Title: Balsamides v. Protameen Chemicals

State: new-jersey

Issuer: New Jersey Supreme Court

Document:

(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please note that, in the interests of brevity, portions of any opinion may not have been summarized). GARIBALDI, J., writing for a unanimous Court. The primary issue in this appeal is whether, in a buy-out ordered under the Oppressed Shareholder Statute, a court should apply a marketability discount to determine the fair value of the shares of stock. Two former friends and close business associates, Emanuel Balsamides, Sr. (Balsamides) and Leonard M. Perle (Perle), were each fifty percent shareholders of Protameen Chemicals, Inc. (Protameen or the Company), a corporation that supplies chemicals to the cosmetics industry. Balsamides, using the contacts he had made over the years at Revlon Corporation, was responsible for sales. Perle, with his chemistry background, was responsible for the technical and administrative sides of the business. Protameen became very successful, with gross sales exceeding $19 million by mid-1995. Perle and Balsamides each had an annual income between $1 million and $1.5 million. The relationship between Balsamides and Perle soured after both brought two sons into the business. Balsamides's sons started in sales and were paid very well. Perle's sons started in administrative and office management positions, his area of expertise. Nevertheless, Perle believed his sons should receive the same compensation as Balsamides's sons. Eventually, Perle's sons were moved into sales. Nonetheless, the parties' relationship continued to deteriorate. In June, 1995, Balsamides sought relief as an oppressed minority shareholder under N.J.S.A. 14A:12-7. He filed a verified complaint and order to show cause with temporary restraints seeking injunctive relief, the appointment of a fiscal agent, and the dissolution of the corporation. The trial court entered a preliminary injunction giving each party equal access to business records and the premises and providing that business decisions were not to be made without the concurrence of both Balsamides and Perle. After a physical confrontation on Protameen's premises between two employees who had taken opposite sides in the dispute, the trial court appointed a provisional director. The primary witnesses at the nineteen-day trial were Balsamides and his sons, Perle, and the parties' experts. The trial court found that Balsamides was an oppressed shareholder and was entitled to buy-out Perle's interest in Protameen and a related business. Although recognizing that the Balsamides group was not entirely blameless, the court found that their wrongdoing was neither intentional nor injurious to the company's business. The court concluded that Perle, on the other hand, had conducted himself in his vendetta against Balsamides in a way that was harmful to the business of Protameen, and that he displayed no regard for the welfare of the company or the interests of his partner. The witnesses' credibility and their demeanor were central to the court's conclusions. The trial court rejected the idea of dissolving the corporation, concluding that it was worth significantly more as a going concern. It concluded that a buy-out by Balsamides presented the greatest possibilities of resolving the matter quickly and of maximizing the benefit to both parties. The trial court based the decision on its belief that Perle was more at fault; the Company's dynamic growth primarily resulted from Balsamides's skill and connections; and most members of the cosmetic industry viewed Balsamides as the face of Protameen. In calculating the fair value of Perle's shares, the trial court concluded that the "excess earnings" method proposed by Balsamides's expert, Thomas J. Hoberman, was more reliable and his evaluation more credible than that of Perle's expert, Robert E. Ott. Hoberman determined that Protameen had a value of $4,176,400, after applying a thirty-five percent marketability discount. Ott, using a combination of "market" and "income" approaches, valued the company at $8,000,000. He did not apply a marketability discount, concluding it was inappropriate because the court was directing the stock buy-out. The trial court specifically rejected Ott's conclusion in respect of the marketability discount. It stated that the evaluation exercise must determine the intrinsic value of the business, which does not change simply because the court happens to direct a buy-out. Balsamides was ordered to pay approximately $1.96 million for Perle's interest, after adjusting for the negative value of the related company. The court denied Balsamides's request for compensatory damages, finding the proofs inadequate. It