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Business Valuation in Family Law CasesMarc Peter Kaplan, CFLS

Should the Business Be ValuedBusiness Valuation in Family Law Cases

Is it a Job or More than a Job?

Understanding Business Valuations

Is It a Job or More Than a Job?

A Job?Earning, truthfully, no more than you could being employed

Consultant business income: $40,000

Salary of available job doing similar work: $40,000-$50,000

More Than Just a JobEarnings > a job salary

Example:

Consultant, earnings from self employment: $180,000 Salary job available doing similar work: $60,000

Part-Time JobDay job, earns salary, computer repair person: $60,000

Part-time evenings, computer consultant to companies: Earns $20,000 working two-three nights/week

Marital Dissolution Value


Marital Dissolution ValueYou will hear it described in numerous confusing ways depending on who wants to use a specific valuation for a specific purpose

Marital dissolution value = Value of the community interest in the business

Commentary: To value the community’s investment of time and capital in the business (it may be a real world fictional valuation if not sellable)

Marital Dissolution Value (cont’d)

Types of ValuationFair market value

Investment value

Asset value

Commentators/courts are not on the same page as to what is the appropriate standard

Fair Market ValueWhat would the business sell for on the open market with a willing buyer and willing seller

Consider just like a house or a car or?

Investment ValueWhat would an investor pay to buy the business to earn a return on the investment and have the investment?

Asset ValueThe value of the assets

No goodwill or other items considered

Types of Businesses


Industry “Rule of Thumb” – Real World ValuesCPA Practices: 1 X annual gross plus or minus 10-20-30%

depending on factors

Dentists: 0.65 X annual Gross

Chiropractors: 0.55 X annual Gross

Standards increase and decrease for reasons

These are basic starting points only

No Active Market“Capitalization of excess earnings method” aka “excess earnings method”

(Standard, when no better method: an investment method valuation)

Other methods

Fair Market ValueLike a house or car

Question: Is fair market value marital dissolution value?

Value & Net Tangible Assets


Excess Earnings MethodAn investor valuation method: What would an investor pay to own the business and realize a return on the purchase of the assets

Excess earnings method

Net Tangible Assets

Net Tangible Assets (cont’d)(Assets – Liabilities) = Book value adjusted to FMV

Book value is typically the cost to the business

I.e. assets and liabilities are recorded at cost – even if purchased 20 years ago

Net Tangible Assets (cont’d)Cash (bank accounts)

Accounts receivable

Inventory

Equipment

Deposits

Intangible assets (goodwill, patents, copyrights, trademarks, etc.)

Investments

Other miscellaneous assets/shareholder loans receivable

Net Tangible Assets (cont’d)Accounts payable

Accrued expenses

Taxes: sales, payroll, other

Credit cards

Line of credit

Bank loans

Other debts/shareholder loans payable

Net Tangible Assets (cont’d)Adjust assets and liabilities to their current FMV

The net result is an adjustment to equity

Net value increases = increase equity Net value decreases = decrease equity

Cash/Bank AccountsShould this asset be valued less or more than its face value?

Can I buy your $1,000 savings account for $800?

Accounts Receivable/PayableBeware: Many businesses don’t use accrual accounting and no accounts receivable or payable are on the balance sheet

Balance Sheet

Accounts receivable: $-0- Actual A/R: $167,000

Must record the asset

Advances to ShareholderAre these really a valid loan or just compensation to be expensed after the divorce, as income to owner?

Are these loans collectible?

If they are not real, why should they be valued as a business asset?

Write them off unless valid notes, interest, payment history, other facts

Equipment/Investments/Other AssetsAdjust to true FMV

Is the computer purchased for $10K one year ago worth the undepreciated balance of $8K?

Is the shopping center purchased 20 years ago for $2M depreciated to $300K, worth $300K?

Income Taxes Payable

Shareholder LoansIs this really a loan? Interest paid? Payments made?

Or is it really tax disguised equity to be withdrawn tax free?

If it is equity, equitize it by adding it to equity

Goodwill


Generic Definition of GoodwillSimplified definition

The ability to earn superior earnings due to reputation, location, unique product, years in business or some other factor, as compared to another business

Formulaic Definition of Goodwill: Excess Earnings Method

Formulaic Definition of Goodwill (cont’d)

Goodwill Example: Oversimplified

Goodwill Example: Simplified (1 Cap)

Goodwill Example: Simplified (2 Cap)

Goodwill Example: Simplified (3 Cap)Valuators & Cap Rate or Multiplier


Valuator NamesValuators use different names/factual data

Names

Subjective value to owner Risk of transfer Market value approach Tax impacting proposed valuation Investment value

Valuators Use Different Factual DataDifferent valuators will use different factual data – why?

Factual data

Cap rate Replacement salary Add backs

These three items are the most critical to any litigation over valuations using capitalization of excess earnings method

A fourth critical item would be the representative operating net income – or normalized earnings

Capitalization Rate or MultiplierA percentage or rate multiplier times excess earnings used to determine goodwill

Determine using the “build up rate” of several factors

Risk free rate Equity risk premium Size premium Industry risk premium Specific company risk adjustment

Capitalization Rate or Multiplier (cont’d)Totals the build up rate which is a percentage converted to a multiplier (generally 1-5)

The higher the multiplier, the lower the risk:5 X excess earnings = A McDonald’s

The lower the multiplier, the higher the risk:1 X excess earnings = low bid construction contractor, attorneys, other high risk professions

Capitalization Rate or Multiplier (cont’d)The more equipment, labor, higher capital invested, less risk

The higher the cap multiplier (between 1 and 5)

San Diego (generally conservative): 1-2-3 Los Angeles (more aggressive): 2-3-4

Caution

Nightmare at Trial: Who Wants High Low?

RememberBusiness valuations

It is a confusing and difficult environment Find an expert to be your consultant!

Understanding Pereira & Van Camp

Business Valuation in Family Law Cases

Pereira & Van CampMethods of apportioning increase in value

During the marriage, between separate property (SP)

And community property (CP)

Pereira v. Pereira (1909) 156 Cal. 1

Van Camp v. Van Camp (1921) 53 Cal.App. 17 (CA-2(1)

Van Camp v. Van Camp (1921) 53 Cal.App. 17 (CA-2(1)“VC” = Valuable Capital

Capital (equipment/inventory) Labor of others

Van Camp MethodSingle question: Was the community reasonably compensated?

Van Camp (cont’d)Reasonable compensation

Less actually paid

Equals owing community for CP interest

Van Camp: Example No. 1

Van Camp Example No. 1 Answer

Van Camp: Example No. 2

Van Camp Example No. 2 Answer

SP Business: Example No. 3

SP Business Example No. 3 Answer

Apportionment between Community & SeparateIncreased value at DOS $500,000

Less due community (200,000) [70-50 = 20 X 10](reasonable compensation)

Separate property = $300,000

Pereira v. Pereira(1909) 156 Cal. 1Pereira method: “P” = Personal Services

Interest on separate property value during the marriage = SP Balance of value above the SP plus interest equals CP (Requires business valuations – unlike Van Camp)

Pereira Method

Pereira Method (cont’d)First, compute separate value

Value at date of marriage Add interest on value from date of marriage to separation Equals value of SP to DOS

Pereira Method (cont’d)Treat date of marriage value

Like a pre-marriage SP savings account earning interest

(Case law not specific whether compound or simple)

Pereira: Example No. 1

Pereira Example No. 1 Answer

Pereira Example No. 1 Answer (cont’d)

Pereira: Example No. 2

Pereira: Example No. 2 (cont’d)Pereira or Van Camp?

Understanding Pereira & Van Camp

Question

Which Method Applies?P = Personal service (Pereira)

VC = Valuable capital (Van Camp)

Capital (equipment/inventory) Labor of others

Pereira or Van Camp?

Which Method Applies? (cont’d)Answer:

Beam v. Bank of America (1971) 6 Cal.3d 12 “Select whichever formula will achieve substantial justice between the parties”

Pereira or Van Camp?

Pereira or Van Camp?Partner/shareholder: In large practice with many employees

Executive/manager/owner: Large factory, lots of employees, inventory, and valuable plant, machinery, and equipment

Sole practitioner: attorney, CPA, dentist, doctor

The Blended Family

Property

Marriage of Brandes (2015) 239 Cal.App.4th 1461

Pereira Approach

Marriage of Brandes (cont’d)

Was the Community Reasonably Compensated?

