Schnabel Says “You have to disclose.”

In a divorce, a spouse cannot hide behind a corporation and fail to produce relevant records. It does not work. We see why in Schnabel v. Superior Court (1993) 5 Cal.4th 704.

In Schnabel, husband was employed by a close corporation and was record shareholder of 30 percent of its stock. The stock was community property. The trial court and Court of Appeal ordered the corporation to produce business records and corporate and quarterly payroll tax returns. The Supreme Court of California (“Supreme Court”) affirmed stating the trial court acted within its discretion in ordering production of these documents. The Supreme Court also concluded that any information in the payroll tax returns identifying other persons need not be disclosed. (id. at p. 708.)

Specifically, husband and wife were married for 25 years. Husband was employed by, and was record shareholder, of 750 shares of Orange Container, Inc,. a close corporation. A third party owned the remainder of the stock. Wife hired a certified public accountant to appraise the corporation’s value and to determine husband’s income available for support. Wife first tried informal attempts to obtain records from husband regarding Orange Container, Inc., and then served a deposition subpoena for production of business records on the custodian of records of Orange Container. The subpoena sought, among other documents, corporate tax returns, quarterly payroll tax returns, profit and loss statements, bank activity statements, and records reflecting compensation and benefits paid to husband.

Business Records. Orange Container produced its profit and loss and financial statements and all records relating to husband personally but moved to quash the remainder of the requested information, claiming it was “irrelevant, privileged, confidential and an invasion of privacy on the non-party shareholder” of the corporation. (Schnabel, supra, 5 Cal.4th at p. 710.) Husband’s declaration filed in support of the motion to quash stated that the remaining documents “may disclose personal information of the majority shareholder….” Wife’s opposition to the motion attached a declaration from her accountant stating the reasons why each of the disputed items of information was necessary in order to independently verify the information already produced. (Ibid.) The superior court denied the motion to quash and husband and Orange Container filed a petition for writ of prohibition/mandate in the Court of Appeal asking that the superior court be ordered to grant the motion.

What is important to note is that while Orange Container voluntarily produced its profit and loss statement, financial statement and all records relating to husband personally, the trial court ordered a wider range of business records be produced. These records included, for a specified time period, bank activity statements, accounts receivable and payable listings, ledgers, cash receipts and disbursement registers, and sales and purchase registers. (Schnabel, supra, 5 Cal.4th at p. 710.)

The Supreme Court pointed out that, based on certain legislation, in family law cases “a full and accurate disclosure of all assets and liabilities in which one or both parties have or may have an interest must be made in the early stages of the dissolution of marriage action, regardless of the characterization as community or separate, together with a disclosure of all income and expenses of the parties.” (Schnabel, supra, 5 Cal.4th at p. 711.) Further, the State of California “has a strong policy of ensuring…and of providing for fair and sufficient child and spousal support awards….[which] can only be implemented with full disclosure of community, quasi-community, and separate assets, liabilities, income and expenses….” (id. at p. 711.) However, the Supreme Court was reasonable and stated that “despite the strong policy in favor of disclosure, we must also consider any third party right to financial privacy.” (Ibid.) To accomplish this, the Supreme Court expressed some consideration that should affect the trial court’s discretion including “the purpose of the information sought, the effect that disclosure will have on the parties and on the trial, the nature of the objections urged by the party resisting disclosure, and ability of the court to make an alternative order which may grant partial disclosure, disclosure in another form, or disclosure only in the event that the party seeking the information undertakes certain specified burdens which appear just under the circumstances.” (id. at p. 712.) The bottom line, and my favorite point in this entire case, “Where it is possible to do so,’…the court should impose partial limitations rather than outright denial of discovery.” (Ibid.) And the general rule that is distilled:

when one spouse in a marriage dissolution proceeding seeks discovery from a third party, the court is required to balance the spouse’s need for discovery against the privacy interests of the third party. In weighing the need of the spouse, the court should consider all relevant factors, including how the requested information would help resolve the issues that remain between the spouses; any relationship between either spouse and the third party; the information that the other spouse or third party has already provided or agreed to provide; and any specific reasons to distrust the adequacy or reliability of the information already obtained or offered.

(Schnabel, supra, 5 Cal.4th at p. 714.)

So, a corporation does not mean “King’s X,” the other spouse gets zero documents. It also does not mean, “game on” and everything gets disclosed. But, outright denial of access to documents is probably not likely. In addressing privacy interests, the trial court can review the information in chambers “before production to assess its value to the requesting spouse and the harm disclosure might cause to the third party.” (Schnabel, supra, 5 Cal.4th at p. 714.) Discovery orders can also be (1) carefully tailored to protect the interests of the requesting spouse in obtaining a fair resolution of the issues and (2) appropriate protective orders can be issued. (Ibid.)

In Schnabel, husband was a shareholder of record, had all the rights of such a shareholder, including the right to inspect records. Since the stock was community property, wife had an equal interest in that stock. Although she was not the “holder of record” under the Corporations Code, she was entitled to the same information as husband. (Schnabel, supra, 5 Cal.4th at p. 715.) The Supreme Court added “each spouse has a fiduciary duty to the other in managing community property, which ‘duty includes the obligation to make full disclosure to the other spouse of all material facts and information regarding the existence, characterization, and valuation of all assets in which the community has or may have an interest…, and to provide equal access to all information, records, and books that pertain to the value and character of those assets and debts, upon request.” (Ibid.) Therefore, whatever right husband has to inspect records of the corporation, wife also has, either indirectly through husband, or directly, as in this case, by means of third party discovery….if [husband] has a right to inspect any corporate records, he cannot, consistent with his fiduciary duty, refuse to cooperate in obtaining for [wife] those records that are relevant to this proceeding.” (Ibid.) Wife had at least as great a right of discovery from the corporation as any shareholder.

Tax Returns. The trial court also ordered the corporation to produce its corporate tax and “quarterly payroll tax returns.” Orange Container argued that the returns were privileged. The question before the California Supreme Court was whether “the state’s policy in favor of full disclosure of information relevant to the issues of this case, together with the shareholder’s right of inspection, creates an exception to the general privilege.” (Schnabel, supra, 5 Cal.4th at p. 718-719.) The Supreme Court held that the privilege was not absolute. Relying on the public policy favoring full disclosure in a marital dissolution proceeding, the Supreme Court held that the corporate tax returns and the payroll tax return regarding husband were discoverable, but that information in the payroll tax returns identifying people other than husband were privileged and may be withheld. (id. at p. 723.)

Ultimately, the trial court acted within its discretion in compelling Orange Container to produce its business records and its corporate tax returns and quarterly tax returns regarding husband himself, but not payroll tax information identifying third parties. So, while there may be some protections available for third party information, more than likely, all business records and tax returns must be produced.

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