Opinion
No. 04-01-00345-CV
Delivered and Filed: July 31, 2002
Appeal From the 45th Judicial District Court, Bexar County, Texas, Trial Court No. 2000-CI-05063, Honorable Phylis J. Speedlin, Judge Presiding.
Reversed And Remanded In Part; Affirmed In Part
Sam C. Bashara, for appellant.
John U. Hemmi, Richard R. Orsinger, for appellee.
Sitting: Sarah B. DUNCAN, Justice, Karen ANGELINI, Justice, Sandee Bryan MARION, Justice.
Robert V. Knapp, M.D. and Lori L. Knapp appeal the trial court's property division in their divorce action. Dr. Knapp contends the trial court erred in refusing to limit the value of the couple's
stock in a radiology practice and medical equipment business in accordance with certain buy/sell agreements. Lori L. Knapp also contends the trial court erred in valuing the couple's stock in the medical practice; she advocates a higher value than found by the trial court. We agree with Dr. Knapp and therefore reverse the trial court's judgment to the extent it divides the community property and remand this aspect of the cause to the trial court for further proceedings consistent with this opinion. In all other respects, we affirm the trial court's judgment.
Factual and Procedural Background
Dr. Knapp is a radiologist who, since May 1997, has been a member of and stockholder in the South Texas Radiology Group, P.A. ("the Radiology Group"), which provides radiology services. Dr. Knapp also owns stock, either directly or indirectly, in DX Partners, L.P.; Diagnostic Imaging Management, L.L.C.; and STRG Nevada Medical Equipment, Inc. Although the relationship among these corporations is complicated, an understanding of it is unnecessary to the resolution of this appeal. Therefore, for purposes of this opinion, we refer to these corporations collectively as "the Medical Equipment Business." The Medical Equipment Business operates and owns an undivided one-half interest in the imaging centers and related equipment used by members of the Radiology Group. Stock ownership in the Radiology Group and the Medical Equipment Business is subject to buy/sell agreements, which are signed by the member physicians and their spouses.
The Radiology Group's buy/sell agreement provides that if an "operative event" occurs, either the Radiology Group or its remaining stockholders must buy the selling stockholder's stock at one of two prices: (1) if a new stockholder purchased stock in the previous fifteen months, the purchaser must pay the price paid by the new stockholder; or (2) absent such a sale, the purchaser must pay the book value of the Radiology Group's assets (other than the accounts receivable and commercial goodwill) less outstanding liabilities. The Radiology Group's buy/sell agreement also provides that if a stockholder desires to sell her stock to a third party, the stockholder first must tender the stock to the Radiology Group, which then has sixty days to purchase the stock at the price offered by the third party. If the Radiology Group does not purchase the stock, it must notify the existing stockholders, who then have an additional sixty days to purchase the stock at the price offered by the third party. Only if neither the Radiology Group nor the other stockholders purchases the stock may the stockholder sell her stock to the third party.
The Medical Equipment Business's buy/sell agreement requires a stockholder to sell his stock to the corporation or to the other stockholders for an amount equal to the stockholder's initial investment upon the occurrence of an "operative event." Under both buy/sell agreements, "operative event" is defined to include the attempted sale, transfer, gift, mortgage, or pledge of stock without the corporation's consent; termination of a stockholder's employment; and termination of a shareholder's marriage by death or divorce if the stockholder does not succeed to his or her spouse's community interest in the stock.
At trial, the business manager for both corporations, Philip J. Russell, testified on Dr. Knapp's behalf. Because there had been sales of stock within the previous fifteen months, Russell based his valuations on the formulas set forth in the buy/sell agreements. He testified that the value of the Knapps' stock in the Radiology Group was $25,000; and the value of the Knapps' stock in the Medical Equipment Business is equal to Dr. Knapp's initial investment of $50,000. Russell also testified that Dr. Knapp was entitled to $256,000 in deferred compensation. Because the amount and divisibility of Dr. Knapp's deferred compensation is undisputed, the remainder of this opinion will focus on the value of the stock only.