Brandes Apportionment





No Further Shared Appreciation

No Further Shared Appreciation (cont’d)

Hypo No. 1: Owner/Tree TrimmerCuts trees every day, owns expensive machine

Gets business, does estimates, collects and pays bills

Supervises one or two other employees when they work

Hypo No. 2: CP Business – Owner FilesDOS: 1-1-2012 (owner)

Salary (2012; owner of biz): $100,000

Reasonable compensation: ($60,000)

Excess over reasonable $40,000

No SS to Either PartyTrial on 1-2-2013: CP result?

Community owed $40,000 by owner (A “reverse” Van Camp or Pereira)

In re Marriage of Imperato(1975) 45 Cal.App.3d 432 (CA-2(5))When a spouse applies skill, efforts, and industry to increase community assets after separation

The apportionment formulas of Pereira and Van Camp must be applied in reverse

Imperato CreditsCont’d

Business Valuation: Legal Analysis2017 Advanced Family Law Course

General RuleAssets are valued as near as practicable to time of trial (or settlement)

This rule applies to businesses unless good cause exists for an alternate date of valuation

Fam C 2552: “(a) For the purpose of division of the community estate upon dissolution of marriage or legal separation of the parties, except as provided in subdivision (b), the court shall value the assets and liabilities as near as practicable to the time of trial.”

Date of Valuation

Small Business Exception

Date of Valuation

Small Business ExceptionSmall businesses which rely on owner’s skills, services, and reputation are normally valued at the date of separation

Underlying principle is that the owner’s services after DOS is SP of the business owner per Fam C 771

So any value gains or losses attributable to such services are also SP

Date of Valuation

In re Marriage of Green(1989) 213 Cal.App.3d 14 (CA-1(5))H owned small law practice, which he argued should be valued at date of trial

T/Ct valued it at DOS

CA-1(5): AFFIRMS

Marriage of Green (cont’d)“At any given moment the major assets of most law firms are not capital assets, but those related to the direct rendering of professional services, most particularly accounts receivable and work in process.... For this reason we adopt the general rule that in determining the community property interest in law partnerships (including goodwill) in marital dissolution actions, the proper date of valuation is the date of separation of the parties, not a date as near as practicable to the time of trial.”

Holding

Marriage of Green (cont’d)Exceptions to general rule were noted

Large firm where spouse is insignificant player in value of firm, or Where formula in partnership agreement provides accurate value [see Marriage of Aufmuth

(1979) 89 Cal.App.3d 446 (disapproved on other grounds)]

Holding

In re Marriage of Stevenson (1993) 20 Cal.App.4th 250 (CA-2)H owned small contracting business and Christmas tree lot

W moved for alternate date of valuation, claiming H had trashed the business

H claimed decrease due to son’s use of his name, number, and address for his own business and decline in construction industry

Marriage of Stevenson (cont’d) Court held that where value of the business is primarily dependent upon the owner’s services (i.e., goodwill, A/R, and work in progress), and not capital assets, business should be valued at date of separation

Marriage of Green rule also applies to small businesses that rely on skill and reputation of owner, such as the contracting business in this case

Holding

In re Marriage of Duncan (2001) 90 Cal.App.4th 617 (CA-4(1))H was investment manager

Assets under his management more than doubled from $1B to $2.6B from DOS to trial; there was significant increase in value of business between DOS and trial

H’s experts included leading expert in investment management industry, who testified value increase due to H’s skill and that he was the business’ most significant asset

Marriage of Duncan (cont’d)W argued increase was due to multiple factors: Contractual fees regardless of H’s work, growth of funds under management, and flourishing stock market

CA-4(1): AFFIRMS – a DOS value

Court not required “to find the entire postseparation change in value was due exclusively to the personal efforts of the operating spouse in order to apply an alternative [Emphasis added.] valuation date.”

Other Factors Affecting Valuation Date

Date of Valuation

In re Marriage of Stallcup (1979) 97 Cal.App.3d 294 (CA-3)Court permitted an alternative date of valuation when business owner failed to cooperate in producing records that would allow for valuation at date he proposed

“Having failed to provide timely evidence of his claimed [postseparation] business reverses, husband may not now benefit from the confusion thus created and we will not further consider his contentions of business losses.”

Failure to Cooperate in Discovery

In re Marriage of Fink (Fink II) (1979) 25 Cal.3d 877 H had so intertwined pre- and post-separation operations in poor record keeping, that it was impossible to determine a DOS value

Even though T/Ct otherwise would have done so

Commingling Business Operations and Poor Record Keeping

Breach of Fiduciary DutyMarriage of Stevenson effectively addressed most cases involving mismanagement since a business in which an owner spouse has the capability to mismanage would likely qualify for DOS value

However, there could be circumstances in which a business which would normally be valued at trial because of growth not typically attributable to spouse, but spouse’s actions in some way decreased value

Breach of Fiduciary Duty (cont’d)I.e. an action which wouldn’t normally greatly enhance reputation, but if outrageous enough, damages reputation of business

See Marriage of Koppelman (1984) 159 Cal.App.3d 627 (Disapproved on other grounds), in which court stated that neglecting fiduciary duty could be grounds for alternate valuation date

In re Marriage of Reuling (1994) 23 Cal.App.4th 1428 (CA-1(5))Court held that a failure to disclose insider information

When barred from doing so under securities law

Is not a basis for an alternate date of valuation

Failure to Disclose Insider Information

In re Marriage of Zaentz (1990) 218 Cal.App.3d 154 (CA-1(1))Court permitted reopening case after trial to allow evidence re post trial profits of “Amadeus”

Unusual facts because such a significant increase in value and profit generation could be tied all the way back to community efforts

Even though movie not even completed at DOS

Change in Value After Trial

After Judgment Set Aside: Fam C 2126“As to assets or liabilities for which a judgment or part of a judgment is set aside, the date of valuation shall be subject to equitable considerations. The court shall equally divide the asset or liability, unless the court finds upon good cause shown that the interests of justice require an unequal division.”

In re Marriage of Munguia (1983) 146 Cal.App.3d 853 (CA-1(3))Value of bar greatly affected by whether lease could be renewed, which could not be determined until soon after trial

CA-1(3): Held T/Ct should have reserved jurisdiction until that fact resolved because of such a significant difference in value

Unknown Fact Which Greatly Affects Value

Procedure for Alternate Date of Valuation

Date of Valuation

Fam C 2552(b)“(b) Upon 30 days’ notice by the moving party to the other party, the court for good cause shown may value all or any portion of the assets and liabilities at a date after separation and before trial to accomplish an equal division of the community estate of the parties in an equitable manner.”

CRC Rule 5.390Court may bifurcate one or more issues on own motion, case management, stipulation, or part of a RFO (FL-300)

Bifurcation of Date of Valuation Determination

CRC Rule 5.390 (cont’d)“(b) The court may separately try one or more issues before trial of the other issues if resolution of the bifurcated issue is likely to simplify the determination of the other issues. Issues that may be appropriate to try separately in advance include:”


CRC Rule 5.390 (cont’d)“(1) Validity of a postnuptial or premarital agreement;

(2) Date of separation;

(3) Date to use for valuation of assets;

(4) Whether property is separate or community;

(5) How to apportion increase in value of a business; or

(6) Existence or value of business or professional goodwill.”


Can Court “Split the Difference?”

Methods of Valuation

In re Marriage of Webb (1979) 94 Cal.App.3d 335 (CA-1(3))Issue was goodwill value of H’s private investigation business, “Jack Webb Associates”

W’s expert (E) valued it at $31,468 using capitalization of excess earnings method

However, E admitted (presumably on cross) that he had never valued a P.I. business before and had no knowledge as to what the firm would sell for

E also admitted that cap rate he used “was somewhat arbitrary”

Maybe…

Marriage of Webb (cont’d)H testified that he knew of no recent sales and that, in his opinion, goodwill = $0

T/Ct, Solomon-like, valued goodwill at $16K

W appealed, but CA-1(3) HOLDS

T/Ct properly “combined” W’s evidence and H’s evidence Thus, there was evidence suggesting that this method is not proper, but there was no authority

saying that T/Ct’s method was not acceptable

Authority was provided a scant six years later in Marriage of Hargrave

Maybe…

In re Marriage of Hargrave (1985) 163 Cal.App.3d 346 (CA-2(1))Business known as “Charles Hargrave Associates”

H was manufacturer’s rep, i.e. a sales rep whose relationship to manufacturers he worked with was that of private contractor

Issue was goodwill value of business

W’s expert set value at $100K; H and two experts on his side put it at $0

T/Ct: Value = $35K – in between, but not precisely in the middle

W appealed, and CA-2(1) REVERSES

No…

Marriage of Hargrave (cont’d)H relied on Marriage of Webb

The court, however, limited Marriage of Webb to its facts, noting W’s expert’s lack of experience in that case and absence of recent sales

