The New York Court of Appeals, in Congel v. Malfitano,[1] recently ruled that the “Poughkeepsie Galleria Company” (the “Partnership”) was not an at-will partnership and that therefore Defendant Marc Malfitano’s (the “Defendant”) unilateral dissolution of the partnership breached the partnership agreement. In addition, under Section 69 of the New York Partnership Law, the Court sustained the Appellate Division’s valuation of the Defendant’s partnership interest, including application of a minority discount. The Court modified the order on appeal, holding that the Second Department erred in awarding legal fees in contravention of the American Rule on attorneys’ fee awards.
Factual Background
In 1985, the Defendant in Congel, along with seven others, formed a general partnership to own, operate, and manage the Poughkeepsie Galleria shopping mall. Moselle Associates was the majority owner, holding approximately 56% of the Partnership. The Defendant began with a 2.25% ownership interest, which increased to 3.08% by the 2000s.[2]
The partners memorialized their Partnership in a written agreement (the “Agreement”), which provided that the Partnership “shall continue until it is terminated as hereinafter provided.”[3] The Agreement also specified that the Partnership would dissolve upon “[t]he election by the Partners to dissolve the Partnership” or “[t]he happening of any event which makes it unlawful for the business of the Partnership to be carried on or for the Partners to carry on in Partnership.”[4] The Agreement further provided that “[a]ll decisions to be made by the Partners shall be made by the casting of votes at a meeting of such Partners” and that “[t]he affirmative vote of no less than fifty-one percent” of the partners “shall be required to approve any matter presented for decision.”[5]
By the mid-2000s, the Defendant became troubled by the conduct of the Partnership’s Executive Committee (the “Plaintiffs”). According to his complaint, the Defendant voiced his concerns, but they went unheard.
Ultimately, on November 24, 2006, the Defendant sent his partners a letter announcing his intent to dissolve the Partnership due to a “fundamental breakdown in the relationship between and among us as partners,”[6] citing Section 62(1)(b) of the New York Partnership Law (“NYPL”). Section 62(1)(b) provides that a partner may unilaterally dissolve a partnership, without violating the partnership agreement, if the agreement does not state a “definite term or particular undertaking.”[7] In response, the remaining partners maintained that the Defendant had wrongfully dissolved the Partnership, and they continued operating the Partnership under the same name pursuant to NYPL § 69(2)(b).[8]
Procedural History
In 2007, the Plaintiffs filed a breach of contract action against the Defendant on behalf of the Partnership, seeking a declaration that the Defendant had wrongfully dissolved the Partnership. Plaintiffs claimed that the Defendant had done so in “order to force the partnership ‘to buy out . . . his interest at a steep premium.’”[9] Defendant asserted that the Partnership was at-will because the Agreement did not have a “definite term” or “particular undertaking” as required by NYPL § 62(1)(b). Defendant interposed a counterclaim seeking to recover the value of his Partnership interest under NYPL § 69(2)(c)(II). Defendant also cross-moved to dismiss the complaint for failure to state a cause of action.[10]
The Duchess County Supreme Court denied Defendant’s cross-motion to dismiss. Plaintiffs thereafter moved for summary judgment, asserting that the Agreement provided just two methods for dissolving the Partnership, and that the Defendant’s unilateral action to dissolve the Partnership breached the Agreement.[11] The trial court granted summary judgment to the Plaintiffs, holding that the Partnership was not at-will, given that the Agreement specified a “particular undertaking” (i.e., to own, operate, and manage the mall) within the meaning of NYPL § 62(1)(b); therefore, the Defendant’s unilateral dissolution action breached the Agreement.[12]
The Defendant appealed. In 2009, the Appellate Division Second Department upheld the trial court’s decision but on different grounds, finding that the Agreement specified a “definite term” under NYPL § 62(1)(b) because the Agreement provided that the Partnership would continue until a majority of partners elected to dissolve it.[13] The Second Department remitted the case back to the Supreme Court to determine the amount of any damages owed on Plaintiffs’ breach of contract claim and the “value of [Defendant’s] interest in the partnership”[14] under NYPL § 69(2)(b).[15]
On remand, the Supreme Court held a bench trial to determine the value of the Defendant’s interest in the Partnership and Plaintiffs’ damages. Both sides stipulated that the value of the Defendant’s Partnership interest was $4,850,000.[16] But the parties disagreed as to whether the stipulated value included the Partnership’s goodwill. If it did, then the goodwill would need to be deducted from the Partnership’s value under NYPL § 69. Each side offered expert testimony on whether: (1) the Partnership had goodwill; (2) the value of the Partnership interest should be reduced for lack of marketability; and (3) the Partnership’s value should be further reduced to account for Defendant’s status as a minority partner.[17]
