Lawrence Smith v. Sheila Murphy Smith ( 2020 )

RENDERED: DECEMBER 11, 2020; 10:00 A.M.
NOT TO BE PUBLISHED
Commonwealth of Kentucky
Court of Appeals
NO. 2019-CA-0910-MR
LAWRENCE SMITH APPELLANT
APPEAL FROM WASHINGTON CIRCUIT COURT
v. HONORABLE JANET J. CROCKER, SPECIAL JUDGE
ACTION NO. 10-CI-00117
SHEILA MURPHY SMITH AND
LEBANON MACHINE SHOP, INC. APPELLEES
OPINION
AFFIRMING
** ** ** ** **
BEFORE: CALDWELL, MAZE, AND MCNEILL, JUDGES.
MAZE, JUDGE: Lawrence Smith (Larry) appeals from findings of fact,
conclusions of law, and a judgment valuing the assets of Lebanon Machine Shop,
Inc. (LMS) for purposes of compensating Larry for his interests in the company’s
stock and real property. As an initial matter, we conclude that this appeal is not
moot even though Larry has since transferred his interests in the stock and real
property owned by LMS to the other principals. However, we further find that the
trial court did not clearly err in determining the value of LMS’s inventory, and that
Larry failed to show how he preserved the trial court’s findings concerning the tax
liability. Hence, we affirm the judgment.
This case originated as a dissolution-of-marriage action between Larry
and Sheila Smith. The petition was filed July 10, 2010, and an interlocutory decree
of dissolution was granted on November 22, 2010. The decree reserved all other
issues for later adjudication. The most significant dispute concerned the valuation
and division of the marital interest in LMS, a closely-held, family-owned-and-
operated business. Larry and his two younger brothers, Daniel Smith (Dan) and
Patrick Smith (Pat), each owned a one-third interest in LMS and its affiliated
companies. Larry also owned a one-half interest in some of the real estate on
which LMS operates.
Initially, Sheila and Larry agreed to a public sale of all of their real
and personal property, including the real property on which LMS’s business is
located and LMS’s physical assets. Dan and Pat objected, voting against the sale
at an LMS board meeting. Thereafter, on July 25, 2012, LMS filed a motion to
intervene in the dissolution action. The trial court granted the motion on the same
date.
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During the pendency of this action, the relationship between Larry,
Dan, and Pat disintegrated. Dan and Pat accused Larry of removing equipment and
records from LMS for the purposes of operating a competing business. On July 2,
2013, LMS filed a motion for an injunction against Larry, which the trial court
granted on July 11. Among other things, the injunction prohibited Larry from
coming on the premises of LMS and from removing records and equipment from
LMS. Following issuance of the injunction, LMS filed a motion for contempt
based on Larry’s failure to comply with the injunction’s requirement to return
equipment. The trial court declined to rule on the motion, concluding that the
issues involved could be determined as part of the valuation of Larry’s interest in
LMS.1
From the end of 2013 through 2016, the parties attempted to engage in
arbitration, which was unsuccessful. The matter was scheduled for a bench trial,
which took place over several days in April, June, and July of 2017. Thereafter, on
April 23, 2018, the trial court entered findings of fact, conclusions of law, and a
judgment on the disputed issues. Larry filed a motion to alter, amend, or vacate
1
Subsequently, additional parties were joined as third-party respondents. The additional parties
included Dan and his wife Diane Smith, affiliated companies LMS Crane Services, LLC and
Larry and Dan Smith Rental, and Peggy Smith, Larry’s current wife. An additional intervening
complaint was filed by Chastity and Johnathan Renfro, the daughter and son-in-law of Sheila and
Larry Smith.
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the April 23, 2018, judgment, alleging several erroneous findings. In its amended
findings issued on July 9, 2018, the trial court noted the parties’ agreement that it
had erroneously included the value of certain escrow funds in its valuation of
LMS. But by separate order also issued on July 9, the trial court denied the other
grounds raised in Larry’s CR2 59.05 motion.
