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Buy-Sell Controls Value of Medical Practice in Texas Divorce

by bvertz on May 5, 2010 • Comments Closed • , , , , , , , , , , , , , ,

Texas has once again proven itself to be a haven for the affluent divorcee. In Mandell v. Mandell, 2010 WL 1006406 (March 18, 2010), the Texas Court of Appeals held that a professional spouse’s 25% interest in a medical corporation was limited under the terms of a buy-sell agreement to a nominal fixed price payable to shareholders upon divorce. The decision was summarized at BVLaw Blog as follows:

In a case of first impression, the Texas Court of Appeals considered a buy-sell agreement that purported to bind shareholders and their spouses in the event of divorce. As a further complication, the husband had signed an employment agreement with the private medical association—but neither he nor his wife had signed the shareholders’ agreement.  This unsigned agreement limited the value of a divorcing shareholder’s interest to the equity buy-in price (in this instance, a mere $11,000 for a 25% share in a business with an estimated $3 million to $5 million book value).

I share BVLaw Blog’s incredulity, but my analysis is somewhat different.

In the opinion, the Texas appeals court emphasized that the doctor, who signed the stock purchase agreement during the marriage three years before separation, tendered a check for his buy-in but never signed the shareholders agreement (which was referenced in the stock purchase agreement); and his shares were never issued. After separation, the corporation returned the shareholder’s fixed buy-in payment. At that point, the trial court  might have held that the shares were never acquired, and only the buy-in payment itself was community property.

Yet, during the pendency of the divorce litigation, the wife filed motions compelling her husband and the corporation to complete the transaction. The doctor returned the fixed sum to the corporation, and the corporation issued the shares. When the wife attempted to introduce expert testimony to prove the fair market value of the shares, she was met with a motion in limine, which was granted. The trial court held that the wife was bound by the terms of the agreements.

In Texas, the fair market value of a business is presumed to be zero if the shareholders are contractually obligated to sell back their shares upon retirement, death or divorce. A divorcing spouse may present evidence of book value or comparable sales to rebut the presumption, but in this case, the court held that the net asset value was the property of the corporation, not the shareholders.

It might be signficant that Texas is a community property jurisdiction. Since the marital community exists throughout the marriage in those jurisdictions, it could be said that the doctor’s wife was in privity with her contracting husband when he signed the stock purchase agreement. Furthermore, property in Texas apparently cannot be owned simultaneously by one legal entity (a corporation) and another legal entity (the marital community). These principles might not apply in common law (marital property) states, such as Pennsylvania, where it might be argued that the spouses were neither in privity nor intended third party beneficiaries of such contracts, and where marital property is merely a fictitious estate rather than a legal entity.

Who Really Needs a Cohabitation Agreement?

by bvertz on May 3, 2010 • Comments Closed • , , , , ,

A former client recently asked me to prepare a cohabitation agreement. It was heartening to hear about her successful new relationship after a tough divorce. It had been a while since I had been asked for a cohab agreement, so I spent a couple of weeks polishing up my form. As I considered the provisions of the agreement in light of recent development in the law, I started to think: Who really needs a cohabitation agreement anyway? Four categories came to mind:

1. Committed unmarried couples. Divorce can be difficult, but when long-term unmarried couples split, the breakup can be brutal. The law provides rules, procedures, and remedies for married couples when they part ways, but those rules do not apply to unmarried couples. Lots of different laws can create legal nightmares for unmarried couples when they break up or one of the couple passes away. Tax laws do not authorize tax-free property transfers between unmarried couples; property laws do not specify who is responsible for paying a joint apartment lease when one of the couple moves out; unmarried couples cannot inherit from each other unless they have wills, and even then, death taxes may consume their inheritance. Property laws contain provisions for dividing joint property or allocating joint bank accounts, but those legal provisions do not adapt well to breakups. The procedures for partition of joint property or contribution to joint debts may be slow, inflexible and inequitable. A cohabitation agreement can spell out the consequences of a break up or the death of an unmarried partner, avoiding costly and protracted legal proceedings.