The court also noted, perhaps a bit wryly, that the Marriage of Webb opinion did not state what findings of fact the court had made in that case, or whether those findings supported the judgment

Furthermore, if Marriage of Webb indeed did support a “split-the-difference” approach, the court said that it was rejecting that approach

Holding

Closely Held Corporations

Methods of Valuation

IRS Revenue Ruling 59-60Ruling was a statement of IRS policy regarding valuation of stock in a closely held corporation for estate and gift tax purposes

IRS listed and explained 8 factors to be considered, stating that those factors, “although not all-inclusive are fundamental and require careful analysis in each case”

[1959-1 C.B. 237]

IRS Revenue Ruling 59-60 (cont’d)The nature of the business and the history of the enterprise from its inception

The economic outlook in general and the condition and outlook of the specific industry in particular

The book value of the stock and the financial condition of the business

The earning capacity of the company

IRS Revenue Ruling 59-60 (cont’d)The dividend-paying capacity

Whether or not the enterprise has goodwill or other intangible value

Sales of the stock and the size of the block of stock to be valued

The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter

In re Marriage of Hewitson (1983) 142 Cal.App.3d 874 (CA-2)CA caselaw requires that Family Law Courts consider all eight factors listed in IRS Rev. Rul. 59-60

In Marriage of Hewitson, CA-2 REVERSES T/Ct that valued stock in a closely held corporation by relying exclusively on the price-earnings ratios of publicly traded stock of companies engaged in the same business as the business being valued

Closely Held Corporations

Valuation Based on Income Stream (Income Approach)

Valuation of Entire Business

In re Marriage of Barnert (1978) 85 Cal.App.3d 413 (CA-2(5))

W’s expert valued H’s medical practice using 25% of H’s gross annual billings, and then made an adjustment based on the profitability of the practice

Specifically, he concluded that because H was taking more than 50% of gross receipts out of his practice, correct formula to use in his case was 30% of annualized earnings

He then testified that his margin of error in valuing medical practices was 10% (! !)

Income Approach

Marriage of Barnert (cont’d)T/Ct, taking this margin into account, valued practice at a value that was 2.75% higher than the expert had reached

CA-2(5) AFFIRMS this approach, although it did reverse on the related issue of how to deal with post-separation losses

Valuation Based on Net Assets (Asset Approach)


Elements of ValueCash

Leasehold improvements

Equipment

Furniture

Trade notes

Work in process/ unbilled fees

Accounts receivable

Library

Buildings & other fixed depreciable assets, less accumulated depreciation

Land

Asset Approach

Elements of Value (cont’d)Loans made and outstanding

Other investments, i.e., joint ventures

Pension and profit-sharing plans

Prepaid expenses

Patents, trademarks, and copyrights

Royalty contracts

Tax credits

Capital loss carry forwards

Stockholder advances

Unrealized appreciation of assets

Goodwill

Elements of Value (cont’d)The values of these items are not always reflected by the figures shown in company’s balance sheet

For example, equipment depreciated on the business’ income tax returns will be shown on the balance sheet as having the value remaining after depreciation

That is appropriate for income tax purposes, but for marital disso purposes, value to use is the FMV of the equipment [Fam C 2552(a)]

Therefore, it may be necessary to obtain independent appraisals of particular assets of the business, and the business valuation expert will need to adjust the balance sheet values accordingly

Work in Process and Accounts ReceivableFor many small businesses and particularly professional practices, work in process and/or A/R is the most valuable hard asset

“At any given moment the major assets…are not capital assets, but those related to the direct rendering of professional services, most particularly accounts receivable and work in process....” [Marriage of Green (1989) 213 Cal.App.3d 14]

Asset Approach

Determining the Value of WIP/ARDetermination of initial value: Work in process/accounts receivable (WIP/AR) typically does not appear on a balance sheet prepared using the cash basis accounting method

Info will need to be gathered to determine WIP/AR at DOS and add the value to adjusted balance sheet prepared by the expert [Marriage of Nichols (1994) 27 Cal.App.4th 661]

Asset Approach

Determining the Value of WIP/AR (cont’d)Discount for uncollectibility: Experts typically consider A/R collection history and apply a discount for uncollectibility

The amount of the discount is fact driven and varies significantly from case to case and expert to expert

See Marriage of Nichols: One expert gave a 90% discount, and the other a 50% discount

Determining the Value of WIP/AR (cont’d)Discount for collection costs: Marriage of Kilbourne (1991) 232 Cal.App.3d 1518

The court affirmed principle that costs of continuing to operate business after separation properly allocated between SP and CP when H would be required to continue to work on case and pay office expenses to collect CP share

CA-1(1) approved specific formula method used by T/Ct in absence of adequate evidence by H, but stated in an appropriate case actual expenses could be considered

Determining the Value of WIP/AR (cont’d)Discount for income taxes: WIP/AR will be taxed once received

Typically, the expert will discount the value by an appropriate tax rate as an immediate and specific tax consequence

Marriage of Fonstein (1976) 17 Cal.3d 738

Determining the Value of WIP/AR (cont’d)But see Johnson v. U.S. (9 Cir 1943) 135 F.2d 125

H awarded the business with outstanding AR Each party reported one-half of A/R when collected IRS gave W a refund and assessed H a deficiency 9th Cir REVERSES, holding that A/R is CP income, so they can’t all be assigned to H

Partnership/Shareholder AgreementsTypically, a court will disregard partner/shareholder agreements which limit the value of the business

As value is determined as “in place” value to spouse who will be continuing in the business

Marriage of Fenton (1982) 134 Cal.App.3d 451

Other Issues re Accounts Receivable

Partnership/Shareholder Agreements (cont’d)However, in the unusual situation in which a business has multiple owners who operate under an agreement which limits a partner/shareholder’s ability to receive his or her pro rata share of AR

Then the court has the discretion to disregard AR

Marriage of Nichols (shareholder agreement provided that a shareholder’s compensation was not linked to A/R and CA-3 affirmed decision which ignored value of AR)


Partnership/Shareholder Agreements (cont’d)Marriage of Nichols was followed in Marriage of Iredale and Cates (2004) 121 Cal.App.4th 321

CA-2(4) held that, where partner did not “buy into” firm’s WIP/AR at the front end, the value of his/her partnership interest for marital disso purposes did not include pro rata value of WIP/AR


In re Marriage of Kilbourne (1991) 232 Cal.App.3d 1518 (CA-1(1))H had personal injury practice with significant WIP at DOS

H argued unsettled cases should be allocated to him at zero value on basis that court should not reserve jurisdiction over an asset and there was no value yet since not settled

CA-1(1) REVERSES but finds a limited time period reservation was acceptable

In addition, H refused to provide evidence necessary to make determination of present value (on confidentiality basis), so reservation only possible method

Contingency Cases

Impact on Spousal SupportMarriage of Marx (1979) 97 Cal.App.3d 552: H awarded A/R and also ordered to pay CS and SS, which were based on his income, including income from AR

H argued double dip CA-2(5) confirmed that W had property interest in A/R which was considered separately

from support

Marriage of Blazer (2009) 176 Cal.App.4th 1438: Upheld that T/Ct permitted consideration of goodwill portion of value of H’s berry business

NOTE: No evidence at trial that “excess earnings method” utilized valued “future earnings”

Case holding opposite Grunfeld v. Grunfeld (2000) 94 N.Y.2d 696


Impact on Spousal Support (cont’d)As stated in Marriage of Blazer, the court is not aware of any CA decisions addressing double-dipping in the context of a former CP business operated by one spouse following separation

However, there are CA cases which address the double-dipping issue in the context of former CP pensions


In re Marriage of White (1987) 192 Cal.App.3d 1022 (CA-2(3))CA-2(3) observed, “Spousal support considerations are separate and distinct from property division concepts.”

Quoting secondary authority, the court concluded that it created no “error of double counting” to award a pension to earner spouse “and then to take the earner spouse's receipt of pension benefits into account in determining whether there should be any alimony awarded to either spouse.”

H’s “now separate property pension must be considered along with other appropriate factors when gauging his ability to pay just and reasonable spousal support.”

Double-dipping Issue in the Context of Former CP Pensions

In re Marriage of Epstein (1979) 24 Cal.3d 76 CASCT rejected “husband's contention that an award of support beyond his mandatory retirement date . . . would conflict with the equal division of community property requirement . . . .”

The court noted that SS was scheduled to terminate “almost three years prior to the date of husband's retirement.”

Double-dipping Issue in the Context of Former CP Pensions

Marriage of Epstein (cont’d)“Moreover,” the court observed, “even if a future award of spousal support must come from husband’s half of the community property there is no requirement excluding such property as a source of that support.

