Estate of Jensen v. Commissioner, 2010 WL 3199784 (U.S. Tax Ct.)(Aug. 10, 2010)
A wealthy widow held the majority (82%) of a private C corporation, which owned and operated real estate and improvements. At her death, the estate's appraiser used the net asset approach to value the corporation at just over $4.2 million, minus $965,000 for built-in long-term capital gains tax (LTCG) liability, calculated on a dollar-for-dollar basis. After applying a 5% marketability discount, the appraiser valued the decedent's share at $2.55 million.
The IRS agreed with the net asset value approach and the 5% marketability discount, but calculated a $250,000 discount for LTCG liability and assessed a deficiency of just over $333,000. (Interestingly, the IRS did not explain how it determined the LTCG liability in its deficiency notice.) The estate appealed to the Tax Court, claiming a 100% LTCG discount applied not only because the net asset method presumes a sale of assets, but also because the U.S. Court of Appeals for the Second Circuit (the appellate forum in this case) would most likely follow recent decisions in both the 5th and 11th circuits that have a dollar-for-dollar discount.
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Divorce Courts Still Caught In 'Quagmire' of Goodwill
Dividing the value of professional practice goodwill is still creating a "quagmire for courts," according to the first of these recent decisions. Are corporate and professional goodwill truly distinct? How does a non-compete agreement affect the distinction? Should there be a rule against considering the professional's earnings in both the practice valuation and the maintenance award? Whether these four cases help answer the questions or deepen the quagmire, only time (and future litigation) will tell.
Wisconsin may have crafted a new standard.
In McReath v. McReath, 2010 WL 2943198 (Wis. App.)(July 29,2010), the husband bought his orthodontic practice during the marriage for $930,000. During divorce, his expert valued the practice at only $415,000, but the trial court rejected this value, based largely on the husband's buy-in price and his consistently high earnings. It adopted the $1 million valuation by the wife's expert, attributing a substantial portion to professional goodwill, and used the husband's earnings to award the wife substantial maintenance. The husband appealed, arguing that state law precluded the division of professional goodwill and, further, it should not be used as a basis for spousal support when it was also factored into the overall practice value (the "double dip"). The wife's argument was simple: because the husband's professional goodwill was all salable-i.e., subject to a non-compete agreement-it was all divisible marital property.
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Analyzing Healthcare AR: Reviewing Underlying Patient Data Is Critical
U.S. Renal Care v. Jaafar, 2010 WL 3405831 (Tex. App.)(Aug. 31, 2010).
The owners of several dialysis clinics sold all of their holdings to a national provider, retaining only accounts receivable (AR) prior to the closing date. The parties disputed this amount and the seller sued for breach of contract, claiming retained AR of over $2.8 million. The jury awarded $750,000 and the defendant appealed, arguing the plaintiffs' expert's calculations were unreliable under the Texas analogue to Rule 702 of the Federal Rules of Evidence.
The appellate court first noted that Texas has adopted a Daubert-type test, essentially requiring an expert's theory to be testable, objective, peer-reviewed, and generally accepted among the professional's community. In this case, the plaintiffs' expert described his calculations as "very straight-forward." He simply took the percentage of payments on past billings and applied that to the outstanding AR balances for private billings as well as Medicare payable. For example, he assumed that private patients who had paid all or some of their past bills would continue to pay their current balances in the same all or percentage portion. Similarly, he assumed that Medicare and secondary insurers would continue to pay current accounts as they had in the past.
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New Guidance from DE Chancery Court on DCF Inputs, Assumptions
Three recent decisions by the Delaware Chancery Court-in opinions authored by Vice Chancellor Leo E. Strine, Jr.-provide important insights into the application of the discounted cash flow (DCF) analysis in statutory fair value appraisal and related merger proceedings.
Focus on the discount rate, management projections
In Maric Capital Master Fund, Ltd. v. Plato Learning, Inc., 2010 WL 1931084 (Del. Ch.)(May 13, 2010), the court enjoined a proposed merger because the proxy statements were misleading. In particular, V.C. Strine found the company misrepresented how its investment bankers selected the discount rate to use in its DCF and related fairness opinion. The prospectus said the advisors calculated a range of discount rates, 23% to 27%, based on the company's weighted average cost of capital (WACC) along with the WACC of the target company and market comparables. The court found, however, that the bankers had actually used a loose variation of the capital asset pricing model and a market analysis to generate discounts of approximately 22%, but disclosed the higher range to suggest a "far more attractive" deal.
Moreover, the court found the proxy statements "inexplicably" omitted the free cash flow estimates prepared by the target's management and provided to the investment bankers. "In my view, management's best estimate of the future cash flow of a corporation that is . . . to be sold in a cash merger is clearly material information," the court held, and ordered a further supplement to shareholder disclosures before the merger vote could proceed.
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Patent Infringement Analysis Needs More Than Plausibility to Support Lost Profits Award
AU Optronics Corp. v. LG Display Co. Ltd., 2010 WL 2720816 (D. Del.)(July 8, 2010)
The U.S. District Court (Delaware) first found that the defendant infringed four of the plaintiff's patents related to liquid crystal display (LCD) technology. In determining the appropriate amount of reasonable royalty and lost profits damages, it considered the plaintiff's expert evidence and his review of the 15 Georgia-Pacific factors (Georgia-Pacific v. U.S. Plywood Corp., 318 F. Supp. 1116 (D.N.Y. 1980).
In particular, the expert accounted for the practice of cross-licensing patent portfolios in the industry (factors 1-4 and 7). He also looked to the parties' past practices in licensing LCD-type patents and examined more than 70 industry licenses, with a particular emphasis on eight cross-licenses between competitors. He then used a regression analysis to summarize the data and derive the terms on which the parties would reach a licensing agreement after a hypothetical negotiation, assuming they would cross-license portfolios with an additional balancing payment unique to these parties. Finally, the expert used a "count, rank, and divide" method to allocate the portion of the claim attributable to each of the four infringed patents (factors 9-11). Assuming the four patents comprised the top 5% of the plaintiff's portfolio, the expert determined that reasonable royalty damages equaled $305,399. He checked this against amounts paid for separate licenses and found they were consistent with his aggregate damages estimate (factor 2). Using a similar "count, rank, and divide" method and assuming once again that the four patents fell into the top 5% of the plaintiff's portfolio, he calculated $7.8 million in lost profits damages.
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