Bates v. Bates - TN Case Supports Many Basic Business Valuation Principles
July 29th, 2020
IN THE COURT OF APPEALS OF TENNESSEE AT NASHVILLE
May 1, 2020 Session
KIMBERLEY ARNOLD BATES V. CHARLES ANTHONY BATES
Appeal from the Circuit Court for Wilson County
No. 2018-DV-8 Clara W. Byrd, Judge
Closely-Held Business Value at Date of Marriage, Buy-Sell Agreement Not Signed by Spouse, Discount for Lack of Marketability (“DLOM”), Discount for Lack of Control (“DLOC”), Existence of Blocking Rights and Existence of a Stock Option
Kimberley Arnold Bates (“Wife”) and Charles Anthony Bates (“Husband”) married in 2001. They had been married to each other once before, with their first marriage ending in divorce in 1997. Wife filed for the second divorce in 2018. During the parties’ first marriage, Husband became the general sales manager of Burchett Ford Subaru, Inc. (the “Company”). He acquired 80 shares or a 20% interest in the Company in 1994 after entering into a Management and Buy and Sell Stock Agreement (“the Agreement”) with the owner of the Company, Glen Burchett. At the time Husband and Mr. Burchett signed the Agreement, the total value of the Company was $1,000,000. Both Husband and Mr. Burchett agreed that the 80 shares had a value of $2,500 per share; therefore, the total amount of Husband’s interest in the Company at that time was $200,000, while Mr. Burchett’s interest was $800,000.
The Agreement contained a provision that allowed the Company to terminate Husband’s employment “for cause.” The Agreement also included a buy-sell provision that provided, in pertinent part, as follows:
The Company agrees to buy or redeem and Burchett for himself, his estate, his Personal Representative and his heirs agrees to sell any and all stock in the Company that he owns at the date of his death for $2,500 per share.
It is specifically agreed by each of the parties that the purpose of the agreements as here set out . . . is to establish a smooth transition and uninterrupted transfer of the stock and ownership and full operation of the Company to [Husband] upon Burchett’s incapacitation or death and each party agrees for themselves, their heirs or assigns, that they will take no action that will hinder or disturb this intended transition.
When the parties divorced the first time in 1997, they entered into an MDA that awarded Husband “all right, title in and to any ownership interest he ha[d] in [the Company]” which was still the 80 shares he received under the Agreement since he had not purchased any additional shares. Following Mr. Burchett’s death in May 2007, Husband purchased the remaining 320 shares of the Company stock owned by Mr. Burchett for $800,000 ($2,500 per share) and changed the name of the Company to Bates Ford.
Value at Date of Marriage
Wife’s expert valued Husband’s 20% interest in the Company at the time of the parties’ second marriage in 2001 using two valuation scenarios based on two different methods. First, he used a combination of the “Company’s income, assets, and fair market value” to value the entire Company at $2,120,000. Husband’s stock was restricted and he owned a minority 20%; therefore, the expert applied a 20% Discount for Lack of Marketability (“DLOM”) and a 20% Discount for Lack of Control (“DLOC”) to conclude that the value of Husband’s 20% interest was $255,000 in 2001. Although not addressed in this Appeal, the 20% interest would have been valued at $424,000 without the discounts. The math is a bit off, but the calculations should have been: $2,120,000 x 20% = $424,000 x/- 20% DLOC = $339,200 x/- 20% DLOM = $271,360. It is unknown how the final value was $255,000. Second, Wife’s expert testified that he believed that the termination provision in the Agreement was a better indicator of the value at $100,000 because that was the maximum amount the termination provision allowed him to sell his stock for at that time.
Husband’s expert valued Husband’s 20% interest in the Company in 2001 and agreed with Wife’s expert that the value was $2,120,000; however, he testified that the Agreement capped the value of Mr. Burchett’s 80% interest in the Company at $800,000 concluding that the remaining value of the Company, $1,320,000, belonged to Husband as accrued equity. The court found this to not be credible and rightly so. How can 20% be worth $1.3m, and 80% worth $800k? That conclusion defies logic in my opinion.
The trial court classified Husband’s 20% interest in the Company as his separate property and valued it at $100,000 using Wife’s expert’s value based on the termination provision of the Agreement because the court found that to be the most compelling evidence of the value of the stock because it was agreed to by Husband and Mr. Burchett.
Value at Date of Trial
Wife’s expert testified that the Company had a value of $3,463,000 at the time of trial in 2019, but acknowledged that his valuation did not include $935,000 in shareholder receivables that he described as personal debt Husband owed to the Company (i.e. Husband had borrowed $935,000 from the Company and owed it back as a personal debt) because he had not been made aware of the receivables until trial.
The trial court found Wife’s expert credible and Husband’s expert not credible; therefore, the court adopted Wife’s expert valuation of the Company at the time of trial as $3,463,000. After subtracting the $100,000 for Husband’s separate property value at Date of Marriage, the court found that his interest in the Company appreciated by $3,363,000 and classified the appreciation as a marital asset. The appellate court concluded the additional $935,000 in shareholder receivables/debt needed to be taken into account when the trial court divided the marital estate by either subtracting it from the $3,463,000 current value of the Company or including it with the marital debt on a marital balance sheet.
Appellate Ruling on Value at Date of Marriage
Both parties agreed that the trial court correctly classified Husband’s 20% interest in the Company at the time of the second marriage as his separate property. Husband argued, however, that the trial court erred in relying on the termination provision of the Agreement to determine that his premarital interest was worth only $100,000. He contended that the trial court should not have relied on that provision to value his premarital interest because he was never terminated and, under that provision, he could only sell his 80 shares if his employment were terminated. Husband further contended that the trial court should not have relied upon the Agreement to value his 80 shares because he had no intention to sell the stock. The appellate court agreed.
