Opinion
Civil Action No. 12845.
Date Submitted: September 16, 1999.
Date Decided: November 23, 1999.
Robert E. Schlusser and Bryan E. Keenan, Esquires, of SCHLUSSER REIVER, P.A., Attorneys for Plaintiffs.
David A. Jenkins, Esquire of SMITH, KATZENSTEIN FURLOW, Attorney for Defendant, Anne M. Magness.
William H. Sudell, Jr. and Denison H. Hatch, Jr., Esquires, of MORRIS, NICHOLS, ARSHT TUNNELL, Attorneys for Defendant, Donald Magness.
MEMORANDUM OPINION
This action is brought by plaintiffs, Susane Stegemeier and Diane Mulrooney, who are beneficiaries under a residuary testamentary trust created under the will of their late father, A. Gray Magness (the "decedent"). The defendants, Anne Magness and Donald Magness are, respectively, the administrator of the decedent's estate (the "Estate") and the testamentary trustee under his will. In this action the plaintiffs claim that the defendants breached fiduciary duties owed to the Estate in a self-dealing transaction in which they caused the Estate to sell certain tracts of land to a corporation that they owned, for less than fair market value.
In a post-trial Opinion dated January 6, 1998, this Court found that the defendants had breached no fiduciary duties. The Court entered judgment in their favor. On appeal, the Delaware Supreme Court reversed. It concluded that the defendants' actions should have been reviewed under principles of trust law rather than corporate law, with the result that the defendants, rather than the plaintiffs, should have had the burden of persuasion. The case, accordingly, was remanded to this Court to decide whether the defendants had carried their burden of showing that the lots which the Estate had sold to the defendants' corporation were sold at fair market value.
Stegemeier v. Magness, Del. Supr. 728 A.2d 557, 559-60 (1999).
This is the Opinion of the Court on remand, following supplemental briefing and argument. I conclude, for the reasons that follow, that the defendants' corporation, Magness Builders, paid fair market value for the lots at issue, and that the defendants have properly discharged their burden of proof on that question. Accordingly, judgment will be granted in the defendants' favor.
I. BACKGROUND
I find the facts to be as follows: A. Gray Magness died testate on December 17, 1980. The decedent's will named his brother, Donald Magness, as the Trustee of his testamentary trusts, including the trust involved in this case. Anne Magness, the decedent's widow, and Charles Allmond, III, Esquire, a son of the decedent's long-time attorney, were appointed the co-administrators of the Estate.
At the time of his death, the decedent owned 171 lots in a real estate development known as Harmony Crest (the "lots"). He also owned 83% of the stock of Magness Construction Company (the "Company"), the remaining 17% of which was owned by Donald Magness.
Because of the extremely depressed residential construction market in the early 1980s, the Company faced severe financial problems. As a consequence, the Company was forced to liquidate some of its real estate holdings (including the lots) to raise cash needed to pay its debts. The lots were listed with a local real estate agent who actively tried to sell them, but without success.
During this period Donald Magness, on the Company's behalf, applied to several banks for mortgage financing. The banks consistently refused to extend mortgage financing because of the Company's straitened financial circumstances. One bank, Colonial Mortgage, suggested that the Company's chances for obtaining financing would be improved if the vehicle to apply for and carry the mortgage loan were a new, debt-free corporation. In response to that suggestion, Anne and Donald Magness formed a new corporation, Magness Builders, Inc. ("Magness Builders") on November 4, 1982. Donald owned 51% and Anne owned 49% of Magness Builders' stock. Donald Magness then proposed that the Estate sell the Harmony Crest lots to Magness Builders, which would obtain the necessary financing. That ultimately is what occurred, and led to this lawsuit.