As the Court of Appeal below noted, ‘in every case where one spouse receives permanent spousal support from the other spouse, the source is from the separate property of the paying spouse, including . . . earnings or property which were once the community property of both spouses.’ ”

In re Marriage of Blazer (2009) 176 Cal.App.4th 1438 (CA-6)H owned profitable produce company in CA valued at $5.6M

T/Ct ultimately awarded entire business to H and all remaining assets to W, plus $1.34M equalization payment

In determining W’s request for permanent support, T/Ct excluded $1.4M H used from his capital acct to expand & integrate the business (after separation) – stating it was a reasonable business expense that should not be charged against H’s income, but rather taken out of the company before assessing H’s reasonable income for purposes of support

Double-dipping Issue

Marriage of Blazer (cont’d)T/Ct also awarded W $20K/mo in permanent SS

Both parties appealed

W argued that the T/Ct should have accounted for all of H’s income – including funds in H’s capital account

H argued that the award unfairly permitted W to double-dip into his business stream – because W was awarded ½ of the business’s goodwill value in the property division; thus, it should not have considered those same earnings in assessing his ability to pay her support

Marriage of Blazer (cont’d)CA-6 (partially unpublished portions are 1st 2 and last 2 paragraphs of “Background” section and II.A, II.C. and III of “Discussion” section): Held that T/Ct acted well within its discretion by attributing reinvested funds to the business instead of H

On issue of goodwill: “[A]n entity’s future earnings do not always correspond with the owners contribution of labor. [Case law] has long recognized [that] goodwill may exist separate and apart from the services of the person who created it”

Although goodwill and earnings may arise from the personal talents, skills, and reputation of an individual, their value may attach and continue with the business even after that employee departs

Holding

Marriage of Blazer (cont’d)CA-6 concluded that T/Ct valued H’s business without including any of his potential or continuing income – additionally, nothing precluded T/Ct from recognizing H’s future earnings as income available for support

“To sum up, California authority offers no basis for treating [H’s] earnings from his ongoing business differently from income generated by other assets divided at dissolution, for purpose of setting [SS].”

Thus, CA-6 declined to adopt any prohibition against the double-dip in divorce

Holding

In re Marriage of House (1975) 50 Cal.App.3d 578 (CA-2(5))H had A/R at DOM which were collected and spent during marriage

And approximately same amount of A/R at DOS which were collected and spent after separation

Court held A/R at DOS was CP because actually earned during marriage

A/R at DOM = H’s SP, but already collected and spent, so no longer exist

AR in Business Which was Started Prior to Marriage

Jewel v. Boxer (1984, on rehg) 156 Cal.App.3d 171 (CA-1(5))Law firm with no written partnership agreement dissolved and 2 new firms formed

T/Ct divided fees from firm clients on quantum meruit theory, allocating more fees to attorneys who worked on case after dissolution

CA-1(5) REVERSES – the Uniform Partnership Act provides that, absent a written agreement, a partner is not entitled to extra compensation for work in winding up partnership business

Division of AE in Non-FL Partnership Dissolutions

Rothman v. Dolin (1993) 20 Cal.App.4th 755 (CA-2(5))Attorneys agreed to dissolve partnership but disagreed on division of WM for hourly and contingency cases

One partner argued that hourly cases were “completed” at end of each month when billed so should be treated differently from “unfinished” contingency cases

Court held that all pending cases were “unfinished” and that the fees should be split equally based upon equal interests in partnership

CA-2(5) AFFIRMS based upon partnership law and Jewel v. Boxer

Division of AE in Non-FL Partnership Dissolutions

Valuation Based on Prospective Sale (Market Approach)


Market ApproachNo published CA appellate case specifically discusses valuation of a business based on the value that could be obtained were the business to be sold — that is, the way real estate is usually valued in marital disso cases

The only case to discuss the issue is Marriage of Sharp (1983) 143 Cal.App.3d 714 (T/Ct valued the business as a “going concern,” and CA-4(1) reversed)

Market Approach (cont’d)The court stated, somewhat cryptically: “The use of a ‘going business’ concept as an equivalent to market value is not sound evaluation methodology. It does not have the same meaning and relevance as the fair market value concept. The term ‘going business’ or ‘going concern’ is applied to a business or corporation which is still pursuing its business with the prospect of continuing to do so even though, for example, its assets may be insufficient to pay its debts.”

Market Approach (cont’d)The court then concluded that the “going business” concept applied by T/Ct was “not the equivalent to fair market value.”

Implicitly, then, Marriage of Sharp stands for the proposition that the true FMV, in the form of an opinion of a business broker or other expert based on the proceeds of the prospective sale of the

business is an appropriate valuation method

Such testimony would include, of course, data concerning recent sales of comparable businesses

Fair Compensation

Business Valuation

Fair CompensationUnder the Van Camp approach to apportioning a business into separate and community interests

The community is entitled to the value of a reasonable salary for the operating spouse, and any increase in value above that value is SP

Van Camp v. Van Camp: If spouse is reasonably compensated by his/her SP business, then generally any increase in value is SP; however, if operating spouse’s actual compensation is less than reasonable salary, the amount of shortage may provide an increase to community with a share of the value of the business

Fair Compensation (cont’d)Therefore, business appraisers routinely compare operating spouse’s income to incomes of similarly situated business owners and managers

If actual income is greater than incomes of similarly situated individuals, an adjustment is made in valuation of the business

Particularly when the income approach or asset approach is used (see also discussion of goodwill, following)

Discount Factors

Business Valuation

In re Marriage of Asbury (1983) 144 Cal.App.3d 918 (CA-5)Business was orthodontic practice in which both H and W worked as orthodontists

Literally a “mom and pop” enterprise

W left, taking some patients with her, and began practicing at a new location

W did not take any equipment, furniture, or any other tangible assets of the joint practice

Discount Factors

Marriage of Asbury (cont’d)At trial, H’s expert based his calculations and used

A factor of 70% on annualized earnings to determine market value of practice as a whole at time of division, as well as the value of the portion that W had split off

W’s expert valued tangible and intangible assets separately in determining value of the combined practice; he used

A factor of 100% of annualized earnings to determine practice’s market value at time of division, but he used a 70% factor in determining the value of the portion that W had taken with her

Marriage of Asbury (cont’d)T/Ct based its property division order on approach and calculations of W’s expert

It rejected H’s argument that the court should have applied same factor (either 70% or 100%) to both interests

The judge reasoned that 70% factor should apply only to portion of practice W had retained because she had relocated while H had kept his portion of combined practice intact

Marriage of Asbury (cont’d)CA-5: AFFIRMS

The court reasoned that, because the evidence showed that W had taken only patients with her and had not received any other assets

T/Ct was justified in discounting the value of the portion of the practice she had received

Holding

In re Marriage of Micalizio (1988) 199 Cal.App.3d 662(CA-4(2))H and W owned, as CP, 15% of the stock in company called “J.R. Norton”

The stock was subject to a buy-sell agreement giving the corporation right of first refusal to purchase any stock in the company that they wanted to sell

Furthermore, the corporation had option of purchasing the stock at either book value or value offered by third party, whichever was lower

Minority Interest, Lack of Marketability

Marriage of Micalizio (cont’d)T/Ct valued the stock at $25 per share

Without considering either the fact that community owned a minority interest

Or that its ability to sell the stock was severely limited by the buy-sell agreement

Marriage of Micalizio (cont’d)CA-4(2): REVERSES

Holding that T/Ct’s holding was not supported by substantial evidence

In so doing, CA-4(2) enunciated a rule of law requiring T/Cts to consider fact that a block of stock in closely held corporation is a minority interest

As well as any limitations on marketability of the stock

In re Marriage of Rosan (1972) 24 Cal.App.3d 885 (CA-4(2))H was minority shareholder in jewelry business

Shareholder agreement required the company’s consent to sell to third party and gave the company right of first refusal

T/Ct gave a discount due to restrictions, and

CA-4(2) AFFIRMS on appeal

Lack of Marketability

Equitable Apportionment

Business Valuation

Patrick v. Alacer Corp. (Alacer II) (2011) 201 Cal.App.4th 1326 (CA-4(3))W appeals judgment on causes of actions against Alacer, its directors, trustees, and trust beneficiaries

In bifurcated declaratory relief cause of action, W asks court to determine her CP interest in Alacer stock

Previously, CA-4(3) ruled that W, while not a record stock holder, had standing as a “beneficial shareholder” to file derivative suit against Alacer, because she may have acquired CP interest in the corp. since H, a record stockholder, devoted more than minimal efforts to the business

Patrick (Alacer II) (cont’d)T/Ct found that Alacer stock was H’s SP, but W had CP interest in its increased value over the business

The court valued the business using Pereira method, determined appropriate date of value was at H’s death and awarded W ½ of increased value, plus prejudgment interest

The court then granted judgment against W on all other causes of action because W’s claims were all based on alleged property interest in Alacer stock – but her interest was only in Alacer’s increased value, not the stock itself

Patrick (Alacer II) (cont’d)T/Ct made a variety of express findings

Alacer was H’s SP – he brought the stock into marriage

Some portion of increased value of the stock must be equitably apportioned to the community The appropriate valuation method would be Pereira because the “business profits are

principally attributed to the efforts of the community.”

