Harvey v. Harvey

This was an appeal and across-appeal in a California divorce case. Michael and Cynthia Harvey were married in 1988. Three years later, Michael formed Enviro Tech ChemicalServices Inc. (Enviro Tech). By 2010, Harvey’s jointly owned 825 shares of EnviroTech, representing nearly 70% of the outstanding stock. In 2011, they entered into a shareholder buy-sell agreement (agreement), including provisions regarding marital dissolution. After the separation in 2011, Michael purchased additional shares from other shareholders

In the final judgment in 2018, the trial court concluded that the fair market value (FMV)of the one-half interest in the jointly owned shares was $21,332,000; awarded all of the shares to Michael, and ordered Michael to pay Cynthia $21,332,000 either in cash or ina seven-year promissory note. The trial court also determined that there was no impairment to her community estate from any breach of fiduciary duty by Michael.

On appeal, Michael contended the trial court erred by disregarding the agreement terms of payment in a buyout by imposing much more burdensome terms of payment. On cross-appeal, Cynthia contended the trial court erred in applying two discounts to the valuation of her interest in the shares: one for possible future taxes that were not immediate and specific and one for a discount for lack of marketability (DLOM) of her jointly held shares.“Cynthia further contends that the court‘ erred by denying relief to [her] regarding Michael’s secret purchases of additional [Enviro Tech] shares.’”The appeals court concluded that the tax liability was erroneously accounted for, but the DLOM was supported by substantial evidence. Also, the trial court“impliedly made the factual findings necessary to support its ruling regarding Cynthia’s breach of fiduciary duty claim.”

The agreement.

The agreement related to two family revocable trusts and to the trustees, Cynthia and Michael and the Archibalds, and Enviro-Tech (collectively, the shareholders). Other shareholders were not included. The agreement as to the shares the shareholders owned was “for the purpose of protecting the Corporation and the Shareholders, as well as providing continuity for the Corporation’s business in the event of the occurrence of certain events discussed in this Agreement.”

Restriction on transfer.

Shares the Shareholders held may be transferred only as allowed under the agreement.

Option to purchase.

A shareholder who desired to sell their stock under the agreement had to give notice to the other shareholders and to“the Corporation” in accordance with the agreement. The option period for EnviroTechran for 180 days following receipt of the offer or 90 days following the final determination of value under the agreement. The option was for the price is determined under Section 10 of the agreement and at the terms in Section 11 of the agreement. If the corporation failed to exercise its option for all of the shares, then, for 90 days, the other shareholders had an option to purchase the shares the corporation did not purchase under the same terms.

Section 8. Sale on marital dissolution or separation of shareholder.

Provisions for divorce. 

Michael Harvey shall be deemed to be the owner of the shares of the Harvey Trust. Any decree of dissolution, etc. between a shareholder and his respective spouse shall include two provisions:

 

1. A shareholder shall purchase and spouse shall sell every interest the spouse has in the Shareholders’shares in the Corporation; and

 

1. A provision granting to the divorced Shareholder the spouse’s entire interest in the shares of the Corporation.

Option to buy spouse’s interest.

If neither provision were included in a decree, etc., then the divorced shareholder shall be required to purchase from the spouse or ex-spouse and the spouse shall be required to sell the shares at the price in Section 10 and terms in Section 11.

Valuation process.

The purchase price to be paid for the shares subject to purchase shall be the FMV of the interest in the corporation represented by the shares being sold. The FMV shall be determined by the agreement of the parties within 30 days. If they do not agree, the FMV shall be determined by an appraisal. The parties shall each appoint an appraiser within 15 days of the end of the negotiation period. “The two appraisers as timely designated shall confer within five (5) days thereafter to designate and appoint a third appraiser who shall be the ‘Final Arbitrator Of Value’ if the same is required hereunder.” There were further provisions explaining how the three appraisers arrive at a final value.

Payment.

The purchase price was paid at the option of the purchaser by a promissory note(s) the purchaser executed for a 15-year period amortized and payable monthly with interest, with prepayment allowed without penalty.

Valuation.

Michael Smith (Smith). Smith was a forensic accountant Michael hired to appraise Harvey’s joint interest inEnviroTech. He concluded that Cynthia’s one-half interest in the 825 shares was $21,331,895.Included was an adjustment for EnviroTech’s deferred tax liability (presumably as recorded on its books). Smith explained that it would be paid as the time differences in deductions (primarily depreciation) reversed themselves in the future.

Smith then applied a DLOM. He explained his reasoning as essentially related to the lack of liquidity in a non-publicly held stock. He used restricted stock studies to arrive at a DLOM of 22.72%.

John Iacopi (Iacopi). 

Iacopi was a forensic accountant Cynthia hired to determine the FMV of shares of stocks he owned. He determined the FMV of her shares to be$39,954,388, exceeding Smith’s appraisal by $18,622,000. Iacopi did not discount. Iacopi did not allow the deferred tax liability to stand and did not use a DLOM, believing that the agreement created a market for the stock and, therefore, no DLOM was appropriate. He also felt, as did Harvey, that the stock was “very marketable.”

