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Divorce and Family Law

“Do I Need a Prenuptial Agreement?”: Preventing Marital Claims Against Separate Property

Premarital agreements allow spouses to modify or “opt out” of the application of Arizona community property law. They can be used to define both spouses’ rights and responsibilities in the event of a death or divorce

Done correctly, prenuptial agreements ˗ also known as antenuptial agreements or, in Arizona, premarital agreements ˗ are enforceable contracts between prospective spouses that become effective upon marriage. Such agreements are governed by the Arizona Uniform Premarital Agreement Act.[1]

Premarital agreements allow spouses to modify or “opt out” of the application of Arizona community property law. They can be used to define both spouses’ rights and responsibilities in the event of a death or divorce that occurs after the date of the marriage. The use of premarital agreements in conjunction with estate planning is discussed in another article. This article will focus on the necessity and use of premarital agreements in the context of a future divorce.

First, what cannot be controlled by a premarital agreement? Such agreements cannot include terms governing legal decision-making (child custody), parenting time (visitation), or child support. Any provisions purporting to define these issues in the event of a divorce are unenforceable.

That leaves property (assets), debts (obligations), and spousal maintenance (alimony) as appropriate subject matter for a premarital agreement. The full permissible scope of a premarital agreement is defined in A.R.S. § 25-203.

To determine whether a premarital agreement might be appropriate, it is first necessary to understand Arizona community property law that would apply, if the spouses decide to divorce, in the absence of such an agreement:

  1. All property owned by either spouse prior to marriage is that spouse’s sole and separate property. However, separate property that is commingled with community property and becomes untraceable could be determined to be community property.

  2. All property acquired by either party after their date of marriage, except as a result of gift or inheritance, would be presumed to be community property.

  3. The spouses’ respective salaries and other compensation for their labor during their marriage would be community property.

  4. Each spouse would own a one-half (1/2) community interest in all property acquired by either party as a result of efforts expended during the marriage.

  5. The increase in value of one spouse’s sole and separate property during the marriage could be either community property or separate property, depending upon whether the increase in value is the result of the individual efforts of a spouse, contributions of sums earned during the marriage, or the inherent qualities of the separate property itself. Upon divorce, such increase in value may be apportioned between the spouses by the Court.

  6. Upon divorce, A.R.S. § 25-318 requires that community, joint and common property must be divided “equitably,” which almost always means “equally.”

  7. Either party would be entitled to claim that he or she should be awarded spousal maintenance pursuant to A.R.S. § 25-319.

A premarital agreement allows the parties to avoid application of the foregoing community property principles and to define by agreement how their property and debts will be apportioned and allocated upon divorce. This is particularly important when one spouse owned significant separate property prior to the marriage. For example, in the absence of a premarital agreement, resolution of the following issues in a divorce case can result in significant expense, both in legal fees and expert fees:

  • Apportioning the equity in a residence that one spouse owned prior to marriage but both parties lived in during the marriage.

  • Apportioning the value of a business owned by one spouse prior to marriage and operated by one or both spouses during the marriage.

  • Resolving one spouse’s entitlement to, and the amount and duration of, spousal maintenance.

Of course, there are many other issues that arise during a divorce case that could be addressed and prevented with a valid premarital agreement, but the foregoing issues are often the most difficult to resolve and can be complicated and expensive, as demonstrated by the following examples.

Dividing Equity in a Sole and Separate Residence

Any property owned by one spouse prior to the marriage is the sole and separate property of that spouse. Upon divorce, all sole and separate property must be awarded to the owner-spouse. However, that does not prevent the other spouse from claiming a financial interest (as opposed to an ownership interest) in the property. Consider the following example:

Wife, while single, purchased a home in 1990 for $500,000 with a down payment of $50,000 and a mortgage of $450,000. Wife and Husband married in 2000, by which time the mortgage had been reduced to $365,000 and the home had increased in value to $550,000. The parties divorced in 2010, and by that time the mortgage had been further reduced to $225,000 and the home had increased in value to $600,000, thus creating total equity of $375,000. Because Wife purchased the home before marriage, she is entitled to all of the equity, right? Not so fast.

