Classic Coffee Concepts, Inc. v. Anderson

Classic Coffee Concepts, Inc. v. Anderson, 2008 NCBC 1

STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
SUPERIOR COURT DIVISION
MECKLENBURG COUNTY 06 CVS 2941

CLASSIC COFFEE CONCEPTS, INC.,

Plaintiff,

v. ORDER & JUDGMENT

J. MICHAEL ANDERSON,

Defendant.

Mayer Brown LLP by Eric H. Cottrell for Plaintiff Classic Coffee Concepts,
Inc.

McNaughton & Shelton, PLLC by Edward J. McNaughton and Gregory L.
Shelton for Defendant J. Michael Anderson.

Diaz, Judge.
{1} The Court called this matter for trial on 1 October 2007. The parties
waived their right to a jury trial.
{2} After considering the opening statements of the parties, the testimony of
the witnesses, the exhibits presented and admitted at trial, 1 and the closing
arguments of the parties, the Court enters the following Order and Judgment.
I.
PROCEDURAL HISTORY
{3} Plaintiff Classic Coffee Concepts, Inc. (“Classic Coffee” or the “Company”)
filed its Complaint in Mecklenburg County Superior Court on 13 February 2006.
{4} On 24 April 2006, Defendant J. Michael Anderson (“Anderson”) answered
the Complaint and also asserted counterclaims (the “Counterclaims”) for Breach of

1 To the extent not ruled on at trial, all objections to the introduction and use of Joint Exhibits 1–89

are OVERRULED. In particular, Anderson having withdrawn his objection to Joint Exhibit 33
following the close of his evidence, the Court considered this exhibit.
Contract (as to a Stockholders Agreement), Unconscionability, Breach of
Employment Contract, and Judicial Dissolution.
{5} The case was subsequently transferred to the North Carolina Business
Court and assigned to me as a mandatory complex business case.
{6} On 22 June 2006, Classic Coffee moved to dismiss Anderson’s
Counterclaims for Unconscionability and Judicial Dissolution. The Court granted
Plaintiff’s motion by Order dated 1 December 2006.
{7} On 24 April 2007, Classic Coffee dismissed its Complaint with prejudice.
{8} On 22 May 2007, the Court granted Classic Coffee’s Motion to Amend its
Notice of Dismissal to reflect that such dismissal was without prejudice.
{9} Prior to trial, Anderson dismissed his Counterclaim alleging breach of the
Employment Agreement, leaving only his claim alleging breach of the Stockholders
Agreement for trial.
{10} As to that claim, Anderson stipulated at trial that he was only pursuing
relief for two specific breaches: (1) Classic Coffee’s alleged failure to properly value
his stock, and (2) Classic Coffee’s alleged failure to redeem his stock within sixty
days of the effective date of Anderson’s termination as a Classic Coffee employee.

II.
FINDINGS OF FACT 2
A.
THE PARTIES
{11} Classic Coffee is a closely-held Delaware corporation with its principal
place of business in Mecklenburg County, North Carolina. (Joint Exs. 1, 33.)
{12} Anderson is a citizen and resident of Statesville, North Carolina.
{13} From 1993 to 22 July 2003, Anderson was employed by Classic Coffee, first
as its Controller, and eventually as its Chief Financial Officer. (Joint Ex. 15.)

