Domestic Relations / 06.28.2019

Divorce and the Family Business (Part 3 of 3): Separate and Marital Property?

By John Ramsey

domestic relationsThe first two articles in this three-part series have dealt with identifying the nature of business assets that are subject to a divorce, as well as beginning the process of having those business interests valued. In this third and final installment, we address specifically why all of this is so important.

As stated before, the Domestic Relations Court must identify all assets, determine their value and, ultimately, determine how those assets are to be allocated between the spouses. Property that is considered “marital property” is to be equitably divided. Ohio law presumes that equitably divided means equally divided. However, property that is considered “separate property” is not subject to equitable division and typically remains with the party who owns it.

A Tale of Two Businesses

Perhaps the best way to explain the profound distinction between marital property and separate property is to contrast two separate hypothetical businesses: Company M and Company S.

Company M: Tom and Andrea Jones were married in 2000. At the time of the marriage, both were working jobs as W-2 employees. After the parties had been married for about 10 years and saved some money, they decided to start a widget manufacturing company called Company M, LLC. Andrea was the sole member of Company M and served as its CEO. Tom continued to work his regular job to help supplement their income. They used all of their joint savings, $100,000, to start the company. They did not borrow any money.

The year is now 2019 and Tom and Andrea have decided to divorce. For the past 9 years, Company M has done well. Andrea has been proficient at navigating the often complicated widget market. And in 2015, Tom left his job in order to stay home with the parties’ two daughters. After reading these prior two articles, the parties have decided to identify the type of business interest they own and to hire a business valuator.

The business valuator issues a report indicating that the fair market value of Andrea’s business interest at this time is $500,000.

Because the parties used joint savings to purchase the company during the marriage, the entire value of Company M is considered marital and subject to equitable division. In other words, if Andrea wishes to retain her ownership in Company M, she will have to pay Tom $250,000 (or assets of equivalent value) to Tom and for his equitable interest in the same

Company S: Carlos and Diana were also married in 2000. But prior to and at the time of the marriage, Carlos owned 100% of Company S, LLC, also a widget manufacturing company. Carlos is the CEO of Company S and has been throughout the marriage. Diana worked outside the home throughout the marriage.

Now, in 2019, Carlos and Diana have decided to divorce. Carlos also navigated the complicated widget market, and Company S has grown substantially since the divorce. Accordingly, they, too, determined the type of business interest and hired a business valuator.

After learning about the case, the business valuator performed two valuations. The first was to determine the fair market value of Company S at the date of marriage. The second was at the time of divorce. The first valuation determined that the fair market value of Carlos’ business interest at the date of marriage was $100,000. The second valuation determined that the fair market value of Carlos’ business interest at the time of divorce was $500,000.

It is undisputed between the parties that $100,000 of business interest belongs to Carlos, because that was his property prior to the marriage. Hence, that is his separate property. Accordingly, there remains $400,000 of value that must be classified as marital property or separate property. This is where many complicated issues arise.

A Little Appreciation Goes a Long Way

The appreciated value of Carlos’100% interest in Company S ($400,000) must be classified as martial or separate property. Simply stated, in Ohio, if the fair market value of Company S grew as a result of either Carlos’ or Diana’s efforts during the marriage (or marital financial contribution), then some or all of the appreciation is marital. However, if the fair market value of Company S grew as a result of market forces (or other forces not resulting from either party’s efforts or marital financial contribution), then some or all of the appreciation remains Carlos’ separate property.

Not surprisingly, this issue can quickly become contentious. In this example, it would be expected that Carlos would argue that the widget industry rose as a result of market forces that had nothing to do with him, and thus, that the appreciation was passive and separate. Diana, on the other hand, would argue that Carlos is a talented CEO and the company grew because of his skill and leadership, and therefore, the growth was considered active and marital.

To make this issue somewhat more complicated, Ohio courts are not all in agreement as to which party carries the burden of proof to demonstrate that the appreciation in value occurred due to passive forces (separate property) or active efforts of either spouse (marital property). Accordingly, putting together the data necessary to prove either passive forces or active involvement is absolutely critical prior to any negotiation or court proceeding involving these issues.

KJK’s Domestic Relations & Family Law Practice Group can assist with all issues regarding divorce/dissolution, including issues pertaining to privately held (including family-owned) businesses. If you need assistance on these or other domestic relations matters, please contact John Ramsey at jdr@kjk.com or 216.736.7289.

 

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