Zelouf
International Corp., Petitioner,
against
Nahal Zelouf, Respondent.
|
653652/2013
Cooley LLP, for petitioner.
Wolf Haldenstein Adler Freeman & Herz LLP, for respondent.
Shirley Werner Kornreich, J.
Petitioner Zelouf International Corporation (New ZIC) commenced this special
proceeding, pursuant to BCL § 623, to fix the value of respondent Nahal Zelouf's
(Nahal) 25% interest in an entity formerly known as Zelouf International Corporation
(Old ZIC), which was merged into New ZIC as of September 5, 2013. This special
proceeding, however, has its genesis in a derivative lawsuit commenced by Nahal in
2009, styled Zelouf v Zelouf, Index No. 603746/2009 (the Derivative Action). As
set forth below, the instant proceeding is the culmination of a dispute over the Zelouf
family textile business that has been ongoing for more than a decade.
Background
To fully understand the context of this action, one must go back to 1984,
when the family patriarch, Shafik Zelouf, who came to America from Iran, started a
fabric import and wholesale business called Zelouf International Corporation. The
company, Old ZIC, was a middleman of sorts between fabric manufacturers and garment
manufacturers. It engaged in two types of deals: (1) it purchased fabric (in recent years,
abroad, usually somewhere in Asia), shipped it to the company's warehouse in New
Jersey, and resold it to American clothing manufacturers; and (2) in recent years, it
facilitated transactions between fabric producers and garment manufacturers by buying
the fabric from the producer who was located abroad and shipping it directly to the
garment manufacturer's factory, also located abroad. Shafik ran this business until he
died in 2002.
Shafik had three sons: Joseph, Rony, and Emil. After Shafik died, Joseph,
who owned 45% of Old ZIC, took over. The remaining equity was owned by Rony
(25%), Emil (25%), and Joseph's son, Danny (5%). Joseph died suddenly and
unexpectedly in 2004. Danny inherited [*2]Joseph's
equity, giving him ownership of 50% of Old ZIC. Danny, however, had only recently
graduated college and had been working for the company in a minor administrative role
under the supervision of his father. His 2004 salary was $44,400. Rony, who worked in
sales, was appointed a director at the beginning of 2004 and made $101,600 that year.
After Joseph's death, Danny, the majority owner, appointed himself
President of Old ZIC and named Rony the Vice President. Emil, who had worked at the
company under Shafik and Joseph, continued to work at the company. In the summer of
2004, Emil made a series of books and record requests. On July 7, 2004, Emil asked
Rony about his records requests. In response, Rony assaulted Emil. Later that day, Emil
underwent a previously scheduled surgical procedure, which rendered him in a coma.
Emil remains in a vegetative state. Nahal, Emil's wife, sought to obtain title to Emil's
shares after his incapacitation. Danny and Rony objected, requiring the involvement of
lawyers. After much cost, Nahal obtained Emil's 25% equity on June 19, 2006.
In 2005, Danny increased his salary to $159,300 and Rony's salary to
$128,500. While Rony's salary continued to rise, topping out at $419,442 in 2011,
Danny's salary increased far more substantially. Danny made $236,800 in 2006,
$426,765 in 2007, $479,600 in 2008, $881,650 in 2009, $1,278,100 in 2010, $1,741,100
in 2011, $1,738,500 in 2012, and $1,746,632 in 2013. Moreover, both men took millions
of dollars of interest-free loans from the company, which they only began to repay with
interest after they were sued by Nahal in 2009.
In 2006, Danny began paying his mother, Kathrin, a "salary" from the
company. Kathrin received $124,800 in 2006, and continued to receive a six figure salary
every year until 2013, when her compensation decreased to $86,000. Danny stipulated
that he paid his mother a total of $906,000 from the company; he admits that she was
paid this money despite performing no work. Danny also admits that the company's
financial statements and tax returns treated Kathrin's "salary" as a business expense.
In 2007, Danny and Rony admit they began leasing a fleet of luxury cars that
cost the company approximately $100,000 per year. Most of the cars were not used for
business purposes but rather for personal use by the men and their families. Additionally,
in 2008, Danny formed another company, called Zelouf West, which he solely owns.
Zelouf West began selling to four of Old ZIC's customers (the Legacy Customers).
Zelouf West does not have its own office, employees, or even its own bank account. It
used the offices, employees and bank account of Old ZIC.
Procedural History
On May 7, 2009, Nahal commenced an Article 78 proceeding in this court
(Index No. 601425/2009), in which she sought the company's books and records. After
receiving some of the company's records, on December 14, 2009, Nahal commenced the
Derivative Action, in which she sued Danny and Rony for, inter alia, waste and
self-dealing. In response, Danny stopped having the company pay for Emil's health
insurance on the supposed ground that, since Nahal complained about benefits given to
non-employees, and Emil could no longer work for the company, continuing to pay for
his health insurance would be inappropriate. Danny, however, continued to pay for his
mother's health insurance and continued to pay her "salary" even though she had never
worked for the company. Nahal, as a result, incurred a massive financial burden.
In discovery, Nahal sought records from a database, called MOD2, which
tracked all of Old ZIC's inventory. Nahal alleged that the MOD2 inventory records
would show that Danny and Rony were understating the company's profitability in its
financial statements. Nahal maintained that Danny and Rony were pocketing substantial
portions of Old ZIC's revenue, much of which was in cash, for themselves. She
contended that while the company's total sales volume was accurately recorded in
MOD2, the company's financial statements overstated the cost of goods sold (COGS) and
understated the value of the inventory, making the company look far less profitable than
it really was. Nahal alleged this enabled Danny and Ronny to steal considerable portions
of the company's revenue in a way that would be undetectable, off the books, and tax
free. Nahal demanded production of the MOD2 records in discovery so she could prove
the discrepancies between MOD2 and the financial statements. The court takes judicial
notice of the fact that Danny and Rony fought bitterly to prevent disclosure of the MOD2
records. The court eventually ordered full disclosure of the MOD2 records, but only after
much litigation and cost.
The Note of Issue in the Derivative Action was filed on February 9, 2012,
and summary judgment motions followed. In an order dated January 3, 2013, the court
dismissed Nahal's direct claims, but denied summary judgment on her derivative claims,
setting the stage for a jury trial. See Index No. 603746/2009, Dkt. 160. During
the pre-trial process, the parties procured an independent valuation of the company in
conjunction with the parties' attempt to mediate and settle the case. The parties retained
Kevin Vannucci of McGladrey LLP, who issued a report dated August 6, 2013, in which
he computed a valuation of Old ZIC as of December 31, 2012 (the Vannucci Report),
which is discussed in detail below. The parties did not settle. A jury trial, therefore, was
scheduled to commence on September 9, 2013.
The case did not go to trial because, on August 19, 2013, Danny and Rony
notified Nahal that they were going to effectuate a freeze-out merger. A new company
(New ZIC) would be formed, which would be owned by Danny and Rony, and Nahal's
shares would be bought out pursuant to a tender offer, which Nahal would have the right
to challenge in a special proceeding if she believed the fair value of her shares was more
than offered. Nahal immediately moved to enjoin the merger. Her motion was denied in
an order dated August 30, 2013 (the Merger Order). See Index No. 603746/2009,
Dkt. 278. As noted in the Merger Order, the parties agreed that the court would try
Nahal's derivative claims in the instant special proceeding. Moreover, the court held that
if Nahal prevailed on her derivative claims, the court also would award her reasonable
attorneys' fees. The parties then filed a stipulation of discontinuance.
