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Unhappiness In Its Own Way: How Family Court Approaches Valuation of Matrimonial Assets
Date: 13/03/2024 Type: Articles Topic: Private Client | Trusts | Wills and Estates | Inheritance | Next Generation Wealth | Investment and HNWI’s | Tax |Leo Tolstoy begins his novel Anna Karenina with this famous line: “Happy families are all alike; every unhappy family is unhappy in its own way.”
When a marital relationship turns sour and a divorce is sought, sometimes what is left to be resolved might unfortunately just be the value and division of the matrimonial assets owned by the parties, which often involves shares in private companies, cryptocurrency and investment properties. The value of these assets is then estimated using commonly adopted valuation approaches, and yet often the party-appointed experts arrive at values with a substantial gap between them, leaving the court to assess and finally determine their value.
Similar to what Tolstoy said, every divorce proceeding is also different in its own way in the sense that the matters to be resolved and key battlegrounds between the party-appointed experts will differ from case to case.
In this article, we focus on some of the issues faced when valuing private companies which, in our experience, can be particularly difficult, as noted from recent family court proceedings and the resulting judgments.
1. Fairness: present day or hindsight approach
When asked to perform a valuation of an equity interest in a private company as of a historical date, a valuation expert would generally use all the information concerning the future growth and risk profile of the company that would have been known or knowable as of the valuation date, without considering the subsequent events. This is referred to as the “present day” approach in GA v. EL [2023] EWFC 187. However, depending on the circumstances, this may not be perceived to give the desired outcome if events after the valuation date clearly diverge from the contemporaneous expectations for the business.
Consider, for example, if the actual performance of the business was significantly below the forecast performance as of the valuation date, due to the negative impact of inflationary pressures or geo-political crises. In these circumstances, a hindsight approach utilizing the information from subsequent events may be preferred.
In E v. L [2021] EWFC60, Mr Justice Mostyn J expressed disapproval of the present day approach:
“I regard it as unreal, and a likely source of real injustice, for calculations to be undertaken to work out the scale of acquest (and thence the wife's award), on historic figures which with hindsight are shown to be completely wrong. It is not consistent with ‘a broad analysis of fairness.’” (emphasis added)
By contrast, if the deteriorating business performance was a result of the actions of the party who remains in control of the company, a present day approach might be more preferred.
Valuation is time-specific as of a particular date because business and market conditions are likely to change after a particular point in time. The value of a business could therefore vary significantly at a different date.
2. Arbitrariness: court discount vs. accountancy discount
Another issue that can arise in situations where the valuation concerns a minority shareholding or an equity interest in a relatively illiquid market, is whether a discount for lack of control or lack of marketability might be warranted. These discounts were referred to as an “accountancy discount” in HO v. TL [2023] EWFC 215.
The court will usually need to decide whether a discount should be applied in light of the risk or illiquidity in a private company if a party is to be awarded with an illiquid business interest (and retain the risks involved) and the other party is to be awarded with liquid cash. In HO v. TL, Mr Justice Peel noted:
“The court might, in the right case, take both the valuation, which includes an accountancy discount, and apply a further court discount …. Moylan LJ in Martin (supra) at para 94 considered that this would not be double counting: “… this is not … to take realisation difficulties into account twice.” It will all depend on the case. If, for example, the accountancy valuation includes a discount for a minority holding, but it is clear that there is no possibility of realisation of interest in the future by sale or otherwise, it seems to me that it would not be unfair to further take that factor into account when allocating assets.” (emphasis added)
3. Evasiveness: hidden assets
The parties are required to disclose fully the assets owned by them for the court’s division of the assets. Where one party suspects the other has hidden assets, a forensic expert might be engaged to perform asset tracing and forensic exercises for the whereabouts of the assets.
In NG v. SG (Appeal: Non-Disclosure) [2011] EWHC 3270, Mr Justice Mostyn J commented:
“… The court is duty bound to consider the process of drawing adverse inferences whether funds have been hidden ….”
A forensic expert can also reconstruct the true financial position of the company or investigate allegations on business activities being diverted to another controlled company by a party in an attempt to result in a lower equity value of the shares owned by the party.
Happiness ever after
A robust expert valuation requires a detailed assessment of the nature and characteristics of the company and the equity interest being valued, the implications from the operating and market circumstances prevailing as of the valuation date and subsequent events, if any, as well as the liquidity of the market. An expert should be able to defend their valuation when challenged by an opposing expert, by explaining and supporting the basis of their valuation in simple language to the court and the legal counsels.
Given some of the complexities illustrated above, the use of valuation experts should be among the first steps when contemplating divorce proceedings to provide a preliminary assessment and to set the client’s expectations in relation to the value of the matrimonial assets in scope.
Valuation experts can also assist during the document disclosure phase by identifying key documents which would help reveal the true value of the matrimonial assets and also identify any potential red flags, which may indicate that forensic investigation input is required to locate hidden assets. A single joint expert or party-appointed experts should be engaged for their valuation expertise but also for their experience in handling family court valuations and their understanding of the complexity, delicacy and fragility of such exercises.
The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.
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Zachary Chang & Raymond Man - Ernst & Young LLP
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