BVWire Issue #155-2 | August 12, 2015


Bombshell property tax ruling includes unreasonable comp issues

A nonprofit hospital in New Jersey has lost its property tax exemption over a number of different issues, including overly lavish compensation of its executives and improper deals with physicians. This case was being closely watched and could trigger similar actions from cash-strapped municipalities—as well as spark challenges to tax-exempt status from the feds.

Crossed the line: The New Jersey Tax Court ruled that the Morristown (N.J.) Medical Center is not entitled to a property tax exemption because its activities are so intermingled with for-profit doings that it no longer resembles a charitable institution. According to an email alert from the American Health Lawyers Association (AHLA), a number of issues caused the hospital to cross the line, including having a corporate structure laced with for-profit subsidiaries, unreasonable compensation of executives, questionable contracts with for-profit physicians, improper incentive pay deals with employed physicians, and third-party agreements that were improper profit-sharing deals in disguise.

According to a report on, Judge Bianco ruled that the hospital failed to establish the "reasonableness" of the salaries it paid to executives. He noted that the hospital’s comparison of its executive salaries only to those of its peer group hospitals creates a "wholly self-serving" justification. The hospital’s CEO was paid $5 million in 2005, including perks such as an automobile stipend, a cell phone plan, and a golf club membership.

As a result of the ruling, the hospital will have to pony up $2.5 million per year in property taxes for the years at issue (2006 to 2008). There is no word on whether the hospital will appeal.

Watch out: “Nonprofit entities everywhere” have been watching this case, according to attorney Rebecca M. Waddell (Hall, Render, Killian, Heath & Lyman PC), who wrote the AHLA alert. Of course, this ruling only concerns the organization’s state property tax exemption and does not affect its tax-exempt status under federal law. “If, however, other courts adopt the reasoning of the New Jersey Tax Court, the door may be open to nonprofit status challenges, with the potential loss of cherished tax-exempt status,” says Waddell.

The New Jersey case is AHS Hospital Corp. d/b/a Morristown Memorial Hospital v. Town of Morristown, Docket Nos. 010900-2007, 010901-2007, and 000406-2008.

A recent BVR webinar on the newly released IRS Job Aid on reasonable compensation includes a discussion on nonprofits. To listen to a recording of this webinar, click here (purchase required).

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IRS assault on valuation discounts for FLPs is looming

In recent months, one persistent rumor has circulated in the blogosphere dedicated to estate and gift tax issues. It’s that the IRS is about to eliminate or at least limit the application of discounts related to family limited partnerships and similar structures. Also, a recent article in The New York Times discusses the impending crackdown.

Popular tool: FLPs and their variants are a popular tool to shift significant family wealth from one generation to the next at greatly discounted value. Under a common scenario, the transferor contributes assets to an FLP and then assigns fractional limited partnership interests to the transferees. Provisions in the partnership agreement or the organizational structure may place restrictions on the fractional ownership interest, as far as concerns control, marketability and liquidity, and transferability. If the restrictions stand up to scrutiny, they can translate into significant discounts and gift and estate tax savings.

The IRS has long been concerned over depressed valuations but has had limited success litigating the issue. Recently, representatives from the IRS and the U.S. Treasury said that new regulations limiting the use of valuation discounts would be forthcoming. It’s not clear when this will be or how the language will read. But business valuators fear the worst.

Relevant law: In 1990, Congress enacted Chapter 14 of the Internal Revenue Code, particularly sections 2703 and 2704, to prevent perceived abuses of the system. Section 2704(b), which deals with restrictions affecting the ability of a partnership or corporation to liquidate, is likely to be the focal point of the threatened regulations. It says that, if there is a transfer of an interest in a corporation or partnership to a member of the transferor’s family, and immediately before the transfer the transferor and his family have control of the entity, any “applicable restrictions” are disregarded when determining the value of the transferred interest.

In a 2001 technical advice memorandum (FSA 200143004), which discusses sections 2703 and 2704, the IRS's office of chief counsel explains how the agency may deploy the provisions in a gift tax matter. A digest of FSA 200143004 and the full text of the TAM are available at BVLaw. More on this issue is sure to follow.

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Chancery savages accounting firm over manipulated valuation

The Delaware Court of Chancery has on numerous occasions called out major financial institutions for providing erroneous or even “motivated” valuations. But few opinions include more searing criticism than a recent decision from Vice Chancellor Laster, in which he said a major accounting firm’s work on a spin/merge transaction “reached a new low.”

