Is a valuation that prevailed in one type of case applicable in another context? This question was at the heart of an unusual case that combined bankruptcy and divorce-related issues.
From divorce to Chapter 13: The husband owned a 25% interest in a dental practice. Under the controlling shareholder agreement, if a shareholder wanted to dispose of his interest, the other shareholders were obligated to buy it back. The agreement included a formula for determining the purchase price for the shares.
At divorce, the wife’s expert valued the husband’s interest based on the going concern of the dental practice as a whole, taking 25% of it. He concluded it was worth $212,000. He also valued the interest based on the formula, which he said was “an absolute floor” in terms of the amount the husband could get from the other shareholders. The husband’s expert said the interest was worth $15,800. He assigned no value to patient records or the practice’s goodwill. The trial court adopted the value the wife’s expert proposed—$212,000. It noted the applicable standard of value in divorce proceedings was the intrinsic value of the business.
Three months later, the husband filed for Chapter 13 bankruptcy and asked the Bankruptcy Court for plan confirmation. In his schedules, he listed the value of the practice at $15,800. But the two experts testifying before the Bankruptcy Court on the husband’s behalf claimed that, since the interest was a minority interest, it was worth “zero.” According to one expert, if he were the Chapter 7 trustee administering the estate, he would abandon the interest altogether. No one on the open market would buy it.
The wife, who was the principal unsecured creditor, objected to the confirmation, arguing the plan failed the applicable liquidation test, which requires that creditors in a Chapter 13 bankruptcy receive present value payments that are at least equal to the amount the creditors would receive in a Chapter 7 case. The analysis involves determining the amount each unsecured creditor would receive if the estate were liquidated in a hypothetical Chapter 7 case.
The Bankruptcy Court’s decision turned on the value of the husband’s shares. The wife contended the divorce court’s valuation was controlling. Based on that value determination, the distribution to unsecured creditors in a hypothetical Chapter 7 liquidation would be much greater than under the husband’s Chapter 13 plan.
Standard of value issue: The Bankruptcy Court said the divorce valuation was not determinative in this context. It noted that, in a hypothetical Chapter 7 liquidation, a Chapter 7 trustee is asked “to reduce to money the property of the bankruptcy estate” by selling or disposing of the property in other ways. “This is different from determining the intrinsic value, or its worth to the parties, in a divorce proceeding.”
But the court also rejected the suggestion that the shares had zero value. Regardless of various impediments to liquidating the asset, there was evidence that it would have “significant value” in a Chapter 7 liquidation, the court said. It was safe to assume a Chapter 7 trustee in this case could recover the amount payable under the buyout provisions of the shareholder agreement. Given this valuation, which exceeded the husband’s scheduled valuation by over $145,000, the court found the husband’s plan failed to satisfy the liquidation test.
Takeaway: In ruling on the confirmability of a debtor’s Chapter 13 plan, the court declined to adopt the valuation that prevailed in the debtor’s divorce proceeding because the value determination entailed a different line of inquiry than was applicable in a hypothetical Chapter 7 liquidation. The most reliable indicator of value was the amount resulting from the shareholder agreement formula, the court decided.
Find an extended discussion of In re Cole, 2016 Bankr. LEXIS 932 (March 24, 2016), in the June edition of Business Valuation Update; the court’s opinion will be available soon at BVLaw.