When Business Interests Are Valued Subsequent to the Date of Commencement

In most instances, business interests and professional practices are classified by the courts as “active” assets ' those whose value is commonly determined by the efforts of the titled spouse ' as opposed to mutual funds, undeveloped land and artwork, which are classified as “passive” assets because their value is typically a result of market forces or other forces outside of either party's control. While it is true that active assets are most often valued as of the date of commencement, a post-commencement date change in value not attributable to the efforts of the titled spouse often requires that a post-commencement date value be applied in the interest of equity.

We explore in this and next month's issues the various circumstances in which courts have found that an active asset should be valued subsequent to the date of commencement.

Adverse Events Outside of the Titled Spouse's Control

Grunfeld v. Grunfeld, 94 NY2d 696 (Ct. App. 2000), is often cited as the leading authority governing the proper date upon which an active asset should be valued. In Grunfeld, a commencement date valuation of the husband's law practice was upheld by New York's Appellate Division, First Department, and the Court of Appeals because the husband's practice was “an active, ongoing business, which type of asset is generally valued as of the date of commencement.” Grunfeld v. Grunfeld, 255 AD2d 12, 17 (1st Dept. 1999), aff'd Grunfeld v. Grunfeld, 94 NY2d 696 (2000). Nonetheless, the First Department explained that, “Under certain circumstances, a date-of-trial valuation of a business may be justified by the loss of the business's major client and resultant loss of the business's value during the pendency of the litigation [citing La Barre, discussed infra], or by other losses due to adverse forces outside of the spouse's control [citing Sagarin, discussed infra].” Id.

The First Department explained that Mr. Grunfeld's firm's loss of several clients in the years following the date of commencement is not ' given the nature of the firm's practice ' “the type of unusual post-commencement event as would necessarily have a substantial, long-lasting effect on its value,” which would warrant a date-of-trial valuation. Id. The Court of Appeals echoed this conclusion, finding that “[a]lthough defendant presented some evidence that his practice had become less profitable as a result of changes in customs laws and the loss of clients, there is ample support for the lower courts' finding that defendant's professional practice had not undergone the type of radical alteration subsequent to the commencement of the action that would warrant a valuation of the practice at the time of trial.” Grunfeld, 94 NY2d 696, at 707-708.

What facts rise to the level of a “radical alteration” sufficient to justify a date of trial valuation? Interestingly, in Johnson v. Johnson, 277 AD2d 923 (4th Dept. 2000), which was decided the same year as Grunfeld, the Fourth Department upheld a date-of-commencement valuation of the husband's interest in an insurance business. Its value was thus estimated as zero, despite the fact that the business was subsequently sold for a profit. Other courts, however, have not adhered to such a high standard, including those cited by the First Department in Grunfeld, namely, La Barre and Sagarin, both of which preceded the Grunfeld and Johnson decisions.

La Barre v. La Barre, 251 AD2d 1008 (4th Dept. 1998), decided by the Fourth Department two years prior to Johnson, held that the Supreme Court's use of a date subsequent to the date of commencement but prior to trial was appropriate and fair under the particular circumstances of that case because the date corresponded to the point in time that the business lost a major client.
In Sagarin v. Sagarin, 251 AD2d 396 (2nd Dept. 1998), the Second Department affirmed the Supreme Court's selection of the date of trial for valuing the husband's business interest. In so holding, the court cited Wegman, supra, for the premise that the trial court has discretion and flexibility in selecting the proper valuation date, and stated, “Here, adverse economic forces outside of the husband's control caused the decline in the value of the corporation. Further, there was no evidence of dissipation or wasteful conduct on the part of the husband.” Sagarin at 396.

Indeed, courts that have upheld post-commencement dates for a business valuation due to adverse events outside of the titled spouse's control have routinely premised such determinations on the fact that there was no malfeasance committed or self-serving motive on the part of the titled spouse. For instance, in Butler v. Butler, 256 AD2d 1041 (3rd Dept. 1998), the husband filed for personal bankruptcy after the commencement of the divorce action but prior to trial, and was consequently forced to sell all of his business assets in connection with the bankruptcy proceeding. The Third Department upheld the trial court's use of a date-of-trial valuation because a commencement date valuation would have resulted in inaccurate and outdated income, revenue and asset valuations. In affirming the trial court's valuation as of the time of trial as justified and equitable, the court noted that there was no evidence that the husband had engaged in the bankruptcy proceeding in order to avoid the financial consequences of divorce.

