In Arizona, property acquired during marriage from the parties’ incomes and efforts is called “community property.” Community property generally includes financial accounts, investments, retirement and pension accounts, houses, land, business interests, tangible items such as furniture and other items and interests that have value.
As a general rule, community property is divided between the parties equally in an Arizona divorce case, although there are some exceptions. For example, if one of the parties lost or destroyed (gambling, drugs, etc.) community property, or hid community property, the Court may award the other party more property. This is generally done by making a “waste claim.”
Sole & Separate Property
In Arizona, property acquired prior to marriage, through inheritance, and/or from gifts, is presumed to be that person’s sole and separate property and is not divided. However, in some instances, the property’s nature as sole and separate may be changed. For example, if a party deposits sole and separate funds to a community account and such funds were co-mingled or spent, such would be presumed to have become community property. On the other hand, if co-mingled sole and separate funds can be explicitly traced to their source, they may retain their nature as sole and separate property.
Another example where sole and separate property may be converted to community property is where a party has a house in their own name prior to marriage but later places the house in both parties’ names. In such event, the house is generally presumed to have become community property. There are always exceptions to these general rules. The firm suggests that you always consult with an attorney regarding your specific circumstances.
There may be a number of financial issues regarding your specific circumstances. For example, retirement accounts and pension benefits may be partially community property and partially separate property depending upon when the contributions were made. A spouse is entitled to receive his or her share of non-vested retirement and pension benefits in the future, if the benefits eventually vest.
If a spouse or both spouses own a business, such business may need to be valued. Some of the business value may have been acquired prior to marriage, and some of the interests accrued after marriage. A more detailed discussion of business interests in divorce cases is set forth under “Complex Property Issues,” below.
These are issues that you should always discuss with an attorney.
As a general rule, debts incurred during marriage will be divided equally; however, there are exceptions to this presumption.
Sole & Separate Debts
Debts incurred prior to marriage are generally the responsibility of the person incurring such debts. Debts incurred during marriage are generally community debts even if only one of the spouses incurred such debts, and even if such debt is only in one spouse’s name. Debts incurred after a divorce proceeding is filed and served is generally the responsibility of the person incurring such debts. However, certain precautions should be made, as you may still be responsible for such debts to the creditors.
There may be reimbursement issues if marital assets were used to pay pre-marriage sole and separate debts, and from various other situations.
Note: These are issues that you should always discuss with an attorney. During your consultation, our law firm will provide you with its opinions or approach regarding your community property, separate property, and debts incurred during your marriage.
COMPLEX PROPERTY DIVISION
BUSINESS VALUATION MATTERS
The starting principles of Arizona community property law provide that property acquired prior to marriage, or by gift or inheritance, constitutes sole and separate property, and that property acquired during marriage pursuant to income received from efforts by either party constitutes community property. However, such may be convoluted, especially when one is dealing with the valuation of a business even if the business was started prior to marriage.
What if We Started a Business During Marriage?
One of the more complex areas of divorce law regards business valuation issues. It is possible that the business may have value to the parties which exceeds the value of the hard assets themselves. The value of a business above and beyond its hard assets is called “goodwill.” This is sometimes referred to in the industry as “blue sky value.” In some states, only businesses which are capable of being sold have a value above and beyond the value of the hard assets. This is often referred to as “enterprise goodwill.” However, in Arizona, a business may have goodwill value even if it is not capable of being sold. Arizona recognizes what is sometimes called “professional goodwill.” In Arizona, “goodwill” has been defined as “that asset, intangible in form, which is an element responsible for profits in a business.” Such has also been defined in a narrow sense as “a probability of repeat customers,” and in its broadest sense as “reputation.” Mitchell v. Mitchell, 152 Ariz. 317, 319, 732 P.2d 208 (Ariz. 1987). To view further explanation of Arizona case law regarding goodwill in Arizona, click here.
In some cases, it is clear that only one of the spouses can continue to operate the business. In such event, it is clear what party will receive the business. Thus, the issue is how much the other party should be compensated for his or her interests in the business. In some cases, both of the parties have the ability to operate the business. In such event, the highest bidder between the partners may receive the business.
