Update (April 12, 2017): Below is a string of posts stretching over the past four years in which Minnesota Litigator emphasizes that “valuation is an inexact science” but that does not mean that valuations or appraisals are entirely manipulable and worthless. Sometimes, though, we wonder.
The property owner’s qualified appraiser had advocated a valuation of $12,800,000 for 2008, $10,000,000 for 2009, and $9,800,000 for 2010 for the same property.
The City’s qualified appraiser had advocated a valuation of $25,000,000 for 2008, $16,000,000 for 2009, and $17,000,000 for 2010.
The “delta” of these valuations is extreme.
The disconnect between the parties’ valuations arose from three “key points”: (1) use of the “income approach” vs. the “market approach,” (2) “the date on which it would have been economically feasible to begin the development of a new downtown office tower,” and (3) “the choice of comparable sales under the market approach.”
It seems that neither side’s appraiser did anything “wrong” in his analysis — neither side’s valuation is “wrong” — but, paradoxically, it is impossible that both valuations are “right.”
When a discipline’s methodology is complex and includes multiple flexible variables, there will never be a “right” answer. Therefore, once the decision-maker reaches a decision (in this case, the tax court) based on experts in these complex contexts, it will be the party that has to establish the decision-maker was “wrong” that faces an almost unwinnable battle… (in this case, Macy’s Retail Holdings, Inc.)
A Wizard. (Photo thanks to John Dallman, Flickr Creative Commons)
Update (May 13, 2016)(under headline: Appraisals Are Imprecise By Definition But They are Not Infinitely Malleable): In 2006, Vaughn Veit donated real property to a foundation (the Veit Foundation) and sought a tax deduction based on the value of the donation. Veit hired ProSource Technologies to appraise the property for purposes of determining the size of hi tax benefit. The higher the valuation, the bigger the tax deduction that Mr. Veit would enjoy.
One has to imagine that the Prosource appraisers had a sense that their customer would be more disappointed in a low estimate than a high estimate and they might have felt some pressure to estimate on the high side.
But, as I have emphasized in earlier posts, below, contrary to the sense I get from many lawyers and many business people, appraisers cannot just make sh*t up. Competent appraisals are within a range of reasonableness. Sure, you can find crooked appraisers, as you can find any other crooked professionals if that is your intent. But you’re kidding yourself if you think you can simply get any appraiser to back into any number that suits your needs.
The IRS decided that the ProSource appraisal was “grossly inflated” and this had tax implications for Mr. Veit.
However, Mr. Veit lost his appraisal malpractice action against ProSource, but not because anyone concluded the appraisal was within a reasonable range. The district court decided that the lawsuit was past the six-year statute of limitation. The Minnesota Court of Appeals affirmed. The key question: did the statute of limitation start to run when ProSource completed the appraisal or when Mr. Veit submitted it to the IRS to support his deduction? The courts held that it started on the earlier date.
The result has to be deeply disturbing to Mr. Veit. How was he supposed to know that the ProSource appraisal was unsound (if it, in fact, was) until the IRS rejected it? What are buyers of appraisals supposed to do to assess the validity of an appraisal they buy? Get a second opinion every time?
On the other hand, as we all know and appreciate in light of the 2008 economic meltdown, the validity of appraisals is critically time-dependent. Over six years, property valuations can change a great deal. Maybe appraisers need the protection of the broadest possible application of a six-year statute to avoid against 20/20 hindsight bias applied to an inherently imprecise practice?
Update (February 19, 2015) (under the headline: What is the value of a 25% Ownership Interest In A Company with 8 Years of Negative Cash Flow Projection?): If I borrow $18 million to buy 25% of a company and the purchased company is not expected to make money for the next 8 years, I am no appraiser or accountant, but it seems to me that I have clear and present debt to the tune of $18 million, which would lower my overall financial worth in the short term, based on my hope and speculation that, over time, the purchased company will start making money and my worth will significantly increase in the future.
For all of you ERISA geeks out there, this one’s for you. Arvig Employee Stock Ownership (“ESOP”) Trust bought Arvig stock in 2006 and Defendant Appraiser estimated the fair value of the stock to be $53.30. The U.S. Department of Labor (DOL) later performed an audit, was critical of the appraisers work, and a substitute appraiser found that the fair market value of the stock at that time was actually $85.60. The difference had to do with how the appraiser assessed the value of the 25% interest in the new non-cash-flowing acquisition.
This, and disagreements about valuations of Arvig stock in other years cost Arvig a substantial amount of money and it has sued its former appraiser for negligence and professional malpractice. The appraiser has now moved for partial summary judgment.