In pertinent part, the trial court valued the assets of LMS as of
December 31, 2013, which the parties agreed was the applicable date for valuation.
Those findings are summarized below:
Cash 94,599.00
Accounts Receivable 253,787.00
Inventory 250,000.00
Due From: Lebanon Lumber & Hdwe 286,588.00
Lebanon Lumber & Hdwe 40,000.00
DLP, LLC 202,950.00
Marion Co. Metals, LLC 232,052.00
Machinery and Equipment 750,000.00
Building & Improvements 78,100.00
Accounts Payable -7,267.00
Other Current Liabilities -15,462.00
Loans Due Shareholders -148,988.00
Total Net Assets 2,017,359.00
Based upon this calculation, the trial court determined that the value
of Larry’s one-third interest in LMS was $672,453.00. The trial court directed that
Dan and Pat pay Larry this amount, representing the value of his shares as of
2
Kentucky Rules of Civil Procedure.
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December 31, 2013, with interest retroactive to the following day. The trial court
also made findings on other claims which are not the subject of this appeal.
Thereafter, on May 9, 2019, the trial court entered supplemental
findings of fact, conclusions of law, and a final judgment dividing the marital
assets and debt, including the marital interest in LMS. Larry now appeals from
portions of the judgment valuing his interest in LMS. Additional facts will be set
forth below as necessary.
Larry raises two issues involving the trial court’s valuation of LMS’s
assets. First, he argues that the trial court erred in its valuation of LMS’s
inventory. And second, Larry contends that the trial court erroneously failed to
include the tax liability from LMS’s post-2014 distributions in its valuation of his
interest.
As an initial matter, LMS argues that this appeal became moot after
Larry transferred all of his one-third interest in LMS. On September 27, 2019,
LMS paid Larry $1,059,183.71 in exchange for: (1) Larry’s transfer of all his
stock in LMS; and (2) a deed conveying Larry’s one-half interest in the underlying
real estate. Since he no longer has any interest in the company or real property,
LMS argues that those transactions cannot be modified and, thus, no relief can be
granted on appeal.
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LMS relies heavily on AEP Industries, Inc. v. B.G. Properties, Inc.,
533 S.W.3d 674 (Ky. 2017). That case involved a dispute concerning the
enforcement of an agreement giving AEP an option to purchase real property
which it leased from B.G. AEP sought to exercise its purchase option, but the
parties could not agree on the value of the property. Consequently, AEP brought
an action seeking specific performance of the agreement. Id. at 676.
After finding the option agreement to be enforceable, the circuit court
directed the parties to name an appraiser to value the property. AEP was satisfied
with the price set by the appraiser, but B.G. argued that it was insufficient. The
circuit court ultimately accepted the appraisal and entered a judgment ordering
specific performance of the option agreement. Immediately thereafter, B.G.
executed the deed acknowledging the receipt from AEP of the stated consideration.
AEP promptly recorded the deed, and B.G. did not record a lis pendens notice to
signify its retention of ongoing litigative interest in the property. B.G. also filed a
notice of appeal but did not seek a supersedeas bond to stay enforcement of the
judgment. Id. at 677-78.
On appeal, this Court reversed, finding that the circuit court failed to
adequately address the threshold issue of whether AEP had complied with the
option agreement and was entitled to specific performance. But on discretionary
review, the Kentucky Supreme Court held that B.G.’s appeal was rendered moot
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by its conveyance of the property to AEP by general warranty deed without
reservation and its acceptance of the stated consideration for the transfer. Id. at
678. The Court explained:
BG did not preserve its objections to the trial
court’s order of specific performance of the Option
Agreement by posting a supersedeas bond pursuant to
CR 62.03, CR 73.04, and CR 73.06. Nor did BG avail
itself of an alternative means of staying the order by
seeking immediate relief from the Court of Appeals
staying the matter pending appellate review. Instead, BG
transferred the property. As we held in Green Valley
Environmental Corp. v. Clay, citing Section 111 of
Kentucky’s Constitution, the Court of Appeals has the
power “to grant a stay pending appeal in order to
maintain the status quo of the case pending before it on
review.” 798 S.W.2d 141, 143-144 (Ky. 1990) (citing
Crady v. Cranfill, 371 S.W.2d 640 (Ky. 1963)). In
summary, BG sought none of the available remedies that
would have enabled it to avoid the immediate
enforcement of the trial court’s order and defer, at least
temporarily, the conveyance of the property for what it
regarded as an improperly determined price.
