This is the fourth and likely the last post in this series discussing Beway v. Friedman. This is perhaps the leading appellate level case in New York discussing the judicial interpretation of statutory fair value in that state. The first three posts are linked below.

• Beway Provides Conflicting Guidance re Statutory Fair Value in New York.
• New York Statutory Fair Value: Trying to Make Sense of Beway.
• Beway and Giaimo: Is New York Headed in the Right Direction?

In this post, rather than talking about the specifics of cases, we look only at the conclusions of statutory fair value cases regarding marketability discounts. Based on the initial review, there is an apparent difference in the treatment of asset holding entities and operating companies by New York courts. The first look examines conclusions of marketability discounts in statutory fair value cases since 1985 for asset holding companies and operating companies.

Since there is sometimes a difference in treatment regarding marketability discounts between the three judicial departments of the New York Court of Appeals, we have also looked at concluded marketability discounts by department.

Finally, we have looked at concluded marketability discounts over time to discern any trends that might be identified.

We searched for all statutory fair value cases in New York since 1985 and found 31 cases at the appellate and trial levels. This analysis includes 32 concluded marketability discounts because one case reached marketability discounts for two separate companies. If we have missed any cases, it is an unintentional oversight. If we are informed of additional cases, we will, of course, include them in the analysis.

So what have New York courts concluded regarding marketability discounts in statutory fair value cases? You may be surprised, but with a small number of recent notable exceptions, the trend seems to be in the direction of 0%. That will surprise a number of readers, but let’s let the numbers speak for themselves.

Asset Holding Entities: Trial and Appellate Levels

First Department Cases

We identified twelve cases in which New York courts have determined marketability discounts for asset holding companies in statutory fair value cases. The cases are summarized in the figure below.

There are seven First Department asset holding entity cases. The first case in the figure is Beway, which we have discussed in this series of posts. Following Beway, there were three First Department cases where the concluded marketability discounts were 0%. Two of these cases were appellate level, and one was a trial decision that was apparently not appealed.

The Giaimo decision (2011 for the trial and 2012 for the appeal) reversed that trend, finding for a 16% marketability discount as discussed in the prior post. Other than suggesting that there are significant costs associated with the liquidation of an asset holding company, there was little guidance regarding why the 16% discount was appropriate. I testified before a Special Referee in Giaimo. As noted earlier, the Special Referee and the Supreme Court held for 0% marketability discounts. I wrote about Giaimo on this blog here.

Following Giaimo, the First Department Court of Appeals concluded that the appropriate marketability discount in the 2017 Levine v. Seven Pines L.P. matter was 25%. The Company’s expert argued for a 12% minority interest discount and a 25% marketability discount. The Court of Appeals rejected the minority interest discount and affirmed the 25% marketability discount in a two sentence comment:

 …petitioner’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 [2013]).

Citing Giaimo from 2011-12, which allowed a 16% marketability discount at the appellate level, the First Department Court of Appeals allowed a 25% marketability discount to stand in 2017. The Court of Appeals in both Giaimo and Levine v. Seven Pines apparently ignored or did not consider two precedent First Department cases with 0% marketability discounts: Matter of Williamson (2002) and Vick v. Albert (2008).

In Vick v. Albert, the Court of Appeals stated: “The unavailability of the discounts is particularly apt here, where the business consists of nothing more than ownership of real estate.”  That was precisely the case in Giaimo and in every determination of fair value in statutory fair value cases in New York.

Again, there is no rationale for the marketability discount of 16% other than a reference to Giaimo, which justified that discount based on an unrealistic build-up of costs of liquidation of asset holding entities.

Stepping back, the most frequently concluded marketability discount in the First Department is 0%. The average discount has been 11%, and the median discount is 16%.

Second Department Cases

There have been five Second Department asset holding company cases since 1995, of which the first three are appellate decisions and the most recent two are trial court decisions.

The concluded marketability discounts in all five cases were all 0%.

I testified in the Man Choi Chiu v. Chiu matter as well as in the Kassab v. Kassab matter.

Looking at the twelve asset holding company cases as a group, it is interesting to note that the overall average discount for the cases is 7%. Both the median and the mode (the most frequent observation) are 0%

We identified no Third Department asset holding company cases involving fair value determinations.

Operating Companies: Trial and Appellate Levels

We identified twenty cases in which the fair value of operating companies was the subject. Two of these are dated cases from the First Department. The Second Department has been more active and more current, with fourteen cases between 1985 and 2020. The Third Department has four cases dating back to the 1990s.

First Department Cases

The two First Department cases date from the mid-to-late 1990s. The 1995 decision was a Supreme Court decision which found for a 25% marketability discount. The more recent case, Hall v. King, was a 1995 appellate level case that also found for a 25% marketability discount.

Second Department Cases

There have been fourteen Second Department cases involving fair value determinations of operating companies. There were two appellate level cases in 1985, and both concluded with 25% marketability discounts.

The next two concluded marketability discounts were 10% each in appellate level cases in 1986 and 1987. In 1991, in the Matter of Seagroat Floral Co., The Second Department Court of Appeals concluded that the marketability discount should be 0%. (The Third Department Court of Appeals also concluded that a marketability discount of 0% was appropriate in the Matter of Walt’s Submarine Sandwiches in 1991.)  These were the first two 0% marketability discounts in New York, and they were to be followed by more, as we will see.

Since Seagroat, there have been four additional 0% appellate cases in the Second Department. There have also been two appellate level cases with 25% marketability discounts (1994 and 2002) and one Supreme Court case with the same 25% DLOM. That third case was Ferolito v. AriZona Beverages, a 2014 trial court decision.

I testified in the AriZona matter, which has been described as the largest (fair value) corporate divorce in New York History. I testified that the appropriate marketability discount should be 0%, but the trial court concluded that the discount should be 25%. I wrote about the ArriZona matter on this blog here and here. There had been considerable interest from larger, publicly traded companies in the purchase of AriZona. I did not use those “offers” as a valuation method, but rather as support for the fact that AriZona was “marketable.”  The court’s conclusion was what it was.

The two most recent Second Department appellate level cases, Ruggiero v. Ruggiero (2016) and Magarik v. Kraus USA (2020), found for marketability discounts of 0% and 5%, respectively.

The average discount in Department 2 cases is 11%, while the median is 8%. The sample of cases is actually bi-modal, with five conclusions at 25% and five conclusions at 0%.

Third Department Cases

There have been four Third Department fair value cases for operating companies, all of which date to the 1990s. Three were appellate level decisions with marketability discounts of 0%, 0%, and 14%. The most recent case was a trial level matter where the marketability discount was also 0%.

The average marketability discount for the Third Department is 4%, while both the median and the mode are 0%.

Summary for Operating Company Cases

The overall average marketability discount for the twenty fair value cases involving operating companies is 12%, with the median being 10%. The mode for the group is 0%.

Further Discussion of New York Fair Value Cases

Looking at Concluded Discounts

We can make a number of observations from the analysis of New York fair value cases and their concluded marketability discounts.

1. Asset holding companies tend to receive relatively lower marketability discounts than do operating companies.
2. The First Department has reached higher marketability discounts, on average, than the Second or Third Departments.
3. After the 21% marketability discount in Beway, there were three asset holding company cases in the First Department finding for 0% marketability discounts. Then, out of nowhere (to me), the Appellate Court ruled for a 16% marketability discount in Giaimo (see the discussion above). Subsequent First Department asset holding company cases appear to be influenced by the conclusion in Giaimo.
4. All five Second Department cases involving asset holding entities have concluded with 0% marketability discounts.
5. There are no recent First Department cases involving operating companies. The two on record date to the 1990s and both held for 25% marketability discounts.
6. The Second Department has been most active in hearing operating company cases, with fourteen cases since 1985. As noted above, there are five cases with 0% marketability discounts, and five cases with 25% marketability discounts. Nine of the fourteen concluded marketability discounts were either 0%, 5%, or 10%, or fairly low relative to the five higher 25% conclusions.
7. While the Third Department operating company cases are dated, their marketability discount conclusions have been low, with three at 0% and one at 15%.
8. The court in AriZona concluded  that the marketability discount should be 25% in part because of the belief that such discounts were “fairly standard” for cases like AriZona. The analysis thus far would suggest that there is no “fairly standard” marketability discount for New York fair value cases.

In the next figure, we look only at the concluded marketability discounts in New York fair value cases themselves, regardless of whether the cases were appellate level or trial level, and regardless of department. The results are, as I suggested in previous posts, interesting.

We have been discussing marketability discounts from 31 New York fair value cases, but there are 32 conclusions regarding marketability discounts. In the Matter of Quill v. Cathedral, there were two companies and two separate marketability discounts.

The concluded marketability discounts are shown in the first column. The appellate, trial and total cases discounts are shown in the next three columns. The last column shows the percentage of total cases that the conclusions at each noted discount level represent. Observations from this figure include:

1. Conclusions of marketability discounts of 0% represent half of all discounts (and the same for appellate level and trial level discounts).
2. Conclusions with discounts of 25% represent a fourth of all discounts (25% for appellate, trial, and total cases).
3. The remaining discount levels (5%, 10%, 15%, 16%, and 21%) represent the remaining quarter of all discounts.

The idea that marketability discounts of 25% are fairly standard in New York fair value cases is simply not correct. There are twice as many 0% discounts than 25% discounts, and fully 75% of all discounts are less than or substantially less than 25%.

Looking at Concluded Discounts by Department Over Time

Having examined the actual marketability discounts in New York fair value cases, we turn to a look at any trends in discounts over time by the judicial department. This last figure summarizes the findings of this analysis.

The overall trend in concluded marketability discounts is generally downward. We make a number of observations about the figure and its underlying data.

1. The all-in average has generally declined since our first fair value case in 1985. The average marketability discount was 17.5% prior to 1990, 10.1% in the decade to 2000, 4.2% in the decade to 2010, and 8.4% to the present.
2. In the decade to 2000, the average marketability discount for Department 1 was 23.7%. That average included the 21% discount in Beway, and two additional discounts of 25% each.
3. Interestingly, the average marketability discount in the three First Department cases was 0% in the decade to 2010. Giaimo in 2011 reversed the 0% average of the prior decade with a concluded marketability discount of 16%. The Giaimo decision went against the grain of two appellate level cases in the prior decade. This was interesting and seemed out of the blue from my perspective as a participant in Giaimo. Read my further comments in the prior post. Two additional First Department cases had discounts of 16% and 25%, respectively, so the overall average for the most current period is 19.0%. In all, there were nine First Department Cases.
4. The Second Department has been considerably more active in the fair value arena, with a total of 19 cases over the period of analysis. The Second Department has seen a significant drop in concluded marketability discounts. The average discount prior to 1990 was 17.5%. This dropped to 6.3% in the decade to 2000. There was a slight increase in the average in the decade to 2010 to 8.3% based on two 0% discounts and one 25% marketability discount. The average marketability discount for the most current period is 4.4% based on eight cases. Of the eight concluded marketability discounts, five were 0%, two were 5%, and one was 25%. The 25% discount was in the AriZona Supreme Court Second Department case, in which I testified. As with Giaimo, I was surprised at the conclusion in AriZona. Despite its substantial financial success, the AriZona experts attempted to portrayed a company with declining margins and earnings and a prospective inability to meet a large judgment. The court may have been concerned regarding this potential. Nevertheless, the AriZona decision was an outlier in the Second Department in the most recent decade.
5. The Third Department has had no reported statutory fair value cases since the late 1990s. Interestingly, one Third Department case in which I was going to testify in early 2019 settled after opening arguments at an 11% discount to my conclusion of fair value. I wrote about that matter with permission here, in a lengthy post that provided a significant analysis of Beway and other New York precedent cases.

The prior figure showed marketability discounts by the judicial department over time. The overall average marketability discount for the 32 New York fair value cases since 1985 is 8.5%. The overall average marketability discount for the seventeen cases since 2000 is 6.9%., including the recent higher First Department discounts (and the two 25% discounts in the Second Department since 2000).    Excluding the three recent First Department discounts, the average marketability discount (all departments) since 2000 is 4.3%, as seen in the next figure.

Since 2000, of the seventeen, concluded marketability discounts in New York fair value cases, ten have been for 0%, and two have been for 5%. This means that some 70% of the concluded marketability discounts have been 5% or less. Only five concluded marketability discounts have been higher, with two at 16% and three at 25%.

Concluding Observations

Based on this review of Beway and the analysis of marketability discounts in New York fair value cases, it should be clear that, on balance, New York courts seem to be finding for lower marketability discounts over time. This was a First Department and Second Department phenomenon until the period after 2010. It continued with the Second Department through the most recent period. The exception is the First Department, where the Appellate Court in Giaimo reversed the Special Referee (0%) and the Supreme Court (0%) and concluded, without remand, that the marketability discount should be 16%.

