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Divorce Mediation Blog

Same Sex Marriage Meets Civil Union Dissolution

Wednesday, August 01, 2012

In last week’s Massachusetts Supreme Judicial Court’s (SJC) case of Elia-Warnken v. Elia, the court ruled that a civil union from another state (Vermont in the facts of this particular case) is the legal equivalent of marriage when it interacts with our laws of marriage and divorce. The question arose: when a person became part of a civil union in a state that had not yet recognized the right of same sex marriage, and had not obtained a legal dissolution of that union before marrying here, does this constitute polygamy, making the Massachusetts marriage void. The answer was a clear “yes”.

In doing this, the SJC maintained a consistent view that it will not tolerate a continuation of the national practice (that is, in most states individually who do not recognize same sex marriage, and in federal law, where the Defense of Marriage Act (DOMA) precludes it for federal purposes, and exempts the states from having to acknowledge it) of domestic discrimination against gays and lesbians. The court reasoned that to treat civil unions as anything less than a marriage for our state’s purposes would do exactly that.

So, for a civil union partner to marry in Massachusetts he or she must dissolve one legal relationship before entering into another, whether the prior one be one that is called “marriage”, or a civil union. Strike a blow for marriage equity and against one fear mongered by those who continue to champion DOMA: that somehow same sex marriage will lead a creeping acceptance of polygamous marriage.

 

Three Important Massachusetts Valuation Cases

Saturday, March 17, 2012

Bernier v. Bernier (SJC) (448 Mass. 774 (2007)

In this groundbreaking case, the highest court of Massachusetts began the erosion of the “fair market value” standard for privately held businesses in divorce. The case involved two grocery stores on Martha's Vineyard, which the husband owned and operated; and critically, he had no intention to sell either property. The ownership form was and S Corporation, and he was the sole shareholder.

At trial, the husband’s expert witness followed the traditional route and, after deriving a value by using a “income” approach, he applied to discounts of 10% each: one being a “key man” adjustment, and the other for “lack of marketability”. The theory for the first discount was that as owner-operator, the loss of a husband would reduce the value of the business to a third party purchaser; and the second was based upon the reality that there is a limited pool of potential buyers for such a business. The wife's expert did not apply any discounts.

The trial judge accepted the wife’s proposed discounts and the husband appealed. The SJC agreed with the husband, and vacated the trial court valuation. The court's rationale stated, for the first time in our divorce jurisprudence, that the standard of value to be applied was not akin to that which a third party purchaser might pay for the business, but rather, what value was being retained by the owner as its holder, rather than as its seller. The court felt that this was appropriate because:

… where after divorce, the judge must take particular care to treat the parties not as arm’s-length hypothetical buyers and sellers in a theoretical open market, but as fiduciaries entitled to equitable distribution of their marital assets.

Thus, for the first time did a Massachusetts case suggest that the standard of value in divorce could be anything other than fair market value; and based on this premise most experts inferred that the SJC changed the standard of value to “fair value”, the standard applied to withdrawing shareholders in a statutory proceeding. To implement its rationale, the SJC then concluded that where the husband had no intention of selling the business, and where the value of the business to him was not jeopardized by his absence, neither discount should fairly apply, lest the court unfairly penalize the wife.

There were other aspects of this case, notably involving taxation adjustments for an S Corporation, but the trembling ground beneath the feet of divorce lawyers, valuation experts and business owners was caused by this unanticipated departure from the traditional standard of value, and accompanying reduced capacity to discount.

Adams v. Adams (SJC) 459 Mass. 361 (2011)

In this case, the SJC relied upon its previous decision in Bernier, reiterating the fiduciary theory of business property division in divorce, rather than that of the free market. Adams, however, was a far more complicated case involving the valuation of the husband's interest in the Wellington Management Company, LLP. The husband claimed that this partnership interest should be accorded no value in the division of assets, but should be viewed only as a stream of income, which the court might order support. The wife's expert calculated value based on the capitalization of earnings, a result that the trial court (by way of a master) essentially accepted. The husband appealed.

