Frequently, individuals contemplating a divorce seek opinions about divorce laws and procedures from non-family law attorneys with whom they have an ongoing personal or business relationship.
Responding to these clients’ questions can be difficult and perilous when the attorney’s area of expertise is not family law. This article is intended to assist non-family law attorneys in spotting important issues in pre-divorce counseling; it cannot fully address this broad area, nor is it intended to give legal advice about the issues raised.
Providing accurate 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. A client needs to understand the true cost of divorce. Accurately seeing the issues will help a client accurately see the consequences of a divorce. The total costs include attorney 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 Dissolution.
Most people do not know that the simple filing of a Petition for Dissolution or Legal Separation causes restraining orders to be issued automatically by the court. An understanding of these restraining orders may influence the decision to file or the timing.
The following are the Automatic Temporary Restraining Orders that are issued when the Petition is filed:
- 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 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; or
- The cancellation of a life insurance policy, and the like.
Date of Separation
The date of separation is a frequently misunderstood concept. This issue sometimes is the subject of a multi-day bifurcated trial. An understanding of the law and the significance can avoid litigation and unexpected consequences. The date of separation is defined as “the date there is a complete and final breakdown of the marriage.”
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/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; and
- The length of a spousal support order.
Such events as marriage counseling, sex, gifts, cards, and/or social dinners can impact the determination of the date of separation.
The length of the marriage can have long-range consequences relative to spousal support. California defines a ten-year marriage as a “long term” marriage. This characterization could 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 Spousal Support
Individuals contemplating separation are generally concerned about probable spousal and child support levels. Family Code sections 4052 and 4055 dictate the amount of child support. The number is calculated using a complex formula utilizing a computer program known as “DissoMaster” or “XSpouse”. Spousal support is determined by the application of 15 factors set forth in Family Code section 4320.
Spousal and child support are based on the total income from all sources. This can result in a spousal and child support package equaling between 35% and 50% of a payor spouse’s after-tax total income. Circumstances can certainly cause the percentage to be 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, there would likely be no child or spousal support. Each situation is unique. It is impractical to attempt to develop general rules of thumb due to the complexities involved.
Tax can play a very significant role in a divorce. A person should be aware of the significance of this issue, not just before filing, but during the entire process. A person going through a divorce expects to have his/her assets reduced by 50% after the divorce. They probably have not taken into consideration the potential further reduction in net worth based on taxes.
The sale of an asset (e.g., real property, stock) can result in the unexpected recognition of tax. However, the transfer of assets between spouses incident to a divorce does not cause the recognization of tax pursuant to IRC section 1041.
Tax plays a role in the structure of spousal support and family support. 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 are raised relative to the value of accounts receivable, tax-affecting Sub S income in the valuation of a business, tax-affecting stock options, and the like.
Residence Rental Charge
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 attempt an earlier sale to avoid the charge.
The disposition of the family residence is often the key concern to a client. Many clients desire to retain the residence but have not logically analyzed the economics of such a result.
Individuals considering a divorce generally need a basic understanding as to how assets are divided. They want to know what they will likely own after the judgment is entered. If a house is awarded to one spouse, 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 been sold.
Most clients are not aware that evidentiary issues are relevant to a family law matter. They should be counseled that a divorce trial is a trial in the traditional sense in many courtrooms. Some judges are more lax than others. However, if would be a huge error to assume that the rules of evidence do not apply in family law.
This means that hearsay rules apply, records need to be authenticated, burdens of proof need to be met, and so on. A spouse can be sanctioned for destroying electronic evidence on a cell phone, PDA, and/or computer. The age of electronic discovery has arrived in divorce actions.
If a spouse intends to claim certain assets as separate property, there will be a burden to trace separate property monies from their original source into the currently existing assets. Tracing requires records. The records needed may include bank statements, canceled checks, deposit slips, stock/brokerage statements, passbooks, escrow statements, and other documents that show the flow of funds from the later of the date of marriage or the receipt of the original separate money to the date of acquisition of the asset that a spouse seeks to have confirmed as a separate property asset. Banks, stock brokerage houses, 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. A delay of a year to request the records could result in the institution’s destruction of the records. A client should also obtain physical possession of relevant records and place them in a secure place for safekeeping outside the family residence.
If a spouse intends to file for divorce, it is generally advisable to carefully organize and copy a full and complete package of financial records for the other spouse, both attorneys 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; 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
Frequently, one spouse has brought assets into the marriage and used those assets to fund the acquisition of a joint asset. An example of this situation could be the use of one spouse’s separate money for the down payment on the initial marital residence.
