Why Arizona Business Owners Need a Premarital Agreement
Arizona is a community property state which means all property acquired by either spouse during the marriage is, by statute, presumed to be community property. The characterization of property as either sole and separate property or community property is established at the time the property is acquired. Accordingly, in divorces when one of the spouses is the owner of a business established prior to the marriage, that business is his or her sole and separate property. The mere fact of the marriage doesn't change the characterization of the business, but what happens after the marriage has significant implications.
After a marriage, the efforts of both spouses are considered to be efforts of the community. When a separately held business owned by one of the spouses prior to marriage has generated profits during the marriage and/or increased in value during the marriage, the question becomes whether the efforts of the community caused some portion of that increase or profits and whether the community should be compensated for its efforts in determining the equitable distribution between the spouses in a divorce.
Divorce and Community Contributions to a Business
Arizona law on this issue is complicated. Even when the community has received a fair salary for the community efforts or labor during the marriage, the community could still be entitled to additional compensation either as an apportionment of the increase in value or as an apportionment of the profits generated in the business during the marriage.
There is more than one permissible method of calculating the portion to allocate to the community which makes this issue even more complicated to resolve. The standard that trial court judges must adhere to creates further uncertainty because it is simply that the judge is to select the method of calculating this allocation that best achieves "substantial justice" between the parties. Thus, there is no hard and fast mathematical or analytical formula to guide a judge's discretion on this issue.
The owner of the business has a greater risk than the other spouse when these issues are being litigated. There is a statutory presumption in Arizona that all of the earnings during the marriage are community. That presumption can only be overcome by presenting "clear and convincing evidence". As a result of these principles the spouse who owns the business has the burden of presenting evidence that the growth of the business, both profits and value, are the result of the inherent value of the property (the business) itself and not the product of the work efforts of the community.
Entering into a premarital agreement can address this issue and eliminate it from being in contention should the parties' marriage result in divorce. Given the considerable uncertainty of the result should this issue be litigated in a divorce, it is prudent for anyone owning a business who is about to get married or who is considering marriage to fully explore the propriety of a premarital agreement to avoid these uncertainties.
About the author: Mitchell Reichman is a family law attorney at the Phoenix law firm of Jaburg Wilk. He is a certified family law specialist by the State Bar of Arizona. Mitch frequently writes and speaks on divorce and spousal maintenance. He has expertise representing high net worth individuals who have closely held businesses in their marital community.