Prenuptial & Postnuptial Arrangements
§7:70 General Points
A husband and wife may enter into either prenuptial or postnuptial contracts governing their rights and interests in property they own or may later acquire. [See, e.g., Cal. Family Code §850 (married persons may transmute both community and separate property).]
These arrangements eliminate the chance of subjecting transfers between spouses to the gift rules or the rules of implied trusts, and are effective in characterizing property as separate property both for debtor-creditor purposes and bankruptcy purposes. However, a transmutation is subject to the laws governing fraudulent transfers. [Cal. Family Code §851.]
The full step-up in tax basis on death of either spouse will be lost if spouses enter into marital agreements by which they abandon the community property system and hold all their property as sole and separate property. This type of planning should be undertaken only in those cases where the client does not understand or cannot afford more sophisticated planning. In up-market planning, assets normally remain as community property to get the full tax step-up and are still totally asset protected.
§7:71 Validity Against Spouse and Creditors
Since a creditor takes over the rights of the debtor, creditors may attempt to invalidate marital agreements in order to recover assets from the non-debtor spouse.
The agreements should be fair and there should be full disclosure. Generally, both parties should be represented by independent counsel, although this is not a requirement. [See, e.g., Cal. Family Code §1615(c) (party may waive representation by independent legal counsel).] The presence of counsel may negate both duress and prove the parties were informed. The absence of counsel supports an inference of overreaching.
If the agreement is deemed to encourage divorce it will be held invalid. [See, e.g., Norris v. Norris, 174 N.W.2d 368 (Iowa 1970) (stating that the state interest in preserving the marriage relationship makes any provision that tends to induce a divorce contrary to public policy and void).]
It will also be invalid against creditors and for bankruptcy purposes if it is fraudulent, or if the transfer was fraudulent. [In re Claussen, 387 B.R. 249, (Bankr. D.SD 2007) (trustee steps into the shoes of a judicial lien holder and may avoid any transfer that is voidable); Webster v. Hope (In re Hope), 231 B.R. 403, 413 (Bankr. D.D.C. 1999) (transfers under a divorce agreement are subject to avoidance under 11 U.S.C. §§547 & 548).]
§7:72 Writing and Recordation
To be enforceable between spouses, a marital agreement must be in writing. And if the property is real property then the agreement must be recorded to be effective against creditors. [See, e.g., Cal. Family Code §852(a)&(b).]
The recording or non-recording has the same effect as recording or not recording a real estate deed. [Cal Civ C §5202.]
§7:73 Attorney Conflicts of Interest Disclosure
If you are representing both spouses there is a potential conflict of interest.
As attorneys, we are governed by specific rules relating to our representation of clients when present or potential conflicts of interest exist, and a potential conflict must be disclosed in writing to both parties. [See, e.g., California Rules of Professional Conduct, Rule 3-310.]
FORM:
5-2 Conflict Disclosure Letter and Consent (in Chapter 5)
§7:74 Prenuptial Agreements
Prenuptial agreements (Pre-Nups) are drawn up before two people marry to protect each one's assets in case the marriage should end in divorce. Pre-Nups outlines how pre-existing and future earnings and present and future property will be divided up if there is a split up. These agreements are usually created when one party has considerably more wealth than the other party and wants to preserve it if the marriage ends in divorce. Without a Pre-Nup, most divorce laws will allow the assets to be drawn down the middle, granting half of all assets to each spouse [See §7:01]. Instead of allowing a court to decide what is fair, the couple decides.
For asset protection purposes, couples also can also state how debts will be divided, including debts owed before as well as those incurred during the marriage. The Pre-Nup is important where one of the spouses owes a separate debt, and fails to pay it, and creditors come after jointly owned property to satisfy the debt. For example, if the husband is coming into the marriage with outstanding tax liabilities, support obligations to a former spouse or children, a pending lawsuit, debts to other creditors, or other real or potential financial obligations, a premarital agreement may be helpful in protecting the new wife's property or earnings from the husband's creditors. However, a Pre-Nup may not protect a spouse from claims for unpaid joint debt. Creditors are not a party to the Pre-Nup and it cannot be enforced against them.
Document the items that your client brought into the marriage and maintain them as sole and separate property.
The Uniform Premarital Agreement Act sets forth the basic requirements for a valid premarital agreement, and states the specific circumstances under which the agreement is invalid. [See. e.g., California Fam C §852 (providing that a transmutation is not valid unless made in writing by an express declaration that is consented to or accepted by the spouse whose interest in the property is adversely affected).]
