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Zokoych v. Spalding





APPEAL from the Circuit Court of Cook County; the Hon. RAYMOND K. BERG, Judge, presiding.


Plaintiff appeals from a judgment for $19,745.50 in his favor for defendants' conversion of the assets of Ample Tool and Manufacturing Company, Inc. (Ample), a company engaged in the tool and die business. This judgment was entered on remand from this court, which reversed a prior finding denying plaintiff damages for the value of his half interest in Ample. On appeal, plaintiff contends that (1) the holding of a second trial to determine the value of Ample was error; (2) the judgment on remand was contrary to the law of the case; and (3) the judgment is against the manifest weight of the evidence.

In the prior appeal between the parties (Zokoych v. Spalding (1976), 36 Ill. App.3d 654, 344 N.E.2d 805), this court found that the trial court's failure to award any damages for the value of plaintiff's half interest in Ample was against the manifest weight of the evidence. *fn1 The cause was remanded with directions to determine the actual value of Ample prior to the transfer of its assets and to award plaintiff damages equal to one-half of that value.

Two witnesses testified at the first trial as to the value of Ample. This court summarized the testimony of the first witness — Joseph McCauley, then president of a firm which manufactured and sold die sets and related accessories to the tool and die industry, as follows:

"[I]n July 1969, he had considered investing in Ample and had occasion to then study its business, including an inspection of its premises, financial reports, machinery, equipment, and the nature of work it did. At that time he concluded that the value of the machinery and equipment was about $200,000, not including perishable tools which he additionally valued between $20,000 and $25,000. * * *

McCauley further testified that he had bought two other companies which engaged in the general type of business as Ample. Prior to testifying, he examined the financial records of Ample as prepared by Schwartz for the period of July 1969 through April 1970. He stated that the balance and income statements indicated Ample lost $14,300 in 1968, which was a tough year for the industry in the Cook County area; $57,600 in 1969; and $66,710 for the first 4 months of 1970. The records for March 1970 showed a profit of $9,630 on sales of $46,600, and for April a profit of $6,098 on sales of $37,660. In the last 8 months of the 1970 fiscal year, ending February 28, 1970, the records showed a profit of $34,412 and a loss in excess of $30,000, which profit he considered just fantastic. * * * He stated that to determine an evaluation he customarily used a multiplier from 8 to 15 times earnings. In the case of Ample the earnings were in the vicinity of $53,000 a year. In his opinion, based primarily on its profit picture, the value of Ample of April 30, 1970, was in excess of $500,000, evaluated by the use of a multiplier of less than 10 times earnings." (36 Ill. App.3d 654, 673-74, 344 N.E.2d 805, 820-21.)

The other witness who testified at the original trial as to the value of Ample was Jack Schwartz, former accountant for Ample. This court summarized his testimony, in part, as follows:

"In July 1969, he prepared a financial statement for Ample for the first 4 months of the fiscal year which began March 1, 1969, based upon the prior books and records. The statement as of June 30, 1969, reflected assets of $220,000, liabilities of $367,000, and a deficit capital of $147,000. In his opinion, the stock of Ample had a negative book value and the company was worthless. * * * There was a net operating profit in excess of $50,000 for the full 10-month period in which Schwartz kept the books." 36 Ill. App.3d 654, 674, 344 N.E.2d 805, 821.

On remand, both the judge in the original trial and the judge who ultimately heard the remand proceedings ruled over plaintiff's objection that the parties were entitled to present additional evidence as to the actual value of Ample prior to the transfer of its assets.

Dr. John Langum, an economist, testified on behalf of plaintiff that the value of stock represents the market value which would be paid in an arm's length transaction between a willing seller and a willing buyer, with both the buyer and the seller being adequately informed as to the nature of the business and financial position of the company; that when stock is not marketed as such, to determine its value one must look at the net income, present and prospective, in the light of the historical record of the company and then capitalize that by using an appropriate price multiplier; and that the multiplier, or price-earnings ratio, is derived from the actual appraisal of earnings of comparable companies that are in the same line of business, where market data is available. The witness stated that he reviewed the transcript in the original trial, the trial court's decree, this court's opinion, and Ample's tax returns for fiscal years ending February 28, 1962, through February 28, 1970; that he studied the tool and die business in the Chicago area and the United States; that he analyzed the price-earnings ratios for the leading industrial averages for companies engaged in manufacturing; that the 1970 price-earnings ratio of Standard and Poor's averages of the 400 industrial companies was 16.5, whereas the 1970 price-earnings ratio average for the Dow Jones industrials was 14.6; that the mean, modal and median price-earnings ratio as of June 1970 for all of the Standard and Poor's 92 industrial groups was about 12; that of the 32 companies using iron and steel engaged in metal work with businesses similar to that of Ample, the modal price-earnings ratio as of May 31, 1970, was 9 and the median was 11; and that the lowest price-earnings ratio among the 32 comparable companies was 7, and that ratio applied to only one of those firms. He further testified that the price-earnings ratio involved in the sale of the stock interest of Spalding to Zokoych in 1965 for the sale of Ample was 9; that the sales record from 1962 through 1970 for Ample demonstrated a strong and continued increase of demand for its products and was a very strong element in the financial position of the business; that based upon the data analyzed, he determined that the value of Ample immediately before the transfer of assets in May 1970 was $420,000; that this conclusion was reached by applying a multiplier of 7 times to the annualized rate of income of $60,000 based upon the company's income for the last 10 months of its operation; that he chose the smaller multiplier of 7 because Ample is a small company and ordinarily has a somewhat greater risk; and that he used income figures for the last 10 months of the company's operation (July 1969 to April 1970) because (a) Spalding came back to the business in July 1969 and the net income earned after that represented the results of the full input in management by both plaintiff and Spalding and (b) in 1967 through 1969 there was a recession in many parts of the metal manufacturing and tool and die business, and there was a recovery from the recession during the period of July 1969 through April 1970. On cross-examination, Dr. Landum testified that although all of the 32 comparable companies analyzed were larger than Ample, they were comparable in business undertakings and product line; and that in calculating Ample's net worth, it is appropriate to include capital gain on the sale of equipment as it appears to be part of the business of Ample to occasionally sell depreciable property which it has held for more than six months.