Mrs. Knapp's expert, CPA Dan Hanke, testified that the "fair market value" of the parties' stock in the Radiology Group was $663,000; and the "fair market value" of the stock in the Medical Equipment Business was $92,484. However, Hanke's work papers demonstrate that he in fact calculated the value of the Knapps' interest in the "[e]nterprise value" of the Radiology Group. See, e.g., Swope v. Siegel-Robert, Inc., 74 F. Supp.2d 876, 911 (E.D.Mo. 1999) ("Enterprise value has been defined as the amount `a willing buyer realistically would pay for the enterprise as a whole on the statutory valuation date.'"), affirmed in part and reversed in part on other grounds, 243 F.3d 486 (8th Cir.), cert denied, 122 S.Ct. 198 (2001); Jeffries v. Mills, 995 P.2d 1180, 1190 (Ore. App. 2000) (defining "enterprise value" as "earnings or investment value). The work papers thus begin with the Radiology Group's financial statement, continue with its earnings statement, and conclude with Dr. Knapp's interest in the enterprise value. Similarly, the starting point for Hanke's valuation of the Medical Equipment Business stock was a "business valuation" performed in anticipation of a comprehensive reorganization that consolidated the imaging centers owned by the Radiology Group with the imaging centers owned by Methodist Healthcare System. Hanke testified he did not apply a minority discount to reflect Dr. Knapp's minority interest in the corporations, although he admitted he had applied a twenty to thirty percent minority discount in a previous, similar case; and he applied at best "a minor marketability discount" of three-one-hundredths of one percent to reflect the restricted marketability of the Radiology Group stock even though a marketability discount of more than ten percent is more normal.
The dissent states that "Hanke testified that he applied an 8.3% marketability discount to arrive at fair market value." This is incorrect.
Hanke's written report reflects that he credited Dr. Knapp with only 91.7% of the value of his percentage ownership in the Radiology Group, because Dr. Knapp was "[v]ested @ 55 out of 60 months." Of course, 55 divided by 60 is .916666, which of course might be rounded to .917 or 91.7%. However, the report does not indicate whether Hanke arrived at his 91.7% by rounding or by including a .03% marketability discount. On direct examination, Hanke testified that he reduced the value of the Knapps' ownership in the Radiology Group by a little over eight percent "and that's a variety of factors. There would be some expensive marketability if you needed to market this, and he hadn't fulfilled all of his time under the employment [agreement]." On cross-examination, Hanke admitted the 8.3 percent discount reflected in his report included only "a minor marketability discount" and that "normally, you have higher marketability discounts than 10 percent." Thus, at best, Hanke applied a .03% marketability discount.
In a conversation with the trial judge, the parties framed the issue as whether the "commercial goodwill" attributable to the Radiology Group and the Medical Equipment Business was a community asset and divisible upon divorce. Arguing that the commercial goodwill was not subject to division, Dr. Knapp relied upon Finn v. Finn, 658 S.W.2d 735 (Tex.App.-Dallas 1983, writ ref'd n.r.e.) (en banc), in which the court held that a law firm's commercial goodwill was not divisible upon divorce, because "[t]he [partnership] agreement does not provide any compensation for accrued goodwill to a partner who ceases to practice law with the firm, nor does it provide any mechanism to realize the value of the firm's goodwill." Id. at 742. Mrs. Knapp argued that the commercial goodwill was divisible in reliance upon Keith v. Keith, 763 S.W.2d 950 (Tex.App.-Fort Worth 1989, no writ), in which the court held that "the formula set forth in the partnership agreement with respect to death or withdrawal of the partner is not necessarily determinative of the value of a spouse's interest in the ongoing partnership as of the time of divorce." Id. at 953. Given this choice, the trial judge decided to follow Keith, concluding that the Radiology Group's and Medical Equipment Business's buy/sell agreements do not limit the stock's value. She therefore based her 50/50 division of the value of the couple's stock in the Radiology Group and the Medical Equipment Business upon Hanke's "fair market value."
