While we as attorneys may have personal relationships with our clients, we generally advise them in a professional capacity and maintain our focus on business. When a client is getting divorced, business and personal concerns inevitably collide as courts are called upon to make determinations about a couple’s income, liabilities, and assets, which may include a closely held, private business.
Although an expert financial appraiser will be necessary to value the business, the underlying determination of whether a closely held, private business is a marital or separate asset is a legal question key to the outcome of any divorce. This is true whether a business was brought to the marriage, purchased during the marriage, or inherited before or during the marriage. Relevant to anyone who owns a closely held private business going through a divorce, this article focuses on a single question: Under what circumstances have courts found that a closely held business has converted from a separate asset into a marital asset? [1]
Why does this matter?
The short answer is that this matters because separate assets are not subject to division in a divorce. The party who brought the separate asset will keep it following the divorce. Now, a party may still have to pay spousal support (alimony) and child support out of income from the asset, but the asset itself will not be divided.
When is a business clearly marital?
Courts define marital property as any property that came to the parties by way of the marriage, including businesses created or purchased with the labor of the parties during the marriage. Sometimes, a business is unequivocally marital. For example, a client may have used a joint savings account containing wholly funds earned during a marriage to purchase an already operating business. Or a client may have started a business during the marriage after graduating from trade or professional school. In those situations, the business will be a marital asset subject to equitable division by the trial court. To be clear, the business may or may not be equally divided, but it will be subject to division.
What is a separate business?
Courts define separate property as any asset or liability a party brought to the marriage, any property received through gift or inheritance, personal-injury awards unique to an individual such as pain and suffering, and passive appreciation of a separate asset. To use a classic law school example, a client may have inherited the family widget business from his or her parents before the marriage. Given how courts have defined separate property, the trial court’s initial presumption will be that the family widget business is a separate asset not subject to equitable division.
How does a separate asset become a marital asset?
Theoretically separate assets may become marital when both parties contribute to the acquisition, improvement, or accumulation of those assets. [2] Going back to the family widget example, if both spouses helped expand that business, even though it was owned by one spouse before the marriage, that business may be found to be wholly or partially marital. Because courts treat married couples as a single economic unit, labor does not solely encompass working for or on behalf of the business. For example, in Hanaway v. Hanaway, 208 Mich. App. 278 (1995), the Michigan Court of Appeals reversed a determination that a business inherited by the husband through annual gifts of stock from his family was separate property. The Court found that the husband’s ability to work long hours over the parties’ twenty-five-year marriage to improve the business was facilitated by the wife’s commitment to manage the household and raise the parties’ three children. In its ruling, the Court of Appeals explicitly disclaimed the idea that labor means paid work: “That Plaintiff’s contribution to the asset came in the form of household and family services is irrelevant.”
However, Hanaway is just one example of this type of conversion. Domestic relations courts are courts of equity, so there are very few bright-line rules. Cases tend to rise or fall on the specific facts developed in discovery. Relevant facts may include the length of the marriage, whether the parties have children, the division of labor between the parties, the source of the ownership interest, and any increase or decrease in the business’s value during the marriage itself.
What does this mean for me?
At Foster Swift, our family law attorneys regularly assist clients through divorce proceedings where the disposition of a closely held business is at issue. Some of these businesses are family-owned and operated and have been passed down through the generations. Other times, one or both spouses may have started a business during the marriage and now must determine how to apportion it during settlement, or argue how a court should divide the business at trial should settlement negotiations fail. No matter the specific factual situation, the business itself, and any income derived therefrom, will be the subject of negotiation and potential litigation during a divorce proceeding. For that reason alone, anyone getting divorced where one or both spouses have an ownership interest in a closely held business must retain a knowledgeable and experienced attorney to assist throughout the divorce proceeding.
[1] For purposes of this article, we will assume that the client does not have a prenuptial agreement that may impact disposition.
[2] Courts may also invade separate assets when the marital estate itself is insufficient to care for the spouse who requires support, but that is a different topic for another time.
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