marital property

The Supreme Judicial Court of Massachusetts ruled recently that agreements between spouses who plan to continue their marriage but wish to define their legal rights and obligations in the event of divorce are enforceable in that state. Some states (notably Ohio) do not permit spouses to execute agreements waiving their marital rights unless they are actually pursuing divorce, and the law of many states is unsettled. In its recent decision, the highest court of Massachusetts joined the ranks of states (including Pennsylvania) where such “post-nuptial” agreements are permissible.

Post-nuptial agreements may combine certain elements of prenuptial agreements with features of marital settlement agreements. Post-nuptial agreements may divide marital property between spouses, protect their separate property, and establish or restrict spousal support and alimony, like settlement agreements. Post-nuptial agreements can also protect family businesses, inheritance, and other separate property to be acquired in the future, just as prenuptial agreements do.

In Ansin v. Ansin-Cravin, 457 Mass. 283, 929 N.E.2d 955 (2010), the husband and wife entered into a post-nuptial agreement two years before their eventual divorce. The post-nuptial agreement in that case gave the parties a chance to attempt marital reconciliation while removing the financial risk of taking “one last chance”. The couple had been married for nineteen years at the time of their agreement. At that point, the husband separated from his wife and advised her that he would not return unless she would sign an agreement. She hired legal counsel, investigated the nature and value of their assets, and negotiated the terms of the agreement.

Having signed the agreement, the husband and wife reconciled for nearly two years. Ultimately the reconciliation did not last, but the parties were able to avoid the stress and expense of protracted divorce litigation by having an agreement in place (at least, they would have avoid those pitfalls if the wife had not challenged the validity of the agreement). The Massachusetts court applied the same standards to post-nuptial agreements as many states employ when judging the validity of prenuptial agreements and settlement agreements: (1) availability of independent legal counsel; (2) full and fair disclosure of financial resources; (3) absence of fraud or duress; and (4) reasonableness of the provisions for each spouse.

Pennsylvania has long recognized post-nuptial agreements, and for good reason. When entering into a post-nuptial agreement, full and fair disclosure is an essential element; and it may be important to engage legal counsel. While formbooks and software programs may contain “boilerplate” prenuptial agreements, post-nuptial agreements are very different and require the skill of an experienced family law attorney.

A thorny issue that arises early in many divorce proceedings is the question of who may live in the marital residence during the separation period. Generally speaking, the courts will not evict either spouse from the marital residence during separation if they are living together peacefully and have not voluntarily moved away. This principle leads some devious spouses to seek questionable or even fraudulent protection from abuse (PFA) orders. Spouses who have quick tempers must avoid confrontations that can provide legitimate grounds for a PFA order, which are granted when a victim can prove “a reasonable fear of imminent bodily harm.” Some judges will grant PFA orders even where the only grounds are a verbal threat or demonstrative act (such as smashing or throwing an object in the presence of a spouse).

In theory, the courts are authorized by statute to award exclusive possession of a marital residence on an interim basis pending equitable distribution. 23 Pa.C.S. § 3502(c); Laczkowski v. Laczkowski, 496 A.2d 56 (Pa.Super.1985). In practice, exclusive possession is most often awarded to the spouse who remained in the home while the other spouse willingly vacated. If the residence is nonmarital property or titled in the name of one spouse, the titled spouse may have an advantage. The level of conflict between the parties, the ability of a spouse to afford alternate housing, and the effect upon custody arrangements are other likely considerations. An exclusive possession order does not preclude the court from awarding the residence to the excluded spouse in equitable distribution. See, e.g., Kokolis v. Kokolis, 82 Pa.D. &C.4^th 214 (Allegheny Co.2006), affirmed, 927 A.2d 663 (Pa.Super.2007). Yet, practically speaking, it can be very difficult for a spouse who is evicted from the marital residence to return. This is one of the first issues that a spouse should discuss with a lawyer at the beginning of any divorce proceeding.

In Pennsylvania, marital property is divided in a process known as equitable distribution. The method prescribed by the Divorce Code is a “dual classification” equitable distribution scheme because marital property is distinguished from nonmarital or separate property (terms which are used interchangeably). In other jurisdictions governed by an “all-property” equitable distribution scheme, the divorce courts do not distinguish between marital and nonmarital property.

