SHARMAN HARVEY, Administrator of the Estate of ROBERT RICHARD HARVEY, Deceased Plaintiff v. 5505 YUKON, 2012 YKSC 69

SUPREME COURT OF YUKON Citation: Harvey v. 5505 Yukon Ltd. et al ., 2012 YKSC 69 Date: 20120829 S.C. No. 08-A0004 Registry: Whitehorse Between: SHARMAN HARVEY, Administrator of the Estate of ROBERT RICHARD HARVEY, Deceased Plaintiff And 5505 YUKON LIMITED, ROY A. SLADE, and CHRISTINE DOKE Defendants Before: Mr. Justice D.R. O’Connor Appearances: James D. Vilvang, Q.C. Counsel for the Plaintiff P. Daryl Wilson, Q.C. Counsel for the Defendants REASONS FOR JUDGMENT INTRODUCTION [ 1 ] This case involves the entitlement to the proceeds of an insurance policy on the life of Mr. Robert Harvey. Mr.

Harvey died on February 24, 2007. [ 2 ] Mr. Harvey and the defendants, Mr. Roy Slade and Ms. Christine Doke, owned all of the shares of the defendant 5505 Yukon Limited (“5505”). Mr. Harvey and Mr. Slade each owned 43 ¾ per cent of the shares and Ms. Doke owned 12 ½ per cent. [ 3 ] In March 2004, the three shareholders of 5505 caused the company to purchase insurance policies for $1,000,000 on the lives of Mr. Harvey and Mr. Slade and $500,000 on Ms.

Doke’s life. [ 4 ] In reasons for judgment dated December 2, 2011 and indexed at 2011 YKSC 92 , I concluded that in 2004, the three shareholders had entered into an agreement pursuant to which the proceeds of the insurance policies would be used for two purposes: buyout of a deceased shareholder’s shares and key person insurance. The parties agreed that the buyout portion of the proceeds would have priority and would be based on the fair market value of the deceased’s shares at death.

The balance of the proceeds would be kept by 5505 as key person insurance. [ 5 ] My conclusions left open the possibility that there would be a further trial to address the issue of the valuation of Mr. Harvey’s share at the time of his death. I conducted the further trial on August 15 and 16, 2012, and these reasons result from that trial. [ 6 ] At the trial, both sides called expert evidence about the valuation of the shares. The Plaintiff called Mr. Ross Glanville who valued Mr. Harvey’s shares at $1,200,000. He considered a reasonable range to be from $1,000,000 to $1,500,000. The defendants called Mr.

Randy Popik. In his report, Mr. Popik opined that the shares had a value of between $610,000 and $690,000, with a mid-point value being $650,000. [1] [ 7 ] For the reasons that follow, I determine that the value of Mr. Harvey’s shares on his death was $750,000. [ 8 ] The two experts used different methods to reach their conclusions. In the end, I prefer the conclusions reached by Mr. Popik with one exception, which I will discuss below. In doing so, I should not be taken to say that Mr. Glanville’s evidence or his opinion lack credibility or reliability. Rather, I found Mr.

Popik’s approaches and analyses more compelling. Moreover, I conclude that values within the range posited by Mr. Popik are more consistent with two transactions involving the purchases of shares of 5505 in 2002, with evidence of what Mr. Harvey considered the value of the shares to be in 2004 and with evidence about other market transactions for similar companies in the engineering field. VALUATION [ 9 ] The parties agreed that in valuing 5505 and Mr. Harvey’s shares as of February 24, 2007, I should not consider evidence about events after that date.

Both experts valued 5505 on the basis of financial information relating to 5505 and its subsidiaries for the four

years from 2003 to 2006 inclusive. [ 10 ] By way of background, 5505 and its predecessor company had carried on business in the engineering and surveying fields in Whitehorse for over 20 years. On February 24, 2007, 5505 owned 100 per cent of Yukon Engineering Services Ltd. (“Yukon Engineering”), 100 per cent of Yellowhead Engineering Services Inc. (“Yellowhead”) and 17 per cent of Nan Engineering and Survey Services Inc. (“Nan”). Most of 5505’s revenues and profits were generated by Yukon Engineering.

