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The business valuation process can be complicated and expensive, especially if the parties have to go to court. But there’s an alternative: mediation as a form of alternative dispute resolution (ADR). Instead of a trier of fact imposing a solution, the parties reach a solution that they both helped shape and agreed on.
Let’s explore how you can work with your client, a business valuation expert (appraiser), a mediator and the other side to resolve valuation issues with the other party, including the Internal Revenue Service.
What’s ADR?
ADR is a broad heading that presents alternatives to going to court. Two alternatives are arbitration and mediation. In arbitration, the arbitrator makes the decision on the case. In mediation, the parties make the decisions. Mediation may be evaluative, transformative or facilitative.
Evaluative. The mediator is often an experienced attorney or retired judge who works with the parties to fully understand and consider applying the facts and law to the case. The evaluative mediator then presents to both parties what they’ve determined to be the likely outcome of the case. This gives the parties a third perspective that they can work off of as they try to resolve their case.
Transformative. The mediator’s goal is to help transform the relationship between the parties. The mediator uses specific techniques to overcome issues of trust and to focus on the relationship between the parties. This technique is often used in family law. If the issues can be resolved, that’s great, but the primary objective is to alter the relationships between the parties.
Facilitative. The focus is on a specific problem. In this instance, the mediator usually has a background in the area in question and works with the parties to address the area of concern. Transformative mediation techniques may be used, and relationships may be repaired, but the primary goal is to work with the parties to resolve a specific issue.
I’ll focus on facilitative mediation with a skilled mediator in business valuation working with the ultimate client, the attorney and the appraiser on both sides to see if a mediated agreement can be reached. The mediator is neutral and not an advocate for either side. However, a skilled mediator is able to ask questions in such a way that all parties will understand even the most complex elements of the issues, facts and emotions to collaborate1 towards a solution. This allows the parties to assess risk and evaluate whether they can come together with an alternative that both parties either like or can live with for closure.
Typical Participants
In a mediation, the participants are typically the client, the attorney for the client and the appraiser for each side. The clients, with the advice of their attorneys, are the decision makers. With the valuation of a closely held stock between a spouse who owns the business and a spouse who doesn’t own the business, or with issues before the IRS with an estate or gift tax valuation, the mediator skilled in business valuation is there to work with the parties to come to an agreement if possible. Typically, there’s a pre-process initiated by the mediator to see if mediation is indeed an option for the parties involved, followed by the actual mediation itself.
Skilled Appraisers
A skilled appraiser who understands the assumptions, limiting conditions, facts and mediation process can have a very powerful impact on a mediation. The right appraiser properly prepared2 can help the parties understand the facts, processes and implications of how the business valuation was prepared and why. The appraiser can provide insights on the assumptions and limiting conditions made during the development of the appraisal. Understanding these in lay terms is often key to resolving the issue. A skilled business valuation mediator may be able to propose ways to resolve the issue.
On the other hand, some appraisers take the position that their work is entirely correct, and there’s no room for error or a change in assumptions. A skilled business valuation mediator can ask questions and pursue elements that may demonstrate that even the most skilled appraiser relied on various assumptions to decide on a particular valuation amount, but that amount is within some range based on those assumptions and the methods the appraiser applied.
Qualities of an Appraiser
The appraiser, for federal tax purposes, should be familiar with Federal Rules of Evidence (FRE) 702 for testimony, FRE 703 to meet the standards of an expert and Federal Rules of Civil Procedure 263 on an expert report.4 The appraiser needs to have reliably applied the principles and methods applicable to the case and be able to overcome a Daubert5 challenge and the factors6 associated with it.7
Ideally, the appraiser should: (1) have industry knowledge; (2) have appropriate credentials (Accredited Business Valuer as a Certified Public Accountant, Certified Valuation Analyst with the National Association of Certified Valuation Analysts, and/or an Accredited Senior Appraiser with the American Society of Appraisers); (3) be passionately independent; (4) provide an objective assessment; (5) have the ability to explain valuation issues in lay terms; (6) have good analytical skills and emotional intelligence; (7) maintain integrity; and (8) have good communication skills.
When assessing, selecting and preparing your appraiser for mediation, consider several elements:8
- Would an appraiser be helpful? Why or why not?
- Could your appraiser be helpful in finding a qualified mediator familiar with these types of issues?
- Will the appraiser be helpful to resolve the issues, and should you discuss mediation with opposing counsel?
- Is the appraiser familiar with the mediation process?
- Will the appraiser be able to maintain confidentiality regarding the mediation?
- Are you prepared to educate the appraiser on the intricacies associated with state laws?
- Have you considered which sessions the appraiser should attend?
- Have you developed a list of factors to consider or questions to be answered during early joint sessions?
Now, let’s take a deeper dive into the process.
