David Fein sat down with Michel Molder, who is responsible for reviewing and submitting the cases to the Case Law database, to get a behind-the-scenes look at this valuable database.
Case Law and Legal Precedent for Business Valuation
When a case is filed in either state or federal court, it is assigned to a judge, and knowing which judge and how valuation matters are treated in their jurisdiction is a big advantage. By staying on top of case law and legal precedents, valuators put themselves in a position for more strategic preparation and decision-making.
“Knowing how a court and judge will handle matters around business valuation ahead of time can completely change the approach used to ensure best results,” says Michael Molder. “For example, there was a decision out of the Chancery Court in Delaware where around 70% of what they do are business disputes and shareholder cases, called Delaware MRI. In this matter, the judge was not satisfied with the valuation of either expert because he didn’t like the way they handled the income tax issue as it was a pass-through entity. In the judge’s opinion, he gave a complete analysis of the tax ramifications on value for pass-through entities.”
By reading this opinion, the valuator can be sure of how such a valuation should be handled. Some courts have adopted Delaware MRI, and other courts have gone a different route regarding how they want taxes to be treated in valuation.
“Another big one is divorce. In family law in some states, the valuation of a business is done in a very antiquated way that is completely inconsistent with everything that we do as a profession,” says Michael. “Other states look at it and say, if there’s any goodwill at all, it can’t be distributed, which doesn’t make any sense. Other states, like Pennsylvania, carve out personal goodwill.”
“Then some states look at hard assets, essentially, and the identifiable intangible assets, and then to the extent there’s value over and above those things, it is often sort of lumped together as goodwill,” says Michael. “Certain businesses may have a dominant owner, where some of the business’ value may be tied up with that individual and their customers because of their personality. And to the extent, there’s personal goodwill it needs to be separated from enterprise goodwill.”
How it Works
Search results in the Case Law Database show a three or four-sentence summary of the topics the opinion discusses. “When you do a search for personal goodwill, you can drill down to look at cases in a specific state, say Virginia,” says Michael. “The database will give them, say, three or four cases about personal goodwill in Virginia, and then they have to pull up the opinions and read through them.”
The type of information available on each case varies and but the valuator can get an understanding of both the judge’s perspective as well as potential details about valuation-specific comments. The real value to valuation and financial forensics experts is that the court is telling you which things they find problematic about the analysis.
Difference Between Winning and Losing
“For example, there is a case in the database that involved an architect who was hired for a very large project which was divided into seven phases,” says Michael. “This architect was hired for the first two or three and then they decided to go with a different architect for the rest of them, but they still used the original drawings and material from the first few phases as part of their development of the later phases. This upset the architect and she decided to sue for lost profits, not having done the full project.”
During the case, the judge picked her case apart because she didn’t have an expert perform her damages analysis and explain the things that were problematic about what she was claiming as lost profits. Anybody reading his opinion would now understand what this judge wants to see.
Sale of a Surplus School Building
“Another good example is a case I had in Michigan where the school district had arranged a deal to sell a school building, they no longer needed to a church group who wanted to turn it into, among other things, a daycare center,” says Michael. “The transaction ended up falling through and I was approached to deal with the damages.”
The plaintiff claimed they were entitled to lost profits. The most significant issue is the new business rule which traditionally says that a non-established business, a new business cannot claim lost profits because future profits would be speculation. You can only claim lost profits if you can ground that in your experience of generating profits.
“This is a general rule, but each State has its own little twist to how it’s treated. If I were retained for the case as a valuation person, then I would go to that database and search for Michigan and new business rule or lost profits and see what kind of cases come up so I can learn what Michigan courts have said about the ability to claim lost profits,” says Michael.
Judges follow legal precedent and if there isn’t legal precedent because the court has never dealt with such a matter, then they will look for guidance from other courts that have handled similar matters. If valuators apply this same principle and research legal precedent in a particular jurisdiction, they will have a good idea of how their valuation will be scrutinized.
The database also includes the names of the judges. “If I get brought into a case in the Eastern District of Pennsylvania and it’s Judge Smith, I can search of the database in federal cases in Pennsylvania with Judge Smith and it will bring up whatever cases exist in the database for that judge,” says Michael.
Piercing the Corporate Veil
“Another case I can share is one that involved holding people liable where they have claimed that they are protected,” says Michael. “This case involved a carpet installer and the person who arranged the deal and would be footing the bill. The carpet seller had a relationship with the landlord, and someone was hurt on the premises. The installer didn’t have employees doing the installation, they had independent contractors.
“The lawyer brought me in to analyze A, whether these independent contractors are actually independent contractors versus being employees and B, whether the installer is actually a separate entity, or is in fact a division of the company that sells carpet,” says Michael. “Using the database as a guide can help with discovery and gathering the information needed to carry out an analysis of whether or not they have an argument.”
IRS and State Tax Case
Understanding the nuances of inheritance tax cases or state law estate tax cases could help bolster an argument. But if you were just looking at IRS decisions, you’d be taking a tunnel vision approach. The strategic approach involves taking a broad look at case law and legal precedent.
“In commercial litigation, in particular, I was doing securities fraud cases and the first thing we would do is say, okay, Judge Wagner in the Northern District of California — do a search for Judge Wagner in the Northern District of California and Section 10(b) of the Exchange Act because that’s the subject area of that case,” says Michael. “This pulls up all the decisions and you go through those decisions and see where that judge falls on deciding things. Some judges are more inclined to value credentials and expertise, and some really want to see the details. So, it depends.”
When to Get Counsel
“Valuation professionals would use the case Law database as guidance, but it is not a replacement for a law degree and license, particularly in litigation engagements,” says Molder. “The valuation and financial forensics professional would still need to review legal precedent with retaining counsel for a number of reasons, including counsel’s understanding of legal issues that may differ between the judicial opinion and the subject controversy.”
About Michael Molder
Michael started out at Pennsylvania State University’s Accelerated Medical Program but soon realized becoming a doctor wasn’t for him, so he decided to go into accounting.
After a few years in public accounting, Michael went to law school at night. “When I graduated from law school, I started practicing in complex commercial litigation,” says Michael. “After roughly seven years, my partner and I parted ways. My favorite part of being a lawyer was developing and analyzing the story. What I didn’t like was the bickering about who was going to be deposed and whether a document will be produced and when we could expect answers to things.”
Michael went back to accounting, doing what started as financial forensics and fraud investigations. The advisory practice he joined did business valuation, which led to Michael becoming a CVA. Michael’s unique combination of being a lawyer, accountant, and valuator, makes him an all-rounder who can compile the right kinds of legal data for valuators.