The logic for the Appellate Court’s 16% marketability discount was based on the expenses of selling an asset holding company over and above the underlying real estate. That logic is flawed from business perspectives, and will not withstand logical scrutiny. The implied expenses of selling two asset holding entities with attractive Manhattan rental properties with a combined net asset value of just under $100 million are on the order of $15 million. That conclusion simply makes no economic sense.

If the actual expenses of liquidating real estate asset holding companies were anywhere on the order of 16%, no rational actor would place real estate into LLCs, partnerships, or S corporations (or C corporations). The fact that there are likely hundreds of thousands (or more) of real estate holding entities renders this conclusion illogical.

Bucking the downward trend, the First Department concluded with two more discounts of 16% and 25%, respectively, for an overall average of 19% for the period since 2000.

The prior figure showed marketability discounts by the judicial department over time. The overall average marketability discount for New York fair value cases since 1985 has been 8.5%. The overall average marketability discount since 2000 is 6.9%. Excluding the three recent First Department discounts, the average marketability discount (all departments) since 2000 is 4.3%.

These results will likely surprise many readers and, perhaps, judges, who seem to have the perception that all marketability discounts in New York fair value cases are large. They are not. And they are trending to 0%, the level of marketability discount found in statutory fair value matters in the majority of other jurisdictions in the United States.

When we cut through the clutter, it appears that New York courts are headed in the right direction in their determinations of marketability discounts in statutory fair value.

As always, please comment on this post below or to me personally.

Be well,

Chris

Overview

In this post, we continue the analysis of Friedman v. Beway, a 1995 New York Court of Appeals case that addresses the prevailing judicial interpretation of statutory fair value in New York.  In the first post in the series, we examined certain “principles” regarding fair value espoused in Beway.  In the second post, we reviewed the Supreme Court’s (i.e., the trial court’s) valuation analysis and then discussed additional guidance from Beway and Blake, an earlier New York Court of Appeals case.

In this third post in the series, we examine further guidance from  Beway, discuss why “marketing” has already occurred as of valuation dates in both real estate and business appraisal, then look at a more recent case involving asset holding entities, Giaimo v. Vitale, to see where current “logic” has led the Court of Appeals (First Department) in New York on the issue of marketability discounts in statutory fair value determinations.

In the final post in this series, we examine the actual marketability discounts concluded in statutory fair value matters since about 1985.  The analysis will differentiate between appellate-level and trial court cases that stand and were not appealed.  The results will likely be surprising for those interested in statutory fair value in New York.

Caveat

I have said this before, but it bears repeating: I am not an attorney.  Any analysis that I perform regarding case law in any jurisdiction is conducted from my perspective as a business appraiser and a businessman.  I have and offer no legal opinions.  However, I can examine the logic of relevant cases from business and valuation perspectives and do so in this series on statutory fair value in New York.

More Guidance from Beway

In the prior two posts, we cited certain “principles” regarding New York fair value determinations that suggest to me, as a valuation expert reading the case, that marketability discounts should not be allowed.  Nevertheless, the cat is out of the bag: Beway allowed a 21% marketability discount.  But wait, there’s more from Beway arguing for no DLOMs, including the following:

Consistent with that approach, we have approved a methodology for fixing the fair value of minority shares in a close corporation under which the investment value of the entire enterprise was ascertained through a capitalization of earnings (taking into account the unmarketability of the corporate stock) and then fair value was calculated on the basis of the petitioners’ proportionate share of all outstanding corporate stock (Matter of Seagroatt Floral Co., 78 NY2d, at 442, 446, supra [emphasis added]).

Seagroatt was an operating company.  The petitioner’s expert testified that he took the company’s lack of marketability into account in his capitalization rate and applied no marketability discount.  The Court of Appeals affirmed the reasonableness of this position.

When companies are valued, or when buyers and sellers negotiate over price, they negotiate directly based on the expected cash flows, their growth, and the risks associated with achieving them, as well as the net assets available.  I have been involved in more than one hundred corporate transactions over the last forty years.  There has been no discussion of a value and then a lower value based on a “lack of marketability” in a single transaction.

Companies do not lack marketability.  They sell in a different market than the public securities markets.  The market for businesses is not a market where “cash is available in three days.”  It is unrealistic and incorrect to compare the “marketability” of entire companies with transactions of minority interests in the public securities markets.  Owners of companies have all the rights of ownership during any period of marketing entire companies, including access to distributions and any benefits from growth during the marketing period.

The discount rates developed by business appraisers to appraise companies reflect the risks associated with marketing a business.  When multiples are developed based on comparable transactions, those multiples reflect any consideration of prior marketing since they are calculated on the transaction dates.

Marketing Occurs Prior to the Valuation Date in Real Estate

Similarly, the discount rates (or capitalization rates) developed by real estate appraisers to value real property also take “unmarketability” into account.

For further perspective on the applicability of marketability discounts, we look at the concept of exposure time in real estate appraisals.  Exposure time is defined at the right (from the current edition of the Uniform Standards of Professional Appraisal Practice, or “USPAP”).

Real estate appraisals assume exposure to the market has occurred, often for six to nine months before the valuation date and that a hypothetical sale occurs on the effective date of the appraisal.  The implication is that the appraisal conclusion is a cash-equivalent price.

Exposure time has been considered and is not a reason to justify a marketability discount.  Exposure time is defined in the Uniform Standards of Professional Appraisal Practice (USPAP) as (with numbers and emphasis added):

[1] an opinion, based on supporting market data,

[2] of the length of time that the property interest being appraised would have been offered on the market

[3] prior to the hypothetical consummation of a sale

[4] at market value

[5] on the effective date of the appraisal.

In market value determinations for real estate, it should be clear that the property has been exposed to the market before the valuation date.  We now look at the definition of “market value” in real estate for further clarity (from Advisory Opinion 22 of USPAP).  Numbers and emphasis are added.

“Market value means the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.  Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

1. Buyer and seller are typically motivated;

2. Both parties are well informed or well advised and acting in what they consider their own best interests;

3. A reasonable time is allowed for exposure in the open market;

4. Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and,

5. The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.” (emphasis added)

The combination of the concepts of exposure time and market value makes clear that when a real estate appraisal is conducted as of a specified valuation date, the exposure/marketing time to achieve the appraised value has already been considered by real estate appraisers.  A hypothetical transaction occurs on the valuation date for cash or its equivalent in pricing.  The figure below shows exposure time in relation to the valuation date in real estate appraisal.

There is no economic reason to discount appraised real estate for lack of marketability.  Any issues regarding marketability have already been considered, as should be clear from the diagram.

What if Real Estate is in an Asset Holding Entity?

Consider a simple example.  A hypothetical New York LLC, 123 Example Street, LLC, owns the apartment building at 123 Example Street. The LLC is a “wrapper” for the underlying real estate. Many properties in New York and across the country are placed in LLC wrappers to minimize legal exposure from the property to the owners of the LLC and to facilitate ownership by multiple owners. LLCs are legal “wrappers” for properties and are generally not considered to impede the value of their underlying real properties.

123 Example Street was appraised as of an appropriate valuation date at $40 million.  That is a cash-equivalent value; the building is the LLC’s only asset.  There are no liabilities. Therefore, the net asset value of the LLC is $40 million.

Following the hypothetical transaction implied by the real estate appraisal, the LLC has the equivalent of $40 million in cash for fair value purposes. If the asset is sold, the cash proceeds can be distributed effectively without cost.

There is no reason to apply a “marketability discount” to the market value of the building because it has been exposed in an open and competitive market for sufficient time to conclude the hypothetical sale on the valuation date.

Similarly, there is no reason to apply a “marketability discount” to 123 Example Street, LLC, because it effectively has only cash.  Some of that hypothetical cash can be used to pay the dissenting shareholder their pro rata share of the $40 million.  Alternatively, the LLC can borrow the funds necessary to pay the dissenting shareholder, using the real property as collateral.

To bring closure to the concept of “marketability” or lack thereof for real estate or companies holding real estate, we examine one other figure.

The actual market data regarding earnings or revenue multiples for companies and capitalization rates for income-producing real estate reflect the fact that all “marketing” has been accomplished before transactions close.

• For business transactions, multiples derived from actual sales are developed as of the date of actual transactions, and those multiples reflect all considerations of the parties to them, leading to final pricing and closing.
• For real estate transactions, capitalization rates derived from actual sales are developed as of the date of actual transactions, and those cap rates reflect all considerations of the parties leading to final pricing and closing.

This logic and the figures above should clarify that there is no economic reason to discount appraised real estate or entities holding them for their lack of marketability.  The appraisal processes take “unmarketability” into consideration.

A Step Backward in Giaimo

Two asset-holding corporations in Giaimo were owned equally by siblings Janet Vitale and Robert Giaimo, with Janet in control.  The combined net asset values of the companies were about $100 million. Janet was buying out Robert’s shares, and the question before the court was the fair value of his shares.

Mercer testified in the 2011 trial conducted by a Special Referee in Giaimo that the appropriate marketability discount for the entities was 0%. Based on exposure time in the real estate appraisals and the high level of liquidity in the market for apartment buildings in Manhattan (per the real estate appraiser), Mercer further testified that there was no reason to discount the underlying real estate. He also testified that if a marketability discount must be applied, the cost of liquidation of the underlying real estate could be considered, which could not reasonably be more than 5% or so.

The Special Referee found that the appropriate marketability discount for each of the two corporations was 0%.

The Supreme Court (the trial court) also held that the appropriate marketability discount was 0% but differed with the Special Referee regarding the rationale for that conclusion.

The Appellate Division, First Department, concluded in 2012 that the marketability discount should be 16%, with the following rationale:

Here, the motion court correctly held that the method of valuing a closely held corporation should include any risk associated with the illiquidity of the shares (see Matter of Seagroatt Floral Co. [Riccardi], 78 NY2d 439, 445-446 [1991]) [ignoring guidance in Vick regarding valuation as if the “entire entity” had been sold]. It also properly rejected petitioner’s contention that this Court’s decision in Vick v Albert (47 AD3d 482 [1st Dept 2008], lv denied 10 NY3d 707 [2008]) limits the application of marketability discounts only to goodwill, or precludes such discounts for real estate holding companies such as the corporations at issue here.

The motion court erred, however, in assessing that the marketability of the corporations’ real property assets was exactly the same as the marketability of the corporations’ shares (see Seagroatt Floral, 78 NY2d at 445-446). While there are certainly some shared factors affecting the liquidity of both the real estate and the corporate stock, they are not the same. There are increased costs and risks associated with corporate ownership of the real estate in this case that would not be present if the real estate was owned outright. These costs and risks have a negative impact on how quickly and with what degree of certainty the corporations can be liquidated, which should be accounted for by way of a discount.

The Appellate Court believed that there are significant costs involved in liquidating real estate holding companies holding attractive apartment buildings in Manhattan other than commissions. I am not aware of other significant costs involved in liquidating an asset-holding company. The court did not elaborate on what expenses of “marketing” might be that would add up to 16% of the net asset values of the two corporations in Giaimo.  The Appellate Court went on to say:

Only respondent’s expert, Jeffrey L. Baliban, quantified what, in his opinion, would be the appropriate DLOM discount. He employed a number of studies of reported sales that bore some related characteristics to these particular corporations. He also employed a build-up method related to anticipated costs of selling the corporation that included real estate related costs and due diligence costs arising in the sale of closely held corporations. The studies and method employed reported a DLOM range of 8% to 30%, with Baliban recommending 20%. Petitioner criticizes all of the data and methods relied upon by Baliban as inapplicable. Neither the Referee nor the motion court addressed these arguments because they never reached the issue of the quantification of the DLOM. (emphasis added)

The various studies referenced by Mr. Baliban related to discounts at the shareholder level of value and not the company level. Having been present at all testimony of the business appraisers, I believe that the Special Referee did “reach the issue of the quantification of the DLOM.” He heard Mr. Baliban’s testimony and his discussion of several studies. He also heard my testimony in which I quantified the DLOM at 0%. The Special Referee then concluded that the appropriate marketability discount was no marketability discount or a 0% marketability discount, a quantified number.

The court failed to understand that 0% is a quantified discount, just like 5% or 16%.

The Appellate Division concluded:

Since the entire record is included on appeal, it is sensible and economical for us to decide this issue rather than remand the issue to the motion court for further consideration (see Wechsler v Wechsler, 58 AD3d 62, 77 [1st Dept 2008], appeal dismissed 12 NY3d 883 [2009]). We find that the build-up method, which makes calculations based upon expected projected expenses of selling a company holding real estate, best captures the DLOM applicable in this particular case. We conclude that a 16% DLOM against the assets of both corporations is appropriate and should be applied. Since the judgments have been paid, petitioner is directed to make restitution in an amount reflecting the discount (see CPLR 5523). (emphasis added)

It may have been “sensible and economical” for the Court of Appeals to decide the issue of the marketability discount in Giaimo, but the rationale employed made no sense from business and valuation perspectives.

