About 40 years ago, a son and his mother first teamed up to invest in purchasing and managing over a dozen buildings in New York through 4 co-owned entities, each owned on a 50/50 basis. Fast forward several decades and the successful family business has turned into a bitter family feud.

As is all too often the case particularly with family-owned companies, there was far too little documentation of important items. None of the companies had governing agreements. Loans between the companies were undocumented. The potential for trouble loomed large.

Today’s post jumps in at the tail end of nearly a decade of litigation that recently culminated with a post-trial decision by New York County Commercial Division Justice Melissa A. Crane, (Rosenblum v Rosenblum, Index No 654177/2015), following a 3-day valuation bench trial to determine, under LLCL § 509, the fair value of plaintiff Kenneth Rosenblum’s 50% interest in 2 of the co-owned real estate holding companies.

A Contentious Rift in the Rosenblum Household

As the Court noted in the opening paragraph of its Decision:

This case is notable for being a particularly acrimonious, multi-generational family dispute. It has also been lengthy. The parties have been fighting since 1996. They agree on practically nothing, are uncompromising, and change legal positions as it suits them in the moment. This court is confident this decision will only foster further litigation, both here and on the appellate level. There appears to be no real interest in resolving this matter.

The Court might have been hyperbolic for effect, but not by much.

This lawsuit (together with a consolidated action between the same parties) commenced in 2015, following what appears to be a prior attempt to settle a portion of their dispute in 2013. Since its 2015 commencement: the case changed hands from Justice Rakower to Justice Crane; the defendant Bernice Rosenblum passed away, with her Estate stepping in as defendant; there have been a combined 17 sets of motions and 2 appeals; and the Court conducted 2 (!!) sets of full blown, multi-day bench trials—a 9-day trial in 2020 and the 3-day valuation trial that is the subject of today’s blog post.

Without going into the history between the parties, the facts and issues before the Court at the Valuation Trial were relatively limited:

Kenneth and Bernice Rosenblum were 50/50 members in 132 Realty LLC and Village Realty LLC. The LLCs are real estate holding companies: 132 Realty owns a building located at 132 Thompson Street, and Village Realty owns 2 buildings about 10 blocks away at 35 Christopher Street and 37-39 Christopher Street. All three buildings are mixed-used properties in the West Village that are mostly residential with ground floor storefronts.

The Court previously determined at the 2020 bench trial that Kenneth voluntarily withdrew from the LLCs as of September 20, 2019. The Valuation Trial was held to determine the fair value of Kenneth’s 50% interest in the LLCs as of the withdrawal date.

The Parties’ Value Conclusions Are (Unsurprisingly) Miles Apart

Both sides submitted expert reports and live testimony of qualified real estate appraisers (Cushman & Wakefield for Kenneth and Colliers for the Estate) and business appraisers (Chris Mercer for Kenneth and EisnerAmper for the Estate) at trial.

While the expert reports and trial transcripts are not publicly available, we are treated to the parties’ comprehensive post-trial briefs (Kenneth’s and the Estate’s) and reply briefs (Kenneth’s and the Estate’s) where they synthesize their respective positions.

Kenneth concluded that the fair value of his 50% interest in the LLCs as of September 20, 2019 was $33,910,000, summed up as follows:

  • Value of 132 Thompson: $33,000,000
  • Value of 35-39 Christopher: $29,000,000
  • 0% discount for lack of marketability
  • Fair Value of 50% interest in 132 Realty: $17,542,000
  • Fair Value of 50% interest in Village Realty: $16,368,000

The Estate’s conclusion of value was less than half that, at $14,835,000, summed up as follows:

  • Value of 132 Thompson: $18,500,000
  • Value of 35-39 Christopher: $16,000,000
  • 15% discount for lack of marketability
  • Fair Value of 50% interest in 132 Realty: $7,794,000
  • Fair Value of 50% interest in Village Realty: $7,041,000

The Real Estate Appraisals Diverge in 2 Material Areas

Both sides’ real estate experts applied the direct capitalization approach as their primary method of valuation. This requires deriving the Net Operating Income of the subject properties, and then dividing by the appropriate capitalization rate to reach the conclusion of value.

  • NOI: Kenneth’s expert determined that the rents that were being collected for the properties were below market, and thus applied a projected rental income figure that was higher than what the units were “currently achieving” which “mirrored what market participants would do in estimating value” by “project[ing] the income that a reasonable investor could generate by renting all the apartments at the maximum legal rent that the market would bear.” The Estate’s expert, on the other hand, used actual contract rents (i.e. the amounts billed and collected) as the basis of his NOI analysis.
  • Cap Rate: Both experts relied on comparable sales to select their respective cap rates. Kenneth’s expert applied a cap rate of 3.25% – 3.50%, while the Estate’s expert applied a cap rate of 4.75%. Kenneth argued that the Estate’s comparables were not true comps for reasons including differences in property size, location, and usage (e.g., higher commercial rent income, significantly more rent-regulated units). The Estate argued that Kenneth’s comparables were not true comps primarily because each closed before a major change in rent-regulation laws was enacted in June 2019, about 3 months before the date of value, and therefore did not capture the “period of uncertainty in the market” immediately following the change in the law.

