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In Wechsler v Wechsler, --- N.Y.S.2d ----, 2008
WL 4635832 (N.Y.A.D. 1 Dept.) the issue of first impression was the
extent to which the value of a holding company, Wechsler & Co., Inc. (WCI),
a Subchapter C corporation, all the shares of which were owned by the
husband, should be reduced to reflect the federal and state taxes
embedded in the securities it owned. These securities constituted
virtually all of its assets, due to the unrealized appreciation of those
securities. As of the date the divorce action was commenced, the
valuation date, WCI had ceased trading securities for the accounts of
customers and bought and sold securities solely for its own account. All
of the experts who testified agreed that WCI should be valued on a net
asset basis by determining what a willing buyer would pay a willing
seller, with neither being under a compulsion to buy or sell, and with
both having reasonable knowledge of the relevant facts.
The Appellate Division, in an opinion by
Justice James M. McGuire, modified the judgment appealed from by the
husband. It noted that Supreme Court adopted a "baseline" value of
$70,848,107 on the date the action was commenced. That baseline value
was determined by the neutral expert before any deduction for embedded
taxes and then made adjustments to it that differed in various ways from
the adjustments made by the neutral expert. The most significant
adjustment was on the issue of the extent of the reduction for embedded
taxes. Supreme Court rejected the approach of the Fifth Circuit in
Matter of Dunn v Commissioner of Internal Revenue (301 F3d 339 [5th
Cir2002] ), the approach embraced by the neutral expert. Pursuant to
that approach, consistent with the assumption inherent in the net asset
valuation methodology, an actual sale of the corporation's assets is
assumed to occur on the valuation date. The value of the corporation is
reduced on a dollar-for-dollar basis by the full amount of the tax
liability that would arise from the sale of the assets by the
hypothetical buyer on the valuation date. Both the neutral expert and
the husband's expert testified, and the wife's expert did not dispute,
that if the securities were sold as of the date of commencement, the
effective tax rate would be 41.74% of the baseline value of $70,848,107.
Under the valuation methodology adopted in Dunn, the
date-of-commencement value of WCI would be reduced by $29,572,000
(41.74% of $70,848,107). Instead, Supreme Court accepted the approach of
the wife's expert and reduced the baseline value of WCI by 11% of
$70,848,107 ($7,793,292). That percentage approximated what Supreme
Court and the wife's expert denominated the "historical" rate of the
annual taxes paid by WCI, a rate determined by comparing the average
annual taxes paid by WCI to its average annual gross revenue, i.e., its
revenue before all applicable deductions for its various costs of doing
business (including the salaries of its employees). The Court indicated
that Supreme Court relied in significant part on the decision of the Tax
Court in Matter of Jelke v. Commissioner of Internal Revenue (TC Memo
2005-131 [2005] ), a decision that was reversed by a divided panel of
the Eleventh Circuit after the appeal was argued (507 F3d 1317 [2007] ).
In Jelke, the Eleventh Circuit adopted the approach of the Fifth Circuit
in Dunn and concluded that, on the assumption that a sale of the
corporation's assets occurs on the valuation date, the value of the
corporation's assets should be reduced by the full amount of the
embedded taxes that would be payable as a result of the sale. At trial,
Supreme Court was asked to choose between the approach of the Fifth
Circuit and an approach different from the one advanced by the
Commissioner in Jelke. The latter approach, the one Supreme Court
adopted, did not attempt to ascertain the period of time over which the
assets of a corporation would be sold by a reasonable buyer and discount
the taxes that would be due over that period to present value as of the
date of commencement. Rather, it adopts a baseline value of the assets
as of the commencement date and reduces that value by an "historical"
tax rate of the corporation.
Both the neutral expert and the husband's
expert vehemently disagreed with the "historical" approach espoused by
the wife's expert. The Appellate Division pointed out that the wife
offered nothing by way of precedent to support her expert's position.
The Appellate Division rejected the approach of
the wife's expert because it did not accord with common sense,
conflicted with the reasoned testimony of both the neutral expert and
the husband's expert and was without precedential support. The approach
of the wife's expert assumed that the assets will not be sold as of the
valuation date and that WCI would operate in the future as it had in the
past so that each year it both would sell assets to the same extent it
annually had sold assets in the past and would be able to offset income
generated by the sale of assets with the same deductions for salaries
and other expenses that it had been able to take in prior years. The
assumption that WCI would continue to be able to take the same
deductions for salaries was at least brought into question by
proceedings in Tax Court that were pending as of the trial. Furthermore,
the assumption that WCI would sell assets in the future to the same
extent that it had sold assets in the past was even more questionable.
