Basics of Pennsylvania Law: Double Dip, Part V

This is the last in a series of posts containing summaries of Pennsylvania case law on the issue of double dipping in divorce. “Double dipping” occurs when an income-producing asset (such as a pension or business) is counted as marital property subject to equitable distribution, as well as income subject to an alimony or child support obligation.

Steneken v. Steneken, 873 A.2d 501 (N.J. 2005).

            Although it is not a Pennsylvania decision, no discussion of double dipping would be complete without Steneken, a 2005 decision of the New Jersey Supreme Court. In this case, the husband was the sole owner of a business which was marital property subject to equitable distribution. The valuation expert performed a normalization of the owner’s compensation in his report, reducing the company’s salary expense and thereby increasing the value of the company. In determining an alimony award, the husband argued that the court should consider his lower, normalized compensation instead of his actual salary (since the excess compensation had been capitalized as part of the business valuation and divided as marital property). The trial court accepted the husband’s argument and used his normalized salary instead of his actual salary.

            An appeal ensued, and the case was remanded to the trial court because the intermediate appellate court held that the record was not fully developed. On remand, the trial court reversed its earlier position and used the husband’s actual salary to determine the proper amount of alimony.

            The intermediate appellate court, reviewing New Jersey’s divorce statute, held that the prohibition on “double dipping” extended only to pensions and affirmed the trial court’s decision. The husband appealed to the New Jersey Supreme Court to extend the principle to double dipping arising from the capitalization of earnings in the context of a business valuation. Since an income capitalization approach had been used by the valuation expert endorsed by the trial court, and was not challenged, the husband argued that he should not have to pay alimony from the excess compensation that had been capitalized and distributed as part of the value of the business.

            The New Jersey Supreme Court disagreed, affirming the trial court’s decision to permit double dipping. Rather than adopting the intermediate court’s rationale, the New Jersey high court attacked the husband’s reasoning.

The logical flaw in defendant’s argument lies at its core. Defendant mistakenly equates the statutory and decisional methodology applied ni the calculation of alimony with a valuation methodology applied for equitable distribution purposes that requires that revenues and expenses, including salaries, be normalized so as to present a fair valuation of a going concern. Simply said, defendant’s charged mischaracterization of the issue here as one of “double counting” both misstakes the issue and ignores the fundamental principles that undergird related yet nonetheless severable alimony and equitable distribution awards.  As our statutory framework and decisional precedent make clear, the proper issue is whether, under the circumstances, the alimony awarded and the equitable distribution made are, both singly and together, fair and consistent with the statutory design. . . . Because we embrace the premise that alimony and equitable distribution calculations, albeit interrelated, are separate, distinct, and not entirely compatible financial exercises, and because asset valuation methodologies applied in the equitable distribution context are not congruent with the factors relevant to alimony considerations, we conclude that the circumstances here present a fair and proper method of both awarding alimony and determining equitable distribution.

 

            The New Jersey court’s opinion is not convincing; other reasons might have been more forceful. For instance, the court might have started with the observation that a business valuation expert ordinarily has no expertise in executive compensation. To identify part of the owner’s salary as excessive is tantamount to saying that the business could hire someone to do the job for less, or conversely, the owner would earn less if he or she sought employment elsewhere. Such determinations are beyond the expertise of most valuation experts, and should not be relied upon to determine the owner’s earning capacity for alimony and support purposes. Yet, if those normalization adjustments are not suitable to determine the owner’s earning capacity, why should we rely on them for the business valuation?

            The New Jersey court noted that if a different valuation methodology had been applied, there might be no normalization adjustment to the owner’s salary. That is true, in the case of an asset approach. However, an asset approach assumes liquidation of the company, not ongoing concern value. The owner’s excess compensation does not get capitalized under the asset approach, so there is no possibility of double dipping. In the market approach, normalization of the income statement or cash flow is performed before applying a multiplier. Therefore, the potential inconsistency perceived by the Court is illusory.

