BRACE YOURSELVES FOR SUMMER’S PASSING

Share this post

Share on facebook
Share on twitter
Share on linkedin
Fall Colors

Ahh, summer in Vegas. When venturing outside during the day is an act of courage, and you find yourself asking Alexa for the melting point of the soles of your sneakers.

And yet each year as the days grow shorter and the temperatures drop back into the zone of sanity, I mourn summer’s passing. But I digress, because this year, summer is spelled with a capital “S,” and I mourn the passing of Hanf v. Summers (In re Summers), 332 F.3d 1240 (9th Cir. 2003).

Summers has been the pole star of community property issues in bankruptcy for almost two decades. But, the California Supreme Court’s recent decision on the character of real property acquired by a married couple as joint tenants in In re Clifford Allen Brace, Jr. impliedly overruled Summers, although Summers is never mentioned.

In Summers, the Ninth Circuit had held that under California law, the community property presumption of California Family Code (“Cal. Fam. Code”) §760 was rebutted when a married couple acquired property from a third party as joint tenants. It went on that the written transmutation requirements of Cal. Fam. Code §852(a) applied only to interspousal transactions and not to transactions whereby a married couple acquires property from a third party.

Summers provided creative bankruptcy attorneys in community property states with some good planning opportunities for spouses holding property as joint tenants.

That is because where property is jointly owned, 11 U.S.C. §§ 363(h) and (j) allow a bankruptcy trustee to sell the property under certain circumstances, with the proceeds apportioned between the bankruptcy estate and non-debtor joint owners.

But where property is treated as community property instead of joint tenancy property, it can also be sold by the bankruptcy trustee, however in that case, instead of the non-debtor joint owners getting their share of the sales proceeds, all of the sales proceeds are distributed by the bankruptcy trustee to creditors under 11 U.S.C. §726(c).

That’s because 11 U.S.C. §541 provides that all of a couples’s community property is part of the bankruptcy estate, even if only one spouse files. Check out my colleague Cathy Moran’s website for a good discussion on this topic here.

What Became of Summers

In 2014 the California Supreme Court decided In re Marriage of Valli, 58 Cal. 4th 1396 (2014). That case stemmed from the divorce of Frankie Valli of Four Seasons fame, a fact that didn’t dawn on me until the night before I was preparing for oral argument to the Ninth Circuit as amicus curiae for the National Association of Consumer Bankruptcy Attorneys and National Consumer Bankruptcy Rights Center in the Brace appeal (keep reading). You can watch that oral argument here. Fear not, as I refrained from belting out a chorus of Bye Bye Baby, although it did cross my mind.

The Valli facts were relatively straightforward. Frankie Valli bought a life insurance policy on his life, naming his wife as the sole owner and beneficiary. Policy premiums were paid with community property funds from a joint bank account.

Held: the insurance policy was not transmuted to separate property with the necessary express declaration. The California Supreme Court held the life insurance policy was community property upon the Vallis’ marital dissolution.

The open question was whether this analysis would apply in the outside of marital dissolution – in other words, as between spouses and their creditors (and bankruptcy trustees).

Brace Answers The Question

The California Supreme Court’s decision in Brace is long, dense, and not for the faint of heart. But worth reading for anyone interested in an excellent in-depth historical analysis of community property laws in California dating back to 1850.

The Brace facts and procedural history are complicated. In summary, the Braces are a married couple that acquired real properties during their marriage and took title to each property as “husband and wife as joint tenants.”

Brace in Bankruptcy Court

After some questionable transfers of that property Mr. Brace filed a voluntary Chapter 7. The bankruptcy Trustee filed an adversary proceeding against Mr. Brace and his non-debtor spouse seeking in part: (1) a declaration that certain real properties (the “Properties”) were property of the bankruptcy estate; (2) a judgment quieting title to the Properties in the bankruptcy estate; (3) turnover of any of the Properties determined to be property of the bankruptcy estate.

Following a trial, the bankruptcy court ruled in favor of the bankruptcy Trustee, and held that the Properties were part of the bankruptcy estate in their entireties. In so ruling, the bankruptcy court rejected the Braces’ defense that, many years earlier, they had orally transmuted the property from community property to separate property.

The Braces’ timely moved for reconsideration and to amend the judgment, arguing that the Properties were not part of the bankruptcy estate in their entireties. The Braces argued that, under Summers, only the Debtor’s one-half interest in each of the Properties should be included as part of the estate since joint tenancies between spouses were the separate property of each spouse.

The bankruptcy court disagreed and found the Properties were acquired by Mr. Brace and his non-debtor spouse with community assets during their marriage , and thus presumptively community property under applicable law. The bankruptcy court also found the Braces failed to rebut that “community presumption,” and consequently found the Properties were community property included in the bankruptcy estate pursuant to 11 U.S.C. §541 and subject to administration by the bankruptcy Trustee.

Brace At The BAP

The Braces appealed to the Ninth Circuit Bankruptcy Appellate Panel (“BAP”), where they argued the Properties were held separately, and the bankruptcy court erred by applying the community property presumption of Cal. Fam. Code § 760, rather than the record title presumption of Cal. Evid. Code §662. Although the Braces urged the BAP to find that only the Debtor’s separate interest in the Properties was recoverable by the bankruptcy Trustee, the BAP rejected the argument and affirmed the bankruptcy court in a published opinion on March 15, 2017.

Brace At The 9th Circuit

The Braces appealed again, this time to the Ninth Circuit (hence my amicus curiae argument), which certified the following question to the California Supreme Court in a published opinion:

“Does the form of title presumption set forth in section 662 of the California Evidence Code overcome the community property presumption set forth in section 760 of the California Family Code in Chapter 7 bankruptcy cases where: (1) the debtor husband and non-debtor wife acquire property from a third party as joint tenants; (2) the deed to that property conveys the property at issue to the debtor husband and non-debtor wife as joint tenants; and (3) the interests of the debtor and non-debtor spouse are aligned against the trustee of the bankruptcy estate?”