2. Couples who are married under common law. Common law marriage is a tricky subject, surrounded by myths and falsehoods. Pennsylvania no longer recognizes common law marriage for couples who formed their relationships after December 31, 2004. Perhaps the Commonwealth might recognize a common law marriage formed under the laws of another state, or a relationship formed here before 12/31/2004. But the outcome of such cases is very uncertain. A cohabitation agreement might help by memorializing the common law marriage and spelling out the consequences of divorce or death.

3. Unmarried same-sex couples. Pennsylvania does not solemnize same-sex marriages, so same-sex couples must create contractual relationships to protect their children and property. Cohabitation agreements, along with testamentary instruments, are essential to protecting their legal rights, not only upon breakup or death, but in many everyday situations such as hospital visitation, access to children’s school records, and authority to make financial transactions.

4. Married same-sex couples. This category might be surprising. Since some states permit same-sex couples to marry or enter into domestic partnerships, why should they need a cohabitation agreement? The reason is illustrated by a recent Texas appeals court case, in which there is a challenge to the Texas court’s power to divorce same-sex couples who were legally married in another state. If a same-sex couple has been married outside of Pennsylvania, there is no guarantee yet that Pennsylvania will have the legal authority to divorce them under its existing laws. A cohabitation agreement can provide a remedy.

New Case Law – Business Valuation in Divorce

by bvertz on Apr 7, 2010 • Comments Closed • , , , , , , , ,

Two articles from BV Wire recently caught my attention. Both deal with business valuation in divorce cases where personal goodwill was an issue. I will post my own analysis soon. Meanwhile, here are excerpts from BV Wire’s blast email, published by BV Resources.

Med practice valuations still plague appraisers—and the courts

A trio of new divorce cases highlights the constant challenge of appraising medical practices, everything from doctors who won’t disclose their finances to those who insist their opinions should determine value. In Garcia v. Garcia (Fla. App., Jan. 20, 2010), the husband’s expert argued for a strict application of the buy-sell agreement, which would have limited his share in a successful hematology practice to a mere $45,000—compared to the wife’s expert, who used a net asset value to appraise it at $900,000. At the very least, the husband argued, the restrictive buy-sell should considerably discount the NAV (but he lost both arguments on appeal).

Or consider Amaraneni v. Amaraneni, (La. App., Feb. 12, 2010), in which the doctor claimed his interest in an urgent care clinic had no value apart from goodwill attributable to his professional qualities. But he failed to provide any financial documentation to the court-appointed expert; at deposition, he was similarly “vague” and un-responsive. His name was on the wall but the clinic wasn’t named after him. A manager supervised all the operations and staff—and the expert apportioned all goodwill to the enterprise, also confirmed on appeal.

Finally, in Dickert v.Dickert, (S.C., Jan. 11, 2010), the trial court valued the husband’s successful dental practice at $360,000, including over $255,000 of “enterprise goodwill.” In an expedited appeal to the S.C. Supreme Court, the husband argued that state law precluded any consideration of goodwill in a professional practice, due to its speculative nature. The wife claimed the current majority rule on enterprise values was the better law, but the court disagreed, finding the goodwill asset “too intangible” to support an accurate valuation.  (All three case digests will appear in the April 2010 Business Valuation Update™.)

Is this recession enough reason to devalue assets in divorce?

In Mistretta v.Mistretta (Fla. App., Feb. 18, 2010), the trial court valued the husband’s restaurant at $854,000, based on a valuation report prepared nearly a year earlier. The husband moved for reconsideration, claiming the recession caused the restaurant to lose value. The trial court agreed, finding that no one could have foreseen the severity of the economic crisis—but the wife successfully appealed. “Economic recessions, like other vagaries in the business cycle, are contingencies appraisers must take into account in valuing a business,” the appellate court held, despite a strong dissent which likened the recession to a global economic “tsunami.” The wife’s expert, Gary Trugman, obviously agrees with the majority. “The truth is, we did consider the economic downturn, because we used dual valuation dates,” he tells the BVWire™. The husband also lost on his expert’s claim that 50% of the restaurant’s value was personal goodwill. “As I said to the judge, ‘Your Honor, when was the last time you went to a restaurant if the food was lousy, the service was terrible, but the owner was a really nice guy?’ I think that got my point across, that there was very little personal goodwill,” Trugman says. “I used Pratt’s Stats data for restaurants to demonstrate what portion of the purchase price was protected by a covenant not to compete, and used that percentage to allocate some personal goodwill—but it was a relatively small figure.”

