ValueLinks Newsletter

November, 2006

J.M. Huber Corp. (“Huber”) got it right. Beginning in 1993, Huber has retained Ernst & Young (“E&Y”) to prepare an annual valuation of Huber, and its determination is reviewed each year by the chair of Huber’s audit committee. When the IRS challenged gift tax valuations involving Huber stock for the years 1997 through 2000 based on E&Y conclusions, the reported values were upheld. Business advisors often bemoan their closely held clients’ lack of procedure. Huber is not a small company, nonetheless, much can be gleaned for the closely held advisor, if only to have his or her clients aware of how Huber succeeded in reporting defensible stock values for sales and gift transfers of its own stock.

The matter specifically concerns the proper amount of gift tax the Michael W. and Caroline P. Huber, Tabitha A. Huber, and Hans A. and Laurel D. Huber should pay on gifts of J.M. Huber stock. The reported gift values were based on the prices Huber used for shareholder stock transactions. The IRS contends that the shareholder stock transactions, and hence the gift values, do not constitute arm’s length transactions.

Huber was founded in 1883 by Joseph Maria Huber (J.M. Huber). Mr. Huber emigrated from Germany to New York City and started a printing business. Huber is located in Edison, N.J. and generates annual sales in excess of $500 million. During the relevant taxable years there were approximately 250 shareholders, who were generally Huber family members, as permitted by Huber’s bylaws. Although privately held, Huber strives to maintain a high level of communication with shareholders. The Company is governed by its board of directors (“the board”), the majority of whom are not members of the Huber family. There are also 3,000 to 5,000 employees, most of whom are not related to the Huber family.

Huber bylaws permit sale of Huber shares to Huber family members and the Huber Foundation. In addition, the bylaws also authorize shareholders to sell to independent nonprofit organizations after obtaining a waiver from the board. Huber’s bylaws provide the corporation the right of first refusal to purchase shares offered outside the Huber family at a price specified in the bylaws.

During the period from 1994 to 2000, there were approximately 90 transactions of Huber shares between shareholders. Shareholders are not obligated to use the E&Y value to sell their shares. The relationship between buyers and sellers varies. Some were within the immediate family while others were as distant as between a trust and a spouse of a second cousin.

In finding in favor of Huber and its shareholder petitioners, the Tax Court looked favorably upon a number of practices of Huber, its Board and its shareholders. A few are discussed below. Visit our Website, koenigassociatesllc.com, for the full discussion.

Annual Independent Valuation

Since 1993, E&Y has prepared an annual independent valuation of Huber. E&Y does not perform any auditing function for Huber. Furthermore, E&Y has used a consistent methodology for valuing Huber shares, including a 50-percent lack of marketability discount.

Arm’s Length Transaction

The IRS contends that the Tax Court consistently scrutinized purported transactions between related parties, such as family members. In the instant case, there were over 90 transactions that took place between 1994 and 2000 by Huber shareholders. The relationships varied from immediate family to more distant relatives and between shareholders of Huber and independent nonprofit organizations. The Court concluded that many sales took place between parties who had no reason to accept a price that was artificially low. The existence of a close family relationship in some of the transactions is neutralized by the many transactions that took place between parties that were hardly related or who had a fiduciary responsibility to obtain the best price.

Communication with Shareholders

Shareholders are not generally sent copies of the E&Y annual valuation report, but the reports are available for inspection by Huber shareholders. The petitioner, at trial, showed that those shareholders entering transactions in Huber stock had seen the report or at least discussed the value of Huber with a financial officer or at a shareholder meeting. The Court opined that whether the shareholders actually saw the report does not influence its conclusion that the petitioners were well informed because the modus operandi of Huber gave plenty of opportunity for shareholders to educate themselves about the Company and E&Y methodology.

Composition of Corporate Board

In its opinion, the Court noted that Huber is governed by its board of directors, the majority of whom are not members of the Huber family. When coupled with the fact that shareholders need not rely on the E&Y annual valuation in exchange of shares, the credible basis for determining share value as arm’s length is strengthened.

The Right to remain Private

An interesting assertion by the IRS was that by not offering Huber shares for sale to the public, shareholders failed to obtain the optimum price. The IRS rejected the notion that Huber must take itself public in order to sell it shares at a fair price. Courts have long recognized the rights of shareholders in closely held companies to remain private.

A review of Huber might have the advisor to closely held companies thinking these criteria are clear academic strategies. After all, wouldn’t we all advise our clients to have regular periodic valuations, if not annual? This is particularly so if we perceive value and have more than a handful of shareholders. We would certainly advise shareholder meetings and adherence to bylaws in place. Huber refreshes those who would advise the closely held client to get their house in order. While we can’t guarantee an outcome, it’s reassuring that a favorable outcome came to a closely held company that did things by the book.