Getting paid for working is nice. But getting paid over and over again for work that’s already been done is even better.
The problem with a lot of work is that the creator and their investors/distributors have no idea what income the work will generate over time. So, the creator, the artist, the investors and distributors create a system whereby every member of the agreement gets a pre-defined amount of future revenues.
This right to future revenues is called a “royalty interest” and is usually governed by a licensing agreement.
Royalties are a source of income which may be generated during a marriage but not received until after the marriage. In these cases, royalties must be addressed in an Illinois divorce.
What Is A Royalty Interest?
Royalty interests and licensing agreements can apply to a myriad of different careers and work products: mineral rights, software, patents, trademarks, book publishing, music, and/or art.
While an artist might be great at making a movie or song, they probably don’t know how to promote their work and then distribute their work in movie theaters and record stores (admittedly, the internet has made this a lot easier). So, the various other parties involved in the production of the work: producers, promoters, distributers, etc, all get a percentage of revenues, net or gross for their efforts. This way, everyone shares in the risk and everyone gets some of the reward.
Each royalty interest is governed by licensing agreement which is usually unique to the parties involved. A royalty may be a percentage of gross sales or it may be a percentage of net proceeds. A royalty’s amount is negotiated by the parties’ respective agents and lawyers to reflect a fair split of revenues based on the effort and expense required by each party. For example, a book author may get 7.5% gross of physical book sales and 25% gross of e-book sales because the publisher has more expenses in creating and shipping a physical book.
Royalties As Marital Property In An Illinois Divorce
If either spouse is receiving a royalty or is entitled to receive a royalty payment, it must first be determined if the royalty payment is marital property or not.
“”[M]arital property” means all property, including debts and other obligations, acquired by either spouse subsequent to the marriage” 750 ILCS 5/503(a)
The interest in a royalty is a property for the purposes of an Illinois divorce even though it doesn’t generate any real property; i.e., payments of money, until the non-married future.
“The theory behind this treatment is that these rights are valuable rights acquired during the marriage and, although the payments may not be received until after the marriage, they are property divisible as the fruit of the shared enterprise of marriage.” In Re Marriage of Mahaffey (1990), 206 Ill.App.3d at 869, 151 Ill.Dec. at 644, 564 N.E.2d at 1306.
“[R]oyalties are the fruit of the shared enterprise of marriage and should be divided as marital property.” In re Marriage of Heinze, 631 NE 2d 728 – Ill: Appellate Court, 3rd Dist. 1994
How Are Royalties Divided In An Illinois Divorce?
Like most marital property, royalties will be divided via negotiation of the two parties. Royalties, by their nature have an uncertain value so they are especially difficult to negotiate an in-kind payment in exchange for their future value. An Illinois divorce court will not disturb any agreement the parties come to regarding their own valuing of future royalties against other divisible marital assets.
Should the parties be unable to agree to the value and division of the future royalty amounts, the Illinois divorce court will divide the royalty amounts…but there’s not much law for the courts to lean on (at least as to royalties).
Illinois courts “shall divide the marital property without regard to marital misconduct in just proportions” 750 ILCS 5/503(d).
In determining what makes up a “just proportion” Illinois divorce courts shall consider “each party’s contribution to the acquisition, preservation, or increase or decrease in value of the marital or non-marital property” 750 ILCS 5/503(d)(1) So, the creator of the work from which the royalty amount stems can expect to have a greater share of the proceeds from that work allocated to themselves in an Illinois divorce.
That “greater share” is up to each individual court as there is no Illinois statutory law regarding shares of future royalty amounts.