Divorce Court’s Power to Regulate Business

by bvertz on Mar 4, 2010 • Comments Closed • , , , ,

An issue that befuddles some business owners during the course of their divorce litigation is how to regulate the operation and management of their businesses. In cases where both spouses own interests in the business, they may struggle for control of important business and financial decisions.

Some issues may be resolved under the company’s partnership agreement, shareholders’ agreement, limited liability company (LLC) agreement, or corporate by-laws. Yet, these agreements are often too vague to deal effectively with disputes between divorcing spouses who own businesses together.

Early in the evolution of the Divorce Code, the Superior Court of Pennsylvania authorized the Courts to appoint receivers or trustees to prevent the dissipation of an ongoing business concern. Mayhue v. Mayhue, 485 A.2d 494 (Pa.Super.1984). The Superior Court in Mayhue held that 23 Pa.C.S. § 3505(a) and 23 Pa.C.S. § 3323(f) authorized the Courts to enter an injunction to prevent a spouse from continuing a course of conduct calculated to defeat his wife’s property rights in the business. The Superior Court in Mayhue approved the trustee’s powers to liquidate assets to pay business debts, pay delinquent taxes, and satisfy intercompany debts.

The appointment of a receiver is not practical in every case because the expense of paying a receiver may not be justified. Still, there are some cases in which third party supervision of the business might be the only practical way t0 ensure continued smooth operation of a business caught in the middle.

Six Most Important Child Support Cases

by bvertz on Mar 1, 2010 • Comments Closed • , , ,

For each of the past four years, I have been privileged to teach lawyers about the latest developments in child support as one of the hosts of Family Law Update, a satellite broadcast presentation sponsored by the Pennsyvlania Bar Institute. Since I joined the panel in 2005, several important decisions have influenced the direction of Pennsylvania child support law. Here is my summary of the six most important cases (and one change in the law itself) since 2005:

#6 – Reinert v. Reinert, 926 A.2d 539 (Pa.Super.2007). The Superior Court in this case affirmed the continuing viability of the “nurturing parent doctrine,” a policy in which the courts may excuse the mother of a young child from working to contribute toward the support of the child. Prior to this decision, it was established that a mother may refrain from working even to raise the child of a subsequent relationship. Yet, in Reinert, the Superior Court took the policy to its extreme. The Court terminated the support obligation of a mother who did not have custody of her eldest child when she gave birth to twins by a subsequent relationship and elected to stay at home to raise them.

#5 – Murphy v. McDermott, 2009 WL 2365992 (2009). The question of whether a parent must pay private school tuition may be raised in child support proceedings, but it is also a legal custody issue. The problem is: the legal standards to answer that question are different in support and custody proceedings. The Murphy case demonstrates how important “status quo” can be, compelling a parent to pay tuition even if he or she objected at the time when the child was enrolled in private or parochial school. The lesson: parents must get involved in the choice of schooling before the question of paying comes up.

#4 – Berry v. Berry, 2006 Pa.Super. 98 (2006). When child support becomes an issue between divorcing parents, the courts must decide whether certain income sources – such as pensions, rental properties and businesses – should be considered as marital property or income for support purposes. Generally, they cannot be both. In Berry, the Superior Court held that severance pay would be counted as marital property if acquired before separation or income if acquired after separation.

#3 – Estate of Johnson, 970 A.2d 433 (Pa.Super.2009). While this decision might be limited to its unique factual circumstances, the Superior Court certainly affected settlement practice by holding the estate of a deceased parent responsible for the payment of child support. The deceased parent had entered into a marital settlement agreement with his ex-wife, promising to pay child support until the youngest child was 18 years of age. The agreement did not specify whether the obligation would terminate upon the death of a parent, so the court held that it did not. The estate ended up owing nothing, however, because the Social Security derivative benefits received by the child as a result of the parent’s death satisfied the child support obligation. This case has prompted many lawyers to specify death as cause for terminating child support in their agreements, and has also motivated support recipients to demand life insurance as a security device.

