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Buy-Out Provisions Can Cause Higher Valuation

January 12, 2011

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When drafting buy-out provisions in a closely held business, you should anticipate that they will be used for other purposes. Here’s one divorce case where such a provision resulted in a valuation that was higher than the husband desired.

How Business Agreements: Can Figure into a Divorce

The buy-out provisions in a partnership or membership agreement are designed to maintain control of the firm and help partners cash out their interests. However, those same provisions can be used in ways that you may not have anticipated.

For example, the provisions of one law firm’s membership agreement were used to justify a substantially higher valuation in a marital dissolution. Here are the details of the case.

As a member of his law firm, attorney Irvin D. Gordon was entitled to receive a “ceased member” interest upon his death or resignation. The amount was determined using a computation stated in the firm’s membership agreement.

The agreement also stipulated that interests in the firm could not be sold to anyone other than the firm.

For purposes of his divorce from Priscilla M. Gordon, Irvin Gordon’s expert estimated the fair market value of his interest to be $25,438. This value was based on a sale, to a hypothetical third party, of Irvin Gordon’s right to receive his ceased member interest when he expected to retire in 2013. The expected future payments for his interest were discounted to their present value.

Priscilla Gordon’s expert valued the interest at between $166,339 and $184,977 but assumed that Mr. Gordon were to retire today. Both experts used the computations contained in the agreement.

The court affirmed that there was no need to look for a hypothetical buyer when the firm was required to buy Mr. Gordon’s interest at a price determined by the membership agreement. The attorney could retire now if he chose to do so. Penalties for withdrawing to compete against the firm were not applicable in this case because those circumstances were speculative.

The court held that the husband’s interest could be valued as if it were sold today. The fact that an actual sale was not contemplated was irrelevant. The court believed “such a valuation was more reasonable than one based on a hypothetical sale that…could not take place”. It also found a valuation based on a current sale was more equitable than one “severely discounted to reflect future uncertainties…which…are predicated upon the husband’s sole election not to retire at the present time.” (Gordon v. Gordon, New Hampshire Supreme Court, No. 2001-047, 2002).

Important: When drafting buy-out provisions, anticipate that they will be used for other purposes. They may be cited as evidence of higher value in estates, marital dissolutions or other situations where lower values are desired.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.

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