A Smorgasbord of Valuation Issues

Fair v. Fair, 2022 La. App. Unpub. LEXIS 116; 2021 1047 (La.App.1 Cir. 07/19/22); 2022 WL 2812892

Where to start with the delicious buffet of valuation issues presented in Fair v. Fair,¹ a Louisiana Court of Appeals divorce case. The primary issue in the case was the valuation of the husband’s community estate business known in the case as SIS. The business sold surgical medical equipment GE made. The husband, Steven Fair, was a distributor of GE’s equipment through SIS, an S corporation. SIS received a commission for each sale made, but the transaction was between GE and the customer. SIS operated on a yearly contract with GE that must be renewed for each successive year. Darlene Fair, the wife, was shown as the 50% owner, and each party received the same salary and distributions each year.

The trial court determined the value of SIS. The husband appealed, asserting that the trial court erred in determining the value of SIS. Each party offered testimony of a business valuation expert who gave their opinion as to the value. Both experts utilized the income approach to determine the value of SIS. That is where the issues began to arise.

The wife’s expert valued a 100% interest in SIS since the husband was to receive 100% of the company in the divorce settlement. The husband’s expert valued the wife’s interest in SIS as a 50% interest. The husband’s expert applied a discount for lack of marketability (DLOM) of 25% to reduce the value of the wife’s interest. He also determined that the wife’s 50% interest was really a minority interest since she could not reach the assets of the business and added an additional 10% discount for lack of control (DLOC). Both experts took a “discount” against the goodwill of SIS to eliminate the personal goodwill of the husband.

First, in many states, the interests of the husband and wife in a business were combined to determine what was being valued. While the trial court in this case arrived at that conclusion, it was not clear that Louisiana always followed that thinking, i.e. that the interests should be combined. The trial court here, however, did make it clear that it would be unfair to the wife to discount her assumed interest when she will not receive any of the ownership in the settlement.

While neither court told us how either expert determined the amount of total goodwill of SIS, they did inform us that both experts took a discount to remove the personal goodwill from the marital estate. The husband’s expert reduced the total goodwill by 47%, saying it could be higher than that. The husband’s expert utilized the MUM² methodology to determine his 47% discount. While neither court adopted his discount, they did not criticize the MUM method. The wife’s expert opined that a 20% reduction in total goodwill was reasonable, stating that there were offsetting factors indicating entity goodwill that brought his discount down. The trial court (affirmed by the Court of Appeals) used a discount of 25% in determining the personal goodwill. However, since the Trial Court also adopted the wife’s expert’s 100% beginning value, the amount of goodwill excluded as personal was significantly less than the value the husband’s expert offered.

Moving along the buffet, the trial court decided not to take a DLOM/DLOL against value of SIS. The case that the Court of Appeals used in part was a Louisiana Supreme Court Case, Cannon v. Bertrand. The apparent linchpin that the Court of Appeals landed on was the fact that SIS was not to be sold. This conundrum, in my experience, was becoming almost epidemic. In most of the states where I have seen this happen, the standard of value for determining the value of a business in a divorce case was fair market value. How can this be, one might say? Fair market value assumed a hypothetical sale, yet, as in this case, the courts, often egged on by the experts (as also happened in this case), wanted to have it both ways.

Even though there was sufficient evidence in the valuation world that a 100% interest might reasonably incur a discount for lack of liquidity (DLOL) in determining the fair market value of the business, some courts seemed to distinguish between there being a sale of the business and there not being a sale of the business. I can understand where judges might be confused on this issue, but I fail to see how experts can argue that, in determining a fair market value of a business, you can somehow ignore the hypothetical sale.

In the end, the Court of Appeals left in place the trial court’s determination of the value of SIS. Summarizing, the trial court did provide for the exclusion of personal goodwill but roundly excluded any subsequent DLOM or DLOL not for the reason that there was likely not one in existence, but rather because the company was not likely to be sold. Perhaps the right answer for the wrong reason?

A case digest and the full opinion can be found here

¹ Fair v. Fair, 2022 La. App. Unpub. LEXIS 116; 2021 1047 (La.App.1 Cir. 07/19/22); 2022 WL 2812892.

² MUM—multiple attribute utility method.