Fair Value in Stock Valuation Proceedings: Podcast Interview of Peter Mahler by Business Appraiser Mark Gottlieb
.jpg)
Forensic accounting and business valuation specialist Mark S. Gottlieb (on the left; that's me on the right) has a spanking new website featuring podcast audio interviews of professionals addressing topics of interest to business appraisers and lawyers whose practices involve business valuation and other modes of economic analysis.
Mark recently invited me to speak with him on the subject of fair value and discounts in stock valuation proceedings. During the interview I answer Mark's questions about the elusive definition of fair value; the differences between fair value and fair market value, particularly as regards treatment of discounts; the varying quality of expert testimony in these proceedings; and the impact of shareholder agreement buy-sell provisions on judicial determination of fair value.
You can listen to the podcast by clicking here. The play button is at the bottom of the linked page. The interview lasts about 16 minutes.
Bankruptcy Court's Ruling Does Not Establish "Floor" Value in Subsequent Stock Appraisal Proceeding
When bankruptcy interrupts corporate dissolution proceedings, it usually means bad news for the petitioner. For instance, last year I wrote about a petition for corporate dissolution doomed by the petitioner's failure to disclose his stock interest in prior bankruptcy proceedings. A recent decision presents an interesting departure from the norm, involving a dissolution case commenced in 1990 that took a 10-year detour through bankruptcy court before returning to state court to resume a buyout proceeding. The case, Smith v. Russo, 2009 NY Slip Op 32785(U) (Sup Ct Queens County Nov. 13, 2009), raised the question whether the bankruptcy court's basis for rejecting as inadequate a buyout settlement proposed by the bankruptcy trustee should be given collateral estoppel effect -- for the benefit of the former bankrupt -- in the subsequent state court valuation proceeding.
Husband and wife Richard and Nelsi Smith were 27.5% shareholders of Meadow Mechanical Corporation formed in 1980. In 1990, the other shareholders removed Richard as president and barred both Smiths from the business premises, prompting the Smiths to sue for dissolution under Section 1104-a of the Business Corporation Law. The other shareholders then elected to purchase the Smiths' shares for fair value under BCL Section 1118.
Continue Reading...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...In Unusual Case, Illinois Appellate Court Reduces Fair Value Award to Dissenting Shareholder
Dissenting shareholder statutes give shareholders the right to opt out of fundamental corporate transformations -- typically by way of merger or consolidation with another corporation -- by redeeming their shares for "fair value". Case law in New York and many if not most other states defines fair value as the shareholder's proportionate share of the value of the enterprise as a going concern, as opposed to liquidation value, determined as of the date immediately prior to the objected-to transaction.
In some states, including New York, another transformative corporate transaction giving rise to an appraisal remedy is the sale of all or substantially all of the assets of the corporation, other than in the usual course of the corporation's business. However, under the New York statute (Section 910 of the Business Corporation Law), if the sale of assets (a) is wholly for cash, (b) the shareholders' approval is conditioned upon the dissolution of the corporation and (c) the proceeds are distributed within one year, the opt-out/appraisal remedy is not available.
The majority shareholders in the recently decided case, Brynwood Co. v. Schweisberger, No. 02-CH-1297 (Ill. App. Ct. 2d Dist. July 23, 2009), could have saved themselves a lot of trouble had they incorporated in New York rather than Illinois. That's because Section 11.65 of the Illinois Business Corporation Act gives dissenting shareholders an appraisal remedy upon the proposed sale or other disposition of all the corporation's assets with no exception for sales linked to a proposed dissolution and distribution plan, which is what happened in Brynwood.
Making matters even stickier, the corporation in Brynwood owned as its sole asset a highly appreciated parcel of commercial real estate, the sale of which triggered a large gains tax at the corporate level because the corporation was organized as a "C" corporation rather than an "S" corporation. The dissenting shareholder, Mr. Schweisberger, argued with some theoretical justification that his shares in the corporation should be valued based on the going-concern value of the company as of the date prior to the property sale, without regard to the gains taxes and other costs of the actual sale. Schweisberger won at the trial court level but lost on appeal. What exactly happened, and how could the problem have been avoided?