T/Ct Ruling

Patrick (Alacer II) (cont’d)T/Ct made a variety of express findings (cont’d):

The fair rate of return on H’s SP stock was $530K (7.68%) The date of value would be H’s death rather than “the date as close to trial as practicable”

because H’s efforts in business ceased on day he died The value of stock at H’s death was just under $7M: The court used “capitalization of excess

earnings” methodology which was described as most widely used valuation methodology

T/Ct Ruling

Patrick (Alacer II) (cont’d)T/Ct made a variety of express findings (cont’d):

W entitled to prejudgment interest on her half of CP interest because she had not been able to use that money since H’s death in 2003

W not entitled to receive actual shares of stock to satisfy her CP interesto Although W is held to be beneficial shareholder for purposes of bringing derivative suit

against Alacer, this trial makes clear stock was H’s SP and remains his SPo W is simply entitled to half of increased value due to H’s efforts

Because W is not a shareholder, she loses each of her other causes of action

T/Ct Ruling

Patrick (Alacer II) (cont’d)W argues

The court should value company at date “closest to trial as practicable” rather than at H’s death

T/Ct used wrong valuation method W has actual property interest in stock rather than an interest in its increased value

CA-4(3) Ruling

Patrick (Alacer II) (cont’d)Defendants argue

There is no CP interest in stock’s increased valueo Easily dispelled: the court found H was iconic in the industry and Alacer’s growth was

due, in part, to his efforts – therefore, equitable apportionment is necessary The award of prejudgment interest is improper

CA-4(3) Ruling

Patrick (Alacer II) (cont’d)Date of death is the appropriate date of value because Fam C 2552 clearly states that it only applies “upon dissolution of marriage or legal separation”

Further, Prob C 100(a) says that “Upon the death of a married person, one-half of the community property belongs to the surviving spouse and the other half belongs to the decedent” [Emphasis added.]

Date of Valuation

Patrick (Alacer II) (cont’d)The court sees no abuse of discretion in adopting the “capitalization of earnings” method, especially considering the fact that BOTH of the experts used that method (along with other methods)

Also, the other methods used fluctuated wildly and were generally unreliable

Valuation Method

Patrick (Alacer II) (cont’d)First, W argues that previous Alacer decisions established that W was entitled to the stock; the court disagrees in those decisions

The court held W adequately alleged shareholder derivative standing, but did so “‘assuming as we must the truth of [her] allegations’” and giving the “‘derivative suit standing requirements a liberal construction.’””

They did not question W’s allegation that she had CP interest in Alacer; they took that as true, as they were required to do

However, this trial specifically adjudicated the character of the stock as H’s SP

Property Interest in Actual Stock or in its Increased Value?

Patrick (Alacer II) (cont’d)Last, W contends she should receive pro tanto interest in Alacer relying on Moore/Marsden

“But using the Moore/Marsden approach here would conflict with the prevailing approach used when a separate property business is improved by devotion of community efforts—equitable apportionment using Pereira or Van Camp.”

The court did not err by declining to extend the Moore/Marsden approach here

Property Interest in Actual Stock or in its Increased Value?

Patrick (Alacer II) (cont’d)No abuse of discretion: “‘Prejudgment interest is awarded to compensate a party for the loss of the use of his or her property’”

It is within T/Ct’s discretion to award prejudgment interest

“Plaintiff’s loss of use of a community property interest she owned upon [H’s] death in 2003… sufficiently supports the court’s exercise of its discretion to award prejudgment interest.”

Prejudgment Interest

Goodwill

Business Valuation

B&P C 14100

Mueller v. Mueller (1956) 144 Cal.App.2d 245 (CA-3)CA-3 rejected argument that goodwill cannot exist in a personal service business

Goodwill

Mueller (cont’d)“However, we believe the general rule to be as stated in 24 American Jurisprudence 808, as follows:

‘Frequently, it has been held that salable good will can exist only in commercial or trade enterprises and that it cannot arise in a professional business depending upon the personal skill and confidence in a particular person. This view seems traceable to the early and narrow definition given to good will by Lord Eldon.’”

Mueller (cont’d)“‘The better doctrine, however, appears to be that good will also exists in a professional practice or in a business which is founded upon personal skill or reputation. Where a person acquires a reputation for skill and learning in a particular profession, as, for instance, in that of a lawyer, a physician, or an editor, he often creates an intangible but valuable property by winning the confidence of his patrons and securing immunity from successful competition for their business, and it would seem to be well settled that this is a species of good will which may be the subject of transfer.’”

Golden v. Golden (1969) 270 Cal.App.2d 401 (CA-2(4))The issue was the goodwill of H’s medical practice

H made now-classic argument that, without him, the practice had no goodwill

Goodwill

Golden (cont’d)Citing Mueller v. Mueller, CA-2(4) stated:

“We believe the better rule is that, in a divorce case, the good will of the husband's professional

practice as a sole practitioner should be taken into consideration in determining the award to the wife. Where...the firm is being dissolved, it is understandable that a court cannot determine what, if any, of the good will of the firm will go to either partner.”

Golden (cont’d)“But, in a matrimonial matter, the practice of the sole practitioner husband will continue, with the . same intangible value as it had during the marriage. Under the principles of community property law, the wife, by virtue of her position of wife, made to that value the same contribution as does a wife to any of the husband's earnings and accumulations during marriage. She is as much entitled to be recompensed for that contribution as if it were represented by the increased value of stock in a family business.”

In re Marriage of Lopez (1974) 38 Cal.App.3d 93 (CA-3)Disapproved on other grounds (see Marriage of Morrison (1978) 20 Cal.3d 437)

This case involved the goodwill of a law practice

It contains the following now-famous quote listing the factors to be considered in determining the goodwill of a professional practice

Goodwill

Marriage of Lopez (cont’d)“Certain matters merit consideration which may be said reasonably to contribute to, diminish, or affect the intangible value of professional goodwill at the time of dissolution and the continuity and retention of the benefits thereof which the professional practitioner will continue to enjoy after the marital dissolution.”

Marriage of Lopez (cont’d)“In that context some such factors are the practitioner’s age, health, past demonstrated earning power, professional reputation in the community as to his judgment, skill, knowledge, his comparative professional success, and the nature and duration of his business as a sole practitioner or as a member of a partnership or professional corporation to which his professional efforts have made a proprietary contribution. In addition, consideration should be given to the value of the ‘fixed’ and ‘other assets’ of the professional business with which the “goodwill” is to continue its relationship.” [Emphasis added.]

In re Marriage of Fenton (1982) 134 Cal.App.3d 451 (CA-1(2))H was senior partner in what was then the largest insurance defense law firm in the San Jose area

The firm was a professional corporation

The issue in this case was whether H (or his interest in the corporation) had professional goodwill

In holding that H (it) did, CA-1(2) cited Marriage of Lopez and then stated:

Goodwill

Marriage of Fenton (cont’d)“Contrary to husband’s assertion, what a shareholder in a professional corporation is entitled to receive on withdrawal or termination is not controlling. ‘The value of community goodwill is not necessarily the specified amount of money that a willing buyer would pay for such goodwill. In view of exigencies that are ordinarily attendant a marriage dissolution the amount obtainable in the marketplace might well be less than the true value of the goodwill.’”