In a complex opinion, the SJC supported the conclusion of the trial court that the husband’s partnership interest was, indeed, a marital asset to be valued and divided. It rejected the notion that because the expected distributions were subject to some degree of uncertainty, that

… a divorcing spouse’s interest in a partnership that produces a consistent stream of profits, and reliably disperses those profits to the partner spouse over a period long enough to appraise the present value of the partnership interest fairly, is, in the discretion of the judge, assignable to the marital estate if it is inclusion would achieve a fair financial settlement.

The SJC then reviewed the valuation methodology advanced by the wife's expert and adopted by the trial court. The “capitalization of income” carried the day below, but not at the appellate level. Rather, the SJC concluded that because the husband’s partnership entitlement to the distributions was limited to a period of years, it was an abuse of discretion to capitalize income, as if it could be received perpetually. The SJC found, instead, that the trial court should have applied “some variant of the “discounted cash flow method”.

Again, there were numerous other aspects of the Adams opinion, but the SJC’s emphasis of its earlier Bernier holding, it’s affirmation of the trial court’s discretion to divide as property a partnership interest that consists of merely expected cash flow (as distinguished from an asset from which one might expect a yield upon liquidation or sale) and its willingness to wade in to the valuation methodology waters, were dramatic.

An important sidebar to this decision was the way in which the SJC handled the expected confidentiality of the information belonging to Wellington. The extreme level of detail regarding closely guarded Wellington financial information was duly noted, and caused the court to withdraw its opinion for several weeks, while it grappled with the fact that the information that it disclosed had been subject to impoundment orders entered by the lower court. After a period of reflection, the SJC decided to retrospectively amend lower court’s confidentiality orders to the extent of the disclosures that they (the SJC) had already made: a surprise, no doubt, to all of the Wellington partners; and a cautionary tale for all who rely upon impoundment orders of the trial court.

Caveney v. Caveney (Appeals Court) _____Mass. App. ____ (2012)

In Caveney, Massachusetts Appeals Court (an intermediate court between the trial court and the SJC) reviewed the first reported Massachusetts appellate divorce decision that involves two experts, both of whom claimed to apply the “fair value” standard instead of “fair market value”, in the wake of Bernier. In this case, the court was addressing a 24.75% non-voting interest that the wife held in three companies that her father had founded, and in which he had transferred equal interests to each of his four daughters (i.e., the father retained “control” despite gifting a 99% economic interest).

The wife's expert urged acceptance of the “assets” or “adjusted net asset method” as the most appropriate methodology for this particular company. Then, despite his purported use of “fair value”, he applied a 15% discount for lack of control because the wife's interest was a distinctly minority one; and he used a 30% discount for “lack of marketability”, presumably reasoning that the market for a quarter interest in the company otherwise held by a father and his remaining three daughters would attract a limited array of investors, at best. The trial judge accepted these opinions and the husband appealed.

The husband argued that the trial judge in this case had run afoul of Bernier, albeit within the application of the posited “fair value” standard. He drew a direct comparison to Bernier, noting that there was no imminent sale of the business contemplated and that, therefore, the lack of control and marketability discounts would unfairly deflate the value for equitable distribution purposes. The wife replied that her minimal interest in the company, and consequent total lack of control, made the interest essentially illiquid to her and thus worthy of the demanded discounts.

The appeals court agreed with the husband on the matter of the discounts, while acknowledging that the wife did not have the same level of control as did the husband in Bernier; but still finding the marketability of her interest to be of “little consequence” here. Noting that a “minority discount” (essentially lack of control) was not specifically at issue in Bernier, the Appeals Court wrote that the SJC had “made clear that such a discount “should not be applied absent extraordinary circumstances.””

The Appeals Court did not disturb the trial court’s acceptance of the net asset methodology, despite the husbands complaint, but without explanation.

