I often represent business owners and entrepreneurs in divorce, and I am frequently asked about how business ownership interests are treated in a divorce. There is often confusion or misunderstanding about this issue. First, it depends upon what type of business is involved and the ownership interest. It also depends upon when the business or ownership interest was acquired – before or after marriage.
When Was the Business Started?
Any property and assets owned at the time of divorce (including businesses and business interests) are presumed to be community property. Simply because a business or business interest is owned prior to marriage does not mean it is presumed to be separate property. A claim that property and interests owned prior to marriage are separate property (and therefore not subject to division in the divorce) must be affirmatively asserted, and that property/interest must be carved out of the community estate.
The process of carving separate property from the community estate is called “tracing.” Tracing is performed by experts familiar with the formulae and methods accepted by courts to trace separate property through the marriage/community estate and arrive at values and figures for the separate property.
Tracing is required because business interests can have both community and separate property aspects. For example, if an entity is owned prior to marriage, and after marriage community funds are invested into the business, then the community estate would have some interest in the business. The community estate may also have a reimbursement claim against the entity or the separate estate to recoup the community funds. Additionally, gains or losses in value that occur during marriage may also be community property rather than separate property.
Another common misconception is that simply being married to someone that owns a corporate entity, or has an ownership interest in a corporate entity, does not make the spouse a de facto owner of that entity. Ownership and control over corporate entities are governed by corporate governance documents and stock/ownership certificates. This is also a benefit of incorporation over a sole proprietorship. If the business is a sole proprietorship, then the non-owning spouse may have more rights as to the business.
At its essence, what is community property when it comes to corporate entities and ownership is the value of the corporate ownership interest. The value of a corporate ownership interest is arrived at by experts. The ownership interest in the entity has to be valued by a business valuation expert, and a tracing expert has to derive the values of separate and community property aspects of the ownership interest.
It is important to ensure that any corporate ownership issues are handled properly. These are very complicated issues, and guidance of good counsel is essential in ensuring corporate interests are properly handled in a divorce.