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How Are EARNINGS AND PROFITS From a BUSINESS APPORTIONED?
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Q. My Wife is a lawyer with a good practice which she started before we married. We have been separated for two years. I know that she has had some big cases and earned significant income since then. She is telling me that the practice is all hers, and I get no share of either or any of it. Is this true?
A. No.
There are two separate questions here - the increase in value of the law practice owned before marriage, during the marriage (or at its end), and the increase in the value of the practice after separation.
The practice is separate property at is inception, but there is a community property component at date of separation. This needs to be valued. Likewise, increases in value after the date of separation may similarly need to be valued. The same rules apply to the two situations, but the analysis is different for each.
When people marry or become domestic partners, they often already own assets like businesses and professional practices. This is especially likely for people who have been previously married.
During the marriage or partnership they improve those businesses through investments or contributions of their time, skill, and efforts. In the absence of a prenuptial agreement that declares those increases to be owned solely by the one spouse or partner, the premarital (separate property) interest often gets improved through community estate labor or infusions of community money. These are reimbursible to the community, unless they have been waived.
It is a breach of interspousal fiduciary duties to not reimburse the community for this increase. After separation the businesses or professional practices may likewise increase in value through post-separation contributions, which is reimbursible to the separate property estate of the managing spouse because it is unfair that the community should benefit from separate property efforts.
This is called "apportionment" or "equitable apportionment."
There are two basic principles that California judges are trained to apply:
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Fair return on investment. This is called the Pereira approach to apportionment, after
Pereria 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.
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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 sepearate 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 is performed to determine the value of the premarital interest in separate property, or 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 (these analyses are more easlier demonstrated with businesses as opposed to professional practices) as of the date of separation. They have to be applied in reverse to back out the separate property contributions after the date of separation.
In achieving the apportionment between separate and community property the Court has discretion to decide which formula will achieve 'substantial justice' between the parties.
Pereira 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 (Van Camp was turning out cans of tuna before marriage).
Under either analysis, once the community income has been determined, the community's living expenses must be deducted from the community income to determine the balance of the community property interest. This is called the "family expense" presumption, which is very important in all tracing and commingling and mixed asset cases.
It is presumed that the expenses of the family are paid from community rather than separate funds and in the absence of evidence showing a different practice, the communitiy earnings are chargeable with those expenses.
A forensic accountant will almost certainly be required in dealing with any form of business.
I will have to blog the reverse Pereira and
Van Camp issues another day.
Thurman W. Arnold III
http://www.ThurmanArnold.com
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Categories:
Business Valuations, Businesses, Characterization of Property, Community Property, Complex Cases, Date of Separation, Domestic Partnerships, Interspousal Fiduciary Duties, Prenuptial Agreements, Professional Practices, Property Division, Separate Property
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Posted By Thurman Arnold on
September 16, 2010 05:21 pm |
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