As the global pandemic reshapes our world introducing unexpected economic and social challenges - divorces, and other family law matters will continue. There are a myriad of predictions of what will happen and when it will happen. While time will tell the accuracy of these predications, COVID-19 is already having an impact on pending divorce proceedings. Read on to find out how to move your cases forward in this environment.
In considering equitable distribution for divorce, the closely held business is valued as of a certain date (usually the Date of Complaint “DOC”), and that value is apportioned between the parties. For 2020, most business valuation professionals will consider December 31, 2019 financial results as it is the year end closest to the valuation date (assuming the business is a calendar year end). The ongoing and significant downturn related to the COVID-19 virus will require adjustments to this line of thinking. This virus, occurring post the DOC, is clearly not the fault of the business owner, and we will not, and cannot know with certainty, its ramifications as we prepare a valuation in 2020. DOCs after February 2020 will have the same issues since the historic information still will not reflect the post COVID-19 business. (The only practical difference between the pre February DOCs is that we know there is a change – even though we do not know the ramifications of it.)
In the current environment, everyone involved in divorce proceedings should be aware of the following issues:
Disclosures on Reports
Valuation reports will probably include disclosures like: “this report is written during or after the Coronavirus outbreak and the results and opinion of value do not take into consideration these post valuation date events – which were not knowable at the DOC…”. A disclosure by valuation professionals, as outlined above, is required to adhere to professional standards. However, a reasonable conclusion of value based on financial information through 2019 may not be useful at all for a family law practitioner in 2020.
Known/Knowable vs Practical/Usable in 2020.
Goldman v Goldman (248 N.J. Super. 10 (1991). 589 A.2d 1358) involved an active business asset that permanently went down in value post the DOC - through no fault of the business owner. In that case, and others since, the lower, post-DOC value was considered for equitable distribution since the asset, as of the measurement date, dramatically changed. To split an asset that has decreased in value through no fault of the owner would not be equitable. Today, many businesses will have negative consequences from the virus and related concerns. The question is how do we handle this issue equitably?
For cases being adjudicated in 2020, with complaint dates prior to approximately February, 2020, additional consideration will be necessary. Remember valuation is a prophecy of the future. You are actually valuing tomorrow, not yesterday. In the year 2020, yesterday looks very different than tomorrow – yet no one could have possibly predicted what actually has happened since the DOC.
For businesses with consistent performance, the Gordon Growth Single Period Capitalization method and Discounted Future Earnings/Cash Flow method will return the same value if the same profitability and growth assumptions are used. This is why you do not ordinarily see both methods. If you are litigating your case in 2020 – you do not have the luxury of seeing what happens. Now is the time to consult with your valuation professionals, as preparing a useful valuation for a case in 2020 will involve much more subjectivity. Some of the more relevant questions to consider are:
- Was the business affected?
- Will the business recover?
- When will it recover?
- What constitutes “recovery” – for example, a return to historic Revenue? Profits? Book equity?
- Did the business have insurance that will cover part or all of the potential downturn?
- Will the business apply for loans, grants or other relief, and how will these loans, grants or other relief impact the financial stability of the business?
We may suggest that valuations for current cases consider providing values as of the DOC and potentially a later date (similar to concepts in Estate and Gift tax valuations and the Alternate Valuation Date – although its application in a matrimonial matter would be novel). This approach would provide useful information for the litigants to use now, since it may be years before we know the long-term effects of this crisis on the subject business.
Your valuation professional may also recommend a modification of the traditional Discounted Cash Flow (“DCF”) method to include near term cash flow changes and build a return to normalcy based upon realistic assumptions. The modified DCF method will most likely produce a lower value than the single period model using historic earnings, but that lower value may be more realistic when resolving current cases.
Language of Agreements with an Uncertain Future
Let your valuation professional assist you in defining what “recovery” means and how it impacts potential valuation and equitable distribution adjustments. Consider that some businesses will see revenue and profits recover, but may have taken on a great deal of debt to survive. In these circumstances, equity value may still be quite a bit less than it was on December 31, 2019.
The CARES Act includes forgivable loans (tax free) provided the business (up to $10 million for business with less than 500 employees) maintains payroll for a period of time. These loans are more like grants, so consult your valuation professionals to ensure their effect on value is handled appropriately. If the forgiveness of an unknown debt at an unknown time would have a material effect on the pending equitable distribution, we suggest that such contingencies, which have not occurred in the past, be incorporated in your agreements today
In another example of new considerations that may or may not take effect, various aid packages push to forgive $30,000 in loans per student. While the terms of eligibility remain unclear, we suggest couples with two to three college kids and expecting to pay student loans, incorporate an adjustment mechanism should up to $90,000 in debt suddenly be erased.
The proper drafting of agreements and cooperation between the parties will be necessary to ensure that litigation does not become never-ending. The mandate is still to separate the couple as much as practically possible. Your valuation professionals can provide insight on the details of the aid packages, as they are finalized and implemented, to help you continue to move your cases forward fairly
We have overcome events that, like COVID-19, caused economic upheavals. September 11, 2001, the financial crisis of 2008 to 2009 and regional disasters like Superstorm Sandy in 2012. Each event caused uncertainty, fear and economic waves long after taking place. Some of the language and negotiation techniques that you used during those stressful times may be repurposed today.
Effect on Your Practice
The uncertainty of a business’ near and long-term future is enhanced during these stressful periods. Unfortunately, while some businesses will never recover, others will ultimately prosper. We note that clients will be more fee-sensitive during these times. A little creativity and thinking outside the box will help move your clients’ cases along and allow all of us to continue with our businesses.
Randall M. Paulikens, CPA/ABV/CFF/CITP, is a partner in the Forensic Accounting, Litigation Support, and Valuation Services (FLVS) Practice at Friedman LLP. Randy works out of the firm’s Red Bank, New Jersey and New York City offices. He can be reached at 732-852-5501.