Valuing Shares in a Residential Co-op Corporation: Is the Whole Worth More Than the Sum of its Parts?
The residential co-operative corporation is a strange breed of closely held business entity. In New York, the co-op is formed as a for-profit corporation under the Business Corporation Law (BCL), yet it doesn't operate for profit in the traditional sense of returning cash dividends to shareholders. Instead, ownership of co-op shares entitles the shareholder to occupancy of an apartment under an appurtenant long-term proprietary lease. The co-op's income derives mostly if not entirely from tenant-shareholder maintenance payments, the level of which is designed merely to cover the common charges for building expenses. The market value of the shares held by individual shareholders within the same co-op can vary greatly, not just due to the number of shares allocated to the particular apartment, but also due to the unique characteristics of the apartment.
One of the consequences of being a for-profit corporation is that co-ops in New York are subject to the same statutes governing voluntary and involuntary dissolution as any other closely held business corporation, including BCL Section 1104-a authorizing a petition for judicial dissolution by an "oppressed" minority shareholder holding at least 20% of the corporation's shares. At least in New York City, where co-ops tend to have many apartments, the shares usually are too widely dispersed for any single tenant-shareholder to own 20%. In addition, and with all due respect to noise and odor complaints, the idea of a co-op dweller being oppressed by her neighbors is a far cry from the usual freeze-out/squeeze-out scenarios involving loss of employment, removal from the board, financial abuse by the majority, and lack of a market exit.
The fact is, however, that New York City also has many smaller co-op buildings such as converted townhouses and brownstones featuring four or five apartments, each of which may be allocated 20% or more of the co-op's shares. And, New York City being a litigious kind of town when it comes to expensive real estate (think Trump), it's inevitable that an alienated tenant-shareholder in such a co-op would opt to bring a dissolution proceeding instead of exiting by selling her apartment on the open market. A rational shareholder presumably would do so only if she believes she'll get more value from a liquidation of the corporation's assets than from selling her apartment, i.e., that the value of the entire building is greater than the sum of its parts.
Continue Reading...Court Rejects Unconscionability Argument in Family Partnership Valuation Case, Concludes that "Full and True Value" Equals "Net Book Value" as Defined by Agreement
Those who follow the society pages may recall that gossip columnist, television reporter and socialite Claudia Cohen married, had a child with and later divorced billionaire Ronald Perelman, and that she died tragically young in 2007. Less well known is the fact that Cohen herself came from family wealth; her father, Robert Cohen, built a highly successful media distribution business known as Hudson Media. It is from the Cohen-family wealth, and the sorting out of Claudia Cohen's estate, that the following tale of partnership valuation controversy emerges, culminating with a recent New Jersey court decision in Estate of Cohen v. Booth Computers, Memorandum Decision, C.A. Docket No. BER-C-135-08 (N.J. Super. Ct. Aug. 4, 2009).
In 1978, when Claudia was 27 and her two brothers were 21 and 19, their parents set up a general partnership called Booth Computers (the "Partnership") with the children as equal one-third partners. The idea was to provide income for the children and to shift assets for tax and estate planning purposes from the parents to the children. The children did not negotiate the Partnership Agreement which was prepared at the parents' direction by one of their lawyers. Later the same year, a limited partnership was formed called HCMJ Realty Ltd. ("HCMJ") of which the parents owned a 55% general partner interest and the Partnership was given a 45% limited partner interest. HCMJ's limited partnership certificate reflected a $90,000 cash contribution by the Partnership.
HCMJ's sole asset was a Palm Beach ocean front estate used as the Cohen family vacation home, which was transferred by another Robert Cohen entity to HCMJ in 1978. In addition to its 45% interest in HCMJ, the Partnership directly owned a pair of New Jersey commercial warehouses acquired in 1980 and 1984. The court's opinion doesn't disclose the warehouse purchase prices or indicate if they were conveyed to the Partnership by other Cohen-owned entities. In any event, none of the three Cohen children put their own money into the Partnership.
Continue Reading...Majority Shareholders of Accounting Firm Held Liable for Value of Deceased Minority Shareholder's Interest After They Formed New Firm Using Old Firm's Assets and Good Will
It may surprise some of you to learn that the Surrogate's Courts in New York have jurisdiction to hear petitions for judicial dissolution of closely held corporations involving the estate of a deceased shareholder. These cases are relatively rare -- most shareholder agreements contain provision for mandatory stock redemption upon death -- but they do happen from time to time. Case in point: last month the Appellate Division, Second Department, affirmed a ruling by the Surrogate's Court awarding the estate of a deceased minority shareholder the value of its stock interest, to be paid by the surviving shareholders in proportion to their stock interests. Matter of Verdeschi, 2009 NY Slip Op 05355 (2d Dept June 23, 2009).
