Do You Have An Interest In Your Spouse’s Business?

One important issue that often comes up in divorce concerns is whether the community has an interest in a spouse’s separate property business.  Before I provide an explanation, it’s important to understand the laws of community property in California.

General California Community Property Law

California is a community property state.  This means that all property acquired during marriage will be community property, with few exception, and each spouse will retain a one half interest in the property.  However, this rule is not absolute.  This general rule can be rebutted by “tracing” the funds used to purchase the property to a separate property asset.  One example is where husband purchases a home during the marriage with funds that came from his residence prior to marriage.  He would have a separate property interest in the newly acquired real property because of the use of his separate property funds.

Community Property

Why Is the Community Entitled to An Interest In A Separate Property Business?

Separate property includes property acquired prior to marriage, after permanent separation, or by gift, inheritance.  Typically, income from separate property is separate, but the fruits of the community’s expenditures of time, talent, and labor are community property.

So why is this important as it relates to your interest in a separate property business?  Where community efforts increase the value of a separate property business, it becomes necessary to quantify the contributions of the separate capital and community effort that increase in value.  The necessity of apportionment arises when, during marriage, more than minimal community effort is devoted to a separate property business.  The community is entitled to the increase in profits attributable to the community endeavor.  Accordingly, courts must apportion profits derived from community effort to the community, and profits derived from separate capital are apportioned to separate property.  In re Marriage of Dekker (1993) 17 Cal.App.4th 842, 850-852.

Distinction Between A Business Where Value is Derived by Community Efforts Verses Separate Property Investment/Capital

Following this change in law, California courts have developed two alternative approaches to allocating business profits and have endeavored to adopt that formula which is most appropriate and equitable under the circumstances.  Under the Pereira approach, community income is defined as the amount by which the actual income of the separate estate exceeds the return which the initial capital investment could have been expected to earn absent the spouse’s personal management.  Beam v. Bank of America (1971) 490 P. 2d 257.  Under the Van Camp approach, the community is allocated a share of the increased value equal to the fair value of the community services less amounts withdrawn to meet family expenses.

So, depending on varying circumstances of each case, the court will apply the formula that best meets the character and nature of the separate property business and the principal factor contributing to its increase in value.

A.    Value of Business Primarily Derived From Investment

One example of where the increase in value was primarily a result of investment was in Schulman v. Schulman (1976).  The business owner spouse was the sole owner and proprietor of a wholesale and retail meat business.  The court applied the Van Camp formula because it attributed the increase in value of separate property business to the population growth in the area during the time of the marriage, and the business’s expansion made possible by the SBA loan rather than the business owner’s personal efforts being principally responsible for the growth and continuity of the business.

 B.     Value of Business Primarily Derived From Community Efforts

Conversely, in Patrick v. Alacer Corp (2011) 201 Cal. App. 4th 1326, the court applied the Pereira method because the court held that business profits were principally attributed to efforts of the community.  Alacer Corporation was maker of the popular Emer’gen-C vitamin supplements and the company indisputably increased in value during the marriage, and the owner spouse put “much more than minimal efforts into the business.”

Once a California court ascertains the amount of community income, through either the Pereira or the Van Camp approach, it deducts the community living expenses from community income to determine the balance of the community property.  It follows that the community portion is significantly less where the Van Camp formula is applied.

So Which Formula Is Best For Your Case?

The non-owner spouse typically argues in favor of Pereira claiming that the growth and expansion of the separate property business of the owner spouse during the course of marriage was due to his effort, skill, talent and community labor.  On the other hand, the owner spouse will argue in favor of Van Camp claiming that the growth of business was principally due to external factors.  Although, the courts have made it clear that there is no general rule and the application of either theories would vary depending on the circumstances of each case, it is a logical conclusion that Pereira will be used where the business is labor intensive and/or requires special talent of the owner.  Van Camp will be most effective where the growth is due to changes in population, economy and trend.

Disclaimer:  Nothing in this blog should be considered legal advice.  Without considering the particular facts of your case, attorneys with Pocklington Law Offices are unable to unable to offer advice as it relates to a person’s particular case.  If you wish for our office to consider taking your case or to offer legal advice, please contact our office to schedule an appointment by calling (925) 295-7348.

[1] “The Community” refers to the property acquired by a couple during marriage in California.

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