The New York Court Of Appeals To Review Partner Dissolution Case

• Posted on: Feb 1 2017

Last year, the Appellate Division, Second Department, affirmed and modified in part a post-trial judgment against a former minority partner who wrongfully dissolved a general partnership. Congel v. Malfitano, 141 A.D.3d 64 (2d Dep’t May 18, 2016). In a case of first impression in the Department, the Court found that, under Partnership Law § 69(2)(c)(II), a “minority discount” may be applied to the valuation of a minority partner’s interest to reflect the lack of control the partner has in the operations of the partnership.

On January 10, 2017, the New York Court of Appeals agreed to review the Second Department’s decision.

Factual and Procedural Background:

In 1985, the parties to the action entered into a written agreement to form the Poughkeepsie Galleria Company Partnership. The purpose of the partnership was to own and operate the Poughkeepsie Galleria Shopping Center, a 1.2 million square foot shopping mall. The defendant, Marc. A. Malfitano (“Malfitano”), was a general partner who owned a 3.08% interest in the partnership. By letter dated November 24, 2006, Malfitano advised his partners that he was dissolving the partnership due to a fundamental breakdown in their relationship.

In 2007, Robert J. Congel (“Congel”) and the other members of the partnership’s executive committee (the “Plaintiffs”) sued Malfitano, alleging that he had wrongfully dissolved the partnership in violation of the partnership agreement, and that he had done so in order to force the partnership “to buy out . . . his interest at a steep premium.” The Plaintiffs sought, among other things, to recover damages for breach of contract, and a judgment declaring that Malfitano wrongfully dissolved the partnership. In his answer, Malfitano asserted a counterclaim against the Plaintiffs pursuant to Partnership Law § 69 (2)(c)(II), which provides, among other things, that in the event of a wrongful dissolution, if the partners who have not caused the wrongful dissolution elect to continue the partnership’s business in the same name, the partner who has caused the wrongful dissolution shall have “the value of his interest in the partnership, less any damages caused to his copartners by the dissolution, ascertained and paid to him in cash . . . .”

Thereafter, Malfitano moved to dismiss the complaint for failure to state a cause action, arguing that, under Partnership Law § 62(1)(b), he was permitted to dissolve the partnership because it was dissolvable at-will and indefinite in duration. The Supreme Court, Dutchess County, denied Malfitano’s motion, and the Second Department affirmed, reasoning that the partnership agreement provided that the partnership would be dissolved upon a majority vote of the partners and, therefore, it had a “definite term” within the meaning of Partnership Law § 62(1)(b). As such, the partnership was not dissolvable at-will.

In a separate decision, on May 28, 2009, the Supreme Court granted the Plaintiffs’ motion for summary judgment, finding that Malfitano wrongfully dissolved the partnership and breached the partnership agreement, thereby entitling the Plaintiffs to damages. The Second Department later affirmed the ruling, concluding that the terms of the partnership agreement were clear and unambiguous, reiterating that the partnership was not an at-will partnership, and determining that Malfitano dissolved the partnership in contravention of the partnership agreement. See Congel v. Malfitano, 61 A.D.3d 810, 811 (2d Dep’t 2009).

Subsequently, the Supreme Court conducted a non-jury trial to determine the amount that Malfitano would be entitled to recover for his partnership interest, and the amount of damages the Plaintiffs incurred as a result of the wrongful dissolution.  After considering expert testimony from both parties, the Supreme Court determined that the value of Malfitano’s interest in the partnership, minus the damages to the Plaintiffs caused by his wrongful dissolution of the partnership, was $857,164.75 – a fraction of the $4,850,000 the parties had stipulated was the unadjusted value of Malfitano’s total interest in the partnership as of November 24, 2006, the date of the wrongful dissolution of the partnership. In reaching this determination, the court applied, among other things, a 15% discount for goodwill, and a 35% discount to account for the limited marketability of Malfitano’s interest. However, the court declined to apply a minority discount (intended to reflect the lack of control that a minority partner holds in the partnership), concluding that it was not permitted to do so based upon case law involving the valuation of a minority shareholder’s stock in a close corporation. See BCL Sections 623 and 1118.  The court also reduced the award by the amount of legal expenses it determined had been reasonably incurred by the Plaintiffs due to Malfitano’s wrongful dissolution of the partnership.

The parties appealed and cross-appealed the judgment.

The Second Department’s Decision:

On appeal, the parties advanced two primary issues: whether the Court should revisit its prior determination that he wrongfully dissolved the partnership in light of a recent New York Court of Appeals decision; and whether the Supreme Court should have applied a minority discount. As discussed below, the Court rejected the former and agreed with the latter.

Whether to Revisit the Wrongfulness Determination

Malfitano argued that the Court should overturn its prior determination that he wrongfully dissolved the partnership in light of the Court of Appeals’ decision in Gelman v Buehler, 20 N.Y.3d 534 (N.Y. 2013), which was decided after the Court made its determination on this issue. In Gelman, the parties entered into an oral agreement to continue a partnership until the partners found a business with growth potential, acquired it, and increased its value until it could be sold at a profit. The Court of Appeals held that this agreement did not contain a “definite term” of duration or a “particular undertaking” to be achieved within the meaning of Partnership Law § 62(1)(b), and was thus dissolvable at will. The Second Department rejected this argument.

The Second Department found that Gelman was distinguishable because it involved an oral agreement that lacked a definite term of duration. By contrast, in Congel, the partnership agreement was written and contained a specific provision that precluded a single partner from dissolving the partnership without a majority vote. Consequently, the partnership was not dissolvable at-will by a single partner.

