I just read an interesting Delaware Court of Chancery decision in Walker v. FRP Investors GP. This is a post-trial opinion from Vice Chancellor Zurn that offers some interesting insights into Delaware partnership agreements and valuation disputes.
The case involves Cornelius "Cory" Walker, who helped build an insurance brokerage company that entered a lucrative partnership with private equity sponsor Warburg Pincus. As the founding CFO, Walker received incentive units (B Units) allowing him to share in the company's value. The general partner (GP) had the right to issue these incentive units and was required to establish a "threshold value" for newly issued units based on its reasonable determination of the company's enterprise value.
Here's what happened: Warburg became frustrated with Walker's performance as CFO and replaced him. Though they initially considered repurchasing his incentive units, Walker's friends in management convinced them to let him keep his units and give him a vanity title. Later, in anticipation of an acquisition, the GP issued the remaining authorized incentive units with a threshold value that Walker claimed was too low, which reduced his share of the incentive pool.
When the company was eventually acquired, Walker received about $50 million for his units, but he claimed he should have received $2 million more. After trial, the court concluded that the GP did breach its obligations in determining the threshold value, but Walker was only entitled to $416,248.93 in damages (plus interest).
The breach occurred because the GP used a valuation from two months before the issuance date, which violated the requirement in the partnership agreement that the threshold value be determined "immediately prior" to issuance. The GP also failed to account for updated information it had received about quality of earnings adjustments.
To determine damages, the court had to reconstruct what the GP's reasonable determination of enterprise value would have been immediately before the issuance. The court used an internal Warburg model (called the "Grills model") as a starting point, but made adjustments to align it with the GP's contemporaneous view of fair market value.
Key takeaway: This opinion highlights the importance of following specific contractual valuation procedures in partnership agreements. Even when a general partner has broad discretion, specific valuation provisions will cabin that discretion, and courts will enforce them. The case also demonstrates the court's willingness to reconstruct what a reasonable valuation would have been by using contemporaneous internal models and making appropriate adjustments to calculate damages when a breach occurs.
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