Using Contractual Valuation Mechanisms To Reduce Risk

Companies frequently have to determine the value of interests, such as tangible property, stock or other corporate ownership interests, intellectual property, or the overall value of a business. In some instances, these determinations occur in the context of lawsuits. Recognizing the cost, uncertainty, and volatility associated with using lawsuits to resolve valuation disputes, sophisticated parties sometimes negotiate in advance, and incorporate into their agreements, Contractual Valuation Mechanisms. Some of these mechanisms, such as using independent appraisers to resolve valuation disagreements, are common, but the mechanisms that can be utilized are open to the imagination of the negotiating parties. The goals of agreeing in advance to use specific mechanisms to resolve valuation disputes generally include: reduced cost; faster resolution; decreased uncertainty; maintaining a higher degree of control; and, decreasing the potential for damage to the relationship between the parties.

Unfortunately, even with an agreed valuation mechanism in place, parties sometimes disagree about the interpretation or implementation of the mechanism, and end up in the lawsuit they hoped to avoid. Analyzing such lawsuits, however, can shed light on certain provisions to think about when negotiating and agreeing to any valuation mechanism.

One lawsuit that demonstrates the risk associated with parties refusing to accept a valuation flowing from a contractual process is Salt Lake Tribune Publishing Co. v. Management Planning, Inc., 454 F.3d 1128 (10th Cir. 2006). The valuation mechanism at issue in the case was part of a 1997 agreement by which the Salt Lake Tribune Publishing Company acquired an option to purchase the Salt Lake Tribune newspaper. The option could be exercised at “fair market value”, and, if the parties could not agree on that value, the valuation mechanism provided that: party-selected appraisers would value the newspaper; if neither of the two appraisals was more than 110% of the other, the average of the appraisals would constitute fair market value; but, if the appraisals were further apart, the parties would hire a third appraiser whose appraisal, if between the first two, would be averaged with the one to which it was closest to determine fair market value.

After the option was exercised, the parties engaged in the appraisal process, including use of the third appraiser. The buyer nonetheless balked at the determined “fair market value”, and sued claiming the appraisal had not conformed to the standards of the appraisal industry. That lawsuit went on for many years, with the United States Court of Appeals for the Tenth Circuit weighing in on various issues including whether the appraisal process constituted arbitration within the meaning of the Federal Arbitration Act, and whether the outcome of the appraisal process was reviewable in court. In short, notwithstanding the parties’ contractual agreement to resolve valuation differences through an appraisal process, they ended up in years of litigation regarding that very process.

The lengthy Salt Lake Tribune lawsuit might have been avoided by the parties in a number of ways. For example, in addition to incorporating the appraisal process into their contract, the parties could have specified that any dispute regarding the appraisal process would be resolved by arbitration. In addition, the parties could have specified the procedures for any such arbitration to make it fast, relatively inexpensive, and bounded or limited by the appraiser’s appraisals. Still further, the parties could have avoided their dispute by specifying in their contract that the appraisers were required to certify that they performed their appraisals in accordance with agreed standards, such as the Uniform Standards of Professional Appraisal Practice.

While no contract can guarantee that there will never be a lawsuit, utilizing contractual valuation mechanisms can decrease the likelihood of disputes that end up in lawsuits, and thinking through contractual terms related to any chosen valuation mechanism can further reduce the likelihood of a dispute and the cost and time associated with any dispute that does arise.