CHARACTERIZATION PROBLEMS RAISED BY CERTAIN ASSETS

Question 1

What is the Pereira test?

Answer 1

(think personal skills and effort)
Use where spouse’s time, skill, and effort are major factors in growth of business. Look for instances where spouse contributed creative ideas or develops new techniques, and/or worked long hours and only drew modest salary.

Question 2

What is the Pereira formula?

Answer 2

pay interest on separate property; the rest is community property (Pay interest (legal rate of 10% annum) on value of business at time of the marriage.)

Question 3

H owned modest real estate business at time of marriage; worth $3 million at time of divorce. H claimed he was passive investor who got caught up in the real estate boom, but the court found that H was unusually skillful in developing raw land, supervising financing and construction, and negotiating lucrative leases of commercial properties. What test did the court apply?

Answer 3

the Pereira test

Question 4

What is the Van Camp test?

Answer 4

(Think Valuable Company or Asset)
Use where capital investment was the major factor in the business’s growth, and spouse’s skills and efforts were less of a factor. Look for instances where spouse was paid substantial salary and large bonuses (meaning the community was compensated).

Question 5

H owns Ford dealership at time of marriage in 1947, business grows dramatically due to increased demand for cars after WWII. What test will the court use?

Answer 5

The Van Camp test

Question 6

What is the Van Camp formula?

Answer 6

Value of business-community labor and expenses and the rest is separate property

Start with value of spouse’s services at market rates (how much would executives in similar positions be compensated on the market?) MINUS family expenses paid from community funds EQUALS community component. The balance is SP.

Question 7

Wendy owned a computer software company in San Jose worth $100,000 at the time of her marriage to Hal in 1986. When the couple divorce in 1996, the business is worth $4 million.

Hal contends that a substantial portion of the business is CP. He points out that because of the increased volume of business in the 1990’s, Wendy worked long hours and on weekends; they rarely took vacations; that Hal stayed home to watch their daughter; that Wendy drew a modest salary; and thus the great increase in the business was from W’s labor .
Wendy contends that the increase in value stemmed from her incredibly good fortune and timing; that only an idiot couldn’t have made a fortune when the computer and microchip business exploded in San Jose in the 1990’s; that she had hired two Cal Tech graduates whose ideas contributed to the business’s growth; and that the salary and bonuses she drew out of the business were substantial – far above the going rate for similar positions. Therefore, since the business was her SP at the time of the marriage the business is entirely her SP.
What tests are used?

Answer 7

The Pereira test and the Van Camp test.

Question 8

Wendy owned a computer software company in San Jose worth $100,000 at the time of her marriage to Hal in 1986. When the couple divorce in 1996, the business is worth $4 million.

Hal contends that a substantial portion of the business is CP. He points out that because of the increased volume of business in the 1990’s, Wendy worked long hours and on weekends; they rarely took vacations; that Hal stayed home to watch their daughter; that Wendy drew a modest salary; and thus the great increase in the business was from W’s labor .
Wendy contends that the increase in value stemmed from her incredibly good fortune and timing; that only an idiot couldn’t have made a fortune when the computer and microchip business exploded in San Jose in the 1990’s; that she had hired two Cal Tech graduates whose ideas contributed to the business’s growth; and that the salary and bonuses she drew out of the business were substantial – far above the going rate for similar positions. Therefore, since the business was her SP at the time of the marriage the business is entirely her SP.
What is the result under the Pereira test?

Answer 8

if H & W had been married for ten years, W is entitled to the initial $100,000 (value of business at time of marriage) plus $100,000 in interest (10 x 10,000 (interest at 10%)). Therefore, the business is 5% her SP ($200,000/$4,000,0000) and the balance is CP.

Question 9

Wendy owned a computer software company in San Jose worth $100,000 at the time of her marriage to Hal in 1986. When the couple divorce in 1996, the business is worth $4 million.

