Ymelda T. Patrick v. Alacer Corporation, et al. (2011) 2011 WL 5561647
Decided by the Fourth District on November 16, 2011, ordered published on December 14, 2011.
Holding: Sufficient evidence justified the trial court’s holding that a community property interest existed in the increased value of Defendant corporation (Alacer) and its value and apportionment of that interest. It also correctly held that Ymelda Patrick was not entitled to an award of stock in the corporation, as she had no community interest in the stock but only in the increase in value of the shares owned by her deceased husband. For this reason, the trial court properly entered judgment on the pleadings.
Summary of the facts: James Patrick founded Alacer in 1972 to manufacture and market vitamin supplements. He owned all of the stock. He met Ymelda in 1975 and they married in 1988. During their marriage, they created the vitamin supplement formulas, served as Alacer’s officers and supported it financially with community property funds. The corporation increased greatly in value during their marriage. In 2000, James transferred all of the stock to his revocable trust, which became Alacer’s sole shareholder. As amended in 2001, the trust’s “Distribution upon Death” provisions stated as follows:
“(1) Because of the pending dissolution of marriage from my wife, Ymelda, her claims of a community property interest in my Alacer stock, and my desire that she not obtain or have control of a majority of the shareholder interest of Alacer, because of her inability to properly run the business, I direct that upon my death, if I am still married to Ymelda and she has at the time of my death a community property interest in the stock of Alacer, that the trustees distribute not more than 46% of the shares now held in my name to Ymelda, as her community share of my entire estate and that the balance of any community property interest that she may have in the Alacer stock or the community property owned by us be distributed to her from my estate as probated by the court and that it not be Alacer stock. It is my intention that of my entire estate she receive nothing of my separate property and only receive her community share of our community property, if any. [¶] (2) I direct the trustees to distribute 25% of my Alacer stock to my son, Ronald J. Patrick. [¶] (3) I direct the trustees to distribute 4% of my Alacer stock to my daughter, Alice, and (4) I direct the trustees to hold the remainder of my Alacer stock to be distributed, 21 years after the death of my youngest living grandchild, equally to my then living lineal issue.”
While James was “deathly ill,” the Trust’s trustees met to devise a way to place themselves on Alacer’s Board, and sought Ymelda’s support. They represented to her that they would be interim directors only until they retained new management, and would accept limited compensation for their work. In reliance on these representations, Ymelda voted to elect them to the Board. They immediately elected themselves as corporate officers. When James died three weeks later, the trustees did not distribute any Alacer shares to Ymelda; instead, they met and ousted her from the next Board meeting, voted to remove all of Alacer’s officers, including Ymelda, and re-appointed themselves as corporate officers. They terminated Ymelda’s salary and health insurance, seized her furniture and personall possessions from her office, cancelled her corporate credit cards, confiscated her company car and tried to remove her from the Board.
In response, Ymelda filed a shareholder derivative action and direct action against Alacer and the trustees for breach of fiduciary duties, constructive trust, unfair business practices and various forms of relief. She alleged that “once the Director defendants assumed control of Alacer, they began looting it. They stole money from it, took bloated salaries, sold corporate assets below market value for personal gain, failed to record transactions properly or at all, added friends and family to the company payroll and forgave loans they owed to Alacer, rejected bona fide arms-length offers to buy Alacer in favor of pursuing secret sale discussions, and disclosed Alacer’s trade secrets” to an entity owned by one of the defendants. She alleged that she and James built Alacer together both before and during marriage and that she had a community interest in its stock.
