The New Jersey Appellate Division issued an unpublished decision in Wisniewski v Walsh, 2015 N.J. Super. Unpub. LEXIS 3001 [App. Div. Dec. 24, 2015]. The case was interesting in that it attempted to determine a marketability discount in relationship to the “bad behavior” of a selling shareholder. I wrote about the case here after Peter Mahler wrote about it on his blog.
Yesterday, Peter sent me a copy of a New York Court of Appeals case, Congel v. Malfitano. In New York, the Court of Appeals is the appellate court, while trials occur in the lower level Supreme Court. Is this another “bad behavior” case? Let’s see.
A partnership known as Poughkeepsie Galleria Company (“The Partnership”) was formed in 1985 by the defendant in this case, Mr. Molfitano (who is also the appellant) and several other partners. Mr. Molfitano originally owned a 2.25% interest, which had increased to a 3.08% interest by the mid-2000s. The partnership was successful and grew into the Poughkeepsie Galleria Mall. The 3.08% interest was valued on a pro rata basis in the 2011 trial at an agreed upon $4,850,000.
The implied value of the mall is about $157 million, so the enterprise was successful over the years. The mall describes itself as follows on its website today:
Welcome to Poughkeepsie Galleria, the largest and most dominant enclosed shopping center in Dutchess County. At Poughkeepsie Galleria, you’ll find an impressive selection of retail stores, services, entertainment and restaurants to make your shopping experience a truly exceptional one!
In November 2006, Mr. Molfitano attempted to dissolve the partnership unilaterally. The remaining partners did not go along with this attempt, and commenced a breach of contract action against Mr. Molfitano in January 2007. This litigation, together with counterclaims, continued for years, and, finally, there was a trial in Supreme Court in New York to determine “the value” of Mr. Molfitano’s shares.
Mr. Mahler may write about the tortured path of this litigation. I’ll just summarize the history of valuation in the matter for our purposes.
“…the value of his interest in the partnership…”
New York Partnership Law Section 69(2)(c)(II) states that when a partner dissolves a partnership in contravention of the partnership agreement, and the remaining partners continue the business in the same name, the dissolving partner has:
“…the right as against his copartners…to have the value of his interest in the partnership, less any damages caused to his copartners by the dissolution, ascertained and paid to him in cash, or the payment secured by bond approved by the court, and to be released from all existing liabilities of the partnership; but in ascertaining the value of the partner’s interest the value of the goodwill of the business shall not be considered.”
In its determination of “the value” of Mr. Molfitano’s interest, the trial court considered three discounts, a discount for goodwill, a minority discount, and a marketability discount. We will briefly address each of these. My reading of the appellate decision from business and valuation perspectives suggests that the trial court did not have a clear view of what “the value” meant in the quote above.
The Goodwill Discount
In my experience, when a mall like Poughkeepsie Galleria Mall is appraised, it is valued as real property, and goodwill is not a factor in market value determinations. While not seeing the market value determination giving rise to the $4.85 million pro rata value of the Molfitano interest (or the implied $157 million value for the mall), it is unlikely that this value included any consideration of goodwill.
Nevertheless, goodwill was considered by the plaintiff’s expert and the trial court, which reasoned “that the partnership does indeed possess goodwill of its own,” because the mall “and its tenants attract regular, loyal shoppers, which point towards the existence of some goodwill.” Apartment buildings have regular, loyal tenants, and yet, there is no goodwill in this type of real estate oriented enterprise.
The plaintiff’s expert argued for a 44% discount for goodwill. I do not have the original trial court opinion or the expert reports presented there. However, I cannot imagine any economic evidence that plaintiff’s expert might have offered to justify a 44% goodwill discount for a real estate enterprise. Mr. Molfitano’s expert argued effectively for a 0% discount for goodwill. The original trial court applied a 15% discount for goodwill. The trial court’s 15% goodwill discount amounted to $727,500 for a 3.08% interest.
That goodwill discount is likely a discount for “bad will” created by Mr. Molfitano as I read the case as a businessman and valuation guy.To put that into perspective, the 15% goodwill discount implies a total goodwill of $24 million when applied to the pro rata value of $157 million.
The Minority Discount
The issue of a minority discount was a big one. Plaintiff’s expert argued for a 66% minority interest discount. I’m having a difficult time imagining the economic evidence that might have supported that discount, even if one should apply. This expert noted “draconian” restrictions on transferability and an unusual provision that provided that, if a partner sold his or her interest, then he or she would be liable (jointly and severally) with the buyer, for any capital costs. He claimed that this feature was applicable both to the minority discount and the marketability discount. Double-counting risks?
Mr. Molfitano’s expert testified that he had been “advised, under the relevant statutes, that a minority discount was not applicable,” stating that one might be applicable in fair market value determinations, but not in fair value determinations. So we know that the concept of fair value was heard by the trial court.
