In Case You Were Wondering Are Marketability Discounts Appropriate in Divorce Cases?
In Case You Were Wondering Are Marketability Discounts Appropriate in Divorce Cases?
MOORE V. MOORE, Opinion No. 27579 (S.C. Oct. 7, 2015)
Facts of the Case: The parties were married in 2001 and filed for divorce in 2011. Shortly before the marriage, Wife opened Candelabra, a retail business selling high-end lighting, furnishings, and home accessories. Wife owned 51% and Husband owned 49% of the business. At trial, both parties presented expert testimony regarding Candelabra’s value.
Wife’s expert determined Candelabra’s total value to be $1,200,000 as of June 30, 2011. Further, this expert testified that the value should be discounted by 20% to reflect Candelabra’s lack of marketability, resulting in a value of $960,000 to the marital estate. Husband’s expert valued Candelabra at $2,960,000 as of June 30, 2012. This expert opined that Candelabra could be sold fairly readily and that it was inappropriate to apply a marketability discount.
Trial Court Decision: The family court relied exclusively on Husband’s expert’s testimony, determining Candelabra’s value to be $2,960,000. Wife was granted the first option to purchase Husband’s 49% interest in Candelabra over a five-year period. Both parties appealed the decision. Wife argued, in part, that the trial court erred because a marketability discount should have been applied to Candelabra’s value. Husband’s reasons for appeal are not relevant to this discussion.
Supreme Court Decision: The Supreme Court affirmed in part and reversed in part. With regard to the marketability discount, the Supreme Court accepted the opinion of Husband’s expert, stating:
We decline to impose a bright line rule regarding the appropriateness of such discounts in all family court business valuations, but we find no justification for discounting the value of Candelabra in this case due to lack of marketability. Because Wife will retain ownership of Candelabra, we see no legitimate reason to indulge in the fiction of a marketability discount.
GRELIER V. GRELIER, 44 So. 3d 1092 (Ala. Civ. App. 2009)
Facts of the Case: Husband owned a 25% interest in GC Partners, LLC, an entity involved in real estate and commercial ventures. The trial court appointed a Special Master to examine GC’s finances and submit a report of findings to the court. The Special Master testified that the Husband’s business interests were valued at $1,003,154.
Both parties presented expert testimony refuting parts of the Special Master’s report. Wife’s expert testified that the Special Master’s appraisal was based on outdated appraisals of real property but agreed with the Special Master that minority and marketability discounts should not be applied. Husband’s expert testified that a marketability discount is usually applied whenever difficulties will be encountered in converting an asset to cash. Husband’s expert further testified that Husband could not sell any of his interests without the unanimous consent of the other members and that Husband’s expert would apply a 25% minority discount and at least a 25% marketability discount to properly value Husband’s interest.
Trial Court Decision: After hearing testimony from the Special Master and both parties’ experts, the court accepted the Special Master’s proffered value, subject to a combined 40% minority and marketability discount. Husband was awarded all his business interests. On appeal, Wife argued that the trial court erred in the application of the combined discount when valuing Husband’s business interests.
Appellate Court Decision: The Court of Appeals reversed the trial court and remanded the case for “proper valuation” of Husband’s interests (i.e., without any discounts). In its opinion, the court stated that a trial court must determine property value in a way that is fair to all parties concerned. The court found the “fair value” standard used in the context of dissenting shareholder disputes applicable to marital dissolutions cases, as stated below:
In cases in which a divorce court does not contemplate the sale of a business in which one of the spouses holds a minority interest but, instead, intends that the business shall remain a going concern, it makes little sense to determine fair value by the measuring stick of a hypothetical sales price. That methodology would artificially reduce the value of the marital asset in almost every case, which would be unfair … to the party receiving only a portion of the reduced value … but would be advantageous to the party retaining the business interest, including its actual value to him or her as the holder.
In a dissenting opinion, one justice wrote that the trial court acted within its discretion in the application of the discounts to Husband’s business interests.
It is interesting to note that on December 19, 2008, the Court of Appeals issued a decision in this matter affirming the trial court’s decision that the computation of the Husband’s business interests’ value necessitated the application of both the minority and the marketability discounts. The 2008 decision was withdrawn and the 2009 decision was substituted.
Wife appealed again on the basis that the division of the marital estate was inequitable (Grelier v. Grelier, 63 So. 3d 668 [Ala. Civ. App. 2010]). Although the trial court expressly stated that it had considered Husband’s business interests’ value without the application of any marketability or minority discounts, in compliance with Court of Appeals instructions, the trial court still found it equitable to divide the estate as it had in its original decision. The Court of Appeals concluded that the trial court had abided by its mandate and affirmed the decision.
IN RE MARRIAGE OF THORNHILL, 232 P. 3d (Colo. 2010)
Facts of the Case: During the marriage, Husband formed NRG Services, LLC, a successful oil and gas service company. The primary issue in this case involved the validity of a separation agreement entered into by the parties in 2006 that valued Husband’s interest in NRG subject to a 33% marketability discount.
At trial, both parties presented expert testimony as to NRG’s value. Although both experts valued NRG at approximately $2,500,000, Husband’s expert applied a 33% marketability discount.