#2 – Krebs v. Krebs, 944 A.2d 487 (Pa.Super.2008). The Superior Court fortified its prior admonitions warning support payors to report increases in their income. In cases where a payor fails to report an increase, even an increase not precipitated by a job promotion or change in employers, the court may increase child support retroactively to the date when the income increase occurred, even years later. The Superior Court in Krebs granted such a retroactive increase in child support even after the custodial parent

#1 – The 2010 Amendments to the Pennsylvania Child Support Guidelines. The 2010 amendments eliminated the Melzer formula, which was a budget-based method of calculating child support in high-income cases. The uppermost limits of the child support guidelines have been extended to $30,000 per month combined net income, and an income-based formula has been promulgated to calculate child support in high-income cases.

Hidden Assets in Divorce

by bvertz on Feb 13, 2010 • Comments Closed • , , , ,

The South Carolina Family Law Blog contains a great list of frequently-overlooked or hidden assets in divorce. Some of the more interesting items are:

1.Frequent flyer mileage
2.Security deposits (e.g., utilities, car lease)
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8.Unused vacation, sick leave
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10.Income tax refunds
11.Income tax capital loss carry-forwards
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24.Burial plots
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30.Cash
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34.Options to purchase property
35.Unpaid commissions on deals set to close
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39.Taxes prepaid

In our area, don’t forget about subsurface mineral rights, another overlooked asset.

Pennsylvania: Alimony Factors

by bvertz on Feb 3, 2010 • Comments Closed • , , , , , , , , ,

What factors inflence a spouse’s eligibility for alimony after divorce under Pennsylvania law?

Under Pennsylvania law, post-divorce alimony “is a secondary remedy . . . available only where economic justice and the reasonable needs of a party cannot be achieved by way of an equitable distribution award and development of an appropriate employable skill.” These are the well-known words of the Superior Court of Pennsylvania in its Opinion in Nemoto v. Nemoto, 620 A.2d 1216 (Pa.Super.1993). Most of the important concepts in alimony jurisprudence are covered in this sentence. First, the trial courts must attempt to divide marital property in a way that avoids the need for post-divorce alimony. Why? Because the courts encourage a complete cessation of financial ties between divorcing spouses. If enough property (particuarly income-generating property) can be conveyed to a divorcing spouse, then that property can fulfill all of the spouse’s economic needs without the financial “umbilical cord” of alimony.

  • The value of the assets and liabilities distributed to each of the parties must be considered before awarding alimony. 23 Pa.C.S. § 3701(b)(10), (16); Fee v. Fee, 496 A.2d 793 (Pa.Super. 1985).
  • In its determination of alimony, the trial court must consider the income generated by a spouse’s marital and nonmarital assets. Ressler v. Ressler, 644 A.2d 753 (Pa.Super. 1994).

Second, our Courts encourage spouses to maximize their earning capacity and income potential through appropriate employment. In the first decade of the Divorce Code, enacted in 1980, the law provided that alimony could be awarded only for rehabilitative purposes, such as paying for college or vocational training. Alimony was not permitted in Pennsylvania prior to 1980, and the legislators who enacted the  Divorce Code worried that spouses would lose their incentive to become self-supporting if they could easily receive post-divorce alimony. The alimony law has been revised since 1980, allowing alimony for other reasons, such as meeting the budgetary shortfall of a spouse who is incapable of self-support. Still, the old law remains a strong influence among judges and lawyers in Pennsylvania. Several attempts to modernize the alimony law have failed, primarily because they might reduce a spouse’s incentive to go back to work. 23 Pa.C.S. § 3701(b)(1), (9), (17).

  • The Court imputed an earning capacity to a dependent spouse who devoted her time to an unproductive start-up business instead of seeking gainful employment. Thomson v. Thomson, 519 A.2d 483 (Pa.Super.1986).
  • An award of alimony for ten years was deemed excessive when a college education leading to a self-supporting job would require just four years. Barrett v. Barrett, 614 A.2d 299 (Pa.Super.1992).
  • In cases where there is no evidence of an impediment that would prevent a spouse from becoming self-supporting, the court is authorized to limit an alimony award. Adelstein v. Adelstein, 553 A.2d 436 (Pa.Super.1989).
  • In cases where a spouse’s earning capacity was limited by a medical disability or the disability of a custodial chid, Soncini v. Soncini, 612 A.2d 998 (Pa.Super.1992), the court may decline to impose a full time earning capacity upon a dependent spouse, justifying an award of alimony.

