Good Planning Can Reduce The Impact of Divorce

(Originally published in Office Hours)

One of the most often overlooked or under-estimated challenges confronting medical practice owners is the impact of a divorce. This is particularly true when the practice represents a married couple’s largest asset and its main source of income.

Some of the most common issues disputed in a divorce action involving a medical practice include:

• How much of the practice is jointly held “marital” property and how much is “separate” to one party.


• The value of disputed business assets.


• The effect of prenuptial agreements.

Marital vs. Separate

Under Ohio law, any asset or liability acquired during a marriage is considered “marital” property, and is subject to equal division between the spouses -- no matter who owns title to it.  If the practice was formed during the marriage, the law considers it a marital asset -- even if only one spouse was involved in its operation.  

Any asset that was acquired by one spouse prior to marriage or any asset that was inherited or gifted solely to one spouse during the marriage is considered “separate” and is awarded to that particular spouse.   

The “separate” designation also extends to any passive appreciation of a spouse's separate property, such as the appreciation of a medical office building due to market forces. However, as a result of a 1998 Ohio Supreme Court ruling, any appreciation in value “due to either spouse’s efforts” (and not just market conditions) is considered to be marital property.

The spouse that asks a court to declare an asset “separate” has the burden to prove that the asset is indeed non-marital. 

In terms of a practice that was owned prior to the marriage or was gifted or inherited during the marriage, the practice owner must provide documentation of the purchase, gifting, and/or inheritance and further provide a value of the business at the time of that transaction. 

Valuation

One of the most factually and legally complex areas of divorce law is the valuation of a medical practice or any other closely held business. There are three basic approaches, and choosing the wrong method can adversely affect the divorce settlement.

The market approach values a business based on the value of similar businesses.  This approach may include a valuation based on the value of stock of similar businesses that are publicly traded, or a valuation based on the recent sale of a similar business.

A major shortcoming of the market approach is the unique character of medical practices and the difficulty in identifying sufficiently comparable public companies. It is appropriate only if truly comparable, recently sold companies can be located.

The asset approach looks at a practice as the “sum of its parts.” The valuation is based on the practice’s balance sheet and is determined by the difference between the total assets and total liabilities. It does not consider the practice’s earnings and is inappropriate for ongoing practices or those where the goodwill of the owner is an intangible factor in the value of the practice.    

The income approach looks to the practice's historical cash flow or profits to determine value of the expected return of the practice.  This approach multiplies the practice’s benefit stream by some discount or capitalization rate, which takes into consideration the risks associated with the practice. This valuation technique is commonly used in ongoing practices. 

Ultimately, a court decides the value of a medical practice – or any asset -- in a divorce action.

Pre-Nuptial Agreements

In a society where nearly half of the marriages end in divorce, many practice owners rely on prenuptial agreements to keep business interests intact in the event of a divorce.

Ohio courts have upheld prenuptial agreements as long as they were entered into freely and voluntarily without fraud or coercion, included complete financial disclosure and did not promote divorce.

One important consideration for any practice owner in a pre-nuptial agreement is the non-owner spouse's agreement that he or she will not share in any of the owner spouse’s share of the medical practice.

Another important aspect of a pre-nuptial agreement is to gather supporting documentation to establish any separate property claims of ownership, the value of the business assets and the reason for any appreciation in value during the marriage.

Deborah A. Kaufmann can be reached at dkaufmann@hhmlaw.com or at (330) 744-1111.