Valuation Discounts

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When it comes to business valuation principles in contested appraisal proceedings, I’d say the 50 states have far more in common than separates them. Certainly this is true in cases applying the fair market value standard deriving not from state law but from generally accepted appraisal doctrine as embodied in a number of IRS revenue rulings. But even in cases applying the statutory fair value standard, which is derived purely from state law governing buyouts in dissolution and dissenting shareholder proceedings, there is much to be learned by examining cases from other states.

Below I’ve selected five recent business valuation cases decided by appellate courts in five different states. Not surprisingly, the main area of dissension in four of the five cases concerns the applicability of discounts under both statutorily and contractually imposed standards of value. Each case contributes a little bit to our understanding of how courts and appraisers grapple with the difficulty of placing values on interests in closely held business entities for which no ready market exists.

Louisiana: Court Distinguishes “Fair Value” from “Fair Market Value” in Refusing to Tax-Effect S Corporation’s Accounts Receivable

Last month, in Kolwe v Civil and Structural Engineers, Inc., No. 18-398 [Ct. App. La. Feb. 21, 2019], an intermediate Louisiana appellate court upheld a trial court’s determination of the statutory fair value of a one-third stock interest in a professional engineering firm that elected pass-through taxation as an S corporation. Both sides’ experts used a net asset value approach. The company challenged the lower court’s $871,000 award principally on the ground that the company’s accounts receivable should have been tax-effected to reflect the tax liability that would accrue on their collection. Continue Reading A Cross-Country Tour of Five Recent Stock Appraisal Cases

This is the final installment of a three-part series about the basics of contested New York business appraisal proceedings. The first post addresses the various ways in which business owners can steer a dispute into an appraisal proceeding. The second post addresses the legal rules and principles that apply in appraisal proceedings. This final post addresses the appraisal methodologies and principles that apply in valuation proceedings. Without further ado, let’s talk accounting.

Valuation Date

The date on which a business interest is appraised – the “valuation date” – can have a huge impact on its worth. For example, for a real estate holding company in a rising market, generally speaking, the later the valuation date the greater the value. If the valuation date is earlier, the seller may receive and the buyer may pay less for an ownership stake. For most kinds of appraisal proceedings, the valuation date is set by statute, so there is little to litigate on the subject.

Under Partnership Law 69 and 73, a wrongfully withdrawn, retired, or deceased partner is entitled to have the “value” of his or her interest determined as of the date of “dissolution,” meaning the event of withdrawal, retirement, or death. Continue Reading Basics of Valuation Proceedings – Litigating an Appraisal from Start to Finish – Part 3

There’s a lot to digest in last week’s decision by the Court of Appeals — New York’s highest court — affirming and modifying in part the intermediate appellate court’s ruling in Congel v Malfitano, a “wrongful dissolution” case I previously covered here and here, in which a minority partner in a general partnership that owns a shopping mall, whose former 3% interest had a stipulated top-line, pro rata value of $4.85 million, after massive valuation discounts and a seven-figure damages award for the majority’s legal fees, ended up with a judgment against him for about $1 million.

Let’s begin with a synopsis of Judge Eugene M. Fahey’s opinion for the court:

  • Instead of focusing, as did the lower courts, on whether the partnership met Partnership Law § 62 (1) (b)’s durational criteria of “definite term” or “particular undertaking,” the court decided the wrongfulness of the minority partner’s unilateral dissolution without recourse to the statute, and instead employed a purely contractual approach in affirming the lower courts’ finding of wrongful dissolution based on the partnership agreement’s “clear and unequivocal terms” providing the exclusive means by which the partnership could be dissolved.
  • The court affirmed the lower courts’ application of 35% marketability, 66% minority, and 15% goodwill discounts, which collectively erased around 80% of the stipulated top-line valuation. As to the minority discount, based on the objectives and policies underlying the “terminological difference” between the statutes, the court refused to read into Partnership Law § 69 (2) (c) (II) — which requires the court to determine the “value” of the partner’s interest when the remaining partners elect to continue the business following a wrongful dissolution — the case law disallowing any minority discount under the “fair value” standard found in sections 1118 and 623 of the Business Corporation Law governing buyouts in shareholder oppression and dissenting shareholder cases. Two of the panel’s seven judges dissented from this part of the court’s decision and would have disallowed the minority discount as a matter of law.
  • In the one bright spot for the minority partner, the court’s opinion struck the approximately $1.6 million (plus 9% interest) damages award for the majority’s legal fees, holding that the award contravened the so-called American Rule under which each side pays its own litigation expenses absent a contractual or statutory fee-shifting provision, and that the damages recoverable under Partnership Law § 69 are only designed to compensate for legal fees or other losses “incurred in carrying out separate acts necessitated by the breach.”