Over the next six years, Charles Allmond and Anne Magness, as co-administrators of the Estate, caused the Estate to sell 409 lots to Magness Builders in five separate transactions, for approximately $2,062,500. The sale price of the lots over that period ranged from $3,500 to $6,500 per lot, as follows:
December 29, 1982 55 lots for $3,500 each July 26, 1983 55 lots for $4,000 each December 20, 1984 54 lots for $4,500 each September 24, 1986 100 lots for $5,000 each October 11, 1988 75 lots for $6,000 each 70 lots for $6,500 each
After the first of these sales, the Estate contracted with New Castle County in early 1983 to improve 152 lots. It is undisputed that employees, material, and equipment of the Company were used to improve twelve of those lots and to perform construction work on certain of the other lots.
The Estate had previously conveyed 45 of these lots to Magness Builders, while the remainder continued to be owned by the Estate.
II. THE CONTENTIONS AND ISSUES
The plaintiffs' initial claim is that the defendants cannot carry their burden of persuasion unless they prove by clear and convincing evidence that they paid fair market value for the Harmony Crest lots. The plaintiffs contend that the defendants have failed to carry that burden, for several reasons.
First, they argue that all of the lots were "improved," yet were sold to Magness Builders at lower prices appropriate for "unimproved lots." Plaintiffs claim also that the defendants failed to show otherwise at the trial, because they erroneously relied upon land appraisals that failed to take into account the fact that the lots were improved when they were sold. Because the defendants' valuation analysis was flawed, plaintiffs contend, defendants' valuation should be rejected in favor of the more accurate lot valuation established by the plaintiffs' expert valuation witness.
In response, the defendants argue that the applicable standard of proof is the "preponderance of the evidence" standard, not "clear and convincing evidence." Alternatively, defendants contend that regardless of which standard is used, they have successfully established that the lots were unimproved at the time they were sold, and that the lots were sold for fair market value. The defendants emphasize that the source of the evidence they adduced on this subject was from highly credible witnesses who had direct knowledge of the facts. The defendants urge that their valuation of the lots merits far more credit than does the plaintiffs' valuation, because the latter valuation rests upon an improper and unsupported methodology and upon "comparable" sales that were, in fact, not comparable.
These contentions raise three discrete issues. The first is what standard or quantum of proof the defendants must show to carry their burden of persuasion. The second is whether the lots were improved or unimproved at the time they were sold. The third is which party's expert appraisal is the more reliable evidence of the fair market value of the lots. Those issues are now addressed.
III. ANALYSIS
A. The Standard of Proof
Neither side disputes (nor, could they given the Delaware Supreme Court's holding) that the defendants bear the burden of persuasion. What the parties contest is the quantum of evidence required to discharge that burden. The plaintiffs rely upon Walls v. Peck as support for their proposition that the standard is "clear and convincing" evidence. The plaintiffs also rely upon language in Vredenburgh v. Jones, that a trust fiduciary's evidence in a self-dealing transaction must be "unimpeachable and convincing."
Del. Ch. , C.A. 497, Mem. Op. at 7-8, Marvel, C. (October 24, 1979).
Del. Ch. , 349 A.2d 22, 33 (1975).
The defendants respond that the "preponderance of evidence" standard is the law of the case as established explicitly by this Court and implicitly by the Supreme Court. In its post-trial Opinion this Court held that: "Had the plaintiffs shown self-dealing by defendants, the results would have been to shift to the defendants the burden of establishing by a preponderance of the evidence that the Estate received fair value for the Lots." The defendants point out that the Supreme Court, although concluding that the burden of proof had shifted to the defendants by virtue of their self-dealing, did not disturb this Court's "preponderance of the evidence" ruling. The defendants further argue that the phraseology used in Vredenburgh ("unimpeachable" and "convincing") cannot be read to signal a departure from that standard. Finally, the defendants emphasize that while Wall does state that evidence supporting a trust fiduciary's defense of its actions must be "clear and convincing," the Walls Court cited only Vredenburgh, which (defendants urge) did not clearly mandate that higher evidentiary standard.
Stegemeier v. Maganess, Del. Ch. , C.A. No. 12845, Mem. Op. at 5, Jacobs, V.C. (January 6, 1998) (emphasis added).
