Kenneth Raymond Schomp v. William O. Holton, IV, Individually and Derivatively on Behalf of Quality Logistics, LLC ( 2022 )

RENDERED: OCTOBER 14, 2022; 10:00 A.M.
NOT TO BE PUBLISHED
Commonwealth of Kentucky
Court of Appeals
NO. 2021-CA-0511-MR
KENNETH RAYMOND SCHOMP
AND QUALITY LOGISTICS, LLC APPELLANTS
APPEAL FROM FAYETTE CIRCUIT COURT
v. HONORABLE LUCY A. VANMETER, JUDGE
ACTION NO. 18-CI-04270
WILLIAM O. HOLTON, IV,
INDIVIDUALLY AND
DERIVATIVELY ON BEHALF OF
QUALITY LOGISTICS, LLC APPELLEE
AND
NO. 2021-CA-0557-MR
WILLIAM O. HOLTON, IV,
INDIVIDUALLY AND
DERIVATIVELY ON BEHALF OF
QUALITY LOGISTICS, LLC CROSS-APPELLANT
CROSS-APPEAL FROM FAYETTE CIRCUIT COURT
v. HONORABLE LUCY A. VANMETER, JUDGE
ACTION NO. 18-CI-04270
KENNETH RAYMOND SCHOMP
AND QUALITY LOGISTICS, LLC CROSS-APPELLEES
OPINION
AFFIRMING
** ** ** ** **
BEFORE: CLAYTON, CHIEF JUDGE; COMBS AND JONES, JUDGES.
JONES, JUDGE: Following a bench trial, the Fayette Circuit Court entered a final
judgment in favor of William O. Holton, IV with respect to the value of his prior
interest in Quality Logistics, LLC. The parties appealed, and their appeals were
consolidated. Having reviewed the record and being otherwise sufficiently advised
in the law, we affirm.
I. BACKGROUND
Kenneth Raymond Schomp founded Quality Logistics LLC (“QL”), a
transportation brokerage company, in 2011. Approximately two years later, he
hired William O. Holton, IV. In 2014, Schomp and Holton entered into an
incentive agreement whereby Holton was able to acquire an ownership interest in
QL. By January 2017, Holton had acquired 40 ownership units in QL making him
a 30.769% owner of the business. The remaining units were owned by Schomp.
Sometime around 2018, Schomp and Holton became increasingly dissatisfied with
one another. Ultimately, Schomp, as the majority owner, decided to terminate
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Holton and force a buy-out of Holton’s QL units pursuant to QL’s Second
Amended Operating Agreement (“OA”).
On November 2, 2018, QL, by and through Schomp, notified Holton
in writing of its decision to terminate Holton’s employment. Further, QL indicated
that because Holton’s termination was a “Disqualifying Event” pursuant to Section
8.e. of the OA, it was also exercising its right to “require the purchase” of Holton’s
shares in accordance with Section 8.d., which sets forth the method for determining
the value of QL and the outstanding units. Pursuant to these two sections, Schomp,
to whom QL had assigned its rights, notified Holton he would purchase Holton’s
40 units in QL for a total appraised value of $884,559.
Holton refused to sell his units at the price quoted in Schomp’s letter
and took issue with how the units had been appraised. He later notified Schomp
that his own appraiser, Calvin Cranfill, had assigned his units a substantially higher
value. After Schomp refused to purchase the units at the higher value, Holton filed
the underlying suit in Fayette Circuit Court against Schomp and QL.1 In his suit,
Holton sought a declaratory judgment regarding the value of his units of QL.
Over the next several years, the litigation focused heavily on how to interpret and
apply the two key provisions of the OA, Sections 8.d. and 8.e.
1
We recognize that Holton’s suit named both Schomp and QL as defendants and that both are
likewise named as parties in the appeal and cross-appeal. However, in the remainder of this
Opinion we refer to them collectively as “Schomp” when discussing the underlying suit and the
present appeals.
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Section 8.e., entitled “Disposition of Units Upon Disqualifying
Event,” provides:
The Company shall have the right to purchase, and the
Member shall have the right to require the Company to
purchase, the Member’s interest in the Company, upon or
anytime after the Managing Member reasonably
determines that a Disqualifying Event has occurred with
respect to that Member. A Disqualifying Event for a
Member shall be: (i) the termination for any reason,
voluntary of [sic] involuntary, of employment by the
Member with the Company; (ii) breach of this
Agreement by the Member; (iii) any breach by the
Member of any other agreement between the Member
and the Company; or (iv) any failure to guaranty
obligations of the company as determined by the
Managing Member. However, if the Disqualifying Event
is a result of death of the Member, the provisions of
Section 8.d. shall apply in lieu of this provision.
Notwithstanding the foregoing, in the event of a
Disqualifying Event of the Managing Member, the
Managing Member shall not be required to sell the
Managing Member’s interest, and such interest shall
remain owned by the Managing Member. A Member or
the Company wishing to exercise its right to purchase or
require the purchase under this provision shall give
notice in writing to the Company and the other Members.
The purchase price shall be the fair market value of the
interest as determined by the procedure set forth in
Section 8.d., without reference to insurance. The
purchase price shall be paid, and the interest transferred,
within sixty (60) days of the notice. At the option of the
purchaser, the purchase price may be paid by tendering
25% of the purchase price to the selling Member, at
which tiem [sic] the Member’s interest shall be deemed
tranfered [sic], with a promissory note for payment of the
balance of the purchase price over a three-year period,
with equal installments to be paid quarterly without
interest. The Company may assign its right or obligation
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to purchase to another Member or a third party, in the
Company’s sole discretion as determined by the
Managing Member.
(Emphasis added.)
Section 8.d. provides the method for calculating the fair market value
of a member’s ownership units as follows:
Death of a Member. Upon the death of a Member, the
Member’s estate or beneficiary or beneficiaries, as the
case may be, shall be entitled to receive from the
Company, in exchange for all of the deceased Member’s
Ownership Interest, the fair market value of the deceased
Member’s Ownership Interest, adjusted for profits and
losses to the date of death. Fair market value may be
determined informally by a vote of the holders of a
Majority Interest of all Units of Membership then
outstanding and entitled to vote, or by the written assent
of such Members. In the absence of an informal
agreement as to fair market value, the Managing Member
shall hire an appraiser to determine fair market value.
