Appeals court fudges DLOM issue in divorce case

BVWireIssue #165-4
June 29, 2016

Appraisers rely on clear directives from the courts to produce sound valuations, but they may not always get them. A recent Tennessee appellate ruling in a divorce dispute is a case in point. The issue was whether it was appropriate to use a marketability discount in the valuation of the husband’s interests in several businesses. The court’s answer creates a quandary for experts as to what the law is.

Agreement on DLOC: The husband, a successful real estate developer, owned minority interests in three general partnerships that bought land, developed it for residential subdivisions, and sold the lots to builders. Trial focused on the valuation of the interests, with both sides offering testimony from real estate appraisers as well as business valuators.

Both parties’ BV analysts used the net asset approach and agreed it was appropriate to apply a minority discount to account for the husband’s lack of control over the businesses. But they disagreed over the use of a marketability discount. The wife’s expert claimed it was inappropriate to use a DLOM when the owner spouse had no intention of selling his interest. The husband’s expert applied the discount regardless of the husband’s lack of intent to sell, saying the DLOM was “the gauge of a readily available market to turn a particular interest into cash.” Moreover, he said, here the partnership agreements restricted a partner’s ability to sell his interest. Based on restricted stock studies and state case law, he used an 18% DLOM for one partnership, a 12% DLOM for the second business, and a 30% DLOM for the third one.

‘Slight’ DLOM: The trial court awarded the husband all of the business interests but credited the valuations the wife’s experts offered. In terms of the DLOM, it found the rates the husband’s expert used were too high or altogether inappropriate. Concerning one partnership, the court found the “Husband might be compelled to sell some portion of his assets in order to accomplish the property divisions ordered by the Court while still maintaining and supporting the remaining business interests.” Therefore, the court reduced the 18% DLOM to a “slight discount for marketability.” (The opinion fails to state what “slight” means.) As for the other two partnerships, the trial court declined to apply a DLOM because the husband had no intention of selling his interests.

On appeal, the husband claimed the trial court erred in its DLOM rulings.

The appeals court noted that valuation experts typically use a marketability discount to reflect that there is no ready market for an interest or that provisions in a partnership agreement restrict a partner’s ability to liquidate his or her interest. It further said: “Generally, applicability of the use of a lack of marketability discount depends on the characteristics of the ownership interest being valued, not whether the owner of the interest actually intends to sell the interest.”

But, even though the trial court’s DLOM analysis focused on the owner’s intent to sell, the appeals court did not expressly critique or reject the trial court’s findings. Rather, it found, “in many instances, the decision to apply the discount is seen as discretionary” and was “dependent on the facts of the case.” Here, the facts suggested the trial court did not abuse its discretion in applying a “slight” DLOM for one general partnership and no DLOM in valuing the other two interests, the appeals court said in affirming the trial court’s valuations.

Takeaway: The Tennessee Court of Appeals sends a mixed message regarding the use of a marketability discount in valuing marital assets. While the appeals court suggests the trial court focused on the wrong question when deciding on the use of DLOM, the appeals court defers to the trial court, noting valuation is a fact question and as such the province of the trial court.

Find an extended discussion of Grant v. Grant, 2016 Tenn. App. LEXIS 327 (May 12, 2016), in the August issue of Business Valuation Update; the court’s opinion will appear soon at BVLaw.

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