Top Considerations for High Asset Divorce

In most California divorce cases, the California Family Code governs how the property is to be divided, and how spousal and child support is to be determined. Default California law may not apply across the board, however, especially if there was a valid premarital agreement that altered California law regarding division of property or support in some respects. In that case, the terms of the premarital or prenuptial agreement will determine how the property should be divided and how support will be addressed.

Premarital Agreement

Be warned that having signed a premarital agreement doesn’t guarantee smooth sailing, even as to division of the property. It must first be determined whether the enforceability of the prenuptial agreement will be challenged by either spouse. A premarital agreement may be deemed invalid or unenforceable for various reasons, such as lack of proper disclosure of financial information or failure to adhere to the waiting period requirements. In the event a valid and enforceable premarital agreement exists, division of property will likely be streamlined.

Default California Law

In the absence of a valid prenuptial agreement, default California law will ordinarily govern division of the assets in a high net worth estate, just as with any other estate. The same property division laws apply regardless of the size of the estate.  As a general matter, property in the marital estate in California is either separate property, community property, or property that is mixed in some way. 

Community property belongs to both spouses equally, and is usually acquired during the marriage. The value of community property assets is generally divided equally upon divorce. Separate property belongs to one of the spouses, and is usually acquired before marriage, after separation, or by inheritance or gift regardless of when acquired. Separate property assets are generally confirmed to the spouse that it belongs to.

Not all assets are neatly all community property or all separate property, however. Often assets will become mixed or commingled during marriage, so that they have components of both community and separate property. Since default California law generally requires that the community property component be valued and divided equally between the spouses, a large portion of the property analysis done in high net worth divorce cases often involves distinguishing between the community and separate property portions of assets.

Because California is a community property state, it operates under a “community property presumption” wherein the default presumption is that assets acquired during marriage are community property.

This also means that part of the equity in a house, business, or other asset that was brought into the marriage as one spouse’s separate property may be community property, if the amount of equity increased during the marriage. A determination must ordinarily be made of the value of the community property portion, so that it can be divided equally in the divorce. Let’s consider some specific examples of how mixed or commingled assets are addressed.

Real Property

A house or other real property that is brought into the marriage by one spouse is usually entirely the separate property of that spouse at the beginning of the marriage. However, that may change if the mortgage on the property is paid down during marriage with the earnings of either spouse. That’s because those earnings are community property, and so community property is being contributed to “acquisition” of the real property. Over time, the community property estate acquires an increasing proportion of the equity in the real property, and that equity grows with the growth in the value of the real property. In the divorce, the value of the community property portion of the equity in the real property is calculated, so that it can be divided. The formula used for the calculation is called the Moore/Marsden formula, named after cases in which it was developed.

The reverse situation also sometimes occurs. That is, a married couple will buy a home together during marriage, acquiring it as their community property. However, if one or both spouses contributed traceable separate property to the property, such as toward the down payment, the contributing party is entitled to be reimbursed that contribution in the divorce.

Both of the above scenarios can be complicated by a transmutation of the character of the asset. During marriage, a spouse may transmute the character of real property from separate to community. We often see this occur during a refinance that took place during the marriage. Both parties may also transmute a community property home to a separate property home of one spouse, although this is harder to accomplish.

As for the disposition of the real property, it is ordinarily taken by one spouse subject to a buyout of the other spouse’s interest, or it is listed for sale to a third party. For the family home, a rarely chosen option that is nevertheless available in some cases is a Duke or deferred sale of home agreement. This option provides for one spouse to remain in the home for a number of years before it is to be sold, which can be beneficial for divorcing couples with minor children.

Businesses

One spouse may bring a business into the marriage that increases in value during marriage. In this instance the litigants or the court will need to decide what the increased value should be attributed to. This is a factual determination that will vary case-by-case. If the increase in value is due at least in part by the efforts of a spouse, the community may have an interest in the separate property business, since the contribution of efforts of a spouse during marriage is community property.

In the divorce, the value of the community property portion of the business is ordinarily calculated, so it can be divided. There are various formulas that may be used for this calculation, the most common of which are the Pereira and Van Camp formulas, named after cases in which the formulas were developed. The Pereira formula is usually used when the reason for the increase in the business's value is attributable primarily to a spouse’s skill, effort, or talent. Conversely, the Van Camp formula is used when the increase in the business's value is attributable primarily to market forces.

As for the disposition of a business, it also may be taken by one spouse subject to a buyout of the other spouse’s interest, or sold if marketable. In some rare cases, the parties may agree to continue to share ownership after the divorce.