Wells, supra note 3.
I find it unnecessary to venture into this thicket, because even if the heightened standard of proof is applicable, I conclude that the defendants have satisfied that burden. Accordingly, only the second and third issues need be decided.
B. Were the Lots "Improved" at the Time of Their Sale?
The second issue (to reiterate) is whether the lots were improved or unimproved at the time they were sold. The factual basis for the plaintiffs' position that the lots were sold for less than their fair market value, is that the lots were improved yet were sold at price levels appropriate only for unimproved lots. The plaintiffs urge that the defendants failed to establish that the lots were unimproved at the time of the sales, because the defendants' witnesses had no direct knowledge of the facts, and because the defendants did not introduce any documentary evidence to support their position.
I conclude that all the lots were unimproved at the time of their sale, except for the twelve Lute Court lots, which all parties agree were improved. With respect to those twelve lots, the defendants have satisfied me that Magness Builders either paid for all the improvements directly or reimbursed the Company for any improvements paid for by the Company. My reasons follow.
1. The 397 Unimproved Lots
I am persuaded by the testimony of Mr. Charles Allmond, who this Court previously found was disinterested and independent in connection with the sales, and whose disinterestedness and independence was confirmed by the Delaware Supreme Court. Mr. Allmond testified that the 397 lots were unimproved at the time of their sale. One reason why he so concluded was that when the lots were sold no releases of mechanic's liens were required, and that had the lots been improved such releases would have been required. Other reasons were that the Internal Revenue Service had taxed the lots as unimproved, and the 1980 appraisal of the lots (carried out after A. Gray Magness' death) stated that the lots were unimproved. Finally, as a co-administrator of the Estate, Mr. Allmond was in a position to testify that the lots could not have been improved when they were sold, because throughout the relevant (1980-1982) time period, the Estate lacked the requisite financial resources.
See Stegemeier, supra note 1.
Mr. Allmond testified: "[the mortgage lender would have thrown up a red flag if the property had had improvements on it, unless we got a release of mechanic's liens for any of this work to have been done. No such release was required." (Tr. at 398.)
Tr. at 398.
Tr. at 399-400.
The plaintiffs attempt (unsuccessfully) to impeach Mr. Allmond's testimony. They argue that he was the defendants' only witness on this issue and lacked direct knowledge that the lots were unimproved. The plaintiffs point out that the Estate contracted to make improvements to the lots and that the Company (83% of which the Estate owned) paid for those improvements." I conclude otherwise, and find Mr. Allmond's testimony to be credible and sufficient. Mr. Allmond's position as co-administrator afforded him the opportunity to gain in-depth familiarity with the Estate's business affairs. Moreover, the fact that the Estate may have contracted for improvements does not establish that the lots (other than the twelve Lute Court lots) were improved at the time they were sold. There is no persuasive evidence that they were.
Tr. at 90-92.
2. The 12 Lute Court Lots
I also find that the defendants paid for the improvements or reimbursed the Company for any improvements to the twelve Lute Court lots that existed at the time they were sold. Donald Magness testified that Magness Builders had paid for the installation of the sewers on Lute Court and the other improvements, because Magness Builders was the only entity that had the funds to do so. The Company had been denied a construction loan, whereas Magness Builders was granted a construction loan and was able to draw down the cash needed to pay for the improvements. As Donald Magness put it:
Tr. at 331.
Magness Builders was the only entity that had any money at that time. Magness Construction was denied the construction loan. Magness Builders had the construction loan in place, or would be putting it in place, and had the ability to draw for this work. On the construction loan, a portion of that was for the improvements. And we would submit a voucher to Colonial Mortgage with the contract, or with the bill from the contractor — here it was DiSabatino Brothers — to Colonial Mortgage Service. They would issue the check out of our construction loan for the improvements.
Tr. at 33 1-32.