The income used to pay down the mortgage from 2000 (date of marriage) to 2010 (date of divorce) was derived from the work efforts of at least one of the spouses. (It doesn’t matter if the income was from the employment efforts of Wife, Husband or both – all such income earned during the marriage is community property.) Therefore, the marital community contributed $140,000 toward reduction of the mortgage principal balance ($365,000 minus $225,000). Thus, Husband is entitled to his one-half community property share, or $70,000 of the equity.

But wait. Not only is the marital community entitled to a return of its contributions to the mortgage principal reduction; Arizona law also allows the marital community to share proportionately in the increase in value of Wife’s sole and separate property that occurred during the marriage – in this case $50,000 from 2000 (date of marriage) to 2010 (date of divorce). The formula[2] is: C+[C/B x A], where:

A = Appreciation During Marriage ($50,000)

B = Value as of Date of Marriage ($550,000)

C = Marital Community’s Contributions to Principal ($140,000)

This results in the following calculation: $140,000 + [$140,000/$550,000 x $50,000] = $152,727. This is the value of the marital community’s lien on the equity in Wife’s sole and separate residence. In other words, the marital community is entitled to a return of the $140,000 mortgage principal reduction during the marriage, plus $12,727 of the $50,000 increase in value that occurred during the marriage. In this example, Husband’s share of the equity is $76,364, not just $70,000.

The foregoing example is complicated enough, and it requires an expenditure of attorney’s fees to obtain and review the relevant documents to ascertain the appropriate values for the formula and prepare the calculations. Imagine if there have been several refinances throughout the marriage, including additional down payments and/or withdrawals of equity. The calculation (and work required) becomes exponentially more complicated and expensive, and, if all of the pertinent documents cannot be located, it could result in the inability to even prepare a proper calculation.

A properly drafted premarital agreement can eliminate the need for such work, with language clearly stating the intention of the parties, such as:

“From time to time throughout their marriage the parties may reside together in one of the party’s sole and separate property residence. Such cohabitation shall not signify or create any right, title, lien or any interest whatsoever for the non-owning party in the other party’s sole and separate property. Any contributions by one party to the mortgage or other encumbrances, utilities, homeowner’s association dues, homeowner’s insurance, maintenance, upkeep, repairs, improvements and any other costs or expenses associated with the other party’s residence shall be deemed a gift, and the non-owning party shall have no right to claim reimbursement for such expenditures, nor shall any community or separate lien against the separate property, including any increase in value, be created.”

Apportioning Value of a Sole and Separate Business

Assume that Husband owns a business that manufactures, sells and distributes widgets. He took over the business from his father, who started the business in 1970. Husband has been operating the business since 1990. Husband married Wife in 2000, after working hard to grow and build the business for the preceding ten years. Husband continued to operate the business during the parties’ marriage, and he continued to operate the business after the parties decided to divorce in 2010.

The business remains Husband’s sole and separate property because he owned it prior to marriage, and therefore he will be awarded ownership of the business upon divorce. However, Wife asserts that the marital community has a financial interest (as opposed to an ownership interest) in the business because it has grown, and presumably increased in value, during the marriage. Wife may be right.

To determine whether Wife has a valid claim, first the business must be valued as of the date of divorce. This will require the involvement of a business valuation expert. Depending on the nature of the business, the cost of the valuation may be a few thousand dollars to tens of thousands of dollars, plus attorney’s fees related to coordinating the valuation. If the parties agree on a valuation expert, and if both parties agree on the value determined by the expert, this can still be very expensive. If either or both parties disagree with the valuation of a jointly retained expert, each party may then hire his/her own expert, thus doubling or tripling the cost of the valuation. This type of valuation is required to divide any community property business, i.e., a business that was started during the parties’ marriage.

For a separate-property business started by one party before the marriage, the expert will also have to value the business as of the date of marriage, adding time and expense to the process. Assume that, after all of this, the expert determines that the business was valued at $600,000 at the time of marriage, and $1 million at the time of divorce. How does the Court apportion the $400,000 increase in value during the marriage while Husband continued to operate the business?

