The Supreme Court of New Jersey Accepts Trial Court’s Value of Companies and Denies a Marketability Discount in a Long-Running Contentious Shareholder Buyout DisputeSipko v. Koger, Inc.

This shareholder oppression and buyout litigation have been going on since November 2007. The Supreme Court of New Jersey once again stepped in. It reversed the appellate court’s decisions, remanding the case to the trial court. The Supreme Court summarized its holdings:

HOLDINGS: [1]-The appellate court erred by remanding the case to the trial court to determine whether a marketability discount should be applied to the value of the plaintiff’s interests in the corporations because one defendant falsified evidence of the plaintiff’s relinquishment of his interest in one of the corporations and comprehensive accounting of the corporations ordered by the trial court showed defendants’ deliberate and dubious actions undertaken for the sole purpose of rendering the corporations valueless that coincided with the litigation to prevent paying plaintiff for his interests in the corporations. Defendants made an overseas payment of $20 million cash one day after the trial court informed them that they owed the plaintiff approximately the same amount of money; [2]-The appellate court erred by holding the trial court erred by accepting the plaintiff’s expert’s testimony.

The judgment was reversed, and the case was remanded to the trial court for reinstatement of judgment.

The body of the opinion text begins with a syllabus. A syllabus is not part of the opinion but is prepared by the clerk’s office for the reader’s convenience. It might not contain all of the points in the opinion. We do not digest or summarize the syllabus but note that it is there for additional information for the reader.

Opinion.

The Supreme Court must determine whether the trial court’s finding as to the valuation of Robert Sipko’s interest in KDS and KPS, divisions or subsidiaries of Koger Inc., should be upheld or whether a DLOM should be applied, as the appellate court held in its remand to the trial court. The family litigation began 15 years ago, in 2007.

In 2013, the Supreme Court affirmed the appellate court’s ruling that KDS and KPS had value as independent entities. The Supreme Court remanded to the trial court to determine what remedy was appropriate to compensate Robert for his interests in KDS and KPS that were rendered valueless by the time the matter reached the Supreme Court.

This appeal centered around what had happened since the Supreme Court remanded this case in 2013. In 2016, the trial court held that a buyout was the appropriate remedy. The trial court accepted Robert’s expert’s valuations, finding that, in 2007, KDS was worth $1.5 million and KPS was worth $34.9 million. Robert’s interest was worth over $18 million. The appellate court remanded the case to the trial court to determine whether a DLOM should be applied. The Supreme Court reversed the appellate court and reinstated the trial court’s judgment in Robert’s favor.

Background.

George Sipko, a process programmer, formed Koger Inc. in 1994 and gifted 1.5% to each of his twin sons, Robert and Ras. He later founded KDS and KPS, with Robert and Ras owning 50% each. Due to a family dispute, Robert resigned in 2006. He signed documents memorializing the transfer of his 50% interest in both companies. The KDS document was dated February 3, 2006, but the KPS document was dated December 31, 2004. In November 2017, Robert filed suit against George, Ras, and Koger, claiming he was an oppressed shareholder. In January 2009, the trial court ruled that KDS and KPS had no independent value as distinct companies from Koger “and that Robert recognized ‘that his interests in KDS and KPS had no value, [and] voluntarily surrendered those interests.'” In May 2011, the appellate court reversed the trial court’s decision regarding Robert’s surrender of his stock in KDS and KPS, reasoning that his transfers lacked consideration and were void.

The Supreme Court (2013) reversed the appellate court and ruled that George’s gift to Robert of Koger stock was not conditional, and Robert was entitled to his 1.5% interest in Koger. Relevant to the current appeal, the Supreme Court ruled that KDS and KPS had independent value based on the testimony of Robert’s expert, Hubert Klein, in the abovementioned matters. George and Ras instructed their expert not to value the two companies. The Supreme Court found that both companies had value and that Robert had not relinquished his interest in either company. Left intact was the trial court’s determination that Robert was not an oppressed shareholder. The Supreme Court remanded for consideration of what remedy was appropriate, noting that the trial court had broad authority over what remedies were appropriate. “Our remand for determining a potential remedy for Robert’s interests in KDS and KPS forms the backdrop of this current appeal.”

