A. DISSOLUTION WHEN CLIENT IS NOT LIQUID
1. What is Liquidity?
Investopedia describes liquidity as the “degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price.” Generally, people will classify assets such as cash, stocks, bonds, and similar investments in taxable accounts as liquid and assets like real property or a business as nonliquid.
However, it may be more helpful to think of liquidity on a scale. Obviously, cash is the most liquid asset one can have, it is the gold standard. From there, assets become less liquid because there are obstacles when it comes to selling them and converting them into cash. Stocks, bonds, mutual funds, and other investments in taxable brokerage accounts are liquid because there is an active market for them and they can be converted into cash quickly, but there are tax implications associated with selling them. The same investments in a retirement account would be less liquid because there are restrictions such as tax penalties on withdrawals. Personal property items such as vehicles, artwork, firearms, jewelry, antiques, and collectibles are generally nonliquid, but the degree of their liquidity will depend on how active the marketplace for the items is. Similarly, real property is usually classified as a nonliquid asset owing to the fact that it could sit on the market for months or longer before it is sold. Ownership of a business is another example of a nonliquid asset.
2. Why Does Liquidity Matter?
The easy answer is that the Virginia General Assembly has said liquidity matters. Virginia Code § 20-107.3(E)(8) instructs the Judge to consider “the liquid or nonliquid character of all marital property” when making an equitable distribution award. The underlying reason being that nonliquid assets will not be of much use to a person if they do not have the liquid assets to cover short term expenses.
In an extreme scenario envision a divorce where the Husband is awarded the house (with equity of $75,000) and the Wife is awarded the joint bank account with a value of $75,000. On paper the values equal each other, but for Husband to have control over that $75,000 he would need to sell the house. In the meantime, he may not be able to pay short term living expenses whereas the cash received by Wife affords her greater flexibility.
In other words, liquidity matters because $10,000 in cash is not the same as receiving a car with a Kelly Blue Book value of $10,000.
3. Considerations When a Client is Not Liquid
When a client is not liquid or has limited liquidity, it is important to consider their cash flow post-divorce. A client may have a sentimental attachment to the marital residence and may be willing to give up significant liquid assets to retain it, but if the post-divorce cash flow is not sufficient to cover the expenses associated with the home, it will be of little value and need to be sold anyway. It is important that a client receives an adequate share of liquid assets to ensure positive cash flow post-divorce. If sufficient liquid assets are not available ensure the client has a plan to liquidate the assets received.
Another significant consideration is the tax consequences and transaction costs of retaining nonliquid assets. Generally, every time an individual liquidates an asset it will create a taxable event. Investments will have a capital gains tax and early withdrawals from retirement accounts a penalty. Proceeds from selling real property will be exempt up to a limit, but there are costs associated the realtor’s commission. Similarly, when selling personal property items there may be a consignment fee or cost associated with maintaining the property before it is sold. This is why you generally cannot equal a cash amount with a value amount for a nonliquid asset unless that value has incorporated the additional tax and transaction costs associated with liquidating the asset.
Finally, an additional important consideration is ascribing accurate valuations to nonliquid assets. Part of this process will be taking into account the tax consequences and transaction costs previously discussed, but it will also be important to identify the appropriate expert witnesses (appraisers, business valuation experts, etc.) if necessary.
4. Virginia Courts on Liquidity
In Sidall v. Sidall, the Richmond Circuit Court was tasked with distributing a nonliquid asset (a business) and compensating the other party with a cash award:
Siddell, Matus & Coughter, Inc. (net value: $ 558,600) -- This item, the husband's advertising firm, is the most hotly-contested item in this action, both in terms of value and distribution. While the second question is relatively easy, the first one is not.
Siddell, Matus & Coughter is a full-service advertising agency located in Richmond with approximately 43 employees. It has an excellent reputation and has been in business for over 20 years.
The wife asks that she be awarded 60% of the firm to compensate her for the contributions which she made to it, particularly in its early years, those contributions having been referred to earlier in this opinion. While the court recognizes those contributions, and believes that those contributions and the others which she made throughout the marriage entitle her to 50% of the total value of the parties' assets, the court concludes that it is not in either of these parties' best interests to award her any portion of the husband's advertising business. The court cannot imagine that these parties, whose long-standing marriage has ended in bitterness and acrimony, can now work together to maintain the level of success that the business has enjoyed. Accordingly, 100% of the husband's interest in the business will be awarded to the husband. Of course, this does not mean that the wife will be left with nothing, and the court will order a cash award to her to compensate for the award of the business solely to the husband.