Continue Reading...Appellate Court Upholds Denial of Good Will Appraisal in Deadlock Dissolution Case
[Full disclosure: The author represented the prevailing shareholder in the dissolution proceeding and appeal discussed below.]
After the court orders dissolution of a corporation owned 50/50 by two deadlocked shareholders, and the business's tangible assets have been distributed equally pursuant to agreement, may one shareholder demand an appraisal of the corporation's good will associated with the divided assets for the purpose of compelling the other shareholder to make payment for any disparity?
A decision last week by the Brooklyn-based Appellate Division, Second Department, in Matter of Ravitz (Gerard Furst and Marjorie Ravitz, DPM, P.C.), 2009 NY Slip Op 06437 (2d Dept Sept. 8, 2009), holds that the court lacks statutory authority to order such a valuation proceeding.
Ravitz involves a long-established podiatric practice organized as a professional corporation with two equal shareholders. The practice operated out of three leased offices in Smithtown, Port Jefferson and Commack on Long Island. In November 2007, Dr. R filed a petition for judicial dissolution of the practice based on deadlock and internal dissension under Section 1104 of the Business Corporation Law. Dr. F opposed the petition. The court, by Nassau County Commercial Division Justice Ira B. Warshawsky, granted the petition and dissolved the corporation in a short form order dated February 11, 2008.
The two doctors then agreed to close down the Commack office immediately; that the practice would cease operations June 30, 2008; that Dr. R would take over the Smithtown lease, furnishings and equipment; and that Dr. F would take over the Port Jefferson lease, furnishings and equipment. They also agreed that neither one would use the practice's trade name for their new, separate practices.
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...Case Illustrates Importance of Clear Valuation Parameters in Buy-Sell Agreement Among Owners of Closely Held Business
When properly designed, buy-sell provisions in shareholders' agreements of closely held corporations, or in operating agreements of limited liability companies, can avoid disruptive and costly litigation triggered by the voluntary or involuntary dissociation of a shareholder or member. The key elements of a workable buy-sell agreement for lifetime dispositions are (1) defining the circumstances under which a shareholder or member can leave voluntarily or be forced out, (2) setting the valuation date, (3) fixing the value of, or a mechanism to value, the interest of the departing shareholder or member, and (4) setting forth the terms of payment.
Sassower v. 975 Stewart Avenue Associates, LLC, 2009 NY Slip Op 31901(U) (Sup Ct Nassau County Aug. 14, 2009), recently decided by Nassau County Commercial Division Justice Ira B. Warshawsky, illustrates the mayhem that can result when the buy-sell agreement renders uncertain the basis for valuing the departing owner's interest in the entity.
Cardiologist Michael Sassower was one of seven physician-shareholders of a Long Island cardiology practice organized as a professional corporation. He and his fellow shareholders also were members of a real estate holding company called 975 Stewart Avenue Associates, LLC (the "Company") that owned the premises housing the medical practice. In December 2007, Sassower gave six-months notice of his resignation from the medical practice. The Company's operating agreement provided that, upon his departure from the practice, Sassower was required to offer his 12.5% membership interest to the Company and the other members. Section 8.5(c) of the operating agreement described the following process to determine the price to be paid for his interest:
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...Appellate Ruling in Stock Valuation Case Further Muddies the Marketability Discount Waters
In determining the fair value of corporate shares, should the discount for lack of marketability (DLOM) apply only to the company's good will value, or to the entire enterprise value including tangible assets? Court decisions in New York tend to apply DLOM in the 25% range, so the answer can make a big difference in the ultimate award, particularly when the business is asset-heavy.
I've written before (read here) about conflicting case precedents in the Manhattan-based First Department (DLOM applies to enterprise value) and the Brooklyn-based Second Department (DLOM applies to good will value). Permit me to quote from that prior post, where I wrote:
With locked horns in the two downstate appellate departments, and no decisions on the subject from the two upstate appellate departments, it'll likely take some yet-to-be-born big-money valuation case to wend its way up to New York's highest court, the Court of Appeals, before we get a definitive answer.
