Prince, Matter of

Decision Date09 July 1996
Docket Number94-3714,Nos. 94-3474,s. 94-3474
Citation85 F.3d 314
Parties, 29 Bankr.Ct.Dec. 196 In the Matter of Douglas R. PRINCE and Jane Prince, Debtors-Appellants.
CourtU.S. Court of Appeals — Seventh Circuit

Daniel A. Zazove (argued), Barbara L. Yong (argued), Barbakoff, Zazove & Glick, Chicago, IL, Steven B. Towbin, D'Ancona &amp Pflaum, Chicago, IL, for Unsecured Creditors Committee.

David G. Lynch, Rudnick & Wolfe, Chicago, IL, Richard M. Kates (argued), Chicago, IL, for appellants Douglas Prince, Jane Prince.

Before FLAUM, KANNE, and ROVNER, Circuit Judges.

KANNE, Circuit Judge.

When Dr. Douglas R. Prince and his wife, Jane Prince, filed for bankruptcy reorganization in 1981, Dr. Prince operated his orthodontics practice as a wholly owned professional corporation. As part of the plan of reorganization, Dr. Prince was to retain his practice, but the Princes agreed to pay the equity value of his stock in the professional corporation into a fund to satisfy their unsecured creditors. When the Princes and the unsecured creditors committee could not agree upon the stock's worth, they turned to the bankruptcy court for a valuation hearing. The bankruptcy court determined that the stock was worth only the value of the practice's physical assets, but on appeal the district court reversed and remanded for a calculation of the stock's value that included Dr. Prince's goodwill. On remand, the bankruptcy court's recomputation arrived at a markedly higher value for the stock. After the entry of judgment, the unsecured creditors committee filed a motion to alter or amend the judgment on the basis of newly discovered evidence. The bankruptcy court granted the motion and amended its judgment to further increase the value of the stock, and the district court affirmed this decision on appeal. The Princes now challenge both the ruling that Dr. Prince's goodwill was properly included in the value of his stock and the decision to grant the unsecured creditors committee's motion to alter or amend the judgment, and we affirm.

I. HISTORY

On August 17, 1981, Dr. Prince and his wife filed a voluntary petition for bankruptcy reorganization under Chapter 11. See 11 U.S.C. § 1101 et seq. At the time of filing, Dr. Prince was the sole shareholder of a professional corporation, through which he operated his practice as an orthodontist. In February of 1983, the Princes filed a combined disclosure statement and plan of reorganization proposing the liquidation of their estate. The plan was supported by the unsecured creditors committee (the "Committee") and was confirmed on November 4, 1983.

The plan required the Princes to marshal the equity value of all their assets into a fund for distribution to their creditors. The Princes could either sell each asset and remit the sale proceeds to the fund, or they could retain an asset by depositing into the fund, over a three-year period, an amount equal to its equity value. The plan indicated that Dr. Prince wished to retain his orthodontics practice and would therefore pay the equity value of his stock in the professional corporation into the fund. The plan was confirmed, however, without the parties ever agreeing upon the stock's value. In the plan, the Princes disclosed that the corporation's physical assets were worth $25,000, less equipment liens totaling $17,500, and thus proposed to pay an equity value of $7,500 into the fund, subject to audit and negotiations with the Committee. In the event that postconfirmation negotiations failed to reach an accord as to the value of the stock, the plan provided that the dispute would be resolved at a valuation hearing before the bankruptcy court. The parties have yet to agree upon the stock's worth.

Less than four months after confirmation, Dr. Prince negotiated the sale of his practice to an orthodontist from New York, Dr. Timothy J. Clare. On February 25, 1984, the two doctors signed a written sales contract, wherein Dr. Clare promised to pay a purchase price of $450,000, 1 with payments to commence in September of 1984. Dr. Prince's obligation under the agreement was threefold: First, he promised to transfer all of the professional corporation's stock to Dr. Clare. Second, Dr. Prince agreed to enter into a covenant not to compete, under which he was prohibited for five years from practicing within ten miles of any community he had previously served. Third, Dr. Prince undertook a "practice obligation" to provide transitional services during the interim period--i.e., from February to September, Dr. Prince would pay some of Dr. Clare's expenses (salary, housing, gas, insurance, travel), continue to practice on a part-time basis, and use his best efforts to build a rapport between his patients and Dr. Clare. After working together until only June, however, the two doctors had a falling out, and the actual sale in September was never consummated.

