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New Jersey divorce law article
BROWN
V. BROWN
(The Standard
of Value Enigma)
By
Charles F. Vuotto, Jr., Esq.
Scott Maier, CPA
(With
special thanks to Theodore P. Brogowski, Esq.)
2003
The recent Appellate Division decision of Brown
v. Brown, 348 N.J.Super. 466 (App.
Div. 2002) (“the Brown case”), has
sparked much discussion. The fact
that the Supreme Court denied the husband’s Petition for Certification on July
16, 2002, makes the Appellate Division’s decision in this matter one of the
most important since Painter
v. Painter, 65 N.J. 196 (1974), Lepis
v. Lepis, 83 N.J. 139
(1980) and Crews v. Crews, 164 N.J.
11 (2000). This article will
outline issues raised by Brown, define
relevant key terms and provide discussion about competing opinions and policies.
Brown addresses whether
valuation adjustments (specifically, minority interest discounts/control
premiums and marketability discounts) should be applied when valuing a closely
held business incident to divorce in those situations where sale of that asset
is not imminent. According to the
decision, such discounts should only be applied in “Extraordinary
Circumstances”. More importantly,
the decision creates a new standard of value to be applied when valuing an
interest in a closely held corporation. The
ramifications of this decision may affect all future property valuations
incident to divorce in this State, not merely those related to closely held
businesses.
THE
FACTS OF BROWN
In this
divorce proceeding, stemming from a 22-year marriage, the primary issue for
adjudication was the husband’s 47.5% interest in Union County Florist
Supplies, Inc., (“Florist”) a family-owned company. The husband's brother
owned an additional 47.5% interest. The
husband’s mother retained the remainder. In the trial decision, the judge
adopted the wife’s expert’s valuation approach.
The
wife’s valuation excluded discounts for lack of marketability and lack of
control. The husband’s valuation
expert, in contrast, included these discounts in his assessment, consistent with
a Fair Market Value (“FMV”) standard of value. In agreeing with the wife’s expert, the Trial Court
accepted the Fair Value standard used in dissenting/oppressed shareholder cases
(i.e., N.J.S.A. 14A:11-1 to 11
and N.J.S.A. 14A:12-7(1)(c)
), to value the husband’s ownership interest in Florist.
On appeal, the husband contended that the trial court erred by failing to
allow discounts for lack of
marketability and control. Judge
Wecker, writing for the Appellate Division, rejected the arguments regarding
discounts concerning marketability and control, effectively rejecting the FMV
standard of valuation and adopting the above-mentioned “Fair Value”
standard. On March 19, 2002, the
Husband filed a Notice of Petition for Certification.
The NJSBA, seeing the importance of this case, filed a motion for
admittance as Amicus Curiae, which was
granted on May 9, 2002. On June 11,
2002, Judge Wecker released a corrected version of Brown. On July 16,
2002, the Supreme Court denied certification.
Therefore, as the law of the land, the issues and problems raised by the Brown
decision, must be identified so that a consistent approach by the bench, bar and
experts may be developed which furthers the policies of the Equitable
Distribution Statute and the best interests of the litigants involved.
KEY
TERMS AND DEFINITIONS
Certain
terms are used not only in this decision but also by the bench, bar and experts
when discussing the issues involved. The
following definitions may help clarify the issues.
Property/Assets:
"Property of all kinds, real and personal, tangible and intangible….
The entire property of a person… that is … subject to the payment of
his or her or its debts.” Black’s Law Dictionary 108 (5th ed.
1979). Our Supreme Court broadly
interpreted "property” in Painter.
The Equitable Distribution Statute is meant to distribute assets, not income.
Assets are distinct from income. If
we eliminate this distinction, Equitable Distribution becomes a reflection of
future, post-marriage income rather than marital assets. This concept is known
as “double-dipping” (see below). Future
income streams are more properly directed towards support.
