Another interesting and not atypical fixed price buy-sell agreement story begins as follows:
- The Parties entered into an original Operating Agreement on or about January 1, 2000, to form PediatricCare as a limited liability company, with the purpose of owning and operating a medical practice [and amended in March 2001].
- The most recent Certificate of Agreed Value attached to the March 2001 Operating Agreement stated the “Value of the Company” to be $2.4 million, and was signed by[the doctors] dated January 1, 2000.
- Plaintiff announced his intention to retire in January 2016, triggering the application of Section 10 of the Agreement.
Peter Mahler wrote about Namerow v PediatriCare Associates, LLC in his blog post today on New York Business Divorce. Read his post for his interesting perspective, which is not much different from mine and in fact, he links to this blog
To be clear, the following is from my forthcoming book on buy-sell agreements:
Fixed price agreements. The owners agree on a price, record it in Exhibit A to their agreement, agree to update the price each year, and then, never do. Nothing good comes about from dated fixed price agreements. I do not recommend fixed price buy-sell agreements.
More About the Namerow v. PediatriCare Associates Story
From the beginning of the post, we see that the initial value for the PediatriCare buy-sell agreement was $2.4 million and was signed January 1, 2000. Dr. Namerow planned to retire in January 2016, or 16 years later. During that time, the buy-sell agreement pricing was never updated.
This situation is reminiscent of another fixed price agreement we wrote about some years ago, Estate of Claudia L. Cohen, by its Executor Ronald O. Perelman v. Booth Computers and James S. Cohen at A-0319. The post is linked here.
The two cases have the following in common:
- Both had a “fixed price” that was set many years ago and never updated.
- Both agreements had an element of formula to amend their essentially fixed prices.
- The plaintiffs brought litigation to attempt to have courts determine “fair” prices, since the dated fixed prices were obviously not fair (according to the plaintiffs).
- Both cases originated in New Jersey for what that is worth.
- Both courts, while perhaps sympathetic to the plights of the plaintiffs, found that the original agreements were binding on all parties.
PediatriCare: What the Agreement Said
The PediatriCare Operating Agreement’s Section 10 set the mechanism for pricing in the event of a trigger event. Section 10 reads as follows, with parenthetical numbers to facilitate discussion.
 The total value of the Company (“Company Value”) shall be the last dated amount set forth on the Certificate of Agreed Value, attached hereto as Exhibit G and made part hereto, executed by the Members.
This amount was agreed to be and set as $2.4 million.
 The Members shall exercise their best efforts to meet not less than once per year for the purpose of considering a new Value but their failure to meet or determine a value shall not invalidate the most recently executed Certificate of Agreed Value setting forth the Company Value then in effect.
There is no mention in the case of any meetings of the Members to discuss a new Value. In any event, Section 10 states clearly that if they do not, the previously existing and most recent Certificate of Value is binding on the Parties.
 If the Parties fail to agree on a revaluation as described above for more than two (2) years, the Company Value shall be equal to the last agreed upon Value, adjusted to reflect the increase or decrease in the net worth of the Company, including collectible accounts receivable, since the last agreed upon Value.
The Parties did not set a new Certificate of Value and more than two years passed. This invoked the “formula” part of the pricing where Value is adjusted, up or down, based on the change in Net Worth, including accounts receivable, since the last value.
 The value of a Member’s Interest (“Value”) shall mean the Company Value multiplied by the percentage interest held by said Member and being purchased hereunder, less any indebtedness that the Selling or Disabled Member, the Decedent, or a Member departing for any other reason contemplated hereunder may have to the Company or to the other Members, whichever the case may be.
The last portion is a debt adjustment which apparently was not relevant in the PediatriCare matter.
PediatriCare: What the Court Said
Peter Mahler provides more detail about the valuation issues leading to the current court decision, so read about that here. We will cut to the chase for this post.
The expert for the plaintiff (Dr. Namerow) posited an interesting definition of “net worth.” He suggested that the parties must have meant that net worth included intangibles at the time, and used this idea to bootstrap a current appraisal into the equation. He concluded that the Value should be between $5.6 million and $6.8 million. The Court was not persuaded by his analysis.
The expert for the Company used a more standard definition of net worth as the difference between all assets and liabilities on the balance sheet. He concluded that the Value was in a range of $2.8 million to $3.2 million. The Court found his analysis to be credible and adopted it.
The Court concluded as follows:
This Court is mindful that Plaintiff, as the first member of PediatriCare to retire, may feel as though his efforts as one of the founding members and an established physician for thirty-eight years are being shortchanged, and this Court to some extent does not disagree. However, based on the language of the operating agreement and the lack of any updates to the Certificate of Agreed Value, the Court is left with little discretion but to apply the appropriate formula as was agreed upon in 2001.
In providing a range, the Net Worth calculations provided by Defendants’ Expert gives the Court discretion as to what would be the suitable amount, and the Court finds that Plaintiff should be entitled to the higher amount possible under the calculation. [i.e., $3.2 million]
While the Court was sympathetic with the plaintiff, it was bound by the agreement of the parties memorialized in 2000 in the Operating Agreement (and amended in March 2001). Interestingly, the Court’s conclusion was lower than a previous offer made by the Company to the plaintiff.
Conclusion and Recommendations
It is my long-held opinion that fixed price buy-sell agreements should be avoided, period. Value can go up, in which case, any party who is “triggered” will be a loser. And value can go down, in which case, the triggered party is a winner and the remaining owners are losers.
Many owners of interests in businesses apparently believe that courts will be sympathetic to their plight if they are on the wrong end of fixed price agreements. I would not want to make that bet.
I have long suggested that the best pricing mechanism for the buy-sell agreements of most companies is what we call a Single Appraiser, Select Now and Value Now (and Annually Thereafter) process. My first suggestion for those with fixed price agreements is to change them. See Chapter 17 of Buy-Sell Agreements for Closely Held and Family Business Owners for an overview of this process.
See also the post on this blog that summarizes this process.
My next recommendations are to amend fixed price agreements with the first of the two processes named below (even the second is better than doing nothing).
- Single Appraiser, Select Now and Value at the Trigger Event. This process could be invoked if a fixed price is more than two (?) years old at the time of a trigger event.
- Single Appraiser, Select and Value at the Trigger Event. This process provides less certainty than the first, but nevertheless outlines a valuation process in place of a court proceeding to determine value.
Both of these additional valuation processes are outlined in Chapter 17 of Buy-Sell Agreements for Closely Held and Family Business Owners.
New Book Will Have More Detail
We are working diligently to bring my new book on buy-sell agreements, which focuses on the needs of attorneys first, and then of other advisers to business owners. The new book provides substantial detail on four single appraiser valuation processes, including the ones noted above.
Importantly, the new book also contains draft template language so that these processes can be drafted directly into buy-sell agreements and provide workable valuation processes.
If you would like to be notified when the book is available, please send me an email at: email@example.com
In the meantime, please feel free to call or email me if you have questions about buy-sell agreements or to discuss any valuation-related matter in confidence.