Contents

• Arguments for Applying Fair Value Standard in Divorce



• Divorce Court Considers Discount for Lack of Control For a 50% Interest



• Court Considers Built-in Capital Gains Deduction In Applying Fair Value

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Valuations Insights, Fourth Quarter, 2008

Arguments for Applying Fair Value Standard in Divorce

Most state courts apply the fair market value standard when appraising the value of closely held businesses in divorce. These courts generally define fair market value by reference to IRS Revenue Ruling 59-60: the price a willing buyer and seller would agree on when neither is under any compulsion and both are knowledgeable about the business.

However, a growing number of legal and valuation authorities are arguing for the fair value standard in divorce cases. Most statutory schemes define fair value as the pro rata share of the business as a going concern, without reference to discounts for lack of marketability or for minority interests (lack of control). Courts' reactions to these requests have been mixed.

Analogy to dissenters' rights

Opponents of the fair market value standard claim that it denies the non-operating spouse a pro rata share of the business (including his or her contributions to growing the business during the marriage) and unduly enriches the operating spouse. By analogy, they point to the rights and remedies that dissenting shareholders receive under the applicable state business corporation act and the fair value standard.

The analogy is based largely on the Delaware Supreme Court's landmark decision in Cavalier Oil Corp v. Harnett, 564 A.2d 1137 (Del. 1989), denying discounts for lack of marketability and lack of control when calculating fair value in dissenting shareholder actions. The court's rationale turned on three points: 1) fair value assumes that the minority would have maintained an ongoing investment in the business; 2) applying discounts injects speculation into the appraisal process; and 3) discounts penalize dissenting shareholders for enforcing their rights while providing majority shareholders a windfall.
So far, only a handful of state courts have addressed fair value as the standard of value in divorce in a meaningful way, including North Dakota, New Jersey, Florida, and Washington. By contrast, Arkansas courts have found that the fair value standard contravenes established law. Two general observations emerge from these cases:

1. First, when the spouses hold stock in a closely held business—particularly one that is majority-owned and controlled by one of their families—the courts seem inclined to find that discounts for lack of marketability and lack of control (minority interest) are not appropriate, applying the analogy of dissenters' rights and oppressed shareholders cases to the divorce setting. The "outside" spouse is akin to the oppressed/dissenting shareholder, subject to a forced sale of his or her interest to the "inside" spouse, who would receive a windfall by acquiring the stock at a discount. At the same time, the inside spouse enjoys recourse to the corporate business statutes, to appraise his or her interest at full, undiscounted value (per the fair value standard) should post-divorce, intra-family dealings go awry.

2. The second observation arises as a corollary of the first: When both spouses are actively involved and own shares in the business, a discount for lack of marketability and lack of control may be appropriate within the discretion of the trial court. This situation positions the parties more like deadlocked shareholders who petition the court for dissolution of the business.

These are, of course, general distillations from the relevant case law and do not substitute for further legal research and application within a practitioner's relevant jurisdictions. Clearly, those who support the application of fair value principles in marital dissolutions need to develop broader support among legal authorities, legislators, and equitable principles to present persuasive arguments before the courts.

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