BROWN V. BROWN -The Standard of Value Enigma –

New Jersey divorce law article

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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 (5^th 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 (5^th 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 (5^th 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 (4^th 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 (4^th 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 (4^th 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.5^th 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

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.

Given the complexity of the legal issues involved, the almost unanimous outcry for guidance and the importance of this case to families who find themselves before the divorce courts of this State, it was hoped that the Supreme Court would entertain this matter.  They have declined to do so.  However, that does not eliminate the problems.  These issues must still be resolved.  We have attempted to present a broad overview of the issues without setting forth our opinion as to which resolution we believe is appropriate. However, one thing is clear: Uniformity among the bench, bar and experts is absolutely needed, under the guidelines of an objective and fair standard consistent with the underlying policies of the Equitable Distribution Statute.    The recent flurry of unfolding revelations about corporate misconduct and inflated earnings highlight the need to base determinations of value of a business on exact and objective figures and standards. As has occurred with the market, now in its worst shape since the early 90’s, a family’s finances can be devastated by over-valuing assets beyond what they are actually worth in the market place.