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Community Property • Businesses
CPROP#024
Legal Definition
The Pereira formula quantifies separate property as the value of the separate property capital as of the date of marriage, plus the value as of the date of the marriage, times the rate of return over the life of the marriage. The excess of the value of the property at divorce over the separate property is the community property. Family expenses paid by business earnings are NOT subtracted.
Plain English Explanation
It's easier to understand the Pereira formula in contrast to its alternative formula, Van Camp, so I will borrow the simplified explanation used in CPROP#028
This rule handles the tricky situation of how to divide a business when it was started by one spouse before the marriage, but then became much more successful during the marriage. Should all that growth in value be considered the separate property of the original business owner spouse? Or should some portion of it be considered marital property since the business boomed while the couple was married? The law tries to strike a fair balance and has developed 2 approaches depending on the circumstances.
The first method is the Van Camp test. Imagine if Amy started a tech company, HypoCorp, before meeting Bob. She spent years and her own money developing the business into a large, profitable empire that licensed Amy's technology to customers around the world. As her company began to gain traction, she met and fell in love with Bob. They get married. HypoCorp continues to gain in popularity and becomes even more profitable. Amy still runs the company, but its pretty much on autopilot due to the hard work she had previously put in to build it. Now she mostly just overlooks the daily operations, which could be handled by pretty much any competent business person. 10 years after they were married, Amy and Bob decide to get divorced.
HypoCorp was valued at $1 million when they got married. Now, when they get divorced, HypoCorp is worth $50 million. How much of that increased value should be considered Amy's separate property and how much should be considered community property to be split with Bob?
Under Van Camp, the law basically says, "Look, yes the company gained a lot of value while Amy and Bob were a community... but the community didn't really do much to cause that increased value. Most of the work was done when Amy was single. Amy's separate blood, sweat, and tears went into creating an asset that was so uniquely successful and capable of increasing its value over the years that it isn't necessarily fair to give too much of its increased value to the community." So to divide it up, we first calculate the community property value of the business using the following formula: (1) Determine what a fair salary should have been for Amy's community labor (because the community deserves to receive that value); (2) Multiply that salary by the number of years Amy and Bob were married (because this is the total amount of salary the community should receive value for); (3) Subtract any salary that the community actually received during this period of marriage (because if Amy was already taking a salary, that money was already flowing into the community, so it isn't fair to try to double-charge the business for it now); and (4) Subtract any amounts that the business paid towards family or community expenses (because, again, the goal here is to see what the business owes the community, so we need to take account of anything the business has already done to pay the community).
If we apply this formula to Amy and Bob, it would look something like this: (1) A fair salary for a CEO of a successful tech firm is $150,000 (in reality, we'd use market reports to be more accurate); (2) Amy and Bob were married for 10 years, so now we arrive at $1.5 million ($150,000 10); (3) While Amy and Bob were married, she chose not to draw a salary for the first 4 years as the business was building up. So the community received 6 years of a $150k salary ($900,000), which we deduct from the $1.5 million, arriving at $600,000; (4) When Amy and Bob first got married, they relied heavily on the use of a company car valued at $30,000 for their day to day travel needs. The community benefited from this value, so we deduct it from the $600,000 and arrive at $570,000.
We have now calculated the community property portion of HypoCorp's value: $570,000. Next, we need to calculate the separate property value.
To calculate the separate property value, we take the value of the company upon divorce, $50,000,000, and subtract the community property value, $570,000. This equals $49,430,000. In other words, under Van Camp, upon divorce, the community would have a right to $570,000, and Bob would receive 50% of that value. You may be thinking, "Woah, that doesn't seem like much money. Why should Bob only receive such a small amount when the company is worth so much?" As discussed above, the reason is simply that the law acknowledges that HypoCorp's momentum and trajectory was arguably established before marriage, and the community played such a small role in its success that it doesn't deserve a large piece of its increase in value.
Let's contrast Van Camp with the second approach that courts use: the Pereira test.
For this test, I think it's best to use myself as an example. Hi. I'm Shaun Sanders. I'm the law professor, founder, and creator of Law School Boost that writes all of this content you're (hopefully) enjoying. I first developed Law School Boost in 2015 when I was studying for the bar and felt like other study programs didn't work for me. As I write this, it is 2024. I met my now-wife in law school. We started dating after we had graduated and got married in 2018. Since I first started working on Law School Boost, I have created all the content. Every rule statement, simplified explanation, and hypo you read in this program was written by me personally. Every illustration and visual. Every corny joke. I have spent uncountable hours and sleepless nights creating what I feel is the most impactful legal supplements available on the market. I hope one day that Law School Boost becomes more successful than a passion project. However, when that day comes, I will have no right to claim the success as my own. Despite my personal investments and efforts into this venture, I would be nowhere without my wife.