New ZIC filed its petition in this special proceeding on October 22, 2013.
The petition sets forth that on September 19, 2013, Nahal was offered $1,556,250 for her
Old ZIC shares. Pursuant to BCL § 623(g), Nahal was tendered 80% of this
amount. After Nahal did not respond to the tender offer, New ZIC filed its petition. On
November 8, 2013, Nahal filed her answer and asserted counterclaims to recover the fair
value of her shares and her costs and attorneys' fees. Fact and expert discovery ensued. A
bench trial was held before me over 11 days between [*3]March 17, 2014 and July 10, 2014.[FN1]
Post-trial briefs were filed on August 8, 2014.[FN2]
See Dkt. 128 & 130.
For the reasons that follow, the court holds that Nahal is entitled to fair value
for her shares in an amount based on the Vannucci Report's valuation (without a SEAM
adjustment, a discount for lack of marketability (DLOM), an additional control premium,
or adjustment based on Old ZIC's revenue in the first half of 2013, but including revenue
from the Legacy Customers), plus additional compensation for Danny's improper waste
of corporate assets (Kathrin's "salary" and the luxury fleet of cars), plus additional
compensation for the money Danny and Rony stole from the company and hid by
producing fraudulent financial statements, plus attorneys' fees.
Legal Standard
BCL § 623 provides that a dissenting shareholder in a freeze-out
merger is entitled to the "fair value" of her shares. Pursuant to BCL §
623(h)(4):
In fixing the fair value of the shares, the court shall consider the nature of
the transaction giving rise to the shareholder's right to receive payment for shares and its
effects on the corporation and its shareholders, the concepts and methods then customary
in the relevant securities and financial markets for determining fair value of shares of a
corporation engaging in a similar transaction under comparable circumstances and all
other relevant factors.
The BCL, however, "offers no definition of fair value and no criteria by
which a court is to determine price or other terms of the purchase." Matter of
Seagroatt Floral Co., Inc., 78 NY2d 439, 445 (1991). Fair value, therefore, is a
question of fact "that will depend upon the circumstances of each case." Id.
Indeed, "there is no single formula for mechanical application." Id.
Likewise, it is well settled that "[v]aluation of closely held corporations is
not an exact science, and it is the particular facts and circumstances' of each case that
will dictate the result." Giaimo v
Vitale, 101 AD3d 523, 524 (1st Dept 2012), quoting Friedman v Beway
Realty Corp., 87 NY2d 161, 167 (1995). "The determination of a fact-finder as to the
value of a business, if it is within the range of the testimony presented, will not be
disturbed on appeal where valuation of the business rested primarily on the credibility of
expert witnesses and their valuation techniques." Matter of Dissolution of N. Star
Elec. Contracting-N.Y.C. Corp., 174 AD2d 373, 373-74 (1st Dept 1991); see Wechsler v Wechsler, 58
AD3d 62, 95 (1st Dept 2008) ("There is no single set methodology for valuing a
closely held business" and, thus, deference is given to this court's fair value finding if
such finding "has support in the record"). Nonetheless, there are certain mandatory
valuation rules that must guide the court's analysis, such as:
(1) The fair value of a dissenter's shares is to be determined on their
worth in a going concern, not in liquidation, and fair value is not necessarily tied to
market value as reflected in actual stock [*4]trading (2)
The three major elements of fair value are net asset value, investment value and market
value. The particular facts and circumstances will dictate which element predominates,
and not all three elements must influence the result. (3) Fair value requires that
the dissenting stockholder be paid for his or her proportionate interest in a going
concern, that is, the intrinsic value of the shareholder's economic interest in the
corporate enterprise. (4) fair value determinations should take into account the
subsequent economic impact on value of the very transaction giving rise to appraisal
rights, as supplemental to the three basic value factors (net asset, investment and market
values). [and] (5) Determinations of the fair value of a dissenter's shares are governed by
the statutory provisions of the Business Corporation Law that require equal treatment of
all shares of the same class of stock.
Friedman, 87 NY2d at 167-68 (citations omitted; emphasis
added).[FN3]
Simply put, the court must "determine the minority shareholder's
proportionate interest in the going concern value of the corporation as a whole, that is,
what a willing purchaser, in an arm's length transaction, would offer for the corporation
as an operating business.'" Id. at 168, quoting Matter of Pace Photographers,
Ltd., 71 NY2d 737, 748 (1988). Once "the investment value of the entire enterprise
[is] ascertained," the dissenting shareholder should be awarded a pro rata share based on
the percentage of stock owned. Friedman, 87 NY2d at 168-69. While "a discount
for minority status" is not permitted [see id. at 169], courts may apply a DLOM
when a "risk associated with the illiquidity of the shares" is proven. Giaimo, 101
AD3d at 524; see Murphy v
U.S. Dredging Corp., 74 AD3d 815, 818 (2d Dept 2010) (collecting
cases).[FN4]
Though the Court of Appeals has not decided the question of who bears the
burden of proof in a BCL appraisal proceeding, the parties propose following this court's
tradition of applying the "no-burden" approach. Under this approach, the court will
consider the parties' expert testimony as persuasive evidence of fair value, but, at the end
of day, and even if the court finds neither expert to be persuasive, it is the court's burden
to make a fair value determination. See Matter of Cohen, 168 Misc 2d 91, 95
(Sup Ct, NY County 1995), aff'd 240 AD2d 225 (1st Dept 1997).[FN5]
For the reasons set forth below, the court adopts most of Vannucci's valuations, [*5]accepts some of the contentions of the parties' other
experts, and disregards the experts' opinions where such opinions are based on arguments
or methodologies that the court finds not to be compelling or in contravention of New
York law.
That being said, Nahal still has the burden of proof on her derivative claims,
but the impact of such claims on the value of the company, if proven, will be decided by
the court under the no-burden approach.[FN6]
Where the court rules in Nahal's favor, Nahal has met her burden of proof, the standard
for which is discussed in more depth below.
The Vannucci Report
The parties agree that the Vannucci Report is the starting point for the fair
value analysis of Nahal's shares. The court reviewed the Vannucci Report in
comprehensive detail, both as a stand-alone analytical document and in conjunction with
the reports and testimony of the parties' experts. The court finds the Vannucci Report to
be a comprehensive and reliable indicator of the value of Old ZIC.[FN7]
Given the lack of substantial disagreement over the Vannucci Report's findings, the [*6]court limits its discussion to a general explanation of its
methodology and the five issues disputed by the parties.
