By Ron J. Anfuso, CPA, ABV, CFF, CDFA, FABFA
Ron’s Corner
The marriage dissolution trial of Carol Smith (Petitioner) and James Smith (Respondent) commenced on April 8, 2024. Carol and James were married on April 19, 2008 and separated on June 23, 2016. The parties had three minor children. Petitioner filed for divorce on September 14, 2020. Thus, this was a long-term marriage.
A key dispute that arose in the trial focused on child and spousal support. Factors under consideration included the work history and income potential of each party, the ability of the Respondent to pay spousal and child support, the financial needs and obligations of each party, the duration of the marriage, age and health of the parties, tax consequences, hardships, and the determination of separate and community property, including which method should be employed to establish substantial justice for a specific asset.
The asset that was the most difficult to assess and required the greatest degree of in-depth research and litigation was a startup business of Respondent called
Primary Care Viability Analysis (PCVA). This startup would enable primary care practices to choose and maintain the most profitable mix of insurances for participating practices. My task was to determine the most effective method of apportionment to use to achieve substantial justice for this asset. Would it be Pereira, Van Camp, or the Capital-Labor Apportionment Model (CLAM)? In this newsletter, I will focus solely on which method of apportionment we chose for this asset, why we did so, and the ruling by the Court.
Because this case has not been published, I changed the names of the parties involved as well as the name and purpose of the startup business.
If you have questions or comments concerning the portion of this case I present here, I welcome you to contact me.
Ron
Choosing the Right Apportionment Model to Ensure Substantial Justice in a Complex Case
Respondent’s Business
The specific asset in this litigation that required division was Respondent’s business, Primary Care Viability Analysis (PCVA). PCVA was an undisputed community property that officially commenced on February 10, 2017. Thus, it began during the parties’ marriage. PCVA was a startup business that had not made any profits prior to the date of trial. Neither side disputed nor presented evidence to the contrary. Thus, PCVA had no saleable value, possessed or owned any intellectual property, or had anything available for sale. I presented expert witness testimony that opined that there had been no value to PCVA. Nonetheless, Petitioner suggested that the community property
shares, which had been 65% at acquisition, should be divided in kind. Furthermore, Petitioner suggested that PCVA should be valued at $10 million, as that amount was shared as the value by the company’s investors.
Respondent argued that the traditional methods of Pereira would fail to enable the parties to achieve substantial justice as it would lead to “extreme alternatives” for both parties.1 The Van Camp approach would determine the reasonable value of the community’s services, and allocate the amount to the community property and the balance to the separate property. According to Respondent, Van Camp would lead to no interest in PCVA.2
The Pereira approach would allocate a fair return to the separate property investment and allocate the balance of the increased value to community property as it arose from community efforts. Respondent argued that as much of the work for PCVA had occurred in the years post separation, it would result in an unfairly low distribution to him. Generally, Pereira is applied when business profits are principally attributed to efforts of the community, whereas a Van Camp analysis is applied when the community effort is more than minimally involved in a separate business, but the profits are attributed to the character of the assets.
The Reverse CLAM Method
As the expert witness, I suggested a “hybrid” method to divide PCVA using the Reverse CLAM method. It is called the “Reverse method” because the business started during the marriage rather than before the marriage. The CLAM method (Capital-Labor Apportionment Model) was first recognized in Todd v. Commissioner of Internal Revenue (9th Cir. 1945) 153 F.2d 553 and Todd v. McColgan (1949) 89 Cal.App.2d 509. This formula allocates annual income from capital and labor (Forensic Accounting Today newsletters #53 and #54).
In conducting the analysis, I reviewed financial statements, balance sheets, and income statements from PCVA from February 2017 to the date of separation. I opined that the community property money invested in PCVA was
$474,000. The rate of return for a start-up such as PCVA was 25%, with reasonable compensation for work rendered by Respondent as $118,500 a year. Therefore, the calculation for capital and labor, plus the reasonable compensation of Respondent attributed to the community, was $237,000. Based on the calculations, the Reverse CLAM analysis would result in 12% of the ending capital as being community, which would be divided in half for each party.
Because there was no value to be affixed to PCVA at the time of trial, I also engaged in a prospective analysis as to when PCVA would see profits. Respondent believed that when PCVA reached its capital goal of $10 million, the business would become profitable. Therefore, I provided a Reverse CLAM analysis based on capital reaching $10 million. I opined that the calculations would result in a 3% value subject to division since more capital meant more shares or value of PCVA would need to be divided.
Additionally, the Court rejected Petitioner’s request that a division in kind would achieve substantial justice, as it would completely discount Respondent’s separate property efforts to build PCVA post separation. Furthermore, it was primarily Respondent’s efforts, even during the marriage from inception to growth that made PCVA into the essence it became at time of trial. The Court also heard testimony as to multiple loans secured by Respondent to continue to grow PCVA post separation. Thus, the Court found that a division in kind would not achieve substantial justice.
The Court agreed with my analysis and found that the Reverse CLAM method would achieve the Court’s goal of substantial justice between the parties.
More difficulties, however, needed to be dealt with. It was also undisputed that PCVA was not worth any “saleable value” other than what was touted to investors. There was no technology or asset to be sold. Thus, I testified that there was no value. Since there was no proposal for division, the Court, based on the evidence, awarded the Petitioner one half of the 12% of PCVA’s community property interest. Any future division then would be subject to the Reverse CLAM method to calculate the community property interest at division.
1. Forensic Accounting Today newsletter #4: Anna Agnes Pereira, Respondent, v. Frank Pereira, Appellant
2. Forensic Accounting Today newsletter #5: Euphrasia Van Camp, Respondent, v. Frank Van Camp, Appellant/Euphrasia Van Camp, Appellant v. Frank Van Camp, Respondent
