How COVID-19 Affects Divorce Cases - Pandemic Creates Unique Business Valuation Challenges
The COVID-19 pandemic has had a devastating impact on the economy and created significant uncertainty. For couples involved in divorce proceedings, the current environment presents unique challenges as the parties strive to reach an equitable property division agreement.
Matter of Fairness
In both equitable distribution and community property states, fairness is a primary concern. Rarely is ownership of a business, real estate, retirement accounts, or another marital asset simply split 50-50 between the spouses. Rather, courts are more likely to award a business to the spouse who’s active in operating it and a home to the spouse who continues to reside there. To achieve fairness, the parties will work out an agreement to compensate the other spouse by 1) paying him or her a percentage of the asset’s value, or 2) awarding him or her another marital asset of comparable value.
Achieving a fair property division can be challenging in volatile economic times. For example, Mr. and Mrs. Smith reached a property division agreement on January 1, 2020. Under the agreement, Mrs. Smith would keep the family home, and Mr. Smith would retain his closely held tool-and-die shop. Both assets were valued at $1 million as of January 1.
After multiple COVID-19-related postponements, the couple’s property division hearing will be held on September 1, 2020. As of the new trial date, however, the value of the business is only $700,000, while the home’s value is still $1 million. Is the original agreement still fair? Should the parties return to the negotiating table?
Known vs. Knowable
Often, the valuation date is the date of separation or the date the divorce complaint was filed. But what happens if divorce proceedings are initiated in late 2019 or early 2020, and the value of a business has declined dramatically as a result of the pandemic? A business’s value is generally based on facts that were “known or reasonably knowable” on the valuation date. Subsequent events that affect value — but fail to meet this standard — are usually disregarded. However, professional standards generally require valuators to disclose subsequent events in their reports and explain how those events affect value.
For valuation dates that are later in the year, the pandemic’s impact may be clearer. But uncertainty over the future still creates business valuation challenges. Will the business recover? If so, how long will it take? Will it bounce back quickly once the pandemic ends, or has it suffered more lasting damage? Different types of businesses have been affected by COVID-19 differently — and some have even flourished during the pandemic.
During this volatile time, valuation experts are likely to emphasize income-based valuation techniques, such as the discounted cash flow and capitalization of earnings methods. These techniques can be adjusted to reflect current business disruptions while capturing a projected return to a “normal” level of profitability. Predicting if, and when, that will happen is no easy task, however.
Flexibility is Key
Today, divorcing couples need to keep their options open. They might consider waiting to see how the recovery goes before finalizing their divorce settlements — or at least reserve the right to adjust those settlements to reflect future developments. And, for existing agreements, your clients might consider asking the court to change the valuation date or otherwise modify their agreements in the interest of fairness.
To Double-Dip or Not to Double-Dip?
In a divorce context, more than half the states prohibit double-dipping. This refers to using the same future business income stream to determine 1) the business’s value as a marital asset, and 2) the business owner-spouse’s ability to pay spousal support. Double-dipping is generally viewed as unfair, but courts may sometimes permit it under certain circumstances.
For example, in a recent case — Kim v. Kim — the Court of Appeals of Ohio, Ninth District, upheld the trial court’s use of the same income stream to value the husband’s business and determine income available for spousal support. The appellate court found that Ohio statutory law precludes an outright prohibition of double-dipping, because it requires courts “to consider all sources of income, including income derived from a marital asset divided in the property distribution, in determining spousal support.” At the same time, the impact of double-dipping should be considered, with an eye toward avoiding unfairness.
In Kim, the trial court concluded that, based on case facts, equity didn’t require a “double-dipping offset.” Among the facts the trial court cited were:
- The “huge disparity” in the parties’ income,
- The wife’s lost income capacity as a result of her homemaking and child care responsibilities, and
- The fact that the husband’s salary and distributions from the business were entirely within his discretion and control.
In particular, Mr. Kim’s average income was more than half a million dollars, while Mrs. Kim earned only $45,000 per year. The appellate court agreed with the trial court’s interpretation of the facts at hand, noting that some circumstances, including disparity in income between the parties, may “override the unfairness in double-dipping.”