Take nothing for granted in divorce cases

Nothing is a sure win in divorce court. Each state has its own laws governing equitable distributions, which permit family court judges significant leeway in allocating assets and support.

When the parties leave business valuation issues to the discretion of family courts, they risk unexpected outcomes and inequitable allocations. This draws out the divorce process and incurs additional professional fees on appeal.

Out-of-court settlements preclude courtroom surprises. But if court is unavoidable, it’s imperative that the parties review relevant state statutes and case law — in and out of their jurisdiction — to prevent potential hang-ups.

Goodwill - One of the most common areas of discrepancies in divorce valuations is the proper treatment of goodwill. Most states require valuators to appraise goodwill and split it into two components: personal goodwill and business goodwill. In these jurisdictions, the former is a personal asset, excluded from the marital estate. The latter, along with the company’s tangible value, may be subject to division in a marital dissolution.

But not all states agree with the majority view. Idaho recently joined a smaller group of states that make no distinction between personal and business goodwill. Instead, these states include all goodwill in the divisible marital estate.

In Stewart v. Stewart, the Idaho Supreme Court ruled that the personal goodwill of the husband’s dermatology clinic (valued at approximately $211,000) was marital property. The court found “no principled reason to treat the goodwill of a business differently when it is a professional service.”

Accordingly, it refused to “enter the morass of trying to draw a distinction between the value attributable to a professional practice by virtue of the individual attributes of the professional and the value of goodwill not attributable to those personal assets, valuing each separately, and then dividing the latter but not the former.”

A small number of states also refuse to enter this “morass” by specifically excluding all goodwill from the marital estate. When addressing the goodwill conundrum, it’s common to look outside a divorcing couple’s state’s jurisdiction for guidance — especially if little or no relevant case law exists.

Buy-sell agreements - Many businesses have legal contracts that protect against unexpected events, such as the death or disability of an owner. In addition, these agreements may establish the terms of a voluntary buyout. When valuing a business for divorce purposes, the question arises: Does the buy-sell agreement provide evidence of the company’s value?

The answer varies from one jurisdiction to the next. For example, in Barton v. Barton, the Georgia Supreme Court recognized that “the buy-sell price in a closely held corporation can be manipulated and does not necessarily reflect true market value.” (For a closer look at another case, see “Buy-sell agreements: Evidence of value in divorce?” at right.)

Parties who rely solely on buy-sell agreements to determine business valuation may get burned. But buy-sell agreements — along with other documentary evidence — are integral to valuators’ analyses.

Reasonable compensation - Equitable asset allocations and support payments require estimates of reasonable compensation for the monied spouse. Compensation studies — such as those published by the U.S. Department of Labor or the Wall Street Journal — are popular resources for estimating reasonable compensation. Although divorce courts have accepted these studies in countless cases, some situations require valuators to dig deeper.

For instance, in In re Marriage of Ackerman, the wife’s accountant used the Medical Group Management Association’s Physician Compensation and Production Survey to estimate a range of reasonable compensation of $291,000 to $355,000 for her husband, a plastic surgeon in Newport Beach, Calif. Conversely, the husband’s expert used the American Medical Association’s Physician Socioeconomic Statistics surveys to arrive at a reasonable compensation estimate of $515,000.

But the court was not persuaded by either expert’s testimony, opining that neither compensation study was “sufficiently fine-tuned and honed in our area to be particularly valuable.” Applying its own quality control, including an informal survey of local plastic surgeons performed by the husband’s expert, the court determined that reasonable annual compensation was approximately $544,000.

Valuation expertise - One aspect of divorce valuations seems universal: Family court judges prefer independent appraisal expertise and thorough analysis. When divorcing business owners (or their spouses) fail to present adequate valuation evidence, they put themselves at the mercy of the court. A professional appraisal can save time, money and frustration over the long run.

Buy-sell agreements: Evidence of value in divorce? - In one landmark California case, In re Marriage of Nichols, a law firm’s value was based on the buy-sell formula, to which the firm had strictly adhered in past transactions. This divorce case lists three criteria to consider when deciding whether to use a formula set forth in a buy-sell agreement as evidence of value in a divorce case:

1. Proximity of the date of the buy-sell agreement to the date of separation (to ensure the agreement was not entered into in contemplation of marital dissolution),
2. Existence of an independent motivation for entering into the buy-sell agreement, such as a desire to protect all partners against the effect of a partnership dissolution, and
3. Whether the value resulting from the agreement’s purchase price formula is similar to the value produced by other approaches.

Adhering to these criteria can help prevent potential problems in using a buy-sell agreement formula in marital dissolution proceedings.