Income: The
return in money from one’s business, labor, or capital invested; gains,
profits, salary, wages, etc. Black’s Law
Dictionary 687 (5th ed. 1979).
Income is distinct from property.
Value:
Value is “the utility of an object in satisfying, directly or
indirectly, the needs or desires of human beings, … or its worth consisting in
the power of purchasing other objects, called ‘value in exchange.’”
Black’s Law Dictionary
1391 (5th Ed. 1979). For
valuation purposes, there are many kinds of “value” such as FMV, Market
Value, Fair Value, True Value, Investment Value, Intrinsic Value, Fundamental
Value, Insurance Value, Book Value, Use Value, Collateral Value, Ad Valorem Value, and etcetera.
See Shannon p. Pratt, et al.,
Valuing a Business, 28 (4th Ed. 2000)
.
Closely
Held Business:
A business which is not publicly traded and for which there is no ready
market.
Minority
Interest:
A less-than-controlling ownership interest.
Discount
for Lack of Marketability or Liquidity: A
discount based on the inability to sell an ownership interest in a business.
Brown explained that a
marketability discount adjusts for illiquidity in one's interest in an entity,
because there is a limited supply of potential buyers for stock in a closely
held corporation. Brown,
supra, at 483; citing Lawson,
Mardon, Wheaton, Inc. v. Smith, 160 N.J. 383, 398-99 (1999).
Minority
Interest Discount:
A
reduced appraised value of one’s ownership interest in a business due to the
lack of control that the owner of the minority interest can exercise within that
business. See Brown,
supra, at 483.
Standard
of Value:
The standard by which a property or asset is measured. Shannon Pratt, in Valuing
a Business, 28 (4th Ed. 2000)
states that:
“The
standard of value usually reflects an assumption as to who will be the buyer and
who will be the seller in the hypothetical or actual sales transaction regarding
the subject assets, properties or business interests.
It defines or specifies the parties to the hypothetical transaction.
In other words, the standard of value addresses the questions: ‘value
to whom?’ and “under what circumstances?’
The standard of value, either directly by statute or (more often) as
interpreted in case law, often addresses what valuation methods are appropriate
and what factors should or should not be considered?”
The
Legislature did not expressly mandate a specific standard of value when N.J.S.A.
2A:34-23.1
was added to the statutory framework in 1988 (and amended in
1997). Does this imply acceptance
of the standard adopted by case law up to that point in time?
What was that standard?
Fair
Market Value:
Defined by the American Society of Appraisers as “The amount at which
property would change hands between a willing seller and a willing buyer when
neither is acting under compulsion and when both have reasonable knowledge of
the relevant facts”.
Fair
Value:
A context- and geographically-sensitive term, this usually represents a
standard of value created by statute and/or precedent for specific
circumstances. In New Jersey, Fair
Value is basically FMV without discounts for lack of control or lack of
marketability/liquidity, barring extraordinary circumstances.
However, over-application of this general rule is dangerous.
Further, “extraordinary circumstances” usually relates to the good or
bad faith of the shareholders involved in the particular corporate action.
This concept completely contradicts the doctrine, in thedivorce context
which makes marital fault irrelevant in deciding the asset distribution for a
particular divorce matter.
Investment
Value/Value to the Holder:
The specific value of an investment to a particular investor or class of
investors based upon individual investment requirements (Valuing
a Business, 28 (4th Ed. 2000)).
Intrinsic
or Fundamental Value:
The value to an investor of an investment (usually common stock) based
upon available data. On a
meta-level, this becomes the basis of the “market value” for the asset. The
methods of calculating intrinsic value are usually based upon finance theory.
Dissenting
Shareholder Statute:
A statute designed to give minority shareholders relief when they object
to a consolidation, merger, reorganization, sale of corporate assets,
modification of the corporate articles, bylaws or other Director-approved
actions. See 18A Am.Jur.
