HOW TO OBTAIN THE BENEFITS OF A PRE-NUPTIAL AGREEMENT WITHOUT EVER SIGNING ONE
By John M. Mulligan,
Attorney at Law
Copyright © 2011 by John M. Mulligan
INTRODUCTION
As an attorney who represents clients in divorce cases, I am frequently struck by how many problems my clients could have avoided if they had signed a prenuptial agreement.[1]
Prenuptial agreements are often vital prior to a marriage. This is particularly true if (i) there is an imbalance of assets between the two parties, (ii) an imbalance of assets between the families of the two parties, (iii) known factors which cause the marriage to be at a high risk of success in the estimation of at least one party, or (iv) one or more of the parties is adverse to the risk of litigation due to its high emotional and financial cost (likely having been through the divorce process once before).
One enormous problem with prenuptial agreements between younger couples is that it is emotionally challenging to raise the subject and accomplish the signing of the agreement without risk of damage to the relationship. When people enter into a marriage based on selfless love and with an expectation of a lifelong partnership, those expectations will likely be jarred by a document that appears to be divorce planning on the part of one party, and dwells largely on asset protection, which inevitably appears selfish in nature. This emotional component may be reduced for parties marrying later in life, who may each have their own separate assets and their own separate heirs, but in my experience the emotional response never goes away completely.
Therefore, a quandary appears. Is it worth it to bring up the subject prior to the marriage, knowing that the process is likely going to be an unforgettable trip through an emotional wringer, and possibly risk the end of the relationship?
The answer is that a well-drafted prenuptial agreement given careful attention by both sides well in advance of the marriage is always best, if one or both of the parties think it is necessary. If that outcome is not possible, then one could consider getting married without a prenuptial agreement and instead, planning carefully to obtain as many possible benefits of having a pre-nup without ever negotiating or signing one.
With a bit of care, and depending upon the type of assets one has, it can be possible to obtain most of the benefits of having a pre-nuptial agreement without signing one. The purpose of this essay is to explain the principles of Minnesota law that govern division of property in divorces, and to explain how to arrange your affairs with different types of assets to minimize having to share them in the event of a divorce.
Note: This essay focuses on only a divorce outcome, and the same principles do not apply in the event of death of one of the parties. In fact, with regard to the scenario of one party dying during the marriage, it is almost impossible to obtain the benefits a pre-nuptial agreement provides regarding protecting assets without actually entering into a valid agreement.
SUMMARY OF BASIC PRINCIPLES
Here are the basic principles of Minnesota law that should guide your creation and management of financial assets:
- A party getting divorced is not required to share non-martial property, except in hardship cases;
- Non-marital property includes property given to one party during the marriage (but not given jointly to both parties) by way of gift or inheritance;
- Non-marital property also includes property a party had prior to their marriage, including assets that have changed form, subject to the requirements of the paragraphs below;
- A party who wants to claim that certain property is non-marital in character has the burden of proof to trace the property (by using documents primarily) from its original form to its present form;
- Income from non-marital property earned during the marriage is, however, always marital in nature and the accrued income in the form of an asset that still exists at the time of the marriage has to be shared;
- Adding income back into principal (i.e., a typical reinvestment practice) is called “commingling”, and after a period of time makes it difficult or impossible to distinguish between non-marital and marital property. It is considered “tainted” or “commingled” and without clear proof, the courts will consider it all marital property, and divide it.
RECOMMENDATIONS REGARDING FINANCIAL ASSETS
Therefore, a party with non-marital financial assets, or a party who is receiving non-marital assets during the marriage, and who wants to keep assets non-martial, should do the following:
Set Up Sweep Accounts. One or more new separate accounts reflecting gifts, inheritances, or other non-marital property should be set up to “sweep” all income from the assets into a new separate account that holds income only (“the Income Account”). Income earned on the Income Account can be reinvested (commingled) because the second account will hold only income (and therefore non-marital property). A party can use this account to spend on extraordinary expenses, if need be. The account containing the non-marital assets should contain principal only (“the Principal Account”). If possible, use those names on the account, or some other way to distinguish the accounts.
Make Sure Income is Regularly Swept out of Principal Accounts. The sweep can be done at any period of time that is convenient for the brokerage firm or the institution holding the funds. Monthly would be good, but quarterly or annually would be acceptable, so long as it is always possible to identify the difference between the original principal, and the earned income derived from that principal.
