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).


The decision in Cole springs from an epic, 11-year (and counting) litigation between the well-known New York real estate developer, Harry Macklowe, and Warren Cole whom the decision describes as Macklowe’s former “right-hand man.”  In 1994, Macklowe orally advised Cole that he had decided to give him a 10% equity interest in all Macklowe investment projects going forward.  In 1996, Cole drafted, and Macklowe signed, a five-paragraph agreement stating that Macklowe was holding equity interests in a number of specified properties “for the benefit of” Cole and acknowledging their intent to “fully document these interests” in the form of a limited partnership interest or an LLC membership interest.  The more formal arrangement never materialized, and in 1998 Cole drafted, and Macklowe again signed, a four-paragraph “addendum” which added a number of additional properties to those listed in the 1996 agreement.

The close relationship between Macklowe and Cole subsequently deteriorated, leading to Cole’s resignation in April 1999 and Macklowe’s repudiation of the 1996 agreement and 1998 addendum.  Cole sued Macklowe in late 1999 to recover for breach of his equity participation rights along with several additional claims relating to other transactions.

The Prior Proceedings

The case suffered years of procedural delays, including an interim appeal, before Justice Marylin G. Diamond issued her January 2006 decision in Macklowe’s favor (2006 NY Slip Op 30551(U)), in which she held that the 1996 and 1998 documents were non-binding, preliminary agreements which anticipated that Cole would not actually receive an equity interest until the execution of more formal agreements.  Cole appealed to the Appellate Division, First Department which, in a 2007 decision reported at 40 AD3d 396, reversed Justice Diamond’s ruling, held that the 1996 and 1998 agreements were fully enforceable, and remanded the case for a determination of damages under the contract.

In a February 2009 trial court decision reported at 2009 NY Slip Op 30410(U), Justice Diamond rejected Cole’s position that his damages included his pro rata share of ongoing distributions to date, and instead agreed with Macklowe that Cole’s damages

should be calculated based on (1) the total distributions which were withheld from Cole prior to Macklowe’s repudiation of the agreements in September, 1999 and (2) the value of Cole’s interests based on market conditions which existed as of the time of the breach.  [Emphasis added.]

Cole again appealed.  The Appellate Division, in a July 2009 decision reported at 64 AD3d 480, modified the date of Macklowe’s breach to April 1999 but otherwise affirmed Justice Diamond’s stated measure of damages.

The Ruling on Discounts

In anticipation of a bench trial on damages, both sides requested a ruling from the court on whether Macklowe may present expert testimony regarding the application of DLOC and DLOM in valuing Cole’s equity interests in the properties, each of which is owned by a Macklowe-controlled LLC or limited partnership.  Macklowe contended that the prior decisions in the case require application of the FMV standard which, in turn, must include discounts for lack of control and unmarketability.  Cole countered that he is not a “willing seller” as contemplated under the FMV standard, that his damages action is more akin to an involuntary sale by an oppressed or dissenting minority shareholder, and that no discount should be applied.

Justice Diamond begins her analysis by agreeing with Cole that, based on the finding of Macklowe’s breach of contract, the calculation of damages does not involve a willing seller and that, “in cases involving the involuntary sale of the interests of a minority owner who has essentially been forced out of a company, the minority owner is entitled to receive the ‘fair value’ of these interests.”  She then cites decisions in oppressed and dissenting shareholder cases holding that DLOC is inapplicable.  In rebuttal to Macklowe’s contention, that the discount “ban” is limited to statutory valuation proceedings that expressly require the FV standard, Justice Diamond cites Vick v. Albert, 47 AD3d 482 (1st Dept 2008), where the First Department upheld the rejection of DLOM and DLOC for a valuation award obtained by the estate of a deceased partner in a real estate partnership under Section 73 of the Partnership Law, which requires payment to a deceased partner for the “value of his interest” in the partnership.  (Read here my analysis of the Vick decision.)

The application of discounts, Justice Diamond therefore concludes, does not turn on statutory constraints.  “Rather, the issue turns on whether the policy concerns underlying the ban on the use of discounts are present in this case.”  Those concerns are present in Cole, Justice Diamond finds, based on four factors:

  1. Macklowe’s repudiation of Cole’s equity interests “is clearly analogous” to oppressive majority shareholder conduct intended to limit or preclude minority ownership rights, thereby implicating the statutory objective in oppression cases of obtaining a “fair appraisal remedy.”
  2. The use of discounts would “reward” Macklowe by limiting the damages payable by him arising from his own misconduct.
  3. As in Vick, the unavailability of discounts is “particularly apt” since the business assets consist of real estate, and their application would deprive Cole of what the value of his interests would have been had each of the designated properties been sold on the open market.
  4. The use of discounts would result in a “windfall” to Macklowe by virtue of his “consolidating or increasing his ownership and control of the properties,” as opposed to a sale to a third party who gains no right to control or manage the entity.

“Accordingly,” Justice Diamond decrees, “Macklowe’s request for leave to present expert testimony regarding the applicability of minority and marketability discounts is hereby denied.”

Macklowe has filed a notice of appeal from the decision, so it may be that the Appellate Division once again will have the final word.  If it does, we can hope that it will clarify the applicability of valuation discounts to the appraisal of equity interests in determining damages for breach of contract which, traditionally, are predicated on restoring to plaintiff the “benefit of the bargain” as opposed to fair value.  The appeals court also can be expected to focus, even assuming a correct analogy between Macklowe’s breach and majority shareholder oppression, on whether it is appropriate to exclude DLOM which routinely is applied in oppression and other FV proceedings.  Finally, I’m sure many in the legal and business appraisal community would welcome further appellate explication of the controversial rationale for not applying discounts in valuing minority interests in real estate holding entities.