If you own a business and/or your spouse owns a business, you are playing the highest stakes game in divorce law. The valuation of that business is determined as much by the savvy of your divorce lawyer as it is by the experience of the experts opining on that value.
It is not just WHO the business valuator is that matters but, also, what kind of valuator the court deems them to be. The distinction a controlled expert or a 503(l) financial expert will make or cost you thousands to millions of dollars.
Who Gets The Business In An Illinois Divorce?
The business owner and operator is going to be awarded the business in an Illinois divorce. It would be ludicrous to award the business to the spouse that does not know how to operate the business.
If both parties work in the business and presumably know how to operate the business, the court is encouraged to award the business to just one spouse.
“[W]hen the property at issue is a small business and the parties have shown that they cannot work together, it is better to award the business solely to one party or the other.” In re Marriage of Thomas, 608 NE 2d 585 – Ill: Appellate Court, 3rd Dist. 1993
Once it’s determined that one spouse will keep the business in its entirety, the value of the business impacts how everything else is awarded in the divorce.
An Illinois divorce court “shall divide the marital property without regard to marital misconduct in just proportions considering all relevant factors, including:… “the value of the property assigned to each spouse” 750 ILCS 5/503(d)(3)
Why Does A Business Have To Be Valued In An Illinois Divorce?
Businesses that are started or acquired during a marriage are marital and thus, divisible, in an Illinois divorce.
“Real property and business interests acquired after marriage are presumed to be marital property unless they were purchased with nonmarital funds.” IN RE MARRIAGE OF SCHMITT, 909 NE 2d 221 – Ill: Appellate Court, 2nd Dist. 2009
“The business interest of a spouse acquired subsequent to marriage constitutes `marital property’ subject to equitable distribution upon dissolution.” In re Marriage of Schneider, 343 Ill.App.3d 628, 634, 278 Ill.Dec. 485, 798 N.E.2d 1242 (2003)
If the business is marital, an Illinois divorce court An Illinois divorce court “shall divide the marital property without regard to marital misconduct in just proportions” 750 ILCS 5/503(d)
If the business is non-marital, the business shall not be divided and shall be awarded to the business owner. “[T]he court shall assign each spouse’s non-marital property to that spouse.” 750 ILCS 5/503(d)
Even if the business is non-marital, you may have to value the business because the non-marital value of the business, “the value of the property assigned to each spouse” 750 ILCS 5/503(d)(3), is a factor the court must consider when allocating the marital property.
An Illinois divorce court can “award the larger share [of marital property] to [one spouse] because [the other spouse] had greater nonmarital assets.” In re Marriage of Wojcik, 838 NE 2d 282 – Ill: Appellate Court, 2nd Dist. 2005
Who Values A Business In An Illinois Divorce?
Someone is going to have to value your business. That person must be an expert in the field.
“To place a specific value on an item of marital property, there must be competent evidence of its value presented.” In re Marriage of Abu-Hashim, 2014 IL App (1st) 122997
“In determining the value of assets or property under this Section, the court shall employ a fair market value standard.” 750 ILCS 5/503(k)
“Placing a fair market value on the professional corporation is an art, not a science, and the court must rely on expert witnesses to assist it in this difficult task. There is no exact formula that can be applied, so the trial court must rely on experts who may differ significantly in both methodology and valuation. The trial court must consider the relevant evidence before it; determine the credibility of the experts, the reasonableness of their testimony, the weight given to each of them, and their expertise in the particular area of valuation; and then determine fair market value.” In re Marriage of Gunn, 233 Ill. App. 3d 165, 183 (Ill. App. Ct. 1992)
If the “fair market value” of a business “is an art, not a science” then the value of a business is definitely an opinion. Opinions are not allowed in an Illinois divorce court unless they come from a qualified expert.
“[T]he general rule is that testimony of a witness’ opinion is not admissible into evidence” People v. Brown, 558 NE 2d 309 – Ill: Appellate Court, 1st Dist. 1990
However, “a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion” Ill. R. Evid. 702
There are different types of experts that the court can acknowledge. The differences between these expert classifications is crucial to getting a low or high valuation of the business that the court will, hopefully, adopt as a final finding.
The Many Kinds Of Valuation Experts In An Illinois Divorce
An expert who investigates the value of a business and testifies to that value can have one of three classifications in an Illinois divorce court.
Controlled Experts
A controlled expert is an expert who a party in a divorce has personally hired to determine the value of the business. The controlled expert knows who is paying them, knows the party’s position (they want a high or low value) and will, unsurprisingly, conclude remarkably similar to their client’s goal.