The Plaintiffs’ valuation expert testified that the value of the Partnership reflected goodwill of 44%, by which the Defendant’s interest should be reduced proportionately. That expert further testified that the value of the Defendant’s interest should be also reduced by a marketability discount of 35% and a minority discount of 66%. According to the Plaintiffs’ expert, the Agreement contained a restriction on transferability—upon the sale of a partner’s Partnership interest, the selling-partner would still be jointly and severally liable for 5 years, along with the buying-partner, for any of the Partnership’s capital costs. The Plaintiffs’ expert opined that this contractual restriction affected not only the marketability of a partner’s interest, but also warranted a minority discount.[18]
The Defendant’s expert contested the goodwill calculation, arguing that the Partnership was a real estate holding company and did not have any goodwill. The Defendant’s expert did not challenge the applicability of a marketability discount; instead, the expert argued that the discount should be 25%. Further, the expert failed to contest the minority discount because the Defendant contended that a minority discount was impermissible as a matter of law.[19]
The Plaintiffs presented a second expert to show that Plaintiffs’ claimed legal fees were a direct result of the Defendant’s wrongful dissolution of the Partnership, and that those fees should be included as damages since they were necessary actions to avoid a forced liquidation of the Partnership.[20]
The trial court found that the Partnership did possess goodwill because the mall was already established and attracted loyal shoppers. But the court valued that goodwill at 15%, much less than the Plaintiffs’ expert on this point. Next, the trial judge applied a marketability discount of 35%, agreeing with the Plaintiffs’ expert. The trial judge, however, declined to apply any minority discount, concluding that prior cases had barred the use of such a discount for closely held corporations.[21] Lastly, the trial judge held that the Plaintiffs were entitled to attorney’s fees and experts’ fees as part of their damages, because those costs were “not incidental to the litigation” but instead were “damages caused by the Defendant’s breach.”[22] The Supreme Court ruled that the value of Defendant’s Partnership interest was $1,083.467.50 (not considering prejudgment interest).[23]
Accordingly, both parties appealed the trial court’s decision. The Appellate Division adhered to its prior decision regarding the Defendant’s breach of the Agreement and distinguished the case from a 2013 Court of Appeals decision in Gelman v. Buehler.[24] Next, the court addressed the issue of a minority discount, which was one of first impression for the Second Department.[25] The court failed to find the lower court’s reasoning to be persuasive, which had emphasized the N.Y. Business Corporation Law and not the NYPL.[26] Instead, the Appellate Division relied on a decision by the Massachusetts Supreme Judicial Court, that state’s highest court, in Anastos v. Sable, which “interpret[ed] a partnership statute that is identical in all relevant respects” to the NYPL § 69.[27] The Second Department modified the lower court’s decision, finding as had the Massachusetts court that “the partnership remains a going concern, and the defendant has no right to compel a liquidation sale of the partnership's shopping mall and receive a proportionate share of the liquidation value of that asset.”[28] Therefore, “a minority discount may properly be applied to account for the defendant's lack of control in the partnership as a going concern.”[29] The court thus remanded the case to recalculate the value of the Defendant’s Partnership interest.[30] After recalculating that value, the trial court determined that the Defendant owed the Plaintiffs $911,387.75.[31]
Discussion
On appeal to the Court of Appeals, the Court affirmed, in part, and modified, in part, the order of the Second Department, in a 5-2 opinion by Judge Eugene M. Fahey. The majority began its analysis by restating that a partnership is: “a voluntary, contractual association in which persons carry on a business for profit as co-owners.”[32] According to the Court, the NYPL “creates default provisions that fill gaps in partnership agreements, but where the agreement clearly states the means by which a partnership will dissolve, or other aspects of partnership dissolution, it is the agreement that governs the change in relations between partners. . . .”[33]
First, the Court addressed whether the Defendant’s unilateral dissolution action violated the Agreement or the NYPL § 69.[34] If not, the remaining issues would be moot.
