Caselaw Update: Court Cases Shed Light on Key Valuation Topics

2/11/2016 - By Zachary Farrington

The courts are filled with interesting valuation-related cases. Here’s a look at recent litigation that has piqued the interest of valuation professionals.

Gallo v. Gallo - The Case of the Double Dip
One of the valuation issues that commonly arises in divorce is “double dipping.” This occurs when the recipient of spousal support “dips” twice into the same asset — once in the equitable distribution calculation and again when it comes to spousal support.

Since 2008, the seminal case regarding double dipping has been Heller v. Heller, an Ohio Court of Appeals case which essentially banned double dipping. Earlier this year, the same court ruled in Bohme v. Bohme that the Heller ban on double dipping wasn’t entirely relevant when using income from a wholly owned professional practice as a measure of both business value and actual income for spousal support.

In Gallo v. Gallo, the court again quibbled with the Heller ruling. In this case, the husband, an ocular plastic surgeon, owned one practice and had ownership interests in two surgical centers. Based on an annual income of $700,000, the divorce court ruled that the husband should pay $12,000 per month in spousal support for a period of time.

The husband appealed, alleging that a double dip had occurred when the future profits calculated for his interest in one of the surgical centers were also used to calculate his income for the purpose of support.

The appeals court looked at two issues: Did a double dip occur and does the law prohibit it per Heller? On the first issue, the court disagreed with the Heller definition of double dipping, but found that a double dip had in fact occurred in the Gallo case. Perhaps the most interesting part of the ruling was the court’s decision that double dipping was not prohibited under all circumstances.

In fact, the Gallo court said that Heller ignored a provision expressly requiring a court considering spousal support to consider all sources of income, “including income derived from a marital asset divided in the property distribution.” Moreover, the court said in the interest of equity, the disparity in income between the parties may “override the unfairness in double dipping.”

Lessons learned: Courts seem to be retreating from the hard double dipping line drawn in the Heller case. In light of the Gallo and Bohme cases, double dipping might be permissible after all.

Friehage v. Friehage - Debt: Not Lovin’ It
This recent divorce case involved the valuation of an LLC which owned several McDonald’s franchises purchased over the course of the divorcing couple’s marriage. The LLC was created by the husband and he was the only member of the LLC.

The divorcing spouses each hired a valuation analyst. Both analysts were experienced in valuing McDonald’s franchises and were members of a trade association specifically for franchise accountants. Each performed a valuation involving a discounted cash flow analysis, but their conclusions were $10 million apart.

Certain facts weren’t disputed: To purchase the franchises, the husband incurred some debt — $3.7 million to a bank and $5.8 million to a family trust. But the valuation experts had differing opinions on certain key elements of the valuation, including the total debt.

Based on all the data, the husband’s experts determined the total value of the LLC was $10 million. After subtracting the cost of reinvestments, excess liabilities and the debt owed to the bank and the family trust, they determined that the net value was just $310,000.

Not surprisingly, the wife’s expert saw things differently. He determined the LLC was worth $16.1 million, but allowed for only $4.9 million in liabilities — not including the debt to the family trust, which the wife characterized as a gift, not a loan. This brought the final number to $11.2 million. Part of his rationale for excluding the trust debt was that McDonald’s had chosen to exclude it when calculating total business equity for the LLC.

Ultimately, the court decided that the LLC’s value was $10.6 million less debt, which it said included the family trust debt. This brought the “net of debt” total to $1.1 million. While there were several disputes of over the calculation in an appeal, the appeals court agreed that the family trust debt was indeed a loan, and upheld the $1.1 million valuation.

Lessons learned: How debt is treated is based solely on facts and circumstances. Though the wife tried to characterize the loan as a gift, the court didn’t agree. Nor was the court swayed by the fact that McDonald’s itself excluded the family trust debt from the total business equity.

In re: Dole Food Co, Inc. -Must an Expert Be a Person?
Is a financial advisory firm as an entity capable of testifying as a valuation expert in a trial? Or is it imperative that the actual individual who prepared the report testify as the expert? These were the questions at issue in the Delaware Court of Chancery as part of a stockholder dispute with Dole Food Company, the multinational famous for its pineapple rings.

In this case, two investment firms challenged Dole’s 2013 take-private merger and petitioned for an appraisal of the company. Dole named an investment banking firm, Stifel, Nicolaus & Co., as its expert witness. The valuation report was signed by two individuals as representatives of the firm, but neither signed in a personal capacity.

At the deposition, Stifel’s managing director appeared as the person most knowledgeable about the report, with Dole asserting that he was “not the expert,” but rather the firm was the expert. The plaintiffs balked, claiming that an expert witness must be a person, not a firm.

The plaintiffs further asserted that the distinction was important because a human expert witness can only rely on his or her own knowledge — the standard assumption behind a valuation opinion. However, a firm might claim the knowledge of all of the employees of the company.

The court agreed with the plaintiff, noting several requirements set forth by the Delaware Rule of Evidence Rule 702. First, the rule says that “an expert witness must be capable of serving as a witness.” The court interpreted this as a “biological person,” not a corporation, which the court said only existed “in the contemplation of the law.”

Further, the court said that only a person can be “qualified” by demonstrating “knowledge, skill, experience, training or education” and “apply principles and methods.” It concluded that “the expertise belongs to the individuals, not the corporation.”