Appeal from the Circuit Court of Cook County; the Hon. Richard
L. Curry, Judge, presiding.
JUSTICE WILSON DELIVERED THE OPINION OF THE COURT:
This appeal arises from the third trial between plaintiff and defendants where evidence was presented on the question of the value of Ample Tool and Manufacturing, Inc. (Ample), a closely held company in which Stephen Zokoych and Bruce Spalding (Spalding) were the principal shareholders. Ample ceased doing business in 1970.
In the first appeal (Zokoych v. Spalding (1976), 36 Ill. App.3d 654, 344 N.E.2d 805) we affirmed the trial court's award to plaintiff of compensatory damages and further held that because defendants were guilty of fraud and conspiracy, the court's award of punitive damages was not an abuse of discretion. The court's decision that the evidence did not establish a value for Ample was reversed, however, and the case was remanded with directions to determine the value of Ample and to award plaintiff additional damages for one-half that amount.
Four years later this matter was again presented on appeal, this time by plaintiff, and in a second decision we reversed the trial court's finding that Ample had no value beyond the net value of its assets. (Zokoych v. Spalding (1980), 84 Ill. App.3d 661, 405 N.E.2d 1220.) Because of the retirement of the first judge and the demise of the second, we remanded for a trial de novo to determine the actual value of Ample as of May 1970. The trial court found that Ample's value was $420,000 and entered judgment for plaintiff, along with prejudgment interest in the amount of $127,047 which was calculated at the statutory rate of 5% per year from 1970. Defendants now appeal. The allegations presented for review are: (1) whether the trial court improperly relied on testimony given by plaintiff's expert witness, John Langum, as to the value of Ample; and (2) whether the award of prejudgment interest was improper. We affirm in part and reverse in part.
First, plaintiff presented two witnesses who testified as to the value of Ample based on the 10-month period (July 1969 to April 1970) prior to Spalding's fraudulent transfer of the company's machinery and equipment. Both of these witnesses, Dr. John K. Langum, an economist, and Joseph McCauley, a Chicago businessman, had previously testified in the earlier trials.
Langum first explained that for closely held corporations, there are generally two methods to determine stock value. The first value, which in Langum's judgment was more useful, is to capitalize the earnings of a privately held company, which initially calls for ascertaining the amount of net income of the company and then multiplying the amount by a determined price-earnings ratio. *fn1 Since there are no market prices for the stock of a privately held corporation, one must look at the price earnings ratio of the most comparable public companies with listed stock. The second method of evaluation is to relate the price at which a company is purchased to its book value. The market book value is not as acceptable or efficient as the capitalization of earnings method but is sometimes used, Langum stated. Although he used this second method, it was only to check his "basic evaluation."
In Langum's judgment, after studying Ample's tax returns for 1962 through 1970, its financial statements for 1969 and 1970 as well as other factors, the market value of Ample as of April 30, 1970, was $420,000. This figure was based on the company's net income as of April 1970 of $60,000 and a price earnings ratio of seven. Langum then explained that in order to obtain the $60,000 figure he relied on the records and statements of Ample's accountant, Jack Schwartz, who testified at the first trial that Ample's net income for the 10-month period of July 1969 to April 1970 was approximately $50,000. Langum then divided this figure by 10 and multiplied it by 12 in order to yield an annual rate. The 10-month period was used in his analysis because the tool and die industry had recovered from an industry recession by that time. Also, in 1970 Ample's sales volume had increased 55% over what it was in 1962. There was a "good market" and "market possibilities [were] being utilized," Langum stated. Langum then explained that he selected 32 companies to compare to Ample because their businesses were most similar to Ample's.
Testifying further, Langum stated that he relied on McCauley's testimony in the first trial as to the 1969 market value of Ample's machinery and equipment, but that he adjusted this figure by making a deduction for the sale of certain machinery and equipment and by adding the amount of machinery and equipment purchases. Depreciation was also deducted, which yielded a net book value for these items.
