Borrowing Money Can Complicate Divorce
[Source: The San Fernando Valley Business Journal]
Brown Jones had already been through a difficult marriage and a more difficult divorce. He did not want or need more trouble. It had taken him years to rebuild his life and buy a home in Northridge. But Brown fell in love with Diane. Brown proposed to Diane. Brown thought about a premarital agreement because he did not want to go through the same expensive and acrimonious divorce again if this second marriage failed. But the premarital agreement was ice water on the romance.
Brown Jones did not feel comfortable bringing up the idea of a premarital agreement. He was wrongly advised that because he owned the Northridge home before marriage that this home would remain his separate property. Brown and Diane were married.
As interest rates went down, Brown decided to refinance the property. The lender required that he transfer the property into the joint names – Brown and Diane, husband and wife, as joint tenants. He did just that.
What Brown did not know was that changing the title to the property and the financing of real property during the marriage can change separate property to community property.
It is common for a lender to require that a married owner of property place his or her spouses’ name on the property in order to refinance the property. Usually, the lender does not warn the transferor of the effect of this change in title. In fact, this change in title may convert the property to community property with only a right of reimbursement for the transferor of the equity in the property at the time of transfer.
It may protect the separate property owner if the property depreciates because the value of their interest is fixed at the time of the transfer. If the property appreciates, the community will benefit from the transfer and the owner of the separate property will give up his sole right to the appreciation. Without an agreement in writing between the parties, a change in title for estate planning purposes can transmute separate property to community property.
Even if Brown had entered into an agreement with Diane, that agreement might not be enforceable. If Diane could show that Brown took advantage of her in the transaction, a court could set aside the agreement. Even if Diane could not show she was taken advantage of, if Diane was not represented by an attorney and Brown did not make a full disclosure of his assets, obligations, and income, the agreement still may not be valid.
Not only does changing the title to real estate affect whether the property will be treated as community or separate property, but encumbering real property during the marriage will affect its character (even if there is no change in title). The characterization of money that is borrowed during the marriage is based on the intent of the lender.
If the lender intends that the lender’s recourse is the general credit of the community, as it is in most cases, then the money that was borrowed is community property.
When the community proceeds of a loan are used to make improvements to real estate or pay off a preexisting loan, those proceeds are treated as a community contribution to the purchase price of the real estate.
When calculating the community interest in what was once solely the client’s separate property, the borrowed funds will affect the calculation of the community interest in separate property.
The “intent of the lender” rule not only impacts the community or separate characterization of real estate, it can also affect the ownership interest in businesses. This application of the intent of the lender rule would have an impact on the real estate developer who refinances his development company during marriage (as opposed to the individual real estate parcel as discussed above).
Most businesses rely on financing to grow.
If the owner of the business is married, then the proceeds of a loan will likely be community property.
In a worst-case scenario, the borrowed funds are commingled with the owner’s separate property interest in the business to such a degree it is impossible to trace the separate component of the property.
If the business has increased in value, it must also be determined whether the increase in value of the business is separate or community.