The court remitted the case to the trial court to recalculate damages (I’ll explain below). As best as I can tell, the likely net effect of the rulings will be to swing the judgment from around $1 million against the minority partner to around $1 million in his favor — still a jaw-dropping reduction from the pro rata value of the partnership interest he gave up.

Continue Reading New York’s High Court Takes Fresh Approach to Wrongful Dissolution, Sustains Valuation Discounts, Limits Damages in Partnership Case

The steady flow and scholarly character of Delaware Chancery Court opinions in company valuation contests provide an important resource and learning tool for business divorce practitioners, appraisers, and judges in New York and elsewhere.

Over the years, I’ve reported on a number of Chancery Court decisions in statutory fair value cases arising from dissenting shareholder proceedings. In this post, I highlight two recent post-trial opinions by Vice Chancellors Sam Glasscock (photo left) and Tamika Montgomery-Reeves (photo right) addressing valuation and what I’ll call quasi-valuation in more atypical settings.

In the first case, Vice Chancellor Glasscock applied a fair value standard to resolve a buy-out settlement agreement between ex-spouses who co-owned two operating companies and a real estate holding company. In the second case, Vice Chancellor Montgomery-Reeves determined whether a biotechnology start-up company was insolvent for purposes of appointing a receiver under Section 291 of the Delaware General Corporation Law. Continue Reading Delaware Chancery Court Rulings Address Valuation and Insolvency Disputes

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. Continue Reading A River’s Divide: Time for the Manhattan and Brooklyn Appellate Courts to Agree on Marketability Discount in Fair Value Proceedings

If you haven’t yet listened to prior episodes of the Business Divorce Roundtable (a) it’s time you did and (b) absolutely you won’t want to miss the latest episode (click on the link at the bottom of this post) featuring first-hand, real-life, business divorce stories told by business appraiser Tony Cotrupe of Melioria Advisors (photo left) and attorney Jeffrey Eilender of Schlam Stone & Dolan (photo right).

Tony’s and Jeff’s stories have a common element: both involve the contentious break-up of a poisonous business relationship between two brothers. The similarity ends there. In my interview of Tony, he puts us inside a fast-paced and ultimately successful effort by the feuding second-generation owners of a propane distributorship, guided by their respective lawyers working in collaboration, to avoid litigation by engineering a buy-out of one brother by the other based on Tony’s business appraisal as the jointly retained, independent evaluator. It’s a happy ending to what otherwIse could have turned into a drawn-out courtroom slugfest.

Courtroom slugfest aptly sums up Jeff’s story as counsel for the brother owning the minority interest in Kassab v. Kasab, a case I’ve featured on this blog several times including last month’s post-trial decision giving the other brother the opportunity to buy out the minority interest upon pain of dissolution if he doesn’t (read here, here, and here). Jeff’s insider analysis of the case provides unique insights into a multi-faceted, roller-coaster-ride of a case involving novel issues under the statutes and case law governing business corporations and limited liability companies.

If you’re a lawyer, business appraiser or business owner with a business divorce story you’d like to share for a future podcast, drop me a line at pmahler@farrellfritz.com.

 

Regular readers of this blog know it’s been anything but summer doldrums in the world of business divorce, what with case law developments such as the Appellate Division’s potentially far-reaching ruling on the purposeless purpose clause and LLC dissolution in Mace v Tunick reported in last week’s post, and the astonishing story of minority shareholder oppression in the Twin Bay Village case also reported earlier this month.

This year’s edition of Summer Shorts picks up the summer pace with short summaries of three must-read decisions by New York and Delaware courts on three very different business divorce topics: use of a Special Litigation Committee to evaluate derivative claims brought by LLC members (New York); grounds for dissolution and the court’s remedial powers in shareholder oppression cases (New York); and LLC deadlock dissolution (Delaware).