Pennsylvania does not recognize community property, which is a method by which married persons may hold title to property in certain jurisdictions, creating mutual fiduciary duties between spouses and usually resulting in an equal division upon divorce. See, Drake v. Drake, 555 Pa. 481, 489-490, 725 A.2d 717, 720-721 (1999); Wilcox v. Penn Mutual Life Ins. Co., 357 Pa. 581, 55 A.2d 521 (1947). Instead, married persons in Pennsylvania may hold joint title to property as tenants by the entireties (“per tout et non per my”), which cannot be severed by partition or attached by creditors of an individual spouse. See, Fazekas v. Fazekas, 727 A.2d 1262 (Pa.Super.1999). Entireties property ceases to exist upon marital dissolution, 23 Pa.C.S. § 3507(a), and unlike community property, is not presumed to be divided equally.

Pennsylvania is in the minority of jurisdictions where the increase in value of separate property is subject to equitable distribution, regardless of whether the appreciation is active or passive. In most states, the appreciation of separate property due to inflation or market forces is not divided in equitable distribution. This approach was advocated in the early days of the Pennsylvania Divorce Code. See (Hon.) Emanuel A. Bertin, Equitable Distribution: Preparing the Case for Settlement or Trial 92-94 (PBI 1982). The Superior Court soon took a different view. Aletto v. Aletto, 537 A.2d 1383 (Pa.Super.1988); Anthony v. Anthony, 514 A.2d 91 (Pa.Super.1986).

The preceding is an excerpt from a new book published by the Pennsyvlania Bar Institute (2010), entitled “Slicing Up the Pie: Equitable Distribution in Pennsylvania” (David Ladov, Editor).

While doing research on corporate control issues recently, I came across the following article, published by The Wilmington Trust, a venerable private wealth management firm:

Imagine attending the next board meeting of your venerable family firm, only to be seated across from your former spouse’s new partner, who is 15 years your junior. With the divorce rate high, the liklihood of these situations occurring is increasing. But when it comes to protecting your family business from such potentially disagreeable divorce fallout, it’s important to take some precautionary steps:

• Develop a corporate culture that separates ownership from authority and control.
• Employ legal tactics and structures to prevent a divorce from deadlocking the business.
• Establish mechanisms (including participation in family business associations) to keep the channels of communication open and prevent small conflicts from becoming big.

Corporate Culture
Too many families confuse a stake in the business with authority and control. Here is one textbook example from Paul Karofsky, director of the Northeastern University Center for Family Business: “A century-old company, in which ownership was diluted among 18 grandchildren, gave everyone an identical salary, private office and luxury car regardless of their job with the now-defunct company. It would have been much more appropriate to provide salaries and benefits commensurate with their job descriptions and to distribute dividends based on their ownership and profits.”

The model for separating ownership from control in a mature family company, such as the one with 18 owners, is akin to a public company. At Staples®, where just about everyone owns stock — from truck drivers to senior management — no one has grounds to complain when a truck driver, who bought Staples stock 20 years ago, owns a bigger stake in the company and has a higher net worth than his newly hired, better-paid branch manager.

Legal Tactics
When children marry and their spouses enter the family with a presumption of status in the company, the stresses can severely impede business success. Add divorce, and the business could be doomed. As the founder, or senior family member, you have a responsibility to protect the company from being deadlocked by an irate ex-spouse following a child’s divorce. When the children are young and unmarried, it is relatively easy to insist on prenuptial agreements to prohibit spouses from owning stock. To encourage acceptance among the adult children and their betrothed, make it clear that the lack of stock ownership bears no relationship to a financial settlement in the event of divorce.

Obviously, prenuptial agreements cannot be required if marriages have already taken place or in situations where spouses feel justified in owning part of the business. For example, two sisters started a small, mail-order company to sell gardening tools. One sister’s husband offered to set up and run the website, which became hugely profitable. Meanwhile, the other sister’s husband helped out with the books and eventually joined the burgeoning company as CFO. The small business grew into a sophisticated corporation, with no one addressing any of the tough issues such as divorce, death, succession, and so forth.

In an emerging business, such as the gardening tool company, the owners and their spouses must recognize that their obligation to the business far outweighs their individual need for control. Since the spouses are already active in the company, one solution is to create a trust which will own and control all of the stock. In addition to family members, the trust should have one or more outside trustees, preferably a corporate trustee, to break any deadlock. Without a trust in place, shareholders can seek, and will likely receive, a remedy from the courts if a deadlock threatens the business. Unfortunately, having the courts make business decisions is costly and cumbersome, and everyone can wind up with bruised feelings. Trust documents should be re-examined and revised periodically to make sure they continue to serve business and family interests.

