Jim Reed-Divorce Related Issues

8/4/2019 Jim Reed-Divorce Related Issues

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Overview of Divorce-Related Issues Involving Highly Compensated

Executives and Business Owners

IndyBar Las Vegas Destination CLEThe Mirage Hotel & Casino

Las Vegas, NevadaOctober 13-16, 2011

Speaker:

JAMES A.REED

With written materials by:

MICHAEL R.KOHLHAAS

JAMES A.REED

BINGHAM MCHALE LLP


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I. Business Valuations and Goodwill Issues

A. Statutory Foundation for Business ValuationsIndiana statute guides a trial court, sitting in a marital dissolution action, to divide the

marital estate in a just and reasonable fashion. See Ind. Code 31-15-7-4, -5. There is a

rebuttable presumption that an equal division of the marital estate is just and reasonable. See I.C.

31-15-7-5. Implied with this obligation is that the trial court divide the marital property in an

arithmetically-based, just and reasonable manner, in that the assets of the marital estate be valued

appropriately. This includes, of course, any business interests of the marital estate.

B.Practical Importance of Business Valuation

In many marriage dissolutions, the parties ownership interest in a business is the

dominant and overarching asset of the marriage. To use an extreme example, in theBobrow case,

the trial court determined the net marital estate of the parties to be approximately $25,000,000.

Of that amount, however, approximately $20,000,000 was attributable to the Husbands interest

in Ernst & Young, of which he was the CEO. Bobrow v. Bobrow, 2002 WL 32001420 (Ind.

2002) (unpublished opinion). Therefore, in many cases even in which the scale of values is

much smaller than existed in Bobrow the substantial gravitas of the dissolution rests within

litigating the value of the business interest; the balance of the marital estate is comparatively less

important.

C. Standard of Review and Burden of EvidenceA trial court has broad discretion in ascertaining the value of marital property, and the

trial courts determination of value will not be disturbed by an appellate court absent running

afoul of the highly deferential abuse of discretion standard. Nill v. Nill, 584 N.E.2d 602, 603

(Ind. Ct. App. 1992). In the event of an appeal, there is a strong presumption that the trial court


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valued the marital property appropriately. Id. The burden is on the parties to produce evidence of

the value of the marital property at the dissolution hearing, and a party is bound by the evidence

he or she presented at trial. Stetler v. Stetler, 657 N.E.2d 395, 399 (Ind. Ct. App. 1995).

D.Practical Legal Clarifications and Methodologies1. Range of Values Presented in Evidence

Indiana case law as to business valuations has developed what is named here as the

range-of-values doctrine. Range-of-values is one of the most important legal factors in

litigating a business value before an Indiana trial court. Under the range-of-values doctrine, a

trial courts determination of value will almost never be disturbed on appeal if the trial courts

finding of value is within the range of values that were presented into evidence during the trial.

For example, consider the recent case ofBalicki v. Balicki, 2005 WL 3071588. InBalicki,

the trial court heard evidence of three expert valuations of Husbands business, which ranged

from $145,000 to $433,000. In its Decree, the trial court found the value of Husbands business

to be $400,000. Since this value was within the range of values presented into evidence, the

Court of Appeals refused to disturb the trial courts finding: [t]he trial courts chosen valuation .

. . falls within this range and, therefore, is supported by the evidence and not clearly erroneous.

Balicki, 2005 WL 3071588at 2.

A similar analysis was offered by the Court of Appeals in Nowels v. Nowels, 836 N.E.2d

481 (Ind. Ct. App. 2005). InNowels, Husband owned an interest in a lumber company. The trial

court received testimony from Wifes expert that Husbands interest in the company was worth

$3,550,000. Husbands expert testified the value to be $818,000. The trial court eventually

concluded the value to be $2,500,000. In affirming the value determination, the Court of Appeals

reasoned that [t]he value placed on the [business] by the trial court was within the bounds of the


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evidence presented and within the trial courts broad discretion. Nowels, 836 N.E.2d at 487.

Thus, Nowels, Balicki, and predecessor cases stand for the proposition that a trial court has

tremendous discretion, bordering on irreversible discretion, to make a finding of value on a

business interest, provided its determination of value is within the range of values presented into

evidence.

It is unclear, in light of the range-of-values doctrine, to what extent certain interesting

dicta survives fromAxsom v. Axsom, 565 N.E.2d 1097, 1100-02 (Ind. Ct. App. 1991). At issue in

Axsom was the value of Husbands barbershop. The only evidence of specific value presented to

the trial court was Wifes expert witness, who opined the barbershop had a value of $30,000. The

Court of Appeals reversed the trial courts finding that the barbershop was worth $3,000,

concluding that such a finding was unsupported by any evidence. However, in dicta, the Court of

Appeals observed:

[A]lthough the only evidence of a specific market value was [Wifes experts] estimate,there is evidence that the assumption on which he relied in making the estimate . . . couldbe questioned. Based on the evidence, the court could have discounted the value of thebusiness as not being worth $30,000 . . . .

Thus, this language in Axsom suggests that a trial court may go outside the range of

values presented in evidence, if there is an evidentiary basis to do so. It remains unclear to what

extent thisAxsom dicta survives in light of the seemingly clear range-of-values holding in more

recent cases, such as Balicki discussed above. Or, perhaps the distinguishing characteristic of

Axsom is that the trial court received into evidence only one value, which is a fairly unusual

circumstance.

2. Valuation Date

Frequently, many months or even years can pass from the date that one party files a

petition for dissolution of marriage until the trial court conducts a final hearing and, later, issues


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its decree of dissolution of marriage and related orders. As this time passes by, changes in

circumstances can affect the value of marital assets, including that of a business. For example,

suppose a petition for dissolution is filed in July 15, 2004, and in the marital estate is a business

that sells home heating oil. The case goes to trial in December 2005. To be certain, there has

been tremendous volatility in home heating oil prices from July 2004 through December 2005

and, presumably, that has affected the value of the marital business interest. Thus, what valuation

date should be used in determining the value of the home heating oil company?

Historically, a trial court has had unfettered discretion to value a marital asset as of (1)

the date that the petition for dissolution is filed, (2) the date of the final hearing, or (3) any date

in between. See, e.g., Eyler v. Eyler, 492 N.E.2d 1071, 1074 (Ind. 1986). This doctrine was

squarely tested, however, in Quillen v. Quillen, 671 N.E.2d 98 (Ind. 1996). In Quillen, the

Husband operated a construction business. Husband was arrested and incarcerated on child

molesting charges and, three days later, Wife filed for dissolution of marriage. At the final

hearing, Wife presented expert testimony that, as of the date of filing, Husbands interest in the

construction company was worth $328,000.

On appeal, the Indiana Court of Appeals concluded that the trial courts valuation of the

business as of the date of filing was an abuse of discretion because the value of the business

changed radically after the date of separation, due to Husbands criminal legal problems and

related stigma. Quillen v. Quillen, 659, N.E.2d 566, 573 (Ind. Ct. App. 1995). However, after

granting transfer, the Indiana Supreme Court affirmed the trial courts valuation date decision,

disapproving of the Court of Appeals intention of reviewing with a heightened standard the

valuation date selected by the trial court. Quillen, 671 N.E.2d at 102-03. Thus, in light of

Quillen, it is difficult to envision a scenario in which the trial courts valuation date provided


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the trial court selects for that valuation date either the date the petition is filed, the date of filing,

or some date in between would be reversed on appeal.

There is no statutory or case law guidance in this regard, however, practitioners in this

area generally follow an unwritten rule that the best valuation date for any marital asset,

including a business interest, that changes in value during the pendency, is to use the most recent

valuation date available provided thatthe change in value during the pendency is not

substantially attributable to the actions of one of the parties. By way of example, if, after the date

of filing, the Husband, the sole owner of a barbershop, decided to start working 6 days a week,

instead of 5, and this decision, in turn, made the barbershop more profitable and more valuable,

then everything else constant, the proper valuation date would probably be the date of filing,

because the substantial cause of the change in value during the pendency is attributable entirely

to Husbands individual, post-filing efforts. Suppose, on the other hand, the only change in

circumstances during the pendency was a decision by Wal-Mart to build a store immediately

adjacent to the barbershop, thereby increasing both the value of the barbershops real estate, as

well as its prospects for steady business. That decision by Wal-Mart, presumably, was sheer luck

and not attributable to Husbands individual efforts; therefore, a most-current valuation would

likely be considered appropriate.