The plaintiffs argue that Donald Magness' testimony is unsubstantiated, because he said only that he "believed" that Magness Builders reimbursed the Company, not that he definitely "knew" that that was the case. Moreover (plaintiffs contend), the defendants failed to adduce any direct evidence to corroborate Mr. Magness' testimony. Lastly, the plaintiffs insist that the Company must have had sufficient cash to pay for the improvements, because if the Company had no cash, how could it have made any payments that necessitated Magness Builders later reimbursing it?
Tr. at 325.
I find these arguments unpersuasive. To begin with, Donald Magness was the only witness called to testify on this issue, but only because the testimony of the only other person having direct knowledge — Donald's son, Kenneth Magness — would have been repetitive of his father's testimony. Moreover, no records of payments for the improvements were introduced because, despite a diligent search, the records could not be located. Finally, the plaintiffs' suggestion that the Company must have had cash rests upon an inference that was factually unfounded. The reimbursements made by Magness Builders were for (i) labor and supplies, not cash disbursements, and (ii) the use of the Company's assets to build houses on those lots after they were sold, not for improvements made at or before the time the lots were sold.
Donald Magness testified that he looked for, but could not find the actual documents. (Tr. at 33 1-32.)
C. Whether Magness Builders Paid the Fair Market Value for the Lots
The third and final issue is whether the price received for the lots represented fair market value. To resolve that question, the Court must decide which party's fair market value appraisal of the lots is the more accurate and reliable. If the plaintiffs' appraisal is the more reliable, then it would follow that Magness Builders did not pay fair market value for the lots, and damages would be awardable. If, however, the defendants' appraisal is found to be the more reliable, then it follows that Magness Builders did pay fair market value for the lots, and would be entitled to judgment in its favor.
Turning first to the defendants' expert valuation, the plaintiffs' only criticism of that appraisal is that it is based upon the incorrect assumption that the lots were unimproved at the time they were sold. The Court, however, has found that assumption to be correct. Because the plaintiffs do not fault the defendants' appraisal in any other respect, and because the plaintiffs' expert's appraisal testimony is clear and convincing, it will be accepted unless the plaintiffs' evidence is found to be more persuasive. I conclude, for the following reasons, that it is not; indeed, in my view the plaintiffs' appraisal is not persuasive at all.
The plaintiffs' expert appraiser, Mr. Thomas Reynolds, used the comparable sales method. He first obtained the deeds for the lots at issue and then located comparable properties that would have sold over the same ten-year period as the lots at issue, adjusting for the differences between the comparable and the subject properties. From his research Mr. Reynolds concluded that the value of an approved but unimproved lot in 1980 was $4,000. Using $4,000 as his base figure, he then increased that amount by a constant 12% each year, up through and including each of the four dates of sale. In that manner he arrived at his estimates of fair market value, as follows: Transaction Date Actual Sales Price Reynolds' Value
Tr. at 198.
Tr. at 205-06.
December 29, 1982 $3,500 $5,100
July 26, 1983 $4,000 $5,380
December 20, 1984 $4,500 $6,055
September 24, 1986 $5,000 $6,900
October 11, 1988 $6,000/$6,500 No Estimate
The plaintiffs' appraisal labors under several infirmities. To begin with, Mr. Reynolds' valuation methodology was unsupported. That methodology assumes a $4,000 per lot base value (representing the value of the lots in 1980) and then uniformly increases that base value by 12% per year for each of the four transfers. The defendants' expert witness, Mr. Robert McKennon, testified that he had never seen that appraisal methodology (or anything similar to it) employed during his years as an appraiser, nor was he aware of this approach having been validated in any authoritative appraisal texts or courses. The plaintiffs introduced no evidence to defend this approach.
Tr. at 204-06, see also PX 39, ¶ 30-32, Tab H.
Tr. at 454.
