The Importance of Defining Value

The Importance of Defining Value

      Under Louisiana law, a member is entitled to resign from an LLC and received the “fair market value” of their interest in the company.  These rules are subject to modification in the operating agreement.  In a decision from earlier this year, a Louisiana court highlighted the importance of adopting specific rules as to valuation.  In this instance, the withdrawing member received far less than he thought he was entitled.  Fancher v. Prudhome, 112 So.3d 909 (La. App. 2 Cir. 2013).

      Diamond Shield Services, LLC was organized in Louisiana and by the time of this dispute had three equal members, Steven Prudhome, Ray Fancher and Cody Robbins.  Fancher, through his industry contacts, was the primary (almost exclusive) source of business to the LLC.  Fancher became aware that Robbins and Prudhome, on the LLC’s behalf, had entered into a loan agreement with a third party on terms he believed to be unreasonable. For that reason he elected to withdraw from the company.  See La. Stat. Ann. 12:1325(C).

      Fancher’s expert, a CPA, prepared and submitted a going-concern valuation of $2 million, yielding to Robbins’ a liquidation payment of $666,666.  This calculation did not reflect any adjustments for lack of marketability or lack of control.  In contrast, a book valuation of the company yielded a value of slightly less than $38,000, resulting in a payment to Fancher of $12,463.74.  It was this book valuation that was accepted by the trial court, leading the appeal.

      On appeal, the determination of the trial court was upheld.  In that Fancher was the primary source for company business, the court found, in effect, that upon his withdrawal a going-concern valuation was inappropriate.  Rather, the adjusted book value methodology was accepted.

      Under Kentucky law, a member resigning or otherwise withdrawing from an LLC is not entitled to any liquidating payment except to the extent provided in a written operating agreement.  That said, many agreements are incomplete and imprecise as to the valuation methodology to be employed.  Beyond the simple confusion as to what is the distinction between “fair value” and “fair market value,” there is typically lacking specificity as to the methodologies to be employed.  While, depending on whose ox is being gored, lack of detail may be advantageous to one party or another, specificity in the document avoids the need for costly litigation.  That specificity may include the valuation methodologies to be employed, distinctions to be drawn between individual members (in some instances, such as that discussed  in this Louisiana case, different methodologies may be appropriate depending on the services provided by the particular member) and similar factors.  A statement that company equipment will be valued based upon its “depreciated” value only invites the question of whether depreciation will be calculated on the basis of GAAP or tax rules.  All of these matters need to be considered.