Mediation Pre-Process
The mediator should have a pre-meeting with each of the parties. Typically, each attorney speaks with the mediator to see if it’s in everyone’s best interests to proceed with mediation. If that’s the case, the mediator meets separately with the client and attorney on each side to discuss the process in detail and again assess if mediation is appropriate. If not, the mediator withdraws from the case. If yes, the mediator obtains the appraisers’ reports, is introduced to the appraisers and interviews each of the appraisers separately. These interviews are listening sessions to gain insight, understanding and trust.
The Mediation Process
With business valuation mediations, the client, the attorney for the client and the appraisers9 are typically in attendance with the mediator. Each appraiser explains the process in general so that the clients and the attorneys understand the report. Then, the mediator facilitates a discussion, remaining neutral but digging deeper to help the decision makers assess risk.
The mediator has no stake in the outcome. The ultimate outcome is up to the decision makers. The results could be 90-10, 10-90 or anywhere in between, but both sides should expect to concede something.
Skilled Mediator
A skilled mediator prepares the parties regarding the process. The mediator then follows the agreed-on process and enforces it in a fair and equitable manner. This facilitative process encourages open dialogue and professional interaction on the various issues involved. The mediator identifies areas of agreement and disagreement and gets the parties to agree as to which issues will be discussed and in what order.
The key elements for listening by the mediator include paraphrasing, asking open-ended questions, summarizing, suspending personal judgment, empathizing and not offering opinions. During the education phase, remaining calm, confident and competent helps the process move more efficiently.
The mediator asks probing questions, makes sure everyone is on the same page by checking in with participants and asks additional questions to clarify facts. After the process has been concluded with the appraisers, they’re excused. In some instances, the attorney and client, with or without their appraisers, may caucus to discuss next steps.
The attorneys typically meet with the mediator to further discuss the issues. Having assessed risks and how the client may want to proceed and having heard the appraisers, the attorneys are typically the main players with the mediator to see if they can reach an agreement.
It tends to reduce stress when the parties feel that they’re in control, can predict what the process will be like, see that the process is followed and see that progress is taking place. The mediator knows this and uses this knowledge to facilitate an effective mediation.
Observations About Mediation
Flexibility is very helpful. An appraiser who understands negotiation and how to make concessions with the IRS10 can prove very valuable.
In some instances, the attorneys and clients appear without the appraisers to present their opening statements and allow for questions. In other instances, the attorneys and clients know each other well, want the mediator to meet with the appraisers and want the mediator to recommend the process.
Typical in-person mediations may last a fraction of a day to a very long day (12 hours). On rare occasions, the process may last for several days. My longest experience has been four days.
With virtual mediations, two documents are typically signed. One is the standard mediation agreement. The second document addresses a number of points associated with the virtual mediation. The initial virtual mediation allows about 30 minutes to explain technology and go over the main points of the virtual mediation agreement before the actual virtual mediation. Typical sessions in virtual mediations last for 90 minutes. It’s been shown that after 90 minutes, neuroscience cognitive abilities can significantly become impaired.11 I’ve found that to be the case. Scheduling follow-up virtual sessions also gives participants time to digest what’s happened and be better prepared for the next session.
Throughout the process, the mediator needs to overcommunicate the process to avoid miscommunications and make sure that everyone stays on the same page.
Mediation works best when initiated early in the litigation process or when the participants have become tired litigating and want to resolve the issues.Typical Reservations
Attorneys and clients may have reservations about mediation. They could have had a bad experience with a poor mediator. Or they may have never used a mediator before. Fear of the unknown is a valid concern. There could be a fear of cost, even though, typically, mediation is far less expensive than going to court.
Effect of COVID-19
Prior to COVID-19, nearly all mediations were face-to-face. Virtual mediations took place, but they were relatively rare. With COVID-19, the entire process went virtual, and the process has evolved based on the experience of all of the participants. Additional clarifications have been incorporated into the virtual mediation agreement.
Participants have remarked that better solutions have developed with the slowing down of the process. Giving participants time to reflect on the status of the mediation, how it’s proceeding and the alternatives available may result in more creative solutions.
For example, instead of an all-day or nearly all-day six-to-12 hour face-to-face meeting with closure, a series of four virtual 60-to-90 minute sessions over two weeks to three months may be necessary. The longer calendar time revolves around scheduling with the various participants.
Mediation Involving the IRS
It’s been my experience that at the IRS, the mediation process may not flow as smoothly as presented in the commentary above. The IRS mediator may have varying perspectives on what mediation means and may not be neutral. IRS mediators typically push the parties towards settlement. However, your client is allowed to bring their own skilled mediator to co-mediate with an IRS mediator if your client chooses and the IRS agrees. Mediation has to do with the skill level and experience of the participants and how the participants see their roles. The IRS has processes for pre-filing, examination, collection, appeals and pre-counsel involvement as presented in “Process for Internal Revenue Service Mediation,” p. 55.
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Here’s how the mediation process works at the IRS’ Small Business Self-Employed (SBSE) Division (part of the Estate and Gift Tax Program) regarding examination and appeals.
