In the

United States Court of Appeals

For the Seventh Circuit

No. 00-1107

Joseph D. Olsen, Trustee

of Huntley Ready Mix, Inc.,

Plaintiff-Appellant,

v.

Gary A. Floit,

Defendant-Appellee.

Appeal from the United States District Court

for the Northern District of Illinois, Western Division.

No. 99 C 50203--Philip G. Reinhard, Judge.

Argued June 1, 2000--Decided July 14, 2000

 Before Bauer, Easterbrook, and Manion, Circuit Judges.

 Easterbrook, Circuit Judge. In May 1993 Huntley

Ready Mix sold all of its operating assets for

$151,000 to Harvard Ready Mix. This plus cash on

hand was just enough to pay off Huntley’s secured

debt, which had been guaranteed by Gary Floit,

Huntley’s founder, president, and principal

shareholder. Huntley retained its accounts

receivable, eventually collecting and

distributing about $100,000 to its general

creditors, but another $200,000 or so remained.

When Huntley filed a petition under Chapter 7 of

the Bankruptcy Code of 1978 its only asset was

some $125,000 owed by deadbeats. As part of the

transaction, Harvard hired Floit as its plant

manager under a three-year employment contract

(at approximately the salary he drew from

Huntley) and paid $249,000 for a five-year

covenant not to compete in the concrete business.

Huntley’s trustee believes that Huntley’s assets

were worth at least $400,000, more than enough to

pay off its debts, and that Floit diverted to

himself under cover of the no-compete agreement

the value of the unsecured creditors’ interests.

If so, then Huntley "received less than a

reasonably equivalent value in exchange for [the]

transfer". 11 U.S.C. sec.548(a)(1)(B)(i). As

events revealed that Huntley either was insolvent

when the sale occurred or became insolvent as a

result, the transaction may have been a
fraudulent conveyance, and the estate might have

recovered from Floit as "the entity for whose

benefit such transfer was made". 11 U.S.C.

sec.550(a)(1). But Huntley entered bankruptcy 15

months after the sale, and sec.548(a)(1) reaches

back just one year.

 Instead of giving up or arguing that Floit is

equitably estopped to take advantage of the time

limit in sec.548(a)(1), Huntley’s trustee in

bankruptcy tried a novel approach: he sued Floit

(in an adversary proceeding) under state

corporate law on the theory that Floit violated

his fiduciary duty to Huntley as one of its

directors. The theory is akin to that of a

fraudulent-conveyance action--that Floit obtained

too little for Huntley and too much for himself--

without the need to show that Huntley was

insolvent, and with the benefit of a longer

period of limitations under Illinois law. We call

this "novel" because the state-law claim is

designed to protect shareholders rather than

creditors, and the Floit family held all the

shares. Under 805 ILCS 5/8.60, the statute in

question, a director who receives a personal

benefit from a transaction with or by the

corporation must demonstrate that the arrangement

was "fair" to the corporation, unless either

disinterested directors or disinterested

shareholders approved the transaction with

knowledge of all material facts. This statute--

similar to the 1984 version of the ABA’s Model

Business Corporation Act sec.8.31--provides that

directors and shareholders who do not participate

in the transaction are free to approve it, which

they will do when it benefits them (or at least

does not harm them) as equity holders. Because

shareholders acting in their own interests are

entitled to approve, 805 ILCS 5/8.60 cannot be a

creditor-protection rule. It is passing strange

to say that a single minority shareholder with a

trivial stake could have approved the sale to

Harvard and thus insulated it from any later

attack (other than a fraudulent-conveyance

action), but that, because there were no minority

shareholders in Huntley, approval was impossible.

Yet Floit has not picked up on this logical

problem in the trustee’s invocation of 805 ILCS

5/8.60, forfeiting whatever arguments might be

available to terminate the claim on strictly

legal grounds. His sole response is that the

transaction was indeed "fair" to Huntley. The

bankruptcy judge held a trial and agreed with

Floit; the district judge affirmed; the trustee

now contends that the critical findings were

clearly erroneous, an uphill battle. See Anderson

v. Bessemer City, 470 U.S. 564 (1985).

 Illinois defines "fair" as market value. A

transaction is "fair" to a corporation when it
receives at least what it would have obtained

following arms’ length bargaining in competitive

markets. Shlensky v. South Parkway Building

Corp., 19 Ill. 2d 268, 283, 166 N.E.2d 793, 801

(1960) (discussing common-law requirement of

fairness preceding enactment of 805 ILCS 5/8.60);

cf. BFP v. Resolution Trust Corp., 511 U.S. 531

(1994) (a foreclosure sale produces "reasonably

equivalent value" for purposes of bankruptcy

law). Floit and the trustee produced expert

witnesses who estimated the price that Huntley’s

assets would have fetched in a competitive sale.

Floit’s expert valued the business (including

Floit’s services) at approximately $440,000, and

the trustee’s at $380,000 to $410,000. Floit’s

expert differed from the trustee’s by opining

that most of this value was contributed by Floit

personally and that the corporation assets were

worth $151,000 or less. Floit also offered his

own testimony and that of Jay Nolan, Harvard’s

president, in support of the lower valuation. The

bankruptcy judge accepted this view.

