Friedman v. Beway Realty Corp.

• Decision Date: 07 December 1995
• Citation: 661 NE2d 972,638 N.Y.S.2d 399,87 N.Y.2d 161
• Parties: , 661 N.E.2d 972 In the Matter of Selma K. FRIEDMAN et al., Respondents, v. BEWAY REALTY CORP. et al., Appellants.
• Court: New York Court of Appeals Court of Appeals

Page 399

638 N.Y.S.2d 399

87 N.Y.2d 161, 661 N.E.2d 972

In the Matter of Selma K. FRIEDMAN et al., Respondents, v. BEWAY REALTY CORP. et al., Appellants.

Court of Appeals of New York.

Dec. 7, 1995.

Kirkpatrick & Lockhart LLP, New York City (Gerald A. Novack and Alan S. Brodherson, of counsel), for appellants.

LeBoeuf, Lamb, Greene & MacRae, L.L.P., New York City (Milton S. Gould and Steven E. Levitsky, of counsel), for respondents.

OPINION OF THE COURT

LEVINE, Judge.

Petitioners are minority stockholders in nine family owned close corporations, each of which had as its sole asset a parcel of income-producing office, commercial or residential real estate in New York City. In 1986, the board of directors and the requisite majority of stockholders of each corporation voted to transfer all of its property to a newly formed partnership. Petitioners voted their shares against the transfers and, pursuant to Business Corporation Law § 623, timely elected to exercise their appraisal rights and receive the "fair value" of their shares in each corporation. When the corporations failed to offer to purchase their shares, petitioners commenced this proceeding to have a judicial determination of the fair value of the shares (see, Business Corporation Law § 623[h] ).

In the first phase of a bifurcated valuation trial, Supreme Court determined the net value of the leasehold interest in an office building held by one of the family corporations, a decision not now disputed. The parties then stipulated to the net asset values of the remaining corporations. It is undisputed that, based on the percentages of each petitioner's stockholdings in the nine corporations, her proportionate share of the aggregate net asset values of all nine corporations was $15,200,833.

The second phase of the trial was devoted to a determination of the fair value of petitioners' shares in the nine corporations, given the net asset values previously fixed. At the conclusion of the trial, Supreme Court rejected the testimony of petitioners' expert, who had essentially arrived at his opinion of fair value by simply applying petitioners' fractional corporate stock ownership to the aggregate corporate net asset values. The court reasoned that this approach ignored the effect of the lack of marketability of the corporate stock and "valued these shares as if petitioners were co-tenants in the real estate rather than corporate shareholders".

Instead, Supreme Court adopted the net asset-based valuation methodology employed by Kenneth McGraw, the corporations' expert. McGraw's technique was, first, to ascertain what petitioners' shares hypothetically would sell for, relative to the net asset values of the corporations, if the corporate stocks were marketable and publicly traded; and second, to apply a discount to that hypothetical price per share in order to reflect the stocks' actual lack of marketability. As to the first step in this valuation process, Supreme Court accepted the comparability of one group of publicly traded shares suggested by McGraw, that is, of real estate investment trusts (REITs). McGraw suggested that REITs shares traded primarily in direct relation to each REIT's net asset value and, hence, the mean discount between REIT net asset values per share and REIT stock prices (which McGraw found was 9.8%) could be applied to determine what petitioners' stocks were worth if they were marketable. Thus, McGraw opined that the hypothetical value of the dissenters' shares here, if marketable and publicly traded, would be 9.8% less than their net asset value per share.

For the second step in McGraw's valuation process he applied a discount to reflect the illiquidity of petitioners' shares, i.e., that a potential investor would pay less for shares in a close corporation because they could not readily be liquidated for cash (see, Matter of Seagroatt Floral Co. [Riccardi], 78 N.Y.2d 439, 445-446, 576 N.Y.S.2d 831, 583 N.E.2d 287). The primary unmarketability discount recommended by McGraw was 30.4%. According to McGraw, that figure represented the mean reduction in price per share when ordinarily publicly traded shares in "comparative" corporations became unregistered and thus, restricted shares, which could only be sold in private placements. The corporations' expert then exacted an additional 14.6% discount in the value of the shares, which he based upon the existence of restrictions on transfer contained in stockholder agreements covering the shares of all nine corporations.

