THE COMMUNITY PROPERTY DILEMMA
Let’s flesh out the question stated in the title:
In California, a community property state, if a married couple buys an asset during their marriage in which the deed or other legal indication of ownership shows them purchasing as joint tenants (instead of as community property), when one of the spouses subsequently files a Chapter 7 “straight bankruptcy” case is the asset considered joint or community property?
This is a crucial distinction because if that purchased property is community property then the bankruptcy trustee has a right to the non-filing spouse’s interest in the property; if it’s joint property the trustee has no right to the non-filing spouse’s interest.
WHAT IS A “COMMUNITY PROPERTY STATE”?
As a recent California Supreme Court opinion explains:
California is, and always has been, a community property state. “The community property system originated in continental Europe, came to Mexico from Spain, and became California law through the treaty of 1848.” “From the inception of its statehood, California has retained the community property law that predated its admission to the Union and consistently has provided as a general rule that property acquired by spouses during marriage, including earnings, is community property.” “The general theory is that the husband and wife form a sort of partnership, and that property acquired during the marriage by the labor or skill of either belongs to both.”
In re Marriage of Valli (2014) 58 Cal.4th 1396, 1408 (concurring opinion, citations omitted, involving the divorce of the pop singer Frankie Valli).
WHAT DOES CALIFORNIA LAW SPECIFICALLY SAY ABOUT ASSETS ACQUIRED DURING MARRIAGE?
The starting point is a California family law statute stating that
[e]xcept as otherwise provided by statute, all property, real or personal, wherever situated, acquired by a married person during the marriage while domiciled in this state is community property.
According to courts interpreting this statute, it provides what in the law is called a “rebuttable presumption” that an asset acquired during marriage is community property. This means that if there’s strong evidence that the spouses agreed to hold the asset as joint property instead of community property, that evidence could overcome the presumption in favor of community property. The question is what evidence would be strong enough to overcome this presumption.
SO, SPOUSES CAN PURCHASE PROPERTY SO THAT IT’S NOT COMMUNITY PROPERTY?
Right. Another statute in the California Family Code says simply that “[s]pouses may hold property as joint tenants or tenants in common, or as community property, or as community property with a right of survivorship.” Cal.Family Code § 750 . Another section of California statute provides that a joint tenancy ” is “one owned by two or more persons in equal shares, by a title created by a . . . transfer, when expressly declared in the . . . transfer to be a joint tenancy. . . .” So it seems clear that spouses can agree during their marriage to take title to an asset as joint property instead of community property.
IN CALIFORNIA HOW WOULD THE ASSET PURCHASED DURING THE MARRIAGE BE CHARACTERIZED IF THE DEED OR OTHER OWNERSHIP DOCUMENT STATES THAT THE PURCHASED ASSET IS HELD JOINTLY?
Different community property states (there are 9 or 10 of them, depending on how you count them) answer this question, and many other community property questions, quite differently. (See, for example, this summary by the IRS of some of the main differences—refer to the exhibit at the end.) In some states there’s a presumption in favor of the acquired asset being community property in spite of what is said in the deed/ownership document. But in California the purchased asset is refutably presumed to be a joint tenancy. “A declaration in a deed or other title instrument that the parties take the subject property as joint tenants raises a presumption that the married couple intended to take title in joint tenancy.” Rhoads v. Jordan (In re Rhoads), 130 B.R. 565, 567 (Bankr.C.D.Cal.1991) (citation omitted).
So, there’s a presumption that a purchased asset would be community property, which can be overcome if the deed or ownership document clearly states the asset is owned jointly (instead of as community property). So that shifts the presumption in favor of joint ownership. So what other factors would make the asset one type of ownership or the other?
DOES THE SOURCE OF THE FUNDS USED TO PURCHASE THE ASSET DETERMINE WHETHER THE PURCHASED PROPERTY BECOMES COMMUNITY OR JOINT PROPERTY?
Usually an asset acquired with community property becomes community property. But there is at least a good argument that when spouses use community funds to buy an asset but clearly state that the title to the asset is to be held as joint property, the title controls. “The presumption that the title reflects the parties’ intent cannot be overcome simply by evidence of the source of the funds used to purchase the property.” Hanf v. Summers (In re Summers), 278 B.R. 808, 812 (9th Cir. BAP 2002).
