Arthur J. Ciampi

In March, the New York State Court of Appeals issued a decision, in the non-law firm partnership context, which outlined some fundamentals of New York partnership law concerning dissolution, and decided, in an apparent matter of first impression, that it was appropriate to apply a minority discount to the value of the partnership to be paid to a minority partner.  In its decision, New York’s highest court also reversed the Appellate Division, which had affirmed an award of attorney fees to the majority partners.

In this month’s column, we analyze this recent decision, which will likely influence law firm partnership dissolutions in the future.

‘Congel v. Malfitano’

Congel v. Malfitano, 317 N.Y.3d 272 (2018), concerned partners in a partnership that owned and operated a shopping mall. In 1985, Malfitano and seven others entered into a written partnership agreement to form a general partnership for a shopping mall, which opened in 1987, and operates to this day. Malfitano had a 2.25 percent and then a 3.08 percent ownership interest. Id. at 279.

Concerning dissolution, the written partnership agreement provided, among other things, that the Partnership “‘shall continue until it is terminated as hereinafter provided,’” that the Partnership would dissolve upon “‘[t]he election by the Partners to dissolve the Partnership,’” and that “‘[a]ll decisions to be made by the Partners shall be made by the casting of votes at a meeting of such Partners’” with “‘no less that fifty-one percent (51%) … required to approve any matter presented for decision.’” Id.

In the mid-2000s, Malfitano sought to withdraw from the partnership. Negotiations for a buy-out ensued, but failed. In November 2006, Malfitano wrote to his partners to “elect” to dissolve the partnership in accordance with Section 62(1)(b) of the New York Partnership Law. Section 62(1)(b) states, in pertinent part, that a partner may unilaterally dissolve a partnership without violating the partnership agreement if “no definite term or particular undertaking is specified.” Id. at 280 (citing N.Y. Partnership Law §62(1)(b)).

The majority partners argued that Malfitano wrongfully dissolved the partnership. As a result, they did not liquidate the partnership, but continued the business of the partnership, as permitted pursuant to Partnership Law §69(2)(b). Id.

In January 2007, the majority partners commenced an action for breach of contract, a declaratory ruling that Malfitano wrongfully dissolved the partnership, and damages. Id. The majority partners moved for summary judgment “on their wrongful dissolution and breach of contract claims, asserting that the agreement provided for only two methods whereby the Partnership would dissolve without violation of the agreement, and that defendant’s unilateral dissolution breached the agreement. Defendant cross-moved for summary judgment.” Id. at 281.

The Supreme Court granted summary judgment to plaintiffs and held that the Partnership was not a partnership-at-will because it delineated a “particular undertaking” pursuant to the Partnership Law. The Supreme Court also dismissed Malfitano’s counterclaims, including his claim for judicial dissolution. Id.

In April 2009, the Appellate Division affirmed the Supreme Court’s decision, finding that the partnership agreement specified a “definite term” or temporal limit under Partnership Law §62(1)(b), and holding that Malfitano had dissolved the Partnership in contravention of the agreement. Id. at 281-82. The Appellate Division also dismissed Malfitano’s counterclaims for dissolution, and remitted to the Supreme Court the remaining issues, including the issue of damages. Id. at 282.

The Supreme Court, on remittal, in response to motion practice, ruled that plaintiffs were entitled to attorney and expert fees as part of their damages, reasoning that those costs “are not incidental to the litigation” but instead are “damages caused by the defendant’s breach” of the agreement. Id.

In addition, the Supreme Court conducted a bench trial to establish the value of Malfitano’s interest in the Partnership pursuant to New York Partnership Law §69(2)(c)(II). Section 69(2)(c)(II), which provides in pertinent part that a partner who dissolves a partnership in contravention of the partnership agreement is entitled to “‘have the value of his interest in the partnership, less any damages caused to his copartners by the dissolution, ascertained … but in ascertaining the value of the partner’s interest the value of the good-will of the business shall not be considered.’” Id. at 282 (citing New York Partnership Law §69(2)(c)(II)). Expert testimony was elicited concerning the value of goodwill, the application of the lack of marketability discount, and the value of a minority discount. Plaintiffs also provided testimony concerning plaintiffs’ legal fees. Id. at 284.

Prior to the trial, the parties stipulated that the value of Malfitano’s share in the Partnership was $4,850,000. Id. at 282. The Supreme Court ruled that the stipulated amount would be reduced by 15 percent, or $727,500, to represent the value of the Partnership’s good will. Id. at 284. The Supreme Court then applied a marketability discount of 35 percent, or $1,442,875, to the stipulated value reduced by good will but refused to apply a minority discount. The Supreme Court relied upon cases that prohibited the use of a minority discount in evaluation of a minority shareholder’s stock in a closely held corporation. Id.

The Supreme Court also held that the plaintiffs were entitled to attorneys’ and experts’ fees. The Supreme Court ruled, among other things, that the plaintiffs were required “‘to incur enormous legal fees’ to avoid the ‘devastating consequences’ of a forced liquidation [and that] defendant was ‘clearly much more responsible than the plaintiffs’” for the contentious litigation. Id.

In May 2016, the Appellate Division modified the Supreme Court’s judgment, which, among other things, remitted to the trial court for a new calculation incorporating a 66 percent minority discount, applied to the discounted value of defendant’s interest in the partnership. Id. at 285. The Appellate Division relied upon a Massachusetts decision, Anastos v. Sable, 443 Mass. 146 (2004). The Appellate Division held that, since the partnership was a going concern, Malfitano had no right to compel a liquidation sale and receive a share of the liquidation value of the Partnership. “Under these circumstances,” the court held, “a minority discount may properly be applied to account for the defendant’s lack of control in the partnership as a going concern.” Id. at 286.

