In re Duggan, 2007 WL 2155704 (Bankr.N.D.Cal. July 26, 2007) was a bankruptcy case commenced by the wife of an insurance agent whose practice was a sole proprietorship. The agency had “negligible” personal property. The opinion doesn’t mention that there was any agreement between these long-time spouses that the practice, which existed prior to the marriage, would remain the husband’s separate property. Although the brief opinion provides no details, it appears that the debtor wife made “efforts to enhance, maintain and grow” the business during the marriage.
The opinion explains the applicable legal principal as follows:
Where a spouse has a separate property business in which he is employed and the business increases in value, the enhanced value and profits are attributable in part to the original capital (the separate property) and in part to the spouse's labor and skill (community property). . . . To allocate the proper portion of the enhanced value and profits to the separate and community interests, California courts typically choose between two approaches. . . . The first, the approach set forth in Pereira v. Pereira, 156 Cal. 1, 103 P. 488 (1909), is generally applied where, as here, profits are attributable to community effort. . . . Under Pereira, the court allocates a fair return on the separate property as separate income and allocates the rest to the community property.
In Duggan, Judge Montali found (in the absence of any contrary showing by the Trustee) that the sole proprietorship business had a value of $100,000, which had not increased at all in value since 1979, and that therefore the proprietorship was the separate property of the non-filing husband.
If instead the Court had applied the formula explained above and concluded that, say, 20% of the value of the practice was community property, the Trustee might have faced an uphill struggle in liquidating that interest if the husband had been unwilling to cooperate by paying a settlement. It would require an adversary proceeding to sell an unincorporated professional practice free and clear of the non-cooperating professional’s interest. The trustee would be without the ability to deliver a covenant not to compete to a buyer. Not impossible, maybe, but a row to hoe. Perhaps the most likely candidate might be a dental practice, but it would have to be an awfully good one to justify the legal effort.Copyright Dean T. Kirby 2007. All rights reserved.