While not dispositive, the opinions of our
predecessor Court in Rose v. Cox, 297 Ky. 458, 179
S.W.2d 871 (1944), and Sedley v. Louisville Trust Co.,
419 S.W.2d 531, 532 (Ky. 1967), are instructive even
though they contain important factual differences. Those
cases establish that when property is sold to a third party
pursuant to a judicial sale ordered by the trial court, in
the absence of a supersedeas bond or other stay of
execution, a subsequent determination by an appellate
court that the order directing the sale was erroneous does
not void the sale. “Where the court has jurisdiction of
the parties and the subject matter of the suit, and has
statutory authority to decree the sale, a subsequent
reversal of the judgment decreeing the sale is a mere
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declaration that the judgment is erroneous, but does not
render it void.” Rose, 179 S.W.2d at 872. “The fact that
the judgment ordering the sale of the property was not
superseded prevents us from granting [the Appellant] the
relief to which she is allegedly entitled” and the case is
thereby moot. Sedley, 419 S.W.2d at 533.
Id. at 679-80 (internal footnotes omitted).
The Supreme Court determined that B.G.’s conveyance of the
property and acceptance of consideration was inconsistent with its argument that
the order compelling specific performance was erroneous. Id. at 680. The Court
also noted that the delivery and acceptance of the deed extinguished any rights
under the contract for conveyance of the property. Id. at 681. Under the
circumstances, the Supreme Court concluded that B.G.’s appeal was moot. No
further relief could be granted because B.G. failed to preserve its objections to the
circuit court’s final order. Id. at 682-83.
The Court in AEP distinguished a judgment ordering specific
performance of a real estate option contract from a judgment awarding a fungible
sum of money. In the case of the latter, a defendant is not required to post a
supersedeas bond but may simply pay the judgment without forfeiting his right of
appeal. Id. at 682. But where the res subject to the order compelling specific
performance is real estate, the Court held that the defendant’s failure to seek a stay
of the judgment precludes any subsequent relief setting aside the conveyance. Id.
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 In this case, Larry does not challenge the order of the trial court
directing him to transfer his interest in the assets of LMS, including the real
property. Rather, he simply disputes the trial court’s valuation of that interest. The
relief sought would not require unwinding of any conveyances, but merely a re-
calculation of the appropriate amount to be paid for his interests. Thus, unlike in
AEP, the issues raised in Larry’s appeal do not implicate any laws relating to the
transfer of real property. Therefore, we conclude that this appeal is not moot.
As noted above, Larry challenges the trial court’s factual findings
relating to two aspects of its valuation of the assets of LMS. As with any matter
heard before a trial court outside the presence of a jury, we review the trial court’s
factual findings for clear error. CR 52.01. See also Owens-Corning Fiberglas
Corp. v. Golightly, 976 S.W.2d 409 (Ky. 1998). “A factual finding is not clearly
erroneous if it is supported by substantial evidence.” Gosney v. Glenn, 163 S.W.3d
894, 898 (Ky. App. 2005). Substantial evidence constitutes proof of facts which
have sufficient probative value to permit a reasonable person to reach a factual
determination. God’s Ctr. Found. Inc. v. Lexington-Fayette Urban County Gov’t,
125 S.W.3d 295, 300 (Ky. App. 2002).
The testimony at trial concerning the value of LMS’s inventory was
the subject of much debate, but little definitive evidence. LMS did not maintain a
schedule of its inventory. On its tax returns for the applicable period, LMS valued
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its inventory at $31,677.00, but the parties agreed that this amount was not an
accurate representation of the inventory’s value as of December 31, 2013.