Jerome Engerman, a certified public accountant, testified for defendant that he reviewed Ample's tax returns and financial statements; that in determining its fair market value, he could not find any earning power to include; that the February 28, 1970, tax returns reflected a $32,069 loss; that this loss included an extraordinary gain on the sale of equipment of $16,325; that he added that gain back, thereby concluding that the corporation actually lost $48,394 for its operations in the fiscal year ending February 28, 1970; that the 1969 and 1968 tax returns reflected losses of $72,266 and $10,306 respectively; that the 1967 tax return showed a profit of $24,752; that the cumulative loss for those four years of operations was $106,714; that Ample's corporate statements for March and April of 1970 reflected income of $15,728 which, when analyzed without any adjustments, resulted in a profit of $94,368; that after deducting that projection from the cumulative loss of fiscal years 1967 through 1970, the five-year total net loss is $11,846 — or an average loss per year of $2,569; that from these calculations, he concluded that Ample had no history from which an earnings evaluation could be made; that the company's earnings in the last 10 months were $34,460 which, when analyzed, resulted in a projected income of $41,352; and that as of April 30, 1970, the fair market value of Ample's assets was $39,491. On cross-examination, the witness testified that he had not read the transcript of the previous trial; that he gave no special weight to the 10-month period prior to the transfer of Ample's assets, but rather weighed all of the last five years of the company equally; that he would tend to discount situations which occurred in the prior years that are not likely to recur; that he did not attempt to determine any reason why Ample turned around in its performance after July 1, 1969; that additional depreciation and interest expense for newly purchased equipment increased from 1967 to 1969 by $6,000 and $7,000 respectively; and that payroll for labor had been declining since July 1969, and the higher payroll prior to July 1969 was not likely to recur.

Dr. Allen Drebin, chairman of the Department of Accounting and Information Systems at Northwestern University, testified for defendant that from his review of Ample's income statement based upon Federal income tax returns, it did not appear that the company had earning power since it experienced losses for its last three accounting years; that he was very skeptical about the prediction of earnings based on a 10-month period taken from two different fiscal years; that income Ample received from the sale of equipment and machinery could not be used in determining future earnings because it is an event which is not likely to recur; that since a price-earnings ratio is a ratio of the market price of a stock divided by its earnings per share, it cannot apply to Ample because it had a loss; and that his methodology in reaching the value of a manufacturing company is to determine the current market value of the assets, subtract the identified liabilities, and then add any intangible assets and going concern value. On cross-examination, in response to a hypothetical question, the witness testified that using his methodology a company having annual earnings of $60,000 and net assets valued at $47,392 would be valued at $433,000 (including net assets); that the price-earnings approach utilized by Dr. Langum is a commonly used method of analyzing stock in publicly held corporations and is a factor to consider in evaluating closely held corporations; that a turnaround situation takes place when companies which had a history of loss suddenly expect to become profitable; and that if the causes of a turnaround can be determined and would continue in the future, it is an important consideration in valuing the business.

The trial court found that plaintiff did not establish that Ample had any earning power as of May 28, 1970. In making this finding, it rejected plaintiff's approach in determining earning power based upon the 10 months immediately preceding May 28, 1970, and adopted "the usual and customary historical approach to determine earning power." It also rejected plaintiff's projections based upon a comparison of Ample with various other corporations on the basis that the companies were not comparable to Ample. The court then awarded plaintiff $19,745.50 — an amount equal to one-half of what it determined to have been the value of Ample's assets. Plaintiff appeals from this judgment.


Plaintiff first takes the position that we found in our prior opinion that the evidence in the original trial was sufficient to establish a value of his half-ownership of Ample, and he argues this finding was binding on the trial court so that ...

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