The “build-up method” employed by Mr. Baliban made certain calculations “based upon expected projected expenses of selling a company holding real estate.” This so-called “build-up method” is not a recognized valuation method. Based on this evidence, the Appellate Division concluded a marketability discount of 16%. Real estate commissions the real estate appraisers in Giaimo might be on the order of 1.5% to 3.0% for transactions in the range of $50 million or more and up to 5% for smaller transactions. I have personally been involved in well over 100 transactions involving businesses over the last 40 years. I have not seen transaction expenses rise to the level of 16% in any of them.

A footnote comment regarding Mr. Baliban’s “build-up method” is appropriate.  There is nothing improper about “building up” a list of expenses and then totaling them. The conclusion of the build-up of expenses associated with selling a company holding real estate in the Baliban Report was apparently 20%. However, the build up has to make economic sense. The Appellate Court picked 16% as the cost of selling two corporations with very attractive Manhattan rental properties but made no comment regarding why 16% should be the appropriate discount and no comment about the reasonableness of the discount.

To put the court’s 16% marketability discount into some perspective, the combined net asset value of First Ave Village Corp. and EGA Associates was $97.1 million per the Mercer Report. At the Baliban Report’s 20% discount, the implied selling expenses are $19.4 million. At the Appellate Court’s concluded 16% discount, the implied expenses are $15.5 million.  This conclusion is simply mind-boggling.

If the cost of liquidating an asset-holding entity was 16% of the net asset value, no one would put real estate into an asset-holding entity.  The implied marketing expenses make no economic sense.

For further perspective, the NAV was $48.55 million for each of Janet and Robert based on my concluded NAV for the two corporations combined. Applying a 16% marketability discount lowered Robert’s value to $40.8 million, a reduction of 16%. Applying the 16% marketability discount increased Janet’s value to $56.3 million, an increase of 16%. The economic effect of the 16% marketability discount was to transfer $7.8 million of value from Robert to Janet. The shares owned by Robert and Janet were the same class of shares and identical except for the dissolution process. Nevertheless, Janet had shares worth $56.3 million upon closing, and Robert had shares worth $40.8 million for his otherwise identical shares. Janet’s shares were therefore worth 38% more than Robert’s shares.

Contrary to Beway, Robert did not get his proportionate interest a going concern and received unequal treatment relative to Janet’s shares.

Wrapping Up

From an economic standpoint, and business and valuation perspectives, applying a 16% marketability discount in Giaimo is tantamount to applying an implied or implicit minority interest discount of 16%. Whatever one calls the 16% discount, the detrimental economic impact on the selling shareholder is the same. The beneficial impact to the controlling shareholder is, dollar for dollar, equal to the detrimental impact to the selling owners.

From an economic standpoint and business and valuation perspectives, the application of a 21% marketability discount in Beway is tantamount to the application of an implied or implicit minority interest discount of 21%.  Whatever one calls the 21% discount, the detrimental economic impact on the selling shareholders is the same.  The beneficial impact to the controlling shareholders is, dollar for dollar, equal to the detrimental impact to the selling owners.

Recall that the combined net asset values of the nine corporations in Beway were $15.2 million.  Applying a 21% marketability discount reduced that amount by $3.2 million to $12.0 million.  Where did that “lost” $3.2 million go?  It went directly to the controlling shareholders, as illustrated in the final figure for this post.

The first quote in the first post in the series was from the Delaware Supreme Court’s decision in Cavalier (Cavalier Oil Corp. v. Harnett – 564 A.2d 1137 (Del. 1989)

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.

In the final analysis, the economic effect of applying a 21% marketability discount in Beway “…imposes a penalty for lack of control, and unfairly enriches the majority shareholders who may reap a windfall from the appraisal process…”

The same is true for the imposition of a 16% marketability discount in Giaimo.

Both results are contrary to the preponderance of guidance in Beway regarding statutory fair value determinations in New York.

In the next and likely final post in this series, we will look at the actual marketability discounts applied by New York courts in fair value determinations since about 1985.  As I have alluded, the results are interesting.

In the meantime, be well!  And certainly, please do comment below on this blog or to me personally.

Chris

The last post on this blog began a discussion of Friedman v. Beway, a 1995 New York Court of Appeals (First Department) decision.  Beway is considered by many New York attorneys to be the leading New York case on statutory fair value determinations in New York. In this post, we examine the trial court decision for help in understanding what happened at the Court of Appeals.

As always, I examine cases from business and valuation perspectives.

Net Asset Value is a Beginning Point

At trial in the Beway matter, the Supreme Court (the lower court in New York) held one session in which the net asset values of nine family-owned asset-holding companies were determined to total $128.2 million. The combined net asset values of petitioners’ shares totaled $15.2 million, as seen below.¹

Fair Value is Determined

The second session of the Beway trial addressed the determination of fair value for each entity and in total. The agreed upon combined net asset value was $128.2 million. The petitioners owned the interests indicated in the exhibit above, which was developed in the McGraw Report.

The petitioners’ expert concluded that the fair values for each of the interests were the net asset values of their percentage interests. He concluded the combined fair value was to be $15.2 million. Unfortunately, from my perspective, while his opinion was ignored, it was the “right” conclusion.

The Company’s expert, McGraw (identified as such in Beway), determined the fair value of the nine interests to be $5.9 million through a multi-tiered process of discounting. This conclusion represented a total discount of 61% to the combined net asset value of $15.2 million determined in the first court session.

The McGraw Report provided three methods in arriving at its preliminary conclusion:

• A net asset value method that examined the prices at which a number of publicly-traded REITs were trading. The average REIT discount was 9.8%, but the McGraw Report increased that to 25.0%. There was no discussion of what caused the increase from the 9.8% REIT discount to the concluded 25.0% discount. The indicated values summed to $11.4 million.
• The second method was a closed-end fund analysis. McGraw concluded that the appropriate discount to net asset value was 20% and reached an indicated value of $12.2 million.
• The third method was an investment value analysis. McGraw looked at several publicly traded real estate-oriented companies and used their metrics to apply to the Beway entities. The conclusion with this method was $9.5 million, or a 38% discount to the net asset value.

These three methods were then weighted 40% (net asset value using REITs), 20% (closed end fund analysis), and 40% (investment value method). The concluded value of all nine entities was $10.8 million, or a 29% discount to the net asset values of the nine entities.

This value was then discounted by an additional 45% based on an analysis of several restricted stock transactions (30.4%) and an incremental discount of 14.6% to reflect restrictions on transfers in the various operating agreements.

The Supreme Court evidently discounted a good bit of the discounting in the McGraw Report, accepting only its 30.4% restricted stock discount reduced by a 9.4% REIT discount (the actual discount was 9.8%, but the court used 9.4%), yielding a 21% marketability discount. The Supreme Court’s conclusion relative to that of the McGraw Report as shown below.

The Supreme Court did not accept McGraw’s REIT discount (neither the 9.8% nor the 25%). The Supreme Court did not accept McGraw’s closed-end fund analysis or his investment analysis, either. The Supreme Court’s 21% net discount was applied to the net asset values of the entities.

The Court of Appeals believed that reducing the restricted stock discount of 30.4% by 9.4% (actually 9.8%) was a “double counting” of the reduction for the REIT discount.

There was some confusion in the Supreme Court. The Court of Appeals remanded the matter back to the Supreme Court to address that confusion and to reach a conclusion based on a better understanding of the evidence. Following remand, the concluded marketability discount in Beway remained at 21%, as discussed in our prior post.

Having read the trial transcript of the Supreme Court’s valuation trial and the McGraw Report, it is clear to me why things were unclear there.

Perspective Based on Trial Court and Appeal

We observe the following from this analysis of Beway from business and valuation perspectives:

• The decision affirmed the conclusion that minority interest discounts are not applicable in New York fair value determinations.
• A significant portion of the Court of Appeals decision addressed the kind of value that fair value should be in a New York fair value determination.
• Based on my understanding of the case, any marketability discount should be applicable at the company level and not relate to the shareholder level of value.
• Importantly for a discussion of marketability discounts in 2022, we should note that all of the market evidence cited in the McGraw Report pertained to discounts for minority interests and did not pertain to company-level discounts. We will gain a better understanding of this confusion in the further discussion of the levels of value below.

The major valuation adjustments used in the McGraw report were based on:

• Closed-end fund analysis
• REIT discount analysis
• Restricted stock discount analysis

All of these “discounts” reflect shareholder-level discounts and are not applicable to the nine companies in Beway as whole companies. In other words, the discounts employed in the McGraw Report all pertained to moving from the middle level of the chart below to the bottom level and to developing the values of illiquid minority interests in the subject companies.

This three-level chart was generally understood by 1995 when Beway was decided, although it was not published until 1990. At the time, the application of marketability discounts to move from the marketable minority (middle) level to the nonmarketable minority (lowest) level was common. The McGraw Report applied minority interest marketability discounts to the corporation as a whole, which would now be viewed as inappropriate by most business appraisers.

We learned in the 1990s that the Control Value on the chart above related to strategic acquisitions of companies. As a result, it is inappropriate to use control premium information to infer minority interest discounts.

Marketability Discounts Applicable to Companies, Not Shares

The bottom line is that the “marketability discount” based on restricted stock analysis and the REIT and closed-end fund discounts employed by McGraw and accepted by the Supreme Court were discounts for the minority nature of small ownership interests, contrary to the confused guidance of Blake and Beway. I say confused because it is confusing from business and valuation perspectives.

Beway references the 1985 appellate level decision of Blake, stating:

However, a discount recognizing the lack of marketability of the shares of Blake Agency, Inc., is appropriate, and, under the circumstances of this case, the amount of the discount should be 25%. A discount for lack of marketability is properly factored into the equation because the shares of a closely held corporation cannot be readily sold on a public market. Such a discount bears no relation to the fact that the petitioner’s shares in the corporation represent a minority interest (citations omitted, emphasis added).

Reading this guidance carefully, a marketability discount can be considered “because the shares of a closely held corporation cannot be readily sold on a public market.” The inference is that all the shares of a closely held company cannot be readily sold on a public market. Reinforcing this, the quote goes on to say that a marketability discount “bears no relation to the fact that the petitioner’s shares in the corporation represent a minority interest.” If not, then any applicable marketability discount must exist because a corporation itself is not marketable, and its shares cannot be offered to the public markets.

The direct inference is that any marketability discount must be applicable at the level of the corporation itself rather than applicable to minority shares themselves. This is an important inference.

It follows that evidence reflecting comparisons of (minority interest) publicly-traded shares with restricted stock offer prices is irrelevant for marketability discounts in fair value determinations. These studies relate two different minority interest prices, the public price, and the placement price. They bear no relation to the marketability of any company at all.

Nevertheless, there is a failure to recognize this distinction in a number of New York fair value cases.

We look now at a levels of value chart applicable to asset holding entities to clarify these relationships. There is no concept of strategic control for asset holding entities, so now there are only three levels of value, the financial control/marketable minority value and the nonmarketable minority value.

Any Discount to NAV is “Unfair”

It is generally recognized today that the marketable minority and financial control levels of value coexist. The minority interest discount is generally considered to be very small or nil.

For asset holding entities, net asset value (market value of all assets less liabilities) is the financial control value. In practice, there is no minority interest discount. In New York fair value, there is no minority interest discount.

It should be clear that the imposition of a marketability discount takes the financial control value to the nonmarketable minority level of value, which is not the level of the enterprise.

There is no logic for the application of marketability discounts to entire companies, so the application of any marketability discount is really a disguised minority interest discount and creates “unequal treatment of shares of the same class of stock.”

The example below is similar to an example in our last post.

We look at the illustration “by the numbers.”

1. A corporation or LLC is owned by the controllers and the dissenters at 80% and 20%, respectively.
2. There are 100,000 shares outstanding, so shares are allocated pro rata to ownership.
3. The net asset value (NAV) of the entity has been determined by the appraisal to be $50 million.
4. NAV per share is, therefore, $500 per share, with $40 million apportioned to the controlling owners and $10 million to the dissenters.
5. A marketability discount of 16%, as in Giaimo, is applied.
6. The dissenters’ shares are devalued by $1.6 million. Where does that value go? To the controlling owners.
7. The controlling owners experience an increase in value to $41.6 million, and the dissenters realize a loss of $1.6 million ($10 million to $8.4 million).
8. Value per share for the controllers is now $520 per share, up 4% in Column 9, and the dissenters’ value falls to $420 per share, a reduction of 16%.

The math works the same whether a discount is called “minority interest” or “marketability.” Any discount from NAV for asset holding entities or otherwise determined fair value (financial control) results in a transfer of value from the dissenters to controllers.

