marital-value-240px-80403403In re Honer, 2015 Cal. App. Unpub. LEXIS 2531 (April 9, 2015)

In a bitter California divorce, the valuation of two grocery stores was a sore point. The wife attacked the work of the husband’s expert because he used what he called the “marital value.” The appeals court seemed surprised by the term and discussed the validity of “marital value” in terms of valuation methodology. But a reading of the case suggests that the issue was one of standard of value. Ultimately, given the circumstances, both the trial court and appeals court endorsed the expert’s approach.

Valuation dispute. During the marriage, the husband and wife bought and developed two successful grocery stores that offered specialty foods and natural and organic products. The couple owned the businesses through an S corporation in which the husband served as president and CEO and the wife as the vice president.

At the time of the divorce trial, the husband was 64 years old and working full-time at the markets. He said he planned to continue working until he was 70 and passing the business on to his daughter. He received an annual base salary $260,000. The wife suffered from a degenerative disease and stopped being involved in the grocery business. Historically, the couple used profits from the stores to invest in capital expenditures. California is a community property state.

The valuation of the businesses created bitter strife between the parties. The wife filed for divorce in fall 2009. In February 2010, the husband hired an experienced financial analyst with valuation credentials to appraise the stock of the corporation. The husband tried to persuade the wife to agree to a joint appraiser, but she refused. He also asked the wife to commit to a valuation date, but she delayed. Consequently, the appraiser prepared one valuation dated March 2010 and an updated one with a December 2010 valuation date. The trial took place a year later, in December 2011 and January 2012.

Value to the owner. The husband’s expert determined the corporation was worth $2.98 million as of year-end 2010. He used both the market and income approaches because the company was a going concern with considerable cash flow. As for the market approach, he used the guideline public companies method and the industry acquisitions method and arrived at a value of $3.2 million. Under the income approach, he used the income capitalization method, which yielded a value of slightly over $3 million. He weighted the results, saying he believed the value from the income approach more accurately reflected the company’s value. The operating controlling interest value of the company was nearly $3.1 million, which, after factoring in nonoperational assets and liabilities, he adjusted to $2.98 million.

He further explained that he used the “marital value” of the businesses, as opposed to the “investment value.” He explained that this value did not discount for lack of control or lack of marketability. On cross-examination, he explained that, even though a marital value determination “could be different” from an investment valuation, here, the “marital value” was the same as the fair market value. In his declaration, the expert also noted that his findings complied with the Uniform Standards of Professional Appraisal Practice (USPAP).

Third-party buyer assumption. Through her attorneys, the wife eventually retained her own expert. He was a broker in Washington, D.C., whose firm focused on the food industry and who valued the company based on the assumption that the markets would be sold as a going concern to a buyer active in the grocery business. The best way to determine the value of the business would be to “expose it to the market,” the analyst said. Also, he hoped to be able to sell both stores individually. This statement invited skepticism from the husband, who questioned whether it was feasible to run the markets independently. The wife’s expert also observed that a third-party buyer would acquire the inventory, property, plant, equipment, and liquor licenses, leaving the remainder of the balance sheet to be liquidated.

For his valuation, the wife’s expert used a June 2011 valuation date and relied on four valuation methods: comparable public company analysis, comparable transaction analysis, sales analysis, and adjusted EBITDA analysis. He arrived at a value of $5.9 million, from which he deducted $2.4 million based on the liquidation of the balance sheet, to arrive at a final value of $3.5 million.

He explained that he weighted the results, assigning the greatest weight to the value derived from the comparable transaction study. That analysis compared the value of the subject markets to the value of similar-size grocery chains that were sold to grocery operators from 2006 to 2010.

Both experts considered factors such as industry sales, the markets’ historical sales, and the national, state, and local economic outlook for grocery stores.

Throughout the proceeding, the wife appeared to change her mind as to what should happen to the business, i.e., whether it should be sold or awarded to the husband. However, her other objections notwithstanding, she ultimately did not object to the trial court’s awarding the company to the husband.

‘Investment of sweat, toil, worry and hopes.’ The trial court said it found the husband’s expert more credible for a number of reasons. For one, he made an effort to speak with top management at the markets and explore the businesses’ strengths and weaknesses. The wife’s expert conducted no interviews. The court also disagreed with the assertion of the wife’s expert that offering the business for sale would generate the most accurate indicator of value. Family businesses, the court said, “do not simply represent an investment of capital; they are also an investment of sweat, toil, worry and hopes.”

Moreover, the trial court expressed concern over a possible conflict of interest, noting the wife’s expert “could potentially act as broker if the markets were sold.” Further, the wife’s expert did not spell out the costs related to the sale of the markets nor explore the tax consequences arising out of the sale.

And the trial court noted the wife’s indecision as to the business. At times, she pushed for the sale of the markets; other times, she asked to be awarded the property on which they stood, which would have made her the husband’s landlady. Later, she contested the size of the equalization payment. Finally, the court pointed out that awarding the business to the husband was “essential” to ensuring he could continue to earn a living and pay spousal support to the wife.

As for the valuation date, the court pointed out that the husband paid more than $29,000 for the two appraisals, due to the wife’s failure to commit to a valuation date, and that asking him to procure a third one would be “inequitable and impracticable.”

