Thursday, July 2, 2020

California Court Upholds $1 Valuation of Interest in LLC

California Court Upholds $1 Valuation of Interest in LLC

In a recent decision from California, the Court of Appeals upheld a decision that a member who sought judicial dissolution would be bought out for $1.00.  As it did so it upheld apportioning more then $40,000 of appraisal costs to that member, and refused to apply a provision of the operating agreement alleged to have required that he be released of all personal guarantees of the LLC’s debt.  McNaughton v. Newport Harbor Offices & Marina, LLC, No. G056743, 2020 WL 3468002 (Cal. Ct. App. June 25, 2020).

      The LLC in question, Newport Harbor Offices and Marina, characterized by the court as a “litigation incubator,” was owned equally by Kenneth McNaughton and Paul Copenbarger.  McNaughton sought the judicial dissolution of the LLC.  In response, Copenbarger sought to buy out McNaughton’s interest in the LLC pursuant to the LLC Act and specifically California Corporations code 17707.03(c) et seq. The court appointed a panel of three appraisers to value McNaughton’s interest in the LLC. They determined that the LLC had only nominal value ($1.00) as of the valuation date. “The court entered an order valuing McNaughton's interest in NHOM in accordance with the appraisers' unanimous report, and ordered the parties to split the expense of the report, with McNaughton responsible for paying $44,025 of the $64,025 total, and Copenbarger responsible for paying $20,000.”  McNaughton appealed, arguing that “the appraisers' report was fundamentally flawed because (1) it assigned no value to the improvements existing on the property leased by NHOM; (2) it erroneously projected NHOM's expenses; (3) it relied on flawed accounting data; (4) it failed to count NHOM's cash on hand; (5) it failed to properly assess NHOM's debt; and (6) it failed to assign value to the liability release provision in NHOM's operating agreement.”  Copenbarger appealed as well, arguing that none of the costs of the appraisal should have been his obligation. All of these arguments were rejected.

      As for the alleged deficiencies in the appraisal report, the LLC held a land lease that was due to expire in only two years.  Hence the valuation was done entirely on a case flow basis.  That case flow was negative as to the LLC’s existing debt secured by the underlying property. Various other challenges as to the sufficiency of the records upon which the appraisal was performed were rejected as not satisfying pleading standards.  Also, because he had not early in the valuation process raised the alleged requirement that he be released from personal guarantees of the LLC’s debts, but rather had waited to raise the issue until a post-appraisal supplementary brief, the point was deemed at minimum waived.

In refusing to address the issue on the merits, the court stated, “McNaughton cannot properly seek a ruling from the Court on a disputed issue of contract interpretation ... in an opposition brief to a motion to set the valuation of NHOM pursuant to the Corporations Code. That issue is not properly before the Court on Copenbarger's Application/Motion. Indeed, it is not clear to the Court that this issue is even the subject of the Complaint in this Action.” Because McNaughton ignores the court's actual ruling in his appellate brief, he has waived any claim that the court erred in making its ruling. 2020 WL 3468002, *6.

            The allocation of the costs of the appraisal were as well upheld.

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