Case of the Month Archive

Needs of a high-earner’s child not measured by historical spending . . .

In reversal, First District holds that stock options must be recognized as income for child support purposes when they are vested and mature; not, as trial court determined, when holder decides to exercise them; trial court erred by failing to base its evaluation of children’s needs on father’s financial circumstances and station in life

Patricia Macilwaine was a practicing pediatric nurse when she married John Macilwaine in 1996. Between 1997 and 2008, the couple had four children. After their first child was born, they agreed that Patricia would become a stay-at-home Mom in their Danville home and put her career on hold. They separated in 2010. In 2012, John became the Chief Technology Officer for the Lending Club, then a private start-up company. His compensation package included a base salary, an annual performance bonus, and grants of stock options.

On December 27, 2012, the trial court entered John and Patricia’s disso judgment, which incorporated their MSA. The judgment provided that effective January 1, 2013, John was obligated to pay Patricia spousal support of a base amount, plus 12% of his earnings over his annual base salary, capped at $1.2 million. John was also to pay child support of $5,200 per month, plus 14% of his earnings over his annual base. The parties agreed to share specified add-ons equally. The judgment also divided their community property and deferred sale of the family home.

In July 2013, John’s stock options began to vest, giving him the right to purchase shares at a designated “‘strike price.’” Lending Club made its initial public offering late in December 2014. In accordance with the terms of the disso judgment, John paid child support of $32,000 a month in 2014.

In August 2014, John filed an RFO, seeking a cap on his total earnings of $1.2 million for purposes of calculating child support. He contended that given Patricia’s assets and monthly spousal support, a cap that would yield child support of $15,700 a month would be “more than adequate” to meet the children’s needs. Moreover, he argued, that amount would be in their best interests and would not reduce their standard of living. In opposition, Patricia asserted that there had been no material change of circumstances, since John had anticipated increased income from vested stock options when the existing order was made. She also contended that John was “‘not an extraordinarily high earner’” and had failed to show that guideline support would exceed the children’s needs. Patricia’s I&E declaration showed monthly household expenses of $28,017, which were primarily for the children, but included the cost of her graduate nursing program.

In his trial brief, John increased the amount of the requested cap to $1,877,829, which would “cap monthly child support at about $23,600.” He based this on Patricia’s deposition testimony that the kids’ needs were met when they were in her care, and her I&E showing that her household expenses (minus graduate nursing program costs) did not exceed $23,600. In her trial brief, Patricia again contended that there had been no material change of circumstances and that John was not an extraordinarily high earner. She argued that John’s stock options should be considered income for child support purposes when they vested. And, she maintained that the trial court must first calculate guideline support, then identify the point at which guideline support exceeded the children’s needs, and finally, determine those needs by considering more than just past expenses and give reasons why capping is in their best interests. Just before trial, John disclosed that he had exercised and sold stock options in the first nine and a half months of 2015 to the tune of almost $1 million.

During four days of hearing in October and November 2015, John testified that when his stock options vested, Lending Club must approve their sale, after considering an advanced sale plan drawn up by him. When the sale is approved, the vested options would be sold according to the specifications of the plan, which could be amended only in extraordinary circumstances. At the time of the hearing, 450,000 shares were designated for sale under his two active sale plans. Lending Club’s compliance officer testified regarding the procedures for approving stock option sales, and John presented other evidence intended to show that he was not trying to manipulate his income to avoid paying support. He also submitted statistics to show that he is an extraordinarily high earner.

Patricia’s forensic accounting expert, Tracy Katz, testified regarding her analysis of John’s income available for child support, including only the net gain he could expect if the options were exercised and sold on the day of vesting. Katz opined that the options that had vested but were subject to other restrictions should not be included as income. However, Katz concluded, the options should be considered as available for child support when they were vested, not when they were exercised and sold.

