Court Provides Detailed Reasoning Behind Refusal to Allow a Discount for Lack of Marketability

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 FSupp2d 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).