Goodwill Formulas

Goodwill

Multiple of Gross Earnings/Excess EarningsMueller v. Mueller

The methods of determining goodwill by the use of a multiple of gross earnings, and of capitalizing “excess earnings” were approved by the Court of Appeal

By ascertaining the average net income over a period of years, subtracting the portion allocable to salary and by capitalizing the difference over a period of years

Goodwill Formulas: “Excess Earnings” Method

Must be Based on Representative EarningsMarriage of Rosen (2002) 105 Cal.App.4th 808

T/Ct valued H’s law practice at $42K, using his income from one year (1995)

H’s earnings in three preceding years, and the three subsequent years, were considerably smaller than his 1995 earnings ($139K)

CA-4(3) REVERSES, stating that use of one unrepresentative year’s income was error


Not Permitted for Valuing Entire BusinessMarriage of Garrity & Bishton (1986) 181 Cal.App.3d 675

In this case, T/Ct valued W’s law practice using the excess earnings method

CA-2 REVERSES, noting that this method did not consider other elements of value


Not Permitted for Valuing Entire Business (cont’d)

Elements of value, such as

“a) fixed assets, which we deem to include cash, furniture, equipment, supplies and law library;

(b) other assets, including properly aged accounts receivable, costs advanced with due regard for their collectability; work in progress partially completed but not billed as a receivable, and work completed but not billed;

(c) goodwill of the practitioner in his law business as a going concern; and (d) liabilities of the practitioner related to his business.” (Citing Marriage of Lopez)

Willing Buyer / Willing SellerMarriage of Fortier (1973) 34 Cal.App.3d 384

T/Ct based goodwill of H’s medical practice on amount determined for purposes of recent buy-in by a partner of H: $10,963

W’s expert testified, using three different mathematical formulas, that goodwill was $294,333, the average of the results yielded by those formulas

Goodwill Formulas

Willing Buyer / Willing Seller (cont’d)CA-2(5) AFFIRMS, noting that the formulas used by W’s expert included projections of H’s postseparation earnings

Because the community has no interest in H’s postseparation earnings (Fam C 771), the court rejected the value found by W’s expert

Marriage of Fortier Definition Not the Only OneMarriage of Foster (1974) 42 Cal.App.3d 577

W’s expert valued goodwill of H’s medical practice by taking last three pre-separation months received on account, then made adjustments for items such as the practice being located in a small town, and near a hospital

T/Ct accepted finding that goodwill was worth $27K

Goodwill Formulas

Marriage of Fortier Definition Not the Only One (cont’d)CA-1(1) AFFIRMS

In so doing, the court reiterated Marriage of Fortier’s prohibition against using postseparation earnings

But said that any legitimate method that takes into account past results — not just Marriage of Fortier’s willing buyer/willing seller — was permissible

In re Marriage of Riddle(2005) 125 Cal.App.4th 1075 (CA-4(3))F is financial advisor – as of 2-28-03

Forgiveness of principal ($11,423) and interest ($2,365) on hiring advance of $1.39 M Draw: $2,340 Commissions (average month)

o 1-02 through 12-02: $4K (last calendar year)o 1-02 through 2-03: $5K (last fourteen months)o 3-02 through 2-03: $6K (last twelve months)o 1-03 plus 2-03: $10K (most recent two months)

Marriage of Riddle (cont’d)T/Ct: For M – draw and $10K

On F’s appeal, CA-4(3): Reverses – abuse of discretion under Fam C 4060

o Sample too short – here arbitraryo Goodwill analogy (Marriage of Rosen)o Presumption: Most recent 12 mos. an appropriate periodo No imputed income evidence here

The Giant Book of Business

Property Issues

In re Marriage of Finby (2014) 222 Cal.App.4th 977 (CA-4(3))1995: DOM – February 2010 DOS

During the marriage, W works as financial advisor

Before January 2009: W develops list of clients referred to as her “book of business”

As of January 2009: Value of W’s clients’ investments exceeds $192M

Rehg den 1-7-14; rev den & depub req den 3-12-14

Marriage of Finby (cont’d)January 2009: W signs contract with new employer (WFA) entitled “Offer Summary,” agreeing to work as financial advisor and managing director of investments

Offer Summary contains several compensation bonuses


Marriage of Finby (cont’d)W would receive a transitional bonus of more than $2.8M, based on her production during the previous 12 months ($1.8M) and pre-hire assets of more than $192M

W would receive the entire $2.8M if she

Remained with WFA for 112 months Maintained a gross production level of $1.12M/yr Remained current on any other obligations owed to WFA

W chose to receive entire $2.8M immediately, with payment arranged as loan that WFA would forgive in 112 monthly increments


Marriage of Finby (cont’d)If W stopped working for WFA, the loan balance would be due; if she failed to meet production quotas, her monthly increments would be reduced accordingly

The contract also provided that if she remained employed by WFA until 1-31-16, she would receive a deferred recruitment award bonus of $187K

It also made W eligible to receive a first production bonus of $374K if her gross production between 2-2009 and 3-2010 exceeded a certain amount (W received this bonus in 4-2010 set up as loan as before)

And a second production bonus if she met a higher production level between 4-2010 and 3-2011 (W failed to receive this bonus)


Marriage of Finby (cont’d)In mid 2009: WFA announces a “level 4front” bonus payable to financial advisors who met requirements regarding clients and their investment profiles

In mid-2010, W was paid $890K for this bonus, which was also set up as a loan that was gradually forgiven and was conditioned on W’s continued employment


Marriage of Finby (cont’d)Both parties present expert testimony on W’s book of business and the character of the bonuses she received

W’s experts contended that W’s transitional bonus was part CP and part W’s SP and that the other bonuses were her SP

One of W’s experts described her transitional bonus as payment to W for bringing her book of business to WFA and the production bonuses as incentives to work hard and to encourage continued employment


Marriage of Finby (cont’d)One of H’s experts characterized W’s bonuses as CP assets and her book of business as the consideration for the employment contract benefits. Another of H’s experts testified that W’s book of

business could not be sold, but that “ ‘the market for it would be . . . [moving to] another [firm]’ ”

H’s forensic CPA opined that W’s bonuses were CP because they were based on her book of business or pre-separation production, and because W signed contract before separation


Marriage of Finby (cont’d)In statement of decision and judgment, T/Ct found that

W’s book of business had no value and H had no interest in it W’s transitional bonus was CP to the extent that it was earned and received before separation The balance of that bonus, along with the other bonuses, were W’s SP because they were paid

or due post-separation, and were contingent on W’s continued employment


Marriage of Finby (cont’d)Book of business

W received a high salary from WFA because of the value of investments held by her clients BUT H’s assistance in helping W transfer her clients “‘did not give[] him an interest in the

[b]ook of [b]usiness’” “‘[T]here was no expert testimony given as to the value of’ it” The book of business “‘cannot be transferred to another party for a price’” [Marriage of

McTiernan & Dubrow (2005) 133 Cal.App.4th 1090]


Marriage of Finby (cont’d)Bonuses

Portion of bonus earned during the first 11 mos. of W’s employment with WFA (slightly over $380K) was received before separation and thus constituted CP

But T/Ct concluded the balance of the transitional bonus and the remaining bonuses were W’s SP because they were not paid or due until after the parties separated


Marriage of Finby (cont’d)

Bonuses (cont’d)

In addition, T/Ct noted W’s retention of bonuses was subject to her continued employment and minimum production requirements enforced by the promissory notes

T/Ct found reasoning in Marriage of Doherty (2002) 103 Cal.App.4th 895, and Garfein v. Garfein (1971) 16 Cal.App.3d 155 supported its findings


Marriage of Finby (cont’d)The issues presented in H’s appeal are T/Ct’s characterization and valuation of W’s list of clients, i.e., her book of business, and the bonuses WFA conditionally agreed to pay her

On H’s appeal, CA-4(3): REVERSES and REMANDS


Marriage of Finby (cont’d)“‘In general, all property that a spouse acquires during marriage before separation is community property.’” [Citing to Marriage of Green, supra]

Fam C 760 “creates ‘a general presumption that property acquired during marriage by either spouse other than by gift or inheritance is community property unless traceable to a separate property source.’ (In re Marriage of Rossin (2009) 172 Cal.App.4th 725, 731.)” (Emphasis added.)

However, “‘[t]he earnings and accumulations of a spouse . . . while living separate and apart from the other spouse, are the separate property of the spouse.’ (Fam. Code, § 771, subd. (a).)”


Marriage of Finby (cont’d)

“The characterization of ‘property as separate, community, or quasi-community’” “‘is an integral part of the division of property on marital dissolution.’ (In re Marriage of Haines (1995) 33 Cal.App.4th 277, 291.)” (Emphasis added.)

“Courts recognize several factors relevant to this task… but ‘the most basic characterization factor is the time when property is acquired in relation to the parties’ marital status’ (In re Marriage of Haines, supra, 33 Cal.App.4th at p. 291).” (Emphasis added.)

“The ‘factual findings that underpin the characterization determination are reviewed for substantial evidence.’(In re Marriage of Rossin, supra, 172 Cal.App.4th at p. 734)” (Emphasis added.).


Marriage of Finby (cont’d)“[B]ut ‘[i]nasmuch as the basic “inquiry requires a critical consideration, in a factual context, of legal principles and their underlying values”,’ the determination in question amounts to the resolution of a mixed question of law and fact that is predominantly one of law.’ [Citation.]” (Emphasis added.)