Zero-tax goal: A healthcare company tried to raise money to keep two promising but not yet profitable business units funded and generate revenue for its stockholders by spinning off the two entities and merging the remainder of the company with the acquirer. The goal was to avoid a corporate tax liability for the company’s controlling shareholders. For this purpose, top management hired accounting firm 1 to produce IRS-driven valuations. Firm 1, using manipulated projections the company provided, produced a transfer tax valuation that said the first spinoff was worth about $47 million and the second about $15 million. In a different context, management had said one unit was worth about $150 million to $300 million and had expressed optimism that the other unit in time would generate a lot of money.

Uncomfortable with the valuation, the buyer insisted on a second, “independent,” valuation from a different accounting firm. Firm 2 regularly had prepared stock option-related valuations for the seller, using a combination of discounted cash flow analysis and comparable company analyses. Despite different valuation dates, the inputs were generally consistent and so were the results. Also, all the valuation determinations consistently showed that the two separated entities contributed at least a third of the company’s total value. In contrast, the spinoff values firm 2 generated were so low that they only represented 7% of the combined enterprise value for the company in relation to the $725 million deal price.

Employees, who owned about 3% of the company in the form of stock options, sued, claiming that management, driven by tax considerations, had intentionally, and to the detriment of the option holders, undervalued the separated entities.

Copy job: The court agreed. “The option holders were collateral damage,” the court said. Even if the company probably did not want to harm its employees, once management had devised a plan to achieve a zero-tax outcome for the controlling stockholders, it was willing to sacrifice the employees’ interests.

The court called the valuation determination underlying the option price “arbitrary and capricious.” The report firm 2 produced was an example of action “so egregiously unreasonable as to be essentially inexplicable on any ground other than subjective bad faith,” the court said. It noted that the firm’s past work showed that it was capable of valuing the two separated entities as going concerns. But for the spinoff the firm abandoned its rigor and methodology. The firm’s employees viewed their task as “just copying [firm 1’s] report and calling it our own,” which is what they did, the court said. “The copy job was so blatant that the output matched [firm 1’s] even when the inputs differed.” When firm 2 did its own work, it made “fatal errors, such as using the materially lower figure for nine-month trailing revenue rather than twelve-month projected revenue,” the court pointed out. At trial, the defendants “wisely” tried to distance themselves from firm 2’s valuation by saying no one relied on it.

The court determined that damage to the option holders amounted to over $16.26 million.

Takeaway: In trying to understand what motivated the participants in this “transgression,” the court said that humans cross lines when the transgression can be rationalized, the benefits seem immediate, and the potential costs seem distant considering the slim chance of detection and the possibility of a successful defense or settlement. But, as this case illustrates, bad deeds do get uncovered and the cost to reputation may be high.

Find an extended discussion of Fox v. Cdx Holdings, 2015 Del. Ch. LEXIS 194 (July 28, 2015), in the September issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.

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AICPA issues new practice aid on economic damages

Reasonable Certainty in Economic Damages Calculations is now available from the AICPA, according to the August 5 edition of the AICPA’s FVS News. “The objective of this practice aid is to expand upon existing literature and raise awareness concerning those aspects of a damages calculation in which the concept of reasonable certainty is most likely to be scrutinized,” says the AICPA. The practice aid covers client-supplied information, causation considerations, and newly established businesses. In terms of newly established businesses, there is an extensive analysis of factors considered by courts to establish the reliability of benchmark data.

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Duff & Phelps releases inaugural report on fairness and solvency opinions

Duff & Phelps has unveiled the findings from its inaugural 2015 Fairness + Solvency Opinions Report, which examines transaction structures recurring among its global clients. The report describes the most prevalent transaction trends, provides detail on their scale and potential origin, and explains their relevance to fairness and solvency matters.

Current trends: “Two macro trends—stagnant growth and historically low interest rates—have contributed to an increase in certain complex transaction structures ranging from spin-off transactions and dividend recapitalizations to yield-based investment vehicles, among others,” says Christopher Janssen, managing director and leader of the firm’s transaction opinions practice. “Boards of directors and committees contemplating these transactions need, now more than ever, independent financial advice. We published this report to help shed light on these transactions trends and certain key considerations for the companies pursuing them.”

