The valuation of a company in divorce proceedings is often a contentious, but important, issue in the distribution of assets. Where a company reflects a significant portion of the parties’ assets, the valuation of the company can make a material difference to how much a party receives.
In LKW v DD [2010] HKCFA 70 Mr Justice Ribeiro PJ set out the four step approach in distributing assets in a fair manner in ancillary relief proceedings. The first step is the identification of the parties’ assets, namely the income, earning capacity, property and other financial resources which each of the parties has or is likely to have in the foreseeable future. Identifying the company or companies owned by the parties and ascertaining how much a party’s interest in a company is worth will be part of this exercise.
This article considers whether a valuation of an interest in a company is useful, and if so, what are the factors parties and their advisors should consider when seeking a valuation, and relying on it, in ancillary relief proceedings.
Is a valuation necessary or useful?
The first consideration is whether a valuation in respect of this particular interest in a company is necessary or useful.
The difficulty is that often that company is not a realizable asset, particularly a small company, or a family business, or one where a party is a “key man”. Valuations of the same company can differ widely. A valuation at a certain date is a “snapshot”. A valuation does not equate to cash that is available.
Careful consideration needs to be given as to whether a valuation should be obtained, particularly given the expense and utility of company valuations.
Is the value of the company in its shares or the generation of income?
When considering whether a valuation should be sought, the parties need to consider what it is they are seeking and how a valuation will assist. As is often the case, the value of a small company is in its ability to produce an income and the family relies on this income. If in ancillary relief proceedings, the interest in the company is sold, then what?
In some cases, the Court may take the view that the company’s value is in its ability to produce an income.
For example, in N v N [2001] 2 FLR Coleridge J said in respect of White v White and the starting point of broad equality in outcome for each party, “I am sure the House of Lords did not intend the courts to exercise their far-reaching powers to achieve equality on paper if in doing so they, Samson-like, brought down or crippled the whole family’s financial edifice to the ultimate detriment of the children”.
Coleridge J went on to say that the husband was the senior partner of a highly successful group of accountants with an increasing turnover in the order of £7m and “that represents, in my judgment, an asset which will go on producing a very secure income, quite apart from any actual earning capacity attaching to the husband, per se, as an accountant”.
In a similar vein, in TL v SN (Ancillary Relief) [2010] HKFLR 506 the Court of Appeal noted that Melloy J had queried the usefulness of the valuation reports obtained by the parties, “at considerable time and expense” given the company was “the goose that laid the golden egg in the form of income and benefits for the family, there being no ready market for the shares, and as even competent valuers might reach widely different valuations using similar methods”. Melloy J had excluded the value of the husband’s interest in the company in the division of the assets as it could not be sold and taken into account as a resource out of which capital provision could be reasonably made.
How reliable is the valuation?
The usefulness of a valuation in divorce proceedings may depend on how reliable it is. There are some companies which are in an active market with a number of comparables, and there are other companies where it is impossible to value a company with any precision. In H v H [2008] 2 FLR 2092 Moylan J said that “the experts agree that the exercise they are engaged in is an art and not a science”
The reliability of the valuation will impact on the weight the valuation should be given.
In Martin v Martin [2018] EWCA Civ 2866 at paragraph 36 the Court of Appeal pointed to the expert’s valuation changing from £130 million to £227 million in just a year, and stated that this showed that careful consideration needed to be given to the weight which could be placed on the valuation. At paragraph 92 the Court of Appeal stated that “valuations of private companies can be fragile and need to be treated with caution”. It went on to say “even when the court is able to fix a value this does not mean that that value has the same weight as the value of other assets such as, say, the matrimonial home. The Court has to assess the weight … both to the amount and to the structure of the award…the overall allocation of the parties’ assets by application of the sharing principle also effects a fair balance of risk and illiquidity.”
In HO v TL [2023] EWFC 215 Peel J at paragraph 23 set out a number of factors which determine the reliability of a valuation:
- applicable comparables
- how niche the business is
- whether the business is valued on a net asset basis or a recognized income approach
- the extent of the party’s interest and control
- third party interests
- shareholder agreements
- volatility of figures
- reliability of forecasts and
- whether assumptions underpinning the valuation are seriously in dispute.
The treatment of an interest in a company in the equitable distribution of assets
In distributing the assets on divorce, the Court must have regard to both the fairness in the division of assets, including between the copper-bottomed assets and the illiquid and risk laden assets. The dollar valuation of a company will therefore not be the end of the story; its riskiness or illiquidity may also be taken into account in the division and may result in a discount or a company interest being divided in specie.
In WM v HM [2017] EWFC 25 Mostyn J stated that “a valuation of an asset is the estimate of what it will sell for now. If it is perceived as being hard to realise then its value will be discounted to reflect that difficulty. It does seem to me to use discounted figures and then to move away from equality is to take into account realization difficulties twice. Whatever the asset the only difference between it and its cash proceeds is, as Thorpe LJ once memorably said, the sound of the auctioneer’s hammer.”
The Court of Appeal disagreed and held that different assets have different levels of risks, as identified in Wells v Wells which stated that “sharing is achieved by a fair division of both the copper-bottomed assets and the illiquid and risk laden assets”.
The Court of Appeal stated that “the idea of comparing like with like” was stated in White v White, and “the difference in quality between a value of a private company based on opinion evidence and a sum in hard cash” had been stated in Versteegh v Versteegh [2018] EWCA Civ 1050.
If there cannot be a balance in the division between the copper-bottom assets and the illiquid and risk laden assets, then the Court must carefully consider whether there can be a clean break.
Is the goose going to market?
Peel J in HO v TL made the point that in practice there are three choices for the Court to make i) to fix a value (a task for the Court, not the expert) ii) order the asset be sold and iii) divide the asset in specie. Deciding the approach to take and how it should be implemented can give rise to difficult economic and practical questions.
If the Court fixes a value, not only must the Court consider the fairness in the division of copper-bottom and risk laden assets, but it must also consider liquidity and one party’s ability to pay the other. A company is a going concern and will need capital in order to continue to operate.
In Martin v Martin [2018] the Court of Appeal stated when ordering that one party pay another, liquidity is a complex issue of considerable importance which requires specific analysis and determination. The Court of Appeal referred to P v P [2005] 1 FLR 548 where Baron J stated that what sums can be withdrawn from the business is a “vital piece of work”.
In TN v SN the Court of Appeal upheld Melloy J’s decision to allow the husband to retain capital in his bank account, rather than provide the wife with half of this capital, so that he could pledge this to continue to operate the company without interference or undue burden. The Court said the wife could benefit indirectly by receiving periodical payments.
Final considerations
It is important that parties and their advisors carefully consider what it is they say about how a company interest should be dealt with in divorce proceedings, and whether seeking a valuation will assist. Valuation reports are expensive, and even where there is a valuation the Court will ultimately decide how much weight to attribute to it, and how the interest in the company should be dealt with to ensure a fair and equitable division of the assets.
The article was originally published on Hong Kong Lawyer
