Court Rejects Litigation Value Reports as Unreliable

• Valuing a business on an ongoing basis is intended to avoid valuation disputes in litigation and provide fairness and predictability.

• Courts enforce contractual language that establish the the value of a closely held business based on valuation reports conducted by the owners for non-litigation purposes. 

• Courts are likely to view valuation reports conducted for the purpose of litigation with suspicion when they avoid the impact of the parties’  prior agreement

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Courts commonly reject a valuation report of one litigant in favor of another. Rarely, however, will a court reject the valuation reports of both sides. A trial judge in Delaware did just that, however, rejecting the valuation reports of both sides in a recent high-profile case in favor of the company’s periodic valuation report used for internal purposes.

In Catalyst Advisors Investors Global Inc. v. Catalyst Advisors, L.P., the central issue was the valuation of a limited partnership that, according to the terms of its partnership agreement, periodically calculated its value. Both sides submitted valuation reports, but the judge held that it was the terms of the parties agreements that ultimately determined the value of the enterprise based on a report “on file” when the dispute began.

Partners Dissociate from Boutique Recruiting Firm

The dispute arose after two partners, Catalyst Advisors Investors Global Inc. (CAIG) and Christos Richards, dissociated from the limited partnership Catalyst Advisors, L.P. The partnership operated as a boutique recruiting firm specializing in senior executive placements within the biopharmaceutical and medical technology sectors. The parties had a contractual right to leave the firm, and the company had the right to buy out their interest.

The Limited Partnership Agreement (LPA) provided for the purchase of the withdrawing partner based on the pro-rata share of the partnership’s enterprise valuation. That valuation must be based on a specific report “on file” with the company, or, if it were updated, must follow the same methodology as the original report.

Before their dissociation, the plaintiffs and the remaining partners had all agreed to a valuation report prepared by Sun Business Valuations, LLC (Sun) in May 2019. However, after the plaintiffs left, both parties obtained separate valuation reports, each differing significantly from the agreed-upon methodology in the Sun report.

The Parties’ Agreements Defined the Valuation Method

After a five-day trial, the court held that the terms of the parties agreements, both the LPA and other actions taken to determine the partners compensation, were to be applied according to their terms. Thus, the unambiguous language of the LPA referring to a valuation “on file” and the requirement that updated valuations use the same methodology were enforceable, contrary to the positions of both parties.

In a similar manner, actions taken by the partners that adjusted compensation and, ultimately, the partnership percentages were enforceable because their adoption and effect were clear and unambiguous.

This approach, the court held, prevented the parties’ attempts to manipulate the valuations of the business for litigation and was consistent with the parties’ original intent to determine the value of the business in advance of any dispute.

Court Rejects Both Sides’ Reports

The defendant’s 2020 valuation report (also prepared by Sun) was rejected as unreliable. This report was prepared after the plaintiffs had dissociated from the partnership and after the dispute had escalated into litigation. The enterprise value was below that of the report “on file” from 2019:

Revenue Adjustments Due to Plaintiffs’ Departure

• The 2020 report reduced Catalyst’s projected revenue to account for the departure of the plaintiffs. This adjustment significantly lowered the overall valuation of the partnership. The court viewed this change as a clear deviation from the methodology used in the earlier, pre-litigation report. By introducing this adjustment, Catalyst was effectively manipulating the valuation to reflect a lower enterprise value, thereby reducing the plaintiffs’ buyout price.

Exclusion of Goodwill

• The 2020 report also failed to account for the goodwill of the partnership—an intangible yet crucial asset that had been recognized in previous valuations. The exclusion of goodwill was another tactic that artificially deflated the partnership’s value. The court noted that this omission was inconsistent with the established valuation methodology and further demonstrated how the 2020 report had been tailored to produce a lower valuation.

Treatment of Buyout as a Liability

• The 2020 report treated the plaintiffs’ buyout as an accrued liability of the partnership. This approach not only deviated from the previous methodologies but also lacked logical consistency with the terms of the Limited Partnership Agreement (LPA), which did not mandate the partnership to buy the plaintiffs’ units. By treating the buyout as a liability, the 2020 report again sought to reduce the enterprise value of the partnership, favoring the remaining partners.

The court concluded that these adjustments were not consistent with the methodology set forth in the May 2019 report, which had been used by all partners prior to the dispute.

The Court similarly concluded that the plaintiff’s expert report was an attempt to manipulate the value for the purpose of increasing the buyout price through litigation.

Unjustified Reasonable Compensation Adjustment

• The plaintiffs’ report included a “reasonable compensation adjustment,” which was intended to reflect what the company would pay to a non-owner performing the same tasks as the partners. This adjustment resulted in a lower deduction for compensation, thereby inflating the overall valuation of the partnership. The court found this adjustment to be unsupported by the evidence, noting that it relied on comparisons to much larger, publicly traded companies that were not analogous to the small, boutique nature of Catalyst Advisors. This artificial inflation of the partnership’s value was viewed as a manipulation designed to secure a higher buyout price for the plaintiffs.

Failure to Deduct 2019 Profit Distributions

• The plaintiff’s report also failed to deduct the 2019 profit distributions as liabilities, contrary to the methodology used in the May 2019 Sun report. This omission served to further inflate the enterprise valuation, as it disregarded the financial obligations that the partnership had to its partners. The court saw this as a deliberate attempt by the plaintiffs to present a more favorable valuation, again deviating from the established contractual methodology.

Fairness and Predictability Were Intended in Periodic Valuations

The holding here reflects the court’s view that the parties’ attempts to conduct new valuations and disregard their own prior agreements had undermined the fairness and predictability of the valuation process that the parties intended when the agreements were made.

Note: The parties to the litigation in Delaware state court are also parties to litigation in the United States District Court for the Southern District of New York alleging the misappropriation of trade secrets.