Vannucci's Methodology
Vannucci set out to determine the fair value of Old ZIC on a controlling
basis. Vannucci also separately calculated the impact a SEAM adjustment, a DLOM, and
the Legacy Customers would have on the valuation. Vannucci understood fair value to be
"the price that would be received to sell [Old ZIC] in an orderly transaction between
market participants." Vannucci valued Old ZIC as a going concern and assumed it would
be able to generate earnings into perpetuity. He considered utilizing three generally
accepted valuation approaches (the Market-Based Approach, the Income
Based-Approach, and the Asset-Based Approach), and provided a detailed explanation
for why he "determined that the only meaningful and reliable valuation methodology in
this case was the Income Based-Approach." He then explained why and how he applied
the capitalization method (as opposed to the discounted cash flow method). Simply put,
Vannucci determined a normalized measure of sustainable economic income, and, in
doing so, necessarily had to make normalizing adjustments.[FN8]
Vannucci calculated Old ZIC's normalized revenue and sustainable EBITDA margin
(4.3%), the latter of which, as discussed below, the parties dispute based on the 2013
financials. Vannucci further calculated a long-term growth rate of 3%, representing a
nominal real long-term growth rate after accounting for inflation.
Next, Vannucci calculated the fair value of the Legacy Customers —
that is, the value of their revenue to Old ZIC, which Old ZIC would have received if
Danny had not moved those customers' business to Zelouf West. Vannucci was expressly
agnostic on whether, as a matter of law, Old ZIC was legally entitled to such revenue, but
computed the value of the Legacy Customers so the court could utilize the calculation if
necessary, based upon legal determinations.
While Vannucci touched on myriad aspects of Old ZIC's business and the
industry in which it operated, the parties only dispute two portions of Vannucci's
valuation (SEAM and DLOM) and three other possible adjustments to his valuations
(control premium, the Legacy Customers, and the impact of the 2013 financials).
SEAM
SEAM (an S-corporation Equity Adjustment Multiple) is a premium added
to the valuation of an S-corporation to reflect the pass-through tax benefits not applicable
to C-corporations. Since the type of analyses performed by Vannucci were based on
assumptions applicable to C-corporations, a SEAM adjustment is often added to the
valuation to reflect the benefit to the owner of an S-corporation. However, as Vannucci
correctly noted, applying a SEAM premium [*7]is only
appropriate when valuing a minority equity interest, not where, as here, conducting a
valuation of the entire company.[FN9]
This type of valuation is in accord with New York law. See Friedman, 87 NY2d
at 168-69. New York law does not permit an independent valuation of the minority's
equity, which would entail a separate valuation methodology and which might warrant a
SEAM premium. Vannucci only calculated a hypothetical SEAM at the direction of
counsel, but did not believe it should be added. The court agrees. While the parties
dispute Vannucci's SEAM calculation (particularly the issue of the applicable individual
tax rates), this dispute is irrelevant because a SEAM adjustment should not be made.
DLOM
Vannucci computed a 30% DLOM (Discount for Lack Of Marketability).
Vannucci noted: "typically, a [DLOM] is usually only applicable for valuations of
minority interests in closely-held companies under the assumption that a controlling
owner would be able to force the sale of the company. However, at the direction of
counsel, and consistent with the scope of my valuation assignment, I have assumed a
hypothetical condition by including the [DLOM] to conclude on what the value of [Old]
ZIC is on a controlling, non-marketable basis." While the parties' experts opined on
whether 30% would be the proper DLOM, the court does not weigh in on this dispute
because the court agrees with Vannucci's view that a DLOM should not be applied. He
correctly reasoned that the assumptions behind the DLOM and its calculation, such as
hypothetical impediments to sale and the actual likelihood that Old ZIC would be sold,
are entirely irrelevant to the determination of the fair value of Nahal's shares, which is
based on her pro rata share of the value of the entire company on a controlling basis.
Petitioner, however, argues that New York law requires a DLOM. While
many New York cases discuss DLOM, and, particularly, how much DLOM is proper in
various circumstances,[FN10]
no New York case stands for the proposition that a DLOM must be applied to a
closely-held company. The idea of a DLOM is that, since the company as a whole can be
difficult to sell (e.g., buyers of closely-held companies in niche businesses are not as
plentiful as buyers of publicly traded corporations), a frozen-out, minority shareholder
should recover less to reflect this fact. While it is surely true that it would have been
difficult to sell Old ZIC — though this may have as much to do with Danny's
looting of the company as its closely-held status — the rationale for generally
applying a DLOM is inapplicable to Old ZIC.
The methodology employed by Vannucci (the Income Based-Approach,
which neither party contends was improper) values the company based on its perpetual
future earnings. To a holder of Old ZIC equity, this valuation represents the value
received if the equity is held, not sold. Indeed, the record establishes that owning Old
ZIC (and now New ZIC) equity has enticing perks. [*8]Moreover, given Danny's testimony regarding the soul of
the business being personal relationships, it seems unlikely that the company would or
could ever actually be sold. Danny is at the helm of a company in a niche industry that
affords him benefits that another company would not provide.
While these facts, at first glance, might appear to militate in favor of
applying a DLOM, the rationale for a applying a DLOM breaks down when one
considers that any liquidity risk associated with Old ZIC is more theoretical than real. No
sale of the company has occurred since its 1984 founding. Nor is there any reason to
think that Danny will walk away from a company providing him with millions of dollars
in income, a similar, low interest loan facility, personal and family perks and control
unless he eventually turns it over to other family members, years down the road.
The company, without Nahal and her family, will always remain under the
control of the Zelouf family. This makes the company's illiquidity irrelevant, mooting the
concern for which a DLOM accounts. If the other Zelouf family members will never pay
a price for the company's theoretical illiquidity, then there is nothing "fair" about
artificially depressing Nahal's recovery due to a hypothetical sale that will never occur.
To impose such a cost on Nahal is tantamount to levying the very sort of minority penalty
that New York law prohibits. In this court's view, the fair value of Nahal's shares should
be based on the true value of owning the company that Nahal would have enjoyed had
she not been mistreated while a shareholder and forced out when she complained.
Liquidity risk only manifests into real cost in an actual sale and should not be imposed
here where there will never be a sale and, thus, no real cost.[FN11]
The purpose of a DLOM is to account for "risk associated with the
illiquidity of the shares." Giaimo, 101 AD3d at 524 (emphasis added). Risk, of
course, is a function of probability times the threatened harm. While the threat of harm
here (a lower net purchase price due to illiquidity costs) is undisputed, the probability
that such a threat will actually occur is negligible. Ergo, there is no risk that warrants a
DLOM.
While petitioner is correct that a DLOM is applied in most instances,
petitioner provides no support for the proposition that applying a DLOM is a mandatory
part of the formula for valuing Old ZIC. A rule requiring courts to mechanically apply a
DLOM to all closely held companies without considering whether, in some instances, the
purpose of a DLOM may not apply, is inconsistent with this court's legal mandate.
See Seagroatt, 78 NY2d at 445 ("there is no single formula for mechanical
application"). Rather, as the Court of Appeals has long recognized, "[v]aluing a closely
held corporation is not an exact science" because such "legal entities that by their nature
contradict the concept of a market' value." Id. at 446.
Old ZIC is precisely the sort of company for which there is no traditional
"market." Hence, the court must "consider the nature of the transaction" and, in doing so,
the court must consider "all other relevant factors." See BCL § 623(h)(4).