“‘As such, it is examined de novo’” (In re Marriage of Lehman (1998) 18 Cal.4th 169, 184). (Emphasis added.)

“Once the court determines the assets and liabilities of the community estate, it must value them and make an equal division of the estate. (§§ 2550-2552, 2601, 2620 et seq.; see In re Marriage of

Walrath (1998) 17 Cal.4th 907, 924.)”


Marriage of Finby (cont’d)“Issues concerning the valuation and apportionment of community property are reviewed for abuse of discretion. (In re Marriage of Lehman, supra, 18 Cal.4th at p. 187 [apportionment]; In re Marriage of Ackerman (2006) 146 Cal.App.4th 191, 197 [valuation].)” (Emphasis added.)


Effect of Covenants Not to Compete

Goodwill

Effect of Covenants Not to CompeteIf a business is burdened by a covenant not to compete

Whether to certain products or services, or certain geographical areas

It loses potential customers and thus is worth less than the hypothetical similarly situated business that is not so burdened

In re Marriage of Czapar (1991) 232 Cal.App.3d 1308 (CA-4(3)The covenant not to compete has to be real

A covenant not to compete required by a hypothetical buyer may not be considered

In re Marriage of Quay (1993) 18 Cal.App.4th 961 (CA-6)Involved a real covenant not to compete which came into existence when H sold a company during marriage

Company developed contrast agents used in MRI process (in its infancy at the time H started company)

So you can imagine that the sale price was quite high; community received about $7.5M

At trial, H argued that the community owed him $1.3M, the amount of post-separation earnings he lost due to noncompetition agreement

Drinkin’

Rum and Coca Cola

Property

In re Marriage of Greaux and Mermin(2014) 223 Cal.App.4th 1242 (CA-1(4))

H and W operated SBSC

Manufacturing and selling rhum agricole

Both parties contributed to the development and operation of the business

No pet f

Marriage of Greaux and Mermin (cont’d)W filed separate civil suit seeking to dissolve SBSC

In the disso trial, the T/Ct awarded the business to H

Over W’s objection and evidence that the business had little value

No pet f

Marriage of Greaux and Mermin (cont’d)T/Ct imposed a five year covenant not to compete against W

W challenged the covenant not to compete under B&P C 16600

As a void restraint on her right to engage in a lawful business

No pet f

Marriage of Greaux and Mermin (cont’d)W appeals

CA-1(4): REVERSED in part and REMANDED

CA law and public policy prohibits contracts that impair the right to pursue one’s business or employment

A countervailing policy is the authority of the court to preserve an asset through a noncompetition clause

No pet f

Marriage of Greaux and Mermin (cont’d)Under Fam C 2553, family law courts can make orders

To protect the value to the community of the asset awarded

No CA case specifically addresses this issue

No pet f

Marriage of Greaux and Mermin (cont’d)In Lord v. Lord (Me 1983) 454 A.2d 830, the T/Ct was reversed

Based on a lack of evidence to support a 7 year limitation within a 60 mile radius

On remand the T/Ct in Lord was called upon to define the terms of the noncompetition order

To protect the value transferred to H

No pet f

Marriage of Greaux and Mermin (cont’d)In Cesar v. Sundelin (2012) 81 Mass.App.Ct. 721, the panel established a three pronged test

Scope of the restraint necessary to protect the value Terms of noncompetition reasonable and not broader than necessary Limited geography and time to allow other spouse to pursue another business

No pet f

Marriage of Greaux and Mermin (cont’d)On remand, T/Ct shall consider

Geographic limitations necessary to protect the business The scope of prohibited activities and the length of the prohibition The necessity of the order to protect the value of the business as a going concern

No pet f

Effects of Desire to Retire

Goodwill

In re Marriage of Rives (1982) 130 Cal.App.3d 138 (CA-3)This case involved the valuation of a queen bee business operated by H, who was 71 years old at time of trial

T/Ct valued business at $90K, of which about $50K was goodwill

The court based its determination of goodwill on output projections submitted by W’s expert

Effects of Desire to Retire

Marriage of Rives (cont’d)There were two problems with this

Projections were higher than any actual historical performance levels for company; also, they were, in effect, a consideration of post-separation earnings, which Marriage of Fortier and Marriage of Foster decisions forbid

Expert’s calculations did not consider H’s advanced age and expressed desire to retire

For those reasons, CA-3 REVERSES T/Ct’s valuation

Effects of Buy-Sell Agreements

Goodwill

In re Marriage of Aufmuth (1979) 89 Cal.App.3d 446 (CA-1(4))Disapproved on other grounds; H made a shareholder in law firm two years prior to separation

Shareholder agreement provided for no payment for goodwill upon departure and recited specific formula for determining value

T/Ct used formula in agreement and no goodwill

CA-1(4) AFFIRMS and agreement can be considered

However, court noted H’s youth, inexperience, and recently becoming a shareholder, so result may have been same because there may not have been goodwill or added value based upon his insignificant contributions

Provisions Regarding Valuation Upon Departure

In re Marriage of Slater (1979) 100 Cal.App.3d 241 (CA-1(2))H was a partner in a medical practice

Partnership agreement provided formula for payment upon departure which excluded goodwill

T/Ct used formula in agreement and allocated no value to goodwill


Marriage of Slater (cont’d)CA-1(2) REVERSES

Even though W had signed the agreement, she was not bound by it in disso since the agreement’s purpose did not include a determination of value upon dissolution

“[T]he asset being divided in the proceeding was the husband's interest in the partnership, not his contractual withdrawal rights.”

In re Marriage of Fenton (1982) 134 Cal.App.3d 451 (CA-1(2))H was member of law firm for 25 years and the highest earner

Agreement similar to agreement in Marriage of Aufmuth: Specific formula, no goodwill

T/Ct ruled the same as Marriage of Aufmuth – no goodwill

CA-1(2): REVERSES – held that agreement was not binding in determining value in a disso

There is still value for the spouse who continues in the business

Goodwill

In re Marriage of Nichols (1994, on rehg) 27 Cal.App.4th 661 (CA-3)H purchased an interest in law firm 8 years prior to separation

Shareholder agreement provided for specific very small amount to purchase, which was same amount would receive upon departure and excluded AR, WIP and goodwill

Compensation during tenure as partner was not based upon stock ownership

Firm had consistently used agreement for departures in past and had no plans to change


Marriage of Nichols (cont’d)T/Ct determined value by excluding A/R and WIP (the most significant value), but did value goodwill

CA-3 AFFIRMS, holding that under certain circumstances, a T/Ct can consider limitations set forth in a buy-sell agreement

Marriage of Nichols (cont’d)“In assessing whether to use a formula set forth in a buy-sell agreement, the trial court should consider

(1) the proximity of the date of the agreement to the date of separation to ensure that the agreement was not entered into in contemplation of marital dissolution;

(2) the existence of an independent motive for entering into the buy-sell agreement, such as a desire to protect all partners against the effect of a partnership dissolution; and

(3) whether the value resulting from the agreement's purchase price formula is similar to the value produced by other approaches.”

Marriage of Nichols (cont’d)Court allowed the finding of goodwill despite the agreement

On the basis that H had personal goodwill which he would retain even if he left the firm, which thus had a continuing value

In re Marriage of Iredale & Cates (2004) 121 Cal.App.4th 321 (CA-2(4))When W became partner in her law firm, she signed partnership agreement that did not require her to buy into the firm’s WIP/AR and goodwill; the partnership retained ownership of these

At trial, W testified that she owned a .00781 interest in the firm

W also stipulated that she had individual goodwill valued at $42,318, based on a comparison of her salary with salaries of similarly situated attorneys (capitalization of excess earnings)


Marriage of Iredale and Cates (cont’d)A former managing partner of firm testified that departing partners were not entitled to be bought out of their shares of firm’s AR, work in progress, or goodwill

Instead, they received only their share of capital, based on percentage of ownership

T/Ct valued community portion of W’s partnership interest based on what she would have been entitled to receive under the partnership agreement if she left the firm, excluding firm’s AR, work in progress, and goodwill

Marriage of Iredale and Cates (cont’d)Relying on Marriage of Nichols, CA-2(4) AFFIRMS, reasoning that the fact that W did not have to “buy in” to the WIP/AR and goodwill meant that there was substantial evidence supporting T/Ct’s valuation

CA-2(4) also affirmed T/Ct’s finding concerning W’s personal goodwill

Provisions Limiting Transfers

Goodwill

In re Marriage of Rosan (1972) 24 Cal.App.3d 885 (CA-4(2))H was minority shareholder in jewelry business

Shareholder agreement required the company’s consent to sell to third party and gave company the right of first refusal

T/Ct gave a discount due to the restrictions


Marriage of Rosan (cont’d)“[I]n view of the restrictive conditions on the disposition of the stock and its resulting illiquidity, factors substantially affecting its value, the trial court was justified in assessing the value of the stock at 70 percent of its ‘computed value.’ Although that was the lowest value except in the event of a sale to a third person for less, it was the only value that was relatively certain.”

