Fair Market Value vs. Fair Value

crazyWhenever I contemplate New York’s unusual case law on the discount for lack of marketability (DLOM) in statutory fair value buy-out proceedings, I cast my eyes westward, to the far banks of the Hudson River, and take comfort in the fact it could be worse — I could be in New Jersey.

A “business appraiser’s nightmare” is how Chris Mercer described New Jersey’s “bad behavior discount” in his commentary on the Wisniewski v Walsh case decided a little over a year ago by a New Jersey appellate court, in which it affirmed the trial court’s application of a 25% DLOM seemingly plucked out of thin air, and notwithstanding what the trial court itself admitted were “strong indicators of liquidity,” for the stated purpose of penalizing the selling shareholder for his oppressive behavior toward the other shareholders — behavior that in no way harmed the corporation’s business or affected its marketability!

Now comes another New Jersey trial court decision in another fair value buy-out case, and guess what? The court applied the same 25% DLOM without any discussion of the factors supporting its application or quantification other than the court’s finding that the selling shareholder was guilty of oppressive conduct against the purchasing shareholder.

In Parker v Parker, 2016 N.J. Super. Unpub. LEXIS 2720 [Dec. 22, 2016], two brothers, Richard and Steven Parker, took over from their parents and for the next 25 years operated as 50/50 owners a wholesale flower business and a separately incorporated wholesale plant business which eventually became a garden center. Richard ran the flower business and Steven the garden business as separate fiefdoms with minimal overlap. Continue Reading Has New Jersey Gone Off Its DLOM Rocker?

BarberYet another voice, that of Greg Barber, CFA, of Barber Analytics in San Francisco, has joined the growing debate in business valuation and legal circles over the controversial application of the discount for lack of marketability in New York statutory fair value proceedings involving dissenting shareholder appraisals and elective buy-outs of minority shareholders in dissolution cases.

Greg is a corporate valuation expert who focuses on valuations for statutory and mediated minority shareholder buyouts. Greg published a thought-provoking article in the October 2016 New York State Bar Association Journal entitled Marketability Discounts in New York Statutory Fair Value Determinations in which he critically analyzes the leading New York appellate decisions applying the marketability discount in fair value cases — namely, Blake, Seagroatt, and Beway — and highlights what he argues are the “misunderstandings, miscommunications, and inconsistences” entangling the discussion among appraisers, attorneys, and the courts. A copy of Greg’s article is available on his website here.

I followed up Greg’s article with an interview of him for my Business Divorce Roundtable podcast, a link to which appears at the bottom of this post.

Continue Reading Marketability Discount Revisited: Interview With Greg Barber

66discountTalk about playing your cards wrong.

A partner with a 3.08% interest worth $4.85 million in a partnership that owns a major shopping mall likely will walk away with only a few hundred thousand dollars after a court decision finding that he wrongfully dissolved the partnership and deducting from the value of his interest the other partners’ damages including legal fees, a 15% discount for goodwill, a 35% marketability discount, and a whopping 66% minority discount.

Last week’s decision by the Brooklyn-based Appellate Division, Second Department, in Congel v Malfitano, 2016 NY Slip Op 03845 [2d Dept May 18, 2016], rejected the partner’s appeal from the trial court’s determination of wrongful dissolution and also upheld its valuation determination with one major exception: the appellate court held that the trial court erred by failing to apply a minority discount and that it should have applied a 66% minority discount based on the “credible” expert testimony “supported by the record.”