The cost of any appraisal shall be deducted from the fair
market value to which the deceased Member’s estate or
beneficiary or beneficiaries is or are entitled. In the event
that the Company has purchased insurance on the life of
the deceased Member, (i) the fair market value shall be
the value provided to the insurer; and (ii) the proceeds
from such insurance, to the extent they are based on such
fair market value (that is, not including additional
amounts for which insurance may be obtained) shall be
used to purchase the deceased Member’s interest, which
proceeds shall be paid to the estate or beneficiaries of the
deceased member within 60 days of receipt of such
proceeds from the insurer. In the event no such insurance
exists, the Company may elect, by written notice to the
deceased Member’s estate or beneficiary or beneficiaries,
within thirty (30) days after the Member’s death, to
purchase the deceased Member’s Ownership Interest
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over a one-year (1 year) period, in four (4) equal
installments, with the first installment being due sixty
(60) days after the Member’s date of death. Prior to the
completion of any such purchase, the Member’s estate or
beneficiary or beneficiaries shall have no right to become
a Member or to participate in the management of the
business and affairs of the Company as a Member, and
shall only have the rights of an Assignee and be entitled
only to receive the share of profits and the return of
capital to which the deceased Member would otherwise
have been entitled. Notwithstanding the foregoing, in the
event of the death of the Managing Member, the
Company shall not be required to sell the Managing
Member’s interest, and such interest shall thereafter
continue in the estate (and ultimately the beneficiaries) of
the Managing Member.
Broadly summarized, the circuit court was tasked with interpreting
Sections 8.d. and 8.e. consistently with both the explicit terms of the OA and the
implied covenant of good faith and fair dealing. It did so by adjudicating several
dispositive motions and conducting a bench trial. Ultimately, the circuit court
concluded that the fair market value of Holton’s outstanding shares was
$1,804,878, a substantially higher sum than Schomp had originally proposed. The
circuit court added prejudgment interest at the rate of 8%, compounded annually
from January 1, 2019, until paid, for a total judgment in Holton’s favor of
$2,150,889, as of April 10, 2021. This appeal and cross-appeal followed.
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II. STANDARD OF REVIEW
This is an appeal from a bench trial. The factual findings of the trial
court will not be set aside unless clearly erroneous. CR2 52.01. Although we grant
a high degree of deference to factual findings, “appellate review of legal
determinations and conclusions from a bench trial is de novo.” Barber v. Bradley,
505 S.W.3d 749, 754 (Ky. 2016).
III. CROSS-APPEAL NO. 2021-CA-0557
The arguments Holton puts forth in cross-appeal No. 2021-CA-05573
concern: (1) the circuit court’s interpretation of the nature of his right to dispute
QL’s appraisals of his ownership units, pursuant to Sections 8.d. and 8.e. of the
OA; and (2) the circuit court’s ultimate decision to accept an appraisal by John
Herring as an adequate valuation of his units’ fair market value.
A. The nature of Holton’s right to dispute any of QL’s appraisals
Schomp’s initial position throughout much of the underlying
proceedings – as outlined in a motion for partial dismissal he filed on January 3,
2019 – was that the “procedure set forth in Section 8.d.” entitled him to hire
anyone he deemed an “appraiser” to give Holton’s units any “fair market value,”
2
Kentucky Rule of Civil Procedure.
3
Although unusual, we begin our review with the cross-appeal, rather than the appeal, because
its arguments require a more thorough consideration of the facts of the case. In addition, we
determined that arguments made in the cross-appeal could affect and possibly moot the
arguments made in the appeal.
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and to require Holton to sell at that price.4 Schomp insisted the explicit language
of Sections 8.d. and 8.e. provided Holton no means for contesting how his units
were valued or for resisting their sale.
Holton, on the other hand, argued he had a right to contest QL’s
appraisal. He also argued that Sections 8.d. and 8.e. – which provided that Schomp
could hire “an appraiser” – at most gave Schomp the right to hire only the first of a
possible succession of appraisers. Holton reasoned that if the circuit court
ultimately determined the appraiser Schomp hired was unqualified or had
otherwise acted inappropriately in conducting the initial appraisal, Sections 8.d.
and 8.e. entitled the circuit court to consider any other relevant evidence (including
his own appraisal from Calvin Cranfill regarding his units’ value) and to conduct a
de novo review of the value of his ownership units.
The circuit court resolved these issues over the course of two separate
orders. First, in a December 23, 2020 order of partial summary judgment, it
explained:
PECO[5] concerned a similar valuation dispute. In
that case, the operating agreement provided the company
4
In ascertaining the “fair market value” of Holton’s units, Schomp did not attempt to utilize his
authority as the majority unit holder, pursuant to Sections 8.d. and 8.e., to determine fair market
value “informally” by vote – which, based solely upon the explicit language of those provisions,
would have entailed only Schomp’s vote on a valuation that only Schomp created. Accordingly,
any effect that the implied duty of good faith and fair dealing would have had upon that aspect of
Sections 8.d. and 8.e. is a non-issue.
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“must engage at its cost ‘a nationally recognized
valuation firm . . . to determine the Fair Market Value of
the Put Units as determined by the Valuation Firm in
accordance with this Agreement . . .’” Id. at *2. The
operating agreement specifically set out the formula to be
used by the valuation firm and stated the parties “shall be
bound by the determination of the Valuation Firm . . .
pursuant to this Section 9.2(b) and the terms of this
Agreement.” Id. at *4.
In PECO, the Court noted there are three
conceptual levels of judicial review of appraisals that
may be used in an operating agreement:
First, the parties could agree to de novo
judicial review, with the calculated
valuation merely acting as a starting point
for the reviewing court in case of a dispute.
Second, as an intermediate level of review,
the parties could choose to appoint an
appraiser to determine a valuation, and
designate that appraiser as an arbitrator
should the parties disagree on the
valuation, with review of the appraiser’s
decision limited to whatever statutory or
private regime is chosen to govern the
arbitration. Third, the parties could agree
to a regime in which the appraiser’s
valuation is final, thereby precluding
judicial or any other form of review of the
appraiser’s substantive determination of
value. The rationale for this final option is
captured in a rhetorical question the
Chancellor posed in Senior Housing:[6]
5
PECO Logistics, LLC v. Walnut Inv. Partners, L.P., No. CV 9978-CB, 2015 WL 9488249(Del. Ch. Dec. 30, 2015).
