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DOUBLE TROUBLE – The Appellate Court’s Decision in Steneken Misses the Mark on the Double Dip

by

Charles F. Vuotto, Jr., Esq.
Lisa Steirman, Esq.

2004

 

                        Just as the tidal wave created by Brown[i] was beginning to subside among the matrimonial legal community, the recent decision in Steneken[ii] has arrived to create some waves of its own and further muddy the already cloudy waters concerning business valuations in divorce and their inter-play with spousal support.  This article discusses the manner in which the Steneken Court addressed the concept of the “double-dip and the ramifications thereof.  The “double-dip” refers to the double counting of a marital asset, once in the property division and again in the alimony award.  More specifically, where a court uses a business owner’s “excess earnings” to value the interest in the business and also fixes support on that spouse’s total income (inclusive of the “excess earnings” used to value the business), a “double-dip” occurs.  The tacit acceptance (by some) of a rule against the “double-dip” served to ameliorate the harsh result of distributing undiscounted business values while also fixing alimony on the same income stream used to value a business.  However, the recent decision ofSteneken, has submerged the availability of a rule against  the “double-dip”.  As will be demonstrated in this article, the decision in Steneken is based on a misunderstanding of valuation theory and therefore incorrectly diminishes the “double-dip” effect.  

The Decision

                        This matter involved a twenty-four year marriage with three children, where the single largest asset was the husband’s interest in Esco Corporation.  The Appellate decision discussed herein arose from the husband’s appeal of the trial court’s February 24, 2003 order increasing alimony to $66,000 per year, which was entered as a result of a remand from the Appellate Court after the wife appealed the initial judgment.  The trial judge’s initial ruling accepted the business valuation of the owning spouse’s expert, who calculated a capitalization rate of twenty-four percent for the business and applied that rate to the business’s average annual income, which was adjusted to reflect a ‘reasonable’ annual salary for the husband of $150,000 per year[iii].  Using the same compensation level (i.e., $150,000 per year), deemed ‘reasonable’ for purposes of valuing the business, as opposed to the husband’s actual income, the trial judge awarded the wife alimony in the amount of $48,000 per year[iv].  The wife appealed the trial judge’s initial rulings as to the amount of permanent alimony, equitable distribution and the value of Esco.  On appeal, the Appellate Court affirmed the trial court’s valuation and distribution of 35% of the value of the business to the non-owning spouse, but remanded the issue of alimony, declaring that the record was unclear as to why the trial judge based alimony on the owning spouse’s reasonable compensation of $150,000 per year[v].  On remand, the trial judge interpreted the Appellate Court’s decision as mandating that alimony be based on the owning-spouse’s actual yearly income, rather than reasonable income, which resulted in the trial judge increasing the award of alimony to $66,000 per year[vi].  The husband then moved for a reconsideration of the decision, arguing the impermissible use of a “double-dip”.  That motion for reconsideration was denied, leading to a second appeal.  At issue on this second appeal was whether the trial court had mistakenly ‘double-dipped’ by valuing a business based on the owning spouse’s excess salary and then calculating an alimony award based on the same excess salary that was already added back to the business to arrive at its value[vii]. Concluding that there was no error with the trial court’s decision, the Steneken Appellate Court relied heavily, if not entirely, on its determination that the excess salary added back into the value of the business constituted the owning spouse’s past, rather than future, earnings.  Based on this determination, the Appellate Court reasoned that since only the owning spouse’s past income had been actually distributed in the equitable distribution of the business, the owning spouse’s future income stream had not been distributed.  Based on this premise, the Appellate Court concluded that it was equitable to utilize these future earnings when calculating the owning spouse’s alimony obligation[viii].  Unfortunately, the conclusion reached by the Appellate Court relies upon a mistaken premise of valuation theory. 

Basic Valuation Theory

                        The value of a business is equal to the present worth of the future benefits of ownership[ix].  This statement is a fundamental principle of business valuation.  This is bolstered by the fact that, “a rational buyer normally will invest in a company only if the present value of the expected benefits of ownership are at least equal to the purchase price.  Likewise, a rational seller normally will not sell if the present value of those expected benefits is more than the selling price.  Thus, a sale generally will occur only at an amount equal to the benefits of ownership[x].

