biotechnology company with a drug in phase two clinical trials for auto immune disease mass and other drugs in development for cancer spends all its money on r and d does not have a marketable product and has no sales it's acquired it through a series of transactions and that stock has redemption provision at the heart of this case the redemption provision provide that if the net worth of merrimac as determined in accordance with generally accepted accounting principles and as shown on the balance sheet is greater than five million dollars the plaintiff has a right to redeem his stock both of those problems have to be met in other words it has to be a net worth or greater than five million supreme court case more power tool be commissioner of internal revenue where the judge was not persuaded and he seems to rely among other things on concept six why don't you work judge shows your honor errors in taking his own interpretation of gaps while other than that of the experts rather than that of the independent auditors who certify that the financials were prepared in accordance with gatt another words let me interrupt for one second there is nothing this annual audit no your honor not because the contract provision says as shown on the balance sheet and shareholders equity is not worth there are numerous cases we've cited ten in our brief from footnote six including two of th f which is from fasting and it really equity it's just not permanent equity it's just there for it or you have time it is exactly what the balance sheet requires it to be called which is redeemable preferred stock and in fact  not be titled equity under the appropriate gap rules and you know titled equity but isn't it really equity it's not permanent equity no your argument it's not an in fact the only gap authorities that do address the preferred shareholders kemah sensually call it back it would be misleading to combine it with equity and because of the characteristics of it like debt you may not combine it with equity and therefore they could call it back presenting it in the residual interest in the net worth in the shareholders equity would be misleading now i'm gap accounting because it does not convey the deduct the total liabilities from the total assets isn't that the definition of net worth that we should look at and is it really that different in your definition and isn't that what's contained in black's law dictionary and what  say shareholders equity the residual is net worth if there's nothing else on the balance sheet the world is not black and white the world contains grey and the f c c has said with respect to this precise security this security that's redeemable preferred stock the e i t f t ninety eight says you may not combine it with equity and the reason it says that is that it would be misleading to shareholders it's perfectly uses this that those shares must be considered outside of permanent equity outside of shareholders equity well what about these characteristics tell me whether the they point toward equity or liability the fact that the holders of the series the stock have voting rights the fact that they have the power to elect one board member the fact that they have preemptive rights right to acquire new shares rent dilution which way to those characteristics point those characteristics are not relevant but can be considered to be of debt or equity depending on the obligation whether it can be redeemed another words those characteristics can be present in both way the contract provision is written it's as shown on the balance sheet and as determined in accordance with gas well under supreme court precedent and for the district court has discretion only to look if there was an accounting treatment that must be used outside of the one used it knowledge is that there are multiple presentations sometimes available under gap it's up to the management of the issuer of the financial statements to choose one and respectfully your honor as long as the balance sheet presented that was mutual interest that shareholders equity that now worth in accordance with that plaintiff's even if he had an alternate presentation that didn't violate gav would not be able to redeem his share however you asked about concepts your honor concepts would say and as judge indicated in his opinion that a liability is defined as claims to the entities assets by other entities and once incurred involve non discretionary future sacrifices of assets that must be satisfied on demand at a specified or determined date were on occurrence of the specified on discretionary that certainly doesn't describe the series  says non discretionary meaning occurrence of a specified event so in other words that does describe the series b because if the board votes to be deemed the company does not have discretion toward liability non mandatory points toward equity no your honor it doesn't in fact in fact yapp require and does not allow you to combine with equity a conditionally redeemable preferred stock and the reason is and this is what the f c c says is that the commission thinks that's a very important to highlight for shareholders would be mobile securities that are not within the control of the issuer another words because a majority of the board at all is irrelevant for purposes of yap the accountants must for purposes of transparency and conservatism not portray that conditionally redeemable preferred stock as part of equity and in fact because the facts here weight does that carry doesn't isn't that at a higher level then this concept regulation it's not a higher level than concepts conflicts with the high level but it's definitional it says this is what a liability is which by the way judge sho recognize it includes redeemable securities on an occurrence of one of the let's go that's one fifty right came into effect for balance sheets for non government entities after december thirty first two thousand and three and what to the december thirty first two thousand and one balance sheet at issue here however it does add support tomorrow max argument because what it said was within the scope of one fifty if you have a to say that the accounting series released to sixty eight that we cite continues to apply to securities not within the scope of one fifty so what the district court missed your honor is and he did it by misquoting not because it acknowledged that accounting series released to sixty eight and the f c c is you still hold which is you may not put those in equity there are three things here not two and calling assets minus liabilities net worth simply ignores the point with a scenario described that is this security that says you