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


SSTMy late grandfather, Samuel S. Tripp, had a remarkable career in the law spanning almost 70 years. He was admitted to the bar in 1928 after graduating from NYU School of Law. As a second year lawyer in private practice he argued his first appeal in the New York Court of Appeals when Benjamin Cardozo was its Chief Judge. In 1937 he became Chief Law Assistant of the Queens County Supreme Court, a position he held until retirement in 1973 after which he joined Farrell Fritz where he served as counsel to the firm and mentor to many for more than 20 years. He was President of the Queens County Bar Association, Vice President of the New York State Bar Association, and author of a leading treatise on New York practice. He was fastidious about everything he did. He had an amazing memory. He was the ultimate lawyer’s lawyer.

During his years at Farrell Fritz, from time to time Sam served as court-appointed Referee to hear and report in litigated matters. In 1982, he was appointed Referee in a corporate dissolution case involving a family-owned insurance agency to hear and report on the “fair value” of the petitioner’s 25% stock interest following the majority owner’s election to purchase in lieu of dissolution. The buy-out statute, § 1118 of the Business Corporation Law, had been enacted only three years before and there was virtually no case precedent construing the statute’s undefined “fair value” standard. Continue Reading The Birthing of New York’s Marketability Discount in Fair Value Cases: A Family Affair

fair valueThe discount for lack of marketability (DLOM) is one of the most hotly debated and heavily litigated issues in New York fair value proceedings involving dissenting shareholder appraisals and oppressed minority shareholder buyouts.

A new note in the DLOM debate is sounded in an article by Gilbert E. Matthews, CFA, Senior Managing Director and Chairman of Sutter Securities, published in this month’s Business Valuation Update with the provocative title, “NY’s Unfair Application of Shareholder-Level Marketability Discounts.” The article’s thrust is that New York law is singularly out of step with predominant fair value jurisprudence excluding DLOM in statutory fair value proceedings. (BV Update subscribers can access the article here; non-subscribers can obtain a copy by email request to Mr. Matthews at gil@suttersf.com.)

For those not familiar with valuation discounts, the International Glossary of Business Valuation Terms defines DLOM as “an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability” where marketability in turn is defined as “the ability to quickly convert property to cash at minimal cost.” It is not to be confused with the minority discount a/k/a discount for lack of control (DLOC) defined as “an amount or percentage deducted from the pro rata share of value of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control.” Continue Reading The DLOM Debate Heats Up

This is the second installment of a two-part examination of a recent post-trial decision by Queens County Supreme Court Justice Allan B. Weiss in Chiu v. Chiu, a decade-long fight between two brothers over the ownership of commercial realty in Long Island City purchased in 1999 for use as a warehouse for a business separately owned by one of the brothers. Last week’s post analyzed the court’s ruling, based on some old tax returns and subsequent advances deemed to be capital contributions, that the percentage ownership split of the title-holding LLC is 90/10. This second post looks at the court’s valuation of the 10% member’s interest triggered by his withdrawal from the LLC.

 

In Chiu v. Chiu (read decision here), after deciding that brothers Man Choi Chiu (MCC) and Winston Chiu (WC) held 90% and 10% membership interests, respectively, in the single asset realty company known as 42-52 Northern Boulevard, LLC (the “LLC”), Justice Weiss’s next task was to calculate the “fair value” of WC’s 10% interest as of February 9, 2008, the date on which WC withdrew from the LLC pursuant to LLC Law §509.

Justice Weiss initially observes that the LLC Law “does not define ‘fair value,’ and the parties have not called the court’s attention to any cases which discuss the term in connection with a limited liability company.” He then proceeds to interpret fair value “as used in connection with other business forms,” i.e., by reference primarily to fair value case law involving stock buy-outs and dissenting shareholder appraisals under New York’s Business Corporation Law.