This is the second published appellate decision in this case. In the first one, Patrick v. Alacer Corp. (2008) 167 Cal.App.4th 995, 84 Cal.Rptr.3d 642 (“Alacer I”), Alacer demurred to the complaint, claiming inter alia that Ymelda lacked standing to bring a shareholder derivative action because she was not a shareholder. The court granted the demurrer without leave to amend. On Ymelda’s appeal, the Fourth District reversed. It held that Ymelda was a beneficial shareholder in Alacer and thus had standing to bring the derivative causes of action. Here was its reasoning:
“Defendant wrongly contends plaintiff lacks beneficial ownership because no court has yet adjudicated her community property claim. It likens her interest in Alacer to an unexercised stock option or undistributed inheritance. Not so. ‘The respective interests of the husband and wife in community property during continuance of the marriage relation are present, existing, and equal interests.’ (Fam.Code, § 751, italics added; cf. D’Elia v. D’Elia (1997) 58 Cal.App.4th 415, 427, 68 Cal.Rptr.2d 324 (D’Elia) [spouses had equal interest in stock by ‘operation of California's community property laws’].) Plaintiff’s alleged community property interest was created during their marriage. She allegedly has a present and existing interest in Alacer stock already—she does not need to do anything to trigger her interest. And while a court may confirm her community property interest, it cannot create it. At any rate, plaintiff seeks such confirmation here in her declaratory relief cause of action.
…
The plain language of the Trust amendment shows a restriction on the trustees’ ability to transfer Alacer stock to plaintiff, not a donative transfer. The amendment notes plaintiff’s husband’s ‘pending dissolution of marriage from my wife, Ymelda,’ his ‘desire that [plaintiff] not obtain or have control of a majority of the shareholder interest of Alacer, because of her inability to properly run the business,’ and his ‘intention that of my entire estate [plaintiff] receive nothing of my separate property and only receive her community share of our community property, if any.” It directs the trustees to ‘distribute not more than 46% of the shares now held in my name to Ymelda, as her community share of my entire estate,’ but only if ‘at the time of my death [she has] a community property interest in the stock of Alacer.’ And it directs the trustees to satisfy any remaining community property interest plaintiff may have with assets ‘from my estate as probated by the court and that it not be Alacer stock.’ Plaintiff’s husband thereby limited the trustees to satisfying plaintiff’s community property interest with no more than 46 percent of the Alacer stock. He did not make a gift of his separate property to plaintiff. There was no donative transfer of property to plaintiff.
Thus, defendant confuses being a trust beneficiary with being a beneficial shareholder. Plaintiff is a beneficial shareholder of Alacer because she alleges a community property interest in the Alacer stock held by the Trust. Through her alleged community property interest, plaintiff is already entitled to some of the Alacer stock held in the trust’s name. (Fam.Code, § 751; D’Elia, supra, 58 Cal.App.4th at p. 427, 68 Cal.Rptr.2d 324.) Although the Trust contains no donative transfer of property to plaintiff, and in fact restricts the trustees’ ability to transfer Alacer stock to plaintiff to satisfy her community property interest, the Trust does not and cannot defeat her alleged beneficial ownership.” Alacer I, at 1012, 1013.
After this decision, the matter returned to the trial court. Ymelda filed a fifth amended complaint, asserting direct causes of action for impairment of community property, constructive trust, breach of fiduciary duty, and injunctive relief, as well as shareholder derivative causes of action for breach of fiduciary duty and injunctive relief. Plaintiff also reasserted a declaratory relief cause of action. She sought a declaration of her “community property and stock ownership interest in Alacer.” The court bifurcated this cause of action, staying discovery on the others.
First, it held that “’the declaratory relief cause of action essentially arises out of Family Code § 1101 [subdivision] (b),’ which authorizes it to “’”determine the rights of ownership in … community property, and the classification of all property of the parties to a marriage.’”’ Analyzing Family Code, section 1101, the court concluded: ‘by stating that, upon death, an action may be brought “without regard” to the three-year limitation, the language [of section 1101] indicates that no limitations period applies.’ Because no limitation period governed plaintiff’s claim, the only time restriction would be laches, which defendants failed to establish.’
Second, the trial court found that the Alacer stock was Jay’s separate property, because the evidence showed that he founded the company and issued all of the stock to himself before he married Ymelda.
