Zelouf International Corp. v. Zelouf

OPINION OF THE COURT

In this fair value proceeding, the parties each move for partial reargument of the court’s trial decision, which is set forth in an order dated October 6, 2014 (45 Misc 3d 1205[A], 2014 NY Slip Op 51462[U] [2014] [the Decision]). Familiarity with the Decision is assumed, and all defined terms used herein have the same meaning as in the Decision. For the reasons that follow, the court addresses the parties’ reargument applications on four issues (statute of limitations, total damages calculation, SEAM, and DLOM), denies reargument on all other matters, and adheres to the Decision on all issues except for the statute of limitations and total damages calculation.

*348At the outset, the court notes that it will not discuss in detail and hence denies reargument on its holding that Danny misappropriated $14 million from the Company between 2004 and 2010, a conclusion proven by Lesser’s forensic analysis of the MOD2 records and the Company’s financial statements. “A motion for leave to reargue . . . shall be based upon matters of fact or law allegedly overlooked or misapprehended by the court in determining the prior motion, but shall not include any matters of fact not offered on the prior motion.” (CPLR 2221 [d] [2]; see Mendez v Queens Plumbing Supply, Inc., 39 AD3d 260 [1st Dept 2007].) The court did not overlook any material law or fact with respect to Lesser’s analysis.

However, since the Decision was issued, another Commercial Division Justice issued a fair value decision in a case with striking similarities to the instant proceeding. (See Cortes v 3A N. Park Ave Rest Corp., 46 Misc 3d 670 [Sup Ct, Kings County, Oct. 28, 2014, Demarest, J.].) In Cortes, the company fought tooth and nail to avoid producing complete and reliable financial records in order to “hide the true value and the extent of [its] defalcation” (id. at 692), just as the Company here did with MOD2. Justice Demarest, therefore, allowed plaintiffs forensic expert to rely on a sample of the company’s records to establish the real value of the business. (See id. at 693 [“The defendants cannot be permitted to benefit from their purposefully inadequate record-keeping, as a means of concealing their diversion of funds, to defeat plaintiffs claims. The sole reason that the plaintiffs expert (extrapolated based on sampling) ... is because the defendants maintained such inadequate, and obviously fraudulent, records”].) Cortes, moreover, provides support for this court’s reliance on sophisticated forensic analysis to prove the existence of corporate value not reflected on the company’s financial records.

I. Statute of Limitations

In the Decision, the court erred by applying CPLR 214 (4)’s three-year statute of limitations to Nahal’s derivative claims. On reargument, Nahal correctly avers that the applicable statute is CPLR 213 (7), which provides a six-year limitations period for

“an action by or on behalf of a corporation against a present or former director, officer or stockholder for an accounting, or to procure a judgment on the ground of fraud, or to enforce a liability, penalty or *349forfeiture, or to recover damages for waste or for an injury to property or for an accounting in conjunction therewith.” (See Oxbow Calcining USA Inc. v American Indus. Partners, 96 AD3d 646, 651-652 [1st Dept 2012].)

In opposition, petitioner argues that CPLR 213 (7) does not apply because this is an appraisal proceeding under Business Corporation Law § 623, not a plenary derivative action. However, as noted in the Decision and the merger order, quasi-derivative claims are relatively unknown in New York. (See 2014 NY Slip Op 51462[U], *5 n 6.) Unsurprisingly, as a result, petitioner cites no case, nor does there appear to be any that holds CPLR 213 (7) does not apply to quasi-derivative claims in an appraisal proceeding.

This court holds that CPLR 213 (7) applies because, as discussed in the court’s prior decisions, the allowance of the merger was predicated on Nahal being able to assert her derivative claims in the instant proceeding. Hence, whatever derivative claims were not time-barred in the derivative action should not be deemed time-barred in this action. Since the derivative action was commenced in December 2009, Nahal is entitled to maintain derivative claims as far back as December 2003, six years beforehand. As a result, all of the derivative damages, from 2004 through 2010, are timely. Consequently, the court vacates its statute of limitations ruling in the Decision and holds that none of Nahal’s derivative claims are time-barred.

