Book Value Pricing for Buy-Sell Agreement Upheld in New Jersey

Booth Computers, a New Jersey family partnership (“Booth”), was created in 1976.  In 1978, a related partnership, HCMJ Realty Ltd. was formed, of which Booth was a limited partner. Interests in Booth were given to James, Michael and Claudia Cohen by their father, Robert.  The partnership acquired substantial assets over a period of more than thirty years, when Claudia Cohen died.

A recent case from the New Jersey Superior Court Appellate Division [download Estate of Claudia L. Cohen, by its Exeuctor Ronald Ol Perelman v. Booth Computers and James S. Cohen at A-0319], tells the story of how the Cohen children obtained their interests, and how Booth and at least one related partnership of which Booth was a limited partner, acquired substantial assets.

Claudia Dies and Paragraph 16 is Invoked

The story is somewhat long and complicated, but we’ll shorten it to focus on the relevant issue for this post, which is the Booth Computers partnership agreement and the buy-sell agreement therein.

  1. Claudia Cohen died on June 15, 2007.
  2. In July 2007, an attorney sent a letter on James’ behalf implementing the buyout of Claudia’s partnership interest for an amount of $177,808.50.
  3. Claudia’s estate objected to the buyout, suggesting that the true value of the partnership, $11,526,162, vastly exceeded its book value.
  4. The trial court concluded that the buyout price of net book value (with a small adjustment), as called for in the partnership agreement, was the price that the parties had agreed to and was appropriate in the matter.
  5. Claudia’s estate appealed.

Paragraph 16

The death of a partner was a trigger event for purposes of the partnership’s buy-sell agreement.  The agreement stated the pricing mechanism at its Paragraph 16:

16. The purchase price of any part or all of a Partner’s interest in the Partnership shall be its value determined as follows:

(A) Each of the Partners has considered the various factors entering into the valuaiton of the Partnership and has considered the value of its tangible and intangible assets and the value of the goodwill which may be present.  With the foregoing in mind, each of the Partners has determined that the full and true value of the Partnership is equal to its net worth plus the sum of FIFTY THOUSAND ($50,000) DOLLARS.  The term “net worth” has been determined to be 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;

(B) The value of any interest in the Partnership which is sold and transferred under the terms of this Agreement shall be determined by multiplying the full and true value of the Partnership as above determined by that percentage of the capital of the Partnership which is being sold and purchased hereunder.

The partnership agreement is clear that book value plus $50,000 is the price at which partnership interests would trade hands under the agreement.  We learn in the case that Michael Cohen, brother to James and Claudia, died in June 1997.  James and Claudia invoked the partnership agreement and “Michael’s estate was paid $34,503.08 for his one-third interest in Booth based on the formula in paragraph sixteen of the partnership agreement.”

The Appellate Court Rules

The New Jersey Appellate Division noted the following:

We recognize the disparity between net book value and fair market value, yet the controlling factor as to which buyout method is applicable is the language of the partnership agreement. [going on to quote a treatise]…

…The trial judge’s determination that Claudia’s shares should be bought out at book value, rather than at fair market value, was supported by both substantial credible evidence and the applicable law.  The judge did not err in holding that defendants established their entitlement to specific performance of the buyout provision as a matter of law.

Claudia’s estate argued, among other things that the trial judge erred because he should have determined that the buyout price was unconscionable given the “gross disparity” between net asset value and fair market value.  Basically, the estate argued that the result of the judgment was that James obtained sole ownership, through Booth, of an asset worth vastly more than the price received by the estate.

The Appellate Court concluded:

Disparity in price between book value and fair market value, where a buyout provision is clear, is not sufficient to “shock the judicial conscience” and to warrant application of the doctrine of unconscionability.  This view is consistent with the basic principle that where the terms of the contract are clear, it is not the court’s function to make a better contract for either of the parties.

Fair Warning to All

This case, Estate of Claudia Cohen v. Booth Computers, should be a clarion call to every business owner who has a buy-sell agreement with a formula pricing mechanism.  The formula in this case was book value, an historical cost concept.  Book value does not get adjusted as the market values of properties in a partnership rise.  The formula in this case created a value that was only a small fraction of the fair market value of Booth’s underlying assets.

If any partner wanted to obtain fair market value in a transaction, Booth’s Paragraph 16 was, indeed, a ticking time bomb.  While stated as a “formula,” the Booth partnership agreement essentially called for a fixed price of book value.

I have said for years that formulas and fixed prices are not good pricing mechanisms for most buy-sell agreements.  Two short quotes from Buy-Sell Agreements for Closely Held and Family Business Owners state the conclusion succinctly:

Re Formulas (at p. 85)…My experience suggests that no formula selected at a given point in time can consistently provide reasonable and realistic valuations over time.  This is true because of the myriad of changes that occur within individual companies, local or regional economies, the national economy, and within industries.  Formulas simply cannot take into account these many factors in a meaningful and consistent manner.