Larry testified that, in 2012, he and his current wife conducted a
partial “hand count” of the inventory. He submitted a summary of that count,
valuing the inventory at approximately $670,000.00. Based on that partial
calculation, he extrapolated the total value of the inventory to be $1,000,000.00,
which he acknowledged should be reduced by 25% to $750,000.00. However, the
trial court noted that Larry did not know the quantities on hand nor did he provide
a basis for his pricing.
David Issacs was responsible for ordering parts and assigning duties at
the LMS shop. He testified that inventory was at “an all-time low” in 2013 due to
the ongoing dispute between the brothers. He also noted that the inventory
contained many old items, some of which dated to before Larry and Dan bought
the business in the 1980s. While he knew the cost of the individual items, Issacs
admitted that he did not know the quantities on hand. He estimated that
$500,000.00 was “pretty close” to the replacement cost of the inventory. The court
found that this was not an appropriate method of valuing the inventory.
LMS presented the expert testimony of Calvin Cranfill (Cranfill), a
CPA and business valuation expert. Cranfill testified that he viewed the inventory
of LMS but did not attempt to undertake a count or obtain specific pricing. He
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agreed with Issacs that much of the inventory included older items for which it was
difficult to determine an exact value. Cranfill testified that, even if a full count of
the inventory were practical, there was no reliable way to set a value for older or
obsolete items. For purposes of determining LMS’s book value, Cranfill adopted
the recommendation of Pat and Dan that the inventory should be valued at
$100,000.00.
Cranfill further testified that, in the commercial, industrial, and
machinery equipment industry, companies doing between $1 million and $3
million in sales have an average inventory of 16.1% of total assets. Based on this
standard, Cranfill stated that LMS’s inventory value would average as high as
$285,000.00. Cranfill went on to testify that he did not believe that this standard
was applicable to determine the value of LMS’s inventory. First, he again noted
that the age of the inventory would likely decrease its overall value. He also
observed that LMS had a high rate of turnover in its newer inventory but kept its
older, unsold inventory on hand. And second, he noted that the principals of LMS
operated the business very conservatively. Until 2014, they did not take “normal
levels of salary”; they frequently re-invested income to build up equity in the
assets; and they incurred little or no debt on the business. Consequently, he opined
that the ratio would overstate the actual value of the inventory. Based on these
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factors, Cranfill concluded that the inventory should not be valued based on the
industry standard, but using the lower $100,000.00 figure offered by Dan and Pat.
Despite this testimony, the trial court concluded that the “industry
standard” identified by Cranfill was the only reliable method. Based on the five-
year average of gross sales, the trial court valued the inventory at $250,000.00.
Larry argues that the trial court had no basis to adopt this standard as a basis to
determine the value of the inventory. Rather, he contends that the only reliable
basis was his partial hand count valuing the inventory at $750,000.00.
In its order denying Larry’s CR 59.05 motion, the trial court noted
that ratio analysis is an accepted method in the valuation of a business enterprise.
The court also observed that ratio analysis may be especially useful to value the
stock of a closely-held company such as LMS, “which by definition does not have
a fair market value, since a market wherein a willing buyer will meet a willing
seller, neither under any compulsion, generally does not exist.” (Quoting Levene v.
Levene, 392 A.2d 621, 623-24 (N.J. 1978)). While we generally agree with this
analysis, we note that the application of such a ratio must be supported by expert
testimony demonstrating its applicability to the case at hand.
But as pointed out in Gaskill v. Robbins, 282 S.W.3d 306 (Ky. 2009),
“[t]he valuation of a business is complicated, often speculative or assumptive, and
at best subjective.” Id. at 311. In cases where there is no definitive testimony
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concerning the value of an asset, the trial court has some latitude to fix a value
within the range of competent testimony. Roberts v. Roberts, 587 S.W.2d 281, 283
(Ky. App. 1979). Here, the trial court did not find Larry’s valuation of the
inventory at $750,000.00 to be credible or accurate. Similarly, the trial court found
that the proposed $500,000.00 “replacement value” was not an appropriate method
to value the inventory.
