New York’s High Court Takes Fresh Approach to Wrongful Dissolution, Sustains Valuation Discounts, Limits Damages in Partnership Case

Farrell Fritz, P.C.
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There’s a lot to digest in last week’s decision by the Court of Appeals — New York’s highest court — affirming and modifying in part the intermediate appellate court’s ruling in Congel v Malfitano, a “wrongful dissolution” case I previously covered here and here, in which a minority partner in a general partnership that owns a shopping mall, whose former 3% interest had a stipulated top-line, pro rata value of $4.85 million, after massive valuation discounts and a seven-figure damages award for the majority’s legal fees, ended up with a judgment against him for about $1 million.

Let’s begin with a synopsis of Judge Eugene M. Fahey’s opinion for the court:

  • Instead of focusing, as did the lower courts, on whether the partnership met Partnership Law § 62 (1) (b)’s durational criteria of “definite term” or “particular undertaking,” the court decided the wrongfulness of the minority partner’s unilateral dissolution without recourse to the statute, and instead employed a purely contractual approach in affirming the lower courts’ finding of wrongful dissolution based on the partnership agreement’s “clear and unequivocal terms” providing the exclusive means by which the partnership could be dissolved.
  • The court affirmed the lower courts’ application of 35% marketability, 66% minority, and 15% goodwill discounts, which collectively erased around 80% of the stipulated top-line valuation. As to the minority discount, based on the objectives and policies underlying the “terminological difference” between the statutes, the court refused to read into Partnership Law § 69 (2) (c) (II) — which requires the court to determine the “value” of the partner’s interest when the remaining partners elect to continue the business following a wrongful dissolution — the case law disallowing any minority discount under the “fair value” standard found in sections 1118 and 623 of the Business Corporation Law governing buyouts in shareholder oppression and dissenting shareholder cases. Two of the panel’s seven judges dissented from this part of the court’s decision and would have disallowed the minority discount as a matter of law.
  • In the one bright spot for the minority partner, the court’s opinion struck the approximately $1.6 million (plus 9% interest) damages award for the majority’s legal fees, holding that the award contravened the so-called American Rule under which each side pays its own litigation expenses absent a contractual or statutory fee-shifting provision, and that the damages recoverable under Partnership Law § 69 are only designed to compensate for legal fees or other losses “incurred in carrying out separate acts necessitated by the breach.”

The court remitted the case to the trial court to recalculate damages (I’ll explain below). As best as I can tell, the likely net effect of the rulings will be to swing the judgment from around $1 million against the minority partner to around $1 million in his favor — still a jaw-dropping reduction from the pro rata value of the partnership interest he gave up.

Wrongful Dissolution

The minority partner in Congel precipitated the ensuing litigation onslaught by giving a unilateral notice of dissolution in which he took the position that the partnership was at-will under Partnership Law § 62 (1) (b) because the partnership agreement did not specify a “definite term” or “particular undertaking.” The majority elected to continue the partnership’s business, reconstituted the partnership without the former minority partner, and then sued him for wrongful dissolution.

In their suit, the majority partners relied on a provision in the partnership agreement stating that the partnership “shall continue until it is terminated as hereinafter provided,” and, in a subsequent provision, that the partnership would dissolve under either of two circumstances: (1) the “election by the Partners to dissolve the Partnership” and (2) the “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.”

The trial judge held that the minority partner’s dissolution was wrongful because the partnership agreement specified a “particular undertaking.” The intermediate appellate court agreed with that outcome, but substituted its finding that the partnership agreement specified a “definite term” based on the provision allowing the partners to hold an election to dissolve.

Judge Fahey’s opinion for the Court of Appeals adopted the reasoning of neither the trial court nor the lower appellate court. Instead, the court reasoned that the partnership agreement wholly displaced the statutory criteria for determining an at-will partnership, and that the minority partner’s dissolution notice fell outside, and therefore breached, the contractual bases for dissolution. As Judge Fahey wrote:

The partners clearly intended that the methods provided in the Agreement for dissolution were the only methods whereby the partnership would dissolve in accordance with the Agreement, and by implication that unilateral dissolution would breach the Agreement. In other words, the Agreement contemplated dissolution only in two instances, leaving no room for other means of dissolution that would be in accordance with its terms.