This result is contrary to my understanding of guidance from Beway. And, it does not make sense from business and valuation perspectives to forbid a minority interest discount because it is “unfair” to dissenters,” and yet to allow a marketability discount through pained logic which is equally as “unfair.”

We will have one or two more posts related to Beway in the near future.

In the meantime, please comment on the blog below or to me personally.

Be well,

Chris

¹ Mercer Capital obtained the transcript of the Supreme Court trial in the Beway matter. We also obtained the valuation report prepared by Kenneth W. McGraw on behalf of Patricof & Co. Capital Corp (“the McGraw Report.”) The table below is excerpted from Exhibit 2 of the McGraw Report.

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

Peter Mahler of New York Business Divorce Blog wrote a post today titled “Disclosure of Estate Tax Stock Appraisals in Shareholder Disputes.” The question addressed is if or whether, in the context of contested stock valuation procedures stemming from elections to purchase in statutory dissolution or dissenting shareholder cases, pre-litigation appraisals rendered for estate tax purposes (or other purposes) should be discoverable. That’s a good question. Read Peter’s post for his comments regarding the law. I’ll comment briefly as a business appraiser and businessman.

First Response: Facetious

I have said the following before and even had it put in front of me at a deposition.

In litigation, if evidence (like pre-litigation appraisals) is supportive of my opinion, it will not be admitted.  If it is not supportive, it will be admitted.

In this case, I make clear that the comment is facetious.

Next Response: More Serious

Peter Mahler’s question regarding the admissibility of pre-litigation valuation reports is a good one. Many closely held companies have appraisals conducted for any number of purposes over time. The shareholders of the companies also have, for gift or estate tax purposes, their own appraisals from time to time. The point is, it is not at all unusual in a statutory fair value matter like Mahler writes about for pre-litigation appraisals to be around.

Should they be admitted into evidence in a statutory fair value matter?  One party or the other will certainly desire that the pre-litigation appraisal be admitted into evidence.

Suppose the issue goes the other way.  Assume the statutory fair value determination precedes the death of a shareholder. Is the statutory fair value appraisal (or appraisals) relevant for purposes of a later estate tax appraisal? Certainly, the Internal Revenue Service will ask to see it (them).

The question is, what will any given court in a current valuation proceeding do about admitting pre-litigation appraisals into evidence?

One side or the other will assume that the pre-litigation report supports or affirms or impeaches the other side’s now current appraisal.  It is not necessarily so simple.

Pre-Litigations Appraisal Will Differ from Current Appraisals

Every appraisal must be defined in a number of ways:

• Valuation Date. The valuation date sets the time at which the hypothetical transaction represented by the appraisal is assumed to occur. The value of any company can or will change over time. So a first question for comparing a current appraisal with a pre-litigation appraisal is simply, when did it occur in relation to the current valuation date. Things change over time with the economy, industries, and companies.
• Standard of Value. Every appraisal must be rendered under a particular standard of value to describe to the reader the kind of value being determined and the rules of valuation applicable to the appraisal. There can be significant differences between appraisals rendered under the fair market value standard, the (statutory) fair value standard in a particular state, the (accounting) fair value standard for financial reporting purposes, or some other standard. When comparing a pre-litigation appraisal with a current valuation date, it is necessary to examine the standards of value under which they were rendered – same, different?
• Level of Value. Readers of this blog are familiar with the levels of value chart that is used by business appraisers. The version we use, which is consistent with the Integrated Theory of Business Valuation, is reproduced below:
• Clearly, if one appraisal is rendered at the nonmarketable minority level of value (the lowest in the chart above), and another is rendered at the strategic control level of value (the highest level), then their conclusions will differ substantially, even if all else is equal. The top level would represent the value of the business as a whole in a strategic, synergistic hypothetical transaction.  The lowest level represents the value of an illiquid minority interest. They may represent the same company, but they are different valuation interests.
• Qualifications of Appraisers. Business appraisers often earn valuation credentials that reflect their education, background, and experience in rendering appraisals. Were the credentials of the appraiser(s) rendering the pre-litigation appraisal comparable to those of the current appraiser(s)?
• Appraisal Standards Followed. Credentialed business appraisers are required to follow the valuation standards of their respective organizations. Those without appraisal credentials, like industry experts or investment bankers, may not follow appraisal standards at all.
• Methodologies Employed. An appraisal that is an appraisal is an appraisal. Not. Appraisals must employ appropriate valuation methodologies based on the facts and circumstances. Each appraisal must make appropriate normalizing adjustments relevant at their respective valuation dates. And each appraisal must make and support reasonable valuation assumptions in reaching their conclusions. Not all appraisals are created equal.

The Pre-Litigation Appraisal is Admitted

Assume you are in litigation to determine the current value (statutory fair value, fair market value, accounting fair value) of a business or business interest. Assume further that a pre-litigation appraisal has been admitted into evidence. Assume still further that this pre-litigation appraisal’s conclusion appears to call into questions your (or your appraiser’s) current conclusion.

The bottom line is that you will have to compare the two appraisals along the lines outlined above. It complicates life in court to have to reconcile a current conclusion with a pre-litigation appraisal. This is the historical equivalent to the admission of a subsequent event that would appear to call a current appraisal’s conclusion into question.

In either case, depending on the economic stakes, you may need to obtain an independent appraisal review of the pre-litigation appraisal, the current appraisal, or a comparative review of both in order to address any apparent discrepancies. I wrote a post about independent appraisal review in litigation some time ago.

Concluding Thoughts

I’ll let Peter Mahler address the legalities of admission of pre-litigation appraisals (or for that matter, the valuation-disrupting equivalent, the subsequent event). As an appraiser, I always ask so that I’ll know if there are any pre-litigation appraisals. I want to know this regardless of the side we are working for.

Rather than wonder if an appraisal will be admitted, my preference is to address its existence in any current report, regardless of whether it appears to support or contradict my own conclusion.

If you find yourself in the situation where an apparently conflicting, pre-litigation appraisal report has been admitted into evidence, give me a call.  Let’s see if we can use the comparative logic outlined above to place it into appropriate perspective or if you need a more formal appraisal review. Either way, give us a call at 901-685-2120 or an email at mercerc@mercercapital.com.

New Books on the Way

• An Attorney’s Handbook for Buy-Sell Agreements (in production).  This book provides guidance based on 30-plus years of dealing with buy-sell agreements. Importantly, it provides for the first time ever, anywhere, draft template language for the valuation portions of buy-sell agreements that will work for clients or companies.  You will not want to miss this book!
• Business Valuation: An Integrated Theory Third Edition (with Travis Harms). The draft is due to the publisher (Wiley) shortly and will be available subject to their publication schedule. This book updates the Integrated Theory of Business Valuation and will include the Integrated Theory on an equity basis and on an enterprise (total capital) basis, as well. This book will be must reading for all business appraisers and anyone interested in business valuation.

E-mail me if you would like to be notified when these books become available.

In the meantime, be well!

Chris

It has been some time since I’ve written about statutory fair value in New York.  However,  I was retained in a recent matter by Nicholas J. Faso, an attorney with Cullen and Dykman in Albany, New York, in a statutory dissolution action involving a real estate holding company.  Mr. Faso and his team worked hard on this matter, and it was a pleasure to work with them.

His client, the plaintiff, owned a 40% interest in the equity of an S corporation we will call HoldCo, whose primary assets were a small retail shopping center and some adjacent vacant land.  The action was brought for the court to determine the fair value of the plaintiff’s 40% interest.

We prepared the case for trial.  I submitted an expert report, which included a formal rebuttal of the report of the opposing expert.  Further information regarding rebuttal was submitted shortly before trial by both sides.

The trial began on Monday morning at 10:00 am.  The plan was for me to fly up on Monday, listen to the testimony of the real estate appraisers, to be present during the direct examination of the opposing business appraisal expert on Tuesday, and then, to testify, likely on Wednesday.

I boarded the plane in Memphis to Atlanta at 9 am (after using a wheel chair assist—another story) to fly through there on the way to New York.  During the layover in Atlanta, I had an early lunch and then boarded the plane for New York, which was scheduled to depart Atlanta at 12:06 pm.  I had assumed that, if the case were going to settle, it would have settled by then.

While seated in seat 9C, at precisely 12:00 noon (est), I looked at my phone and saw a new email which said:

Settled don’t get on plane

Well, I was already on the plane and it was full and very close to departure.  Somehow I was able to get off the plane before it departed the gate.  The plane actually pushed off at 12:04 pm while I was still on the jetway with the attendant, who pulled it away from the plane. Things don’t get much closer than that.  I flew home to Memphis Monday afternoon and my checked bag flew to New York.

Later on Monday afternoon, while back in the office in Memphis, I talked with Mr. Faso about what happened.  The judge heard opening statements, which began shortly after 10 am.  He then asked a number of questions regarding the meaning of Beway (see below) and what the case said about the application of a discount for lack of marketability.  Those are the questions we wanted the judge to be asking.  The opening must have been unsettling for the defendants and their counsel because the case settled—in time for me to receive notice at noon and get off the plane.

This post, then, is about this New York fair value case that settled at the beginning of its trial.  We will leave the parties out of the discussion, but counsel indicates that it is okay to talk about the concepts, issues, and numbers.

Statutory Guidance in BSC §1118

The case was a dissolution action under New York’s BSC §1118.  The statutory discussion (definition) of fair value is repeated here:

(a) In any proceeding brought pursuant to section eleven hundred four-a of this chapter, any other shareholder or shareholders or the corporation may, at any time within ninety days after the filing of such petition or at such later time as the court in its discretion may allow, elect to purchase the shares owned by the petitioners at their fair value and upon such terms and conditions as may be approved by the court, including the conditions of paragraph (c) herein.  An election pursuant to this section shall be irrevocable unless the court, in its discretion, for just and equitable considerations, determines that such election be revocable.

(b) If one or more shareholders or the corporation elect to purchase the shares owned by the petitioner but are unable to agree with the petitioner upon the fair value of such shares, the court, upon the application of such prospective purchaser or purchasers or the petitioner, may stay the proceedings brought pursuant to section 1104-a of this chapter and determine the fair value of the petitioner’s shares as of the day prior to the date on which such petition was filed, exclusive of any element of value arising from such filing but giving effect to any adjustment or surcharge found to be appropriate in the proceeding under section 1104-a of this chapter.  In determining the fair value of the petitioner’s shares, the court, in its discretion, may award interest from the date the petition is filed to the date of payment for the petitioner’s share at an equitable rate upon judicially determined fair value of his shares. (emphasis added)

According to §1118 (and New York interprets the related §623 similarly), fair value is, well, fair value.  If the corporation (buyer) and the petitioner (seller) cannot agree on “the fair value of such shares,” then the court will determine their fair value.  What guidance is there in §1118 regarding just how the court(s) are to determine fair value?  Well, it is all in the quote above.

Fair value will be determined “as of the day prior to the date on which such petition [to determine fair value] was filed.”  This guidance sets the valuation date.  The statue also refers to “the fair value of such shares.”  Does this mean that if the subject shares represent a minority interest, that their fair value should be determined as a minority interest?  All we can say is that the statute makes no comment regarding the nature, whether minority or control, of fair value in New York.

However, the statute goes on to say that fair value shall be determined “exclusive of any element of value arising from such filing but giving effect to any adjustment or surcharge found to be appropriate…”

I’ve been involved in a number of New York statutory fair value cases over the years.  The first part of the last quoted sentence says exclusive of any value arising from the filing.  That has never been an issue in any of the cases I have seen.  The second element says to give effect to any adjustment or surcharge found to be appropriate.  I’ve never seen this element considered in a fair value determination, either.

The bottom line for business appraisers retained to provide opinions of the fair value of shares in cases involving dissenting shareholders, oppression, or corporate dissolution, §1118 provides little guidance regarding the nature of the valuation that is to be determined.  To make matters worse, §1118 provides no more guidance to the New York courts that are required to determine fair value in such matters.

Facts of the Case

HoldCo, the real estate holding company involved in the matter, owned a small retail shopping center in a well-developed urban location and a fairly large plot of vacant, adjacent land suitable for residential or mixed-use development.  Counsel also retained a qualified commercial real estate appraiser to appraiser to appraise the real estate (see 1 below).

The business appraiser retained by HoldCo did not provide a determination of fair value.  Rather, he provided an “Expert Opinion of Computation of Discount for Lack of Marketability [for] HoldCo” as of the stipulated valuation date.  Interestingly, HoldCo relied upon real estate appraisals provided on behalf of a commercial bank where it was seeking financing for the buyout, so there was some question about the independence of the HoldCo’s real estate appraiser (2 below).

As an interesting aside, HoldCo had the word “development” in its name.  On the eve of trial, defendants counsel introduced the argument that HoldCo was not a real estate holding company, but a rather a development company with plans for further development of its assets. It therefore should not be treated as a real estate holding company according to this novel argument.  Fortunately, the judge saw through this specious argument.

