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?