Upon remand, the Supreme Court applied the minority discount, reduced the defendant’s interest to $911,072.50, and ruled that the plaintiffs were entitled to $1,882,460.25 in fees and statutory interest, the net result being that Malfitano owed the plaintiffs $911,387.75. Id.

The Court of Appeals Decision

The first issue the high court addressed was whether Malfitano wrongfully dissolved the partnership. The Court of Appeals ruled that he did. The court’s rationale was that, since the agreement provided for the means for dissolution, with which Malfitano had not complied, his actions constituted wrongful dissolution; accordingly, no reason existed to rely upon Partnership Law §62(1)(b), as discussed above. The court stated that “[t]he partners clearly intended that the methods provided in the agreement for dissolution were the only methods whereby the partnership would dissolve in accordance with the agreement, and by implication that unilateral dissolution would breach the agreement.” Id. at 289 (emphasis in original).

The Court of Appeals did not permit the award of attorney or expert fees to stand. The court concluded that “to award fees to plaintiffs would be to contradict New York’s well-established adoption of the American Rule that ‘the prevailing litigant ordinarily cannot collect … attorneys’ fees from its unsuccessful opponents.’” Id. at 290.

The Court of Appeals next affirmed the finding that the value of goodwill should be deducted from Malfitano’s share pursuant to Partnership Law §69(2)(c)(II). Id. at 292-94. The Court of Appeals found that the goodwill question was a factual one in which its scope of review was narrow, and, thus, it was “without power to review findings of fact if such findings are supported by evidence in the record.” Id. at 294. Finding that the conclusion was based upon expert testimony and other evidence, the Court affirmed. Id.

Matter of First Impression—Application of the Minority Discount

The court also affirmed the application of the marketability discount, and completed its discussion with an analysis, seemingly of first impression, of the application of a minority discount in the calculation of a wrongfully dissolving partner pursuant to Partnership Law §69(2)(c)(II). Id.

As the court explained, a “minority discount is a standard tool in valuation of a financial interest, designed to reflect the fact that the price an investor is willing to pay for a minority ownership interest in a business, whether a corporation or a partnership, is less because the owner of a minority interest lacks control of the business.” Id. at 294-95.  The Court of Appeals found unpersuasive defendant’s argument that a minority discount should not be applied in the valuation of a minority partner’s interest after the partners depart a business, which is a going concern. Id. at 295.

Like the Appellate Division, the Court of Appeals relied upon the Massachusetts court’s decision in Anastos. In Anastos, the plaintiff wrongfully dissolved a real estate partnership, but the partnership continued as a going concern.  Because “no ready market” existed for the minority partner to sell his interest, and because contractual “limitations and restrictions” existed on the control a minority partner could exercise, the Massachusetts court had found that the application of a minority discount was appropriate. Id. The Court of Appeals, applying Anastos, agreed and stated:

Here, similarly, Partnership Law §69(2)(c)(II) contemplates a valuation of a wrongfully dissolving partner’s interest based on treating the partnership as a going concern, rather than an asset to be liquidated. In other words, the statute does not contemplate a valuation of the entire business as if it were being sold on the open market, but rather a determination of the fair market value of the wrongfully dissolving partner’s interest as if that interest were being sold piecemeal and the rest of the business continuing as a going concern. Given that the focus is on one partner’s interest in a persisting concern, we agree with the Massachusetts high court that a minority discount is applicable, because a minority interest is worth less to anyone buying that interest alone.

Id. at 296.

Finally, the court noted that partnerships that wished not to have a minority discount applied to departed partners upon dissolution could provide for such in their written partnership agreements. Id. at 298.

In a 10-page dissent, Paul Judge Feinman objected to the affirmance of the application of the minority discount. The dissent disagreed with the majority’s reliance on the proposition that the value of the partner’s interest is “‘the price at which [the interest] would change hands between a willing buyer and a willing seller’ ‘as if that interest were being sold piecemeal and the rest of the business continuing as a going concern.’” Id. at 300. The dissent relied upon the Revised Uniform Partnership Act (RUPA)—although not the law in New York—to support its position. RUPA permits a dissociated partner to be paid a proportionate share of the value of the business as a going concern set off against contractual damages. Id. at 301-02. That is, the focus of the value under RUPA is not on the value of the individual partner (as a willing seller), but on the sale of all the partnership’s assets, which may be explained by RUPA’s entity theory of partnership. Thus, according to the dissent, the application of a minority discount would be inappropriate. Id. at 302 (citations omitted).

Similarly, the dissent reasoned that the application of a minority discount in the wrongful dissolution context is inappropriate because the purchasers (the then current partners) were “merely consolidating and increasing whatever degree of control they already have over the business.” Id. at 305.  Finally, the dissent, relying on the New York Partnership Law, concluded:

The structure of Partnership Law §69(2)(c)(II) already deters wrongful dissolution in two ways: by requiring the dissolving partner to pay damages, and by discounting the value of its partnership interests attributable to goodwill. A further discount for a lack of control is cumulative and unnecessary in light of these other provisions.

Id. at 310.

Conclusion

Congel provides the Court of Appeal’s most recent thinking concerning the methodology for partnership dissolution and the valuation of such interest in the case of wrongful dissolution. The decision will impact all partnerships in New York, including law firms organized as partnerships.

Arthur J. Ciampi is the coauthor of the treatise ‘Law Firm Partnership Agreements’ and is the managing member of Ciampi LLC. Maria Ciampi, of counsel to the firm, assisted in the preparation of this article.