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The Family Business in the Divorce Context

The Small Family Business in the Divorce Context.

Very often the small family business is the most valuable asset in the divorce context.  The following primer on business organizations address how they are valued and then divided by the court.

Sole Proprietorship in the Divorce Context

A sole proprietorship is about the individual and is the individual. The individual owns the business and its assets outright. The law will treat the business (sole proprietorship) and the individual as one. Therefore, the assets of the business are subject to division by the court as individually owned. The Court can award one tractor to one spouse and the other tractor to the other spouse, for example.

If a sole proprietorship, the individual assets of a professional practice were acquired during marriage, they will most likely be community assets. They are therefore, subject to division by the court. See, e.g., Zeptner v. Zeptner, 111 S.W.3d 727, 738 (Tex.App.–Fort Worth 2003, no pet.) In Butler v. Butler, 975 S.W.2d 765, 786 (Tex.App.–Corpus Christi 1998, no pet) the sole proprietorship’s furniture, fixtures, machinery, equipment, inventory, cash, accounts, goods, supplies, and all personal property used in connection with the operation of the business, were acquired during the marriage and were therefore community property and subject to division.

In a divorce action, the valuation of a sole proprietorship will focus on the assets of the business where in a partnership or a corporation the focus will be upon the partner’s interest in the partnership or the value of the shareholder’s stock in the corporation. As you can see, the sole proprietorship may not have been the best choice for a business entity form. In this case, we will not be valuing the business entity but the individual assets of the business – chairs, computers, receivables, cash on hand, long term contracts, etc. That said, this is one of the most common ways the business enterprise will start.

The Partnership in the Divorce Context

1. In General

A partnership is an association of two or more persons to carry on as co-owners of a business for profit. The essential elements of a partnership are (1) an agreement to share profits and losses, (2) a mutual right of control, and (3) a community of interest in the partnership. See, e.g., MacMorran v. Wood, 960 S.W.2d 891, 897 (Tex.App.–El Paso 1997, writ denied). If there is no written partnership agreement, then the partnership will be controlled by statute. See below.

2. Effect of the Aggregate Theory

A partnership is not treated the same as a sole-proprietorship. In 1961, Texas adopted the entity theory of partnership (discarding the aggregate theory) with the passage of the Uniform Partnership Act. Under the entity theory, the individual assets are owned by the partnership, and not by the individual partners. Consequently, partnership property can be characterized neither as community nor separate. The only partnership property right possessed by a partner which is subject to a community or separate property characterization is the partner’s interest in the partnership.

  • Marshall v. Marshall, 735 S.W.2d 587, 593-594 (Tex.App.–Dallas 1987, writ ref’d n.r.e.)(Texas Adopts Entity Theory)(Partnership property cannot be characterized as either community or separate property).
  • Harris v. Harris, 765 S.W.2d 798, 802 (Tex.App.–Houston [14th Dist] 1989, writ denied)(Individual assets are owned by the partnership and not the individual partners).
  • McKnight v. McKnight, 543 S.W.2d 863, 867-868 (Tex. 1976); Farley v. Farley, 930 S.W.2d 208, 213 (Tex.App.– Eastland 1996, no writ) (the rights of a divorcing spouse can attach only to the partner’s interest in the partnership, and not specific partnership property); see also and cf., Lifshutz v. Lifshutz, 61 S.W.3d 511, 517 (Tex.App.–San Antonio 2001, pet. denied) (the trial court improperly pierced partnership to award partnership assets to the wife).

In a divorce case, a value must be placed on the partner’s interest in the partnership, which may include the value of the partnership assets. Tangible partnership assets include cash, accounts receivable, work in progress, tangible personality and realty, etc. Intangible partnership assets include goodwill and going concern value (and should be accounted for in any valuation process). “Intangible property” is commonly defined as property that has no intrinsic and marketable value, but is merely the representative or evidence of value, such as certificates of stock, bonds, promissory notes, and franchises. Brandes v. Rice Trust, Inc., 966 S.W.2d 144, 149 (Tex.App.–Houston [14th Dist.] 1998, pet. denied). It should be noted that one Texas appellate court has held that, under the entity theory of partnership, undistributed partnership income retained in the partnership is neither the community nor the separate property of any individual partner, but rather remains partnership property, non-divisible upon divorce. Cleaver v. Cleaver, 935 S.W.2d 491, 494 (Tex.App.–Tyler 1996, no writ).

A Texas partnership will involve either (1) the Texas Uniform Partnership Act (TUPA) or (2) the Texas Revised Partnership Act. See, Salinas v. Rafati, 948 S.W.2d 286, 289 (Tex. 1997). The Texas Revised Partnership Act became effective in Texas on January 1, 1994; the older statutory scheme, the Texas Uniform Partnership Act, did not expire until January 1, 1999. Hawthorne v. Guenther, 917 S.W.2d 924, 934, n. 2 (Tex.App.–Beaumont 1996, writ denied). Until January 1, 1999, the older statutory scheme (TUPA) continued to apply to partnerships formed prior to January 1, 1994, except for those pre-1994 partnerships that expressly elected to have the new law applied. Id.; see also, Kahn v. Seely, 980 S.W.2d 794, 798 (Tex.App.–San Antonio 1998, pet. denied) (the partnership agreement recited that the partnership was formed on January 1, 1980, and nothing in the agreement indicated the partners intended their relationship to be governed by the 1994 Texas Revised Partnership Act; therefore, the earlier Texas Uniform Partnership Act applied).