Family Business Associations
Family Business Associations can assist in facilitating communication, resolving conflict, and providing management, legal, and other insights. In addition, these organizations offer family business owners, including spouses and children, an opportunity to share their problems and solutions in a non-threatening, peer-to-peer forum.

In a Nutshell

• The divorce rate is high, but the probability of divorce increases when the number of family members involved in the business grows.
• Disputes over power, money, and control at home will be played out in the business.
• Be alert to status issues, both within the company and community.
• Clearly distinguish between ownership and jobs, but do not go overboard by being unduly tough on an heir apparent.
• Communicate and revise the trust and other agreements to cope with advancing age, marital status, involvement, health, and the like.
• Establish an exit strategy, such as a Texas Shootout, which allows one partner to set the price for his or her half of the business and the other partner to either buy or sell at that price.
• Employing spouses offers substantial benefits, including participation in business travel, the company pension plan, health plan, and Social Security. But roles and compensation for spouses must be well defined, recognizing that other family members and employees will notice every scintilla of preferential treatment.
• Assess your strengths as the business grows; if running the business day-to-day is not your forte, consider hiring an outside CEO or general manager.

Developing an ongoing relationship with your financial institution and a family business forum is well worth the effort. No corporate job can compare to a well-run family business when it comes to flexibility, financial reward, and an opportunity to work with people whom you know, love, and trust.

Source: The Wilmington Trust

The Colorado Supreme Court, in Marriage of Thornhill (June 1, 2010), held that it would not mandate the “fair value” standard for valuation of business in divorce proceedings. The husband in Thornhill operated an oil and gas service company that was valued at $1.625 million after applying a 33% marketability discount as part of an FMV valuation for divorce purposes. The wife argued on appeal that the marketability discount should not be applied, citing a Colorado precedent in which marketability discounts were prohibited in minority shareholder oppression cases. The Supreme Court affirmed the trial court’s refusal to prohibit marketability discounts in divorce cases. The Supreme Court noted that the “fair value” standard was required under the state’s shareholder oppression statute but not under the state’s divorce statute.

This decision contains a good explanation of the reasons why “fair value” is not necessarily appropriate to divorce cases. The wife argued that divorce cases are similar to shareholder oppression cases because a divorce involves an involuntary divestiture of a party’s interest in the business. The Colorado Supreme Court explained that valuation discounts are prohibited in shareholder oppression cases to discourage majority shareholders from engaging in oppressive behavior. In other words, the prohibition of marketability discounts in shareholder oppression cases forces the majority shareholders to pay more than fair market value as a penalty for their conduct. Imposing the fair value standard in divorce cases would not serve the same purpose.

The Colorado Supreme Court did not go as far as prohibiting the fair value standard in divorce cases. Instead, the court held that marketability discounts must be considered on a case-by-case basis. It is conceivable, under certain circumstances, that marketability discounts might not be applied in divorce cases. It would not be appropriate, however, to impose the fair value standard in every divorce.

Texas has once again proven itself to be a haven for the affluent divorcee. In Mandell v. Mandell, 2010 WL 1006406 (March 18, 2010), the Texas Court of Appeals held that a professional spouse’s 25% interest in a medical corporation was limited under the terms of a buy-sell agreement to a nominal fixed price payable to shareholders upon divorce. The decision was summarized at BVLaw Blog as follows:

In a case of first impression, the Texas Court of Appeals considered a buy-sell agreement that purported to bind shareholders and their spouses in the event of divorce. As a further complication, the husband had signed an employment agreement with the private medical association—but neither he nor his wife had signed the shareholders’ agreement.  This unsigned agreement limited the value of a divorcing shareholder’s interest to the equity buy-in price (in this instance, a mere $11,000 for a 25% share in a business with an estimated $3 million to $5 million book value).

I share BVLaw Blog’s incredulity, but my analysis is somewhat different.

In the opinion, the Texas appeals court emphasized that the doctor, who signed the stock purchase agreement during the marriage three years before separation, tendered a check for his buy-in but never signed the shareholders agreement (which was referenced in the stock purchase agreement); and his shares were never issued. After separation, the corporation returned the shareholder’s fixed buy-in payment. At that point, the trial court  might have held that the shares were never acquired, and only the buy-in payment itself was community property.

