Kristen C. Wright v. Clinton A. Phillips ( 2017 )


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  •                              COURT OF CHANCERY
    OF THE
    SAM GLASSCOCK III           STATE OF DELAWARE                   COURT OF CHANCERY COURTHOUSE
    VICE CHANCELLOR                                                         34 THE CIRCLE
    GEORGETOWN, DELAWARE 19947
    Date Submitted: September 20, 2017
    Date Decided: December 21, 2017
    Richard E. Berl, Jr., Esquire                  James D. Griffin, Esquire
    Berl & Feinberg, LLP                           Parkowski, Guerke & Swayze, P.A.
    Dartmouth Business Center―Suite 3              19354C Miller Road
    34382 Carpenter’s Way                          Rehoboth Beach, DE 19971
    Lewes, DE 19958
    Re: Kristen C. Wright v. Clinton A. Phillips, Civil Action No. 11536-
    VCG
    Dear Counsel:
    This matter involves litigants, formerly husband and wife, who together own
    a recycling and shredding business, pursued via three business entities. Each party
    owns a 50% interest in each entity. The matter initially raised numerous legal and
    equitable issues, but the parties—wisely, in my opinion—decided to settle the matter
    via one co-owner buying out the other. Accordingly, this matter is before me on the
    sole issue of a determination of the value of the half interest in the three companies
    that one party will buy from the other. After a trial and post-trial briefing, I find the
    combined pre-adjustment value of the entities is $1,767,465, with a pre-adjustment
    half interest value of $883,733. This amount must be adjusted in accordance with
    this Letter Opinion.
    I. BACKGROUND
    The parties each own 50% of DataGuard, Inc. (“DG Shredding”), DataGuard
    Recycling, Inc. (“DG Recycling”), and CK Aurora Business Ventures, LLC
    (“Aurora”).1 DG Shredding primarily shreds waste materials and DG Recycling
    (together with DG Shredding, the “DG Companies”) recycles certain discarded
    materials.2 Aurora’s “sole function is to own real estate located at 9174 Redden
    Road, Bridgeville, DE 19933 [(the ‘Aurora Property’ or the ‘Property’)], and to lease
    the Aurora Property to the two DataGuard businesses.”3 The Property is encumbered
    by a mortgage, which amounted to $855,635 as of May 24, 2017.4 Both of the DG
    Companies operate out of the Aurora Property and share some resources, including
    personnel and equipment.5
    The Petitioner and the Respondent divorced in 2013 and jointly ran the
    businesses until they reached an impasse in 2015.6 The businesses have done well,
    and the Petitioner and the Respondent were together paid a total of $300,000 in
    2016.7 The Petitioner initially filed a complaint alleging breaches of fiduciary duty
    1
    Pre-Trial Stipulation and Order (“PTS”) 1.
    2
    
    Id. at 1,
    5 (noting that DG Shredding and DG Recycling are both Delaware subchapter S
    corporations).
    3
    
    Id. at 2.
    4
    
    Id. 5 Id.
    6
    
    Id. at 3.
    7
    Trial Tr. 148–49, May 24, 2017. The record states that this was taken in “salary” and as “Officers’
    Compensation” but does not describe if the parties received any member draws, dividends or
    otherwise, or detail from which entity the particular §payments came. These issues are not
    pertinent to my decision here, except, as noted, to the issue of “synergies.”
    2
    by the Respondent and seeking his exclusion from the affairs of the business.8 The
    parties each filed Motions for Order of Sale.9 Ultimately, the parties agreed that the
    Respondent would purchase the Petitioner’s 50% interest in each of the jointly
    owned businesses.10
    The parties disagree on the value of the DG Companies.11 The Petitioner
    retained Charles Sterner to value the businesses.12 Sterner is a Certified Public
    Accountant (“CPA”) and certified by the National Association of Certified
    Valuation Analysts (“NACVA”).13 Sterner completed his first report in May 2016
    for the period ending December 2014.14 He created an updated report in April 2017,
    but noted that he lacked certain pertinent information.15 Sterner initially concluded
    that the combined value of the DG Business was $1,671,675 but revised his April
    2017 estimate to $1,359,000.16 The Respondent retained Dale Mitchell as his expert
    witness. Mitchell is a former CPA but allowed his certification to lapse.17 He is a
    Certified Valuation Analyst.18        Mitchell used Sterner’s income figures and
    8
    
    Id. 9 Id.
    at 3–4.
    10
    
    Id. at 1–2.
    11
    
    Id. at 4.
    12
    
    Id. at 77.
    13
    Pet’r’s Opening Br. 12.
    14
    Pet’r Ex. 3.
    15
    Trial Tr. 97, 109.
    16
    