While there is some dispute as to the level of profitability of 5505 for the four-year period, the gross revenues of Yukon Engineering are not in dispute and were as follows: 2003 – $2,300,000 2004 – $1,700,000 2005 – $2,400,000 2006 – $4,200,000 The above figures are rounded.

a) Mr. Popik [ 11 ] Mr. Popik valued 5505 on a going concern basis. He used generally accepted valuation principles to do so. He valued 5505 using an adjusted net asset approach, that is, he calculated the market value of its assets net of liabilities. He also used a market-based approach to confirm his valuation. I will come back to that later. [ 12 ] In order to value 5505, Mr. Popik made certain adjustments to 5505’s tangible assets and liabilities as reported on its balance sheets.

Most importantly, he valued 5505’s investment in Yukon Engineering on a capitalized cash flow basis to be within a range of $940,000 to $1,140,000. He valued 5505’s interests in Yellowhead and Nan at the nominal amount of $1,000 each. To the above amounts, he added an advance from 5505 to Yukon Engineering in the amount of $577,000 and the value of certain other assets, primarily the real estate owned by 5505. He then deducted current liabilities and came to a range of values from $1,550,000 to $1,750,000 for 5505 as a whole. He calculated Mr.

Harvey’s estate’s 43 ¾ per cent interest to be in the range of $687,000 to $765,000. From these amounts he deducted a minority discount of ten per cent and arrived at a range of values from $610,000 to $690,000. He described the range as approximate. He favoured the mid-point of $650,000. The above calculations are set out in

Schedule 3 to his report. [ 13 ] I do not propose to go over all of the details of Mr. Popik’s calculations which were clearly and fully set out in his report and in his evidence. However, I will address certain specific issues on which he was challenged in cross-examination and in closing argument. [ 14 ] Let me start, however, by saying that I was impressed with Mr. Popik. He is a very well-qualified expert. His C.V. is most impressive. He gave his evidence in a clear and forthright manner. I am satisfied that he used well-accepted valuation principles.

Moreover, he appeared to apply those principles evenly and fairly. [ 15 ] I will now address some specific areas of Mr. Popik’s evidence that were somewhat contentious.

i) Yukon Engineering [ 16 ] As mentioned, Yukon Engineering was the primary revenue generator for the 5505 business enterprise. Valuing Yukon Engineering was by far the most difficult part of the valuation exercise. [ 17 ] Mr. Popik used a capitalized cash flow approach to value Yukon Engineering. This approach quantifies the present value of future benefits associated with share ownership. The future benefits that accrue to a shareholder are then discounted or capitalized at a rate appropriate for the risks associated with realizing those benefits. [ 18 ] Mr.

Popik’s starting point was to calculate the normalized earnings before interest, taxes, depreciation and amortization (“EBITDA”) for Yukon Engineering. He used this as a basis for projecting future available cash flows. EBITDA is calculated by taking reported earnings from operations adjusted for non-recurring and non-arms length transactions and deducting interest, taxes, depreciation and amortization. In

Schedule 5 to his report, Mr. Popik also made adjustments for management fees to Nan and Yellowhead, rent, bank charges and interest, amortization and inflation. He concluded that Yukon Engineering had a normalized EBITDA for the years 2003 to 2006 as follows: $611,000, $107,000, $149,000 and $598,000. [ 19 ] I accept Mr. Popik’s opinion that these calculations were fair and in accordance with proper valuation principles. [ 20 ] Mr. Popik then chose a two-year weighted average (2:1) of the normalized EBITDA as a basis for determining maintainable EBITDA in the future.

I accept his evidence that this was a reasonable approach and indeed he could have adopted some of the other approaches set out in

Schedule 5 that would have resulted in a lower valuation. [ 21 ] Mr. Popik calculated that the maintainable EBITDA was $449,000. From this he deducted normalized interests, income taxes and sustaining capital reinvestment and added back certain tax savings to arrive at a maintainable after-tax cash flow of $208,000. Again, while one may quibble with details, I accept that Mr. Popik’s calculations were made in accordance with accepted valuation principles and were fair in the circumstances. [ 22 ] The most contentious part of Mr. Popik’s evidence related to the multiple that he used to capitalize the cash flow. The multiple

is the inverse of the rate a willing purchaser and a willing seller would consider reasonable in the circumstances. In reaching the multiple, Mr. Popik used a number of well-accepted measures of risk. Those are set out in

Schedule 11 to his report. The Plaintiff contends that he erred in attributing a specific company risk in the range of 7 to 13 per cent in arriving at the appropriate multiple. I disagree. At page 22 of his report, Mr. Popik sets out in some detail the strengths and weaknesses of Yukon Engineering that were relevant to assessing the company related risks.

