This post discusses recent trial court or appellate division cases from the commercial division. The cases discussed below concern the application of a marketability discount in valuing a business, when a law-firm’s internal emails must be produced, and a rare vacature of an arbitral award.
On December 22, 2014, Justice Kornreich of the New York County Commercial Division issued a decision in Zelouf International Corp. v. Zelouf, 2014 NY Slip Op. 24405, discussing the issue of discounts for lack of marketability in valuation proceedings.
In Zelouf International Corp., the court granted reargument on a prior decision relating to a business divorce. This post repeats the Court’s discussion of whether a valuation should include a discount for lack of marketability, an issue the Court described as the subject of “contentious . . . jurisprudence and . . . persuasive opinions of the academic community and non-New York courts.”
The court begins by noting that no 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. Indeed, the Court of Appeals recognizes that valuing a closely held corporation is not an exact science because such corporations by their nature contradict the concept of a market’value. As set forth in the Decision, since Danny is not likely to give up control of the Company, Nahal should not recover less due to possible illiquidity costs in the event of a sale that is not likely to occur.
In effect, applying a DLOM here would be the economic equivalent of imposing a minority discount — that is, Nahal realizing less for her shares because she is being forced to sell while Danny gets to realize their full value by staying in control. It is well settled that minority discounts are not permitted under New York law. Indeed, it is the tension between the application of a DLOM, which is done in most cases but is not legally required, and the practical effect of a DLOM here serving as a minority discount, repugnant to New York courts and never allowed, that drives the court’s ruling.
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Finally, it should be noted that serious consideration ought to be given to arguments made by those who question the theoretical and empirical underpinnings of the premises behind DLOMs. See generally Peter Mahler, “The Marketability Discount in Fair Value Proceedings: An Emperor Without Clothes,” New York Business Divorce, July 11, 2011 (and links to other analysis therein); see also Floorgraphics, Inc. v News Am. Marketing In-Store Servs., Inc., 546 F. Supp. 2d 155, 177 n.7 (D NJ 2008). This is an area of heated debate in the legal and valuation communities, and more compelling appellate resolution of these issues would surely be welcomed by all.
Additionally, in other jurisdictions, courts have refused to apply a DLOM for various reasons in cases such as this.
That being said, this court is not holding that a DLOM is necessarily legally inappropriate in valuations of closely held companies. Such a holding would be incompatible with binding New York precedent. Rather, in this case, under the unique set of facts set forth in the Decision, applying a DLOM is unfair. This court’s understanding of the applicable precedent is that, while many corporate valuation principles ought to guide this court’s analysis, this court’s role is not to blithely apply formalistic and buzzwordy principles so the resulting valuation is cloaked with an air of financial professionalism. To be sure, sound valuation principles ought to be and indeed were utilized in computing the Company’s value (i.e., the court’s adoption of most of Vannucci’s valuation). Nonetheless, the gravamen of the court’s valuation is fairness, a notion that is undefined, making it a classic question of fact for the court. Fairness, in this court’s view, necessarily requires contextualizing the applicable valuation principles to the actual company being valued, as opposed to merely deciding a priori, and in a vacuum, that certain adjustments must be part of the court’s calculus. From this perspective, the court reached its conclusion that an application of a DLOM here would be tantamount to the imposition of a minority discount. Consequently, the court finds it fairer to avoid applying a minority discount at all costs rather than ensuring that all hypothetical liquidity risks are accounted for.
(Internal quotations and citations omitted) (emphasis added).
On December 5, 2014, Justice Schweitzer of the New York County Commercial Division issued a decision in Stock v. Schnader Harrison Segal & Lewis LLP, 2014 NY Slip Op. 33171(U), holding that certain intra-law firm emails were not privileged.
In Stock, the plaintiff sued the defendant law firm for malpractice and breach of fiduciary duty. The plaintiff alleged that the firm did not tell him that his departure from MasterCard would accelerate the expiration date of stock options worth $5 million. After the options expired, the firm advised him to commence an arbitration against MasterCard and its plan administrator, Morgan Stanley Smith Barney. During the arbitration, Morgan Stanley Smith Barney sought to call one of the defendant’s partners to testify on the issue of whether the defendant’s failure to advise the plaintiff contributed to his losses. The partner was advised and prepared to testify by the defendant’s attorneys, including attorneys who were also representing the plaintiff in the arbitration. The plaintiff alleged that the firm never told him about the conflict or advised him to seek independent legal advice.
The defendant firm asserted that certain email communications regarding legal advice given to the partner in preparation for her testimony was privileged as against the plaintiff, but Justice Schweitzer disagreed. First, he held that there was no expectation that communications between the defendant’s lawyers would be kept confidential from the plaintiff. Second, the fiduciary exception to attorney-client privilege applied—the plaintiff alleged that the firm engaged in self-dealing and had a conflict of interest while it was representing him, and the court held that those claims were colorable. And third, the court held that by asserting a counterclaim for unpaid attorney fees—not recoverable if they are incurred through improper conduct—the defendant firm put their continued representation of Plaintiff “at issue.”
On December 4, 2014, Justice Bransten of the New York County Commercial Division issued a decision in New York Central Mutual Fire Insurance Co. v. Bronx Chiropractic Services, P.C., 2014 NY Slip Op. 33210(U), vacating a no-fault arbitration award as arbitrary and capricious because it did not follow clear legal precedent.
In New York Central Mutual Fire Insurance, the court granted the petitioner’s motion to vacate a no-fault arbitration award, explaining:
CPLR 751l(b)(l)(iii) permits a reviewing body to vacate a no-fault arbitration award on the ground that the arbitrator making the award exceeded his power or so imperfectly executed it that a final and definite award upon the subject matter was not made.
CPLR 7511 also has been construed to include review of whether the award was arbitrary, capricious, and unsupported by the evidence in the record. The arbitrator’s award will be upheld if the award is supported by a reasonable hypothesis and not contrary to what could fairly be described as settled law.
Further, in Matter of Petrofsky [Allstate Ins. Co.], 54 N.Y.2d 207, 210 (1981), the Court of Appeals held that the Master Arbitrator’s authority to review he award of the lower arbitrator is derived from Insurance Law § 6754 which states in pertinent part that a master arbitrator may vacate or modify an award made by an arbitrator in accordance with simplified procedures to be promulgated or approved by the superintendent, but that the grounds for vacating or modifying an arbitrator’s decision shall not be limited to those grounds for review set forth in article seventy five of the civil practice law and rules. Therefore, in accordance with the superintendent’s directive, 11 NYCRR 65.17(a)(4), as well as the grounds set forth in CPLR Article 75, the Master Arbitrator may vacate or modify an award if, among other things, the award was incorrect as a matter of law. However, the master arbitrator is expressly precluded from reviewing factual or procedural errors.
In a CPLR 7511 proceeding, a court may not set aside a Master Arbitrator’s determination unless it is irrational. The Master Arbitrator’s decision will be upheld if there is any reasonable basis to support it. However, the award cannot be contrary to what could fairly be described as settled law because it is arbitrary and capricious for an arbitrator not to follow clear precedent.
(Internal quotations and citations omitted) (emphasis added). The court went on to hold that the decision failed to follow clear precedent, and for that reason vacated it.