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Estate of Cohen v. Booth Computers

BER-C-135-08 (N.J. Super. Ch. Div. 2009) (Unpublished)

PARTNERSHIPS; BUY-SELL — A partnership agreement need not use any commonly understood meaning for the term “net worth” and can give that term the meaning that the partners choose to use and, unless a court’s conscience has been shocked, a court will not write a fairer buy-out provision for the partners.

Three siblings entered into a partnership agreement containing a buy-out formula. Under the agreement, upon the death or divorce of a partner, that partner’s interest was to be bought out at “net worth,” defined as the “net book value as shown on the most recent Partnership financial statement at the end of the month ending with or immediately preceding the date of valuation …,” plus $50,000. None of the three siblings/partners apparently negotiated or created the terms of the agreement, which was the brainchild of their parents to shift income to their children. The reason for the buy-out provision in the event of a divorce was to shield the partnership and assets from involvement in divorce proceedings. When one of the surviving spouses divorced her spouse, this was not an issue because the divorced spouse signed a prenuptial agreement that prevented claims against the sibling’s interest by her spouse. Thus, the partners agreed to permit the surviving sibling to remain a partner, notwithstanding the provision mandating a buy-out of a partner’s interest. When one of the siblings died, the agreed-upon formula was applied with each of the surviving siblings winding up with a 50% interest in the partnership. The buy-out payment was not remotely related to fair value or actual value, but was set at net book value as provided in the agreement.

The partnership owned several assets of disputed, but substantial value. Upon the death of one of the two remaining partners, the sole surviving partner sought to buy out the recently deceased partner’s estate. The sum tendered was derived using the formula mandated by the partnership agreement. The estate rejected the offered amount and contended that the fair market value of its one-half interest in the partnership was much higher. The estate sued, alleging that the buy-out provision was being erroneously interpreted by the remaining partner and that, in any event, the remaining partner’s application of the provision was unconscionable based on the actual value of the partnership’s assets. The estate also alleged that the remaining partner breached his fiduciary duty to the partnership and to the deceased partner by failing to perform an accounting of the partnership assets.

The Chancery Division dismissed the estate’s complaint. It held that the plain language of the disputed provision, given its natural reading, indicated that the full and true value of the partnership in the event of a buy-out was to be determined by a specific and clear formula. The “full and true value,” as set forth in the agreement, was equal to the partnership’s net worth plus $50,000. Although the Court found that the term “net worth” could have several meanings, the buy-out provision specifically defined this term to mean “the net book value as shown on the most recent partnership financial statement.” It believed that if the partners had intended the buyout to be at fair market value, they could have easily have said so. Plainly, the partnership agreement did not provide for a fair market value buyout. Further, the Court noted that the history of the partnership, as shown by its financial statements – including its tax returns – never reflected the market value approach to net worth, but only reflected a cost approach. The Court found this to be a standard practice used by most businesses. Moreover, the Court thought it was compelling that when the first sibling/partner died, the newly deceased sibling/partner knew that she received the benefit of a buy-out calculated in the exact manner that the sole surviving partner utilized in ascertaining the pay out to her estate, but did not contest the provision as being unfair. Finally, it noted that the formula could just as likely have been applied to the remaining partner’s estate if he had died first.

As to the audit issue, the Court observed that no partner ever insisted that audits be done. To the Court, this was unsurprising since many family partnerships are run informally and their partners may not be careful with respect to bookkeeping protocols. Nevertheless, the Court found that this partnership always filed annual tax returns reflecting the partnership’s income, expenses, the value of partnership assets, as well as the state of each partner’s capital accounts. Thus, it opined that everything needed to calculate book value was readily available from the partnership’s books and records.

The Court also held that the buy-out provision was not unconscionable. First, it ruled that the provision applied equally to all partners and was, in fact, used without contest when the first sibling/partner died. Second, the Court found that many small family businesses use the same or similar formulas for easily and quickly providing for the buy-out the interest of a deceased family member. The Court understood that pegging the value to “fair value” invited exactly the sort of disruptive litigation (from the family’s perspective) occurring here. Third, although the Court thought that although a fairer buy-out provision could have been written, it was not up to a court to write a better or different contract than the parties themselves had agreed to, other than where enforcement would be so egregious so as to “shock the conscience.” Here, the Court’s conscience was not shocked by enforcing the partnership agreement under the circumstances presented to it.

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