As laid out more fully in the underlying September 2006 Decision and Order issued by Westchester County Surrogate's Court Justice Anthony Scarpino, Jr., Verdeschi involves an accounting firm known as G.B. Tepper & Associates Ltd. ("Tepper & Associates") organized in 1992 as a business corporation (as opposed to the more common professional corporation) with four shareholders: the decedent, Carl Verdeschi (35%), Gerald Tepper (35%), Monte Tepper (15%) and Jay Samuels (15%). They had no shareholders agreement. Prior to Verdeschi's death in late 2003, each shareholder received a salary and a share of profits proportionate to their stock percentage. After Verdeschi died, the surviving shareholders conducted no further business through Tepper & Associates. Instead, Monte Tepper and Jay Samuels formed a new firm known as Tepper Tax Associates, Inc. ("Tepper Tax") which occupies the same office used by Tepper & Associates, provides the same accounting services to the old firm's clients, and uses all of the old firm's office equipment, computers and furnishings. The new firm also employed Gerald Tepper.
Continue Reading...What's the Difference Between Marketability and Minority Discounts?
The following testimony was given by an accredited business appraiser, testifying on behalf of the purchasing majority shareholders in a buy-out valuation proceeding under Section 1118 of the Business Corporation Law, to determine the "fair value" of the petitioner's 45% interest in two related companies:
Q: . . . I see that for the [first] appraisal there was no separate marketability discount analysis, but there is one for the [second] appraisal. Could you explain the basis of that?
A: After the issuance of both reports, . . . we were asked to come up with a value on a fully enterprise, the value of both entities. After the second report, [the majority shareholders' lawyer] asked me to address it because the case had become a 1118 case, and in that case the definition of value is fair value, and under that definition of value for the minority interest, what other considerations would one take into consideration, and I said, well, you would address the marketability discount of that specific block of stock under that statute. And he asked me then could I quantify what the marketability discount would be applicable to the stock.
Q. Applicable to the minority interest?
A. To the block of stock, the 45 percent interest.
The same expert, in a written report, wrote that "[a] minority equity holder of [the two companies] owns an equity interest for which no market exists. . . . It is our opinion that no less than a 30%-to-35% discount for lack of marketability is appropriate for the equity interest in [the two companies] to derive the fair value of the specific fractional interest in each company . . .."
The judge in that case rejected the expert's position and refused to apply the proposed discount. Can you guess why?
Continue Reading...Court Rejects Experts' Appraisals in Fair Value Proceeding, Relies on Own Computation Using Income Approach
No matter how many times I see it happen, I'm always intrigued when a new stock valuation decision comes along in an oppressed shareholder buyout proceeding in which the opposing experts come up with valuations light years apart. How is it that two impeccably credentialed business appraisers, operating under the same independence principle, looking at the same data, and following the same valuation guidelines, can produce such divergent numbers? Is the court required to accept one or the other, or should it appoint its own neutral appraiser, or compute value itself?
Last December I wrote about one ill-fated valuation decision in which the lower court adopted wholesale one of the two widely divergent expert appraisals, only to be reversed on appeal and remanded for a new valuation hearing. Today I write about another valuation decision in which the trial court rejected both experts' appraisals and came up with its own computation of fair value. Matter of Beattie (PlanData Systems Corp.), 2009 NY Slip Op 30181(U) (Sup Ct Suffolk County Jan. 15, 2009).
PlanData Systems Corp., located in Huntington, New York, offers space management services to owners and facility managers of commercial buildings. The business uses a proprietary computer program called SpaceMan to design and manage the clients' commercial properties. In 2006, 40% shareholder Ronald Beattie sought judicial dissolution of PlanData under the oppressed minority shareholder statute, Section 1104-a of the Business Corporation Law. The 60% shareholder, Steven Smith, elected to purchase Beattie's shares for fair value under the buyout statute, BCL Section 1118. After the two shareholders failed to reach agreement on price, the fair value question went to a hearing before Suffolk County Commercial Division Justice Elizabeth Hazlitt Emerson.
Continue Reading...Stock Valuation, Dr. Pangloss, Mr. Scrooge and Do-Overs
It's a common courtroom scene in stock valuation proceedings: two credentialed business appraisers locked in a "battle of the experts," ostensibly describing the same company using the same raw data, offering two conclusions of value light years apart. Former Vice Chancellor Steele of the Delaware Court of Chancery, in a case called Gilbert v. MPM Enterprises, Inc., 1997 WL 633298 (Del. Ch. Oct. 9, 1997), described the phenomenon thusly (keep in mind this was written in Apple's dark days, before it launched the iPod):
One might expect the experts' desire to convince the Court of the reasonableness and validity of their assumptions and financial models would produce a somewhat narrow range of values, clearly and concisely supported, despite the individual parties' obvious conflicting incentives. Unfortunately, as this case and other cases most decidedly illustrate, one should not put much faith in that expectation, at least when faced with appraisal experts in this Court . . .. Reading petitioner's submissions, one might easily conclude that MPM was poised to become the Microsoft of the SMT industry. By contrast, respondent's submissions give the impression that a more likely comparison, given MPM's myriad management, technical and legal problems, is Apple. In sum, one report is submitted by Dr. Pangloss, and the other by Mr. Scrooge.
