How The Marital Estate Gets An Interest In a Spouse’s Business

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Jay founded Alacer in 1972.  He married Ymelda in 1988.  Jay transferred all of his Alacer stock into a trust in 2000.  The parties started their divorce in 2001.  Jay died in 2003.  The case has been working its way throught the courts for ten years, and includes many related actions.  Eventually the trustees of the trust were brought into the cases, as was Alacer.

The trial judge in Orange County ruled that :

  • Alacer was Jay’s separate property because he was its sole shareholder before he married Ymelda.
  • That the value of the company had increased during the marriage in large part due to Jay’s efforts while he and Ymelda were married.
  • Some portion of the increased value had to be apportioned to the community.
  • That the method recognized in Pereira v. Pereira (1909) 156 Cal. 1 would be the most appropriate apportionment method. i.e., because the “business profits are principally attributed to the efforts of the community.”
  • The fair return on Jay’s separate property investment in Alacer was about $530,000.  The parties’ experts used slightly different methods to determine the Alacer’s value at the October 1988 date of marriage, but defendant’s expert agreed it would be appropriate to use the average of their values — just over $250,000.  The experts agreed a fair rate of return would be 7.68 percent per annum through Jay’s death in February 2003.  Applying that return to Alacer’s value at marriage resulted in a separate property interest of just over $530,000.
  • Jay’s February 2003 date of death would be used to value the remaining community property interest in the Alacer stock.  While community property is generally valued at the date of trial, Alacer was Jay’s separate property.  The only community property here was “the skill, effort and talent of Jay Patrick that was expended during the marriage.  Hence, the court must value that skill, effort and ability from the time the marriage began until Jay died.  To state the obvious, when Jay passed away, he no longer contributed any community skill, effort, or talents to increase the value of Alacer.”
  • Alacer’s value at Jay’s death was just under $7 million.  The court adopted defendant’s expert’s use of the “capitalization of excess earning” methodology, which the expert described “as the ‘primary’ or ‘most widely used’ valuation methodology . . . .”
  • Ymelda was entitled to prejudgment interest starting at Jay’s death.  Her “community property interest existed as of the date of Jay’s death” in February 2003, and she had “lost the use of her share of the community property” ever since.
  • Ymelda was not entitled to receive Alacer shares to satisfy her community property interest.

The Appellate Court upholds the decisions of the trial court.

  • An overview of community property apportioning rules provides some much needed perspective.  “[I]n California, property acquired prior to marriage is separate, while property acquired during the marriage is presumed community property.  Income from separate property is separate, the intrinsic increase of separate property is separate, but the fruits of the community’s expenditures of time, talent, and labor are community property.”
  • 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 to the increase.  [T]he 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 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
  • Once the court is satisfied that it should apportion business profits, the question arises which method to apply.  California courts have developed two alternative approaches to allocating business profits.  The Pereira approach is to allocate a fair return to the separate property investment and allocate the balance of the increased value to community property as arising from community efforts.  The Van Camp approach is to determine the reasonable value of the community’s services, allocate that amount to community property and the balance to separate property
  • [C]ourts have not developed a precise standard in choosing between Pereira or Van Camp, but have endeavored to adopt that formula which is most appropriate and equitable under the circumstances.   The court is not bound to adopt a predetermined percentage as a fair return on separate business capital, nor need it limit the community interest to a salary as reward for a spouse’s efforts, but may select whichever formula will effect substantial justice between the parties.  Pereira is typically applied where business profits are principally attributed to efforts of the community.   Conversely, Van Camp is applied where community effort is more than minimally involved in a separate business, yet the business profits accrued are attributed to the character of the separate asset.  The court has discretion to choose whichever formula will effect substantial justice.
  • Having done so, the court was called upon only to determine the value of Jay’s separate property interest in Alacer at the start of the marriage, and then “allocate a fair return to the separate property investment” during the marriage.  The court did so based on substantial evidence; defendants do not challenge on appeal the valuation of the separate property interest or the calculation of the return rate.
  •  The court properly then “allocate[d] the balance of the increased value to community property as arising from community efforts.”  It was not required to find whether plaintiff’s community property interest was already satisfied by Jay’s Alacer compensation during the marriage.1  The court need not “limit the community interest to a salary as reward for a spouse’s efforts . . . .”  “To limit the community to compensation received by way of salary during the marriage would ignore California’s egalitarian marriage model and the apportionment formula of Pereira . . . .”  “[Defendants’] point, that the community received market value compensation, does not affect our inquiry.  Whether or not the community received salary, a court must determine to what extent the increased value of the separate property business is attributable to community effort.”  Nor was plaintiff obligated to show the precise percentage of growth attributable to Jay’s efforts.  Under Pereira, the community property award itself is essentially an implied finding of that.
  • The court properly fixed the increase in Alacer’s value at Jay’s death.  “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.”  (Prob. Code, § 100, subd. (a).)  So plaintiff was entitled to one-half of the community’s interest in Alacer’s increased value “[u]pon the death of” Jay.  Thereafter, Alacer itself and any increase in its value continued to be Jay’s separate property.  (§ 770, subds. (a)(1), (a)(3), (b).)  Plaintiff, contending Alacer must be valued at the time of trial, relies heavily upon section 2552 and cases applying it.  But its plain language renders it inapplicable here:  “For the purpose of division of the community estate upon dissolution of marriage or legal separation of the parties . . . the court shall value the assets and liabilities as near practicable to the time of trial.”  (§ 2552, subd. (a).)  The apportionment here was not made “upon dissolution of marriage or legal separation of the parties . . . .”  (Ibid.)  And valuing Alacer’s increased growth at the time of trial would essentially transform plaintiff’s one-half interest in Jay’s community efforts into a one-half interest in Alacer itself.  That would affect an unwarranted transmutation of Jay’s separate property into community property.  (Cf. § 852 [transmutation requirements].)
  • The court also permissibly used the “capitalization of excess earning” method to value Alacer.  Plaintiff criticizes defendant’s expert for using this method and relying “solely at historical information prior to the date of valuation.”  Thus, the expert discounted Alacer’s value for possible threats during Jay’s lifetime, regardless of whether they came to pass after his death.  Even so, and despite plaintiff’s further flyspecking of the expert’s opinion, we see no abuse of discretion in adopting the “capitalization of excess earning” method — a method that plaintiff’s own expert used to value Alacer at the date of marriage.  And the court reasonably rejected plaintiff’s valuation, which “fluctuated wildly” from $19 million to $73 million, before settling at $30 million.
  • California law does not require apportionment of community efforts devoted to separate property on an ongoing basis, upon pain of transmuting that separate property into community property.  Courts account for community efforts toward separate property through equitable apportionment after the marriage, not transmutation during the marriage.
  • [Ymelda’s] loss of use of a community property interest she owned upon Jay’s death in 2003 (§ 751; Prob. Code, § 100, subd. (a)) sufficiently supports the court’s exercise of its discretion to award prejudgment interest.

Please click here to read the original Patrick v. Alacer opinion.



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