2 Where appropriate, the Court has identified the joint exhibit supporting a particular finding of fact.

Many of the Court’s findings, however, come from the testimony presented at trial. Because no final
transcript has been prepared, the Court’s order does not refer to a record citation for such facts.
{14} Anderson also served as a director of Classic Coffee.
{15} Anderson owns 15,000 of Classic Coffee’s 45,000 issued and outstanding
shares of common stock. 3 (Joint Ex. 2.)
B.
THE DISPUTE
{16} On 5 December 2000, Anderson and Classic Coffee entered into a
Stockholders Agreement. (Joint Ex. 1.)
{17} On or about that same date, Anderson entered into a Pledge Agreement
and a separate Continuing and Unconditional Guaranty Agreement (“Guaranty
Agreement”) with Bank of America, N.A. (the “Bank”). (Joint Exs. 3, 10.)
{18} On 22 July 2003, Anderson’s employment with Classic Coffee was
terminated “without cause,” effective 1 August 2003. (Joint Exs. 13, 15.)
{19} The Stockholders Agreement requires Classic Coffee to purchase, and the
stockholder whose employment is terminated without cause to sell, all of the
Company’s stock held by such stockholder. (Joint Ex. 1 ¶ 3.1(b).)
{20} The Stockholders Agreement also provides that the “price per share at
which the Stock of a Stockholder shall be purchased and sold . . . shall be equal to
the quotient of the ‘fair market value’ of [Classic Coffee] . . . divided by the total
number of shares . . . issued and outstanding.” (Joint Ex. 1 ¶ 3.2(a).)
{21} The Stockholders Agreement defines Classic Coffee’s “fair market value” as
the difference between the fair market value of the Company’s capital stock
determined by the independent appraisal of the Employee Stock Ownership Plan
and Trust (“ESOP”) “for the most recent valuation that precedes the date of the
Stockholders termination of employment” and the liquidation preference of any
preferred stock of the Company issued and outstanding as of the date of
termination.” (Joint Ex. 1 ¶ 3.2(b).) 4

3 Anderson was unclear about what he paid for his shares, at one point testifying that it may have

been a total of $150.00, then later stating that it may have been only $1.00.
4 The Company never issued preferred stock.
{22} The Stockholders Agreement allows Classic Coffee to pay a stockholder for
his shares by equal installments on a sixty-month promissory note. (Joint Ex. 1 ¶
3.3(b).)
{23} As to stockholder employees who are terminated “without cause,” the
Stockholders Agreement requires that the “fair market value” of the employee’s
shares be re-calculated on the anniversary date of the stockholder’s termination
until the stockholder is paid in full, and that any increase in the value of the stock
be added to the balance of the promissory note. (Joint Ex. 1 ¶ 3.3(b).)
{24} Under paragraph 3.4 of the Stockholders Agreement, “[t]he closing of any
purchase and sale [of stock] . . . shall be consummated . . . within sixty (60) days
following . . . the termination of the Stockholder’s employment with [Classic
Coffee].” (Joint Ex. 1 ¶ 3.4.)
{25} Classic Coffee never established an ESOP.
{26} Pursuant to the Pledge Agreement, Anderson’s stock was assigned to the
Bank as collateral for his personal guarantee of Classic Coffee’s loan agreements
with the Bank. (Joint Ex. 3.)
{27} The termination of Anderson’s employment with Classic Coffee did not
discharge his obligations under the Guaranty Agreement. (Joint Ex. 10 ¶ 7.)
{28} The Stockholders Agreement addresses the question of pledged stock in
the context of a mandatory redemption following termination of an employee:
If one of the events described in Article . . . III of this Agreement
occurs prior to the time that all of a Stockholder’s Stock is released
from the Stock Pledge, the Company, if otherwise permitted under
the terms of the Stock Pledge, . . . shall exercise its rights pursuant
to Article III to purchase said pledged Stock. In such event, the
total purchase price for the Stock shall be determined in accordance
with this Agreement and the Company shall be entitled to a dollar-
for-dollar credit against the purchase price to be paid to such
Stockholder for the Stock for any amounts paid to the Bank to
retire the obligation of the Stockholder to the Bank or to otherwise
obtain the release of the pledged Stock from the Stock Pledge.

(Joint Ex. 1 ¶ 1.2(b) (emphasis added).)
{29} Following the termination of Anderson’s employment, Classic Coffee asked
the Bank to release Anderson’s stock. (Joint Exs. 58, 64.) However, Classic Coffee
owed a substantial amount of money to the Bank at that time, and the Bank
refused to release the stock. (Joint Ex. 58.)
{30} Classic Coffee made no monetary offer to the Bank to release Anderson’s
stock.
{31} Classic Coffee did not redeem Anderson’s stock within sixty days of the
effective date of his termination.
{32} Anderson made numerous demands for redemption of his shares following
his termination. (Joint Exs. 53–54, 56–57, 59.)
{33} On each occasion, Classic Coffee responded either (1) that it could not
redeem Anderson’s shares while they were pledged to the Bank, or (2) that it was
conducting a valuation to determine the price it would pay for Anderson’s shares.
(Joint Exs. 53, 55–56, 58.)
{34} Several months before Anderson was terminated, Classic Coffee’s outside
accountants (Cherry Bekaert Holland, hereinafter “CBH”) prepared a draft
appraisal of the Company for purposes of conducting a goodwill impairment
analysis. 5 (Joint Ex. 31.)
{35} CBH’s draft appraisal (prepared on 7 February 2003) set the Company’s
fair value at $12,500,000.00, on a controlling interest basis. 6 (Joint Ex. 31.)
{36} The information used by CBH to prepare the draft appraisal consisted of
sales projections prepared by Anderson, with input from other Classic Coffee
employees. (Joint Ex. 26.)
{37} The sales projections provided to CBH included markedly more aggressive
sales numbers (the so-called “bright” plan) than those provided by the Company to
its lenders (the so-called “bank” plan). (Joint Ex. 87.)

