Dodgy Real Estate Valuation Compromises Dependent Business Valuation In re Discontinuance & Disposition of P.K. Smith Motors, Inc. 2016 La. App. LEXIS 475 \ CVS Comment: In a family dispute over a Chevrolet car dealership, the trial court decided against dissolution and instead held a fair value hearing to determine the price at which the company would buy back the shares of the decedent shareholder. Expert testimony was critical to the outcome, with both sides offering two experts each. Three experts made the cut, but one came up short. The problem

had the option to acquire them.

Finally, the divesting

shareholder had the right to dispose of any shares neither the corporation nor the other shareholders chose to buy. The agreement included a “Purchase Price” provision that failed to state a value. It said: “The purchase price for each share of stock purchased pursuant to this Agreement

December 2015

shall be $_____.”

that was a careless cut-and-paste job and using

After the mother’s death, the brothers ran the business as

noncomparable businesses in his analysis. Since this

equal partners until one of them died in 2009. Discord

expert’s valuation was the basis for another expert’s

between the decedent’s son, who acted as executor of the

business valuation, it risked upending the dependent

estate, and the surviving brother ensued, resulting in a suit

analysis.

in which the estate asked the court to discontinue the

was the expert’s working on autopilot, submitting a report

business and dispose of its assets. The petition included a Request for dissolution. Two brothers each owned 50% of the car dealership their parents had incorporated in 1974.

After

the

father’s

death,

the

surviving

shareholders—the mother and the two sons—signed an agreement that restricted the transfer of shares in the company during the lifetime and upon the death of a

plan to hire a third party to value the business for sale as a whole. The surviving brother and the corporation—the defendants—objected and asked the court to enforce the shareholder agreement, which, they said, required a sale of the decedent’s shares to the corporation or the surviving shareholder.

shareholder. Basically, the corporation had an option to buy the shares that were for sale. If the corporation declined to exercise its option, the remaining shareholders

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Subsequently, the defendants filed their own plan under

The surviving brother noted the point of the shareholder

which the court would determine the value of the

agreement was to ensure the dealership stayed in the

decedent’s interest in a fair value proceeding. The

family. He explained that the purchase price provision left

defendants would either pay it or else agree to liquidation.

the actual amount blank because, in 1984, the year the

The defendants specifically pointed to the executor’s lack

agreement was executed, there was considerable volatility

of experience in running a car dealership and the negative

in the oil business and car sales plummeted. The signers

effects the dissolution of the business would have on its

of the agreement did not believe they could state a price or

employees and the local economy. The estate wanted to

per-share value that would be relevant in the future.

go forward with the dissolution. It claimed that, since the

Instead, the signers intended for a fair market value (FMV)

shareholder agreement failed to state a price, it was an

determination when needed.

unenforceable contract. Two types of valuators at work. Both parties engaged The court agreed to hold a valuation trial in early 2014

real estate appraisers as well as business valuators to value

during which the executor and the surviving brother as

the dealership and its land.

well as their experts testified. The real estate appraiser for the surviving brother and the The executor claimed his uncle, the surviving brother,

company, the defendants, first valued the company in

engaged in self-dealing and mismanagement of the

2011. He appraised the dealership at $800,000 and the

company. The latter had acted unilaterally and “kept the

land that went with the dealership at nearly $240,000. He

estate in the dark” about the company’s finances. But the

identified the highest and best use of the property and

executor also said he never had wanted to shut the

performed an analysis to determine what it would cost to

company down and did not know what the cost of

build a similar facility and a comparative study of other

liquidating it would be. He said he would accept a “fair

dealerships in similar, competing areas. He also looked at

value” and allow the business to continue operating.

comparable sales to value the excess land around the dealership. He explained that his analysis factored in a

The surviving brother said that he had served as the

total depreciation of 75% based on his assessment of the

company’s dealer-operator and president since his father’s

market of comparable sales.

death.

The father intended for him to run the car

dealership and for his brother to run the oil and gas

He also performed an appraisal as of 2009, the date of the

business the family also owned. The decedent played no

decedent’s death. The resulting value was essentially the

real role in the business, the defendant said. At the same

same as the 2011 value. Market conditions between 2009

time, he admitted the decedent had been the successor

and the time of trial had not changed substantially, the

dealer in the franchise agreement with General Motors and

appraiser said.

a guarantor of loans from General Motors Acceptance Corp. (GMAC) and a bank.

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The estate’s real

The defendants also offered the opinion of a CPA who was

Cross-examination exposes flaws.

an expert in valuing closely held companies as to the

estate appraiser said the dealership was worth about $2

dealership’s value in January 2013, when the request for

million at the time of the decedent’s death—double the

dissolution was filed.

amount the defendants’ real estate appraiser had proposed.

