Texas Business Dispute Blog

Tuesday, May 27, 2014

Not So Fast, Mrs. Sterling! Part I

By Matthew Schultz (San Francisco)

Does the spouse of a professional sports team have the right to claim rights as a partial owner of the franchise based on the fact that the ownership of the team is part of the marital community estate?  This is by no means an academic question as the recent comments made by Sherry Sterling, the estranged wife of LA Clippers owner Donald Sterling, have presented the issue for public consideration.

Ms. Sterling who is separated from her husband, has publicly stated that she plans to file for divorce, but she claims that she owns a 50% share of the Clippers and cannot be required to sell her interest in the team by the NBA.  In effect, Ms. Sterling is alleging that she jointly owns the Clippers with her husband and that their joint ownership is part their “community” property, which allows her to prevent the NBA from forcing the sale of this property interest.  Her claim also raises the issue of how their ownership interest in the Clippers should be valued upon divorce.  In this regard, should Ms. Sterling have to pay the price if the value of the Clippers franchise has declined substantially in value as a result of her husband's widely condemned comments?

These property issues are not at all uncommon in divorce proceedings.  While few couples own professional sports teams together, many couples own and have significant investments in privately held corporations, partnerships, and other types of businesses that are difficult to liquidate (monetize), which must be addressed when a divorce takes place.

“Community” Property

In California, which is home to the Clippers, determining what is “community,” vs. “separate” property is an “integral part of the division of property on marital dissolution.”  See Marriage of Rossin, 172 Cal. App. 4th 725, 732 (2009).  This “characterization” question is critical, because absent an agreement to the contrary, “community” property must essentially be divided equally between the two spouses.  See Cal. Fam. C. § 2550; Marriage of Campi, 212 Cal. App. 4th 1565, 1572 (2013). 

This determination generally depends on several factors, including the date the property interest was acquired, the form of title to the property, and how the property was acquired.  A community property interest may only be acquired during the marriage and before separation, and the time of acquisition will often be decisive in characterization determinations.  See Cal. Fam. C. §§ 760, 771(a) & 772. 

The form of the title of the property is also important, however:  if a spouse acquires property in his or her name only with the knowledge and consent of the other spouse, this can create a “rebuttable presumption” that the property interest is not “community” property.  See, e.g., Marriage of Brooks & Robinson, 169 Cal. App. 4th 176, 185 (2008); Simonton v. Los Angeles Trust & Sav. Bank, 205 Cal. 252, 256-57 (1928). 

How the property came to be acquired is also important:  gifts, inheritance, and “rents, issues, and profits” of property acquired prior to marriage remain a spouse’s separate property, even if “acquired’ during marriage. Cal. Fam. C. § 770.  All of these factors will play a role in determining whether their joint ownership interest in the Clippers will be considered “community” property.

Division Of “Community” Property

Assuming that the Clippers are part of the “community” property held jointly by the Sterlings, it remains unclear whether Ms. Sterling, by divorcing her husband, would automatically be entitled to an award that would evenly split this interest by 50%.  Absent agreement to the contrary, courts must effectuate a “net equal” division of community property.  Cal. Fam. C. § 2550.  Courts have broad discretion as to how to effectuate this division. 

The Sterlings are exceptionally wealthy and their interest in the Clippers is only a portion of the community estate.  An equal partition of each item in the community estate is not required, and courts may award a community asset exclusively to one party and/or cash-out to the other party, or “on such conditions as the court deems proper to effect a substantially equal division of the community estate.”  Cal. Fam. C. § 2601.  Alternatively, for fungible assets, such as shares of stock, courts can order an in-kind division of the property, wherein each spouse gets one-half of the particular assets in question.  See Marriage of Brigden, 80 Cal. App. 3d 380, 391 (1978). 

Of particular significance for Ms. Sterling, where a contingency event is on the horizon, or where other “economic circumstances” warrant, courts may also reserve jurisdiction to value and/or divide specified community assets at a later time.  See Marriage of Kilbourne, 232 Cal. App. 3d 1518, 1524–1525 (1991).  In other words, a court could simply wait until the “forced sale” Ms. Sterling apparently seeks to avoid occurs and divide the proceeds at that time.

Valuation Of “Community” Property

Absent an “in-kind” division or sale and division of proceeds, valuing each item in the community estate is a prerequisite to the court's responsibility to effect a net equal division.  For shares in a public companies, these are generally valued by their “over the counter” trading price on the valuation date.  See Marriage of Hewitson, 142 Cal. App. 3d 874, 191 (1983).  In contrast, shares of stock in a closely-held corporations or ownership interests in other ongoing businesses will not necessarily have a “liquidity value,” since they are often not readily saleable, and the court will ordinarily have to determine the net market value of these interests on a case-by-case basis.   See Marriage of Lotz, 120 Cal. App. 3d 379, 384 (1981).

This can bring up a number of issues where a spouse’s post-separation actions affected the value of the community property.  For example, something which could be relevant to Ms. Sterling is what happens if community property is damaged, destroyed or declines in value during the post-separation period because of a spouse’s mismanagement.  In this situation, courts will sometimes value the community assets “at a date after separation and before trial to accomplish an equal division of the community state . . . in an equitable manner.  Cal. Fam. C. § 2552(b); see also Marriage of Campi, 212 Cal. App. 4th 1565, 1574 (2013). 

Also significant:  if a party breaches his or her fiduciary duty in the management of community property, the value of any mismanaged asset must be determined to be its “highest value” at (i) the date of the breach of fiduciary duty, (ii) the date of its sale or disposition, or (iii) the date of the court's award.  Cal. Fam. C. § 1101 (g); see Marriage of Margulis, 198 Cal. App. 4th 1252, 1279 (2011).  It is also notable that this is a two-way street.  If one spouse’s post-separation efforts have greatly increased the value of a community asset, or where the value of an asset (such as a business) devolves largely from the personal skill, industry and guidance of the operating spouse, courts will often use a valuation as of the separation date, not the trial date.   See Marriage of Stevenson, 20 Cal. App. 4th 250, 254 (1993); Cal. Fam. C. § 771(a).

Ms. Sterling's insistence that she is a 50% owner of the Clippers has some basis, but it is hardly the final word and her claim to ownership as a community asset -- as distinguished from the right to receive her share of the value of the asset -- may not hold up if challenged in the divorce.  If Ms. Sterling is able to persuade the divorce court that, in fact, the Clippers are part of the community estate, she may have strong arguments that her husband, during the separation period, caused the value of this asset to decline, and that the value should be determined using the separation date rather than the trial date.  This may be small comfort to her in the event she is ultimately forced to part with her ownership in the Clippers.

Ms. Sterling's situation serves as a warning to divorcing spouses that following separation, they continue to owe duties to one another to preserve the community assets for valuation and division and, further, that they may be liable in the event they take actions which substantially damage the property before division.


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