5 “Goodwill impairment” is an accounting standard requiring that the recorded value of a company’s

goodwill be equal to or greater than its fair value. If it is not, goodwill is said to be impaired,
requiring a write-off to its present fair value.
6 Applying that value, Anderson’s 15,000 shares would be worth over $4 million.
{38} The “bright” plan was created for internal planning purposes and was
never intended to be disseminated outside of the Company.
{39} Had CBH known about the two sets of conflicting sales projections, it
would have “thought long and hard” about conducting an appraisal without
addressing this discrepancy.
{40} The CBH draft appraisal valued Classic Coffee at its fair value, not fair
market value.
{41} An appraisal based on “fair value” does not account for certain discounts in
value that are typical for closely-held companies, including lack of marketability of
the stock, discounts for minority interests, and “keyman” discounts.
{42} CBH used its draft appraisal to support its goodwill impairment analysis,
and accounting conventions limit its use to that purpose.
{43} Because CBH was using the appraisal for a limited purpose, it did not
issue it in final form.
{44} Standard accounting conventions make it inappropriate to use the 7
February 2003 draft appraisal to value the Company’s stock as if an ESOP had been
in place.
{45} Anderson also asked CBH to prepare a second appraisal in conjunction
with potential merger talks with an outside entity. (Joint Ex. 32.)
{46} For purposes of this appraisal, CBH was asked to determine the
Company’s fair market value as of 31 December 2002. (Joint Ex. 32.)
{47} CBH took its February 2003 valuation of “fair value” and factored in
discounts applicable to a closely-held corporation to arrive at a fair market value for
the Company (on a controlling interest basis) of $8,390,000.00. 7 (Joint Ex. 32.)
{48} CBH submitted its second appraisal (in draft form) to Anderson on or
about 18 March 2003. (Joint Ex. 32.)
{49} CBH advised Anderson that its appraisal was valid only for the specific
purpose for which it was prepared. (Joint Ex. 32.)

7 Applying that value, Anderson’s 15,000 shares would be worth over $2.7 million.
{50} An ESOP fair market value appraisal is markedly different than a
conventional fair market value appraisal. 8
{51} ESOP regulations require appraisals to be “full appraisals” and neither
one of CBH’s draft appraisals were full appraisals.
{52} Pursuant to standard accounting conventions, it is inappropriate to use
CBH’s second draft appraisal to value the Company’s stock as if an ESOP had been
in place.
{53} Anderson did not share the CBH draft appraisals with the other members
of the Company’s board of directors.
{54} On or about 3 November 2003, Classic Coffee retained Marshall & Stevens
(“M&S”) to perform a valuation as if an ESOP were in place for the purpose of
determining Classic Coffee’s fair market value and, in turn, the value of Anderson’s
stock. (Joint Ex. 33.)
{55} According to the M&S report, as of 31 December 2002 (approximately one
year before Anderson was terminated), “the fair market value of 100% of the equity
in Classic Coffee Concepts, Inc., on a non-marketable, minority interest basis [was
$360,000.00].” (Joint. Ex. 33).
{56} In turn, the fair market value of one share of the Company’s stock (based
on 45,000 outstanding shares) was $8.00, thus setting a value of $120,000.00 for
Anderson’s 15,000 shares. (Joint Ex. 33.)
{57} Classic Coffee notified Anderson of this valuation on or about 19 February
2004, but did not tender this amount to Anderson because the Bank had not yet
released Anderson’s shares from the stock pledge. (Joint Ex. 81.)

