Raley v. Brinkman

• Decision Date: 30 July 2020
• Docket Number: No. M2018-02022-COA-R3-CV,M2018-02022-COA-R3-CV
• Citation: 621 S.W.3d 208
• Parties: Terrell K. RALEY, et al. v. Cees BRINKMAN, et al.
• Court: Tennessee Court of Appeals

621 S.W.3d 208

Terrell K. RALEY, et al.

v.Cees BRINKMAN, et al.

No. M2018-02022-COA-R3-CV

Court of Appeals of Tennessee, AT NASHVILLE.

February 4, 2020 Session

FILED July 30, 2020

W. Scott Sims and Michael R. O'Neill, Nashville, Tennessee, for the appellant, Cees Brinkman.

Seth McInteer and Howell O'Rear, Nashville, Tennessee, for the appellee, Terrell K. Raley.

Frank G. Clement Jr., P.J., M.S., delivered the opinion of the Court, in which Thomas R. Frierson II, and W. Neal McBrayer, JJ., joined.

This appeal arises from a business dispute between the two members of a Tennessee limited liability company, 4 Points Hospitality, LLC("4 Points"), each owning a 50% interest.The plaintiff-member, Terrell K. Raley("Raley"), commenced this action asserting, individually and on behalf of the LLC, inter alia , that the defendant-member, Cees Brinkman ("Brinkman"), breached the operating agreement by failing to make a $175,000 capital contribution.Brinkman asserted counterclaims, individually and on behalf of the LLC, for breach of contract and breach of fiduciary duty, alleging that Raley misappropriated funds for his personal benefit and that he withheld a large portion of Brinkman's distributions and salary.Brinkman also claimed that Raley was liable for conversion and punitive damages.Brinkman sought to terminate Raley's membership interest because he willfully and persistently breached his fiduciary duty, and because it was no longer reasonably practicable for the two men to continue operating the business.Brinkman also claimed he was entitled to recover his attorneys’ fees in accordance with Tenn. Code Ann. §§ 48-249-804 and -805, and the operating agreement.Upon Raley's pretrial motion, the trial court summarily dismissed Brinkman's claim for attorneys’ fees under the operating agreement, holding that the attorneys’ fees provision only pertained to disputes submitted to arbitration.Following a lengthy bench trial, the court ruled that (1) Brinkman breached the operating agreement by failing to make a $175,000 capital contribution, (2) Raley was liable for breach of fiduciary duty, breach of contract, and conversion for underpaying Brinkman's distributions and salary and for using 4 Points’ funds to satisfy unrelated, personal expenses, (3) Raley was not liable for punitive damages because his conduct was not egregious, and (4) Brinkman was not entitled to attorneys’ fees under §§ 48-249-804 and -805.The court also terminated Raley's membership interest in 4 Points in accordance with Tenn. Code Ann. § 48-249-503(a)(6)(B) and (C), finding that Raley's wrongful conduct adversely and materially affected the business, and it was no longer reasonably practicable for the members to continue operating the business together.Brinkman filed a motion to alter or amend the court's order, and the court denied his motion in all respects but one, ruling, in accordance with Tenn. Code Ann. § 48-249-805, that Brinkman was entitled to equitable relief in the form of attorneys’ fees.Therefore, the court revised its order to allow half of the $240,275.59 Raley owed 4 Points as reimbursement for personal expenses to be paid to Brinkman, individually.Brinkman then filed notice that 4 Points intended to purchase Raley's membership interest in accordance with Tenn. Code Ann. §§ 48-249-505 and -506, which necessitated an evidentiary hearing to determine the "fair value" of Raley's interest.In preparation for the hearing, Brinkman's expert prepared a valuation report applying shareholder-level discounts for lack of control and lack of marketability and adjusting 4 Points’ income for the corporate income tax.Raley responded by filing a motion in limine to determine the meaning and components of "fair value" under Tenn. Code Ann. § 48-249-506(3), arguing that any testimony or other evidence relating to discounts for lack of control and marketability and the corporate income tax should be excluded at the evidentiary hearing.In response, Brinkman submitted the affidavit of his valuation expert, explaining the expert's valuation methodology and the reasons for applying a corporate income tax rate.The court ruled that because the company, rather than a third party, was purchasing the membership interest, the fact that the interest was non-controlling was irrelevant to its fair value.The court also excluded evidence and testimony on discounts for lack of marketability.As for the applicability of the corporate income tax, the court ruled that "no entity level tax should be applied in the valuation analysis for a non-controlling interest in an electing S corporation, absent a compelling demonstration that independent third parties dealing at arms-length would do so as part of a purchase price negotiation."Following the evidentiary hearing, the court determined that the fair value of 4 Points was $4,774,278.18, and that Raley's 50% interest was $2,387,139.09.Brinkman timely filed this appeal contending the trial court erred in determining that (1) Brinkman breached the operating agreement by failing to make a capital contribution, (2) Raley was not liable for punitive damages, and (3) Brinkman was not entitled to attorneys’ fees pursuant to the operating agreement and/or §§ 48-249-804 and -805.As for the trial court's valuation of Raley's membership interest, Brinkman contends the trial court erred in (1) disallowing discounts for lack of control and lack of marketability and (2) determining that tax-affecting did not constitute relevant evidence of the fair value of Raley's membership interest in 4 Points.We affirm the trial court's judgment in every respect but one.We have determined that the trial court erred by failing to consider evidence relative to tax-affecting when determining the fair value of Raley's membership interest because Tenn. Code Ann. § 48-249-506 provides that relevant evidence of fair value includes the "recommendations of any of the appraisers of the parties to the proceeding."Brinkman's valuation expert stated in his affidavit that the application of a 38% tax rate "comports with generally accepted valuation standards and methods" and reasoned that there is a risk of inaccurate valuation when the components of the capitalization rate are based on after-tax values, and no tax-affecting is applied to the income of the company.Therefore, we vacate the judgment valuing Raley's interest and remand for the trial court to consider evidence relative to tax-affecting in determining the fair value of Raley's membership interest and to enter judgment accordingly.