The appellate court considered a similar issue in Harmon v. Harmon, No. W1998-00841-COA-R3-CV, 2000 WL 286718 (Tenn. Ct. App. Mar. 2, 2000). In Harmon, the trial court based its valuation of the husband’s ownership in a limited partnership solely on the terms of the husband’s buy-sell agreement with the business because the court found the agreement controlled the issue. Harmon, 2000 WL 286718, at *5. After reviewing case law from other jurisdictions, the appellate court adopted the majority view that “the value established in the buy-sell agreement of a closely-held corporation, not signed by the non-shareholder spouse, is not binding on the nonshareholder spouse but is considered, along with other factors, in valuing the interest of the shareholder spouse.” Id. at *8. In this case, Wife did not sign the Agreement and was not bound by the values set by the Agreement; therefore, the Agreement’s valuation of Husband’s 80 shares in the termination provision did not control the issue. The Court said that it is but one of the factors to be considered for determining Husband’s premarital interest in the Company. See id. at *8.
Husband claimed he never intended to sell his shares, thus the appellate court concluded the Agreement was not applicable for determining value. See Bertuca, 2007 WL 3379668, at *8 (holding that buy-sell provision did not affect the value of the husband’s interest in a partnership because “such a provision only affects the value if he plans to sell his interest in the partnership,” and there was no evidence he intended to sell). The appellate Court concluded that the trial court erred in relying on the Agreement to value Husband’s interest in the Company at Date of Marriage. The reasons Wife’s expert provided for discounting the value of Husband’s 20% interest were persuasive, and the evidence did not preponderate against discounting the value by 40% using the DLOC and DLOM. The appellate Court concluded that Wife’s expert’s alternative method was appropriate and increased the trial court’s finding of value of $100,000 to $255,000.
Although not addressed in the Appeal, valuation of assets and closely-held businesses under a true Fair Market Value standard as is required in Tennessee divorces necessitates the consideration of the DLOC and DLOM if applicable. Tennessee Code Annotated, Section 36-4-121(c)(10) states:
In determining the value of an interest in a closely held business or similar asset, all relevant evidence, including valuation methods typically used with regard to such assets without regard to whether the sale of the asset is reasonably foreseeable. Depending on the characteristics of the asset, such considerations could include, but would not be limited to, a lack of marketability discount, a discount for lack of control, and a control premium, if any should be relevant and supported by the evidence; [emphasis added.]
Existence of Husband’s Alleged “Blocking Rights”
Husband next argued that the trial court erred in undervaluing his premarital interest as of 2001 because the court ignored the appreciation of this interest due to the bundle of rights the Agreement assigned to him. He asserted that the Agreement assigned him a blocking right that absorbed all excess equity in the Company above $800,000 by capping Mr. Burchett’s 80% interest in the Company at $800,000. Thus, Husband contended that his 20% interest in the Company was valued at $1,320,000 in 2001 - the difference between the total value of the Company in 2001 ($2,120,000) and Mr. Burchett’s capped value ($800,000). The trial court dismissed Husband’s argument on this issue because it found that Mr. Burchett continued to control the Company at the time of the parties’ second marriage.
The appellate Court determined that Husband and Mr. Burchett did not intend for the buy-sell provision to apply until Mr. Burchett’s “incapacitation or death.” Upon either of those occurrences, the terms of the provision would then apply and neither Husband, Mr. Burchett, nor Mr. Burchett’s heirs could take any action that would “hinder or disturb” transfer of the Company to Husband. The Court determined that Mr. Burchett maintained control of the Company and could do as he pleased regardless of any objection from Husband. Mr. Burchett displayed these control rights as evidenced by his actions in increasing the dealership’s rent payable to himself only by almost double to $20,000 per month and allowing a competitor to come into the same county. Mr. Burchett had the right as majority owner to object to that competitor to Ford Motor Co. and did not. As the minority 20% owner, Husband did not have the right to object prior to Mr. Burchett’s death. Husband tried later to object to the competitor but was denied due to the lateness of his action. The appellate Court found no language in the Agreement providing Husband with a blocking right, capping Mr. Burchett’s interest at $800,000, or stating that all equity in excess of that amount accrued to Husband.
Existence of Husband’s Alleged “Stock Option”
Husband also contended that the trial court erred in undervaluing his premarital interest as of 2001 by assigning no value to his “stock option”. According to Husband, the Agreement assigned him a stock option allowing him to purchase Mr. Burchett’s shares at $2,500 per share at the time of Mr. Burchett’s death or incapacitation. The buy-sell provision in the Agreement provided that the purpose of the Agreement “is to establish a smooth transition and uninterrupted transfer of the stock and ownership and full operation of the Company to [Husband] upon Burchett’s incapacitation or death.” This language evidenced an intent for Husband to assume full ownership and control of the business upon Mr. Burchett’s death or incapacitation; however, did not specify a price at which Husband may purchase Mr. Burchett’s shares if either event occurred. Rather, the buy-sell provision provided: “The Company agrees to buy or redeem and Burchett for himself, his estate, his Personal Representative and his heirs agrees to sell any stock in the Company that he owns at the date of his death for $2,500.00 per share.” The appellate Court found no language in the Agreement setting a price at which Husband could purchase the outstanding shares from Mr. Burchett or the Company and determined that the language clearly and unambiguously allowed the Company, not Husband, to purchase Mr. Burchett’s shares for $2,500 per share upon Mr. Burchett’s death or incapacitation. Consequently, the Court concluded that the Agreement did not assign Husband a stock option and concluded that the trial court did not undervalue Husband’s premarital interest by finding no appreciation in value due to a stock option.