With regard to the value of the firm, each party presented an expert witness, each of whom the court found to be fully knowledgeable and competent in his field. In fact, using what they called the "discounted cash flow" method of valuation, their estimates of the husband's share of the business were very close to each other. Specifically, the husband's expert valued the husband's interest at $ 35.75 per share of stock owned by the husband. The wife's expert valued the husband's interest at $38.94 per share. While the husband's expert stated that one of these values should be accepted by the court for equitable distribution, the wife's expert went further. He considered two additional factors -- comparable transactions and the husband's recent purchase of stock from one of the original principals in the firm -- to come up with a proposed valuation of $ 57 per share. The court accepts the valuation made by the wife's expert.
The experts' testimony was lengthy and detailed. The wife's expert submitted a 24-page report with eight exhibits totalling another 150-200 pages. The court will not attempt to state or even summarize those analyses and testimony here. The court does believe, however, that a consideration of acquisitions of similar businesses and, to a greater extent, the price paid by the husband in May, 1995, to buy out the last remaining original principal of the firm other than himself, give a truer picture of the firm's worth. That value, $ 57 a share, will be used.
The parties also disagree on the number of shares owned by the husband which should be used in determining the value of his interest in the business. The court finds that the husband owned 9,800 shares when the parties separated, and that is the number of shares which the court will use in determining his interest. While the husband also owned shares of the firm in his employee stock ownership plan, that item will be considered and distributed separately. The court also does not include the shares purchased by the husband in May, 1995, since that transaction occurred after the parties' separation. Thus, the value of the husband's interest in the firm is $ 57 times 9,800 shares, or $ 558,600. That value will be used for equitable distribution purposes.
Cash Award - One of the most difficult aspects of this case is the fact that there simply are insufficient liquid assets to make a nice, neat distribution of 50% of the marital property to each party. Accordingly, the court will order the husband to make a cash payment to the wife of $ 256,414. By ordering this payment, the court brings each parties' share of the marital property to 50%, which is the court's intention.
In ordering this cash payment, the court is aware that the husband does not presently have the cash to satisfy it. He does, however, have several options. For example, he can explore the possibility of liquidating his 401(k) and stock ownership plans. He may also seek a new principal in his firm. If all else fails, the court will favorably consider periodic payments as a means of satisfying the award. Rather than setting the amount of such payments now, however, the court will allow the parties an opportunity to negotiate a mutually agreeable plan. If the parties cannot agree, the court will impose a schedule itself. Sidall v. Sidall, 1996 Va. Cir. LEXIS 596.
In Brake v. Brake, the Virginia Court of Appeals affirmed the trial court’s valuation of Husband’s interest in a law firm and the court’s decision that Husband would to have to compensate Wife for her share in cash instead of a portion of his 401(k) by Qualified Domestic Relations Order:
In making its equitable distribution award, the trial court specifically found: "There is no tax consequence in granting wife her marital share of the ten percent interest in [the law firm]." Husband asserts on appeal that there would be tax consequences if he were to withdraw funds from his 401(K) in order to pay wife. He notes that the trial court found his 401(K) was a liquid, marital asset, whereas his ten percent interest in the law firm and the parties' real estate were non-liquid, marital assets. He contends the trial court erred in not permitting him to pay wife her share of the equitable distribution by use of a QDRO because that method of payment would eliminate the penalties and tax implications that would result from his withdrawing cash from his 401(K).
During the hearing, the trial court never directed or suggested that husband withdraw funds from his 401(K) to pay wife the equitable distribution award. The trial court noted several times that husband had recently received a bonus of $124,000 and that, as a shareholder in the law firm, he would be entitled to future distributions. Further, the trial court asked counsel, "But where . . . is the law that says the [c]ourt has to consider whether he has an ability to pay it, whatever it is?" Husband failed to produce any legal basis in support of his argument.
In denying husband's motion asking it to reconsider its equitable distribution award, the trial court did not order husband to pay wife by way of a QDRO. However, it did extend the deadline for husband to pay wife her share of the equitable distribution award, giving husband the option of paying the full amount by June 30, 2013 or paying in three annual installments, plus interest, by June 30, 2015.