In November of 1988, the bankruptcy court held a hearing to determine the value of Dr. Prince's stock in his professional corporation. The Committee and the Princes each put forth an expert witness, and the bankruptcy court believed that "[b]oth experts testified in a credible fashion, consistent with their respective assumptions." The Committee's expert concluded that the stock of the professional corporation was worth $650,000, based on a capitalization of the stream of cash flows that the practice was likely to produce in the future (Dr. Prince had previously disclosed that he enjoyed an annual income from the practice of between $250,000 and $300,000). The Committee's expert conceded, however, that this value would not exist if Dr. Prince were to leave and compete with the corporation. The expert testified that without the personal goodwill of Dr. Prince--defined by the bankruptcy court as "the confidence that his patients had in him as an orthodontist"--the stock would have only nominal value.

The methodology of the Princes' expert assumed that Dr. Prince's goodwill should not be included in the stock's value because the professional corporation did not possess a covenant not to compete from Dr. Prince. As a result, and consistent with the Committee expert's concession, he determined that the corporation's stock was equal to the liquidation value of its physical assets, or $7,500. The Princes' expert admitted, however, that almost every sale of a medical or dental practice entails the execution of a covenant not to compete, the exceptions usually being where a physician has expired and thus presents no risk of competition.

On the basis of the experts' testimonies, the bankruptcy court found virtually every fact in this case to be undisputed and distilled the valuation down to one issue of law: "whether Dr. Prince's personal goodwill should be included in the calculation of [the stock's] value." The bankruptcy court determined as an initial matter that Dr. Prince's goodwill fell within the personal earnings exception of 11 U.S.C. § 541(a)(6), which excludes the debtor's postcommencement earnings from the bankruptcy estate in a liquidation. Because the liquidation of the Princes' estate was proposed as part of a plan of bankruptcy reorganization under Chapter 11, rather than as a Chapter 7 liquidation, the bankruptcy court recognized that the parties could have bargained around § 541(a)(6)'s presumptive exclusion and particularly specified whether the value of Dr. Prince's goodwill was to be paid into the fund. However, the court found that the plan itself did not evidence the parties' intention either to include or exclude the value of Dr. Prince's goodwill, and thus it concluded that the stock's worth was limited to the $7,500 value of the professional corporation's physical assets.

On appeal, the United States District Court for the Northern District of Illinois disagreed with the bankruptcy court and held that Dr. Prince's goodwill did not fall within the personal earnings exception of 11 U.S.C. § 541(a)(6). As a result, the district court remanded the case, instructing the bankruptcy court to include the worth of Dr. Prince's goodwill in the stock's value. Because the bankruptcy court had determined that the stock's worth was limited to $7,500, and thus had not endeavored to assign a value to Dr. Prince's goodwill, the district court advised the bankruptcy court how it should go about calculating the value of the goodwill. Finding the arm's length sale agreement between Dr. Prince and Dr. Clare to be an accurate proxy for the worth of the stock, the district court directed the bankruptcy court to calculate the value of Dr. Prince's stock (physical assets plus goodwill) by subtracting the amount of Dr. Clare's salary and expenses paid under the contract, as well as the value of the tangible services performed by Dr. Prince during the interim period, from the purchase price to be paid by Dr. Clare.

On remand, the bankruptcy court accepted evidence and argument as to the value of the amounts that should be offset against the purchase price in determining the worth of the stock. During final argument, it occurred to the court and the parties that a crucial issue was whether Dr. Prince or Dr. Clare received the income from the practice during the interim period. If Dr. Clare received the income, then some portion of the purchase price could be considered compensation for Dr. Prince's part-time labors during the interim period rather than for the stock, and thus the value of these labors would be properly deducted from the purchase price in determining the value of the stock. On the other hand, if Dr. Prince received the income himself, then that income would be his compensation, and the value of his interim labors would not be offset against the purchase price.

Without adjournment, the bankruptcy court recalled Dr. Prince to testify as to which doctor received the practice's income...

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