Closer to home, in one of the earliest reported decisions to address the problem under New York's buyout statute (BCL 1118), the court in Matter of Taines (Gene Barry One Hour Photo Process, Inc.), 123 Misc. 2d 529 (Sup Ct NY County 1983), aff'd, 108 AD2d 630 (1st Dept 1985), disregarded the testimony of both sides' experts, whose determinations of the fair value of the subject company's shares differed by almost 30,000 percent, writing as follows:
Continue Reading...Certified Partisan Accountant? Court Allows LLC Member's Suit Against Company's CPA, Alleging Improper Assistance to Other Member in Judicial Dissolution Proceeding
Judicial dissolution proceedings have spawned legal malpractice cases; I once testified as an expert witness in such a case. Likely there have been accountant malpractice cases as well, brought by company owners disappointed with their own accountant's advice in connection with buyout negotiations or judicial valuation proceedings.
But until Anda Management, LLC v. Needlemen & Schacter, LLP, 2008 NY Slip Op 31534(U) (Sup Ct Nassau County May 20, 2008) (read decision here), I'd never heard of spin-off litigation involving charges against a professional for improperly taking sides in the underlying dissolution case.
Here's what happened: Anda Management and Wilmington Paper Corp. formed a Delaware LLC called Worldwide Fibers to market paper products overseas. Worldwide retained the defendant accounting firm as its accountant without a written agreement. Three years later, Worldwide's principals had a falling out, prompting Wilmington to file a proceeding for judicial dissolution of Worldwide in Delaware Chancery Court. Wilmington accused Anda's principals of impermissibly withdrawing funds from Worldwide for personal reasons and then falsely booking them as legitimate business expenses.
Continue Reading...Court Discounts Fair Value Award for Built-In Gains Tax in Shareholder Oppression Case
In a posting last December I wrote about an important estate tax case, Jelke v Commissioner, in which a federal appeals court adopted a bright-line rule requiring 100% discount for built-in capital gains tax ("BIG") in the valuation of C corporation assets. At the time I made the following prediction about Jelke's impact on stock valuation in corporate dissolution cases:
Jelke likely will not have wide impact on valuation contests in dissolution cases, for two main reasons. First, the great majority of dissolution cases involve S corporations and other entities that opt for pass-through partnership tax treatment. Second, the standard of value in estate tax cases such as Jelke is fair market value as opposed to the fair value standard specified by New York’s buyout statute. In a BCL §1118 valuation case involving a real estate holding C corporation called Matter of La Sala, a New York trial court refused to apply a discount for BIG tax liability on the ground that it was required to value the corporation as a going concern and, therefore, it would not consider capital gains taxes triggered upon liquidation. Undoubtedly, this will not be the last word on the subject of BIG discounts in stock valuation proceedings.
I was right about one thing: it was not the last word on BIG and §1118 stock valuation proceedings. As it turns out, when I wrote those words there already was percolating in Nassau County Supreme Court a buy-out proceeding in a shareholder oppression case, Murphy v. U.S. Dredging Corp., requiring the court to decide the same issue presented in the La Sala case, namely, the appropriateness under the fair value standard of applying a BIG discount to the appreciated assets of a real estate holding C corporation. The Murphy court's answer -- applying a partial discount based on the present value of future gains taxes -- lands between Jelke's 100% discount and La Sala's zero discount.
Continue Reading...Dissenting Shareholder Loses Right to Receive Dividends Upon Merger Consummation
Like most states, New York's Business Corporation Law (BCL) permits a shareholder to opt out of mergers and certain other corporate restructurings by electing to be cashed out for the "fair value" of his or her shares. The so-called dissenting shareholder statute, BCL Section 623, sets forth procedures and deadlines for submission of the shareholder's written objection to the proposed transaction, for the corporation's making of a price offer, and for the filing of a judicial appraisal proceeding in the event the shareholder rejects the corporation's offer. A statutory appraisal proceeding also may result from a "freeze-out merger" in which the controlling shareholders compel minority shareholders to redeem their shares for cash. The dissenting shareholder statute typically comes into play with merger transactions involving corporations with relatively large capitalization and whose minority shareholders include passive investors. Section 1005 of the New York Limited Liability Company Law likewise permits members to dissent and cash out from mergers or consolidations involving LLC's.
A recent court decision, in a case called McCully v. Jersey Partners, Inc., 18 Misc 3d 1138(A) (Sup Ct NY Co 2008), raises a caution flag for dissenting shareholders and their counsel when it comes to asserting claims for dividends that accrue prior to merger consummation but are not payable until afterward.
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