Articles

DIVISION OF A BUSINESS IN A MARRIAGE DISSOLUTION

By Laurie A. Mack and Lymari J. Santana

Clients often ask us at Mack & Santana what happens to their business in a divorce.

A spouse’s interest in a closely-held business is subject to division in a marriage dissolution if it is marital property. A court will generally award the business to the spouse who has been actively involved in or managing the business to ensure that company operations continue unaffected by the dissolution (this spouse is sometimes referred to as the inside spouse.) The inside spouse who holds an interest in the business will maintain his or her interest in the business. The outside spouse would then be paid an equitable share of the value of the business in cash or other assets. The spouse making the payment may be ordered to do so in a lump-sum or in periodic payments. For these reasons, valuation of the business is a key process in the dissolution to which both parties must pay close attention.

The Minnesota Supreme Court has identified three methods for dividing a closely-held business or other property in a marriage dissolution:

1. After determining the value of the business, the Court may award the entire asset to one spouse and order the recipient to pay a just and equitable portion of the value to the other spouse.

2. The court can divide the asset and order an in-kind distribution (this method is not often used if the asset is a closely-held business.)

3. The court can order a sale or liquidation of the business to a third party and equitably divide the proceeds from the sale between the parties.

In order to properly divide the parties’ interest in the business the court must first determine the value of the business. The court has broad discretion in determining the value of the closely held business. However, there are essentially three well accepted valuation methods:

1. Cost Approach;

2. Income Approach; and

3. Market Approach.

Another critical component of the analysis is determining whether the business is marital asset, a nonmarital asset, or an asset which has both marital and nonmartial components. Under Minnesota law, "[a]ll property acquired by either spouse subsequent to the marriage and before the valuation date is presumed to be marital property." Minn. Stat. § 518.54, subd. 5. The presumption that property is marital property may be overcome by proving that the property is nonmarital. Nonmarital property is defined as:

"... property real or personal, acquired by either spouse before, during, or after the existence of their marriage, which (a) is acquired as a gift, bequest, devise or inheritance made by a third party to one but not to the other spouse; (b) is acquired before the marriage; (c) is acquired in exchange for or is the increase in value of property which is described in clauses (a), (b), (d), and (e); (d) is acquired by a spouse after the valuation date; or (e) is excluded by a valid antenuptial contract." If a spouse has a nonmarital interest in a closely held business, any increase in value during the marriage may be considered marital or nonmarital depending on whether the increase in value is active or passive. Increases in value during marriage attributable to efforts of the spouses whether by financial investment, labor, or entrepreneurial decision-making, are marital property. An increase in value of nonmarital property remains nonmarital if the party can show that it is attributable "solely to market forces or conditions, such as simple appreciation in value of an asset."

Parties in a dissolution typically agree to use a neutral expert to value the business. The risk with using a neutral business valuation expert is that this witness will often walk into the courtroom carrying more weight and credibility than an independent expert a party may bring to trial to challenge the neutral expert's valuation. As set forth above, however, the courts have the discretion to use different valuation methods, and there are times when an expert could legitimately take two different approaches to the valuation. For example, so-called minority discounts may come into consideration or be disregarded under certain circumstances. If enough money is at stake, one strategy we recommend is to hire a business valuation expert at the outset of the case to work with your lawyer during the neutral valuation process, preferably an expert who is familiar with the neutral expert’s work. This expert then educates you and your lawyer as to what to expect from the valuation process, where the debatable points lie, and how to present the best evidence to that expert to advocate your position. Also, the neutral expert may prepare a "Draft" valuation report and ask for feedback from both sides before putting it in final form. At that point, you should have your own expert review the report and give you feedback on the report. If there is something that needs to be revised, or there are certain facts that were not considered, your individual expert can provide advice to you and your attorney on the best way to present the issues.

We have found that neutral business experts consider what both sides have to say and treat both sides fairly with respect to the business valuation process. These experts appreciate both sides raising their concerns and presenting information throughout the process in a timely manner rather than saving it for cross-examination at trial. The parties to the dissolution should remain involved in the business valuation process and provide the expert the information necessary to ensure an accurate valuation of the closely held business. This is not a circumstance where clients should sit back and watch the process unfold. The likelihood of getting an expert to change an entrenched position at trial is low, so early intervention is very important.

Laurie A. Mack and Lymari J. Santana work with Mansfield, Tanick & Cohen in an "of counsel" capacity. For more information you can reach them at laurie@macksantanalaw.com and lymari@macksantanalaw.com.

DIVISION OF A BUSINESS IN A MARRIAGE DISSOLUTION.LAW.WATCH.021506.doc