6
Senior Housing Capital, LLC v. SHP Senior Housing Fund, LLC, No. CIV.A. 4586-CS, 2013
WL 1955012 (Del. Ch. May 13, 2013).
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‘When parties contractually decide to have
a qualified expert with relevant credentials
make a determination of value without any
indication that the expert’s judgment is
subject to judicial review, on what basis
would it make sense to infer that the parties
intended to have a law-trained judge do a
de novo review of the expert’s
determination?’
Id. at *10 (emphasis added). The PECO court held the
parties, by agreeing to be “bound” by the appraisal, chose
the third method which does not provide for judicial
review. In other words, the Court would not second
guess the judgment calls made by the appraiser. Id. at
*10.
However, the PECO court noted there is an
implicit duty of good faith and fair dealing such that even
parties who agree to be “bound” by an appraisal may
seek judicial review to ensure the “appraiser’s
determination was the product of good faith, independent
judgment.” Id. at *11. The Court explained the scope of
judicial review as follows:
Even in this [third] scenario . . . it is not the
case that a party bound by an appraiser’s
determination has no procedural
protections. In such a scenario, it is a
contractual expectation that the appraiser
make a good faith, independent judgment
about value to set the contractual input. If
one of the parties to the contract takes
action to taint the appraisal process – for
example, by providing the appraiser with
false financial statements – a court can of
course protect the injured party. Such
judicial review would not, however, involve
second-guessing the good faith judgment of
the appraiser or examining the appraiser’s
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valuation judgments for consistency with a
judge’s understanding of relevant corporate
finance principles. It would instead involve
a judge determining that a party had
breached the contract’s implied covenant
of good faith and fair dealing, and that this
breach, as its proximate result, deprived the
appraiser’s work of contractual integrity.
Thus, judicial review is not unavailable,
but is restricted to considering a claim that
the appraisal is unworthy of respect
because it does not, as a result of
contractual wrongdoing, represent the
genuine impartial judgment on value that
the contract contemplates.
Id. (emphasis added).
In Leach v. Princeton Surgiplex, LLC, 2013 WL
2436045 (N.J. Super. Ct. App. Div. June 6, 2013), the
Court similarly held “[i]mplied in the operating
agreement must be an understanding that the appraiser
will utilize accepted professional norms and that a party
to the operating agreement reserves the right to challenge
the appraisal’s results upon the appraiser’s failure to
conform to accepted standards.” Id. at *3. The Court
further explained:
[S]uch a contractual provision [regarding
fair market valuation] does not eliminate
all grounds for attacking the appraiser’s
methodology or results.
*** *** ***
First, we discern from plaintiff’s arguments
that he contends it would frustrate the
purpose of the buy-out provisions to assume
those provisions preclude any inquiry into
the appraiser’s methods, the information
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considered by the appraiser, the calculations
made, or the conclusions drawn by the
appraiser, even though the agreement does
not contain any provisions for questioning of
the appraisal. We agree. The operating
agreement expressly designates the appraiser
(or its substitute) and directs a determination
of Surgiplex’s fair market value. It cannot
be seriously argued that the appraiser is
entitled to determine fair market value by
spinning a wheel or flipping a coin, or that
the appraiser may consider less than all
relevant evidence, or that no party could
question a mathematical error in the
appraiser’s calculations. Implied in the
operating agreement must be an
understanding that the appraiser will
utilize accepted professional norms and
that a party to the operating agreement
reserves the right to challenge the
appraisal’s results upon the appraiser’s
failure to conform to accepted standards.
Id. at *2 (emphasis added). See also Leone v. Owsley,
810 F.3d 1149, 1155 (10th Cir. 2015) (holding, “at the
time the parties entered into the Operating Agreement
they clearly would have expected a ‘good faith’ valuation
of their ownership interests would require the Managers
to refrain from taking action that would result in an
unreasonably low figure. Focusing on the express
contractual provision, one would expect the same fidelity
at the time of the valuation.”)
In the subject OA, the parties agreed the “purchase
price shall be the fair market value of the interest as
determined by the procedure set forth in Section 8.d.” In
turn, Section 8.d. provides “the Managing Member shall
hire an appraiser to determine fair market value.”
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By employing the mandatory “shall,” the parties
agreed to be bound by the appraisal of the firm selected
by the Managing Member. The plain language of the OA
does not contemplate de novo judicial review.
Accordingly, the Court will not second-guess the good
faith judgment of the appraiser. However, implied in the
OA is a duty of good faith and fair dealing.
The circuit court also rejected Holton’s additional argument that
Sections 8.d. and 8.e. entitled it to conduct a de novo review of the value of his
ownership units if it ultimately determined the first appraiser was unqualified or
had otherwise acted inappropriately in conducting the appraisal. In a subsequent
order of April 1, 2021, in which the circuit court rendered its post-trial findings of
fact and conclusions of law, the circuit court concluded the OA “does not prohibit
[Schomp and QL] from proffering an alternative opinion in the context of Holton’s
legal challenge.”
To be clear, there is now no dispute among the parties that the first
appraisal Schomp commissioned relative to this matter (from Daniel King) was
entitled to the deferential level of review described by the circuit court, set forth
above; and that the circuit court otherwise properly applied the law, and properly
interpreted Sections 8.d. and 8.e. of the OA, in rejecting it; indeed, no one asserts
any argument to the contrary. Why the circuit court rejected King’s appraisal will
be a subject of greater discussion later in this Opinion, in the context of a separate
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issue involving prejudgment and post-judgment interest raised by Schomp in
appeal No. 2021-CA-0511.
However, in cross-appeal No. 2021-CA-0557, Holton argues the
circuit court erred in determining that a subsequent appraisal Schomp elected to
obtain (from John Herring) was also entitled to that deferential level of review. As
he did below, Holton asserts that the explicit language of the OA – stating Schomp
had the right to hire “an appraiser” – indicates that Schomp should not have had
any right to “a second bite at the appraisal apple.” In his view, since the circuit
court rejected the first appraisal, Schomp did not have the right to expect that any
subsequent appraisal he commissioned would be entitled to the same level of
deferential review. Instead, Holton asserts that in that situation, the circuit court
should have made a de novo determination of QL’s fair market value and should
not have afforded either of Schomp’s appraisals any sort of presumptive weight.
