Business Law

Court Finds 27% discount in purchase of LLC Interest

In one of the first cases decided under the California Revised Uniform Limited Liability Act, the Second Appellate District of the Court of Appeal upheld a 27% discount in the purchase of a minority interest of the LLC to halt an action for dissolution.  The case is one of the first to test the definition of “fair market value” under Corporation Code Section 17703.03.  Cheng v. Coastal L.B. Associates, LLC, 2021 DJ DAR 9883 involved a 25% membership interest of a Member who had filed for dissolution.  Corporation Code Section 17707.03 allows the remaining members to halt a dissolution if they agree to purchase the complaining member’s interest at fair market value.  The LLC held a single tenant industrial building whose five year lease was to expire in three years.  The court appointed three appraisers who submitted a joint report applying at 27% discount to the minority interests of the LLC.  The trial court confirmed the appraiser’s valuation and which was affirmed by the Court of Appeals.

The court found that the appraisers’ relied in part on Revenue Ruling 59-60, 1959-1 C.B. 237, which requires discounts when valuing fractional interest.  The court determined that minority discounts for less than 50% that given assets in an entity typically referred to as “discounts for lack of marketability and control” were appropriate.  Importantly the court rejected the standard found in Corporation Code Section 2000 that requires a shareholder who purchases stock to avoid dissolution in a closely held business to pay “fair value” which does not permit a lack of marketability and control discounts.  The court noted the difference between “fair value” with respect to corporate dissolutions of “fair market value” with respect to LLC dissolutions.  Fair value is effectively the liquidation value as of the valuation date but taking into account the possibility, if any, of the sale of the entire business as a going concern in liquidation.  Mart v. Severson (2002) 95 Cal.App.4th 521, 526.  In many respects, for the buying members this reflects a significant benefit in using an LLC rather a corporation.  The result may lead to corporations converting into or merging with LLCs filing a check the box election to be taxed as a C or S Corporation and being a state law LLC taxed as a corporation for federal and state tax purposes.

Author: Phil Jelsma, of Crosbie Gliner Schiffman Southard & Swanson LLP, pjelsma@cgs3.com

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