3. Goodwill: Personal vs. Enterprise Goodwill

One of the most interesting and important business valuation cases of the last decade has

been Yoon v. Yoon, 711 N.E.2d 1265 (Ind. 1999). To understand the significance ofYoon, it is

important to first understand the concept of goodwill. A widely accepted definition of

goodwill is the value of a business beyond the combined value of its net assets. That

goodwill, in turn, can be thought of having two distinct components: enterprise goodwill is


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the portion of the goodwill that is derived from the benefit enjoyed by the business of having

established relationships with customers, employees, and suppliers; personal goodwill, on the

other hand, is goodwill that is attributable to the presence and continued existence of a particular

individual (or individuals) associated with the business.

To illustrate the example, suppose a group of people elect to eat at McDonalds rather

than other fast food establishments; these patrons are loyal to McDonalds, presumably in part

because they prefer McDonalds food; they recognize McDonalds brand name, they may visit a

McDonalds restaurant while traveling after simply seeing and recognizing the McDonalds sign,

and their continued patronage can be reasonably expected. These same patrons do not choose to

eat at McDonalds because of the presence of any particular employee that works at McDonalds

and, were the entire staff of McDonalds to turn over, they likely would continue to patronize

McDonalds. It can reasonably said in this example, then, that McDonalds has significant

enterprise goodwill, but little or no personal goodwill.

Other businesses, especially professional practices, are heavily dependent upon the

personality providing the services. Suppose, for example, that Dr. Smith is a very highly-

regarded pediatrician in a small community. Dr. Smith is a sole practitioner. Based upon Dr.

Smiths reputation, he is very busy and attracts more new patients that he can accept. If Dr.

Smith were to sell his practice to a pediatrician that just moved to the community, but then Dr.

Smith opened up a new practice across town, would we expect the new pediatrician to continue

to be as busy, and to receive as many new patients, as did Dr. Smith? Probably not. We would

expect that Dr. Smith would continue to be very busy in his new practice, and prospective

patients that knew of Dr. Smiths favorable reputation would seek him out at his new location,

instead of opting for the new pediatrician. Because the financial well-being of Dr. Smiths


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medical practice is so inextricably intertwined with Dr. Smith personally, it could be said that Dr.

Smiths practice had significant personal goodwill, but little or no enterprise goodwill.1

Prior to Yoon, Indiana law did not draw a distinction between personal goodwill and

enterprise goodwill, and instead the total goodwill as assigned value by an expert was

includable as a marital asset. Yoon was significant because it drew the distinction between

personal goodwill and enterprise goodwill and, moreover, held that while enterprise goodwill

could be properly included as an asset of the marriage, personal goodwill could not. The Indiana

Supreme Courts stated rationale in Yoon was that personal goodwill is essentially a measure of

an individuals ability to generate future income in the business and, since under Indiana law an

individuals future income is expressly not marital property subject to division in a dissolution,

neither should be personal goodwill. Yoon, 711 N.E.2d at 1269. (This distinction was critical in

the facts of Yoon because Dr. Yoons medical practice was valued at a total of roughly

$2,519,000 by Mrs. Yoons expert, of which 93% of that value was attributable to Dr. Yoons

personal goodwill.) The dicta ofYoon did note, however, that personal goodwill is not entirely

irrelevant, and it can be used to evaluate the future income earning ability of a party, which, in

turn, can be used as a basis to deviate from the presumed equal division of the marital estate.

Yoon, 711 N.E.2d at 1269.

Another noteworthy post-Yoon case is Bertholet v. Bertholet, 725 N.E.2d 487 (Ind. Ct.

App. 2000). In Bertholet, the Husband owned a bail bond business, but Wife was actively

involved in its day-to-day operations. The trial court heard expert testimony that the bail bond

business was worth $1,150,000 if Husband continued to run it, but it would be worth only

1 The example of professional practices being rich in personal goodwill does not necessarily hold true as the sizeof the practice takes on additional professionals. For example, prospective clients may contact a large, regional lawfirm based upon the reputation of the enterprise as a whole, and not based upon the individual attorneys practicing atthe firm.


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$950,000 if retained by Wife. The trial court awarded the business to Husband, finding its value

to be $1,150,000. Following Husbands appeal, the Indiana Court of Appeals remanded the

valuation issue to the trial court to determine the value of the business, excluding Husbands

personal goodwill; Husband argued that, assuming the business would be worth $950,000 if

Wife retained it, then the difference in values could be explained only by Husbands personal

goodwill. The Court of Appeals in Bertholetagreed with Husband, and remanded the issue for

further analysis and findings by the trial court as to personal goodwill.

Yoon has had two general implications for marriage dissolution litigation. First, a new but

very important angle on the litigation of a business value concerns its personal goodwill versus

its enterprise goodwill; to be certain, as with business valuation generally, this distinction is part

science and part art. Second, stripped of its personal goodwill, most professional practices

especially medical and law practices have very little value relative to the income generated for

its principals.

It is also critical that, when representing a spouse who owns a business that may have

personal goodwill, to be certain to put on evidence of that personal goodwill and its value. If

personal goodwill is erroneously included in the business valuation, the Indiana Court of Appeals

is generally inclined to remand that matter for further consideration by the trial court if evidence

of personal goodwill is in the record. See, e.g.,Bertholet v. Bertholet, 725 N.E.2d 487 (Ind. Ct.

App. 2000); see also, Frazier v. Frazier, 737 N.E.2d 1220 (Ind. Ct. App. 2000). However, where

the record is silent on personal goodwill, the Court of Appeals seems less inclined to consider

remand of that determination, deeming it a waived issue since it was not appropriately raised at

trial. See, e.g.,Houchens v. Boschert, N.E.2d 585 (Ind. Ct. App. 2001). In fact, to the extent that

Bertholetand Frazierwere immediately post-Yoon cases that seem to stand for the proposition


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that a trial court held the burden to make a personal goodwill determination and see that it was

properly excluded from division, the Houchens case makes clear that this burden is not on the

trial court, but on the litigant seeking the personal goodwill exclusion.

4. Importance (or Lack Thereof) of Buy-Sell Agreements

Some practitioners assume that if a marriage dissolution litigant has a business interest

that is subject to a buy-sell agreement, that the buy-sell value is dispositive as to the value of the

business interest for purposes of marriage dissolution. This conclusion, while perhaps intuitive,

is nevertheless inconsistent with Indiana law and, therefore, is incorrect.

The Indiana Court of Appeals addressed this issue squarely in Nill v. Nill, 584 N.E.2d

602 (Ind. Ct. App. 1992), rehg denied, trans. denied. InNill, Husband was the owner of certain

shares in a closely held company (Pease). At trial, the Pease CFO testified that Husbands

stock was subject to a buy-sell agreement and, pursuant to the buy-sell, Husbands stock had a

value of $186,431. However, Wife presented expert testimony that valued Husbands Pease

interest in a traditional fashion, using six variously weighted values for the stock: adjusted

book value, recent sale of Pease stock to a new shareholder, two formulas based upon the buy-

sell, and two formulas based upon the companys goodwill. Using this method, Wifes expert

opined the value to be $523,600. After hearing this evidence, the trial court adopted a value for

Husbands interest in Pease at $350,000.

On appeal, Husband argued that the buy-sell value should be dispositive. The Court of

Appeals disagreed, concluding that, where a buy-sell exists it must be considered as a factor

when determining the value of the business interest, but it certainly is not conclusive. Therefore,

the existence of a buy-sell agreement is not the end of the story.

A similar result was reached in Houchens v. Boschert, 758 N.E.2d 585 (Ind. Ct. App.


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2001). In Houchens, Wife was a 1/3 owner of an LLC. The LLC was subject to an operating

agreement that included buy-sell language that calculated value as the book value as determined

by the Companys accountant. Houchens, 758 N.E.2d at 590. However, the trial courts final

valuation used a higher value a value concluded by Husbands expert but which ostensibly

gave some consideration to the buy-sell issue.

So, in light ofNill and Houchens, buy-sell agreements are certainly to be considered by

the trial court in making a determination of value, but the trial court certainly is not constrained

to follow the buy-sell value determination.

5. Covenants Not To Compete

It is well-settled law that a partys post-filing income is generally not marital property

and, thus, those funds are not subject to division in the marital estate. See, e.g., Bressler v.