There were obvious strengths: Yukon Engineering had experienced material growth in 2006, there was a proven market for engineering services in the Yukon, Yukon Engineering had a good reputation and the economic outlook for the Yukon was favourable. [ 23 ] Included among the weaknesses were risks arising from the fact that Yukon Engineering’s significant revenue increase in 2006 was largely predicated upon two non-recurring jobs. In addition, Yukon Engineering had a relatively low net tangible asset backing and a relatively large percentage of past revenue had come from non-recurring sources. I agree with Mr.

Popik’s range, although I would be inclined to favour the lower end of the risk range because of the importance of the strengths to which he referred. [ 24 ] That said, I accept Mr. Popik’s opinion that an appropriate range for an equity capitalization rate for Yukon Engineering in 2007 was 22.33 to 28.33 per cent. These percentages lead to price/cash flow multiples in the range of 3.5 to 4.5. [ 25 ] Multiplying the estimated cash flow of $208,000 by these multiples and adding the present value of the existing tax shield of about $35,000, the going concern value of 5505 in 2007 ranged from $763,000 to $971,000.

To that Mr. Popik added the net realizable value of the redundant assets in the amount of $173,000 to arrive at a fair market value of the equity of Yukon Engineering of $940,000 to $1,140,000. The mid- point of the range is $1,040,000. [ 26 ] Mr. Popik relied upon transactional information obtained from Pratts Stats in the Engineering Services industry to support the reasonableness of the multiples he used in valuing Yukon Engineering. I think this was appropriate. I agree with Mr.

Popik that this data supports his conclusion that a multiple in the range of 3.5 to 4.5 was appropriate to value Yukon Engineering. ii) Use of Insurance Proceeds [ 27 ] The Plaintiff argues that in calculating the value of 5505 at the time of Mr. Harvey’s death, the court should consider the value of the $1,000,000 insurance proceeds as an asset of the company. Mr. Popik did not do so. I agree with Mr. Popik for two reasons. First, the 2004 agreement with respect to the insurance proceeds was that the proceeds would be used first to pay the deceased’s estate for the value of the shares at the date of death.

The remainder would be used as key person insurance for the company. Including that portion of the proceeds intended to buy the deceased’s shares as an asset of the company for valuation purposes would ignore the obligation of the company to pay that money to the deceased’s estate. Paying the deceased’s estate is, in effect, a first charge on the insurance proceeds. Thus, I am satisfied that the buyout portion of the insurance proceeds should not be included as a company asset.

I note that this view is consistent with the treatment of the proceeds of buyout insurance on death for income tax purposes. [2] [ 28 ] To the extent that some of the proceeds of the insurance policy will be used as key person insurance it seems apparent that those proceeds would be more than offset by the loss in the value of the company resulting from Mr. Harvey’s death. [ 29 ] I wish to make two further points about this issue. Mr. Glanville, the Plaintiff’s expert, included the insurance proceeds as an asset of 5505 for the purpose of valuing the company at the time of death.

However, having done that, he arrived at essentially the same value for the company as he would have had he not included the insurance proceeds. Thus, in his calculation, this issue was in effect a non-issue. [ 30 ] I would also note that the insurance in this case was term insurance, not whole life, as such there was not a cash surrender value at the time of death. iii) Minority Discount [ 31 ] Having arrived at a range of value for 5505 of $1,550,000 to $1,750,000, Mr. Popik calculated the estate’s interest of 43 ¾ per cent to be in the range of $678,000 to $765,000.

