Lamm v. Preston, 2023

This was a tip of the iceberg Idaho Supreme Court decision on a very complex divorce case. This particular decision related to the magistrate court’s order, upheld by the district court, as to the fair market value of one of the parties’ business, Black Sage Acquisition LLC. The magistrate court determined the value of a 25% interest in Black Sage Acquisition to be $163,373. All remaining value was determined to be personal goodwill.

Leslie Preston (the wife) first appealed the magistrate court’s decisions to the district court, which upheld the magistrate court. She then appealed to the Supreme Court, which also affirmed.

Factual and procedural background.

Ross Lamm (the husband) and Leslie Preston (the wife) were married in California in 2000. Among other businesses, the husband and two others founded Black Sage Technology Inc. in 2014. “The value of Ross’ and Leslie’s respective business interests became the primary contested issue in these divorce proceedings.” In November 2018, Ross filed for divorce. Black Sage Technology was experiencing financial difficulties about this time. In May 2019, Ross and his partner, David Romero, determined that it was necessary to sell Black Sage Technology and agreed to an acquisition by Acorn Growth Cos. LLC. Acorn desired Leslie to sign an acknowledgement form because of the divorce proceedings. “On June 28, 2019, Leslie signed the Acknowledgment.” The sale to Acorn resulted in Acorn acquiring a 55% stock interest in Black Sage Technology for a cash payment of $4,207,500. Black Sage Acquisition was also created with the transaction. Ross received a 25% interest in Black Sage Acquisition. “He also received $1,275,569 for 5,000 of his shares in BST (which was 50% of his interest).” Remaining shares of Black Sage Technology were rollover shares in Black Sage Acquisition. Ross may also receive tiered earnout payments for 2019, 2020, and 2021. At the date of trial, earnout payments, if any, were not known for 2019. Black Sage Acquisition employed Ross under a two-year contract, including a noncompete trail for three years after the two years of employment. Based on the acknowledgement she signed, Leslie would only be a “silent partner” if the shares were divided. The parties disagreed as to the division and valuation of Black Sage Acquisition and Black Sage Technology. The Black Sage Technology value had not been appealed in this case. The magistrate court held a two-day trial on the values of Black Sage Acquisition and Black Sage Technology.

Ross testified that he was one of the only ones who could modify the source code for the video tracking software transferred to Black Sage Acquisition. Other testimony indicated that Ross’ expertise was irreplaceable. Acorn would not have made an investment in Black Sage Technology without a covenant not to compete and the implementation of a $5 million key-man insurance policy with the proceeds payable to Black Sage Technology. “Similarly, the largest customer of BST stated that his company expected to continue business with BST ‘solely’ because of ‘Ross Lamm’s knowledge, skills, and abilities, not any aspect of Black Sage itself.’” 

As to the values of Black Sage Technology and Black Sage Acquisition, Keith Pinkerton testified as an expert for Ross and Peter Butler testified as an expert for Leslie. Both parties agreed that Black Sage Acquisition shares should be discounted 25% for DLOC and 20% for DLOM. Both agreed that the value of the earnout payments was too speculative to be valued. The experts disagreed as to whether these payments should be part of the marital estate.

Pinkerton used an asset-valuation approach to value to calculate a fair market value of Black Sage Acquisition shares of $1,147,500 at the time of the acquisition, net of DLOM and DLOC. Pinkerton determined the community property value of Black Sage Acquisition at $163,373. That amount is calculated by taking Black Sage Acquisition’s identifiable assets and subtracting speculative intellectual property values, which represented personal goodwill attributable to Ross. Per Pinkerton’s testimony, “And, I believe, it’s my understanding, that the appropriate standard, that the fruits of a person’s labor, accrue to that person post-divorce; that that’s not a divisible asset, and so I’ve tried to estimate what his pro rata share of those assets are.” That amount Pinkerton determined to be $163,373, and the remainder of the $1,147,500 was personal goodwill. The court noted the bases upon which Pinkerton determined the personal goodwill.

Butler believed Pinkerton’s calculation to be speculative and “materially low.” Butler did not offer his own valuation as of the divorce valuation date but agreed with the value of $1,147,500 at the acquisition date. “He concluded that the value of the BSA shares had likely increased ‘significantly’ over time ‘based on fast-moving developments related to the company and the industry.’” With the difficulty of valuation, Butler maintained the Black Sage Acquisition interest should be divided 12.5% to each party. Butler noted that “personal goodwill is non-transferrable,” thus none of the assets transferred were personal goodwill. 

