When contemplating divorce, most spouses will think about rental properties, family homes, and financial assets. According to California law, business is also an asset that couples need to deal with during marital distribution. Business distribution has its intricacies, especially when valuing and dividing. So here is what you need to know about business in divorce.
Small Businesses and Professional Practices
Part of the marital dissolution process for spouses is valuing and dividing assets. While some properties like bank accounts are relatively easy to divide, others such as businesses are incredibly complex to value and divide. In most cases valuing a small business in divorce require the intervention of experts. In finding the value of a business, the experts will evaluate a number of components like accounts receivable, liabilities, fixed assets, and goodwill.
It is important to note that when valuing businesses, accounts receivables are not always included at nominal value. There is always a reduction in bad debts, taxes on collected amount as well as collection costs. The percentage write off is determined based on expert testimony.
Financial Interests in Small Businesses or Professional Practices
For the court to determine the ownership rights to a business in divorce, it must decide if its a separate property or a marital property. Some of the factors that the court will look at include establishment date of the business, nature of funds used to establish the business, couple’s contribution to the business, and change in the value of the business at the start of marriage and at the time of divorce.
After determining the ownership rights, the court will divide the business in divorce based on the following factors.
(i) Premarital Separate Business in divorce Generally Remains Separate Property
Generally, a business acquired before marriage always remains the property of one of the spouses. Also, businesses that may be regarded as separate property include:
- Those acquired as a gift by one of the spouses
- Inherited businesses
- Businesses obtained using one spouse’s asserts with intentions of keeping it separate
- Businesses acquired in the name of one spouse and not used for the benefit of the marriage or both spouses
(ii) Transmutation and Other Agreements
Business in divorce can be determined to be marital property based on signed agreements between the spouses or through transmutation. Such agreements include those entered premarital and postmarital.
Discovery, on agreements between spouses always focuses on the formation and language of the agreement and how it affects the business in divorce in order to establish if there is a transmutation of interest between the spouses.
Another factor considered when looking at spousal agreements is the type of business. If it is a joint venture like multiple shareholder corporations, partnerships, limited liability partnerships (LLPs), or limited liability companies (LLCs), agreements between a spouse with the other participants will also be considered to define valuation. In such a case, discovery will focus on the language of the agreement, agreement interest, ‘out’ spouse’s consent, and prior drafts.
(iii) Effect of Agreements Between Principals of Business or Practice
Agreements on a fixed value of interests between principals of business have been used in the valuation of businesses in divorce. However, these agreements are not always binding even when signed by both parties. Discovery in effect of the accords should focus on the time when the interest was created.
(iv) Pereira or Van Camp Apportionment of Interests
The method of determining the interest of a business in divorce was set up in the two cases of Pereira v. Pereira (1909) and Van Camp v. Van Camp (1921).
According to these cases, if the value of a business in divorce increases during the time of marriage (period after marriage and before separating), the increase will be apportioned. The apportionment will be based on one of Pereira method or Van Camp approach, or both.
Under Pereira’s approach, the court will award the community a fair share of the increase and give the rest as the spouse’s separate property. The court uses Pereira’s formula when spouse’s time, skill and effort are major factors in growth of business. On the other hand, under Van Camp method, the court, through the help of an expert, will determine the value of the services offered by the community during the time of marriage and apportion it to the community. The rest is allocated as spouse’s separate property. The court uses Van Camp where capital investment was the major factor in the business’s growth.