From the very first days of elementary school, teachers have been imploring students to show and explain their work. Such good advice continues to be relevant in the world of valuation as the matter of MSKP Oak Grove, LLC v. Carol Venuto, et al. clearly highlights.1 In this matter, the Defendants moved to exclude Plaintiff’s valuation expert through a Daubert challenge primarily on the grounds that the expert’s valuation was not based on reliable principles or methodology. The expert, however, was careful to not only provide substantial details as to her methodology and assumptions applied, but prudently supported those decisions based on industry-accepted practices. In brief, the Daubert challenge was denied as a result of the expert’s attention to detail and sufficient documented explanation for the approaches executed. In other words, the expert did as the teacher asked and showed her work.
At the center of this matter is Hollywood Tanning Systems, Inc. (“HTS”), a New Jersey-based tanning salon company, which operated franchises and sold tanning salon equipment.2 In 2003, HTS leased retail space from Plaintiff’s predecessor and in 2004, the parties agreed for HTS to sublease the space to an HTS franchisee, with HTS still liable for the lease in the event of the franchisee’s default.3
In the spring of 2007, HTS executed an asset purchase agreement with Tan Holdings, LLC, whereby Tan Holdings would acquire effectively all of HTS’s assets in exchange for: 1) $40 million; 2) 25 percent of the issued and outstanding preferred units of Tan Holdings; and 3) contingency payments.4 Upon closing of the agreement in June 2007, the defendants each received distributions of approximately $5.9 million, with the remaining proceeds paying off HTS’s outstanding debt. Shortly after of the closing, Tan Holdings filed for bankruptcy.5
In July 2008, Plaintiff notified HTS that the franchisee defaulted on the leased premises and subsequently filed a complaint against HTS to recover damages for the breach of lease. In May 2009, summary judgment was granted in favor of Plaintiff and damages were awarded in the amount of $411,573.45. However, no portion of that amount was paid. Plaintiff commenced this matter alleging that the distribution of approximately $5.9 million to each Defendant in connection with the sale in 2007 was a fraudulent transfer, arguing HTS at the time of the asset purchase agreement did not have the funds to pay all of its creditors, such as the Plaintiff.
Plaintiff put forth an expert in the field of valuation to examine HTS’s solvency before and after the shareholder distribution and to opine on the fair market value of Tan Holdings as of June 22, 2007, the date of the asset sale. In two expert reports (one on solvency; the other on the value of Tan Holdings), submitted only a few days apart, Plaintiff’s expert found that: 1) HTS did not receive reasonably equivalent value for the cash distributions to Defendants; 2) HTS’s assets were unreasonably small with respect to its operations; 3) HTS knew or should have known that the distributions would result in debt that was beyond the company’s ability to pay; and 4) the distributions left HTS insolvent.
Defendants filed a motion in limine against Plaintiff’s expert asserting: 1) the solvency report cited no reliable principles or methodology; 2) the expert used hindsight in her valuation of HTS; 3) the expert “rendered opinions on Defendants’ state of mind which she is unqualified to present;” and 4) the expert’s valuation report is not helpful to the trier of fact.6 A Daubert hearing subsequently took place on June 22, 2016.
The court initiated its discussion by stating that Plaintiff’s expert was undoubtedly qualified as an expert in valuation, citing her many credentials including her years of valuation experience as a Certified Public Accountant, being accredited in Business Valuation and Financial Forensics by the American Institute of Certified Public Accountants (AICPA), and being certified in valuation by the National Association of Certified Valuation Analysts.7
The central issue, therefore, focused on the reliability of the methodologies applied by the expert. The court first found that despite the two expert reports being submitted days apart, the analyses should be viewed holistically and established that the two reports should be seen as one. In doing so, the court rejected Defendants’ claim that the expert did not sufficiently explain her methodology in the first report since it was detailed in the second report.8
The court further narrowed the scope of the issue to whether the expert, “explains her methodology in a way that allows the Court to evaluate the reliability of her opinions.”9 At the Daubert hearing, the expert explained that her report contains an entire section on Valuation Methodologies and Valuation Approaches; furthermore, the expert included AICPA standards and valuation treatises as exhibits. This supporting documentation provided the necessary justification and relevance for the analyses included in both expert reports. In particular, these references explained the normalization adjustments that the expert performed as a result of the incomplete financial records received from the opposing party. The expert included in her report a lengthy explanation in which she provided a detailed assessment of the issues with the HTS financial documents including the fact that many documents “normally maintained by companies of this size for tax and management purposes” were not available. Even when documents were provided, many were PDF versions of native documents, which complicated the analysis process. As a result, the expert stated that she referred to AICPA and GAAP standards, as well as other industry treatises for guidance in order to normalize and create financial statements that would assist in her analysis.
In summary, the court stated that the expert “normalized HTS’s incomplete financial records and identified the assumptions and estimates on which she relied, in accordance with accepted business valuation principles. In short, she described her application of reliable, recognized principles of accounting and valuation analysis.”10 The court, having found that the expert’s methodologies were reliable, ultimately denied Defendant’s Daubert challenge stating that it was now the jury’s purview to decide whether or not the expert’s analysis was credible.
The MSKP Oak Grove case is a healthy reminder that details count and that there is no substitute for well thought out, strongly supported, and appropriately referenced analyses in an expert report. As the Plaintiff’s expert in this matter underscored, methodologies that are squarely based on industry standards (e.g., AICPA, GAAP in this case) and supported by valuation treatises (in this case Plaintiff’s expert referenced Pratt and Hitchner treatises) are the best defenses against a Daubert challenge. In contrast, untested theories or methods without sufficient support run the risk of an expert being eliminated. Valuation experts will therefore be well served by harnessing the lessons of elementary school days by always showing your work.
1.MSKP Oak Grove, LLC v. Carol Venuto, individually and as executrix of the Estate of Ralph A. Venuto, Sr., et al., Unites States District Court for the State of New Jersey, Civil Action No. 10-6465 (JBS/JS).
2.MSKP Oak Grove, LLC v. Carol Venuto, individually and as executrix of the Estate of Ralph A. Venuto, Sr., et al., Unites States District Court for the State of New Jersey, Opinion, June 29, 2016 (“Opinion”), at 3.
3.Id. at 4.
5.Id. at 5.
6.Id. at 15-16.
7.Id. at 19.
8.Id. at 19-20.
10.Id. at 22.