Take, for instance, its 2010 Murphy decision, in which it noted without elaboration that the application of a discount for lack of marketability (DLOM) is not in all cases limited to the enterprise’s goodwill without so much as acknowledging 25 years of its own contrary precedent.
Then there’s last week’s decision in Chiu v Chiu, 2015 NY Slip Op 01427 [2d Dept Feb. 18, 2015], in which it upheld without comment a lower court’s decision to apply 0% DLOM in valuing a membership interest in a realty-holding LLC co-owned by two brothers. Considering the ongoing, vigorous debate in legal and valuation circles surrounding the existential propriety of DLOM under the statutory fair value standard, as recently played out in the Zelouf and Giaimo cases, it would have been extremely helpful to other litigants had the Second Department explained why it believed DLOM was inappropriate in Chiu. Oh well.
I wrote extensively about the lower court’s fair value determination in Chiu in a two-part post (here and here), so I won’t rehash the full, convoluted story. The case basically involves a dispute between two brothers, Winston Chiu and Man Choi Chiu, over the ownership and control of an LLC formed in 1999 to acquire for $5.5 million a warehouse in Queens, New York. They had no written operating agreement. The LLC’s 1999 and 2000 tax returns identified Winston Chiu as 25% member and Man Choi Chiu as 75% member in proportion to their initial capital contributions. The LLC filed no subsequent returns because of the brothers’ falling out in 2001, which precipitated multiple lawsuits lasting more than a decade.
After years of inconclusive litigation, in 2008 Winston Chiu exercised his statutory right to withdraw from the LLC and receive fair value for his 25% membership interest. Man Choi Chiu contended that his brother had no membership interest or, at best, had an approximate 10% interest based on their relative, aggregate capital contributions including monies contributed solely by Man Choi Chiu after the falling out.
The Lower Court’s Decision
In 2012, after a lengthy trial which included expert testimony concerning fair value, the lower court agreed with Winston Chiu that the 1999 and 2000 tax returns estopped his brother from contesting the ownership percentages in those years, but not in subsequent years over which, the court concluded, Man Choi Chiu’s membership interest increased to 90% based on about $1.23 million he put into the project, which the court characterized as capital contribution rather than loan as contended by Winston Chiu.
The real estate and business appraisals offered by each sides’ experts were remarkably consistent for the most part. The trial court ultimately selected the approximate $10,450,000 net asset value computation offered by Man Choi Chiu’s business appraiser, Joseph Nelson, which was about $23,000 higher than the figure offered by Winston Chiu’s business appraiser, Chris Mercer. The big difference between the two appraisers was on DLOM. Mr. Nelson argued for a 25% DLOM based on restricted stock studies and case precedent. Mr. Mercer offered a two-prong argument for 0% DLOM: (1) application of DLOM in a statutory fair value proceeding effectively constitutes a prohibited minority discount, and (2) the marketability risk was fully reflected in the market exposure period built into the real estate appraisal.
The trial court agreed with Mr. Mercer’s 0% DLOM, if not with his precise reasons, stating as follows:
[Man Choi Chiu] is not entitled to a lack of marketability discount. It is true that in determining the fair value of a limited liability company, as with a close corporation, the illiquidity of the membership interests should be taken into account. While the application of a lack of marketability discount is not always limited to the goodwill of a business, in the case at bar, the LLC’s business consisted in nothing more than the ownership of realty which is easily marketable. In any event, Nelson’s testimony that [Man Choi Chiu] is entitled to a whopping 25% lack of marketability discount for what is essentially real property placed in a limited liability company package has no credibility, and the record does not permit the court to determine what lesser percentage might be appropriate.
Based on these findings, the court entered a money judgment for Winston Chiu in the amount of $1,044,974 representing 10% of the LLC’s undiscounted net asset value as computed by Mr. Nelson, plus statutory interest from the date of Winston Chiu’s withdrawal from the LLC in 2008.
The Appellate Decision
Both sides appealed, leading to last week’s Second Department ruling in which the court held in Winston Chiu’s favor on his claimed 25% membership interest and also directed the lower court on remand to recalculate the fair value award using the slightly lower net asset value ($10,427,000) computed by Mr. Mercer which, the court commented, “was more accurate than that of Man Choi Chiu’s expert.”
Although the decision’s factual recitation mentions that the lower court did not apply a DLOM, it says nothing further on the subject, other than impliedly in the decision’s ultimate sentence stating that “[t]he parties’ remaining contentions are without merit,” which would appear to include Man Choi Chiu’s challenge to the lower court’s 0% DLOM.
The Second Department’s endorsement of Winston Chiu’s 25% membership interest is predicated on a twofold analysis: (1) estoppel arising from the LLC’s 1999 and 2000 tax returns, which Man Choi Chiu signed, reporting the initial 75/25 membership split, and (2) the absence of evidence of any agreement to treat the additional monies advanced by Man Choi Chiu as capital contribution rather than as loan. Here’s what the court wrote:
Here, the Supreme Court properly determined that the LLC’s records, which included the LLC’s tax returns for the years 1999 and 2000, established that Winston Chiu’s initial membership interest was 25% (see Reichman v Reichman, 88 AD3d 680, 682; Man Choi Chiu v Chiu, 38 AD3d 619, 621; Matter Capizola v Vantage Intl., 2 AD3d 843, 844). Although Man Choi Chiu contends that the LLC’s records were incorrect, he cannot subsequently take a position contrary to that taken in the income tax returns which he admitted that he signed (see Mahoney-Buntzman v Buntzman, 12 NY3d 415, 422; Livathinos v Vaughan, 121 AD3d 485; Winship v Winship, 115 AD3d 1328; Czernicki v Lawniczak, 74 AD3d 1121, 1125; Peterson v Neville, 58 AD3d 489). However, the Supreme Court incorrectly determined that the subsequent contributions by Man Choi Chiu should be treated as capital contributions, and not as loans, as the record was bereft of any evidence of an agreement between the members to such treatment (see Mizrahi v Cohen, 104 AD3d 917, 920; Matter of KSI Rockville v Eichengrun, 305 AD2d 681; Rich, Practice Commentaries, McKinney’s Cons Laws of NY, Book 32A, 2014 Cumulative Pocket Part, at 72). Accordingly, on the date of his withdrawal, Winston Chiu’s membership interest remained at 25%.
It’ll be interesting to see to what effect other litigants in other cases will cite Chiu on the DLOM issue. If it’s cited for the proposition, suggested by the lower court’s decision, that there should be no DLOM when valuing a firm whose only asset is “readily marketable” realty, does that put it in tension with the First Department’s Giaimo decision? In that case involving realty holding companies with a large portfolio of Manhattan tenement buildings, the court overturned a 0% DLOM finding and applied a 16% DLOM, stating:
While there are certainly some shared factors affecting the liquidity of both the real estate and the corporate stock, they are not the same. There are increased costs and risks associated with corporate ownership of the real estate in this case that would not be present if the real estate was owned outright. These costs and risks have a negative impact on how quickly and with what degree of certainty the corporations can be liquidated, which should be accounted for by way of a discount.
For those who’d like to delve deeper into the factual contentions and legal arguments presented in the Chiu appeal, below are links to the appellate briefs:
- Man Choi Chiu’s Opening Brief
- Winston Chiu’s Opening Brief
- Man Choi Chiu’s Reply Brief
- Winston Chiu’s Reply Brief
Update September 17, 2015: It’s officially over! Today the Court of Appeals (New York’s highest appellate court) issued an order turning down Man Choi Chiu’s application for leave to appeal to that court.