WHAT OTHER FACTORS ARE IMPORTANT?
There is another potentially important statute which refers to other factors that may determine whether a purchased asset would be community or joint property, the so-called California “transmutation” statute.
That statute was explained as follows by the California Supreme Court in its unanimous Valli opinion cited above:
Married persons may, through a transfer or an agreement, transmute — that is, change — the character of property from community to separate or from separate to community. (Fam. Code, § 850.) A transmutation of property, however, “is not valid unless made in writing by an express declaration that is made, joined in, consented to, or accepted by the spouse whose interest in the property is adversely affected.” (Id., § 852, subd. (a).) To satisfy the requirement of an “express declaration,” a writing signed by the adversely affected spouse must expressly state that the character or ownership of the property at issue is being changed.
So the factual consideration that flows from this “transmutation” statute is whether the purchase documents, deed and/or other ownership documents involving the acquired asset at issue includes an “express declaration” that the asset is indeed intended to be held as joint instead of community property.
WHAT’S THE POINT OF THE CALIFORNIA “TRANSMUTATION” STATUTE?’
The state Supreme Court, again in the Valli ruling, said that the
. . . [state] Legislature adopted the statutory transmutation requirements in 1984 upon a recommendation of the California Law Revision Commission. [The Commission] observed that under then existing law it was “`quite easy for spouses to transmute both real and personal property'” because a transmutation could be proved by evidence of an oral agreement between the spouses or by “`implications from the conduct of the spouses.'” This “`rule of easy transmutation … generated extensive litigation in dissolution proceedings'” where it encouraged spouses “`to transform a passing comment into an “agreement” or even to commit perjury by manufacturing an oral or implied transmutation.'” (Ibid.) As this court has concluded, therefore, in adopting the statutory transmutation requirements the Legislature intended “to remedy problems which arose when courts found transmutations on the basis of evidence the Legislature considered unreliable.”
So the point of the “transmutation” statute is to require spouses to go through clearer formalities in order to change the character of their assets from community to separate, or vice versa.
BUT DOES THE “TRANSMUTATION” STATUTE APPLY TO TRANSFERS TO SPOUSES FROM THIRD PARTIES?
The “transmutation” statute itself (Cal. Family Code § 852(a)) seems to directly refer only to interspousal transfers between married persons. It lays out three different kinds of “transmutations,” allowing married persons to:
(a) Transmute community property to separate property of either spouse.
(b) Transmute separate property of either spouse to community property.
(c) Transmute separate property of one spouse to separate property of the other spouse.
The statute does not refer—at least directly—to purchases by married couples from a third parties. So is such a purchase a “transmutation” requiring compliance with its “express declaration” and/or other conditions?
A dozen years ago the federal Ninth Circuit Court of Appeals said “no” in an opinion involving a Chapter 7 case filed in California. (The rulings of this Court of Appeals are binding on bankruptcy courts in California and 8 other western states.) The court reviewed the pertinent California statutes and court opinions and concluded:
California courts have applied the [“transmutation” statute] solely in the context of interspousal transactions.
. . .
Our reading of California law leads to the conclusion that the transmutation requisites had no relevance to the conveyance in this case. There simply was no interspousal transaction requiring satisfaction of the statutory formalities.
In re Summers (9th Cir. 2003) 332 F. 3d 1240, 1245.
However, the Valli California Supreme Court opinion referred to above seems to have subsequently overturned this conclusion about California law. The state Supreme Court took great pains to debunk the argument that the “transmutation” statute should apply only to interspousal transfers and not to assets acquired from third parties by one of the spouses. The Supreme Court said:
The distinction that wife here urges us to draw between interspousal property transactions (which are subject to the transmutation statutes) and property acquisitions from third parties (which would not be subject to those statutes even when it has the claimed effect of changing community property funds to a separate property asset or vice versa) bears no relation to these legislative concerns [about the purpose of the transmutation statute], and it produces arbitrary and irrational results that the Legislature could not have intended.
Valli, 58 Cal.4th 1396, 1401.