Here, the explicit language of the OA was silent regarding whether
Holton had any means of contesting an appraisal. And, if he never had any means
of contesting an appraisal, Schomp would never have had any need to commission
more than one appraisal. Nevertheless, as the circuit court properly held, the
implied covenant of good faith and fair dealing did provide Holton a limited means
of contesting the appraisal of his units’ fair market value, consistent with the OA.
Indeed, absent any means of challenging Schomp’s appraisal, the “fair market
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value” mandate of the appraisal “procedure” of Sections 8.d. and 8.e. would have
been rendered superfluous; any “appraiser” Schomp commissioned could conduct
a valuation by simply flipping a coin or spinning a wheel, and those sections
would, as a practical matter, have amounted to nothing more than unenforceable
forfeiture provisions. See, e.g., Man O War Restaurants, Inc. v. Martin, 932
S.W.2d 366, 368 (Ky. 1996) (citations omitted) (“Equity detests forfeiture
provisions and frequently will find them unenforceable.”).
In other words, providing Holton a means of contesting the
company’s first appraisal was certainly a term the parties would have agreed upon
during their original negotiations, had they thought to explicitly address that
matter. But this, in turn, begs the question Holton poses: If Holton successfully
contested the first appraisal, what about the second? Holton would have us
determine that once the first appraisal was rejected, he essentially stood on equal
ground with Schomp such that the circuit court was free to conduct its own
valuation of QL and to rely on any and all evidence it deemed competent in doing
so.
This is where it is important to understand how an implied covenant
of good faith and fair dealing actually operates. The implied covenant generally
imposes on contractual parties “a duty to do everything necessary” to carry out
their contract. Farmers Bank and Trust Co. of Georgetown, Kentucky v. Willmott
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Hardwoods, Inc., 171 S.W.3d 4, 11 (Ky. 2005). To that end, it is a means of
implying terms which are essential to a determination of the rights and duties of
parties to a contract, which the parties would have agreed to during their original
negotiations if they had thought to explicitly address them. For example, when a
contract does not explicitly specify a time for performance, a “reasonable time” is
implied by virtue of the covenant. See Greg Coats Cars, Inc. v. Kasey, 576
S.W.2d 251, 252 (Ky. App. 1978).
As the circuit court observed, nothing in the OA provided Holton any
right to have an appraiser of his choosing or to have the circuit court (sitting de
novo) value his shares in any binding way. Recall, the valuation procedure Holton
agreed to was for “the Managing Member” (Schomp) to “hire an appraiser to
determine fair market value,” per Section 8.d.; and, per Section 8.e., Holton further
agreed “[t]he purchase price shall be the fair market value of the interest as
determined by the procedure set forth in Section 8.d. without reference to
insurance.” (Emphasis added.) The overarching purpose of the limited review
process Holton was entitled to litigate was to determine whether Schomp had
fulfilled his duties relative to that valuation procedure, which entailed essentially
two overarching determinations from the circuit court: (1) whether Schomp had,
within the bounds of good faith and fair dealing, hired “an appraiser”; and (2)
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whether the appraiser, within the bounds of good faith and fair dealing, had
assigned a “fair market value” to Holton’s units.
In other words, any judicial determination that Schomp failed to fulfill
either of those duties would not logically lead to the result advanced by Holton;
rather, it would merely indicate that Schomp had not, as of yet, fulfilled his duty to
“hire an appraiser to determine fair market value.” As stated, the circuit court
concluded the OA “does not prohibit Defendants from proffering an alternative
opinion in the context of Holton’s legal challenge.” If Schomp’s first appraisal
violated the duty of good faith and fair dealing, it would not have qualified as the
type of “appraisal” that the parties would have contemplated during their original
negotiations, had they thought to explicitly address that matter. Thus, it was
consistent with the parties’ bargain, as well as principles of specific performance,
to continue to recognize Schomp’s sole right to hire an appraiser to value Holton’s
units and to accord the subsequent appraisal the deference demanded by the
contract. Holton’s position is not grounded in the contract’s terms. Therefore, we
find no error with the circuit court’s decision to accord the second appraisal
deference.
B. The circuit court’s valuation of Holton’s units
Again, Schomp ultimately had Holton’s units “appraised” twice –
once by Daniel King, QL’s longtime accountant, and several months afterward by
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John Herring. Utilizing the standard of review set forth above, the circuit court
accepted Herring’s appraisal as an adequate valuation of Holton’s ownership units.
Holton’s remaining argument in cross-appeal No. 2021-CA-0557 is that the circuit
court erred in doing so.
In its April 1, 2021 order, the circuit court summarized the evidence
related to this argument in detail. In short, the circuit court recognized that QL
experienced significant growth from 2014 to 2017. For example, in 2014 QL had a
brokerage revenue of $6,655,635.79 and hired three new brokers. By 2018, it had
a brokerage revenue of $30,972,725.72 and hired eighteen new crew members. Its
gross profits in 2018 exceeded $72,000,000. Due to the nature of QL’s business,
its expenses were quite high. In addition to payroll, fuel, and carrier expenses, QL
regularly incurred expenses for travel, entertainment, and meals (collectively
referred to as travel-related expenses). The travel-related expenses were usually
charged on a company credit card by employees. In 2014, QL’s travel-related
expenses were $45,348. By 2018, the travel-related expenses had risen to
$467,341. While Holton acknowledged that approximately $180,000 of the travel-
related expenses were legitimate, he contended that QL’s employees regularly
abused the company credit card by charging personal items to the company, a
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practice which the company both tolerated and encouraged.7 QL’s poor record
keeping made it extraordinarily difficult to ascertain which of the travel-related
expenses were legitimate. For 2018, Schomp admitted that at least $148,252.30 in
personal expenses were claimed as “business expenses” on company financial
records. While Schomp claimed the remaining balance of $319,088.70 was for
legitimate business expenses, QL had no records to substantiate his claim.