Bressler, 601 N.E.2d 392, 397 (Ind. Ct. App. 1992). However, it remains something of an open

question as to whether the proceeds of a covenant not to compete that is executed during the

marriage, but payable at least in part after the date of filing, is subject to the same rule of

exclusion.

Several pre-Yoon cases stand for the proposition that a restrictive covenant which is

signed in conjunction with the sale of a business represents the goodwill of that business and,

thus, should be included as a marital asset because [t]he value of the goodwill of a business is

included in the marital estate. Reese v. Reese, 671 N.E.2d 187 (Ind. Ct. App. 1996), trans.

denied; see also Berger v. Berger, 648 N.E.2d 378, 384 (Ind. Ct. App. 1995) (noting for remand

that the portion of the restrictive covenant which is in the nature of compensation for the

goodwill of husband's [dental] practice should be included in the marital estate for distribution.)


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There have been no restrictive covenant cases since Yoon. However, in light ofYoons

central holding that personal goodwill is not a marital asset subject to division coupled with

the general consensus that restrictive covenants incident to the sale of a business are

representative of that sellers personal goodwill, it would seem improbable that the average

restrictive covenant would be considered marital property subject to division. But it is possible to

envision an argument that the payments made pursuant to a restrictive covenant represented not

future income or personal goodwill (which would not be divisible), but instead represented a

portion of the payment for the purchase of the business, re-characterized as future income.

6. Hearsay Issues

Often times, business valuators rely upon third-party appraisal work to provide estimates

of value as to business assets. For example, a business may own real estate, and the business

valuation expert will rely upon a real estate appraiser to provide a value for that asset which, in

turn, is a factor relied upon by the business valuator in determining the overall value of the

business.

To avoid hearsay objections, prudence indicates that careful litigation should seek either

a stipulation with opposing counsel as to the admissibility of an underlying appraisal (even if the

value of the business remains in dispute) or, if necessary, to have the third-party appraiser

prepared to testify.

This hearsay issues was raised on appeal in Showalter v. Brubaker, 650 N.E.2d 693 (Ind.

Ct. App. 1995). In Showalter, Husbands expert performed a business valuation that, in turn,

relied upon an equipment valuation by a third-party appraiser. That third-party appraiser never

testified in the trial court. However, Husband did affirm in his trial court testimony the findings

of the equipment appraiser for all but one item of equipment. Because Husband provided this


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testimony that corroborated nearly all of the equipment appraisers values, the Court of Appeals

concluded that the business valuation overcame any hearsay issues. The clear lesson of

Showalter is, though, to have independent means of admissibility as to materials that may be

nested within the business valuation.


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II. Stock Options

Stock options can become a tricky issue in the course of a dissolution of marriage,

usually arising from one (or more) of the following issues: (1) Are the stock options marital

property?, (2) How much are the stock options worth?, and (3) How can the stock options be

divided between the parties?

A. Option Primer

A stock option is simply a contractual right to buy a share of stock at a pre-determined

price (usually referred to as the strike price). For example, a stock option might grant its owner

the right to purchase one share of stock in XYZ, Inc. at a strike price of $30. If, at the time,

shares of XYZ, Inc. are trading above the strike price say, trading at $40 per share the value

of owning the option is obvious because, at the option owners election, he can immediately

exercise the option and buy a share of XYZ, Inc. for $30, immediately sell it on the market for

$40, thereby making an immediate $10 profit.

As a practical matter, most individuals who own stock options acquired those options

from his employer as part of his compensation (often referred to as employee stock options, or

ESOs). Options are often viewed by companies as a good form of incentive compensation for

employees because, typically, at the time the options are given to the employee (or granted to

the employee), the strike price for the option is set at the then-prevailing market price of the

underlying stock. So, if Husband is granted 100 options in XYZ, Inc., as of January 1, 2006, and

shares of XYZ, Inc. are then-trading at $30 per share, then the strike price of the options granted

to Husband will usually be set at $30 as well. (The preceding generalization notwithstanding,

there was a mini-scandal on Wall Street involving improperly back-dated options used to mask

the true value of the grant.) The important thing to know about the option grant is that, because


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the strike price is usually set at the share price at the time of the grant, options tend to be

worthless at the time of the grant, and will acquire value if at all only if the share price of the

company climbs following the date the options are granted. This is why options are considered a

form of incentive compensation, because the ultimate future value of the options is dictated

entirely by the future share value of the companys stock.

Typically, option grants also have vesting dates and expiration dates. The vesting

date provides that the options may not be exercised unless the employee remains with the

company for some period of service after the grant date, typically two or three years, thus

providing an incentive for retention of the employee; the options are usually subject to forfeiture

in the event of termination, quitting, or death. Additionally, a grant of options will typically set

forth an expiration date by which the options must be exercised, if at all. Options commonly

expire five or ten years after the grant date.

B. Stock Options as Marital Property

When a party to a divorce is an owner of stock options, there may be a legitimate dispute

as to whether the options are marital property or not. Usually, this dispute arises from a question

over the vesting status of the options. Suppose, for example, that Husband files for divorce on

October 1, 2005, at which time he is an owner of 100 XYZ, Inc. stock options that do not vest

until December 21, 2005. Is this grant of options marital property subject to division?

In 1995, the Indiana Court of Appeals held that only those stock options granted to an

employee by his or her employer which are exercisable upon the date of dissolution or separation

which cannot be forfeited upon termination of employment [are] marital property. Hann v.

Hann, 655 N.E.2d 566, 570 (Ind. Ct. App. 1995), trans. denied. In reaching its conclusion, the

Hann majority looked at the history of Indiana law requiring property interests to be vested in


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order to be included in the marital estate. The Court viewed stock options as similar to pension

benefits, and relied upon the prior law requiring pension benefits to be vested to be included in

the marital estate. (A dissenting Judge Chezem unsuccessfully advanced several arguments that

unvested options should be included in the marital estate, including that: (a) the options were

granted during the marriage and had the employee not received them, presumably he would have

received additional cash or other marital property instead; and (b) as a practical matter, the

overwhelming majority of stock options do proceed to a vesting status, so there is not a

substantial issue of uncertainty of vesting with options.)

The Court of Appeals tackled a slightly different vesting issue in Henry v. Henry, 758

N.E.2d 991 (Ind. Ct. App. 2001). In Henry, as of the date of Decree, Husband held substantial

options that were entirely exercisable, but nevertheless remained subject to forfeiture in the event

of Husbands termination. They were nevertheless immediately exercisable (if Husband opted to

do so) and would not be forfeited upon Husbands death or disability. Thus, the Court held the

Henry options were, unlike those reviewed inHann, marital property subject to division because

they were immediately exercisable. The issue not yet expressly resolved by Indiana case law

concerns options that are not vested at the date of filing, but then subsequently vest while the

case is pending. Dicta inHann andHenry suggest that such options are marital property subject

to division. In addition, Indiana courts repeatedly find an analogue to stock options in retirement

benefits. Of course, Indiana had long held that a retirement interest, not vested at filing but which

vests while a divorce is pending, is marital property subject to division. See, e.g., In re the

Marriage of Adams, 535 N.E.2d 124 (Ind. 1989). However, the recent Granzow case seems

inconsistent with Adams and its progeny. Granzow v. Granzow, 855 N.E.2d 680 (Ind. Ct. App.

2006). The issue in Granzow was similar to that faced inAdams. The Husband was a long-time


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employee at USX and he participated in the USX pension plan. Under the terms of the plan,

Husband was eligible for a substantial pension enhancement on the 30th

anniversary of his

employment. Husband experienced this anniversary, and the related pension enhancement

vested, after the divorce had been filed but while the case was still pending. The issue before the

Court was: was the pension enhancement a marital asset subject to division. The Court of

Appeals held:

The enhanced portion of Husband's pension, which would accrue when he reached thirtyyears of employment with USX, was forfeitable upon termination of employment andwas not yet vested when the petition for dissolution was filed. Thus, the trial court did noterr when it determined that the enhancement was not part of the marital estate subject to

division.