“Third, some portion of Alacer’s increased value must be equitably apportioned to the community. Alacer indisputably increased in value during the marriage, and Jay ‘put much more than minimal efforts into the business.’ His efforts during the marriage were community efforts. Fourth, Alacer’s value would be apportioned using the method in Pereira v. Pereira (1909) 156 Cal. 1, 103 P. 488 (Pereira). …
Fifth, the fair return on Jay’s separate property investment in Alacer was about $530,000. The parties’ experts used slightly different methods to determine the Alacer’s value at the October 1988 date of marriage, but defendant’s expert agreed it would be appropriate to use the average of their values—just over $250,000. The experts agreed a fair rate of return would be 7.68 percent per annum through Jay’s death in February 2003. Applying that return to Alacer’s value at marriage resulted in a separate property interest of just over $530,000.
Sixth, Jay’s February 2003 date of death would be used to value the remaining community property interest in the Alacer stock. While community property is generally valued at the date of trial, Alacer was Jay’s separate property. The only community property here was ‘the skill, effort and talent of Jay Patrick that was expended during the marriage. Hence, the court must value that skill, effort and ability from the time the marriage began until Jay died. To state the obvious, when Jay passed away, he no longer contributed any community skill, effort, or talents to increase the value of Alacer.’
Seventh, Alacer’s value at Jay’s death was just under $7 million. The court adopted defendant’s expert’s use of the ‘capitalization of excess earning’ methodology, which the expert described ‘as the ‘primary’ or ‘most widely used’ valuation methodology….’ It rejected that expert’s attempt to average the result of that methodology with the significantly lower result of ‘capitalized cash flow method,’ as he ‘offered no explanation as to why an average would be appropriate in this case.’ And the court rejected [Ymelda’s] expert’s reliance on a 2006 bank valuation that led to results that ‘fluctuated wildly’ – $19 million (low end), $73 million (high end), $46 million (initial average), $30 million (‘corrected’ average). Besides, [Ymelda’s] expert has also used the ‘capitalization of excess earning’ methodology to value Alacer at the date of marriage. Adding ‘the value of Alacer business assets using the excess earnings method’ and ‘the value of non-income producing assets’ yielded a total value of just under $7 million. Deducting about $530,000 for Jay’s return on his separate property investment left a community interest of just under $6.5 million. [Ymelda’s] 50 percent share of the community was just over $3.2 million.
Eighth, [Ymelda] was entitled to prejudgment interest starting at Jay’s death. Her ‘community property interest existed as of the date of Jay’s death’ in February 2003, and she had ‘lost the use of her share of the community property’ ever since.
Finally, [Ymelda] was not entitled to receive Alacer shares to satisfy her community property interest. To be sure, Alacer held [Ymelda] had alleged ‘standing as a beneficial shareholder to bring her derivative causes of action.’ And ‘[i]t is clear that, if Alacer were a community property business, [Ymelda] would have a ‘present, existing, and equal’ community property interest as a stockholder in Alacer.’ But Alacer appropriately did not reach the merits to determine whether Alacer was a community property business. That was the trial court’s duty and, after the bench trial on the declaratory relief cause of action, the court found the Alacer stock was Jay’s separate property. ‘[Ymelda]‘s community interest prior to Jay’s death was in one half of the profits arising from the skill, efforts and industry he applied during the marriage to increase the value of his separate property business. His death does not transform Alacer into a community property business or transform [Ymelda]‘s right into one for stock ownership.’”
Given those holdings, the trial court granted judgment on the pleadings for defendants on the remaining causes of action, holding that they were all were based on Ymelda’s claimed community property interest in Alacer stock. Because it held that her interest was only in Alacer’s increased value, not the Alacer stock itself, she had no ability to maintain causes of action resting on shareholder status.
The result on appeal: Unsurprisingly, Ymelda appealed, but the Fourth District affirmed. First, it agreed with the trial court that her declaratory relief action was not time-barred, because Family Code §1101(d) provides that when a marriage ends through “litigation or death,” there is no limitations period except for laches. Here is what it said:
“Defendants contend section 1101, subdivision (d)(2)’s exception does not apply to claims arising pursuant to subdivision (b). They note subdivision (d)(1) sets forth a limitation only for claims arising pursuant to subdivision (a), and so the exception in subdivision (d)(2) must apply only to those claims. This reads out of subdivision (d)(2) the reference to actions ‘under this section.’ ‘This section’ is section 1101, both subdivisions (a) and (b). When the Legislature wanted to refer only to one subdivision of section 1101, it did so unambiguously—as it did in subdivision (d)(1), which set the three-year limitations period for ‘any action under subdivision (a).’