On the other hand, the trial court also believed that the $100,000.00
value offered by Dan and Pat and adopted by Cranfill did not accurately reflect the
value of the inventory. Given the absence of any definitive evidence, we cannot
find that the trial court clearly erred by using the $250,000.00 amount reached
through the application of the ratio. Although we do not endorse the use of such
ratios without adequate foundation, we cannot find that the evidence compelled a
valuation of the inventory greater than this amount. Under the circumstances, the
trial court did not clearly err by valuing the inventory at $250,000.00.
Larry next argues that the trial court failed to include his tax liability
from distribution in its valuation. LMS is a subchapter S corporation, meaning that
it pays no corporate income taxes as an entity. Instead, its income or losses are
divided among its shareholders and the shareholders then report the income or loss
on their personal income tax returns. See Chamberlin v. Chamberlin, No. 2009-
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CA-001256-ME, 2010 WL 668792, at *2 n.2 (Ky. App. Feb. 26, 2010) (citing 47B
C.J.S. Internal Revenue §§ 374 to 378 (2009)).
On June 27, 2014, the trial court entered an order directing that LMS
cease distribution of income to its shareholders. However, LMS continued to issue
Schedule K-1 forms to each of the shareholders, reporting each partner’s share of
taxable distributions as ordinary income. Larry’s CPA testified that Larry was
issued K-1s allocating to him $251,924.00 in income for which he paid taxes at the
personal rate. Larry contends that this tax liability represents a windfall to Pat and
Dan, since they were able to raise their salaries from LMS to compensate for the
cessation in distributions. As a result, he argues that the trial court should have
included the value of these withheld distributions in its valuation of LMS to
compensate for the tax liability which he incurred.
The trial court did not address the tax liability, but “surmised that
[Larry] may be able to file amended returns based on the retroactive effective date
of the purchase of his shares.” “Findings of Fact, Conclusions of Law And
Judgment,” April 23, 2018, p.11 n.15. Larry argues that there was no evidence
supporting this conclusion. Rather, he contends that the trial court was obligated to
address this issue in its findings determining the value of LMS. LMS responds that
the trial court accounted for the tax liabilities by making the sale of Larry’s shares
retroactive to January 1, 2014, and awarding him interest from that date. It also
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contends that the reported distributions and retained income increased the value of
LMS to Larry’s benefit.
We are not clear how Larry preserved this issue for review. An
appellant’s brief must include “ample supportive references to the record and
citations of authority pertinent to each issue of law and [] shall contain at the
beginning of the argument a statement with reference to the record showing
whether the issue was properly preserved for review and, if so, in what manner.”
CR 76.12(4)(c)(v). Larry’s brief only includes a general statement that this issue
“was properly preserved for appeal,” without any citation to the record. We also
note that Larry did not raise the issue in his CR 59.05 motion, nor did he ask the
trial court to make additional findings on this issue pursuant to CR 52.02.
It is well-established that a final judgment shall not be set aside
because of the failure of the trial court to make a finding of fact on an issue
essential to the judgment unless the failure is brought to the attention of the trial
court by a written motion pursuant to CR 52.02. CR 52.04. In the absence of such
a motion, this Court must presume that the evidence presented at trial supports the
trial court’s conclusions. Cherry v. Cherry, 634 S.W.2d 423, 425 (Ky. 1982).
Here, the trial court concluded that it was not necessary to account for the K-1
distributions because Larry has the option of filing amended tax returns. Since
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Larry fails to show that he requested more specific findings or that this conclusion
was clearly erroneous, we decline to address the issue further.
Accordingly, we affirm the findings of fact, conclusions of law, and
judgment of the Washington Circuit Court with respect to its valuation of the assets
of Lebanon Machine Shop, Inc.
ALL CONCUR.
BRIEFS AND ORAL ARGUMENT BRIEF AND ORAL ARGUMENT
FOR APPELLANT: FOR APPELLEE LEBANON
MACHINE SHOP, INC.:
Lloyd C. Chatfield, II
Lexington, Kentucky E. Gregory Goatley
Springfield, Kentucky
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