    Id. at 98,
    124.
    17
    
    Id. at 227.
    18
    
    Id. at 174,
    177, 181–82. Mitchell does have business experience; he owned a large record
    management business in the Seattle, Washington area for twenty years.
    3
    assumptions in his calculations.19 Mitchell created an updated report after receiving
    new information from Sterner’s April 2017 report.20 Mitchell valued the DG
    Companies at $1,155,000.21
    Sterner and Mitchell have a number of discrete disagreements on how to value
    the entities. The experts contest the applicability of marketability and brokerage
    discounts, the role of certain synergies, and the proper valuation of Aurora.22 Sterner
    accounted for the subchapter S corporation status of the DG Companies by applying
    an individual tax rate of 14.5% instead of a C corporation rate of 31%, resulting in a
    $204,000 valuation increase; Mitchell disagrees with this analysis.23
    The gap between the experts’ valuation of Aurora—the sole asset of which is
    the Aurora Property—is wide. The parties purchased the Aurora Property in 2009
    for $1,080,000.24 Community Bank retained Sue Parsons at the Trice Group to
    perform a real estate appraisal of the Aurora Propety in 2015 (the “Trice Report”).25
    Parsons has more than thirty years’ experience in property appraisal and holds the
    highest level of real estate appraisal certification.26 Parsons’ analysis included both
    19
    
    Id. at 183,
    234.
    20
    
    Id. at 184.
    21
    
    Id. at 202–03.
    22
    Pet’r’s Opening Br. 16; Resp’t’s Answering Br. 16–17.
    23
    
    Id. at 203
    (“So the difference between the 1,600,000 or 1,360,000 and . . . 1,155,000 is about
    205,000 . . . [or] the difference using a different tax rate.”).
    24
    Trial Tr. 31.
    25
    
    Id. at 8.
    26
    
    Id. at 6.
                                                   4
    a comparable sales method and an income approach.27 Parsons also assumed an
    ongoing maintenance cost of $12,000 per year in repair expenses.28 She valued the
    Aurora Property at $1,375,000 under a comparable sales valuation method, at
    $1,425,000 under an income generation valuation method, and averaged the two to
    conclude that the Property was worth $1,400,000 as of February 2015.29
    The Respondent retained Wesley Cox, a commercial real estate agent, to
    provide an estimate of the potential value of the Property.30 Cox collected a series
    of comparable properties and calculated an average listing price of approximately
    $1,200,000 to $1,250,000, with a predicted sale price of $1,100,000 for the Aurora
    Property.31 Cox did not use the income-generation valuation method, but conceded
    that such an approach could yield a higher estimated value for the Aurora Property.32
    The Respondent also retained Gary Neal, a general contractor who previously
    performed work on the Property, to provide estimates for Neal’s company to repair
    or replace particular items identified by the Respondent.33 The total repairs came to
    $92,000, although Parsons disputes the necessity and relevance of some of those
    repairs.34 My analysis of the parties’ disputes follows.
    27
    
    Id. at 11.
    28
    
    Id. at 47–48.
    29
    
    Id. at 19–22.
    30
    
    Id. at 276–77.
    31
    
    Id. at 275,
    291.
    32
    
    Id. at 296–97.
    33
    
    Id. at 244–45,
    259.
    34
    
    Id. at 39,
    47.
    5
    II. ANALYSIS
    A court of equity has authority to order the sale of a deadlocked company in
    certain circumstances.35 Here, the parties have agreed to the sale of the Petitioner’s
    half interest in the entities to the Respondent. Before me is the issue of the value of
    that interest. I start by analyzing the value of the entities as going concerns. Because
    Petitioner, via agreement, has agreed to give up, and the Respondent has agreed to
    purchase, an interest in a going concern (the business or businesses represented by
    the three entities), a fair value analysis by analogy to a Section 262 appraisal
    valuation is appropriate here. This requires me to determine the fair value of the
    three entities as going concerns as of the time of the transfer, using recognized
    valuation techniques.36 The basic approach of the experts is to add the value of the
    Aurora Property to a valuation of the DG Companies based on an income approach
    analysis. I accept this methodology and address below only the parties’ disputes as
    to valuation. I depart from appraisal action standards where, and to the extent that,
    equity here requires.
    A. The Corporate Tax Status
    The Petitioner argues that the DG Companies’ status as S corporations adds
    value beyond that of a Delaware C corporation. The Respondent disputes that the
    35
    See, e.g., In re TransPerfect Glob., Inc., 
    2017 WL 3499921
    , at *1 (Del. Ch. Aug. 4, 2017).
    36
    See, e.g., In re of SWS Grp., Inc., 
    2017 WL 2334852
    , at *1 (Del. Ch. May 30, 2017).
    6
    S-corporation status adds value cognizable here.37            The Petitioner points to then-
    Vice Chancellor Strine’s explanation of the value of subchapter S status to justify
    the addition of 4.08% to the capitalization rate in Sterner’s reports. In Kessler, this
    Court stated that:
    Assessing corporate taxes to the shareholder at a personal
    level does not affect the primary tax benefit associated
    with an S Corporation, which is the avoidance of a
    dividend tax in addition to a tax on corporate earnings.
    This benefit can be captured fully while employing an
    economically rational approach to valuing an S
    corporation that is net of personal taxes.38
    To illustrate this principle, then-Vice Chancellor Strine created a chart to show that
    the amount of after-tax dollars returned to stockholders was greater under an S
    corporation than a C corporation in those circumstances.39
    I find that the DG Companies’ status as S corporations has a discrete value
    applicable here.      Accordingly, I find that the amount attributable to the DG
    Companies’ status as S corporations―$204,000―should be included in the DG
    Companies’ valuation.
    B. The Sterner Reports
    The Respondent and his expert disagree with the Sterner valuation of the DG
    Companies in three particulars: (i) the addition of $40,000 in Sterner’s revised
    37
    Pet’r’s Opening Br. 10–11; Resp’t’s Answering Br. 13–15.
    38
    Del. Open MRI Radiology Assocs., P.A. v. Kessler, 
    898 A.2d 290
    , 328–29 (Del. Ch. 2006).
    39
    