8 One distinguishing factor (although not the only one) is how the existence of an ESOP affects the

“marketability” discount used by a valuation professional. Such a discount reflects the financial
reality that shares of small closely-held corporations do not trade frequently and therefore are
generally less attractive than similar publicly held stocks for which there is a ready market.
Okerlund v. United States, 365 F.3d 1044, 1050 (Fed. Cir. 2004). A typical ESOP, however, obligates
an employer to purchase a departing employee’s stock, thus establishing a potential market for the
stock. As a result, while a marketability discount still applies to ESOP shares in a closely-held
corporation, it is typically less than would be applied otherwise. (Joint Ex. 33.)
{58} On or about 3 May 2005, Classic Coffee engaged M&S to perform another
fair market value appraisal for the purpose of valuing Anderson’s stock as of 31
December 2004, in the context of a hypothetical ESOP. (Joint Ex. 34.)
{59} The second M&S appraisal placed the fair market value of Anderson's
stock at $192,000.00. (Joint Ex. 34.)
{60} In or around November 2005, Classic Coffee began negotiating a
refinancing of its credit facility with the Bank. In connection with those
negotiations, Classic Coffee again requested that the Bank release Anderson’s
shares.
{61} This time, the Bank agreed to release Anderson’s shares.
{62} On 14 December 2005, Classic Coffee informed Anderson that it would
“proceed with the mandatory redemption of [Anderson’s] stock as required by the
Stockholders Agreement.” (Joint Ex. 83.)
{63} Classic Coffee’s letter, which was enclosed with copies of documents setting
forth the terms and conditions of the proposed transaction, set a purchase price of
$192,000.00 and a closing date of 30 December 2005. (Joint Ex. 83.)
{64} Anderson refused to tender his stock to Classic Coffee.
{65} On 6 March 2007, M&S modified its 31 December 2004 appraisal. (Joint
Ex. 85.) In arriving at its $192,000.00 value for Anderson’s shares, M&S failed to
consider the effect of an agreement between Classic Coffee and another company on
Plaintiff’s equity value.
{66} Accounting for this agreement should have resulted in the value of the
equity of Classic Coffee being zero as of 31 December 2004, except for some nominal
speculative value. (Joint Ex. 85.)
{67} Thus, the value of Anderson’s stock as of 31 December 2004, based on the
M&S modified appraisal, was at or near zero. (Joint Ex. 85.)
III.
CONCLUSIONS OF LAW
{68} This Court has subject matter jurisdiction over this dispute and personal
jurisdiction over the parties.
{69} Venue is proper because Plaintiff’s principal place of business is in
Mecklenburg County and the events giving rise to this action occurred, in whole or
in part, in Mecklenburg County.
{70} Venue is also proper because the 5 December 2000 Stockholders
Agreement that is the subject of this action provides that all litigation relating to it
shall be brought and maintained exclusively in the courts of Mecklenburg County,
North Carolina. (Joint. Ex. 1, ¶ 5.8.)
{71} Classic Coffee stipulated at trial that it breached the Stockholders
Agreement by failing to perform valuations of Anderson’s shares annually.
{72} Anderson also claims that Classic Coffee breached the Stockholders
Agreement by failing to purchase his shares within sixty days of his termination.
{73} Classic Coffee contends it did not breach this provision of the Stockholders
Agreement because Anderson’s shares were at all relevant times pledged to the
Bank as collateral, and therefore Anderson was in no position to tender them for
redemption.
{74} The Court, however, concludes that the Bank’s release of Anderson’s
shares was not a condition precedent to Classic Coffee’s obligation to redeem them.
{75} To the contrary, the Stockholders Agreement required Classic Coffee to (if
necessary) purchase Anderson’s shares from the Bank and credit the purchase price
to the net amount due Anderson for the redemption.
{76} Alternatively, nothing on the face of the Stockholders Agreement
prevented Classic Coffee from redeeming the shares in exchange for Anderson
relinquishing any and all rights to those shares upon their release by the Bank.
{77} Classic Coffee never did anything more than request that the Bank release
Anderson’s shares.
{78} Accordingly, the Court concludes that Classic Coffee breached the terms of
the Stockholders Agreement by failing to redeem the shares within sixty days of
Anderson’s effective date of termination.
{79} The Court concludes further that Classic Coffee’s over two-year delay in
tendering performance amounted to a material breach, and Anderson is therefore