The objective of safeguarding against wrongdoing on the part of the titled spouse when selecting the appropriate valuation date for active assets was also squarely addressed by the Court of Appeals in McSparron v. McSparron, 87 NY2d 275, 287-288 (1995). While McSparron concerned the valuation and distribution of a law license, the court's analysis is equally applicable to ' and commonly cited in the cases that address the valuation date applicable to ' business interests because both such assets are frequently valued as of the commencement date due to their “active” qualities. In McSparron, the court explained that one of the reasons for using the date of commencement to value an active asset is to prevent the titled spouse from unilaterally manipulating the interest's value. Furthermore, the court cautioned that, while it is commonly appropriate to value active assets as of the date of commencement, strict formulations which require that active assets be valued as of the commencement date and passive assets be valued as of the date of trial, “may prove to be too rigid to be used in particular cases” and should therefore “be regarded as helpful guideposts and not as immutable rules of law.” McSparron at 287-288.

Consistent with the cases discussed above, the court in McSparron held that a post-commencement date valuation was proper based largely on the fact that there was no concern that the titled spouse had manipulated the value of his law license. Rather, quite the contrary was true, as it was the post-commencement date actions of the non-titled spouse that had impacted the asset's value. See id. at 288 (explaining that the wife's “acrimonious and vindictive conduct” in a public setting caused the husband to lose his job and remain unemployed).

In Naimollah v. De Urgarte, 18 AD3d 268 (1st Dept. 2005), the First Department reiterated the premise set forth in McSparron that, “the principle that active assets are valued as of the commencement date is a helpful guidepost rather than a rigid rule” (Naimollah at 270 (citing McSparron, supra at 288)), and upheld a date of trial valuation of the wife's business where the business had “suffered losses due to adverse forces outside the spouse's control.” Id. (citing Grunfeld, supra at 17). This emphasis on giving the court enough flexibility to reach the “right” result demonstrates that principles of fairness and equity are elevated above the desire for a more straightforward rule that has the potential to cause grossly inequitable results.

Similarly, in a case where the valuation of the husband's medical practice was at issue, Basile v. Basile, 199 AD2d 649 (3rd Dept. 1993), the Third Department held that there was no abuse of discretion in employing a valuation date 11 months after the commencement of the divorce action where expert evidence was presented to demonstrate that, because the husband was totally disabled from employment during the year in which the action was commenced, the business's corporate tax return would not accurately reflect annual income for that year. In so finding, the court explained, “It is well-settled that the trial court is not constrained to value an asset as of the action commencement date, but has the discretion and flexibility to determine the most appropriate date for valuation as circumstances warrant. This is especially so where questions involving the valuation of a business are at issue.” Basile at 651.

Furthermore, in Cohn v. Cohn, 155 AD2d 412 (2nd Dept. 1989), another case that emphasized the importance of giving the court discretion to select a valuation date that is “appropriate and fair under the particular facts and circumstances presented,” (id. at 413, affirming the lower court's selection of a valuation date for the husband's business interest that was subsequent to the date of commencement of the divorce action and prior to the time of trial), the court was not concerned that the lower court failed to set forth the specific reasons for selecting the post-commencement valuation date, so long as the record “discloses an adequate basis for the court's determination.” Id. (explicitly overruling Yunger v. Yunger, 133 AD2d 451 (2nd Dept. 1987), to the extent such case indicates to the contrary, but failing to identify the “adequate basis” that was set forth on the record in that particular case).

Next month, we will discuss post-commencement date changes in value when value is affected by market forces, the efforts of the non-titled spouse and post-commencement value-altering events.

Marcy L. Wachtel, a member of this newsletter's Board of Editors, is a partner in the firm of Katsky Korins LLP. Shireen G. Arani is an attorney in the firm's matrimonial and family law department.

One of the most significant questions presented at the outset of any valuation of a business-type interest (such as an ongoing business concern, professional practice, or other assets intrinsically linked to an individual party's efforts) conducted in connection with the equitable distribution of marital property upon divorce is: What date should be used to value the asset?

Inasmuch as the Domestic Relations Law (DRL) does not specifically prescribe the date on which each marital asset (or each type of marital asset), must be valued, this determination has been left to the courts. As explained by the Second Department in Wegman v. Wegman , 123 AD2d 220 (2nd Dept. 1987), “The question of a valuation date is of prime importance since, in complicated matters and in the urban areas of the state, protracted pretrial proceedings and calendar delays can mean that months, if not years, will pass between the commencement of the action and the time of trial. In that time, property values may not ' and probably will not ' remain constant.” Wegman at 231 (citing Scheinkman, 1984 Practice Commentaries, McKinney's Cons. Laws of N.Y., Book 14, Domestic Relations Law C236B:32, p. 117 (1986 Supp. Pamphlet)). As Scheinkman has indicated, as a result of the absence of a general rule governing when marital assets should be valued, “[t]his area of the law has been fraught with confusion.” Id. at 27.