One such factor is that an actual sale of the company is highly unlikely. Applying a
DLOM to Old ZIC (now, New ZIC), therefore, does not reflect the fairest value of
Nahal's shares, since the most valuable form of such equity is to own it and reap the
benefits. Simply put, Danny and Rony do not suffer from Old ZIC's illiquidity, and, thus,
neither should Nahal.
Control Premium
Similarly, no control premium should be applied. Nahal's expert, Professor
Anthony Saunders, argued that a control premium should apply due to the myriad
benefits of and powers associated with controlling a company. Professor Saunders is
correct about the benefits of control (and he is also correct about the private equity
market, albeit that is irrelevant since an additional marketability adjustment, be it DLOM
or otherwise, is inappropriate here). Nonetheless, a control premium is improper because
the company is being valued as a whole. Neither Danny's majority nor Nahal's minority
stake is being valued. All inquiries regarding the particular benefits or disadvantages of
certain percentage equity stakes are wholly irrelevant to this inquiry.[FN12]
The level of control that Danny gained over the company after the freeze-out merger,
therefore, is irrelevant.
The Legacy Customers
Next, the value of the Legacy Customers should be included. While Danny
explained that these customers purchased different types of fabric than those usually sold
by Old ZIC ("junior sportswear" instead of "dressy fabrics"), given the countless
variations of fabrics that the company dealt in (as set forth in the MOD2 data), Danny has
not convinced the court that the company was not in a position to sell junior sportswear
to the Legacy Customers. Indeed, while it is not necessarily inappropriate for Danny to
have started a separate division for a different line of fabrics, that is not what he did. He
created a separate legal entity, wholly owned by him, and diverted four of Old ZIC's
long-time customers to that company, while using Old ZIC's resources to operate it. It is
to no avail for Danny to explain that he segregated the businesses with the use of, for
instance, intercompany loans and separate allocations of costs and revenues. The
problem here is not the lack of adherence to corporate formalities, but rather that Danny's
formation of Zelouf West was yet another example of the manner in which his operation
of the business advantaged him while disadvantaging Nahal, the minority shareholder.
That is the hallmark of this case and the point of Nahal's lawsuit.
The 2013 Financial Statements
Finally, the parties argue about whether the company's 2013 financials
warrant an adjustment to Vannucci's valuation. No such adjustment should be made.
While Nahal is correct that the law requires Old ZIC to be valued as of the merger date,
which occurred in late August 2013 and that Vannucci's valuation was only as of
December 31, 2012, Nahal has not submitted any evidence that the value of the company
materially increased in the intervening eight months. Nahal merely took the company's
financial statements for half of 2013 (which Vannucci did not have) and annualized them
by assumed that the company would perform equivalently the rest of the year (a
questionable assumption for many reasons, such as the seasonal nature of the industry).
Nahal concluded that, in 8 months, the company increased in value by $2.1 million, a
23% increase. But, the company's financials do not actually show improvements to the
company's fundamentals, nor did Nahal's experts contend that the company's
performance improved. They simply claimed to have conducted the mathematical
exercise of plugging in the 2013 numbers and applying various weighting schemes. In
other words, Nahal presented no evidence of any actual improved performance. By using
a 4-year look-back with equal weighting — when Vannucci chose a 3-year
look-back period with the most recent year (2012) weighed double — [*9]Nahal computed a greater normalized EBITDA margin of
5.1% (versus 4.3% calculated by Vannucci). This is problematic for many reasons, but
two in particular.
First, even assuming that the company's EBITDA was in the 5% range in
2013, this does not suggest that Vannucci's 4.3% calculation was wrong or even
underestimated. The 4.3% number is an average profitability metric that Vannucci
thought the company would realize into perpetuity. No matter the projected EBITDA,
across an infinite number of future years, the company will have above and below
average years. Had Nahal provided substantive evidence of a material change to the
business in the first eight months of 2013, such as some market condition improving in a
way that warranted a reassessment of the company's projected income, such a fact along
with better numbers for the first six months might warrant an upward EBITDA revision.
A better six months, without more, does not.
Second, it is entirely unclear if the 2013 numbers were really better. Once a
double weighting for the most recent year (2012) is used, the computed increase in value
(approximately $350,000 on an $8.893 million valuation) is immaterial. For these
reasons, the court finds that Vannucci's valuation based on the Old ZIC's financials
through December 31, 2012 is a reliable and accurate measure of the company's fair
value as of late August 2013.
Nahal's Derivative Claims
The court assumes familiarity with its prior decisions in the Derivative
Action, which discuss the full scope of Nahal's derivative claims. Pursuant to the court's
in limine rulings, the only derivative claims tried were for events occurring
between 2004 and 2010. Moreover, as petitioner correctly argues, since Nahal
commenced the Derivative Action on December 14, 2009, Nahal's claims, which are
"purely monetary in nature," are subject to a three year statute of limitations under CPLR
214(4). IDT Corp. v Morgan
Stanley Dean Witter & Co., 12 NY3d 132, 139 (2009).[FN13]
Thus, recovery for waste that occurred prior to December 14, 2006 is time
barred.[FN14]
Additionally, Nahal chose not to pursue certain claims at trial, such as improper tuition
payments made to (alleged) family members
Nahal's remaining claims fall into two categories: (1) corporate waste, i.e.,
Danny's and Rony's excessive salaries and no-interest loans, a no-show "salary" paid to
Danny's mother, leasing of luxury cars, and the diversion of the Legacy Customers to
Zelouf West; and (2) Danny's and Rony's improper taking of company money, which
Nahal proves through a comparison of a forensic audit of MOD2 and Old ZIC's financial
statements.
[*10]Corporate Waste
It is well settled that "the business judgment rule prohibits judicial inquiry
into actions of corporate directors taken in good faith and in the exercise of honest
judgment in the lawful and legitimate furtherance of corporate purposes."
Levandusky v One Fifth Ave. Apt. Corp., 75 NY2d 530, 537-38 (1990), quoting
Auerbach v Bennett, 47 NY2d 619, 629 (1979). "So long as the corporation's
directors have not breached their fiduciary obligation to the corporation, the exercise of
[their powers] for the common and general interests of the corporation may not be
questioned.'" Levandusky, 75 NY2d at 538, quoting Pollitz v Wabash R.R.
Co., 207 NY 113 (1912); see Fletcher v Dakota, Inc., 99 AD3d 43, 48 (1st Dept
2012). However, the business judgment rule does not apply when a director engages in
"fraud, self-dealing, unconscionability or other misconduct [not] taken in good faith and
in furtherance of the legitimate interests of the corporation." Levine v Greene, 57 AD3d
627, 628 (2d Dept 2008), quoting Gillman v Pebble Cove Home Owners Ass'n,
Inc., 154 AD2d 508 (2d Dept 1989). "[T]hose types of abuses are incompatible with
good faith and the exercise of honest judgment." See Fletcher, 99 AD3d at 48,
quoting 40 W. 67th St. Corp. v Pullman, 100 NY2d 147, 157 (2003).