It follows that Partnership Law § 62 (1) (b) has no application here, because the parties to the Agreement clearly specified under what terms it could be properly dissolved, i.e., what would constitute a dissolution under the Agreement and what would constitute a dissolution in contravention of it. Accordingly, this was plainly not intended to be an “at-will” partnership.

Stating that the minority partner’s “breach is clear from the Agreement alone,” the opinion carefully qualified that there was no need for the Court of Appeals to determine whether the lower courts erroneously found that the partnership agreement in Congel contained a “particular undertaking” or a “definite term.” Judge Fahey also pointed out that the majority partners “did not take the position that [the minority partner’s] action had no legal effect and failed to dissolve the Partnership,” and therefore the court had no occasion to consider whether the majority partners “would prevail if they had argued that under the Agreement a purported unilateral dissolution is no dissolution at all.”

The high court’s contract-based analysis of the partnership’s at-will status, wholly detached from Partnership Law § 62 (1) (b), represents a new and interesting development in New York’s partnership dissolution jurisprudence, in which the threshold issue will be whether the partners in their partnership agreement have contracted around and thus supplanted the Partnership Law’s at-will criteria provided, as Judge Fahey clarified, “they do so in language that is clear, unequivocal and unambiguous” (internal quotation marks and citations omitted).

Marketability Discount

The lower courts applied a 35% discount to the value of the minority partner’s interest for lack of marketability. On appeal to the Court of Appeals, the minority partner broadly urged the court to adopt a highly restrictive approach to the discount’s application. The argument gained no traction. As Judge Fahey wrote, not only did the minority partner “fail to preserve any challenge to the applicability of a marketability discount to the value of a partnership interest after wrongful dissolution,” his expert appraiser at trial “conceded that a marketability discount would apply and [the minority partner] did not depart from this in his posttrial motion papers.”

Tis a shame. What with the seemingly disparate views of the First and Second Departments when it comes to marketability discounts for real estate holding companies, it would have been a great opportunity for the high court to settle the issue.

Minority Discount

In contrast to the marketability discount, which applies at the enterprise level, the minority discount applies at the ownership level and, as described by Judge Fahey, “reflects the fact that the price an investor is willing to pay for a minority ownership interest in a business, whether a corporation or a partnership, is less because the owner of the minority interest lacks control of the business.”

In Congel, the trial court looked to “fair value” jurisprudence in rejecting any minority discount, a ruling that faltered when the intermediate appellate court held that the fair value cases are irrelevant to partnership “value” under Partnership Law § 69, and adopted a whopping 66% minority discount based on the unrebutted testimony of the majority’s expert.

The only preserved issue before the Court of Appeals was whether minority discounts apply in the valuation of a minority partner’s interest after the partner exits the business that remains a going concern, i.e., the gargantuan size of the minority discount was not before the court.

Judge Fahey’s opinion, drawing upon the Massachusetts Supreme Judicial Court’s 2004 ruling in Anastos v Sable, agreed with the majority partners that:

the statute [Partnership Law § 69] 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. Given that the focus is on one partner’s interest in a persisting concern, we agree with the Massachusetts high court that a minority discount is applicable, because a minority interest is worth less to anyone buying that interest alone.

Judge Fahey also noted that New York has not adopted the 1997 Revised Uniform Partnership Act under which a wrongfully dissolving partner’s interest is valued based on the partner’s pro rata share of the partnership’s going concern value. Judge Fahey also distinguished the Court of Appeals’ 1995 ruling in Matter of Friedman v Beway Realty Corp. which rejected any minority discount under the fair value standard used in dissenting shareholder appraisal proceedings, as opposed to the fair market value standard under Partnership Law § 69. As Judge Fahey further explained:

[W]rongful dissolution of a partnership may happen at any time, and valuation of a partner’s interest occurs only if the remaining partners have agreed to continue their business as if nothing changed. Unlike shareholder dissent and appraisal, wrongful dissolution is not necessarily preceded by upheaval inimical to the position of the minority, so trial courts need not substitute a “fair value” for the actual value a third party would pay. Indeed, here the upheaval took the form of an action by a minority partner inimical to the majority’s interests. [Internal quotation marks and citation omitted.]

In an important footnote to his discussion of the minority discount, Judge Fahey cautioned that the court’s holding is not that the trial court was required to apply a minority discount, but only whether the application of a minority discount “in this case was contrary to law.”

