Has New Jersey Gone Off Its DLOM Rocker?
March 13, 2017
Whenever I contemplate New York’s unusual case law on the discount for lack of marketability (DLOM) in statutory fair value buy-out proceedings, I cast my eyes westward, to the far banks of the Hudson River, and take comfort in the fact it could be worse — I could be in New Jersey.
A “business appraiser’s nightmare” is how Chris Mercer described New Jersey’s “bad behavior discount” in his commentary on the Wisniewski v Walsh case decided a little over a year ago by a New Jersey appellate court, in which it affirmed the trial court’s application of a 25% DLOM seemingly plucked out of thin air, and notwithstanding what the trial court itself admitted were “strong indicators of liquidity,” for the stated purpose of penalizing the selling shareholder for his oppressive behavior toward the other shareholders — behavior that in no way harmed the corporation’s business or affected its marketability!
Now comes another New Jersey trial court decision in another fair value buy-out case, and guess what? The court applied the same 25% DLOM without any discussion of the factors supporting its application or quantification other than the court’s finding that the selling shareholder was guilty of oppressive conduct against the purchasing shareholder.
In Parker v Parker, 2016 N.J. Super. Unpub. LEXIS 2720 [Dec. 22, 2016], two brothers, Richard and Steven Parker, took over from their parents and for the next 25 years operated as 50/50 owners a wholesale flower business and a separately incorporated wholesale plant business which eventually became a garden center. Richard ran the flower business and Steven the garden business as separate fiefdoms with minimal overlap.
The court’s 39-page, post-trial opinion addresses in great detail dueling shareholder oppression claims and a host of additional claims and counterclaims against each other. The judge nicely captures the fraternal fracas’s flavor on the opinion’s first page, writing, “Both litigants seek to have the court remedy every injustice they perceive has befallen them over the last 25 years at the hand of the other. This, of course, cannot be done.”
I’ll spare you the details. Essentially, each brother accused the other of various and sundry mismanagement, financial abuses, usurpation of corporate opportunities, and generally being frozen out of the other’s fiefdom. The court concluded that Steven alone was guilty of oppressive conduct toward his brother Richard, based mainly on its finding that Steven incurred losses in the millions of dollars on his side of the business over many years which he covered by withdrawing funds from Richard’s side of the business without Richard’s consent.
When it came to remedy, the court granted Richard’s application to purchase Steven’s shares under Section 14A:12-7(8) of New Jersey’s Business Corporation Act which authorizes the court to compel any shareholder who is a party to the litigation to sell his or her shares either to the corporation or to any other shareholder party for “fair value” in lieu of dissolution. Based on the testimony of Richard’s and Steven’s opposing business appraisers, the court ultimately assigned a fair value of about $540,000 to Steven’s shares and ordered payment within 30 days.
For those interested in the minutiae of the court’s valuation analysis, I highly recommend reading pages 30-35 of the decision. For the rest, I’m going to focus solely on the court’s discussion of DLOM, which began by defining it in conventional terms as a discount that “reflects the decreased worth of shares of stock in a closely-held corporation, for which there is no readily available market; a decrease due to the lack of liquidity.”
However, the court went on, the New Jersey Supreme Court in its 1999 Balsamides decision categorically rejected application of a DLOM in shareholder oppression/fair value cases except in “extraordinary circumstances” when not applying a DLOM effectively would reward oppressive behavior by the party whose shares are being purchased or sold.
In Balsamides, the Supreme Court approved a 35% DLOM in a fair value buy-out by the oppressed shareholder of the oppressor’s shares, stating that “[i]n cases where the oppressing shareholder instigates the problems, as in this case, fairness dictates that the oppressing shareholder should not benefit at the expense of the oppressed.”
In the Wisniewski case mentioned at the top of this post, the minority shareholder who sued for dissolution and accused his siblings of oppression ended up being tagged by the court as the oppressor and being compelled to sell his shares to his siblings. The purchasing siblings argued for a 35% DLOM — the same as in Balsamides — but the court trimmed it to 25% without offering any appraisal-based rationale for doing so.
In Parker, Richard’s appraisal expert applied a 25% DLOM to his valuation. Steven’s expert applied no DLOM, which I gather is related to the fact that Steven’s counterclaim under the New Jersey statute only requested, as an alternative to dissolution, that Richard be compelled to buy Steven’s shares, i.e., he did not seek to purchase Richard’s shares.
The court adopted Richard’s expert’s 25% DLOM without shedding any light on what factors or data the expert relied on, if any. The only rationale stated by the court, however, makes clear that it had little or nothing to do with appraisal doctrine or methodology, and that it was based on the notion that a shareholder who is found guilty of oppression and is forced to sell his or her shares should suffer a penalty:
The court believes a marketability discount should be applied. The actions of the defendant [Steven] were the cause of the lawsuit. He cannot be rewarded by not applying this discount. In cases where the oppressing shareholder instigates the problems, as in this case, fairness dictates that the oppressing shareholder should not benefit at the expense of the oppressed. Balsamides v. Protameen Chems., 160 N.J. 352, 382 (N.J. 1999). The potential buyer base for Richard Parker will remain illiquid because it is not publicly traded and public information about it is not widely disseminated moving forward. Id. at 378. In this matter, Steven Parker’s wrongful act caused an extraordinary circumstance which requires this court to apply a marketability discount. Steven Parker, the oppressing shareholder, cannot receive a windfall as a result of his actions, the marketability discount will be applied.
Note the court’s reference to the ongoing illiquidity of the business after Richard becomes the 100% owner. In the first place, there is debate in the business valuation community whether DLOM exists at the control level. But even assuming it does, it still doesn’t justify the outcome, among other reasons, because in cases applying Balsamides‘s general rule prohibiting DLOM, it would punish the purchasing shareholder and unduly reward the selling shareholder.
Does it make sense for Parker and its predecessors to untether DLOM from appraisal theory and practice in service of a punitive rationale based on a judge’s assessment of a party’s misconduct? Does doing so render the testimony of a business appraiser irrelevant to DLOM when recast as such? Why bother calling it DLOM if it’s an arbitrary percentage deduction from fair value intended to punish a shareholder’s oppressive conduct? And should it be left to a judge’s total discretion whether the “bad” shareholder’s behavior merits a 35% or 25% or 10% or any other specific percentage deduction?
I used to think that the New Jersey dissolution statute’s flexible remedial authority reflects a more enlightened approach than found in the New York statute, which provides the respondent shareholder in a dissolution suit brought by an oppressed minority shareholder the unqualified right within 90 days of commencement to elect to purchase the petitioner’s shares for fair value in lieu of dissolution.
Not any more. At least in New York, the election avoids the necessity of litigating oppression and allows the court to focus on valuation alone. The combined effect of the New Jersey statute’s remedial provisions and the Balsamides rule on DLOM does an injustice to appraisal doctrine, puts valuation experts in the highly awkward position of espousing for or against DLOM based on legal doctrine and case precedent (or pretending that it’s based on something else), and has the perverse effect of encouraging both sides in a shareholder dispute to assert and to litigate to verdict dueling oppression claims in order to avoid or achieve a substantial discount, depending whether the shareholder believes he or she ultimately will be allowed to purchase from, or be forced to sell to, the other shareholder, which pretty much tells the story of Parker.