2d Corporations § 805 (2002). Relief
generally constitutes a right to have the corporation repurchase the
dissenter’s shares. See
Id.
Oppressed
Shareholder Statute:
A statute designed to protect a minority shareholder from any unjust
exercise by majority shareholders, usually remedied through a buy-out of the
oppressed shareholder. See
Christopher Vaeth, Propriety of applying
minority discount to value of shares purchased by corporation or its
shareholders from minority shareholders, 13 A.L.R.5th
840 (1993).
Double
Dip Conundrum:
Utilizing the stream of income upon which support will be based to also value a
business for distribution. The FMV 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 the business, appears to minimize
the risk of double-dipping. Conversely,
“Fair Value” tends to (1) create “value” where none truly exists in the
marketplace and (2) aggravate the double-dipping problem.
This conclusion is supported by the landmark case of Stern
v. Stern, 66 N.J. 340 (1975)
, where Justice Mountain wrote that “earning capacity is not a separately
identified and distinct asset eligible for equitable distribution.
Id. at 345. Further, he stated that,
a
person’s earning capacity, even where
its development has been aided and enhanced by the other spouse, as is here the
case, should not be recognized as a separate, particular item of property within
the meaning of N.J.S.A. 2A:34-23
. Potential earning capacity is doubtless a factor to be
considered by the trial judge in determining what distribution will be
‘equitable’ and it is even more obviously relevant upon the issue of
alimony. But it should not be
deemed property as such within the meaning of the statute.”
(Emphasis added) Id.
VALUATION
ISSUES RAISED BY THE BROWN CASE
1.
What is the appropriate standard of value for divorce law?
2.
Should an existing standard of value (e.g. FMV, Investment Value or Fair
Value) be used, or should a hybrid be created (e.g., “Equitable Distribution
Standard of Value”)?
3.
Should the standard of value be uniform for all assets or vary depending
on the type of asset?
4.
If a standard of value other than FMV
is used, should any valuation adjustments (e.g. lack of marketability discounts,
minority discounts, control premiums, etc.) be considered?
If so, which adjustments should be considered, when and how?
5.
If Fair Value is the standard, should concepts from the
oppressed/dissenting shareholder statutes be applied to the context of Equitable
Distribution (in essence, as stated above, making marital fault a factor in the
valuation/distribution process?
6.
Does the public policy behind Equitable Distribution dictate a particular
standard of value?
7.
How do we address the “double-dip conundrum”?
8.
Does “Fair Value” really distribute income, as has been prohibited?
If so (and under a Fair Value standard), would we then need to allow Equitable
Distribution awards of businesses to be modified based upon
changed circumstances if the future income stream assumed to exist at the
time of divorce changes?
9.
Should the likelihood of sale be a factor when valuing assets
incident to divorce?
10.
Should discounts
be factored in as we do hypothetical taxes under the current law?
See Orgler
v. Orgler, 237 N.J.Super. 342
(App. Div. 1989).
STANDARD
OF VALUE
Numerous
New Jersey cases appear to support the use of FMV (as detailed below) in
divorce. However, no New Jersey
cases until Brown gave per se mandates on divorce standards of value.
Therefore, we must look to other authorities for direction
on this issue. First, we
refer to Shannon P. Pratt, a widely acknowledged business valuation expert.
Pratt recently commented on Brown.
…
[This] reliance on shareholder dispute cases and the ALI Principles of Corporate
Governance for a marital dissolution case is unprecedented, at least this is the
first time I have seen it. I
question whether it is really warranted.
Shannon Pratt, Marital Court Denies
Discounts Based on Shareholder Fair Value Standard, Shannon Pratt’s Bus. Valuation Update, May 2002, Vol.8,
No.5, at 6.
Other
jurisdictions have specifically addressed the difficult question of standard of
value in a divorce context. Some
states have adopted the “Intrinsic Value” standard of value.
See
Howell v. Howell, 31 Va.App. 332, 338, 523 S.E.2d 514, 517 (2000)
. More have adopted the FMV approach. See Champion v.