Two judges dissented from this portion of the court’s opinion only. They criticized the majority opinion for failing to “advance an affirmative rationale” in support of its approach to the “piecemeal” sale of the dissolving partner’s interest. They opined that “it is not clear” what the drafters of the Uniform Partnership Act meant by “value” and that the majority gave undue meaning and weight to the Revised Uniform Partnership Act’s resolution of the ambiguity by explicitly defining the buyout price without application of a minority discount. The dissenters also opined that the rationale for a minority discount disappears “where the actual purchasers of the minority interest are the remaining shareholders, rather than a hypothetical ‘willing buyer,'” i.e., the purchasers are “merely consolidating and increasing whatever degree of control they already have over the business rather than entering into a noncontrolling position.”

Goodwill Discount

Partnership Law § 69 (2) (II) provides that in ascertaining the value of the interest of a partner who has caused dissolution wrongfully, “the value of the good-will of the business shall not be considered.” In Congel, the lower courts ruled, and the Court of Appeals agreed, that the realty-holding partnership had goodwill value justifying a 15% reduction in value.

The minority partner argued unsuccessfully that goodwill does not exist in a real estate holding company — a position with which at least one highly regarded commentator agrees. Judge Fahey wrote that “the goodwill question is a factual one” as to which the Court of Appeals “is without power to review findings of fact if such findings are supported by evidence in the record.” Defining goodwill as an intangible asset reflecting value attributable to “patronage and the support of regular customers,” Judge Fahey concluded that the expert testimony and other evidence supported the trial court’s finding that “the shopping mall and the mall’s tenants attract regular, loyal shoppers and there is record support for the affirmed finding that the value of the Partnership included, in addition to its real property and cash, a goodwill component.”

Damages

Partnership Law § 69 (2) (a) II) also allows a deduction from value when the business is continued by the other partners for “damages caused to his copartners by the [wrongful] dissolution.” The lower courts accepted the majority partners’ argument that their recoverable damages included approximately $1.8 million in attorney and expert fees (including interest) incurred in litigating their wrongful dissolution lawsuit.

The Court of Appeals disagreed and vacated the fee award, holding that it “contradict[ed] New York’s well-established adoption of the American Rule that the prevailing litigant ordinarily cannot collect attorneys’ fees from its unsuccessful opponents” (internal quotation marks omitted). In so ruling, Judge Fahey distinguished between “on the one hand, legal fees incurred in prosecuting or defending a successful civil lawsuit and, on the other hand, legal fees, in the nature of damages, incurred in carrying out separate acts necessitated by the breach.” Driving home the point, he added that the majority partners’ approach:

would mean that fees could be awarded to the victorious party in any breach of contract litigation, as long as that party persuaded a court that it had to litigate the issue in order to avoid the consequences of defendant’s breach. Indeed, this purported exception would be so large as to swallow the American Rule.

The court nonetheless remanded the case to the trial court for recalculation of damages, stating that the majority partners, “if they so choose, may argue on remand that certain attorneys’ fees, not related to their lawsuit, were incurred as a direct result of [the minority partner’s] breach and should be included as damages,” such as fees incurred prior to the litigation totaling around $15,000 for legal advice and representation at partner meetings relating to giving assurances to the partnership’s lender as to the continuation of the business.

Closing Thoughts

The Court of Appeals’ Congel decision ends (or almost ends, subject to the damages recalculation) an amazing 11-year litigation saga that has taken multiple zigs and zags through the trial and appellate process. Its contract-centric approach to the question of wrongful dissolution offers a new mode of analysis and suggests new drafting solutions for transactional lawyers who, however infrequently in this era dominated by LLCs and other limited liability business entities, opt to use the general partnership form.

The court’s approval of marketability and minority discounts clearly brands Partnership Law § 69’s use of the term “value” as meaning fair market value, not fair value, but without compelling application of either discount, much less giving guidance as to the size of the discount in any particular case, which also can be said of the court’s approval of a goodwill discount for realty holding partnerships. In that sense, Congel did not materialize as the change agent it might have been for more frequent fair value appraisal litigation under Business Corporation Law sections 1118 and 623.

Finally, the court’s unsurprising disallowance of litigation expenses as recoverable damages under Partnership Law § 69 takes away significant incentive for commencing legal proceedings, and reduces negotiating leverage, that otherwise would exist for majority partners who continue the business following a wrongful dissolution.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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