There was a significant difference in the conclusions of the two real estate appraisers.  I relied on the real estate appraiser retained by counsel for the plaintiff and HoldCo relied on the other appraiser’s conclusions.

• My conclusion of fair value began with the net asset value of HoldCo, with the real estate at appraised market values.  It then applied a marketability discount of 0% to that net asset value.  The fair value of plaintiff’s 40% interest was, therefore, a pro rata share of net asset value ($3.10 million).
• As noted, the business appraiser for HoldCo did not provide an opinion of its fair value.  Rather, he opined only as to a “discount for lack of marketability,” or DLOM, which was 35%.  Using information provided by HoldCo, we estimated their implied fair value of the plaintiff’s 40% interest to be $1.48 million.

The discussion thus far sets the stage for the trial that started, but did not reach completion.

Net Asset Values

My report provided an opinion of net asset value of HoldCo of $7.75 million.  We estimated the opposing side’s net asset value based on figures provided by HoldCo to be $5.71 million, as seen in the figure below.

The $2.1  difference in asset values (at market values) is comprised almost entirely of differences in the real estate appraisals.  The majority of that difference pertained to the adjacent vacant land.  Based on my reviews of all the real estate appraisals, I relied on those provided by the appraiser retained by counsel for the plaintiff.

The cash, current liabilities, and mortgage balance shown in my appraisal were sourced from the Company’s financial statement for the month-end immediately prior (one day) to the valuation date (3 above).  I am uncertain of the source for cash and current liabilities in the Company’s filings, and the differences were not resolved (4 above).

The net asset value of HoldCo in my appraisal was $7.75 million (5 above).  Our best calculation of the implied net asset value based on the Company’s position is $5.71 million (6 above).  This was interesting because prior to trial, there was no indication of this figure, which was the apparent base from which the discount for lack of marketability (“DLOM” or “marketability discount”) concluded by HoldCo’s business appraiser was to be applied.

We will assume for purposes of this discussion that the net asset value indications of HoldCo ($7.75 million per my appraisal and the $5.71 million calculation above) were the base levels for discussions regarding settlement or that would have been considered by the Court had the case gone to trial.

We have indications of net asset value.  Now we need to determine the fair value of the 40% interest held by the plaintiff.

Beway: The Leading Fair Value Case in New York

We saw above that §1118 does not provide clear guidance on how to determine fair value in New York.  As with other jurisdictions, when the statutory guidance is incomplete or unclear, the definition of fair value in New York is determined (or estimated) by judicial interpretation as it evolves over time.

There are many real estate holding companies in New York (as well as many other operating entities).  I can’t speak to specific numbers, but I can say that I have been involved as a business appraiser with more fair value determinations of real estate holding entities in New York than in any other state.  So we looked to judicial guidance in our determination of fair value.

According to counsel for the plaintiff, the leading appellate level case providing guidance on fair value is that of  Matter of Friedman v. Beway Realty Corp., 661 N.E.2d 972 (NY 1995).  I was also aware of this fact from involvement in prior cases.  There are numerous other fair value cases in New York, but none provides the clarity of analysis, at least from my perspective as a business appraiser, as found in Beway.

No Minority Discounts

One thing is clear to me as a business appraiser from reading Beway.  It is not permissible to apply a minority interest discount in a New York fair value determination.  This is apparent from the following quote from Beway.

The corporations’ primary argument for reversal is that Supreme Court [the lower, or trial court in New York] erred as a matter of law in refusing to take into account in its fair value determination the financial reality that minority shares in a close corporation are worth less because they represent only a minority, rather than a controlling interest…

Although the corporations’ argument may have validity when corporate stock is valued for other purposes, it overlooks the statutory objective here of achieving a fair appraisal remedy for dissenting minority shareholders…

Mandating the imposition of a “minority discount” in fixing the fair value of the stockholdings of dissenting minority shareholders in a close corporation is inconsistent with the equitable principles developed in New York decisional law on dissenting stockholder statutory appraisal rights [a position shared by the courts in most other jurisdictions], and the policies underlying the statutory reforms giving minority stockholders the right to withdraw from a corporation and be compensated for the value of their interests when the corporate majority takes significant action deemed inimical to the position of the minority. (emphasis added)

This guidance prohibiting minority discounts in fair value determinations is generally accepted by the legal and appraisal communities based on my experience in New York.  Since Beway, I have never seen an appraiser attempt to apply a minority discount in a fair value case.  The opposing expert in this case went out of his way to argue that his concluded DLOM was not a minority discount, in spite of basically proving himself wrong by his own discussion.

At this point, let’s take a look at what appraisers call a levels of value chart to illustrate the conceptual “levels” or kinds of value that might exist.  Recall that the statute quoted above called for determinations of “the fair value of such shares.”

This language could be interpreted as calling for a determination of the fair value of minority shares, which could include discounts for their minority interest nature and for their lack of marketability.

The key question in fair value determinations in most jurisdictions is whether minority interest discounts and marketability discounts (DLOMs) are appropriately used.  In most jurisdictions, the answer to the question is no for both discounts, which suggests that fair value in many jurisdictions is determined at the financial control level of value in the figure above.

At the financial control level of value, there is no application of a minority interest discount and no application of a marketability discount (DLOM).  Further, there is no application of a strategic control premium, either.  This would be particularly true for an asset holding company where the value is based on the market values of assets and no goodwill is created.

We know from the discussion above that it is inappropriate to apply a minority interest discount in fair value determinations in New York.

Principles re Appraisal Rights Under §623 and §1118 per Beway

Beway enunciates several principles regarding appraisal rights of dissenting shareholders under §623 (and makes clear that the principles apply under §1118).  The following comments restate (quote) these principles followed by brief comments.

• “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]).”

The “value for investment” in a real estate holding company is its pro rata share of net asset value, and nothing less.  Generally, when assets are sold in a real estate holding company, the proceeds are either used to pay down debt (thus increasing each owner’s value for investment pro rata) or distributed (thus providing current returns on their investments).  In valuation-speak, the value for investment is the financial control value of a real estate holding company.

• “The three major elements of fair value are net asset value, investment value and market value. The particular facts and circumstances will dictate which element predominates, and not all three elements must influence the result (Matter of Endicott Johnson Corp. v Bade, 37 N.Y.2d 585, 587-588).”

The net asset value method is the most appropriate method to value a real estate holding company.  Net asset value for a real estate holding company is the financial control level of value.

• “Fair value requires that the dissenting stockholder be paid for 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).”

A proportionate interest in a going concern represents the financial control value for a real estate holding company.

• “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).”
  

Equal treatment of all shares of the same class of stock suggests financial control value is appropriate. Any discount to financial control, by whatever name it might be called, creates unequal treatment of the selling owner’s shares and would violate this important guidance from Beway.

Further Guidance from Beway re “Unmarketability”

Beway continues beyond the list of principles and provides still further guidance regarding the meaning of fair value in New York.  The following three quotes (followed by brief comments) continue to suggest that financial control is the appropriate level of value in fair value determinations in New York.  If there was any doubt in a reader’s mind, the guidance should be clear as applicable to real estate holding companies (and to operating companies as well).

• “Thus, we apply to stock fair value determinations under section 623 the principle we enunciated for such determinations under section 1118 that, in fixing fair value, courts should determine the minority shareholder’s proportionate interest in the going concern value of the corporation as a whole, that is, “what a willing purchaser, in an arm’s length transaction, would offer for the corporation as an operating business'” (Matter of Pace Photographers [Rosen], 71 NY2d, at 748, supra, quoting Matter of Blake v Blake Agency, 107 AD2d, at 146, supra [emphasis added]).”

A (knowledgeable, unmotivated and) willing seller of the “corporation as an operating business” would not sell for less than net asset value for an asset holding entity.  A willing buyer would offer that value to induce the transaction.  Only under these assumptions does the minority shareholder obtain “proportionate interest in the going concern value in the corporation as a whole.”  This guidance continues to suggest that the appropriate level of value in New York fair value determinations is the financial control level of value as illustrated in the figure above.

• “Consistent with that approach, we have approved a methodology for fixing the fair value of minority shares in a close corporation under which the investment value of the entire enterprise was ascertained through a capitalization of earnings (taking into account the unmarketability of the corporate stock) and then fair value was calculated on the basis of the petitioners’ proportionate share of all outstanding corporate stock” (Matter of Seagroatt Floral Co., 78 NY2d, at 442, 446, supra).

Seagroatt, in the quoted case above, was an operating company. The Petitioner’s expert testified that he took the company’s lack of marketability into account in his capitalization rate, and applied no marketability discount. The appellate court affirmed the reasonableness of this position.  This guidance is important for all companies, since market capitalization rates do anticipate “unmarketability.”

It is particularly important for real estate holding entities. Both real estate appraisers took into account appropriate periods for “exposure to market” in their appraisals of HoldCo’s real estate assets.  What this means is that in terms of the hypothetical transactions implied by their market value determinations, exposure to market has occurred prior to the valuation date.  Any “unmarketability” of HoldCo’s real estate assets has already been taken into account by exposure to market.  This is emphasized since their cap rates were developed from market transactions where the underlying properties had been exposed to market prior to their actual sales.  Since the only assets of HoldCo are the real estate (and a bit of cash), the S corporation “wrapper” provides no impediment to liquidity for owners if and when its real estate assets are sold.  This reinforces that the appropriate level of value for fair value determinations in New York is that of financial control.

Conclusion of Analysis of Beway re Level of Value

We know from reading Beway and its predecessor lower court decision that the appellate court rejected the application of the minority discount proposed by the company’s appraiser, as well as other discounts that were advanced.  The appraiser did propose a marketability discount of 21% (where the other appraiser effectively applied a 0% marketability discount).

The case was remanded for reconsideration of the marketability discount.  To the best of my knowledge, there was not another decision in Beway, so we may never know exactly what happened in the final analysis.  What is clear, at least to me from business and valuation perspectives, is that if there had been a retrial and the court had rendered an opinion on an appropriate marketability discount, it should have been much lower than 21% or none at all.

We see the result of the discussion regarding level of value in the conceptual figure below.

Marketability Discounts for Financial Control Values

If financial control is the appropriate level of value for fair value determinations in New York, any marketability discount would have to be applicable to the entire company and not to an interest in a company. The buyers agents Melbourne are experts that can guide you.

Recall the discussion above regarding exposure to market in real estate appraisals.  That exposure has already occurred prior to the valuation date, and market value appraisals consider that fact.

Similar logic applies to operating companies.  I set out the logic in an article I wrote for the Business Valuation Review of the American Society of Appraisers in June 1994.  It goes like this:

Any historical transactions involving the sale of business enterprises that might be used as comparable transactions using the guideline transactions method occurred at the prices at which they were recorded (and at which their transaction multiples were calculated).  The prices reflected the entire negotiations between the real buyers and sellers involved in the transactions involving enterprises that sold.  Any issues related to the “unmarketability” of any of these enterprises were included in the negotiations between the buyers and sellers leading to the actual transactions at their actual prices.  The application of any DLOM or “unmarketability” discount is therefore inappropriate when valuing companies based on historical transactions.

This is the same logic involved with exposure to market for real estate appraisals.