Under cross-examination, Langum testified that 23 of the 32 companies he had selected to compare to Ample were not strongly financed, based on their earnings and dividends; that he compared the number of employees of these companies with Ample but that that comparison was not a criteria as to whether to include or exclude the company and that although he did not compare the number of plant facilities that each company had with Ample, he did compare the earnings history of these companies to determine whether the general business of Ample and the 32 were similar. Langum did not compare the companies' dividend history, debt structure or management performance but relied on information provided by the American Institute of Management. He stated that the basis of his comparison of the companies with Ample was principal business undertaking and product line. None of the 32 companies showed a negative net worth on their balance sheets.
Testifying further under cross-examination, Langum said that he had not studied the ability of the 32 companies to service their debt although he was aware that in certain years they experienced net losses which limited their ability to do so. He also did not compare the nature of Ample's debt to its net worth with the nature of the debt of the companies to their net worth. Langum had never made a valuation of a company based on a 10-month earning record and did not know whether any of the selected companies needed an infusion of capital to continue its operation. He further acknowledged that he "perhaps" should have studied whether any of the 32 companies were financially weaker than Ample but explained that he used the price earnings ratio of seven because it was the lowest ratio for any of the companies.
Under redirect examination Langum said that Ample experienced a "very strong and impressive increase in dollar volume" starting in 1962, followed by a loss in profits in 1967 from $24,751 to a deficit of $10,306 in 1968. He also said that he studied the comparative companies' investments, earnings and the progress of their sales and profits and that these factors formed "a very adequate basis" to determine which companies would be selected. Langum further stated that he made a substantial discount in the multiplier to account for differences in size and other factors. This analysis resulted in Langum's final decision to apply a price-earnings ratio of seven.
Next to testify was Joseph McCauley, president of Marathon Corporation, which manufactures components for metal die sets and springs. McCauley testified that he had been employed by Marathon for 27 years. His qualifications included an undergraduate degree in chemistry and math from Northwestern University and "about 50 percent of the work done" for a master's degree in business administration. McCauley also held a law degree from John Marshall Law School.
McCauley stated that he was familiar with the metal manufacturing industry in the Chicago area because he had sold products to these companies for over 20 years. Also, Marathon had been a member of the Tool and Die Institute of Chicago for 25 years. McCauley stated that he had extensively purchased and sold machinery and equipment used in the metal manufacturing industry, most recently at an auction in 1980. He said that his company supplied die sets as well as other materials to Ample from 1962 to 1970 and that he was aware that plaintiff was responsible for the company's promotion and sales and that Spalding oversaw production and manufacturing. In McCauley's opinion, the two worked extremely well together.
McCauley first made an evaluation of Ample in 1969 when plaintiff asked whether he would be interested in buying into the company. McCauley evaluated Ample's assets, income, books and records and conducted a physical view of the machinery and equipment in order to determine a reasonable purchase price. He stated that the final value he placed on the machinery and equipment was $200,000 and small tools were valued at $25,000. Although plaintiff later rescinded his "buy in" offer to McCauley, McCauley continued to do business with Ample until 1970.
Further testifying, McCauley stated that after Spalding returned to Ample in 1969 its operations immediately changed from unprofitable to profitable as determined by the company's financial statements and bill payments. McCauley's company was Ample's largest trade creditor, he said, and after Spalding returned to Ample acceptable terms of payment were arranged whereby McCauley began receiving regular monthly payments for approximately three months but then, "they started slowing down again."
Prior to trial, McCauley reviewed Ample's tax returns from 1962 through 1970 and its monthly reports for that period as well. He stated that based on these documents, the company's financial statements (particularly after Spalding's return in 1969), and his personal knowledge of Ample's assets, in his opinion, Ample's value immediately prior to the transfer of its assets in May 1970 was $650,000.
McCauley then testified that his calculations revealed that Ample's sales averaged $41,000 per month for the four-month period prior to Spalding's departure but increased to $50,000 per month after he returned, which McCauley attributed to a general recovery in the economy and because plaintiff was not beset by plant responsibilities and was "free to do what he did best." Expenses for outside services declined from $8,300 to $4,288 per month as did labor costs.
McCauley further testified that he used $60,000 as Ample's yearly earnings instead of $53,000, which was the figure he used in the first trial because, he said, his calculations during that trial were based only on earnings for 10 months rather than one year. Using a second or alternative method of evaluation which took into account Ample's net assets, equipment appreciation, the owners' salaries and perquisites (boat, horse and other items), McCauley said that Ample's estimated value was $722,145. He then took the average between his valuation at the first trial, $571,000 and his second valuation, $722,000, which yielded his current and final valuation of Ample of $650,000.
