.

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Deferral of New Revenue Recognition Standard: Contracts with Customers

Posted 3:28 PM by

The Financial Accounting Standards Board (FASB), on July 9, 2015, approved a one-year deferral of the effective date of Accounting Standards Update (ASU) 2014-09 Revenue from Contracts with Customers. The new revenue recognition standard will now become effective Jan. 1, 2019, for nonpublic, calendar-year entities.

Although deferred until the 2019 calendar year, entities that present comparative financial statements are required to present both years under the new standard. Therefore, entities need the ability to track their revenues under the new rules starting in 2017.

This decision was driven largely by the input of stakeholders through the FASB’s Transition Resource Group (TRG), which is charged with informing the FASB about potential implementation issues.

The FASB will next draft an Accounting Standards Update for formal written vote to incorporate the deferral into the codification.

For more information on this ASU or the TRG, visit fasb.org.

About the Author
Matt Bishop is a director in Katz, Sapper & Miller’s Audit and Assurance Services Department. Matt audits and reviews financial statements, and he advises clients on accounting, reporting and compliance matters. Connect with him on LinkedIn.


 

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Trucking Toward State Tax Compliance: Is a VDA the Right Option?

Posted 2:59 PM by
Many companies struggle to determine if they have sufficient activity in a state, or nexus, to force them to file state tax returns. This can be especially difficult for transportation companies. One of the issues is whether driving more than a de minimis amount of miles through a state creates a tax filing obligation. 
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Senate Finance Committee Extends “Tax Extenders”

Posted 7:38 PM by
Yesterday, Senate Finance Committee Chairman Orrin Hatch (R-Utah) and Ranking Member Ron Wyden (D-Ore.) announced progress on a bipartisan bill to extend multiple pro-business and pro-individual tax provisions that expired at the end of 2014. 
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2015 Tax Amnesty Dates Announced

Posted 8:11 PM by

Many legislative changes were made by the Indiana General Assembly during the 2015 legislative session, one of which included a mandate for the Indiana Department of Revenue (IDOR) to implement a tax amnesty program before 2017.

Yesterday, Gov. Mike Pence announced that IDOR will conduct “Tax Amnesty 2015” from Sept. 15, 2015, through Nov. 16, 2015. 

Similar to the amnesty offered by Indiana in 2005, the program provides an opportunity for individuals and businesses to disclose and pay unreported taxes that were due and payable for a tax period ending before Jan. 1, 2013, in exchange for abatement of penalties, interest, and collection fees or costs that would have otherwise been imposed.

Taxpayers who are eligible to participate in the amnesty program and choose not to participate will be subject to an additional penalty, effectively doubling the penalty that would ordinarily be imposed on a delinquent liability. Taxpayers who participated in the 2005 amnesty program are not eligible to participate.

For more information, visit in.gov/dor/amnesty/.

About the Author
Donna Niesen is a partner in Katz, Sapper & Miller’s State and Local Tax Practice. Donna provides a wide variety of tax consulting services in the areas of multistate sales and income taxes, business incentives, controversy services, and other state taxes. Connect with her on LinkedIn.



About the Author
Tim Cook is the partner-in-charge of Katz, Sapper & Miller's State and Local Tax Practice. Tim supervises and coordinates all state and local tax consulting services, including business incentives and site selection, multistate taxes, and unclaimed property. Connect with him on LinkedIn.

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The ACA and PCORI Fee Updates

Posted 5:25 PM by
The Affordable Care Act (ACA) created the Patient-Centered Outcomes Research Institute (PCORI) fee. This fee is to be used to fund research on medical treatment effectiveness and is to be paid by both fully-insured and self-funded group health plans.
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