Bloomberg News

Empire State Building IPO Plan Nears Pivotal Test

April 26, 2013

Empire State Building IPO Plan Approaches Pivotal Court Test

Office and residential buildings stand around the Empire State Building in midtown Manhattan. Photographer: Andrew Harrer/Bloomberg

A 15-month effort to take New York’s Empire State Building public is approaching a crucial ruling in a legal challenge by investors who oppose the deal put together by the family that controls the iconic skyscraper.

On April 29, New York State Supreme Court Justice O. Peter Sherwood may decide whether unit-holders who object to the transaction can be bought out for $100 a share, as proposed in the plan. He previously said he could throw out the votes the Malkin family has already received approving the plan if he determines the provision is illegal. Sherwood is also set to hold a hearing on a $55 million class-action settlement that is opposed by some of the tower’s more than 2,800-plus investors.

“This represents a kind of watershed moment for the case,” David Reiss, a professor of real estate finance law at Brooklyn Law School, said in an interview.

The Malkins’ proposal (ESB:US) for the second-biggest initial public offering of a U.S. real estate investment trust on record has faced challenges by investors, and both sides are fighting to bring the few remaining votes to their side. Peter Malkin, Malkin Holdings LLC’s chairman, and his son Anthony, its president, said on April 3 that shareholders representing about 75 percent of the skyscraper’s 3,300 ownership units had voted in favor. They need 80 percent approval to move ahead and have been calling holdouts individually to urge their support.

The Malkins said last month they would leave voting open until Sherwood rules on the $100-a-share buyout or until May 2, the scheduled date for the hearing on the class-action settlement.

New REIT

Empire State Realty Trust Inc., as the new company would be called, is seeking to raise about $1 billion for the REIT, which would include the 102-story tower and 20 other properties the Malkins supervise. Only the 2006 debut of Santa Monica, California-based Douglas Emmett Inc. (DEI:US) was bigger in the industry, at $1.6 billion, according to data compiled by Bloomberg.

The dissidents say a conversion to a REIT would mean giving up a reliable income stream that should rise when renovations at the skyscraper are finished. The Malkins have said their plan would give unit-holders liquidity, regular dividends and greater growth opportunities. Some investors are also questioning more than $300 million in shares the Malkins would potentially receive under the deal.

At the end of 2012, the skyscraper was about 69 percent occupied, with such tenants as LinkedIn Corp., the Federal Deposit Insurance Corp. and Coty Inc., according to the building’s annual report.

With the $100 buyout issue, investors have claimed that the provision coerces them to vote in favor of the REIT because their units are potentially worth more than $300,000 each.

‘Fair Value’

Holders are entitled under New York state law to the “fair value” of their shares, regardless of how they vote, Stephen Meister, an attorney representing opponents of the class-action settlement tied to the plan, said in a March 15 court filing. He said it’s obvious “that $100 is not the fair value of a participation worth thousands of times that nominal sum.”

Opponents can avoid being bought out if they change their vote to “yes” within 10 days after receiving written notice that the 80 percent approval has been achieved, a time frame Meister called “impermissibly short.”

In defending the proposal, Thomas E.L. Dewey, an attorney representing Malkin Holdings, said the dissenters “misrepresent essentially every relevant fact concerning the allegedly punitive buyout” and have provided no evidence that any unit-holder has been coerced. The provision is necessary to prevent small minorities from thwarting the wishes of most investors, according to Dewey. It was fully disclosed and agreed upon when the partnership was formed in the 1960s, he said.

Dissident Campaign

The opponents are connected with a group who have “waged a campaign of distortion and misrepresentation against the transaction,” Dewey wrote in an April 8 court filing. “These individuals will do or say anything to stop, delay or complicate” the offering.

He was referring to conference calls and other efforts coordinated by investors including Richard Edelman of Solana Beach, California, a grandson of an original unit-holder. In letters to investors, the Malkins have accused Edelman, who operates a website critical of the plan, and others of lying in their attempts to persuade shareholders to reject the REIT.

The law cited by Meister, a 1994 measure that governs limited-liability companies, protects just “members” of Empire State Building Associates LLC, the tower’s owner, and the only official members are Peter and Anthony Malkin and Thomas Keltner, its general counsel, Dewey said.

Share Dispute

Another issue raised by investors is whether the Malkins should be allowed to collect stakes in the REIT valued at about $304 million based on an appraisal of the properties done last year. The value might decline both in dollar amount and by percentage if the IPO prices lower than estimated, according to the prospectus. The Malkins have said they are entitled to the shares because transferring the buildings to the trust is a “capital transaction” akin to a property sale, which under earlier investor agreements would trigger the so-called overrides.

