Malik v. Falcon Holdings, LLC, 11–2815.

• Decision Date: 14 March 2012
• Docket Number: No. 11–2815.,11–2815.
• Citation: 675 F.3d 646
• Parties: Tariq MALIK, Mahdiur Rahman, and Janice Quinn, Personal Representative of the Estate of Joe Lee Lott, Plaintiffs–Appellants, v. FALCON HOLDINGS, LLC, and Aslam Khan, Defendants–Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

675 F.3d 646

Tariq MALIK, Mahdiur Rahman, and Janice Quinn, Personal Representative of the Estate of Joe Lee Lott, Plaintiffs–Appellants,

v.FALCON HOLDINGS, LLC, and Aslam Khan, Defendants–Appellees.

No. 11–2815.

United States Court of Appeals, Seventh Circuit.

Argued Feb. 21, 2012.Decided March 14, 2012.

Mary Massaron Ross (argued), Attorney, Plunkett & Cooney, Detroit, MI, for Plaintiffs–Appellants.

Samuel G. Harrod, IV (argued), Attorney, Meltzer, Purtill & Stelle LLC, Schaumburg, IL, for Defendants–Appellees.

Before EASTERBROOK, Chief Judge, BAUER, Circuit Judge, and SHADID, District Judge.^*EASTERBROOK, Chief Judge.

Falcon Holdings was organized in 1999 to own and operate 100 fast-food restaurants. Aslam Khan owned 40% of Falcon's common units. (Falcon is a limited liability company rather than a corporation; ownership is represented by units rather than shares.) The remainder of the common units, and all of the preferred units, were owned by Sentinel Capital Partners II and Omega Partners (collectively “Sentinel”). According to the plaintiffs, Khan told Falcon's managers that he would acquire full ownership one day, and that, when he did, he would reward the top managers with 50% of Falcon's equity. Plaintiffs say that they accepted lower salaries because they anticipated receiving a stake if Falcon proved to be a success, and that they worked hard to make it prosper (which it did).

Sentinel was bought out in 2005, and Khan became Falcon's sole equity owner. He did not distribute common units to any of the top managers and has denied ever promising that he would. Five of the managers filed this suit. The district court assumed that the evidence in the summary-judgment record would permit a jury to conclude that Khan had promised the plaintiffs an equity stake in Falcon. (Contracts for the sale of stock are not subject to the statute of frauds in Illinois, see 810 ILCS 5/8–113, so the absence of a writing signed by Khan is not dispositive.) Two of the original plaintiffs nonetheless lost on the basis of releases; they have not appealed. The others lost because, the district judge held, they had not adequately estimated the damages they sustained. 2011 WL 2790168, 2011 U.S. Dist. LEXIS 77983 (N.D.Ill. July 15, 2011). These three have appealed. (One has died; his estate's representative has been substituted.)

Plaintiffs offer a simple estimate of damages. They calculate that the price paid for Sentinel's ownership interest (100% of the preferred units and 60% of the common units) implies that Falcon as a whole was worth approximately $48 million in 2005. Half of $48 million is $24 million. In 2005, twenty managers qualified for units under the terms of Khan's offer. Thus each plaintiff lost about $1.2 million when Khan did not keep his promise.

The district court stated that plaintiffs' approach has two flaws, each fatal: first, because Sentinel did not own 100% of Falcon, it is impossible to derive the value of the whole firm from the amount paid for its holdings; second, the amount that Sentinel was paid depended on how much Khan and Falcon could borrow rather than Falcon's true value. Neither of these propositions is sound; indeed, each supposes that there is some measure of “true” value that differs from what a willing buyer will pay a willing seller in an arms'-length transaction. Yet that is the gold standard of valuation; other measures are approximations. The value of a thing is what people will pay. The judiciary should not reject actual transactions prices when they are available.

Let us simplify the transaction by assuming that Sentinel owned 60% of Falcon and accepted $6 million for its units. Falcon as a whole then must be worth at least $10 million. If it is worth less than that, Khan has overpaid. Khan does not contend in this litigation that he paid Sentinel too much. Falcon might be worth more than $10 million in this example; Sentinel would accept “only” $6 million if it thought that Khan, as the controlling manager, would prevent Sentinel from receiving payments equivalent to 60% of the firm's full value. But if the price Sentinel accepted represents less than 60% of Falcon's value, then plaintiffs have underestimated their damages. A court can't dismiss a suit because the plaintiffs are asking for less than their due.

The same thing is true about the district court's belief that the ability of Khan and Falcon to borrow money set a cap on what Sentinel received. If this means that Sentinel accepted less for its units than their proportional share in Falcon represented, then again plaintiffs have underestimated their damages. That's not a good reason why they should go home empty-handed.

There's another problem with this aspect of the district court's analysis. The amount that Khan and Falcon could borrow depended on Falcon's value. Although the record surprisingly does not contain the details of the transaction, it appears to be a leveraged buyout (LBO). In an LBO, a business borrows money against its own value, promising to repay from its anticipated net earnings. Outside investors are cashed out; insiders own the equity in a highly leveraged venture. The amount a firm can borrow to conduct an LBO depends on the lender's estimate of its future earnings, which is a good indicator of value. So to say that Falcon could not pay Sentinel more than Falcon could borrow is not to say that the price was an arbitrary number. If the amount offered were a poor estimate of Falcon's value, Sentinel would have said no. Instead it took the offer. To repeat, we have a willing buyer and willing seller...