Guidance from Other Fair Value Cases

A number of New York cases have reached conclusions of 0% marketability discounts, particularly as they apply to real estate holding entities.  Selected cases and comments follow:

• Cinque (212 A.D.2d 608 (1995) 622 N.Y.S.2d 735)
  • Determined that marketability discounts are only applicable to a company’s goodwill and are not appropriate when the company (like ODC) held only cash and real estate.  The court stated: “The Judicial Hearing Officer properly refused to discount the value of the petitioner’s shares of the corporation due to their lack of marketability. Such a discount should only be applied to the portion of the value of the corporation that is attributable to goodwill. Here, the value of the corporation is attributable solely to real property and cash.” This case supports a marketability discount of 0% based on the fact that HoldCo has no goodwill and is a real estate holding company.
• Vick (Appellate Division, First Department case in New York).  47 A.D. 3d 482, 484, 849 N.Y.S. 2d 250, 252-53 (1st Dep’t 2008), leave to appeal denied, 10 N.Y. 3d 707 (2008). Citations omitted, parentheticals and emphasis added.
  • Addresses minority interest and marketability discount issues in a case involving a partnership which was a real estate holding company.  The court states: “However, application of the discounts [minority interest and marketability] sought by defendants would deprive plaintiffs of the value of the decedent’s proportionate interest in a going concern, since they would not receive what they would have received had the entire entity been sold on the open market unaffected by a diminution in value as a result of a forced sale. The unavailability of discounts is particularly apt here, where the business consists of nothing more than ownership of real estate [like HoldCo], and where the valuation ensues from the death of a partner and not as the result of any misconduct of a withdrawing partner in causing dissolution…”
  • Again, the guidance is clear that there is no reason to discount a business for lack of marketability that only holds real estate.
• Ruggiero (Appellate Division, Second Department case in New York).  Nilva Ruggiero, etc., appellant, v Pasquale Ruggiero, et al., respondents. 143 A.D.3d 964 2nd Dept 2016
  • Addresses minority interest and marketability discount issues in a case involving a corporation which was a restaurant company, i.e., an operating company.
  • In Ruggiero, adjustments were made to the monies owned to certain parties due to the court’s treatment of debt. The valuation of an operating business was a significant factor in the Ruggiero case; however, the Supreme Court of the State of New York Appellate Division, Second Judicial Department affirmed without comment Justice Pines’ omission of discount for lack of marketability in the Ruggiero case.
• Man Choi Chiu v Winston Chiu (Appellate Division, Second Department case in New York).  Index No. 21905/07 (Sup Ct Queens County Aug. 30, 2012) Citations omitted, emphasis added.
  • I testified on behalf of plaintiff Winston Chiu in this matter, offering the opinion that the appropriate marketability discount was 0%.  The court stated: “MCC is not entitled to a lack of marketability discount.  It is true that in determining the fair value of a limited liability company, as with a close corporation, the illiquidity of the membership interests should be taken into account.  While the application of a lack of marketability discount is not always limited to the goodwill of a business, in the case at bar, the LLC’s business consisted in nothing more than the ownership of realty which is easily marketable [like with HoldCo]. In any event, Nelson’s testimony that MCC is entitled to a whopping 25% lack of marketability discount for what is essentially real property placed in a limited liability company package has no credibility [compared to the 35% marketability proposed in opposing expert’s report in the case I’m writing about], and the record does not permit the court to determine what lesser percentage might be appropriate.” (emphasis and parentheticals added, parenthetical citations removed)
  • The trial court’s opinion was later upheld without comment on appeal without further comment.  See Man Choi Chiu v Chiu 2015 NY Slip Op 01427
    

There are cases where courts have applied a (greater than zero) marketability discount.  I testified in one such case involving a real estate holding company, Giaimo v. Vitale (2012 NY Slip Op 08778 Decided on December 20, 2012, Appellate Division, First Department).

In Giaimo, a special master held the initial trial in which I testified.  My logic in Giaimo was similar to that discussed in this post.  The master found for a 0% marketability discount.  The case then went to the trial judge who ruled that the 0% marketability discount was appropriate, although for a different rationale than the special master advanced based on testimony.  The appellate court concluded that the marketability discount was 16% without specifying its logic.

Nevertheless, I believe that the logic advanced in this case (and in this post) was appropriate from business valuation perspectives.  It is also consistent with the great majority of guidance in Beway, and that a 0% marketability discount was the appropriate discount in the HoldCo case.

Opposing Expert Says 35% DLOM

The opposing expert wrote a short report advancing a 35% marketability discount.  His support for this conclusion was based on vague references to average discounts found in unnamed restricted stock studies and pre-IPO studies.  His logic involved heavy discussion of the minority interest nature of the 40% interest held by the plaintiff.  The conclusion of the expert’s report is provided here:

“These issues are heavily weighted in developing a discount. Generally, with such a long-term holding period, a mathematical model or a model based upon the premiums paid for puts and calls would be utilized. However, as is typical of a company like [HoldCo], the necessary data to use these models does not exist. This leaves us with only the empirical restricted stock and pre-IPO studies to base an opinion. Since these studies quantify discounts where the holding period is under three years, they serve more as a minimum discount in situations where the holding period is longer.

Lacking a firm basis for a higher discount, it is my opinion within a reasonable degree of certainty in accordance with the standards of my profession that a minimum discount of 35% is warranted.” (emphasis added)

In my opinion, this expert’s 35% marketability discount was a forbidden minority discount in disguise.

In the next figure, we see the conclusions of fair value for the plaintiff’s 40% interest based on my appraisal report and our interpretation of the implied conclusion for HoldCo.

The parties proceeded to court on a Monday morning with the above difference that would come before the court if the trial advanced.  My conclusion of the fair value of the plaintiff’s 40% interest was $3.1 million.  The implied conclusion for the other side was $1.48 million, or a $1.62 million difference.  As I mentioned, the case settled after opening statements, but before the trial proceeded.

Applying 35% Marketability Discount Violates Beway

Now we have all the relevant facts in the matter of determining the fair value of HoldCo.  Two indications of net asset value are shown in the initial figure.  My conclusion was that fair value (and net asset value) of HoldCo was $7.75 million and the implied net asset value for HoldCo was $5.71 million.  That range is repeated in the second figure above, which reaches conclusions of fair value for the plaintiff’s 40% interest in HoldCo.

My report included the following figure, which illustrates the economic impact of applying a 35% discount (or a discount of whatever name, marketability or minority) to the net asset value conclusion in my report.

Columns 1 and 2 above show the ownership of the common stock of HoldCo, including the plaintiff’s 40% interest, and the proportionate allocation of net asset value to the owners.  The plaintiff’s proportionate share of net asset value is $3.1 million.

Columns 3 and 4 above illustrate what happens when a 35% discount is applied to the plaintiff’s shares.  First, his value drops 35%.  Note that the respective values of the other owners increase by 23.3% each.  In dollar terms, $1.08 million of value is transferred from the plaintiff to be shared equally ($361.5 thousand each) by the other owners.

Given my conclusion that any “unmarketability” regarding HoldCo’s assets has already been considered in the real estate appraisals, there is a double-dipping effect that, from my perspective as a business appraiser, violates the guidance of Beway discussed in this post.

Column 5 shows that, relative to Column 1 (proportionate allocation), there is a disproportionate allocation of value to the plaintiff, which violates Beway’s guidance.

Finally, Column 6 looks at the impact of the discount on value per 1% interest.  The plaintiff’s interest would be valued, post-discount, at $50,356 per 1% interest.  The other owners’ interests, however, would be valued at $95,546 per 1% interest.  This violates the guidance of Beway calling for equal treatment of all shares of the same class of stock in HoldCo.  Note that the proportionate value of a 1% interest of HoldCo is $77,740, which can be seen at the bottom left of the figure above.

Legal Opinions in This Analysis?

When filing information regarding rebuttal, opposing counsel suggested that I was providing legal opinions with my analysis of Beway from business and valuation perspectives.  I have no legal opinions.  I am a business valuation expert and a businessman.  I do, however, have to read relevant case law for numerous types of valuations, including statutory fair value cases in New York.

This post analyzes the plain language in Beway from my perspective as a businessman.  When the leading case in a jurisdiction says “no minority interest discounts,” then I can read and heed.

That case also says  that “in fixing fair value, courts should determine the minority shareholder’s proportionate interest in the going concern value of the corporation as a whole, that is, “what a willing purchaser, in an arm’s length transaction, would offer for the corporation as an operating business.'”  I can only interpret those words from business and valuation perspectives, but they say to me as a business appraiser that fair value should be determined at the financial control level of value.

As a business valuation expert, I do my best to provide sound business and valuation guidance to the courts where I testify.  As an appraiser, I provide my opinion of fair value to courts.  However, in every bench case on statutory fair value I’ve been in so far, it is the judge who makes the legal determination of what is fair value.  He or she does that based on the facts of each case and on the valuation evidence provided by business appraisers (and real estate appraisers).

The Case Settled Before Trial Began

So the case settled.  My opinion of the fair value of plaintiff’s 40% interest in HoldCo was $3.10 million.  The opposing “opinion” was $1.48 million.

The case settled at $2.76 million, or an 11% discount to my conclusion of fair value, and an 86% premium to HoldCo’s position.

The plaintiff “won” the settlement.  He won, at least from my perspective, because:

• My opinion of fair value was soundly reasoned and well-written.
• The opposing expert did not have an opinion of fair value, and his “discount opinion” was neither credible nor convincing.
• The real estate appraiser retained by the plaintiff wrote, in my opinion, more convincing and credible appraisals of the two pieces of real estate than the bank’s expert whose opinions were offered by HoldCo.
• I prepared a substantial rebuttal of the opposing expert’s “discount opinion.”  I think my rebuttal was much more credible and convincing than his opinion.
• Plaintiff’s counsel and I prepared for trial and were ready for my testimony.  I don’t know how Mr. Faso conveyed that to HoldCo’s counsel, but I believe he did.

What would have happened if the case had been tried?  No one knows.  But given the uncertainties of trial, a settlement at 89% of my opinion of fair value seems reasonable.  Had the judge ruled, he could have provided for interest for up to about two years.  Whether that would have been at 9% or 4%, no one knows.  The bottom line is that the plaintiff knows that he will receive fair value, or at least close to it when the financial settlement occurs in a couple of months.

Wrapping Up

I hope this post regarding statutory fair value in New York has been of interest.  Please feel free to comment below or to contact me directly:

mercerc@mercercapital.com

901-685-2120

We are getting closer to publication of my new book, Buy-Sell Agreements: A Handbook for Attorneys.  If you would like to be on the notification list when it is available, please email me at the address above.

In the meantime, be well.

Chris

Several months ago, I wrote a post about a recent ruling of the Tennessee Supreme Court addressing the issue of statutory fair value in Tennessee.  The post was titled Tennessee Supreme Court Addresses Statutory Fair Value for the First Time in 35 Years in Athlon Sports Communications.  The Supreme Court reversed the trial court and remanded the case for reconsideration.

In my earlier post, I called this a “friendly reversal” because the Supreme Court reversed with what seemed to me to be an invitation for the trial judge to reach the same conclusion and to be consistent with the Supreme Court’s new ruling.

The Old Law

For decades, the “law of the land” in Tennessee statutory fair value determinations required business appraisers to employ what was (and is) called the Delaware Block method for determining fair value.  The leading case was  Blasingame v. American Materials, Inc., 654 S.W. 2d 659 (Tenn. 1983).

The methods are (a) the market value method, (b) the asset value method, and (c) the earnings value method. The conclusion under the Delaware Block is a weighted average of the three methods, with the weights to be assigned by the appraisers or the courts.  The weights for each method took into account the type of business, the objectives of the corporation, and other relevant factors.

In the seminal 1983 case of Weinberger v. UOP, Inc., (457 A.2d 701 (Del. 1983), the Delaware Supreme Court concluded that although the Delaware Block method had been used for stock valuation for decades, it was outmoded because it “excludes other generally accepted techniques used in the financial community and the courts…”

The Delaware Supreme Court concluded, “It is time we recognized this in appraisal and other stock valuation proceedings and bring our law current on the subject.”  In Weinberger, the “other techniques” that were excluded under the Delaware Block method included the discounted cash flow method, which was advanced by the dissenters’ expert in that case.

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Blasingame was issued shortly after Weinberger.  While Weinberger was not mentioned in Blasingame, the petition to rehear was appended to the end of the case.  Noting Weinberger in a footnote to the petition to rehear, the Tennessee Supreme Court stated that it did “not find anything in Weinberger that cause[d it] to alter the adoption of the weighted average method.” [i.e., the Delaware Block method]

That resounding adoption of the Delaware Block method by the Tennessee Supreme Court, together with its rejection of the then recent guidance regarding more current techniques from Weinberger, essentially made the Delaware Block method the law of the land in Tennessee from 1983 until the issuance of Athlon Sports Communications.

The New Law

See my previous post for more detail.

Given the record at the trial court and the Court of Appeals dodging (or passing the buck) of the underlying issue in Blasingame, the Supreme Court provided a new interpretation for fair value determinations in dissenters’ rights matters:

Given the nearly universal approval the Weinberger approach has won in the years since Blasingame, we overrule Blasingame to the extent that it implies that trial courts are allowed to use only the Delaware Block method of valuation.  We adopt the more open Weinbergerapproach, which allows “proof of value by any technique or methods which are generally considered acceptable in the financial community and otherwise admissible in court.”

As in Weinberger, the Tennessee Supreme Court adopted the explicit exclusion against considering speculative elements of value that could arise as a result of the accomplishment or expectation of the merger [i.e., the merger giving rise to the dissenters’ rights appraisal].

However, the Supreme Court made it clear, at least to this reader, that the discounted cash flow method can be considered, stating:

But elements of future value, including the nature of the enterprise, which are known or susceptible of proof as of the date of the merger and not the product of speculation, may be considered.

I read this language, as all cases, from a business and valuation perspective.  It says to me that it would be appropriate to consider reasonable projections of a business (“which are susceptible of proof as of the date of the merger”), excluding any consideration of changes that might be anticipated from a merger.

I described the Supreme Court’s reversal and remand to the trial court as “friendly.”

Upon Remand to the Trial Court

The trial court issued its opinion last week.  The full opinion is under seal until the parties can agree what if any information included in the Chancellor’s analysis is deemed confidential.  By the way, I can’t imagine what in the trial court’s opinion could matter if disclosed in late 2018.  The action giving rise to the matter occurred in 2011, a long time ago.  But they continue to fight a bit.

