Moriarty & Dee, Attorneys at Law, in Buffalo, New York.

Marital Property:

Examining the Impact of Divorce on Business
(Written by senior partner Robert B. Moriarty, Esq. and originally published by Business First)

Equitable Distribution Law Sees Marriage as Economic Partnership

It is now more than thirty years since the advent of the divorce boom, and the impact of divorce on the family and society is well known and well documented. Only in the last two decades, however, have the laws governing the distribution of property upon marital dissolution begun to catch up with the laws governing the breakup of the marriage itself.

Background

In 1965 few states made any attempt to distribute property equally, or at least equitably, between husband and wife. Most states adhered to a titlehold approach, which blocked the award of assets accumulated during the marriage, including the family home, to the spouse not in title, no matter how harsh the result. Today, all states have passed some form of legislation empowering the courts to distribute property upon divorce regardless of how title is held in order to do justice and equity between husband and wife.

In 1980 New York State enacted sweeping changes to its divorce code by bringing New York into line with most other states in the distribution of marital property. The result, commonly known as the Equitable Distribution Law, takes as its premise the concept that marriage is an economic partnership between husband and wife. Upon dissolution of the partnership, the law mandates the equitable distribution of the assets, regardless of how title is held.

Four Steps

Basically, the process of equitable distribution involves four steps: identification, classification, evaluation and--when all property, its nature and its worth is known--distribution in a fair and reasonable manner.

A fifth factor, tax consequences, will play a role in some cases. Although the 1984 Tax Return Act has greatly simplified the tax treatment of marital property transfers, property distribution still requires competent tax analysis, and complex property distribution can present many pitfalls for the inexperienced attorney or client.

One word of caution at this point. Although nearly twenty years old, the Equitable Distribution Law remains in flux, with many important issues still unresolved by our trial and appellate courts. Furthermore, the Legislature, in response to pressures from lobbyists and the real and perceived deficiences in present law, can be expected to amend the existing law in perhaps significant ways in the future. A key issue will be whether the law should provide for equal, rather than equitable, distribution.

Before discussing equitable distribution it will be helpful to understand the nature and workings of the procedural process used to obtain the information necessary to make equitable distribution work.

Gathering Information

In order to fairly distribute property, courts and litigants must have financial information sufficient to identify classify and evaluate it, and to give proper consideration to the tax consequences. Ordinarily the client is able to supply some or even all of the information necessary, particularly when the client runs a family business or controls the family assets and income. In other situations it is necessary to obtain needed information from the opposing party. The process of obtaining this information from the opposing party is known as ìdisclosureî. It is the single most important part of the litigation process.

The tools of the disclosure process are known as "discovery proceedings". Discovery proceedings, backed by court order where necessary, compel those in control of business books, records and documents to produce them for inspection, copying and examination.

Discovery normally begins with the service of a notice by one side to the other to produce certain documents, usually as part of an oral deposition of the parties.

The deposition is known as examination before trial (EBT). In this part of the state, the deposition is held at the office of the attorneys for one of the parties. The parties, attorneys and a court stenographer are present . The examination is conducted under oath, and usually continues until the examination of both parties has been completed. In cases of some complexity, or if the requested records have not been produced, additional sessions of the EBT may be scheduled until all documents are produced and all questions are answered.

Other forms of disclosure such as Interrogatories (written questions requiring written answers) or the Notice to Produce (requiring the production of documents for review and consideration prior to the examination before trial), may be used in certain circumstances.

The documents required of a typical closely held family corporation will include but not be limited to the corporate income tax returns, corporate minutes, stock transfer, ledger, stock certificate, profit and loss statements, balance sheets, monthly, weekly, and daily statements and compilations records of sales of assets, canceled checks, check registers and even the most routine records. All of these and more may be necessary to a full understanding of the nature, ownership and worth of the business.

Similarly, all personal financial records are subject to discovery and copies of items such as federal and state income tax returns, W-2 statements, weekly pay stubs, records of expenses, bonuses, commissions and dividends, records of pension, retirement, profit-sharing, annuity, medical and dental insurance and other fringe benefits of employment, personal checking account registers, canceled checks, savings account statements, brokerage summaries, life insurance policies, charge account statements and real property records will, in the ordinary case, be required. Close attention will be paid during the process of discovery to the manner and extent to which corporate assets and income have been used for non-business purposes.

It is important to note that the courts generally favor disclosure and encourage it to facilitate the settlement process. Attempts to block disclosure are frowned upon and penalized when necessary.

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Learning About Corporate Assets

In one recent precendent-setting example of the judicial attitude toward full disclosure, a New York appellate court broadened substantially the rules relating to disclosure of minority corporations. In this case, the husband owned a 40% interest in two closely held corporations and a 12% interest in a third closely held family corporation. The husbandís father was sole owner of a fourth corporation. The husband sought to block the production of books and records of the corporations, claiming that he lacked control of three of the corporations and had no interest whatsoever in the fourth.

With respect to the three corporations in which the husband held some owner interest, the appellate court ruled that "the requirements of a meaningful evaluation mandate a fairly extensive evaluation of the financial affairs of the corporation and that a spouseís status as a majority or minority shareholder is irrelevant to that process."

In making its decision, the court summarized the position of a trial court faced with the responsibility of dividing marital property and the need for full disclosure to assist the court in reaching its determination.