Granzow, at 855 N.E2d at 686. Because the Indianas stock options cases rely so heavily on the

analysis in pension cases, it appeared prior to Granzow stock options that were awarded but

unvested at filing of the divorce, yet which vested during the pendency, were properly included

in the marital estate. However, Granzow has made that outcome less clear, and there is now

legitimate legal argument to be advanced on both sides of the issue. Either way, a careful

practitioner will review the vesting schedule of any options owned by either party to the

dissolution, and will prudently monitor the pace of the case accordingly.

As an aside, also note that, even if unvested stock options are not part of the marital

estate, it may be prudent to calculate the value of the unvested options to include as part of an

economic circumstances argument that could affect the percentage division of the overall

marital estate. By way of example, the trial court in Henry was reversed because it had

improperly excluded approximately $582,000 of Husbands exercisable options from the marital

estate (see discussion, above); however, theHenry trial court had used that issue as an economic

circumstance to allocate the remaining property 75/25% in favor of Wife.

C. What Are the Options Worth?


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1. Valuation Methods

The valuation of stock options is not an issue that has received substantial attention in the

scarce amount of Indiana case law that addresses options. Presumably, as with any other

valuation issue, the trial court could receive varying evidence of value and would be acting

within its discretion to select any value at, or in between, the goal posts established by that

competent evidence. The main purpose of this section is to set forth the method by which stock

options are typically valued at the trial court level, but also to offer a valuation alternative.

In most cases, stock options are valued essentially as the difference between prevailing

market value of the underlying stock, less the strike price of the option. Thus, if Husband owns

one option in XYZ, Inc. with a $30 strike price, and shares of XYZ, Inc. are then selling for $40,

then Husbands option is worth $10, since it costs Husband $30 to exercise the option, but he

will receive $40 when he promptly sells the resulting share of XYZ, Inc. Indeed, in a footnote,

the Indiana Court of Appeals has spoken approvingly of precisely this valuation method: We

would suggest that the value of [Husbands] options be determined by the difference between the

striking price, which is typically the market price when the option was written, and the value of

the stock on the day of the final hearing, times the total number of shares involved. Henry v.

Henry, 758 N.E.2d 991, 995 fn 2 (Ind. Ct. App. 2001). Thus, when options are in the money

which is to say, when options have value this method is by far the easiest and probably the

most common valuation method used for stock options.

The more difficult valuation issue arises when stock options are under water, that is,

when the market price of the stock remains below the strike price. Using the above methodology

will always produce a value of $0 for under water options. However, the authors of this text

believe that in certain instances (especially when a party to a divorce has a large number of


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options, that are only slightly under water and which do not expire for a significant period of

time), the prudent practitioner will explore other valuation methods.

The most common alternative valuation method for stock options, though one not

widely used in the divorce context due to its complexity, is called the Black-Scholes option-

pricing formula. Black-Scholes was derived by economists Myron Scholes, Robert Merton, and

the late Fischer Black which, in fact, earned Scholes and Merton the Nobel Prize in Economics

in 1997.

Black-Scholes is a complicated equation, the details of which are beyond the scope of

this article. For what its worth, the Black-Scholes equation is as follows:

where

We are not going to discuss this equation in any detail here (thankfully), but consider it

worthwhile to take two pieces of information away from this Black-Scholes introduction:

a.

Under Black-Scholes, an options value is a function of, among other factors, theprice of the stock, the strike price, and the time until the option expires. Thus, underBlack-Scholes, an option that is technically under-water can still have a positivevalue, especially if the market value of the stock is only slightly below the strikeprice and there is significant time remaining until the option expires.


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b. Black-Scholes is, obviously, very complicated and one should strongly considerretaining an expert, such as an actuary with Black-Scholes experience, for assistanceand/or testimony in developing a Black-Scholes valuation argument.

Black-Scholes essentially attempts to quantify what is intuitive: a stock option, even if it is under

water, is not entire worthless because there remains some chance that, between the valuation date

and the options expiration date, the value of the underlying stock will increase, thereby putting

the option in the money.

2. Tax Considerations

As with most tax-sensitive property that is not sold incident to the dissolution of the

marriage, stock options are to be valued and allocated to a party (or to both parties) based upon

their fair market, pre-tax value. It is error for a trial court to value stock options with their

prospective future tax consequences factored in. The Court of Appeals addressed precisely this

issue in the stock option arena in Knotts v. Knotts, 693 N.E.2d 962 (Ind. Ct. App. 1998). In

Knotts, the trial court awarded Husband various Lilly stock options, but allocated those options

to Husband at a value that Husband prepared and which included a discount for taxes that

Husband would pay in the event the options were exercised. Wife appealed, and the Court of

Appeals concluded that, [i]n the present case, the trial court improperly considered tax

consequences incident to the future disposition of the Lilly stock option. Knotts, 693 N.E.2d at

968.

Compare Knotts to another case decided the same year, Hiser v. Hiser, 692 N.E.2d 925

(Ind. Ct. App. 1998). InHiser, Husband owned various stock options that were indisputably an

asset of the marriage. After the divorce was on file, but before the final hearing, Husband

unilaterally exercised the options and sold the resulting stock, yielding gross proceeds of

approximately $147,000. Critically, Husband undertook this exercise without Wifes consent or

any Court order. At the final hearing, since the exercise had tax consequences, Husband


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requested that the trial court give Husband a credit of approximately $53,000 to reflect the tax

consequences Husband would be required to pay as a result of the option exercise. The trial court

agreed with Husband, in part, but allowed Husband a credit only based upon the taxes Husband

would have paid had he exercised the stock on the date of filing, when the options were worth

less (and, thus, the tax consequences would have been smaller). Wife appealed, but the Court of

Appeals concluded that it was within the trial courts discretion to award the credit for the taxes

to Husband.

It may be difficult to articulate what public policy objective is advanced, but the lesson of

Knotts and Hiserseems to be and it is easy to extend this reasoning beyond stock options to

any marital asset that if a client owns property with substantial tax consequences, and it is

likely the client would be awarded that property in the divorce, then it may be prudent to

consider liquidation so that the resulting tax consequences are essentially shared with the spouse.

(On the flip side, it may be prudent to seek a Trial Rule 65 restraining order on assets if your

clients spouse is in that position, so as to preclude aHiser-type liquidation.)

D. Division Issues: How Can the Options Be Divided?

The short answer is that the stock options probably cannot be divided. Most employer

sponsored option plans do not permit a transfer of stock options from the employer-participant to

any third party, including a spouse incident to a divorce. In these cases, the parties (or the trial

court) have only two options. First, of course, all of the options can be awarded to the owner

spouse at some value, and the other spouse receives other property of off-setting value. Second,

the options can be constructively divided between the parties, even though they will need to

remain nominally titled in the name of the owner spouse until exercise. If electing this second

choice, the most important potential pitfall to be mindful of the option tax consequence.


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Most employee stock options are non-qualified options.2

The following is an example of a starting point for language in a final settlement

agreement that can effectively divide one partys non-qualified stock options, even though the

options remain technically and nominally titled solely in the name of the participant spouse.

Please note the special treatment of taxes:

In the interest of brevity, the

most important aspect of non-qualified options is that, upon exercise, the owner incurs ordinary

income taxes based upon the difference between the stocks market price and the strike price,

multiplied by the number of options exercised, and irrespective of whether the stock is held or

promptly liquidated. Moreover, plan administrators typically withhold only 25% of the option

proceeds for taxes, which results in under-withholding for most taxpayers.

1.01 XYZ, Inc. Stock Options.

(a) Summary of Husbands XYZ, Inc. Options

(b)

. As of February 1, 2006,Husband held 100,000 vested non-qualified stock options in XYZ, Inc. (Vested XYZOptions) which shall be divided equally between Husband and Wife. Husband alsoowns 20,000 XYZ, Inc. Options that were not vested on February 1, 2006, and these shallbe Husbands separate property, free and clear of any and all claims by Wife.

Wifes Option Allotment

2 The other common variety of employee option is an Incentive Stock Option or ISO. ISOs are generallyawarded, if at all, to top-level management. The tax treatment of ISOs is considerably different than that of non-qualified options. ISOs are not subject to regular income tax at the time of exercise but, instead, are taxed at thetime the shares that result from the option exercise are sold. Further, and importantly, if the shares resulting from theISO exercise are held for in excess of a year, the resulting income is potentially eligible for the preferable capitalgain tax rate, rather than an ordinary income rate. However, holding ISOs can trigger the Alternative MinimumTax, too. Best advice: include your clients accountant at every step of the decision making process concerning thedisposition of stock options.

