Equitable Distribution

Mark Hess, a partner in our Los Angeles office and an attorney who specializes in employee benefits, wrote an article on Qualified Domestic Relations Orders (QDRO’s) and an interesting 5th Circuit case, Brown v. Continental Airlines, Inc.  In  the Brown case, Continental Airline pilots and their spouses used QDRO’s and what amounted to sham divorces to avoid retirement plan rules and receive their retirement funds without taking the usual tax hits.

QDRO’s can be complicated and very technical; for the layperson, they can be overwhelming, but the Brown case shows not only a great example of legal creativity, but the facts as conveyed in Mark’s article also help demonstrate how a QDRO operates in a divorce, its utility, and their purpose.

              Pre-Nuptial Agreements are a hot button for engaged couples, but they can be a great way to minimize risk, exposure, and litigation in the event of a divorce or death of one of the parties. You may want to consider a Pre-Nuptial Agreement if it is a second marriage for at least one of the spouses and there are children of one or both people who will inherit instead of the spouse; if there is an existing business to be kept out of the marriage; or  if the parties about to marry do not want to share their assets or the increases in value of those assets after they marry.  Without a Pre-Nuptial Agreement, pre-marital assets are valued by the increase value from the date of marriage to the date of separation or distribution (whichever results in the lesser increase). However, with a Pre-Nuptial Agreement, parties can agree that separate assets do not become part of the marital estate. In addition, parties can also determine how assets in joint names will be divided in the event of divorce or death. The parties can also negotiate temporary support and alimony in the event of a separation/divorce. 

A well-written Pre-Nuptial Agreement will provide a clear road map in the event of a divorce or death of a party, and hopefully minimize the inevitable stress associated with either occurrence.

Family law has seen an evolution of facts in cases that are directly tied to the economy. One of the more common has been the long-term separation in the same house, but another has been the motivation of business owners to pursue a divorce. Anecdotally, we have seen cases in which the plaintiff is an entrepreneurial business owner who has opted to take advantage of the economic downturn to seek a divorce and secure ownership of their company through equitable distribution. Not surprisingly, a good businessperson who can build a successful company can also see the upside to divorcing in a recession: a depressed business value means they can buy-out their spouses interest for less.

A recent article posted by Reuters and reprinted from Entrepreneur.com offers ways to “divorce-proof” a business.

Some of the suggestions make more sense than others under Pennsylvania’s equitable distribution laws, but it makes the point that good business planning does not stop with the business; it should also include contingencies for things like divorce, death, or incapacity. These events should be considered early on in the creation of the business and at the time of marriage.

The best way to keep your business after a divorce is to create a good plan before you get married.

We all know that the world economy is a mess, and if you are getting divorced, chances are your own personal "economy" is a mess as well.  Here are a couple of pointers to protect your credit  during your divorce:

1.  Make a list of all of your joint credit cards, and take the necessary steps to close joint credit cards.  If there is a balance, look into transferring the balance to a credit card with no interest rate on a balance transfer.  Keep your credit card statement as of the date of separation, and keep track of all payments made to the joint credit card.  If possible, have an agreement with your spouse as to how the payments will be made and how a credit will be given in equitable distribution.

2.  Establish your own credit by getting a credit card in your name alone.  If you maintain a low balance (or no balance) in comparision to your credit limit that will help re-establish your credit in the event it was damaged.

3.  Think about what is going to happen to the marital residence.  If both names are on the mortgage, the mortgage will have to be refinanced or the house sold.  It is unlikely if your name is on one mortgage that you will be likely to qualify for another mortgage, which could limit your ability to purchase a new home.

There are many things you can do to protect your credit during a divorce, you just have to know what to do.

Not surprisingly, the two year rule has been coming under fire in Congress with the introduction of legislation by presidential candidate and Minnesota Representative Michele Bachmann, as well as a demand by Senate Finance Committee Chairman Max Baucus that the IRS review the two year deadline.

With respect to divorce, particularly in Pennsylvania where two years of separation is not an uncommon occurrence, people could easily sign a joint tax return as a routine action, without taking the time to carefully review the contents of the filing. Factor in abuse, fear, and intimidation and it is not a surprise that truly "innocent spouses" are being denied the right to raise that defense due to the two year limitation.

For most families, filing joint taxes is a routine affair – seldom is the time when filing under a different designation other than "married filing jointly" place a family in the most advantageous tax position. For couples who are separated, continuing to file jointly may continue to make the most sense.