"The essence of a waste claim is the diversion of corporate assets for
improper or unnecessary purposes.' To disprove a waste claim, a director who had a
personal interest in challenged payments has the burden of showing that they were made
in good faith and were fair to the corporation." SantiEsteban v Crowder, 92 AD3d 544, 546 (1st Dept
2012), quoting Aronoff v Albanese, 85 AD2d 3, 5 (2d Dept 1982). To establish a
waste claim based on alleged excessive compensation, "[t]he objecting stockholder must
demonstrate that no person of ordinary sound business judgment would say that the
corporation received fair benefit. If ordinary businessmen might differ on the sufficiency
of consideration received by the corporation, the courts will uphold the transaction."
Aronoff, 85 AD2d at 5-6 (citations omitted). This inquiry turns on whether "there
is a great disparity in values between the assets expended and the benefits received."
Id. at 6. In other words, the shareholder must prove that the challenged
compensation bore no relationship to the value received by the company, rendering it
unjustifiably excessive.
Nahal has not made this showing with respect to Danny's and Rony's
salaries. To be sure, their salaries were substantial and, perhaps, may have been
excessive.[FN15]
However, Nahal provides no proof that their salaries were disproportionate to the benefit
they conferred on Old ZIC. While the court finds Danny severely lacking in his
adherence to his ethical obligations to family and [*11]company, the court recognizes that Danny's value to the
company is substantial.[FN16]
Without Danny, the company would likely suffer greatly, as its customer relationships
would be imperiled as they were after Joseph's death.[FN17]
Nahal's reliance on industry average salaries is inapposite because such averages do not
account for Danny's actual value to the company. Vannucci, who computed those
averages in his report, recognized that his normalizing adjustments are not proof that
seemingly excessive salaries are legally wasteful.
Similarly, with respect to no-interest loans, while such loans appear
untoward and are in line with how Danny otherwise looted the company, in reality, the
only marginal compensation received by taking these loans is the interest expenses
Danny and Rony would have incurred had they borrowed this money from traditional
credit sources.[FN18]
While Nahal makes much of the fact that the loan balances, from time to time, reached
seemingly egregious amounts like $2 million, the principle was always repaid. Moreover,
Nahal does not even allege that the company had liquidity concerns that were caused or
exacerbated by these loans.[FN19]
Furthermore, the value of the avoided interest expense is immaterial in proportion to
Danny's and Rony's overall compensation. Given that their base salary compensation has
not been proven to be so excessive as to be wasteful, the marginal compensation they
procured by not having to pay interest does not tip the scales of reasonableness.
Kathrin's no-show "salary" and the luxury car leases, however, are another
matter. Paying your mother almost $1 million for nothing is a textbook example of
corporate waste. While Danny claimed his mother provided him with emotional support,
no reasonable businessman would consider such payments to be justified in the absence
of any real value to the company. Similarly, while there is nothing necessarily wrong
with a company leasing cars for its employees, when the cars are used by non-employees,
or are driven by employees for personal use, and are of a brand of [*12]luxury well beyond what any reasonable company would
pay for, the leases are wasteful.
Finally, as discussed earlier, Danny's justifications for diverting the Legacy
Customers to Zelouf West are uncompelling. Although the impact of that lost business
was computed by Vannucci, and thus does not require a further addition to Nahal's
recovery,[FN20]
the court finds it appropriate to mention the Legacy Customers in the context of Nahal's
derivative claims since the propriety of diverting the Legacy Customers is a question of
law for the court, not the parties' experts.
"The doctrine of corporate opportunity' provides that corporate fiduciaries
and employees cannot, without consent, divert and exploit for their own benefit any
opportunity that should be deemed an asset of the corporation." Alexander &
Alexander of NY, Inc. v Fritzen, 147 AD2d 241, 246 (1st Dept 1989). There is no
single test for determining the existence of a corporate opportunity, but the "tangible
expectancy" and "line-of-business" tests are commonly employed. See Lee v Manchester Real Estate
& Const., LLC, 118 AD3d 627 (1st Dept 2014). Nahal's brief, however,
does not set forth these tests or any other applicable legal standard. Petitioner's brief
briefly mentions them, but lacks substantive analysis. Based on the evidence produced at
trial, the court finds that the Legacy Customers' business was substantially similar to Old
ZIC's business, and hence loss of that business was a lost corporate opportunity. The
court reaches this conclusion despite those customers buying "junior sportswear", as the
court does not find Danny's testimony about Old ZIC's incapability of servicing them to
be credible. Moreover, while utilizing a separate company to sell junior sportswear is not
inherently illegal, doing so conferred no benefit onto Old ZIC since Danny, and not any
of Old ZIC's other shareholders, owns Zelouf West. Even if Old ZIC never before sold
junior sportswear, getting into that market by selling to four of its current customers is a
corporate opportunity that Danny cannot take for himself before at least offering it to the
company. This is particularly true here where Danny used the company's offices,
employees and bank accounts to run Zelouf West. The Legacy Customers, therefore, are
included in the court's valuation of Old ZIC in the amount computed by Vannucci.
MOD2 Forensic Accounting
Nahal's expert, Elloit A. Lesser, performed what is perhaps the most
significant work in the 6 years since Nahal first sued Danny. Lesser, a forensic
accountant employed by Berdon LLP, analyzed the MOD2 records and concluded that,
for the period between 2004 and 2010, Old ZIC's financial statements understated the
value of the company's inventory by $4.9 million, overstated COGS by $717,000, and
failed to account for over $14 million in gross profits.[FN21]
For the reasons [*13]discussed herein, the court agrees
with Lesser's conclusions. As a result, Nahal is entitled to 25% of the value of these
omissions. Had such amounts been properly recorded on Old ZIC's financial statements,
Vannucci would have incorporated them into his valuation, which then would have been
significantly higher.
According to Danny, MOD2 "runs the company." When Danny began
working at Old ZIC, he made the astute observation that the company could greatly
benefit from an electronic inventory tracking system given the substantial volumes
bought and sold by the company. Indeed, without a robust tracking system, it would be
nearly impossible to get a grasp of what was stored in the company's warehouse. While
the parties agree that the cost data in MOD2 is unreliable, and hence was rightly not used
in this proceeding, since MOD2 was implemented in 2002, it is undisputed that MOD2's
inventory records are accurate.[FN22]
MOD2 contains a comprehensive inventory breakdown, including quantity,
color, style, and yardage data. Lesser conducted an inventory roll forward to value the
inventory recorded in MOD2 between 2004 and 2010. Lesser started by looking at the
inventory on hand at the end of each year, and then accounted for inventory bought and
sold during that year. This allowed Lesser to compute the total volume of inventory on
hand and the amounts sold between 2004 and 2010. Then, to assess value, COGS,
revenue, and profit, Lesser compared the results with those reported on the company
financial statements, which were unaudited and prepared by Old ZIC's long-time
accountant, Joel Helman.[FN23]
Since Lesser did not have actual inventory sales revenue or purchase cost
data because such data was not reliably recorded in MOD2, Lesser relied on data from
the Risk Management Association (RMA) to determine benchmark profitability margins
for similar companies. Lesser used RMS data for NAICS code 424310 (the same code
Vannucci used to make his normalizing adjustments).[FN24]
Lesser used the most conservative of that industry's benchmark profit margins, 25%, and
computed a total difference of $14 million between that benchmark rate and the actual
gross profit margins reported by Old ZIC.