    Id. at 329
    (highlighting that, with a hypothetical $100 investment return, stockholders would
    receive $51 post-tax dollars from a C corporation and $60 post-tax dollars from an S corporation).
    7
    report; (ii) Sterner’s failure to apply marketability and brokerage commission
    discounts; and (iii) Sterner’s addition of certain “synergies” of the transaction to
    overall value.
    First, the Respondent argues that Sterner added $40,000 to his revised report
    with respect to one of the entities due to a transcription error in calculating the
    figures.40 The Petitioner argues that any error is harmless because it is offset by a
    devaluation of the other entity; essentially, any error is a wash and does not change
    the cumulative value of the two DG Companies.41 Because my examination of the
    record confirms that any error is indeed a wash, no adjustment for the transcription
    error is warranted here.
    Second, Mitchell applied a 20% marketability discount, including a 10%
    brokerage commission, because doing otherwise would “result in the Petitioner
    receiving the full benefit for the value of her shares but would result in passing her
    50% share of those unrecognized costs on to the Respondent, who will pay 100% of
    those costs when he sells the entities to a third party.”42 Mitchell testified that the
    costs must someday be incurred and that those costs should be shared equally
    between the parties at the current time.43 The Petitioner contends that, because this
    40
    Resp’t’s Answering Br. 17.
    41
    Pet’r’s’ Reply Br. 7–8.
    42
    Resp’t’s Answering Br. 19.
    43
    Trial Tr. 214–15.
    8
    transaction is between a known buyer and seller, I should not consider the transaction
    costs of an uncertain future transaction.44
    I find that a lack of marketability is part of the operative reality of the entity,
    half of which is being purchased by the Respondent and sold by the Petitioner here.45
    While this court-enforced sale does not involve marketing the businesses, a lack of
    marketability is inherent in the property the Petitioner owns, and not accounting for
    such would result in a windfall here. I therefore include a 10% marketability
    discount. However, I reject the additional 10% discount that Mitchell ascribes to a
    brokerage commission and other costs as too speculative to be justified.
    Finally, the experts agreed that the DG Companies could realize additional
    value through “synergies” found in the combined entity.46 Most significantly,
    Sterner includes the value he opines will be attributable to the absence of his client
    from the business in his overall valuation.47 The Respondent, however, argues that
    increasing the valuation to represent certain synergies arising from the sale is
    inappropriate because the DG Companies already share a single facility and other
    44
    Pet’r’s Reply Br. 4.
    45
    Nonetheless, I reject the trial testimony that Bridgeville, home to the businesses here, is a
    “remote” small town. It may be remote to Washington, Baltimore, and Philadelphia, as those
    metropolises are remote to it; it is convenient, however, to Greenwood, Cannon, and Federalsburg,
    among many others. It is the former home of a renowned Vice Chancellor in this Court, now sadly
    removed to New Castle County. And as those unfortunate enough to live elsewhere learn when
    they visit, if they lived in Bridgeville, “[they] would be home now.”
    46
    Trial Tr. 147–48, 237–38.
    47
    
