The California Societ of CPAs (CalCPA), at the request of the Litigation Sections Steering Committee and the Family Law and Business Valuation Sections, recently filed an application for leave to file a petition for rehearing, modification or depublication of opinion and supporting declaration (Petition) as amicus curiae with the California Supreme Court of Appeal (Court). The Petition responded to In re Marriage of Rosen (2003 DJDAR 921), in which the Court overturned a trial court ruling finding of goodwill in Bruce Rosen’s law practice. While CalCPA agreed with the Court’s finding of no goodwill, it disagreed with the Court’s rationale in arriving at that conclusion.
Two of the issues addressed in the Petition were: 1) the Court stated the appraiser “should have averaged Bruce’s earnings” in his calculation of normalized earnings, and 2) the Court questioned the use of compensation surveys to determine reasonable compensation.
Mrs. Rosen’s appraiser measured Mr. Rosen’s income using the highest of his recent years’ income. The trial court agreed, finding $42,500 of goodwill. The Court reversed, finding no goodwill in Mr. Rosen’s law practice. The court stated that earnings should be averaged over three years and was critical of the appraiser’s work and commented that “a reasonable trier of fact could not help but conclude the expert chose to use Bruce’s net income from 1995 – one of Bruce’s highest earning years – solely to inflate the value of goodwill.”
While it appears appropriate to use the average of the three years prior to the date of separation, in this case the wording of the decision may have precluded experts from exercising their judgment in deciding whether or not to use an average.
There are circumstances when the use of an average would not result in the best estimate of the normalized earnings, such as when the earnings have been steadily increasing and are expected to continue rising, or steadily declining and expected to continue declining.
The Court was also critical of the role of compensation surveys in determining reasonable compensation. The Court opined that the surveys used by Mrs. Rosen’s expert (RMA and Altman Weil) were not “statistically accurate” and should, therefore, not be used. The Court was on firm ground in its criticism of Mrs. Rosen’s appraiser’s lack of thoroughness and possible bias, and therefore reversed the trial court’s conclusions.
The Court’s working on this point, however, was troubling to CalCPA. CalCPA believes that compensation surveys are valuable sources of evidence and if properly used can, and should, be allowed in business appraisals.
Although the Court denied CalCPA’s petition for rehearing and depublication, it granted the petition for modifications.
In response to CalCPA’s comments, the opinion was modified to state, “[u]nder the facts presented in this case, the expert should have averaged Bruce’s net earnings.” This removed the requirement to average and allows appraisers flexibility in deciding the most appropriate estimate of normalized earnings.
The Court also modified its opinion regarding surveys. It removed its reference to statistical accuracy and added, “We do not disapprove of compensation surveys as a general matter. We realize they can be useful when used properly.” The Court retained its question of “whether a national survey of lawyer compensation (such as the Altman Weil survey) is a proper basis for offering an opinion on average lawyer compensation in Southern California.” This comment by the Court has merit, but the cited survey, Altman Weil, in addition to national averages, contains compensation information describing industry specialty, geographic location, size of firm, billing rates, billable hours, years in practice, etc. In the modification, the Court reasoned, “[t]he expert did not attempt to relate the information in the surveys to an analysis of Bruce’s law practice.”
The lesson for the appraiser is to correlate survey data to the subject case. The Court’s modified opinion now provides guidance and caution on the use of surveys, not their prohibition, which was one of the thrusts of CalCPA’s petition.
Two of the issues addressed in the Petition were: 1) the Court stated the appraiser “should have averaged Bruce’s earnings” in his calculation of normalized earnings, and 2) the Court questioned the use of compensation surveys to determine reasonable compensation.
Mrs. Rosen’s appraiser measured Mr. Rosen’s income using the highest of his recent years’ income. The trial court agreed, finding $42,500 of goodwill. The Court reversed, finding no goodwill in Mr. Rosen’s law practice. The court stated that earnings should be averaged over three years and was critical of the appraiser’s work and commented that “a reasonable trier of fact could not help but conclude the expert chose to use Bruce’s net income from 1995 – one of Bruce’s highest earning years – solely to inflate the value of goodwill.”
While it appears appropriate to use the average of the three years prior to the date of separation, in this case the wording of the decision may have precluded experts from exercising their judgment in deciding whether or not to use an average.
There are circumstances when the use of an average would not result in the best estimate of the normalized earnings, such as when the earnings have been steadily increasing and are expected to continue rising, or steadily declining and expected to continue declining.
The Court was also critical of the role of compensation surveys in determining reasonable compensation. The Court opined that the surveys used by Mrs. Rosen’s expert (RMA and Altman Weil) were not “statistically accurate” and should, therefore, not be used. The Court was on firm ground in its criticism of Mrs. Rosen’s appraiser’s lack of thoroughness and possible bias, and therefore reversed the trial court’s conclusions.
The Court’s working on this point, however, was troubling to CalCPA. CalCPA believes that compensation surveys are valuable sources of evidence and if properly used can, and should, be allowed in business appraisals.
Although the Court denied CalCPA’s petition for rehearing and depublication, it granted the petition for modifications.
In response to CalCPA’s comments, the opinion was modified to state, “[u]nder the facts presented in this case, the expert should have averaged Bruce’s net earnings.” This removed the requirement to average and allows appraisers flexibility in deciding the most appropriate estimate of normalized earnings.
The Court also modified its opinion regarding surveys. It removed its reference to statistical accuracy and added, “We do not disapprove of compensation surveys as a general matter. We realize they can be useful when used properly.” The Court retained its question of “whether a national survey of lawyer compensation (such as the Altman Weil survey) is a proper basis for offering an opinion on average lawyer compensation in Southern California.” This comment by the Court has merit, but the cited survey, Altman Weil, in addition to national averages, contains compensation information describing industry specialty, geographic location, size of firm, billing rates, billable hours, years in practice, etc. In the modification, the Court reasoned, “[t]he expert did not attempt to relate the information in the surveys to an analysis of Bruce’s law practice.”
The lesson for the appraiser is to correlate survey data to the subject case. The Court’s modified opinion now provides guidance and caution on the use of surveys, not their prohibition, which was one of the thrusts of CalCPA’s petition.
