While the pandemic has stymied many businesses, important valuation litigation has continued to make its way through the courts. The following provides an overview of a few cases of particular interest to the valuation community and the lessons we can learn from the rulings.
Lesson: Contract Language Rules
Hartman vs. BigInch Fabricators
BigInch Fabricators terminated Blake Hartman, a former officer and shareholder of BigInch Fabricators, from the company without cause in 2018. The shareholder agreement signed in 2006 by all shareholders, including Hartman, dictated that BigInch repurchase Hartman’s 17.7% interest and pay him the “appraised market value” as determined by a third-party valuation analyst.
The analyst hired by the company used the fair market value standard and discounted the share value by 32% based on its lack of marketability (DLOM) and lack of control (DLOC).
Hartman sued, saying that the discounts could not apply because the shareholder agreement did not “contemplate a fair market value standard,” but rather an “appraised market value standard.” The trial court issued a summary judgment in the company’s favor, stating that the word “appraised” simply modified “market value,” and thus “market value” and “fair market value” meant the same thing.
Hartman appealed, and in May 2020, the Indiana Court of Appeals sided with him, reversing the trial court ruling by determining that DLOMs and DLOCs do not apply to compulsory sale to a controlling party where there is a ready-made market. In this ruling, the majority opinion discussed the difference between valuing assets in a divorce — when no sale occurs — versus valuation involving a sale in a closed market, regardless of which standard applied.
The company petitioned for transfer of the case to the Indiana Supreme Court which, in early 2021, reversed the Court of Appeals ruling, finding that there was no “blanket rule” prohibiting discounts in a compelled buyback and reinforcing the idea that parties can enter into a contract using whatever terms they wish.
In its decision, the Supreme Court said that “under the plain language of this shareholder agreement — which calls for the ‘appraised market value’ of the shares — the discounts apply.”
The court explained further that prior case law regarding a statutory buyout “doesn’t control” in this case, “where the valuation term comes not from a statute but from a contract that contemplates the shares’ ‘appraised market value,’ not their ‘fair value.’” The court concluded that Hartman’s shares could indeed be discounted for lack of control and marketability.
Words matter! While it might not make sense to discount a minority shareholder’s shares in every case, here the contract language ruled. The shareholder agreement should clearly express the standard of value or valuation formula dictated.
Lesson: Tax Planning Prevents Issues
Warne v. Commissioner
In 1981, Thomas and Miriam Warne created a family trust, which, over the ensuing decades, became the majority owner in five LLC real estate holding companies. Miriam Warne served as managing member until her death in 2014.
Over the years, Miriam gifted fractional interests in the five LLCs to her sons and granddaughters, but a family trust, of which Miriam was the trustee, held the majority interest in the LLCs. When she died, her sons donated 75% of one of the five LLCs — Royal Gardens LLC — to a family foundation and the remaining 25% to a church.
On the estate’s 2014 tax return, the estate reported the donation’s value to the foundation to be $19.2 million and the gift to the church at $6.4 million, which reflected 100% of the property’s value included in the estate. The IRS noted deficiencies in gift tax (based on a 2012 gift Miriam had made but not reported) and various estate tax deficiencies, one of which regarded the estate’s charitable contribution deduction for the donation split between the foundation and the church.
Regarding the estate tax deficiency, the IRS disagreed with the estate’s value, saying that the value of the contributions should be discounted because neither group received the actual, full value of the estate’s reported interest.
In a 2019 trial, both parties’ experts testified about the value of the estate’s various properties, with both sides arguing vigorously about DLOMs and DLOCs and the experts’ use of particular studies for calculation purposes. Regarding Royal Gardens’ charitable contribution discount, the estate insisted that discounts were inappropriate because the estate donated 100% of Royal Gardens to charities and therefore the estate was entitled to a deduction of 100% of Royal Gardens’ value.
Conversely, the Tax Commissioner argued that the value of the deduction should reflect the benefit the beneficiaries received. In his ruling, the tax court judge said, “In short, when valuing charitable contributions, we do not value what an estate contributed; we value what the charitable organizations received.” The IRS suggested a discount of 27.385% for the church gift deduction and 4% for the foundation deduction, which the parties eventually agreed to.
Don’t skip tax planning. Splitting the charitable contribution failed to have the intended results. While the estate had good intentions, the IRS and the tax court focused on what was received rather than what was given. Had the estate left 100% of Royal Gardens to one beneficiary, it would have avoided the discount issue.
Lesson: Leave a Will
Prince’s Estate
In celebrity valuation news, The IRS and the estate of world-famous rock star Prince R. Nelson have gone to court to dispute the value of the musician’s estate. Not surprisingly, the IRS claims the executors have undervalued Prince’s estate.
Prince, who died without a will, left an estate valued by its executor, Comerica Bank & Trust, at $82.3 million. The IRS claims that the estate is worth double that figure, resulting in a $32.4 million tax deficiency. Among the assets at issue are various real estate holdings and the estate’s interest in music publishing, compositions, and recordings.
Prince was known for his tight control of his music and associated intellectual property (IP). As a fiduciary “charged with monetizing and protecting” the estate’s IP for the benefit of Prince’s heirs, Comerica has indicated it will move forward with a similar level of control. The estate has requested a review and trial, so look for further information as the case unfolds.
If Prince had left a will, much of this could have been avoided, including the large legal fees the estate must cover.
Next Step
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Source: Allinial Global and Business Valuation Resources
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