Form Premarital Agreements are generally available. [See, e.g., http://www.ilrg.com/forms/premarit.html]
The courts have consistently enforced premarital agreements that permit all earnings and accumulations during the marriage to be kept separate. [See, e.g., Marriage of Dawley, 17 C3d 342 (1976).]
Those cases provide examples of effective language for such agreements. For example, in Marriage of Dawley a key clause in the agreement stated as follows:
Betty Jean Calvert Johnson acknowledges that she understands that, except for this agreement, the earnings and income resulting from the personal services, skill, effort, and work of James R. Dawley after the marriage would be community property, but that by this agreement such earnings and income are made his separate property.
§7:75 Postnuptial (Transmutation) Agreements
Community property may be converted into separate property and vice versa. This is critical in the protection of assets, especially when one spouse has a higher degree of liability than the other. Spouses may deviate from a statutory community property scheme through an agreement between themselves.
By dividing property between themselves as separate property rather than community property, spouses can protect half of a family’s assets. The transmutation agreement ensures that creditors of one spouse cannot attach the assets of the other spouse (unless they were jointly and severally liable). A post-nuptial agreement is a valuable asset protection tool. Property acquired during marriage in a community property state vests in both spouses immediately, and, therefore, this property becomes subject to the claims of the creditors of either. Transferring from community to separate status can prevent creditors from attaching property. Creditors "step into the shoes of their debtors". The right of a creditor to your property is the same as your right. Classification of property for asset protection is important because it determines:
- The rights of one spouses' creditor to reach all or only part of the spouses’ assets
- The rights of both spouses in divorce
- The rights of each spouse's creditors in the event of divorce
- Control rights to property, including the ability to make gifts or sell the property
After the transmutation agreement is entered into to lend further strength against creditors:
- Record the agreement in the county where the spouses reside,
- Record any transfers of real property pursuant,
- Prepare separate Financial Statements for the parties to show the separate property each owns
The concern that recording causes is that assets unknown to creditors become public knowledge. Does a Post-Nuptial Agreement have to be recorded to be effective? If properly drawn up, it should be effective among the spouses, they are certainly aware of the Agreement. But what about creditors who are unaware? If the Agreement is being used because the couple has serious asset protection concerns, record it.
A spouse who wants to transfer assets to his or her spouse can transfer the assets into an irrevocable, lifetime Q–TIP trust rather transferring the assets outright. This allows asset protection from creditors of both spouses.
Once the estates are equalized by transmutation and gifting, the assets of the first spouse to die can be placed in trust for the benefit of the surviving spouse. These assets are thus kept out of the surviving spouse’s estate both for creditors’ and estate tax purposes.
Caveat:
Inform clients that by holding property as separate property instead of community property, they lose the full tax step-up in basis to fair market value at the death of the first to die. A community property full step-up eliminates income tax on the date of death up to fair market value. With separate property only half of the property receives a step-up to fair market value, and therefore on its sale more tax will be due than on the sale of community property.
FORM:
7-1 Postnuptial Agreement
§7:76 Avoid Commingling
Proper ownership must be maintained of assets that are transmuted by a marital agreement. If the assets are commingled, they may be considered to have reverted to community property status, and can be lost to lawsuits against the other spouse.
Because certain types of separate assets may become commingled, the marital agreement should have a specific clause providing that even if these assets are commingled the parties agree they remain separate property. There are numerous rules by which creditors can trace funds to determine there origin. These agreements may make such tracing fruitless.
[For more on maintaining separate property, see §§7:90 et seq.]
§7:77 Living Trusts
In many community property states, property held by a trustee continues its status as community property if the trust was originally comprised of community property. Because of this, the asset protection planner should separate the spouses’ property prior to placing it into trust if they want to be certain that the property is indeed held as separate property.
Example:
The Living Trust may contain the following two clauses:
• Community Property: Any community property transferred to our trust (including income from the property and proceeds from the sale or exchange of the property) shall retain its character as community property during our lives to the same extent as if it had not been conveyed to our trust.
• Separate Property: Separate property transferred to our trust shall retain its character as separate property. Our separate property may be identified as the separate property of either of us on the attached schedules. The separate property of either of us (including income from the property and proceeds from the sale or exchange of the property) shall remain separate property. Each of us shall have the unrestricted right to remove all or any part of our separate property at any time.
An inventory of separate property may be notarized and filed for the record. The reason to do so is both to prove a document was signed when the document says it was signed, and to put the document “on record” as notification of the action taken.
Unless there is a marital agreement stating otherwise, payments for assets held by a living trust that require maintenance and periodic payments must be made from the personal accounts of the person who claims it as sole and separate property, rather than from a community property account.
[§§7:78-7:79 Reserved]
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