Thus, the intermediate appellate court, where the vast preponderance of domestic relations cases are heard and disposed of, appears to have broadened Bernier by extending its “no discount” policy to non-controlling interests, simply because no sale is contemplated. Note: the sale of a closely held company is rarely contemplated in a divorce setting because the asset is generally the most significant source of income to the family. The business owner is often charged with support obligations based upon his or her earnings history from that very company, that most cases, the owner views as his or her optimal earning environment. It is interesting to note that the Caveney court could have, but did not choose to limit it’s holding to the specific facts of this case (as many believe the SJC attempted to do Bernier). The court could have noted that the close identity of interest among the father and his daughters made control irrelevant. And, perhaps, the court could have observed that a piecemeal sale of individual interests was so unlikely as to make marketability marginal as well.

Is Caveney the death knell of discounting business interest values in Massachusetts divorce matters?

 

What Is a Business Worth in Divorce When the Owner Plans to Keep It?

Tuesday, March 06, 2012

When dividing assets at divorce, one of the more challenging jobs is how to divide the value of a business that one or both of the parties owns. Usually, the business is the source of the family’s income, and after divorce, it will become the source of alimony and/or child support. Usually, also, the business owner-spouse does not plan to sell the business, at least not for a long while, because it is the best way for this person to generate income and, therefore, support. Often, this business owner doesn’t think that he or she will ever sell it, and may not even realize that the business is a “marital asset.”

Yet, the law defines the business as a piece of property to be factored into property division, so it has to be considered. How, then, do we figure out the value to be assigned? This generally done by use of what are called “experts”, most often accountants with special training in business valuation. In simplest terms, the expert (s) (either one hired by each spouse separately, or often in mediation for example, one jointly hired person) decide (in very simplified terms) to value the company by estimating the kind of income that the company may generate for the business owner in the future and how much another person or entity would pay for that expected income.

Then, historically, valuation experts would reduce the estimate just described by factors known as “discounts”. These were used to account for such factors as the lack of a large number of others prepared or desiring to buy a small company (called “marketability”), or in situations where the business owner does not own a large enough share of the company to control the company him or herself (called “lack of control”) or the belief that the business owner is personally critical to the success of the business (called “key man”). These discounts often reduced the value of the business owner’s property interest by 15 – 30 per cent.

This all began to change in 2007, when the Massachusetts Supreme Judicial Court (SJC) decided a case that involved a man who owned two grocery stores on Martha’s Vineyard, called Bernier v. Bernier. On appeal from a trial decision, the SJC learned that the business owner-husband had no intention of selling the business. Because of this, the court concluded that it was not fair to the wife to reduce the value by factors related to a sale, when a sale was not expected to occur. The SJC believed the real value that was relevant to the case was the value of the expected income to the husband himself in the future (since he was keeping the stores), and the value to a hypothetical buyer.

Many experts called this change in focus a shift from “fair market value” (what a buyer would pay) – the traditional value in divorce cases -- to “fair value” (what the future income is worth to the spouse keeping the business). Because fair value implies that no discounts should apply, the result is usually a higher value and results in the non-owner spouse receiving more of other property to offset this higher business value.

A very recent case, Caveney v. Caveney, supported this view. A trial judge applied discounts to reduce the value of the business owner-wife’s 24.75 per cent interest in a business run by her father. The husband appealed these discounts and convinced the Massachusetts Appeals Court (an intermediate court that hears many more divorce appeals than the SJC) that because “the sale of the business is not imminent” that the discounts were wrong. The Appeals Court reversed the trial judge’s decision. The Caveney Appeals Court actually referred to the use of the “fair value” approach, confirming in the minds of many that this is actually the value premise to be used in all cases in the future where a sale is not contemplated.

This blog entry is a very simplified discussion of these issues, which tend to be very complex and full of individual judgment. In mediation we discuss these concepts and others that are difficult and important. We also encourage clients to have independent counsel to help them understand and know how apply and respond to these issues. People’s sense of “fairness” is certainly affected by the side of the question the person finds him or herself. What do you think?

 



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