‘The absence of a limitations period for particular causes of action is not without precedent,’ as the court observed. If anything, it is entirely understandable for no limitations period to govern the determination of community property after a marriage ends. A spouse’s interest in community property during marriage is ‘present [and] existing.’ (§ 751.) When the marriage ends, the spouses hold any unadjudicated community property as tenants in common. (Berry v. Berry (1989) 216 Cal.App.3d 1155, 1159, 265 Cal.Rptr. 338.) And ‘[t]he statute of limitations never bars relief between tenants in common in an action of partition.’ (Adams v. Hopkins (1904) 144 Cal. 19, 27, 77 P. 712.) Thus, no limitations period applies to actions to partition and account for the community’s interest in vested retirement benefits. (Sangiolo v. Sangiolo (1978) 87 Cal.App.3d 511, 513, 151 Cal.Rptr. 27.) And no limitations period should apply here, where plaintiff seeks a determination of the community’s interest in Alacer or its increased value.”
The court also held that Ymelda need not file a creditor’s claim before pursuing her community property interest in Alacer. It said that
“(p)ending dissolution, plaintiff could not enforce her community property interest against Jay before his death. Moreover, a spouse has a ‘present existing interest’ in community property, ‘not a mere money claim.’ (Kenworthy v. Hadden (1978) 87 Cal.App.3d 696, 702, 151 Cal.Rptr. 169.) Thus, the community property interest in a spouse’s partnership interest may be pursued without first filing a creditor’s claim. (Id. at p. 703, 151 Cal.Rptr. 169.) Similarly here, no creditor’s claim was necessary for plaintiff to pursue her community property interest.”
Next, it held that the trial court properly valued and apportioned Ymelda’s community interest in “Alacer’s growth,” disagreeing with her contention that the community had an interest in the stock itself. It said that
“(n)o party is satisfied with the court’s apportionment. Defendants contend there was no community property interest in Alacer’s growth to apportion because Alacer already over compensated Jay for efforts during the marriage. They further contend the court failed to find Jay’s efforts were the primary source of Alacer’s growth, and plaintiff failed to show the precise percentage of any growth attributable to Jay’s efforts. Plaintiff contends the court should have valued Alacer at the time of trial, not the date of Jay’s death, when apportioning the community property interest. She also contends the court should have used her expert’s ‘capitalized cash flow’ valuation method instead of the ‘capitalization of excess earning’ method. None of these challenges withstands review.”
First, it held that because the court has discretion to select an apportionment method that will “effect substantial justice” and was not “constrained, as defendants insinuate, to using Van Camp by default unless the facts somehow compelled the use of Pereira.”
“Having done so, the court was called upon only to determine the value of Jay’s separate property interest in Alacer at the start of the marriage, and then ‘allocate a fair return to the separate property investment’ during the marriage. (Dekker, supra, 17 Cal.App.4th at p. 852, 21 Cal.Rptr.2d 642.) The court did so based on substantial evidence; defendants do not challenge on appeal the valuation of the separate property interest or the calculation of the return rate.
