How a new wardrobe, a new car, and longer working hours lead to millions . . .
In partial reversal, Fourth District holds that trial court did not err by using hybrid Pereira/Van Camp method to allocate community interest in husband’s separate property business, but reverses and remands for trial court to determine and value the community interest in shares of company stock that husband bought from another investor during marriage, and its right to share in profit distributions made after it acquired ownership interest in part of those shares.
In re Marriage of Brandes
(August 14, 2015; ordered published August 31, 2015)
California Court of Appeal 4 Civil D062729 (Div 1) __Cal.App.4 th __, 192 Cal.Rptr.3d 1, 2014 FA 1705, per McConnell, PJ (Huffman and McIntyre, JJ, concurring). San Diego County: Bostwick, J, affirmed in part and reversed in part with directions. For appellant: Edward Silverman, CALS, (619) 744-0694, Stephen Wagner, CFLS, (916) 920-9504, and Rex Jones III, CFLS, (619) 544-7090. For respondent: Marjorie Fuller, (714) 339-9100, and Dennis Wasser, CFLS, (310) 277-7117. CFLP §§M.75, M.78, M.89.
Charles Brandes founded Brandes Investment Partners (BIP) in 1974 to provide investment advisory services to clients who would pay fees based on the percentage of their assets under BIP management. By the time he met Linda in 1983, BIP had managed assets of $8.2 million and Charles’s annual income was $44,148. After a few months of dating, Charles asked Linda to marry him, but she declined, believing that he had not shown enough initiative to earn enough to support the two of them and their respective children from previous marriages. At Linda’s insistence, Charles agreed to change his appearance, clothes, car, and work hours. In 1985, a long- time client of Charles’s, Charles Brown, bought 10 percent of BIP, which subsequently amounted to 10,000 shares after stock splits. In addition, Charles and Brown signed a shareholder agreement giving Charles the option to buy any or all of Brown’s shares after April 1, 1990, in accordance with a stated formula.
Charles and Linda were married in August 1986. At that time, BIP’s managed assets totaled approximately $20 million; they rose to $63 million by the end of 1986. Between 1986 and 1989, Charles was the sole manager of BIP. He had established its investing philosophy, attracted investors, hired, trained, and directed employees and was “the central figure in business marketing . . . .” Through his efforts, BIP’s managed assets grew to $213 million by the end of 1991. By that time, Charles had made Glen Carlson CEO of BIP and Jeff Busby its COO. Carlson and Busby urged Charles to branch out into institutional markets and to hire Barry O’Neil to head up a new division for this purpose. Charles reluctantly agreed and the new fund was established with O’Neil as its chief marketer. After 1991, BIP management decisions were made by an executive committee and its growth was largely attributable to outside factors, such as bull markets and “the popularity of foreign investing.” By June 2004, Charles had purchased Brown’s interest in BIP and BIP’s managed assets totaled $85 billion.
June 2004 was also the month in which Charles and Linda separated; Charles subsequently filed for divorce. In July 2005, the trial court issued the parties’ status-only disso judgment. The following month, the parties signed a stipulation that divided their community bank accounts and real properties. Charles got their homes in Rancho Santa Fe and Borrego Springs. Linda got the Park Avenue penthouse, the beach house in Del Mar, and another house in Rancho Santa Fe. The unencumbered value of Linda’s properties was close to $50 million and her total separate property estate was approximately $100 million.
In 2008, the trial court heard “Phase 1” of the unresolved financial issues, specifically the characterization of BIP. Linda contended that BIP had become “a completely different business” during the marriage and should be characterized as community property. Alternatively, she argued that the trial court should apply a Pereira formula to BIP between the date of marriage and approximately 1995, when Charles’s efforts were no longer the reason for BIP’s growth, and that after 1995, the community had “an ownership interest in BIP commensurate with its interest in BIP’s growth at the close of the Pereira period.” (Emphasis in opinion.) Charles, on the other hand, maintained that BIP was his separate property and that the trial court should apply a Van Camp formula to determine the community interest in the company because BIP’s growth was chiefly attributable to things other than his personal efforts. After hearing testimony from experts and forensics, the trial court issued a statement of decision in which it found that BIP was Charles’s separate property, that a Pereira formula applied to the period between August 1986 and 1991, when BIP’s growth was due to his personal efforts, and that a Van Camp formula applied to the period between 1992 and June 2004, when BIP’s growth was due to other factors. The trial court determined that the community acquired an interest in BIP during the Pereira period, but found that the community had been “substantially overcompensated” for Charles’s services during the Van Camp period and was entitled to no additional funds. Charles and Linda then stipulated that the community interest in the increased value of BIP during the Pereira period was $3,600,932.
