For more than twenty years, the case of Brown v. Brown, decided by the Appellate Division in 2002, essentially changed the standard of value in divorce cases from fair market value to fair value or fair market value without discounts. For more than 60 years, “Fair market value” is defined as “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.” This definition emanates from IRS Revenue Ruling 59-60.
Prior to Brown, when businesses were valued for divorce purposes, they included minority interest discounts and/or lack of marketability discounts. The minority interest discount reflects the notion that a partial ownership interest may be worth less than its pro-rata (proportional) share of the total business, largely because of lack of control. Marketability discounts “reflect the decreased worth of shares of stock in a closely held corporation, for which there is no readily available market.”
In Brown, the Appellate Division affirmed the trial court’s elimination of discounts, holding:
…We see no reason to reward the spouse who holds title to the shares by allowing him to retain the value of the entire bloc at a bargain “price,” that is, crediting the non-owner spouse with less than the owner’s proportionate share of full value when determining equitable distribution of the marital assets. Here, allowing the marketability or minority discounts would unfairly minimize the marital estate to the wife’s (sic) detriment and is inconsistent with the concept of equitable distribution. While “there is no ready market for the shares and consequently no fair market value” of Florist, the husband’s (sic) shares in the going concern have value to him and to his co-owners that does not depend upon a theoretical sale to an outsider and has not changed as a result of the divorce complaint or judgment.
Given the purpose of equitable distribution to fairly divide the accumulated wealth of a marital partnership, and that the purpose of valuing the shareholder spouse’s interest is to determine the non-owner spouse’s fair share of other marital assets; where the shareholder will retain his shares and the divorce will not trigger a sale of those shares, lack of liquidity does not affect the fair value of the minority interest. Neither discount is appropriate.
We therefore find no legal error in the judge’s holding marketability and minority discounts inapplicable in this case, and we affirm the trial judge’s determination that there are no “extraordinary circumstances” to warrant use of those discounts.
The decision in Brown was based in large part on the decisions in Balsamides v. Protameen Chemicals, Inc. and Lawson Mardon Wheaton, Inc. v. Smith, oppressed shareholder suits decided by the Supreme Court on the same day in 1999. Curiously, despite the fact that both the trial court and Appellate Division relied on these two cases in deciding Brown, both cases cautioned that ” We further recognized that valuation principles that are appropriate for appraisal actions are not necessarily useful in other contexts such as valuation of stock for tax and equitable distribution purpose.”
Notwithstanding, for the last 20 years, valuation experts and courts have been reflexively ignoring discounts in divorce cases – rarely ever looking to see if there are “extraordinary circumstances” to warrant the use of discounts. In fact, the term “extraordinary circumstances” has not really even been defined in divorce contexts. However, one wonders whether, given the fact that both Balsamides and Lawson and for that matter, Brown, were based upon concepts of equity and fairness, whether reflexively ignoring discounts makes sense, particularly in cases dealing with minority shareholders that lack any control of the business.
The genesis of my writing this blog today was a Supreme Court case (released on June 23, 2022) entitled Robert Sipko v. Koger, Inc. Though not a divorce, this was a case that involved a business dispute via family members regarding the value of certain businesses owned by the family. The case provides a good primer of general business valuation principles, as well as both Balsamides and Lawson and cites some family law cases along the way in the opinion. The tipping point in Robert Sipko was the need to use discounts to create and fair and equitable result in this case.
Quoting Balsamides, the Court starts by noting that the standard of review is “,,,deferential because the valuation of closely held corporations is “inherently fact-based[,]” not based in
“exact science,” and “frequently become[s] battles between experts.” The Court goes on to further note that discounts and premiums do not require deference because they are questions of law.
Again citing Balsamides, the Court went on to note that much of New Jersey’s jurisprudence regarding marketability discounts arises in shareholder oppression cases, though a court is not required to find oppression in order to apply a discount. Further, the court noted that the statutes “…does not limit or preempt the courts’ equitable power in fashioning appropriate remedies to a business dispute…”
Citing Bowen which is a divorce case, the Court noted that “[t}he determination of fair value does not involve a rigid application of an inflexible test because “[n]o general formula may be given that is applicable to the many different valuation situations.” Citing Lawson, the Court noted that “[t}he “assessment of fair value requires consideration of ‘proof of value by any techniques or methods which are generally acceptable in the financial community and otherwise admissible in court.’”
Here is one of the lines in Sipko that got me thinking about this issue:
As we stated in Lawson, “[t]he very nature of the term ‘fair value’ suggests that courts must take fairness and equity into account in deciding whether to apply a discount to the value of the dissenting shareholders’ stock.” 160 N.J. at 400. In fact, N.J.S.A. 14A:12-7(8) expressly authorizes a court, “[u]pon motion of the corporation or any shareholder who is a party to the
proceeding,” to judicially order a sale of the corporation’s stock held by any shareholder who is party to the litigation if the court determines that “would be fair and equitable to all parties under all of the circumstances of the case.”
Depending on the facts, we have held that fairness and equity can compel the decision to apply such a discount, or not. Stated differently, “[a]pplication of the equities . . . [can] dictate opposite results.” Balsamides, 160 N.J. at 382.
Put another way, and as noted in this decision, Balsamides and Lawson underscore the importance of determining the “fair value” of a corporation on a case-by-case basis. Citing Balsamides again, the Court went on to note that “[a]lthough it would be helpful to pronounce a consistent rule regarding the determination of ‘fair value’ and the applicability of discounts
under various circumstances, we cannot do so” because “[e]ach decision depends not only on the specific facts of the case, but also should reflect the purpose served by the law in that context”
As noted previously on this blog, the Slutsky case in 2017 reminded us that we cannot ignore the partnership agreement for a partner in a large law firm, particularly one that was not a rain maker. There are many businesses that have partnership agreements, buy/sell agreements and other agreements dictating what a minority owner might receive. Similarly, with the changes in the medical field wherein there are many roll ups of what were small practices by hospitals and/or venture capital companies, if a doctor remains an “owner”, they are often very small fish in big ponds vs. what they were prior to the merger/acquisition.
In these cases, if discounts are ignored, a business owner can be hit with a double or triple whammy, especially if the case requires the payment of long term alimony as well. Both the business is valued (often) and the alimony is computed based upon the same cash flow. Now if there is some type of agreement that limits what the owner gets when he leaves, and that number is far less than what a business valuation expert might determine in absence of an agreement, the non-titled spouse could get a buyout at top dollar and also receive alimony on that same top dollar. Put another way, the non-titled spouse can get more from the business than the actual owner. Add another layer to that, a minority owner may have no control of allocation of expenses, how much they get paid, whether they will have to contribute more capital, whether their interest will get further diluted by more mergers or acquisitions, etc.
The point is not to say that discounts should be used. They just should not be ignored either in the appropriate case.