Well, we still don't have a definitive answer from the Court of Appeals, but we do have a new decision on the subject from one of the upstate departments. The result aligns the Rochester-based Fourth Department with the First Department (DLOM applies to enterprise value), but the decision offers no analysis and, if anything, further muddies the DLOM waters.
Continue Reading...Can Corporate Dissolution Proceedings Be Brought in Federal Court?
This month's Business Valuation Update includes a lengthy analysis of a recent stock valuation decision in a high-stakes corporate dissolution case, Kaplan v. First Hartford Corp., 2009 WL 737681 (D. Me. Mar. 20, 2009), brought by an oppressed minority shareholder of a Maine corporation that developed, owned and operated strip malls. The court, which had to contend with three different expert appraisals that came in $9 million at bottom and $48 million at top, valued the entire enterprise at $15 million based on "Pink Sheets" market trades adjusted -- as required by Maine's buyout statute -- to exclude any minority and marketability discounts. The decision is well worth the read for students of the art of stock valuation, but that's not what I want to address here. Rather, what I find most interesting about the case is who decided it: a federal judge.
Why is that interesting? The federal courts have two basic sources of subject matter jurisidiction: (1) the case involves a federal question, meaning the complaint asserts claims arising under federal statute or the U.S. Constitution, and (2) diversity of citizenship, meaning in most cases that the plaintiffs and defendants are citizens of different states. The typical case seeking judicial dissolution of a state-chartered corporation seeks state law remedies solely, which leaves diversity of citizenship as the only possible avenue to bring a corporate dissolution case in federal court.
Pay Attention to the Latent Power of Corporate Bylaws
The lead-up to business divorce litigation is a tense pas de deux in which, once the dispute reaches critical mass, the two sides "lawyer up" and begin tactical maneuvers to best position themselves for the coming court battle. Sometimes the maneuvering consists of a series of back-and-forth letters between the lawyers staking out their positions and attacking the other's. Especially when one faction owns a controlling interest in the company, the maneuvering also may include formal meetings of the shareholders or the corporation's board of directors (or members/managers in the case of an LLC) to authorize actions adverse to the non-controlling faction.
Never mind that the owners never once held a formal meeting or kept minutes or adopted written resolutions since the day the corporation was formed. Never mind that the corporate kit, containing the organizational documents, stock ledger and certificates, has been sitting untouched, gathering dust since day one.
Among the likely neglected documents in the corporate kit are the corporation's bylaws. Bylaws are to be distinguished from the shareholders' agreement. The latter typically sets forth the stock interests of the individual shareholders, designates directors and officers, and contains restrictions on the transfer of shares, among other provisions. In contrast, think of bylaws as the corporation's operating system, consisting of internal rules not specific to any named individuals, governing such matters as quorum and notice requirements for meetings of the shareholders and board of directors; procedures for the election and replacement of directors; the number and term of directors; and the titles and duties of the corporation's officers. Section 601 of the Business Corporation Law mandates the adoption of bylaws by the incorporators at the initial organization meeting required under BCL Section 404.
I can't say whether all the parties and counsel in Matter of McDaniel (162 Columbia Heights Housing Corp.), 23 Misc 3d 784, 2009 NY Slip Op 29047 (Sup Ct Kings County 2009), were cognizant of the bylaws as they maneuvered prior to commencement of dissolution proceedings. I can say that the bylaws played a dispositive role in the court's determination of their preliminary dispute over a certain stock transfer involving shares of a residential co-operative corporation.
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...Court Rejects Attempt to Vary Statutory Valuation Date in Oppressed Shareholder Buyout
 |
CLE SUPER SUNDAY: MIND YOUR OWN BUSINESS! On Sunday, January 11, 2009, from 9 a.m. to 3:30 p.m., the Nassau County Bar Association is sponsoring a terrific, multi-panel CLE program (6 credits including 1 ethics) on business formation, sale of business, and dissolution. I'll be on the dissolution panel along with Nassau County Commercial Division Justice Stephen Bucaria, attorney Erica Garay of Meyer Suozzi and appraiser Phil Kanyuk of Holtz Rubenstein. Here are links to the program description and registration. Hope to see you there! |
The value of a business can change from year to year, month to month or even week to week. Sales trends go up and down. New products take off or flame out. Major contracts are gained or lost. Industry-wide prospects wax and wane.
