How Are BUSINESSES Owned Before Marriage DIVIDED In Divorce?

Q. My Wife is a personal injury lawyer with a good practice which she started six years before we married. We have been separated for nine months, after nine years together. She just sent me a settlement agreement. It says the law practice is ordered to her, but it says nothing about me receiving any money for that. She says that since I am not a lawyer and can't practice law, and I get no share of its value. Is she right?

A. No, assuming it has a value that is greater than its value on the date you married!

The fact that you are not a lawyer has nothing to do with whether the "community estate" (the two of you as an economic unit) has an interest in the business that must be reimbursed. This would be true if she or you were a doctor, married to a person who isn't, and so who must have a license to practice their trade. Obviously the law practice must be awarded to her in your dissolution, but that doesn't mean she won't be forced to buy you out as though you were a licensed "silent partner."

When people marry or become domestic partners, they commonly already own assets like businesses or professional practices. This is especially likely for those who've been previously married.

During marriage a professional-trade spouse may increase the worth of a business they manage, whether as a sole proprietorship or as a shareholder of a professional corporation. Per Family Code section 760, all economic value that is created during marriage is presumed to belong to both parties. Value in this sense is measured by a benchmark date, and these dates vary according to circumstances and scenarios. This is called the "date of valuation", but there may be more than one. What gives rise to the community property interest is either spouse's contribution of time, skill, and efforts (TS&E) to - pretty much whatever - from the period from the DOM (date of marriage) to DOS (date of separation).

By the way, a prenuptial (or post-nuptial) agreement may waive a legal interest derived from these TS&E increases, meaning that the community estate acquires no interest in the separate property of the business-owner spouse. I assume you didn't sign one.

Unless you've waived the community property interest in your wife's separate property, it is a breach of interspousal fiduciary duties to deprive the community estate - of which you own one-half - of increases to a party's separate property resulting from TS&E. This means that the community (and separate) interests must be priced in terms of recent or present values. Always a controversial area. Once you physically separate, all your wife's TS&E belongs once again to her alone.

After separation a business or professional practice may likewise increase in value through continuing TS&E type contributions. These may be reimbursable to the separate property estate of the managing spouse and so backed out of the community interest, because it is likewise unfair that the community should benefit from separate property efforts.

There are three time periods relating to the value of your wife's practice that matter here: (1) the value of the law practice as of the date you married, (2) the increase in value (if any) that occurred during marriage that existed as of the date of separation, and (3) at the time of trial. Indeed, California law presumes that the property date for valuing an asset is at trial. Family Code section 2552.

Legal professionals refer to this manner of calculating the community property interest as an "apportionment" or "equitable apportionment."

There are two basic apportionment "formulas" that California judges are trained to apply in these situations:

  • Fair return on investment. This is called the Pereira approach to apportionment, after Pereira v. Pereira (1909) 156 Cal. 1, 103 P. 488, which involved a husband saloon owner. It apportions a "fair return" on the owning spouse's separate property investment in the business as separate property, then apportions any excess to the community property as arising from that spouse's efforts during marriage.
  • Reasonable compensation. This is the Van Camp apportionment method, which derives from Van Camp v. Van Camp (1921) 53 Cal.App. 17, 199 P. 885 (yes, seafood in Long Beach), which apportions the reasonable value of the spouse's services during marriage as community property, then treats the balance as separate property attributable to the normal earnings of the separate estate. Reasonable compensation is typically the analysis used in small business valuation cases, and is often found by looking at what other people in the same field performing the same functions tend to earn.

Either analysis (and there are hybrids and others) may be performed to determine the value of the premarital interest in separate property and in deriving the community interest in what began as separate property.

These methods deal with the first half of your question - valuing the law practice as of the date of separation. They may have to be applied in reverse to back out the separate property contributions after the date of separation when a business is valued at time of trial.

Trial courts can pick the approach that they reasonably conclude makes the best sense given the facts of each case. In achieving the apportionment between separate and community property the Court has discretion to decide which formula will achieve 'substantial justice' between the parties.

The Pereira formula is commonly used when business profits are principally attributed to the community efforts (i.e., during marriage). Van Camp is applied when the community efforts are more than minimally involved in a separate business, but the business profits that accrued are attributed to the character of the separate asset (Mr. Van Camp was turning out cans of tuna before marriage).

I'll write more on this fascinating subject.

T. W. Arnold, III, C.F.L.S.