By Mark E. Minyard, CFLS
Frequently, individuals contemplating a divorce seek opinions about divorce laws and procedures from non-divorce lawyers with whom they have an ongoing personal or business relationship.
Responding to these individuals questions can be difficult and perilous when the lawyer's area of expertise is not Family Law. This divorce article assists non-divorce lawyer's in spotting important issues in pre-divorce counseling. Of course, this short article cannot fully address this broad area and is not intended to give legal advice.
Providing accurate and early guidance to a client considering divorce may be critical to a client's decision-making process. The advice may encourage a client to act more quickly or it may encourage a client to work on the relationship, seek counseling and avoid a divorce altogether. A client needs to understand the true cost of divorce. Accurately seeing the issues will help a client see the true consequences of a divorce. The total costs include lawyer and other professional fees for the client and potentially for his/her spouse, opportunity costs due to spending one to three years in divorce litigation, spousal and child support, taxes and commissions relative to the sale of assets, and so on. An accurate and honest analysis of all divorce costs is important for a client to understand before the filing of a Petition for Divorce.
Standard Family Law Restraining Orders
Filing a petition for divorce or legal separation automatically issues restraining orders. These restraining orders may influence the decision to file or the timing of the filing of a divorce.
The Standard Family Law Restraining Orders ("SFLRO") issued when the divorce petition is filed, prohibit each party from the following:
- Removing the minor child or children of the parties, if any, from the state without the prior consent of the other party or an order of the court;
- Cashing, borrowing against, canceling, transferring, disposing of, or changing the beneficiaries of any insurance or other coverage, including life, health, automobile and disability, held for the benefit of the parties and their minor child or children;
- Transferring, encumbering, hypothecating, concealing, or in any way disposing of any property, real or personal, whether community, quasi-community, or separate, without the written consent of the other party or an order of the court, except in the usual course of business or for the necessities of life; and
- Creating a non-probate transfer or modifying a non-probate transfer in a manner that affects the disposition of property subject to the transfer, without the written consent of the other party or an order of the court. Before revocation of a non-probate transfer can take effect or a right of survivorship to property can be eliminated, notice of the change must be filed and served on the other party.
These orders could stop and/or complicate:
- A vacation;
- A residential move of a parent and child;
- The sale of a business;
- The sale of stock or other investments;
- The sale of a house;
- The completion of a buy-sell agreement and transfer of a share of a business to an existing employee, or other third party;
- The cancellation of a life insurance policy, and the like.
Date of Separation in Divorce
The date of separation is "the date there is a complete and final breakdown of the marriage." The date of separation is a frequently misunderstood concept. This issue can be the subject of a multi-day bifurcated separate divorce trial. An understanding of the law as it relates to separation and its significance can avoid litigation and unexpected consequences.
A separation does not necessarily occur when a spouse moves into a separate bedroom or moves out of the family residence. It is a date when one spouse clearly communicates that the relationship is irrevocably over and subsequently, conducts his or her life consistently as a non-married person. One spouse must have a subjective intent to end the marriage and there must be objective evidence of conduct furthering that intent.
The date of separation may be important relative to the following issues and many more:
- The valuation date of a business;
- The responsibility for a debt;
- The characterization of earnings as separate or community;
- The length of a spousal support order; and
- The characterization of stock options.
Such events as marriage counseling, sex, gifts, cards, and/or social dinners may affect the date of separation utilized relative to child support.
The length of the marriage may affect spousal support. California defines a ten-year marriage as a "long term" marriage. Characterization of a marriage as long term, may result in lifetime spousal support. It can certainly impact the Court's reservation of jurisdiction to make spousal support orders long after it would have terminated in a "short term" marriage.
Amount of Support in Divorce
Individuals contemplating separation and divorce are generally concerned with spousal and child support. Family Code sections 4052 and 4055 control child support. Child support is calculated using a complex formula reflected in a software program known as "DissoMaster" or "XSpouse." Permanent spousal support is determined by the application of 15 factors in Family Code section 4320. Temporary spousal support is generally determined by a software program.