There are times, however, when one spouse has no knowledge of the family’s financial affairs. If the situation warrants it, that spouse could claim relief from the IRS under the "innocent spouse" rule. This rule is designed to protect taxpayers who should not be responsible for the tax liability incurred by the culpable spouse, even in situation where a joint return was signed by the "innocent spouse."

A recent article, however, highlighted how the IRS has persistently struck down appeals by "innocent spouses" due to their failure to seek relief within two years of their receipt of an IRS tax collection notice. What makes these decisions particularly difficult to accept is that they are being made against battered spouses or other parties who were not in a position to know about the tax liability due to abuse or estrangement from the other spouse.  Consequently, they often do not even know there is a problem before the two year limit lapses.

Following up on Mark Ashton’s “celebrity” themed blog entry on the Los Angeles Dodgers’ ownership, another high profile individual is having a residual effect on divorces: Bernie Madoff.

Mr. Madoff’s crimes are well-documented and high profile. His arrest has given rise to a media niche on scan artists, including Montgomery County’s own “Madoff”, Robert L. Krikorian, who was recently convicted of a Ponzi scheme and sentenced to three to seven years in jail for bilking investors out of (a paltry) $870,500.00 over about four years. If you rip off your investors you are labeled a “Madoff.”

But in being duped, should people get the chance to redo the a Marital Settlement Agreement negotiated and executed years before the fraud was discovered? That is the question being asked in New York where a well-heeled couple split their assets in 2006, including a large investment account with Madoff. Wife pulled her money from the investment, while Husband kept his in. You probably can guess what happens next: Husband’s money gets lost in the Madoff scandal while Wife continues to live well in her Upper East Side apartment.

 

The question before the New York bar is whether Husband can sue to have the Marital Settlement Agreement reopened and the funds Wife retained redistributed to account for his Madoff loses. Sides are being taken in this dispute and many practitioners view a favorable outcome to Husband as having wide reaching implications to contract law and beyond; it calls into question whether a deal is ever really “done.”

 

The crux of Husband’s case rests on the argument that the parties’ Agreement (contract) is nullified by “mutual mistake;” they were both mistaken by the existence of an account with Madoff. It appears that Husband is arguing in that they were both mistaken their belief that they had an account containing millions of dollars with Madoff. – the Madoff fraud proves they, in fact, had no “account” with Madoff. So, even if they had moved $1 million dollars over to Madoff, they really weren’t investing it. Madoff stole just stole it…except for the $6.6 million cash payment Husband swung over to Wife from the account.

 

This case basically sets up the possibility that events subsequent to an agreement could allow for a total reexamination of the deal. Interestingly, we had (have) a national crisis over real estate values (many would argue millions of frauds were committed), yet I am not aware of any parties successfully trying to re-litigate a deal in which they kept the marital residence and off-set its equity value with cash assets. No one is successfully re-litigating their stock holdings that tanked. In my experience, a client and her husband split their stock account when they separated; my client moved her money into cash, while Husband – allegedly a financial guru – keep his in stocks. Two years later, my client has retained most of her money in cash, while husband has lost all of his money to his lifestyle and stock market.  Husband unsuccessfully argued that Wife should bear some of the liability because the assets were marital in nature, but the court held that he was responsible for his portion of the money.

 

In New York, Husband’s case looks, in many respects, as a brazen attempt to capitalize on a highly publicized crime for which neither party had any knowledge or control over. The only control they had was how they decided to invest their individual pieces of the marital estate after the divorce. Wife chose to pull her money out; Husband opted to keep his in. Wife mitigated her risk; Husband appeared to have raised the stakes.

 

After a trial court dismissal, the New York appellate court reached a 3-to-2 decision in favor of Husband’s right to sue to revise the deal based on “mutual mistake.” Whether he will successfully revise the deal remains to be seen.

It was announced on May 24, 2011 that new home sales rose for the second month in a row; a fact that startled many economists. Have we reached the bottom?  No one can be certain but a device from the estate planners portfolio is getting renewed interest and it is one that Domestic Relations lawyers like because it would appear to insulate family members from “increase in value” claims by spouses who are not part of the family.

The devise is called a Qualified Personal Residence Trust.  The purpose from the estate planners viewpoint is to get appreciating residential property out of a person’s estate. Here is how it works.