The defendant partner’s fateful decision took place in 2006, when he sent his fellow partners a written notice unilaterally electing to dissolve the partnership due to what he described as a “fundamental breakdown in the relationship between and among us as partners.” The other partners quickly responded with a damages lawsuit claiming that he had wrongfully dissolved in violation of the partnership agreement in an effort to force the partnership to buy out his interest at a steep premium. The defendant, arguing that the partnership was at-will and of indefinite duration, denied wrongful dissolution and counterclaimed for his full, pro rata share of the partnership’s value upon dissolution. Continue Reading Partner Who Wrongfully Dissolved Partnership Hit With Whopping 66% Minority Discount

An epic corporate governance and stock valuation battle between rival siblings, fighting over a Manhattan real estate portfolio worth upwards of $100 million, generated an important ruling last week by New York County Supreme Court Justice Marcy S. Friedman.  Justice Friedman’s decision in Matter of Giaimo (EGA Associates, Inc.), 2011 NY Slip Op 50714(U) (Sup Ct NY County Apr. 25, 2011), and the underlying, 184-page Report & Recommendation by Special Referee Louis Crespo dated June 30, 2010, are must reading for business appraisers, attorneys and owners of closely held real estate holding corporations who are involved in, or who are contemplating bringing or defending against, a “fair value” proceeding under New York’s minority shareholder oppression or dissenting shareholder statutes.

In the end, after both sides essentially accepted Referee Crespo’s net asset valuation of the 19 real properties owned by two Subchapter “C” corporations, the valuation controversy boiled down to two issues presented to Justice Friedman.  First, did Referee Crespo properly adopt what he dubbed the “Murphy Discount” (I’ll explain below) in requiring the deduction of the present value of taxes on built-in capital gains (BIG)?  Justice Friedman answered “yes.”  Second, did Referee Crespo properly exclude a separate discount of the companies’ shares for lack of marketability (DLOM)?  Although she disagreed with Referee Crespo’s reasoning, Justice Friedman again answered “yes.”

Giaimo involves two corporations, abbreviated as EGA and FAV, owned more or less in equal one-third shares by siblings Edward, Robert and Janet.  Together the corporations owned 18 residential apartment buildings (mostly walk-up tenements) and one undeveloped land parcel located mostly in Manhattan’s Upper East Side.  Edward died in March 2007.  His will provided for division of his shares equally between Robert and Janet, however Janet produced an assignment to her of one EGA share made by Edward two weeks before his death, giving her majority control of that company.  Robert brought a lawsuit challenging the assignment as a violation of the corporation’s right of first refusal endorsed on the back of the stock certificates.

Continue Reading Court Rejects Marketability Discount, Applies “Murphy Discount” for Built-In Gains, in Determining Fair Value of Shares in Real Estate Holding Corporations

By statute in New York and many other states, including Delaware, the standard of value used in dissenting shareholder appraisals and buy-outs in corporate dissolution proceedings brought by minority shareholders is “fair value.”  Fair value is to be distinguished from its better known cousin, “fair market value,” which is the standard applied in federal estate and gift tax proceedings and in matrimonial cases.  In one of the first posts I wrote for this blog over three years ago, I quoted Shannon Pratt’s leading treatise’s definition of fair value — “a legally created standard of value that applies to certain specific transactions” (Valuing a Business, p. 45 [5th ed. 2008]) — which I in turn translated as meaning “whatever the courts say it means.”

Leave it to Chris Mercer, one of America’s leading authorities on business appraisal and author of countless books and articles, to tackle the elusive subject of fair value in a series of posts for his new blog called ValuationSpeak.  Chris’s posts are must reading certainly for any attorney or business appraiser who handles a valuation proceeding applying the statutory fair value standard.  I also commend the articles to any business owner who wants to get a handle on what a fair value appraisal entails, and what discounts will or won’t be taken, to help them make more informed decisions about commencing or defending a judicial valuation proceeding.  Here’s an overview of the six posts written to date:

Part 1: Introduction.  Calling himself an “agnostic” on the subject, Chris begins his series with the fundamental observation that “fair value is ultimately a legal concept” as to which the appraiser must take guidance from legal counsel “regarding their legal interpretation of fair value in each jurisdiction.”  He then highlights the Delaware appraisal statute’s definition of fair value, which he says gives “little effective guidance” and merely requires consideration of “all relevant factors” akin to the criteria found in IRS Revenue Ruling 59-60 applicable to fair market value determinations.  (Note: New York’s fair value jurisprudence, beginning with the seminal Blake case, likewise invites consideration of the factors identified in Revenue Ruling 59-60.)  Chris contrasts the willing buyer/willing seller, “objective” standard of fair market value versus the willing buyer/unwilling seller “equitable” standard of fair value, leading him to conclude that “fair value is intertwined with concepts of fair market value and equity, which can be highly confusing for participants in fair value proceedings and for business appraisers as well.”