When an oppressed minority shareholder petitions for judicial dissolution under Business Corporation Law (BCL) 1104-a, and the controlling shareholders or corporation elect to avoid dissolution by purchasing the petitioner's shares for fair value under BCL 1118, the latter statute requires the court to determine fair value "as of the day prior to the date on which such petition was filed."
The statute's language leaves no wiggle room. The few reported attempts by parties to vary the valuation date uniformly have met defeat under the courts' strict construction of the statute. See, e.g., Matter of Vetco, 260 AD2d 642 (2d Dept 1999); Matter of Davis (Shayne-Levy Associates, Inc.), 174 AD2d 449 (1st Dept 1991).
But that didn't stop the purchaser from taking a valiant run at the statute in Matter of Kurins (SilverSeal Corp.), 2008 NY Slip Op 33328(U) (Sup Ct NY County Dec. 2, 2008). And little wonder that it didn't: at stake was a $1,000,000 increase in the value of the parties' investigative and security business as of the statutory valuation date versus the valuation date three months earlier proposed by the purchaser.
Continue Reading...Court Enforces Stock Buyout Triggered by Shareholder's Death Notwithstanding Pending Dissolution Proceeding
According to one online review, Greek restaurant Telly's Taverna located in Astoria, Queens, "exudes Mediterranean calm with its beach mural, bucolic back garden and airy main dining room."
Nine miles away, in the courtroom of Queens County Commercial Division Justice Orin R. Kitzes, the atmosphere has been anything but bucolic as the restaurant's 50-50 owners have waged a bitter shareholder dispute for over two years, including a deadlock dissolution proceeding under Section 1104 of the Business Corporation Law.
In the midst of those proceedings, the 50% shareholder who petitioned for dissolution died. The ensuing, convoluted legal proceedings ultimately boiled down to one question: Did the petitioner's death entitle the surviving shareholder to enforce the valuation and buyout provision in the shareholders' agreement, thereby mooting the dissolution proceeding?
The short answer is "yes". Here's the full story:
In January 2001, Joanna ("Nana") Loiselle and Aristotelis ("Telly") Vagianderis as 50-50 shareholders formed Kalamaki Taverna, Inc. to operate the restaurant known as Telly's Taverna. A month later they entered into a written shareholders' agreement including an optional provision for stock buyout upon death, as follows:
Continue Reading...In the event of the death of a stockholder, the Corporation business may be continued by the surviving parties on giving notice of such election to continue to the legal representative of said deceased party within thirty (30) days following the death of such deceased party. The deceased party's interest in the Corporation shall terminate on the date of his or her death and the value of the interest of such deceased party in the Corporation shall be determined as of the date of such deceased party's death. The interest so determined shall be paid to his or her legal representative . . ..
Courts Differ on Application of Marketability Discount in Stock Valuation Proceedings
Ever since the Appellate Division, Second Department's 1985 landmark decision in the Blake case (107 AD2d 139), it has been fairly well settled that courts apply a discount for lack of marketability -- but not for lack of control -- in stock valuation proceedings under Section 1118 of the Business Corporation Law. That's the statute that permits the majority stockholder to elect to purchase for "fair value" the shares of an "oppressed" minority shareholder who seeks judicial dissolution of a close corporation under BCL Section 1104-a.
The discount for lack of marketability (DLOM) typically is the single largest downward adjustment to stock value, and therefore tends to be the most heavily contested in valuation proceedings. DLOM essentially reflects the greater time and expense of selling shares of a close corporation versus shares for which there exists an efficient public market. The cases generally reflect DLOM percentages ranging from 10% on the low end to 35% on the high end, with 25% being most frequent. Of course, every case is different and it is up to the expert appraiser to do a proper analysis taking into account all relevant factors.