And having done this, the court properly then ‘allocate[d] the balance of the increased value to community property as arising from community efforts.’ (Dekker, supra, 17 Cal.App.4th at pp. 852–853, 21 Cal.Rptr.2d 642.) It was not required to find whether [Ymelda’s] community property interest was already satisfied by Jay’s Alacer compensation during the marriage. The court need not ‘limit the community interest to a salary as reward for a spouse’s efforts….’ (Id. at p. 853, 21 Cal.Rptr.2d 642.) ‘To limit the community to compensation received by way of salary during the marriage would ignore California’s egalitarian marriage model and the apportionment formula of Pereira ….’ (Id. at p. 854, 21 Cal.Rptr.2d 642.) ‘[Defendants'] point, that the community received market value compensation, does not affect our inquiry. Whether or not the community received salary, a court must determine to what extent the increased value of the separate property business is attributable to community effort.’ (Id. at p. 852, 21 Cal.Rptr.2d 642.) Nor was plaintiff obligated to show the precise percentage of growth attributable to Jay’s efforts. Under Pereira, the community property award itself is essentially an implied finding of that. (See Deckker, at p. 854, 21 Cal.Rptr.2d 642 [‘Implicit in the trial court's finding that [the husband] was responsible for the increase [in business value] is a finding the [separate property] capital investment would not have returned its 927 percent increase without his efforts’].)”
On the reasonable compensation issue, in footnote 8 the panel said that “(t)he parties offered conflicting evidence on the amount of Jay’s total Alacer compensation during the marriage. The court found ‘Jay was reasonably compensated during the marriage,’ but aptly noted ‘neither under-compensation nor over-compensation during marriage affects an apportionment analysis.’”
Next, the panel said that the trial court “properly fixed the increase in Alacer’s value at Jay’s death” under Probate Code §100(a), which provides that “(u)pon the death of a married person, one-half of the community property belongs to the surviving spouse and the other half belongs to the decedent.” It also said that contrary to Ymelda’s complaint that the property division was “profoundly unequal,” it was “exactly equal,” because “(t)he court awarded 50 percent of the community property interest to plaintiff, 50 percent to Jay. Plaintiff may be disappointed she did not share in Jay’s separate property interest in Alacer, but there is nothing unequal about that.”
Finally, the panel disagreed with Ymelda “that her community property interest in Alacer’s increased value must be satisfied with an award of Alacer stock.” It held that the stock was, and remained, James’s separate property, and that the only thing Ymelda had an interest in was its increase in value during marriage, which was not the same thing as the stock itself. It said that its holding in Alacer I that she adequately alleged shareholder status was not a determination that she, in fact, had an interest in the stock, because for purposes of that appeal, “we did not question plaintiff’s allegation she had a community property interest in Alacer, which ‘the Trust directs the trustees to satisfy … by transferring Alacer stock to plaintiff.’”
Second, it disagreed that the trust constituted an agreement between herself and James “that she would receive her community property interest in the form of Alacer stock.” It said that she “relies upon the trust, which (again) directs the trustees to transfer shares only to satisfy her alleged ‘community property interest in [Jay's] Alacer stock….’ But, she showed no community property interest in Alacer stock. She showed only a community property interest in the increased value of Alacer. The trust is silent on how the trustees should satisfy that.”
Next, Ymelda argued that “Alacer became community property because Jay commingled plaintiff’s community property interest with his separate property.” She argued that his “community efforts were ‘reinvested’ in Alacer against her will. How? On our best reading of plaintiff’s briefs, this occurred when Jay’s efforts were not apportioned to the community as he made them. But California law does not require apportionment of community efforts devoted to separate property on an ongoing basis, upon pain of transmuting that separate property into community property. Courts account for community efforts toward separate property through equitable apportionment after the marriage, not transmutation during the marriage.”
Finally, Ymelda argued that she was entitled to a pro tanto interest in the company under the Moore/Marsden rule, but the appellate panel was equally unpersuaded. It said that “using the Moore/Marsden approach here would conflict with the prevailing approach used when a separate property business is improved by the devotion of community efforts – equitable apportionment using Pereira or Van Camp. The court did not err by declining to extend the Moore/Marsden approach to this set of facts.”
As to defendants’ argument that the trial court erred in awarding prejudgment interest to Ymelda, the panel found no abuse of discretion. It first said that prejudgment interest is properly awarded under Civil Code §3288 and that Ymelda’s “loss of use of a community property interest she owned upon Jay’s death in 2003 (§751; Prob.Code, §100, subd. (a)) sufficiently supports the court’s exercise of its discretion to award prejudgment interest.” It also gave short shrift to defendants’ argument that she “does not really deserve prejudgment interest,” holding that “(t)he trial court was in the best position to consider these allegations, yet it found the prejudgment interest award ‘equitable and appropriate.’ The deferential standard of review does not allow us to second-guess the court on the ground of defendants’ frustration with plaintiff.”