Procedurally, the Court held that its initial determination that the dissolution was wrongful was “law of the case” and foreclosed reexamination notwithstanding the later decided Gelman case.

Minority Discount

As noted, the Court concluded that the Supreme Court erred by not applying a minority discount to the value of Malfinato’s partnership interest. In rejecting the Supreme Court’s holding, the Court found that the lower court’s reliance on cases concerning the rights of minority shareholders in close corporations was misplaced. It explained that those cases involved claims under Business Corporation Law § 623, which allows minority stockholders to withdraw from a corporation and be compensated for the “fair value” of their shares when the majority takes action that is inimical to the minority shareholder, and Business Corporation Law § 1118, which provides that, following a minority stockholder’s petition for dissolution for oppressive majority conduct, if the corporation elects to purchase the minority stockholder’s interest, it must pay the minority shareholder fair value.

The Court reasoned that the concerns expressed in those cases were not implicated in a case involving the wrongful dissolution of a partnership pursuant to Partnership Law § 69(2)(c)(II).  For starters, Congel did not “involve a determination of the ‘fair value’ of a dissenting shareholder’s shares pursuant to Business Corporation Law §§ 623 and 1118, but rather, involve[d] the determination of the ‘value’ of the shares of a partner who has wrongfully caused the dissolution of a partnership pursuant to Partnership Law § 69(2)(c)(II).” Moreover, even if the Business Corporation Law governed the outcome, applying a minority discount to Malfinato’s interest would not contravene any of the objectives provided in the statute – that is, it would not treat holders of the same class of stock differently, undermine the statutory protection for shareholders from being forced to sell at unfair values, or encourage oppressive majority conduct.

The Court found support in a decision by the Massachusetts Supreme Judicial Court, Anastos v. Sable, 443 Mass 146, 819 NE2d 587, in which the court interpreted a partnership statute identical in all relevant respects to Partnership Law § 69. In Anastos, the court held that it was proper to apply a minority discount in order to determine the market value of the partner’s minority interest in a going concern, rather than determining the partner’s proportionate share of the liquidation value of the partnership’s assets. In Anastos, the plaintiff and the defendants were members of a partnership formed to own and operate a manufacturing facility. After the plaintiff dissolved the partnership in contravention of the partnership agreement, the defendants elected to continue the partnership business rather than liquidate.

In affirming the lower court’s determination to apply a minority discount, the court stated:

In this case, the remaining partners chose to exercise their statutory right to continue the partnership business for the remainder of the partnership term, so the partnership business is not winding up and must therefore be treated as a going concern. Because the plaintiff cannot compel liquidation of the business at the point of dissolution, we read [Massachusetts G.L. ch. 108A § 38(2)(c)(II)] as offering a nonliquidation based method of calculating the value of his partnership interest. The statute’s exclusion of good will from the valuation of the wrongfully dissolving partner’s interest supports this reading, as good will is an asset only if the partnership business is a going concern. Were it meant to regard the partnership business as assets to be liquidated, good will need not have been mentioned.”

Applying the reasoning from Anastos, the Second Department concluded that since the partnership was a going concern and Malfitano did not have a right to compel the partnership to liquidate its assets, he was not entitled to receive a proportionate share of the liquidation value:

Here, as in Anastos, 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. Under these circumstances, a minority discount may properly be applied to account for the defendant’s lack of control in the partnership as a going concern.

Accordingly, the Court remanded the case to the Supreme Court to apply a 66% minority discount – a figure the Court drew from the Plaintiffs’ expert, who was deemed to be credible and supported by the record – to the value of Malfinato’s interest.

(Note: At trial, the Plaintiffs’ expert testified that, in determining the fair market value of Malfinato’s 3.08% partnership interest, a minority discount should be applied to reflect the lack of control that a minority owner has in the operations of the partnership and that, based on a variety of factors, including sales of comparable interests and provisions in the partnership agreement restricting the rights of minority owners, the appropriate minority discount was 66%. Malfinato’s expert did not offer any minority discount analysis or computation. As explained in the decision, the expert testified that, although a minority discount “would ordinarily be applied to determine the fair market value of the defendant’s interest, he did not apply a minority discount in his valuation in this case because he ‘was advised, under the relevant statutes, that a minority discount was not applicable.’”)

Takeaway:

The Court of Appeals has been asked to consider three issues:

• “Did the Appellate Division’s decision determining that Malfitano engaged in a wrongful dissolution of the Partnership based on its finding that the Partnership Agreement contained a “definite term” conflict with Court of Appeals precedent?”
• “Did the Appellate Division create a conflict with the other Departments when it ruled that counsel fees were recoverable by a prevailing partnership in a breach of contract action contesting a minority partner’s notice of dissolution under Partnership Law § 62(1)(b)?”
• “Did the Appellate Division err in applying a minority discount, a marketability discount, and a goodwill reduction when determining the value of a minority partner’s interest under Partnership Law § 69(2)(c)(II)?”

If the Court of Appeals agrees with Malfitano that the he did not wrongfully dissolve the partnership, then the damages issue (e.g., the attorney’s fees and goodwill reduction) and presumably the minority discount issue would be moot. If, on the other hand, the Court finds that Malfitano wrongfully dissolved the partnership, then it would have to address each of the damages, goodwill, and discount issues.

The Court of Appeals will likely hear argument sometime this year.  Whatever the outcome, the decision will have important ramifications for partnership law in the state of New York

Tagged with: Business Litigation, Complex Litigation