. It is the parties intention and agreement thatone-half (1/2) of Husbands Vested XYZ Options shall belong to Wife (Wifes XYZOption Allotment), with the exercise of such options described more particularly below.This division shall be accomplished within each applicable Vested XYZ Options grant(that is, Wifes allocation shall include one half of each of Husbands option grants thatcomprise the Vested XYZ Options). The remaining one-half (1/2) of the Vested XYZOptions shall be Husbands separate property, free and clear of any and all claims byWife. The parties understand and agree that, due to restrictions on the Vested XYZOptions, Wifes XYZ Option Allotment shall need to remain nominally titled inHusbands name, even though both parties agree that Wifes XYZ Option Allotment shallconstructively belong to Wife.


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(c) Wifes Exercise of Wifes XYZ Option Allotment

(d)

. Wife may instructHusband to exercise Wifes XYZ Option Allotment as Wife wishes to exercise her shareof these options; provided, however, that at the time of any given exercise, Wife mustexercise her entire one-half (1/2) share of any given Vested XYZ Options grant, ratherthan exercising options on a piecemeal basis. That is, at any given exercise, Wife must

instruct Husband to exercise all of Wifes options within a given grant, but notnecessarily all of Wifes XYZ Option Allotment in its entirety. Husband shall thenexecute Wifes instructions to exercise the options as soon as is practical thereafter, but inno event longer than three (3) business days after receipt of instruction, subject toapplicable blackout and other policies pertaining to the Vested XYZ Options, and thentransfer to Wife the net, after-tax withholding proceeds (as set forth herein) of theexercise upon his receipt of same. This transfer from Husband to Wife shall be as a tax-free property settlement transfer.

Tax Withholding

(e)

. The parties agree that, for purposes of this option saleHusband shall be presumed to have a total and combined (federal, state, and local)marginal tax rate of Forty Percent (40%). Therefore, upon the exercise of Wifes XYZOptions, Forty Percent (40%) of the gross proceeds of the exercise shall be retained byHusband, in a restricted interest-bearing joint account, requiring joint signatures (TaxAccount), less any tax withholding by XYZ, Inc. on Husbands behalf, for purposes ofpaying the tax liability arising from that exercise of Wifes XYZ Options. The remainingSixty Percent (60%) of Wifes share of the exercise shall be transferred to Wife, as tax-free property settlement. (That is, by way of example, if an exercise on behalf of Wifegenerates proceeds of $10,000, and XYZ, Inc. withholds $2,500 for taxes, Husband shallretain an additional $1,500 in the Tax Account and then tender the remaining $6,000 toWife.)

Settling Up of Tax Liability. The parties acknowledge that the precise tax

liability to Husband arising from the sale of Wifes XYZ Options is neither known norknowable at this time. Therefore, within thirty (30) days of the filing of any tax return(s)by Husband containing any income arising from the sale of Wifes XYZ Options, or anyportion thereof, Husband shall furnish to Wife a summary calculating the actual taxliability to Husband arising from the sale of Wifes XYZ Options, or any portion thereof(the Option Tax Summary). Within fourteen (14) days thereafter, the parties will settleup between them all resulting tax liability obligations. That is, in the event that XYZ,Inc.s withholding from the option sale combined with the Tax Account withholdingwere insufficient to cover the taxes accruing to Husband as a direct result of the exerciseof Wifes XYZ Options, or any portion thereof, then Wife shall immediately pay toHusband any shortfall. Conversely, in the event that XYZ, Inc.s withholding from the

option sale combined with the Tax Account withholding resulted in over-withholding tocover the taxes accruing to Husband as a direct result of the exercise of Wifes XYZOptions, or any portion thereof, then Husband shall immediately pay to Wife any over-withholding (along with any interest accrued on the Tax Account, which interest shall beclaimed by Wife on her tax return as Wifes income). Notwithstanding any otherprovision in this Agreement, it is the parties express intention that Wife be responsiblefor all taxes accruing to Husband as a direct result of the exercise of Wifes XYZOptions.


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(f) Blackout Periods and Other Applicable Rules

(g)

. The parties understand andacknowledge that the exercise of the options is subject to various rules and regulations,including blackout periods, during which options may not be exercised. If, during ablackout period or other restricted term, Husband is instructed by Wife to exercise anyof Wifes XYZ Option Allotment, Husband shall exercise the options as reasonably soon

thereafter that he becomes able to do so.

Husbands Options

Hopefully, the above information and draft language provides useful information for the

potentially complex issue of treatment of stock options during dissolution of marriage.

. Husband may exercise, may not exercise, or mayotherwise dispose of his half of the options solely at his discretion.


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III. Direct Stock Awards and Restricted Stock Units (RSUs)

A. Direct Stock Awards

As discussed above, stock options became a widely used compensation benefit for key

executives (and, later, rank-and-file employees) during the 1990s. The appeal of stock options as

compensation was that, as opposed to a larger salary or other immediately received benefits,

stock options typically have no value at the time they are awarded, and will acquire value only if

the company does well. Therefore, stock options were viewed as form of compensation that had

the added benefit of providing a strong financial incentive to the executive that the company

share price increase.

With the crash of the high-flying technology stocks in 2000, and the generally cool stock

market that followed for the next few years, a shortcoming to stock options manifested itself:

stock options provide a stronger performance incentive for executives in a strong market than

they do in a weak market. To address this situation, many companies sought to offer more

predictable long-term rewards for their employees. In many cases, companies committed to a

pay-for-performance compensation approach, which began to replace option grants with

restricted stock awards. These companies believed that with this direct-ownership approach,

employees would begin to focus on the benefits of sustained, long-term company performance as

opposed to the get-rich-quick attitude of the 1990s.

To better understand restricted stock, first recall a stock option. A stock option represents

a contractual right to buy a share of stock at a predetermined price ( the strike price). If the

market value of the stock is above the strike price, then the option has value (or, it is in the

money); but, if the market value of the stock is below the strike price, then the option has no

immediate value (or, it is underwater) unless and until the share price rises above the strike


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price. Companies have tried to address previously-awarded options going underwater by granting

the executive new options at the lower, prevailing stock price. However, critics of stock options

have two major reservations with this approach to executive compensation. First, they contend

that the economic interests of the employees are not well matched with those of the shareholders

because the nature of an options value is inherently different from the nature of stocks value

(even if the value of the former is derived, in large part, from the value of the latter). The

incentives of the option-owning executive may not be well aligned to the interests of the

companys shareholders. For example, if an executive can always count on receiving a new

option grant when the company's stock price goes down, the executive never incurs any real

loss as a result of the companys decline in value. Rather, the shareholders bear that burden,

alone. Second, the company shareholders face increased stock dilution if the company's stock

price decreases, additional overlapping option grants are issued, and then the stock price returns

to higher values. The exercise of options ultimately represents a cost to the company (and, thus,

to its shareholders), which cost is only increased when options are issued during dips in share

value.

In response to these concerns (and others), enter the restricted stock award. Under a

restricted stock program, the company awards a number of shares of the companys stock to an

employee, subject to vesting restrictions. A common vesting restriction is that the employee

remains employed by the company for one year before the stock award vests. The employee

becomes the owner of the restricted shares at the time of the award even if they are not yet

vested and the employee is entitled to vote and receive dividends on those restricted shares. If

the shares never vest (e.g., because the employee quits before the vesting date), the company has

the right, effectively, to cancel the stock award. The vesting of the restricted stock award


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typically creates a taxable event for the employee. To generate money to pay the income tax on

the stock, the employee typically sells some portion of the awarded stock, with the employee

retaining the remaining shares. The employees interests are now better aligned with the

company's shareholders generally: when the company's stock price goes down, the employee

suffers along with all its other owners. As such, restricted stock awards are becoming an

increasingly favored tool for executive compensation, being used either in place of, or in concert

with, traditional stock option awards.

B. Restricted Stock Units (RSUs)

A more versatile permutation of direct stock award is the restricted stock unit, or

RSU. An employee who is awarded RSUs obtains a right to receive shares of stock when the

RSUs become vested. Upon vesting, the company issues the shares and the recipient then

becomes a shareholder. The RSU contrasts with a direct stock award, where the employee

receives the shares up front subject to forfeiture if the stock does not vest. Most large companies

like RSU programs because they are easier to administer and ensure that employees are only

entitled to dividends and voting rights upon vesting of the shares.

