The Importance of Establishing the Date of Valuation for Businesses During the Ongoing Pandemic
One of the most complicated aspects of a divorce litigation is the valuation and distribution of a business in the context of equitable distribution. This is an issue which has doubled in complexity since the advent of the COVID-19 pandemic.
Imagine an ongoing divorce proceeding in which one of the parties is a business owner. The divorce has been in ongoing litigation for over a year and the business, whether it is dental practice, retail clothing store, or restaurant, was valued at $1,000,000 at the time the Complaint for Divorce was filed. Now, as a direct result of the global pandemic, the value of the business, in some cases, may be worth nothing.
How is this issue to be handled in the time of a pandemic? Is it fair that the business owner, to no fault of his or her own, is stuck with an asset that is ascribed a value of $1,000,000 but may be worth nothing, or close to nothing, at the time of trial or distribution. Does the business owner spouse have to buyout the other spouse’s interest in the business using the valuation from the date of the complaint even though it is worth substantially less, if anything, at the time of trial or distribution?
The goal of equitable distribution is to bring about a "fair and just division of marital assets." Steneken v. Steneken, 183 N.J. 290, 299, (2005). To effectuate that goal, Courts engage in a three step process in equitably distributing marital assets – namely, a court must: (1) identify the asset or property subject to equitable distribution; (2) determine the value of each asset; and (3) decide how to allocate each asset most equitably. Rothman v. Rothman,65 N.J. 219, 232 (1974).
One of the most important aspects of this process is establishing the date of valuation for each asset subject to equitable distribution. “During the early years of the evolution of the concept of equitable distribution, it was held that the date for valuing assets should be the same as the termination date for determining eligible assets." Bednar v. Bednar, 193 N.J. Super. 330, 332 (App. Div. 1984). Under this theory, absent extraordinary circumstances, assets should generally be valued at the time of the complaint. Nonetheless, Courts have recognized that there is "no absolutely iron-clad rule" for determining the date of valuation, and a more equitable approach may be required based on the "nature of the asset and any compelling equitable considerations." Ibid.
Historically, the appropriate valuation date has hinged on whether the subject asset is classified as “active” or “passive.” Passive assets are "defined as those assets whose value fluctuations are based exclusively on market conditions." Scavone v. Scavone (Scavone I), 230 N.J. Super. 482, 486 (Ch. Div. 1988), aff’d, Scavone v. Scavone (Scavone II), 243 N.J. Super. 134 (App. Div. 1990). In contrast, "[a]ctive assets involve contributions and efforts towards their growth and development which directly [affect] their value." Id. at 487.
Generally, passive assets, such as a retirement account, the value of which may fluctuate after the filing of the complaint by virtue of market forces, are valued as of the date of the trial or distribution; whereas active assets, such as a business, are valued as of the date of the complaint. However, as noted in the above example, what happens if there is a drastic change in an active asset’s value, such as a business, from the date of the complaint to the date of distribution? The case of Goldman v. Goldman, 275 N.J. Super. 452 (App. Div. 1994) provides some valuable instruction and application.
In Goldman, the husband owned an imported car dealership. When the complaint for divorce was filed, the husband’s car business was valued at $294,000. However, by the time of trial, the business had virtually no value as the market for purchasing imported specialty cars had crashed – no pun intended. Id. at 457. On these facts, the trial court determined that if it applied the normal rule regarding active and passive assets, the husband alone would suffer the loss of the business along with the funds he advanced to the business in an attempt to rescue it from ruin, and the court would not be "carrying out the legislative mandate to distribute marital assets equitably." Goldman v. Goldman, 248 N.J. Super. 10, 16 (Ch. Div. 1991). The court held that under the special circumstances presented, it would be unfair to the husband to value the dealership at the time of the complaint. Ibid. Instead, the Court chose to value the dealership at the date of trial. Ibid. As such, the Husband was not charged with an asset that was valued at nearly $300,000 at the time of the complaint when it was worth nothing at the time of trial.
In affirming the trial court’s decision, the Appellate Division found that the trial judge "was confronted with a unique situation and that application of a rigid categorical analysis would have only hindered [the court] in fulfilling [its] ultimate obligation to effectuate a distribution of marital assets which, overall, was equitable to both parties." Goldman v. Goldman, 275 N.J. Super. 452, 457 (App. Div. 1994). Accordingly, the Appellate Division determined that the "consequence of value fluctuations for purposes of equitable distribution should not . . . turn wholly on whether an asset is properly classified as . . . active or passive." Ibid. Essentially, Goldman recognized that special circumstances may arise which require flexibility in determining the valuation date of an active asset, such as a business, to ensure that the underlying goal and aim of equitable distribution – namely, a “fair and just division of marital assets” – is met.
The application of Goldman is going to be critical and prevalent in today’s world, where the pandemic has crippled many businesses that may have been thriving just a few months ago when their divorce litigation began but has since spiraled to no fault of the business owning spouse. These are difficult times in which special circumstances abound. Of course, in some cases, the effects of the pandemic may only be temporary such that the short-term effects should not ultimately impact on the value. Parenthetically, the decline of a business during the pendency of the litigation may also impact on the business owner’s ability to pay support, both on an interim and post-divorce basis, in addition to the business valuation issues. Notably, if the effects of the pandemic on the particular business are only temporary in nature, which might be difficult to gauge at the present time, the short-term effects may not ultimately impact on the final support obligation (although it may require short term and interim adjustments depending on the circumstances). As is so often true in family law practice, every case will rise and fall on its own unique facts and circumstances.
In conclusion, advocates should consider the use and application of the “exception to the general rule” espoused in Goldman in mitigating against a potentially unfair result to a business owning spouse. Conversely, the non-business owning spouse should expect the Goldman argument to be utilized, whether based on reality or the opportunism of the business owning spouse looking to secure a better outcome in the case. In either event, the applicable force of Goldman will likely play a major part in establishing business valuation dates for the foreseeable future.