entitled to judgment in his favor. Cf. Avesair, Inc. v. Inphonic Inc., 2007 NCBC 32
¶¶ 15, 27 (N.C. Super. Ct. Oct. 16, 2007), http://www.ncbusinesscourt.net/opinions/
101607%20Order%20Webpage.pdf (applying Delaware law, which the court stated
recognizes many of the same principles of contract construction as North Carolina,
and concluding that a party materially breaches an agreement where he fails to
perform within a reasonable time).
{80} As to the form of the judgment, a person damaged by a breach of contract
is entitled to be placed, insofar as this can be done by money, in the same position
he would have occupied if there had been no breach. Lee Cycle Ctr., Inc. v. Wilson
Cycle Ctr., Inc., 143 N.C. App. 1, 9, 545 S.E.2d 745, 750 (2001) (quoting Perfecting
Serv. Co. v. Prod. Dev. & Sales Co., 259 N.C. 400, 415, 131 S.E.2d 9, 21 (1963)).
{81} Here, this means Classic Coffee should have tendered payment for
Anderson’s shares within sixty days of the effective date of Anderson’s termination
as a Classic Coffee employee.
{82} The principal dispute at trial, however, was the amount that Anderson
should receive for those shares.
{83} Anderson contends the price Classic Coffee offered him for his shares on 14
December 2005 was too low because the Company did not follow the terms of the
Stockholders Agreement in calculating the share price.
{84} The parties in this case attempted to fix on a valuation mechanism
precisely to avoid this type of dispute.
{85} To that end, the Stockholders Agreement provides that the price for an
exiting shareholder’s shares would be the “fair market value” of those shares as
“determined by the independent appraisal obtained by the ESOP for the most
recent valuation that precedes the date of the Stockholder’s termination of
employment.” (Joint Ex. 1 ¶ 3.2(b).)
{86} North Carolina courts are bound to follow the agreement of the parties as
to valuation of stock, “whether the value appears to be high or low compared to the
original purchase price.” Hickory Orthopaedic Ctr., P.A., v. Nicks, 179 N.C. App.
281, 287, 633 S.E.2d 831, 835 (2006) (citing Lagies v. Myers, 142 N.C. App. 239,
247, 542 S.E.2d 336, 342 (2001)).
{87} The evidence at trial, however, showed that Classic Coffee never
established an ESOP and therefore never timely determined the “fair market value”
of Anderson’s stock consistent with the Stockholders Agreement.
{88} The Court has considered whether the failure to establish an ESOP
amounted to a failure of a condition precedent excusing performance by both
parties. It has declined to so find in this case for the following reasons: (1)
conditions precedent are not favored by the law, Craftique, Inc. v. Stevens & Co.,
321 N.C. 564, 566, 364 S.E.2d 129, 131 (1988), and (2) neither party argued the
point at trial, requesting instead that the Court fix the value of Anderson’s shares
on the evidence presented.
{89} Accordingly, the Court proceeds to consider the evidence as to value.
{90} Anderson argues that the two CBH draft appraisals are the most reliable
evidence of value because they rely on management’s contemporaneous sales
projections. In support of that proposition, Anderson points me to the Delaware
Court of Chancery’s opinion in Prescott Group Small Cap, L.P., v. Coleman Co., No.
17802, 2004 Del. Ch. LEXIS 131 (Del. Ch. Sept. 8, 2004).
{91} Prescott involved an appraisal proceeding brought by former minority
shareholders of the defendant following defendant’s merger into its parent
corporation. Plaintiffs in that case claimed that the fair value of their shares on the
merger date was over five times what defendant was willing to pay. Id. at *3.
{92} The Delaware Court of Chancery accepted plaintiffs’ valuation, noting that
it was based on management projections available as of the date of the merger,
while defendant’s evidence of value relied exclusively on “after-the-fact adjustments
to such projections made during litigation.” Id. at *75.
{93} Prescott, however, is inapposite because the management projections
reviewed by the court in that case were entirely consistent with what the defendant
was contemporaneously representing to all of its constituencies, including its
shareholders, lenders, and outside financial analysts. As the court explained,
[t]hose projections had been furnished to [defendant’s] banks in
circumstances where [defendant’s] performance and prospects were
being carefully scrutinized and where it was essential that
[defendant’s] actual performance met or exceeded those projections.
Second, the projections had been ‘vetted’ for reliability by an
independent firm, . . . which the banks had engaged for that
purpose. Third, management had represented the projections as
their best estimate of the future.