 Both sides also looked through the other end of

the telescope, asking whether the covenant not to

compete would have been worth $249,000 in a

competitive market--on the sensible theory that

if the covenant had been overvalued, then it must

have represented a disguised portion of the

purchase price for Huntley’s assets.

Unsurprisingly Floit, Nolan, and Floit’s expert

all testified that the covenant was worth at

least $50,000 per year, for a total of $250,000.

This testimony received some support from a

disinterested source: when Harvard Ready Mix was

itself sold in mid-1996, the buyer paid $200,000

for the two remaining years of Floit’s

abnegation. Perhaps conditions changed in the

cement industry, making the threat of his

competition more serious; the question in this

litigation is what the covenant was worth in

1993, not what it was worth in 1996; but a

$100,000-per-year valuation in 1996 lends

verisimilitude to the assertion that in 1993 the

covenant was worth at least $50,000 per year. The

trustee’s expert disagreed, stating that a

covenant not to compete in the cement business

should be valued at between 0.7 and 1.5 times the

promisor’s annual earnings, which implies that

the value of Floit’s covenant could not exceed

$93,000 (given his salary of $62,000 during the

year preceding sale). The expert conceded that

covenants sometimes represent a percentage of a

closely held corporation’s sales, and that in one

case of which he was aware the owner-principal of

a closely held firm had received 16% of its

annual sales. Applied to Huntley’s sales (about

$1.5 million in 1992, its last full year of

operation), this implied a value of $240,000 for

the covenant not to compete, but the trustee’s
expert rejected this conclusion as unrealistic

for Huntley and Floit. The bankruptcy judge,

however, thought it entirely realistic given

Nolan’s testimony and the $200,000 value later

placed on two years of Floit’s covenant by

parties who had no stake in the outcome of this

litigation. That buyer also paid Nolan and his

brother (Harvard’s two principals) $1.5 million

apiece for their covenants not to compete for

five years.

 Valuation of closely held businesses is

something of a black art. Experts try to project

the firm’s net cash flow into the future, then

discount that stream to present value. This

process is difficult for public companies, see

Metlyn Realty Corp. v. Esmark, Inc., 763 F.2d 826

(7th Cir. 1985); Richard A. Brealey, Stewart C.

Myers & Alan J. Marcus, Fundamentals of Corporate

Finance 122-35 (2d ed. 1999); Lucian Arye Bebchuk

& Marcel Kahan, Fairness Opinions: How Fair Are

They and What Can Be Done About It?, 1989 Duke

L.J. 27, 35-37, and almost impossible for private

companies, for which uncertainties abound. What

was apt to happen to Huntley? The trustee’s

expert assumed that, if not sold, it would have

remained in business and generated about the same

cash flows as before; Floit and Nolan testified,

however, that Huntley’s plant was decrepit and

that the expense of renovation could not be

justified. Nolan recounted that most of Huntley’s

equipment had been "hauled off to the junkyard"

soon after the acquisition. These two stories

implied dramatically different futures for the

firm and correspondingly large differences in the

present value of its earnings and the priceearnings multiple on sale.

 Similarly unclear was how to calculate the

firm’s real earnings. The trustee’s expert

calculated that over the last few years before

its sale Huntley generated a weighted annual

average of $115,000 in "discretionary income,"

with a high of $166,000 in 1992. "Discretionary

income" in this formulation is whatever is left

after the costs of paying for all materials and

labor, other than Floit’s. But it is artificial

to assume that the full cost of an entrepreneur’s

labor is the nominal salary he pays to himself;

the entrepreneur also benefits from perquisites

of office and changes in the value of the firm’s

stock. To determine how much Huntley’s assets

could have fetched in an arms’ length sale, it

would have been necessary to know the full cost

of Floit’s services--which is to say his

reservation wage, what he could earn in other

employment--not just his nominal salary.

Sometimes a court can pin down the entrepreneur’s

entitlement by asking whether what remains

adequately compensates minority investors for the
risk they bear, see Exacto Spring Corp. v. CIR,

196 F.3d 833, 838-39 (7th Cir. 1999), but Huntley

did not have minority shareholders. Reservation

wages, alas, are hard to pin down otherwise,

unless perhaps by observing how much Harvard was

willing to pay Floit. That answer turned out to

be $115,000 per year ($65,000 in salary plus

$50,000 as the annual portion of the covenant not

to compete). Viewed this way, the numbers imply

that Huntley didn’t have much if any value beyond

its physical assets; its net cash flow was needed

to retain Floit’s services. (That the

"discretionary income" increased to $166,000 in

1992 may do more to show that Huntley had

deferred replacing its assets, and thus curtailed

its out-of-pocket costs, than to show an

improvement in its true economic position. Nor is

it dispositive that Harvard paid Floit both for

employment and for a covenant not to compete. The

latter was independently valuable to Harvard in

the event Floit should quit, be fired, or just

leave at the expiration of the three-year

employment contract.)