C. Stock Awards and Divorce

Of course, these stock awards, like stock options, can feature prominently in a divorce

case. As with stock options and nonqualified retirement plans, it is important to be certain that

discovery requests are tailored to address stock awards in the event an executive is the opposing

party. Fortunately, the valuation of stock awards is potentially more straightforward than with

options. The critical distinction is whether the stock award has yet vested.

If the stock award has vested, then the executive is the outright owner of the shares, and

the, say, 100 shares of XYZ, Inc., would be included in the marital estate and valued just as


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though the executive had purchased those 100 shares of XYZ, Inc., on the open market during

the marriage. (Or course, if the vesting is recent, the value of the stock award may be partly

offset by an outstanding tax liability for the executives receipt of the stock.)

The more complicated stock award issue arises if the executive has been granted a stock

award as of the date the petition for dissolution is filed, but the stock award has not yet vested.

There are several, not-mutually exclusive means by which this situation can be addressed:

1. Arguments on Vesting. Under the above scenario, it is quite possible that the stockaward, though not vested when the petition for dissolution was filed, will vest whilethe divorce is pending. There is an argument that stock awards that are not vested onthe date of filing, but which vest during the pendency, should be included in the

marital estate. See, e.g.,Adams v. Adams, 535 N.E.2d 124 (Ind. 1989) (holding thatpension rights were [] subject to disposition as marital property, notwithstanding thatthe pension rights did not become marital property . . . until after the separation.).ThisAdams holding is supported, in the stock option realm, byHenry v. Henry, 758N.E.2d 991 (Ind. Ct. App. 2001). InHenry, the Court of Appeals opined that,inasmuch as [Husband] had a present right to exercise the GE stock options andobtain their benefit up to the time of the final dissolution hearing

The enhanced portion of Husband's pension, which would accrue when hereached thirty years of employment with USX, was forfeitable upontermination of employment and was not yet vested when the petition for

dissolution was filed. Thus, the trial court did not err when it determined thatthe enhancement was not part of the marital estate subject to division.

, it was error for thetrial court not to have included the values of the GE options in the marital estate.(emphasis added). Thus,Henry suggests that the central holding ofAdams thatproperty interests acquired during the marriage, but which vest while the divorce ispending, are marital property is extended to stock options. However, this line ofcases has a more recent wrinkle in Granzow v. Granzow, 855 N.E.2d 680 (Ind. Ct.App. 2006). The issue in Granzow was similar to that faced inAdams. The Husbandwas a long-time employee at USX and he participated in the USX pension plan.Under the terms of the plan, Husband was eligible for a substantial pensionenhancement on the 30th anniversary of his employment. Husband experienced thisanniversary, and the related pension enhancement vested, after the divorce had beenfiled but while the case was still pending. The issue before the Court: was the pensionenhancement a marital asset subject to division? The Court of Appeals held:

Granzow, at 855 N.E2d at 686. Prior to Granzow, it appeared probable that propertyinterests (whether pension, stock option, stock award, or otherwise) that wereawarded but unvested at filing of the divorce, and which vested during the pendency,were properly included in the marital estate underAdams and its progeny. However,


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Granzow has muddied these waters, and there is now legitimate legal argument to beadvanced on both sides of the issue.

2. Arguments of Economic Circumstances

3.

. At bare minimum, even if an awarded butunvested stock award is deemed excluded from the marital estate, the executivesownership of the unvested stock award is arguably an economic circumstance in favorof the executive for purposes of determining whether the trial court should deviatefrom the statutorily presumed equal division of the marital estate under Ind. Code 31-15-7-5. The existence of the unvested stock award and its value to the executivewhen it does vest may be part of a multi-pronged argument in favor of theexecutives spouse receiving more than 50% of the marital estate (e.g., the executivehas much greater earning ability than the spouse, the spouse has been out of theworkforce for 20 years as a homemaker, and the executive will have $500,000 ofstock awards that are not included in the marital estate that vest in 6 months, etc.).

Arguments on Valuation

D. Conclusion

. In some circumstances it may be useful to determine thevalue of an unvested stock award. In the past, the authors have retained an actuary to

determine the present, discounted value of unvested stock awards (and unvested stockoptions). As with all valuation, there is a subjective component to this process.Typically, the actuary will focus in on the period of time between the date ofvaluation and the date of vesting, and then make appropriate discounts on the value ofthe stock based upon the probability that the executive will depart employment withthe company in the interim. There are various published schedules that provideguidance on the turnover of executives, which may guide the actuary in making thisdetermination. In short, give consideration to valuing even unvested stock and optioninterests, if doing so can advance your case.

Stock awards and RSUs are an increasingly common component of compensation totodays executive. It is important to be aware of how this asset plays a role in a divorce case, andthe arguments (on either side) about how stock that is awarded but is unvested at filing can behandled to your clients strategic advantage.


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IV. Nonqualified Retirement Plans

A. Nonqualified Plan Basics

Attorneys that have been involved in divorce work are very familiar with the concept of a

partys employer-sponsored retirement interest being marital property that is subject to valuation

and division as part of the marriage dissolution. Usually, however, the retirement interest

involved is a part of a qualified plan. That is, the retirement plan has been specifically

designed to meet the various requirements of Section 401 of the Internal Revenue code (or

Section 403, in the case of public employers). The advantage that qualification gives to the

retirement plan is that the employer is entitled to a current deduction for contributions to the

plan, the participants are not taxed on the retirement benefits until they are received, and the

plans earnings grow tax-free. Qualified plans may include defined benefit plans (which commit

to paying the employee a specific monthly amount from retirement for life), or defined

contribution plans (such as 401(k)s, Profit Sharing Plans, SEPs, and 403(b)s.)

By contrast, nonqualified plans have failed to meet the requirements set forth under

federal law to acquire favorable tax treatment. In addition, though not coextensively,

nonqualified plans generally fall outside of, or are exempt from, the Employee Retirement

Income Security Act of 1974 (ERISA). When it comes to qualified retirement plans, the rules

generally require that an employers basic compensation package be equally available to all

employees in order to get the associated tax benefits. Nonqualified plans, by contrast, are

generally used to provide augmented benefits for top management, or other key employees,

whom the employer wishes to give special consideration not available to employees generally.

The employer can use nonqualified plans to compensate important employees above and beyond

the basic compensation package provided to rank-and-file employees.


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Broadly defined, a nonqualified plan is a contractual agreement in which an employee (or

independent contractor) agrees to be paid in a future year for services rendered. Deferred

compensation payments generally commence upon termination of employment (e.g., retirement),

or pre-retirement death or disability. Nonqualified plans are often geared toward anticipated

retirement in order to provide cash payments to the retiree and to defer taxation to a year when

the recipient is in a lower bracket. Although the employers contractual obligation to pay the

nonqualified plan benefit is typically unsecured, the obligation still constitutes a contractual

promise.

Nonqualified plans are not without their inherent disadvantages, including that the

participants may be taxed on the retirement benefits even before they receive them, the plan

might not be funded, and the plan will not be bailed out by the government in the event of default

all of which creates added cost and risk to the participant.

However, nonqualified plans can be created with substantially more flexibility than

qualified plans, as they simply represent a contract that the employer will pay certain defined

sums (or, more frequently, sums based upon formulas set forth in the plan documents) to the

employee at a future date, usually commencing at retirement. Nonqualified plans offer

advantages to both the employee and the employer. To the employee, a high income earning

executive is likely unable to save, under the annual contribution limitations of a qualified plan,

sufficient money to provide for continuity of lifestyle after retirement. The nonqualified plan

helps to bridge this shortfall. For employers, nonqualified plans offer the advantage of being a

benefit that helps to retain key employees, but need not be paid (or necessarily even funded) until

many years into the future, and perhaps not at all (for example, if the employee quits the

company prematurely).


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B. Addressing Nonqualified Plans in the Divorce Context

For purposes of divorce litigation, here are some tips for dealing with the high-earner

executive and related nonqualified plans:

1. Inquire About Nonqualified Plans Specifically

2.