The magistrate court determined that proceeds of the Black Sage Technology acquisition are community property and there was no personal goodwill in Black Sage Technology’s value. It also determined the fair market value of Black Sage Technology to be $1,275,569, the amount of cash received from Acorn to Ross. The magistrate court ordered the cash received less some adjustments for predivorce distributions to be divided equally between the parties for the remaining community interest in Black Sage Technology. Though agreeing Black Sage Acquisition being speculative to value, the magistrate court determined it necessary to value Black Sage Acquisition in order for the parties to be “disentangled.” The magistrate court noted that Black Sage Technology was “essentially still a start-up venture” as noted by Pinkerton. A willing buyer was unlikely to pay the same amount for Black Sage Technology as what Acorn paid for Black Sage Acquisition. Accordingly, Pinkerton’s use of identifiable assets solely to determine the value of the 25% interest in Black Sage Acquisition was appropriate. Any additional value can be traced to Ross’ personal attributes and was thus personal goodwill. The magistrate court also found any earnout payments to be solely Ross’ property.

Leslie filed an amended appeal to the district court, arguing that the magistrate court incorrectly valued the Black Sage Acquisition shares and erred in determining that the earnouts are Ross’ separate property. The district court affirmed the magistrate court’s value of Black Sage Acquisition shares, noting that Pinkerton’s goodwill analysis supported the valuation. However, the district court also determined that the magistrate court erred in determining that earnout payments were not community property. “Leslie timely appealed to this Court, assigning error to both lower court decisions, but only regarding their rulings on the division of the BSA shares.”

Analysis.

The district court did not err in affirming the magistrate court’s valuation of the Black Sage Acquisition shares and its determination of Ross’ personal goodwill in those shares. Leslie argued that the lower courts mischaracterized Black Sage Acquisition shares by deeming the vast majority of their value to be Ross’ separate property. Leslie further argued that the entirety of the Black Sage Acquisition shares were community property, citing the nature of the property used to acquire them, i.e., given the community property nature of Black Sage Technology. The court proceeded to address each of Leslie’s arguments.

The magistrate court did not err in concluding that, although the community has an interest in the Black Sage Acquisition shares, much of their value was comprised of Ross’ personal goodwill. Ross argued that it is necessary to value Black Sage Acquisition shares with consideration of goodwill. The magistrate court determined the value of the Black Sage Acquisition shares at $163,373 with any remaining value attributable to Ross’ personal goodwill. Two values had to be considered in determining the value of a business: intangible assets and tangible assets. Goodwill was an intangible asset, and it was appropriate to determining the value of a business, and it is the most complex aspect of business valuation. How the trial court assessed and weighed each of the various methods and the variables within them in each particular case was within that court’s discretion.

According to Black’s Law Dictionary, “personal goodwill” was defined as “[g]oodwill attributable to an individual’s skills, knowledge, efforts, training, or reputation in making a business successful.” (See also Stewart v Stewart). A majority of American jurisdictions exclude personal goodwill from marital property because it was the “individual nontransferable reputation of a specific owner.” Idaho also treated personal skill and reputation and separate, noncommunity property assets. The Supreme Court had consistently held, in Idaho, “that an individual’s knowledge, background, and talent are personal assets rather than community property.” The cases “instruct us” that business goodwill was community property, while personal goodwill was not. “Here, the magistrate court determined that all proceeds from the Black Sage Technology acquisition were community property of the marital estate as both the business’s creation and the transaction at issue occurred during the marriage of Ross and Leslie.”

The issue here was whether there was evidence that supported the magistrate court’s conclusion that the community interest in Black Sage Acquisition shares had a value of $163,373, with the remaining value being goodwill. Both experts showed concern over the speculation in determining a value of the Black Sage Acquisition shares. “This led to Butler (Leslie’s expert) making no attempt to value the BSA shares while Pinkerton (Ross’s expert) concluded that much of the shares’ value beyond its identifiable assets consisted of Ross’s personal goodwill.” The magistrate court determined that the identifiable assets had a market value of $163,373, which was community property to be divided between the parties. The magistrate court further determined that any value beyond this amount was due to Ross’ personal attributes. The record supports Acorn’s statement that it would not have acquired Black Sage Technology without Ross’ continued involvement.

Leslie argued that Pinkerton’s analysis was speculative and lacked foundation. He ultimately used the “identifiable asset approach” as the best way to determine the fair market value of the Black Sage Acquisition shares. The magistrate court summarized its analysis of the valuation issues presented. It noted that the balance sheets Pinkerton used did not include software or intellectual property transferred to Black Sage Acquisition as those assets were speculative, but he did include other intangible assets. The experts agreed that Ross’ interest should be discounted a cumulative 40% for DLOC and DLOM. 

