DLOMs and DLOCs in Buyouts

Case: Dipak Patel v. Siddhi Hospitality LLC, 312 Ore. App. 347 (June 16, 2021)

The courts in the past few years have been sprinkled with cases dealing with whether a discount for lack of control (DLOC) or marketability (DLOM) should be applied in the case of a shareholder buyout. There is no right or wrong answer to that question. Each case has its own set of facts to which the court applies its decision. That being said, some broad categories can be noted:

• Cases where the appropriate law in a particular case must be applied correctly in order to arrive at a conclusion (e.g., Pourmoradi v. Gabbai, 2021 Cal. App. Unpub. LEXIS 5471; 2021 WL 3732682 (Aug. 24, 2021));
• Cases where tradition has allowed a DLOM but not a DLOC (e.g., Ferolito v. AriZona Beverages, 2014 N.Y. Misc. LEXIS 4709 (Oct. 14, 2014)); and
• Cases where the court must interpret a shareholder agreement or similar document in applying a DLOC and/or a DLOM (e.g., Patel v. Siddhi shown above).

In reviewing a buyout situation, it is important to note the distinctions outlined above before determining whether to apply a DLOM and/or a DLOC to your facts. If you are dealing with a situation where there is a contract such as a buy-sell agreement or a contractual or organizational agreement, the wording of that agreement can be critical to the outcome.

Take, for example, the Siddhi case noted above. The application of a DLOM/DLOC in this case turned completely on the wording in the operating agreement for the LLC being valued for the buyout of a member’s 25% interest in the LLC. The trial court allowed a combined DLOM/DLOC in awarding an amount of the buyout to the 25% member. However, the appellate court noted that the trial court had applied the fair market value standard of value, which would appropriately allow for a DLOM/DLOC, in determining its award while the operating agreement called for the award to be based on the member’s 25% interest in the fair market value of all of the assets of the LLC. This, the court noted, is akin to the fair value of the group of assets and not akin to a sale transaction between a willing seller and a willing buyer. The appellate court remanded the case to the trial court to determine a new award to the selling member without applying a DLOM or a DLOC.

The obvious conclusion to this and many other similar cases is that words matter.  When an entity enacts a buyout agreement, it is important that it not just be thrown together as part of a boilerplate package. The shareholders or members of the entity should be included in a discussion of what they intend. If there should be a minority owner separation, do they intend that the value of the selling member’s interest be at fair value or at fair market value? In either case, it is wise to include the “answer” regarding discounts specifically in the wording of the agreement so that there is no confusion and no room for interpretation not intended by the parties. For example, the agreement might call for fair market value and state: “[T]he value paid to the selling shareholder shall be determined as the fair market value of the member’s interest. In determining the fair market value any appropriate discounts for lack of control and/or lack of marketability should be applied.” If the value is to be a fair value, it might be appropriate to include a statement clarifying that no DLOM or DLOC is to be applied in determining the fair value of the member’s interest.

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