Arizona has rejected the “all or none” rule whereby the increase in value was allocated either 100% to the separate property of the owner spouse or 100% to the marital community.[3] Instead, the increase in value must be apportioned between community property (the increase attributable to the efforts of the spouse) and separate property (the increase attributable to the inherent nature of the business). Depending on the case, apportionment approaches may include:

  • determining the reasonable value of the community's services, allocate that amount to the community, and treat the balance as separate property attributable to the inherent nature of the separate estate; or

  • allocating to the separate property a reasonable rate of return on the original capital investment, with any increase above that amount being community property.

This type of apportionment can be highly subjective, and it can promote, rather than eliminate, disputes between the parties. This can result in substantially higher expert fees and attorney’s fees as the parties review expert reports, take depositions of each party’s expert witness, and prepare for and conduct a trial to the Court.

A properly drafted premarital agreement can eliminate the need for such work by providing language that clearly states the intention of the parties, such as:

“All earnings from, or increases in the value of, the property identified as one party’s sole and separate property, regardless of whether such earnings or increases in value are the result of either party’s individual efforts, toil or labor, or the inherent qualities or characteristics of the property, shall remain that party’s sole and separate property. The intent is that each party is waiving any claim of community property, community lien, profits, distributions or increase in value of the other party’s sole and separate property that he/she might otherwise have pursuant to the theories, rationales and holdings in Arizona law recognizing such claims.”

Litigating the Spousal Maintenance Claim

Resolving a claim for spousal maintenance, or alimony, is often the most difficult issue in a divorce case. Unlike child support, there is no formula used to calculate spousal maintenance. If the same facts were presented to ten different judges, there would be ten different rulings, which would likely vary widely in both the amount and duration of the spousal maintenance award.

The uncertainty surrounding spousal maintenance awards impedes settlement of this issue and can substantially increase litigation expenses. For self-employed spouses, even determining his or her true income can become difficult and laborious, sometimes requiring the services of a financial expert. In many cases, there is a dispute over one spouse’s “earning capacity,” which can require the services of a vocational evaluation expert.

Premarital agreements can resolve spousal maintenance claims in advance, thereby significantly reducing attorney’s fees, and possibly expert witness fees, incurred in reaching a settlement of the divorce case. A valid premarital agreement can eliminate spousal maintenance for either party, provided that the elimination of spousal maintenance does not render the person “eligible for support under a program of public assistance at the time of separation or marital dissolution.”[4] Alternatively, rather than eliminate spousal maintenance entirely, many premarital agreements define each spouse’s rights and obligations to receive and pay spousal maintenance, thereby eliminating the costs attendant to resolving such disputes as part of the divorce case. Some examples include:

  • Establishing a baseline monthly amount that vests after one year of marriage and increases for each year of marriage.

  • Eliminating spousal maintenance per se but requiring a lump sum, non-taxable property settlement payment that increases for each year of marriage.

A properly drafted premarital agreement can eliminate expensive and often contentious negotiation and litigation to resolve spousal maintenance claims; it can also ensure that both spouses can survive financially after a divorce.

Conclusion

The goal of a premarital agreement is not to plan for a failed marriage; rather, it is to eliminate significant stress and expense that can arise in resolving complicated issues in the event the parties do decide to divorce.

The examples cited in this article are some of the more complex and expensive issues that can be addressed in a valid premarital agreement, but such agreements can cover a much broader range of issues involving division of property and debts as part of a divorce case.

When it comes to premarital agreements, the adage holds true: An ounce of prevention is worth a pound of cure.

 

[1] A.R.S. §25-201 to § 25-205.

[2] Barnett v. Jedynak, 219 Ariz. 550, 200 P.3d 1047 (Ct. App. 2009).

[3] Cockrill v. Cockrill, 124 Ariz. 50, 601 P.2d 1334 (1979).

[4] A.R.S. §25-202(D).

 
          

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