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QUESTROM v. FEDERATED DEPARTMENT STORES

February 25, 1999

ALLEN QUESTROM, PLAINTIFF,
v.
FEDERATED DEPARTMENT STORES, INC., DEFENDANT.



The opinion of the court was delivered by: Kaplan, District Judge.

  OPINION

In 1990, Allen Questrom was hired as chief executive officer of Federated Department Stores, Inc. ("Federated") and given the task of leading the company out of bankruptcy. As a spur to his efforts, Questrom's employment contract provided that he would receive, inter alia, incentive compensation calculated as a fixed percentage of the increase in Federated's equity value from 1990 until 1995. The contract provided also that the necessary determinations of equity value were to be made by a third party chosen, subject to Questrom's reasonable objection, by Federated. Federated paid Questrom incentive compensation of $16 million, an amount it asserts was determined by the contractually specified method. Questrom here claims that the third party determination was flawed and that he was entitled to $63 million. He now seeks to recover the $47 million difference. Federated moves to dismiss the action or for other relief.

Facts

As this is a motion to dismiss the complaint, the Court assumes the truth of the well pleaded factual allegations of the complaint.

Questrum's Relationship With Federation

Questrom originally joined Federated as a management trainee in 1965. Over the next twenty-three years, he climbed through the ranks to become, successively, executive vice-president of the Bullock's division, president of the Rich's division, chairman and chief executive officer of Rich's, chairman and chief executive officer of Bullock's and, in 1987, vice-chairman of Federated. He left the company in 1988 in the wake of a hostile takeover to become the chief executive officer of Neiman-Marcus Group, Inc.

The Employment Agreement

Federated filed for Chapter 11 bankruptcy protection in January 1990. *fn1 Perceiving a need for "strong management" in order to restore creditor, consumer, vendor, and employee confidence, Federated sought out Questrom's services.*fn2 In February 1990, Federated signed Questrom to an employment contract (the "Employment Agreement") making him Federated's new chief executive officer for an initial tenure of five years.*fn3

The terms of Questrom's compensation are set forth in Article II of the Employment Agreement.*fn4 Questrom was entitled to $2,000,000 upon commencement of his employment followed by annual payments of $800,000 on January 31 of each of the years 1991 through 1995.*fn5 The Agreement further provided that Questrom was to receive incentive compensation of 0.75 percent of any amount of "Equity Appreciation" up to $500 million, plus 1.5 percent of any Equity Appreciation in excess of $500 million up to $1 billion, plus 2 percent of any Equity Appreciation in excess of $1 billion.*fn6

As might be expected, of such sophisticated parties in a matter potentially involving so much money, the contract carefully defined the terms by which Questrom's incentive compensation, if any, would be computed and the process by which the critical economic determinations would be made.

The Definitions

"Equity Appreciation" — of which Questrom was to receive a share — was defined as "the amount by which the Equity Value of Federated/Allied on the Valuation Date [January 28, 1995] exceeds the Base Equity Value of Federated/Allied."*fn7 "Base Equity Value" in turn was defined as "the market value of the common equity of Federated/Allied on a consolidated basis [of February 3, 1990.]"*fn8 The Agreement further provided that the "Equity Value Federated/Allied on the Valuation Date shall be the market value of the common equity of Federated Allied on a consolidated basis as at that date, increased by the amount of any unusual or special dividends or other special or unusual distributions shareholders after February 3, 1990, and prior to the Valuation Date."*fn9

The Process

The Employment Agreement contained detailed provisions governing the manner in which the components of Equity Appreciation were to be determined and, in some respects, the factors to be considered in doing so.

In all events, the components of Equity Appreciation were to be determined by an outside third party. Section 2.1C provided that, both for determining the Base Equity Value and the Equity Value of Federated/Allied on the Valuation Date:

    "the common equity value of Federated/Allied shall
  be determined by an investment banking or other
  qualified firm selected by the Board of Directors of
  Federated and Allied, provided that [Questrorm] has no
  reasonable objection to such firm."*fn10

In making those determinations, vestment banking or other firm was to base its determination on market values of similar businesses (on a going concern basis), taking into account net income, cash-flow, capital structure, and such other factors as such firm deems relevant in establishing such values."*fn11 In certain circumstances, however, a different approach to valuation was to be employed:

    "Notwithstanding the foregoing, in the [event that
  on January 28, 1995] common shares of Federated and/or
  Allied are being traded publicly (with not less than
  25% of the common shares of Federated or Allied, as
  the case may be, held by the public) and if the firm
  determining such value determines that such at public
  trading price accurately reflects the market value of
  Federated or Allied as the case may be without
  minority to discount, then the market value of
  Federated and/or Allied, as the case may be, shall be
  the average of the closing prices for the common
  shares of such company in the public market for the
  ninety (90) calendar days preceding [January 28, 1995]
  (or such shorter period during which common share of
  such company have been traded publicly). If the firm
  determining such value does not determine that such
  public trading price accurately reflects the market
  value of Federated or Allied, an the case may be,
  without minority discount, then the market value as of
  [January 28, 1995] shall be determined as provided in
  Section 2.1C."*fn12

The Morgan Determinations

The values that ultimately would be placed on Federated for purposes of Questrom's Employment Agreement evidently were a matter of discussion within the company long before Questrom departed. Notable for present purposes is the fact that G. William Miller, then chairman of Federated's board, wrote a memorandum dated January 25, 1993 stating his expectation that "by January 1995 the two tests; for using trading prices in determining equity value would have been met."*fn13 Questrom responded by rejecting Miller's assumptions.*fn14

In time, Federated retained J.P. Morgan Securities, Inc. ("Morgan") to determine the company's Base Equity Value. In July 1993, it reported its determination that the Base Equity Value as of February 3, 1990 was $1,627,376,864 "plus additional equity investments made prior to the final Valuation Date."*fn15 The figure subsequently was adjusted to account for these investments, resulting in a figure of $2,800,805,341. *fn16 As Questrom raised no objection to Morgan or its work in 1993,*fn17 and raises none here, the determination of Base Equity Value is not in controversy in this action.*fn18

Federated again retained Morgan to perform the 1995 valuation, i.e., to determine the Equity Value of Federated/Allied on the Valuation Date.*fn19 Questrom initially did not object to this selection.*fn20 After Morgan completed its preliminary work, however, Questrom claims that

  "it became apparent . . . that Morgan was failing to
  apply the normal and customary valuation procedures
  necessary to value a large, complex organization like
  Federated and that its preliminary conclusions varied
  substantially from any reasonable judgment regarding
  Federated's value as of January 28, 1995."*fn21

As a result, Questrom requested and received materials forming the basis of Morgan's preliminary work.*fn22 These included the Miller memorandum, although not Questrom's 1993 response to it.*fn23 Questrom asserts that "it was apparent that Morgan, despite protestations to the contrary, was influenced by ...


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