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In Re Estate of Kaplan





APPEAL from the Circuit Court of Cook County; the Hon. STANLEY W. THOMAS, Judge, presiding.


Rehearing denied February 2, 1979.

This action centers upon the construction of certain provisions of a stock alienation agreement (hereafter referred to as the "agreement") entered into between M.S. Kaplan Company (hereafter referred to as "MSK") and Benjamin G. Kaplan (hereafter referred to as the "decedent") on August 5, 1966. The agreement provided that upon the decedent's death, his estate was obligated to sell, and MSK was obliged to purchase, decedent's shares of stock at their book value as of the end of the month immediately preceding his death. MSK's accounts determined that decedent's stock was worth, at the time of his death, $9,181,504. MSK has paid this amount to decedent's estate. Petitioners were dissatisfied with that determination and instituted this suit. The trial court ordered MSK to pay petitioners an additional $1,052,414.82. MSK appeals and petitioners cross-appeal, both sides contending that the court erred with respect to several accounting issues. Petitioners also allege error in the trial court's treatment of their claim for statutory penalties under section 45 of the Business Corporation Act (Ill. Rev. Stat. 1977, ch. 32, par. 157.45).

Respondent MSK is a family-owned corporation engaged in the scrap metal business. Petitioners are Bertha Kaplan, decedent's widow and co-executor of his estate, and her two children. Continental Illinois National Bank and Trust Company of Chicago (hereafter referred to as "Continental") is co-executor of the decedent's estate.

The crucial provision of the agreement in question is paragraph 5.12 which provides in pertinent part:

"For the purpose of determining the purchase price * * *, book value * * * shall be determined by the certified public accountants regularly employed by the Company. In determining the book value, the certified public accountants shall apply the same principles, practices and procedures used in the preparation of the Company's year-end statements of operations, after:

A. Eliminating goodwill and other items not in dispute;

B. Creating a reserve for bad debts or increasing the existing reserve so as to equal the amount customarily set up in the past;

C. Adjusting the value of the inventories shown on the last yearly audit report of the company by the increase or decrease therefrom reflected in the books of the company as of the date on which book value is determined;

D. Making provision for all federal, state and local taxes for the period immediately preceding the month in which the death occurred."

The decedent died on November 21, 1969. At the time, he owned 6,076 shares or approximately 51% of MSK's stock. Pursuant to the agreement, Ernest Newton, and the firm of Laventhol, Krekstein, Horwath & Horwath (hereafter referred to as "LKH&H"), MSK's regularly employed accountants, determined that the book value of decedent's stock as of October 31, 1969, was $1,511.11 per share. In accordance with that determination, MSK paid the aforementioned $9,181,504 to decedent's estate.

Petitioners brought the present action seeking a construction of the agreement and also to set aside the determination of the book value of decedent's shares in MSK. Petitioners further requested that they be granted access to MSK's books and records.

After examining MSK's books and records pursuant to court order, petitioners filed an amended petition alleging that the accountants' valuation report did not constitute a determination of book value as required by the agreement and further, that the report was so permeated by fraud, error or gross mistake as to render it not binding on the parties. Petitioners sought to set aside, or in the alternative to increase, the determination of book value. Petitioners also requested the allowance of section 45 penalties on the basis of MSK's refusal to grant access to its records.

In response, MSK contended that, in the absence of proof of fraud or gross mistake, the valuation report was binding upon the parties and was not subject to redetermination by the trial court. MSK further maintained that petitioners, as decedent's legal representatives, were estopped to challenge the accounting principles and procedures employed by Newton in preparing the valuation report since the decedent, during his lifetime, had been responsible for the formulation and approval of both MSK's accounting methods and the agreement in question. MSK also argued that since decedent had accepted and retained the benefits of buy-outs involving other shareholders' estates, his estate was equitably estopped to repudiate or alter the valuation provisions of the agreement in a manner inconsistent with past transactions. After a lengthy hearing and discussion of several accounting issues raised by both sides, the court entered judgment for petitioners in the aforementioned amount.

We first consider MSK's contention that the accountants' determination of the book value of decedent's shares was binding and consequently not subject to redetermination by the trial court.

Petitioners maintain that the valuation report did not in fact constitute a determination of book value as required by the agreement. They rely upon a letter accompanying the report which stated:

"[T]he scope of our examination did not provide for direct confirmation of receivables nor did it include the observation of inventories at October 31, 1969.

Because the receivables and inventories at October 31, 1969 enter materially into the determination of the company's financial position we do not express an opinion on the accompanying balance sheet taken as a whole."

Petitioners state this disclaimer indicates that the accountants in effect made no finding in connection with the financial statements they had examined.

In the alternative, petitioners contend that if the report did constitute a determination of book value, it was so permeated by fraud, error and gross mistake as to have no binding effect upon the estate. Specifically, petitioners allege that the accountants failed to verify figures given them by MSK management relative to materials shipped by MSK to complete certain overseas sales. In the valuation report the sum of $1,980,964 was reflected as accounts payable to merchandise creditors. An investigation of MSK's books revealed no invoices for these transactions and that, in fact, the materials had been withdrawn from MSK's own inventory or bailment inventory. Petitioners maintain that the accountants' failure to verify these figures or to advise petitioners that they had not been verified constituted gross negligence.

Petitioners also allege that the accountants utilized a method for setting up a bad debt reserve which was neither in accordance with MSK's past practices nor with the provisions of the agreement. The valuation report contained a bad debt reserve for amounts advanced to a wholly owned subsidiary of MSK, California Auto Reclamation Company (hereafter referred to as "CARCO"), in the amount of $1,310,000. A similar reserve was set up for $73,027 advanced to Prolerized St. Louis Corporation (hereafter referred to as "PROLERIZED"), an auto hulk shredding business created by MSK and another corporation. Petitioners contend that the bad debt reserve customarily set up in the past to cover all items of this nature was $225,000 and that any reserve in excess of that amount was unauthorized. Petitioners further claim the valuation report was in conflict with MSK's past practices and with the terms of the agreement.

In its written opinion, the trial court did not discuss petitioners' allegations of fraud and gross mistake. Rather, the court held it was free to correct the valuation report because the agreement did not provide the accountants' determination of book value was to be conclusive upon the parties. The court reasoned that the essential element of the agreement was a binding contract to sell and to purchase at book value. The requirement that the accountants determine book value was not a submission of this issue to the accountants' sole discretion, but rather, was simply a means of fulfilling the contract. The court also noted that the agreement specifically provided for recourse to the courts in the event of any controversy concerning the right or obligation to ...

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