Opinion
20105003.
Decided March 31, 2005.
Prior to the trial of this matter, the parties have consented to introduce into evidence their respective expert reports, on the issue of the value of the enhanced earning capacity of the defendant, as it relates to his law license.
But, each of the expert's reports here, have adopted a "wooden" forensic accounting methodology — their omission of fact-sensitive information in computing the "discount factor" is contrary to the Court of Appeals maxim that "theoretical methods for determining the value of a professional license must be discarded in favor of more pragmatic and individual analysis based on the particular licensee's remaining professional earning potential." See, McSparron v. McSparron, 87 NY2d 275. In valuing licenses, "because the valuation method is driven by work-life expectancy, it produces its highest values precisely when the licensed spouse's earnings are at their lowest level and few tangible assets exist. Thus, trial judges and lawyers confront the challenge of making something out of nothing. . . ." See, Tippins, " O'Brien Revisited, a Contribution Solution to Classification," New York Law Journal, June 10, 2002.
To the extent that both counsel here have proffered diligent and efficacious preparation prior to trial, they have facilitated the remediation of potential valuation dilemmas of considerable significance.
ENHANCED EARNING CAPACITY
Enhanced earning capacity is the present value, after tax, of the incremental income an individual earns over his/her expected work life, which can be attributable to additional education or training achieved during the marriage. With respect to professional degrees and licenses, the incremental income is considered to be the difference between the expected earnings without the additional degree and license [base-line earnings] and anticipated income with the degree and license [top-line earnings].
"One of the most complex issues in valuation involves the assessment of risk. The valuator's quantification of risk is a crucial component of the valuation and should not be ignored because of its difficulty or subjectivity." See, Cercone, Jr., " Consideration of Risk in Valuation of Enhanced Earning Capacity," Brisbane Consulting Group, Matrimonial Newsletter, Dec. 1999. In my view, the Court must be vigilant and fervent in identifying and rejecting the expert report that fails to adequately detail facts unique to the license holder, which may impact the inherent risk of his/her career and stability of earnings stream therefrom. The greater the risk, the more that value is affected. The report/opinion that does not sufficiently address this, will cause an overstatement of value and flaw the equitable distribution to be had.
The notion that a 3% risk-free approach fails to consider the risks associated with attaining the annual earnings differential has been viewed with cogent criticism. In Philippou v. Philippou (New York Law Journal, Nov. 18, 1997) Justice Geoffrey O'Connell comprehensively articulated that the use of the risk-free rate with respect to the valuation of a physician's license ignored the basic elements of risk inherent in economic endeavors. The court succinctly noted that the use of a risk-free rate would pertain only in the most risk-free of investments and consideration must be given to client location, demographics, client persistence, direct as opposed to referral business, contractual relationships, reputation, facilities, work habits, managed care and other factors as may be appropriate. See, also, Jafri v. Jafri, 267 AD2d 352.
A 3% discount rate, to recognize risk, has been seemingly force fitted, but rotely accepted by many forensic accounting experts, as in the instant case. "Somehow, however, people have simply assumed that licenses are to be valued only as it was done in O'Brien v. O'Brien ( 66 NY2d 576), and only by using those theoretical parameters . . ." See, Florescue, " Kudrov, Matisoff: How Marital Agreements are Enforceable," New York Law Journal, March 16, 2005.
In O'Brien, the Court allowed a risk-free discount rate, which was computed at 3%. But, the testimony in O'Brien was uncontroverted and, as such, was the only information available for the Court to determine its valuation decisions. I categorically reject the blanket and arbitrary use of such 3% "risk-free" discount rates as "inherently flawed," in that:
1. Health issues and age may restrict the defendant's abilities to perform his duties to his full capacity.
2. Top-line and base-line earnings are nothing more than forecasts, which are always subject to a host of economic uncertainty.
3. The possibility of disability and early retirement are not accurately quantified in a risk-free rate.
4. Projected earning differentials are made with an "after tax basis," utilizing current tax rates, which change based upon political and budgetary considerations over the expected work life.
In the instant case before me, each of the litigants' experts have erroneously misapplied the 3% discount factor. While both parties have stipulated that these reports will be placed into evidence, neither report, in my view, provides sufficient detail, consideration or quantification of the "risk factors," or the circumstances unique to the license holder, so as to result in a significant overstatement of value. The fact sensitive nature of the defendant's status was either wholly ignored, or baldly placed within a range [3% — 7%] without appropriate amplification.