In its final word to the parties, in its last footnote the court said that “(a)fter many years, the parties have made it painfully clear they do not like each other. Less apparent is why they think we care.” Ouch.
My comment: There is so much to talk about regarding this case that it is difficult to know where to begin. This may be the first case to discuss the limitations periods in Family Code §1101 in the context of the end of a marriage by death rather than a dissolution, but it essentially says that the statute says what we thought it said. It also reaffirmed that the trial court has the discretion to fashion an apportionment method that is appropriate to the case and effects substantial justice, and need not mechanically apply either a Pereira or a Van Camp method – although to my knowledge every case on the issue has applied either one or the other.
In its opinion, the Fourth District cites no apportionment case other than Dekker in its analysis. It follows the statement in Dekker to the effect that the operating spouse’s compensation during marriage – reasonable or otherwise – is immaterial to the issue of the community’s interest in the increase in value of the business during marriage. To me, this approach is a hybrid Pereira/Van Camp.
Under Pereira, where the principal ingredient in the marital appreciation was the operating spouse’s personal character, energy, ability, and capacity, the separate property is entitled to a “reasonable gain to the separate estate from the earnings properly allowable on account of the capital invested,” amounting “at least to the usual interest on a long investment well secured.” In Van Camp, the court held that H was paid an adequate salary during marriage for his community efforts; thus, the proper apportionment method was to allocate the salary received to the community and remainder of the business’s value to the separate property capital investment. Under “traditional” apportionment, the issue of the adequacy of the operating spouse’s compensation during marriage as a reflection of the value of his or her contribution to the enterprise determined the apportionment method to be used.
In this case, the trial court found that James “was reasonably compensated during the marriage.” Under Van Camp, that should have ended the analysis. However, after Dekker and Alacer II, the operating spouse’s compensation, even if more than that paid for the same efforts to other professionals running comparable businesses, does not dictate the apportionment method. Rather, the community will – or at least can – have an interest in the business even if the operating spouse was overcompensated for those efforts. It is as if Van Camp has been absorbed into the Pereira method. Perhaps this is the reason why there have been no Van Camp cases since Somps v. Somps (1967) 250 Cal.App.2d 328, 58 Cal.Rptr. 304. If that is true, then there is no reason to present a compensation analysis at trial, we can essentially consider Van Camp dead, and stop using “Pereira” to describe equitable apportionment of business interests.
More interesting – and perhaps “revolutionary” in family law cases – is the Fourth District’s affirmance of the trial court’s conclusion that the community does not accrue any interest in the operating spouse’s separate property business as a result of his marital efforts. Rather, it accrues ONLY an interest in the marital increase in value of that business (presumably as a money judgment), only accounted for through equitable apportionment after the marriage. Such a holding has wide ranging implications, not only on the issues in this case, but for every marriage in which one spouse operates a separate property business.
In the case itself, that holding dictated the result of the other issues. Obviously, if the trust “directs the trustees to transfer shares only to satisfy her alleged ‘community property interest in [Jay's] Alacer stock….’” and the court held she HAD no interest in the stock but “only a community property interest in the increased value of Alacer,” the trust provision did not apply. Also, if the community accrues no interest in an ongoing business during marriage (whether as a result of the operating spouse’s failure to withdraw reasonable compensation or based on an apportionment theory), then there is no Moore/Marsden-type contribution of any sort and Ymelda’s argument that there was necessarily failed.
