Senior Housing Capital, LLC v. SHP Senior Housing Fund, LLC: Chancery Court Articulates Standard for Judicial Review of Contractually Designated Appraisal Process
May 22, 2013
In Senior Housing Capital, LLC v. SHP Senior Housing Fund, LLC, the Court of Chancery considered, inter alia, the level of judicial review applicable to an appraisal process required by an LLC agreement. The Court held that “[w]here, as here, (i) a contract written by one party, (ii) says that that party will make a payment based on a formula, (iii) the formula says that an input into the formula will be determined by an appraiser, and (iv) the party making the payment gets the contractual right to select the appraiser, the parties have clearly agreed to be bound by that appraiser’s professional judgment.” The Court will not disturb the results of such an appraisal unless the objecting party can show that the result was tainted by improper conduct of the other party.
The parties to this dispute were investors in SHP Senior Housing Fund, LLC (the “Fund”), a company formed to invest in retirement homes. The main plaintiff (“Plaintiff”) was the former manager of the Fund and held a minority interest. The main defendant (“Defendant”) held a majority interest in the Fund. Under the Fund’s LLC agreement, Plaintiff was to receive an “Incentive Distribution” at the end of 2007 and a payment in redemption of its limited liability company interest when Plaintiff withdrew as a member of the Fund. Both payments were to be calculated based upon the fair market value of the Fund’s assets, and the LLC agreement provided that such value was to be determined by an appraiser selected by Defendant. The LLC agreement did not provide a mechanism whereby a party unhappy with the results of an appraisal could appeal to a court for review.
In 2007, the assets of the Fund were appraised for purposes of calculating the Incentive Distribution. In 2008, Plaintiff withdrew from the Fund, and a new appraisal was conducted for purposes of calculating the redemption payment. The appraisal showed substantial appreciation in the value of the assets, and such appraisal would have entitled Plaintiff to payments in excess of $50 million. Defendant balked at the high payment and pressured Plaintiff to renegotiate the terms of the LLC agreement. Failing to achieve a compromise, Defendant pressured the appraisers to revise their estimates and hired additional appraisers, hoping to receive lower estimates. Defendant did not pay either the Incentive Distribution or the redemption, and Plaintiff filed suit.
The key issue to resolving both the Incentive Distribution and the redemption payment was the appropriate judicial standard of review where “one of the parties seeks to dispute the value determined by the contractually designated appraiser.” The Court agreed with Plaintiff and held that a court may not second-guess appraised values that have been contractually committed to determination by an expert, but a court may consider claims that the appraisal process has been tainted by the conduct of one of the parties. In reaching this conclusion, the Court noted that Delaware respects the freedom of contract, and when parties agree that the valuation of the property will determine a contractual payment, the parties may also agree to establish the level of judicial review over that valuation. Here, the parties designated an appraiser to determine definitively the value of property and did not provide for substantive review by a third party; therefore, a court may not review the appraiser’s determination of value. Judicial review was limited to a determination of whether misconduct by the opposing party tainted the appraisal process.
The Court did not find any evidence of misconduct by Plaintiff. However, the Court found that Defendant’s conduct in pressuring the appraisers to reduce their estimates improperly tainted the appraisal process, thereby breaching the implied covenant of good faith and fair dealing. Therefore, for purposes of calculating the Incentive Distribution and the value of the limited liability company interests, the Court ruled that the parties must use the original appraisal values.