Aside from the love, support, and encouragement that my wife provides me every day to keep focusing on my passion to develop more content for Law School Boost, she has become an invaluable resource and supportive community partner that has given me the ability to pursue something like this. Law School Boost requires me to take time away from my family and the community, and yet my wife supports that decision and helps to keep the family going when I need to work late (as I write this, for example, my wife is putting our son to bed). Even practically speaking, my wife's income into the community helps to pay for our shelter, food, and caffeine to keep me powered while I try to think up more hypos. And don't even get me started about how great it is to have healthcare insurance thanks to my wife's job.
This is why the Pereira test exists. If, in a few years, Law School Boost is worth millions of dollars, Van Camp would be an unfair way to compensate the community for the amount of value it contributed towards Law School Boost's success. Where a company under Van Camp was on a path to success and destined for increased value regardless of the actions of the community, a company under Pereira is only successful as a result of the sacrifices that the community endured to foster its growth. Let's jump into an example:
Imagine if Amy started a tech company, HypoCorp, but never really had the time or resources to grow it. Amy meets Bob and they get married. At the point in time when Amy and Bob got married, HypoCorp was worth $1 million. While married, Amy finally finds the time to grow the company. She develops a new, novel, proprietary technology that she is able to license and sell to generate income. 10 years after they were married, Amy and Bob decide to get divorced. HypoCorp is now worth $50 million. Under Pereira, how do we figure out what part of the value is Amy's and which belongs to the community?
First, we calculate the separate property value using the following formula: (1) Multiply the value at the time of marriage by a reasonable rate of return (generally, we use 10%); (2) Next, multiply that result by the number of years that the spouses were married; lastly (3) take the result and add it to the value at the time of marriage. Next, to calculate the community property we simply take the value of the company at the time of divorce and subtract the previously calculated sperate property.
Let's apply it to Amy and Bob:
(1) First, we start with the value of HypoCorp when Amy and Bob got married, which was $1 million, and multiply that by 10% to get $100,000; (2) They were married for 10 years, so we multiply $100,000 by 10 to get $1,000,000; (3) We add that result ($1,000,000) to the original value of the business at marriage ($1,000,000) and calculate the final value of Amy's separate property: $2 million.
This means that, in the divorce, Amy's separate value of HypoCorp would be $2 million. The community property value would then be the value at the time of the divorce ($50 million) minus Amy's separate property value ($2 million) leaving $48 million in community property value.
This rule handles the tricky situation of how to divide a business when it was started by one spouse before the marriage, but then became much more successful during the marriage. Should all that growth in value be considered the separate property of the original business owner spouse? Or should some portion of it be considered marital property since the business boomed while the couple was married? The law tries to strike a fair balance and has developed 2 approaches depending on the circumstances.
The first method is the Van Camp test. Imagine if Amy started a tech company, HypoCorp, before meeting Bob. She spent years and her own money developing the business into a large, profitable empire that licensed Amy's technology to customers around the world. As her company began to gain traction, she met and fell in love with Bob. They get married. HypoCorp continues to gain in popularity and becomes even more profitable. Amy still runs the company, but its pretty much on autopilot due to the hard work she had previously put in to build it. Now she mostly just overlooks the daily operations, which could be handled by pretty much any competent business person. 10 years after they were married, Amy and Bob decide to get divorced.
HypoCorp was valued at $1 million when they got married. Now, when they get divorced, HypoCorp is worth $50 million. How much of that increased value should be considered Amy's separate property and how much should be considered community property to be split with Bob?
Under Van Camp, the law basically says, "Look, yes the company gained a lot of value while Amy and Bob were a community... but the community didn't really do much to cause that increased value. Most of the work was done when Amy was single. Amy's separate blood, sweat, and tears went into creating an asset that was so uniquely successful and capable of increasing its value over the years that it isn't necessarily fair to give too much of its increased value to the community." So to divide it up, we first calculate the community property value of the business using the following formula: (1) Determine what a fair salary should have been for Amy's community labor (because the community deserves to receive that value); (2) Multiply that salary by the number of years Amy and Bob were married (because this is the total amount of salary the community should receive value for); (3) Subtract any salary that the community actually received during this period of marriage (because if Amy was already taking a salary, that money was already flowing into the community, so it isn't fair to try to double-charge the business for it now); and (4) Subtract any amounts that the business paid towards family or community expenses (because, again, the goal here is to see what the business owes the community, so we need to take account of anything the business has already done to pay the community).
If we apply this formula to Amy and Bob, it would look something like this: (1) A fair salary for a CEO of a successful tech firm is $150,000 (in reality, we'd use market reports to be more accurate); (2) Amy and Bob were married for 10 years, so now we arrive at $1.5 million ($150,000 10); (3) While Amy and Bob were married, she chose not to draw a salary for the first 4 years as the business was building up. So the community received 6 years of a $150k salary ($900,000), which we deduct from the $1.5 million, arriving at $600,000; (4) When Amy and Bob first got married, they relied heavily on the use of a company car valued at $30,000 for their day to day travel needs. The community benefited from this value, so we deduct it from the $600,000 and arrive at $570,000.