A spouse is entitled to reimbursement of his/her separate property used to acquire a community asset if that contribution can be traced (Family Code § 2640). For example, if a wife used $100,000 of her separate money as the down payment for a home that was vested in joint names, she will be reimbursed that $100,000 from the house-sales proceeds in the event of a divorce if she can trace the $100,000 to the separate property source.
The owner-operator of a business will want to know how a business is addressed in a divorce. This issue presents a number of very complex issues. Many individuals often have a number of serious misconceptions.
The owner-operator of a business contemplating a divorce should understand that the business will be valued and will generally be awarded to that 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 does not prevent the business from being considered an asset to be valued.
The operator of the business should understand that he/she will generally be forced to “buy” the business from the community. The operator generally cannot force a sale of the business or force the non-operating spouse to accept it. The owner cannot employ the tactic of shutting down the existing community business and open a new similar business in order to avoid being charged with the value of the community business.
A business is generally valued differently in family law matters than in the open market. The value is based upon the historical earnings not the projected future earnings and/or potential events of the future. The business value is not reduced for capital-gains taxes or sales commissions in that the business is not being sold. The business is valued as an ongoing investment.
Community Interest in Separate Property Business
In some cases, the most important question a client will have will relate to whether there is a community interest in a business that was owned before the date of marriage.
Generally speaking, the case law provides for reimbursement to the community for community services given to the separate property business. The case 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 two leading cases are Van Camp v. Van Camp (1921) 53 Cal.App. 17, 199 P. 885, and In re 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
A potentially divorcing individual should understand that the issues of disclosure and fiduciary duty 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 recent case of In re: 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 and given a huge injection of steroids.
A client should be proactively prepared to make full and immediate disclosure to his/her spouse to avoid potential and serious sanctions.
Traditionally in family law matters, the spouse who did not have access to the key documents and/or did not operate the business (the “out-spouse”) had to ask the right questions and demand the key documents and information necessary to determine the extent, nature, and value of the community estate.
This burden placed the “in-spouse” in a very advantageous position. Frequently the “out-spouse” did not know what to ask, failed to aggressively require production of the records, could not afford to fight a discovery war.
The Feldman court seems to have changed the rules, or at a minimum, has 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.)
Family Code §1100(e) requires each spouse 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 clearly includes the obligation to make full disclosure 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.
Family Code §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.
The Feldman case involved a husband who failed to disclose to his wife the existence of assets and income. He demonstrated a pattern of non-disclosure, showing he had no intention of complying with the disclosure rules, thus warranting sanctions. (153 Cal.App.4th 1485, 1488.)
The court ordered him to pay the wife financial sanctions and fees in the amount of $390,000.
Of particular significance was the fact that the sanctions were not ordered pursuant to the California Code of Civil Procedure but rather under the fiduciary duty related Family Law Code sections (Family Code §§271, 2107).
The sanctions were ordered even though there was no economic damage to the wife. Ms. Feldman learned of the non-disclosed assets prior to the trial and thus was able to do the necessary investigation to receive her share of the assets. The 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.
The court stated 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 In re Marriage of Brewer & Federici ((2001) 93 Cal.App.4th 1334, 1348), 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 Mr. Feldman’s argument that the non-disclosure was not intentional. It 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 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 were not acceptable.
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 has been entered until the assets are distributed between the parties.
In order to avoid significant financial sanctions, it appears that a divorcing spouse must proactively provide his/her spouse with information sufficient to allow that spouse to determine the extent, nature, character, and value of the community estate. The court was attempting to level the playing field in discovery matters.
This ruling should provide a motivation to managing spouses to disclose fully, early, and often. This, in turn, should make many discovery battles unnecessary and thus reduce the cost of family law litigation.
On the other hand, it will likely increase the fees to the business operator. The owner will need 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 Judgment after its entry.
There will be real questions as to what level of disclosure is enough.
It will be up to the spouse with superior access to documents and knowledge to determine the level of disclosure that is required. This spouse will be at risk if the disclosure is insufficient.
The Feldman court held that responding to discovery accurately does not necessarily prevent a party from being guilty of non-disclosure. The duty to disclose requires disclosure to be made early in the proceedings. If the event in question is not the subject of early discovery, a party is not excused from the duty to inform his/her spouse of the events, facts, and/or information. Disclosure should be a part of 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 in order to avoid financial sanctions and/or a Judgment set aside months after the entry of the Judgment. 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 and testify under penalty of perjury about his/her and/or his/her spouse’s income. Careful consideration should be given to consulting with criminal tax counsel and amending prior tax returns. 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.
Mark E. Minyard, CFLS is a Partner at Minyard Morris, LLP, a 15-attorney firm that limits its practice to family law matters in Newport Beach, Orange County, California.