Yet, during the pendency of the divorce litigation, the wife filed motions compelling her husband and the corporation to complete the transaction. The doctor returned the fixed sum to the corporation, and the corporation issued the shares. When the wife attempted to introduce expert testimony to prove the fair market value of the shares, she was met with a motion in limine, which was granted. The trial court held that the wife was bound by the terms of the agreements.

In Texas, the fair market value of a business is presumed to be zero if the shareholders are contractually obligated to sell back their shares upon retirement, death or divorce. A divorcing spouse may present evidence of book value or comparable sales to rebut the presumption, but in this case, the court held that the net asset value was the property of the corporation, not the shareholders.

It might be signficant that Texas is a community property jurisdiction. Since the marital community exists throughout the marriage in those jurisdictions, it could be said that the doctor’s wife was in privity with her contracting husband when he signed the stock purchase agreement. Furthermore, property in Texas apparently cannot be owned simultaneously by one legal entity (a corporation) and another legal entity (the marital community). These principles might not apply in common law (marital property) states, such as Pennsylvania, where it might be argued that the spouses were neither in privity nor intended third party beneficiaries of such contracts, and where marital property is merely a fictitious estate rather than a legal entity.

Two articles from BV Wire recently caught my attention. Both deal with business valuation in divorce cases where personal goodwill was an issue. I will post my own analysis soon. Meanwhile, here are excerpts from BV Wire’s blast email, published by BV Resources.

Med practice valuations still plague appraisers—and the courts

A trio of new divorce cases highlights the constant challenge of appraising medical practices, everything from doctors who won’t disclose their finances to those who insist their opinions should determine value. In Garcia v. Garcia (Fla. App., Jan. 20, 2010), the husband’s expert argued for a strict application of the buy-sell agreement, which would have limited his share in a successful hematology practice to a mere $45,000—compared to the wife’s expert, who used a net asset value to appraise it at $900,000. At the very least, the husband argued, the restrictive buy-sell should considerably discount the NAV (but he lost both arguments on appeal).

Or consider Amaraneni v. Amaraneni, (La. App., Feb. 12, 2010), in which the doctor claimed his interest in an urgent care clinic had no value apart from goodwill attributable to his professional qualities. But he failed to provide any financial documentation to the court-appointed expert; at deposition, he was similarly “vague” and un-responsive. His name was on the wall but the clinic wasn’t named after him. A manager supervised all the operations and staff—and the expert apportioned all goodwill to the enterprise, also confirmed on appeal.

Finally, in Dickert v.Dickert, (S.C., Jan. 11, 2010), the trial court valued the husband’s successful dental practice at $360,000, including over $255,000 of “enterprise goodwill.” In an expedited appeal to the S.C. Supreme Court, the husband argued that state law precluded any consideration of goodwill in a professional practice, due to its speculative nature. The wife claimed the current majority rule on enterprise values was the better law, but the court disagreed, finding the goodwill asset “too intangible” to support an accurate valuation.  (All three case digests will appear in the April 2010 Business Valuation Update™.)

Is this recession enough reason to devalue assets in divorce?

In Mistretta v.Mistretta (Fla. App., Feb. 18, 2010), the trial court valued the husband’s restaurant at $854,000, based on a valuation report prepared nearly a year earlier. The husband moved for reconsideration, claiming the recession caused the restaurant to lose value. The trial court agreed, finding that no one could have foreseen the severity of the economic crisis—but the wife successfully appealed. “Economic recessions, like other vagaries in the business cycle, are contingencies appraisers must take into account in valuing a business,” the appellate court held, despite a strong dissent which likened the recession to a global economic “tsunami.” The wife’s expert, Gary Trugman, obviously agrees with the majority. “The truth is, we did consider the economic downturn, because we used dual valuation dates,” he tells the BVWire™. The husband also lost on his expert’s claim that 50% of the restaurant’s value was personal goodwill. “As I said to the judge, ‘Your Honor, when was the last time you went to a restaurant if the food was lousy, the service was terrible, but the owner was a really nice guy?’ I think that got my point across, that there was very little personal goodwill,” Trugman says. “I used Pratt’s Stats data for restaurants to demonstrate what portion of the purchase price was protected by a covenant not to compete, and used that percentage to allocate some personal goodwill—but it was a relatively small figure.”