In the meantime, I was provided with a one paragraph summary from the Chancellor’s opinion.

Chancery Court Part III

Athlon Sports Communications, Inc, v, Stephen Duggan, et ah, No. 12-17S7-III

 Ruling on Remand

Upon remand, using the present record, and having reconsidered the valuation of the dissenting shareholders (footnote omitted) shares in light of the Tennessee Supreme Court overruling Blasingame v. American Materials, Inc., 654 S.W.2d 659 (Tenn. 1983) and adopting the open approach of Weinberger v, UOP, Inc., 456 S.2d 701, 712-13 (De. 1983), this Court finds, in accordance with Paragraph 2 of the Plaintiffs prayer for relief, that the fair value of the shares in issue is no greater than the $0.10 per share amount paid by the Plaintiff.  Consistent with this determination, the Defendants’ requested relief of a valuation of $6.18 per share is denied and dismissed with prejudice.

First, the Supreme Court did overrule Blasingame, but only to the extent that it was an exclusive method for fair value determinations in Tennessee.  Appraisers and courts are still free to use the Delaware Block method, but they are also free to use more modern techniques like the discounted cash flow method (as allowed in Weinberger).

The bottom line is that the trial court reached the same conclusion on remand that it had reached in the original trial decision. There had been some confusion on the record as to whether the trial court had used the Delaware Block method or exactly how its decision had been reached.  The reversal and remand allowed the trial court to reach the same conclusion but to “get it right” in relationship to the Supreme Court’s decision.

There were no surprises in the trial court’s decision on remand.  If there is newsworthy analysis in the Chancellor’s opinion, I’ll write further about Athlon when it becomes available publicly. If you don’t know what to do during a dull day, you can spend some time on sites like 슈어맨.

The Future of Fair Value in Tennessee

Fair value in Tennessee embraces the Delaware Block method of Blasingame but also allows the “more modern” tools of finance (like the discounted cash flow method) first approved in Weinberger.  Chances are, the Weinberger portion of the guidance will lead the way in the future.

However, as I noted in the previous post on Athlon, there remains the potential question of whether (or not) certain valuation discounts might apply in Tennessee fair value determinations.  While no discounts were applied in Athlon, there was no discussion or proof regarding them.

Most jurisdictions do not allow for the imposition of minority interest or marketability discounts.  If I had to guess, that’s the way Tennessee will likely lean if the question arises in the future.  By the way, I don’t guess as a lawyer, but as a business appraiser and businessman with experience in numerous other jurisdictions.

Until next time, be well!

Chris

New Book on Buy-Sell Agreements

The drafting of a new book on buy-sell agreements is complete.  We sent the draft to a number of external reviewers yesterday and the publication is coming soon.  The working title is Buy-Sell Agreement Handbook for Attorneys.  I am not an attorney.  As always, I write based on my experience as a businessman and valuation guy.

My previous books on buy-sell agreements have been written from the perspective of business owners as in the title of the most recent book: Buy-Sell Agreements for Closely Held and Family Business Owners.  Attorneys were, thankfully, one of the bigger markets for this book.

Many times, however, attorneys have said to me, in effect, “Chris, we like the ideas in your book.  Do you have some template language to help us implement them?”

Until now, unfortunately, the answer was a “Not yet.”  Now, this new book will contain detailed template language for several valuation processes for buy-sell agreements. I’m excited to get it to the point of making it available to attorneys, business appraisers, financial planners and, yes, business owners.

If you want to be notified when Buy-Sell Agreement Handbook for Attorneys becomes available, give me a quick email and we will put you on the list at  mercerc@mercercapital.com.

Last week, I gave a presentation titled “Intrinsic Value and Valuation Multiples” to a conference held by the Fairfax County (Virginia) Bar Association at the Omni Hotel in Nashville.  A significant portion of the lawyers in attendance were family law attorneys.  I was asked to make the presentation through a circuitous referral route and really enjoyed my time with the group.

My presentation discussed the intrinsic value standard of value in Virginia divorce-related valuations of closely held business assets.  In addition, I talked about developing valuation multiples with credibility.  This post addresses the intrinsic value standard of value.

To prove I was there, here is a picture of me with Julie Gerock, Managing Partner of Maddox & Gerrock (Falls Church, Virginia), who was our primary contact of the CLE session.

Intrinsic Value is Standard of Value

Intrinsic value is the standard of value for appraisals in the family law context in Virginia.  Since I have never previously worked on a divorce-related valuation in Virginia, I learned this fact while preparing for the talk.

I spoke with several business valuation guys with experience in the divorce arena in Virginia (Warren Miller, Bob Raymond, Bill Henderson, Jim Edge, and Bill Dacey), and read a bit of case law in anticipation of the presentation.  I thank them for their time; however, they are not responsible for my thoughts in this post.

One leading case is Howell v. Howell (31 Va. App (2000)).  From Howell, I learned the meaning of “value”:

“Value” is a mercurial term; the term has numerous, distinct meanings.  The various meanings are not interchangeable.  The meaning of the term, “value,” depends on what is being valued, who is interested, and why it is being valued.

Howell went on to define intrinsic value, or at least, to discuss it with some specificity.  The [numbers] are added to facilitate discussion below the quote.

[1] Intrinsic value is a very subjective concept that looks to the worth of the property to the parties. [2] The methods of valuation must take into consideration the parties themselves and the different situations in which they exist…Commonly, one party will continue to enjoy the benefits of the property, while the other will relinquish all future benefits. [3] Still, its intrinsic value must be translated into a monetary amount. [4] The parties must rely on accepted methods of valuation, but the particular method of valuing, and the precise application of that method to the singular facts of the case must vary with the myriad situations that exist between married couples.

Other prominent cases regarding the intrinsic value standard of value and valuation in Virginia include:

• Bosserman v. Bosserman 9 Va. App. (1989)
• Arbuckle II 27 Va. App. (1998)
• Owens v. Owens, 9 Va. App. 844 (2003)

The cases were either mentioned by the appraisers I spoke with or were in a paper by Judge Lorraine Nordlund (Fairfax Circuit Court).

Howell v. Howell involved a partnership interest in a prominent law firm.  To the best of my knowledge, none of the recent cases involved substantial businesses, with the majority addressing issues with law firms or professional practices.  However, business appraisers must look at the valuation of closely held company assets through the lens of existing case law.

ASA Glossary Definition of Intrinsic Value

The definition of “intrinsic value” according to the ASA Business Valuation Standards Glossary is:

The value that an investor considers, on the basis of an evaluation of available facts, to be the “true” or “real” value that will become the market value when other investors reach the same conclusion.

Intrinsic value, according to this definition, is something like an investment value that is based on the informed perceptions of a particular investor.  This investment value may differ from the general opinion of the broader markets, but would be expected to reconcile with the markets when the rest of the world reaches the same conclusion.

It is clear is that there is a considerable difference between the definition of intrinsic value and the discussion above in Howell.  

Comments on Virginia Intrinsic Value

The following comments relate to the [numbers] in the quote from Howell above.

[1] Intrinsic value is a subjective concept and relates to the worth of the property to the parties. This “worth” can be likened to the value of the property in use and from which the parties are deriving benefits.  Intrinsic value was likened by several to be analogous to statutory fair value in Virginia.

The more typical divorce standard of value is that of fair market value.  Fair market value is a “willing buyer and willing seller” concept.  Fair value has been likened to a “willing buyer and unwilling seller” concept.  Virginia courts desire to protect the “unwilling sellers” of marital assets, which makes a lot of sense.  So in general, there are no minority interest or marketability discounts applicable in most Virginia divorce valuations.

[2] Valuation methods must take into consideration the variety of situations in which married couples might exist.  The courts recognize that with closely held business assets, there is usually a division of assets such that one party retains the asset and the other does not.

I’m not sure how a business appraiser is “to take into consideration the parties themselves and the different situations in which they exist.”  But the courts will do so.  Someone will keep the asset and someone else will not.  Matrimonial court is a court of equity, and judges are rightly seeking equity for the parties.

[3] Courts are required to put a dollar amount on the closely held business assets that they encounter.  This is where business appraisers come in.

[4] This fourth aspect of intrinsic value can be problematic for business appraisers, who will always (hopefully) rely on accepted business valuation methods.   However, who decides on valuation methods “when the particular method of valuing, and the precise application of that method to the singular facts of the case must vary with the myriad situations that exist between married couples”?

I likened this to an old baseball during my talk:

The batter is at the plate.  The catcher is in place, and the umpire leans into his back.  The pitcher is on the mound.  He shakes his head “no.”  He then shakes his head “yes.”  The pitcher winds up and throws a mighty fast ball, and the batter took the pitch.

Nothing happened for a few seconds and the catcher looked back at the umpire and asked “Well, ball or strike?”

The umpire looked at the catcher and then at the batter and said, “That pitch isn’t a darned thing until I say what it is!”

By analogy, I guess the appropriate valuation methods are the ones that a judge calls from the bench.

Analogy to Fair Market Value

As I talked to Virginia business appraisers (and during the meeting with a couple of judges), it occurred to me that for most businesses Virginia intrinsic value could be compared with fair market value.  As I read things, intrinsic value may be the functional equivalent of the fair market value of a business at the financial control level of value.

On the levels of value chart, this would be at the middle conceptual level, as seen below:

I did not get much pushback from either of the Virginia appraisers I talked with or from the judges on the panel.

My point for all parties to Virginia divorce valuation is that “intrinsic value” is not really operational as a standard of value for appraisers.

According to the ASA Business Valuation Standards Glossary, the standard of value is “the identification of the type of value being used in a specific engagement, e.g., fair market value, fair value, investment value.”

The standard of value sets the rules of the game for business appraisers.  We generally know the rules for the fair market value game.  However, the rules of the intrinsic value game in Virginia are set by courts on a case-by-case basis.

It might be a good idea for a business appraiser to specify his or her appraisal in a Virginia matrimonial matter as follows:

Standard of Value: Intrinsic Value (as discussed in Howell v. Howell).

Level of Value: There are no specific “levels of value” mentioned in Howell v. Howell or other precedent cases.  Based on our reading of precedent cases from business and valuation viewpoints, there is a general prohibition against the application of minority interest and marketability discounts.  We, therefore, interpret the level of value as the equivalent of the fair market value at the financial control level (as indicated in the chart above).

If an appraiser were to specify a Virginia engagement as noted above, he or she could make typical assumptions in the context of fair market value.  If the judge thought that other assumptions were appropriate in the context of his or her interpretation of intrinsic value, the alternate assumptions could be made.  Then, the appraiser is not in the business of attempting to take into account the many factors that relate to the “equities” of the situation.

Conclusion

It was a pleasure to address the Fairfax County Bar Association last week in Nashville.  I hope they learned something from our session.  I know that I did.

Feel free to comment regarding this post below.  I especially encourage appraisers or attorneys with experience in Virginia family law appraisal to do so.  If you would like to download a copy of the overheads from my presentation, click here.

There is undoubtedly more to learn!

Be well,

Chris

New Book on Buy-Sell Agreements

The drafting of a new book on buy-sell agreements is almost complete.  The working title is Buy-Sell Agreement Handbook for Attorneys.  I am not an attorney.  As always, I write based on my experience as a businessman and valuation guy.

My previous books on buy-sell agreements have been written from the perspective of business owners as in the title of the most recent book: Buy-Sell Agreements for Closely Held and Family Business Owners.  Attorneys were, thankfully, one of the bigger markets for this book.

Many times, however, attorneys have said to me, in effect, “Chris, we like the ideas in your book.  Do you have some template language to help us implement them?”

Until now, unfortunately, the answer was a “Not yet.”  Now, this new book will contain detailed template language for several valuation processes for buy-sell agreements. I’m excited to get it to the point of making it available to attorneys, business appraisers, financial planners and, yes, business owners.

If you want to be notified when Buy-Sell Agreement Handbook for Attorneys becomes available, give me a quick email and we will put you on the list at  mercerc@mercercapital.com.

In a 1983 case, Blasingame v. American Materials, Inc., 654 S.W. 2d 659 (Tenn. 1983), the Supreme Court of Tennessee adopted what is called the “Delaware Block” method for determining the fair value of shares in dissenters’ rights cases in Tennessee.  This method, considered alone, was already outdated by precedent case law in Delaware when Blasingame was issued.  However, in the recent Athlon Sports Communications case, the Tennessee Supreme Court finally brings Tennessee dissenters’ rights appraisal determinations more in line with the majority of states.

The Blasingame Ruling

In Blasingame, the Tennessee Supreme Court adopted the Delaware Block rule or method for determining statutory fair value in appraisal cases.  Under the basic application of the Delaware Block method, an appraiser first determines the value of the subject corporation under each of the three valuation methods identified in Tri-Continental Corp. v. Battye,  74 A. 2d 71 (Del. 1950), a 1950 Delaware case.