. Do not assume that the existence of anonqualified plan will be volunteered to you. If you inquire vaguely aboutretirement interests, nonqualified plans may not be disclosed. In addition, someexecutives do not have keen awareness about their own nonqualified plan interests,since there usually is not a monthly statement or other periodic reminder of thenonqualified plans existence. Be sure that discovery requests are carefully drafted toinclude nonqualified plans by their commonly used names (e.g., top hat plans,supplemental executive retirement plans (SERPs), etc.). Make sure to request copiesof any documents that evidence any contractual obligations, whether current orfuture, that the employer may have for the benefit of the executive. If you remain

concerned that nonqualified plans may exist but were not disclosed, consider a non-party discovery request to the employer for copies of all documents related to theemployees compensation, including nonqualified plans.

Involve a Professional for Valuation. As with qualified plans, there is a subjectivenature to the valuation of nonqualified retirement plans.

3

3.

It would be quite difficult topresent any meaningful evidence of a nonqualified plans value without expert,actuarial testimony. So, if you learn that nonqualified plans exist in the marital estate,it is best to involve an expert early.

Do Not Rely on Potential for Division

C. Conclusion

. Part of the reason that valuation of thenonqualified plan, discussed above, is so important is because rights to receive money

under a nonqualified plan generally cannot be directly assigned. The nonqualifiedplan will almost certainly not be subject to ERISA and, therefore, the participantsinterest in the nonqualified plan cannot be divided and awarded to your client by wayof a QDRO. Therefore, often the only option is to have the nonqualified plan valuedand placed in the participants column of the marital balance sheet so that anincreased and offsetting amount of other marital property can be awarded to the non-participant spouse.

In sum, the award of nonqualified retirement plans and similar deferred compensation

agreements are becoming increasingly common in the higher echelons of corporate governanceand management. Whenever involved with a divorce to which an executive is a party, be keenly

3 Beyond the scope of these materials, but nevertheless very relevant to a divorce that includes nonqualified planinterests, is the more fundamental question of whether the executives interest in the plan is marital property at all.Every plan can differ, but some nonqualified interests may be well-suited for the executive participant to argue thathe has no vested interest in the plan until he retires and, thus, the nonqualified plan interest is not marital property.This analysis will be highly fact-dependent and, thus, will vary from plan to plan depending upon the plans specificterms.


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aware of the prospect that nonqualified deferred compensation may be in the marital estate.Unfortunately, these plans do not always leave their fingerprints on other financial documents(there may be no statements, no reference to them in personal tax returns, etc.). Therefore,discovery requests need to be specifically tailored to address the prospect that nonqualified planinterests exist. And, a suitable expert should be involved early in the case both to value the

executives interest in the plan, and to prepare for litigation in the event trial on the plan interestvalue is necessary.


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V. Child Support, 2010 Changes Affecting High-Income Earners, the 21.88%

Normalization Calculation, and Phantom Income

A. A Brief History of the Guidelines

In 1989, Indiana adopted the Indiana Child Support Guidelines (the Guidelines). The

Guidelines were adopted for various reasons, but primarily so as to establish a statewide

methodology for the calculation of child support in divorce and paternity cases. The Guidelines

were advanced with a rationale that they would assist in providing uniformity to the means by

which child support was calculated from county to county, and from judge to judge. The

Guidelines would also provide a more objective and quantitative means by which child support

orders could be reviewed on appeal.

At the heart of the Indiana Guidelines is the Income Shares Model. The Income

Shares Model is a term of art based on the concept that the child should receive the same

proportion of parental income that he or she would have received if the parents remained

together; in an intact household, the income of both parents is generally pooled and spent for the

benefit of all household members, including any children. There are models, other than the

Income Shares Model, that are used by other jurisdictions as the foundation for their child

support frameworks.4

B. Reliance on Gross Income, Rather than Net-of-Tax Income

For these materials, the critical point is that child support under the Indiana Guidelines is

based upon the incomes of the parents. And, more specifically, the Guidelines rely upon the

gross incomes

4 These include primarily: the Percentage of Income Model, in which the non-custodial parent is ordered to pay apercentage of his income as child support, irrespective of and without relation to the income of the custodial parent;the Melson Formula, used in Delaware, Hawaii, and Montana, is a more complex version of the Income SharesModel, which seeks to establish a base level of child support and then adds to that base child support amount as thenon-custodial parents additional income allows; and, various Hybrid models which generally endeavor to pickamong the favorable characteristics of the Income Shares Model and the Percentage of Income Model.

of the parents. Some other jurisdictions base their child support calculations upon


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net, after-tax incomes of the parents. However, the Guidelines recite that Indiana considered

using net, after-tax incomes to calculate child support, but that approached was rejected out of

concern that the additional amount of discovery that could be required to make the extra

calculation of net, after-tax income. Child Supp. G. 1. So, instead of using net, after-tax income

to determine child support, the Indiana Guidelines elected to use gross pre-tax incomes, but in

addition to assume that every parent has an effective, overall tax rate of 21.88%

Of course, taxes vary for different individuals. This is the case whether a gross or netincome approach is used. Under the Indiana Guidelines, where taxes vary significantly

from the assumed rate of 21.88 percent, a trial court may choose to deviate from theguideline amount where the variance is substantiated by evidence at the support hearing.

. Child Supp. G.

1. But the Guidelines also observe as follows:

Child Supp. G. 1. As a practical matter, most parents fall so close to the 21.88% presumed tax

rate that it is cost prohibitive or otherwise not worthwhile to demonstrate a basis for a deviation

in favor of that parent because his or her actual tax rate differs from 21.88%. However, as tax

rates get substantially higher than the 21.88% presumed rate, a normalization calculation and

related argument to the Court should be considered.

C.2010 Revisions to the Indiana Child Support GuidelinesThere were several important revisions to the Indiana Child Support Guidelines that

became effective on January 1, 2010. Most of the changes are beyond the scope of these

materials about high income earners, but one change dramatically changed the child support

calculation process for parents with combined income over about $400,000 per year.

The subject high-earned change can be found in Guideline 3(D). The new Guidelines

retain a substantially similar means of calculating the parties Combined Weekly Adjusted

Income. Likewise, the Combined Weekly Adjusted Income is still plugged into the Guidelines

Schedules Table to determine the parties Basic Child Support Obligation. The Basic Child


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Support Obligation which is simply a function of: (1) the parents Combined Weekly Adjusted

Income; and (2) the number of children. However, under the old Guidelines, the Schedules

maxed out at $4,000 per week (or $208,000 per year) of Combined Weekly Adjusted Income.

For income levels in excess of $4,000 per week, the Guidelines applied a complicated formula

which had the effect of causing support amounts to plateau as income increased further.

Under the new Guidelines, the Schedules max out at $10,000 per week (or $520,000 per

year) of Combined Weekly Adjusted Income. Further, for income levels in excess of $10,000 per

week, the plateau-causing formula has been jettisoned in favor of a simple linear calculation. For

all income above $10,000 per week, the Basic Child Support Obligation will increase at a fixed

percentage of the income above $10,000 per week, depending upon the number of children (e.g.,

7.1% for one child, 10% for two children, 11.5% for three children, 12.9% for four children,

etc.).

Examples. To give a sense of how the old Guidelines and new Guidelines create divergingresults for high income earners, consider the following. For simplicity, suppose that Father is thesole income earner and that Father and Mother are calculating support for one child. Below, foreach level of income, is what Father would pay to Mother in weekly child support (again, forease of calculation, we are not factoring in parenting time or other credits) under the oldGuidelines and the new Guidelines:

Support Amount Under OldFathers Annual Income Support Amount Under NewGuidelines

$208,000/yr

Guidelines

$330/week $330/week

$260,000/yr $350/week $413/week

$312,000/yr $367/week $457/week

$364,000/yr $380/week $500/week

$416,000/yr $392/week $584/week

$468,000/yr $403/week $648/week


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$520,000/yr $412/week $712/week

The new Guidelines also provide that, beyond $10,000 per week, the support obligation increases

in a linear fashion at 7.1% of combined weekly income for one child. So, there never is any

"plateau" in support obligation. Everything else held constant, child support for someone earning

$20,000 per week will be roughly twice what it would be earning $10,000 per week. This is a

substantial departure from the operation of the old Guidelines, greatly affecting high-earners and

making the litigation of their incomes more important in the course of calculating child support.

