Source: https://chrismercer.net/statutory-fair-value-re-a-new-york-real-estate-holding-company/
Timestamp: 2019-04-22 02:57:00+00:00

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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.
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.
(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.
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.
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.
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.
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.
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.
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.
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.
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.
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 “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 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.
A proportionate interest in a going concern represents the financial control value for a real estate holding company.
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.
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).
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).
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.
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.
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.
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.
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.
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.
Again, the guidance is clear that there is no reason to discount a business for lack of marketability that only holds real estate.
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.
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.
“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.
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.
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).
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.
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.
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References: §1118
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