The Business Appraisals Also Diverge in 2 Material Areas

Two issues markedly divided the parties’ position at the business valuation level.

  • Treatment of Inter-Company Loans: Both experts acknowledged that there were substantial inter-company loans both to and from the parties’ other two jointly owned companies, Standard Realty (a partnership) and Restoration Realty (a corporation), none of which were ever memorialized by any notes or instruments. Kenneth’s expert “took account of all these Intercompany Loans at their face value, as they are found on the companies’ books.” The Estate’s expert, on the other hand, “adjusted the LLCs net asset values to remove Standard Realty’s loans as an asset because he concluded they were uncollectible,” as Standard was “insolvent” as of the date of value.
  • Discount for Lack of Marketability: Kenneth’s expert opined that a 0% DLOM was appropriate where the LLCs’ assets are “freely marketable real estate and cash,” and that any marketability discount is “baked in at the property level—in other words, exposure to the market is already embedded in the underlying real estate appraisals.” The Estate’s expert opined that a 15% DLOM was appropriate because there is no ready market for a stake in a closely-held family owned realty company. Furthermore, the Estate argued that the added risk and uncertainty due to the LLCs’ lack of operating agreements, as well as the ongoing litigation, militates against treating the LLCs as mere corporate “wrappers” for the underlying real estate.

Justice Crane’s Decision

Those familiar with statutory fair value proceedings know that it is for the Court to determine fair value in an appraisal proceeding. The Court, thus, has the prerogative to adopt all, some, or none of either sides’ positions (or any combination thereof).

For those keeping score, here is where Justice Crane fell on each of the disputed issues:

NOI… goes to the Estate. The Court determined that the Estate’s analysis calculating the NOI was more reliable than Kenneth’s, crediting the Estate’s expert’s reliance on “actual contract rents, not some theoretical higher amount the market clearly would not bear or that higher rent would have been charged.” The Court found Kenneth’s expert’s rent roll projections to be “inflated and speculative” which were “overstated amounts listed in the RENT column on the rent rolls that he admitted were NOT the amounts the properties actually collected or even billed.”

Cap Rate… goes to Kenneth. The Court found that the Estate’s comps were not appropriate because the properties were either outside of the West Village, incomparably sized, or had different mixes of commercial use and/or rent-regulated designations. The Court also appeared to take issue with the fact that during the 2020 Trial, the parties apparently submitted competing valuations presuming a 2016 valuation date, for which the Estate’s value conclusions and comps were significantly higher (to the tune of 21% for 132 Thompson and 34% for Christopher Street).  The Court specifically did not find persuasive that the June 2019 change in rent-regulation legislation explained the precipitous drop in value from what was previously proffered as a 2016 valuation, finding the argument to be “speculative”.

Inter-Company Loans… goes to Kenneth. The Court determined that even if Standard Realty was insolvent, the loans made to Standard Realty are nevertheless collectible. “This is because Standard Realty is a partnership and partners are personally liable for the debts of the partnership.” That said, the Court also noted, “it is difficult to understand how, as a practical matter, with each side owing 50% of these loans, the amounts do not cancel out at the individual level once payment occurs.”

DLOM… goes to the Estate. The Court credited the Estate’s application of a 15% DLOM “primarily due to the protracted litigation between the parties (they have been fighting since 1996) and the lack of an operating agreement that has contributed to the protracted litigation.” The Court rejected the argument that the LLCs are mere corporate “wrappers” as it “ignores that the exercise here is to value the entirety of the business as a going concern. We cannot do that while ignoring the horrible relationship between the parties and the lack of operating documents.” The Court acknowledged that “what case law prohibits is a de facto minority discount” but found that the facts do not demonstrate a prohibited de facto minority discount since Kenneth “is a 50% shareholder,” and “has not been frozen out of the LLCs, but voluntarily chose to withdraw.” Finally, without much (read: any) discussion, the Court took issue with Kenneth’s position that a marketability discount is “baked in at the property level.”

The End (Or Is It?)

While the Court made clear determinations on each of the disputed issues, the Court did not undertake the mathematical adjustments to the value conclusion, instead directing the parties to submit a proposed judgment that conforms with the Decision within 30 days. That is, the fair value of Kenneth’s 50% interest in the LLCs are to be recalculated using “plaintiff’s comps and cap rate, but defendant’s NOI” in valuing the real properties, the Standard Realty loans are to be factored into the LLCs’ balance sheets, and a 15% DLOM applied.

But the devil is in the details.

Given the parties’ history, it seems unlikely that the parties will cooperatively come to a value conclusion as directed by the Court and then go their separate merry ways. Time will tell whether the Court’s prediction of further litigation comes true.