Terrell K. Raley, Et Al. v. Cees Brinkman, Et Al.

This appeal arises from a business dispute between the two members of a Tennessee limited liability company, 4 Points Hospitality, LLC (“4 Points”), each owning a 50% interest. The plaintiff-member, Terrell K. Raley (“Raley”), commenced this action asserting, individually and on behalf of the LLC, inter alia, that the defendant-member, Cees Brinkman (“Brinkman”), breached the operating agreement by failing to make a $175,000 capital contribution. Brinkman asserted counter claims, individually and on behalf of the LLC, for breach of contract and breach of fiduciary duty, alleging that Raley misappropriated funds for his personal benefit and that he withheld a large portion of Brinkman’s distributions and salary. Brinkman also claimed that Raley was liable for conversion and punitive damages. Brinkman sought to terminate Raley’s membership interest because he willfully and persistently breached his fiduciary duty, and because it was no longer reasonably practicable for the two men to continue operating the business. Brinkman also claimed he was entitled to recover his attorneys’ fees in accordance with Tenn. Code Ann. §§ 48-249-804 and -805, and the operating agreement. Upon Raley’s pre-trial motion, the trial court summarily dismissed Brinkman’s claim for attorneys’ fees under the operating agreement, holding that the attorneys’ fees provision only pertained to disputes submitted to arbitration. Following a lengthy bench trial, the court ruled that (1) Brinkman breached the operating agreement by failing to make a $175,000 capital contribution; (2) Raley was liable for breach of fiduciary duty, breach of contract, and conversion for underpaying Brinkman’s distributions and salary and for using 4 Points’ funds to satisfy unrelated, personal expenses; (3) Raley was not liable for punitive damages because his conduct was not egregious; and (4) Brinkman was not entitled to attorneys’ fees under §§ 48-249-804 and -805. The court also terminated Raley’s membership interest in 4 Points in accordance with Tenn. Code Ann. §§ 48-249-503(a)(6)(B) and (C), finding that Raley’s wrongful conduct adversely and materially affected the business, and it was no longer reasonably practicable for the members to continue operating the business together. Brinkman filed a motion to alter or amend the court’s order, and the court denied his motion in all respects but one, ruling, in accordance with Tenn. Code Ann. § 48-249-805, that Brinkman was entitled to equitable relief in the form of attorneys’ fees. Therefore, the court revised its order to allow half of the $240,275.59 Raley owed 4 Points as reimbursement for personal expenses to be paid to Brinkman, individually. Brinkman then filed notice that 4 Points intended to purchase Raley’s membership interest in accordance with Tenn. Code Ann. §§ 48-249-505 and -506, which necessitated an evidentiary hearing to determine the “fair value” of Raley’s interest. In preparation for the hearing, Brinkman’s expert prepared a valuation report applying shareholder-level discounts for lack of control and lack of marketability and adjusting 4 Points’ income for the corporate income tax. Raley responded by filing a motion in limine to determine the meaning and components of “fair value” under Tenn. Code Ann. § 48-249-506(3), arguing that any testimony or other evidence relating to discounts for lack of control and marketability and the corporate income tax should be excluded at the evidentiary hearing. In response, Brinkman submitted the affidavit of his valuation expert, explaining the expert’s valuation methodology and the reasons for applying a corporate income tax rate. The court ruled that because the company, rather than a third-party, was purchasing the membership interest, the fact that the interest was non-controlling was irrelevant to its fair value. The court also excluded evidence and testimony on discounts for lack of marketability. As for the applicability of the corporate income tax, the court ruled that “no entity level tax should be applied in the valuation analysis for a non-controlling interest in an electing S corporation, absent a compelling demonstration that independent third parties dealing at arms-length would do so as part of a purchase price negotiation.” Following the evidentiary hearing, the court determined that the fair value of 4 Points was $4,774,278.18, and that Raley’s 50% interest was $2,387,139.09. Brinkman timely filed this appeal contending the trial court erred in determining that (1) Brinkman breached the operating agreement by failing to make a capital contribution; (2) Raley was not liable for punitive damages; and (3) Brinkman was not entitled to attorneys’ fees pursuant to the operating agreement and/or §§ 48-249-804 and -805. As for the trial court’s valuation of Raley’s membership interest, Brinkman contends the trial court erred in (1) disallowing discounts for lack of control and lack of marketability and (2) determining that tax-affecting did not constitute relevant evidence of the fair value of Raley’s membership interest in 4 Points. We affirm the trial court’s judgment in every respect but one. We have determined that the trial court erred by failing to consider evidence relative to tax-affecting when determining the fair value of Raley’s membership interest, because Tenn. Code Ann. § 48-249-506 provides that relevant evidence of fair value includes the “recommendations of any of the appraisers of the parties to the proceeding.” Brinkman’s valuation expert stated in his affidavit that the application of a 38% tax rate “comports with generally accepted valuation standards and methods” and reasoned that, there is a risk of inaccurate valuation when the components of the capitalization rate are based on after-tax values, and no tax-affecting is applied to the income of the company. Therefore, we vacate the judgment valuing Raley’s interest and remand for the trial court to consider evidence relative to tax-affecting in determining the fair value of Raley’s membership interest and to enter judgment accordingly.