            In a vigorous and well-reasoned dissent, three of the seven Justices enunciated a compromise position: that the trial court need not use normalized compensation when computing the owner’s alimony obligation but should have discretion to adjust the value of the business or the alimony award to alleviate the double dip.

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Basics of Pennsylvania Law: Double Dip, Part III

This is the third in a series of posts containing summaries of Pennsylvania case law on the issue of double dipping in divorce. “Double dipping” occurs when an income-producing asset (such as a pension or business) is counted as marital property subject to equitable distribution, as well as income subject to an alimony or child support obligation.

Miller v. Miller, 783 A.2d 832 (Pa. Super. 2001)

In Miller, the parties settled their division of property, and Wife subsequently sought a modification of child support based on the income that Husband derived from the sale of his share of marital assets. The Superior Court held that the proceeds from the sale of assets were not “income” within the statutory definition. The Superior Court affirmed the trial court’s refusal to modify child support when the payor received proceeds from the sale of marital assets after the divorce and division of property. The double dip in Miller was another reason for the Court’s decision.

Rohrer v. Rohrer, 715 A.2d 463, 465 (Pa. Super. 1998).

            Rohrer was the first published decision to prohibit double dipping in Pennsylvania. (Interestingly, the opinion was written by Judge Popovich, who had held in McFadden that double dipping was permitted.) In Rohrer, the husband was an owner of a business organized as a Subchapter “S” corporation. At an early stage of the proceedings, the pass-through earnings of the business were included in the husband’s income when calculating his support obligations. At equitable distribution, the husband asked the master to exclude retained earnings from the value of the business, in order to avoid double dipping. Husband’s request was granted by the master, but only to the extent that retained earnings from the date of the support order forward into the future were excluded. The retained earnings that accrued prior to the support order were counted as part of the value of the business.

            The trial court reversed the master’s decision and excluded all of the retained earnings. On appeal, the Superior Court reversed and adopted the master’s finding. The Superior Court held that “money included in an individual’s income for the purpose of calculating support payments may not also be labeled as a marital asset subject to equitable distribution.” Rohrer, at 465.

Basics of Pennsylvania Law: Double Dip, Part II

This is the second in a series of posts containing summaries of Pennsylvania case law on the issue of double dipping in divorce. “Double dipping” occurs when an income-producing asset (such as a pension or business) is counted as marital property subject to equitable distribution, as well as income subject to an alimony or child support obligation.

Cerny v. Cerny, 656 A.2d 507 (Pa.Super.1995).

            Prior to separation, the husband received a cash severance payment, which was counted as income in determining his support obligation. The severance payment was excluded (in a prior, unpublished Superior Court decision) from the marital estate to avoid double dipping. Subsequently, the IRS issued a tax refund to the husband, as the severance payment was not taxable income. The trial court held that the tax refund should be counted as marital property. On appeal, the Superior Court reversed, holding that the tax refund retained the same nonmarital nature as the income from which it was derived. The opinion does not reveal whether the tax was deducted from the payor’s income when determining his support obligation, but if so, then the result may have been inequitable.

Basics of Pennsylvania Law: Double Dip, Part I

The concept of a “double dip” is logical and intuitive. If an income-producing asset has been awarded to a party in equitable distribution, the same asset cannot be counted as a source of income from which alimony may be paid. For instance, a pension in pay status cannot be counted as income for alimony purposes if it was also a marital asset that has been divided in equitable distribution. This concept has been recognized and adopted by the Pennsylvania courts at the trial and appellate levels. Butler v. Butler, 541 Pa. 364, 663 A.2d 148, 156 (1995)(professional goodwill); Diament v. Diament, 816 A.2d 256, 277 (Pa.Super.2003)(advance of marital assets); Miller v. Miller, 783 A.2d 832 (Pa.Super. 2001)(proceeds from sale of marital property); Rohrer v. Rohrer, 715 A.2d 463 (Pa.Super. 1998)(retained earnings of a business); Kokolis v. Kokolis, 83 Pa.D. & C.4th 214 (Ally. 2006)(pension in pay status), affirmed, 927 A.2d 663 (Pa.Super. 2007); cf. McFadden v. McFadden, 563 A.2d 180 (Pa.Super.1989)(pension in pay status).

