EQUITABLE DISTRIBUTION VALUATION LAW VALUATION WAKE FOREST UNIVERSITY

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EQUITABLE DISTRIBUTION VALUATION LAW & VALUATION WAKE FOREST UNIVERSITY LAW SCHOOL April 14, 2004

EQUITABLE DISTRIBUTION VALUATION LAW & VALUATION WAKE FOREST UNIVERSITY LAW SCHOOL April 14, 2004 A. Doyle Early, Jr.

What is the Standard of Value for Equitable Distribution in North Carolina? A. B.

What is the Standard of Value for Equitable Distribution in North Carolina? A. B. C. D. E. F. G. H. Fair Market Value - Poore v. Poore (1985) Investment Value Intrinsic Value - Fountain v. Fountain (2002) Fair Value - Hamby v. Hamby (2001) Royals v. Piedmont Electric Going Concerns Value Liquidation Value Book Value/Adjusted Book Value Net Value - Beightol v. Beightol (1988)

Fair Market Value Rev. Ruling 59 -60 The price at which property would change

Fair Market Value Rev. Ruling 59 -60 The price at which property would change hands between a willing buyer and a willing seller, when the former is not under any compulsions to buy and the latter is not under any compulsions to sell, both parties having reasonable knowledge of relevant facts. Carlson v. Carlson (1997)

Classification And Date of Valuation 1. 2. 3. Marital Separate Divisible N. C. G.

Classification And Date of Valuation 1. 2. 3. Marital Separate Divisible N. C. G. S. § 50 -20(b) 1, 2 and 4

Real Estate Valuations A. B. C. Direct Sales Comparison Approach Income Approach Cost Approach

Real Estate Valuations A. B. C. Direct Sales Comparison Approach Income Approach Cost Approach

Valuing Personal Property 1. 2. 3. 4. By the Parties/Affidavits By an Appraiser Publications

Valuing Personal Property 1. 2. 3. 4. By the Parties/Affidavits By an Appraiser Publications Court Valuations

Valuing Stock Options 1. 2. Intrinsic Value - Fountain v. Fountain (2002) Black Scholes

Valuing Stock Options 1. 2. Intrinsic Value - Fountain v. Fountain (2002) Black Scholes Method

Valuation of Life Insurance 1. 2. Cash Surrender Value Fair Market Value - Surles

Valuation of Life Insurance 1. 2. Cash Surrender Value Fair Market Value - Surles v. Surles (2002)

Valuation of Pension, Retirement and Deferred Compensation Benefits Types of Plans A. Defined Contribution

Valuation of Pension, Retirement and Deferred Compensation Benefits Types of Plans A. Defined Contribution B. Defined Benefit C. Vested D. Non-Vested

Vested and Non-Vested Pensions Vested pensions may be payable: 1. As a lump sum

Vested and Non-Vested Pensions Vested pensions may be payable: 1. As a lump sum by agreement; 2. Over a period of time in fixed amounts by agreement; 3. By appropriate Domestic Relations Order as a prorated portion of the benefits made to the designated recipient at the time the party against whom the award is made actually begins to receive the benefits; or 4. By awarding a larger portion of other assets to the party not receiving the benefits and a smaller share of other assets to the party entitled to receive the benefits. Non-vested pensions may be payable: Same as 1, 2 and 3, but not 4.

Determining Present Value Bishop v. Bishop (1994) 1. Determine the amount of monthly benefit

Determining Present Value Bishop v. Bishop (1994) 1. Determine the amount of monthly benefit that would be received at retirement age if party had retired on date of separation 2. Determine the life expectancy 3. Determine the appropriate discount rate 4. Calculate present value 5. Use of PBGC Tables

Example of Valuation of Defined Benefit Plan $5, 820 7. 5% 3. 486 $19,

Example of Valuation of Defined Benefit Plan $5, 820 7. 5% 3. 486 $19, 564. 51 79% $15, 455. 96 39. 5% Annual benefit at age 65 PBGC interest rate on the date of separation Table IV-A for 7. 5% - PBGC actuarial value of $1. 00 per year deferred to age 65…and payable for life thereafter -- healthy lives PBGC interpolated actuarial factor Annual benefit x PBGC factor Coverture fraction (15/19) Present value of defined benefit after applying coverture fracture Prorated benefit at date of retirement

Valuing Closely Held Corporations and Professional Practices “Further, in reviewing the trial court’s valuation

Valuing Closely Held Corporations and Professional Practices “Further, in reviewing the trial court’s valuation of an ongoing business or an interest therein for purposes of equitable distribution, the task of the appellate court is to determine whether the approach used by the trial court reasonably approximates the net value of the business interest…. If it does, the valuation will not be disturbed. ” If no credible evidence is presented as to value of business, the court does not have to value it. Grasty v. Grasty (1997)

Factors to be Considered under Revenue Ruling 59 -60 1. The nature of the

Factors to be Considered under Revenue Ruling 59 -60 1. The nature of the business and the history of the enterprise from its inception. 2. The economic outlook in general and the condition and outlook of the specific industry in particular. 3. The book value of the stock and the financial condition of the business. 4. The earning capacity of the company. 5. The dividend paying capacity. 6. Whether or not the enterprise has goodwill or other intangible value. 7. Sales of the stock and the size of the block of the stock to be valued. 8. The market price of stocks of corporations engaged in the same or similar line of business having their stocks actively traded in the free and open market, either on an exchange or over the counter.