Regarding the Herring appraisal, the circuit court’s summary was as
follows:
QL subsequently hired appraiser John Herring of
Dean Dorton Allen Ford PLLC. Herring is a CPA and a
member of the American Institute of CPAs (“AICPA”).
As to King’s Appraisal, Herring testified the
capitalization of earnings method using the weighted
averages should not have been used for the valuation of
QL. Herring testified that methodology is appropriate
only when a company has stable cash flow. Here, QL
had experienced significant recent growth.
Herring used a discounted future net cash flow
method. Because his methodology was tied to net
revenue for 2018, it was necessary to begin with an
accurate figure for net income.
In this case, Herring believed the 2018 expenses
for travel and entertainment were “notable.” He testified
the test for normalization is whether a private equity firm
would pay the expenses for a business of this type.
7
Schomp admitted that both he and his girlfriend charged personal expenses to the company
credit card. Holton likewise admitted that he was encouraged to charge personal expenses to the
company credit card. The evidence suggested other employees did so as well.
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Herring asked a “fairly standard question” of Schomp
regarding whether there were any non-business expenses
running through the business. At his request, Schomp
undertook a review of company credit card invoices for
2018 and, as set out above, allocated $148,252.30 of
claimed business expenditures to personal expenses
(although Schomp’s review was limited to the first three
quarters of 2018).
Herring accepted Schomp’s analysis without
question and did not conduct an independent review or
perform any forensic analysis. Based on this
information, Herring made a normalizing adjustment of
$148,252 to the 2018 operating expenses. Plainly
speaking, Herring “added back” $148,252 to account for
personal expenses erroneously categorized as business
expenses.[FN] He applied discounts for lack of control
(20%) and lack of marketability (22.5%). Based on
these, and other, calculations, Herring valued Holton’s
interest at $1,645,544 (“Herring Appraisal”).
[FN] Herring’s use of historical financial
data was limited to 2018.
During his testimony, Herring conceded that
Schomp’s review of business expenses was limited to the
first three quarters of 2018 and the figure of $148,252.30
almost certainly underreported the actual amount of
personal expenses deducted from QL profits. Herring
freely admitted that he “missed that in my analysis.”
During his testimony, Herring estimated personal
expenses for the last quarter of 2018 and amended his
estimate of fair market value to $1,689,803.
Herring also modified his valuation by normalizing
Schomp’s salary to reflect that Schomp worked 50% of
the time. Making this adjustment amended his valuation
to $1,760.619.
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Normalizing both the 2018 expenses and
Schomp’s salary yields an amended value of $1,804,878.
Regarding the Cranfill appraisal, the circuit court’s summary was as
follows:
Holton retained Calvin D. Cranfill to perform an
independent assessment of the value of Holton’s units.
Cranfill is a CPA, a member of the AICPA, and has
extensive experience in business valuation. Like
Herring, Cranfill used a discounted future net cash flow
method.
Unlike Herring, Cranfill normalized expenses for
travel, entertainment and meals to a flat $50,000,
resulting in normalization of 2018 expenses of $417,341
instead of Herring’s $148,252. As Defendants point out,
the amount of $50,000 is significantly less than Holton’s
estimate of $180,000 for legitimate client development
expenses.
Cranfill also normalized QL’s 2019 expenses
related to travel, entertainment and meals (an adjustment
of $900,757), personal automobiles (an adjustment of
$50,000) and professional fees (an adjustment of
$167,641). The total adjustment for 2019 expenses was
$1,118,398.
Cranfill applied a discount for lack of control (30%
to Herring’s 20%) and lack of marketability (10% to
Herring’s 22.5%). Based on these calculations, Cranfill
issued a written report on February 6, 2020 valuing
Holton’s interest at $7,370,000.
Defendant pointed to two errors in Cranfill’s
report, including a claimed 42% increase in growth for
2018-2019 (Defendants assert this figure is actually
8.76% and therefore discredits the assumed future growth
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rates) and the use of a low-risk rate of 1.5 (Defendants
assert this should be 3.5).
At trial, Cranfill amended his valuation to
$6,400,000, although the Court does not believe the
amended figure takes into account the allegedly incorrect
low-risk rate.
Cranfill testified that if his normalized expenses
are substituted into Herring’s report, using Herring’s
discounts, then Holton’s interest has a value of
$2,552,944. However, as Herring pointed out, Cranfill’s
example is not based upon 2018 expense figures. Rather,
it is keyed off Cranfill’s significant normalization
adjustments for 2019 expenses. Applied over 2019-2023,
this results in a normalization adjustment of
approximately $1,000,000 each year.
Herring testified that the most significant
differences between his valuation and Cranfill’s
valuation were the treatment of revenue growth, cash
flow growth, and discounts. Cranfill was more
aggressive in estimating growth. Herring applied more
significant discounts. Herring does not believe their
differences in the normalization of expenses for 2018
was as significant a factor.
(Internal citations to evidentiary record omitted.)
As indicated, the circuit court ultimately determined that Herring’s
appraisal of QL’s fair market value, and his consequent valuation of Holton’s
ownership units, comported with the obligations of good faith and fair dealing.
Holton asserts the circuit court erred in doing so. He points out various errors,
most of which concern in one way or another the failure to properly account for all
the personal expenses charged to QL. He contends that Cranfill’s valuation is
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more accurate because he attempted to take into account personal expenses besides
those specifically identified by Schomp. Because Herring did not also do so,
Holton maintains that the circuit court should not have afforded his appraisal any
deference.
As already discussed, Herring’s appraisal was entitled to a
presumptive level of deference pursuant to the OA. The circuit court could not
disregard Herring’s appraisal without some determination that it was in bad faith
(or the product of wrongdoing), as was the case with the King appraisal. The
circuit court explained:
[T]he plain language of the OA does not contemplate de
novo judicial review of the fair market valuation of the
company. Accordingly, the Court will not second-guess
the good faith judgment of the appraisers.
The purpose of the bench trial is to determine
whether the King and Herring appraisals are the result of
contractual wrongdoing or represent a genuine impartial
judgment as to fair market value.
Implied in the OA is a duty of good faith and fair
dealing. Courts have established a variety of
considerations relevant to the question of whether
Defendants breached their duty of good faith and fair
dealing, including the following:
• Whether the “appraiser’s determination was the
product of a good faith, independent judgment.”