 When hard numbers are difficult to come by or

evaluate, people often rely on reputations. The

trustee insists that his expert had better

academic credentials and more experience valuing

closely held companies than did Floit’s, so that

the bankruptcy judge should have adopted the

estimates of the trustee’s expert. A reasonable

trier of fact might have proceeded that way, but

we cannot say that a contrary view was clearly

erroneous. After all, the bankruptcy judge’s

views do receive support from the $100,000-peryear valuation of Floit’s covenant as of 1996.

Floit may have been well respected by others in

the business, and thus able to attract a

substantial package of compensation to deter him

from starting a new firm or defecting to another

producer. What is more, the trustee’s expert did

not do all that would be expected of a specialist

in valuing closely held firms. Why leap to a

discounted cash flow analysis when other methods

are available? Most trade associations maintain

records of sale prices for firms in the business.

What multiple of free cash flow did other small

cement ready-mix producers sell for? See To-Am

Equipment Co. v. Mitsubishi Caterpillar Forklift

America, Inc., 953 F. Supp. 987, 996-97 (N.D.

Ill. 1997), affirmed, 152 F.3d 658 (7th Cir.

1998). It would have been especially interesting

to know the answer to this question for sales

following the departure (or death) of the

founding entrepreneur. For although Huntley owned

its assets, Floit was not among these. He did not

have a long-term contract with Huntley or a nocompete agreement and thus could leave and

compete at will. E.J. McKernan Co. v. Gregory,

252 Ill. App. 3d 514, 530-31, 623 N.E.2d 981, 994
(2d Dist. 1993). Floit owned his human capital

and was free to withdraw from Huntley and sell

his services to a higher bidder without violating

any fiduciary duty. For what price could

Huntley’s plant, customer list, goodwill, and so

on have been sold without assurance of Floit’s

services? That’s where price-earnings ratios for

firms sold after the death or departure of their

founders would have come in handy. The trustee’s

expert did not attempt to estimate this figure;

instead he assumed that whatever value Floit’s

services produced was "owned" by Huntley and

would be capitalized in its sale price. When

asked about this at oral argument, the trustee’s

counsel conceded that his expert had valued

Huntley as a going concern with Floit as its

manager, adding that Floit’s expert had done the

same thing and that Floit bears the risk of nonpersuasion. But this case was not a tossup as the

bankruptcy judge saw things, so allocation of the

burden was not dispositive. A solid demonstration

that Huntley was worth more than $150,000 even if

Floit was planning to leave would have gone a

long way toward establishing that the bankruptcy

judge made a clear error. Without such evidence

it is awfully hard to say that the bankruptcy

judge’s findings are clearly erroneous.

 According to the trustee, however, valuation is

a matter of law rather than fact, and the trustee

contends that under In re Prince, 85 F.3d 314

(7th Cir. 1996), corporate value includes the

value of its entrepreneur’s services. If that is

so, then even a penny for Floit’s covenant not to

compete violates the duty he owed to the firm.

But it is not so. Prince does not concern

Illinois corporate law in general or 805 ILCS

5/8.60 in particular. It is instead an

application of contract law to a bankruptcy case.

Prince, an orthodontist, promised his creditors

as part of an agreed plan of reorganization that

he would turn over the value of his stock in his

professional corporation. He agreed to sell that

practice to a Dr. Clare for $450,000 but proposed

to turn over only $7,500 to his creditors,

claiming that the rest of the value was

attributable to a no-competition agreement. One

difficulty with this contention is that the

$450,000 was the price set on "the practice";

unlike Harvard Ready Mix, Clare did not pay

separately for physical assets and a covenant not

to compete. What Prince had to sell was

principally goodwill--that is, a client base,

client records (exceptionally valuable in a

dental practice), and a promise to continue

working for six months to ensure that patients

transferred their allegiance to Dr. Clare. Prince

held that the agreement between Prince and his

creditors included goodwill as part of the

practice’s value. We did not hold that for this
purpose "goodwill" included the value of Prince’s

personal services for the indefinite future. Our

understanding of the bargain between Prince and

his creditors does not imply that Huntley owned

the value of Floit’s services for the foreseeable

future, despite the absence of an employment

agreement between Huntley and Floit.

 Doubtless Huntley owned its goodwill--its

customer lists, the value of repeat business, and

so on. See Hagshenas v. Gaylord, 199 Ill. App. 3d

60, 557 N.E.2d 316 (2d Dist. 1990). But the

trustee does not accuse Floit of trying to make

off with these assets, or of including their

value in the $249,000 allocated to the covenant

rather than the $151,000 allocated to assets.

Even the trustee’s expert conceded that Huntley’s

tangible assets were worth no more than $106,000;

the rest was goodwill. Harvard did not assume

Huntley’s name, and cement usually is sold by

competitive bid, so Huntley did not have the sort

of goodwill that is associated with a personalservices business such as a medical practice. In

the end, the trustee’s position depends on

allocating the value of Floit’s human capital to

Huntley, and we do not think that the bankruptcy

judge committed clear error in ruling otherwise.

Affirmed