To that he applied a minority discount of ten per cent to arrive at final figures of $610,000 to $690,000 (rounded). [ 32 ] In my view, the circumstances of this case do not warrant the application of a minority discount. I recognize that in valuing small, privately owned companies, minority discounts in the range of 10 to 40 per cent are routinely applied. [ 33 ] However, this case is different. The valuation here results from an agreement among the shareholders of 5505. Mr. Slade and Ms. Doke used the term Fair Market Value to describe the agreement as to what would be paid to a deceased’s estate.

However, all of the parties to the agreement contemplated that there would only be one purchaser of the shares – the company – in effect the remaining shareholders. They were already integrally involved in the company. None of the parties to the agreement considered that the shares would be sold in the open market, nor did they discuss applying a minority discount to the value of the shares of a deceased shareholder. Indeed, the effect of the buyout of the shares of a deceased shareholder is that the remaining shareholders receive a pro-rated increase in the equity of the company.

In my view, it would be unfair to the Plaintiff to apply a minority discount to the shares being sold. I am satisfied that when the parties considered the buyout value of the deceased share, they did not expect that such a discount would be applied.

b) Mr. Glanville’s Valuation

[ 34 ] Let me repeat what I said at the outset. While I prefer Mr. Popik’s approach and his valuation to that of Mr. Glanville, I do not have a problem with Mr. Glanville’s qualifications nor with his credibility or reliability. [ 35 ] Mr. Glanville used a number of approaches to value 5505. His primary method involved using a multiple of EBITDA as determined by four different methods. The critical factor, however, in each of those four methods was the multiple he applied to the EBITDA figure he used. [ 36 ] 5505, including its subsidiaries, was a relatively small, private engineering company.

In deciding what multiple to apply to 5505’s EBITDA, Mr. Glanville used a 2011 Raymond James research report entitled Canada’s Engineering Firms: Designing Impressive Shareholder Returns (the “James Report”) . That report, as Mr. Glanville fairly conceded, was focussed almost entirely on valuing public engineering firms. The report, with virtually no analysis, observed that small, private engineering firms have been valued using a range of multiples of trailing EBITDA from 3.0 to 7.0. Larger firms have been valued at an average of 8.5 times EBITDA. Mr.

Glanville selected the mid-point of the 3.0 to 7.0 range and used a multiple of 5.0 in his four EBITDA valuation methods. Obviously, the use of a lower multiple would have had a significant impact on his conclusions. [ 37 ] The difficulty I have with the selection of the multiple is two-fold. First, the James Report gives no insight about the details of the private companies or the transactions that led to this very broad range of multiples. As a result, it is difficult to know where to place 5505 within the range.

Second, the James Report does not say what the median multiple was for the companies that gave rise to the range. The average used by Mr. Glanville may or may not be a fair application of the underlying data. [ 38 ] In short, while Mr. Glanville’s EBITDA approaches may be acceptable ways to value a company, I am left with uncertainty about his use of the multiple of 5.0 to 5505’s EBITDA. [ 39 ] As a backup, Mr. Glanville tested his EBITDA conclusions by valuing 5505 on the basis of a percentage of the amount of revenues.

He relied upon ValuAdder, a business valuation firm that generates a Business Valuation eBook, setting out multiples of revenues for valuing engineering and surveying companies. However, Mr. Glanville only applied the multiples obtained from ValuAdder to the 2006 results. As I pointed out above, the 2006 results were a spike and I wonder if a better approach would not have been to apply the ValuAdder multiples to an average or weighed average of more than one year. [ 40 ] Mr.

Glanville also suggested that the total amount of insurance purchased by 5505 in 2004 (i.e. $2,500,000) may be indicative of the value of 5505 at that time. I disagree. There was no evidence to support this suggestion. Indeed, the evidence is that Mr. Harvey considered the value of the company to be approximately $1,200,000 at the time 5505 purchased the insurance.

c) Market Value [ 41 ] Both valuators sought confirmation of their conclusions by examining two purchases of shares of 5505 in 2002. [ 42 ] In 2002, Mr. Harvey and Mr. Slade purchased ⅓ of the shares of 5505 from Mr. Douglas McLean for $400,000. In the same year. Ms. Doke acquired 12 ½ per cent of the shares of 5505 for $147,000. These were arms length transactions and are very good indicators of the value at the time. These transactions indicated a value of the company of approximately $1,200,000. Moreover, as mentioned above, when the insurance was purchased in 2004, Mr.