 

Mr. and Mrs. Warbucks buy a house in Longport NJ in 1970 for $35,000. To quote Billy Joel, they live in Allentown but spend their weekends at the Jersey shore.  Mr. and Mrs. Warbucks are now in their 70s and still enjoy the property but it is mostly a grandchild magnet today.  At the height of the market in 2007, the property was worth $3,000,000 and thus had a $2,930,000 capital gain.  The Warbucks children would like to keep the property after their parents die and pass it along to other family members. 

 

The game with a QPRT is this.  Today, the Longport property would appraise for $2,200,000.  If the Warbucks deed the property into a QPRT, they do so at today’s appraised value and they report that as a gift depending on how long they want the trust to last.  The key is deciding how long the trust should last because if you guess wrong and the grantors die before the trust term expires, the magic of the tax scheme turns into a pumpkin.  But if they are still living when the trust does terminate (typically 5-10 years) any increase in the value of the property is not part of the Warbucks’ taxable estate for federal purposes.  At the end of the trust, the property goes to the trust beneficiaries as owners in fee (i.e., complete owners) subject to the right of the grantors to remain in residence for their lives.  In a world where prices are rising, this is a very efficient tax device.

 

This has a useful divorce device as well.  Many folks with property like the Warbucks tried to do the same thing by turning the house into a partnership and conveying increasing interests to the next generation each year.  This also is tax efficient.  Once an interest is conveyed to the child, the increase in the value of the interest belongs not to the older generation but the new partners.  But, as we saw in a case a couple of years ago, when the second generation couple split up, the daughter in law of the Warbucks laid claim to an increase in value on the partnership interest.  It cost more than $100,000 to buy out the “increase in value” of the partnership interest when the divorce settlement was reached. Did Mr. and Mrs. Warbucks want to give their no good ex daughter in law $100,000 so that their son could settle his divorce case?  Of course not.  But the claim was made and the claim was real.

 

With the QPRT a similar result was achieved but because the son of Mr. and Ms. Warbucks never had a “possessory” interest in the trust assets, it is our impression that any increase in value up to the time the trust terminates would be excluded as property subject to equitable distribution. That probably changes when the interest becomes possessory and there is an interesting question as to whether the property is in possession but subject to a life estate by the grantors.  The leading case on “increase in value” of trusts is Solomon v. Solomon, 611 A.2d 686 (Pa. Supreme 1992).

 

In any event, if your family is in the range of paying federal estate taxes and you have folks with very highly appreciated property, the QPRT is a device worth speaking to an estate planning attorney about.  Because if prices do begin to rise again, this device has a means of seeing the fruit grow in the estate of a new generation.

Many marital settlement agreements contain language that says, in effect, that just because a party does not pursue a contempt action for a breach of the agreement, does not mean they waive their right to enforce the agreement in the future. In other words, just because I don’t take you to Court over your mistake, does not mean I am saying what you did was okay and will let it slide indefinitely.

A recently published Erie County case, however, highlights the fact that both attorneys and parties need to remember that even marital settlement agreements are subject to common law contract principals like statutes of limitations. In the Erie County case, Deeter v. Deeter, 94 Erie 24 (Dec. 17, 2010), the Court considered the issue of whether a party’s breach of the marital settlement agreement was actionable or barred by a four year statute of limitation. In this instance, the Court found that the party had to file an enforcement action within four years of the breach rather than within four years of the execution of the agreement.

This holding reminds parties and practitioners that a Marital Settlement Agreement, Pre-nuptial Agreement, or Ante-nuptial Agreement is, at its essence, a contract that applies contract principles for the enforcement, creation, and interpretation of that contract. Diligence as to the adherence and prosecution of breaches of the agreement are equally important to ensure that both parties to the agreement fulfill their contractual duties. If you are the party to such an agreement and have any questions as to what you’re supposed to do or what the other party is supposed to do under the agreement, consult with an attorney immediately. As the Deeter case demonstrates, if you do not act within four years of the breach, you can eventually lose your right to enforce the terms of the contract.

Each year I get phone calls from clients around the tax filing deadline asking for advice regarding tax filings.  First of all, your attorney likely is not an accountant and certain tax issues need to be discussed directly with an accountant.  However, there are some important things to consider when doing your taxes during a separation and/or divorce proceeding.

The first question is how are you going to be filing – married filing jointly, married filing separately, etc.  If you are still married on the last day of the tax year then you can file married filing jointly.  If you are filing separately, the second question becomes, who will be claiming the children?  Typically, the parent who has the children the majority of the time gets to claim the dependency exemption. However, the court has discretion to allocate the dependency exemption to the non-custodial parent wherein it would result in a higher net income to that party.  Of course, the parties can always agree to share the dependency exemption, and to do so, they would have to fill out, sign, and file the appropriate federal tax form.