II. Total Damages Calculation

The court instructed the parties to submit proposed judgments after the reference on attorneys’ fees was completed. (See 2014 NY Slip Op 51462[U], *15.) In an attempt to avoid relitigation of the Decision at the judgment stage, the court thought it prudent to provide the parties with guidance on how the various categories of damages should be computed. This was a mistake. Rather than thoroughly discuss the exact amounts due, the court vacates its holdings on its damages calculations and defers the matter until after the reference is completed. To be clear, the court is also vacating its decision that prejudgment interest of 9% is necessarily required. Business Corporation Law § 623 (h) (6) provides that the court should apply an “equitable” interest rate.1 (See Matter of Jamaica Acquisition, Inc. v Shea, 25 Misc 3d 1212[A], 2009 NY Slip Op 52046[U], *27 [Sup Ct, Nassau County 2009].)

*350The parties’ motion practice over the Referee’s report shall include their position on the total calculation of damages and how much prejudgment interest is equitable. The briefing shall be limited to how much Nahal’s total award should be and its breakdown, but may not serve as yet another round of re-argument on the merits.

III. SEAM

In the Decision, the court held that an S-corporation equity adjustment multiple (SEAM) adjustment should not be made. (See 2014 NY Slip Op 51462[U], *6-7.) The court adheres to that determination and rejects Nahal’s additional arguments on the matter. The court only mentions SEAM because, as noted above, the court’s damages breakdown is vacated. The parties’ proposed judgments must utilize Vannucci’s valuation without a SEAM adjustment.

IV. DLOM

Finally, the court abides by its decision not to apply a discount for lack of marketability (DLOM). The factual basis for finding a DLOM inappropriate in this case is set forth in the Decision (see id. at *7-8) and will not be repeated here. However, given New York’s contentious DLOM jurisprudence and the persuasive opinions of the academic community and non-New York courts, this court believes the issue merits further discussion.

The court begins by noting that no New York appellate court has ever held that a DLOM must be applied to a fair value appraisal of a closely held company. On the contrary, the Court of Appeals has held that “there is no single formula for mechanical application.” (Matter of Seagroatt Floral Co. [Riccardi], 78 NY2d 439, 445 [1991].) Indeed, the Court of Appeals recognizes that “[v]aluing a closely held corporation is not an exact science” because such corporations “by their nature contradict the *351concept of a ‘market’ value.” (Id.) As set forth in the Decision, since Danny is not likely to give up control of the Company, Nahal should not recover less due to possible illiquidity costs in the event of a sale that is not likely to occur.2

In effect, applying a DLOM here would be the economic equivalent of imposing a minority discount — that is, Nahal realizing less for her shares because she is being forced to sell while Danny gets to realize their full value by staying in control. It is well settled that minority discounts are not permitted under New York law. (See Matter of Friedman v Beway Realty Corp., 87 NY2d 161, 169 [1995].) Indeed, it is the tension between the application of a DLOM, which is done in most cases but is not legally required, and the practical effect of a DLOM here serving as a minority discount, repugnant to New York courts and never allowed, that drives the court’s ruling.

Moreover, although the court is aware that this is a commercial part which strictly adheres to legal principles and does not decide cases based on sympathy, the Decision should make clear that nothing about how Nahal has been treated in any way resembles normative notions of fairness. Her husband was rendered comatose shortly after he complained about the controlling family members’ conduct, she and her husband were deprived of company medical insurance when she complained about the controlling family members’ conduct, her equity was taken from her on the eve of trial before a jury when the controlling family members effected a freeze-out merger, and, throughout it all, Nahal incurred millions of dollars of legal costs.

