In the past year our Advisory practice has seen frequent citations to the landmark case Zelouf International Corp., Petitioner v. Nahal Zelouf, Respondent1 in various business divorce matters in New York State court proceedings, where the fact pattern differs greatly from the facts of the Zelouf case. With the recent retirement of Judge Shirley Werner Kornreich, remembering the reasoning behind her decision in Zelouf is important because of the wider interpretation of why a market discount should be disregarded, particularly under New York State Business Corporation Law (BCL) Section 623.
It is well known from the Friedman v. Beway Realty Corp2 and Giamo v. Vitale3 cases involving real estate assets that “valuation is not an exact science, and it is the particular facts and circumstances of each case that will dictate the result.” Furthermore, the BCL provides no definition of fair value; there is only judicial guidance and no specific criteria provided by the court to determine the value of a presumed purchase price in appraisal rights cases.
With a thorough analysis of the trial record in Zelouf, the petitioners argued for and asked the court neutral (with the acquiescence of the respondents and the Court) to perform an alternative business valuation utilizing market discounts– to perform a non-marketable, controllable interest valuation. Meanwhile, the respondents identified numerous areas of corporate expenditure resulting in a six-page analysis and opinion by Judge Kornreich which influenced her ultimate decision as to whether the president, who was also the largest shareholder (with 50% ownership) and the key employee maintaining customer relationships, Danny Zelouf, would ever want to sell the business.
The facts and circumstances of the Zelouf case are so unique that the citing of this case should be carefully considered. First, prior to the commencement of the actual trial, existing company management attempted a freeze-out merger to negate the respondent’s standing in court. This was admitted to by the petitioners. Next, it was recognized that salaries were extraordinarily significant among the two owners who controlled 75% of the company, salaries and perks were paid to no-show employees including the mother of Danny Zelouf, there was a fleet of vehicles beyond the two that the court neutral appraiser normalized for, and there were further questions regarding the accuracy of the financial statements and the gross profit margins due to the accounting for inventory. All of this contributed to Judge Kornreich’s commentary that it was unlikely that Danny Zelouf would give up control of the company, and the respondents should not recover less due to the possible illiquidity costs in the event of a sale that is not likely to occur.
It is important to understand Judge Kornreich’s thinking, which was further espoused in her partial decision on partial re-argument dated December 22, 2014. In supporting her earlier ruling that no New York case stands for the proposition that a discount for lack of marketability must be applied and the fact that no New York appellate court has ever held that a discount for lack of marketability must be applied to a fair value appraisal, she stated:
“Fairness, in this court’s view, necessarily requires conceptualizing 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.”
Thus, any valuation professional or attorney representing parties in a business divorce should not assume that a market discount is applicable in each business valuation. All business valuation analyses should assess both the internal and external factors that influence the profitability, the cash flow, and the intangible value, if any, of a company. In the same vein, any citations to the Zelouf case should be cautioned by the unique facts of the case and the courts’ responsibility to apply concepts of fairness in their decisions.
*It should be noted that one of the authors of this article testified on behalf of the respondent in this matter.
1. Zelouf International Corp. v. Nahal Zelouf, 2014 NY Slip Op 52462, Index 653652/2013
2. Friedman v. Beway Realty Corp., 87 N.Y. 2d 161 (1995)
3. Giamo v. Vitale, 101 A.D.3d 523 (1st Dep’t 2012)