Equally important, the $4,000 base value and the 12% inflation factor were at odds with objective reality. The plaintiffs introduced no evidence to support their expert's assumption that the lot prices would increase uniformly by 12% each year. Moreover, the credible evidence showed that the $4,000 base estimate was "significantly higher than the market was at that time, or, indeed, even a couple of years later." As Mr. McKennon testified, at that time the local area and the entire nation were undergoing a serious recession. As a consequence, the real estate market was relatively flat, with the average annual price appreciation being only 5%.
Tr. at 454.
Tr. at 455-56.
The plaintiffs' expert's "comparable sales" were also faulty, and as a consequence, each of the five transfers was overvalued. Mr. Reynolds' determinations of the value of the lots were flawed because his estimates of those values at particular points in time was higher than the actual sales prices of comparable lots during the same year. Additionally, Mr. Reynolds' "comparable" lots were for the most part, not comparable, because they included lots that were larger than the subject lots, lots developed for commercial (as opposed to residential) use, lots located in areas where the land was substantially more valuable than the Harmony Crest area, lots that were improved, and lots upon which more expensive homes had been built.
The December 1982 lots were estimated to have a fair market value of $5100 each. (PX 39 at 33). However, during cross-examination, Mr. Reynolds conceded that this value was higher than every comparable lot sale in his report until three years later. (Tr. at 230). The July 1983 lots were estimated to have a fair market value of $5,380 each, (PX at 33), but no comparable actual sale at that price took place until March 1986. (Tr. at 232). Mr. Reynold's December 1984 fair market value estimate of $6,055 had no counterpart in reality until two years thereafter (Tr. 232), and his September 1986 valuation was $6,900, at which time the comparable lot he had used had sold for only $5,520. (Tr. 235).
Tr. at 2 12-28, 458-63.
Far more reliable and persuasive are the conclusions of Mr. MeKennon, the defendants' appraisal witness, who also used the comparable sales approach. To avoid any suggestion of bias, Mr. McKennon was not told the actual sales prices of the lots and he did not know those prices at the time he testified at trial. Mr. McKenn on:
Tr. at 442-44.
"[r]esearched the market for sales of groups of lots that could be related to the Harmony Crest lots. . . [and]. attempted to find groups of lots that sold in the approximate decade from 1980 through 1990. That basically bracketed the transaction date.
[He] looked for building lots that had locations which were generally comparable, similar zoning types, similar economic characteristics. . . [and]. . . tried to concentrate on as large a group of lots as [he] could find, since the Harmony Crest lots were an extremely large package of lots."
Tr. at 444-45.
I find Mr. McKennon's appraisal methodology and his testimony to be sound. His appraisal, which the Court accepts, establishes that the defendants, through Magness Builders, paid fair market value for the lots that were sold, as follows:
Transaction Date Sales Price (per lot) McKennon's Fair Market Value (per lot)
December 29, 1982 $3,500 $3,500
July 26, 1983 $4,000 $3,800
December 20, 1984 $4,500 $4,200
September 24, 1986 $5,000 $5,000
October 11, 1988 $6,000/$6,500 $6,500
The defendants' evidence persuades me that their valuation represents more reliably the fair market value of the lots at the time they were sold. The defendants' assumed 5% inflation factor more closely approximates the historical growth rate that actually occurred in the real estate market during the 1980s, than does the plaintiffs' 12% inflation factor, which overvalues the market as it then existed. In contrast, plaintiffs' expert's appraisal methodology was faulty and unsupported, and many of his selected comparable sales were not, in fact, comparable to the lots at issue here. For those reasons, and because the plaintiffs do not challenge the validity of the defendants' expert's methodology or the comparable sales he used, I find the defendants' fair market valuation to be the more reliable and credible. I therefore accept it.
Accordingly, I conclude that the defendants have shown by clear and convincing evidence that their corporation, Magness Builders, paid fair market value to the Estate for the lots that were sold.
IV. CONCLUSION
For the foregoing reasons, judgment shall be entered against the plaintiffs and for the defendants. The parties shall confer and submit an appropriate form of implementing order.