The interests equal about 10 percent of the exchange value of units held by Empire State Building investors who consented to the overrides.

Former Partner

Two former partners in the Malkins’ law firm, who are also Empire State Building unit-holders, don’t agree the Malkins are entitled to the overrides. They contend the proposal shifts assets from one Malkin Holdings-controlled entity to another and violates past contracts with the co-investors.

The overrides are “an improper and indefensible confiscation of ownership rights in contravention of all understandings and expectations,” Robert Machleder, 73, wrote in a February letter to Peter Malkin. Machleder worked in the Wien Malkin & Bettex law firm from 1966 to 1994.

Another former Wien partner, Robert Gelfman, concurred with Machleder and raised a similar objection to $31 million in overrides from 60 E. 42nd St., formerly known as the Lincoln Building. The office tower, across from Grand Central Terminal, is the second-most valuable property proposed for the REIT.

Machleder said a 1991 agreement approved by investors representing 81 percent of the Empire State Building units, and a follow-up 10 years later, never explicitly said that conversion to a REIT could trigger the 10 percent payout. The term “capital transaction” meant an outright sale of the building to a third party, a refinancing, creation of a joint venture or money received if the property were condemned, he wrote.

Ordinary Words

Because the participants, mostly retirees and second- and third-generation holders, are unsophisticated in high-end real estate investing, ordinary meanings of words should apply, Machleder wrote.

“The terms of the consent were not negotiated by those whose consents were solicited,” he said in the letter. “Ambiguity, vagueness and uncertainty will be construed against the supervisor as the drafter of the documents.”

“There is no ambiguity,” the Malkins’ attorneys said in a memorandum responding to Machleder’s letter. The REIT “intends to acquire, directly or indirectly, the right, title and interests” of the properties involved, including the Empire State Building, they wrote.

Independent Board

The REIT would be governed by an independent board of directors and not be controlled by the Malkins, the attorneys said. Anthony Malkin would be its chief executive officer.

The Malkins’ voting stake would be between 30.4 percent and 20.2 percent depending on which classes of shares the unit-holders take, according to the prospectus.

George Leder, an investor in the Empire State and Lincoln buildings who voted in favor of the IPO, said he was delighted with the Malkins’ plan to convert his units into REIT shares and that he never gave the overrides any thought.

“It’s a great way to get a market value for my investments,” he said in an interview. “There was never any ambiguity to me. It was definitely a sale. I know there were overrides involved in any sale of a Wien building, so it wasn’t a surprise to me.”

Very Common

The proposal was a “very common structure throughout the ’80s” as a means of compensating investment sponsors for the profits they made for their investors, said James Kuhn, president of brokerage Newmark Grubb Knight Frank and a former partner of Bernard Mendik, who put together deals similar to those done by Lawrence Wien. Wien led the original syndication of the Empire State Building with fellow real estate investor Harry Helmsley in the early 1960s.

Kuhn has no interests in the Empire State Building or other Malkin properties. Newmark is the tower’s leasing agent.

While the overrides are probably legal under the prior agreements, they fail to adhere to best corporate-governance practices, said Paul Hodgson, an independent compensation analyst based in Camden, Maine.

From a “moral standpoint,” unsophisticated investors would expect that a capital transaction means “a sale to a third party rather than a rollover like this is,” Hodgson said in an interview. To understand that a capital transaction might include a REIT transition “would rely on everybody having read all of the small print in the agreement, which is highly unlikely. Even sophisticated shareholders don’t always read” the entire prospectus, he said.

‘Modern Governance’

The overrides “are valid and triggered by the proposed transaction,” Hugh Burns, a spokesman for the Malkins with Sard Verbinnen & Co., said in an e-mailed response to Hodgson’s comments. “The successful conclusion of the proposed consolidation and subsequent IPO as a REIT will bring to all investors, including the Malkin family, modern governance.”

Malkin Holdings estimated that it would spend $75 million on the IPO effort, according to the prospectus, and the only way that money will be returned to investors is if the REIT goes through.

If the hearings go in the Malkins’ favor, “they are going to face very few legal challenges to creating the REIT,” said Reiss, the Brooklyn Law School professor. “And if it goes against them, I see delay in the future. I see further hearings, further lawsuits, further challenges.”

The case is Meyers v. Empire State Realty Trust Inc. (ESB:US), 650607/2012, New York State Supreme Court, New York County (Manhattan).

To contact the reporter on this story: David M. Levitt in New York at dlevitt@bloomberg.net

To contact the editor responsible for this story: Kara Wetzel at kwetzel@bloomberg.net


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