The meticulous care that is essential in determining values, is undermined when there is a failure to consider risk in the valuation of enhanced earning capacity. This was not done here, and in rejecting these reports that the parties have stipulated to put into evidence, I may reject one over the other ( Patricia B.V. Steven B., 186 AD2d 609) and, in this instance, I reject both, given the flawed valuation methodology utilized. Ferraro v. Ferraro, 257 AD2d 596.
THE COURT MUST DISTRIBUTE ASSETS
The Court does "not have the discretion to refuse to distribute property." Harrell v. Harrell, 120 AD2d 565; cf. LeVigne v. LeVigne, 220 AD2d 561. The rejection of the accounting methodology used here, and the missing values that are a consequence of such rejection, warrant my consideration of all approaches to facilitate appropriate findings "considering the circumstances of the case and of the respective parties." See, Domestic Relations Law § 236[B][5][c].
In addressing the issue of valuation, the Court of Appeals, in O'Brien v. O'Brien, 66 NY2d 576, tells us that "[t]he trial court retains the flexibility and discretion to structure the distributive award equitably * * * and, once it has received evidence of the present value of the license and the working spouse's contributions toward its acquisition and considered the remaining factors mandated by the statute (see, Domestic Relations Law § 236[B][5][d][1]-[10], it may then make an appropriate distribution of the marital property including a distributive award for the professional license if such an award is warranted." Towards that end, the trial court has broad discretion in fashioning an equitable distribution of marital assets (see, Kiprolova v. Kiprolova, 255 AD2d 362; Johnson v. Johnson, N.Y.L.J. Aug. 12, 2002). But, with a provident exercise of discretion comes an attendant obligation for the Court to "be mindful of the precedential, consequential and future effects of their ruling" (see, Lauer v. City of New York, 95 NY2d 95, 100) and to follow the express guidance provided by our Court of Appeals.
If "economic reality" is to be truly considered under the unique circumstances of this case, then a distribution of a percentage of earnings made by the defendant from his license for an appropriate period of time, would "tie everything to reality as it actually occurs." See, Florescue, " Kudrov, Matisoff: How Marital Agreements are Enforceable," New York Law Journal, March 16, 2005. This approach (see, also, R.R. v. P.R., 298 AD2d 169; Kutanovski v. Kutanovski, 120 AD2d 571), avoids "the potential for unfairness" in distributive awards for licenses as articulated by Judge Meyer's concurrence in O'Brien, while it simultaneously avoids those consequences when "wooden applications" of accounting formulas and theories are made without regard to common sense applications, as urged by Judge Smith's dissent in Holterman v. Holterman, 3 NY3d 1. Without resort to practical considerations, the theoretical accounting applications tangle into desultory speculation as to value — and this unwittingly converts equitable distribution into inequitable distribution. Moreover, mindful that a distributive award pursuant to Domestic Relations Law § 236[B][5][e] is not subject to change, this method of fashioning of an award of equitable distribution would not run afoul of this statutory prohibition. Instead, it would provide the recipient of such equitable distribution with an appropriate percentage of the income, as it continues to be earned by the license holder, as opposed to immediately "satisfying the non-titled spouse's claim against a hypothetical asset . . ." See, Tippins, supra.
This distribution model would reflect current payment for income derived from the license, a realistic antidote to a factually insensitive accounting projection of risk-free earnings potentials, that are frequently risk affected but always paid for — in advance.
The authority afforded by 22 NYCRR 202.18, enables this Court to appoint an "accountant, appraiser, actuary, or other appropriate expert to give testimony with respect to equitable distribution." Careful and prudent analysis, especially in the absence of the license value rejected here, mandates the appointment of an expert to provide the Court with all ramifications and appropriately detailed methodology, with respect to an assignment of a percentage of income, derived from the license of the titled spouse, to the non-titled spouse.
Counsel for both parties shall appear before me on April 13, 2005 for selection of an appropriate expert.
The careful exercise of discretion to determine license valuation on a case-by-case basis requires a hands-on, common sense approach and the circumspect avoidance of expert reports that "simply plug numbers into a computer model, generating a conclusion that ignores the facts of the case." See, Circone, Jr., Brisbane Consulting Group, Dec. 2001 Matrimonial Newsletter. Similarly, the discretion afforded to fashion an award of equitable distribution is broad enough to consider the kind of distributive award modeled in the instant case, to facilitate "economic reality in real time" in considering the "circumstances of the case and the respective parties." See, Domestic Relations Law § 236[B][5][c]; O'Brien, supra; McSparron, supra.
This constitutes the decision and order of this Court.