In other words, Lesser computed the profit a typical firm in the industry
would have earned had that firm sold the quantity of inventory sold by Old ZIC between
2004 and 2010. While many firms actually achieve much higher margins (in the 30%
range), Lesser's 25% profit margin [*14]assumption
represents what a poorly performing, yet profitable firm would have
generated.[FN25]
To be sure, while it is not a given that a firm makes a profit at all, it was reasonable for
Lesser to assume that Old ZIC could not make less than a 25% profit margin and also
stay in business for as long as it did. As Lesser explained, firms with profit margins that
are consistently well below the low end of industry norms do not stay in business for
long, let alone for over a decade (which included the biggest recession since the Great
Depression). Indeed, Danny testified that many of the firms that competed with Old ZIC
when Danny started in the early 2000's went out of business. It is implausible that Old
ZIC could have stayed in business without making at least an average profit margin of
25% between 2004 and 2010.[FN26]
Lesser also noted that it was highly suspicious that in the years immediately
after Nahal filed her lawsuits, the company started reporting higher gross profit margins,
even though such time period was during the Great Recession. Indeed, not only did Old
ZIC report higher profit margins after Nahal sued Danny, but Danny's compensation
doubled as well. As noted earlier, one explanation is that, for some reason, the company
suddenly became unexpectedly more profitable, and Danny decided to reward himself
accordingly. However, there is no support for this theory in the record, nor does any
credible evidence (which, of course, does not include Old ZIC's unaudited financial
statements) lend credence to this narrative. In fact, the company's financial records since
Nahal's lawsuit was filed, including the MOD2 cost data, may well be accurate. But this
is not necessarily proof of improvement. Rather, in the absence of any actual explanation
for the company's sudden profitability surge in the middle of a recession, the only
reasonable conclusion the court can draw is that, as a result of Nahal's lawsuit, Danny
decided the threat of judicial scrutiny warranted making accurate financial disclosures for
the first time.[FN27]
If that is what occurred, then the company did not become more profitable, nor did
Danny's actual salary really double. Rather, the reported profit margins were simply the
amounts the company was always making, and Danny's reported salary reflects the total
value of the compensation he always procured, in one way or another, from the company.
Only, this time, it was on the books, and not from secret transfers of money from
inventory transactions not reported on the company's balance sheet.
Finally, the court notes that Lesser's methodology is not perfect.[FN28]
For instance, if the company's real profit margin was in the 20-22% range, much of
Lesser's presumed underreporting of profit would disappear. However, given that Lesser
used an extremely conservative comparable profit margin, the implausible and
unexplained sudden appearance of profitability along with Danny's attendant supposed
salary increase, and, most importantly, Danny's history of committing egregious acts of
corporate waste, the court makes a finding of fact that Danny and Rony stole
approximately $14 million of profits between 2004 and 2010. The statute of limitations,
however, precludes recovery for amounts misappropriated before 2007. Nahal, thus, is
limited to recovering 25% of the amounts stolen between 2007 and 2010.
It also should be noted that the incredible amount misappropriated —
$14 million — is not implausible. After all, Danny admittedly gave almost $1
million to his mother. The $14 million taken over 7 years represents an additional $2
million per year for Danny and Rony to split. For instance, in 2009, if Danny was willing
to pay himself more than $1.2 million, take millions in interest-free loans, and also loot
another $125,000 for his mother, it does not strain credulity to believe than Danny was
willing to take another $1.5 million per year for himself and give the rest to Rony or
other family members. While these are not trivial amounts of money, given the sums
Danny made and the other amounts he took, there is nothing implausible about the notion
that he plundered $14 million from the company over a 7-year period.
Attorneys' Fees
In the Merger Order, it was made clear that the allowance of the merger was
expressly conditioned upon [*15]Nahal being able to
pursue her derivative claims and recover her reasonable attorney's fees. As mentioned
earlier, while there is scant New York precedent for how to handle quasi-derivative
claims, the court never had to reach the issue of whether such claims are permitted
because, at oral argument before the merger, "the parties stipulated that the alleged
diminution in value of [Nahal's] shares caused by defendants' alleged corporate waste
and self-dealing can be factored into the court's appraisal." Merger Order at 3. This
understanding was repeatedly confirmed by the parties in this proceeding. While
petitioner maintained that Nahal should not recover any attorneys' fees because she was
not capable of proving that the fair value of her shares materially exceeds the tender offer
or be able to prevail on her derivative claims, these contentions are no longer viable in
light of the instant decision.
Therefore, the calculation of Nahal's reasonable attorneys' fees expended in
both the Derivative Action and in the instant special proceeding is referred to a Special
Referee to hear and report. Such amount will be added to Nahal's recovery. Once the
hearing and motion practice, if any, regarding the Referee's report has concluded, a final
judgment will be entered.[FN29]
billed her substantial sums of money, and, at trial, when too many attorneys' attended,
most of whom did not participate in the proceedings. As to trial, Nahal may only recover
trial fees for the lead counsel and for the two associates who meaningfully assisted.
Third, for the reasons set forth in the Merger Order, Nahal may not recover
attorneys' fee on the direct clams she asserted in the Derivative Action (which were
dismissed on summary judgment).
Fourth, Nahal may not recover fees paid to Professor Saunders, whose
testimony on a control premium was clearly irrelevant for the reasons discussed
earlier.
On all other issues, the Referee shall exercise his or her discretion as to what
amounts Nahal should recover. The parties are free to challenge the Referee's findings,
but are reminded that the court typically confirms the reports of this court's referees so
long as they are reasonable and supported by the evidence in the record. See Namer v
152-54-56 W. 15th St. Realty Corp., 108 AD2d 705 (1st Dept 1985).
Damages
As noted above, the parties will submit proposed judgments computing
Nahal's damages. They must be computed based on the following rulings: (1) the fair
value of Old ZIC, accounting for everything except the derivative claims and attorneys'
fees, is $8,893,000, 25% of which equals Nahal's share — $2,223,250 minus the
amount previously tendered pursuant to BCL § 623(g); (2) Nahal is entitled to 25%
of the amounts (a) Kathrin was paid by Old ZIC between 2007 and 2010 ($473,600, 25%
of which is $118,400) and (b) Old ZIC paid to lease cars between 2007 and 2010
($401,000, 25% of which is $100,250); (3) Danny stole $14 million from Old ZIC over
seven years, but since 3 of the years preceded 2007, the court will only permit Nahal to
recover 25% on $8 million (assuming Danny stole $2 million per year for four years,
2007 to 2010), which is $2 million; and (4) pre-judgment interest of 9% shall be
computed from (a) October 22, 2013 (the date this action was commenced) on the
difference between $2,223,250 and the amount Nahal was tendered and (b) from January
1, 2009 on the derivative damages, a reasonable intermediate date (the midpoint in the
2007-2010 period). See Arany v Arany, 282 AD2d 389, 390 (1st Dept 2001),
accord CPLR 5001(b) (when damages are incurred at various times, interest may
be computed "upon all of the damages from a single reasonable intermediate date").
