The East River and roughly five miles as the pigeon flies separate the equally beautiful courthouses of the Appellate Division, Second Department in Brooklyn and the Appellate Division, First Department in Manhattan. Because of the limited jurisdiction and very selective docket of New York’s highest court known as the Court of Appeals, in the vast majority of cases these two intermediate appellate courts effectively are the courts of last resort for their respective geographic slices of downstate New York.
Over many years, a different sort of divide has separated the two appellate courts when it comes to statutory fair value proceedings and, in particular, their treatment of the controversial discount for lack of marketability (DLOM).
The earliest version of the DLOM divide concerned whether it should apply to good-will value only, that is, not to the value of realty, cash, and other net tangible assets. For over two decades, prevailing Second Department case law limited application of DLOM in that fashion; the First Department did not. The decisions of one court didn’t acknowledge the other’s. Then, in 2010, without discussion or even acknowledging a change, the Second Department in the Murphy case seemingly healed the rift by dropping the good will limitation.
I say seemingly because, in recent years, the DLOM divide between the two appellate courts quietly has resurfaced in the context of fair value contests involving real estate holding companies where, on the Manhattan side of the river, First Department cases have accepted the appropriateness of a marketability discount on account of the realty’s “corporate wrapper.” Meanwhile, on the Brooklyn side of the river, Second Department cases have rejected DLOM on the theory that the value of a realty holding entity is the value of the realty or, alternatively, that a marketability discount already is incorporated in the underlying realty appraisal by way of an assumed market-exposure period.
The main protagonists in the divide are, for the First Department, its 2012 ruling in the Giaimo case which applied a 16% DLOM in valuing two corporations holding a portfolio of Manhattan apartment buildings and, for the Second Department, its 2015 ruling in the Chiu case affirming a 0% DLOM in valuing an LLC that owned a commercial property. Both cases are the focus of prior posts on this blog, here and here.
The continuing vitality of both cases is manifested in several very recent appellate and trial court decisions.
First Department: Seven Pines and Burntisland
The most recent of these is Matter of Levine v Seven Pines Associates L.P., 2017 NY Slip Op 08740 [1st Dept Dec. 14, 2017], a post-merger, dissenting partner fair value proceeding under Section 623 of the Business Corporation Law which, lest you think it odd that a partnership case falls under a statute governing corporations, is incorporated by reference in Section 121-1105 of New York’s Revised Limited Partnership Law (“Payment for interest of dissenting limited partners”).
In Seven Pines, the First Department affirmed for the most part the lower court’s fair value determination of a 4% interest in a limited partnership that owns a 26-story apartment building appraised at around $21 million. The partnership’s business valuation expert testified in support of a 25% DLOM and a 12% minority discount a/k/a discount for lack of control (DLOC). The petitioner’s business appraiser testified there should be no DLOM or DLOC. The trial court adopted the partnership’s expert’s analysis in a 2-page post-trial decision that mentioned the petitioner’s lack of control but said nothing of substance about DLOM.
The petitioner’s appeal challenged both discounts (among other issues). The First Department’s unanimous decision last week not surprisingly erased the 12% DLOC under well established case law prohibiting a minority discount under the statutory fair value standard. In upholding the 25% DLOM, the panel devoted all of two sentences and one case citation — Giaimo — to the subject:
[P]etitioner’s expert did not discount the value of the Trust’s interest for lack of marketability, while respondent’s expert did. In the past, we have applied discounts for lack of marketability (DLOM) to real estate holding companies (Matter of Giaimo v Vitale, 101 AD3d 523, 523-525 [1st Dept 2012], lv denied 21 NY3d 865 ).
Giaimo also made a silent appearance in another recent fair value decision by a Manhattan trial judge in Matter of Burntisland II LLC, 2017 NY Slip Op 32482(U) [Sup Ct NY County Nov. 20, 2017]. Burntisland is an unusual case in which the court determined fair value without holding an evidentiary hearing. Whether that occurred with or without both sides’ consent I can’t say.
Like Seven Pines, Burntisland involved the post-merger valuation under BCL Section 623 of a dissenter’s small interest in a realty holding company — this time an LLC — that owns a 4-story, landmarked building leased to a private arts club under a long-term, triple net lease. The company’s business appraiser applied a 20% DLOM. The dissenter’s business appraiser opined that the DLOM range should be 0% to 6.9%.
The judge’s opinion, as in Seven Pines, devoted only two sentences, including a vague reference to “relevant case law,” to its determination of a 16% DLOM, a figure proposed by neither party but which coincidentally or not — I strongly suspect not — matches the 16% DLOM applied by the First Department in Giaimo. Here’s what the court wrote:
Based on the arguments presented and the relevant case law, the court determines that a DLOM of 16% is appropriate in this case. Here, the court is persuaded by [the company’s] arguments in favor of a DLOM, however, the court determines that 16%, instead of 20%, more accurately reflects the appropriate discount commensurate with the lack of the public market for a private LLC of this type.
Second Department: Kassab
Since Chiu in 2015 the Second Department has not had occasion to revisit the application of DLOM to realty holding companies in fair value proceedings. Chiu‘s influence nonetheless made itself felt in at least one recent trial court decision previously featured on this blog, namely, the Kassab case decided last August involving a fair value determination of minority interests in two realty holding entities, one a corporation and the other an LLC.
The valuation argued by the respondent majority owner in Kassab included a 25% DLOM. That of the petitioning minority owner — who relied on the expert report of Chris Mercer, the same expert used by the petitioner in Chiu — excluded a DLOM. The court sided with the petitioner and adopted Mr. Mercer’s rationale that there should be no DLOM “since the companies were real-estate holding companies, whose valuation already relies upon market exposure.”
Reconciliation is Needed
I am an agnostic on the heated subject of DLOM, both as matters of public policy and appraisal doctrine. When representing a client in a fair value proceeding whose interest lies on either side of the issue, I will advocate as forcefully as I can utilizing the case precedents and appraisal theories that favor my client’s position and distinguishing those that don’t. That’s a lawyer’s job. The rest is up to the courts and perhaps the legislature if it ever sees fit to tackle a statutory definition of fair value.
Some day, perhaps, some litigant will bring a case in the Court of Appeals asking it to reconsider wholesale its 1995 decision in Friedman v Beway Realty permitting courts to apply a marketability discount in fair value proceedings, that is, regardless of the nature of the entity and assets being valued.
In the meantime, there’s something discomfiting about the notion that the owner of an interest in a real estate holding company with property in Manhattan or the Bronx, comprising the First Department, should incur a substantial marketability discount that would not be incurred by an identically situated owner of a realty holding company with property in any of the ten counties comprising the Second Department (Brooklyn, Queens, Richmond, Nassau, Suffolk, Westchester, Dutchess, Putnam, Orange and Rockland).
Again, I’m not suggesting that either of the Second Department or First Department got it right or wrong. I’m only highlighting the pressing need for convergence of the disparate positions so as to bring uniformity to our fair value jurisprudence in a large sub-universe of cases involving realty holding companies.