subject: Asset Protection And Marital Planning [print this page] Community Property and the Division of Community Property between Spouses
a. Introduction
California is a community property State and under California law:
1) Community property is generally property acquired during the marriage and any separate property that may have been transmuted into community property or commingled with marital property.
2) All post marital accumulations are community property. See California Family Code Section 760.
3) Community property generally is liable for the debts incurred by either spouse. See Family Code Section 910. In other words, the community estate is liable for a debt incurred by either spouse before or during marriage irrespective of which spouse has the management and control of the community estate and regardless of whether one or both spouses are parties to the debt or to a judgment for the debt.
4) In this regard, it should be noted that it is the community estate and not the non debtor spouse that incurs the liability. There are no "community debts", only "debts for which community property is liable". See Lezine v. Security Pacific Financial Services, Inc. 58 Cal Rptr. 2d 76 (1996).
5) On the other hand, the spouse's separate property is liable only for that spouse's debts. See Family Code Section 913.
b. Transmutation
Under California law, a married couple can transmute community property into separate property. See Family Code Section 850. The agreement of spouses to separate and divide their community property whether by formal written contract or informal transmutation between themselves will be enforced. See Kennedy v. Taylor 201 Cal. Rptr. 779, 781 (4th Dist. Ct, App. 1984). Under the Kennedy case cited above, informal transmutation will be binding on third parties including creditors. Any separate property that has been transmuted from community property cannot be reached by creditors. The intended outcome under California law is to protect a separate and non contracting spouse from the debtor spouse's obligation. See Kennedy, Supra at 201 Cal. Rptr. at 780. Parenthetically, it should be noted if the debtor spouse receives primarily exempt and illiquid assets, it may be that the creditor's recovery has been diminished by more than 50%.
c. Transmutation and the Fraudulent Transfer Laws
Transmutation is subject to the fraudulent transfer laws. See Family Code Section 851. However, in a transmutation process where each spouse receives equivalent amounts as separate property, each spouse will be treated as having given fair value thereby avoiding the application of the fraudulent transfer laws. See Britt v. Damson 334 F. 2nd.. 896, 903 (9th Cir. 1964), cert. den., 379 US 966 (1965). See also In re Chappel, 243F. Supp. 417 (S.D. Cal 1965). However, community property transferred to the non debtor spouse as part of the distribution of community assets upon dissolution of marriage may still be liable for the debts of the debtor spouse. See Family Code Section 916. The following summary of cases is relevant with respect to the application of Section 916:
1) In the case of In re Marriage of Braendle, 54 Cal. Rptr 2d. 397 (1996), the Court found that "[o]nce the marriage was dissolved and division of community property had occurred, ...the provisions of Section 916 of the Family Code control." Therefore, the separate property of the non-debtor spouse allocated to him/her by the marital settlement agreement cannot be attached by the creditor of the debtor spouse.
2) In the Lezine case previously cited, the Court in commenting on the predecessor to Family Code Section 916, observed: "Under this provision, following the division of property, the community property awarded to one spouse no longer is liable for marital debts that are assigned to the other spouse, with the exception that the award of community real property to one spouse that is subject to a lien remains liable for satisfaction of the lien, i.e., the lien remains enforceable to satisfy the underlying debt."
3) In Gagan v. Gouyd, 73 Cal. App. 4th 835 (4th Dist. Ct. App. 1999), the Court held "... that to engraft the fraudulent transfer remedies onto a valid and approved marital settlement agreement would result in needlessly complicating the already emotionally laden dissolution process." The Court further cited California Practice Guide: Family Law (the Rutter Group 1999), Paragraph 8:778 at Page 8-191: " ... unless the nondebtor (sic) spouse was assigned the debt by the property division judgment, he or she is not personally liable thereafter for the other spouse's debts incurred before or during marriage. The nondebtor (sic) spouse's separate property and his or her share of the community estate awarded by the dissolution judgment may be reached by creditors only if payment of the debt was assigned to the nondebtor (sic) spouse in the property division."
4) After the Gagan Case, the 6th District (Santa Clara County) issued its decision in Mejia v. Reed, 97 Cal. App. 4th 277; 118 Cal Rptr. 2nd 415 (6th Dist. Ct. App. 2002). In Mejia, the Court held that marital property settlements and judgments are subject to the fraudulent transfer laws and specifically rejected the holding in Gagan. However, it appears that the bankruptcy court will accord substantial weight to a determination by the State court in a marriage dissolution proceeding even though made as a non- contested approving the party settlement. (See Britt v. Damson and In Re Chappel cited above).
5) Subsequently, the defendant in Mejia v. Reed sought review of the judgment from the Court of Appeal, 6th District (Santa Clara County) decision. In Mejia v. Reed, 3 Cal. Rptr. 3d. 390 (2003), the Supreme Court of California held that the Uniform Fraudulent Transfer Act (UFTA) applied to property transfers under marital settlement agreements. The court determined, however, that there was no triable issue of fact as to constructive fraud. The discounted value of future child support, because it was generally paid from future income rather than current assets, was not to be considered as a debt in determining solvency under Cal. Civ. Code 3439.05. Thus, the Defendant was not rendered insolvent by the transfer. Actual fraud, however, was a triable issue.
d. Conclusion
In view of the foregoing, a transmutation or marital settlement agreement is subject to avoidance as a fraudulent conveyance. However, see State Board of Equalization vs. Woo 98 Cal Rptr. 2d 206 (2000), (Rehrg denied, August 7, 2002), wherein the California Court of Appeals held that a wife's attempt to transmute her future earnings into separate property in order to avoid her husband's existing tax debt constituted a fraudulent transfer in violation of Family Code Section 851. Query whether the dicta in Mejia overrules Woo and allows future earnings to be transmitted into separate property. One of the problems of transmuting community property into separate property is the loss of the step up in basis that would otherwise occur upon the death of the transferor spouse. If property is classified as community property under State law, upon the death of the first spouse to die, the entire property (even the community property one-half ownership interest of the surviving spouse) receives the step up in basis for income tax purposes. Accordingly, the surviving spouse can thereafter sell such property and there will be little, if any, gain on the sale as a result of the step up in basis. However, if community property is transmuted into separate property either by gift or by means of the marital settlement agreement, when the transferor spouse predeceases the transferee spouse there will be no step up in basis at that time with respect to the property transferred.