Accordingly, it is
ORDERED that the calculation of Nahal's reasonable costs and attorneys'
fees is referred to a Special Referee to hear and report in accordance with this decision;
and it is further
ORDERED that a copy of this order with notice of entry shall be served on
the Clerk of the Reference Part (Room 119) to arrange a date for the reference to a
Special Referee and the Clerk shall notify all parties of the date of the hearing before the
Special Referee; and it is further
ORDERED that within 10 days of the entry of the Referee's report, the
parties shall contact the court to set a briefing schedule on a motion to confirm or modify
the report; and it is further
ORDERED that the parties will be instructed on the procedure for
submitting proposed judgments in the decision on the Referee's report.
Dated: October 6, 2014ENTER:
__________________________
J.S.C.
Footnotes
Footnote 1:The trial was held on
March 17, March 18, March 19, March 20, March 21, April 8, April 11, June 10, June
11, July 9, and July 10. The transcripts for each day can be found at Dkt. 131-141.
Footnote 2:On August 28, 2014, the
parties also filed briefs on attorneys' fees. See Dkt. 142-155. While the court
provides guidance below on the categories of fees that Nahal may recover, the
calculation of such amounts is referred to a Special Referee to hear and report.
Footnote 3:While much of the fair
value case law pertains to valuation under BCL § 1118, "there is no difference in
analysis between stock fair value determinations under [BCL] § 623, and fair value
determinations under [BCL] § 1118." Friedman, 87 NY2d at 168.
Footnote 4:Nahal erroneously relies
on Cavalier Oil Corp. v Harnett, 564 A2d 1137, 1144 (Del 1989) for the
proposition that a DLOM should never be applied. The excerpt quoted by Nahal
[see Dkt. 130 at 10] concerns a discount for minority status, which both New
York and Delaware law prohibit. A DLOM is something different, and is explained
below. Nonetheless, in this case, the court finds that a DLOM should not be applied.
Footnote 5:Justice Crane looked to
the burden rules in various jurisdictions and ultimately adopted the burden applicable in
the Delaware Court of Chancery, whose governing statute is analogous to BCL §
623 and provides that the court " shall appraise' the fair value of the dissenting
shareholders' shares." Cohen, 168 Misc 2d at 94, quoting Cavalier Oil Corp. v
Harnett, 1988 WL 15816, at *20 (Del Ch 1998) ("the Court [must] independently
determine that valuation component, even where the parties themselves have tried and
failed"), aff'd 564 A2d 1137 (Del 1989). It should be noted that, while recent
Delaware opinions frame the burden as a double, rather than a no-burden approach
["both parties bear the burden of proving their respective valuations by a preponderance
of the evidence"], since "the court may not adopt an either-or' approach to valuation and
must use its own independent judgment to determine the fair value of the shares," it
appears that Delaware effectively continues to employ a no-burden approach. See In
re Orchard Enters., Inc., 2012 WL 2923305, at *5 (Del Ch 2012) (Strine, C.).
Footnote 6:While this case is
governed by New York law, the court notes that under Delaware law, a post-merger
"quasi-derivative" claim can be maintained, where, as here, "the merger itself is the
subject of a claim of fraud, being perpetrated merely to deprive shareholders of their
standing to bring or maintain a derivative action." Ark. Teacher Ret. Sys. v
Countrywide Fin. Corp., 75 A3d 888, 894 (Del 2013), accord Lewis v
Anderson, 477 A2d 1040, 1049 (Del 1984). As this court noted in the Merger Order,
New York also has a general rule prohibiting post-merger derivative claims [see
Alpert v 28 Williams St. Corp., 63 NY2d 557 (1984)], but permits the injunction of a
merger under fraudulent circumstances akin to those set forth in Lewis. However,
New York courts have not developed a system for dealing with quasi-derivative claims.
The only similar case on point was In re Carolina Gardens, Inc., 1995 WL
17961777 (Sup Ct, NY County 1995) (Cahn, J.). This court, nonetheless, does not have
to rule on the viability of quasi-derivative claims because the parties agreed to have
Nahal's derivative claims evaluated in this appraisal proceeding. The viability of
quasi-derivative claims when the parties do not agree to allow them, however, remains an
unsettled issue in New York.
Footnote 7:Of course, as with any
corporate valuation, which inherently involves discretionary judgment calls and reliance
on limited information, one can always nitpick at certain conclusions or point to an
example of an imperfect analytical method. Aside from the few issues disputed by the
parties, Vannucci did an outstanding job and should be commended for his work,
especially given the context of the litigation. His report is neutral, thoughtful, precise,
and paints a clear picture of the company that is not colored by the parties' rhetoric.
While Vannucci did not conduct a forensic accounting audit to determine if Old ZIC's
financials were accurate — and, as explained herein, they most certainly were not
— his analysis is a trustworthy approximation of Old ZIC's worth without
accounting for the value Danny and Rony misappropriated. While Nahal is being
awarded additional compensation on her derivative claims, the core of Nahal's award is a
corporate valuation that is beyond reproach.
Footnote 8:Vannucci was clear that
normalizing adjustments, such as to Danny's salary, were for valuation purposes only, not
for the evaluation of a waste claim, the merits of which he did not weigh in on. For
instance, a normalizing adjustment to Danny's salary indicates the impact his salary
would have on the purchase price of the company, but not whether, as a matter of law
(under the standard set forth below), Danny's salary was so excessive that it was legally
wasteful.
Footnote 9:One reason is that a
controlling shareholder has the ability to change the corporate structure to correspond to
the shareholders' (or his own) optimal personal tax circumstances. Hence, a buyer of the
entire corporation is often indifferent to the "C" or "S" status of the company since such
status can simply be changed after the sale (of course, the corporation must qualify for
S-corporation status, and if it does not, a SEAM adjustment would certainly be
inappropriate). Ergo, a rational purchaser of 100% of a company would not pay a
premium based on a company's status as an S-corporation.
Footnote 10:See, e.g.,
Giaimo, 101 AD3d at 524 (discussing a DLOM for real estate holding
companies); Murphy, 74 AD3d at 818 (collecting cases regarding a DLOM for
goodwill).
Footnote 11:While theoretical
illiquidity might increase the cost of debt, this concern was not raised nor was evidence
presented that illiquidity affects the company's borrowing costs.
Footnote 12:It should be noted
that it would be inequitable to allow for a control premium while the law otherwise
prohibits a discount for minority status.
Footnote 13:Though Nahal
simply assumes damages are recoverable since 2004, she fails to cite to a case that rebuts
petitioners' statute of limitations argument. Indeed, while Nahal's post-trial brief is long
on argument, it only contains citations to 5 cases, one of which is the Derivative Action
and another is an irrelevant Delaware case discussed earlier. The court also notes that it
reviewed Nahal's pre-trial brief (Dkt. 105), but that brief also fails to fully set forth the
applicable law of corporate waste. Bare allegations that Danny's behavior was improper
is no substitute for establishing that it amounted to waste as a matter of law.
Footnote 14:The parties
computed the value of the derivative claims on an annualized basis. While calculating
damages as of January 1, 2007 omits 17 days of damages, such amounts are immaterial in
light of the overall recovery being awarded.