also did not award Balsamides counsel fees as requested, or explain its reason for doing so. However, it assessed punitive damages against Perle in the amount of $75,000. The parties appealed. The Appellate Division affirmed the buy-out order as well as the award of punitive damages. However, it disagreed with the trial court's application of a marketability discount as well as its complete rejection of Ott's valuation method, remanding for a revaluation as well as a determination of counsel fees. The most important disagreement was with the trial court's use of a thirty-five percent marketability discount. The Appellate Division concluded that such a discount was not appropriate in this case because there was no sale of Perle's stock to the public, nor was Balsamides buying an interest that might result in the later sale of that interest to the public. Both parties filed petitions for certification. The Supreme Court granted Balsamides's petition seeking reversal of the Appellate Division's decisions rejecting the use of a marketability discount and remanding for reconsideration of Protameen's valuation. It denied the petition of Perle. HELD: The fair value of the oppressor shareholder's stock should include a marketability discount; the company that the oppressed shareholder is buying will remain illiquid because it is not publicly traded and information about it is not widely disseminated. 1. Great deference is due a trial court's findings in respect of the valuation of a closely-held corporation. The credibility and reliability of the expert witnesses are critical. The Court finds adequate support in the record for the trial court's approval of Hoberman's use of the "excess earnings" valuation method. The trial court's conclusion on that issue should not be disturbed. (pp. 22-28) 2. The determination whether a "marketability discount" is applicable implicates a question of law, and is subject to de novo review. In refusing to apply such a discount to determine the fair value of Perle's shares, the Appellate Division ignored the reality that Balsamides is buying a company that will remain illiquid because it is not publicly traded and information about it is not widely disseminated. If it is resold in the future, Balsamides will receive a lower purchase price because of the company's closely-held nature. Because the equities of this case quite clearly lie with Balsamides, it would be unfair to allow Perle to receive Protameen's undiscounted value. (pp. 28-44) 3. The decision regarding the determination of "fair value" and the applicability of discounts depends not only on the specific facts of the case, but should reflect the purpose served by the law in that context. The guiding principle applied in this case and in Wheaton v. Smith, ___ N.J. ___ (1999), also decided today, is that the marketability discount cannot be used unfairly by the controlling or oppressing shareholders to benefit themselves to the detriment of the minority or oppressed shareholders. (pp. 44-46) The judgment of the Appellate Division is AFFIRMED in part, REVERSED in part, and the matter is REMANDED to the trial court. CHIEF JUSTICE PORITZ and JUSTICES HANDLER, POLLOCK, O'HERN, STEIN and COLEMAN join in JUSTICE GARIBALDI's opinion. EMANUEL BALSAMIDES, SR., EMANUEL BALSAMIDES, JR. and THOMAS BALSAMIDES, Plaintiffs-Appellants, v. PROTAMEEN CHEMICALS, INC., ADAM PERLE, DANIEL PERLE, MANLEN REALTY CORP. AND RELCO CHEMICAL CO., INC., Defendants, and LEONARD M. PERLE, Defendant-Respondent. Argued May 3, 1999 -- Decided July 14, 1999 On certification to the Superior Court, Appellate Division, whose opinion is reported at 313 N.J. Super. 7 (1998). Alan S. Pralgever argued the cause for appellants (Brach, Eichler, Rosenberg, Silver, Bernstein, Hammer & Gladstone, attorneys; Mr. Pralgever, Stuart L. Pachman and John A. Snyder, II, on the briefs). That standard is particularly significant in valuation disputes, which frequently become battles between experts. Rapid-American Corp. v. Harris, 603 A.2d 796, 802 (Del. 1992). The findings of the trial court are critical as the valuation of closely-held corporations is inherently fact-based. Rev. Rul. 59-60, C.B. 1959-1. In other words, valuation of closely-held corporation is not an exact science. Lavene v. Lavene, 148 N.J. Super. 