Community Lien AZ

The Arizona appellate court in the matter of Patricia Rowe v. Jack Rowe was faced with an appeal concerning the characterization of a business as Jack’s sole and separate property or the parties’ community property, as well as the correct valuation methodology to use to value that business or any community lien attaching community lien attaching to that business that business.

The facts are straightforward. Jack owned an unincorporated business prior to his marriage to Patricia. Jack made the decision to incorporate that business shortly after the parties’ marriage. In doing so, Jack issued all of the shares in the newly formed corporation to himself and named himself as an officer of the company. Jack also named Patricia as an officer of the company. Shortly before filing for divorce, Jack removed Patricia as an officer of the company.

The Arizona trial court found that the business was Husband’s sole and separate property and that the community had been fairly compensated for any increase in the equity of the home. The trial court used the “reasonable value of community services” valuation methodology, as opposed to the “fair rate of return on the initial capital investment” approach in valuing the business.

Patricia’s argument at trial was that the incorporation of the business owned prior to marriage turned into community property in Arizona by the mere creation of the newly incorporated business. The Arizona appellate court disagreed. Specifically, the appellate court held that the Arizona case of Bender v. Bender does provide a rebuttable presumption that property acquired during a marriage is presumed to be community property. However, the appellate court also pointed out the ruling in Cockrill v. Cockrill providing that property acquired prior to marriage remains the separate property of the spouse who acquired that property unless and until the parties agree otherwise.

The appellate court agreed with the trial court’s reliance on the case of Porter v. Porter, which held that a simple change in the form of a company as a result of incorporation during marriage does not change that separate property into community property.

The trial court found the value of the business had no increased and that the community was fairly compensated for the work Jack provided to his company from the earnings that flowed through to the community during the parties’ marriage. The appellate court one step further to cite Michelson v. Michelson and Katson v. Katson in support of the proposition that a spouse should not be required from withholding his or her labors during marriage towards their sole and separate business out of fear of converting the sole and separate business into a community asset.

Patricia, however, argued that the day to day balances in the Jack’s business accounts varied on a regular basis and that those funds were earned from Jack’s community labors and, therefore, the business accounts were commingled and, therefore, were transmuted to community accounts. Patricia relied upon existing Cooper v. Cooper, which held that the commingling of separate and community funds into accounts may transmute those accounts into community property.

The Arizona appellate court disagreed. The appellate court distinguished the Cooper v. Cooper rule by holding business accounts are treated differently that personal accounts because the commingling of sole and separate funds with community funds in a personal account may make the identity of the separate funds too difficult to determine and it appears as those spouses intended to treat such personal accounts as community property. Such was not the case here where the business accounts remained in the sole name of the community and the trial court found that community had been adequately compensated for Jack’s labors spent in his business during the parties’ marriage.


Community Lien AZ | How is a Community Lien Calculated

Patricia then challenged the business valuation methodology adopted by the Court. Patricia argued that the “fair compensation to the community” approach in the California case of Van Camp v. Van Camp emphasizes the focus upon the capital of the business, whereas the “fair rate of return on initial investment” approaches in the California case of Pereira v. Pereira case focuses on the community efforts expended on the business by a spouse during the marriage. Patricia argued the latter approach was more appropriate because the increase in value of the business was not related to the initial premarital capital investment but, instead, the labors of Jack during the parties’ marriage.

The appellate court relied upon the Cock rill v. Cock rill decision and held that the Cock rill decision made it clear that all businesses and situations in a divorce will be uniquely different and, further, that there needed to be different valuation methodologies based upon those differences. In a situation wherein the growth was solely the result of the capital investment or, on the other extreme, solely the result of labor then Patricia’s argument may have prevailed. However, there will rarely be a situation that falls into either extreme scenario.

The appellate court then cited the language in Cock rill that provided a trial court is not bound by any one methodology and must select the business valuation methodology that will achieve substantial justice. The appellate court agreed with the trial court that the value of the business was not based solely upon Jack’s initial investment but the ten years of pre-marital labor he invested in that business.


Community Lien AZ | Community Lien and Fair Compensation Approach

The appellate court, therefore, confirmed the trial judge’s use of the “fair compensation to the community” approach and affirmed the trial court’s ruling.