Pre-owned business: when do non matrimonial assets become shareable in a divorce?

Divorce|October 22nd 2012

Law Commissioner Professor Elizabeth Cooke will be attending the University of Leeds on 8th November at 18.30 for a discussion of the Law Commission’s consultation paper Matrimonial Property, Needs and Agreements.
I have the great pleasure of introducing her as the guest speaker and also welcoming the Head of the Law Faculty, Professor Ian Cram. The intention of the evening is not to hear particularly from lawyers (although there will be some present) but rather to canvas the views of the public on this area of the law, and any readers interested in attending should please contact us
To kick off the event, and start people thinking, Benjamin Stowe, a paralegal in our London office has written this guest post about the case of Jones –v- Jones, which involves the treatment by the Court of Appeal of a business which began before the marriage but significantly increased in value during it. He shows just how complicated it can be to calculate the value of a business at given reference points over time and to arrive at an ultimately fair award for both parties.
There has been a lot of discussion recently about the Law Commission consultation paper on the meaning of needs and non-matrimonial property. I do not intend to go over old ground here. However I feel the treatment of business assets on divorce needs to be looked at more carefully. The Law Commission defined non-matrimonial assets as ‘property held in the sole name of one party to a marriage…acquired before the marriage took place that should no longer be subject to the sharing principle save where it is required to meet the parties’ needs’. The problem arises where this non-matrimonial property is transformed into matrimonial property: how one should value this asset on divorce?
Consider the position of such non-matrimonial property as a company set up by one party years before the marriage, where its success is based on that party’s knowledge and expertise. What if it increases in value during the marriage and on separation? Does the other spouse get to share in that increase because it happened during the marriage or can it be defined as a wholly non-matrimonial asset?
These questions arose in the case of Jones v Jones [2011] EWCA Civ 41. I set out below my thoughts on the ruling and the implications it may have for parties entering into financial proceedings.
The case in a nutshell
The parties married in 1986, where the husband was 44 years old and the wife almost 30. They separated in July 2006. The case involved the existence of a substantial asset, which was peripheral to the marriage but still treated as a resource. In this case the asset was Mr. Jones’ company in the oil and gas industry, founded 10 years before the parties married. For the purposes of ancillary relief proceedings the company was the only substantial asset up for grabs. Many people would be sympathetic to a spouse who has generated a valuable business asset before a marriage and who wants to protect this asset from claims of their spouse. Being surrounded all my life with strong, independent and financially successful men and women I would certainly respect one party’s desire to protect a valuable asset generated before the marriage but problems arise when the asset in question has both matrimonial and non-matrimonial elements to it.
A professional assessment of the husbands company took place at the date of marriage, valuing it at £2 million. From the date of the marriage to the date of the ancillary relief hearing the value of the company had increased substantially, producing £25 million net profit. The husband argued that the wife should have 50 per cent of the difference between the value of the company at the date of the marriage (£2 million) and the value at the date of separation (£12 million). In other words the wife was entitled to £5 million. By contrast, the wife wanted a clean break lump sum of £10 million (40 per cent of the value of the total net assets). As a general rule, all assets which the parties have an interest of whatever nature are taken into account during financial proceedings. But the husband wanted to limit the damage by arguing that his former wife was only entitled to half the increase in value from the date of the marriage to the date of separation.
Ruling at first instance
The trial judge awarded the Wife £5.4 million on the basis that that 60 per cent of the net proceeds of the sale of the company represented what the Husband had brought into the marriage. Before the marriage the company had been in existence for ten years and it had enjoyed success thanks to his special skills.
The Court of Appeal and the ruling of Lord Justice Wilson
The Court of Appeal ruled that the judge at first instance had made an error in capitalizing the husbands earning capacity at the date of the marriage and then treating this capital as a non-matrimonial asset. Lord Justice Wilson argued that the £25 million net profits on sale should be divided into matrimonial and non-matrimonial assets. He was of the opinion that the wife had no right to share the non-matrimonial part but the matrimonial part should be divided equally between the parties, looking at the need for fairness and taking into consideration all the circumstances of the case.
