In-kind Distribution of Stock Disfavored by Divorce Court
A decision announced recently by the Supreme Court of Rhode Island, McCulloch v. McCulloch, 69 A.3d 810, illustrates why buyouts are generally favored over in-kind distributions of stock when dividing the value of family businesses in equitable distribution proceedings. The trial court in McCulloch, faced with uncertain valuations of the businesses from both sides and a court-appointed expert, elected to award 25% of the stock to Wife and 75% to Husband, without determining the values of the businesses. The Supreme Court reversed, holding:
[T]here was an abuse of discretion when the trial justice declined to value Microfibres and MPL before assigning them. This is so, in part, because those assets constitute such an enormous portion of the marital estate. . . . More importantly, the trial justice’s decision not to place a value on the specific portions of Microfibres and MPL that he assigned to the parties also constituted an abuse of discretion, because he assigned the parties unequal percentages, thereby rendering Hope a minority shareholder of a closely held corporation. . . . [A] n assignment of stock in a closely held corporation, which makes one spouse a minority shareholder, is generally disfavored and should be avoided whenever possible. See Robbins v. Robbins, 549 So. 2d 1033, 1033-34 (Fla. Dist. Ct. App. 1989) (“Such a financial arrangement is intolerable, * * * and places the spouse without any real control over the closely held corporation at a distinct disadvantage to the spouse who runs the business.”); Josephson v. Josephson, 115 Idaho 1142, 772 P.2d 1236, 1243 (Idaho Ct. App. 1989) (holding that a distribution of “stock in a closely held corporation, with majority control in one spouse and with virtually no public market for the stock * * * does little to completely separate the parties and their property”); Savage v. Savage, 658 P.2d 1201, 1205 (Utah 1983) (“[W]henever possible, continued joint ownership by divorced spouses of closely held corporate stock should be avoided * * *.”); see also Stephen W. Schlissel, The Hazards of “In-Kind” Distributions of Closely-Held Stock in Divorce Actions, 17 J. Am. Acad. Matrim. Law. 381 (2001).
Ironically, Rhode Island is one of the “fair value” jurisdictions that (unlike Pennsylvania) does not apply valuation discounts when assessing the “fair market value” of a business in equitable distribution proceedings. In this case, the Supreme Court instructed the trial court on remand to apply valuation discounts for lack of marketability and lack of control, but only if the trial court were measuring the value of the stock to be assigned to each party. If, on the other hand, the trial court were to award cash to the non-owner spouse as compensation for her interest, no discounts would be applied.
No compelling rationale is provided by the Rhode Island court why a spouse who is compensated in cash or property for his or her interest in a business should receive more (fair value, without discounts) than he or she would receive if the stock were distributed in kind (fair market value, after discounts). In fact, the opposite is probably fairer. If a spouse received stock in a divorce, and tried to sell it, that spouse would actually incur the expenses of sale, such as a broker’s commission, taxes and other selling expenses. The selling spouse might have to accept less than fair value if he or she owned a minority interest, because buyers might not pay a premium for the prerogatives of control. Therefore, the in-kind distribution should be valued at gross value, without discounts, and the cash-out distribution should be valued at fair market value.