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...Court Orders Return of Investment as Equitable Remedy in LLC Dissolution Proceeding
It would be hard to find a business dissolution case with messier facts and thornier legal issues than Tal v. Superior Vending, LLC, 2008 NY Slip Op 51205(U) (June 6, 2008). The 28-page decision by Justice Alan D. Scheinkman of the Westchester County Supreme Court's Commercial Division describes a business relationship between two individuals that arose from friendship and degenerated in bitter acrimony and litigation over the dissolution of a limited liability company that supplied and maintained vending machines. The decision also grapples with a novel remedial problem: After Partner A freezes out Partner B, how does a court equitably liquidate a company whose assets and business have been transferred to another company controlled by Partner A which thereafter acquires additional assets that are commingled with the original assets, thus making it impossible to determine the assets and value of the company being dissolved? Justice Scheinkman's solution -- a money judgment in favor of the frozen-out partner equal to his capital investment plus interest -- is equally novel.
Peter Plotkin started a vending machine business in 1997 called Superior Vending Corp. ("SV Corp.") that reached almost $1 million in gross revenues by 2000 when Arik Tal became his business partner. Tal and his wife had become friends with Plotkin and his wife, and had rented a summer house together. In exchange for a 50% interest in SV Corp., in August 2000 Tal invested $170,000 which was used to acquire the assets of another vending company called Vernon Vending Corp. Tal also guaranteed payment of the $150,000 purchase price balance. In October 2000, Plotkin and Tal formed a new LLC called Superior Vending, LLC ("SV LLC") to which they informally transferred all the assets of SV Corp. Plotkin and Tal both were active in the business. They had no shareholders agreement for SV Corp. and no operating agreement for SV LLC.
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.
Continue Reading...Court Refuses to Apply Marketability and Minority Discounts in Valuing Deceased Partner's Interest
A federal appeals court once remarked that "the valuation of a closely held company is an inexact science", adding, "some might say an art" (Okerlund v. U.S., 365 F3d 1044 [Fed. Cir. 2004]). Looking at the gallery of New York valuation law, the artist must be Jackson Pollack.
By that I mean, the valuation rules seem like a hodgepodge when one compares the different settings in which interests in closely held companies are valued by the New York courts, including dissenting shareholder appraisals and oppressed minority shareholder buyouts under the Business Corporation Law, accounting proceedings under the Partnership Law, and equitable distribution proceedings under the Domestic Relations Law. This holds especially true with respect to valuation discounts, as highlighted in a recent appellate decision concerning a fractured partnership in a case called Vick v. Albert, 47 AD3d 482 [1st Dept 2008] (read decision here).
Vick involved a nasty family feud that spawned multiple litigations and arbitration lasting almost a decade. Beginning in 1975, Susan Vick and her brother, Richard Albert, co-owned a number of investment real properties in New York City. Some of the properties they owned as tenants in common, others were owned by partnerships in which Vick, Albert and others held partnership interests. Vick died in 1999, leaving her interests to her two children. About eight months after their mother's death, the children sued their uncle and others seeking, among other things, a partition of certain properties and a dissolution and accounting with respect to various partnerships. The complaint alleged that the uncle took exclusive control of the partnerships' books, records, properties and assets; that he misappropriated certain assets including rental income for his own benefit; and that he failed to wind up the partnerships' affairs after his sister died and failed to provide a final accounting for each of the partnerships. (The appellate court's decision unfortunately recites very few facts. More can be learned from the prior lower court decisions, two of which from 2001 and 2004 can be viewed here and here.)
Continue Reading...Fair Value vs. Fair Market Value
New York’s statutes governing buyouts in dissolution and dissenting shareholder cases use the term “fair value” (FV) as the standard used to determine purchase price. The statutes do not define FV.
In contrast, “fair market value” (FMV) is a widely recognized standard of value used in the business world, in tax assessment proceedings and elsewhere. The International Glossary of Business Valuation Terms defines FMV as “the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”
Are FV and FMV the same?
Not by a long shot. As succinctly stated in one of the more prominent valuation treatises, “the term fair value is usually a legally created standard of value that applies to certain specific transactions”. S. Pratt, R. Reilly & R. Schweihs, Valuing a Business, p. 32 (4th ed. 2000). My even more succinct translation: FV means whatever the courts say it means.