The key part of the judgment involved Lord Justice Wilson’s attempts to value the non-matrimonial part of the company in order to determine what matrimonial slice the wife would be entitled to on the basis of the sharing principle.
Non-matrimonial assets
Lord Justice Wilson considered the value of the non-matrimonial assets – in other words the value of the company at the date of the marriage. Lord Justice Wilson criticized the original judge for his acceptance of the valuation of the company at £2 million.
He argued that there had to be an adjustment in the valuation based on two factors.
Firstly, the valuation had to take into consideration the concept of ‘latent potential’ or ‘springboard’. This refers to the inherent potential of the company at the date of the marriage which would result in a substantial increase in its value over subsequent years. Taking this into account Lord Justice Wilson adjusted the valuation of the company at the date of the marriage to £4 million.
Secondly, consideration had to be given to ‘passive economic growth’ between the date of the marriage and the date of sale – that is to say, growth that is not a result of the contributions or active steps taken by either party during a marriage, but purely as a result of general circumstance. Lord Justice Wilson argued that the increase in value of a company due to passive economic growth is non-matrimonial and so the figure of £4 million was indexed upwards to £9 million.
My only criticism of the ruling is that by ignoring a professional valuation of the company at the start of the marriage and applying adjustments of the kind mentioned above it is difficult to practically determine how much the value of the asset has increased and who is responsible for this increase.
The court’s mathematical approach
With the value of the non-matrimonial assets being £9 million (with the total pot £25 million), the value of the matrimonial assets amounted to £16 million. Matrimonial assets should be divided equally on separation and therefore the judge increased the award to the wife, giving her £8 million. There was no reason to depart from equality in respect of matrimonial property. This amount was justified on the basis that, although it only amounted to 32 per cent of the £25 million total asset pot an award of 40 per cent (which is what the wife argued for) would be inherently unfair to the husband. It appears that Lord Justice Wilson, despite taking what appears to be a mathematical approach to the division of assets; actually used his own discretion as to what he thought was intrinsically fair to both parties. He used the ‘cross check of overall fairness’.
The effect of the ruling
So what does this ruling mean for those who go into financial proceedings with pre-martial assets, where the value of these has increased substantially both during and after the marriage?
There is still confusion over the division of pre-marital assets that are used or in existence during the marriage and significantly increase in value. This case should not be seen as a departure from the sharing principle, but rather as a practical and broad-brush approach taken by Lord Justice Wilson to realizing that equality would not have been fair under the circumstances to the husband. The ‘cross check of overall fairness’ was used, even when using a mathematical approach to ancillary relief proceedings in order to calculate the award.
It seems that until we have the Law Commission consultation paper codified as law, judges will continue to use what they call a mathematical approach to financial proceedings but in actual fact use their discretion to achieve what is fair. In this case and in many others, judges seem to arrive at a figure that lies conveniently in between both parties’ claims. Here the husband offered £5 million, the wife wanted £10 million and was awarded £8 million.
A word of warning for those with business assets in existence both before and during a marriage: what you may think is an independent, objective and professional valuation of your business is not necessarily the determining factor in deciding the asset’s value. When judges use their discretion in relation to pre-marital business assets it makes the task of advising a client on their true value much more difficult for legal professionals. Even Lord Justice Arden in Jones v Jones found the use of passive growth to ‘uplift’ the value of the asset confusing and ‘difficult to compute’. If the esteemed Lord Justice found this task difficult, what chance have we mere mortals have when advising our clients?
The Law Commission has invited responses to their consultation paper until 11 December 2012. They aim to publish their final consultation by autumn 2013. In my view this cannot come too soon!
Photo by s_falkow under a Creative Commons licence

Author: Benjamin Stowe

Benjamin was a solicitor at the firm's London office, specialising in all work relating to family law. He advised people on the practical, legal and financial consequences resulting from the breakdown of relationships.

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