MCC and WC each offered the testimony of two experts — a real estate appraiser and a business appraiser — to value WC’s membership interest. In an unusual twist, MCC’s real estate appraiser (representing the buyer) valued the property $200,000 higher than WC’s real estate appraiser (representing the seller), with the former arriving at a figure of $13.7 million versus the latter’s $13.5 million.

Continue Reading Court Rejects Marketability Discount in LLC Fair Value Case

A Manhattan judge last month awarded a dissenting shareholder over $2 million plus another $1 million for attorneys’ fees and expenses in a battle of the experts featuring disputes over valuation methods, discounts, and consideration of future tax benefits arising from the merger. Matter of Harlem River Yard Ventures, Inc., Decision and Order, Index No. 602341/07 (Sup Ct NY County July 11, 2011).

In 1991, the New York State Department of Transportation as owner entered into a 99-year lease with Harlem River Yard Ventures, Inc. (“Ventures”) to develop an industrial park on the site of the abandoned Penn Central rail yard at the southern tip of the Bronx bordered by the Harlem River, directly opposite Manhattan. Real estate developer Francesco Galesi of the Galesi Group is the majority and controlling owner of Ventures. The operator of the famous Hunts Point Market in the Bronx, organized as a cooperative association, took a 5% stake (later diluted to 4.6%).

Between 1997 and 2006, Ventures entered into long-term net sub-leases with Waste Management, Inc. for a waste transfer station; with News Corporation for a colorizing plant for the New York Post; and with Federal Express for a package transfer facility. A large portion of the approximately 100-acre site remains unused.

In March 2007, Galesi, who, along with other officers of Galesi Group controlled over 90% of Ventures’ shares, merged Ventures into a new corporation called Harlem River Ventures II, Inc. (“Ventures II”), with the intention that Ventures II would elect to be taxed as a partnership under subchapter “S”. The squeeze-out merger required Hunts Point Market, which, as a cooperative association could not own stock in an “S” corporation, to accept cash for its shares.

Continue Reading Court Endorses Discounted Cash Flow Method, Rejects Post-Merger Tax Benefits, in Determining Fair Value Award to Dissenting Shareholder

The discount for lack of marketability, or DLOM, has reigned supreme in New York fair value proceedings since 1985 when the Appellate Division, Second Department, decided Matter of Blake, 107 AD2d 139.  DLOM’s basic premise accepted in Blake is that “shares of a closely held corporation cannot be readily sold on a public market” (id. at 149) and therefore should be discounted to reflect the additional risk factors associated with the time and difficulty of finding buyers for non-publicly traded shares.

Equally vital to the Blake doctrine is the assumption that DLOM “bears no relation to the fact that the petitioner’s shares in the corporation represent a minority interest” (id.).  For that same reason, Blake ruled out application of a separate minority discount, also known as discount for lack of control or DLOC, as inconsistent with the protections afforded minority shareholders against oppression by the majority under the judicial dissolution statute, BCL  §1104-a, and likewise to deny controlling shareholders a “windfall” from exercising their right to elect to purchase the petitioning minority shareholder’s stock for fair value under BCL  §1118.

In other words, the dichotomy between DLOM and DLOC adopted in Blake views “good” DLOM as applicable at the enterprise level to all shares in determining the selling shareholder’s proportionate interest in the going concern, whereas “bad” DLOC applies only at the shareholder level to minority shares.  New York’s highest court, the Court of Appeals, further cemented this view in its 1995 Beway decision.  Since then it has been followed without question in countless trial and appellate court decisions wherein business appraisers have relied primarily on restricted stock and pre-IPO studies to compute DLOM. 

The question is, is there any sound appraisal doctrine or empirical evidence supporting Blake‘s premise that DLOM exists and can be quantified at the enterprise or majority-control level?  If not, are BlakeBeway and their progeny predicated on flawed, internally inconsistent assumptions that effectively compute fair value at the non-marketable minority interest level of value rather than proportionate interest in the company’s going concern value at a control level?  

Continue Reading The Marketability Discount in Fair Value Proceedings: An Emperor Without Clothes?

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