4. Partnership Agreement

A partnership agreement governs the rights of partners. A valuation will emphasis and consider the partnership agreement. If a partnership agreement is silent as to a particular issue then Texas Partnership Law (the statutory provisions) control. Salinas v. Rafati, 948 S.W.2d 286, 289 (Tex. 1997). Dobson v. Dobson594 S.W.2d 177, 180 (Tex.Civ.App.–Houston [1st Dist.] 1980, writ ref’d n.r.e). McLendon v. McLendon, 862 S.W.2d 662, 676 (Tex.App.–Dallas 1993, writ denied). TEX.REV.CIV.STAT. art. 6132b-1.03(a).

Note, many partnership agreements will have a “kickout” provision in the event of some event or a stated valuation.  For example, a partnership agreement may state that the partner’s value in the partnership is $10,000.00 wherein the partnership may generate an income substantially higher than the value.  Therefore, for purposes of the divorce the value to be divided is $10,000.00.

The Joint Venture in the Family Law Context

A joint venture is similar to a partnership but addresses only one particular business enterprise.  Examples, would be a combination of persons who invest in an office building or, this is very common, a group of attorney’s who operate office space in a building sharing in the costs of the rent, receptionist, copiers, facsimle machine(s), and internet.

A joint venture is a special combination of persons in the nature of a partnership engaged in the joint involvement of a particular transaction for mutual benefit or profit. Carlyle Joint Venture v. H.B. Zachry Co., 802 S.W.2d 814, 816 (Tex.App.–San Antonio 1990, writ denied). A joint venture must possess each of the following characteristics: (1) a community of interest in the venture; (2) an agreement to share profits; (3) an agreement to share losses; and (4) a mutual right of control or management of the enterprise. See, Coastal Plains Development Corp. v. Micrea, Inc., 572 S.W.2d 285, 287 (Tex. 1978). A joint venture is in the nature of a partnership, and is, as a general rule, governed by the same rules as a partnership. See, Truly v. Austin, 744 S.W.2d 934, 938 (Tex. 1988) (Kilgarlin, J., concurring); Carlyle Joint Venture, 802 S.W.2d at 816 (partnerships and joint /ventures are so similar in nature that the rights concerning the members of a joint venture are governed by substantially the same rules that govern partnerships). In contrast to a typical partnership, a joint venture is usually limited to a single transaction. Harrington v. Harrington, 742 S.W.2d 722, 724-725 (Tex.App.–Houston [1st Dist.] 1987, no writ). Because a joint venture is normally utilized for only a single transaction, professionals rarely, if ever, engage in joint venture professional practices.

A corporation is a legal fiction and can act only through its agents. Ownership of a corporation is evidenced by stock; an individual owns stock in a corporation (thereby an interest in the corporation), while the corporation owns the actual corporate assets. Thus, upon divorce, the trial court can award only shares of stock, and not corporate assets. See, e.g.,Thomas v. Thomas, 738 S.W.2d 342, 343 (Tex.App.–Houston [1st Dist.] 1987, writ denied); see also and cf., In re Marriage of Scott, 117 S.W.3d 580, 583 (Tex.App.–Amarillo 2003) (realty transferred to the ex-husband and ex-wife in satisfaction of a debt owed to a corporation of which the ex-husband was a shareholder and the president belonged to the corporation, not the ex-husband, and thus the trial court properly vested the corporation with title to such realty in the parties’ divorce action). In other words, the value of an individual’s interest in a corporation is limited to the value of his or her stock, which may include the value of the corporation’s tangible and intangible assets; however, the actual assets belong to the corporation and cannot be “partitioned” out of the corporation by a Texas trial court.

The Small Corporation in the Family Law Context and Alter-Ego Theory

The general rule as to the non-divisibility (upon divorce) of corporate assets holds true unless the corporation is a spouse’s alter ego. See, e.g., Siefkas v. Siefkas, 902 S.W.2d 72, 79 (Tex.App.– El Paso 1995, no writ). Piercing the corporate veil in a divorce case allows the trial court to characterize as community property corporate assets that would otherwise be the separate property of one spouse. Zisblatt v. Zisblatt, 693 S.W.2d 944, 952 (Tex.App.–Fort Worth 1985, writ dism’d). Unlike traditional piercing in which the stockholder is held liable for debts of the corporation, piercing in the divorce context allows the trial court to move assets out of the corporation and divide them between spouses as part of the shareholder’s community estate. Lifshutz v. Lifshutz, 61 S.W.3d 511, 517 (Tex.App.–San Antonio 2001, pet. denied), citingZisblatt, 693 S.W.2d at 955.