Money, Debt, and the Modern Divorce – Part Two, the Wildcards
In the first post of Money, Debt, and the Modern Divorce, we covered the regulars of marital liabilities, the biggies, aka mortgage and credit card debt. While no walk in the park, these complicated financial dilemmas are nothing new for the family law attorney.
Here we address those unique situations we don’t see every day, but often enough to take notice.
Unique situations involving expensive, luxury gifts made by one spouse to the other during the marriage on which a liability is attached do occur. A spouse’s separate property generally refers to property owned prior to marriage; property acquired by gift, devise, or descent during marriage; and certain categories of recovery for personal injuries sustained by the spouse during marriage. Additionally, if one spouse makes a gift of property to the other, the gift is presumed to include all the income and property that may arise from that property.
With the above-stated provisions (found in Chapter 3 of the Texas Family Code) in mind, consider the following hypothetical: Joe visited the Ferrari dealership and declared he wanted to buy a brand-new Ferrari for his wife’s 50th birthday. Joe purchased the 2018 Ferrari Portofino, sticker price $215,000, for which he paid $15,000 down using separate property funds and financed the remaining $200,000. Joe put a red bow on the Ferrari, parked it in the driveway, and called Jane outside where he smugly or sweetly (who knows) presented her with the keys. Freshly fifty, one month later, Jane filed for divorce. Woops.
How would this vehicle and the debt therein be handled? There is clear and convincing evidence that Joe intended the Ferrari as a gift. The Ferrari, then, is presumed to be Jane’s separate property, an interspousal gift made during marriage for which Joe furnished separate property as a down payment. One argument says the Ferrari should be confirmed as sole and separate property of Jane sans the attached debt. Under this argument, Jane would be awarded the $215,000 asset as separate property, which means the value she is receiving in the vehicle is not being offset by the debt, nor is it being accounted for in the just and right division of the community estate. In other words, this is a windfall for Jane as she receives a substantial asset that is not made part of her piece of the community pie.
Further, nothing in the Family Code (or any other provision of law) establishes a link between Jane and the liability on the Ferrari that is held in Joe’s name alone. Joe acted on his own in purchasing the Ferrari, Jane was not present when the debt was accepted, and Joe talked the salesman’s ear off that he was purchasing the Ferrari as a gift for his wife: evidence that the creditor could not have reasonably believed that Joe was acting as an agent for Jane or that she intended to bind herself to the repayment of this debt. Jane should receive the full value of the Ferrari as her separate property, the value of the Ferrari should not be included in the overall division of the community estate, and the debt on the Ferrari should remain Joe’s obligation.
Conversely, one could also argue that Jane’s act in accepting the Ferrari is evidence of her willingness to be contractually bound and assume either sole responsibility, or at least shared responsibility, for the repayment of the debt. This argument might be further bolstered with evidence that Joe shared details with her regarding the purchase and she was put on notice of the debt associated with the vehicle at the time she accepted possession.
Further, if Joe had intended the gift to be given free and clear of any debt obligation to Jane, he would have made such a recital in the loan documents specifying his intent that the creditor look solely to his separate property for satisfaction of the debt. By not doing so, Joe merely gifted to Jane $15,000 in the form of his separate property down payment on the vehicle. This line of thinking contends the vehicle and outstanding debt should be characterized as community property; i.e., both should be accounted for in the overall division of the community estate.
Let’s assume that the Ferrari was confirmed as Jane’s separate property free and clear of the debt, which Joe remains solely obligated to pay. What happens when Jane goes to sell or trade-in the Ferrari one year after her divorce is finalized? What happens when Joe decides to stop making payments 6 months after the divorce because he would rather be held in contempt than continue to fund his ex-wife’s joyrides? Even though the Ferrari was confirmed as Jane’s separate property, it was titled in her name only, and Joe remains fully responsible for the debt, in order for Jane to trade-in the old Ferrari for a new Ferrari (it has been a year since the divorce, after all, and the 2020 Ferraris really do get better gas mileage), she would need to secure possession of the title, which would only occur when Joe satisfied the debt obligation.