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Global BV news:

Latest data on car rental brand values

This month’s brand value snapshot from Markables compares the brand valuations of 14 car rental businesses between 2006 and 2014 in six countries. The sample not only includes well-known international firms such as Dollar Thrifty, Europcar, National, and Alamo, but also small local businesses. The interquartile range analysis shows trademark royalty rates between 2% and 5% of revenues and trademark values between 10% and 30% of enterprise value, depending on the profitability of the business. Not surprisingly, these brand value multiples for car rentals are three times higher than for a peer group of equipment rentals (e.g., RSC and NationsRent), and 10 times higher than for a peer group of container rental businesses (e.g., Mobile Storage, Royal Wolf). This example of different subsegments within a business segment illustrates the importance of precise selection of comparable guideline cases. Different value driver and asset structures necessarily result in different comparables and multiples, even more so for intangible assets.

Markables has a database of over 6,500 trademark valuations published in financial reporting documents of listed companies from all over the world. The database reports value solely for the use of trademarks (not bundled with other rights).

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BV movers . . .

People: Robert M. Clinger III, founder of Highland Global Business Valuations of Myrtle Beach, S.C., and Orlando, Fla., was named as a 2015 “40 Under Forty” honoree by the National Association of Certified Valuators & Analysts (NACVA) and the Consultants' Training Institute Kathryn Peters has been promoted to manager of business valuation and economic analysis at Arlington, Va.-based Morten Beyer & Agnew, an international aviation consulting firm specializing in the valuation and analysis of commercial jet transport … Sheri Fiske Schultz, director of litigation support and valuation services at the Plantation, Fla.-based Fiske & Co., has been appointed to the Davie/Plantation advisory board of Regent Bank, a full-service community bank serving South Florida … Christina Yaccarino has joined Baker Tilly’s New York City office as firm director to provide expertise in dispute resolution services and valuations related to business combinations, purchase price allocations, and intangible asset valuations.

Firms: CBRE Group Inc. acquired the research firm specializing in the Canadian hospitality and tourism industry PKF Consulting Inc., which will become part of CBRE’s valuation and advisory services business to provide comprehensive hotel financial information in North AmericaCharter Capital Partners, a Grand Rapids, Mich.-based investment banking firm focused on buy, sell, and capital raise transactions, has announced the opening of a new office in downtown Detroit … Moss Adams has acquired the Issaquah, Wash.-based boutique IT consulting firm Curtis Consulting Group (CCG) in an effort to expand its IT consulting and software development capabilities, specifically in the areas of business process improvement and business process automation … O'Toole-Ewald Art Associates Inc. (OTE), a New York City-based industry leader in fine art and personal property appraisals, has entered into a strategic partnership with AN Valuations, a boutique valuation advisory practice focusing on business and intellectual property, headquartered in Leiden, The Netherlands … Prairie Capital Advisors Inc., a corporate advisory and investment banking firm headquartered in Oakbrook Terrace, Ill., announced the re-establishment of its New England presence with a Boston office and has hired Andrew O’Neill to lead the office as director.

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A special message . . .

Neil Beaton (Alvarez & Marsal) has sent BVWire a special message, and we would like to share it. “Many of you have worked with, or have come into contact with, Robert Duffy at some point in the past and know him as a pillar in the valuation community. Bob has been my business partner for over 25 years but has been battling ALS (Lou Gehrig’s disease) for the past five years. I want to let you know about an initiative that his wife, Karen, and I are spearheading along with Mike Shannon of Answer ALS that culminates in a tribute to be held on September 20 at the VFW Hall on Mercer Island in Washington.”

Beaton explains that, although Bob’s body is being ravaged by ALS, his spirit is strong and he wants to help other ALS patients with new technology to increase the quality of life as much and as long as possible. The Answer ALS initiative is designed to provide funding for more ALS research. BVWire joins with Beaton in urging you to please visit the site, give what you can, and mark your calendar for the September 20 event, which will start at around 3 p.m.

For more details and to support this ALS initiative, click here.

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Hot slate of August CPE events

  • Goodwill in Physician Practices (August 17), with Stacey Udell (Gold Gerstein Group) and Stacy Preston Collins (Financial Research Associates). This is Part 3 of BVR's 2015 Special Series on Healthcare Valuation;

Important note to webinar attendees: To ensure that you receive your dial-in instructions to BVR’s training events, please make sure to whitelist

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We welcome your feedback and comments. Contact the editor, Andy Dzamba at: or (503) 291-7963 ext. 133
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In this issue:

Shocking case

FLP attack

Chancery seethes

New AICPA practice aid

Fairness solvency opinions

Global BV news

BV movers

A short message

CPE events












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