Examination. Typically, there’s interaction on behalf of the taxpayer by the taxpayer’s representative (TR) and an IRS estate and gift tax attorney (the agent). How you interact collaboratively12 defines the likelihood of success. The agent may bring on board an IRS engineer for the valuation issue. It’s possible that the TR and the agent may reach an agreement. It’s also possible that the TR and their appraiser may have a negotiation allowing the parties to reach an agreement with the agent and the TR. If not, the TR and agent may follow up after the appraisers have been heard and possibly reach an agreement. If no agreement is reached, the TR and the agent may reach out to the agent’s manager to try to resolve the issue. If no agreement is reached, the parties may be open to informal mediation at the examination manager level. At one time, a formal process for mediation existed in an SBSE examination. That’s no longer the case. Now the process may or may not be accepted by the agent’s manager.
In SBSE, some managers have been trained in mediation and embrace the concept of mediation. If the manager is comfortable and interested in mediation as suggested by the TR, mediation may be appropriate. The manager may reject mediation. Both parties need to agree to mediation for it to proceed. The manager may be willing to be the mediator, requiring the manager to take on a different role. In some instances, another IRS employee trained in mediation may act as the mediator. The parties need to work out the process.
Fast track. In an SBSE examination, there’s also the alternative of a fast track.13 Fast track is a voluntary mediation program that may help your client resolve their tax dispute more quickly than a traditional appeal. You can request fast track for most examination disputes and offer it in compromise cases and trust fund recovery penalty cases once the examiner or collection officer (the IRS) has completed their work, and there are issues that remain unresolved.
With fast track, an independent appeals mediator will try to help your client and the IRS reach an agreement on the disputed issue(s). The appeals mediator will facilitate settlement discussions and may offer settlement proposals.
Because fast track is voluntary, the appeals mediator can’t force your client or the IRS to participate or to accept a proposed agreement. You and your client retain control over decisions about your case. If your client is unable to resolve their dispute through fast track, they’ll still have the right to request a traditional appeal or a conference with an IRS manager.
Early referral to appeals. In some instances, there may be multiple issues, but one issue in particular may be applicable for an early referral to appeals.14 Because appeals is oriented towards settling the issue based on the hazards of litigation, this path is particularly useful for legal issues. Because valuation is a factual issue, typically this wouldn’t be as applicable to a business valuation.
If an IRS examiner or collection office is working on your client’s tax matters, you may request the transfer to appeals of a developed but not agreed-to issue, while the IRS continues to develop other issues in the case. This is known as an “early referral.” Resolving a key issue early may help you and the IRS resolve other issues in the case.
Post-appeals mediation. IRS appeals have a different system. After the appeals process has been completed and before going to court, the taxpayer may request mediation at appeals. The IRS states:
Mediation—also known as Alternative Dispute Resolution (ADR)—can help you if you have an unresolved issue with the IRS or disagree with an IRS decision or action. It’s informal, confidential and voluntary.
An Appeals officer who is trained in mediation techniques works with you and with the IRS employee assigned to your case. Mediators fulfill their role of helping the parties reach an agreement by:
- Facilitating communication between you and the IRS,
- Helping identify core issues or barriers to settlement,
- Helping identify possible settlement terms,
- Providing perspective and encouragement, and
- Ensuring a level playing field and mutual respect during the mediation session.
You can also learn more information at this link.15
Final Thoughts
Mediation may be a way for the participants to develop a resolution that everyone can live with going forward. Mediation at the IRS can be a viable alternative on valuation issues with an outside mediator familiar with resources while providing for a more timely closure.
Endnotes
www.amazon.com/dp/B08LHFX9RY.
www.cices.org/news/events/what-should-experts-expect-in-mediation.
www.mcguirewoods.com/news-resources/publications/BRK-Article-Kutrow.pdf.
https://supreme.justia.com/cases/federal/us/509/579/.
Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993).
www.law.cornell.edu/supct/html/96-188.ZO.html.
www.expertinstitute.com/resources/insights/daubert-trilogy-navigating-standard-expert-witness-challenges/.
www.plaintiffmagazine.com/recent-issues/item/including-an-expert-in-mediation.
www.expertinstitute.com/resources/insights/best-ways-for-expert-witnesses-to-participate-in-mediation/.
https://mikegreg.com/blog/token-concessions-and-counteroffers-negotiations-irs-business-valuations.
https://better-teams.com/getting-the-meeting-timing-and-breaks-right-is-important/; https://better-teams.com/what-is-the-appropriate-length-for-a-lunch-break-in-an-all-day-online-meeting/; www.sae.org/standardsdev/virt_meetings.pdf; https://imprintgroup.com/digital-meetings-101/; www.pon.harvard.edu/research_projects/negotiation-pedagogy-program-on-negotiation/negotiation-and-neuroscience-possible-lessons-for-negotiation-instruction/.
https://mikegreg.com/blog/how-interact-irs-estate-and-gift-tax-attorney-valuation-issue.
www.irs.gov/appeals/fast-track.
www.irs.gov/appeals/early-referral-to-appeals.
www.irs.gov/appeals/appeals-mediation-programs.