Further, Jane would be trading in her separate-property vehicle subject to the collateralized debt obligation that is in Joe’s name, and that is printed on the front of the car’s title. What if she just wanted to sell the vehicle and get as much money as she could, would she need the third-party creditor to be part of the transaction? Alas, no easy answers. This hypothetical highlights the dichotomy between the marital property liabilities between spouses and marital property liabilities between a spouse and a third-party creditor.
Okay, forget the Ferrari. Consider the following hypothetical dealing with a residence and mortgage owned prior to marriage: Joe purchased a residence in December 2016 for $500,000; he paid $250,000 cash as a down payment and financed the remaining $250,000 in his name as a single person. In March 2017, Joe met Jane, and after a three-week whirlwind romance, they married and began residing in Joe’s separate-property residence. In May 2017, Joe decided that he wanted to do something special for Jane to celebrate their two-month anniversary, so he gifted her 50% of his separate-property residence (the conveyance contained gift recital language). In June 2017, the honeymoon phase had passed, and Joe and Jane realized that the current had dropped on their passionate limerence.
They agreed to file for divorce and go their separate ways. Unfortunately for Joe, Jane took the position that she would go her separate way after he paid her for her 50% interest in the residence that he had gifted to her during their brief marriage. Joe acknowledged that their marriage, albeit short, was valid and that his intent was to voluntarily gift Jane half of his residence, free from any chains of duress or undue influence, and spurred only by his robust and ardent love. Under these facts, what is Jane entitled to receive with regard to the residence in the divorce? Ouch.
In this hypothetical (and in other similar situations involving a gift to a spouse that conveys an interest in a separate-property residence owned prior to marriage), the person receiving the gifted interest can argue that the value of her interest should be based on the value of the house as if no mortgage debt existed. Jane could argue that she was gifted a 50% interest in the asset—not the debt—so she should receive $250,000, which represents half of the total value of Joe’s residence free and clear of the mortgage debt.
Since an interspousal gift is presumed to include all the income and property that may arise from that property, without a specific reference that the gift conveying the 50% interest in the residence to Jane was being transferred subject to the debt attached to the residence, and without a specific reference that limited the conveyance to 50% of the current equity in the residence only and not the total value of the house, Jane could argue that Joe gifted to her the $250,000 portion of the residence that was not encumbered by the remaining mortgage debt. As such, Jane should receive $250,000 in value as her separate property, and Joe will receive the other $250,000 in value and the $250,000 mortgage indebtedness.
Another interesting martial property liability conundrum that pops up on occasion is the brokerage account that is pledged as collateral for a loan issued by the brokerage to the account holder. For example, Joe has a Merrill Lynch containing $1,500,000. Joe requests a loan from Merrill Lynch for $1,000,000 to purchase a business that sells mittens. Merrill Lynch issues the loan, and Joe’s account is pledged as collateral for the new loan account. After the factory that produced the mittens burned down when an employee was smoking a cigar on the assembly line, the financial hardship drove Jane and Joe apart: they agreed it was best for both to leave the ash in the past and get divorced.
Despite the $1,500,000 account being made up entirely of cash, Jane is only permitted to transfer $500,000 from the pledged account as Merrill Lynch will not permit transfer of funds below the collateralized loan amount. While Joe would be more than glad to use the funds in the pledged account to pay off the loan balance, the Merrill Lynch account is the only source of liquidity in their entire estate and paying down the loan would swallow two-thirds of their cash and create an untenable lack of liquidity for Jane. Yikes.
Similar to loans against a 401(k), it is vital to double-check that the accounts being divided in a divorce are not encumbered by debt or pledged as collateral. However, unlike a 401(k), when a brokerage account is pledged as collateral for an outstanding loan balance, this can sometimes create liquidity complications that may mitigate settlement options and stagnate negotiations. On the other hand, having the option to pledge brokerage accounts with little to no cash basis as collateral for a loan that provides an influx of liquidity into the estate may be a beneficial bargaining chip when negotiating a settlement with a spouse who needs immediate access to cash.
As generational shifts and social changes have made debt more tolerable and socially acceptable than ever, complications spawned from marital property liabilities in divorce are becoming more prevalent. Buyers beware!
About the Author
Bryce Hopson is an associate attorney at Hance Law Group. Bryce excels in breaking down complicated legal issues and examining them with his clients in a clear, comprehensible, and concise manner, in matters such as property division, child custody, and pre-marital agreements.