Spousal and child support are based on the total income from all sources. The combination of a child and spousal support can result in a spousal and child support package equaling up to 50% of a payor spouse's income. Circumstances can certainly cause the percentage to be far lower, but it is accurate to say that the total support level can be devastating. If the parties share custody on a 50/50 basis and have equal incomes, then there would likely be no child or spousal support. Every situation is unique.
Tax in Divorce
Tax can play a significant role in a divorce. An individual should be aware of the significance of this issue, not just before filing, but during the entire process. An individual going through a divorce expects to have their assets reduced by 50% after the divorce. Individuals probably have not considered the potential further reduction in net worth based on taxes if assets are sold.
The sale of an asset (e.g., real property, stock) in a divorce can result in the recognition of tax. However, the transfer of assets between spouse's incident to a divorce does not cause the recognition of tax pursuant to Internal Revenue Code (26 U.S.C. § 1041).
Tax affects the amount of pre-12/31/2018 spousal support and family support order. Money paid to a spouse after separation as spousal support, without a written agreement or court order, will not be tax deductible. It will be a tax free payment to the recipient spouse. Child support is tax-free to the recipient.
Tax issues also affect the value of accounts receivable, tax affecting S-corporation, income in the valuation of a business, tax affecting stock options, asset basis, etc.
Residence Rental Charge in Divorce
A spouse remaining in the family residence after the date of separation may be charged for the fair rental value of the residence in what is referred to as a Watts Charge. (In re Marriage of Watts (1985) 171 Cal.App.3d 366.) This issue may motivate an individual to move out of the residence or sell the residence to avoid the charge.
Residence Valuation in Divorce
The disposition of the family residence is often the key concern to a client in a divorce. Many individuals desire to retain the residence but have not logically analyzed economics of such a decision.
Individuals considering divorce will need to understand how assets are divided. This is particularly important if an individual wants to know what they will own after the divorce. If a house is awarded to one spouse then in a divorce, it is awarded to the spouse at fair market value less existing liens. There is no deduction for capital gains taxes and/or commissions that would have been incurred had the house had been sold.
Evidence in Divorce
Most clients are not aware that evidentiary issues are relevant to divorces. A divorce trial is a trial in the traditional sense. It would be a huge error to assume that the rules of evidence do not apply in divorces.
Hearsay rules apply, records must be authenticated, burdens of proof must be met, and so on. A spouse can be sanctioned for destroying electronic evidence on a cell phone, PDA and, computer. The age of electronic discovery has arrived in divorce actions.
If a spouse intends to claim certain assets as separate property in a divorce case, then there will be a burden to trace separate property monies from their original source into the currently existing assets. Tracing requires records. The records may include bank statements, canceled checks, deposit slips, stock/brokerage statements, passbooks, escrow statements, and other documents that show the flow of funds. Banks, stock brokerages, and escrow companies do not retain these records indefinitely. The earlier the request is made for the records, the better the chance that the records will still exist. Any delay to request the records could result in the institution's destruction of the records. If the records are not available directly from the institution, it may not be possible to trace.
If a spouse intends to file for divorce, then it is generally advisable to carefully organize and copy a full and complete package of financial records for the other spouse, both divorce lawyers, and both accountants. The initial and basic record package should include at least the following:
- Five years personal tax returns;
- Five years corporate tax returns;
- Most recent corporate financial statements;
- Deeds to real estate;
- Credit card statements for the last 24 months;
- Bank statements and canceled checks for the last 24 months;
- Check registers for the last 24 months;
- Stock brokerage statements for the last 24 months;
- IRA/401(k) statements for the last 24 months;
- Most recent personal financial statements; and
- Other relevant financial records.
The time spent organizing and copying these records will expedite the resolution of the case and reduce costs significantly.
Separate Property Reimbursement in Divorce
Frequently, a spouse contributes pre-marriage assets to the marriage and uses those assets to buy a joint asset. The spouse may be entitled to a reimbursement when the contribution can be traced to the spouse’s separate property. For example, wife contributes $100,000 in separate property money to buy a martial residence and at divorce, the community may reimburse wife $100,000 if wife can trace the $100,000.
Businesses in Divorce
The owner-operator of a business may want to know how a business is characterized in a divorce. This issue presents a number of complex issues in divorces. Many individuals often have significant misconceptions.