The Court agreed with the courts below, ruling that the Defendant’s unilateral dissolution of the Partnership violated the Agreement but held that those courts erred in applying NYPL § 62(1)(b).[35] The Court proceeded to summarize the provisions of NYPL § 62(1)(b), explaining that a partnership is at-will and can be dissolved at any time by one or more of the partners if the partnership lacks a definite termination date or a particular objective to achieve. On the other hand, when a partnership agreement contains a termination date, definite objective, or method of dissolution, the partnership is not at-will and a partner cannot unilaterally dissolve the partnership. Moreover, a partner that wrongfully dissolves the partnership can be held liable to the other partners for a breach of the partnership agreement.[36]
In Congel, the Court of Appeals ruled that the Agreement was clear and contemplated a dissolution of the Partnership in only two instances: (1) upon “[t]he election by the Partners to dissolve the Partnership”; (2) upon “[t]he happening of any event which makes it unlawful for the business of the Partnership to be carried on or for the Partners to carry it on in Partnership.”[37] The Court concluded that the Partnership could not be deemed to be at-will. Further, given that the Agreement was clear regarding dissolution, NYPL § 62(1)(b) did not apply.[38] The Court reasoned that the parties had contracted out of Section 62 of the NYPL by providing for their own method of dissolution. Therefore, the Defendant’s unilateral action to dissolve the Partnership breached the Agreement.
Next, the Court turned to the issue of the damages flowing from the Defendant’s breach. The Court ruled that it was an error to award awarding attorneys’ and experts’ fees incurred during the lawsuit as part of the damages award.[39] The Court explained that fee award was contrary to the American Rule against shifting legal fees and the Plaintiffs had failed to point to any provision of the Agreement, the NYPL, or the CPLR that would authorize an exception.[40]
The Court then addressed the valuation issues. According to the NYPL, when a partner wrongfully dissolves a partnership in breach of a partnership agreement, the goodwill of the partnership is to be deducted in determining the value of the dissolving-partner’s partnership share.[41] The Court defined goodwill as an “intangible asset of a business, corresponding in this context to what a buyer would pay for the business, over and above its value as a mere sum of tangible assets, because of the patronage and support of regular customers.”[42]
The Defendant argued that the Partnership lacked goodwill as a matter of law because it is a real estate holding entity. According to the Court, that generalization was incorrect given that goodwill is a fact-specific determination. The Court of Appeals’ narrow scope of review left it without power to upset that determination absent findings of fact that are unsupported by the record. The Court concluded that the record here supported a valuation of the Partnership that included a goodwill component given there was evidence that the mall attracted loyal customers, and that a goodwill discount was thus appropriately applied.[43]
The Court then affirmed the Appellate Division’s decision to apply the minority discount. The Court wrestled with the meaning of “value of his interest in the partnership” from NYPL § 69(2)(c)(II). [44] The Court of Appeals agreed with the rationale of the Massachusetts high court decision in Anastos. New York, like Massachusetts, has not adopted the 1997 Revised Uniform Partnership Act (“RUPA”) and the Massachusetts statute was “identical in all relevant respects to [N.Y.] Partnership Law § 69 (2)(c)(II).”[45] Because the Partnership continues to operate, the Court held that the application of a minority discount was not erroneous as a matter of law:[46] “the statute does not contemplate a valuation of the entire business as if it were being sold on the open market, but rather a determination of the fair market value of the wrongfully dissolving partner's interest as if that interest were being sold piecemeal and the rest of the business continuing as a going concern.”[47] The Court noted that parties are free to contract out of a minority discount in their partnership agreement if they so choose, as with other provisions of the NYPL.[48] Given that the parties, in Congel had not done so, the Court held that the minority discount was properly applied to the Defendant’s interest.[49]
Finally, the Court ruled that the Defendant’s appeal regarding the applicability of a marketability discount would not be considered because the Defendant had failed to preserve that challenge in the courts below.[50]
The Court remitted the case to the Supreme Court to recalculate the final valuation of the Defendant’s partnership interest.[51]
In dissent, Judge Paul G. Feinman disagreed only with the majority’s application of a minority discount. He criticized the majority for failing to “advance[] an affirmative rationale” to support the application of a minority discount.[52] The dissent, however, agreed that the meaning of “value” in the UPA is unclear.[53] But Judge Feinman urged that an analysis of the RUPA can help interpret the meaning of “value.”[54] Therefore, the dissent reasoned that “value” in the RUPA and UPA “means a pro rata share of the partnership’s value as a whole[]”[55] not the piecemeal fair market value of the minority interest. Judge Feinman argued that the use of the minority discount to punish or deter wrongful conduct by partners is unnecessary since the NYPL already deters wrongful dissolution by requiring the dissolving partner to pay damages and discounting the value of the partnership interest that is attributable to goodwill. [56]
Conclusion
As Congel confirms, parties forming a general partnership are free to chart their own course and contract out of provisions of the NYPL. However, when a partnership is silent regarding an area of the NYPL, courts will apply the relevant NYPL provision to that agreement. Of note, the Court of Appeals concluded that a minority discount was appropriate in valuing a dissenting partner’s partnership interest in these circumstances. Drafters of partnership agreements ought to keep these issues in mind in choosing options for a partnership.