In re Marriage of Micalizio (1988) 199 Cal.App.3d 662 (CA-4(2))H was minority shareholder in business

The shareholder agreement had some limitations on transfer, which T/Ct did not consider

CA-4(2) REVERSES, holding that limitations associated with being a minority shareholder should be considered


Tax IssuesBusiness Valuation in Family Law Cases

IRC 1041(a) General rule. No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)—

a spouse, or (2) a former spouse, but only if the transfer is incident to the divorce.

(b) Transfer treated as gift; transferee has transferor’s basis. In the case of any transfer of property described in subsection (a)—

for purposes of this subtitle, the property shall be treated as acquired by the transferee by gift, and

(2) the basis of the transferee in the property shall be the adjusted basis of the transferor.

Tax Issues

IRC 1041 (cont’d)(c) Incident to divorce. For purposes of subsection (a)(2), a transfer of property is incident to the divorce if such transfer—

occurs within 1 year after the date on which the marriage ceases, or (2) is related to the cessation of the marriage.

(d) Special rule where spouse is nonresident alien. Subsection (a) shall not apply if the spouse (or former spouse) of the individual making the transfer is a nonresident alien.

IRC 1041 (cont’d)(e) Transfers in trust where liability exceeds basis. Subsection (a) shall not apply to the transfer of property in trust to the extent that—

the sum of the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject, exceeds

(2) the total of the adjusted basis of the property transferred.

Proper adjustment shall be made under subsection (b) in the basis of the transferee in such property to take into account gain recognized by reason of the preceding sentence.

Immediate and Specific Tax Consequences

Tax Issues

In re Marriage of Fonstein (1976) 17 Cal.3d 738 H requested that court consider tax consequences if he sold his law practice in the future

CASCT held that tax consequences could not be considered unless “immediate and specific”

“Regardless of the certainty that tax liability will be incurred if in the future an asset is sold, liquidated or otherwise reduced to cash, the trial court is not required to speculate on or consider such tax consequences in the absence of proof that a taxable event has occurred during the marriage or will occur in connection with the division of the community property.”


In re Marriage of Epstein (1979) 24 Cal.3d 76 CASCT allowed consideration of tax consequences flowing from immediate sale of family residence

“[T]he court can take account of tax liability by providing that the liability incurred, if any, is owed equally by both spouses. In unusual cases, it could retain jurisdiction to supervise the payment of taxes and adjust the division of the community property.”

If jurisdiction was to be retained, should only be for short period of time


Postseparation Income

Tax Issues

Bass v. Commissioner (1983) T.C. Memo. 1983-228 (USTC)H was CEO and operated business after separation

Business had inventory and other key employees

H took draws but not a salary

Disso Court allocated a salary to him to continue to operate business pending a sale, which was about a third of the business profit in postseparation year

Post-separation Income

Bass (cont’d)Disso Court’s salary allocation was accepted by Tax Court as a determination of a reasonable salary for his services

The profit which exceeded the salary allocated to H was community income which W should have reported

Bass (cont’d)

“[A] wife’s ownership rights in community income render her taxable on one-half of such income, …and it is clear that the law imposes on her the obligation, and does not merely grant her the right, to report her share of the community income as her own.… Furthermore, the wife's failure to 'receive' her share of the income does not alter the incidence of tax liability.”

Taxation of Business Income

Tax Issues

Taxation of Business IncomeDivision of marital assets and “assignment of income doctrine” have created much uncertainty in family law cases

The rulings and decisions have been inconsistent, especially in the Ninth Circuit

In general, the doctrine is supposed to “assign” item of income to appropriate taxpayer

Often used by the taxing authorities in income, gift, or estate tax cases where taxpayers have attempted to “separate the fruit from the tree”

States that owner of property must include income produced by that property even if right to income was previously given away

Revenue Ruling 2002-22Very important ruling covering nonqualified deferred compensation and nonqualified stock options

First time that IRS ruled that assignment of income doctrine would not be applicable in the context of a marital disso and division of assets

Nonemployee spouse was taxed upon collection of deferred compensation and upon exercise of the nonqualified stock options rather than employee spouse


Revenue Ruling 2002-22 (cont’d)Ruling specifically addressed that assignment of income doctrine would frustrate intent [IRC 1041]

CAUTION: The ruling is not applicable to qualified retirement plans, incentive stock options (“ISOs”) or to installment obligations

It also does not apply to deferred compensation, stock options, or other future income rights that are unvested or subject to substantial contingencies at the time of transfer

[2002-1 C.B. 849, 2002 WL 881644]


Meisner v. United States (8 Cir 1998) 133 F.3d 654H was member of “The Eagles” and transferred royalty rights to W

W was taxed on the royalties (40% of total) transferred to her in disso

Court addressed assignment of income doctrine noting that divorce transfers were more like arms-length transactions than gifts


Stock Redemptions & Partnership Interests

Tax Issues

Stock Redemptions RegulationsIRS released guidance on divorce-related stock redemptions in Final Reg 1.1041-2 (68 F.R. 1534-01)

According to the rules (adopted 2-13-2003), the federal income tax consequences of such a divorce-related stock redemption can fall into one of two scenarios

Parties can make the redemption taxable to either the recipient or nonrecipient spouse

Counsel should now be able to achieve the expected and desired tax outcome

SP-CP ApportionmentBusiness Valuation in Family Law Cases

SP-CP Apportionment

Pereira v. Pereira

Van Camp v. Van Camp

Marriage of Winn

Marriage of Denney

Marriage of Denney (cont’d)

In re Marriage of Watts (1985) 171 Cal.App.3d 366 (CA-5)Medical practice

OK to reimburse CP for its use post-DOS Cf. Pereira-Imperato – alternate date valuation notice granted Error to find no goodwill if evidence supports any “excess earnings”

In re Marriage of McTiernan & Dubrow(2005) 133 Cal.App.4th 1090 (CA-2(8))9-yr marriage

H = film director

#1 in production budget High sevens per movie

W says “excess earnings”

H says no B&P C 14100 “business”

Marriage of McTiernan & Dubrow (cont’d)T/Ct: For W – excess earnings = $1.5M

On H’s appeal, CA-2(8): REVERSES (2-1)

No goodwill w/o “business” No business if personal and not transferable H cannot sell or transfer his standing or talent Unlike lawyers and physicians “Excess earnings” irrelevant

Marriage of McTiernan & Dubrow (cont’d)Dissent (Cooper)

B&P C 14102 defines goodwill as property Persons have businesses – whatever form Computer consultant (Marriage of King (1983) 150 Cal.App.3d 304) H’s business is more than his talent Absence of buyers is immaterial Spouse helped create it Even directors can hire replacements

Marriage of McTiernan & Dubrow (cont’d)No CASCT goodwill Marriage ofs

CA-2(8) ignores Fam C 771 and pre-marriage G/

Majority cannot plausibly distinguish lawyers and physicians

Dissent cannot plausibly distinguish all others on salary

Entertainer goodwill – see Piscopo v. Piscopo (1989) 232 N.J.Super. 559

Goodwill is arbitrary partial exception to 50/50 – true or false?

Marriage of Honer

I wish I didn’t know now, what I didn’t know then

In re Marriage of Honer (2015) 236 Cal.App.4th 687 (CA-1(4))Divorce filed September 2009 – grocery store owners

W would not agree to a single appraiser; nor willing to specify date of valuation

H’s expert’s first date of valuation: March 31, 2010

H’s second valuation: December 31, 2010 – $2.98 million

Date of Valuation

Marriage of Honer (cont’d)W wants more current valuation

T/Ct: By not ordering H to pay for third valuation, W delayed and was not cooperative

W’s expert’s valuation: June 30 2011 – $3.5 million

T/Ct: H’s expert more credible/used better methods

But income has gone up since 12-31-2011

Date of Valuation

Marriage of Honer (cont’d)H expert Report $2.98

Add for increase in income $ .20

Value determined at DOT $3.18 $3.50

Difference only $300K to Wife’s Expert

Date of Valuation

Marriage of Honer (cont’d)CA-1(4)

T/Ct used valuation at time of trial, not 12-31-2010 T/Ct used more credible experts valuation And, “as near as practicable to time of trial within meaning of FC 2552”

Date of Valuation

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