An Impermissible Double Use of the Same Stream of Income

                        Perhaps the strongest argument against the Steneken decision is also the most basic; utilizing the same stream of income that forms the basis of valuing a business when calculating alimony provides the non-owning spouse with the benefit from the same stream of income  twice.  The Steneken Appellate Court attempted to circumvent the above argument by asserting that the excess income used to value the business for purposes of equitable distribution represented past, rather than future, income.  Unfortunately, the Appellate Court’s rationale was based on a misunderstanding of valuation law, as stated above.  The Appellate Court concluded that the valuation was based on an averaging of past income, rather than an educated guess as to what the future projected income will be, based upon the historical earnings of the company.  However, whether one is applying a capitalization of earnings method or an excess earnings valuation method (i.e., the latter pursuant to Revenue Ruling 68-609), the earnings to be capitalized are indicative of the beginning point of future earnings.  A future earnings growth rate is subtracted from a discount rate to yield a capitalization rate.  Thus, the role of past earnings is to simply provide an indication as to projected future earnings.  The result of the valuation is the present value of future, not past, income. 

                        The Steneken Appellate Court’s conclusion that the capitalized value of an owning spouse’s future excess earnings represents only a portion of the value of the business is similarly inaccurate unless the hybrid valuation method of “Excess Earnings” under the aforementioned Revenue Ruling is utilized.  In other words, the Appellate Court’s conclusion that the capitalized value of the owning spouse’s future excess earnings is only one of several factors along with real estate, equipment, inventory and accounts receivable that comprises the corporate value ignores the fact that under most valuation methodologies, those items would be viewed as “operating assets” and not added to the capitalized value of the owner’s future excess earnings[xi].  Without consideration of these other assets when determining capitalized value, the great weight placed on the excess earnings component of a business valuation is patent.  This is why the “double-dip” conundrum is more problematic in a personal services business, which is highly dependent on the business owner’s presence and work effort to generate income.

There is no Distinction Between a Pension and a Business When it Comes to the Double Dip

 

                        The analysis used by past New Jersey courts in applying the “double-dip” rule to pensions should be followed with regard to businesses[xii].  If we accept that businesses are valued based on an educated guess of the future benefit to be derived from the business, then there is no logical reason to differentiate between retirement assets and businesses when it comes to the “double-dip.”  Although affirming the application of the “double-dip” rule to pensions, the Stenenken Appellate Court declined to extend the same rule to business interests[xiii].  The rationale applied by the Steneken Appellate Court to distinguish the pension from the business interest was again based upon the Appellate Court’s inaccurate classification of the income used to value the business as past, rather than future, income. 

                        The fact that case law applying the rule against the “double-dip” to retirement assets has been codified at N.J.S.A. 2A:34-23(b) is all the more reason that the same rule should be applied with equal force to businesses.  That statute reads:  “When a share of a retirement benefit is treated as an asset for purposes of equitable distribution, the court shall not consider income generated thereafter by that share for purposes of determining alimony.”  The fact that the legislature did not include reference to businesses is not a purposeful limitation.  The legislature was not considering the method in which a business is valued when it modified the statute to include a rule against the “double-dip” as to retirement assets; it was a reaction to case law that permitted the “double-dip”.  Perhaps Steneken will lead to a similar legislative response with regard to business interests. 

Steneken further skews the already uneven playing field created by Brown

                        The “double-dip” conundrum is further exacerbated by the mandated non-applicability (except in extraordinary cases) of discounts when valuing a business as mandated by Brown[xiv].  In the absence of these discounts, a future stream of income is valued and then distributed.  This resulting valuation and distribution of future income was specifically prohibited by Justice Mountain  in Stern[xv] wherein he stated: 

A person’s earning capacity, even where its development has been aided an enhanced by the other spouse…should not be recognized as a separate, particular item of property within the meaning of N.J.S.A. 2A:34-23.

                        This article will not address the impact of Brown.  However, the impact of Brown has far more of a severe impact in light of the decision in Steneken.  Without the  protection against the “double-dip” that has been effectively watered down, if not eliminated altogether, by the Steneken decision, the problem of valuing and distributing future income is compounded. Applying the principles of Brownand Steneken will ultimately result in the non-owning spouse receiving an undiscounted share of the business owning spouse’s income twice. One can logically and rationally argue that the Fair Market Value standard, by accounting for the lack of marketability of a closely held business and/or adjusting for indices of control or the lack thereof of a block of ownership of a business, necessarily minimizes the risk of double-dipping.  If correct, the converse is also true.  Therefore, without the application of discounts, the dangers of “double-dipping” are exacerbated. 

