Peter Mahler writes the New York Business Divorce blog. Last week, he published his eighth annual list, the Top Ten Business Divorce Cases for 2015. I was interested and pleased to discover that the number one case on the list was that of Chiu v. Chiu, a case in which I testified as an expert witness in 2012. Mahler writes, in summary, about the case:
Top 10 Business Divorce Cases of 2015 | NY Business Divorce
1. Chiu v Chiu, 125 AD3d 824 [2d Dept 2015], in which the appellate court affirmed without comment a 0% discount for lack of marketability in fixing the fair value of a membership interest in a single asset realty company pursuant to LLC Law § 509, but disagreed with the lower court’s assignment of a 10% interest to the withdrawn member — rather than 25% as reflected in the LLC’s initial tax returns — based on additional capital contributions made by the other member that, according to the appellate court, should have been characterized as loans.
Mahler cites two earlier posts he wrote about the Chiu case. The two-part series was written following the release of the lower court’s decision and can be found here and here. I also wrote about the case on my former blog, ValuationSpeak.com.
New York Fair Value
The case made Mahler’s top ten list, in part at least, because the decision allowed for a marketability discount of 0%. There is some confusion in the case law regarding the application of the marketability discount in statutory fair value cases in New York. I am not a lawyer, so I can only approach fair value matters from business and valuation perspectives. I’ve now testified in four fair value matters in New York.
The first case occurred many years ago, and there is no written record in our files that has survived our document retention policies. Mahler mentions another in his article, that of Giamo v. Giamo, in which a Special Master ruled, after an extensive trial, that the appropriate marketability discount for another real estate holding company was 0%. The trial court agreed with the Special Master, but on different logic. The appellate court then held that the marketability discount should be 16%. Mahler writes about Giaimo here.
In Chiu, as in Giaimo, I made the same argument that there is no theoretical basis for a marketability discount applicable to a controlling interest in a company. I also testified that all of the real estate appraisers (in both matters) had taken an appropriate marketing period into account in their appraisals of the underlying real estate. To take an additional discount because there is a corporate wrapper around the real estate was therefore not appropriate from a valuation perspective. Finally, I suggested that to take a marketability discount in a fair value matter was the functional equivalent of taking a minority discount, which is specifically prohibited by New York case law.
The most recent case in which I testified was that of AriZona Iced Tea. I wrote about that case here. Unlike all three of my previous testimonies, which involved the fair value of real estate holding companies, AriZona was an operating company. Based on theoretical grounds, the overall attractiveness of AriZona as an acquisition candidate, and references to New York cases in which other attractive companies had been accorded 0% or very small marketability discounts, I concluded that the appropriate discount was 0%. The court disagreed and applied a 25% marketability discount, which lowered value by a whopping $478 million. Even so, the court’s valuation was based on my discounted cash flow valuation method in which a few changes were made to assumptions. Before the marketability discount, our results were reasonably close.
Concluding Thoughts
I don’t normally write about cases on this blog, but Mahler’s post was interesting. And it reminded me of the other cases.
From the viewpoint of business owners and their advisers, just know that if you have minority shareholders and a company engages in a transaction that gives rise to the statutory right to dissent (in its state), then you may learn more about statutory fair value than you ever wanted to know. All such transactions should consider good legal and valuation advice prior to engaging in them.
My best to all for a wonderful holiday season and a wonderful New Year!
Chris
Chris, I agree wholeheartedly that there should be no marketability discount on 100% equity interests. You taught me that many years ago when I heard you say during a conference presentation that valuation professionals should not confuse the value of a company with the proceeds to the seller. You noted that, while a home may sell for $400,000 less a 5% sales commission for the real estate agent, the value of the home to both buyer and seller is still $400,000, not $380,000. And, if the buyer is going to use it as rental property, the carrying value for the home (ignoring capitalizable expenses), as well as the basis on which any rate-of-return analysis would be done by a knowledgeable analyst, would be $400,000. As we both know, too many in our profession confuse, and then equate, selling expenses with marketability discounts. As H.L. Mencken used to say, “Buncombe!”
However, I respectfully disagree with you about a marketability discount for a controlling interest that is lt; 100%. Even with tightfisted control of, say, 90%, there is still what I call a hassle factor; that the 90% control holder has in dealing with a 10% minority owner. As the minority stake increases, that hassle factor also goes up, if only marginally, until the threshold for major corporate actions is reached (50%+ in a few states, and 66-2/3% in the majority of jurisdictions). In our shop, we call this range imperfect control.
In states that have 66-2/3% super-majority rules for certain major corporate actions, the marketability discount, at least to my way of thinking, is notably higher when the majority stake is between 50% and 66-2/3%. I have made this argument in a number of tax-related valuation reports and have never been challenged. I also made it in a shareholder-oppression case in New York–that settled out of court, so I didn’t testify.
Also, as I recall, shareholder oppression law in New York also provides for a 20% marketability discount for intangible assets (only). I don’t know the history of that, though.
If you disagree with my rationale, I’d appreciate it you would post a reply when you have the time. As always, thank you for all you’ve done, and continue to do, for our profession. Ours is a better, more-enlightened community as a result of your many contributions to our thinking and to valuation theory.