DRL Section 236(B)(4)(b) sets certain parameters and requires that “[a]s soon as practicable after a matrimonial action has been commenced, the court shall set the date or dates the parties shall use for the valuation of each asset. The valuation date or dates may be anytime from the date of commencement of the action to the date of trial.” DRL Section 236(B)(4)(b)(McKinney 2011). Furthermore, “A court may set different valuation dates for different assets, may take into consideration transfers and dissipations by a spouse seeking to hinder equitable distribution, and may change a valuation date after it is set if equity so requires.” Wegman at
236-237 (citing New York State Assembly Memorandum in Support of Legislation, L.1986, ch. 884).

In most instances, business interests and professional practices are classified by the courts as “active” assets ' those whose value is commonly determined by the efforts of the titled spouse ' as opposed to mutual funds, undeveloped land and artwork, which are classified as “passive” assets because their value is typically a result of market forces or other forces outside of either party's control. While it is true that active assets are most often valued as of the date of commencement, a post-commencement date change in value not attributable to the efforts of the titled spouse often requires that a post-commencement date value be applied in the interest of equity.

We explore in this and next month's issues the various circumstances in which courts have found that an active asset should be valued subsequent to the date of commencement.

Adverse Events Outside of the Titled Spouse's Control

Grunfeld v. Grunfeld , 94 NY2d 696 (Ct. App. 2000), is often cited as the leading authority governing the proper date upon which an active asset should be valued. In Grunfeld , a commencement date valuation of the husband's law practice was upheld by New York's Appellate Division, First Department, and the Court of Appeals because the husband's practice was “an active, ongoing business, which type of asset is generally valued as of the date of commencement.” Grunfeld v. Grunfeld , 255 AD2d 12, 17 (1st Dept. 1999), aff'd Grunfeld v. Grunfeld , 94 NY2d 696 (2000). Nonetheless, the First Department explained that, “Under certain circumstances, a date-of-trial valuation of a business may be justified by the loss of the business's major client and resultant loss of the business's value during the pendency of the litigation [citing La Barre, discussed infra], or by other losses due to adverse forces outside of the spouse's control [citing Sagarin, discussed infra].” Id.

The First Department explained that Mr. Grunfeld's firm's loss of several clients in the years following the date of commencement is not ' given the nature of the firm's practice ' “the type of unusual post-commencement event as would necessarily have a substantial, long-lasting effect on its value,” which would warrant a date-of-trial valuation. Id. The Court of Appeals echoed this conclusion, finding that “[a]lthough defendant presented some evidence that his practice had become less profitable as a result of changes in customs laws and the loss of clients, there is ample support for the lower courts' finding that defendant's professional practice had not undergone the type of radical alteration subsequent to the commencement of the action that would warrant a valuation of the practice at the time of trial.” Grunfeld, 94 NY2d 696, at 707-708.

What facts rise to the level of a “radical alteration” sufficient to justify a date of trial valuation? Interestingly, in Johnson v. Johnson , 277 AD2d 923 (4th Dept. 2000), which was decided the same year as Grunfeld , the Fourth Department upheld a date-of-commencement valuation of the husband's interest in an insurance business. Its value was thus estimated as zero, despite the fact that the business was subsequently sold for a profit. Other courts, however, have not adhered to such a high standard, including those cited by the First Department in Grunfeld, namely, La Barre and Sagarin, both of which preceded the Grunfeld and Johnson decisions.

La Barre v. La Barre , 251 AD2d 1008 (4th Dept. 1998), decided by the Fourth Department two years prior to Johnson , held that the Supreme Court's use of a date subsequent to the date of commencement but prior to trial was appropriate and fair under the particular circumstances of that case because the date corresponded to the point in time that the business lost a major client.
In Sagarin v. Sagarin , 251 AD2d 396 (2nd Dept. 1998), the Second Department affirmed the Supreme Court's selection of the date of trial for valuing the husband's business interest. In so holding, the court cited Wegman, supra, for the premise that the trial court has discretion and flexibility in selecting the proper valuation date, and stated, “Here, adverse economic forces outside of the husband's control caused the decline in the value of the corporation. Further, there was no evidence of dissipation or wasteful conduct on the part of the husband.” Sagarin at 396.

