New York has been one of only a very few states allowing the imposition of marketability discounts in statutory fair value appraisal processes. Like nearly all other states, New York case law prohibits the use of minority interest discounts in fair value appraisals.

In this post, I will provide a review of a portion of a leading New York case in which the New York Appellate Division, First Department addresses the issue of minority interest and marketability discounts in statutory fair value determinations. As always, I review cases from business and valuation perspectives. I am not a lawyer; however, business appraisers are required to have a working knowledge of statutory and case law that are relevant to determinations of business value.

In a later post, I’ll review the Supreme Court’s (the lower court) decision in Beway to provide an understanding of the facts of the case that led to the Appellate Division’s decision. Following that, I will provide an analysis of historical marketability discount determinations in all (or, at least close to all) New York appellate court decisions addressing the issue. Readers will likely be surprised at the results.

Beway on Fair Value

The leading appellate level decision on the definition of fair value in New York is Beway, (Friedman v Beway Realty Corp., 206 A.D.2d 253, 614 N.Y.S.2d 133 (1st Dept. 1995).  Citing the Delaware Supreme Court case of Cavalier (Cavalier Oil Corp. v. Harnett – 564 A.2d 1137 (Del. 1989), Beway refers to the portion of the Cavalier decision that states:

More important, to fail to accord to a minority shareholder the full proportionate value of his shares imposes a penalty for lack of control, and unfairly enriches the majority shareholders who may reap a windfall from the appraisal process by cashing out a dissenting shareholder, a clearly undesirable result.

Beway goes on to discuss several “principles” of law relating to statutory fair value determinations. (emphasis added below):

Several principles have emerged from our cases involving appraisal rights of dissenting shareholders under Business Corporation Law § 623 or its predecessor statute.

(1) The fair value of a dissenter’s shares is to be determined on their worth in a going concern, not in liquidation, and fair value is not necessarily tied to market value as reflected in actual stock trading (Matter of Fulton, 257 N.Y. 487, 492).”The purpose of the statute being to save the dissenting stockholder from loss by reason of the change in the nature of the business, he [or she] is entitled to receive the value of his [or her] stock for sale or its value for investment” (id., at 494 [emphasis supplied]).

(2) The second principle does not inform any position on marketability discounts and is omitted.

(3) Fair value requires that the dissenting stockholder be paid or his or her proportionate interest in a going concern, that is, the intrinsic value of the shareholder’s economic interest in the corporate enterprise (Matter of Cawley v SCM Corp., 72 N.Y.2d 465, 474).

(4) The fourth principle does not inform any position on marketability discounts and is omitted.

(5) Determinations of the fair value of a dissenter’s shares are governed by the statutory provisions of the Business Corporation Law that require equal treatment of all shares of the same class of stock (Matter of Cawley, supra, at 473).

Principles (1), (3) and (5) relate directly to the applicability or not of marketability discounts.

Principle (1) requires that fair value “…be determined on their worth in a going concern. The same principle says further that “…he [or she] is entitled to receive the value of his [or her] stock for sale or its value for investment”  Principle (1) is inconsistent with the imposition of marketability discounts in fair value determinations.

Principle (3) is direct. “Fair value requires that the dissenting stockholder be paid for his or her proportionate interest in a going concern…”  The guidance goes on to describe fair value as “…the intrinsic value of the shareholder’s economic interest in the corporate enterprise.”  As with Principle (1), Principle (3) is inconsistent with the imposition of marketability discounts in New York fair value determinations.

Principle (5) provides the clearest guidance of all. Fair value determinations “…are governed by the statutory provisions of the Business Corporation Law that require equal treatment of all shares of the same class of stock”

This point from Principle (5) needs to be clear. Assume the following:

• The net asset value of an asset holding entity is $50 million
• There are 50,000 shares outstanding, so net asset value is $1,000 per share.
• A dissenting shareholder owns 5,000 shares or 10% of the entity.
• If a marketability discount of, say, 16% is allowed (as in Giaimo), the dissenter’s shares would be valued at $840 per share ($1,000 per share x (1 – 16%)), and his shares would be worth $4.2 million, or a total discount of $0.8 million.

What about the controller’s shares? The net asset value of the 90% controlling interest is $45 million. If a discount of $0.8 thousand is added to her value, they are worth $45.8 million. The controller’s 45,000 shares are, therefore worth $1,018 per share, or 21% greater than the $840 per share value for the dissenter. That is hardly “equal treatment of all shares of the same class of stock.”

Beway apparently did not consider additional guidance from Cavalier that pertains to the appropriateness of marketability discounts in fair value determinations in Delaware. A few paragraphs prior to the first quote from Cavalier above, we find:

Cavalier contends that Harnett’s “de minimus” (1.5%) interest in EMSI is one of the “relevant factors” which must be considered under Weinberger’s expanded valuation standard. In rejecting a minority or marketability discount, the Vice Chancellor concluded that the objective of a section 262 appraisal is “to value the corporation itself, as distinguished from a specific fraction of its shares as they may exist in the hands of a particular shareholder”. We believe this to be a valid distinction. [emphasis added]

The point is that Cavalier allows neither marketability nor minority interest discounts. If I quoted a business appraisal resource as supporting my opinion, that support would be undermined if, on review, that same source provided conflicting guidance two pages earlier and I did not somehow reconcile the apparent discrepancy in my report.

In the final analysis, the trial court allowed a 21% marketability discount in Beway. After providing the guidance noted above and much more that effectively argues for no marketability discounts, the Appellate Division, First Department did not disagree with the discount allowed by the lower court. The case was remanded to the Supreme Court to reconcile what the Court of Appeals thought was an apparent discrepancy in the lower court’s marketability discount. The final marketability discount, after remand, was 21%.

Beway clearly allowed unequal treatment of the same class of stock. It did not provide a value representing a proportionate interest in a going concern. And it did not provide the value of the dissenters’ shares and investments, rather charging them for illiquidity. Beway is difficult for me to understand. But then, I’m just a businessman and a valuation guy. However, as we will see in the near future, the final marketability discount in New York Appellate Court decisions has been 0% in half of the cases since 1985.

As always, please feel free to comment on this blog or to me personally. I’m interested in your feedback. In the meantime, be well.

Chris