Marcus v. Quattrocchi, 2014 U.S. Dist. LEXIS 19041 (Feb. 4, 2014)

In an estate and trust case featuring a major real estate family, the plaintiff beneficiaries retained two experts to prove damages resulting from the alleged improper depletion of trust assets by way of an investment company in which the defendants had a stake. In their Daubert motion, the defendants attacked one of the experts, a highly credentialed business valuator, arguing that he was not qualified to value real estate, the investment company’s principal asset. Also, his valuation methodology was unreliable. The court took a more liberal attitude toward admissibility.

The decedent was the head of a leading real estate investment, development, and asset management company. In 1971, her lawyers designed an estate plan that pivoted around a revocable trust that became a flashpoint between the plaintiff beneficiaries and the defendant trustees. The plaintiffs were the decedent’s two great-granddaughters; the defendant trustees included granddaughters.

Trustees’ broad discretion. The trust had several noteworthy features: (1) it gave the trustees “absolute and uncontrolled discretion” to provide trust income and principal to the decedent, and after her death, to her son; (2) it exempted the trustees from liability for conflicts of interest related to dealings with entities in which they had a monetary interest; and (3) it permitted the decedent’s son to “appoint” trust assets to beneficiaries of the trust during his life or by will. After the son’s death, the trustees had an obligation to distribute the remaining trust assets in specified proportions to his widows, children, and grandchildren.

The estate plan simultaneously created an investment company that was a partnership between the trust at issue and other family trusts. It provided for the transfer of 90% of the trust’s real estate holdings to the company in exchange for a 50.6% controlling ownership interest in the company. The initial capitalization was $1.6 million, to which the trust contributed approximately $800,000. The son was the investment company’s general manager and also the sole owner of a third entity that managed all of the family’s properties. Two of the trustees were his daughters.

The partnership agreement also provided for redemption of 49% of the trust interest following the decedent’s death and redemption of any remaining interest within 10 years. The decedent died in 1972, triggering redemption for $392,000 of the 49% of the $800,000 trust interest. The final redemption did not take place until 1987 for nearly $624,000. Since the defendant granddaughters were beneficiaries of the investment company’s remaining partner-trusts, each time the trust redeemed a portion of its interest in the partnership, their interests increased such that they owned all of the real estate assets that the trust originally contributed. The son died in 2005.

The plaintiffs sued the trustees in federal court (S.D.N.Y.) under a number of theories, including breach of trust, common law fraud, fraudulent conveyance, and Rule 10b-5 securities fraud. In essence, they accused the trustees of allowing the investment company to acquire the trust’s assets and subsequently redeem them for inadequate consideration. Moreover, they allowed the son to divert trust assets to entities in which he and they had a private financial stake. Also, they concealed the existence of the trust and its substantial assets.

The plaintiffs retained two damages experts to value the assets underlying the investment company and determine the trust deficiency resulting from the trustees’ actions during the life of the trust. The defendants offered their own expert. In conjunction with their motion for summary judgment, the defendants also filed a Daubert motion to exclude the plaintiffs’ experts, reasoning that without damages evidence the plaintiffs had no case.

‘Imprecise nature of real estate valuation.’ The plaintiffs’ first expert was a CPA, who also was a certified fraud examiner, and an accredited senior appraiser in business valuation. To calculate the trust deficiency, he not only considered the investment company’s real estate but “all of [its] assets other than the property, plant and equipment” and subsequently subtracted all liabilities to “achieve a 100% control, marketable value of equity.” He said he used rent multipliers that the decedent appeared to have generated in 1971 and rent rolls that the defendants provided as evidence of income.

The defendant’s expert valued the investment company by determining the market value of its properties based on his estimate of the partnership’s net operating income. He said the “typical discount range” for a minority ownership was “anywhere between 25% and 60%.” He selected a 36% rate. The trust’s minority ownership in the investment company, he said, was “subject to market resistance.” (The court’s opinion does not provide any figures or additional details.)

1. Qualification. The defendants first claimed the plaintiffs’ expert lacked the qualifications to appraise real estate, which, they said, was the partnership’s principal asset. The plaintiffs retorted that the investment company “was not a piece of real property,” but “a business whose assets included stocks and bonds, mortgages receivable, equipment,” as well as “accounts receivable”—all in addition to real estate.

The court agreed with the plaintiffs and found the expert was qualified.

2. Methodology. Next, the defendants objected to the expert’s methodology, particularly what they called his application of “rent multiplier[s] of unknown origin to rental income.” Without verification that they reflected the multipliers used in the market, the expert’s calculations were unreliable, the defendants argued.

The court was not persuaded. The market value of real estate, it said, “was difficult to establish with precision, particularly when there is no ready market for the property,” as likely was the case here. If the defendants wanted to challenge the expert’s multipliers, they could do so during cross-examination. The expert’s approach—adding up the assets of the partnership and subtracting its liabilities—was not unreliable as a matter of law, “particularly in light of the imprecise nature of real estate valuation,” the court added. In fact, it was “hard to see” how his approach differed materially from that of the defendants’ expert. For these reasons, the court declined to exclude the testimony.

Complementary valuations. The plaintiffs’ second expert, a certified general appraiser, reviewed the income and expense statements for the assets the plaintiffs’ first expert valued. Because the defendants did not make the investment company’s relevant tax returns available, he was unable to perform a full real estate appraisal. Therefore, he relied on the listed insurance expense for each property to calculate the value of the buildings the company owned but not the land on which they stood. Insurance value, he emphasized, did not include land value and as such did not represent the entire value of the property.

The defendants did not object to the appraiser’s qualifications but argued his method undervalued the investment company and thus rendered his valuations “useless” to the jury.

The court saw it differently. Merely because those valuations valued some but not all of the investment company’s assets did not make them irrelevant, said the court. To the contrary, his opinion could complement that of the first expert since both opinions concerned the value of real estate assets that the investment company owned in 1987, the year of final redemption. Therefore, the court also admitted the plaintiffs’ second expert and denied the defendants’ Daubert motion and summary judgment motion.

By: Kim Onisko