In adjudicating a New Jersey family dispute that escalated into an oppressed shareholder action, the trial court recently found the oppressing shareholder had created a situation that mandated the application of a discount for lack of marketability (DLOM) in order to achieve a “fair and equitable” outcome. The decision discusses the how-to of valuing a closely held company under the state’s oppressed shareholder statute and case law.
Two brothers, Richard and Steven, formed two separate companies, Plant Interior Plantscapes (PIP) and Parker Wholesale Florists (PWF), in which each brother had a 50% interest. The companies did business from the same location and shared overhead but were otherwise independent enterprises. Decades later, each brother sued the other under the oppressed shareholder act.
The court found Steven had engaged in shareholder oppression by allowing PWF to incur huge losses over 20 years and by “continually” withdrawing funds from PIP to cover the losses, without obtaining Richard’s consent. Based on this conduct, the court found he also had violated his fiduciary duties as director of PIP and PWF. The court ordered Steven to sell his interest in PIP to Richard.
Under New Jersey law, in determining fair value, the court has “substantial” discretion to adjust the purchase price to reflect the stock’s lack of liquidity by way of a DLOM. The resulting value must be “fair and equitable.” Although New Jersey courts typically disfavor the use of DLOM in determining fair value in forced buyout situations, the state Supreme Court has held that in “extraordinary circumstances” a DLOM may be appropriate to ensure the shareholder whose conduct necessitates the litigation does not receive a windfall as a result of the court-ordered buyout. Balsamides v. Protameen Chemicals, 1999 N.J. LEXIS 836.
In the instant case, the court found that Steven’s wrongful conduct created an extraordinary situation.
Both parties retained accredited appraisers to calculate the price of Steven’s interest in PIP, and both experts relied essentially on a discounted cash flow analysis and IRS Revenue Ruling 59-60.
The court, with adjustments, accepted the valuation Richard’s expert proposed, including the application of a 25% DLOM to Steven’s $778,000 share. However, the court rejected the expert’s 15% minority discount, explaining that the majority approach in New Jersey was a “no-discount-absent-exceptional-circumstances rule.” Even if exceptional circumstances in this case justified a DLOM, they did not “automatically” entitle Richard, the plaintiff, to a minority discount, the court said.
The practice in New Jersey to use DLOM as a tool of correction was on full display in an earlier ruling, Wisniewski v. Walsh, and has raised concern among some valuation professionals.
One commenter recently noted that using DLOM to impose a legal penalty depleted a carefully developed valuation measure of its meaning and separated it from its economic basis. The DLOM application should not become contingent on the character of the parties but be based instead on the actual value factors of marketability.