In New York case law, the main difference between FMV and FV concerns application of a minority discount in valuing the shares of a dissolution petitioner or dissenting shareholder. A minority discount, also referred to as a discount for lack of control (“DLOC”), reflects the lower price a hypothetical buyer would pay for shares in a corporation that do not give their owner control of the board of directors, company management, distributions, changes to the articles of incorporation, etc. For over 20 years New York courts consistently have ruled that, unlike in proceedings applying the FMV standard of value, the FV standard excludes DLOC. In many other states that also use the FV standard in statutory buyout proceedings, unlike New York, the courts also exclude the discount for lack of marketability (“DLOM”) applicable to non-publicly listed shares that cannot be sold quickly and at low cost. Bottom line: in New York statutory valuation proceedings applying the FV standard, the selling shareholder gets a significantly higher price compared to the FMV standard.
For those who want to learn more on the subject, I recommend reading a recent appellate decision out of Arkansas in which the court explains the difference between FMV and FV in the context of a dispute over the valuation of the interests of withdrawing partners in a family limited partnership.
The Case of the One-Dollar Buyout
Under Section 1118 of the Business Corporation Law, when a minority shareholder files a petition for judicial dissolution of a close corporation based on oppressive conduct by the conrolling shareholders or directors, the respondent shareholders may avoid dissolution by electing to purchase the petitioner’s shares for fair value.
I recently got a call from someone deciding whether to make the election, asking if it’s possible for a court to assign a zero value to the petitioner’s shares. The practical side of my brain responded, If the business has no value, why are both sides spending legal fees fighting over a corpse?
In law as in life, however, the practical answer does not always carry the day. It is not unusual for one business owner (i.e., the purchaser) to see a sow’s ear where the other owner (i.e., the seller) sees a silk purse. There is nothing in the buyout statute or case precedent that precludes a court from deciding that the petitioner’s shares are worthless. In one recent decision in a valuation proceeding, the court ordered the petitioner to deliver his shares to the purchasing shareholder for a symbolic $1.00 payment. The court credited the opinion of the purchaser’s expert appraiser, who testified that the shares had no positive value based on the company’s debt, its continuing losses and the short remaining term of its lease. The petitioner appears to have sealed his own fate by failing to offer his own appraiser. Worse yet, the court also denied the petitioner’s application to remove his surname from the company’s name. A very painful dollar to accept, indeed.
The case, Matter of Giraud, 2007 NY Slip Op 32473 (U) (Sup Ct NY County Aug. 3, 2007), was decided by Justice Lewis Bart Stone of the New York County Supreme Court.
Big News for BIG Discount
Business appraisers generally apply discounts of one sort or another to value an interest in a closely held business entity. Discounts for lack of control (DLOC) and lack of marketability (DLOM) are most commonly used, depending on the context (estate taxes, matrimonial divorce, dissenting shareholder appraisal, etc.) and the applicable standard of value (fair market value, fair value, investment value).
Once in a while a more exotic discount makes the news. Case in point: the discount for built-in capital gains (BIG) affecting subchapter C corporations. A recent appellate decision scores a major victory for estate taxpayers, and ultimately may also become a factor in valuation cases arising out of dissolution proceedings involving C corporations. First, some background.
Under changes made by the Tax Reform Act of 1986, proceeds from the sale of appreciated assets held by a C corporation upon liquidation are subject to gains tax at the corporate level. A buyer of C corporation shares therefore is willing to pay less for the shares than if the same assets were held by a subchapter S corporation. A C corporation can avoid capital gains taxes at the corporate level upon sale of all its assets by converting to a subchapter S corporation. [IRC §1361 et seq]. However, this option is of limited use since, among other things, the corporation must retain the appreciated assets for ten years from the date of conversion in order to avoid the tax. [See IRC §1374(d)(7)].
In a 2005 decision in a case called Estate of Jelke, in valuing an estate’s 6.44% stock interest in an investment holding company, the Tax Court reduced a $51 million BIG tax liability to $21 million by computing the present value of tax liabilities assuming the future sale of company assets over a 16-year period. On November 15, 2007, the U.S. Court of Appeals for the Eleventh Circuit ordered the Tax Court to recalculate the stock value using a dollar-for-dollar reduction of the entire $51 million in BIG tax liability, under the assumption that the company is liquidated on the date of death and all assets sold.
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.