Indeed, courts that have upheld post-commencement dates for a business valuation due to adverse events outside of the titled spouse's control have routinely premised such determinations on the fact that there was no malfeasance committed or self-serving motive on the part of the titled spouse. For instance, in Butler v. Butler , 256 AD2d 1041 (3rd Dept. 1998), the husband filed for personal bankruptcy after the commencement of the divorce action but prior to trial, and was consequently forced to sell all of his business assets in connection with the bankruptcy proceeding. The Third Department upheld the trial court's use of a date-of-trial valuation because a commencement date valuation would have resulted in inaccurate and outdated income, revenue and asset valuations. In affirming the trial court's valuation as of the time of trial as justified and equitable, the court noted that there was no evidence that the husband had engaged in the bankruptcy proceeding in order to avoid the financial consequences of divorce.

The objective of safeguarding against wrongdoing on the part of the titled spouse when selecting the appropriate valuation date for active assets was also squarely addressed by the Court of Appeals in McSparron v. McSparron , 87 NY2d 275, 287-288 (1995). While McSparron concerned the valuation and distribution of a law license, the court's analysis is equally applicable to ' and commonly cited in the cases that address the valuation date applicable to ' business interests because both such assets are frequently valued as of the commencement date due to their “active” qualities. In McSparron, the court explained that one of the reasons for using the date of commencement to value an active asset is to prevent the titled spouse from unilaterally manipulating the interest's value. Furthermore, the court cautioned that, while it is commonly appropriate to value active assets as of the date of commencement, strict formulations which require that active assets be valued as of the commencement date and passive assets be valued as of the date of trial, “may prove to be too rigid to be used in particular cases” and should therefore “be regarded as helpful guideposts and not as immutable rules of law.” McSparron at 287-288.

Consistent with the cases discussed above, the court in McSparron held that a post-commencement date valuation was proper based largely on the fact that there was no concern that the titled spouse had manipulated the value of his law license. Rather, quite the contrary was true, as it was the post-commencement date actions of the non-titled spouse that had impacted the asset's value. See id. at 288 (explaining that the wife's “acrimonious and vindictive conduct” in a public setting caused the husband to lose his job and remain unemployed).

In Naimollah v. De Urgarte , 18 AD3d 268 (1st Dept. 2005), the First Department reiterated the premise set forth in McSparron that, “the principle that active assets are valued as of the commencement date is a helpful guidepost rather than a rigid rule” ( Naimollah at 270 (citing McSparron , supra at 288)), and upheld a date of trial valuation of the wife's business where the business had “suffered losses due to adverse forces outside the spouse's control.” Id . (citing Grunfeld , supra at 17). This emphasis on giving the court enough flexibility to reach the “right” result demonstrates that principles of fairness and equity are elevated above the desire for a more straightforward rule that has the potential to cause grossly inequitable results.

Similarly, in a case where the valuation of the husband's medical practice was at issue, Basile v. Basile , 199 AD2d 649 (3rd Dept. 1993), the Third Department held that there was no abuse of discretion in employing a valuation date 11 months after the commencement of the divorce action where expert evidence was presented to demonstrate that, because the husband was totally disabled from employment during the year in which the action was commenced, the business's corporate tax return would not accurately reflect annual income for that year. In so finding, the court explained, “It is well-settled that the trial court is not constrained to value an asset as of the action commencement date, but has the discretion and flexibility to determine the most appropriate date for valuation as circumstances warrant. This is especially so where questions involving the valuation of a business are at issue.” Basile at 651.

Furthermore, in Cohn v. Cohn , 155 AD2d 412 (2nd Dept. 1989), another case that emphasized the importance of giving the court discretion to select a valuation date that is “appropriate and fair under the particular facts and circumstances presented,” ( id . at 413, affirming the lower court's selection of a valuation date for the husband's business interest that was subsequent to the date of commencement of the divorce action and prior to the time of trial), the court was not concerned that the lower court failed to set forth the specific reasons for selecting the post-commencement valuation date, so long as the record “discloses an adequate basis for the court's determination.” Id . (explicitly overruling Yunger v. Yunger , 133 AD2d 451 (2nd Dept. 1987), to the extent such case indicates to the contrary, but failing to identify the “adequate basis” that was set forth on the record in that particular case).

Next month, we will discuss post-commencement date changes in value when value is affected by market forces, the efforts of the non-titled spouse and post-commencement value-altering events.

Marcy L. Wachtel, a member of this newsletter's Board of Editors, is a partner in the firm of Katsky Korins LLP. Shireen G. Arani is an attorney in the firm's matrimonial and family law department.