Telfer v. Telfer: Discount for Lack of Marketability Upheld on Appeal
Courts are divided on whether to allow discounts when valuing business interests in shareholder disputes and divorce cases. Whether discounts are equitable typically depends on state law and legal precedent, case facts and, ultimately, the court’s discretion.
In a recent divorce case, the Tennessee Court of Appeals upheld a discount for lack of marketability (DLOM) taken on the appreciation in value of two business interests. The appreciation in value during the marriage — rather than the value of the family business interests — was included in the marital estate. Here are the details.
The couple was married in 1985. They generally deposited income into and paid expenses from a joint checking account. The wife’s father owned RJ Young Company, a supplier and servicer of office equipment. He created the following business entities to transfer wealth to his children:
- Crunk Connected Products (CCP), a partnership that owned the real estate on which RJ Young was situated, and
- Young Leasing, a limited liability company (LLC) that owned no assets when it was created and that operated at a loss until 2005.
By October 1999, the wife owned a 74.8% interest in CCP. In 2000, she began receiving monthly distributions from CCP of $8,500. These distributions were deposited into the couple’s joint checking account and used to pay marital expenses.
In 2005, Young Leasing reported its first profit of approximately $619,000. The company retained all of its earnings, however.
The couple had significant tax liabilities from their family business interests. From 1999 through 2006, they received no additional distributions from CCP or Young Leasing to pay the increased tax liability.
The wife filed for divorce in 2010. Contentious litigation ensued, including disputes over the treatment of the wife’s business interests and their appreciation in value as either separate or marital property, for purposes of equitably dividing the marital estate.
Eventually, the Tennessee Court of Appeals determined that the appreciation in value of the business interests was includable in the marital estate, because “the parties made real and significant contributions to appreciation and preservation of both Young Leasing and CCP.” The wife’s business valuation expert determined that a 7.7% DLOM should be applied to the appreciation in value of CCP and a 10% DLOM should be applied to the appreciation in value of Young Leasing.
On remand, the husband argued that it was inequitable to discount the value of the business appreciation for its lack of marketability. The wife and her valuation expert disagreed.
To Discount or Not to Discount?
Business valuation professionals apply a DLOM to reflect the lack of liquidity of an ownership interest. Because liquidity refers to how quickly and easily an interest can be converted into cash, a DLOM may be relevant when no ready market exists for an interest or when the provisions in a partnership agreement restrict the ability of a partner to liquidate the interest.
Generally, the applicability of a DLOM depends on the characteristics of the ownership interest, not whether the owner of the interest intends to sell it. After considering the facts of this case, the Tennessee Court of Appeals found no abuse of discretion in the trial court’s application of “slight” DLOMs to CCP and Young Leasing.
After the final order was issued in Telfer, the law in Tennessee was amended to require courts that are divvying up marital assets to consider all relevant evidence in determining the value of an interest in a closely held business or similar asset. This includes valuation methods typically used without regard to whether the sale of the asset is reasonably foreseeable.
The new law effectively overrides any previous case law that suggested that DLOMs shouldn’t be applied when valuing businesses in divorce cases unless the business was for sale or a sale was contemplated.
State to State Variations
Decisions in divorce and shareholder dispute cases are state-specific, and the laws vary significantly from state to state. Before valuing a private business for any purpose, the parties should discuss this issue in the context of relevant legal precedent and the facts of the case.