Re Fixed Prices (at p. 80)In my opinion, for most situations, fixed-price buy-sell agreements should be avoided like a contagious disease.  However, if you have a fixed-price agreement, you must have the discipline to update the price periodically.  And you must amend the agreement to include a workable appraisal process in the (likely) event that you fail to update it.

The Court’s Final Words

Does the result in Estate of Claudia Cohen v. Booth Computers and James Cohen (download at A-0319) seem unfair?  Does it seem unreasonable?  Does it offend your sense of how family members should treat each other?  Does this case raise questions in your mind?  If so, now is the time to take a look at your buy-sell agreement.  If you are an adviser to business owners, now is the time to take a look at their agreements.

My suggestion is that, for most successful companies and partnerships, the best buy-sell agreement pricing mechanism calls for the parties to:

  1. Select a single appraiser, agreeing on his/her qualifications and the standards under which appraisals will be rendered.
  2. Have that appraiser provide an appraisal for purposes of the agreement.  If there are problems or issues with the kind of value that the parties desire, they can be fleshed out while the appraisal is in the draft stage.  Make sure there is agreement between the standard and type of value called for in the agreement and that obtained in the draft appraisal.  When all this is clear —
  3. Finalize the appraisal, which becomes the price for the agreement for the next period (year most likely).
  4. After a year, have the selected appraiser reappraise the company to reestablish the purchase price for the agreement.
  5. After another year…

Claudia’s estate would have been happier with this type of pricing mechanism, rather than being stuck with Booth’s Paragraph 16.  Michael’s estate would likewise have been happier (if more money is more happiness).

The court concluded, as does this post:

We reiterate what is critical about this agreement and its terms.  This was a family partnership created by and funded (except for modest contributions by the children) by Robert [the father] for the benefit of his children according to his terms.  He intended the beneficiaries to be family members and understood that the buyouts would require the children to provide funds to the other children.  The possibility or even the probability that a surviving child would be the ultimate beneficiary of the assets of the partnership was apparent on the face of the agreement.  Judge Contillo did not abuse his discretion by finding that the buyout provision was not unconscionable.

Call a business appraiser who is experienced with buy-sell agreements to work with you and your counsel to assure that the pricing mechanism in your buy-sell agreement will work as you intend.

Please note: I reserve the right to delete comments that are offensive or off-topic.

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5 thoughts on “Book Value Pricing for Buy-Sell Agreement Upheld in New Jersey

  1. This case demonstrates the reality of lex dura lex sed lex (Law, hard law, but law). The buy-sell agreement was set up to effectively reward the survivor, which happened.

    • Paul,

      In this buy-sell agreement case, James Michael and Claudia were all betting that their siblings would predecease each of them. It turns out that James was right. It is also apparent that the appellate judge saw through the bet, which had been made, in essence by Robert, the father, when he formed the partnership.

      The “kids” had many years to make a change to the partnership’s provisions. Both Claudia and James received the clearest of warnings when Michael died in 1997. Still no changes were made.

      Readers should take advantage of the experience of the Cohen clan and get about the important business of working on their buy-sell agreements.

      Since the agreement was binding in death, I presume that it was binding for federal estate tax purposes? But that is another question.

      • Chris,

        I think your last comment regarding whether the agreement will be binding for estate tax purposes is going to be an interesting matter to watch for in the future. In fact that was my first thought when reading your discussion.

        I see many similarities in this case and the 10th Circuit’s decision to uphold the T.C. decision on Estate of True.

        This gives even more credence to the necessity to review Buy Sell Agreements now and potentially prevent a low fixed price buyout on one end and a huge IRS tax bill at FMV at the other end. Claudia’s Estate may well have found themselves in a perfect storm.

        Thanks again for advancing the profession.

  2. Chris: Will you permit that this message in its entirety be forwarded to lawyers, accountants and other interested parties as an example of a poorly constructed Shareholders Agreement?
    Folks looking for meaningful work should look at Shareholder Agreements that are currently in place to see if they make sense-a furtile area of work!!
    Regards Vern

    • Vern,

      It is absolutely okay to provide the greatest possible distribution to this post (and other posts on this blog)! To your point on using discussions about buy-sell agreements to develop business, I did a webinar at the beginning of the year on exactly that topic: The Business Appraiser’s Buy-Sell Agreement Business Development Plan. Anyone can listen to the webinar and download the handouts (complimentary) here:

      However, I believe that the business opportunity with buy-sell agreements is shared by lawyers, accountants, financial planners and others, as well.

      And, the book, Buy-Sell Agreements for Closely Held and Family Business Owners ( is being used by appraisers, accountants, financial planners and others as an integral part of their BD efforts. Quantity discounts are available.

      So, thanks for this opportunity to add to your recommendation and to provide access to a couple of tools to help.

      See you soon!