Of all the types of small, closely held businesses caught in the maelstrom of a judicial dissolution proceeding, in my experience the one that’s most likely to go all the way to liquidation — as opposed to a buyout settlement — is the real estate holding company. Probably that’s because there’s an active, ready market to sell real estate assets, unlike the situation facing many other sorts of businesses with relatively few hard assets whose going concern value lies to a large degree in the good will derived from the individual talents and efforts, and customer relations, of the disputing owner-managers.
When a court orders dissolution of a real estate holding company whose owners are not cooperating with each other, the court may appoint a receiver to wind up the business and sell the realty. Can the receiver sell the realty in a private sale transaction, or must the receiver conduct a public auction sale to maximize the liquidation proceeds?
Even though the answer lies in plain sight in the governing statutes, the question nonetheless prompted a noteworthy decision earlier this month in a deadlock dissolution case that I highlighted last year called Matter of Darvish. The decade-old case involves a fight between two 50/50 shareholders of several single-asset real estate holding companies, all of which eventually were ordered dissolved and placed in receivership. In an August 2010 decision by Manhattan Supreme Court Commercial Division Justice Melvin L. Schweitzer, the court imposed a disproportionate share of the receiver’s fees against the distributive share of one of the two shareholders based on his “vexatious litigation tactics” (read here my prior post on the decision).
Following that decision, the receiver filed a motion for authority to sell one of the properties by negotiated private sale rather than at public auction as stipulated in the court’s original order of appointment. The property at issue is a valuable four-story building on Manhattan’s Upper East Side. One of the shareholders, Lavian, objected to a private sale while the other, Darvish, agreed with a private sale but objected to the receiver’s proposed $2.8 million asking price which Darvish believed should be higher based on a $3.9 million valuation estimate he obtained from his own broker.
Justice Schweitzer’s latest decision in Matter of Darvish (Haslacha, Inc.), 2011 NY Slip Op 30134(U) (Jan. 19, 2011), summarizes as follows the rationale for the receiver’s request:
Based on his experience in the real estate business, Mr. Landis believes that a public auction of the Property would not attract purchasers willing to pay the market price because they would view the auction as a foreclosure sale of distressed property, and would expect a substantial discount. On the other hand, Mr. Landis argues, a private sale would allow him to “pre-screen potential purchasers and negotiate only with those willing to pay market rate for the property.”
The receiver proposed to engage two qualified real estate brokers to market the property at an asking price of $2.8 million based on the broker’s “initial valuation” between $2,550,000 and $2,575,000. The proposed single 6% broker’s commission would be paid even if the successful purchaser is an insider, i.e., one of the shareholders or the current tenant who apparently held a right of first refusal.
Lavian argued that case law prohibits a receiver from liquidating assets in dissolution other than by means of public auction, citing Matter of Oak Street Management, Inc., 307 AD2d 320 (2d Dept 2003). In that dissolution case, an appellate panel reversed a lower court’s order appointing a referee to value the corporation’s properties and leasehold interests and to recommend the appropriate procedures following dissolution. The appellate court noted that the post-dissolution procedures set forth in Sections 1005 through 1008 of the Business Corporation Law do not include appointment of a referee. It then added:
Absent an agreement between the parties to sell the shares of the corporation to each other or to an outside buyer, the only authorized disposition of corporate assets is liquidation at a public sale. Thus, no appraisal of the value of the corporation’s asset was warranted in this case.
In rejecting Lavian’s position, Justice Schweitzer narrowly reads Oak Street‘s holding as simply restricting a court’s authority to appoint a referee for valuation purposes. More to the point, Justice Schweitzer relies on the explicit authorization for private sale found in BCL Section 1206(b)(2), which empowers a receiver in dissolution cases:
To sell at public or private sale all the property vested in him, in such manner and on such terms and conditions as the court shall direct, and to make necessary transfers and conveyances thereof.
The receiver’s statutory authority to sell at public or private sale mirrors a corporation’s own post-dissolution statutory authority found in BCL Section 1005(a)(2):
The corporation shall proceed to wind up its affairs, with power to fulfill or discharge its contracts, collect its assets, sell its assets for cash at public or private sale, discharge or pay its liabilities, and do all other acts appropriate to liquidate its business.
Justice Schweitzer’s ruling also finds support in the Oak Street decision’s citation to Matter of Sternberg, 181 AD2d 897 (2d Dept 1992), where the Second Department held that “if there is no agreement between the parties within a reasonable time, and no outside buyer of the business as a whole can be found, a liquidation of the corporation’s assets by public sale shall be held.” In contrast, Justice Schweitzer continues,
That is not the case here, since finding an outside buyer is exactly what Mr. Landis purports to intend to do. Indeed, Mr. Landis wants to hire [brokers] to obtain a substantially higher price for the Property than would otherwise be available at a public sale. . . . Therefore, the court agrees with Mr. Landis that a negotiated private sale is in the best interest of the Haslacha estate.
Responding to shareholder Darvish’s objection to the proposed $2.8 million asking price as too low, Justice Schweitzer states that the court “will not impose a minimum threshold for the asking price.” Justice Schweitzer further observes that Darvish, having already consented to the appointment of the broker that ascertained the appropriate pricing, “cannot now try to impose another broker’s valuation opinion.” He also notes the receiver’s representation that the proposed brokers’ initial valuation and proposed asking price are both “works in progress” and that he has asked his brokers to review Darvish’s broker’s valuation opinion and the comparables on which it is based. “Since its commission is tied to the ultimate success of the sale,” Justice Schweitzer adds, “[the receiver’s broker] has a strong incentive to seek out the best available price, and the court need not needlessly restrain its business judgment.”
One can infer from the decision the back story of this latest episode in Darvish: one shareholder wants to bid on the building himself and therefore has an economic incentive to depress third-party bids, while the other shareholder likely is not a potential buyer and therefore wants the highest possible third-party bids.
It is generally true that bidders at a real estate public auction sale will offer less than bidders in a private sale, for several reasons. First, particularly for high-end properties such as the one in Darvish, a broker’s marketing efforts can generate greater buyer interest. Second, bidders at public auction usually cannot obtain as much information about the property and perform as much due diligence as private buyers. Third, the terms of sale at a public auction are usually harsher than a private sale, generally requiring the successful bidder to pay a 10% deposit by certified funds the day of the auction and to close within 30 days.
That is not to say I agree entirely with the receiver’s stated rationale for private sale as quoted by the court, i.e., that a prospective private buyer will not view the offering as a distress sale opportunity to buy at discount. If not disclosed upfront by the broker, any interested bidder with internet access can quickly ascertain that the property is owned by a dissolved corporation in receivership with the attendant mandate by court order to sell the property. Heck, in the case of the building being sold in Darvish, all they have to do is read this blog post!
Update September 10, 2011: The receiver’s broker subsequently procured, and the receiver applied for court approval of, a $2.4 million offer. Darvish opposed the application and asked the court to order the receiver to accept a $2.7 million offer from another buyer apparently procured by Darvish. By Order dated August 16, 2011 (read here), the court agreed with Darvish, stating that “the court fails to understand why the receiver prefers” the lower offer and ordering the receiver to accept the higher offer.