D. Calculation of Normalized Gross Income

One technique to employ on behalf of a higher-earner is to argue for a deviation for a

high-income earner (or, more accurately, a high rate tax payer) is to calculate the equivalent

gross income for the parent if he or she were paying only 21.88% in taxes, rather than the higher

actual tax rate. (See the discussion about the Guidelines assumption of tax rate, above.) By way

of example, suppose that Father has a gross, pre-tax income of $500,000 per year. Ordinarily,

this amount $9,615 per week would be the input for Fathers income in a child support

worksheet. But, suppose further that a review of Fathers Federal and Indiana tax returns for the

last year shows that Father paid total income taxes of $165,000. This represents an overall tax

rate for Father of 33% ($165,000 / $500,000 = .33, or 33%), which obviously is much higher

than the Guidelines presumed tax rate of 21.88%. This disparity of tax rates begs the question:

rather than basing Fathers child support on his gross income level of $500,000 per year, what

gross annual income would give Father the same, after-tax income were it assumed that Father

instead paid only the presumed 21.88% tax rate on his income?

To make the calculation for the Fathers Normalized Gross Income, one need only to

solve the following equation:


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Normalized Gross Income = Actual Gross Income * (1 Actual Tax Rate) / (1 - .2188)

Inserting the information from the Fathers hypothetical, above, into the equation and solving:

Normalized Gross Income = $500,000 * (1 - 0.33) / (1 - 0.2188)

= $500,000 * 0.67 / 0.7812

= $335,000 / 0.7812

= $428,827

Thus, the argument can be advanced to the Court that, because Fathers actual tax rate is so

different from the Guidelines presumed tax rate of 21.88%, Fathers child support calculation

should be normalized by imputing him to $428,827 gross income.5

In addition, the Normalized Gross Income need not be specifically calculated to have

strategic value. For example, frequently, the negotiation of a child support amount can be a

nebulous process, where opposing counsel each seeks to construe income histories in a light

most favorable to his or her client, to include (or exclude) the values of employer perquisites in

the parents gross income, etc. The threat of gross income normalization can play a role in those

negotiations. For example, If we can agree to calculate support with my client at $435,000 per

This is true because this is

the gross income that Father would need to earn to have the identical net, after-tax income if the

Guidelines presumption that all parents pay income taxes at a rate of 21.88% were true in his

particular case.

5 The authors have prepared a simple Excel spreadsheet that performs this calculation automatically. You need toinput only your clients Actual Gross Income and his Actual Tax Rate. The Normalized Gross Income will then becalculated for you. Please feel free to e-mail [email protected] for a copy of the spreadsheet.


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year, then I will not push to lower it further based upon his income tax rate being well over the

Guidelines presumed rate of 21.88%.

E. Phantom Income

When working with cases involving business owners or investors, it is important to resist

the temptation to look only to the first page of the tax return to determine party income. This is

because a tax return will include as income and taxes will be due upon pass-through income

that is attributable to the parents ownership in a company, but which was never actually

distributed to the parent.

The Tebbe case held that, when calculating child support, pass-through income

attributable to a parent, but not actually distributed by the underlying company to the parent,

should not be included as income for child support purposes. Tebbe v. Tebbe, 815 N.E.2d 180

(Ind. Ct. App. 2004), rehg denied. It should be noted, however, that the father in Tebbe was the

49% minority owner of the company, and thus, lacked the control to determine whether earnings

would be distributed. The decision of the Tebbe case suggests it would be resolved differently

and the income would be included in the child support calculation if the parent is a control

owner, or if there was evidence that corporate income was deliberately retained to avoid child

support.

F. Conclusion

In sum, in any case involving child support in which a high-income earner is represented,

it is worthwhile to review recent tax returns to determine the existing of any pass-through

income, and to calculate the clients overall effective tax rate. To the extent a parents actual

overall tax rate deviates substantially from the Guidelines presumed rate of 21.88%, it may be

worth undertaking a gross income normalization calculation, and including related argument in


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the child support establishment process.


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VI. Trust and Real Estate Remainder Interests

As estate planning has become more sophisticated, and as sophisticated estate planning

has become more accessible, divorce counsel see increasing numbers of cases in which at least

one of the parties has a remainder interest in a trust or a real estate parcel. Sometimes, this is

simply a case of being a beneficiary of a trust that was established by a parent or grandparent. In

other cases, the relative may have conveyed real estate to the party, subject to the life estate of

another relative that is still alive. Are these remainder trust and real estate interests marital

property under Indiana law? If so, how are they valued? And can they be divided?

A. Is the Remainder Interest Marital Property Subject to Division?

Pursuant to Ind. Code 31-9-2-98, property, as the term is used in Indianas dissolution of

marriage statute, is defined broadly as all of the parties assets whether owned jointly or

individually. It is well established under Indiana law that the Court must divide the property of the

parties at the time of dissolution in a just and reasonable manner, if the property was owned by

either of them before the marriage, after the marriage but before final separation, or acquired by the

parties joint efforts. See I.C. 31-15-7-4. Indiana law prohibits the exclusion of any asset in which a

party has a vestedinterest from the scope of the trial courts power to divide and award. See, e.g.,

Moyars v. Moyars, 717 N.E.2d 976 (Ind. Ct. App. 1999).

Whether or not remainder interests are considered marital property is without clear and

authoritative disposition in Indiana due to the rather confused evolution of Indiana case law, and

intertwined legislative developments, affecting this issue. But, several cases offer important

guidance.


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The seminal case in Indiana with respect to trust interests and divorce wasLoeb v. Loeb, 301

N.E.2d 349 (Ind. 1973). InLoeb, the Indiana Supreme Court ruled that Husbands beneficial trust

interest, in a trust settled by his mother, was not marital property subject to division. The Courts

rationale, and it proved a rather fact-sensitive one, turned on the particulars of the subject trust,

which provided that, in the event Husband predeceased his mother, Husbands estate would receive

no property, and Husbands interest in the trust would be divested. The Loeb Court engaged in a

rather extensive discussion of whether or not Husbands interest was contingent or vested,

eventually deciding that the interest was in fact vested, but subject to complete defeasance should

Husband predecease his mother. Importantly, the Court also stated that the central question is not

whether the interest is vested or contingent, but, rather, the issue is whether the future interest is so

remote that it should not have been included in the property settlement award.Loeb, 301 N.E.2d at

352 (emphasis supplied). TheLoeb decision, however, never defines or otherwise lists the elements

to be considered in determining whether an interest is too remote. Subsequent cases would

grapple with that uncertainty.

Later decisions suggest that the primary focus should be on actual possession of the

property. See, e.g.,Hirsch v. Hirsch, 385 N.E.2d 193 (Ind. Ct. App. 1979). InHirsch, the Indiana

Court of Appeals, in an opinion guided byLoeb, held that Husbands remainder interest in a trust

was properly omitted from the marital estate because Husband did not have a present possessory

interest in the trust and that his remainder interest did not have a pecuniary value of which the court

could have disposed. The Hirsch Court, like the Court in Loeb, offered very little direction in

defining the elements or factors to be considered in determining what vested interests are too

remote for inclusion in the marital estate.


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The next substantial case in this line was Fiste v. Fiste, 627 N.E.2d 1368 (Ind. Ct. App.

1994). In Fiste, Husband owned a remainder interest in certain real estate. Husbands grandfather

had died with a will that conveyed real estate to his wife for her life (Husbands grandmother), then

to daughter for her life (Husbands mother), then finally to her children (which included Husband).

The trial court found Husbands remainder interest to be too remote to include in the marital estate.

On appeal, the Court of Appeals, relying onLoeb, agreed that Husbands remainder interest in the

parcel was too remote for inclusion in the marital estate, particularly because it was subject to

complete defeasance in the event Husband died before his mother.

There was arguably a shift in the law withMoyars v. Moyars, 717 N.E.2d 976 (Ind. Ct. App.

1999), trans. denied. In Moyars, Husband inherited a remainder interest in a parcel of land as a

tenant in common with his two siblings, subject to a life estate in his mother. Husband received the

remainder interest immediately upon his fathers death, which occurred during the marriage. As in

Loeb, Husband would not receive actual possession of the land until sometime in the future,

following his mothers death. The Court in Moyars ruled, however, that Husbands remainder

interest was properly includable in the marital estate, even though Husband had no present

possessory interest. The Moyars Court distinguished its case from Loeb by pointing out that the

Husband inMoyars, while not able to possess the land, nevertheless had a legal right to the land

which he could sell, mortgage or transfe

Documents

Jim Reed-Divorce Related Issues