Sadly, according to recent statistics, roughly half of marriages end in divorce. When “irreconcilable differences” occur, one of many important considerations is how to equitably divide marital assets.
Arizona is a community property state. Absent other contracts or agreements, when a couple resides in a community property state, when they marry, everything that each of them earns from the day they get married belongs to both spouses.
In most cases, the assets a person had before marriage remain that person’s sole and separate property, as do any gifts or inheritances received after marriage. If one chooses to combine his or her sole and separate property with the couple’s community property, generally speaking, the property that is combined then becomes community property.
These legal principles apply to real estate and businesses that a husband or wife has an ownership interest in. In the context of divorce proceedings, as with all other community property, after receiving evidence submitted by the parties, the judge will determine the value of the asset, and then equitably divide the community property interest in the assets between the spouses.
If the ownership of the business predates the marriage, the judge will examine what the community invested in the business by time and money during the marriage. The judge will also look at the value of the business on the date of the marriage and on the date the Petition for Dissolution was served. In order to present such evidence to the court, the spouse can hire a forensic accountant and obtain the businesses’ financial records for the past 5 years (or longer in some cases).
For some businesses, it may be necessary for the judge to assign a value to the intangible assets of the business as well as the tangible assets of the business. Intangible assets may include patents, trademarks, contracts, and goodwill. The courts recognize two types of goodwill, personal goodwill and enterprise goodwill. Personal goodwill is also known as professional goodwill and attaches to a particular individual such as a REALTOR®, surgeon, or a lawyer, rather than the business the individual owns. Enterprise goodwill or business goodwill comes from the attributes of the business itself.
A business valuation expert is essential to assigning a value to the intangible assets of a business to present to the court. Enterprise goodwill is recognized as a community asset of the business in all states, including Arizona. Some states have declined to include personal goodwill as a part of the community assets of a business. Arizona continues to include personal goodwill as a community asset of a business in a divorce.
SIDS (Sudden Income Deficiency Syndrome)
One spouse is often unfamiliar with a business that has been started and managed by the other spouse. This lack of knowledge leaves that spouse vulnerable to pre-divorce financial maneuvering that has become so common that it is known as “SIDS” (sudden income deficiency syndrome).
Example: A business that has been supporting the family for years that suddenly has little or no income or value. Clues that the sudden lack of income from the business is a result of improper financial maneuvering include correlating the drop in income with a time when the couple began having serious marital difficulties. Other clues include:
- when the spouse operating the business begins having the business pay his personal expenses; or
- when one spouse’s involvement in the business is reduced.
The more that one spouse performs work or provides services for the business, the stronger her claim is for an partial ownership of the business and the more likely the spouse is to have knowledge of the value of the business.
To prove to the court that the value or income of the business is not what it seems, an attorney will need to call upon a forensic accountant to assist in gathering evidence of manipulation to present to the court.
Prenuptial Agreements, Management and Operating Agreements
In Arizona, the laws regarding community property can be limited by contracts, such as prenuptial agreements. A “prenup” is the most common contract to limit or modify the application of community property law in a divorce. A prenuptial agreement can clearly state whether a business becomes community property after a marriage and which spouse will get to keep the business after a divorce. If a business is created after the marriage, the prenuptial agreement can determine whether that business is community property. In order to be a valid contract, the prenuptial agreement must be fair to both sides, and each party must fully disclose their financial condition. Each party should have their own attorney review and attest to the fairness of the prenuptial agreement and that their client was not coerced into signing the prenuptial agreement.
Absent a prenuptial agreement that establishes ownership and management of the business, the business should have a management agreement and operating agreement that restricts stock transfers to anyone without the consent of all partners. The operating agreement should define who would manage the business if a Petition for Dissolution is filed and served.
The equitable division of assets, especially business-related assets can be difficult. This article briefly summarizes the basic principles of how the business interests of a couple going through a divorce are treated by the courts in Arizona and the steps that can be taken to simplify the division of business interests in a divorce. Each situation is unique. If you or someone you know has questions concerning a specific situation, please contact us for a case strategy session.