Although Supreme Court approved of the net asset valuation methodology of the corporations' expert as a generally valid approach to determining the fair value of petitioners' shares, it found various flaws in McGraw's evaluation and modified the values accordingly. First, the court eliminated the initial 9.8% discount from each petitioners' share in the aggregate net asset value of the corporations. The court based this upon McGraw's testimonial concession that the discrepancy between net asset value per share and price per share in REITs actually represented for the most part the minority status of the REIT shares traded. Thus, the court reasoned, to reduce petitioners' share of net asset value by 9.8% would in effect impose a discount based upon petitioners' status as minority stockholders, a result the court concluded violated New York precedents (citing Matter of Raskin v. Walter Karl, Inc., 129 A.D.2d 642, 514 N.Y.S.2d 120; Matter of Blake v. Blake Agency, 107 A.D.2d 139, 486 N.Y.S.2d 341, lv. denied 65 N.Y.2d 609, 494 N.Y.S.2d 1028, 484 N.E.2d 671).

Second, Supreme Court rejected McGraw's rationale for the imposition of a second unmarketability discount of 14.6% based upon stockholder agreement restrictions, as factually "unpersuasive". Finally, the court found that McGraw's 30.4% unmarketability discount actually included "a minority interest factor which is implicit in any minority stock holding". Consequently, the court considered it necessary to eliminate that factor from the value equation. It did so by reducing the 30.4% discount by 9.4%, which the court regarded as the discount McGraw had testified reflected the minority status of the shares traded in comparable REITs. ¹ Thus, Supreme Court only applied a 21% discount for unmarketability against each petitioner's proportionate share of the aggregate net asset value of the corporations, resulting in a fair value determination of each petitioner's total stock interests of $12,008,682.

The Appellate Division affirmed for the reasons stated by Supreme Court.

I

The corporations' primary argument for reversal is that Supreme Court erred as a matter of law in refusing to take into account in its fair value determination the financial reality that minority shares in a close corporation are worth less because they represent only a minority, rather than a controlling interest. Although the corporations' argument may have validity when corporate stock is valued for other purposes, it overlooks the statutory objective here of achieving a fair appraisal remedy for dissenting minority shareholders. Mandating the imposition of a "minority discount" in fixing the fair value of the stockholdings of dissenting minority shareholders in a close corporation is inconsistent with the equitable principles developed in New York decisional law on dissenting stockholder statutory appraisal rights (a position shared by the courts in most other jurisdictions), and the policies underlying the statutory reforms giving 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.

Several principles have emerged from our cases involving appraisal rights of dissenting shareholders under Business Corporation Law § 623 or its predecessor statute. (1) The fair value of a dissenter's shares is to be determined on their worth in a going concern, not in liquidation, and fair value is not necessarily tied to market value as reflected in actual stock trading (Matter of Fulton, 257 N.Y. 487, 492, 178 N.E. 766). "The purpose of the statute being to save the dissenting stockholder from loss by reason of the change in the nature of the business, he [or she] is entitled to receive the value of his [or her] stock for sale or its value for investment " (id., at 494, 178 N.E. 766 [emphasis supplied]. (2) The three major elements of fair value are net asset value, investment value and market value. The particular facts and circumstances will dictate which element predominates, and not all three elements must influence the result (Matter of Endicott Johnson Corp. v. Bade, 37 N.Y.2d 585, 587-588, 376 N.Y.S.2d 103, 338 N.E.2d 614). (3) Fair value requires that the dissenting stockholder be paid for his or her proportionate interest in a going concern, that is, the intrinsic value of the shareholder's economic interest in the corporate enterprise (Matter of Cawley v. SCM Corp., 72 N.Y.2d 465, 474, 534 N.Y.S.2d 344, 530 N.E.2d 1264). (4) By virtue of the 1982 amendment to Business Corporation Law § 623(h)(4) (L.1982, ch. 202, § 9), fair value determinations should take into account the subsequent economic impact on value of the very transaction giving rise to appraisal rights, as supplemental to the three basic value factors (net asset, investment and market values). (5) Determinations of the fair value of a dissenter's shares are governed by the statutory provisions of the Business Corporation Law that require equal treatment of all shares of the same class of stock (Matter of Cawley, supra, at 473, 534 N.Y.S.2d 344, 530 N.E.2d 1264).

Further, contrary to the corporations' contention here, there is no difference in analysis between stock fair value determinations under Business Corporation Law § 623, and fair value determinations under Business Corporation Law § 1118. The latter provision...