Hal contends that a substantial portion of the business is CP. He points out that because of the increased volume of business in the 1990’s, Wendy worked long hours and on weekends; they rarely took vacations; that Hal stayed home to watch their daughter; that Wendy drew a modest salary; and thus the great increase in the business was from W’s labor .
Wendy contends that the increase in value stemmed from her incredibly good fortune and timing; that only an idiot couldn’t have made a fortune when the computer and microchip business exploded in San Jose in the 1990’s; that she had hired two Cal Tech graduates whose ideas contributed to the business’s growth; and that the salary and bonuses she drew out of the business were substantial – far above the going rate for similar positions. Therefore, since the business was her SP at the time of the marriage the business is entirely her SP.
What is the result under the Van Camp test? (the market rate forexecutives in comparable positions was $100,000 and living expenses were $80,000/year)

Answer 9

if H&W married for 10 years, and the market rate forexecutives in comparable positions was $100,000 and living expenses were $80,000/year, the value of the community component would be $200,000. The business would be 5% CP ($200,000/$4,000,000) and the balance W’s SP.

$100,0000 x 10 years = $1,000,000 value of community labor

-( $80,000 x 10 years = - $800,000 family expenses paid from CP)
=community component: $200,000

Question 10

California Supreme Court has said that court is not bound either to adopt Pereira or Van Camp. May select whichever formula will achieve substantial justice between the parties. So you must discuss ______

Answer 10

Both

Question 11

H had worked for Shell Oil Co. for 10 years at the time he married W in 1982; the marriage ended by divorce in 1992, and H will be eligible to retire in 2002. In all of these years, H was a participant in Shell’s qualified pension plan, where the pension benefit is measured by years of service. H was not eligible for retirement at the time of the divorce action. W contends that a portion of the pension benefit is CP. Is she right?

Answer 11

Yes, Employee retirement benefits accumulated during marriage, whether or not vested at the time of divorce, are community property.

Question 12

For pension benefits at divorce what formula do you use?

Answer 12

The proration formula

Years in service while married/total years employed to retiring

Question 13

H had worked for Shell Oil Co. for 10 years at the time he married W in 1982; the marriage ended by divorce in 1992, and H will be eligible to retire in 2002. In all of these years, H was a participant in Shell’s qualified pension plan, where the pension benefit is measured by years of service. H was not eligible for retirement at the time of the divorce action.
Do the math

Answer 13

10/30= a 1/3 of the pension will be community property.

Question 14

H had worked for Shell Oil Co. for 10 years at the time he married W in 1982; the marriage ended by divorce in 1992, and H will be eligible to retire in 2002. In all of these years, H was a participant in Shell’s qualified pension plan, where the pension benefit is measured by years of service. H was not eligible for retirement at the time of the divorce action.
Given that H is not yet eligible for retirement, in awarding W a share of the benefit, what form should the decree take, what are the 2 options?

Answer 14

1. “if and when received decree”- if and when received, she gets her share (1/6, which is half of 1/3 CP share).
2. “cash her out”- by awarding other assets of equal value.

Question 15

H had worked for Shell Oil Co. for 10 years at the time he married W in 1982; the marriage ended by divorce in 1992. In all of these years, H was a participant in Shell’s qualified pension plan, where the pension benefit is measured by years of service. H was eligible for retirement at the time of the divorce action. W seeks payment of her community share of H’s pension benefit even though H has not retired. Is she entitled? Why or why not?
How much of the retirement plan is she entitled to?

Answer 15

Yes, Since H could have retired at the time of the divorce, his retirement benefit had matured. H’s election not to retire cannot defeat wife’s present right.
She is entitled to 1/6 (1/2 of the 1/3 in the pension plan that is community property)

Question 16

If a nonparticipant spouse (“NPS”) in a qualified pension plan divorces a participant spouse, her community property interest is recognized; under what law?

Answer 16

Federal law

Question 17

If a nonparticipant spouse (“NPS”) in a qualified pension plan divorces a participant spouse, her community property interest is recognized; under under federal law she can get a what? For what purpose?

Answer 17

qualified domestic relations order (“QDRO”) and receive payments from the plan.

Question 18

What if the marriage ended by death rather than divorce. Does the nonparticipant spouse (NPS) have a devisable interest in a qualified plan if she predeceases the participant? Why or why not?

Answer 18

No, There is federal preemption under the Employment Retirement Income Security Act (“ERISA”), which trumps CP laws. Her interest is terminated when she predeceased the participant.

Question 19

Disability retirement benefits and workers’ compensation benefits are treated as what? At what point are they classified?

