Court of Appeals to Decide Controversial Partnership Dissolution Case
January 16, 2017
In a controversial ruling last year in Congel v Malfitano, the Appellate Division, Second Department, affirmed and modified in part a post-trial judgment against a former 3.08% partner in a general partnership that owns an interest in a large shopping mall, and who unilaterally gave notice of dissolution, finding that
- the partnership had a definite term and was not at-will for purposes of voluntary dissolution under Partnership Law § 62 (1) (b) based on the partnership agreement’s provisions authorizing dissolution by majority vote, notwithstanding a 2013 ruling by the Court of Appeals (New York’s highest court) in Gelman v Buehler holding that “definite term” as used in the statute is durational and “refers to an identifiable terminate date” requiring “a specific or even a reasonably certain termination date”;
- the former partner’s unilateral notice of dissolution therefore was wrongful; and
- having wrongfully dissolved the partnership and upon the continuation of its business by the other partners, under Partnership Law § 69 (2) (c) (II) the amount to be paid to the former partner for the value of his interest properly reflected a 15% reduction for the partnership’s goodwill value, a 35% marketability discount, a whopping 66% minority discount, and a further deduction for damages consisting of the other partners’ litigation expenses over $1.8 million including statutory interest.
The Appellate Division’s decision, which I wrote about here, and the former partner’s subsequent application for leave to appeal to the Court of Appeals, which you can read here, reveal, to say the least, a remarkable result: the former partner, whose partnership interest had a stipulated topline value over $4.8 million, ended up with a judgment against him and in favor of the other partners for over $900,000.
But the story’s not over. Last week, the Court of Appeals issued an order granting the former’s partner’s motion for leave to appeal. Sometime later this year, the Court of Appeals will hear argument in its magnificent courtroom pictured above and issue a decision in the Congel case which likely will have important ramifications for partnership law whatever the outcome.
The appellant’s application for leave to appeal presented three issues for the high court’s consideration:
First, does the lower court’s determination that the former partner wrongfully dissolved the partnership, based on the partnership agreement’s termination provisions, conflict with the Court of Appeals’ interpretation of “definite term” in its Gelman decision?
The Appellate Division’s ruling on this point had two components, one procedural and the other substantive. Procedurally, the court held that its initial determination that the dissolution was wrongful, in a pair of appellate decisions in 2009, was “law of the case” and foreclosed reexamination in light of the 2013 Gelman decision. Substantively, the court distinguished Gelman as limited to the facts in that case involving an oral partnership agreement as opposed to the written partnership agreement in Congel containing a provision authorizing termination by majority vote of the partners.
As laid out in his application for leave to appeal, the former partner will argue that the Appellate Division was not bound by its earlier decisions finding wrongful dissolution under the law of the case doctrine because Congel was still being litigated when the Court of Appeals decided Gelman, whose interpretation of “definite term” as used in Partnership Law § 62 did not create new law and must be applied retroactively. The former partner will then argue that because the subject partnership agreement’s provision for termination of the partnership by majority vote lacks any temporal element, it fails the test for “definite term” articulated in Gelman.
The respondent partners can be expected to argue that the Appellate Division properly construed the partnership agreement as forbidding a partner’s unilateral dissolution of the partnership, and that the agreement’s termination provision distinguishes the case from Gelman in which the Court of Appeals examined an oral partnership agreement that, as alleged, lacked any terms governing dissolution.
Second, does the lower court’s award of the prevailing partners’ litigation expenses as “damages” deductible from the value of the former partner’s interest contravene the “American Rule” generally barring a fee award except where authorized by agreement, statute, or court rules?
The former partner’s appeal challenges the award against him totaling over $1.5 million (plus interest) for the prevailing partners’ attorney’s and expert fees incurred in the litigation as “damages” to be deducted from the value of his partnership interest under Partnership Law § 69. The Appellate Division upheld the award as “recoverable expenditures directly occasioned and made necessary by the defendant’s breach of the partnership agreement.”
The former partner will argue that the American Rule governs and that neither Partnership Law § 69 nor the parties’ partnership agreement authorizes an award of legal expenses for breach of the agreement. He also will argue that the award, if sustained, will chill minority objections and the exercise of statutory rights under the Partnership Law.
The respondent partners likely will counter that, rather than being governed by the American Rule, the award of litigation expenses should be upheld as incidental or consequential damages for breach of contract, and that the expenses were necessarily incurred in pursuit of a judicial determination that the former partner’s notice of dissolution was wrongful and did not require liquidation of the partnership.
Third, should the lower courts have applied a marketability discount, a minority discount, and a goodwill reduction in determining the value of the former partner’s interest?
It appears from his application for leave to appeal that the former partner will go big with his challenge to the 35% marketability and 66% minority discounts sequentially applied to the $4.8 million value of his partnership interest, by arguing (1) the Court of Appeals has never opined on the standard and level of value under Partnership Law § 69; (2) Partnership Law § 62 recognizes that dissolution can be caused by express will of a partner even if such dissolution is in contravention of the partnership agreement; (3) where the other partners elect to continue the partnership and avoid liquidation, lack of marketability is not an issue and such discount would hand the other partners a windfall; (4) the court should reject any minority discount for the same policy reasons it rejected it in Friedman v Beway under the fair-value standard; and (5) even if discounts are allowed, the court should order further proceedings to determine their reasonableness, having erased about $3.2 million of the $4.8 million valuation.
The former partner also will contest the lower court’s application of a 15% statutory deduction for partnership goodwill, based on his contentions that goodwill does not exist in a real estate holding company, that the partnership’s financial statements have never reflected goodwill value, and that, in any event, as a passive holder of a non-managing interest in a shopping mall, any goodwill attributable to the shopping mall is attributable to the mall’s management group.
The respondent partners can be expected to argue that the lower courts properly valued the appellant’s interest under a fair market value standard including its application of discounts and a goodwill reduction, and that the statutory “fair value” standard applied in Friedman v Beway is inapplicable to the naked term “value” used in Partnership Law § 69. They also likely will argue that the record evidence including their valuation expert’s trial testimony provides adequate support for both discounts and for the goodwill reduction determined by the lower courts.
Stay Tuned. The line-up of the several, discrete issues in Congel opens up a range of possible outcomes when the Court of Appeals ultimately decides the case. If it agrees with the appellant that his dissolution was not wrongful, that should moot the issues of damages for counsel fees and for goodwill reduction but presumably still require decision regarding the two discounts. If it agrees with the respondents that the dissolution was wrongful, presumably it will go on to address each of damages, goodwill, and discounts, with the possibility of a straight win for the appellant or the respondents on all three, or partial victories for both sides. It’s also conceivable the court’s ruling on marketability discount could have spillover effect on statutory fair value proceedings under Business Corporation Law §§ 623 and 1118.