Also, there is no issue of reverse apportionment. “Traditional” apportionment approaches held that once the court established the percentage of community interest under Pereira based on the community efforts, that percentage continued to participate in the business’s post-separation growth just like the separate property percentage did. Family Code §2550 requires the court, upon dissolution, to value and equally divide community assets; under that statute, community assets remain community property until division either by the court or pursuant to the parties’ agreement, regardless of their valuation date. Also, all interest, dividends, profits and other increases flowing from a community asset is community property, and this status continues after separation and until the court divides the asset at trial. “Under the community property doctrine, rents, issues and profits have the same character as the property source itself.” Marriage of Worth (1987) 195 Cal.App.3d 768, 241 Cal.Rptr. 135. Therefore, in order to accomplish an equal division of community property at trial, the court must compensate the community not only for its interest in the asset itself, but for all “rents, issues and profits” flowing from that asset up to the day of trial.
Marriage of Imperato (1975) 45 Cal.App.3d 432, 438-439, 119 Cal.Rptr. 590, specifically held that the court must credit the community with the investment value of its interest in a business after separation. If the community acquires an interest in a separate property business as a result of the spouse’s efforts but those efforts end at separation and the business is not valued until the time of trial, the community should be compensated for the contribution of that percentage interest to the date of trial. However, the Alacer II court’s holding completely does away with this argument.
The panel held that the trial court “properly fixed the increase in Alacer’s value at Jay’s death” under Probate Code §100(a), which provides that “(u)pon the death of a married person, one-half of the community property belongs to the surviving spouse and the other half belongs to the decedent.” That is obvious; however, it also held that the community has no interest in even the increase in the business value during marriage until after a court holds it has such an interest at trial. So, there is nothing to apportion after separation and before trial. This court “compensates” the community for this period by awarding Ymelda pre-judgment interest on her half of the amount it held that the community’s interest in the marital increase was worth. Whether that comes anything close to a percentage of the post-separation increase based on the community’s “percentage share” obviously depends on the facts.
The Alacer II court’s holding on the nature of the community’s equitable apportionment interest has other implications. For example, if the community accrues no interest in the business during marriage either as a result of the application of efforts or of retained community “earnings,” then the operating spouse has no fiduciary duty to the other spouse whatsoever in the management of that business. This brings up even more questions. For example, can the operating spouse draw out a significant amount of the business’s value just before separation and argue that there has been no net increase in that value between marriage and separation, or at least limit any community interest to the “increase” after the withdrawal of the value? If the community interest is solely in a net increase in value between the date of marriage and the date of separation, and the operating spouse has no fiduciary duties to the other spouse in its management, it would seem so.
However, in Marriage of Frick (1986) 181 Cal.App.3d 997, 226 Cal.Rptr. 766, for example, H owned and operated a hotel and restaurant business as of the date of the parties’ marriage. The trial court found, inter alia, that
“(a)lthough the business and real estate remained Jerome’s separate property, Jerome devoted his full labor to the business. Moreover, Jerome commingled community and separate funds so no separate property funds could be found to be the source of the payments on the real estate after marriage. The real estate increased in value due to inflation while the business increased in value in large part due to Jerome’s labor. As such, the court is applying a Pereira calculation to the business and a Marsden calculation to the real property.”
The Frick court said that “(d)uring the course of the marriage, Jerome took out of the business whatever income he needed to meet the expenses of the community, i.e., disbursements from the business covered the community living expenses. Community expenses were met with disbursements from the business. These disbursements in fact represented profits from the business which the community would have been entitled to under the Pereira formula had they not been withdrawn from the business.” This add-back is inconsistent with the court’s approach in Alacer II.
Also, during the dissolution the non-operating spouse would have no right to request a receiver or have any other remedy for any of the operating spouse’s actions, because there is no community interest until the trial court applies apportionment doctrine at trial and reduces that interest to a dollar amount.
This brings up the final problem I have with the case, which is its holding that the community has no interest in the stock itself, only in the increase in its value during marriage. Apparently, this means that the community interest based on equitable apportionment is an inchoate interest, not a property right. However, several equitable apportionment cases treat it much differently. Tassi v. Tassi (1958) 160 Cal.App.2d 680, 325 P.2d 872, for example, was a probate case involving characterization of assets owed by W and the decedent during their marriage. H had owned a meat packing business when the parties married. It prospered during their 11-year marriage, and after H’s death, W sued his brother for a one-half interest in various assets that W had left to him, claiming that they were gifts of community assets made without her consent. H had withdrawn more from the business than it earned. He had paid all community expenses from business profits and also purchased various assets, which were the subject of W’s claim.
