The Second Appellate District of the California Court of Appeal has upheld a 27% discount in the purchase of a minority interest of an 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. The case, Cheng v. Coastal L.B. Associates, LLC, involved a 25% membership interest of a Member who had filed for dissolution. Corporations 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 a 27% discount to the minority interests of the LLC. The trial court confirmed the appraiser’s valuation, and the confirmation 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 a fractional interest. The court determined that minority discounts for less than 50% of that given asset in an entity typically referred to as “discounts for lack of marketability and control” were appropriate. 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.

For the buying members, this reflects a significant benefit in using an LLC rather than 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. However, what is appropriate for your business may vary. Be sure to consult with legal counsel to assure any changes are necessary and, if they are necessary, to make sure the changes will help the company realize its goals in dealing with the sale of minority interests in dissolution.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.