Footnote 15:It should be noted
that Danny's narrative about the business improving in 2009 proffered as a justification
for his salary doubling cannot be reconciled by the company's financials, which indicate
that the business was relatively stable over the years. Indeed, the sudden appearance of
higher profitability after Nahal filed the Derivative Action was only due to a more honest
reporting of the company's true earnings and Danny's real salary, something the MOD2
forensic analysis discussed below proves. Simply put, it is the belief of this court that
Danny was always making much more than reported because he was stealing from the
company by pocketing revenue not recorded on the financial statements. It was only in
the face of judicial scrutiny that Danny felt the need to accurately report his salary and
stop stealing. Of course, Danny did not take a pay cut. He merely declared a salary at the
rate he was making all along.
Footnote 16:Ethics and business
acumen are not always correlated.
Footnote 17:Nahal disputes
Danny's testimony that there was a crisis of customer confidence after Joseph's death.
While no definitive evidence on this issue was presented, Danny's testimony, in this
instance, is not entirely implausible.
Footnote 18:Since the principle
was never fully and permanently paid back, as Danny and Rony would continually
re-loan themselves the money each year, the principle can also be considered part of their
compensation. However, this extra compensation cannot be deemed legally wasteful for
two reasons. First, as with their base salaries, Nahal did not submit proof of Danny's and
Rony's value to the company, making it impossible for the court to make a finding that
their compensation bore no relationship to their value. Second, even if the average loan
balance, for instance, was $1 million, the total amount of marginal compensation that
represents on an annual basis does not materially increase their total, already substantial
compensation, to an obviously excessive level. Danny and Rony did not, as Nahal
suggests, actually procure millions of dollars of extra compensation by taking no-interest
loans. Rather, they had access to the loan balances every year. Simply looking at the
nominal total amount borrowed without accounting for the amount repaid is an
inaccurate calculation of their compensation.
Footnote 19:Nor does Nahal raise
or prove the potential issue that the loans were the cause of her not receiving substantial
stockholder distributions.
Footnote 20:The $8.893 million
valuation includes the value of the Legacy Customers.
Footnote 21:Petitioner argues that
the allegation that Danny stole $14 million in profits is implausible because, according to
Vannucci, the company's sustainable yearly cash flow on a normalized basis was only
$737,000. This argument misses the point of Lesser's analysis. According to Lesser, the
real, total amounts made on an annual basis were not accurately reported in the
company's financial statements, financial statements used by Vannucci to produce his
valuation. If the financial statements did not reflect the company's true profits (which
they did not), Vannucci would have undervalued the company. Hence, if the court agrees
with Lesser's conclusions (it does), 25% of the value that Lesser determined was not
accounted for in the financial statements must be added to Vannucci's valuation.
Moreover, as such amounts were part of Nahal's derivative claims, the reasonable fees
paid by Nahal to Lesser and her attorneys in connection with the MOD2 analysis are
recoverable.
Footnote 22:Danny testified that
the cost data has been accurate since 2011, but this is irrelevant to this proceeding
because the only records analyzed were those between 2004 and 2010.
Footnote 23:Helman denies
knowingly committing accounting fraud based on his contention that he simply relied on
the data given to him by Danny. Helman maintains he had no involvement with the
preparation of the MOD2 data, nor can he vouch for its accuracy. While this may be true,
Helman provided no explanation for why he believed it was proper to claim Kathrin's
salary and a fleet of luxury cars as a business expense.
Footnote 24:Piece Goods,
Notions & Other Apparel Wholesaling for companies with over $25 million of
sales.
Footnote 25:It is possible, of
course, that Old ZIC's profits were higher, which would mean that Danny took much
more than $14 million from the company.
Footnote 26:Danny bragged
about how well he ran the company and used the company's stellar performance to justify
his ever increasing (reported) compensation. There is a cynicism in Danny bragging
about the company's performance when it comes to defending his compensation while
trashing the company's performance to rebut Lesser's analysis.
Footnote 27:This is a factor
militating in favor of awarding attorneys' fees to Nahal. See Ret. Plan for Gen.
Employees of City of N. Miami Beach v McGraw-Hill Cos., 2014 WL 4452678,
2014 NY Slip Op 06154, at *3 (1st Dept Sep. 11, 2014) ("investigating alleged
misconduct by management and obtaining information that may aid legitimate litigation
are, in fact, proper purposes for a BCL § 624 request, even if the inspection
ultimately establishes that the board had engaged in no wrongdoing") (emphasis
added). That Nahal's lawsuit may have been the impetus to corporate reform is all the
more a reason to ensure that she is reimbursed.
Footnote 28:The court recognizes
that, aside from methodology issues, Lesser clearly made certain clerical errors, such as
not realizing that certain cost amounts, such as $50, were data entry errors that should
have read $0.50. However, the sum of these errors did not materially impact his analysis.
Additionally, petitioner made certain arguments about hypothetical possibilities that
Lesser did not consider that could have explained the company's reported profit margins.
Petitioner speculated that lower overseas margins or sample inventory might be the
culprit. However, petitioner did not submit evidence corroborating this theory, nor does
the court think these explanations were proffered for any reason other than to plant a
seed of doubt in the court's mind about Lesser's methodology. The court will not
disregard Lesser's outstanding work, the basis for which petitioner knew about well
before trial. If petitioner could establish a methodological flaw (e.g., such as by proving
how much sample inventory was actually stored in the warehouse), petitioner's
objections might be taken seriously. Instead, the court finds such objections unduly
speculative. While Nahal has the burden of proof on her derivative claims, she made a
compelling prima facie case. Petitioner's speculative objections are insufficient to
rebut that case. This is particularly the case, given the court's view of Danny's testimony
as less than forthcoming and truthful. Of course, it must be mentioned that Lesser also
did not consider the impact of an inventory write down, but the court will not consider
that speculation either due to petitioner's failure to produce evidence of that write down.
While petitioner claims such data can be gleaned from MOD2, simply averring that such
records are contained in MOD2 is an insufficient response to Nahal's repeated demands
for evidence of an inventory write down. Petitioner's failure to produce documents or
provide pre-trial deposition testimony is the reason this court issued an in limine
order precluding reliance on a write down as an explanation for the company's seemingly
low profit margins.
Footnote 29:Below, the court
provides a summary of the recoverable damages. The parties shall submit proposed
judgments in accordance with this decision after the attorneys' fees dispute has been
resolved.
While the Referee has discretion to decide how much to award Nahal, the court directs
the Referee on four issues.
First, since Lesser's work was essential to Nahal's recovery, the Referee shall
award Nahal the full amount paid to Lesser, including for work performed before the
Derivative Action was commenced. Nahal claims such amounts totaled $507,140.53
[see Dkt. 152 at 21], but the Referee should confirm that this amount was
paid.
Second, Nahal hired at least four law firms to represent her in her disputes
with Danny and Rony. Much of the work performed was duplicative, both in the early
stages when Nahal's prior counsel [FN30]
The services of Morrison Cohen, whose invoices totaled over $500,000, were
particularly inefficient and wasteful. See Dkt. 142 at 24-25 (discussing, inter
alia, $71,312 spent on a potential copyright case against Zelouf West that was never
filed).