While Pennsylvania has not adopted one set standard for valuing businesses in a divorce, the case law demonstrates that Pennsylvania has traditionally adhered to a fair market value standard. But this approach is not absolute as evidenced by the recent Superior Court case of Brubaker v Brubaker, decided Dec. 18, 2018.
In this case, the court rejected the expert reports of both parties which found that the business had zero value as its debts exceeded the value of its assets. Instead, the court found that because the husband’s real estate venture was begun during the marriage, the wife participated in the venture, and the venture was expected to be profitable in the future, the assignment of a value to the venture was warranted.
The business, a real estate venture begun in 2011, three years prior to the parties’ separation, was the development of a six-building apartment complex on land for which the husband purchased an option to buy during the marriage with marital assets. The husband entered into a partnership with two other individuals who provided the majority of the financing for the land purchase and the project, while he managed the day-to-day operations of the venture. In a 2011 partnership agreement, the husband’s interest was set at one-third and the partners agreed upon a value of the husband’s contributions to the project of $515,152.21. At separation the site preparation and construction were underway. The projected worth of the completed apartment complex was $19.35 million, with an estimated debt of $15.9 million, which would yield a value for the husband’s one-third interest of $1.15 million.
Despite the fact that both expert reports found that the debts of the project exceeded the “present value” of the development, the court assigned $515,152.21 to the value of the husband’s share of the business using the 2011 partnership agreement as a yardstick. The court reasoned that the husband’s business was a long-term project that could produce a valuable asset and significant income stream in the future. Further it was started during the marriage, both parties contributed their time to the venture and the family made financial sacrifices to support the venture. The husband spent marital funds and much of his time prior to separation working on the venture. The wife assisted the husband with the early phases of the project, including helping name the project, designing its logo and business cards, and visiting various apartment complexes with the husband in order to conceptualize the apartments being built. Further, the wife handled the childcare and maintenance of the family home.
There are no cases directly on point which are analogous to the facts of this case, i.e., the value of a real estate project that is a work in progress at the date of separation. The court distinguished Diamond v. Diamond, 360 Pa. Super. 101, 519 A.2d 1012 (1987), appeal denied, 516 Pa. 633, 533 A.2d 92 (1987) where the husband owned real estate during the marriage but did not begin to improve it until after the separation. Other cases cited by the parties were also inapplicable. Butler v. Butler, 541 Pa. 364 (1995) which dealt with the value of a law partnership and McCabe v. McCabe, 525 Pa. 25 (1990) which dealt with the value of an accounting firm, were not applicable as they involved businesses which were going concerns, with accounts receivable, accounts payable and a client base.
In looking to assign a value to the husband’s and the wife’s pre-separation efforts to the real estate venture, the court adopted the 2011 partnership agreement value as a fair estimate of the husband’s cash and in-kind contributions to the venture. The husband testified at trial that if he sold his interest, he would receive the $515,152.51 outlined in the partnership agreement and could obtain a job earning about the same amount of money doing something else.
True that the court’s rationale places the risk of the success of the business solely on the husband. The court could have adopted a wait-and-see approach, and award the wife a portion of a future income stream realized by the husband. But this approach has inherent problems as it would require the parties to remain financially entangled into the future. It also would award the wife with post-divorce efforts or require speculation as to what alternative distribution percentage would be appropriate to account for those efforts.
This case is a good example of the application of creative thinking when traditional methods of valuing an asset do not create equitable results. It also serves as a reminder that the court is free to place its own value on an asset, regardless of what value experts may place on that asset. Divorce, unlike other areas of the law, has no set methodology to value businesses. In appropriate cases, practitioners should think beyond a business valuation if it does not create an equitable situation for one or both spouses.
In similar cases, where there is no partnership agreement setting forth a value of a spouse’s pre-separation contributions to a work in progress, further creativity would be required. Following Brubaker that marital contributions are the equitable value measure, the practitioner, along with a financial expert, could estimate the value of the marital contributions, both monetary and nonmonetary. The value of the nonmonetary contributions would in large part be based on the value of the uncompensated time and effort put into the project.
Julie A. Auerbach is a partner at Astor Weiss Kaplan & Mandel. Her practice is focused in the area of family law. She practices in the counties of Philadelphia, Delaware, Chester, Montgomery and Bucks, and has written and lectured extensively on the subject of family law. Contact her at firstname.lastname@example.org.
Sandra R. Klevan is a managing director at Financial Research Associates, which has offices on Pennsylvania, New Jersey and New York. The firm provides business valuation, litigation support and forensic accounting services, primarily in the area of marital dissolution. Conctact her at email@example.com.