The trial court found ‘(t)hat the source of the funds which set up the accounts and purchased the securities and bonds … was the earnings and profits of a wholesale meat business known as Associated Meat Company.’ It found that the decedent set up the trustee bank accounts with the intention of passing the money to the beneficiaries with a minimum of expense and delay in the event of his death. The court found further that the meat company was at all times decedent’s separate property and that the earnings and profits from the business ‘are allocable 27% to the community property of decedent and plaintiff and 73% to the separate property of decedent.’ It was also found that the transfers to defendant Edwin Tassi ‘were the community property of decedent and plaintiff to the extent of 27% thereof …’”
In other words, the trial court held that the company “was at all times decedent’s separate property” but that “the earnings and profits from the business” were allocable between the estates, determined a percentage interest for the community and retroactively imposed that percentage interest on funds withdrawn from the business during marriage and assets purchased with those funds. W’s main attack on appeal was on the sufficiency of the evidence to support the allocation of earnings from the business “in the ratio of 73 per cent separate property and 27 per cent community property.” In analyzing that claim, the court said that
“(i)t is the duty of the court to allocate earnings from a business which is the separate property of a husband and in which the husband is actively employed, finding as separate property the portion of the earnings properly attributable to the business, and as community property the portion of the earnings properly attributable to the husband’s efforts. The evidence showed that during the marriage decedent withdrew $447,805.75 from the business and paid living expenses of $44,093.16. No attempt was made by decedent to allocate these withdrawals between salary and business earnings.”
Obviously this is a much different approach than that used in Alacer II. Also, cases that apply the family expense presumption to profits withdrawn from a business during marriage, such as Beam v. Bank of America (1971) 6 Cal.3d 12, 98 Cal.Rptr. 137, must be holding that some of the business profits are community property as earned during marriage by the operating spouse. Essentially, Beam held that there was no community interest left in the “business” operated by H during marriage because he had withdrawn everything to which the community would have been entitled in salary during marriage. The high Court said that
“(a) long line of California decisions has established that ‘it is presumed that the expenses of the family are paid from community rather than separate funds (citations) (and) thus, in the absence of any evidence showing a different practice the community earnings are chargeable with these expenses. (Citations.)’ This ‘family expense presumption’ has been universally invoked by prior California decisions applying either the Pereira or Van Camp formula. Under these precedents, once a court ascertains the amount of community income, through either the Pereira or the Van Camp approach, it deducts the community’s living expenses from community income to determine the balance of the community property.
If the ‘family expense’ presumption is applied in the present case, clearly no part of the remaining estate can be considered to be community property.”
“Family living expenses are relevant to the issue of the community or separate nature of property acquired during marriage because of the presumption that such expenses are paid out of community rather than separate funds.” Estate of Murphy (1976) 15 Cal.3d 907, 918, 126 Cal.Rptr. 820. If family expenses are presumed to be paid first from community funds, and if the apportionable interest in a separate property business operated by one spouse during marriage can be exhausted as the marriage goes on by withdrawing that interest as salary and paying community expenses with it, then logically the community interest must exist during marriage as the operating spouse earns it, not – as Alacer II holds – only at trial after the end of the marriage when the court figures out how much of the increase in value during marriage resulted from the community efforts.
Business owners facing an equitable apportionment claim at dissolution will be delighted with Alacer II. However, in my opinion it conflicts with other cases on the issue and severely undercuts fiduciary obligations imposed on spouses during marriage.
It is a civil action and not a dissolution action. Although the court relied almost completely on Family Code sections and rules and dissolution cases to support its conclusions, it did not apply interspousal fiduciary duties in its analysis, nor did any of the Family Code post-separation fiduciary disclosure duties apply. This could be a basis upon which to distinguish it. Because it could be used to support the gutting of any community interest in a separate property business at dissolution, whether or not family courts will follow it remains to be seen.
Dawn Gray
www.dawngray.com
