November 2011 | Issue 55
In Estate of Cohen v. Booth Computers (421 N.J. Super. 134, 22A. 3d 991, July 13, 2011), the question addressed was whether a family partnership agreement that provides for a buyout based on net book value may be enforced when the disparity between book value and fair market value is substantial. In this case, book value was less than 2% of fair market value.
Booth Computers was a family partnership established by Robert Cohen for his three children, Claudia, Michael and James. The Partnership Agreement provided that in the event of the death of a partner, the remaining partners were obliged to buy out the interest of the deceased partner, and the estate of the exiting partner was obliged to sell. The Agreement specified that the buyout price was to be equal to the partner’s share of the Partnership’s value. This value was defined in the Agreement as net book value as shown on the Partnership’s most recent financial statement, plus $50,000.
The principal assets of the Partnership were two warehouses in Egg Harbor, New Jersey, acquired in 1980 and 1984, and a 45% LP interest in a limited partnership which owned an oceanfront estate in Palm Beach, Florida. The Florida LP interest was acquired in by the Partnership in 1978 for a capital contribution of $90,000. The Partnership’s assets were carried on the Partnership’s books at cost.
The First Buyout
Michael Cohen died in 1997. James and Claudia invoked the buyout provision, and Michael’s estate was paid $35,000 for his 1/3 interest in the Partnership, based on the formula in the Partnership Agreement.
The Second Buyout
Claudia died on June 15, 2007. James sent a letter to Claudia’s estate implementing a buyout in the sum of $178,000, again based on the buyout formula. Claudia’s estate sued, challenging the buyout on a number of grounds, including that the buyout’s valuation provision was “unconscionable.” Plaintiff’s appraisal expert valued the interest in the Palm Beach property at $20 million, and the whole Partnership at $23,100,000. Plaintiff’s interest, he claimed, was worth half that total, or $11,550,000.
The Judges’ Reactions
The trial court (Superior Court of NJ, Chancery Division, Bergen County) found for the defendants, as did the Appellate Division. The judges were influenced by the plain language of the Partnership Agreement, and by the fact that Michael had been bought out earlier at book value. Some of the judges’ comments are as follows.
“We recognize the disparity between net book and fair market value, yet the controlling factor as to which buyout method is applicable is the language of the partnership agreement.”
“Nothing in New Jersey law suggests that the term book value, without further definition or explanation, is inherently ambiguous. Nor is there any requirement that the term be defined in an agreement in order to avoid a claim of ambiguity.”
On the issue of unconscionability, one judge said, “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.”
In a buy-sell agreement, little things can mean a lot. One of these little things is the definition of value. A well-thought-out and unambiguous definition of value can potentially save a great deal of pain.
IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction(s) or tax-related matter(s) addressed herein.