The business will generally be awarded to the operator-spouse with offsetting assets awarded to the other spouse. The fact that the business would not exist or would not be successful without the services of the operating spouse is not relevant to valuation.
The owner-operator will generally be ordered to "buy" the business from the community in a divorce. The owner-operator generally cannot force a sale of the business or force the non-operating spouse to accept the business in the divorce. The owner-operator cannot shut down the existing community business and open a new similar business to avoid being charged with the value of the community business.
A business is generally valued differently in divorces than in the open market. The value is based upon the historical earnings not the projected future earnings and/or potential future events. In a divorce, the value of the business is not reduced for potential capital gains taxes or sales commissions in that the business is not being sold. The business is valued as an ongoing investment. It is valued at the value it has to the operator-spouse as an ongoing investment.
Community Interest in Separate Property Business
In some cases, the most important question a client in a divorce will have will relate to whether there is a community interest in a business that was owned before the date of marriage.
Generally speaking, family law provides for reimbursement to the community for community services given to a separate property business. Family law provides for two basic methods to allocate the increase in the value of the business during the marriage between community and separate property. The non-operating spouse does not acquire an interest in the business but rather a right to reimbursement.
The two leading cases are Van Camp v. Van Camp (1921) 53 Cal.App. 17, 199 P. 885, and in Marriage of Pereira (1909) 156 Cal. 1, 103 P. 488.
Simply stated, Van Camp allocates an adequate compensation for the services of the operator spouse to the community and allocates the remainder of the increase in the value of the business to the separate property of the operator spouse. The formula is applied most often to a capital intensive business and generally favors the separate property spouse.
Pereira gives a reasonable rate of return to the separate property business and allocates the remainder of the increase in the value of the business to the community. This formula is applied most often to a labor-intensive business and generally favors the community.
Fiduciary Duties and Disclosure in Divorce
A potentially divorcing individual should understand that the issues of disclosure and fiduciary duties are very significant in family law. The issues have been present in family law from the beginning. However, with relatively recent legislation (Family Code §§ 721(b), 1100(e) and 2100(e)) and the case of Marriage of Feldman (2007) 153 Cal.App.4th 1470, 64 Cal.Rptr.3d 29 (4th District), these issues have now been brought to the forefront.
In a divorce, a client should be proactively prepared to make full and immediate disclosures to his/her spouse to avoid potential and serious sanctions.
Traditionally, in divorces, the spouse who did not have access to key documents and/or did not operate the business ("out-spouse") had to ask the right questions and demand the key documents to determine the extent, nature, and value of the community estate. This burden placed the "in-spouse" in an advantageous position. Frequently the "out-spouse" did not know what to ask, failed to aggressively seek records, could not afford to fight a discovery war, etc.
In the landmark divorce Feldman, the Court of Appeal seemingly changed the rules in divorce litigation, or at a minimum, signaled the beginning of new thinking regarding the production of documents and disclosure. The Feldman court stated that under Family Code §721(b), "in transactions between themselves, a husband and wife are subject to the general rules governing fiduciary relationships which control the actions of persons occupying confidential relations with each other." (153 Cal.App.4th at 1476.)
In a divorce, Family Code section 1100(e) requires each party to act with respect to the other consistent with the general rules governing fiduciary relationships until the assets and liabilities have been divided by the parties. The duty obligates to make spouses full disclosures to the other spouse of all material facts and information regarding the existence, characterization, and valuation of assets that are or may be community property.
In a divorce, Family Code section 2100(c) requires a full and accurate disclosure of all assets and liabilities in which the parties have or may have an interest. The disclosure must be made in the early stages of the proceeding.
In Marriage of Feldman, a husband who, during the divorce, failed to disclose the existence of assets and income to his wife. He demonstrated a pattern of non-disclosure, showing he had no intention of complying with the disclosure rules, thus warranting sanctions. (In re Marriage of Feldman, SUPPA, 153 Cal.App.4th 1485, at 1488.) The family law court ordered him to pay his wife financial sanctions and fees in the amount of $390,000 in the divorce action.
Of particular significance, sanctions were not ordered pursuant to the California Code of Civil Procedure but under the fiduciary duty related Family Code sections (Family Code §§ 271, 2107).