Save All Bank Statements. Arrange for different statements for the Income Account and any Principal Accounts to be sent monthly, and for the 1099 for the accounts to be sent at year end. Consider having the statements sent to two different addresses. Save the statements.
Recommendations Regarding Preservation of Records. If possible, the records on accounts with non-marital assets for the period of time of the marriage should be preserved in either hard copy or electronic form so that it is possible to reconstruct what was income and what was principal from the time of the marriage up until it is time to calculate what is marital or non-marital in any divorce case. Keeping a duplicate set of records outside the homestead to ensure access regardless of circumstances is a prudent measure.
RECOMMENDATIONS REGARDING REAL ESTATE ASSETS
Overall View. The most common form of real estate ownership is ownership of the homestead, which is the primary resident of the parties to a marriage. If the parties used joint assets, such as a savings account, for any down payment required, and then obtain a mortgage and begin making payments of mortgage installments over time, the result will always be that the homestead is marital property, and subject to equal division in the event of a divorce. Absent a pre-nuptial agreement, it does not make any difference that one party worked and the other did not during the marriage, because all earned income is marital in nature. It does not make any difference that one party actually paid the monthly mortgage installment, if the payment was coming out of earnings.
The Down Payment. The most common form of non-marital claim relating to homesteads derives from the down payment for the house. If a party uses his/her separate non-marital funds acquired prior to the marriage, or if a party obtains a gift from his/her parents for the down payment, that portion of the value of the property will remain non-marital in nature, assuming a party can produce the documents to prove the source of the funds. In addition, Minnesota courts use a formula to divide the equity which allocates part of the overall value to the non-marital portion in proportion to the total equity, so it becomes critical to retain records of the property purchase as well as the source of the financing involved.
Adding a Spouse to Title. A typical scenario is that one party owns property prior to the marriage, and following marriage, a request is made that the new spouse be added to the title to the property. This is an act of tremendous legal significance, and an attorney should be consulted as to the consequences of taking this step. As a general rule, adding a spouse to title will be interpreted as an intent to make the property marital in nature, and is viewed by courts as a gift of a half ownership interest in the property. This result can be avoided by either resisting the creation of joint ownership, or by entering into a legally binding Post-Nuptial Agreement, for which you will need to involve an attorney to represent each party.
Remodeling Expenses. If parties re-finance their home to pay for a home improvement, it can complicate the calculation of marital and non-marital shares. If the parties do not obtain new financing for a remodeling project, the most important question is “where did the money come from?” If the parties used a gift from a parent, or if they used separate non-marital assets for the improvement, the non-marital nature of the funds can be preserved with the retention of proper records. The construction contracts and any receipts should be preserved. It is rare that any home improvement provides a dollar-for dollar increase in fair market value equivalent to the amount spent. To determine the value provided, at the time of a divorce, an appraisal will be done as to the market value, and also a sub-appraisal as to the value provided attributable to the home improvements if a party is making a claim that the improvements are non-marital in nature. In any event, records of the source and use of the funds should be preserved. If the parties obtain financing for a home improvement, and then pay it off over time from marital income sources, the resulting fair market value of the improvements will be considered marital in nature.
Rolling Over Equity Into a Subsequent Home. It is not uncommon that in marriages of longer duration, the parties accrue equity in one homestead, and then use it for the purchase of another homestead. It is possible to trace an original non-marital equity share into one or more replacement houses, but it is an accounting exercise, and retaining (or being able to find) all the documents from the various loan transactions is essential. Again, the courts will use an acknowledged a formula to calculate the allocation between the marital and non-marital interests.
Lump Sum Payments Towards Principal. It is not uncommon for parties having a homestead mortgage to make a lump sum payment to pay down the mortgage principal, particularly if there is a significant event in their life such as an inheritance, a sizable gift of cash from a relative, or liquidation of another asset, which could include a non-marital asset. Making a lump sum pay down of a homestead mortgage, either as part of a mortgage re-financing or even without re-financing, provides the benefit of having more of each installment payment go towards principal reduction, rather than just paying interest. However, this too is an act of tremendous legal significance; a lump sum payment from non-marital sources towards a joint obligation on a joint asset will likely be interpreted by the courts as a gift to one’s spouse. The best alternative is to undertake a written Post-Nuptial Agreement if this type of transaction is contemplated.
[1] A prenuptial agreement is often referred to as an “ante-nuptial agreement” or a “pre-nup”. Others and I use the terms interchangeably, but they all mean the same thing.