Answer 19

Wage replacement, When they are received, not when they are earned.

Question 20

H had worked for 10 years before marriage, 10 years during marriage, but H was also covered by Shell’s disability insurance program. Shortly before the divorce, H suffers an on-the-job injury and is given disability retirement; under the Shell plan H received disability pension of $900/month. Also, H is awarded a workers’ compensation benefit of $150/week. W claims a community interest in the disability and workers’ compensation benefits, arguing that these benefits were derived from H’s labor, and should be treated the same as pension benefits. Is W right? Why or why not?

Answer 20

No, Disability retirement benefits and workers’ compensation benefits are treated as wage replacement. Therefore they are treated as wages, anything after the permanent separation or divorce would be SP.

Question 21

H had worked for 10 years before marriage, 10 years during marriage, but H was also covered by Shell’s disability insurance program. Shortly before the divorce, H suffers an on-the-job injury and is given disability retirement; under the plan H could elect to take, at his option, either a regular retirement benefit at $1,200/month or disability retirement at $900/month; H chooses disability retirement. Does W have CP interest in H’s retirement benefit?

Answer 21

Yes, H cannot elect go defeat her community interest.

Question 22

How do courts treat severance pay?

Answer 22

There is a split.
H’s severance pay is SP because it replaced lost earnings which after a divorce or permanent separation would be H’s SP; OR
H’s severance pay is CP because it arose from a collective bargaining agreement and was thus earned by employment during marriage.

Question 23

If a stock option is awarded during marriage but does not vest until after the economic community has ended how is it distributed?

Answer 23

the proration formula that is used in determining what portion of the option is CP and what portion is SP depends on the primary intent of the employer in granting the option.

Question 24

Hank, married to Wynn, was employed by the Ajax Company on June 10, 1998. OnJune 10, 2004, Ajax Company granted Hank a stock option entitling him to purchase 5,000 shares of Ajax common stock if he is still employed by the company on June 10, 2008. Hank and Wynn are divorced in 2006; the economic community ended when Hank and Wynn permanently separated (with an intent not to resume the marital relation) on June 10, 2006. The divorce court determines that the stock options were awarded primarily to reward Hank for his past services, as a form of deferred compensation. The court should employ what method?

Answer 24

the Marriage of Hug proration formula

Question 25

How does the marriage of hug proration formula work?

Answer 25

the starting point for both the numerator and denominator of the fraction is the date of employment. The fraction is then multiplied by the number of shares of stock that can be purchased under the options.

(years from the date of employment to date economic community ends/years from date of employment to date options become exercisable)*number of shares of stock that can be purchased under the options

Question 26

Hank, married to Wynn, was employed by the Ajax Company on June 10, 1998. On June 10, 2004, Ajax Company granted Hank a stock option entitling him to purchase 5,000 shares of Ajax common stock if he is still employed by the company on June 10, 2008. Hank and Wynn are divorced in 2006; the economic community ended when Hank and Wynn permanently separated (with an intent not to resume the marital relation) on June 10, 2006. The divorce court determines that the stock options were awarded primarily to reward Hank for his past services, as a form of deferred compensation. How much is the community entitled to?

Answer 26

(8/10)*5000=4000 Shares are community property

Question 27

Hank, married to Wynn, was employed by the Ajax Company on June 10, 1998. OnJune 10, 2004, Ajax Company granted Hank a stock option entitling him to purchase 5,000 shares of Ajax common stock if he is still employed by the company on June 10, 2008. Hank and Wynn are divorced in 2006; the economic community ended when Hank and Wynn permanently separated (with an intent not to resume the marital relation) on June 10, 2006. the divorce court determines that the stock options were awarded primarily to encourage Hank to remain with the company. The court should employ what method to see what the community is entitled to?

Answer 27

the Marriage of Nelson proration formula

Question 28

How does the marriage of Nelson Proration formula work?