The trial court leaned in the direction of fair value by declining to apply a minority discount. The trial court cited “cases that have barred the use of a minority discount in evaluation of a minority shareholder’s stock in a closely held corporation.” The trial court may have been concerned with excessive discounting in reaching this conclusion of applying no minority discount.
The Marketability Discount
Plaintiff’s expert argued for a 35% marketability discount, and Mr. Molfitano’s expert put forward a 25% marketability discount. No evidence regarding the magnitude of the marketability discount was mentioned in the appellate court’s decision.
The trial court (the Supreme Court) applied a 35% marketability discount. The Supreme Court explained that it had taken into consideration all factors inhibiting transfer of a defendant’s partnership interest that would result from a limited market. Perhaps the trial judge was concerned with double-dipping with a marketability discount and a minority discount.
The First Appeal
In May 2016, the Appellate Division modified the Supreme Court’s judgment
…by deleting the provision in favor of defendant [not related to valuation] and against plaintiffs, affirmed as modified, and remitted to the trial court for a new calculation incorporating a 66% minority discount, applied to the discounted value of defendant’s interest in the partnership, and for a new judgment…
When I read that, I realized that the Appellate Division required the trial court judge to modify his opinion by including a 66% minority discount where he had originally concluded that a 0% minority discount was appropriate.
One of the reasons raised in Beway against the application of a minority discount in fair value determinations is concern that there would be a transfer of value between the minority owner and the controllers.
The argument for application of the minority discount by the Appellate Division in the first appeal seems strained to me as I read it (as summarized by in the present decision, which is the second appeal).
The Second Time at Trial Court
Upon remand, the trial court applied a 66% minority discount and addressed the other issues raised in the Appellate Division’s decision.
The Second Appeal
The second appeal yielded the decision we have been discussing. The numbers pertaining to values and discounts are all in the decision, but they are not easily accessible. I prepared the following table to summarize the results of the valuation process in Congel v. Malfitano.
The table above summarizes all of the arithmetic of the discounting by the experts, the trial court, and the Appellate Division (by instruction to the trial court). Note the following:
- The combination of discounts by plaintiffs’ expert imply an 88% discount from pro rata value. That is a lot of discounting!
- The defendant’s expert suggested only a 25% marketability discount, so that is the total discount from pro rata value for this valuation.
- The trial court applied a 15% goodwill discount and a 35% marketability discount. The total of discounts from pro rata value is 45%. That’s still a lot of discounting.
- In the first appellate decision, the trial court’s 15% goodwill discount and its 35% marketability discount were affirmed. The matter was remanded for the trial court to apply an additional 66% minority discount.
- The trial court must have done what the appellate division asked, because the second appeal states that it is. By applying discounts for goodwill, (lack of) marketability, and minority interest of 15%, 35% and 66%, respectively, in sequence, the trial court’s decision reached a “value” of $911 thousand for the 3.08% interest owned by Mr. Malfitano. That conclusion represents an 81% discount from pro rata value. Importantly, given a pro rata value of $4.85 million, the discounts total $3.94 million. Now that’s a mighty lot of discounting.
I wonder if any of the judges made calculations like shown in the table above and thought in terms of the common sense and reasonableness of valuation.
The Dissenting Opinion
Judge Feinman began his 11 page (partial) dissent to the majority’s decision with the following:
I fully concur with the well-reasoned analyses in Parts I through V of the majority opinion. I do not join Part V1, the majority’s holding that the trial court was required to apply a minority discount to the value of a partner’s interests under Partnership Law…
In reading the dissenting opinion, it is clear that Judge Feinman takes issue with the majority’s position that “the value” for purposes of a partnership is, in effect, a determination of fair market value, which would be inclusive of appropriate minority interest and marketability discounts. He cites cases in the fair value line indicating that it is inappropriate in fair value determinations to discount for minority status, doing so results in a transfer of wealth from the minority to the majority.
The same occurs in the majority’s determination of “the value” of Mr. Malfitano’s interest, and the dissenting opinion provides logic suggesting that “the value” in partnership law could well be akin to fair value in other aspects of New York law.
The End Result
As a businessman and a valuation guy, reading Congel v Malfitano reminds me of the Wisniewski v. Walsh case noted at the outset. In Wisniewski, the marketability discount applied by the court seemed to be a discount for bad behavior. Based on my reading of the case, discounting at the cumulative level of 81% from pro rata value does not appear to be warranted on economic grounds, either in the context of fair market value or fair value as I understand these two standards of value.
This discussion spends little time on the details of Mr. Malfitano’s attempted dissolution of the Partnership and the ensuing litigation or its costs. Could it be that the cumulative impact of the discounting, with significant discounts for goodwill (15%), marketability (35%) and minority status (66%) related to his bad behavior?
I don’t know. What I do know as a valuation expert is that we as experts do not have latitude to make decisions regarding the behavior of parties in litigation involving valuation or to fashion our valuation and discounts accordingly.
Until next time, be well!
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