August 2010

State Courts Address Key Questions on Business Valuation in Divorce

Is a severe recession sufficient reason for a divorce court to revalue business assets? Does the statutory fair value standard preclude
marketability and minority discounts in divorce? Does the selection of a valuation date impact the value conclusion in divorce?

The following three recent divorce cases address these questions. Although these cases are not Arizona decisions, the issues presented are relevant and provide some interesting perspective.

An Unprecedented Recession

In Mistretta v. Mistretta, 2010 WL 547149 (Fla. App. 1 Dist) (Feb. 18, 2010), the trial court valued the parties’ restaurant at $845,000, based on expert appraisals conducted in 2007. Not long after the divorce was final, the husband filed a motion to reconsider. The husband claimed that the economic recession caused the restaurant to lose nearly $57,700 in 2008, and this “newly discovered evidence” merited a new trial and valuation. The trial court granted the motion, finding that the 2007-2008 recession was “totally unforeseen.”

The wife appealed, arguing that the economic downturn was merely a change in circumstance, and the appellate court agreed. Business valuation, the court reasoned, is a forward-looking exercise, based on financial facts currently in existence as well as projected revenues and cash flows.

“Economic recessions, like other vagaries in the business cycle, are contingencies appraisers must take into account in valuing a business,” the court said.

Although no valuation expert could have predicted the severe economic crisis, the trial court’s order did not explain why, on rehearing, these same experts were more likely to accurately predict future economic conditions.

“A cloudy crystal ball is no basis for a new trial,” the court held, and it denied the motion.

Application of Discounts and the Statutory Fair Value Standard

In Lemmen v. Lemmen, 2010 WL 454959 (Mich. App.) (Feb. 9, 2010), the husband owned a minority interest (25%) in a profitable, privately held oil and gas business with his brothers. The husband’s expert valued his interest at $5.5 million; the wife’s expert said it was worth $17.5 million.

The trial court rejected the husband’s valuation expert, finding that he incorrectly applied a discount rate to the company’s dividend stream rather than net cash flows. This left testimony from the wife’s expert, who declined to discount his $17.5 million value for lack of marketability or lack of control because the company enjoyed exceptionally strong cash flows, low debt, and a substantial cash base.

Four years prior to the divorce, however, the wife’s expert had valued the same company for one of the co-owners, applying a 25% minority discount and a 30% marketability discount. He did so only at the behest of the lawyers, the expert explained; it was not his general practice to discount the valuation of closely held stock. Nevertheless, the trial court applied the expert’s prior discounts to his current valuation in divorce and valued the husband’s 25% interest at $11 million. Both parties appealed.

The appellate court deferred to the trial court’s broad latitude to determine the value of stock in closely held corporations and accepted its valuations, including discounts. It also rejected the wife’s arguments that the statutory fair value standard should apply to divorce cases. One judge on the panel dissented, which may set the case for an appeal to the Michigan Supreme Court.

Emphasis on the Correct Date

In Goodwin v. Goodwin, 2010 WL 669244 (Tenn. App.) (Feb 25, 2010), the parties owned and operated a steel detailing business. The husband’s expert valued it at $385,000, excluding goodwill. Importantly, he valued the company as of the date the wife stopped working for the company as a bookkeeper, in 2007, and the husband took over sole operations.

By contrast, the wife’s expert concluded that the steel business was worth $1.65 million, valued as of December 31, 2008, just months before the parties’ trial. After considering the evidence and applicable law, the trial court adopted the value as calculated by the wife’s expert, and the husband appealed.

Resolving such a wide range of values is “one of the main roles of a trial court,” the appellate court said. The court noted that a trial court is free to value a marital business within the range of evidence presented, and “that is exactly what [this] court did.” The court went on to note that Tennessee law requires valuing a marital business as close as “reasonably possible” to the date of trial. Since the wife’s expert valuation was 19 months closer to this date than the husband’s, the wife’s evidence was more in line with the law, and the appellate court confirmed the lower court’s $1.65 million valuation. ■