Active Passive Appreciation – Causation

William C. Dameworth
Managing Member
March 21, 2018

The business appraiser performing an active passive appreciation analysis looks to their engaging legal counsel to define and interpret state law in the particular jurisdiction. An active passive analysis is performed when state divorce law requires a determination of whether, and under what circumstances, appreciation in otherwise separate property is classified as a divisible marital asset. A commonly recurring requirement in such jurisdictions is that separate property appreciation during the marriage is divisible marital property to the extent it was caused by marital efforts.

There can be many different types of property in a divorce case (e.g. real property, furnishings, retirement plans), but this discussion focuses on property consisting of business interests.

A jurisdiction requiring the isolation of separate business interest appreciation caused by marital efforts necessarily requires the business appraiser to also identify and quantify appreciation caused by factors other than marital efforts. Separate property appreciation during the marriage caused by marital efforts is called active appreciation and is typically included in divisible property. Separate property appreciation during the marriage caused by other factors is known as passive appreciation, and typically remains separate property.

Once it has been determined that a separate business interest appreciated in value during a marriage, learned treatises and case law often delineate the active passive analysis into the following elements:

  • Identifying and quantifying market forces that caused the separate property appreciation.
  • Identifying and quantifying the separate property appreciation caused by the active efforts of third party managers, employees or owners (other than the divorcing parties).
  • Identifying and quantifying the separate property appreciation caused by the active efforts of the divorcing parties (typically including efforts of either the business owner spouse or the non-owner spouse).

From an overall perspective, while case law differs on the market forces and efforts of individuals given weight based upon case facts and the particular jurisdiction, almost uniformly learned treatises and case law have required causation. There must be a reasonable connection or relationship such that market forces and/or the efforts of individuals caused separate property appreciation. In many jurisdictions, for example, merely because a party was active in a business going to work and laboring daily does not mean that that labor reasonably caused some or all the separate property appreciation.  In practice, in most equitable distribution jurisdictions, causation is determined not by a single mathematical formula, but rather by a more flexible facts and circumstances analysis.

While there is near uniformity among equitable distribution jurisdictions to require a reasonable causal link, differences in classification can arise when appreciation in a separate business interest has been caused both by market forces and by efforts of individuals during the same time period. The range of case outcomes varies by specific case facts and jurisdiction, but often the outcome reflects an allocation among the various factors.

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CATEGORIZED UNDER: Litigated Business Valuation