PECO Logistics, LLC v. Walnut Inv. Partners,
L.P., 2015 WL 9488249 at *11 (Del. Ch.
December 30, 2015). Included in this review is a
consideration of whether “one of the parties to the
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contract takes action to taint the appraisal process
– for example, by providing the appraiser with
false financial statements . . .” Id.• Whether the appraisal is “unworthy of respect
because it does not, as a result of contractual
wrongdoing, represent the genuine impartial
judgment on value that the contract contemplates.”
Id.• Whether the appraiser “utilize[d] accepted
professional norms . . .” Leach v. Princeton
Surgiplex, LLC, 2013 WL 2436045 at *2 (N.J.
Super. Ct. App. Div. June 6, 2013).
• Whether the appraiser considered “less than all
relevant evidence” or made a “mathematical
error.” Id. at *2.
• Whether the manager “[took] action that would
result in an unreasonably low figure.” Leone v.
Owsley, 810 F.3d 1149, 1155 (10th Cir. 2015).
Accepting Herring’s appraisal under this standard, the circuit court
initially noted Holton’s concession that Herring had used a proper methodology –
the “discounted future net cash flow method” – in conducting his appraisal.
Further, in relevant part, it explained:
[A] business valuation is not a mathematical equation for
which there is only one right answer. Both Cranfill and
Herring are experienced CPAs with plausible
explanations for their opinions. Because the Court is not
conducting a de novo review, it will not quibble with
Herring’s value judgments, such as those related to the
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SWOT[8] analysis or the particular discount percentages
appropriate for this valuation.
Moreover, Herring’s decision not to deduct from
net profits those expenses related to personal use
automobiles was not bad faith and does not render his
report unreliable. Although expenses related to personal
use automobiles might have been treated improperly on
the tax returns, the expenses are arguably part of
employee compensation packages and, therefore, proper
business expenses.
The primary issue relates to Herring’s acceptance
of Schomp’s assessment, without forensic review, of the
2018 business expenses for travel, entertainment and
meals. Certainly, Herring’s first attempt at valuation in
his written report did not consider all relevant
information because it included business expenses for the
last quarter of 2018 that were personal in nature.
However, Herring admitted this error and adjusted his
valuation. Further, he admitted that certain adjustments
might be appropriate to account for Schomp’s reduced
work schedule. With both of those adjustments, Herring
testified Holton’s membership interest is valued at
$1,804,878.
There remains an issue regarding whether the
balance of $319,088.70 reflects legitimate travel, meals
and entertainment expenses for 2018 or whether this
constitutes false financial data such that Herring’s
appraisal is tainted. The Court does not view the
question as whether Schomp’s analysis was perfect.
Rather, the Court views the question as whether
8
Herring testified that as part of his process of appraising QL, he relied on his “general
knowledge of businesses” and “interviews with management” to conduct an analysis of QL’s
business-related strengths, weaknesses, opportunities, and threats (e.g., a “SWOT” analysis). He
further testified that, while it is reasonable to conduct such an analysis in this context, not every
appraiser does so as part of a valuation report.
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Schomp’s review was reasonable and in good faith such
that the data provided to Herring was reliable.
As to this issue, Schomp testified that having a
successful logistics business requires a certain amount of
client development and travel. Holton does not refute
this basic proposition. According to Defendants and
Cranfill, Holton admitted that amounts up to $180,000
would be reasonable for such expenditures on an annual
basis. In addition, the record is clear that QL used meals
as incentives for its employees and was free with such
expenses.
As it concerns his review for purposes of the
Herring Appraisal, there is no affirmative evidence that
Schomp intentionally failed to designate expenses that
were personal in nature. Holton has raised questions, but
has not, with any certainty, pointed to any specific charge
that Schomp failed to categorize as personal in nature.
Of course, QL’s total lack of documentation regarding
these expenditures makes this inquiry difficult for both
parties. As an owner of the business, Holton acquiesced
in the practice of spending without accountability and is
therefore partly accountable for the lack of
documentation.
The bottom line is that, while Schomp’s review
may not have been perfect, there is insufficient evidence
to suggest that it was so lacking in good faith as to make
the financial data provided to Herring unreliable.
Accordingly, the Court concludes Herring’s valuation of
$1,804,878 is reliable.
(Internal citations to evidentiary record omitted.)
We find no error and have no need to add to the circuit court’s sound
analysis. The circuit court’s disposition in this respect was consistent with the
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language of the parties’ agreement, the evidence of record, and the circuit court’s
limited role of review in this matter.
Having considered the substance of Holton’s arguments in cross-
appeal No. 2021-CA-0557, we are unable to conclude that the circuit court abused
its discretion or misapplied the law. While Holton quibbled with Herring’s
methodology and the expenses identified by Schomp, he failed to convince the
circuit court that Herring’s appraisal was the product of wrongdoing. Whether the
second appraisal was the product of wrongdoing was a factual question for the
circuit court. The evidence supports the circuit court’s conclusion and certainly
does not compel a contrary result.
IV. APPEAL NO. 2021-CA-0511
We now turn to the direct appeal. While Schomp does not contest the
circuit court’s valuation, he does take issue with the circuit court’s decision to
award Holton pre- and post-judgment interest. The judgment provides, in relevant
part:
2. The amount due from the Defendants [$1,804,878]
shall bear interest at the rate of 8% compounded annually
from January 1, 2019 until paid.
3. The full sum owed for the purchase of Holton’s Units
with accrued interest as of April 10, 2021 is $2,150,889.
4. The interest shall continue to accrue at $461.42 per
day until paid or a Final Judgment is entered.
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5. Upon the entry of a Final Judgment, the sums then
due to Holton shall accrue interest at 6% per annum,
compounded annually.
Schomp argues the circuit court abused its discretion in awarding any
interest on the judgment because Section 8.e. of the OA stated that the ownership
units would be paid for in “equal installments” and “quarterly without interest.”
We begin our analysis of this argument with the language of Section 8.e., which
provides, in relevant part, as follows:
A Member or the Company wishing to exercise its right
to purchase or require the purchase under this provision
shall give notice in writing to the Company and the other
Members. The purchase price shall be the fair market
value of the interest as determined by the procedure set
forth in Section 8.d., without reference to insurance.