The sanctions were ordered even though there was no economic damage to the wife. Wife learned of the non-disclosed assets prior to the family law trial and thus was able to do the necessary investigation to receive her share of the assets. The family law court held that the wife need not prove damage. The court stated that the sanctions were designed to deter repetition of non-disclosure and to encourage disclosure during a divorce.
The court found that the husband had the duty to:
- Disclose material facts to the wife in writing;
- Supplement and augment the discovery continually; and
- Disclose material data immediately and before a new project.
The Feldman court cited Marriage of Brewer & Federici (93 Cal.App.4th 1334, 1348 (2001)), which stated: "a spouse who is in a superior position to obtain records or information from which an asset can be valued and can reasonably do so must acquire and disclose such information to the other spouse." (153 Cal.App.4th 1487-88.)
The court rejected Ms. Feldman's argument that the non-disclosure was unintentional. The court held that the fact that the non-disclosed assets were insignificant in relation to the entire estate did not excuse the failure to disclose. The family law court also rejected the husband's argument that his non-disclosure of new companies was excused because their formation was simply part of his "standard business transactions."
The court made it clear that "hide the ball" and delay tactics in a family law matter were unacceptable.
Of significance also is the fact that the duty to disclose continues until the assets are divided. This means that the duty to disclose will continue after the judgment is entered until the assets are distributed between the parties.
To avoid significant financial sanctions in a divorce, a divorcing spouse must proactively provide the other spouse with sufficient information to allow the other spouse to determine the extent, nature, character and value of the community estate. The court was attempting to level the playing field in divorce discovery.
This ruling motivates the managing spouses to disclose fully, early, and often. In turn, discovery battles should be unnecessary, resulting in reduced fees. On the other hand, it will likely increase the fees incurred by operator-spouse. The operator-spouse needs to determine what is "material." Time and money will certainly be spent attempting to determine what needs to be disclosed to avoid sanctions and/or a potential "set aside" of the divorce judgment. There will be real questions as to what level of disclosure is enough. In a divorce, the spouse with superior access to documents and knowledge must determine the level of disclosure required. This spouse will be at-risk if the disclosures are insufficient.
In Marriage of Feldman, the Court of Appeal held that responding to divorce discovery accurately does not necessarily prevent a party from being guilty of non-disclosure. The duty to disclose, in a divorce, requires disclosure to be made early in the divorce. If the event in question is not subject to early discovery, a party is not excused from the duty to inform the other spouse of the events, facts, and/or information. Disclosure should be a part of divorce strategic planning from before the date of separation. Although not the within scope of this article, the duty to disclose exists during the marriage.
Significant time, attention, and analysis should be given to these disclosure requirements to avoid financial sanctions and/or a judgment set aside. Obviously, no one wants to go through a divorce twice with the same spouse.
A spouse should understand that fiduciary duties may exist after the date of separation and even after a divorce. If a spouse starts preliminary planning relative to a business project prior to the date of separation, there is a high likelihood that the investment completed after the date of separation will be characterized partially or fully as community property due to a marital opportunity doctrine theory and fiduciary duties.
A discussion about the effects of a divorce would be incomplete without a careful analysis of a prenuptial agreement. Prenuptial agreements can be attacked on a number of grounds. Voluntariness is a significant issue. Ambiguity is another potential issue with many agreements. A contest regarding a prenuptial agreement can increase the cost of a divorce, increase the time required to litigate the matter and dramatically increase the financial exposure. The validity and interpretation of prenuptial agreements are the subject of multi-day bifurcated trials.
A person contemplating a divorce who has received unreported income in the last several years should carefully consider the consequences of voluntarily placing themselves in a position of having to execute mandatory forms (e.g. income and expense declaration) and testify under penalty of perjury about his/her income and/or his/her spouse's income. Careful consideration should be given to consulting with criminal tax counsel and amending prior tax returns prior to filing for divorce. Some judges feel duty bound to report unreported income.
A lawyer not specializing in family law can be of significant assistance to a client contemplating a separation or divorce. Spotting issues and alerting clients to issues that need further exploration and analysis may turn out to be invaluable.