Champion, 54 Mass.App.Ct. 215, 219, 764 N.E.2d 898 (2002); Chalker v. Chalker, 2002 WL 450115 (Conn. Super. Ct. 2002); Redd
v. Redd, 774 So.2d 492, 495 (Miss. 2002); In
re Marriage of Bidwell, 172 Or.App. 292, 295, 18 P.3d 465, 466 (2002)
. Arkansas stands out amongst them. In Crismon v. Crismon,
72 Ark.App. 116, 34 S.W.3d 763 (2000)
, the Arkansas Court of Appeals rejected the “Fair Value” standard of
valuation for divorce. See
72 Ark.App. at 119, 34 S.W.3d at 765. Instead,
the court stated that it would not “borrow [the Fair Value standard] from
other jurisdictions’ case law on shareholder suits… [as] use of the ‘fair
market value’ standard for valuing closely held businesses in a marital
property division context [had been expressly approved by that state’s Supreme
Court].” Ibid. See
Ohio
allows the use of two standards of value: the FMV standard and the Intrinsic
Value standard. See Brookhart v. Brookhart, 1993 WL 483206 (Ohio Ct. App. 1993)
. In Brookhart
, the Ohio Court of Appeals stated that the standard of value to be used for
equitable division of marital property is normally the FMV of the property. See 1993 WL 483206,
at *4. However, the court stated
that, in certain circumstances, it would allow a court to consider standard of
value to the owner (also known as intrinsic value).
See ibid.
With this backdrop from out-of-state authority, we next analyze New
Jersey cases that referenced FMV in the divorce context.
·
The concept of fixing value at the standard of FMV between spouses in New
Jersey dates back to Berla v. Meisel,
52 A. 999 (C.Ch. 1902)
. In
Berla, the Court of Chancery ruled
that, “A fair sale for cash is the standard
of value by which the character of the transaction must be judged…”
Id., at 1000.
·
In Stern v. Stern, 66 N.J.
340 (1975)
, the Court stated that the circumstances surrounding the spouse’s interest
in certain businesses (in this case, a law practice) precluded use of the
customary method to obtain market value
of the asset. Therefore, the Court
used an alternate method to obtain the value of the partnership interest.
·
In Gemignani v. Gemignani, the
Appellate Division overturned a trial court’s equitable distribution award
because, based on the FMV of the
former marital home, the husband was receiving only thirty percent (30%) of the
net marital assets. 146 N.J.Super.
278, 282-83 (App. Div. 1977).
·
In Levy v. Levy, 164 N.J.Super.
542 (Ch.Div. 1978)
the Chancery Division applied the directives concerning the
valuation of goodwill under the formula set by the Internal Revenue Service.
id., at 550-52, citing Rev.Rul. 68-609, 327-28 (1968).
The Revenue Ruling adopts a FMV standard.
·
The case of Lavene v. Lavene,
162 N.J.Super. 187 (Ch.Div. 1978)
, may supported the conceptual
framework of the FMV standard for equitable distribution.
In Lavene, the Chancery
Division faced an issue quite similar to Brown:
valuation of a closely held corporation. Lavene
, supra, 162 N.J.Super. at
192. The Chancery Division
determined that “the valuation of the stock of a closely held corporation
calls for an attempt to fix a fair market
value for the stock.” Id. The Chancery Division adopted the FMV appraisal of one
party’s expert, but declined to allow
use of a marketability discount, and divided the property accordingly.
See id., at 193, 202.
Therefore, was the actual intent to arrive at a standard different than
FMV without identifying the precise terminology?
·
In Pascarella v. Pascarella,
165 N.J.Super. 558 (App. Div. 1979),
the Appellate Division ruled that the trial court had not erred when it set the
value of the marital home based on its present fair
market value less the value of the mortgage debt set against it, thereby
providing implicit support for that standard.