To fulfill its mandate to equitably distribute the marital assets and to be able to properly set forth both the factors considered and the reasons for its decision, the court must be provided with the relevant financial information necessary to fix the value of those assets. Broad pretrial disclosure which enables both spouses to obtain necessary information regarding the value and nature of the marital assets is crucial if the trial court is to properly distribute the marital assets.

A key concern of the appellate court was the wifeís ability to gain information about the economic history of the corporations both prior to and during the marriage in order to enable her to value the shares held by the husband and the extent of their appreciation during the marriage, if any. The question of each spouse's rights to claim or share in appreciation will be discussed later in this series.

With respect to the fourth corporation in which the husband had no ownership interest, the court ruled that an extensive audit of its affairs was not warranted. The court did, however, allow limited examination to determine what financial relationship, if any, the husband had with this corporation.

Identifying Assets

The first step in the disclosure process is the identification of assets. Assets may change in nature before and during litigation for many reasons--some legitimate and ordinary, some not. If the assets of a marriage ("marital property") have changed, it is important to determine why, particularly where the assets have diminished substantially in value or ceased to exist altogether, or where property transfers have occurred which do not appear to be in the ordinary course of business.

Ordinarily, the identification of assets is the simplest part of the task and consists merely of compiling a list of all items of property owned by the parties. Property may be real or personal, and will range from the family home to the husbandís stamp collection and the wife's collection of Hummel figurines. Some items not commonly regarding as property will be listed. Notable examples are the parties' pension interests and rights of inheritance, if any, or the value of a degree or license leading to an enhanced earning capacity.

Both marital and separate property will be identified, particularly in situations where separate property has been commingled with, or it may be claimed has been changed to, marital property.
When records have been lost or destroyed over the passage of time, the tracing of assets to their original source can present severe problems of proof. The importance of good record keeping can become painfully clear.

HOW PROPERTY IS CLASSIFIED IN DIVORCE CASES

Rules for Listing as "Marital" or "Separate" Before Evaluation

Once all property has been identified, the task becomes to classify it as either 1) marital property, to be divided by negotiations between the parties or by the court or 2) separate property, free of claim by the other spouse.

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The rules for classification are relatively straightforward.

Defining Marital and Separate Property

Marital property is "all property acquired by either or both spouses during the marriage or before the execution of a separation agreement or the commencement of a matrimonial action, regardless of the form in which title is held."

Separate property is "1) property acquired before marriage or property acquired by bequest, devise or descent, or gift from a party other than the spouse; 2) compensation for personal injuries; 3) property acquired in exchange for or the increase in value of separate property, except to the extent that such appreciation is due in part to the contribution or efforts of the other spouse; and 4) property described as separate property by written agreement of the parties."

Changes in the Nature of Property

The line dividing marital and separate property is sometimes blurred. Growth or change in the nature or value of property, for example, may affect its essential character as marital or separate.

By way of illustration, suppose 1) the husband purchased an apartment complex prior to the marriage and continues to own it in his name only, 2) rental income from the apartment meets operating expenses and even provides a small cash flow (negating the possibility of an argument by the wife that the income of the parties during the marriage in some way pays for the property), and 3) the property has appreciated from the $150,000 paid for it in 1985 (three years before the marriage) to $350,000 in fair market value today.

Clearly, the property is separate property--it was acquired before the marriage and remains in the husband's name only. The fact the building pays for itself strengthens the argument for separate property. Assuming the property was worth more today than when it was bought, no one could credibly claim that the wife has a stake in the property.

In our example, however, the property has increased substantially in value and now is worth $350,000. The critical question becomes the nature of the appreciation in fair market value of $200,000 since its purchase in 1985.

Is the appreciation separate property? Recalling that the parties were married in 1988, is the appreciation from 1985 to 1988 separate property and the appreciation from 1988 to the present marital property? Do the reasons for the appreciation affect the nature of the property? Does it make a difference whether the appreciation is ordinary market appreciation representing a normal increase in the fair market value of similar real estate or whether it is due to the hands-on management and financial skills of the wife, who is actively involved in the business? Certainly it does. As noted above, the language of the statute specifies that separate property includes the increase in value of separate property, except to the extent that such appreciation is due in part to the contributions or efforts of the other spouse.

In our example, therefore, the husband would be credited with the first $150,000 of the present market value and the appreciation in value, between 1985 and 1988, as separate property. Only the appreciation since 1988 would be subject to claim, and then only to the extent the wife is able to demonstrate the appreciation is due to her contributions or efforts.

In one case which grappled with the knotty problem of distinguishing marital from separate property, the court was faced with a task of determining the wifeís interest in the husband's furniture business after 32 years of marriage. It was not in dispute that the business existed prior to the marriage, "albeit on a much smaller scale." The husband argued that the company's present worth represented merely the appreciation and value of the business since the marriage.

The court ruled that "the increase in the value of the separate property" does not apply to the growth and development of a business that was the primary economic foundation of a lengthy marriage. The court made a distinction between "active" and "passive" appreciation, refusing to equate the financial rewards of active efforts made by the husband during the marriage, which resulted in the substantial increase in the business value, with the passive appreciation of separate property in the form of bank accounts, works of art, or investment portfolios.

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