Also of note is the Court’s reaffirmation of the American Rule regarding fee‑shifting. This ruling reduces some of the negotiating leverage on the part of the partnership when a minority partner seeks to dissolve a partnership. Again, this is an issue that can be addressed in drafting a partnership agreement.
[1] 2018 BL 104517 (Mar. 27, 2018).
[2] Id. at *1.
[3] Id.
[4] Id.
[5] Id.
[6] Congel v. Malfitano, 141 A.D.3d 64, 67 (2d Dep’t 2016).
[7] N.Y. Partnership Law § 62.
[8] Section 69 provides: “when dissolution is caused in contravention of the partnership agreement . . . [t]he partners who have not caused the dissolution wrongfully, if they all desire to continue the business in the same name . . . may do so, during the agreed term for the partnership and for that purpose may possess the partnership property, provided they . . . pay to any partner who has caused the dissolution wrongfully, the value of his interest in the partnership at the dissolution, less any damages recoverable . . . . N.Y. Partnership Law § 69(2) (b).
[9] Congel, 141 A.D.3d at 67.
[10] Congel, 2018 BL 104517, at *2.
[11] Id. Although the case was not heard in a Commercial Division part, the Congel decision has potential ramifications for cases litigated in the Division across the State.
[12] Id. at *3.
[13] Congel v. Malfitano, 61 A.D.3d 807, 808-809 (2d Dep’t 2009).
[14] N.Y. Partnership Law § 69(2)(b).
[15] Congel, 2018 BL 104517, at *3.
[16] Id. at *3-4.
[17] Id. at *4.
[18] Id.
[19] Id.
[20] Id.
[21] Congel, 141 A.D.3d at 71-72; See Matter of Friedman v Beway Realty Corp., 87 NY.2d 161 (1995)(holding minority discount should not be applied in determining the "fair value" of a dissenting shareholder's shares within the meaning of N.Y. Business Corporation Law §§ 623 and 1118).
[22] Congel, 2018 BL 104517, at *3.
[23] Id. at *5; [$4,850,000.00 – $727,500.00 (goodwill) – $1,442,875.00 (marketability) – $1,516,452.00 (attorneys’ fee) – $79,705.50 (expert fees)] = $1,083.467.50.
[24] Id. at *5-6; Gelman v. Buehler, 20 N.Y.3d 534 (2013) (ruling that a partner may unilaterally dissolve an oral partnership agreement because it did not provide a “definite term” or particular undertaking”).
[25] Congel, 141 A.D.3d at 67.
[26] Id. at *73.
[27] Id., citing Anastos v. Sable, 819 N.E.2d 587 (Mass. 2004).
[28] Id. at *74-75.
[29] Id.
[30] Congel, 2018 BL 104517, at *6.
[31] Id. at *6; [$4,850,000.00 – $727,500.00 (goodwill) – $1,442,875.00 (marketability) – $1,516,452.00 (attorneys’ fee) – $79,705.50 (expert fees) – $1,768,552.50 (minority discount)] = $911,387.75.
[32] Id. at *1.
[33] Id.
[34] Id.
[35] Id. at *7.
[36] Id. at *8.
[37] Id.
[38] Id.
[39] Id. at *9.
[40] “Under the ‘American rule,’ to which this State adheres, the prevailing litigant ordinarily cannot collect its reasonable attorneys' fees from its unsuccessful opponents.” Hunt v. Sharp, 85 N.Y.2d 883, 885(1995) (internal citation removed). See also Matter of A. G. Ship Maintenance Corp. v. Lezak, 69 N.Y.2d 1, 5 (1986).
[41] Congel, 2018 BL 104517, at *10.
[42] Id. at *10-11.
[43] Id. at *11.
[44] Anastos v. Sable , 819 N.E.2d 587, 590-92 (Mass. 2004) (finding “[t]he method of valuation of a partnership interest in a going concern necessarily differs from the valuation of the same interest at the point of liquidation[]” and the former includes a minority discount).
[45] Congel, 2018 BL 104517, at *12.
[46] Id. at *14 n.13.
[47] Id. at *13.
[48] Id. at *15.
[49] Id. at *14-15.
[50] Id. at *12. At trial, the Defendant’s expert conceded that the marketability discount would apply, and the parties only disputed what percentage would apply.
[51] Id. at *14.
[52] Id. at *15 (Feinman, J., dissenting).
[53] The NYPL is a UPA-based statute. Id. at *12.
[54] Id. at *16-17 (Feinman, J., dissenting).
[55] Id. at *17-18.
[56] Id. at *23.