may not put it in the residual you may not put it in stock holders equity and the reason they describe is a wesen that shareholders will be misled i submit your honor that i'd be in court defending a suit against misleading financial statements of merrimac put in its residual a security that can be called back at the will of a majority of the board at any time and that's why these investors put such provisions in they take on a lot of risk with biotechnology companies but they control the money and they can take it out of the company if they choose which means you may not put it in the residual what is your best argument then that i missed argument your honor is that as shown on the balance sheet what number are we talking about we're talking about shareholders equity numerous cases including two in this court howard the ever actually nelson v star walt we pulled the balance sheets from the s e c filings and they're in the record those talk about net worth and shareholders equity plaintiff's complaint talks about shareholders equity in paragraph thirteen he says america's balance sheet reflected a negative two point four million shareholders at shareholders equity net worth and should have with all due respect to her and to this court the issue is what is the net worth as shown on this balance sheet and there are some black and white issues in this case which the district court saw immediately and wrote down in a very very thorough sixteen page opinion here the black and white issues my client signed a stock agreement that specifically states that he has a right to redeem his shares at ten dollars per if in fact the balance she read in accordance with gat reflects a net worth in excess of five million dollars it does the district court look at that balance sheet provided that balance sheet in its decision subtracted in a black and white world that is not only we should defer to a point that controls we have no issue with the audit report and the argument she is making is an effort maybe even not intentional but it is a distraction from the specifically under equity but is referenced in the mezzanine there are cases that equate stockholder equity with net worth but those cases are simple in that they do not deal with situations where there are contingently redeemable preferred shares none of those cases and i've looked at every single one in the court did as well none of those cases deal with this situation in this situation the court being that in the city in a situation where you've got contingently redeemable preferred share and it's listed in the mezzanine for f c c purposes that is a presentation issue that is not a measure issue the measure issue in this case is what you get if you take the assets of the company subtract the liabilities what is the net worth and that is what the definition that you're asking has to apply yes here yes it is you're right the black and white definition yes it is but it's more than that the argument is nuanced for a number of reasons because we do have to address the fact that for instance merrimac is relying on i thirty two which is an international accounting standards for the proposition that for the proposition that with contingently redeemable preferred shares you list them as liabilities that is not the case in this country that is not gap standards gas specifically states that if you got contingently redeemable preferred shares those shares have to be accounted for as equity in the context of finding out what the net worth of the company is there is no reference in their briefing to this court of some of the most important language in fashion one fifty and the question was asked doesn't that take preceden isn't that at the top of the order that was my understanding that fast one fifty is takes precedent over any of these other you're are going to have a saluki does i was surprised at the response to that the statement an audit team standard sixty nine s a s sixty nine only document and it's probably gated by the ai c p a is a doctor that sets forth the hierarchy what are we to look at in order to figure out what all the pronouncement means all these pronouncements mean with respect to get it specifically that there is nothing more important to your determination or to account of the practice in this field nothing more important than the f a s part pronouncements we have an s f a s one fifty now the position taken by merrimack is that doesn't really apply here because that came out after march of two thousand and one but what's relevant about that particular pronouncement is that hold the line on everything that was said before addresses one issue and that issue is maybe a few more issues but the issue that's relevant to this case is how do we deal with mandatorily redeemable preferred shares and the f a s pronouncements specifically states if in fact years instead of being contingent are suddenly mandatory at that point in time those shares are considered liabilities but that same pronouncement says everything we've done in the past stays the same in the appendix he specifically states and they've been mandatorily redeemable that instrument should be reclassified as a liability so what does that mean reclassified is a liability means that prior to its reclassification it is considered an asset of the company for purposes of terminating that worth b seventy eight i'm sorry eighty seven in the same appendix he say's if the event has occurred the instrument is reclassified as a liability so what  has one fifty states and it's at the very top of the hierarchy is if you've got a contingently redeemable preferred share that particular share is a part of the company's assets you take liabilities from that measurement and you come up with net worth i take it concept six is fully consistent of not reinforcing on as one fifth of your concepts that x is is an interesting pronouncement judge looked at the pronouncement and the subsequent pronouncement and said it doesn't matter because they're talking about ownership in the in the sense of ownership i read concept six as confusing but it is on the lesser standard with liability it's an equity arguably arguably but in this particular case fazul in fifty is right on point fast one fifty attacks head on the question of how you handle in a balance sheet in terms of measuring net worth not presentation for f c c purposes but in terms of measuring net worth what do you do with preferred shares if they are contingent in once they become mandatory that's one fifty says once they become mandatory they are liabilities but they also says fazul once just fifty says this is not change we've done in the past only when they become