By Andrew Z. Soshnick
Throughout the United States, there are varying standards applied when valuing businesses and professional practices in divorce cases. That phenomenon exists even though valuation experts consider Internal Revenue Service Revenue Ruling 59-60 to be the seminal guidance for valuing closely held corporations. That Revenue Ruling provides that “fair market value” is “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.” Even with that directive, states differ in the standard of value applied to business and professional practice valuations in dissolution of marriage actions. According to one study by Jay Fishman, Shannon Pratt and William Morrison, 35 states and Washington, D.C., employ a “fair market value” standard, three states use a “fair value” standard, five states use an “investment value” standard and seven states use a “hybrid” standard. Indiana nominally falls into the “fair market value” category, but the route to this conclusion is far from linear.
The roadmap begins with an inauspicious start. In Eyler v. Eyler, 485 N.E.2d 657, 661 (Ind. Ct. App. 1985), rev’d 492 N.E.2d 1071 (Ind. 1986), a divided Indiana Court of Appeals reviewed how to determine the “fair market value” of stock in a closely held corporation and endorsed the application of a minority interest discount. On transfer, the Indiana Supreme Court found error in the application of the minority interest discount due to the parties owning 90.2 percent of the business at the date of filing. Read in concert, the Eyler opinions infer that “fair market value” is the standard to be applied in divorce cases. However, without the Supreme Court enunciating that standard in its opinion, the stage was set for further evolvement.
The now-discredited opinion of Porter v. Porter, 526 N.E.2d 219 (Ind. Ct. App. 1988), rev’d by Yoon v. Yoon, 711 N.E.2d 1265 (Ind. 1999) offered a new perspective with the inclusion of intangible value. In Porter, the trial court valued the husband’s otolaryngology practice at $400,000 and included both personal and enterprise goodwill in the marital estate. The Indiana Court of Appeals rejected the husband’s contention that the professional practice’s shareholder agreement fixed the value of his medical practice and held that all professional practice goodwill is includable in marital estates.
A little over a decade later, the Indiana Supreme Court revisited how professional practices are valued. Yoon v. Yoon, 711 N.E.2d 1265 (Ind. 1999) disapproved of Porter and held that only enterprise goodwill is a marital asset when a self-employed business or professional practice is implicated in a divorce. Personal goodwill is not a marital asset because it is future earning ability that is considered in determining the percentage of property to be given to each party pursuant to Ind. Code 31-15-7-5(5). Again, the word “value” was not defined. However, the Supreme Court dropped a hint by rejecting an expert’s use of an “intrinsic value” standard and concluding the “intrinsic value” standard conflicted with the statutory mandate that only property, not future earning ability, be divided.
Another clue followed 16 days later in In re Marriage of Conner, 713 N.E.2d 883 (Ind. Ct. App. 1999), where the trial court valued the husband’s radiology practice at $144,000, used an income approach and applied a 20 percent lack of marketability discount. The Indiana Court of Appeals reversed, concluding the purported valuation contained several deficiencies and did not distinguish between personal and enterprise goodwill as mandated by Yoon. Conner continued with the generic term “value,” but, by acknowledging a marketability discount could apply, gave tacit approval to the use of a “fair market value” standard.
Three years later, in a non-divorce shareholders’ dispute, the Indiana Court of Appeals considered an alternate standard that could be applied. Wenzel v. Hopper & Galliher, P.C., 779 N.E.2d 30 (Ind. Ct. App. 2002) explored the “fair value” standard and provided a glimpse as to why “fair market value” is the standard to be applied in divorce cases. Although the Indiana Professional Corporations Act did not define “fair value,” it allowed for reference to the Indiana Business Corporation Law, which defined “fair value” as “the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.” The Court of Appeals explained that “fair value” is not the same as “fair market value.” “Fair value” carried the statutory purpose that shareholders be fairly compensated, which might or might not equate to the market judgment of value. Alternatively, “fair market value” represents the amount for which property will sell upon open market negotiations between a willing buyer and a willing seller without obligation. Minority and marketability discounts apply when determining “fair market value,” but not when determining “fair value.” Wenzel clarified the definition of “fair market value” and pointed to a strong presumption that the appellate courts’ prior use of the word “value” actually meant “fair market value.”
By 2005, that strong presumption became even more of a reality. In Nowels v. Nowels, 836 N.E.2d 481 (Ind. Ct. App. 2005), the husband owned a non-controlling interest in a subchapter S lumber business. The trial court made a specific finding that the “fair market value” of the husband’s interest was $2.5 million at the date of the final hearing. The Indiana Court of Appeals affirmed, finding the trial court’s valuation was not arbitrary and was a well-reasoned resolution of conflicting evidence. The Court of Appeals noted each expert used the “same general approach” in attempting to arrive at “fair market value,” but applied divergent discount rates. The trial court acted within its broad discretion in assigning a value to the husband’s business interest. Nowels provides the most express reference to and use of the term “fair market value” in the divorce business and professional practice context.
In a relatively recent opinion, the Indiana Court of Appeals tied all of these concepts together. Alexander v. Alexander, 927 N.E.2d 926 (Ind. Ct. App. 2010) considered the valuation of multiple businesses. Most relevant, the wife owned a 5 percent interest in a farm business that the trial court valued at $253,670. The husband argued the trial court should not have applied minority and marketability discounts. Noting a majority of other jurisdictions rejected the application of minority and marketability discounts when determining the “fair value” of stock in cases where a majority shareholder or corporation purchases the stock, the Court of Appeals undertook a detailed analysis that differentiated divorces. The Court of Appeals first noted that the Indiana Supreme Court implicitly approved the application of a minority interest discount in divorce cases. The Court of Appeals acknowledged the wife might someday inherit a controlling interest in the farm from her parents or sell her interest to the controlling owners for the then-fair market value that would be considerably higher than the value the trial court applied, or that the wife might sell her 5 percent interest to her parents the day after the divorce became final for “fair market value.” Nevertheless, the Court of Appeals reasoned that minority and marketability discounts were appropriate for use by trial courts in divorce cases because trial courts have broad discretion in valuing marital property; because the trial court was valuing the wife’s interest as a going concern; and because trial courts can only value marital assets as they exist between the date of filing and the date of final hearing. As a result, the trial court acted within its discretion and did not commit clear error in applying minority and marketability discounts. Cf. Crider v. Crider, 15 N.E.3d 1042 (Ind. Ct. App. 2014).
Although at first blush Alexander might suggest that “fair market value” is not the applicable standard of value to be applied to businesses and professional practices in divorce cases, closer inspection yields the opposite conclusion. Alexander rejects the “fair value” standard, hones in on going concern value, endorses the application of “fair market value” discounts when appropriate and reinforces the fact that standards of value that divide future earnings are inconsonant with Indiana law. The unmistakable gist of the analysis and conclusions in the Alexander opinion, when coupled with Eyler and Nowels, leaves little doubt Indiana courts are to use the “fair market value” standard when valuing businesses and professional practices. And that is the “fair” that is the standard fare in divorce cases.•
• Andrew Soshnick is a partner and trial lawyer at Faegre Baker Daniels LLP. The opinions expressed are those of the author.