The New Jersey Appellate Division has recently held that a court may review the appraisal performed under an LLC operating agreement to determine the value of a departing member’s interest. Leach v. Princeton Surgiplex, LLC (June 6, 2013).
The unpublished decision overturned the trial court’s grant of summary judgment to the defendants. The lower court had reasoned that, because the operating agreement specified that an appraisal would determine the payment to a departing member, the court had no power to look behind the appraisal’s bottom line result. The rationale of Leach would appear to require courts to scrutinize similar appraisal results whenever disappointed members, shareholders or partners can assert that the appraiser did not follow proper methodology or failed to consider relevant information.
Leach was a member of Surgiplex who gave notice of withdrawal effective December 31, 2008. Under the LLC’s operating agreement, Surgiplex was regularly appraised by Physicians Business Advisors (PBA). Prior PBA appraisals determined Surgiplex’s fair market value to be $3,600,000 as of December 31, 2004 and $5,900,000 as of June 30, 2006. Pursuant to the operating agreement, to determine the value of Leach’s interest, a new appraisal had to be performed by PBA or another appraiser who shall be “a member of the American Society of Appraisers” with a designation of ‘Accredited Senior appraiser’ or have “national” or other acceptable experience “in appraising or valuing ambulatory surgery centers.” Surgiplex retained 7/49 Solutions, LLC and its principal, David J. Shuffler, who had been affiliated with PBA and had done the prior two appraisals. Shuffler determined the fair market value of Surgiplex to be $2,325,000 as of June 30, 2008. Leach then filed a lawsuit against Surgiplex, two individual members, 7/49 and Shuffler alleging breach of contract, breach of fiduciary duty, breach of the covenant of good faith and fair dealing, fraud, conspiracy and negligent representation.
Leach contended that Shuffler had departed from the methodology he had employed in the two prior appraisals. Specifically, Shuffler had changed the way he computed EBITDA, using only the actual revenues for the last 12 months ending on December 31, 2007, rather than annualizing Surgiplex’s revenues from January 1, 2008 through September 30, 2008. Shuffler had also used a higher debt service coverage ratio (DSCR) without offering any explanation, even though the facts suggested that the DSCR figure should have been consistent with or lower than the one used in the prior appraisal. Nevertheless, the trial court granted summary judgment to the defense on the ground that the value of Leach’s interest was set by the appraisal required under the operating agreement, and the result could not be reviewed by the court.
The Appellate Division reversed and remanded, holding that the operating agreement appraisal provisions did not preclude judicial review of the appraisal. The appeals court reasoned that, “[i]t cannot be seriously argued that the appraiser is entitled to determine fair market value by spinning a wheel or flipping a coin, or that the appraiser may consider less than all relevant evidence, or that no party could question a mathematical error in the appraiser’s calculations.” Slip op. at 7. The court found that the operating agreement contained an implicit requirement that the appraiser would utilize accepted standards and norms. Moreover, Leach had a legitimate expectation that the appraisal would be conducted in a manner consistent with the prior appraisals. The court thus concluded that it would be a breach of the covenant of good faith and fair dealing if the defendants had altered the methodology in an effort to produce a lower value. The appeals court found that, unlike an arbitration provision, in which judicial review was narrowly limited to bias, fraud or similar wrongdoing, the appraisal provision in the operating agreement could be reviewed for mistakes of law or fact. The Appellate Division remanded the case to the trial court for further development of the record on those issues.
Leach portends greater scrutiny by courts of appraisals rendered under agreements governing the rights of LLC members, shareholders and partners. It also suggests that more comprehensive and careful drafting of appraisal provisions may limit the scope of such review.