Inter-play Between Equitable Distribution & Support

Although equitable distribution and alimony are not the same and serve different purposes, they are closely related[xvi].  In fact, the equitable distribution statute mandates that a trial court, in setting alimony, is required to consider the property division.  N.J.S.A. 2A:34-23(b)(10)).  This statutory factor provides that among the considerations of alimony is “the equitable distribution of property ordered and any payouts on equitable distribution, directly or indirectly, out of current income, to the extent this consideration is reasonable, just and fair.” Therefore, there is a statutory mandate for considering the “double-dip.”  The question is how to fairly do so.  If we simply give lip service to the double-dip problem by loosely directing courts to consider the issue in the percentage entitlements in business interests valued under a ‘Fair Value’ standard, the statutory mandate will be left meaningless.

More Specific Guidelines are Required

The decision in Steneken causes concern that only lip service will be given to the concept of taking the “double-dip” into account when distributing a business interest in the context of divorce.  This is highlighted by the fact that the Steneken Appellate Court, while giving honorable mention to the concept of the “double-dip” being taken into account in percentage distribution, affirmed the trial court’s distribution to the non-owning spouse of 35% of the value of the business.  If the Appellate Court affirmed the trial court’s distribution without altering the percentage share allotted to the non-owning spouse, how is it possible that they took into account the “double-dip” in the distributive percentage share? 

Although the Appellate Court states that, in appropriate circumstances, proper adjustment to equitable distribution on the one hand, or the alimony award on the other, or both, may be made to satisfy its underlying goal of fairness, there is so little direction provided that the end result will be that no consideration at all will be given .  The Appellate Court seems to imply that the business should be valued first and alimony calculated thereafter.  Such an inference can be drawn from the following statement of the Appellate Court, “in our view, the extent to which the asset may be looked to as a source of alimony should be influenced by the extent by which its value is distributed to the supported spouse as part of the equitable distribution of marital property.”  Steneken, 420 N.J. Super. at 441.  The authors would agree with this statement.  The Appellate Court further states: 

Our quarrel is with the rule’s absolute ban on dual consideration.  Although in certain circumstances it would be unfair to look to a marital asset as a source for both alimony and equitable distribution, it is simply too categorical to conclude that because an asset is treated as a marital asset for purposes of equitable distribution, it can never be regarded as a partial source of alimony.  Such an absolute bar on counting the asset in the property division and the alimony formula disregards the inter-relationship between the two and impermissibly encroaches on the judicial function to consider all relevant circumstances.

Steneken, 420 N.J. Super. at 441-42.   

            These authors don’t disagree with the above statement.  However, the fact that a rigid rule may be wrong, does not mean there should not be any rule.  On the one hand, there should be no absolute bar to counting an asset both in the property division and the alimony formula.  On the other hand, however, a directive with no firm guidelines, will do little to protect against the very real inequity created by the “double-dip”.  Firm guidelines resting fairly between a complete bar and no bar need to be developed. 

Conclusion

            There can be no doubt that the Steneken Appellate Court sought to arrive at a fair result.  The problem is not with the objectives of the Appellate Court, but rather with the Court’s misunderstanding of valuation theory, which resulted in a lack of emphasis on the problems of the “double-dip” and a consequent lack of direction for the bench and bar.  Although an absolute rigid application of a rule against the “double-dip” may lead to an unfair result, no direction at all is just as bad.  Guidelines must be developed that will work fairness to both sides of the divorce. 

            The key to any guidelines, which appropriately consider the “double-dip,” is an understanding of why non-owning spouses have historically received a lesser percentage in business assets than in the other non-business assets.  By creating and agreeing upon a list of factors, which will vary from case to case and business to business, the “double-dip” and other consideration can be weighed and considered in the total financial award.  We suggest that the following factors be considered by a court when determining a non-owning spouse’s share of the value of an owner spouse’s interest in a business:

1.      Uncertainty of Business Valuations:  Courts must consider the fact that business valuation is more of an art than a science.  Multiple experts can arrive at different values.  The resulting values are “soft” rather than hard and fast figures such as would be applied to a bank or brokerage account, or even the value of a piece of real estate.  As such, great care must be given when awarding a spouse a share of “soft” value, which will be paid with cold hard cash.

2.      “Fair Value” and Lack of Discounts:  The distribution of a very theoretical value such as “Fair Value” (as mandated byBrown) versus distribution of a value which more easily translates into “hard dollars” (i.e., Fair Market Value”) must also be weighed heavily in the equitable distribution process. 

