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In a Valuation Dispute, Commercial Division Refuses to Credit “Unrealistic and Optimistic” Projections Made by a Corporation in Obtaining a Loan

A recent Commercial Division decision provides an example of a court rejecting “unrealistic and optimistic” business projections in determining the valuation of a petitioner’s shares in a corporation.  In Magarik v. Kraus USA, Inc., Index No. 606128/2015, Doc. No. 252 (Sup. Ct., Nassau Cnty. Apr. 28, 2020), Justice DeStefano refused to credit the valuation made by the petitioner’s expert, which depended heavily on a set of projections that the corporation at issue made in the process of obtaining a loan.

The case involves Kraus USA, Inc., a private company that imports and distributes faucets, sinks, and related plumbing fixtures as well as accessories.  It does not manufacture any of its products, and it sells its products through links on the websites of other companies.  The Petitioner, Sergio Magarik, owned 24% of the shares of Kraus; the Respondents, Michael Rukhlin and Russel Levi, owned 25% and 51% of the company respectively.  The business grew significantly, from $21 million in sales in 2012 to $36 million in 2015; however, the business had cash flow problems.

On September 21, 2015, Magarik filed a petition demanding, inter alia, an order dissolving Kraus under BCL § 1104-a—for alleged abuses committed by the Respondents—and damages from the Respondents.  The Respondents elected to buyout Magarik’s shares in Kraus under BCL § 1118(a).  As the litigation progressed, all of the claims and counterclaims were dropped, and the sole issue for trial was the fair value of Magarik’s 24% interest in the company as of September 20, 2015, which was the relevant valuation date under BCL § 1118(b).  The Commercial Division conducted the trial over six days.  It heard testimony from the Petitioner, Respondents, and Kraus’s CFO, and also the valuation experts for the Petitioner, Randall Paulikens, and the Respondents, Paul Marquez.

The experts provided highly disparate valuations of Kraus.  The Petitioner’s expert, Paulikens, valued the company at (i) $21.9 million, using discounted cash flow analysis that was based on projections that Kraus used to obtain a loan in the summer of 2015and (ii) $38.78 million, using a market approach that was based on comparisons with public companies.  Paulikens averaged the two methods out, and came to a final valuation of roughly $30 million.[1]  In his post-trial brief, the Petitioner placed significant emphasis on the fact that this valuation was consistent with the $30 million valuation that Kraus’s owners represented—subject to criminal penalties—to obtain the aforementioned loan.  In their post-trial briefings, the Respondents argued, inter alia, that the Petitioners reliance on the loan valuation and associated projections was flawed because Kraus never met the projections that it made.

The Respondent’s expert, Marquez, valued the company at $6.16 million using capitalization of earnings, $6.1 and $5.9 million through a cash flow method, and range of $5.26 to $6.1 million under a market approach—using comparisons with private companies.  Marquez factored these approaches together—placing more weight on the capitalization of earnings and cash flow income approaches—and came to a valuation of $6.05 million; he then applied a 25% discount for lack of marketability due to Kraus’s status as a close corporation. 

The Court accepted the $6.05 million valuation offered by Marquez, noting that it was supported by “credible evidence which demonstrated a successful and growing business that was not especially liquid.”  As to Paulikens’s valuations, the Court stated that they “were based on income projections that were unrealistic and optimistic and not based on appropriate comparable businesses.” 

As to the valuation in the loan application, the Court noted that “[i]n reality, the value of the business was never $30 million and the projections contained in the loan application were never realized.”  Then, presumably in response to Petitioner’s discussion of criminal penalties, the Court stated that it “need not comment further on representations made by the parties to [the bank] in order to secure a loan, or what reliance may have been placed on such representations by [the bank] . . . .”

After accepting Marquez’s $6.05 million valuation, the Court applied a discount for lack of marketability, in recognition of the nature of Kraus as a close corporation; however, the Court only applied a 5% discount, instead of the 25% proposed by Marquez, and came to a value of $1,379,400 for Magarik’s shares.  This 5% discount was consistent with the position that Marquez took in another Commercial Division matter where he served as the valuation expert on the petitioner-side of the dispute.[2]

The Court also applied the standard 9% pre-judgment interest from the date that the petition was filed, holding that there were “no additional factors to warrant imposition of a different rate or date.” 

Finally, the Court gave Kraus two years to pay the judgment, observing that “[t]he two-year period is intended to balance the cash flow issues experienced by Kraus with the fact that [Magarik] has not received the value of his interest during the pendency of the proceedings.”

 

[1] In the Petitioner’s post-trial briefing, the Petitioner listed the values as $21.39 million from the income approach and $38.79 million from the market approach, with an average of $30.09 million as the valuation.  The values in the body of the text are those listed in the Court’s decision.

[2] See Matter of Adelstein v. Finest Food Distrib. Co N.Y. Inc., 2011 NY Slip Op 33256(U) (Sup. Ct., Queens Cnty. Nov. 3, 2011).  The Petitioner noted this situation in his post-trial briefings, without explicitly citing to Adelstein.  The Respondents actually cited to Adelstein, but for a different set of propositions, in their post-trial briefings.