The state Supreme Court rejected this argument against applying the “transmutation” statute to marital purchases from third parties, and did so in part by directly addressing and rejecting the Ninth Circuit Court of Appeal’s Summers conclusions cited above:
In re Summers is “not persuasive insofar as [it] purport[s] to exempt from the transmutation requirements purchases made by one or both spouses from a third party during the marriage. [It does not attempt] to reconcile such an exemption with the legislative purposes in enacting those requirements, which was to reduce excessive litigation, introduction of unreliable evidence, and incentives for perjury in marital dissolution proceedings involving disputes regarding the characterization of property. Nor does [the Summers] decision attempt to find a basis for the purported exemption in the language of the applicable transmutation statutes. Also, these decisions are inconsistent with three Court of Appeal decisions stating or holding that the transmutation requirements apply to one spouse’s purchases from a third party during the marriage. . . . .
Our examination of the statutory language leads us to reject the purported exemption for spousal purchases from third parties.
Valli, at 1405 (citations omitted).
BUT CAN A FEDERAL COURT BE OVERRULED BY A STATE COURT?
Yes, a state supreme court can trump a federal court of appeals as to the interpretation of that state’s laws. And as the Ninth Circuit Court of Appeals itself quoted in Summers, “[i]t is well established that state law determines the nature and extent of a debtor’s interest in property.” Summers, at 1242 (citations and internal quotation marks omitted). Throughout that opinion it cited California Supreme Court and Court of Appeal rulings (as well as some bankruptcy ones) to try to interpret California law. In the end the state Supreme Court is the final arbiter of California law (other than the U. S. Supreme Court in appropriate situations).
FINALLY, IS THERE SUPPORT FOR THE ARGUMENT THAT THE “TRANSMUTATION” STATUTE DOES NOT APPLY IN A BANKRUPTCY CASE AS TO THE RIGHTS OF THE BANKRUPTCY TRUSTEE, OUTSIDE THE DIVORCE CONTEXT?
The issue presented at the beginning of this blog post did not involve a divorce, but rather the rights to marital property between the spouse not filing bankruptcy and the filing spouse’s bankruptcy trustee. Given that the “transmutation” statute was intended to protect spouses from each other, it doesn’t seem to meet that purpose in this bankruptcy context. That statute is part of California’s family law—i.e., divorce law—and so arguably should not apply in adjudicating the rights of a married spouse and his or her spouse’s trustee (and creditors). Also, the “transmutation” statute involves community versus separate property whereas in the bankruptcy context juxtaposes community vs. joint property. Also the non-divorce bankruptcy context presents an entirely different set of public policy and statutory considerations than all the divorce-related considerations that the “transmutation” statute was designed for.
The California Supreme Court in Valli expressly acknowledged that the Ninth Circuit Summers opinion “was a bankruptcy proceeding rather than a marital dissolution proceeding.” Yet in the midst of it criticizing of the Summers opinion, the Valli court fails to clear any of its own three hurdles.
First, the Supreme Court fails to consider that the Summers non-divorce bankruptcy context is not served by “the legislative purposes in enacting those [transmutation] requirements, which was to reduce excessive litigation, introduction of unreliable evidence, and incentives for perjury in marital dissolution proceedings involving disputes regarding the characterization of property.” If the “transmutation” statute was intended to serve these purposes, these purposes do not apply to the non-divorce bankruptcy context and so the statute ought not extend to that context.
Second, the Supreme Court fails to consider and acknowledge that there is “a basis for the purported exemption in the language of the applicable transmutation statutes” in that the statute makes absolutely no reference to marital purchases from third parties but only to interspousal transfers. There is certainly nothing in the statute that says that this statute designed to protect spouses in divorce ought also to be applied to the rights between a bankruptcy trustee and a non-filing spouse.
Third, contrary to the state Supreme Court’s opinion, the three opinions it cites as being inconsistent with Summers are all about one spouse’s purchases from a third party, not about both spouses’ purchase of a property jointly as in Summers. Also, these decisions do not directly address whether the “transmutation” statute applies to this context, but at best only assume so.
The bottom line is that whether the “transmutation” statute ought to apply to the non-divorce bankruptcy context is an interesting and apparently open question, not satisfactorily answered by the California Supreme Court in the Valli opinion.