Tariq Malik, Mahdiur Rahman v. FALCON HOLDINGS, LLC, and ASLAM KHAN

Of the Central District of Illinois, sitting by designation. å
In the
United States Court of Appeals
For the Seventh Circuit
No. 11-2815
TARIQ MALIK, MAHDIUR RAHMAN, and JANICE QUINN,
Personal Representative of the Estate of Joe Lee Lott,
Plaintiffs-Appellants,
v.
FALCON HOLDINGS, LLC, and ASLAM KHAN,
Defendants-Appellees.
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 10 C 2952—Ronald A. Guzmán, Judge.
ARGUED FEBRUARY 21, 2012—DECIDED MARCH 14, 2012
Before EASTERBROOK, Chief Judge, BAUER, Circuit Judge,
and SHADID, District Judge.å
EASTERBROOK, Chief Judge. Falcon Holdings was orga-
nized in 1999 to own and operate 100 fast-food restau-

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2 No. 11-2815
rants. Aslam Khan owned 40% of Falcon’s common
units. (Falcon is a limited liability company rather than
a corporation; ownership is represented by units rather
than shares.) The remainder of the common units, and
all of the preferred units, were owned by Sentinel Capital
Partners II and Omega Partners (collectively “Sentinel”).
According to the plaintiffs, Khan told Falcon’s managers
that he would acquire full ownership one day, and that,
when he did, he would reward the top managers with
50% of Falcon’s equity. Plaintiffs say that they accepted
lower salaries because they anticipated receiving a
stake if Falcon proved to be a success, and that they
worked hard to make it prosper (which it did).
Sentinel was bought out in 2005, and Khan became
Falcon’s sole equity owner. He did not distribute
common units to any of the top managers and has
denied ever promising that he would. Five of the
managers filed this suit. The district court assumed that
the evidence in the summary-judgment record would
permit a jury to conclude that Khan had promised
the plaintiffs an equity stake in Falcon. (Contracts for
the sale of stock are not subject to the statute of frauds
in Illinois, see 810 ILCS 5/8-113, so the absence of a
writing signed by Khan is not dispositive.) Two of the
original plaintiffs nonetheless lost on the basis of releases;
they have not appealed. The others lost because, the
district judge held, they had not adequately estimated
the damages they sustained. 2011 U.S. Dist. LEXIS 77983
(N.D. Ill. July 15, 2011). These three have appealed. (One
has died; his estate’s representative has been substituted.)

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No. 11-2815 3
Plaintiffs offer a simple estimate of damages. They
calculate that the price paid for Sentinel’s ownership
interest (100% of the preferred units and 60% of the
common units) implies that Falcon as a whole was worth
approximately $48 million in 2005. Half of $48 million
is $24 million. In 2005, twenty managers qualified for
units under the terms of Khan’s offer. Thus each
plaintiff lost about $1.2 million when Khan did not keep
his promise.
The district court stated that plaintiffs’ approach has
two flaws, each fatal: first, because Sentinel did not own
100% of Falcon, it is impossible to derive the value of
the whole firm from the amount paid for its holdings;
second, the amount that Sentinel was paid depended
on how much Khan and Falcon could borrow rather
than Falcon’s true value. Neither of these propositions
is sound; indeed, each supposes that there is some
measure of “true” value that differs from what a willing
buyer will pay a willing seller in an arms’-length trans-
action. Yet that is the gold standard of valuation; other
measures are approximations. The value of a thing is
what people will pay. The judiciary should not reject
actual transactions prices when they are available.
Let us simplify the transaction by assuming that
Sentinel owned 60% of Falcon and accepted $6 million
for its units. Falcon as a whole then must be worth at
least $10 million. If it is worth less than that, Khan has
overpaid. Khan does not contend in this litigation that
he paid Sentinel too much. Falcon might be worth more
than $10 million in this example; Sentinel would accept

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4 No. 11-2815
“only” $6 million if it thought that Khan, as the con-
trolling manager, would prevent Sentinel from
receiving payments equivalent to 60% of the firm’s full
value. But if the price Sentinel accepted represents
less than 60% of Falcon’s value, then plaintiffs have
underestimated their damages. A court can’t dismiss a
suit because the plaintiffs are asking for less than their due.
The same thing is true about the district court’s belief
that the ability of Khan and Falcon to borrow money set
a cap on what Sentinel received. If this means that
Sentinel accepted less for its units than their propor-
tional share in Falcon represented, then again plaintiffs
have underestimated their damages. That’s not a good
reason why they should go home empty-handed.
There’s another problem with this aspect of the
district court’s analysis. The amount that Khan and
Falcon could borrow depended on Falcon’s value. Al-
though the record surprisingly does not contain the
details of the transaction, it appears to be a leveraged
buyout (LBO). In an LBO, a business borrows money
against its own value, promising to repay from its antici-
pated net earnings. Outside investors are cashed out;
insiders own the equity in a highly leveraged venture.
The amount a firm can borrow to conduct an LBO
depends on the lender’s estimate of its future
earnings, which is a good indicator of value. So to say
that Falcon could not pay Sentinel more than Falcon
could borrow is not to say that the price was an arbitrary
number. If the amount offered were a poor estimate of
Falcon’s value, Sentinel would have said no. Instead it