3.      Fault:  Also, consideration of the extent to which the application of the dissenting or oppressed shareholder rights (as those terms are defined with the applicable statutes, to wit: N.J.S.A. 14A:11-1 to 11 and N.J.S.A. 14A:12-7(1)(c)) as required by Brown necessitates the inclusion of marital fault in the calculus of the non-owning spouse’s distributive share.  To a large degree, the application or non-application of discounts in civil shareholder disputes rests on a determination of the good or bad faith of the competing shareholders.  If “Fair Value” is to be applied in divorce, the concept of fault considerations (which exists on the civil side) must also be taken into account.

4.      “Double-Dip”:  As explained throughout this article, the impact of using the same stream of income to fix support, which was also used to value and distribute a business, must be factored in so that the non-owning spouse does not receive the same benefit twice.

5.      Taxes:  Although Orgler prohibits Courts from reducing the value of an asset by taxes due upon its sale unless said sale is imminent, Courts are still required to “consider” these taxes.

6.      Passive/Active Increases in Exempt Business Interest: When distributing the increase in a business interest that was pre-marital, gifted or inherited, Court’s must consider the extent to which the increase in value was active or passive.  Also, even if an active increase, remember that the non-owning spouse is not entitled to a share of that increase if he/she did not contribute to it in any way.  See Sculler v. Sculler, 348 N.J. Super. 374, 381 (Ch. Div. 2002) (holding that “proof” that an asset is immune from equitable distribution raises a rebuttable presumption that any subsequent increase in value will also be immune.  The burden then shifts to the non-owner spouse to demonstrate that …the increase in value is active and can be linked in some fashion to the efforts of the non-owner spouse.).

7.      Contributions to the Business:  Without diminishing the non-financial contributions of a stay-at-home spouse and parent, Court’s should not assume that these contributions are equal.

            With the foregoing factors adequately considered, the authors believe that a fair distribution between the parties will occur.

Mr. Vuotto is shareholder with the Woodbridge based law firm of Wilentz, Goldman & Spitzer.  He is Certified by the Supreme Court of the State of New Jersey as a Matrimonial Law Attorney.  Mr. Vuotto is a member of the New Jersey State, Union and Middlesex County Bar Associations and a member of each Association’s Family Law Section.  He is a member of the Executive Committee of the New Jersey State Bar Association’s Family Law Section, and serves on various subcommittees regarding arbitration and technology.  He is a delegate to the General Council of the State Bar Association on behalf of the Family Law Section.  He is also the Chair-Elect of the Matrimonial Section of the Association of Trial Lawyers of America – New Jersey.  Additionally, Mr. Vuotto is an Associate Managing Editor of the New Jersey Family Lawyer. 

Ms. Steirman is an associate in the Family Law Department located in the Eatontown office of Wilentz, Goldman & Spitzer.  She is a member of the New Jersey State Bar Association, the Monmouth County Bar Association, and the Ocean County Bar Association.  She received her J.D. from Rutgers School of Law-Newark and received her B.A. from Lafayette College, where she graduated with honors, Phi Beta Kappa. 

 


[i] Brown v. Brown, 348 N.J. Super. 467 (App. Div. 2002)

[ii] Steneken v. Steneken, 367 N.J. Super. 427 (App. Div. 2004)

[iii] Steneken, 367 N.J. Super. at 431-32

[iv] Steneken, 367 N.J. Super. at 432

[v] Steneken, 367 N.J. Super. at 432-33

[vi] Steneken, 367 N.J. Super. at 433

[vii] Steneken, 367 N.J. Super. at 430

[viii] Steneken, 367 N.J. Super. at 440

[ix] PPC’s Guide to Business Valuations by Jay E. Fishman, MBA, CBA, Shannon P. Pratt, DBA, FASA, CFA, CBA, J. Clifford Griffith, MPA, CPA, D. Keith Wilson, CPA, Volume 1, page 2-4. (Emphasis added)

[x] Id.

[xi] Steneken, 367 N.J. Super. at 440

[xii] See D’Oro v. D’Oro, 187 N.J. Super. 377 (Ch. Div. 1982), affirmed 193 N.J. Super. 385 (App. Div. 1984) and Innes v. Innes, 117 N.J. 496 (1990).

[xiii] Steneken, 367 N.J. Super. at 439

[xiv] Brown v. Brown, 348 N.J. Super. 467 (App. Div. 2002)

[xv] Stern v. Stern, 66 N.J. 340 (1975)

[xvi] Lavene v. Lavene, 162 N.J. Super. 198, 203 (App. Div. 1978)

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