Id. at *52.

{94} In contrast, the 7 February 2003 CBH draft appraisal tendered by
Anderson was not based on fair market value and was created for purposes of
complying with an outside accounting requirement related to goodwill impairment.
{95} Moreover, unlike the projections in Prescott, the projections used by CBH
to prepare its first draft appraisal relied on wildly optimistic sales figures that the
Company never realistically expected to meet and that flatly contradicted the more
realistic projections provided by the Company to its lenders.
{96} Similarly, the 18 March 2003 draft appraisal, while premised on fair
market value, (a) was prepared for a specific purpose unrelated to the valuation of
Anderson’s stock, (b) was not a full fair market value appraisal, as would have been
required for purposes of an ESOP appraisal, (c) was never finalized by CBH, and (d)
relied on the same distorted sales projections generated by Anderson.
{97} Additionally, at trial Anderson put the onus on the Court to fill in
substantial gaps in his valuation model to arrive at his preferred estimate of fair
market value. The Court declines that invitation.
{98} Instead, the Court concludes that the most reliable estimate of the fair
market value of Anderson’s stock at the time he was entitled to receive payment for
it is $120,000.00, as calculated by M&S in November 2003. (Joint Ex. 33.)
{99} The M&S appraisal is the only evidence of value that attempts to honor
the parties’ agreement, by arriving at a fair market value of Anderson’s shares as of
31 December 2002, based on the existence of a hypothetical ESOP. 9
{100} At trial, Classic Coffee conceded that the $120,000.00 amount was the
appropriate measure of value, but requested that it be allowed to pay Anderson in
installments over sixty months, as provided by the terms of the Stockholders
Agreement. (Joint Ex. 1 ¶ 3.3(a).)
{101} However, because Classic Coffee materially breached the Stockholders
Agreement, the Court DENIES that request.
{102} As for Anderson’s remedy, generally, “where there is a material breach of
the contract going to the very heart of the instrument, the other party to the
contract may elect to rescind and is not bound to seek relief at law by an award for
damages.” Wilson v. Wilson, 261 N.C. 40, 43, 134 S.E.2d 240, 242 (1964).
{103} Nevertheless, to rescind a contract “there must be, within a reasonable
time after knowledge of the material breach, an election by the aggrieved party to
cancel.” Marantz Piano Co. v. Kincaid, 108 N.C. App. 693, 696, 424 S.E.2d 671, 673
(1993).
{104} Anderson did not present evidence of such an election, nor did he request
at trial that the Court rescind the Stockholders Agreement.
{105} Accordingly, the Court concludes that Anderson is entitled to judgment in
his favor for $120,000.00, together with interest at 8% from 1 October 2003 until

9 Two years later, M&S prepared a second fair market value appraisal of Anderson’s interest in

Classic Coffee, which resulted in a value of $192,000.00 for the shares. See supra ¶¶ 58-59. After
carefully reviewing the record, however, the Court credits the evidence presented by the Company at
trial, which demonstrated that this valuation was based on an erroneous assumption (not made in
the first M&S report) regarding the Company’s overall debt (Joint Ex. 85), and that the value of the
Company’s shares as of 31 December 2004 was at or near zero. Nevertheless, because the
Stockholders Agreement explicitly protected Anderson from any downturn in the value of his stock
following his termination without cause, the Company remains obligated to pay Anderson
$120,000.00 for his shares. (Joint Ex. 1 ¶ 3.3(b).)
paid, said date being the sixty-first day following the effective date of Anderson’s
termination as a Company employee.
{106} Upon satisfaction of the judgment, Anderson shall tender his 15,000
shares to Classic Coffee.

IV.
JUDGMENT
{107} Based on the foregoing, it is ORDERED that judgment is entered for
Defendant J. Michael Anderson in the sum of $120,000.00, with interest at the legal
rate from 1 October 2003 until paid.
{108} Upon satisfaction of the judgment, Anderson shall tender his 15,000
shares to Classic Coffee.
{109} The costs of this action are taxed to Plaintiff.

SO ORDERED, this 31st day of January, 2008.