This post is the first of a series describing Pennsylvania case law concerning the double dip.

Berry v. Berry, 898 A.2d 110 (Pa.Super.2006).

The husband in this case was terminated from his employment as a partner in an accounting firm just weeks after the commencement of a support claim within a divorce action. Upon his termination, the husband received a distribution of his partnership capital account plus a cash severance payment equal to seven months’ base salary. The wife argued at the trial court level that neither of these items should be included in the husband’s income when determining his child support obligation. (The husband had secured other employment paying a salary sufficient to justify a Melzer analysis.) The trial court held that the capital account distribution and cash severance were income for support purposes. The wife appealed, prompting the Superior Court to vacate and remand the case.

The Superior Court held that the partnership capital account was marital property which should not have been included in the husband’s income because doing so would constitute a double dip.  On the other hand, the Superior Court held that the cash severance payment was strictly income. In its decision, the Court distinguished between money earned prior to the marital separation (in this case, a partnership capital account) and money acquired after separation (in this case, a severance payment). Since the partnership capital account was acquired prior to separation, it fell within the statutory definition of marital property. The cash severance acquired after separation did not.  The Superior Court held that the capital account was marital property while the severance payment was income. In both of its findings, the Superior Court refused to double dip.

Discounts in Art: “Starving Artist” Prices?

The 9th Circuit Court of Appeals recently issued a decision (highlighted by Carsten Hoffman’s FMVOpinions) affirming a tiny fractional interest discount applied to a jointly-owned collection of paintings. In Stone vs. U.S. (2009), the district court rejected the opinion of the estate’s expert, who testified in favor of a 44% fractional interest discount, citing the expert’s “total lack of experience with the art market; the dissimilar motives driving purchasers to acquire art, on one hand, and real estate or limited partnership shares, on the other; and the unreasonably low appreciation rate and unreasonably high present-value discount rates Hoffmann used in his cost-of-partition analysis.” The district court refused, on the other hand, to apply no discount, as urged by the government. Instead, the district court settled upon a 5% fractional interest discount, the percentage that was conceded by the IRS. The 9th Circuit affirmed.

On appeal, the estate argued that the lack of data regarding real-world  sales of fractional interests in art justified its use of discounts derived from sales of fractional interests in real estate and limited partnerships. The estate also argued that the district court had erroneously assumed that the estate’s 50% interest in the art collection would be sold together with the other 50% interest. The appellate court dismissed both arguments under an abuse of discretion standard.

In his post-mortem analysis, Carsten Hoffman (who was the estate’s expert in Stone) speculated that fractional interest discounts in art should actually be higher than, not lower than, discounts in real estate and partnerships.

To begin with, empirical data regarding discounts for lack of marketability as it relates to restricted stock, demonstrates that the magnitude of the discount is directly related to the degree of volatility. This is logical, as an investor would rather surrender liquidity for low volatility assets compared to high volatility assets. For example, the FMV Restricted Stock Study shows that the discount for lack of marketability is approximately 300 percent higher for stocks in the top 10 percent, measured by volatility, compared to those in the bottom 10 percent (approximately 45 percent vs. 11 percent). This is significant, as art has provided the least attractive risk and return potential of any asset class as reported by Merrill Lynch. The report also indicates that over a 5-year investment horizon, the risk of loss in art ownership is 70 percent higher than the risk of loss in the S&P 500 Index. Further, the standard deviation (a measure of volatility) for art is 44 percent higher, on average, than for the S&P 500.

Hoffman noted that data did not exist in 1982 when the courts first confronted the challenge of applying a fractional interest discount to real estate and partnership interests. The data that supports such discounts has been developed over the intervening years. Similarly, the scholars will have to compile data for the art market.