    Id. at 95–96,
    237–38.
    9
    costs, and thus will not recognize any true increase in value from the consolidation
    of ownership.48
    There is a certain irony in the Petitioner’s insistence that her removal from the
    businesses she helped to build should increase their value, in an amount of which
    she is entitled to half. In my view, addition to the value of these businesses of any
    savings from the discharge of the Petitioner is too speculative to include here. This
    is true particularly in light of the state of the record, which provides the amount the
    parties are “paid” as “Officer Compensation,” but little detail about how the
    Petitioner’s compensation is determined, the exact nature of the compensation, or
    what she was “paid” for. The Sterner valuation, therefore, must be adjusted to deduct
    from income the amount attributed to the removal of the Petitioner as a principal of
    the companies.
    C. The Valuation of Aurora
    The parties dispute the valuation of the Aurora Property, and by extension,
    Aurora. Sterner used the Trice Report and the existing mortgage debt to value
    Aurora.49 The Petitioner argues that the Trice Report is the most credible valuation
    because it was performed by an independent appraiser hired by a bank, in contrast
    to a real estate agent hired directly by an interested party.50 The Petitioner also
    48
    Resp’t’s Answering Br. 23.
    49
    Trial Tr. 78.
    50
    Pet’r’s Opening Br. 21–23.
    10
    argues that Parson’s use of an additional valuation method in creating the Trice
    Report, the income approach, increased the accuracy of the valuation.51                         The
    Petitioner attacks the Respondent’s hiring of Neal (who opinioned on the cost to
    make certain repairs) as an “obvious . . . attempt by the Respondent to reduce the
    amount he will have to pay” by deducting substantial but spurious repair expenses
    to decrease the value of the property.52
    The Respondent points out various minor errors made by Parsons during trial
    and disputes the useful economic life assigned to the Aurora Property, the difference
    between the list and sale price, the relative familiarity Parsons with the particular
    comparable properties, and the timeframe and choice of comparable properties used
    in the Trice Report.53
    Despite the Respondent’s efforts, I find the Trice Report, performed by an
    appraiser and commissioned by a non-party, to be representative of the fair value of
    Aurora at the relevant time. I find that the addition of the income generation
    valuation method used in the Trice Report makes it more likely an accurate indicator
    of the value of the Aurora Property than the Cox estimate. Finally, I find the
    51
    
    Id. at 21.
    52
    Id.; Trial Tr. 40 (“I would think they would try to use [Neal’s estimate] as a negotiating tool on
    price.”).
    53
    Resp’t’s Answering Br. 26–29, 31; Trial Tr. 42.
    11
    maintenance cost estimate in the Trice Report reasonable, and do not, therefore,
    discount the value for the repair costs testified to by Neal.
    III. CONCLUSION
    In summary, I apply a fair valuation analysis here by analogy to Section 262.
    I find that the tax status of the DG Companies is relevant to their valuation, giving
    them an underlying value of $1,359,000, consistent with the Sterner report but
    subject to the adjustments below. First, the Sterner valuation must be recalculated
    to remove from income the amount Sterner ascribed to savings from the discharge
    of the Petitioner, which I have found both inappropriate and speculative. Obviously,
    this will reduce the value of the DG Companies to some extent. Because the record
    is insufficient for me to do this adjustment, I leave this calculation to the parties.
    Next, I find a 10% marketability discount is appropriate. Applying the 10%
    marketability discount to the pre-adjustment amount described above, $1,359,000,
    results in a fair value of the DG Companies of $1,223,100 (less the other adjustment
    described).
    I note that the valuations employ a hodgepodge of valuation dates. Valuation
    should be done as of the transfer date, which I deem to be the date of this Letter
    Opinion (the “Transfer Date”). That will require the parties to reconcile the
    valuations, either by bringing them up to the Transfer Date or agreeing that for
    purposes of an order in this matter, the valuations shall be deemed unchanged.
    12
    To repeat, the DG Companies’ valuation amount of $1,223,100 is subject to
    the following adjustments in accordance with this Letter Opinion: (1) recalculation
    of value after deduction from income of the amount of assumed avoided payments
    to the Petitioner, included as “synergies”; and (2) any minor adjustments required to
    accord with the parties’ future agreement regarding alignment with the Transfer
    Date.
    Lastly, I find the Trice Report of $1,400,000 to be representative of the fair
    value of Aurora as of February 2015. Subtracting the mortgage amount of $855,635
    as of May 24, 2017, the net pre-adjustment value of Aurora is $544,365. This
    amount should also be adjusted to account for (1) any changes to the mortgage
    amount to accord with amount of the outstanding mortgage as of the Transfer Date;
    and (2) the parties’ future agreement regarding alignment with the Transfer Date.
    Taken together, the combined pre-adjustment value of the DG Companies and
    Aurora is $1,767,465, with a pre-adjustment half interest value of $883,733.
    The parties should confer and submit an appropriate Form of Order based on
    this Letter Opinion. To the extent issues regarding the timing and method of
    payment remain, the parties should so inform me.
    Sincerely,
    /s/ Sam Glasscock III
    Sam Glasscock III
    13
    

Document Info

Docket Number: CA 11536-VCG

Judges: Glasscock, V.C.

Filed Date: 12/21/2017

Precedential Status: Precedential

Modified Date: 4/17/2021