An Open Letter to the Judiciary Concerning the State of Business Valuation


I recently had the opportunity to attend the Fourth Annual Valuation Summit hosted by FMV Opinions. Lance Hall was the speaker, and he did an outstanding job. In fact, Lance inspired me to pen this open letter to the judiciary concerning the damage that it is doing to business valuation as applied to the courts that decide tax disputes. Nevertheless, the following words are mine, and mine alone, so don’t blame anyone else. These words are based upon a long history of paying critically close attention to business valuation in the courts. While my words may be acerbic, remember that they are lovingly delivered—tough love, if you will.
This is a letter that I might not have written had I still been practicing law and possibly having to appear before some of these judges, because I plan on naming names and calling out courts, although I was fairly gutsy in criticizing courts in print when I was in practice. But I’m not. I also can understand why business appraisers who might have to defend their opinions before these very courts also wouldn’t want to go on written record as criticizing these esteemed members of the bench. However, I’m only doing this because I care deeply about preserving business valuation, which remains in its infancy as a profession, still splintered along the lines of accounting, finance and general business.
At the outset, judges, let me say that I feel your pain. I know that your day is not filled with joy or ease. Nor are you highly paid. Your dockets are crammed with routine type cases like liens and collection matters or immigration and hunting violations. Valuation disputes come across only every so often, and you detest them. Nevertheless, how you’re handling business valuation cases right now is damaging business valuation. So please give heed to my advice.
In short, it needs to stop. Seriously. Right now. I give some further reasons and examples below.
Increase the number of Daubert exclusions. The United States Supreme Court made you the “gatekeepers” of expert witness evidence. However, this did not mean that you are now also experts who, but for your hallowed robes, would also be passing through the same gate. To date, although there are some signs recently that this is changing, at least in the Tax Court, you have done a poor job of gatekeeping function in business valuation cases, opting instead to take on the cloak of super appraiser, divining between theories and conclusions reached by the appraisers to arrive at your own conclusions, usually cherry-picked from bits and pieces of the work of the opposing appraisers, understandably because you don’t have the education or training to be appraisers. As I will describe in painstaking detail below, this practice has led to some highly nonsensical, even Frankensteinesque results.
In short, although you lack the certifications, training and education necessary to be appraisers, you have become appraisers by personal fiat. This is literally turning business appraisal theory on its ear. I firmly believe that your job is to only evaluate the experts’ credibility and conclusions, not to launch off into either a haranguing of an appraiser or a half-baked nitpicking and choosing between the work of the two appraisers in the mistaken belief that this will “split the baby.” (I’ll also give kudos where they are due, and they go to Judge Swift of the Tax Court, who purposefully makes it a practice to not name the appraisers in his opinions.)
You are the gatekeepers. Then keep the gate. If you suspect an appraiser of significant bias, instead of admitting the report and testimony with reservation and resentment and then taking that resentment out on the appraiser in your opinion, simply refuse the evidence and testimony under Daubert and its progeny. I guarantee you that the “bias” that you are allegedly seeing will disappear. Pronto. In my almost 20 years of practice, I must admit that I never saw even one iota of bias from the appraisers that I hired, and I believe that this is true from most other tax lawyers. The business appraisers simply resisted our indirect coaxing in that regard because not one engagement does that appraiser’s career make. But you say that you are seeing bias from business appraisers from both sides though, so I’ll take that at face value.
I strongly assert that the effect of your collective actions increases, rather than decreases, so-called bias, because appraisers play to the court’s out of tune rather than to the melody of sound business appraisal practice. So does your seemingly intractable belief that the truth must lie somewhere between the conclusions of the opposing appraisers. The valuation gymnastics that you go through to get to a middle position are ugly and very problematic. Pick a winner. And simply say why the winning appraisal report prevailed.
If the appraisers for both sides do something one way, that way might be supportable. Say what you will about business appraisers, but, in my humble opinion, the quality of business appraisal work has increased by leaps and bounds over the past 20 years. During that time period, business appraisal standards have proliferated, and practices have begun to coalesce. Therefore, help nurture them along. When appraisers for BOTH sides do something a certain way, think long and hard before you simply dismiss it out of hand, especially if your reason is prior court jurisprudence. Just because some non-appraiser judge in the past either didn’t understand or didn’t care for the way that the method was used by one appraiser in one situation is no reason to reject the method. Stare decisis is no way to deal with business valuation methodology.
Prior court precedent is no way to set business valuation practice rules. For example, in the area of tax-affecting S corporations, this is routinely done in business transactions every day. However, tax-affecting has a black eye, at least in the Tax Court, because of two cases, Gross and Heck, in which tax-affecting was probably inappropriate under those facts. However, the Tax Court blew it in the Dallas case by not permitting tax-affecting in a case in which it was clearly advisable, solely because it wasn’t done in the two prior cases in which tax-affecting wasn’t appropriate. That doesn’t make any sense.
Consequently, the Tax Court summarily rejected tax-affecting in two recent decisions, Gallagher and Guistina, also due to prior precedent. Again, that doesn’t make any sense. In fact, it is reckless and troublesome because it encourages gamesmanship in valuation disputes and puts business appraisers in a very difficult position of having to go against generally accepted appraisal practices and principles, which they shouldn’t have to do. Frankly, the Tax Court is starting to look like the Flat Earth Society on tax-affecting.
The same is true with respect to business valuation theories like CAPM and WACC, just because some non-appraiser judge rejected the methods in the past is no reason to summarily dismiss them or even cast aspersions on them, like in the Gallagher opinion. While neither methodology is perfect, both are sound and supported by a bevy of finance research. Business appraisal remains part art, part science. And rejecting the methods because they might be difficult to understand is no excuse to do so either.
Resist simplicity in some situations. While I normally support the notion that simple is better, it doesn’t always work. For example, the “bright line” test that the Fifth Circuit enunciated in Dunn and followed by the Eleventh Circuit in Jelke regarding the dollar-for-dollar reduction in valuation for the tax on built-in capital gains is simply too good to be true, makes little sense and violates the fair market value standard. You are effectively forcing appraisers to do something, i.e., deduct the projected capital gains tax liability dollar-for-dollar, that they know is contrary to generally accepted business appraisal practices, which is just wrong.
A special word for those judges who want to be valuation gurus. It seems as if some members of the Tax Court are trying to take up the mantle of Tax Court business valuation guru. Resist this urge. Mightily. For example, the Gallagher opinion was chock full of problems that are making lots of business appraisers wince. I read both appraiser’s reports from that case, and while some of the problems pointed out by the court were indeed there, the opinion didn’t bother to go into much detail about why the court had problems with a particular aspect of the report other than to say that you did, i.e., little rationale, which is exactly what the opinion railed against. One can’t have it both ways. While I can’t quarrel much with the end result in Gallagher, how the court got there sends the wrong signals to the business appraisal community, which I’m sure that the court didn’t want to do. Resist making the mistake of Icarus; one can get too close to the valuation sun.
Off of my soapbox. I’m done. Thanks for reading! Hopefully, you all will take this criticism to heart and are not offended. Nevertheless, I couldn’t resist saying publicly what is on the minds of lots of folks right now.
Paul

About lpaulhoodjr

I am an inactive lawyer who practiced almost 20 years as a tax and estate planning lawyer. Today, I am the Director of Planned Giving for The University of Toledo Foundation. I am the co-author of four books, the sole author of another book and a frequent speaker and writer on estate planning, planned giving and business valuation.
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