Minority Discount Properly Applied When Valuing Minority Holder's Share of Ongoing Partnership

On March 27, 2018, the Court of Appeals issued a decision in Congel v Malfitano, 2018 NY Slip Op. 02119, holding that a minority discount was properly applied when valuing a minority holder's share of an ongoing partnership, explaining:

The final question we must resolve is whether a minority discount may be applied in the calculation of the value of a wrongfully dissolving partner's interest in a partnership, pursuant to Partnership Law § 69(2)(c)(II), when the remaining partners continue the business under Partnership Law § 69(2)(b). 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.

Defendant contends that, as a matter of law, minority discounts are not applicable in the valuation of a minority partner's interest after the partner exits a business that remains a going concern. This issue is properly preserved, but we cannot agree with defendant on the merits.

In requiring the minority discount, the Appellate Division relied on Anastos v Sable (443 Mass 146), in which the Massachusetts Supreme Judicial Court interpreted a UPA-based statute that is identical in all relevant respects to our Partnership Law § 69(2)(c)(II). There, the plaintiff dissolved a partnership in violation of the partnership agreement, and, as here, the other partners continued the partnership business, rather than liquidate. The trial court in Anastos, in determining the value of the plaintiff's interest, applied a minority discount to reflect that there was no ready market for the purchase of a minority interest in a general partnership whose primary asset is real estate where the partnership agreement contains limitations and restrictions on the control that any minority owner can exercise. The Supreme Judicial Court of Massachusetts upheld this decision, stating:

In this case, the remaining partners chose to exercise their statutory right to continue the partnership business for the remainder of the partnership term, so the partnership business is not winding up and must therefore be treated as a going concern. Because the plaintiff cannot compel liquidation of the business at the point of dissolution, we read Massachusetts General Laws, chapter 108A, § 38(2)(c)(II) as offering a nonliquidation based method of calculating the value of his partnership interest.

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.

Notably, New York, like Massachusetts, has not adopted the 1997 Uniform Partnership Act commonly known as RUPA. The dissent's discussion of RUPA and of cases from states that have adopted RUPA does not illuminate the law in New York. In particular, while RUPA, by focusing on a top-down valuation keyed to a sale of all of the assets of the partnership, directs the analysis away from a valuation of the interests of a particular partner, so that a minority discount is inappropriate, we conclude that the same cannot be said of the UPA.

It is true, of course, that in the Partnership Law § 69(2)(c)(II) context the wrongfully dissolving partner's interest may simply be absorbed by the remaining partners. In our view, this does not render the value generated by application of a minority discount an inaccurate valuation of the intrinsic worth of that partner's interest. To repeat, the exiting partner's interest may appropriately be valued in light of the fair market value of that minority interest given that the partner is departing and the partnership continuing.

As defendant observes, the closest this Court has come to examining the issue is Matter of Friedman (87 NY2d 161). There, we held that the use of a minority discount should be rejected in the context of valuing the interests of dissenting shareholders in a closely held corporation. That context, however, is clearly distinguishable from ours. Friedman involved a proceeding under Business Corporation Law § 623, which gives minority stockholders the right to withdraw from a corporation and be compensated for the value of their interests when the corporate majority takes significant action deemed inimical to the position of the minority. Business Corporation Law § 623 invokes a statutory term of art, "fair value," in requiring that a dissenting shareholder who exercises appraisal rights be paid the fair value of his or her shares, as opposed to their fair market value. The term "fair value" is not present in the statute under review here.

The terminological difference reflects an underlying difference in statutory scheme. As plaintiffs note, Business Corporation Law § 623 contemplates a significant change to a business that the majority of shareholders have adopted over the minority's dissent. The value of the corporation's stock will likely be very different from the value prior to dissent and appraisal. This provides the rationale for the statutory requirement that the dissenter be paid "fair value," as opposed to fair market value, as a remedial matter. By contrast, wrongful dissolution of a partnership may happen at any time, and valuation of a partner's interest occurs only if the remaining partners have agreed to continue their business as if nothing changed. Unlike shareholder dissent and appraisal, wrongful dissolution is not necessarily preceded by upheaval inimical to the position of the minority, so trial courts need not substitute a "fair value" for the actual value a third party would pay. Indeed, here the upheaval took the form of an action by a minority partner inimical to the majority's interests.

In short, Friedman does not offer a rationale for rejecting the view that third-party market value is the compensation to which a wrongful dissolver is entitled, a view consistent with the use of a minority discount to capture any impact that a lack of control may have on that market price. While the application of minority discounts is a matter of some debate in close corporations, courts usually allow the application of a minority discount in determining the value of an interest in a partnership.

Defendant also draws our attention to a decision by the Maryland Court of Special Appeals, E. Park LP v Larkin (167 Md App 599 [2006], lv denied 393 Md 243 [2006]). In that case, partners withdrew from a limited partnership under a statute providing that a partner could do so without dissolution, and "receive, within a reasonable time after withdrawal, the fair value of the partner's partnership interest in the limited partnership as of the date of withdrawal, based on the partner's right to share in distributions from the limited partnership" (Md. Code Ann., Corps. & Ass'ns § 10-604). Again, as in Friedman, it is clear that a different statutory scheme, involving cashing out an interest for "fair value," was at work. By contrast, the statute we are analyzing relates to wrongful dissolution, rather than a statutory right to withdraw, and it makes no mention of "fair value." Of course, this is not to say that the assessed value should not be fair. The point is simply that the statutory scheme in the Partnership Law is consistent with the application of a fair market value assessment of the particular partnership interest, and the use of standard valuation tools including a minority discount.

(Internal quotations and citations omitted).

This decision relates to a significant part of our practice: business divorce (a break-up between the owners of a closely-held business). Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding a business divorce.