We have now calculated the community property portion of HypoCorp's value: $570,000. Next, we need to calculate the separate property value.
To calculate the separate property value, we take the value of the company upon divorce, $50,000,000, and subtract the community property value, $570,000. This equals $49,430,000. In other words, under Van Camp, upon divorce, the community would have a right to $570,000, and Bob would receive 50% of that value. You may be thinking, "Woah, that doesn't seem like much money. Why should Bob only receive such a small amount when the company is worth so much?" As discussed above, the reason is simply that the law acknowledges that HypoCorp's momentum and trajectory was arguably established before marriage, and the community played such a small role in its success that it doesn't deserve a large piece of its increase in value.
Let's contrast Van Camp with the second approach that courts use: the Pereira test.
For this test, I think it's best to use myself as an example. Hi. I'm Shaun Sanders. I'm the law professor, founder, and creator of Law School Boost that writes all of this content you're (hopefully) enjoying. I first developed Law School Boost in 2015 when I was studying for the bar and felt like other study programs didn't work for me. As I write this, it is 2024. I met my now-wife in law school. We started dating after we had graduated and got married in 2018. Since I first started working on Law School Boost, I have created all the content. Every rule statement, simplified explanation, and hypo you read in this program was written by me personally. Every illustration and visual. Every corny joke. I have spent uncountable hours and sleepless nights creating what I feel is the most impactful legal supplements available on the market. I hope one day that Law School Boost becomes more successful than a passion project. However, when that day comes, I will have no right to claim the success as my own. Despite my personal investments and efforts into this venture, I would be nowhere without my wife.
Aside from the love, support, and encouragement that my wife provides me every day to keep focusing on my passion to develop more content for Law School Boost, she has become an invaluable resource and supportive community partner that has given me the ability to pursue something like this. Law School Boost requires me to take time away from my family and the community, and yet my wife supports that decision and helps to keep the family going when I need to work late (as I write this, for example, my wife is putting our son to bed). Even practically speaking, my wife's income into the community helps to pay for our shelter, food, and caffeine to keep me powered while I try to think up more hypos. And don't even get me started about how great it is to have healthcare insurance thanks to my wife's job.
This is why the Pereira test exists. If, in a few years, Law School Boost is worth millions of dollars, Van Camp would be an unfair way to compensate the community for the amount of value it contributed towards Law School Boost's success. Where a company under Van Camp was on a path to success and destined for increased value regardless of the actions of the community, a company under Pereira is only successful as a result of the sacrifices that the community endured to foster its growth. Let's jump into an example:
Imagine if Amy started a tech company, HypoCorp, but never really had the time or resources to grow it. Amy meets Bob and they get married. At the point in time when Amy and Bob got married, HypoCorp was worth $1 million. While married, Amy finally finds the time to grow the company. She develops a new, novel, proprietary technology that she is able to license and sell to generate income. 10 years after they were married, Amy and Bob decide to get divorced. HypoCorp is now worth $50 million. Under Pereira, how do we figure out what part of the value is Amy's and which belongs to the community?
First, we calculate the separate property value using the following formula: (1) Multiply the value at the time of marriage by a reasonable rate of return (generally, we use 10%); (2) Next, multiply that result by the number of years that the spouses were married; lastly (3) take the result and add it to the value at the time of marriage. Next, to calculate the community property we simply take the value of the company at the time of divorce and subtract the previously calculated sperate property.
Let's apply it to Amy and Bob:
(1) First, we start with the value of HypoCorp when Amy and Bob got married, which was $1 million, and multiply that by 10% to get $100,000; (2) They were married for 10 years, so we multiply $100,000 by 10 to get $1,000,000; (3) We add that result ($1,000,000) to the original value of the business at marriage ($1,000,000) and calculate the final value of Amy's separate property: $2 million.
This means that, in the divorce, Amy's separate value of HypoCorp would be $2 million. The community property value would then be the value at the time of the divorce ($50 million) minus Amy's separate property value ($2 million) leaving $48 million in community property value.
Hypothetical
Hypo 1: Bob owned a bakery worth $100,000 before marrying Amy. Over their 10-year marriage, the bakery's value increased to $300,000. Using the Pereira formula, it's decided that the bakery's value would have naturally grown to $150,000 over those 10 years due to Bob's management. Result: The remaining $150,000 increase in the bakery's value is considered community property, split between Bob and Amy.
Hypo 2: Before his marriage to Amy, Bob purchased an apartment complex for $500,000. After 15 years of marriage, the complex is valued at $800,000. The Pereira formula determines that a fair rate of return over those years would have brought the value to $650,000. Result: The $150,000 excess value of the complex is seen as community property, to be divided between Bob and Amy.
Hypo 2: Before his marriage to Amy, Bob purchased an apartment complex for $500,000. After 15 years of marriage, the complex is valued at $800,000. The Pereira formula determines that a fair rate of return over those years would have brought the value to $650,000. Result: The $150,000 excess value of the complex is seen as community property, to be divided between Bob and Amy.
Visual Aids