Continue Reading Chris Mercer Tackles Statutory Fair Value

The rules for the two most important valuation discounts in New York statutory “fair value” (FV) proceedings, such as shareholder oppression and dissenting shareholder cases, are well established:  the discount for lack of marketability (DLOM) is in; the minority discount a/k/a discount for lack of control (DLOC) is out.  DLOM applies because it reflects the additional time and risk of selling even a controlling, nonmarketable interest in a closely held business as compared to publicly traded shares.  In contrast, the reasoning goes, if DLOC were applied in FV proceedings the majority shareholders would receive a windfall that would encourage squeeze-out and unfairly deprive minority shareholders of their proportionate interest in the venture as a going concern.

As I’ve previously written here and here, the exclusion of DLOC in FV appraisals is the principal distinguishing feature from the “fair market value” (FMV) standard used in matrimonial, gift and estate tax matters where, premised on a hypothetical arm’s-length transaction under which neither buyer nor seller is under any compulsion to buy or sell, both discounts generally apply.  The two discounts, individually and certainly when combined, can substantially reduce the value of an interest in a closely held business entity.

Along comes an interesting court decision by a Manhattan judge that adds a new twist to the FV/FMV discount dichotomy, holding that neither discount should apply in measuring damages due for breach of an agreement to give the plaintiff a 10% equity interest in specified real properties owned by the defendant through a series of closely held entities.  The unreported decision is Cole v. Macklowe, Memorandum Decision, Index No. 604784/99 (Sup Ct NY County Sept. 25, 2010).

Continue Reading Court Rejects Minority and Marketability Discounts in Assessing Damages for Breach of Equity Participation Agreement

Viewers of Saturday Night Live in the late 1970’s remember Gilda Radner’s frumpy, hard-of-hearing character, Emily Litella, who gave misguided, agitated responses to TV editorials.  At the end of each sketch, after being told by Chevy Chase or Jane Curtin that she had misheard a critical word in the editorial, rendering moot her hilarious thesis, Litella would look straight into the camera and reply meekly, “Never mind.”  It became a catchphrase of the times.

I thought of Ms. Litella’s catchphrase when I read the Appellate Division, Second Department’s important decision last week affirming the trial court’s key stock valuation rulings, in Matter of Murphy (United States Dredging Corp.), 74 AD3d 815, 2010 NY Slip Op 04794 (2d Dept June 1, 2010).  Essentially, without even acknowledging it was doing so, the appellate court overruled 15 years of its own precedents, and aligned itself with contrary rulings by the other Appellate Divisions, by deciding that the discount for lack of marketability may be applied to the corporation’s entire enterprise value and not just its good will value.  (Read here and here my August 2008 and June 2009 articles on the inter-departmental split of authority.)

The trial judge in Murphy, Nassau County Commercial Division Justice Ira B. Warshawsky, over the minority shareholders’ objection, had applied a 15% discount for lack of marketability against the subject holding corporation’s entire enterprise value which consisted primarily of its ownership of several triple-net-leased real properties.  In so doing, he implicitly rejected theoretically binding Second Department precedent (the Whalen and Cinque cases) holding that the discount for lack of marketability is applicable only to the company’s good will value, and instead sided with the First Department’s contrary ruling in Hall v. King where the discount was applied to the entire enterprise value.  (What was implicit in Murphy became explicit in Justice Warshawsky’s later decision in the Jamaica Acquisition case where he openly agreed with Hall v. King.  This later case, which I wrote about here, settled prior to appeal.) 

Continue Reading Ruling on Valuation Discounts for Marketability, Built-In Gains Tax Ends Rift Among New York Appellate Courts

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.

See full size imageDissenting 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 In Unusual Case, Illinois Appellate Court Reduces Fair Value Award to Dissenting Shareholder