Stock Options

Another set of assets that may be mixed between community and separate property are equity awards like stock options or RSUs. This is often because some of the options may remain unvested at the time that the divorce is filed or the parties separate, so there must be an apportionment between the community and separate property shares.

The two most common formulas applied to determine the separate and community character of stock options are the Hug and Nelson formulas. In determining which formula is appropriate, the court will often consider the purpose of the award. If the stock options were intended to attract a spouse to a job, the Hug formula is more likely to be used. On the other hand, if stock options were intended to be used as compensation for future performance or to keep a spouse at a job, the Nelson formula is likely to be used.

Division of the stock options varies depending in part on whether there are restrictions on transferring the options. If there are such restrictions, the employee spouse may have to buy out the other spouse’s community property interest. In other cases, the employee spouse may be able to divide the actual shares, which is called an “in kind division.”

California law requires that divorcing spouses disclose all material facts and information about their finances starting early in the case. This is a fiduciary duty that can come with stiff penalties where there is a breach of the duty based on inadequate disclosure or some other prohibited activity. The purpose is to ensure that each spouse has complete knowledge of the material facts regarding the assets, debts, income, and expenses at the time of trial or settlement to help ensure the community property is divided as required by law and child and spousal support orders are proper. 

The key vehicle for the required disclosures in divorce cases is the preliminary declaration of disclosure. This is a packet of forms you complete within 60 days of filing the petition for petitioner and 60 days of filing the response for respondent. The two key forms are called the schedule of assets and debts and income and expense declaration. The schedule of assets and debts is where you will list all assets and debts or other liabilities that may be in the marital estate, and assemble certain supporting documents like current account statements. Completing this form can be tedious. The income and expense declaration is the document in which information regarding income and expenses is supplied. When complete, the declaration of disclosure is provided to the other spouse and a one page document is filed with the court declaring that this exchange has occurred.

Sometimes a spouse will balk at the idea of dividing the property acquired during marriage at its actual value, and will either fail to disclose certain assets or actively seek to devalue them. Whatever the motivation for this, it is a bad idea. The penalties for failing to disclose material information about assets can be hefty, including an award of 100% of the value undisclosed to the other spouse, plus payment of the other spouse’s legal fees uncovering the omission or devaluation. 

High net worth estates provide more opportunities for assets to be hidden or devalued. Attorneys that handle these cases often engage forensic accountants to analyze the finances in the divorce, and sometimes information about hidden assets is uncovered by the forensic accountant in the process. Hidden assets may otherwise be found during discovery in the divorce case. Discovery is the process in which the parties may subpoena documents and other information from the other party or third parties. If there is not appropriate cooperation in the discovery process, the court will order compliance and may impose a punishment. In some cases, other investigations may be conducted outside of the discovery process to uncover hidden assets. A spouse who believes the other spouse may be hiding assets should consult a high net worth divorce attorney about options for uncovering them.

Child support and spousal support (or alimony) is often required to be paid by one spouse to the other in a divorce. This applies regardless of the financial status of the spouses. However, the process of establishing appropriate child and spousal support is often more complex in a high income and high net worth cases. There are many reasons for this, but a key one relates to determining the income that a spouse has available to pay support with.

The default rule is California is the amount of child support to be paid is the amount indicated by the statewide child support guideline. The key inputs for the guideline figure are each parent’s income and the custodial timeshare. The output is the amount of monthly child support to be paid. There can be adjustments made to the guideline child support amount, and one allowable adjustment is where the guideline figure results in child support that is beyond the child’s needs, because the paying spouse is an extraordinarily high income earner. In that case, the Court will calculate what the guideline figure would be, but then deviate downward from the guideline figure to an amount deemed proper.

Determining the income input figure for a high income individual is often not a straightforward task. High income individuals often have their compensation structured in ways more complicated than simply having a paycheck twice a month. Additionally, there are often deductions taken from income that are appropriately made on the tax returns, such as certain types of depreciation, but which may be added back to the income for purposes of calculating guideline support. Finally, high income earners may sometimes have perquisites or certain personal expenses paid through the business that a Court will add back to the income of the earner, often as nontaxable income.

High net worth divorce attorneys often engage forensic accountants to assist in determining income available for support, and other analyses to assist in addressing appropriate support. One such analysis that is relevant to spousal support is a marital standard of living analysis. This analysis provides information to the participants in the case and the court that is helpful to setting long term spousal support in particular, since a key factor in that determination is what the standard of living was near the end of the marriage.