Value of a law firm is controlled by “standard of value”

Hartley v. Hartley, 2010 WL 2071444 (Ala. Civ. App.)(May 21, 2010)

Lawyers and their financial experts face particular discovery challenges when the business in a divorce case is a law firm.

Restrictive buy-sell poses a barrier, too. In this case, the wife subpoenaed the husband’s law firm for all personnel and payroll records, retirement plans and employment contracts that involved his partnership interest. The law firm tried to intervene, claiming the wife sought confidential and proprietary information. The trial court denied the motion and required the firm to produce the records under a protective order—among them a buy-sell agreement that limited the repurchase of any partner’s interest (on death, retirement, or termination) to $10 per share; or in the husband’s case, a mere $1,000.00.

The wife filed supplemental discovery requests for the law firm’s financial statements and compensation records; its principal clients, accounts receivable, and unbilled work. The husband objected, claiming the buy-sell agreement rendered the requests irrelevant “as an evidentiary matter,” and that any valuation of a professional spouse’s interest must be limited to the buy-sell formula. The wife objected, arguing that under applicable procedure and case law, the buy-sell agreement did not control the valuation of professional practice in divorce.

The trial court agreed with the husband, however, and issued an order declaring the only relevant information “for a fair division of the assets” was the husband’s compensation records, benefits, and tax returns. “If he leaves the firm, he has contractually agreed to get $1,000.00,” the trial court said. “If the firm dissolves in the future, the speculative value of any profit or loss cannot be determined at this point.”

Case requires extraordinary relief. The wife sought an immediate review by the Court of Appeals (Alabama)—an extraordinary request granted only when the petitioner clearly has a legal right to the discovery but no other adequate remedy. The appellate court found the wife’s request fell within this exception, because the trial court’s order “essentially forecloses any further discovery, as well as any further presentation of evidence at trial, concerning…the value of the husband’s interest in the law firm.” At the same time, it considered the husband’s renewed argument: i.e., that because the buy-sell agreement limited the value of his interest, the wife was seeking irrelevant, immaterial evidence.

The wife countered by invoking what she termed the “majority rule” among U.S. jurisdictions that a buy-sell agreement does not control the ultimate value of a shareholder’s interest. After the parties briefed the issue, the same Court of Appeals decided Grelier v. Grelier 2009 WL 5149267 (Dec. 30, 2009)(available at BVLaw™), which adopted the equitable “fair value” standard in divorce cases. Under this rule, the issue is not the effect of buy-sell agreements in divorce but more the appropriate standard of value and its determination of the relevant (and discoverable) evidence.

“We need not…conclusively determine for all cases the proper valuation of an ownership share of a partnership of legal-service providers,” the Court of Appeals explained. Rather, the crucial inquiry in divorce cases “is to determine the fair value of the parties’ assets rather than to adhere in all cases to their ‘fair market value,’ i.e., to the price that the general market might assign to them.” (emphasis added) Accordingly, any discovery that is reasonably tailored to obtain information related to an asset’s “fair value” falls within the scope of [the state’s version] of Rule 26, the court said:

In the words of Grelier, the trial court’s . . . order erroneously prevented the wife from obtaining discoverable materials [by]…in effect [determining] the ‘fair value’ of the husband’s partnership interest in the law firm solely ‘by the measuring stick of a hypothetical sales price’ provided in the buy-sell agreement, even though the law firm will almost certainly ‘remain a going concern’ for an extended period after a final judgment . . .

That position “makes little sense,” the court held, and granted the wife’s motion and her requests for records to the husband’s law firm.