Price water house Coopers LLC (PWC). 

The parties hired PWC to be the final arbiter of the FMV. PWC concluded that Smith’s opinion “most closely approximated the actual value of the shares which are subject to purchase (owned by Ms. Cynthia Harvey).” The trial court also found Smith’s appraisal to be more reasonable and adopted it.

Post-separation acquisition of additional Enviro Tech shares.

Michael acquired 115 additional shares post-separation, which he purchased with a combination of post-separation earnings and a loan obtained on Plant 6. The Plant 6 building was owned by a partnership Michael partly owned, which he received as part of the divorce property settlement. Cynthia testified that she did not receive any advance notice of these additional share purchases. “Iacopi testified that he and Smith ‘normalized’ Michael’s‘alleged bad acts’ as part of their valuations and these acts ‘did not impair [his] opinion of the value of Enviro-Tech.’”

Michael’s appeal.

The opinion went into an extensive discussion of prior proceedings(Harvey I) as they relate to the manner in which the value was determined and upheld the methodology of the agreement. Michael’s appeal went to the issue of the trial court determining its own method of payment for the determined value of Cynthia’s shares. Michael essentially contendedthatHarvey I“required the lower court to impose the terms and conditions set forth in Section 11 (‘Payment and Transfer of Shares’).”Harvey, I did not address whether the payment provisions of Section 11 of the agreement applied in this case. The appeals court went into a lengthy discussion of the application of the contract, in this case, this issue, and concluded that the trial court was free to set its own terms and conditions for the equalization payment.

Cynthia’scross-appeal.

Valuation. 

Cynthia made two arguments regarding the valuation of her one-half interest in the jointly owned Enviro Tech shares. “First, ‘the [trial court] erred in applying a discount for possible future taxes that were not immediate and specific.”Second, “the trial court improperly utilized a marketability discount in valuing [Enviro Tech].’” The trial court had the discretion to award the property to one party and then provide for an equalization. However, the trial court may not divide the community property estate in any manner other than equally. There was no one applicable way to determine the value of the closely-held stock. The value of the property may be shown by qualified expert witnesses.

Deferred tax liability.

“[I]t is improper to take into consideration the tax consequences of an order dividing a community asset unless the tax liability is immediate and specific and will arise in connection with the division of the community property.” Future tax consequences were inherently speculative. Smith accounted for Enviro Tech’s $2.5million deferred tax liability. The tax is primarily related to depreciation that would reverse itself in future years. Iacopi testified that both he and Smith agreed that the deferred tax liability was neither immediate nor specific. Michael countered that the trial court did not err in adjusting for the deferred tax liability but cited no authority for this. “We conclude that the valuation erroneously accounted for a tax liability that was not immediate and specific.”

Discount for lack of marketability (DLOM). 

Smith opined that a DLOM was appropriate for this closely-held business. A closely-held business would lack liquidity. Iacopi believed such a discount was a misnomer because Michael was a specific buyer (under the agreement) who was not “exposed to an open and free market” and Enviro Tech was “highly marketable.” The trial court adopted Michael’s valuation, finding it “more persuasive,” “compelling,” “accurate,” “reasonable,” and “equitable.” Any quarrel went to the weight of Smith’s testimony. The determination of the credibility and weight went to the trier of fact and not to the appeals court. “We conclude substantial evidence supported a discount for lack of marketability.”

Relief for breach of fiduciary duty.

Cynthia identified as a contested trial issue “Breaches of Fiduciary Duty by Mi[chael],” including his post-separation acquisition of additional shares of Enviro-Tech stock, which she believed should be community property. The trial court decided that Cynthia failed to prove any impairment of her one-half interest in the825 Enviro Tech shares as a result of Michael’s acquisition of additional shares. If anything, the trial court noted that the acquisition of those shares by Michael was similar to a corporate buyback and helped to consolidate ownership with control. Demonstrably, Enviro Tech increased significantly in value post-separation, so there was no diminution in the value of the community estate. “Likewise, Husband’s increases in income contrary to court orders and his, frankly, candid admission of what Husband refers to as ‘bad acts and what Wife refers to as ‘money laundering’ or ‘round tripping,’ as troubling as the Court finds them, are nevertheless not demonstrated by the evidence to have resulted in impairment of Wife’s community interest in [Enviro Tech].” The trial court seemed to say that Michael did breach some of his fiduciary duties, but it also found that none of these breaches impaired the value of Enviro-Tech or the community estate.

In her objections to the statement of decision, Cynthia did not sufficiently identify any lack of findings with respect to Michael’s use of community property to purchase additional Enviro Tech shares.“Under the doctrine of ‘implied findings,’…appellate courts reviewing the appealed judgment must presume the trial court made all factual findings necessary to support the judgment for which there is substantial evidence.’“The appeals court concluded that community property was not used to purchase the additional shares in both purchases.

The judgment of the trial court was reversed in part and remanded to reevaluate Cynthia’s one-half interest in the jointly owned shares to eliminate the consideration of the deferred tax liability and to readjust the division of community property accordingly.