The Marital Property Committee recently hosted a brown-bag lunch to discuss the potential impact of the financial downturn on valuations. We recognize that states follow different rules for the date of valuation for different types of assets, with some valuing assets at the date of separation, and some at date of trial. In my home state of New York, Courts default to valuing active assets (e.g. a business) at the date of commencement of a divorce action, and passive assets (e.g. real property) at the date of trial. Courts have discretion to value active assets at a later date if they deem appropriate, such as where the value changed due to circumstances outside of the titled party’s control. The coming months, and more likely years, will no doubt include much litigation over whether Courts should shift valuation dates, taking into consideration the impact of the financial downturn on valuation, and what external factors should be considered in valuing assets.
On our brown bag call, we highlighted the issues around valuations regarding three main types of assets.
Often, one party in a divorce may opt to keep the family home, trading its value for other assets to be retained by the other spouse. Licensed real estate appraisers routinely tell us the value of the house, based on a review of comparable sales in the neighborhood. Now, the true value of that home may be difficult to know. It may take many months to ascertain whether there has been a significant impact on the value of similar homes as a result of the downturn. While we sometimes look at general market trends too, we may find that the market varies significantly depending on price point. For our cases that are already in litigation, heading to trial once the courts re-open, or closing in on settlement, we may be considering a re-appraisal, but we might not have valid data available to us before trial or finalizing an agreement. Add to this the fact that the party who plans to keep the home may no longer be able to afford to refinance a mortgage if the house is encumbered.
One option here is to fix a future date on which the parties will re-appraise the home, adjusting any buyout at that time. The parties may also agree to continue as co-owners, giving the “purchasing” party more time to refinance. Ultimately, as we know, the only way to know what real property is worth is to sell it on the open market and more parties may find themselves going down that path.
Investment Portfolios and Retirement Assets
With respect to investment portfolios and retirement accounts, now more than ever is the time to divide such assets in kind. Investment accounts are fluctuating in value from day to day and week to week, and in-kind divisions assure that both parties share in the risk of such fluctuations. Some investments may actually being doing better as some major companies are thriving as they try to meet the needs created by the COVID-19 crisis, but in general, the stock market is down significantly since the start of 2020. Risk sharing is the best solution here.
Special Provisions Regarding Retirement Accounts
Lawyer should be aware of the provision of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act which lifts the income tax penalty for early withdrawals from retirement accounts. Under this new rule, qualifying individuals may withdraw up to $100,000 from a retirement plan during 2020 without incurring the 10% tax penalty that usually applies to such withdrawals made prior to age 59 ½. In addition, the income tax on that withdrawal can be spread out over the next three tax years. An individual qualifies if the account holder, his or her spouse or dependent was diagnosed with COVID-19, or if the account holder has experienced adverse economic consequences as a result of COVID-19, such as a layoff, furlough, inability to work due to illness or lack or childcare, a reduction in work hours, or need to shutter a business due to COVID-19.
While this benefit may be appealing and helpful to some of our clients, the clients of course need to consider whether his or her spouse is entitled to share in those retirement assets as part of the division of property under the divorce, and how such withdrawal may impact that division. Additionally, some states issue automatic orders that go into place upon the commencement of a divorce action that might restrict one’s ability to make such a withdrawal without the consent of the other party. If both parties benefit from such a withdrawal, the deferred tax liability will need to be shared as well.
Perhaps the greatest area of uncertainty is around business interests. The impact of the global shut-down is widespread, with nearly every industry impacted in some way. But what does this mean for our cases? We may be confronted with clients who are insisting on an update to the valuation of his or her business, and we may be representing the non-titled spouse, who is opposed to revisiting such valuation.
As with real estate, there is no certainty about how well a re-valuation can capture the true value of a business on a going forward basis. This is particularly true now, as the future of the economy is uncertain, as is the future of each individual business, particularly as no one has a crystal ball and can predict the duration of the impact of this current financial crisis, and whether it will have short-term or long-term effects on the valuation of any particular asset or industry.
Certainly, a valuation cannot be fairly based on the business’s performance during the second quarter of 2020, as such time is an aberration for virtually every industry. Restaurants, salons, and much retail is closed; commercial real estate owners are not collecting rents consistently. Professional service providers such as lawyers, dentists, and non-essential medical providers are working at a fraction of what they once were. It may take a year or more for the economy to evolve to a “new-normal” that can be reliable for valuation services. Does a forensic account discount the results of 2020? Every business valuation already has some element of risk to the business factored in; should that risk factor be adjusted? Further complicating the aberration of 2020 are the resources available to business owners during this economic crisis, including the Federal Reserve Main Street Lending Program and the Paycheck Protection Program. Some business owners may be able to stay afloat thanks to these programs; and some non-titled spouses may later argue that the business owner should have taken advantage of such programs if the business suffers. Additionally, valuation experts will have to consider whether the loans will be forgiven or should stay on the business’s books as a liability.
Further complicating such business valuation issues is the uncertainty about a business’s long-term prospects. For example, a business that is struggling now, such as a bankruptcy law firm, may be thriving in a year. Some other business owners may be forced to close a business, such as a restaurant, under the current financial conditions, leaving no value for that asset in a divorce. But what happens if they open a new one in six months or a year? Does the non-titled spouse benefit at all from that new venture or the future increase in value?
We would have loved to use this space to give you answers, but we are all finding our way here. What we can be certain of is that there will be much litigation, and much negotiation, in the months and years to come around these issues.