The purchase price shall be paid, and the interest
transferred, within sixty (60) days of the notice. At
the option of the purchaser, the purchase price may
be paid by tendering 25% of the purchase price to the
selling Member, at which tiem [sic] the Member’s
interest shall be deemed transferred, with a
promissory note for payment of the balance of the
purchase price over a three-year period, with equal
installments to be paid quarterly without interest.
(Bold emphasis added.)
As Section 8.e. makes clear, QL’s liability for paying Holton the
“purchase price” of his ownership interest became an outstanding liability sixty
days after November 2, 2018, the date QL provided him “notice in writing” of its
intent to “require the purchase.” Id. The installment payment “option” was merely
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an alternative to paying the entire purchase price within sixty days after QL
provided written notice; it did not modify the “within sixty (60) days” language.
Accordingly, invoking the installment payment “option” required QL to tender
“25% of the purchase price” to Holton – along with a note for the remaining
balance – within sixty days after providing written notice of its intent to require the
purchase of his ownership units.
With that said, the dispositive phrase is “purchase price,” which
Section 8.e. defines as “the fair market value of the interest as determined by the
procedure set forth in Section 8.d., without reference to insurance.” As the circuit
court correctly and exhaustively explained, Section 8.e. cannot be divorced from
the OA’s implied covenant of good faith and fair dealing. Accordingly, that
provision implicitly gave Holton the right to contest whether QL’s “tender,”
pursuant to any purported exercise of this “option,” was indeed a good faith
representation of the fair market value of his ownership units (e.g., the “purchase
price”). If it was not a good faith representation of the fair market value of his
ownership units, it follows that QL did not provide Holton the benefit of the
parties’ bargain, and consequently did not invoke the installment payment option.
The circuit court did not memorialize in any written order why it
determined Holton was entitled to pre- and post-judgment interest, or why Holton
was entitled to it in the manner described in the April 14, 2021 judgment; nor did
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the parties ask it to do so. But the crux of the circuit court’s reasoning, as it
explained from the bench during the April 9, 2021 hearing on this issue, was that
QL could not be deemed under the circumstances of this case to have effectively
invoked the installment payment option:
I did go back and look at the operating agreement. And,
you know, they did bargain for 25% of fair market value
within sixty days with a promissory note for the balance
payable over three years without interest. That’s what
they bargained for. But that’s not what Holton got. He
didn’t get 25% of the fair market value because the court
found that Schomp violated, or breached, this duty of
good faith and fair dealing. He didn’t get installments
over three years. So, it just seems to me that it’s
inequitable to try to hold him to that provision of the
contract that he bargained for three years without interest
when in fact he didn’t get the benefit of that bargain . . . .
Upon review, we agree with the circuit court’s conclusion. Here, all
that QL “tendered” to Holton within sixty days of providing him “notice in
writing” of its intent to “require the purchase” of his shares was 25% of the King
appraisal’s valuation of his shares, plus a promissory note for the remaining 75%
of that valuation. Below, the circuit court determined that King’s appraisal, and
QL’s reliance upon it to ascertain the fair market value of Holton’s ownership
units, breached the OA’s implied covenant of good faith and fair dealing. In
rejecting King’s appraisal on this basis the circuit court pointed out that King was
not a certified business evaluator and that his final appraisal was based, in part, on
false information relayed from Schomp. The circuit court further noted that King
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did not conduct his valuation using recognized methods relying instead on his own
research and experience, which he was unable to articulate. As explained by the
circuit court:
When the proper methodology is applied to financial data
normalized for QL’s use of revenue to pay personal
expenses, the valuation increases from $884,559 (King’s
Appraisal) to at least $1,645,544 (Herring’s Appraisal),
an amount nearly double King’s Appraisal.
Accordingly, the Court concludes King’s Appraisal is
unworthy of respect because it does not, as a result of
contractual wrongdoing, represent the genuine impartial
judgment on value that the Operating Agreement
contemplates.
Despite having conceded below that King’s appraisal was not
procured in good faith, Schomp argues on appeal that, as related to the award of
interest, the circuit court incorrectly determined that he breached the OA’s implied
covenant of good faith and fair dealing by attempting to require Holton, pursuant
to Sections 8.d. and 8.e., to sell his ownership units at a price based upon what the
King appraisal represented was his units’ “fair market value.”
Schomp’s argument in this vein is mutually exclusive. Schomp
conceded that the circuit court correctly determined that the fair market value of
Holton’s ownership units in QL was $1,804,878 – not King’s appraised value of
$884,559. The basis of the circuit court’s determination in that regard was that
Herring’s appraisal comported with the implied covenant of good faith and fair
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dealing, whereas King’s appraisal did not. Thus, Schomp effectively waived any
argument concerning the validity of King’s assessment. Alternatively, even if one
could parse and appeal the circuit court’s determination in this manner, the circuit
court’s determination would only be subject to review for clear error. CR 52.01.
The circuit court’s assessment of the evidence is consistent with the record, and we
find no error under that standard.
Schomp also argues Holton should be “estopped” – insofar as it
relates to any award of pre- and post-judgment interest – from contending that it
breached the implied covenant of good faith and fair dealing because Holton also
used company credit cards for personal use. This argument fails because it was not
the fact of the personal expenses that breached the OA’s covenant of good faith
and fair dealing. Rather, it was the fact that Schomp knowingly procured a
valuation based, in part, on those expenses the effect of which was a devaluation of
QL. As the circuit court explained in its April 1, 2021 findings of fact and
conclusions of law, “Simply because Holton acquiesced and participated in this
behavior does not make personal expenses properly deductible from net profits for
the purpose of arriving at a fair market value of QL.”
In short, what QL “tendered” to Holton “within sixty (60) days” of its
notice was not a good faith representation of the fair market value of Holton’s
ownership units (e.g., the “purchase price”). It follows that the circuit court’s
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assessment was correct: QL did not invoke the installment payment “option” of
Section 8.e., and accordingly had no right to pay the value of Holton’s shares in
“equal installments” and “quarterly without interest.”