Our review of the record on appeal does not establish that the trial court abused its discretion in applying the statutory factors in Code § 20-107.3 when determining its equitable distribution award. We conclude that the trial court did not err in denying husband's motion for reconsideration, except for the method of payment. Brake v. Brake, 2014 Va. App. LEXIS 126.
B. DISABILITY/PERSONAL INJURY AWARDS: PAST/FUTURE LOST WAGES AND PAIN AND SUFFERING
1. Supplemental Security Income (SSI)
SSI is a benefit based on financial need and is calculated based on the financial resources available to the recipient. Often it can increase post-divorce because the former spouse’s financial contributions are no longer part of the equation. However, if the recipient begins to receive spousal support that will be taken into account for the calculation.
2. Social Security Disability Insurance Benefits (SSDI)
In contrast to SSI, SSDI benefits are derived from the recipient’s record of earnings. A disabled individual paid payroll taxes or had self-employment tax deductions from their income which funds the monthly SSDI benefit. Because the SSDI benefit is based on the individual’s own work history it should not be impacted by divorce.
3. Military Disability
Military members may waive a portion of their retirement benefits in lieu of receiving disability pay. The Supreme Court has ruled that the disability pay is not divisible under the Uniformed Services Former Spouses Protection Act (USFSPA) and neither is the amount of retirement waived. In other words, a court will only consider the difference between the retirement pay and the disability pay as divisible. This creates an enormous incentive for retired service members to elect disability pay.
To stop service members from electing disability after the fact, Property Settlement Agreements can indemnify the former spouse from any change in the retirement amount he/she is set to receive. A service member can also agree not to take any action that would diminish the amount of retirement the former spouse is set to receive. The Court of Appeals of Virginia has upheld these types of provisions and the court may even imply an indemnification provision.
4. Personal Injury Awards
Since 1990, personal injury awards (and worker’s compensation awards) have been governed by Virginia’s equitable distribution statute, Virginia Code § 20-107.3. Specifically, provision A(3)(c) states that, “In the case of any personal injury or workers' compensation recovery of either party, the marital share as defined in subsection H shall be marital property.” Subsection H states:
H. In addition to the monetary award made pursuant to subsection D, and upon consideration of the factors set forth in subsection E, the court may direct payment of a percentage of the marital share of any personal injury or workers' compensation recovery of either party, whether such recovery is payable in a lump sum or over a period of time. However, the court shall only direct that payment be made as such recovery is payable, whether by settlement, jury award, court award, or otherwise. "Marital share" means that part of the total personal injury or workers' compensation recovery attributable to lost wages or medical expenses to the extent not covered by health insurance accruing during the marriage and before the last separation of the parties, if at such time or thereafter at least one of the parties intended that the separation be permanent.
Breaking down the statute, there are three important components. First, the statute classifies personal injury awards as hybrid property (part marital and part separate). The marital share is the portion that stems from lost wages or medical expenses not covered by health insurance that were incurred during the marriage. Second, once it is established that there is a marital share of the personal injury award, at that point the court may award a percentage of the marital share to the other spouse. When making that determination the court looks at the factors in § 20-107.3(E). Third, if there is a marital share and if the court awards a percentage of the marital share then it must direct payment to be made as the recovery is payable. In other words, the person recovering the personal injury award will not be forced to front the portion awarded to a spouse in a divorce before receiving it.
After the legislative amendments, there were two important questions left for courts to determine: (1) Is the non-marital portion of the personal injury award automatically separate property; and (2) Who has the burden of proof for showing that there is a marital share of the personal injury award. Both questions were addressed by the Virginia Court of Appeals in Chretien v. Chretien. In Chretien, the Court held that any remaining portion of the personal injury award that does not meet the definition of marital share from subsection H is separate property. The Court stated that, “the circuit court must first determine what part of the recovery was attributable to lost wages and medical expenses not covered by healthinsurance, and classify this portion as marital property. The remainder of the recovery, if any--that portion not ‘attributable to lost wages or [unreimbursed] medical expenses’– is separate property.” Chretien, 53 Va. App. 200, 205 (2008).
As to the second question, the Court found that party seeking to show that part of the personal injury award is separate property bears the burden of proof. That is because there is a presumption that property acquired during the marriage is marital. In Chretien, the Wife (the person that received the personal injury award) did not submit any evidence showing that the award was attributable to lost wages and unreimbursed medical expenses so the Court held that the entire award was marital. Regardless, the Husband did not receive any portion of the award because the trial court evaluated the factors in § 20-107.3(E) and directed the entire award to Wife.