The South Carolina Family Law Blog contains a great list of frequently-overlooked or hidden assets in divorce. Some of the more interesting items are:

1.Frequent flyer mileage
2.Security deposits (e.g., utilities, car lease)
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8.Unused vacation, sick leave
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10.Income tax refunds
11.Income tax capital loss carry-forwards
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24.Burial plots
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30.Cash
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34.Options to purchase property
35.Unpaid commissions on deals set to close
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39.Taxes prepaid

In our area, don’t forget about subsurface mineral rights, another overlooked asset.

What factors inflence a spouse’s eligibility for alimony after divorce under Pennsylvania law?

Under Pennsylvania law, post-divorce alimony “is a secondary remedy . . . available only where economic justice and the reasonable needs of a party cannot be achieved by way of an equitable distribution award and development of an appropriate employable skill.” These are the well-known words of the Superior Court of Pennsylvania in its Opinion in Nemoto v. Nemoto, 620 A.2d 1216 (Pa.Super.1993). Most of the important concepts in alimony jurisprudence are covered in this sentence. First, the trial courts must attempt to divide marital property in a way that avoids the need for post-divorce alimony. Why? Because the courts encourage a complete cessation of financial ties between divorcing spouses. If enough property (particuarly income-generating property) can be conveyed to a divorcing spouse, then that property can fulfill all of the spouse’s economic needs without the financial “umbilical cord” of alimony.

• The value of the assets and liabilities distributed to each of the parties must be considered before awarding alimony. 23 Pa.C.S. § 3701(b)(10), (16); Fee v. Fee, 496 A.2d 793 (Pa.Super. 1985).
• In its determination of alimony, the trial court must consider the income generated by a spouse’s marital and nonmarital assets. Ressler v. Ressler, 644 A.2d 753 (Pa.Super. 1994).

Second, our Courts encourage spouses to maximize their earning capacity and income potential through appropriate employment. In the first decade of the Divorce Code, enacted in 1980, the law provided that alimony could be awarded only for rehabilitative purposes, such as paying for college or vocational training. Alimony was not permitted in Pennsylvania prior to 1980, and the legislators who enacted the  Divorce Code worried that spouses would lose their incentive to become self-supporting if they could easily receive post-divorce alimony. The alimony law has been revised since 1980, allowing alimony for other reasons, such as meeting the budgetary shortfall of a spouse who is incapable of self-support. Still, the old law remains a strong influence among judges and lawyers in Pennsylvania. Several attempts to modernize the alimony law have failed, primarily because they might reduce a spouse’s incentive to go back to work. 23 Pa.C.S. § 3701(b)(1), (9), (17).

• The Court imputed an earning capacity to a dependent spouse who devoted her time to an unproductive start-up business instead of seeking gainful employment. Thomson v. Thomson, 519 A.2d 483 (Pa.Super.1986).
• An award of alimony for ten years was deemed excessive when a college education leading to a self-supporting job would require just four years. Barrett v. Barrett, 614 A.2d 299 (Pa.Super.1992).
• In cases where there is no evidence of an impediment that would prevent a spouse from becoming self-supporting, the court is authorized to limit an alimony award. Adelstein v. Adelstein, 553 A.2d 436 (Pa.Super.1989).
• In cases where a spouse’s earning capacity was limited by a medical disability or the disability of a custodial chid, Soncini v. Soncini, 612 A.2d 998 (Pa.Super.1992), the court may decline to impose a full time earning capacity upon a dependent spouse, justifying an award of alimony.

Finally, the law looks to the reasonable needs of a spouse. After a divorce, each spouse must have sufficient cash flow to meet his/her monthly household expenses. Yet, judges realize that two households cannot exist as cheaply as one combined household. The marital standard of living is just one of the seventeen statutory criteria for alimony awards, and in practice, it is one of the least influential. The expenses associated with custody of a child is more influential in an ex-spouse’s request for alimony. Just as important is the ability of a dependent spouse to become self-supporting through appropriate employment and the financial hardship that alimony may cause to the payor. When determining the amount and duration of an alimony award, the courts scrutinize the budget of a spouse seeking alimony carefully. 23 Pa.C.S. § 3701(b)(7), (8), (13).

• The Court will not allow an award of alimony that would divert twice as much income to the alimony recipient as the payor, which would allow her to enjoy a better standard of living than she had enjoyed during the marriage Ressler v. Ressler, 644 A.2d 753 (Pa.Super.1994).

Marital misconduct is just one of the seventeen factors in awarding alimony, and it has remained one of the least influential since the enactment of the Divorce Code. 23 Pa.C.S. § 3701(b)(14); Nuttal v. Nuttal, 562 A.2d 841 (Pa.Super.1989).