I.FACTUAL BACKGROUND AND PROCEDURAL HISTORY

When Raley and Brinkman met in 2009, Raley had been working in the restaurant industry for a number of years, and Brinkman owned Brinkman Holdings, LLC("Brinkman Holdings"), which owned two commercial properties located on the corner of McFerrin Avenue and West Eastland Avenue in East Nashville.Upon learning that Brinkman stored used restaurant equipment at the West Eastland Avenue property, Raley contacted Brinkman to inquire about the equipment.During their discussions, Raley expressed an interest in starting his own restaurant, and Brinkman expressed an interest in having a restaurant as a tenant.

When the two men decided to go into business together, they first formed TC Hospitality, Inc. to own and operate the Holland House Bar and Refuge ("Holland House").Brinkman Holdings entered into a lease with TC Hospitality and agreed to cover the cost of converting the West Eastland Avenue property to a restaurant in exchange for Brinkman's 10% ownership in TC Hospitality and $5,000 in monthly rent.Holland House opened in 2010 and was fairly successful.

Thereafter, Brinkman and Raley decided to open a second restaurant called The Pharmacy Burger Parlor & Beer Garden ("The Pharmacy").They formed a separate business entity, 4 Points, to own and operate The Pharmacy, with each of them owning a 50% membership interest in 4 Points.

The operating agreement¹ required Raley to make an initial capital contribution of $30,000 in labor and required Brinkman to contribute $175,000 in cash.It also provided that they would be 50/50 owners of 4 Points and that Brinkman and Raley were entitled to an even split of net profits.Raley was designated the managing member, and the agreement provided that he would "take responsibility for the administrative duties and ministerial functions" of the restaurant and "make day-to-day business decisions on his ... own accord, subject to Acts Requiring Majority Consent[.]"Raley's responsibilities included, inter alia , responsibility for expenses, payroll, and the distributions of net profits to himself and Brinkman.The agreement also stated that both members shall maintain the books "and shall make proper entries in such books of all sales, purchases, receipts, payments, transactions and property" of the LLC.The operating agreement provided that "working capital and other funds" received by the LLC be deposited in accounts "which shall be kept separate and apart from any other individual accounts of the [members]."4 Points elected to be taxed as an S corporation.²

Neither party disputes that they also entered into an oral salary agreement; however, the terms of the salary agreement were disputed.Raley claimed that, per their agreement, he would receive a salary of eight percent of gross sales and Brinkman would receive a salary of four percent.Brinkman claimed that Raley would receive eight percent "gross," and he would receive four percent "gross" with an additional four percent set aside in a separate account for the development of other restaurants.³

Shortly after forming the company, 4 Points and Brinkman Holdings entered into a lease whereby 4 Points would pay a rent of $2,500 per month, and Brinkman Holdings would provide a "build to specification operational restaurant and parking."

The Pharmacy opened to the public in December 2011, offering full-service, casual dining...