It is important to note that if one party’s income is not documented you should be cautious about signing and filing a tax return with that person.  An attorney can prepare an indemnification form to help prevent financial liability, but the Court could possibly hold your spouse to the income reported on the tax return for purposes of support because you signed off on the "income" – meaning your support award could be less.

We recently had an inquiry with respect to the status of common law marriage in Pennsylvania.  The quick answer is that this doctrine was long abandoned in other states but survived in Pennsylvania until this century.  The more correct answer is that common law marriage is still alive in a diminished form and will survive in that form for many years to come.

First, what is a common law marriage?  There are two terms involved.  The common law is defined by statute in Pennsylvania.  It is the law that was in existence at the time America declared its independence in 1776.  The leading source for what was the common law in 1776 is the 1765 four volume compilation by Sir William Blackstone titled Commentaries on the Law of England.  Blackstone’s influence on American law was so great that his Commentaries were published in the United States well into the 20th century.

In 1700 any boy 14 years of age could lawfully marry a girl of 12.  By statute a man who married a girl under 15 without parental consent could be fined or imprisoned.  In the early 18th century another statute was passed that made marriages voidable by parents except where the children were over 21 or parents consented.

Typically marriage involves either a member of the clergy or a public official conducting a ceremony intended to confirm the public assent of the couple being joined in marriage. But a common law marriage was one intended to solemnize marriage for people who were not formally churched or too distant from places where public officials could be found.  It required only the capacity to marry (i.e., sufficient age and mental capacity) and the intent to marry.  Lord Hardwicke’s Marriage Act of 1753 sought to change this and tighten the requirements.  But that Act exempted Jews, Quakers and did not affect colonists in America.

So in America and, particularly in Quaker Pennsylvania, marriage could be recognized whenever the celebrants were of age and expressed words of present intention to be married.  The Philadelphia Yearly Meeting calls these “promises” and they are made by one intended spouse to the other without benefit of clergy.

In America this evolved into acceptance of marriage without clergy and without the requirement of a license or a public ceremony.  As time passed, these common law relationships were often viewed as instruments of fraud.  A woman living with a man who died could step forward and claim a common law marriage and thereby make tort or worker’s compensation claims for the death of her husband.  Over time many states passed legislation abandoning these types of marriage.

Pennsylvania retained this doctrine until 2003 when the Commonwealth Court issued its ruling in PNC Bank Corp. v. Worker’s Compensation Appeal Board (Stamos) 831 A.2d 1269 ( Pa. Commnwlth., 2003).  The ruling was that courts in the commonwealth would no longer recognize marriages formed after the court decision. This was adopted as a statute effective January 2, 2005.

The key is in the language.  If the claim is that the common law marriage was formed before January 2, 2005, the right to assert the marriage exists.

But the standard established in a 1988 Pennsylvania Supreme Court case Staudenmayer v. Staudenmayer, remains quite high.  As Justice Newman wrote in that case, “We have allowed, as a remedial measure, a rebuttable presumption in favor of a common law marriage based on sufficient proof of cohabitation and reputation of marriage where the parties are otherwise disabled from testifying regarding verba in praesenti (words of present intent).  However, where the parties are available to testify regarding verba in praesenti, the burden rests with the party claiming a common law marriage to produce clear and convincing evidence of the exchange of words in the present tense spoken with the purpose of establishing the relationship of husband and wife, in other words, the marriage contract.  In those situations, the rebuttable presumption in favor of a common law marriage upon sufficient proof of constant cohabitation and reputation for marriage, does not arise.” 714 A.2d 1016 (Pa. Supreme 1988).

In a nutshell, unless one of the parties is deceased, proof of a common law marriage does not come from living together or owning bank or brokerage accounts together or even filing tax returns as married individuals.  It does not come from exchange of rings or carrying the intended over the threshold.  It comes from an exchange of vows or other words clearly meant to establish that a couple has assumed the bonds of marriage.  Note also that an invitation to marry or even a plan to marry does not a marriage make.

This is a fact-driven area of the law, and no one should abandon what they think may be a claim of common law marriage without having those facts evaluated by someone familiar with case law that goes back more than a century.  But the quick tests that people think make people married (living together for seven years is the most common one we hear about) do not comport with the state of the law.