Inevitably, when there is a business to value as part of a divorce, the valuation experts will ask for buy/sell and/or shareholders agreements. I often wonder why because quite often, you really don’t see much discussion about these agreements in the valuation reports. Moroever, since Brown v. Brown changed the landscape, did away with discounts and essentially ushered in more of a value to the holder construct, it seems like consideration of an agreement was dead. Rather, a myopic view of methodologies focused on income seemed to be the norm – disregarding all else.
In fact, I had a case not long after Brown where my client was a second year partner at on of the highest paying law firms in the world. He had no clients, but was very smart, worked very hard and made a lot of money. My adversary and I agreed that we would use a joint expert to give us a number of what my client would get under his shareholder agreement if he left (because that really was all that he would get if he left and any calculation based upon cashflow would really be a pure fiction in that case). That said, when we got the report, we got two calculations. One dealt with the agreement and the other was a capitalization of earnings. The reason for the second calculation – the expert believed, wrongly in my opinion and thankfully our mediator’s opinion, was that Brown required it.
That said, there is New Jersey Supreme Court case law (Stern v. Stern and Bowen v. Bowen to be precise) that suggests the use of a “trustworthy” buy-sell agreement to establish value, noting that in some instances it may appropriately establish a presumptive value of a party’s interest. Often the issue is what is a a “trustworthy” buy-sell agreement? What makes an agreement trustworthy? It is updated frequently and routinely used when people enter and exit a business.
That issue was the subject of a recent unreported (non-precedential) decision by the Appellate Division in a case called Levitt v. Jakobs. In that case, the Appellate Division affirmed a trial judge that valued plaintiff’s two percent interest in his group medical practice at $446,000, consisting of the value of his stock, his retirement compensation and his longevity bonus, and awarded defendant twenty-eight percent of that sum. The Plaintiff contended that the trial judge erred in using the stockholder and employment agreements to value his interest in the practice instead of using the discounted cash flow approach employed by his expert.
The Appellate Division disagreed and held:
We find no error in the judge’s considered decision that the practice’s regularly updated corporate agreements were a better measure of value than plaintiff’s expert’s projection of cash flows through 2020, discounted by a rate chosen on the basis of U.S. Treasury bonds, augmented by selected risk premiums and reduced by an assumed long-term growth rate.
The Court further held:
Here, the judge found that the practice’s governing agreements “set forth a clear basis to determine the value of plaintiff’s . . . interest” in the practice, noting that there had been thirty-two purchases or sales of stock under the formula in the stockholder’s agreement in the prior ten years.
Here, rather that looking at a calculation that was theoretical in basis, the court looked at what actually happened in 32 prior transactions within the same business. Put another way, for better or for worse, the plaintiff was not likely going to get more or less than what he was entitled to in the formula used on the last 32 occasions. Seems to be a fair result.
Interestingly, it is usually the business owner who urges the use of the agreement which often will provide a lower value than some type of income approach to valuation. Here, the business owner was arguing for the opposite result which suggests that the income approach used by his expert suggested a lower value.
The take away from this case is that the shareholder/buy-sell agreements should not be ignored. Find out how often they have been updated and whether they have been used if it is appropriate in the case. Then determine whether it is appropriate to argue in your case. If you do so, remind the court that Stern is still good law.
Eric Solotoff is the editor of the New Jersey Family Legal Blog and the Co-Chair of the Family Law Practice Group of Fox Rothschild LLP. Certified by the Supreme Court of New Jersey as a Matrimonial Lawyer and a Fellow of the American Academy of Matrimonial Attorneys, Eric is resident in Fox Rothschild’s Roseland and Morristown, New Jersey offices though he practices throughout New Jersey. You can reach Eric at (973)994-7501, or firstname.lastname@example.org.