Answer 28

the starting point for both the numerator and denominator of the fraction is the date the options are granted. The fraction is multiplied by the number of shares of stock that can be purchased under the options

years from date options are granted to date economic community ends/years from date options granted to date options become exercisable

Question 29

Hank, married to Wynn, was employed by the Ajax Company on June 10, 1998. OnJune 10, 2004, Ajax Company granted Hank a stock option entitling him to purchase 5,000 shares of Ajax common stock if he is still employed by the company on June 10, 2008. Hank and Wynn are divorced in 2006; the economic community ended when Hank and Wynn permanently separated (with an intent not to resume the marital relation) on June 10, 2006. The divorce court determines that the stock options were awarded primarily to encourage Hank to remain with the company. How much is the community entitled to?

Answer 29

(2/4)*5000= 2500 stock option

Question 30

What is goodwill?

Answer 30

Goodwill are those qualities that generate income beyond that derived from (1) the professional’s labor; and (2) reasonable return on capital and physical assets

Question 31

Goodwill of a professional practice (to the extent acquired during the marriage) is considered what type of asset?

Answer 31

is cp subject to division on divorce

Question 32

Winkie is a CPA with a solo practice. At the time of her divorce from Hobie, she is netting $100,000/year after expenses. If she went on the job market, she could earn $60,000/year as an associate. Winkie’s firm has $100,000 in capital assets; at a 10% return, these assets would earn $10,000/year. Hobie contends that the “goodwill” of Winkie’s professional practice, which Winkie opened a year after marriage to Hobie, is community property. Is Hobie right? Why or why not?

Answer 32

Yes, Goodwill of a professional practice (to the extent acquired during the marriage) is cp subject to division on divorce

Question 33

How is the value of goodwill established?

Answer 33

Goodwill is primarily established by expert witness testimony as to its value.

Question 34

Winkie is a partner in a small firm. The partners have a buy-sell agreement which provides that any partner who dies or leaves the firm will receive $5,000 for his or her interest in the partnership. Winkie contends that the buy-sell agreement puts a $5,000 cap on the value of her goodwill in the partnership for purposes of division on divorce. Is she right?

Answer 34

No, it is a factor but it is not conclusive.

Question 35

When does the community get reimbursement for education expenses paid for with CP?

Answer 35

CP gets reimbursement if the education enhanced the spouse who received the educations’ earning capacity

Question 36

Is reimbursement available if the educational expenses were incurred before marriage and the loans were paid with community funds after the marriage?

Answer 36

Yes

Question 37

What are the equatable defenses to reimbursement of community estate for educational expenses?

Answer 37

1. Community has already substantially benefited from the earnings of the educated spouse. If more than 10 years have elapsed since the degree was awarded, the presumption is that the community has substantially benefited, meaning that unless presumption is rebutted, no reimbursement.
2. OR if other spouse also received a CP-funded education.

Question 38

Hobie and Winkie are married shortly after Hobie graduates from USC with a degree in history and Winkie graduates from nursing school. They both want to go to medical school, but realize they cannot both do so at the same time. Because Winkie’s prospects for employment as a nurse are better than Hobie’s, they decide that Winkie will work the night shift in an emergency room while Hobie gets his MD. Four years (and $120,000 in GSL ) later, it is graduation day. Hobie tells Winkie he has good news and bad news. The good news is that he will finally be a doctor. The bad news is he is filing for divorce. Is Hobie’s professional degree “property” that is subject to division on divorce?

Answer 38

No, it is not CP.

Question 39

Hobie and Winkie are married shortly after Hobie graduates from USC with a degree in history and Winkie graduates from nursing school. They both want to go to medical school, but realize they cannot both do so at the same time. Because Winkie’s prospects for employment as a nurse are better than Hobie’s, they decide that Winkie will work the night shift in an emergency room while Hobie gets his MD. Four years (and $120,000 in GSL ) later, it is graduation day. Hobie tells Winkie he has good news and bad news. The good news is that he will finally be a doctor. The bad news is he is filing for divorce. How is the 120K in GSL loans treated?

Answer 39

They are assigned solely to the party who incurred the debt.

Question 40

What 2 valuation techniques are used for good will?

Answer 40

1. Market sales valuation

2. capitalization of past excess earnings

Question 41

How does market sales valuation work to assess value of goodwill?

Answer 41

The price the goodwill would command in a sale of business or professional practice.

Question 42

How does the capitalization of past excess earnings work to assess value of goodwill?

Answer 42

It ascertains the present value of the future stream of income that goodwill developed during the marriage will generate in a business or professional practice.