The argument for defendant’s motion for summary judgment: (1) the appraiser had a very clear explanation, which it communicated to Arvig about its 2006 share price valuation, which had to do with Arvig’s having borrowed $18 million to buy a stake in Hector Communications, which, in the short term, had a negative cash flow projection for the following 8 years, and (2) the ESOP is effectively complaining that it got too good a deal, that the price it paid for the shares was far less than their fair market value at the time. One does not usually get into trouble under such circumstances.
If there are any Minnesota Litigator readers who want to dazzle the rest of us with their knowledge of such cases (DOL audits and/or alleged appraisal malpractice), I invite you to add a comment. The memorandum by counsel for the appraiser, Weinress, looks strong to me. On the other hand, briefs often look strong before you read the opposition and also I am simply not deep enough in the case to feel strongly about my view. Finally, though, the narrowness of the motion — applying to one year’s alleged under-valuation when the allegations apply to six years of valuations — makes it seem quite modest in ambition.
Original post (October 30, 2013) (under the headline: Appraising Appraisers: Valuation is not A Non-Falsifiable Dark Art): We hire some experts for things like removing cataracts or fixing cars. When they blow it, we know it. The patient still cannot see, the car still won’t start, etc.
We hire other experts, though, not to perform tasks with easily measured results. In these circumstances (like valuation experts), we can certainly catch and condemn outright frauds, corrupt decision-making, or methodologically incoherent processes — extreme or obvious failures — but can we distinguish a 35% successful job, or an 85% successful job, from a 100% successful job in a mushy or more complex discipline like valuation or appraisal?
We absolutely can. Appraisers (and other professionals who work in complex areas with no “right answer”) can and should be held accountable (and liable) when they do their work badly. But holding them accountable can be subtle, difficult, and expensive.
In a recent case of mine, I encountered opposing appraisals for the same parcel of land that were inconsistent by a factor of more than 1,000%. Two trained appraisers hired by opposing sides, both purporting to use widely accepted appraisal standards, arrived at wildly inconsistent appraisals of the same land. Either one of valuations was wrong or the field of real property appraisal is so imprecise and malleable that it has no actual meaning or value. (Would it not be ironic if the job of valuation was itself devoid of value?) One appraisal was wrong. (The other side’s.)
Valuation is not a hard science; but it is not a non-falsifiable dark art either.
Which brings us to Arvig v. Menke & Associates. According to its website, Arvig has grown from the small, family-owned East Ottertail Telephone Company to one of the largest independent telecommunications providers in the nation.
Back in 2002, Arvig set up an employee stock ownership plan (“ESOP”) to help employees share in Arvig’s success and help them save for retirement, the company said. Under applicable law, Arvig was obligated to have Arvig stock periodically appraised as part of the set-up of the ESOP. For this, Arvig hired California-based Menke & Associates, “the nation’s premier ESOP advisors,” according to their website. Menke, in turn, hired others in connection with its work with Arvig.
In 2009, the U.S. Department of Labor conducted a review of Arvig’s ESOP. It did not go very well. New appraisers were brought in. The “Menke Defendants” (Menke, Sansome Street Appraisers, Weinress & Associates, Inc., M.O. “Tony” Weinress) were out. Their appraisals were thrown out as well. Arvig takes the position that the Menke defendants’ valuation errors have cost or will end up costing Arvig more than $20 million once Arvig extracts itself from the mess that botched appraisals allegedly cost the company.
Arvig’s counsel, Paul Hunt of the Perham, Minnesota firm formerly known as Svingen, Karkela, Cline, Haugrud, Hunt, Larson & Jensen and now Karkela, Hunt, Cichosz, & Jensen, is taking on big guns from California behemoths Littler Mendelson and Moscone Emblidge Sater & Otis (note a curious pattern: the larger the law firm, the shorter the name (see, e.g., Skadden, Dorsey, “O“) but there are exceptions (LEVENTHAL)).
So far, Arvig’s Perham lawyers seem to be doing quite well against the Menke defendants’ Goliaths. At least, when I read Sr. U.S. District Court Judge Richard H. Kyle’s recent order (D. Minn.) on defendants’ motions to dismiss, it seems to me that defendants lost that round decisively.
Bottom line (and without reaching any conclusion on the Arvig case (it is way too early in the case for that)): The fact that valuations, by necessity, have to be approximate is not a license to make sh*t up. Many appraisers (of real property and otherwise) seem to have lost sight of that in recent years and the exercise sound standards, judgment, and discipline is past due.