In March 2011, the trial court held trial on “Phase II” of the remaining financial issues, which dealt with the characterization of BIP profit distributions labeled as W-2 income, the 10,000 shares of stock that Charles bought from Brown, and the correct valuation method for BIP, along with Linda’s request for spousal support and her continuing contention that the community held an ownership interest in BIP. In a statement of decision issued in May 2012, the trial court confirmed that the community did not acquire an ownership interest in BIP, but was entitled to an equitable allocation under a hybrid Pereira/Van Camp formula. The statement of decision also reaffirmed that the community was not entitled to an additional payment under Van Camp , that the stock shares Charles bought from Brown were his separate property (because he bought them with his separate funds), and that Linda was entitled to spousal support of $450,000 per month. The court also determined that BIP should be valued in accordance with its investment value, not the fair market value, and that per the parties stipulation, the value of Charles’s interest in BIP on September 30, 2010, was $372,982,000. In a disso judgment issued on July 23, 2012, the trial court also included an order directing Charles to make an equalizing payment to Linda of $10,052,042.
Linda appealed (and Charles appealed the spousal support order), and the Fourth District affirmed in part, reversed in part, and remanded.
Reviewing the rules . . .
The justices noted that when the personal efforts of one spouse increase the value of that spouse’s separate property business, the trial court must determine how much of the increased value should be attributable to community property. They began by reviewing the two formulas in this case and when they are applicable. The Pereira formula, the explained, is appropriate where business profits are primarily applicable to community efforts. This formula allocates a fair return to the separate property investment in the business and the rest of its increased value to the community. Moreover, the panel noted, the allocation to separate property need not be limited to the salary of the spouse whose efforts increased the value of the separate property business. The Van Camp formula, the panel continued, is appropriate where business profits are primarily attributable to factors other than community services. It allocates the reasonable value of the community services to community property and the balance to separate property. The trial court’s choice of formula must be based on which formula will be the more substantially just; however, there are no precise standards for making the choice. Moreover, Linda had not challenged any of the lower court’s factual findings, but rather, its “ ‘application of the law to those findings.’ ”
It’s a whole other thing . . .
Linda contended that BIP had become an entirely separate business during marriage and should be characterized as all community property. She relied on Mueller v. Mueller (1956) 144 Cal.App.2d 245, which dealt with the characterization of the husband’s separate property dental lab. There, the increase in the size and income of the business, its changed location, and its new furniture, fixtures, and equipment acquired during marriage, were factors, she maintained, in the appellate court’s determination that the dental lab was community property. The panel here, however, found that the Mueller court’s characterization was not based on those factors, but on the husband’s inability to overcome the community property presumption that arose from the comingling of community and separate property in connection with the business. Mueller , the justices emphasized, did not suggest that a business loses its separate property character because it grows substantially during marriage. Linda also asserted that the value of the managed assets controlled by BIP did not determine the value of Charles’s separate property interest in BIP because the assets belonged to the private investors and not to him. The panel reminded Linda that she and Charles had already stipulated to the value of BIP at the date of marriage and the value of Charles’s ownership interest at that time. Therefore, he was not required to trace his separate property interest, as the husband failed to do in Mueller . Summing up, the justices could find nothing to support Linda’s contention that BIP became a whole new business, simply because it grew in size and revenue during marriage.
Community efforts v. community funds . . .
Undeterred, Linda argued that since the stipulated $3.6 million value of BIP at the end of the Pereira period “was not distributed to the community,” the funds were commingled with the separate property business giving the community an 80% ownership interest in BIP. The justices didn’t agree. They pointed out that a similar contention was raised and rejected in Patrick v. Alacer Corp. (2011) 201 Cal.App.4 th 1326, 136 Cal.Rptr.3d 669, 2012 CFLR 12051, where the court noted that community efforts need not be apportioned to the community on an ongoing basis in order to avoid commingling. Linda countered that Alacer was wrongly decided because it failed to consider and/or apply the equitable apportionment method found in In re Marriage of Moore and In re Marriage of Marsden ( Moore/Marsden ), where the courts held that the community acquires a pro tanto interest in the separate property of one spouse if community property is used to reduce the principal balance of the mortgage on that property. The panel advised Linda that Moore/Marsden had been cited and considered in Alacer , but that court had found that using Moore/Marsden in the determination of the community interest in a separate property business “ ‘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 justices determined that Alacer controlled here. They found that Linda had presented “no cogent argument for the application of the Moore/Marsden rule pertaining to the use of community funds to improve separate property.” (Emphasis in opinion.) And they declined to be the first to conclude that community efforts to improve a separate property business should be treated the same as community funds contributed to improve separate property.
