Thursday, October 18, 2018

Court Case Insights

Investment Banking

There is a high standard for a business appraiser’s “palpable errors” as the following case illustrates.

Olli Salumeria Americana, LLC v. Vosmik, 2018 Va. Cir. LEXI S 72 (Jan. 5, 2018)

This matter involved the interpretation of an operating agreement in which the owner of a 49% interest in the plaintiff company had a put right that required the company to buy his ownership interest. The price was the greater of $3.75 million or a price determined by an appraisal company. Eventually, Cornerstone Valuations was selected to do the appraisal, but, whereas the defendant accepted the valuation, the company sued in state court. The complaint asked the court to set aside the appraisal because Cornerstone’s valuation included numerous “palpable errors:” The plaintiff claimed that Cornerstone misinterpreted the operating agreement, acted out of bias, and committed numerous errors of commission and omission.

Both parties retained experienced business valuators to opine on the alleged errors in the underlying appraisal, although neither expert performed an independent valuation. In its opinion, the court explained that its responsibility was to determine whether Cornerstone understood and executed the provisions of the valuation contract, i.e., the operating agreement. Moreover, under applicable Virginia law, a court may set aside a valuation only for “errors apparent on its face, misconduct on the part of the valuators, some palpable mistake or fraud in one of the parties.”

The operating agreement required the appraiser to determine the “enterprise value” of the company, defined there as “the fair market value of the Company as a going concern.” The plaintiff argued that Cornerstone misinterpreted the agreement and should have deducted the value of the company’s debt for its valuation. While both parties’ trial experts, as well as the Cornerstone appraiser, agreed that they had never seen a provision addressing the valuation of a shareholder’s interest as enterprise value, the court said it was bound by the words in the operating agreement. Accordingly, Cornerstone’s interpretation of the operating agreement was not a palpable error but a “fair and reasonable exercise of business judgment,” the court concluded.

The plaintiff also maintained there was evidence that Cornerstone was biased in favor of the defendant. For one, Cornerstone made changes to its report that the plaintiff did not request during the drafting process. By changing the discount rate and growth rate, Cornerstone allegedly tried to justify a predetermined value that was advantageous to the defendant. The court noted the operating agreement did not say the appraiser was only entitled to make the changes the parties proposed. Moreover, at trial, Cornerstone’s appraiser explained he made the unrequested changes to correct errors he had discovered in his draft. He said that failing to do so would be a violation of his standards of professionalism and would negate the purpose for which Cornerstone was hired, which was to perform the most accurate valuation of the company. The court found the changes were instances in which the appraiser properly exercised its business judgment.

The plaintiff also alleged a number of errors of commission and omission, including incorrectly determining the cost of goods sold, the cost of selling, and the company’s general and administrative expenses. Also, Cornerstone allegedly used an incorrect estimate of capital expenditures and selected noncomparable companies and multiples and under the guideline transaction method. The court found that none of these examples rose to the level of palpable error. In summary, the court refused to set aside the contested appraisal and dismissed the plaintiff’s complaint. Palpable, shmalpable.


A financial advisor’s fairness opinion was found not to be materially misleading.

City of Hialeah Employees. Retirement Sys. v. FEI Co., 2018 U.S. Dist. LEXIS 11989 (Jan. 25, 2018)

The plaintiff, a city employees’ retirement plan, was a shareholder in the defendant company, FEI, which was sold to Thermo Fisher in September 2016. FEI’s board had retained Goldman Sachs (Goldman) as its financial advisor. The board’s agreement with Goldman specified that Goldman would receive $10 million contingent on the announcement of a merger and $35 million contingent on the closing of the merger. FEI provided Goldman with two management projections sets. At the time, neither the company nor Goldman expressed a view that one set of projections was more realistic or reasonable than the other. In its fairness opinion, Goldman found that, based on the lower projections, the acquisition price of $107.50 was a fair price. The merger went through.

The plaintiff’s complaint focused on the proxy in which the board recommended that company shareholders vote for the acquisition. The merger proxy included both sets of management projections and explained that the board had asked Goldman to rely on the lower projections, believing the lower projections “were more likely to reflect the future business performance of FEI on a standalone basis than would the higher projections. To prevail, the plaintiff had to show that the contested proxy included a material misrepresentation or omission that harmed the plaintiff and that the defendant’s act or omission caused the loss for which the plaintiff seeks to recover damages. Put differently, the plaintiff must show “loss causation.”

The plaintiff argued the proxy included false and misleading statements because it stated that the board believed the higher projections were unrealistic. According to the plaintiff, this was objectively and subjectively false. Moreover, Goldman’s discounted cash flow analysis, which underpinned the fairness opinion, improperly double counted for risk.

In its opinion, the court noted that the higher and lower projections were “quintessential forward-looking statements.” The court further found that the proxy included a lengthy cautionary statement that identified various factors that could affect the actual results. There was language in bold about “the uncertainties inherent in the Management Projections” and a caution to shareholders “not to place undue, if any, reliance on the projections included in this proxy statement.” In combination with the forward-looking statement, the cautionary statement was sufficient to justify dismissal of the case at the pleadings stage, the court found.

At the same time, the court provided an alternative analysis that led to the same conclusion, stating that, for the plaintiff to survive the defendants’ motion, it had to show that the higher projections actually more accurately represented the company’s prospects and that the defendants believed this was so. A company statement following the first quarter of 2016 predicted full year EBITDA to be near $235 million – lower than those appearing in both sets of management projections for 2016. Also, the plaintiff mentioned the company’s rebounding from “a temporary industry downturn,” which allowed for the inference that the public statements “may have been most consistent with the more modest projections,” the court said. Finally, the board’s statement about the lower projections being more realistic was based on the assumption that historically it was rare that all business units achieved their projected financial goals. The plaintiff’s acknowledgment of a temporary industry “downturn” seemed to support the board’s statement, the court found. According to the court, the record also did not show the board acted in bad faith and with improper motive.

The plaintiff’s attack on the financial advisor’s fairness opinion also was unsuccessful. According to the plaintiff, the financial advisor’s discounted-cash-flow (DCF) analysis on which the fairness opinion was based “double discounted” the company’s value by “aggressively discounting” the already discounted lower projections “once more for risk.” Further, Goldman applied a discount rate of “9.5% to 11.5%” that was improperly high, the plaintiff argued. The defendants noted that the discount rate in a DCF analysis does not reflect risk but determines the present value of a business. The court agreed, finding the plaintiff failed to sustain its claim that the fairness opinion was a material misstatement. Based on all these factors, the court granted the defendants’ motion to dismiss the plaintiff’s complaint.


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