Trial Court Decision: The trial court ruled that the separation agreement was enforceable and adopted Husband’s expert’s opinion that the marketability discount should be applied to NRG’s value. Wife appealed on the grounds that marketability discounts are never appropriate in marital dissolution proceedings.
Appellate Court Decision: The court affirmed the trial court’s holding that failure to apply a marketability discount could unfairly penalize a party for ownership of shares that cannot be readily sold or liquidated. As courts of equity, trial courts in dissolution proceedings should have discretion as to the application of a marketability discount in the valuation of closely held corporations. In this case, the court declined to express an opinion as to the amount or percentage of discount that could be applied, noting that courts in other jurisdictions have approved discounts ranging from 10% to 35%. The court advised that trial courts should make a clear record as to the reason for the application of a specific discount based primarily on valuation experts’ testimonies.
Wife appealed to the Supreme Court.
Supreme Court Decision: The Supreme Court affirmed the Court of Appeals’ decision, stating: [T]here is no per se rule against marketability discounts in the divorce context and [we] hold that it is within the trial court’s discretion to apply a marketability discount when valuing a spouse’s ownership interest in a closely held corporation.
CAVENEY V. CAVENEY, 81 Mass. App. Ct. 102, 960 N.E. 2d, 342 (2012)
Facts of the Case: The parties both owned interests in various family businesses at the time of the divorce. Wife had a 24.75% ownership in three closely held real estate construction and management corporations. The parties stipulated to the fair value of Husband’s holdings.
Wife’s expert testified that the combined value of Wife’s interest in the three companies was approximately $616,000 on a pre-discounted basis. Using what he termed a “fair value” standard to value the interests, this expert then applied a 15% discount for lack of control and a 30% discount for lack of marketability.
Trial Court Decision: The court accepted Wife’s expert’s testimony in its entirety, including the application of the significant discounts taken for lack of control and lack of marketability. Husband appealed, arguing that the trial court erred in relying on Wife’s expert’s opinion that a 30% marketability discount was warranted in this case.
Appellate Court Decision: The Court of Appeals reversed the trial court, finding that the application of a marketability discount to Wife’s interests’ value would unfairly deflate the marital assets’ value. Because no sale of the business interests was anticipated, liquidity or marketability was of little consequence in this case.
In its decision, the court cited the holdings in Bernier v. Bernier, 449 Mass. 774, 873 N.E. 2d 216 (2007) and Brown v. Brown, 348 N.J. Super., 466 792 A. 2d 463 (2002). In Bernier, the court held that where valuation of assets occurs in the context of divorce, and where one of the parties will maintain, and the other be entirely divest of, ownership of a marital asset after divorce, the judge must take particular care to treat the parties not as arm’s-length hypothetical buyers and sellers in a theoretical open market, but as fiduciaries entitled to equitable distribution of their marital assets. In Brown, the court cautioned that neither marketability nor a minority discount should be applied absent extraordinary circumstances… Close corporations by their nature have less value to outsiders, but at the same time their value may be even greater to other shareholders who want to keep the business in the form of a close corporation.
TRAHAN V. TRAHAN, 49 So. 3d 889 (La. 2010)
Facts of the Case: The parties were married in 1998 and filed for divorce in 2007. The estate’s major asset was Husband’s two-thirds interest in Chemtech Chemical Services, LLC (“Chemtech”). Pursuant to a marriage contract the parties executed in 1998, Wife was “entitled to a cash payment equal to one-half Chemtech’s value as of the date of divorce.”
Both parties presented expert testimony regarding Chemtech’s value. Wife’s expert valued Chemtech at $14,800,000, and Husband’s expert valued Chemtech at $8,177,530. Both experts provided Chemtech’s value both before and after application of marketability discounts. Wife’s expert acknowledged the court’s discretion to apply discounts but suggested that the application of such discounts may be inappropriate when there is no intention to sell the business.
Trial Court Decision: Finding Husband’s expert’s testimony more credible, the trial court established Chemtech’s value at $8,177,530. Including a 20% marketability discount, the court determined a net value of $6,642,000. In its decision, the court acknowledged that there was no clear standard for marital business valuation in Louisiana. Historically, Louisiana courts inconsistently applied marketability discounts in divorce cases when there was no intention to sell the business. Wife appealed, alleging, among other things, that the trial court abused its discretion by discounting the value of Husband’s interest in Chemtech for lack of marketability.
Appellate Court Decision: The Court of Appeals affirmed the lower court, rejecting Wife’s reliance on Cannon v. Bertrand, 2008-1073 (La. 1/21/09), 2 So. 3d 393, a case involving a partner’s withdrawal from a partnership. In Canon, the Louisiana Supreme Court declined to apply a marketability discount; however, the court recognized that such a discount may be appropriate in some cases, but the discount should be used only when the facts support its use. In the present case, the court determined that a marketability discount was warranted based on the case’s facts and circumstances.
It is clear from the review of these cases that there is no national consensus as to the propriety of the application of marketability discounts to business interests in the context of divorce. It is essential that attorneys and valuation experts be aware of any statute that addresses the issue or of any binding case precedent in the jurisdiction(s) in which they practice.