Patricia and John each testified about the money each spent on meeting their children’s needs. Patricia clarified that in her deposition testimony she testified as to the amount that would meet the kids’ basic essential needs, not taking into account John’s station in life. She stated that there were things she could not afford to provide for the kids that John was able to when they were in his care. She detailed the things that John was able to provide that were beyond her means to provide, contrasted the family home with John’s home, and described the differences between the vacations she could afford, and those John could afford. She and John each described the standard of living that the children enjoyed when they were in each one’s care.

In a proposed statement of decision, the trial court decided to use an “exercise and sale” rule, reasoning that a vesting rule should apply only if necessary to ensure that the kids’ needs were being met. It found that John was indeed an extraordinarily high earner, and concluded that he had established that capping his total income at $2 million would meet the children’s needs, but any more would exceed them. Patricia filed objections to the proposed statement of decision, claiming that the trial court failed to calculate guideline support using a vesting rule, or to give reasons why guideline support would harm the kids’ best interests, and had impermissibly relied on past expenditures to establish their needs, rather than considering John’s income and societal position and the disparities in their respective abilities to provide for the kids. She also asked the trial court to “identify the point at which guideline support exceeds the children’s needs.”

In its final statement of decision, the trial court declined to use the vesting rule to determine when John’s stock options were available for consideration for child support and chose the exercise and sale rule as more appropriate. The court concluded that John was an extraordinarily high earner who had established that a downward adjustment from guideline was warranted. The trial court listed the things which made up John’s exceedingly high standard of living and considered the amount of child support he had paid in 2014, along with Patricia’s claimed historical expenses and John’s timeshare. The court then concluded that capping income for support at $2 million would maintain the children’s current standard of living and made that order.

Patricia appealed, and the First District reversed and remanded.

Who’s in charge . . .
Patricia again contended that the trial court erred by determining that John’s stock options were not available for inclusion in child support calculations until he chose to exercise and sell them. The justices noted that under Fam C §4058(a), stock options constitute income for child support calculation purposes. The question here was at what point do they constitute income, which is a question of first impression. The panel reasoned that John’s preference for deferring the exercise and sale of his stock options should not control when they are included in his income; permitting him to minimize his assets in that way, they said, is incompatible with the underling purpose of child support to provide for the kids’ current needs. The justices thought that when the company restrictions on the exercise and sale of the stock options no longer apply, the options “are not materially distinguishable” from deferred salary, which is included in income available for child support. Moreover, when they ran the numbers, they found that a vesting rule does not, as the trial court assumed, result in a lower child support order. Summing up, the justices held that the trial court must consider vested stock options as available income under Fam C §4058(a)(1) at the time when the restrictions on the employee’s ability to exercise and sell them no longer exist. Accordingly, they concluded, the trial court erred by using an exercise and sale rule and deferring to John’s investment strategy.

Changing the focus . . .
The justices then turned to Patricia’s contention that the trial court erred by putting a cap on John’s child support obligation. Starting off, they declined to accept her argument that there had been no material change of circumstances. They did agree, however, that the trial court’s “construction and application of the ‘extraordinary earner’ exception was infected by legal error.” The panel reasoned that a trial court must consider the needs of the children of a high earner by looking at the high earner’s station in life and ability to provide for the children, not just at the kids’ basic needs and the amounts that the earner has paid in the past. Here, the justices found, the lower court had focused on John’s current lifestyle and historical spending on the kids, instead of his financial circumstances and attainable standard of living. Moreover, the justices continued, the trial court had compounded the error by relying on Patricia’s historical spending to determine the children’s needs. And, the lower court inappropriately reverse-engineered the kids needs from Patricia’s current household expenses by subtracting non-support items, instead of making an independent determination of them. In addition, the panel found, the trial court’s ruling regarding the stock options meant that it failed to consider all available income in making its determination of the feasibility of a child support cap. Further, it failed to issue sufficient findings for deviating from guideline support or to explain how the support cap was in the children’s best interests. Accordingly, the panel reversed the lower court’s judgment and remanded for the trial court to recalculate guideline support to include all income available to John, including vested and matured stock options, to independently determine the children’s needs based on his financial circumstances and station in life, and if it orders lower than guideline support, to give its reasons for concluding that guideline support would exceed the kids’ needs.