Because a controlled expert’s provides a foregone conclusion, the controlled expert must disclose how they came to that conclusion so the other side has an opportunity to challenge that conclusion.
“Controlled Expert Witnesses. A “controlled expert witness” is a person giving expert testimony who is the party, the party’s current employee, or the party’s retained expert. For each controlled expert witness, the party must identify: (i) the subject matter on which the witness will testify; (ii) the conclusions and opinions of the witness and the bases therefor; (iii) the qualifications of the witness; and (iv) any reports prepared by the witness about the case.” Ill. S. Ct. R. 213(f)
“Controlled expert witnesses” include persons such as retained experts. The party can count on full cooperation from the witnesses in this category, so the amended rule requires the party to provide all of the details required by the former rule. In particular, the requirement that the party identify the “subject matter” of the testimony means that the party must set forth the gist of the testimony on each topic the witness will address, as opposed to setting forth the topics alone.” Ill. S. Ct. R. 213(f), Committee Comments
Independent Experts
Independent Expert Witnesses are not beholden to some final goal. In the context of a business valuation for an Illinois divorce, independent experts are almost always appointed as the result of a happy accident. An independent expert will have usually valued the business for the purposes of a loan application, a prior possible sale, or estate planning. That is, their original valuation was not the result of a particular party’s divorce strategy.
“Independent Expert Witnesses. An “independent expert witness” is a person giving expert testimony who is not the party, the party’s current employee, or the party’s retained expert. For each independent expert witness, the party must identify the subjects on which the witness will testify and the opinions the party expects to elicit. An answer is sufficient if it gives reasonable notice of the testimony, taking into account the limitations on the party’s knowledge of the facts known by and opinions held by the witness.” Ill. S. Ct. R. 213(f)
503(l) Financial Experts
Finally, there is a court’s financial expert witness, often called a “503(l)”.
“The court may seek the advice of financial experts or other professionals, whether or not employed by the court on a regular basis. The advice given shall be in writing and made available by the court to counsel. Counsel may examine as a witness any professional consulted by the court designated as the court’s witness. Professional personnel consulted by the court are subject to subpoena for the purposes of discovery, trial, or both.” 750 ILCS 5/503(l)
This 503(l) expert witness works for neither party and, instead, works for the court as an independent investigator to determine what a business is truly worth.
What Kind Of Expert Do You Want To Value Your Business In An Illinois Divorce Trial?
If you are the business operator expecting to be awarded the business in an Illinois divorce, you want the business to have the smallest value possible. You will have the option of interviewing multiple experts who will describe the ways that they value businesses and how they weight discounts of that value (personal goodwill, lack of marketability). If you discover an expert who values businesses on the low side and seems especially persuasive, that’s the expert you want testifying to the court.
Conversely, if you are the spouse who does not expect to be awarded the business, you want an expert that comes to the opposite conclusion: that the business has great enterprise value with minimal discounts.
So, both parties will want a controlled expert that has likely friendly conclusions for them about the value of the business.
But, the actual operator of the business is at a great advantage. The operator of the business can give their possible controlled expert all the information the potential controlled expert needs to value the business. At this stage, the business operator can claim that the potential controlled expert is a 201(b)(3) consultant.
“Consultant. A consultant is a person who has been retained or specially employed in anticipation of litigation or preparation for trial but who is not to be called at trial. The identity, opinions, and work product of a consultant are discoverable only upon a showing of exceptional circumstances under which it is impracticable for the party seeking discovery to obtain facts or opinions on the same subject matter by other means.” Ill. S. Ct. R. 201(b)(3)(emphasis mine)
If the potential controlled expert opines that the value of the business is too high for the business operator’s tastes, the business operator does NOT have to disclose that consultation and its conclusions.
“Rule 201(b)(3) speaks not only to a consultant’s work product but also his or her identity and opinions.” Dameron v. MERCY HOSPITAL AND MEDICAL, 181 NE 3d 833 – Ill: Supreme Court 2020
The business operator can literally keep interviewing potential controlled witnesses until the business operator gets the result that they want.
The spouse that does not operate the business does not enjoy this same advantage because they do not, presumably, have access to the myriad of financial documents the potential controlled witness would need in order to make a preliminary estimation of the business’s value. Those financial documents must be subpoenaed or requested via a notice to produce. The business operator spouse is likely to delay production or provide incomplete production so as to not allow the non-operator spouse the same “expert shopping” experience.