Moreover, by also assuming that the securities owned by WCI will not
depreciate in value over time, the approach of the wife's expert
required the husband to bear all the risk of a decline in their value.
The Appellate Division held that as between the
competing methodologies advanced by the parties at trial Supreme Court
should have adopted the one accepted by the Fifth Circuit in Dunn. It
concluded that Supreme Court overvalued WCI by $21,778,708 (the
difference between the $7,793,292 reduction in value based on the
"historical" tax rate methodology and the $29,572,000 reduction that
would result under the methodology adopted in Dunn ). This amount
differed from the "baseline" value of $70,848,107 because of other
valuation adjustments made by Supreme Court. The husband did not dispute
all of these adjustments and the discrepancy between the two "baseline"
values was of no moment.] That amount should be subtracted from the
total value of WCI at the time of the commencement of the action found
by Supreme Court ($74,387,630), leaving a total value of $52,608,922.
The Court pointed out that shortly after oral
argument, the wife moved to dismiss the appeal on the ground that the
husband was a fugitive from this jurisdiction and barred from
maintaining the appeal under the fugitive disentitlement doctrine. By an
order dated November 27, 2007, it granted the wife's motion and
dismissed the appeal with leave to the husband to move to reinstate the
appeal on the condition that, within a certain time frame, he post an
undertaking of approximately $10 million (45 AD3d 470 [2007] ). The
husband posted the undertaking and moved to reinstate the appeal.
The Appellate Division affirmed that part of
the judgment of Supreme Court which declined to award permanent
maintenance in part because the wife would be "vastly wealthy in her own
right." The wife did not perfect her cross appeal, so there was no
occasion to decide whether a permanent maintenance award would be
appropriate in light of the reduction of the distributive award. The
Court noted that Supreme Court awarded the wife over $27 million in
assets, reflecting approximately 88% of the other marital assets.
On appeal, the husband argued that, consistent
with the approach adopted in Dunn, pursuant to which the hypothetical
buyer is assumed to liquidate the assets of the corporation upon
acquiring it, an additional reduction in value is warranted to account
for the non-tax costs of liquidating the corporation that the buyer
would incur. The husband's expert computed those costs by assuming that
WCI's assets would be liquidated over a six-month period after the
valuation date (the date the action was commenced), an assumption that
results in higher non-tax liquidation costs than would be incurred if
the assets were liquidated on the date of commencement. Although the
parties did not discuss the issue, the assumption by the husband's
expert of a six-month liquidation period is not consistent with the
assumption, for purposes of determining the extent of the reduction for
embedded taxes, that the corporation's assets are liquidated on the
valuation date. Supreme Court held that no such reduction in the value
of WCI was appropriate. Supreme Court did not make any specific findings
on what the non-tax liquidation costs of WCI would be. Determining
whether and the extent to which a reduction in value for non-tax
liquidation costs is warranted was complicated further by the parties'
contentions about those costs. The Court pointed out that there were
other complications that the parties did not discuss. The Court
concluded that the value of WCI should not be reduced by any non-tax
liquidation costs. It had no rational basis in the record for
determining what the amount of the non-tax liquidation costs are,
assuming it were to hold that the value of WCI should be reduced by some
such costs. It also believed that the amount of any of the costs it
might recognize was small relative to the overall value of the marital
property and might not exceed the costs of additional briefing and the
possible fact-finding proceeding. It added that its resolution of this
issue sets no precedent on the question of whether or the extent to
which a reduction in value for non-tax liquidation costs is appropriate
in other circumstances.
The Appellate Division held that Supreme Court
erred in concluding that the husband’s right pursuant to a subscription
agreement to purchase additional shares of the common stock of WCI's
predecessor entity at a price of $4,900 per share, a right that when
exercised entitled him to 12 additional shares of preferred stock for
each share of common stock, was not his separate property. The
subscription agreement was entered into prior to the marriage and, as
amended prior to the marriage, entitled the husband to purchase 10
additional shares of common stock and thereby acquire 120 shares of
preferred. Prior to the marriage, the husband purchased pursuant to the
subscription agreement 2.65 shares of the common stock, thereby also
acquiring 31.8 shares of preferred. Supreme Court concluded, and the
wife did not contend otherwise, that these shares and fractional shares
constitute separate property of the husband. The remaining 7.35 shares
of common
stock, and the attendant 88.2 shares of
preferred, were paid for and acquired during the marriage. Because
marital property is defined to include "all property acquired by either
or both spouses during the marriage" (Domestic Relations Law
236[B][1][c] ), Supreme Court concluded that these shares were marital
property. The flaw in Supreme Court's reasoning was that it did not
recognize that, especially given the broad meaning of the term property
in the Domestic Relations Law the husband's right to acquire the 7.35
shares of common stock and 88.2 shares of preferred was itself property
that he acquired before the marriage. The husband's right to acquire the
shares was tantamount to an "in-the-money option" as the purchase price
of the shares was far below their fair market value. Thus, he was
entitled to a credit in the amount of the value as of the date of the
marriage of his right to acquire the additional shares of stock pursuant
to the subscription agreement.