To be clear, this result does not punish Schomp for failing to perfectly
appraise Holton’s shares within a sixty-day period; nor does it apply an unfair
degree of hindsight to QL’s valuation. Rather, it is mandated because QL did not
provide Holton the benefit of their bargain – a point the circuit court emphasized.
Any unfairness Schomp perceives in this result is tempered by the highly
deferential standard of review he was accorded throughout these proceedings –
“good faith and fair dealing” in this matter was a relatively low bar. Furthermore,
it is also tempered by the fact that QL received the benefit of its bargain with
Holton on November 28, 2018, when it undisputedly received Holton’s ownership
interest.9 As of the date of this Opinion, Holton has received no payment from QL
9
Below, Holton argued that QL’s attempted tender of 25% of a flawed appraisal was
insufficient to trigger a termination of his interest in the company, and that he remained an owner
of 30.77% of QL. The circuit court disagreed. In sum, the circuit court considered the language
of Section 8.e., that “The purchase price shall be paid, and the interest transferred, within sixty
(60) days of the notice.” It also considered these seemingly inflexible deadlines in conjunction
with the process it recognized was nevertheless available for Holton to challenge QL’s valuation
– a process it recognized could last well beyond sixty days. It held that giving effect to all of
these considerations meant further recognizing at least two propositions: (1) whether QL
actually paid Holton fair market value for his ownership units was a subject that could be
resolved in a process that could last well beyond sixty days; and (2) the resolution of that
“process” had no bearing upon when Holton’s ownership interest was effectively deemed
transferred. It accordingly determined Holton was divested of his ownership interest in QL as of
November 28, 2018. The circuit court’s determination in that regard is not an issue on appeal.
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whatsoever.10
We are left, then, with what Section 8.e. provided in the event QL did
not exercise the installment payment option: “The purchase price shall be paid,
and the interest transferred, within sixty (60) days of the notice.” In other words,
the OA provided that regardless of what the fair market value of Holton’s
ownership units was or how long it took to determine, the fair market value of
Holton’s ownership units would be considered an outstanding obligation sixty days
after the notice. And in that event, Section 8.e. was silent regarding interest.
Regarding the issue of post-judgment interest, QL’s sole argument
with respect to why the circuit court erred in applying the 6% rate expressed in
KRS11 360.040 is that subsection (3) of that statute precluded it. It provides:
A judgment rendered on a contract, promissory note, or
other written obligation shall bear interest at the interest
rate established in that contract, promissory note, or other
written obligation.
As discussed previously, however, the OA “established” no rate of
interest and was otherwise silent regarding that issue under the circumstances.
10
In his brief, Schomp complains it is Holton’s fault that he has received nothing to date
because Holton “rejected the initial 25% payment of the King valuation. And, as Holton has
made clear, even if Appellants had tendered 25% of the value determined by Herring, he still
would not have accepted it based on Cranfill’s overinflated pre-litigation valuations.” Schomp’s
complaint is disingenuous at best. Had Holton accepted QL’s tender of “the initial 25% payment
of the King valuation,” Schomp would have undoubtedly cited his acceptance as an accord and
satisfaction. Nothing precluded Schomp from unconditionally tendering to Holton the minimum
of what he agreed was owed to Holton, or from otherwise escrowing that amount.
11
Kentucky Revised Statute.
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Accordingly, the circuit court lacked authority under KRS 360.040(3) to specify a
post-judgment interest rate other than 6%, and Schomp’s argument has no merit.
For parity of reasoning, see Service Financial Company v. Ware, 473 S.W.3d 98,
106 (Ky. App. 2015) (reasoning, under prior version of KRS 360.040, that a
judgment for liquidated damages based upon a contract specifying no rate of
interest could not deviate from the statutory post-judgment interest rate, which was
then 12%); see also Doyle v. Doyle, 549 S.W.3d 450, 456 (Ky. 2018) (“All
judgments bear interest. The amount of interest is mandated at the statutory rate
unless the claim is unliquidated or interest is provided for in a separate written
obligation.”).
Regarding the issue of pre-judgment interest, the same analysis
applies to the rate specified by the circuit court: “Absent a contractually agreed
upon rate, the appropriate rate of interest is governed by statute. KRS 360.010
(setting the legal rate of interest in general) provides that the ‘legal rate of interest
is eight (8%) percent per annum.’” Reliable Mech., Inc. v. Naylor Indus. Servs.,
Inc., 125 S.W.3d 856, 857 (Ky. App. 2003) (internal footnote omitted).
As to whether pre-judgment interest was warranted, the circuit court
made no determination in any written order of whether Holton’s damages were
liquidated or unliquidated; it was never pressed by the parties to make such a
determination; but for our purposes, it makes no difference. In the context of
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liquidated damages, “prejudgment interest follows as a matter of course.” Nucor
Corp. v. General Elec. Co., 812 S.W.2d 136, 141 (Ky. 1991).
In the context of unliquidated damages, prejudgment interest may be
awarded if doing so is consistent with justice and equity. Id. at 143. Here, that
standard is met, because awarding Holton pre-judgment interest as of January 1,
2019, was consistent with giving him the benefit of his bargain with QL. “[J]ustice
and equity demand an allowance of interest to the injured party. Where under a
contract a debt is due at a certain time, both reason and authority say that it carries
interest from that time.” Friction Materials Co., Inc. v. Stinson, 833 S.W.2d 388,
392 (Ky. App. 1992) (citations omitted). As previously stated, the OA
contemplated that regardless of what the fair market value of Holton’s ownership
units was determined to be, or how long it might take to make that determination,
the fair market value of Holton’s ownership units would be considered an
outstanding obligation sixty days after November 2, 2018, when QL provided
written notice of its intent to require the purchase of his ownership units. January
1, 2019 – the date that the circuit court specified prejudgment interest began to
accrue – was sixty days after November 2, 2018.
V. CONCLUSION
For the reasons set forth above, we affirm the Fayette Circuit Court’s
judgment.
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ALL CONCUR.
BRIEFS FOR BRIEFS FOR APPELLEE/CROSS-
APPELLANTS/CROSS- APPELLANT:
APPELLEES:
Thomas W. Miller
Brian M. Johnson Lexington, Kentucky
Logan J. Mayfield
Lexington, Kentucky
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