mandatorily redeemable do we reclassify these shares as liabilities as opposed to assets now  i spent a lot of time talking about stockholders equity and they've acquitted stockholders equity of net worth but that's not the issue here because all of the cases that are citing we don't quibble with them at all either did judge all those cases are dealing with simple situations where there's not mezzanine financing instrument this particular case has a mezzanine instrument which fan has one fifty which sits at the top of the hierarchy specifically defines by implication through the append the se as an asset which much must be added to the calculation now the contract that mike my client is insisting upon exercising here which is not been exercised his his request specifically says you look under gap at the balance sheet and you and what is the balance sheet show merrimac wants to say well it shows what we want to show it shows the stockholders equity is less than five million dollars so it's too bad they can't do that we don't quibble with the fact that the f c c says you've got to list these types of securities the series a and series b in the mezzanine we don't quibble with that but that's not the issue of net worth nothing that pricewaterhouse did addressed net worth in the balance sheet that's not even the function of the balance sheet the function of the balance sheet is not to tell us what the net worth of the company is it's to reflect the instruments the financial instruments of the company and so judge should have looked at the balance sheet and said let's take one step behind this in peer into what we have to peer into under section five point two of the stack agreement and says now what is net worth then you go back to gap and it's very very clear that there are three types of instruments assets liability and equity he took the assets of the company as listed on the balance sheet he did after the liabilities he found that it was greater than five million dollars he decided for my client if merrimac is correct that these particular shares a series b shares are truly liabilities they would have listed those liabilities though that particular instrument as a liability in its balance sheet it didn't do it for a reason because they're confusing presentation pursuant to f c c pronouncements with measurement of point but we don't have to get there they want to so as to deny mike my client his rights but we don't need to get their in we shouldn't we have no quibble with that the f c c has got its presentation requirements they complied that's not the question in this case though i respectfully disagree with what the district court did and what the district court did it was expressly a that and that's the on the record page for sixty five have twenty nine merrimac argument that the series b share should be classified outside equity is an argument against the generally accepted accounting principles the judge also said that it wasn't the complete representation of equity in all types of shares with the complete picture of all shareholders equity a page was nine to eleven so what the district court did was say that definition of liability included items that must be redeemed on an event occurring would seem to end the story for that analysis by doing his own research and pulled up an additional accounting authority that was purportedly well event cited by neither party that plane just a police council has still not gotten behind on this appeal because on the face of it and this was our motion to supplement the record we included the pronouncement that the district court sided it has no authority it was tentative and it doesn't address this issue with addresses a different security what is very concerning for auditors and issue dollar line i don't know the measurements in the accounting literature refers to how you measure do you credit do you what is the dollar value the sole issue in a contract provision is as determined in accordance with and as shown on the balance sheet so if you take a balanced prepared under gap and it shows shareholders equity the residual net worth of negative two point four million dollars you win the only way you get to a different conclusion is you do what job shop did which is he said he disagreed with the classification of the series outside of the shareholders equity and thought that that argument is an argument against generally accepted accounting principles well that's simply incorrect he misinterpreted one face which is very important and controlling for two things balance sheets after december two thousand and three and you said that one fifty only applies after december thirty one or three and is not applicable to this case to the balance sheet which is december thirty one two thousand and one that issue here in other words it could not possibly have been part of gap when it at it for guidance which is where you can look at it i have violence but it's not what's binding under gap and in fact case law and the circuit and auditing standards for eleven point zero nine which is that two seventy six of the record express this case we don't have a senior source even point because one fifty didn't come into effect till after december so three and in its scope it doesn't deal with the security it doesn't deal with the contingently redeemable ones only the mandator t ninety eight as explained by the s t c in its accounting series release must be outside of shareholders equity one fifty when it came in for things after zero three so that the mandator classified as equity you cannot simply ignore the sophisticated instruments that exist today because context was written forty something years ago in black and white terms those instruments must be dealt with and gap does deal with them what judge shum did unfortunately was to do his own gap research and not give the deference gap is complicated and the supreme court has said that it is not a cannot can i call set of rules in thor and you have to give deference therefore to the authors so what judge did was interpretations based on his own as he called it commonsense understanding but he specifically reasoned his opinion i agree it's wrong but the reasoning is faulty because the reasoning expressed lee said that it was viol gap he had contradicting sentences in the opinion in one place he said they agreed that the balance sheet may have been prepared under gap and another he said not including the series b in shareholders equity was violet in the thank you counsel your time has expired is the case just argued will be submitted for decision and we'll hook your argument next in our b versus the napa valley school district