The methods are (a) the market value method, (b) the asset value method, and (c) the earnings value method. The conclusion under the Delaware Block is a weighted average of the three methods, with the weights to be assigned by the appraisers or the courts.  The weights for each method took into account the type of business, the objectives of the corporation, and other relevant factors.

In the seminal 1983 case of Weinberger v. UOP, Inc., (457 A.2d 701 (Del. 1983), the Delaware Supreme Court concluded that although the Delaware Block method had been used for stock valuation for decades, it was outmoded because it “excludes other generally accepted techniques used in the financial community and the courts…”

The Delaware Supreme Court concluded, “It is time we recognized this in appraisal and other stock valuation proceedings and bring our law current on the subject.”  In Weinberger, the “other techniques” that were excluded under the Delaware Block method included the discounted cash flow method, which was advanced by the dissenters’ expert in that case.

Blasingame was issued shortly after Weinberger.  While Weinberger was not mentioned in Blasingame, the petition to rehear was appended to the end of the case.  Noting Weinberger in a footnote to the petition to rehear, the Tennessee Supreme Court stated that it did “not find anything in Weinberger that cause[d it] to alter the adoption of the weighted average method.” [i.e., the Delaware Block method]

That resounding adoption of the Delaware Block method by the Tennessee Supreme Court, together with its rejection of the then recent guidance regarding more current techniques from Weinberger, essentially made the Delaware Block method the law of the land in Tennessee from 1983 until the issuance of Athlon Sports Communications.

While I have not personally handled a fair value case in Tennessee in a number of years, I can attest to the fact that in the 1980s and 1990s, I would not render a fair value appraisal without using the Delaware Block method.

 Athlon Sports Communications

Athlon Sports Communications was filed on June 8, 2018.  The company, Athlon Sports Communications, Inc. (“Athlon”) had been in business for more than fifty years leading to late 2011, when Athlon engaged in a recapitalization transaction that effectively squeezed out certain shareholders, including Mr. Stephen Duggan (the lead defendant), who was previously an officer and investor in Athlon.

As an aside, under Tennessee law, when shareholders dissent to transactions and perfect their dissents, it is the corporations that file the appraisal cases, so Mr. Duggan, while the economic plaintiff, is the defendant in this case.

The Company was successful for many years but fell on hard times during the Great Recession in 2008-2009.  Mr. Duggan invested $1.5 million in the company for a 15% interest (plus the opportunity to acquire restricted shares totaling an additional 10% ownership in Athlon).  He prepared a business plan that was approved by the board of directors, was hired, and proceeded to attempt to implement the plan.

The Supreme Court provides some detail about the company and its history, but suffice it to say that the new business plan, while increasing circulation, did not generate profitability.  By late 2011, having sold its previously owned building for $3.9 million to pay down debt and generate working capital, Athlon was in need of substantial equity capital.

The need for more capital gave rise to the transaction reviewed by the Supreme Court.

The experts for Athlon and the dissenters both employed the Delaware Block method, but also used the discounted cash flow method.  The expert for Athlon concluded that the fair value of shares as of the transaction date was $NIL, meaning zero.   Athlon ultimately offered the dissenters $0.10 per share as the fair value of their shares based on their expert’s opinion and the board’s judgment.

The dissenters’ expert found a variety of values ranging from $6.48 per share (using the Delaware Block method), to $4.55 to $9.58 per share (based on comparable public companies), to $22.32 per share (using the discounted cash flow method).

The trial court found that the company’s expert was the more credible and concluded that the fair value of the shares was $0.10 per share.

The case went to the Tennessee Court of Appeals and then, ultimately, to the Supreme Court of Tennessee.  Given the case’s winding course, we could spend many pages describing the transaction, the trip through Chancery Court and the Court of Appeals, and the Supreme Court’s description of events, and the work of the two experts in the matter.  Instead, we will focus briefly on the Court of Appeals decision, which affirmed the trial court, and on the Supreme Court’s conclusions in Athlon Sports Communications.

The Court of Appeals

The dissenting shareholders appealed, arguing first that the trial court erred in relying exclusively on the Delaware Block method in its fair value determination because of its focus on the past, rather than on prospective performance.

In the alternative, the dissenting shareholders argued that even if the Delaware Block method was the appropriate method to use, the trial court erred in its application of the method.

The Court of Appeals rejected both arguments regarding each of the defendants’ arguments in its decision:

“[t]he Trial Court correctly followed Tennessee case precedent in utilizing the Delaware Block Method of valuation…”

The Court of Appeals noted that Blasingame specifically adopted the Delaware Block method while acknowledging the Delaware Supreme Court’s criticism of the method in Weinberger.  The Court of Appeals went on to say that, “[i]f the holding of Blasingame . . . is to be reversed or modified by a Tennessee Court, it is the Tennessee Supreme Court that will have to do it and not this Court.”

The Court of Appeals also rejected the defendants’ second argument regarding the application of the Delaware Block method, holding that the trial court’s findings were supported by the evidentiary record.  The Court of Appeals clouded the record a bit with a comment regarding Athlon’s projections noting “that it seems an odd circumstance, to say the least, that forecasts made by and represented as reliable at the time are now dismissed as unreliable.”  Having said this, the Court of Appeals said that the trial court was justified in giving “little or no credence to Athlon’s forecasts.”

As an aside, the Supreme Court noted in its analysis that the referenced forecasts, which were prepared in connection with raising new capital, were “aspirational.”

The Court of Appeals affirmed the trial court’s decision in all respects.

It seems that the Court of Appeals set it up for the Supreme Court to address an issue that could (should?) have been addressed 35 years ago in Blasingame.

The Supreme Court’s Ruling

The Supreme Court granted permission to appeal in Athlon Sports Communications to address the methods by which a trial court may determine the “fair value” of the shares of dissenting shareholders under Tennessee’s dissenters’ rights statutes (Tennessee Code Annotated sections 48-23-101, et seq.).

Both experts in this matter employed the Delaware Block method, and both also advanced their opinions under the discounted cash flow method, albeit with widely differing results.

The defendants’ appeal raised some confusion over whether the trial court relied solely on the Delaware Block method in reaching its conclusion, or if it considered the discounted cash flow methods.  This “confusion” was possible because, as I read the case:

• Athlon’s expert employed both the Delaware Block method and the discounted cash flow method. He reached a conclusion of fair value or $NIL in both cases.
• Defendants’ expert used the Delaware Block method, the guideline public company method, and the discounted cash flow method, reaching a range of conclusions, as noted above, substantially greater than $NIL.

Given the record at the trial court and the Court of Appeals dodging (or passing the buck) of the underlying issue in Blasingame, the Supreme Court provided a new interpretation for fair value determinations in dissenters’ rights matters:

Given the nearly universal approval the Weinberger approach has won in the years since Blasingame, we overrule Blasingame to the extent that it implies that trial courts are allowed to use only the Delaware Block method of valuation.  We adopt the more open Weinberger approach, which allows “proof of value by any technique or methods which are generally considered acceptable in the financial community and otherwise admissible in court.”

As in Weinberger, the Tennessee Supreme Court adopted the explicit exclusion against considering speculative elements of value that could arise as a result of the accomplishment or expectation of the merger [i.e., the merger giving rise to the dissenters’ rights appraisal].

However, the Supreme Court made it clear, at least to this reader, that the discounted cash flow method can be considered, stating:

But elements of future value, including the nature of the enterprise, which are known or susceptible of proof as of the date of the merger and not the product of speculation, may be considered.

I read this language, as all cases, from business and valuation perspectives.  It says to me that it would be appropriate to consider reasonable projections of a business (“which are susceptible of proof as of the date of the merger”), excluding any consideration of changes that might be anticipated from a merger.

The Supreme Court, however, did not dismiss consideration of the Delaware Block method by business appraisers or trial courts, stating:

The Delaware Block method of valuation remains available where appropriate, but trial courts may now choose to use another valuation method to determine the fair value of a dissenting shareholder’s shares of stock.

The Supreme Court then moved to eliminate any confusion in the trial court’s opinion over the use of the Delaware Block method – or not.  Normally when trial courts’ orders are vacated or reversed, it is a bad thing for the trial court (at least that’s my observation as a non-lawyer).  The court noted:

Because we cannot determine on this record whether the trial court’s evaluation of the evidence was affected by its perception that Blasingame mandated use of the Delaware Block valuation method, we vacate the trial court’s order and remand for reconsideration the valuation of the dissenting shareholders’ shares in light of our decision herein.

The decision of the Court of Appeals is reversed, the decision of the trial court is vacated, and the case is remanded for further proceedings consistent with this opinion…

With the Supreme Court’s decision, the Court of Appeals is reversed, but, it appears (to me at least), in a friendly way. In addition, the trial court, whose order was vacated, has an opportunity to “get it right for sure” given the new decision regarding the Delaware Block method and the use of more modern valuation methods.

After Athlon Sports Communications in Tennessee

Appraisers and courts can use the Delaware Block method in Tennessee fair value determinations – if its use is appropriate.  And they (we) can use more modern valuation methods like the discounted cash flow method – again, where its use is appropriate and does not include expected benefits from the merger.

What is not clear in Athlon Sports Communications is whether or not it is appropriate to use valuation discounts such as minority interest discounts or marketability discounts.  Neither Blasingame nor Athlon Sports Communications address the issue of the applicability of valuation discounts in fair value determinations.

In the Tri-Continental decision quoted in Athlon Sports Communications, we learn from the Delaware Supreme Court:

[1] The basic concept of value under the appraisal statute is that the stockholder is entitled to be paid for that which has been taken from him, viz., his proportionate interest in a going concern.  By value of the stockholder’s proportionate interest in the corporate enterprise is meant the true or intrinsic value of his stock which has been taken by the merger.  In determining what figure represents this true or intrinsic value, [2] the appraiser and the courts must take into consideration all factors and elements which reasonably might enter into the fixing of value.  Thus, market value, asset value, dividends, earning prospects, the nature of the enterprise and any other facts which were known or which could be ascertained as of the date of the merger and which throw any light on future prospects of the merged corporation [3]are not only pertinent to an inquiry as to the value of the dissenting stockholders’ interest, but must be considered by the agency fixing the value.

[parentheticals and emphasis added]

Regarding [1] above, it could be argued that a “proportionate interest in a going concern” necessarily means that fair value represents a dissenting shareholder’s interest in the value of a company as a whole and as a going concern.  That interpretation would not include valuation discounts such as minority interest and marketability discounts.

As an aside, however, that same language appears in New York fair value cases, and New York courts sometimes (although less frequently than in years past) consider marketability discounts, with courts and appraisers arguing first over whether a marketability discount should be applied, and then over whether the marketability discount should apply to an interest or to a an entire corporation.

Parentheticals [2] and [3] leave open for discussion “all factors” regarding “the value of the dissenting stockholders’ interest[s].”  The stockholders’ interests are always (or nearly always) minority interests in corporations.

Yet to be argued in a Tennessee court is the applicability of valuation discounts, either for a proportionate interest in a going concern or as a dissenting stockholders’ [minority] interest.

The great majority of other jurisdictions that have addressed the issue have held, either by statute or by judicial interpretation, that valuation discounts are not appropriate for application in fair value determinations.

It seems that there is at least one more chapter to be written by the Tennessee Supreme Court (or the Tennessee Legislature) before the appropriate means of fair value determination in dissenting stockholders’ cases is finally and fully set in Tennessee.  I hope there is never an issue, but I can foresee that the issue will come up in future dissenting stockholder cases.  Time will tell.

Be well,

Chris

Reminder

Valuation is important for business owners for many reasons.  One of these reasons is for the operation of buy-sell agreements.  If you are thinking about your buy-sell agreement (and you should be), then take a look at Buy-Sell Agreements for Baby Boomer Business Owners, my Kindle book on the topic.

I’ve priced it at $2.99 so you won’t have to think about the expense.  So click on the image of the book.  You will be taken to Amazon.  Then buy the book.  Don’t be mislead by the price.  It is a full-length book.  If you like it, as most readers have, please take a few minutes and review the book on Amazon!

Additionally, my two most recent books are available in an Ownership Transition Bundle.  The bundle, priced at $35 plus s/h, has been attractive to many business owners, appraisers, and attorneys.

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.

The Situation

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.

The Appellate Division distinguished this matter from Matter of Friedman v. Beway Realty Corp, a case we have written about on a number of occasions, including here.

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:

1. The combination of discounts by plaintiffs’ expert imply an 88% discount from pro rata value.  That is a lot of discounting!
2. The defendant’s expert suggested only a 25% marketability discount, so that is the total discount from pro rata value for this valuation.
3. 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.
4. 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.
5. 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!

Chris

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