The trial court expressly stated that, in crediting the valuation of the husband’s expert, it valued the business “as near as practicable to the time of trial,” as the applicable family code section required. Further, the court increased the value the husband’s expert determined by $200,000 based on the wife’s arguments and evidence. It found the corporation was worth $3.18 million. It ordered the husband to make an equalization payment of over $1.5 million and pay to the wife 20% of any distributions the corporation made to the husband. In the final analysis, the wife’s award exceeded the husband’s by one dollar.

Increased profit no surprise. Five months after the trial court’s statement of decision, the wife asked to reopen the proceedings, arguing that, since the business valuations, the company recorded a substantial increase in earnings that represented an “undivided asset,” which the court’s ruling did not take into account in its division of assets. In support of her request, she presented declarations from two accounting experts. One said earnings between year-end 2010 and mid-2012 (near the time of judgment) had grown by $400,000; the other said the wife was due nearly $430,000 to cover the period of January 2011 through September 2012.

In response, the husband submitted a declaration from a CPA and business valuation expert who denied that the retained earnings had increased to the extent the wife’s accounting experts suggested. He also noted that there were fewer capital expenditures during the litigation and said $250,000 was urgently needed to reinvest in the business and return the company back to industry norms. A business was “not an ATM machine,” from which one could withdraw cash at whim, he testified.

The trial court denied the wife’s request. It found the nature of the business had not changed since trial; the current financial results were not “substantially different from what [the wife] knew or suspected they would be at the time of trial.” Also, the wife and her counsel “were well aware that [the corporation] generated profits pre-trial and, in the absence of unforeseen circumstances, would continue to do so after trial concluded,” the trial court observed. Counsel made a “tactical decision of error” not to raise this issue at trial. Accordingly, there was no reason to revalue the business.

The wife appealed the trial court’s valuation to the state Court of Appeals on a number of grounds:

  •  Valuation date. The wife contended the trial court adopted the valuation of the husband’s expert, which in turn was out of date and failed to consider the significant additional income to the corporation between its valuation date (December 2010) and the date of judgment (December 2012).

The Court of Appeals quickly disposed of this argument, pointing out that the trial court made it clear that it valued the business at the time of trial, not at the end of December 2010. What’s more, the trial court “did not blindly accept” the valuation the husband’s expert proposed. Rather, it settled on a value that was between the valuations of the two experts. They differed by about $500,000. By adding $200,000 to the value the husband’s expert proposed, the court “narrowed the gap to $300,000.” This approach aligned with testimony from the husband’s expert that a “variance of five to 10 percent between one expert’s valuation and another’s would not be unusual.”

  •  ‘Marital value.’ The wife suggested the husband’s expert used a standard of value—marital value—that represented a “forbidden departure from ordinary rules of business valuation. By relying on his valuation, the trial court committed legal error. The trial court should have used the approach her expert used: determining the value the grocery stores would be worth if sold to a third-party buyer.

The appeals court tried to divine the meaning of “marital value,“ noting this appeared to be a term the husband’s expert had coined to indicate the value to the spouse holding onto the business. (The appeal court’s definition brings to mind the “intrinsic value” standard of value.) It agreed that the difference in the experts’ valuations hinged on the assumption of a third-party sale.

The appeals court said it saw no legal error in the method and reasoning the husband’s expert used. He was qualified as an expert and explained the facts and assumptions underlying his valuation. Even if his approach were “novel,” which the court said it did not believe it was, “that would not be indicative of a misunderstanding of the concepts governing valuation of business assets in a marital dissolution action.”

The court pointed out that, while the wife militated in favor of adopting the valuation her expert produced, she failed to address the reasons why the trial court rejected a sale of the business. One of them was practical: If there were a sale, the husband would lose his job; if he were awarded the business, “he will have a steady income stream from which to pay permanent spousal support, thus benefitting both parties.” What’s more, the wife did not actually appeal the court’s decision to award the business to the husband.

If the appeals court were to reweigh the evidence, it would “overstep” the acceptable scope of review, the court concluded.

  •  Motion to reopen evidence. The wife also attacked the trial court’s refusal to allow her to introduce more evidence of an increase in the earnings of the business. Those earnings, she claimed, belonged to the community and should be divided, but they were not captured in the experts’ valuations.

The appeals court found there was no error in the trial court’s decision. For one, the financial information available to the wife at trial already showed an increase in retained earnings, from $1.7 million in 2000 to $4.2 million in September 2011. Likewise, the legal theory that part of the amount was a community asset subject to division was available to her attorneys at trial. Also, the husband’s expert contradicted the statements the wife’s accounting experts made. The wife’s supposedly “new evidence” was not sufficiently material to require a reopening of the evidence.

Spousal support dispute. Finally, on appeal, the wife also challenged the trial court’s determination of spousal support.

The trial court found that the husband had available $278,000 annually from which to pay spousal support. The wife asserted he had about $1 million at his personal disposal. She contended that the trial court should have considered at least part of the company’s retained earnings as available for spousal support. It should have imputed to the husband any amounts not necessary for capital investment in the business, and it should have placed the burden on the husband to justify the amounts retained for reinvestment.

The appeals court firmly rejected that argument. It pointed to the statement from the husband’s accounting expert that the markets were undercapitalized and in need of reinvestment. Testimony about the “realities of the grocery business supports the view that taking cash from [the company] requires restraint and careful consideration” in order not to jeopardize the future success of the markets, the appeals court said. Therefore, it also upheld the trial court’s spousal award.