Standard of Value dictates Use of Discounts in Divorce Case

The Alabama Court of Appeals recently issued an opinion in Grelier v. Grelier, holding that the parties’ agreement to employ the fair market value standard in a divorce case precluded wife from arguing on appeal that the trial court should not have applied marketability and minority discounts.

In Grelier, the parties appointed a neutral expert to determine the value of the husband’s business, a retail and commercial real estate development company. The husband owed a 25% interest; his father, brother and college roommate owned the other interests. The consent order appointing the expert specified that he would determine the fair market value of the business. Husband and Wife each hired independent experts to offer their opinions of value as well.

The court-appointed expert testified that marketability and minority discounts should not be applied to the husband’s interest in the real estate business, but the opinion does not reveal why. Wife’s expert testified that the court-appointed expert’s valuation was flawed because it relied on out-dated appraisals and verbal statements of value but agreed that discounts should not be applied. Husband’s expert testified that a minority interest discount was appropriate because the wife had not proven that the husband had a right to act independently from the majority stakeholders; and that a marketability discount was standard practice when determining the FMV of close corporations. Husband’s expert suggested a 25% minority discount and 25% marketability discount, but the trial court reduced the combined discounts to 40%.

On appeal, the wife argued that the trial court should have utilized the fair value standard instead of FMV; and that the minority interest and marketability discounts should not have been applied. The Alabama Court of Appeals held that the wife’s argument was waived for failure to raise it in the trial court, where she had consented to a FMV standard in the order appointed the expert. Moreover, the appellate court held that the trial court had not abused its discretion in applying the discounts to arrive at FMV.

Can the Court Award Legal Fees in a Child Suppot Modification Proceeding?

An interesting, and perhaps unanswered, question which may arise in a child support modification proceeding is, “Can the court award legal fees to the prevailing party?” Since 1997, there has been statutory authority for awarding legal fees in a child support case. Previously, no statutory authority existed.

23 Pa.C.S. 4351 authorizes an award of legal fees where “an obligee prevails in a proceeding to establish paternity or to obtain a support order.” Soon after the enactment of this law, it was tested in the Pennsylvania Supreme Court by a lawyer who advocated an automatic award of legal fees to all support recipients, based on a simple disparity in their net incomes.

The Supreme Court rejected that notion in Bowser v. Blom, a case that established several criteria for determining whether a support recipient should receive reimbursement of legal fees.

Factors which the court may consider include: (1) whether the obligor’s unreasonable or obstreperous conduct impeded the determination of an appropriate support order; (2) whether the obligor mounted a fair and reasonable defense in a child support order; (3) whether the obligor’s failure to fulfill his moral and financial obligation to support his children required legal action to force him to accept his responsibilities; and (4) whether the financial positions and financial needs of the parties are disparate.

Subsequently, the Superior Court was asked to determine, in Krebs v. Krebs, whether the trial court should have forced a father to reimburse the mother’s legal fees, in a case where child support was modified retroactively for several years because the father had concealed an increase in his income. The Superior Court vacated and remanded the case, instructing the trial court to consider whether the mother’s claim for legal fees was appropriate under 23 Pa.C.S. 4351 or 42 Pa.C.S. 2503 (a different statute authorizing an award of legal fees as a sanction for dilatory, obdurate or vexatious conduct by a litigant).

More recently, in Sirio v. Sirio, the Superior Court was again asked to decide whether the mother should have been awarded legal fees in a child support modification proceeding. Once again, the Superior Court vacated and remanded the trial court’s decision not to award fees, instructing the trial court to consider 23 Pa.C.S. 4351 as well as 42 Pa.C.S. 2503. The Sirio Court alluded to Krebs, suggesting that it answered the question of whether fees could be awarded in a modification proceeding (despite statutory language that refers to “establishing” paternity or “obtaining” a support order).

I think both Krebs and Sirio have asked the question, but I have yet to see an authoritative decision (or, for that matter, a strong policy argument).