*352Finally, it should be noted that serious consideration ought to be given to arguments made by those who question the theoretical and empirical underpinnings of the premises behind DLOMs. (See generally Peter A. Mahler, New York Business Divorce, The Marketability Discount in Fair Value Proceedings: An Emperor Without Clothes? [July 11, 2011], http:// www.nybusinessdivorce.com/2011/07/articles/valuationdiscounts/the-marketability-discount-in-fair-value-proceedings-an-emperor-without-clothes/ [and links to other analysis therein]; see also Floor graphics, Inc. v News Am. Mktg. In-Store Servs., Inc., 546 F Supp 2d 155, 177 n 7 [D NJ 2008].) This is an area of heated debate in the legal and valuation communities, and more compelling appellate resolution of these issues would surely be welcomed by all.

Additionally, in other jurisdictions, courts have refused to apply a DLOM for various reasons in cases such as this. (See Lawson Mardon Wheaton, Inc. v Smith, 160 NJ 383, 402, 734 A2d 738, 749 [1999] [“We find most persuasive those cases holding that marketability discounts should not be applied in determining the ‘fair value’ of a dissenting shareholder’s share in an appraisal action”];3 Camino, Inc. v Wilson, 59 F Supp 2d 962, 971 [D Neb 1999] [applying a DLOM “would allow the ma*353jority to victimize the minority,” which is not allowed and is incompatible with a valuation of a corporation as a going concern]; Cox Enters., Inc. v News-Journal Corp., 469 F Supp 2d 1094, 1108-1109 [MD Fla 2006] [noting that in Florida, courts may apply DLOM, but it is not mandatory, and refusing to apply DLOM based on restricted stock study comparisons in lieu of actual evidence of illiquidity of company being valued], affd 510 F3d 1350 [11th Cir 2007]; Diluglio v Providence Auto Body, Inc., 1997 WL 839873, *2-3, 1997 RI Super LEXIS 40, *5-6 [Jan. 13, 1997, C.A. No. 89-0628] [Rhode Island Superior Court prohibits DLOMs and disagrees with New York’s interpretation of fair value]; accord Charland v Country View Golf Club, Inc., 588 A2d 609, 612-613 [RI 1991],)4

That being said, this court is not holding that a DLOM is necessarily legally inappropriate in valuations of closely held companies. Such a holding would be incompatible with binding New York precedent. Rather, in this case, under the unique set of facts set forth in the Decision, applying a DLOM is unfair. This court’s understanding of the applicable precedent is that, while many corporate valuation principles ought to guide this court’s analysis, this court’s role is not to blithely apply formalistic and buzzwordy principles so the resulting valuation *354is cloaked with an air of financial professionalism. (Cf. Agranoff, 791 A2d at 896 [“Although valuation exercises are highly dependent on mathematics, the use of math should not obscure the necessarily more subjective exercise in judgment that a valuation exercise requires”].) To be sure, sound valuation principles ought to be and indeed were utilized in computing the Company’s value (i.e., the court’s adoption of most of Vannucci’s valuation). Nonetheless, the gravamen of the court’s valuation is fairness, a notion that is undefined, making it a classic question of fact for the court. Fairness, in this court’s view, necessarily requires contextualizing the applicable valuation principles to the actual company being valued, as opposed to merely deciding a priori, and in a vacuum, that certain adjustments must be part of the court’s calculus. From this perspective, the court reached its conclusion that an application of a DLOM here would be tantamount to the imposition of a minority discount. Consequently, the court finds it fairer to avoid applying a minority discount at all costs rather than ensuring that all hypothetical liquidity risks are accounted for.5

Accordingly, it is ordered that the parties’ motion and cross motion for reargument are granted in part as follows: (1) the portions of the Decision regarding the applicable statute of limitations and total damages calculation are vacated and decided in accordance with the instant decision; (2) the court adheres to all other aspects of the Decision; and (3) judgment in this action shall only be entered after post-reference briefing is submitted in the manner described herein.