Standard of Review
We review the trial court's division of the community estate under an abuse of discretion standard. Murff v. Murff, 615 S.W.2d 696, 700 (Tex. 1981). Because "[a] trial court has no `discretion' in determining what the law is or applying the law to the facts," "a clear failure by the trial court to analyze or apply the law correctly will constitute an abuse of discretion." Walker v. Packer, 827 S.W.2d 833, 840 (Tex. 1992).
"Commercial Goodwill"
On appeal, Dr. Knapp's first issue asks "whether the trial court erred in concluding the buy-sell agreements did not limit the value of [the Radiology Group's and the Medical Equipment Business's stock] for purposes of valuation in a divorce action." His argument, however, focuses upon Finn and Keith and whether a buy/sell agreement controls the valuation of stock. In response, Mrs. Knapp argues we should follow Keith and hold that the buy/sell agreements do not limit the value of the stock for purposes of divorce. Hanke, too, states in his November 3, 2000 letter to Mrs. Knapp's attorney:
In determining the fair market value of an ownership in a professional practice, one must consider corporate or group goodwill as contrasted to individual goodwill and must further determine what portion of owner compensation is being received for services rendered and what portion is in reality entity profits which are distributed as compensation because of the operations of the tax law. We have taken these factors into consideration. . . .
But this is the only mention of "goodwill" in Hanke's reports and accompanying worksheets. In fact, as discussed more fully below, the distinction between Hanke's and Russell's valuations is not "commercial goodwill" but their underlying assumption regarding marketability of the stock. Hanke assumed stock without a significant marketability restriction, while Russell assumed stock whose marketability is significantly restricted by the buy/sell agreements. Because commercial goodwill is not the basis for Russell's and Hanke's differing valuations of the stock, we deem it unnecessary to accept the parties' invitation to choose between Finn and Keith. We instead turn to the substance of Dr. Knapp's broadly-framed issue — "whether the trial court erred in concluding the buy/sell agreements did not limit the value of [the Radiology Group's and the Medical Equipment Business's stock] for purposes of valuation in a divorce action."
Valuation of Stock Subject to a Buy/Sell Agreement
As a general rule, the value to be accorded community property that is to be divided in a divorce proceeding is "market value." See Walston v. Walston, 971 S.W.2d 687, 689 (Tex.App.-Waco 1998, pet. denied); see also Beavers v. Beavers, 675 S.W.2d 296, 299 (Tex.App.-Dallas 1984, no writ). "Fair market value has been consistently defined as the amount that a willing buyer, who desires to buy, but is under no obligation to buy would pay to a willing seller, who desires to sell, but is under no obligation to sell." Wendlandt v. Wendlandt, 596 S.W.2d 323, 325 (Tex. Civ. App.-Houston [1st Dist.] 1980, no writ); see City of Pearland v. Alexander, 483 S.W.2d 244, 247 (Tex. 1972). If the property does not have a market value, the parties may show the actual value of the property to the owner. Beavers, 675 S.W.2d at 299 (holding that because a buy/sell agreement required the stockholder to first tender his stock to the other stockholders at book value, book value was an appropriate method to value stock).
Contrary to Dr. Knapp's argument, the Knapps' divorce has not triggered the buy/sell agreements. There has not been an "operative event" — an attempted sale, transfer, gift, mortgage, or pledge of stock without the corporations' consent; termination of Dr. Knapp's employment; or termination of his marriage by death or divorce in a manner that dictates that Dr. Knapp will not succeed to Mrs. Knapp's community interest in the Radiology Group and the Medical Equipment Business stock. But it is equally clear that Hanke's analysis does not reflect either market or actual value of the stock. As Hanke admitted at trial, the Knapps could never receive for the Radiology Group stock the amount he claimed to be its "market value":
Q. And Dr. Knapp is never, ever, ever going to get that [$663,000] for the sale of his [Radiology Group] stock, is he?
A. No. He's going to get an income stream until he leaves the organization which includes a huge profit element over and above salary which is very substantial which would indicate that the fair value of such an interest is, in fact, worth more than what is in the agreement.