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No. 11-2815 5
took the offer. To repeat, we have a willing buyer and
willing seller dealing at arms’ length; the price they
agree on is the value of the asset.
The real problem with plaintiffs’ damages estimate is
not inability to value Falcon Holdings as an entity. It is
that what Khan promised was half of the equity interest
in Falcon. Khan emerged from the LBO owning 100% of
the equity—but not 100% of Falcon. Suppose Falcon
borrowed $38 million from a bank (or syndicate of banks)
to pay off Sentinel. Then, if Falcon was worth $48 million
as a whole in 2005, the lenders’ debt interest was
$38 million and Khan’s equity interest was worth
$10 million. Half of that, split 20 ways, would come to
$250,000 for each plaintiff, not the $1.2 million apiece
they have demanded. Because the record does not
contain the details of the transaction, we have no idea
whether this example is even approximately accurate.
But it is unsound to assume, as plaintiffs do, that
Khan’s equity interest in Falcon is worth 100% of the
firm’s value. It might take an expert financial economist
to derive an equity valuation, and plaintiffs did not
disclose an expert in discovery. For their part, however,
defendants have not asked us to affirm on the ground
that the record is silent about the value of Khan’s
equity interest in Falcon.
In addition to assuming that the value of Falcon as
a whole is the same as the value of Khan’s equity
interest, plaintiffs make a second questionable assump-
tion: that Khan would hand over to each of the 20 man-
agers 2.5% of Falcon’s equity units without any terms or

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6 No. 11-2815
conditions. That would be a disaster not only for
the ownership structure of a closely held firm but also
from a tax perspective. The units’ value would be taxed
as ordinary income, just like a cash bonus. To pay the
tax, many of the managers might have had to sell some
or all of their units—yet there is no market for units in
a limited liability company. To avoid problems such as
these, firms usually distribute options rather than
shares (or units). The exercise price of the options will
be set at the value of the shares (or units) on the date
the options are awarded, so there is no taxable income
until the options are exercised—and then the tax is at
the capital-gains rate rather than the higher ordinary-
income rate. Options not only have tax benefits but
also offer managers a share in any appreciation without
the risk of capital loss. (Rewards for past success
can be distributed as bonuses, also without exposing
managers to loss from future operations.) Many man-
agers hold under-diversified portfolios and are risk
averse as a consequence. Exposing them to a risk of
capital loss could injure the firm by inducing them to
be timid when making decisions.
Perhaps Khan indeed offered Falcon’s managers
illiquid units that would require them to pay immediate
taxes without a means to raise the money to do so,
and without any terms such as buy-sell agreements
(which would provide a means for valuing the units
and preventing distribution to outsiders). But such a
transaction would be sufficiently unusual that plaintiffs
cannot simply assume that a promise to give them an
equity interest in the firm was to be accomplished by

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No. 11-2815 7
handing out units rather than options. If ownership
would have entailed options, then it becomes necessary
to know the exercise price, the duration of the options,
and at what rate they would vest. (Deferred vesting
is common in order to give managers an incentive to
remain with the firm.) So many vital terms are missing
that any promise may well be too indefinite to enforce,
see Brines v. XTRA Corp., 304 F.3d 699 (7th Cir. 2002);
ATA Airlines, Inc. v. Federal Express Corp., 665 F.3d 882
(7th Cir. 2011)—but once again defendants have not
asked us to affirm on this ground.
Defendants do try to defend their judgment by
arguing that plaintiffs waited too long to quantify their
damages. According to defendants, details should
have been set out before the close of discovery, perhaps
as early as the initial disclosures under Fed. R. Civ.
P. 26(a)(1)(A), and plaintiffs’ delay entitles them to
prevail outright. This is absurd. Litigants are entitled to
use discovery to learn facts (such as how much
Sentinel received in the buyout) that will affect the
remedy; a party can wait until the facts are in hand
before adding specifics to the claim adumbrated
in the complaint. Anyway, if defendants thought that
plaintiffs had failed to perform their obligations under
the rules, they should have asked the district judge for
a sanction before discovery closed rather that waiting
(as they did) until their motion for summary judg-
ment. Fed. R. Civ. P. 37(c)(1) gives the judge discretion
to match a remedy to the wrong. Defendants have not
explained how the plaintiffs’ delay injured them, so a
remedy (if any rule was transgressed) would have

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8 No. 11-2815
been mild. (We have explained in Ball v. Chicago, 2 F.3d
752 (7th Cir. 1993), and many other cases, that the
remedy for procedural missteps in litigation must be
proportionate to the injury.) As defendants did not ask
for any arguably appropriate sanction, however, they
are in no position to complain that the district judge
did not award one.
The judgment is vacated, and the case is remanded
for proceedings consistent with this opinion.
3-14-12

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