Dental Practice Divorce Valuation Upended in Bankruptcy

Dental Practice Divorce

Dental Practice Divorce Valuation Upended in Bankruptcy

When a dental practice divorce valuation is used to divide marital property, the valuation might not apply for other purposes. That’s the conclusion reached by a federal bankruptcy court recently when deciding whether to approve a Chapter 13 restructuring plan in which the dentist would pay 22 cents on a dollar to creditors, including his ex-wife. When the bankruptcy court rejected the plan, the dental practice owner ended up paying more than he thought he would.

In re Cole, 2016 Bankr. LEXIS 932 (March 24, 2016)

Dr. Cole was a 25% owner of a dental practice in Virginia. When his wife divorced him, Dr. Cole was ordered to pay $38,000 in support arrears, $4,000 per month alimony, and $70,000 in legal fees. Dr. Cole filed a Chapter 13 petition in bankruptcy court two months after his divorce was final.

The bankruptcy court found that it was not bound, under principles of res judicata, by a dental practice divorce valuation that was adopted by the Virginia court.  The Virginia divorce court applied an “intrinsic value” standard for valuing marital property.  The Bankruptcy Court, on the other hand, applied a liquidation value standard to decide whether to approve a Chapter 13 debtor reorganization plan.  The bankruptcy test for approving a Chapter 13 plan is whether the plan would deliver more value to creditors than a Chapter 7 liquidation.

Dental Practice Divorce Valuation

In this case, the divorce court chose the dental practice divorce valuation of wife’s expert over husband’s expert when valuing the business.  The husband/dentist’s expert used a net asset approach that yielded minimal value ($15,782).  Wife’s expert testified that the customer lists had intangible value, which was quantified as a going concern under an income approach ($212,000).

When the dentist filed his bankruptcy, he listed his business at its minimal net asset value in his petition.  Wife and the trustee objected when the dentist attempted to partially discharge his unsecured debts (including his divorce obligations to wife) under a Chapter 13 plan that would have paid 22 cents on a dollar.  In deciding whether to approve the Chapter 13 plan, by comparing it to the outcome of a Chapter 7 liquidation, the bankruptcy court rejected both husband’s and wife’s valuations of the dental practice.  Since the applicable standard of value was different in the bankruptcy court (liquidation vs. intrinsic value), the bankruptcy court was not bound by the valuation that the divorce court had adopted.

The dentist was a contracting party to a buy-sell agreement that required the business, or its owners, to buy out withdrawing shareholders under a formula.  The bankruptcy court held that the Chapter 7 trustee would have the power to force the other owners to buy out the bankrupt dentist at the buy-sell value ($161,268), which was less than wife’s expert’s opinion, but much more than husband’s net asset value.  The bankruptcy court held that the dentist did not pass the test to approve his Chapter 13 plan to pay 22% of his unsecured debts, because a Chapter 7 liquidation would produce more assets to distribute than husband has proposed.  In a hypothetical Chapter 7 case, using the business valuation derived from the buy-sell formula, the bankrupt dentist would be capable of paying 94 cents on a dollar to his unsecured creditors.  The dentist was instructed to develop a new Chapter 13 plan and pay more of his debts to the creditors, including wife.  The bankruptcy court also found that the portion of the ex-wife’s claim for legal fees, which had been treated as an unsecured debt, was entitled to priority in bankruptcy as a domestic support obligation.

Get Help with Professional Practices in Divorce

The opinion is available here. For more information about dental practice divorce valuation and related topics, consult my book Frumkes & Vertz on Divorce Taxation.  In Western Pennsylvania, call me (Brian C. Vertz 412-471-9000) for a family law consultation or visit my firm’s website, pollockbegg.com.