Q. Can he get a single penny of that money if he doesn't work for them? Let's say he stops working. Does he get anything?
A. No. If he stops working — he leaves, he gets what's in the buy/sell agreement.
Q. And so the bottom line on this — The only way he can get the money, the substantial benefit that you're talking about, is to continue to work. You just think that he's getting paid more than his services were actually worth if he was in the open market?
A. Uh-huh. He has to continue to work in order to realize the value.
Hanke's testimony, like his work sheet for the Radiology Group, demonstrates the flaw in his reasoning.
With respect to the Radiology Group, Hanke valued the assets, liabilities, and income stream of the corporation as a whole — its "enterprise value," "the highest level at which a company's worth may be assessed." Swope, 74 F. Supp.2d at 911. But "enterprise value by its nature does not include a discount based on shares' minority status or lack of marketability . . ." Id. Enterprise value may thus be an appropriate means of valuing the stock of an ongoing business to determine its "fair value" in the context of a stockholder who dissents to a merger or acquisition since "the purchase contemplated gives the buyer total control over the corporation. . . ." Id. Similarly appropriate was the use of enterprise value in anticipation of merging the imaging centers to form the Medical Equipment Business. But "enterprise value" is entirely inappropriate in the context of valuing a minority position in stock subject to a buy/sell agreement for purposes of divorce. See Beavers, 675 S.W.2d at 299. Because the business is not being sold as a going concern, the buy/sell agreement, whether triggered by an "operative event" or not, will dictate both the significantly limited marketability of the stock and the importance of the minority position. See id.
Indeed, the record in this appeal does not contain even a scintilla of evidence that the market or actual value of the Radiology Group and Medical Equipment Business stock even approximates Hanke's "fair market value" valuations. To the contrary, this record establishes that the "fair market value" of the stock in all likelihood does not exceed the values placed on the stock by the buy/sell agreements — $25,000 for the Radiology Group stock and $50,000 for the Medical Equipment Business stock. In short, Hanke's "fair market value" represents the fair market value of Dr. Knapp's ownership in ongoing businesses — including the value of his future compensation arising out of his employment — not the fair market value of the Knapps' stock on the date of divorce, the only asset subject to valuation.
Conclusion
Because the trial court erred in failing to consider the buy/sell agreements' significant restriction on the marketability of the stock, it failed to derive the stock's market value. We therefore reverse that part of the trial court's judgment dividing the community property and remand this aspect of the cause to the trial court for further proceedings consistent with this opinion. See Jacobs v. Jacobs, 687 S.W.2d 731, 732 (Tex. 1985) ("court of appeals must remand the entire community estate for a new division when it finds reversible error which materially affects the trial court's "just and right" division of the property."). In all other respects, we affirm the trial court's judgment.
In light of our disposition of Dr. Knapp's appeal, it is unnecessary to address Mrs. Knapp's cross-appeal. Mrs. Knapp first asks that we "remand to the Trial Court with instructions to redivide the community estate using the value of $663,000 [for the Radiology Group stock]"; we have, in effect, rejected this requested relief in resolving Dr. Knapp's appeal, just as we have, in effect, granted Mrs. Knapp's request alternative relief "to remand for a redetermination of the value of [the Radiology Group], and a new property division."
Dissenting opinion by: Sandee Bryan Marion, Justice
I respectfully dissent and I would affirm the trial court's judgment. I believe this court should answer the question presented at trial and on appeal: should the Finn decision or the Keith decision be followed when determining the value of a professional practice upon divorce? I agree with Annette Stewart's concurring opinion in Finn and the court in Keith, and would hold that the value of Dr. Knapp's interest should be based on the present value of the entities as ongoing businesses, which would include consideration of commercial goodwill.
