Book Value is Not Fair Value in Partnership Buyout


Socialite’s Family Partnership Interest

Book value can have a few different meanings. The best definition is simply the value of assets and liabilities that a company carries on its books. Is it different than the “fair value” standard applied in statutory buyouts?  Yes– a lot different.

There are many partnership agreements and corporate 13958-partneragreementbuy-sell agreements still in effect with a book value buyout provision. They tend to be older entities, often involving family businesses, and I cringe whenever I look at the agreement and see the term applied to the company’s value.

Book Value Used to Buy Socialite’s Interest

A recent decision involving the estate of socialite Claudia Cohen demonstrates why. Estate of Claudia Cohen v. Booth Computers, et al., Docket No. A-0319-09T2. Estate of Cohen App Div.pdf. (Thanks also to Peter Mahler’s NY Business Divorce blog for finding the trial decision. Cohen Chancery Div.pdf.) In that decision, the Cohen’s estate argued that the book value of a successful business was just less than 2 percent of its fair value – $ 178,000 as opposed to $11.526 million – and sought to reform the partnership agreement. The effort failed and the Appellate Division affirmed the trial court’s enforcement of the agreement. The disparity between book value and fair value was not, in the court’s opinion, reason to alter an otherwise unambiguous document.

The result was a windfall for the last surviving partner, Claudia’s bother James, and the same result is likely to occur in most agreements that set the value of the business at book value rather than fair value.

The Cohen case involved a partnership formed by the late Robert Cohen, an entrepreneur who amassed a considerable fortune through various entities including the Hudson News Group. He had three children – Claudia, Michael and James. Claudia, well known in Manhattan and Hamptons social circles, was also an editor of Page 6 of the New York Post and the ex-wife of entrepreneur Ronald Perelman.

The estate, with Perelman as executor, brought suit against Booth Computers and Claudia’s brother, James, after Claudia’s interest in a family partnership was valued at a fraction of the fair value of the partnership’s holdings.

Family Partnership Agreement

In approximately 1977, Robert Cohen had a partnership agreement drawn for the benefit of his children for Booth Computers to purchase and lease computer equipment. The children signed the agreement without consulting an attorney.

The partnership agreement specified that the value of the partnership was equal to its “net worth plus the sum of fifty thousand dollars.” Net worth was further defined as the “net book value as show on the most recent. Partnership financial statement at the end of the month ending with or immediately preceding the date of the valuation.”

Booth Computers actually invested in real estate, holding several properties and an interest in another real estate investment firm. Michael Cohen died in June 1997. James and Claudia, the two surviving siblings, used the formula to pay his estate his one third interest of $32,440 plus the $50,000 set forth in the agreement. Claudia died on June 15, 2007 and the buyout figure proposed by the surviving sibling, James, was $177,808, using the formula in the partnership agreement.

The formula, however, carried the real estate investments at their cost, presumably less depreciation, of just $357,842. Meanwhile, the total value of the properties in which the business had an interest was in excess of $30 million.

Unconscionable Contract Claim Rejected

The plaintiff argued that the partnership agreement was unconscionable, in light of the fair value of the business and sought to advance several theories to reform the contract, all of them unsuccessful.  The trial court held that that fact that the amount was not an accurate reflection of the value of the business in itself was not good reason to undo a clear contractual provision.  Both the trial and appellate courts were influenced by the fact that the partnership in 1997 purchased the interest of the first brother to die using the same formula.

“Disparity in price between book value and fair market value, where a buyout provision is clear, is not sufficient to ‘shock the judicial conscience’ and to warrant application of the doctrine of conscionability,” the court held.

Partnership agreements are, the court continued, contracts.  And it is not the province of a court to make a better contract that the one agreed upon by the parties.

Book Value is Poor Substitute for Fair Value

The fundamental problem with using a book value method to calculate the price for a buyout of an interest in a business enterprise is that rarely does book value reflect the actual or “fair” value of a business. A simple example is real estate. The purchase is “booked” or placed on the company’s records at its purchase price. It may also be depreciated each year for tax purposes and eventually have no book value at all.

Meanwhile, the real estate may appreciate in value or it may provide a steady stream of income, neither of which are reflected on the company’s books as an increase in the value of the asset. The same can be true of any number of assets and liabilities on the books of a business. Good will, often the most valuable asset of a business, may not be booked and not reflected in the books of the company.

Fair value, although difficult to define precisely, reflects the actual value of a business as a going concern. Most often it is based on a number of factors that include the price at which the business or an interest in the business could be sold and the ability of the business to generate a return in cash for its owners.

Book value when applied to a successful business will result in a windfall to the last owner, who can purchase the interests of other partners or shareholders that withdraw at steep discounts. Unless that is truly the intention of the owners, the use of book value as a means to value a business makes little economic sense for the owners.



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