The value of the 7.35 shares of common stock
and the 88.2 shares of preferred, assuming the right was exercised as of
the date of marriage, was approximately $232,800. Consistent with the
approach of the neutral expert and the husband's expert in valuing the
husband's right as of the date of the marriage to acquire the shares
pursuant to the subscription agreement, the value of that right was
approximately $196,800 ($232,800 minus the approximately $36,000
purchase price of the 7.35 shares of common stock).
The Appellate Division noted that, in part,
because of its conclusion that the wife would be "vastly wealthy in her
own right" as a result of the equal distribution of the marital assets,
Supreme Court denied the wife's request for permanent maintenance.
However, Supreme Court awarded conditional, durational maintenance to
the wife, with the husband being obligated both to make monthly payments
of $46,666 to the wife, a portion of which was deductible by the
husband, and to pay various expenses, including the mortgage payments
and taxes relating to the home awarded to the wife. Pursuant to the
terms of the judgment, this maintenance award continues until the wife
receives both the specific assets awarded to her and the first payment
on account of the distributive award. Relying on it decisions in Gad v.
Gad (283 A.D.2d 200 [2001] ) and Pickard v. Pickard (33 AD3d 2002
[2006], appeal dismissed 7 NY3d 897 [2006] ), the husband argued that
because Supreme Court did not make a permanent maintenance award he was
entitled to a credit against the distributive award in the amount of all
the temporary maintenance payments he made. The husband contended that
he paid a total of $3,000,987 in temporary maintenance.
The Appellate Division held that the husband's
reliance on Gad and Pickering was misplaced and that he was not entitled
to any credit for the temporary maintenance payments he made, regardless
of the amount of those payments. The mere determination by Supreme Court
not to award permanent maintenance cannot be equated with a finding that
the pendente lite maintenance award was excessive. Supreme Court did not
make such a finding either expressly or implicitly. The determination
not to award permanent maintenance was based in part on the ground that
permanent maintenance was unnecessary given the wife's vastly different
economic circumstances as a result of the equal distribution of the
marital property. In addition, Supreme Court also based this
determination on the consequences of the distribution of the
overwhelming preponderance of the liquid marital assets to the wife. As
a result, a permanent maintenance award would have required the husband
to tap into the income generated by WCI or liquidate securities it owned
even though he was awarded this asset. Accordingly, Supreme Court
cogently observed that an award of permanent maintenance would entail an
element of "double dipping" by the wife into the principal asset awarded
to the husband.
The Appellate Division found that the
date-of-commencement value of the marital interest in WCI was
$47,131,777.95--$52,608,922 minus the sum of the adjusted, after-tax
value of the proceeds of the securities sold prior to the commencement
date ($155,691.18), the value of the husband's property interest in WCI
as of the date of the marriage ($646,271), the value of the husband's
subscription right ($196,800), the value of the common and preferred
stock he inherited from his father ($3,523,904.80) and the amount of the
increase in value of the husband's equity interest at the time of the
inheritance stemming from the controlling interest in the corporation
acquired as a result of the inheritance ($954,477.07).
Supreme Court valued at $30,548,556. the other
marital assets, including securities (virtually all of which were in the
husband's name), cash accounts, a home and an apartment. After
considering the statutory factors Supreme Court determined that the
parties should share equally in all of the marital assets. Given its
conclusion that the husband should retain his ownership of WCI, Supreme
Court was constrained to award to the wife approximately 88% of the
other marital assets, collectively valued at $27,135,154. The husband
was awarded his Colorado residence (valued at $1.95 million) and, to
provide him with "some liquid cash assets," certain securities Supreme
Court had valued at $1,463,422. The result of these discrete awards was
a deficiency in the wife's share of the assets of $22,770,623
($49,905,776, one half of the total value of $99,811,533 that Supreme
Court assigned to the marital assets, minus $27,135,154, the value of
the specific marital assets awarded to the wife). Accordingly, Supreme
Court granted a distributive award to the wife in the amount of the
deficiency, and directed that the husband pay the award over a period of
15 years, with annual payments of $1,518,042 payable in quarterly
installments of $379,510.50. Supreme Court did not grant pre-judgment or
post-judgment interest on the distributive award to the wife, but ruled
that interest would accrue in the event and to the extent of a default
in any of the required payments.