See id., at 564.
·
In companion cases decided on December 15, 1982, (Mahoney
v. Mahoney, 91 N.J. 488 (1982
) and Lynn v. Lynn, 91 N.J. 510
(1982))
, the Court ruled that professional degrees were not assets subject to
distribution. See
id., at 492.
In Lynn, the Court noted the
problem of valuing an asset without a readily obtainable Fair Market Value.
See ibid. Basically,
the Supreme Court, in the “degree” cases, clearly stated that, because an
asset cannot be sold and is not amenable to valuation under the Fair Market Value standard, the asset should not be subject to
equitable distribution.
·
In Dugan v. Dugan, 92 N.J.
423 (1983)
, the Court held that goodwill was an asset subject to equitable distribution. It appeared initially that Dugan
adopted the Fair Market Value standard.
This can be best seen by the adoption of Judge Pressler’s comments from
Lavene v. Lavene, 148 N.J.Super.
267, 275 (App.Div.), certif. den., 75 N.J. 28 (1977)
, “[closely held corporations] cannot be realistically evaluated by a
simplistic approach which is based solely on book value, which fails to deal
with the realities of the goodwill concept, which does not consider investment
value of business in terms of actual profit,
[emph. added], and which does not deal with the question of
discounting the value of a minority interest.”
Id., at 432.
However, by assigning value to an asset which could not be sold (at that
time), was the standard really “Fair Market Value”?
·
In Bowen
v.
Bowen, 96 N.J. 36 (1984), the New
Jersey Supreme Court ruled that the goal of a distributing court should be a
fair award of an asset equal to the FMV
of the asset. See id., at 44. While
the Supreme Court did not prescribe any particular formula for arriving at FMV
for the purposes of equitable distribution, it did base its determination on the
Internal Revenue Service’s Revenue Ruling, which itself adopts a FMV standard
of valuation. See Rev.Rul. 59-60, 1959-1 C.B. 237.
·
The Appellate Division took a different course when dealing with the
goodwill of an entertainer. In Piscopo
v. Piscopo, 232 N.J.Super. 559
(App.Div. 1989) the Appellate
Division dealt with the goodwill attributed to comedian Joe Piscopo.
In this case, as in Dugan, the
Appellate Division adopted a FMV concept
for an asset not readily transferable or commodifiable.
Therefore, what standard of value was intended?
It
appears that there is a long history of the use of the FMV standard of value in
divorce cases, both in New Jersey and other states.
Although certain cases may suggest a different standard, all cases until Brown
state or apply a FMV standard.
APPLICABILITY
OF THE DISSENTING/OPPRESSED SHAREHOLDER’S STATUTES TO DIVORCE LITIGATION
Without a
governing nexus in the divorce arena, the Appellate Division relied heavily upon
the decisions in the companion cases of Balsamides v. Protameen Chemicals, Inc., 160 N.J. 352, 368 (1999)
, and Lawson, supra,
at 397. These cases were
fundamentally different from divorce cases.
In fact, the New Jersey Supreme Court stated, in Balsamides,
that the valuation principles adopted in that case “are not necessarily useful
in other contexts such as valuation of stock for tax and equitable distribution purposes.”
(Emph. added) Balsamides,
supra, at 376, FN9, citing
Lawson, supra, at 399.
The shareholders whose interests were being valued in each case met the
requirements of either a dissenting or oppressed shareholder, as those terms are
defined with the applicable statutes. See
N.J.S.A. 14A:11-1
to 11; and N.J.S.A. 14A:12-7(1)(c)
. Very few divorce litigants would
so qualify. More importantly, the
finding of the existence of “extraordinary circumstances” (which is now
required if certain discount are to be taken under Brown),
requires a finding of fault. This
fault can be multifaceted and broad. Since
we are required now to apply the guidelines of Balsamides
and Lawson, we must determine
(between the husband and the wife) whether one or the other’s or both of their
actions caused the breakdown of the marital partnership in order to determine
whether discounts should be applied.