Valuation of Businesses in Arizona
There are numerous methods of valuing a business. A good business valuation expert will generally address all of the major methods, and then make a recommendation to the Court regarding the method most appropriate under the circumstances. A few of such methods are addressed in this section.
Rule of Thumb Method
Pursuant to a rule of thumb method, the ‘expert’ uses an industry standard multiple which is often applied to either gross revenues or business profits (for example 2 times annual gross revenues). Such method is consistently criticized by most experts as most businesses are very much different from one another, and various factors are not considered in such a simplistic valuation.
Pursuant to the book value method, the value of the business is limited to its hard assets – i.e. equipment, inventory, cash accounts, accounts receivables, etc. Such method does not take into account goodwill, and has a fairly limited purpose. Such method may be appropriate if the profits of the company (or the income to the owner) does not exceed what the owner would make as an employee of another company.
Fair Market Value
Pursuant to fair market valuation, a company is valued at what a hypothetical willing buyer would pay a hypothetical willing seller under normal market conditions without undue duress. Such method may be appropriate where a business is capable of being sold. The business valuation expert will generally apply marketability discounts and minority interest discounts when appropriate.
Fair value is arguably most appropriate in valuing businesses which may not marketable to third parties. Such may include professional practices such as law offices or other businesses which require the owner to continue in the business in order for the business to succeed. Pursuant to the fair value method, the expert determines the inherent value to the owner as opposed to the value to a hypothetical third party. In determining such value, the expert applies a ‘capitalization of earnings’ approach. Simplistically stated, the expert compares the owner’s income and benefits to what an employee of a company with similar experience would receive. The excess income and benefits are then capitalized to determine the goodwill value of the business. Experts often argue over whether a minority or marketability discount should apply where other persons have ownership interests, where a business is not being marketed for sale or is not capable of sale. The fair value of the business generally substantially exceeds the fair market value of the business in light of the lack of marketability and minority discounts.
We have found that expert opinions regarding the value of the business may vary greatly. Sometimes the parties agree upon an expert, and only one valuation is conducted. In other cases, the parties may each retain their own expert. In such cases, the Court makes the decision regarding the value of the business based, in part, upon the factors presented by each expert. The Court may decide that one expert is more credible than the other expert and adopt one of the opinions, or may come to its own conclusions which could be somewhat different than both experts’ opinions.
Business Started Before Marriage, But Increased in Value During Marriage
Although a business started before marriage is technically sole and separate property, the community may have a claim to a portion of the increase in value which took place during the marriage.
This is one of the most complex areas of divorce litigation. There are a number of published cases from Arizona which deal with such issues. The main cases in Arizona are Rueschenberg v. Rueschenberg, and Cockrill v. Cockrill.
The complexity of the cases is exacerbated by the fact that the expert must first perform two valuations, i.e. the increased value of the company at the time of marriage, and the increased value of the company at the time of the divorce. This may be complicated by the various valuation approaches.
There are then various methods in which to apportion the increase in the value of the company between the community and the sole and separate interests. The basic concept is that the community should receive its share of the growth in the company which is attributable to community efforts, and the party that owned the business prior to marriage should receive a return on his or her investment including the portion of the growth which is attributable to external factors (i.e. factors other than community efforts).
The Rueschenberg Court also addressed that the community may have already been adequately compensated for its interests in the increased value of the business pursuant to the income received by the community during the marriage. Thus, even if part of the increase in the value of the company is due to community efforts, it could be determined that the income already received during the marriage satisfied the community’s interests in the increased value, and thus the community would not be entitled to further compensation.
The case law at this time is very complex, and there are different interpretations of the various factors which can be argued. It is extremely important to retain an attorney well versed in such issues if such are present in your divorce.
William D. Bishop of Bishop Law Office, P.C. has substantial experience with valuation issues and wrote an in-depth article regarding business valuation and apportionment issues titled, “A Long and Winding Road – Untangling the Knots In Business Valuation and Apportionment Issues.” You may review the article by clicking the link above.
CONTACT US TO SCHEDULE A CONSULTATION
If you have any questions about property division, or if you would like to schedule a consultation to discuss your case with a Bishop Law Office attorney, please contact us at our Scottsdale, Phoenix or Tempe, Arizona office.