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Estate of Cohen v. Booth Computers

421 N.J. Super. 134, 22 A.3d 991 (App. Div. 2011)

PARTNERSHIPS; BUY-OUTS; VALUATION — New Jersey law does not require the buy-out price for a partnership interest to be based upon fair market value and accepts that the term, “book value,” has a readily understood meeting in the accounting trade and further, even a large disparity in price between book value and fair market value will not, by itself, be grounds to invalidate a partnership’s agreed-upon buy-out provision.

A father created a partnership agreement for his three children, two brothers and a sister, to produce income for them. Then, a limited partnership was formed to own a partial interest in real property. Its general partners were the father and his wife, and the children’s partnership was the limited partner. The children’s partnership agreement provided for a buyout option to be exercised upon the death or divorce or marital separation of a partner. Nonetheless, when the sister got divorced, her brothers did not exercise the option. One of the brothers then died, and the two remaining siblings invoked the buyout provision. Pursuant to it, they paid their sibling’s estate for the estate’s one-third interest based on a formula in the partnership agreement. That formula added a small lump sum amount to the book value of the partnership.

The sister then died. The surviving brother sent a letter to trigger the buyout and included the partnership’s freshly prepared balance sheet to show its book value. The estate responded by requesting that the partnership produce an audited financial statement for the prior year, produce monthly financials for the first half of the current year, and explain a particular distribution that had been made to the partners as well as a particular notation on the balance sheet. The partnership produced the monthly financials and explained the distribution, but did not furnish the audited financial statements.

The sister’s estate sued the children’s partnership and the surviving brother, alleging that it was entitled to receive fair market value for its partnership interest. First, the lower court held that the buyout provision had not been waived when the brothers did not exercise it at the time their sister was divorced because such a failure did not evidence a clear and unequivocal choice to forever waive the right to exercise the option.

The estate offered a forensic accountant as its expert. He claimed that he could not render an opinion as to the partnership’s net book value from the statement that was furnished because it was unreliable, incomplete, and fraught with errors. He opined that the interest held by the children’s partnership in the limited partnership should have been valued using the full value of the property owned by the limited partnership. He did not utilize the income method of valuation, claiming that most of the partnership’s property was not income producing. Instead, he combined cash on hand as of the time of the sister’s death with its forty-five percent interest in the limited partnership.

The partnership’s expert testified that, from an accounting perspective, it would have been erroneous for the children’s partnership to reflect the fair market value of the real property on its books. According to him, the Internal Revenue Code and generally accepted accounting principles required that an investment in a partnership be recorded at cost, and, thus, it was very common for investments in real estate to have a negative value. He disagreed that the children’s partnership’s books and records were unauditable, claiming it was easy to verify the cash balance with the relevant banks. He did not find any discrepancies between the tax returns and the partnership’s books and records.

In its decision, the lower court first ruled as to the value of the real property. If the property value reached by the Court had been used to value the sister’s estate’s interest in the partnership, it would have received over twenty million dollars instead of the less than the one hundred thousand dollars under the buyout provision. It then noted that the three children had neither created their partnership nor negotiated the partnership agreement. Rather, the agreement was the creature created by their parents, prepared at the direction of one of the father’s lawyers. Moreover, the lower court found for that and other reasons, the testimony did not illuminate the meaning of the buyout provision. It then held the valuation formula in the buyout provision to be enforceable. Had the partners intended to provide for the buyout of a deceased or divorcing partner’s interest at fair market value, they could easily have said so, but they plainly did not. The partnership’s financial statements had never reflected the market value approach to find net worth, but used only a cost approach. The lower court also found that the absence of annual audits did not invalidate the buyout provision; no partner ever requested that one be done, and the buyout price, pegged as it was to book value as opposed to fair value or market value, could be readily ascertained when needed using only the company’s records. Finally, the lower court held that the buyout provision was not unconscionable; it was equally applicable to each child; and, it was not inherently offensive. Consequently, it dismissed the estate’s claim and granted judgment on the partnership’s and the surviving brother’s counterclaim specifically enforcing the partnership agreement.

On appeal, the Appellate Division found that the lower court was correct in ruling, on summary judgment, that the buyout provision had never been waived because there was no issue of material fact to support the contention that the children had clearly, unequivocally, and decisively waived the provision. Regarding valuation, the Court noted that New Jersey law does not require that value be determined using fair market value. Further, the Court found that nothing in New Jersey law suggesting that the term “book value,” without further definition or explanation, was inherently ambiguous. Thus, the Court rejected the estate’s suggestion that the gap-filling provisions of the Uniform Partnership Act were applicable to the issue at hand. It found no language in the partnership agreement requiring an audit in order to effect a buyout; only requiring that the partnership’s financial statement, as at the end of the month preceding the valuation, be used. That the balance sheet was created specifically for the buyout did not mean it was inaccurate.

Finally, the sister’s estate claimed that the lower court erred by not finding the buyout price to be unconscionable given the gross disparity between the cost approach price utilized by the partnership agreement and the fair market value price approach the estate sought to be applied. The Court noted that the right to specific performance turns on whether the performance sought represents an equitable result and in affirming, the Court found that a disparity in price between book value and fair market value, where a buyout provision clearly calls for use of “book value,” is not sufficient to shock the judicial conscience sufficient to warrant application of the doctrine of unconscionability.


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