For example, In Re Marriage Of Heinze had the appeals court make the following allocation of royalties: “[T]he petitioner bears the entire federal and state income tax liability for this royalty income. Accordingly, we conclude that it would be inequitable to require the petitioner to bear these tax consequences without imposing an offset upon the respondent’s award of [their percentage] of the…royalties. Consequently, the computation of the respondent’s [percentage] of the…royalties shall be made in the following manner: (1) the petitioner shall compute the amount of each royalty payment from [the publisher/distributor] which is attributable to sales of [works produced] during the marriage (gross royalties); (2) the petitioner shall determine [petitioner’s]liability for federal and state income taxes on the gross royalties based upon [petitioner’s] applicable tax bracket; (3) the petitioner’s income tax liability shall then be deducted from the gross royalties, thereby creating an amount which we will refer to as the net royalties; and (4) the petitioner shall pay the respondent [percentage] of the net royalties from the [works produced during the marriage].” In re Marriage of Heinze, 631 NE 2d 728 – Ill: Appellate Court, 3rd Dist. 1994
In this case, the court picked 25% as the appropriate percentage of the marital royalties the spouse should receive. Each parties’ lawyer should argue for a higher or lower share based on their client’s position. But 25% seems to come up a lot in Illinois appellate decisions that divide future assets like personal injury claims.
When Are Royalties Not Marital Property?
Non-marital property is NOT divided by an Illinois divorce court. “[T]he court shall assign each spouse’s non-marital property to that spouse.” 750 ILCS 5/503(d)
Royalties can last for a long time. Patents last 20 years. Copyrights last for the life of the author plus 70 years. Mineral rights can last forever. Therefore, is easy to imagine a royalty interest being inherited or gifted from a parent or even a grandparent’s estate.
“[P]roperty acquired by gift, legacy or descent” 750 ILCS 5/503 is non-marital and thus non-divisible.
Subject to more argument is the question of when the work was acquired? A work acquired before marriage is non-marital, but the royalty amount is established through the licensing agreement…which may have happened after the marriage date.
In this case, the parties will each argue as to when the property was “acquired” but it’s likely that a work before marriage will allow the actual royalty amount to remain non-marital under this exception: “[P]roperty acquired in exchange for property acquired before the marriage” 750 ILCS 5/503(a)(2)
How To Avoid Dividing Royalties In An Illinois Divorce
The entire point of royalties is to divide the risk and the reward between the various people who contributed to the final work. The reason the risk and reward must be divided as a percentage of the future earnings is because the present value of the future income is too uncertain for anyone to accurately determine today.
If a licensing agreement has not yet been negotiated, any interest in the work will not have a value under Illinois law because it will be too speculative to assign a value to.
A judge is “not obliged to place a value on the husband’s royalties, patents, or copyrights…[a] judge could have concluded on the evidence that the present value of the husband’s future income from this source was too speculative to consider.” Yannas v. Frondistou-Yannas, 481 NE 2d 1153 – Mass: Supreme Judicial Court 1985 (note, this is a Massachusetts court decision)
Without a licensing fee agreement, a patent, book, software or music is worth anywhere from nothing to who knows how much? If the court cannot assign a value, it will not (hopefully (depending on your situation)).
How Do Royalties Affect Maintenance And Child Support In An Illinois Divorce?
“[G]ross income” means the total of all income from all sources” 750 ILCS 5050(a)(3)(A)
Black’s law dictionary even includes royalties under its definition of “income.” “[T]he money or other form of payment that one receives, usu[ally] periodically, from employment, business, investments, royalties, gifts and the like.” Black’s Law Dictionary 778 (8th ed. 2004)
The only way to reduce this gross income amount is to have some kind of set-off for expenses related to the royalties.
“For purposes of calculating child support [and alimony], net business income from the operation of a business means gross receipts minus ordinary and necessary expenses required to carry on the trade or business.” 750 ILCS 5/505(a)(3.1)
There are no real expenses associated with most royalty contracts. Usually the royalty amount is based on a gross sales amount (in which expenses don’t matter) or a net income percentage whereby the expenses have already been accounted for.
If the royalty income is being split between the two parties, both parties’ shares of the royalty income will be accounted for in determining child support and/or maintenance.
If you or your spouse has royalty income coming in today or in the future, you are dealing with a highly speculative amount of money which should be treated with great care…and great leverage. Contact my Chicago, Illinois family law firm to arrange for a free, no-obligation consultation with an experienced Chicago divorce attorney.