Much of the unknown value was the value of the shares going forward. And much of the speculation was due to the intangible nature of Black Sage Acquisition’s assets, much of it the drone technology going forward. Pinkerton’s analysis provided a fair market value of the community property while also considering Ross’ personal goodwill involved with the acquisitions of Black Sage Technology. These findings, per the Supreme Court, were supported by substantial and competent evidence in the record.

Butler’s proposal of equal division of the Black Sage Acquisition shares would leave Leslie with a 12.5% interest in a business that Leslie had no knowledge and no experience. It would also leave Leslie and Ross as business partners and fail to sufficiently “disentangle” the divorcing partners.

The Supreme Court supported and affirmed the district court’s decision to affirm the magistrate court’s decisions. “Substantial and competent evidence supported the magistrate court’s factual findings and the conclusions of law properly flowed from those findings”

The magistrate court did not err in declining to divide the Black Sage Acquisition shares because a simple division of shares would not have disentangled Ross and Leslie. Leslie argued that a silent partner with a minority interest in Black Sage Acquisition would not provide any entanglements. Ross responded that, since he had a critical role in Black Sage Acquisition, he should not be subject to disputes or potential disputes with an ex-spouse. After reviewing the record, the Supreme Court concluded that dividing the shares would not disentangle the parties. The Supreme Court noted, from the Chavez v. Barrus case, that “[p]arties to a divorce ‘have a right to have their respective interests in their property after they are divorced, definitely and finally determined in the decree which divorces them,’ so that the prospect of future litigation is less likely.” Disentanglement might require more than a simple division of stock. Black Sage Acquisition was a small closely held LLC created through the stock purchase agreement between Black Sage Technology and Acorn. It arose through the antidrone technology Ross developed and marketed. “Awarding Leslie a 12.5% interest, with limited control and marketability, does not necessarily offer her a simple monetary value or investment in the business’s success.” But it entangled the parties, which could lead to future litigation or disputes.

The Supreme Court concluded and affirmed the judgment of the magistrate court that the stock should not be divided between the parties.

The magistrate court did not err in applying a ‘willing buyer’ analysis or in adopting Pinkerton’s goodwill analysis. Leslie argued the magistrate court and district court erred in using Pinkerton’s “speculative” goodwill analysis. She said the magistrate court abused its discretion because it ignored Butler’s analysis and relied on Pinkerton’s. The magistrate court noted it was inappropriate to base the Black Sage Acquisition value on Acorn’s purchase price of Black Sage Technology, given that Black Sage Acquisition was essentially a startup and made only a small economic profit in 2018. The Supreme Court concluded that Pinkerton’s use of identifiable assets to determine the value of 25% of Black Sage Acquisition was appropriate. The Supreme Court concluded that the magistrate court and district court were based on competent evidence and its legal analysis was correct. The Supreme Court had recognized goodwill as an appropriate factor to determine the value of a business. “Here, the magistrate court’s analysis considered what a willing buyer would pay for the BSA shares because that is the very goal of business valuations, particularly in trying to establish a fair market value.” (See Chandler and Stewart). The magistrate court concluded that a willing buyer would not pay as much for the Black Sage Acquisition shares as what Acorn paid for Black Sage Technology. The consideration of personal goodwill was also appropriate here in attempting to bifurcate goodwill. Personal goodwill was not community property in Idaho. A willing buyer cannot purchase personal goodwill. There was no abuse of discretion by the magistrate court or affirmation by the district court.

The magistrate court did not err in concluding that the community property value of the shares was $163,373. Leslie pointed to the $1,912,500 paid for Ross’ Black Sage Technology shares as the appropriate value to use for the Black Sage Acquisition shares. As Pinkerton noted, that was a “raw number” for Ross’ 25% interest in Black Sage Acquisition. After a DLOC and DLOM, which both parties agreed should be applied, the amount was $1,147,500. Butler agreed that this was the value of a 25% interest in Black Sage Acquisition at the transaction date. So that was the amount that should be concluded for the Black Sage Acquisition shares. However, neither expert offered this as a solution in their testimony. Nor, the Supreme Court noted, was that the value of the Black Sage Acquisition shares at the time of the divorce. Rather, that amount included a substantial amount of Ross’ personal goodwill. Acorn was only willing to acquire Black Sage Technology assuming that Ross continued in his roles at Black Sage Acquisition. Thus, the Supreme Court agreed with the methodology Pinkerton used and, thus, the $163,373 value of the community property interest at the time of the divorce, based on competent and substantial evidence.

Conclusion.

“The district court’s order upholding the magistrate court’s valuation and division of the Black Sage Acquisition shares is affirmed.”