Brace for Impact

The California Supreme Court answered, holding that Cal. Evid. Code §662 does not apply when it conflicts with the Cal. Fam. Code § 760 community property presumption, and further held:

            1.         When a married couple uses community funds to acquire property with joint tenancy title on or after January 1, 1975, the property is presumptively community property under Cal. Fam. Code § 760 in a dispute between the couple and a bankruptcy trustee.

            2.         For property purchased before January 1, 1975, the Legislature left intact a presumption that separate property interests arise from joint tenancy title.

            3.         Joint tenancy titling of property acquired by spouses using community funds on or after January 1, 1985 is not sufficient by itself to transmute community property into separate property. For joint tenancy property acquired between January 1, 1975 and December 31, 1984, the act of taking title as joint tenants is, in itself, insufficient to prove a transmutation; however, a court may consider the manner of taking title in determining whether the spouses had an oral agreement or common understanding. Finally, as noted, joint tenancy property acquired with community funds before January 1, 1975 is presumptively separate property.

Joint Tenancies After Brace

Brace does not mean spouses in California are precluded from holding separate property as joint tenants or from transmuting community property into separate property held in joint tenancy.  Nor does Brace disturb the operation of the right of survivorship that typically accompanies joint tenancy title at death.

What Brace does mean is Summers is impliedly overruled. After Brace, there is an evidentiary presumption that property acquired by a married couple in California during the marriage is community property, and taking title on a deed in joint tenancy at the time of acquisition is not sufficient to rebut that presumption; additional transmutation requirements must be met in the form of an express declaration.  

That means to rebut the community property presumption, a separate writing must also be created and completed at the time of the property’s acquisition, declaring the mutual spousal intention to transmute the character from community to joint tenancy. With all the havoc this is going to wreak on title companies, I would record that writing along with the property deed.

Another tactic that might work are interspousal deeds, where each spouse signs a grant deed conveying their interests in the community property to themselves as joint tenants. A California Court of appeal in Estate of Bibb, 87 Cal. App. 4th 46 (2001) found the transmutation requirement satisfied where a husband signed a grant deed conveying his interest in his separate property to him and his wife as joint tenants. The court reasoned that the deed was in the statutory form required to convey an interest in property. Because the deed contained language that expressly conveyed the husband’s interest to his wife, the court explained, the property was validly transmuted from his separate property to property held in joint tenancy by the couple.

Brace discussed Bibb, but instead of approving an interspousal grant deed as a valid transmutation method, stated “we do not address interspousal deeds by which one spouse conveys his or her separate property to both spouses as joint tenants, as in Bibb, or by which both spouses deed their community property to each other as joint tenants. “Instead, we focus here on the common scenario of a married couple using community funds to buy property from a third party.” So that’s an open question

Brace also confirmed the community property presumption in Cal. Fam. Code § 760 applies to situations where community property is titled in only one spouse’s name. The California Supreme Court addressed the risk to stability of title for third parties that previously acquired property titled in the name of only one spouse as mitigated by Cal. Fam. Code §1102(c)(2).

That statute validates leases, contracts, mortgages, and deeds between the spouse holding record title to community real property and a third party acting in good faith with no knowledge of the marital relationship. The law thus protects innocent third parties who transact with the spouse holding record title to community property in circumstances where failure to do so would undermine stability of title. This provision is an exception to the general rule in Cal. Fam. Code § 1102(a), (d) that an adversely affected spouse may void unilateral conveyances of community real property.

Bracing For The Aftermath

Brace raises a number of unsettling issues.

Let’s start with the one on everyone’s asking me – if a married couple holding property titled as joint tenancy executes a transmutation agreement now, is that a fraudulent transfer? Creditors and bankruptcy trustees will say yes. Spouses will say the transmutation agreement merely confirms their intent at the time they acquired the property, and relates back.

I think standing alone, a transmutation agreement could well be considered as a fraudulent transfer. The solution may be to incorporate a transmutation into a post-nuptial agreement, where the rights of the spouses can be balanced out. But remember that a post-nuptial agreement, like a marital settlement agreement, can also be set aside as a fraudulent transfer.

How about probate and taxes?

Upon the death of one spouse, community property receives a full step-up in basis for the surviving spouse, so there is a tax advantage in community property status for appreciated property. If, on the other hand, an asset has decreased in value from its adjusted basis at the time of the owner’s death, the opposite is true – income tax basis adjustment rules are disadvantageous to community property.

Are sales and transfers of community property taxed differently than sales and transfers of joint tenancy property? Yes.

Are we way beyond my tax expertise and the scope of this post? Also yes. I leave this one to the tax gurus.

One final thought.

A recent California appellate case Safarian v. Govgassian, 47 Cal. App. 5th 1053 (2020), found a transmutation that does not meet the requirements of Cal. Fam. Code §852 is voidable, rather than void. This is important, because third parties (like creditors and bankruptcy trustees) are not parties to post-nuptial and marital property agreements, and therefore cannot rely on section 852 to invalidate them. Except of course unlike creditors, bankruptcy trustees “step into the shoes of the debtor spouse” (fodder for another day), and there does not appear to be a statute of limitations to challenge the character of property.  

Post Brace, there are still creative ways to deal with property acquired by spouses during marriage titled in joint tenancy. But the time for creativity is before a bankruptcy is filed.

And so, I part with this: “In the depth of winter, I finally learned that within me there lay an invincible [S]ummer.” – Albert Camus.