A Connecticut appellate court recently delivered a resounding rebuke to a trial judge for “double-dipping” in a divorce case.
The court hearing the appeal in Oudheusden v. Oudheusden determined that the trial judge acted unfairly in dividing the couple’s assets and setting alimony, despite warnings from the lawyers for both sides regarding the risk of double-dipping.
According to the appellate decision, Mr. Oudheusden built two businesses during the couple’s decades-long marriage, and they represented his only sources of income. The trial judge awarded Mrs. Oudheusden $452,000, representing half the fair market value of the two businesses, as well as lifetime alimony of $18,000 per month.
In its decision, the appellate court stressed that the lump sum award and the stream of alimony payments were drawn from the same source.
“We agree with the defendant that, under the circumstances of this case, the court effectively deprived the defendant of his ability to pay the $18,000 monthly alimony award to the plaintiff by also distributing to the plaintiff 50 percent of the value of his businesses from which he derives his income,” the decision reads. “The general principle is that a court may not take an income producing asset into account in its property division and also award alimony based on that same income.”
Second bite of the apple
In divorce cases where the assets include a business, the value of the business and its profitability are key considerations in dividing the estate. In Oudheusden v. Oudheusden, the judge sided with the wife’s valuation expert in determining that the businesses were worth a total of $904,000, and that the husband’s annual gross income from them was $550,000.
Under the income approach to valuing a closely held business, the valuation is derived by calculating the present value of future benefits (often cash flow or some variant thereof) that the business is expected to generate. First, the business’s operating results are adjusted, or normalized, for nonrecurring or unrealistic items. In many small, closely held businesses, it is not unusual for the amount of compensation the business pays to its owner-operator to be motivated by tax considerations. In such a case, a business appraiser should normalize the owner’s compensation to reflect a fair market salary for the owner’s job duties. This formalizes the distinction between the reasonable compensation for the owner’s efforts and the business’s return on investment after deducting that compensation.
Next, a multiple of the normalized earnings is calculated based on the perceived risk to the company’s future performance and the expected growth rate of its earnings. The result of that calculation represents the present value of the future benefits to be generated by the business.
When a couple gets divorced, a judge who awards the nonowner spouse half the value of the family business has in essence given that spouse half of the future benefits to be generated by the business, discounted into today’s dollars. Awarding alimony based on a percentage of the same future benefits to be generated by the business would be taking a second bite from the apple, since that stream of benefits has already been divided.
Mrs. Oudheusden’s attorney explained the concept nicely in his closing statement, when he warned the judge of the perils of double-counting a single stream of income:
“Whatever value the court attributes to the business, the court has to, and should back out a reasonable salary for the officer and owner of the company. Because if the court is going to set a support order based on his income, it would not be fair and equitable to also ask that he pay an equitable distribution based on that as well,” he said. “That would be double-dipping.”
After the trial court issued its decision, Mr. Oudheusden filed a post-judgment motion for clarification, asking if the judge considered $550,000 to be his income from his businesses, or his earning capacity if employed elsewhere. The judge responded that the figure was not a measurement of earning capacity, but rather of income from the two businesses.
The appeals court found that the trial judge “failed to take into account that the defendant’s annual gross income was included in the fair market value of his businesses.”
The appeals court also took issue with the trial court’s award of non-modifiable, lifetime alimony, because it barred Mr. Oudheusden from seeking a modification if he became ill or decided to retire, or if his businesses saw a reduction in their earning capacity. But that is a topic for another day.
The appeals court reversed the trial judge’s financial orders in their entirety and returned the case for a new trial on those issues.
The doctrine against double-dipping is largely settled law in many states, including New York, where a substantial body of case law has refined its application to various scenarios, such as the acquisition by one spouse of a professional license during the marriage. Notable cases include McSparrow v. McSparrow (Court of Appeals, 1995) and Grunfeld v. Grunfeld (Court of Appeals, 2000). That said, attorneys and valuation professionals who work in the matrimonial arena should be aware of the potential for a poorly executed valuation, or a misguided judge, to tilt the scales of justice.
Advent Valuation Advisors has a wealth of experience and a variety of research tools and resources at its disposal to help determine the value of a business and a reasonable salary for its owner-operator. For more information, contact Advent at firstname.lastname@example.org.
Read the appellate decision in Oudheusden v. Oudheusden here: jud.ct.gov/oudheusen-v-oudheusen.pdf