For a family law attorney handling a divorce case where a personal injury award is at issue it will be important to target information such as underlying losses, claims, settlement statements, medical bills, and wage loss summaries in discovery. Much of the useful evidence might be available from the underlying personal injury case. For an attorney representing the injured spouse it would be important to ensure any personal injury award includes a breakdown of the portion attributable to lost wages or unreimbursed medical expenses.
A personal injury award for pain and suffering would not be classified as marital property, but the injured spouse would have the burden of proving the amount attributable to pain and suffering. Cunningham v. Cunningham, 1996 Va. App. 524.
C. UNIQUE ISSUES IN FARM DIVORCE
When a spouse or the parties own a farm, it can present unique challenges for the division of assets. Generally, farms can be treated like businesses, but with their own quirks and there is often sentimental or emotional attachment to the farm.
The first step when you encounter a farm in a divorce is to familiarize yourself with the assets and debts of the farm. Farm assets generally include: livestock, growing crops, stored crops, machinery, land, the homestead, buildings, improvement and other farm implements. The farm may also utilize federal, state, or local farm assistance programs (subsidies) that can add value to the farm. Farm debts often include mortgages on the land and/or homestead, as well as loans for machinery and operational expenses. Tax debt should be assessed as well. When searching for hidden assets it can be helpful to use discovery to request documentation including: grain production and expense records, USDA records, crop insurance records, commodity credit loan records, loan records, hedge contracts, and warehouse receipts.
Farms can also present unique challenges due to their ownership structure. Often, they are family run operations that may have been owned by the same family for multiple generations. For instance, in Brown v. Brown, the Virginia Court of Appeals described the ownership of the farm at issue by stating, “This farm had been in his family for several generations. The husband acquired a one-half interest in the farm from his father by deed dated December 23, 1975. At this time, the husband assumed an obligation jointly with his father for payment of a loan secured on the property in the amount of $ 194,830. The father filed a gift tax return in 1975 stating that the value of the property was $ 239,161, and the value of his gift to his son resulting from the conveyance was $ 22,165… In an earlier transaction, the husband's father gave the parties, by deed of gift, a five acre portion of the farm on which the parties subsequently built their marital home.” Brown, 5 Va. App. 238 (1987). In Brown, the Husband argued that his share of the farm was his separate property because it was a gift from his Father. The Court disagreed because “that the husband paid less than full consideration in purchasing the property does not alter the fact that he did pay valuable consideration. Further, we find that his father's treatment of eighteen percent of the transaction as a gift for tax reasons does not change the transaction from a sale to a gift for purposes of equitable distribution.”
Husband also attempted to show that his partnership interest in the farm operation was his separate property. Again, the Court disagreed as it found that the trial court properly evaluated the evidence presented before determining that the partnership interest was marital. Wife’s evidence that the partnership interest was marital included: (1) that Husband received a salary from the farm operation before the marriage; (2) that Husband and his Father did not establish a partnership account until after the date of marriage; (3) a tax form showing that the partnership was created after the date of marriage; and (4) Husband’s Father’s testimony that the Husband would have to earn his partnership interest.
In other ownership situations, farms are held in trusts for the benefit of future generations. In Spreadbury v. Spreadbury, the farm at issue was placed in a trust for the benefit of the parties’ children. Spreadbury, 2010 Va. App. LEXIS 151. At the trial court level the parties’ children filed a Motion to Intervene in the divorce action because they had equitable title to the farm. The trial court denied the motion on the basis that since the parties’ children were not parties to the divorce action any issues regarding the trust could be addressed in separate litigation which would not be precluded by equitable distribution made as a part of the divorce action. On appeal Wife argued that the trial court erred in including the farm in its equitable distribution award because it was subject to unresolved third party ownership claims and was owned by a trust and therefore was not marital property. The Court rejected her argument because Husband’s evidence indicated that the farm was held in a revocable trust. “The evidence presented by husband supported the trial court's determination that Westbury Farm was held in a revocable trust. Thus, under Kelln, the parties' retention of the right to revoke the trust supports the conclusion that the property remained marital and subject to equitable distribution. Accordingly, the trial court did not err in dividing the parties' interest in Westbury Farm.”