The trial court, in July 2014, decided that an accounting of KDS and KPS was appropriate. The accounting determined what transpired with KDS and KPS before and after Robert’s 2007 complaint. Four out of seven KPS contracts were transferred to Koger either during the trial or after the appellate court’s 2011 opinion. One precious KDS contract was transferred to Koger in 2007. “[T]he trial court found that ‘the obvious, purposeful effect of draining these independent entities of value [was] for the specific purpose of shielding value from Robert.’ The trial court further noted that ‘the valuable contracts transferred or surrendered or assigned by KDS and KPS (i.e., by Ras) to Koger, Inc. was part and parcel of a strategy to render Robert’s interests in KDS and KPS zero.'” Since the companies had been drained by the time of the accounting in 2016, the judge (trial court) concluded the only remedy was to impose a buyout obligation upon George and Ras to pay him the value of his interests as of November 13, 2007. The defendants declined the trial court’s invitation to offer an expert to value KDS and KPS as of that date.

According to Klein’s valuations, the trial court ruled that Robert’s interests had a value of $18.2 million before prejudgment interest. With interest and as of August 19, 2016, the total judgment, jointly and severally, was $24.7 million.

Further accountings showed several financial transactions of a suspicious nature, significantly $20 million in cash transfers overseas to various accounts in July 2016. The trial court determined the transfer of $20 million was to keep the money away from Robert. George fled the country, and the money had not been returned to this country.

The appellate court affirmed the buyout remedy but sided with the defendants that the trial court improperly accepted Klein’s valuations, which it had rejected in 2008 and now accepted without explanation. The defendant’s expert, Martin Schmidt, testified that Klein failed to account for the impact that Koger—its infrastructure and goodwill—had on the values of KDS and KPS, including licensing agreements. The appellate court also noted that Schmidt had justified a DLOM, and the trial court had not applied one. “On remand, the Appellate Division instructed the trial court to ‘consider all sources of information that affect the fairness and equity of Klein’s suggested buyout price, including Schmidt’s criticisms.'” The Supreme Court granted the petition for certification on the issue of the reconsideration of the value of KDS and KPS.

Appeal to Supreme Court.

Robert argued that the appellate court erred in remanding to the trial court for reconsideration of the value of KDS and KPS. He argued that a marketability discount (DLOM) should not be applied to benefit the defendants who acted inequitably throughout the litigation. According to the defendants, failure to allow a DLOM would provide Robert with a windfall. The defendants maintained that the trial court was not required to accept Klein’s valuations simply because it was unrebutted. The entities further argued that the alleged misfeasance of George and Ras had nothing to do with the entities.

Standard of review for valuation.

Regarding the application of a DLOM, the Supreme Court held that depending on the facts, fairness, and equity can compel the decision to apply such a discount. “The guiding principle in such cases is that a marketability discount cannot be used unfairly by the parties whose misconduct and bad faith caused the corporate split to benefit themselves to the detriment of the injured parties.” (Balsimides)

Determination.

The defendants continued to argue that KDS and KPS have no independent value, despite the Supreme Court’s 2013 finding that the companies did have value. There was no better indication of how valuable the companies were than the defendants’ transparent actions to swiftly gut the entities of any worth during this litigation. Ras backdated the KPS stock transfer from 2006 to 2004 to deprive Robert of his interest in KPS attributable to cert specific tracts Robert negotiated in 2005. The court-ordered accounting illuminated the defendants’ actions to render the companies valueless.

The trial court noted that the courts, including the Supreme Court, cannot ignore the reality that the defendants knowingly depleted the value of the assets. Thus “equity cannot abide imposing a discount to the benefit of the Defendants.” The Supreme Court disagreed with the appellate court’s decision that the trial court did not support its decision to accept Klein’s valuations after rejecting it initially. The Supreme Court believed the record supported the trial court. The Supreme Court noted that the trial court judge had overseen this case for over a decade and had the best feel for the case. The trial court judge heard testimony from both Klein and Schmidt, including cross-examination and his questioning of both experts. Schmidt admitted during testimony that his application of a 35% DLOM was “instructions from counsel that in this—based on the facts of this case, it was appropriate.” The trial court had the discretion to accept or reject either side’s expert.

Schmidt testified that KDS and KPS had no independent value, and the trial court agreed, but in 2013, the Supreme Court determined that they did have independent significance. So, the Supreme Court would only determine if they had independent value. However, the trial court allowed the defendants to present testimony on the importance of KDS and KPS on remand. The defendants strategically declined. They now argued to the Supreme Court that they did not offer a valuation because they did not believe that the trial court would order a buyout considering the lack of oppression. However, the defendants cannot ignore the Supreme Court’s 2013 decision and pretend they were unaware a buyout was possible.

“For the foregoing reasons, we reverse the judgment of the Appellate Division and remand the matter to the trial court to reinstate its August 19, 2016 judgment.”