Here, it was undisputed at trial that the Radiology Group and the Medical Equipment business have commercial goodwill. The Radiology Group and the Medical Equipment business are part of a complex group of interrelated entities that work together to provide radiology services in nineteen different locations in the Bexar County area. The Radiology Group employs thirty-nine physicians, with some, but not all being shareholders, and fifty-five non-physicians. The Medical Equipment business owns an interest in a partnership, which in turn, owns approximately fifty percent in a limited partnership along with the Methodist Health Care System. The Medical Equipment business holds and manages all the equipment, the facilities, lease agreements, and the technical services agreements for the Radiology Group. These businesses clearly have value separate and apart from the individual physician's personal skills, ability, and reputation.
I agree with the majority's statements that no triggering events occurred here, and that the asset subject to valuation is the Knapps' stock in the businesses. I disagree with the majority that there is a flaw in Hanke's testimony and reasoning. In his formal written report, Hanke stated that the "focus of our evaluation was the determination of the fair market value of Dr. Knapp's ownership in the various entities." In reaching his determination, Hanke stated as follows:
It is our understanding that in both the literature of business valuations and in case law, values computed in accordance with a buy-sell agreement may or may not represent the fair market value of an ownership in an entity. While values computed under a buy-sell agreement may have some instructive value, such computations are determinative only if the terms and conditions of the buy-sell agreement are being implemented with respect to the value. It is our understanding that Dr. Knapp is not selling his interest in these entities, and the buy-sell agreements are not being invoked since he is not parting with his interest. Accordingly, we have taken the computations under the buy-sell agreements as pieces of information to be evaluated with all of the other evidence in arriving at our opinion of the fair market value of the interest of Dr. Knapp in each of these entities. (Emphasis added.)
Further, Hanke testified that he applied an 8.3 percent marketability discount to arrive at fair market value. A marketability discount is one that is applied for the time value and difficulty of finding a market. If a property interest is particularly attractive and there is an active market of people who would be interested in it, then the discount decreases. Hanke concluded that the fair market value of Dr. Knapp's interest in the Radiology Group was $663,000, and the value of his interest in the Medical Equipment business was $92,484. Thus, Hanke calculated the fair market value of the stock based on the value of the businesses as ongoing entities, taking into account the limitations imposed on the stock by the shareholder agreements and the lack of a market for the stock. I believe this was proper.
Hanke did not apply a minority discount to his valuation of the Radiology Group stock. A minority interest discount is one that is applied when the seller is a minority shareholder and has no controlling interest in the company. However, during cross-examination, Hanke admitted that he had recommended a twenty-five to thirty percent minority discount in a similar medical practice valuation case where the doctor owned an eight percent interest in the medical practice. As a result, the trial court properly applied a thirty percent minority discount and determined that the value of Dr. Knapp's stock in the Radiology Group was $464,000, rather than $663,000.00.
In one of his worksheets, Hanke calculated the value of the entire Radiology Group and stated "Enterprise value $16,481,077." He did not define the term "enterprise value," but he used it during his testimony to refer to the value of the Radiology Group as a whole. Hanke then calculated the value of the Knapps' interest in the business. In my opinion, in order to determine the Knapp's interest, Hanke properly determined the value of the entire business first.
While I agree with Dr. Knapp that a spouse who signs a contract should be bound by it absent a showing of fraudulent inducement, none of the triggering events specified in the agreements have occurred here. Unless a triggering event occurs, I believe a trial court should not be limited to the formula in the agreement when determining the value of an individual's share upon divorce. I would conclude that the value of the Knapps' interest should be based on the present value of each entity as a going business, taking into consideration the limitations imposed by the shareholder agreements and the commercial goodwill. In my opinion, that is what the trial court did in this case.
For these reasons, I would affirm the trial court's judgment in all respects.