This expert considered the real

estate appraiser’s value determination as well as the dealership’s monthly financial statements and tax returns

On cross-examination, the estate’s real estate appraiser

from 2007 through 2012, the company’s articles of

admitted to mistakes and misstatements in his expert

incorporation and other corporate records, and financial

report. For example, for his sales comparison, he looked

statements the dealership submitted to GM through the

to completely different businesses, including a furniture

time of trial. The business valuator said he chose the net

store and a grocery store, and businesses located in

asset approach to calculate the company’s FMV because it

affluent areas in other states. Ultimately, he agreed with

would generate the highest value. Considering the

opposing counsel that these

dealership had been in operation for years, he valued the

comparable to the subject company. He explained there

business as a going concern.

was a shortage of automotive service buildings in the

businesses

were

not

market, which made it difficult to find a true comparable. Based on the 2009 and 2011 real estate appraisals, the business appraiser first valued the corporation at $1.37

He admitted that as a result of cutting and pasting his

million and $1.4 million. He then applied a 20% discount

report by mistake included items from other documents.

for lack of marketability (DLOM), which he said was

He admitted that the report contained a section that

inherent in a closely held corporation. And he applied a

purported to be based on discussions with local contractors

10% discount for lack of control (DLOC) because of GM’s

but was not because the expert had not spoken to any of

control over the dealership. In the final analysis, he

the contractors.

concluded the dealership was worth “around a million dollars.” This meant the estate’s interest was worth about $500,000.

To value the improvements to the land, he used an effective age of 10 years for the main dealership building even though the structure was built 50 years ago. He used

He allowed that the valuations were not based on audited

a 33% depreciation compared to the 75% depreciation

financial information. But he said the detailed financial

value the opposing real estate appraiser used. He admitted

information GM required from dealers every month

that, if had he used the same depreciation as the

“added to his comfort” about the reliability of the

defendants’ real estate appraiser, his value determination

financials undergirding the valuations.

under the cost approach would be similar to that of the rivaling expert.

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The estate also offered testimony from a CPA and certified

The trial court concluded the “fair value” of the company

business

was $1 million and set the purchase price for the estate’s

valuator.

The

business

valuator

based

calculations on the problematic real estate appraisal. He

interest at $500,000.

explained he rejected the income approach because the dealership was not making enough money, and he

Permissible transfer restriction. The estate challenged

concluded the market approach was inappropriate because

the trial court’s ruling with the state Court of Appeal. In

of the turmoil in the automotive industry in 2009, the

its appeal, it argued the agreement was an unenforceable

valuation date. As a result, he used a net asset approach.

contract to sell because it lacked a key element: the purchase price. The estate also contended the trial court

Like the defendants’ business valuator, the estate’s

erred when it permitted valuation expert testimony and

business appraiser valued the company as a going concern.

when it relied on the defense experts’ valuations for its

He said he considered financial statements and tax returns

price determination.

for the five years leading up to the valuation date and, on cross-examination, explained he made adjustments based

The appeals court dismissed the estate’s objections. It first

on the real estate appraisal. He arrived at a total adjusted

decided the shareholder agreement was a valid transfer

entity value of over $2.7 million, to which he applied an

restriction that specifically aimed “to prevent the type of

18% DLOM but no DLOC. He concluded the estate’s

deadlock that arose here,” by requiring the sale of the

50% interest was worth over $1.1 million.

decedent’s shares either to the corporation or the remaining shareholder, the surviving brother.

Also, at

When he redid his calculation using the real estate

trial, both the executor and the surviving shareholder

appraisals the defendants’ expert submitted, the estate’s

testified they would agree to a sale between them at a”fair

business valuator concluded the 50% interest was worth

value.”

significantly less, about $673,300.

about the negative impact on the local economy, supported

This testimony, in addition to considerations

the trial court’s decision to avoid dissolving the company. Trial court seeks ‘reasonable price.’

The trial court

ultimately decided not to dissolve the company but to

Moreover, prior to trial, both sides filed plans for resolving

enforce the shareholder agreement. It noted the agreement

the deadlock that required valuing the company’s shares,

reflected a “meeting of the minds” of the signers to keep

the appeals court found. Consequently, “both parties were

the business in the family. The agreement did not specify

aware that valuation would be at issue at trial, and both

a price or formula for buying back the shares in the

had an opportunity over the several months during which

company but required a determination of a “reasonable

trial was held to get and present expert valuation

price,” the trial court found. It rejected the valuation the

testimony.” Permitting expert testimony was not error, the

estate’s real estate appraiser proposed finding “severe

appeals court said.

flaws in [the expert’s] methodology and ultimate conclusions” and instead credited the valuations the defendants’ experts offered.

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As to the trial court’s decision not to credit the estate’s valuation, the appeals court pointed out the valuation evidence “hinged on” the testimony the estate’s real estate

Case Capsule Opinion provided by: Tony Garvy, ASA, CPA/ ABV /CFF, CVA, CDFA, FCPA ([email protected]) is President of Corporate Valuations Services, Inc. and James Arogeti CVA ([email protected]) is Senior Associate of Corporate Valuation Services, Inc.

appraiser gave and which the trial court found to be severely flawed. “The record supports this factual determination,” the appeals court noted. It also observed

If you would like to discuss this opinion or your valuation needs, please contact Tony Garvy at (239) 231-1140 or James S. Arogeti at (312) 238-8690.

that the values both sides’ business appraisers achieved based on the credited real estate appraisals from the defense real estate appraiser in fact were not that far apart. Based on the record of the case and the principle of deferring to the trial court’s fact and credibility

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determinations, the Court of Appeal affirmed the trial court’s valuing the estate’s share at $500,000.

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