267, 275, 372 A.2d 629 (App. Div.), certif. denied, 75 N.J. 28, 379 A.2d 259 (1977). There is no right answer. Experts exercise judgment at many stages in the evaluation process. As a result, their credibility and reliability are critical. Only the trial court has the opportunity to see, hear and question the expert witnesses. Additionally, in complicated proceedings such as this, the trial court's findings on valuation typically are only one aspect of the overall resolution of the matter. Appellate courts should take care in accepting some and rejecting other findings of the court, as that may disturb the logic and equitable balance of the trial court's other conclusions. Accordingly, great deference is due a trial court's finding, which "will not be disturbed unless it is clearly erroneous or shows an abuse of discretion." Madeline Marzano Lesnevich & Francine Del Vescovo, The Minority Discount, 18 N.J. Fam. Law 338, 339 (1998). Whether the Court exceeded the allowable scope of its review by remanding to the trial court to reconsider Hoberman's use of the "excess earnings" approach, the eleven percent rate of return on tangible assets, and the thirty percent capitalization rate is a close question. We find that a careful reading of the Appellate Division's opinion discloses that it did not find that the trial court had abused its discretion, but merely sought a clarification of some of that court's findings on Hoberman's methods. We find adequate support in the record for the trial court's approval of Hoberman's use of the "excess earnings" method. Both Hoberman and the trial court recognized that excess earnings was not the preferred method of valuation. The court noted that although not preferred, excess earnings is an acceptable method, and Hoberman chose it, in part, because defendants would not provide the information needed to employ any other method. We are not convinced that by plaintiff's counsel deposing Perle that Hoberman could have received the data required to use the income approach; given the acrimony between the parties, it certainly would not have been acquired without a great deal of difficulty. Accordingly, the trial court did not abuse its discretion by accepting Hoberman's use of the "excess earnings" approach as the best approach available. At this point in the litigation, the trial court's conclusion on that issue should not be disturbed. Revenue Ruling 68-609 states that in using the "excess earnings" approach: The percentage of return on the average annual value of the tangible assets used should be the percentage prevailing in the industry involved at the date of valuation, or (when the industry percentage is not available) a percentage of 8 to 10 percent may be used. The 8 percent rate of return and the 15 percent rate of capitalization are applied to tangibles and intangibles, respectively, of businesses with a small risk factor and stable and regular earnings; the 10 percent rate of return and 20 percent rate of capitalization are applied to businesses in which the hazards of business are relatively high. The above rates are used as examples and are not appropriate in all cases. In applying the "formula" approach, the average earnings period and the capitalization rates are dependent upon the facts pertinent thereto in each case. Because Revenue Ruling 68-609, supra, recommends a rate of return of between eight and ten percent, the Appellate Division questioned Hoberman's use of an eleven percent return on tangible assets. Hoberman explained that the difference resulted from Protameen's inability to obtain the prime rate. The best rate available to the Company was the prime rate plus two percent, or eleven percent. Although this claim was disputed, we believe there was sufficient credible evidence to support Hoberman's position and would not disturb the trial court's findings. The Appellate Division also questioned the trial court's acceptance of a capitalization rate as high as thirty percent in light of Ott's use of eighteen percent. Balsamides, supra, 313 N.J. Super. at 23. The trial court observed that Hoberman based his rate on six negative factors: (1) lack of a full-time chemist; (2) projected decline in the market for the company's animal-and mineral-based chemicals over the next five to ten years; (3) use of purchasing policies that placed a priority on price over quality; (4) potential cancellation of Protameen's contract with B.F. Goodrich at any time, (5) reliance on six customers that accounted for twenty-seven percent of the sales, and (6) generation of nearly half the Company's sales by Balsamides. The Appellate Division observed that all of those factors could be corrected with Balsamides in full control of the Company. The panel also questioned why those six factors warranted a nine percent increase in the capitalization rate. Moreover, Hoberman relied primarily on information he received from Balsamides to establish those factors. The concerns that the Appellate Division noted with respect to the six factors appear to have merit. Id. at 23-24. Again, the panel did not specifically find that the trial court abused its discretion by accepting the thirty