Finally, the law looks to the reasonable needs of a spouse. After a divorce, each spouse must have sufficient cash flow to meet his/her monthly household expenses. Yet, judges realize that two households cannot exist as cheaply as one combined household. The marital standard of living is just one of the seventeen statutory criteria for alimony awards, and in practice, it is one of the least influential. The expenses associated with custody of a child is more influential in an ex-spouse’s request for alimony. Just as important is the ability of a dependent spouse to become self-supporting through appropriate employment and the financial hardship that alimony may cause to the payor. When determining the amount and duration of an alimony award, the courts scrutinize the budget of a spouse seeking alimony carefully. 23 Pa.C.S. § 3701(b)(7), (8), (13).

  • The Court will not allow an award of alimony that would divert twice as much income to the alimony recipient as the payor, which would allow her to enjoy a better standard of living than she had enjoyed during the marriage Ressler v. Ressler, 644 A.2d 753 (Pa.Super.1994).

Marital misconduct is just one of the seventeen factors in awarding alimony, and it has remained one of the least influential since the enactment of the Divorce Code. 23 Pa.C.S. § 3701(b)(14); Nuttal v. Nuttal, 562 A.2d 841 (Pa.Super.1989).

What’s Your Divorce Pattern? (China Pattern, That is)

by bvertz on Jan 25, 2010 • Comments Closed • , ,

The Guardian ran a news story today about a London department store where they’ve established a new kind of gift registry …. for divorcees. Perceptively, the Debenhams department store realized that newly-separated people need toasters, towels and china, just like fiancees. Apparently England was also the site of the recent “Starting Over” show, a divorce version of a bridal show. These phenomenon were cited by the article’s author as harbingers of a trend toward celebration of divorce, instead of commiseration.  Ironically, the author’s name was Lisa Bachelor.

Dividing CRATs and CRUTs in Divorce

by bvertz on Jan 19, 2010 • Comments Closed • , , , , , ,

A recently-issued IRS ruling (Rev.Rul.2008-41) addressed the issue of whether a charitable remainder annuity trust (CRAT) or charitable remander unitrust (CRUT) can be divided into two equal trusts upon divorce. A charitable remainder annuity trust is a trust in which the grantor receives income in the form of an annuity payment until his or her death, after which the trust principal is donated to charity. The annuity may not be less than 5% nor more than 50% of the trust principal. A CRUT is the same thing, except that the income payments are a fixed percentage of the principal.

Rev.Rul. 2008-41 established that it is possible to divide a CRAT or CRUT into two equal trusts whose terms are identical to the original trust, except that each spouse is the income beneficiary of one of the two resulting trusts. The resulting trusts are qualified as CRATs or CRUTs under IRS regulations, and no excise tax is triggered by the division of the trusts.

A more detailed article on this subject is available from our friends at Strategic Valuation Group in Warren, Ohio.

This post is not intended as tax advice and should not be used to avoid tax penalties by our readers, who should seek tax advice that is specific to their individual circumstances.

Divorce Legal Fees: Tax Deductible?

by bvertz on Jan 16, 2010 • Comments Closed • , , ,

This time each year, divorce lawyers everywhere face the same question from clients: are my legal fees are tax-deductible? For guidance on the subject, I turn to the definitive treatise: Divorce Taxation by Melvin B.  Frumkes. The main principal to keep in mind, when considering whether legal expenses are deductible, is whether they are paid or incurred for the production or collection of taxable income. IRC § 212. Legal fees incurred to collect alimony, for instance, are deductible, but legal fees related to child support are not. Legal fees related to marital dissolution are not tax-deductible, but fees for a spousal support modification proceeding are. The fees related to a divorce lawyer’s advice about tax issues – such as alimony issues, valuation and division of retirement plans, allocation of dependency exemptions, deductibility of mortgage interest, taxpayer filing status, and innocent spouse relief – are likely to qualify as deductible expenses.

Incidentally (and ironically), this post is not intended as tax advice and should not be used by any person to avoid any penalties under the Internal Revenue Code. Readers are urged to contact their divorce lawyers and qualified professionals for advice specifically suited to their factual circumstances.