TECHNICAL
CONSIDERATIONS FOR DIFFERENT STANDARDS OF VALUE
Based
upon the discussion above as well as the authors’ experience in working with
business valuation theory, it is apparent that, notwithstanding Brown,
three choices exist for standards of value
: FMV, Investment Value/Value to the Holder or Fair Value.
We will present some pros and cons for each:
Fair
Market Value:
Pros
– This is
the most objective and reasonably obtainable standard (as well as a standard
rather easy to use in numerous situations as to various assets). It is the most common valuation
method used in the market place. It was the “status quo” in divorce
litigation prior to Brown. FMV is the standard of choice for the IRS.
This standard is the least likely to allow the double-dip, if discounts
are applied correctly, because this standard is based upon the subject
business’s true market value instead of solely upon its income stream.
Cons
– This standard is based upon a hypothetical transaction, which is usually not
going to occur in the divorce context. This standard, as it has been used by the
New Jersey divorce courts, can be and has been bastardized to such an extent
that it is not what true valuation science would recognize as FMV – therefore,
why feign its utilization?
Investment
Value:
Pros
– This standard values the earnings stream to the owner in the specific matter
before the Court and is most reflective of the value to the specific owner of
the business into the future, assuming no changed circumstances. This standard is also relatively objective in its application
(excluding the unpredictability of future events).
Con
– The Courts in this jurisdiction, through cases like Mahoney, already rejected this standard. This standard aggravates the double-dipping problem because
this standard relies solely on the
income stream being produced by the spouse to value the business and pay
support. This standard does not
consider some real valuation factors attributable to the business itself (i.e.
marketability, control, etc.). Additionally,
Equitable Distribution awards may have to be modifiable based upon changed
circumstances if the income stream assumed to exist at the time of divorce
changes at any time in the future.
Fair
Value:
Pro
– The concept of Fair Value exists for just this type of situation.
The equities in a divorce matter require a standard of valuation that is
tailored (not plucked from another inapplicable context) to the policies of the
underlying statute. This standard allows for a balance between objective factors such as those found in valuation under a FMV
standard as well as subjective factors
such as those seen in other standards of value.
Cons
– “Fair Value” as defined under this State’s corporate laws is
inapplicable to divorce, since matrimonial litigants are not similarly situated
to oppressed or dissenting shareholders. To
apply the standard under Balsamides
and Lawson would require the
re-introduction of fault into the divorce case.
Also, applying the standard as an Equitable Distribution Standard of
Value is not an easy task. Because
there are so many fair value standards which have been created around the
country and even, albeit unintentionally, by the Courts in New Jersey, it may
result in an even greater lack of uniformity than currently exists. Further, it may be too easy to achieve information overload
unless the creators of the standard remain myopic in reaching the stated goals
of the standard. Finally, if a Fair Value standard is created, we should create
one on its own merits. Utilizing
the standard created in other types of matters (i.e. oppressed or dissenting
shareholder cases) is a dangerous precedent to set. The equity and public policy
requirements in divorce cases vary significantly from those in these other
matters. Therefore, a standard of
value appropriate in an oppressed shareholder matter may not be relevant or
indeed may be counterproductive in a divorce matter.
CONCLUSION
Recently,
a joint committee (The Standard of Value Committee (“SOVC”)) was formed
between members of the Family Law Section of the New Jersey State Bar
Association and members of the Matrimonial Committee of the New Jersey Society
of Certified Public Accountants to create a universally accepted standard of
value to be applied in marital dissolution matters.
The SOVC was formed due to the growing perception, by both groups, that
the appropriate standard of value in business valuations was unclear.
Specifically, the express mission of the SOVC is to:
To
promote a theoretically sound and objective standard of value,
consistently applied, in appraising closely held business ownership interests
for purposes of equitable distribution.
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