percent capitalization rate, but ordered the trial court to reexamine the significance of the factors on remand and, perhaps, consider other factors. The court observed that one other potential factor for the court to consider is the possibility of competition from Perle's sons, who are not bound by a non competition agreement. Additionally, the trial court cut Perle's non-competition agreement to one year. At oral argument, the Appellate Division was informed that Protameen has already lost customers to competition from the Perles. Id. Although recognizing that the covenants cannot be changed at this late date, the Appellate Division nevertheless suggested that on remand those competition factors be considered in reassessing the thirty percent capitalization rate. Id. at 33. Those additional factors alone may be sufficient to justify the thirty percent capitalization rate. If on remand, the trial court still considers the thirty percent rate applicable, the Appellate Division should accept that court's conclusion. That is an erroneous assumption. The position of the Appellate Division ignores the reality that Balsamides is buying a company that will remain illiquid because it is not publicly traded and public information about it is not widely disseminated. Protameen will continue to have a small base of available purchasers. If it is resold in the future, Balsamides will receive a lower purchase price because of the company's closely held nature. If Perle and Balsamides sold Protameen together, the price they received would reflect Protameen's illiquidity. They would split the price and also share that detriment. Similarly, if Balsamides pays Perle a discounted price, Perle suffers half the lack-of-marketability markdown now; Balsamides suffers the other half when he eventually sells his closely-held business. Conversely, if Perle is not required to sell his shares at a price that reflects Protameen's lack of marketability, Balsamides will suffer the full effect of Protameen's lack of marketability at the time he sells. Accordingly, we find that Balsamides should not bear the brunt of Protameen's illiquidity merely because he is the designated buyer. To secure a "fair value" for Perle's stock, a marketability discount should be applied. To do otherwise would be unfair, particularly since Perle was the oppressor and Balsamides was the oppressed shareholder. The fact that the buyer is known is irrelevant. When Balsamides eventually sells, he will suffer the full effect of any marketing difficulties. Because the "equities" of this case quite clearly lie with Balsamides, it would be unfair to allow Perle to receive Protameen's undiscounted value. We further observe that a thirty-five percent marketability discount, if properly applied, was appropriate in this case. The Appellate Division, although rejecting the use of the discount, commented that marketability discounts typically have ranged between thirty percent and forty percent. Balsamides, supra, 313 N.J. Super. at 27. One author cites a study documenting marketability discounts in the range of thirty percent to forty percent for closely-held companies. Harris, supra, 42 Ark. L. Rev. at 658-59; see also Hood, et al., supra, 65 UMKC L. Rev. at 439-40 (citing study concluding that "35" nonmarketability discount from intrinsic value is appropriate for stock in a closely-held corporation"). Accordingly, we find that a thirty five percent marketability discount is within the generally accepted and reasonable range given the facts presented. NO. A-27 EMANUEL BALSAMIDES, SR., EMANUEL BALSAMIDES, JR. and THOMAS BALSAMIDES, Plaintiffs-Appellants, v. PROTAMEEN CHEMICALS, INC., ADAM PERLE, DANIEL PERLE, MANLEN REALTY CORP. AND RELCO CHEMICAL CO., INC., Defendants, and LEONARD M. PERLE, Defendant-Respondent. DECIDED The court made no decision on Relco, the company owned by the four sons. As the court noted, no evidence about that company had been produced; it seemed to be little more than the structure or shell of a corporation established purely for future use. The court suggested that the owners should privately dissolve that corporation, sell the assets if there were any, and divide the proceeds. [F]air market value [is] the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Although Revenue Ruling 59-60 was disseminated originally for use in calculating estate and gift taxes, in 1965 its use was expanded to include all taxes. Its methodology currently is applied in some states to equitable distribution calculations. Madeline Marzano-Lesnevich & Francine Del Vescovo, The Minority Discount,18 N.J. Fam. Law, 338, 338 (1968). The Ruling lists a large number of factors that might be considered when valuing a closely held business.