The Appellate Division held that husband's
argument that the securities of WCI (and thus WCI itself) and the other
securities he owned or controlled should have been valued as of the date
of trial was without merit. While some "courts have concluded that
'active' assets should be valued only as of the date of the commencement
of the action, while the valuation date for 'passive' assets may be
determined more flexibly," these "formulations" are but "helpful
guideposts" and not "immutable rules of law" (McSparron v. McSparron, 87
N.Y.2d 275, 287-288 [1995] ). Thus, although securities commonly are
"passive assets" that are valued at the date of trial as they may
"change in value suddenly based on market fluctuations" (Grunfeld v.
Grunfeld, 94 N.Y.2d 696, 707 [2000] ), they may be active assets when,
as here, they are actively managed by the titled spouse. The securities
owned by WCI and by the husband required his "specialized knowledge in
order to be appropriately invested," Supreme Court stressed that: "The
parties, by their actions throughout prior proceedings herein, charted a
course of litigation that accepted a [date of commencement] valuation of
WCI ... When this trial began defendant agreed, by words and deeds, that
the court should utilize a [date-of-commencement] valuation. Thus, when,
during discovery, [the wife] demanded up to date financial information
about WCI, defendant refused to produce such information arguing that it
was irrelevant to a [date-of-commencement] valuation."
The Appellate Division declined to disturb
Supreme Court's allocation of the marital assets other than the marital
component of WCI. Accordingly, it held that a distributive award of
$11,705,013 ($38,840,167 minus $27,135,154) was necessary to effectuate
the equal division of the marital property. In accordance with the
payment terms fixed by Supreme Court, the $11,705,013 distributive award
was payable over a period of 15 years, with quarterly payments of
$195,083.55.
The Appellate Division noted that a problem
arose because the written decision and order direct that the husband
transfer to the wife all of the securities owned or controlled by the
husband (other than those owned by WCI) and listed in the decision and
order along with their date-of-commencement market value. The decision
expressly noted that by crediting against the distributive award the
full value of the securities as of the date of commencement, "the risks
of gains and/or losses since the valuation date [were passed] over to
[the wife]." Even assuming that there was some ambiguity in the relevant
terms of the judgment on this score, the decision controls (Madison III
Assoc. Ltd. Partnership v. Brock, 258 A.D.2d 355 [1999] ). With respect
to any of the securities the husband sold while he was free to do so
after the wife's motion for an injunction was denied, the husband argued
that he was required to provide the wife with "the proceeds of
re-investment less the costs of the sale, taxes and reinvestment." The
wife argued that the husband was required to transfer to her the assets
acquired with the sale proceeds. The dispute reduces to whether the
husband is entitled to a credit against the distributive award in the
amount of the costs he incurred, including taxes he paid, in selling and
reinvesting the securities sold. The Appellate Division held that it
would be inequitable not to grant the husband such a credit given that
he was free to sell the securities during the pendency of the action.
Accordingly, it directed a hearing to determine which securities the
husband sold, what he did with the proceeds, what costs he incurred and
the amount of the resulting credit to which he may be entitled.
The judgment of Supreme Court was modified
by(1) reducing the base line value of WCI by $29,572,000 pursuant to the
approach of the neutral expert and the husband's expert, (2) determining
that the husband's right pursuant to a subscription agreement to
purchase additional shares of stock in WCI's predecessor was his
separate property and reducing the base line value of WCI by the value
of that right, $196,800, (3) reducing by $211,403.71 the after-tax value
of the proceeds of the securities sold prior to the commencement date of
the action but not settled until after that date, (4) determining that
the marital interest in WCI was $47,131,777.95, (5) determining that the
value of the marital estate was $77,680,333.95, (6) directing the
husband to pay the wife a distributive award of $11,705,013, payable in
quarterly installments of $195,083.55, and (7) determining that the
wife's share of the tax liability of WCI was 44.8%, and otherwise
affirmed.
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