Appellate Ruling Rejects Appointment of Special Litigation Committee in LLC Derivative Suit Where Not Authorized By Operating Agreement

LNYC Loft, LLC v Hudson Opportunity Fund I, LLC, 2017 NY Slip Op 06147 [1st Dept Aug. 15, 2017].  In Tzolis v Wolff, New York’s highest court recognized a common-law right of LLC members to sue derivatively on behalf of the LLC. Subsequent lower court decisions have clarified other aspects of the right by analogy to corporation law, such as requiring the plaintiff LLC member to allege pre-suit demand or demand futility. In shareholder derivative suits involving corporations, the board’s inherent authority to appoint a Special Litigation Committee composed of independent and disinterested directors to assess derivative claims is well established and, when properly implemented, can result in the court’s dismissal of derivative claims based on the SLC’s conclusion that the claims do not merit prosecution by the corporation. Continue Reading Summer Shorts: Three Must-Read Decisions

Gun4HireThe title of this post notwithstanding, the judge’s decision in the recent, high-stakes stock valuation case I’m about to describe, featuring a clash of business appraiser titans whose conclusions of value differed by almost 400%, did not refer to them as “hired guns.”

But the judge did not mince her words in expressing the view that, while “unquestionably qualified to testify on the issue of valuation,” the two experts, whose “zealous advocacy” for their respective clients “compromised their reliability,” offered “wildly disparate” values that were “tailored to suit the party who is paying for them.” Ouch!

The 54-page decision by a Minnesota state court judge in Lund v Lund, Decision, Order & Judgment, No. 27-CV-14-20058 [Minn. Dist. Ct. Hennepin Cnty. June 2, 2017], rejected both experts’ values — $80 million according to the expert for the selling shareholder and $21 million according to the expert for the purchasing company — in arriving at the court’s own value of $45 million for a 25% interest in a chain of 26 upscale grocery stores in the Twin Cities area known as Lunds & Byerlys together with affiliated management and real estate holding companies. Continue Reading Appraisers’ Valuations Are Light-Years Apart, But Does That Make Them Hired Guns?

crazyWhenever I contemplate New York’s unusual case law on the discount for lack of marketability (DLOM) in statutory fair value buy-out proceedings, I cast my eyes westward, to the far banks of the Hudson River, and take comfort in the fact it could be worse — I could be in New Jersey.

A “business appraiser’s nightmare” is how Chris Mercer described New Jersey’s “bad behavior discount” in his commentary on the Wisniewski v Walsh case decided a little over a year ago by a New Jersey appellate court, in which it affirmed the trial court’s application of a 25% DLOM seemingly plucked out of thin air, and notwithstanding what the trial court itself admitted were “strong indicators of liquidity,” for the stated purpose of penalizing the selling shareholder for his oppressive behavior toward the other shareholders — behavior that in no way harmed the corporation’s business or affected its marketability!

Now comes another New Jersey trial court decision in another fair value buy-out case, and guess what? The court applied the same 25% DLOM without any discussion of the factors supporting its application or quantification other than the court’s finding that the selling shareholder was guilty of oppressive conduct against the purchasing shareholder.

In Parker v Parker, 2016 N.J. Super. Unpub. LEXIS 2720 [Dec. 22, 2016], two brothers, Richard and Steven Parker, took over from their parents and for the next 25 years operated as 50/50 owners a wholesale flower business and a separately incorporated wholesale plant business which eventually became a garden center. Richard ran the flower business and Steven the garden business as separate fiefdoms with minimal overlap. Continue Reading Has New Jersey Gone Off Its DLOM Rocker?

shutterstock_581026324As promised in the postscript to last week’s post about the appellate ruling in the Gould case, affirming Justice Platkin’s order granting the oppressed minority shareholder’s dissolution petition involving a pair of construction firms, we now arrive at Justice Platkin’s subsequent determination of the fair value of the minority shareholder’s equity stake.

The decision raises several important issues of interest to business appraisers and business divorce counsel, including selection of tax rates, the appropriate look-back period in determining historical earnings, adjustments for non-arm’s length inter-company transactions, and use of the market approach.

Justice Platkin’s valuation ruling last month in Matter of Digeser v Flach [Gould Erectors & Rigging, Inc.], 2017 NY Slip Op 50220(U) [Sup Ct Albany County Jan. 31, 2017], is the culmination of an oppressed minority shareholder dissolution petition filed in April 2013. In his November 2015 post-trial decision, which I wrote about here, Justice Platkin found that Digeser, a minority shareholder in the two corporations, established grounds for dissolution based on oppression, but he left open the question of remedy. Continue Reading Business Appraisers Spar Over Tax Rates, Market Approach and Other Key Issues in Fair Value Buy-Out Case