DLOM’s in New York statutory fair value cases continue to be a highly unsettled issue. Following are just three cases (we’ve already commented on Zelouf, but it is worth mentioning here in context) that identify either no DLOM or some sort of DLOM. Note that clicking on the case title will provide you with the court’s ruling.
In my opinion, it is unfortunate that experts have contributed to the confusion by referencing market studies of non-control market data for DLOMs without connecting the dots between control and non-control issues. Certainly in NY, as in most states, any discount or adjustment for lack of control – essentially penalizing the plaintiff non-control interest just for the nature of the non-control interest – to the benefit of the control interest is not allowed. Market evidence for DLOMs for non-control interests can be significant – as much as 60 percent or more. But are such discounts appropriate for controlling interests? Or in the case of fair value, the pro rata share of a control interest? Certainly the Courts don’t believe so, but they are often left to their own devices to rationalize some sort of illiquidity adjustment, often on an intuitive basis, rather than relevant facts and evidence provided by experts.
Nahal Zelouf obtained a 25 percent interest in the family-run textile business from her husband after he fell into a coma. The other owners included her brother-in-law and her nephew, the latter of which who had a majority stake. In 2009, Nahal made a books and records request and subsequently sued the other owners for waste and misappropriation, alleging that the two men plundered the company for their personal gain. The Court excluded the application of a Discount for Lack of Marketability (or DLOM). Regarding such, Justice Kornreich wrote:
“[N]o New York appellate court has ever held that a DLOM must be applied to a fair value appraisal of a closely held company. On the contrary, the Court of Appeals has held that ‘there is no single formula for mechanical application.’ Matter of Seagroatt Floral Co., Inc., 78 NY2d 439, 445 (1991). Indeed, the Court of Appeals recognizes that ‘[v]aluing a closely held corporation is not an exact science’ because such corporations ‘by their nature contradict the concept of a market’ value.”
The entity that was the subject of the litigation owned 18 Manhattan tenement apartment buildings and one land parcel (for a total value of $85 million). One of the appealed issues was the appropriateness and size of a DLOM. There had been several year’s of case rulings that held that no DLOM was appropriate for real estare holding entities – that DLOMs were more appropriate to intangible goodwill values associated with operating companies. However, the Appellate Division, First Department wrote, “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.” Consequently, the Court determined a 16 percent DLOM in this case based, not on empirical evidence regarding DLOMs appropriate in this case, but on a “build up” method that layered costs of creating liquidity profferrd by one of the trial experts.
The Appellate Division, Second Department upheld without comment a lower court’s decision to apply 0 percent DLOM (or no DLOM) in valuing a membership interest in a realty-holding LLC co-owned by two brothers, but unfortunately provided no supporting discussion. The underlying case involves a dispute between two brothers regarding an LLC formed in 1999 to acquire a warehouse. The brothers never executed a written operating agreement but the LLC’s 1999 and 2000 tax returns identified one brother as 25 percent member and the other brother as 75 percent member in proportion to their initial capital contributions. No tax returns were subsequently filed because of the brothers’ falling out in 2001 that led to multiple lawsuits over the ensuing several years.
Finally, after years of litigation, in 2008 the minority member exercised his statutory right to withdraw from the LLC and receive fair value for his 25 percent membership interest. the control member contended that his brother had no membership interest or, at best, had an approximate 10 percent interest based on their relative, aggregate capital contributions including monies contributed solely by controlling member after the falling out.
Regarding the applicability of a DLOM, the court eventually ruled, “[The minority member] 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. In any event, [the expert’s] testimony that [the minority member] is entitled to a whopping 25 percent lack of marketability discount for what is essentially real property placed in a limited liability company package has no credibility, and the record does not permit the court to determine what lesser percentage might be appropriate.”