Would You Rather Be a Talented or Lucky CEO?
Often one spouse’s entitlement to appreciation of the other spouse’s nonmarital asset depends on whether the appreciation was active or passive. Active appreciation is an enhancement in value due to marital funds or marital labor. Passive appreciation is an enhancement in value as a result of market forces rather than the particular actions of a spouse. This distinction became particularly important in the dissolution of marriage case of Harold G. Hamm and Sue Anne Arnall.
The high profile divorce of oil billionaire Harold G. Hamm, founder and CEO of Continental Resources, and ex-wife Susan Ann Arnall has raised the question- are CEOs talented or just downright lucky?
After initial divorce filings in 2012 it was highly speculated that Hamm’s divorce could end up being the costliest of all time. Many high profile attorneys and financiers believed that Hamm would end up paying his ex-wife a settlement somewhere between $3-5 billion. Hamm and Arnall were married for 26 years and it was expected that she would receive 25-30% of their marital assets. However, the settlement check cashed by Arnall in January 2015 was for about $970 million, amounting to only 7% of their marital assets. Currently, both parties are appealing the settlement; Ms. Arnall believes she is entitled to more money, while Mr. Hamm argues the settlement amount should be reduced.
During the 9 week divorce trial, Mr. Hamm looked to exploit a wrinkle in divorce law by arguing that the majority of his wealth came from forces outside of his control. According to Hamm, advances in technology, talented deputies, and rising oil prices were the primary sources of his success. Hamm’s lawyers argued that even though Continental Resources was immensely profitable, he was only directly responsible for 10% of his personal and corporate success; the rest, they claim, was luck.
Determining the valued monetary gains by luck versus skill is a tricky matter, and there is limited academic research and evidence on the subject matter. However, a study conducted from 1992-2011 showed that when luck favors a CEO, their pay is 25% higher. Some management experts have said that luck fluctuates by industry and is nearly impossible to measure, as different industries have varying sensitivities to outside forces.
The Hamm divorce hinged on a divorce law known as “active vs. passive appreciation.” In Hamm’s home state of Oklahoma, as well as many other states, if a spouse owns an asset before the marriage and the asset’s value grows during the marriage due to “passive” appreciation, the asset is not subject to division in cases of divorce. Passive appreciation is an asset’s growth by factors outside of either spouse’s control. Active appreciation, on the other hand, means that an asset’s value grew due to the skills, funding, or efforts of either spouse and is subject to division in divorce cases.
The issue of “active vs. passive appreciation” has been the center of other high profile divorces, including the 2002 divorce of taxi mogul David and Susan Markin in Palm Beach, Florida. Mr. Markin argued that he was just a “passenger” of his corporate success. The judge however did not side with Markin, ruling that Markin was in total control and the “captain” of his success. The judge ruled that although Markin had luck on his side at times during his corporate success, he was directly responsible for everything that happened. The divorce settlement eventually awarded Ms. Markin $30 million along with other marital assets.
Although the divorce trial of Hamm and Arnall was closed to the public, those with knowledge of the case have stated that Hamm’s principal strategy was to claim passive appreciation, since the company was founded before his 1988 marriage to Arnall. Knowing that the argument of passive appreciation could keep his assets from being divided, Hamm claimed to be a “passenger” of his corporate success, just like Markin. Hamm stated that he didn’t attend critical meetings or have ample knowledge about the technical and engineering aspects of oil drilling. Hamm also claims that he could not recall making pertinent decisions for the company.
Hamm’s lawyers argued that he was only directly responsible for 5-10% of his own wealth through his efforts, skills, management, and investments. Ms. Arnall’s lawyers refuted these claims and called over 80 witnesses to the stand, including Continental executives and leading economists. Arnall’s lawyers hoped to prove that Hamm was the key decision maker for Continental, and his actions directly resulted in the company’s success.
The judge’s ruling handed down in November 2014 largely sided with Hamm. Ms. Arnall was only awarded about $1 billion; a fraction of what many experts had expected. Hamm believed the settlement to be fair and equitable at the time of the ruling.
Although Ms. Arnall originally accepted the settlement and cashed Hamm’s check, she is now appealing the ruling. In a statement made through her lawyers she stated, “”I will not dismiss my appeal and do not feel that my right to appeal should be denied because I have accepted, in the interim, a small portion of the estate that we built over more than two decades.”
Mr. Hamm is also appealing the original settlement on the grounds that his net worth has significantly decreased since the ruling. In January 2015, Continental Resources experienced a 50% drop in share price due to falling oil prices, causing Hamm to lose billions of his personal fortune. Hamm believes that decreasing oil prices exemplify that forces outside of his control are directly responsible for his company’s success.
In Florida, the law regarding the distribution of nonmarital assets is governed by 61.075(6)(b), Florida Statutes. This statute provides that nonmarital assets are assets acquired prior to the marriage; assets exchanged for those assets; income from nonmarital assets; and non-interspousal gifts or devises. Appreciation of those nonmarital assets will be deemed marital and subject to equitable distribution if that appreciation is attributable to the contribution of marital funds or marital labor. Specifically, Section 61.075(6)(a)1(b), Florida Statutes, provides that marital assets and liabilities includes the enhancement in value and appreciation of nonmarital assets resulting either from the efforts of either party during the marriage or from the contribution to or expenditure thereon of marital funds or other forms of marital assets, or both. Accordingly, equitable distribution of marital assets should include the appreciated value of a nonmarital asset caused by the expenditure of marital funds or labor, including the parties’ management, oversight, or if the asset is encumbered by indebtedness which marital fund service to reduce the principal.