Characterization Problems with Certain Assets Flashcards
Business owned before marriage (SP) greatly increases in value after marriage
Courts have developed two apportionment methods to divide the business between CP and SP:
PEREIRA ACCOUNTING
The SP component consists of the separate capital plus a fair rate of return thereon (for example, 10% interest on principal × 10 years). The remainder is CP.
VAN CAMP ACCOUNTING
The services of the spouse who is working for the business are valued using the going market salary. Family expenses that were paid from business earnings are then subtracted from that amount. The remainder, if any, represents the CP component of the business. The rest of the business is SP.
Whether to Use Van Camp or Pereira
Courts are not bound by either Pereira or Van Camp. They may select whichever formula will achieve substantial justice between the parties.
Use Pereira accounting if spouse’s management was the primary cause of the business’s growth
Use Van Camp Accounting if the character of the business was the primary cause of its growth
HYPO: Wendy owned and managed a business valued at $100,000 at the time of her marriage to Hal. The marriage lasted 10 years. At the time of divorce, the business was worth $4 million.
How would the value of this business be apportioned under Van Camp and Pereira?
Van Camp:
Value of Wendy’s services - family expenses paid from business earnings = CP. Remaining value is Wendy’s SP
Pereira:
Reasonable rate of return (10%/year) + original principal = W’s SP interest. Remaining value is CP.
Proration Rule for Pension during/outside of marriage.
(Years of employment while married)/ (total years of employment before retirement)
Forms that a decree awarding benefits to the other spouse can take if the covered spouse is not yet eligible for retirement.
“If and when received decree”: If and when the covered spouse receives the benefits, the other spouse gets their share
“Cash out”: This option compensates the second spouse by awarding other assets of equal value
Effect of Death on Pension Interest
A spouse’s ownership interest in a pension earned during marriage is not terminated by the death of either spouse.
Unless otherwise prohibited by law, a spouse is entitled to their share of any remaining benefits if the other spouse dies first.
HOWEVER, Employee Retirement Income Security Act (“ERISA”) pensions, ERISA allows benefits for living beneficiaries only- ERISA preempts California law insofar as it would recognize ownership interests that survive the death of a spouse or former spouse.
When Pensionable Spouse Eligible to Retire But Does Not
Private Employer: a divorce court may order a private employer to pay the non-employee spouse their share of benefits as though the worker had in fact retired.
Public Employer: The worker may be ordered to pay the other spouse if they have a public employer.
Disability Pay and Workers’ Compensation
This compensation is treated as wage replacement, and the benefits are classified according to when they are received (not when earned).
If they replace earnings during the marriage, they are CP. If they replace separate post-divorce earnings, they are SP.
Severance Pay
Replaces a worker’s earnings until they are able to find a new job.
Split of authority regarding classification of a right to severance pay.
- Some courts say it is SP because it replaces lost earnings, which after a divorce or permanent separation would be SP.
- Other courts say it is CP because it arose from a collective bargaining agreement, and thus it was earned by employment during the marriage.
What are Stock Options
A stock option gives an employee the choice to purchase shares of the company’s stock at a set price on a specific date in the future.
Characterization of Stock Options
A stock option is a form of compensation:
- If it becomes exercisable during marriage, it is CP
- If it is not exercisable until after the marriage, then the portion considered CP is determined using a proration rule based on the primary intent of the employer in granting the option (Marriage of Hug or Marriage of Nelson).
Stock Options as Award for Past Service
If stock options were awarded primarily to reward the employee for their past services, the court should employ the Marriage of Hug proration formula:
(Years from the date of employment to the date economic community ends)/ (Years from the date of employment until the date the options become exercisable)
The fraction is then multiplied by the number of shares of stock that can be purchased under the options to obtain the CP interest, which is subject to equal division on divorce.
Stock Options to Encourage Continued Employment
If stock options were awarded primarily to encourage the employee to remain with the company, then the court should employ the Marriage of Nelson proration formula:
(Years from the date the options are granted until the economic community ends)/ (Years from the date the options are granted until they become exercisable)
The fraction is then multiplied by the number of shares of stock that can be purchased under the options to obtain the CP interest, which is subject to equal division on divorce.
Goodwill of Professional Practice
Goodwill is the qualities that generate income beyond that generated from the professionals’ labor and a reasonable return on capital and physical assets.
If Goodwill is earned during marriage, California treats it as CP.
Valuation of Goodwill
Courts generally use one of two valuation techniques: Market sales valuation and Capitalization of past excess earnings