Cross-examination disclosed that although McCauley had previously purchased metal companies, he had not purchased a tool and die company and had never used a multiplier as part of a formula to arrive at the value of a company when making a purchase. Also, when McCauley examined Ample's plant equipment he did not know how much of that equipment did not belong to Ample. This factor was not "something you really focus your attention on right at the beginning," he explained. Testifying further, McCauley said that he added discretionary cash into his evaluation of Ample by "adding back" the owner's salaries, interest, and perquisites because it was money which could be used at the complete discretion of plaintiff and Spalding. He explained that his primary consideration in evaluating a company was to first determine how long it would take him to recoup his purchase price if he bought the company and that the company's earning history and customer lists would be important factors in making this decision.
Next to testify was plaintiff Zokoych who reviewed the history of Ample, his co-ownership with Spalding and the events leading up to the cessation of business in 1970. Plaintiff answered questions about his and Spalding's salaries after Spalding returned to the company in 1969, personal expenses Ample paid for and a company loan for over $100,000 from defendant West Suburban Bank as well as a loan from the same bank to Spalding for $15,000 which plaintiff stated he had not been aware of at the time it was made.
Cross-examination disclosed that Ample did not own any copyrights, did not have any secret processes to manufacture tools and that its only trademark was its name. Following plaintiff's testimony about the various metal products that Ample manufactured, redirect examination was waived and plaintiff rested his case.
Defendant then called Walter Bissell, a chartered financial analyst and group vice president of Duff and Phelps, an investment analysis and financial consulting firm. In Bissell's opinion, Ample had no meaningful value or earning power as of April 1970. He testified that after Spalding returned to Ample the company showed a fairly impressive sales volume for July, August and September which exceeded sales for the same period in 1968. September through May 1970 showed a downward trend and by March and April sales had fallen to levels below the comparable period in 1968.
Testifying further, Bissell stated that although Ample reported $50,000 in pretax earnings for the 10-month period, approximately $49,000 of that was registered in three months. Consequently, Bissell said, the following seven months were at a break-even level and the overall trend was unfavorable.
A final step Bissell took in analyzing Ample's performance was to exclude from earnings a $16,000 sale of machinery in 1969 because, he said, Ample was not in the business of buying or selling machinery and equipment. Bissell also reduced earnings by $36,000 for plaintiff's and Spalding's salaries.
As a result of this analysis, Bissell concluded that Ample had a very weak financial condition with a negative working capital and negative net worth. He further determined that Ample's pretax income for the 10-month period was $9,128, versus a reported figure of approximately $50,000. Ample had a "break even level of profitability subsequent to September 1969," he said.
Testifying further, Bissell said that he did not know of any company that had been valued on the basis of an annualization of 10 months' earnings. In this case, he added, the company experienced earnings for an initial period, followed by losses for three years. Bissell stated that when a company either had no earnings or no meaningful earnings, one must look at asset values either through liquidation or a gradual winding down of business. When a company does have earnings the approach Bissell used was a comparative company approach between the private company and the most similarly publicly traded company. In this analysis, the final step is to look at the public market valuation measures for the public companies and then assign a value to the private company based on its ranking within this peer group. Bissell did not use company comparisons since, in his opinion, Ample had no earning power, equity or working capital.
Bissell also testified that none of Langum's 32 companies were directly similar to Ample and that few, if any, were directly comparable to each other even though all were engaged in metal work and several were affected by the same industry and economic factors. But unlike Ample, he said, all of the companies showed a positive working capital or assets in excess of liabilities at the end of their latest fiscal year and all showed a positive net worth. Several were "large enterprises," Bissell pointed out, adding that one company had a net worth of $191 million and another $320 million. The lowest net worth figure was $2.4 million. By contrast, Ample's net worth was a negative $90,000. Bissell concluded that for these reasons, there could not be a meaningful comparison between those companies and Ample.
In conclusion, Bissell stated that he would have classified the money advanced by the bank to plaintiff and Spalding as loans rather than capital investments because they had been treated as such by the Internal Revenue Service. He added that if a company has no demonstrated earning power, ...