What’s she complaining about . . .
Linda also asserted that applying Moore/Marsden to a business allocation would achieve substantial justice between the parties. The panel, however, was not convinced. The Justices noted that Linda “continues to conflate issues of ownership and equitable allocation.” And, they reasoned, if the trial court had used a single allocation method, instead of the hybrid Pereira/Van Camp that it chose, that method would have been based on the Van Camp formula, with less going to the community. The method the lower court used, the panel concluded was the one that was “considered and fair” and achieved substantial justice between the parties. The justices were equally unmoved by Linda’s claim that Charles had breached his fiduciary duty to her by using community efforts to benefit his separate property. The panel reminded Linda that Charles had expended those efforts openly during marriage and largely in response to Linda’s urging that he work more hours to make the business successful. His efforts allowed her “to have an opulent marital lifestyle and amass a fortune in real estate and other holdings.” Thus, it was hard to see how Linda could reasonably complain that a fiduciary breach had occurred.
All gone, all gone . . .
Linda next maintained that the lower court erred by determining that the stock Charles bought from Brown was his separate property. Linda conceded that Charles’s option to buy the shares arose before marriage; relying on Fam C §2581 [property acquired during marriage is presumed to be community property], she claimed that the funds used to make the purchase were from a joint community account. The justices found that a more specific statute, Prob C §5305 governed here. That statute contains the same presumption, but also permits tracing to a separate property source to rebut the presumption. Here, the lower court had found that Charles successfully traced the funds used to buy Brown’s stock to a separate property source, since the community funds in the joint account were exhausted by other expenditures, leaving only separate property funds in the account.
A bright spot for Linda . . .
Linda contended, however, that the lower court should have applied the lender’s intent doctrine to 6,000 of Brown’s shares, which were acquired partly on credit during the marriage. The justices agreed that applying the doctrine might affect the characterization of at least some of the shares. Therefore, they reversed the part of the judgment relating to the characterization of those shares and remanded for further proceedings to determine the community and separate property interests in those shares, the value of those interests, and Charles’s entitlement to Fam C §2640 reimbursement for separate funds used in the stock purchase. The panel also directed the lower court to consider whether any part of the BIP profit distributions in connection with those shares should be characterized as community property. As for Linda’s spousal support award, the justices noted that her share of the community property may be increased after the lower court re-characterizes the 6,000 shares, and they directed the trial court to reconsider its spousal support award in light of those changes, with the understanding that the original award might require modification.
This is one of the most important family law cases issued this year. Thus, it’s surprising that it was first issued as an unpublished opinion. The Association of Certified Family Law Specialists soon requested publication, so we now have a published opinion on which to rely.
The most important part of the opinion is the part that deals with Linda’s contention that Moore/Marsden should apply to separate property businesses instead of Pereira/Van Camp . This is a theory that has been kicking around for a while, but this is the first case we’ve seen in which it was analyzed and its viability determined. The justices carefully distinguish between the use of community funds to improve separate property and the use of community efforts to improve a separate property business. We would have liked the panel to expand on its reasoning a little more, but what it boiled down to was their saying that this is the way we’ve always done it and we don’t see any reason to change. The most telling example of that is the justices’ finding that Linda had presented “no cogent argument” to support her contention that community efforts to improve a separate property business should be given Moore/Marsden treatment. Neither party in this case is short on funds. Therefore, we may see a request for CASCT review of this case. We will keep you posted.
Linda’s contention that a separate property business can become community property simply by growing substantially larger and more lucrative has a certain novel appeal, but is not persuasive to this panel. And, as the justices did, we had a hard time buying the argument that Charles’s hard work in his separate property business was somehow a breach of his fiduciary duty to the community. As the panel noted, Linda benefited by his efforts (big time) and he didn’t sneak around behind her back in expending those efforts or try to hide the business profits in an off-shore account.