Expert shopping comes to an end sooner or later when the court sets a date for disclosure of all controlled experts.
“[T]he court shall hold a case management…[where]the following shall be considered:
(ii) the area of expertise and the number of expert witnesses who may be called; and (iii) deadlines for the disclosure of witnesses and the completion of written discovery and depositions.” Ill. Sup. Ct. R. 218(a)(5)
On that date, all controlled experts will be disclosed along with their conclusions and bases for their conclusions. There will be no more room for gamesmanship.
If there was a previous valuation, the parties may agree to appoint that valuator as an independent expert. This is an affordable solution. If the parties are this agreeable, there’s no reason not to make the independent valuator a 503(l) financial expert which requires a written report.
A 503(l) financial expert’s only advantage for an individual party valuing a business is that one expert is cheaper than two competing experts.
Competing Controlled Experts Are Expensive
The business operating spouse usually has control of the finances. Hiring a controlled expert invites the other spouse to hire a controlled expert as well. These expert expenses are likely to be initially borne by the spouse in control of the finances.
Expert witnesses and valuing a business are both contemplated by the statute that governs interim fees.
“In assessing an interim award, the court shall consider all relevant factors, as presented, that appear reasonable and necessary, including to the extent applicable:… the degree of complexity of the issues, including allocation of parental responsibility, valuation or division (or both) of closely held businesses, and tax planning, as well as reasonable needs for expert investigations or expert witnesses, or both” 750 ILCS 5/501(c-1)(1)(F)
As a reminder, the expense of all experts comes out of the parties final award of marital assets. “[I]nterim awards, as well as the aggregate of all other payments by each party to counsel and related payments to third parties, shall be deemed to have been advances from the parties’ marital estate.” 750 ILCS 5/501(c-1)(2)
503(l) Financial Experts Will Likely Trump Controlled Experts
Judges are not businesspeople. Judges do not enjoy comparing complex technical opinions. Judges would prefer to have just one expert. Their expert. A 503(l) financial expert.
So, expect a judge to appoint a 503(l) financial expert if requested or sua sponte.
This does not mean you are barred from hiring a controlled expert to value a business if a judge appoints a 503(l) expert. It just means doing so is likely futile.
Judges aren’t stupid. Judges know that controlled experts have an agenda to please their clients while providing logical business valuations. Judges will weigh this agenda compared to a 503(l) financial expert’s purer motives.
This means that being familiar with the 503(l) experts that judges are likely to appoint is crucial (there are very few). Judges will give great weight to an experienced divorce lawyer who praises a particular 503(l) financial expert or who objects a particular 503(l) expert. The last thing a judge wants is an incompetent and impeachable 503(l) expert because then the judge would be forced to start from scratch and appoint a new 503(l) expert.
The Bottom Line on Controlled Experts vs. 503(l) Financial Experts In An Illinois Divorce
A divorce lawyer should always have a strategy. The selection of what kind of expert will be valuing you or your spouse’s business is, possibly, the most strategic decision your divorce lawyer will make. Be sure that they are at least making a decision and not letting the decision be made for them by the opposing counsel or the judge.
Russell Knight is a divorce attorney licensed in Illinois and Florida. Russell Knight has practiced family law for over 19 years and has handled numerous divorces that required the valuation of closely held companies.
Frequently Asked Questions About Controlled Experts vs. 503(l) Financial Experts In An Illinois Divorce
How does a business get valued in an Illinois divorce?
Fair market value. “In determining the value of assets or property under this Section, the court shall employ a fair market value standard.” 750 ILCS 5/503(k) Fair market value, invariably, requires the testimony of an expert in valuing businesses.
Can I interview a business valuator and then not use them if I do not like their valuation?
Yes, if the valuator is retained as a consultant, initially, rather than being disclosed as a controlled expert. “The identity, opinions, and work product of a consultant are discoverable only upon a showing of exceptional circumstances.” Ill. S. Ct. R. 201(b)(3). You can always convert the consultant to a controlled expert later.
What Is A 503(l) Financial Expert?
A 503(l) financial expert is an expert who serves as the court’s expert. This expert must produce a report for the parties and the court to read. It can be expected that the court will give great weight to the testimony of their own expert.
Can I still hire my own expert if the judge appoints a 503(l) financial expert?
Yes. Nothing in 750 ILCS 5/503(l) bars a party from retaining a controlled expert. Expect the judge to negatively weigh a retained expert with a known client objective against the neutrality of the 503(l) expert.