Harvey considered the value of the company to be approximately $1,200,000. [ 43 ] Mr. Popik calculated the implied multiple of EBITDA that underlay the 2002 purchases based on figures from 2003. He concluded that, in comparison to the implied multiple underlying the 2002 purchases, the multiples he used in calculating the 2007 value of Yukon Engineering were generous to the Plaintiff. [ 44 ] Mr.

Glanville concluded that based on the dramatic increase in revenues from an average of $2,078,000 for the years of 2003 to 2004 to $4,259,000 in 2006, as well as a significant increase in gross margins during that period, the value of 5505 had at least doubled from the $1,200,000 value in the 2002 to 2004 period.

SUMMARY [ 45 ] In the end, the exercise in valuing 5505 is not an exact science. Importantly, in this case, the need to value the shares results from an agreement among shareholders in a closely held company. Those shareholders were good friends and had worked together closely for several years. They purchased the insurance with the view to fairly compensate the estate if one of them should die and to provide assistance to the company to replace the loss of a colleague.

The shareholders were primarily concerned with doing what would be fair and reasonable to all the parties in the event of a death. [ 46 ] While the parties said that the agreement was to pay a deceased estate fair market value, I am satisfied that they were not contemplating a sale in an open market. Rather, they contemplated that 5505 would pay a fair price to a deceased shareholder’s estate and it would be a price that was also fair to the remaining shareholders.

In the end, I have attempted to arrive at a value that is consistent with what I conclude was the intention of the parties when they made the agreement. [ 47 ] In my view, a fair value for Mr. Harvey’s shares at the time of his death was $750,000. I reach this conclusion primarily on the basis of a market approach. The 2002 transactions indicated a value for the company of approximately $1,200,000. In 2004, Mr. Harvey considered the company to still be worth approximately that amount. No one disagreed. This value translates to a value of approximately $500,000 for Mr. Harvey’s shares.

[ 48 ] These earlier transactions are the very best evidence of the value of the company, at least in 2004. Undoubtedly the value had increased by 2006. Both Mr. Popik and Mr. Glanville are of that view. In 2006, the gross revenues of Yukon Engineering were nearly double what they were in 2003. [ 49 ] A value of $750,000 represents a 50 per cent increase from the approximate value in 2004. I consider that this fairly balances the substantial growth in revenues in 2006 with the fact that the growth had occurred during only one year. I am satisfied that this value fairly compensates Mr.

Harvey’s estate at the same time as leaving a substantial amount, $250,000, with the company to address, at least in part, Mr. Harvey’s death. It is also fair to the two remaining shareholders. While the company will no doubt suffer from Mr. Harvey’s death, Mr. Slade and Ms. Doke will have the benefit of substantially increased equity interests in 5505. Thus, I consider that based on the earlier market transactions and the subsequent performance of the company, an amount of $750,000 would be a fair value for Mr.

Harvey’s shares and in accordance with the agreement of the parties. [ 50 ] I note as well that a value of $750,000 falls within what Mr. Popik considered in his report to be an appropriate range on the basis of the valuation methods he used if one were not to apply a minority discount. As I said above, I do not think that this is a case for a minority discount. [ 51 ] Finally, I recognize that in his oral evidence, Mr. Popik indicated he would reduce the values in his report to account for certain impaired loans. This proposed adjustment came very late in the day without notice to the Plaintiff.

Be that as it may, even if I were to accept the proposed adjustment, it would not change my conclusion set out above. ORDER [ 52 ] Accordingly, I conclude that 5505 owes the estate of Mr. Robert Harvey $750,000, plus a pro-rated share of the interest accumulated on the insurance proceeds since payment. I direct that there be deducted from $750,000 the amount of $163,338.17, plus interest at the rate realized on the insurance proceeds. This deduction constitutes repayment of Mr. Harvey’s shareholder loan from 5505. [ 53 ] I reserve the issue of costs of this trial.

Submissions may be made to Justice Veale or to me as the parties agree. O’Connor J.