Approaches to Valuation 1. Income Approach A. Capitalization of Earnings B. Capitalization of Discounted

Approaches to Valuation 1. Income Approach A. Capitalization of Earnings B. Capitalization of Discounted Cash Flow C. Capitalization of Discounted Net Income 2. Asset Based Approach A. Adjusted Book Value B. Liquidation Value C. Capitalization of Excess Earnings (Rev. Ruling 68 -609) 3. Market Comparable Approach A. Sales of Comparable Companies B. Arms-Length Transactions C. Prior Sales of Company Stock D. Consideration of Restrictive Agreement (Buy-Sell) - Fox v. Fox (1991) E. Use of Industry Standard Approaches (Rules of Thumb) - Smith v. Smith (1993) 4. Trial Court is permitted to average the approaches utilized by the experts - Sharp v. Sharp (1994) 5. To Challenge methodology, the party must object to the admissability of the evidence Walter v. Walter (2002)

Capitalization of Excess Earnings (Revenue Ruling 68 -609) 1. 2. 3. 4. Average Earnings

Capitalization of Excess Earnings (Revenue Ruling 68 -609) 1. 2. 3. 4. Average Earnings Normalized $ 50, 000. 00 Average Tangible Assets 200, 000. 00 Fair Percentage Return (10%) 20, 000. 00 Average Earnings Attributable to Goodwill or Excess Earnings (1. - 3. ) 30, 000. 00 5. Capitalized Averaged Earnings Attributable to Goodwill at 20% (Multiply by 5 to get the value of Goodwill) 150, 000. 00 6. Add 2. And 5. For Total Business Value $350, 000. 00

Capitalization Rates 1. The rate used to convert income into an asset. 2. Determine

Capitalization Rates 1. The rate used to convert income into an asset. 2. Determine the discount rate, which represents the total annually compounded rate of return the investor requires over the life of the investment. 3. Capitalization rate is discount rate minus long term growth. C=D-g 4. A capitalization rate reflects risk. 5. A capitalization rate may be expressed in a percentage or a multiple (I. e. , a 25% capitalization rate results in a multiple of 4). 6. Capitalization rate equates to P. E. (Price Earnings Ratio) 7. Court can choose it’s own capitalization rate - Smith v. Smith (1994)

Build-Up Method 1. Risk-free, long-term (20 yr. ) government bond rate 2. Equity (common

Build-Up Method 1. Risk-free, long-term (20 yr. ) government bond rate 2. Equity (common stock) risk premium 3. Small company risk premium 4. Specific company risk premium (Determined by appraiser) 5. Discount rate Less long-term growth of Equals Capitalization rate of 7. 30% 7. 40% 5. 10% 8. 00% 27. 80% - 5. 00% 22. 80%

Example of Weighted Value Year Net Income 1985 1986 1987 1988 1989 Total $

Example of Weighted Value Year Net Income 1985 1986 1987 1988 1989 Total $ 95, 000 $102, 000 $115, 000 $140, 000 $154, 000 $606, 000 $1, 974, 000 ÷ 15 = $131, 600 Weighted Net Income 1 2 3 4 5 15 $ 95, 000 $ 204, 000 $ 345, 000 $ 560, 000 $ 770, 000 $1, 974, 000

Restrictive Agreement Weaver v. Weaver (1985) 1. 2. 3. Presumptive Value Reasonable or Rational

Restrictive Agreement Weaver v. Weaver (1985) 1. 2. 3. Presumptive Value Reasonable or Rational Reflection of Value Experience and History

Discounts or Premiums A. B. C. D. E. F. G. Minority Interest Discount v.

Discounts or Premiums A. B. C. D. E. F. G. Minority Interest Discount v. Control Premium Lack of Marketability Discount (Liquidity) Discount for Loss of Key Man Discount for Trapped-In Capital Gains - Davis v. Commissioner (Discount allowed for trapped-in capital gains although there was no sale or contemplated sale of the asset on the date of separation. ) But…Dolan v. Dolan (2002) - the value of commercial real estate should not be adjusted for capital gains distribution did not contemplate an immediate sale Clark v. Clark (1980) - Alimony Shannon Pratt

The Trial Judge as Gatekeeper for Expert Testimony 1. 2. 3. 4. 5. 6.

The Trial Judge as Gatekeeper for Expert Testimony 1. 2. 3. 4. 5. 6. 7. Daubert v. Merrell Dow Pharmaceuticals, Inc. (1993) Scientific testimony Kumho Tire Co. v. Patrick Carmichael (1999) Expanded to technical or other specialized testimony Howerton v. Arai (2003) Danbert applied in N. C. Walter v. Walter (2002) Applies to valuation methodology if there is objections Rule 702 - “If scientific, technical or other specialized knowledge will assist the trier of fact… a witness qualified as an expert… may testify hereto in the form of an opinion. ” Questions for the trial judge: A. Whether testimony is based on scientifically valid reasoning or methodology B. Whether the reasoning or methodology can properly be applied to the facts at issue Factors to consider in determining admissibility: A. Whether theory or technique can be and has been tested B. Whether it has been subjected to peer review and publication C. The known or potential rate of error D. Whether theory or technique has achieved general acceptance in the relevant field