California has been a community property state since 1850, and still we struggle to understand which spouse is liable for debts.
So here, broad brush, is a guide to the legal liability of spouses, ex spouses, registered domestic partners and their community property for debt. Because, as I’ve written, the community is a third “party” to the marital debt equation. The formula reads: he, she, and the community property.
You are liable
Each individual, married or not, has personal liability for a range of debts.
But first, a word about “personal liability“. Once you become personally liable for a debt, it follows you, before, during, and after marriage. Your personal liability isn’t dependent on where you live, who you’re married to, what property you own, or what kind of deal you have with your spouse, or even your ex spouse.
Debts you contract
Any time you sign your name to a promissory note, an apartment lease, a credit cardholder agreement, or hospital admission form, you take on personal liability for paying the debt.
Debts imposed by law
Some financial obligations come your way by law: tax liability, tort liability, family support. You don’t have to agree to assume the debt, it’s just liability that comes with living in a modern society.
Debts triggered by specific events
You can also be personally liable for debts that you didn’t contract for if a judge assigns the debt to you for payment in a dissolution of marriage or if you inherit assets outside of probate from someone who themselves owed the debt. .
The community is liable
Community property includes all assets acquired by spouses during marriage, except assets acquired by gift or inheritance or from assets you had before you married (your “separate property”). Community property can also include assets that a spouse gives to the community, either by an express transfer or by comingling separate property with community property.
Debts either spouse incurred during marriage
Property acquired during marriage is liable for the debts of either spouse. So, a creditor whose claim arose during the marriage can collect your spouse’s unpaid credit card debt from both halves of the community property, including your wages.
Debts of spouses incurred before marriage
As if that weren’t enough, the community is also liable for the debts of either spouse that arose before marriage. And again, a creditor with a right against the community property can access all of the community to satisfy the debt.
Debts of spouse after separation
Spouses cease to acquire community property when they separate in the course of a divorce or legal separation. Debts a spouse incurs after separation can only be collected from that spouse’s half of the community property that existed upon separation, plus any assets the separated spouse acquires thereafter.
Avoiding community property
It turns out that opting out of the community property system takes some doing. As a recent California Supreme Court decision held, it isn’t enough to hold title to an assets or account in the name of one spouse alone.
To defeat the community property presumption, it requires a written agreement establishing the character of an asset as the separate property of one spouse, signed by the other spouse. This is called “transmutation”. If it’s real property being transmuted, the agreement needs to be recorded in the county where the real property is located.
The concept is that one spouse and that spouse’s creditors can only be deprived of the spouse’s share of the community property by a clear written instrument by which the spouse giving up an interest in something that would otherwise be community agrees to the deal.
A sufficient writing can be a prenuptial agreement, entered into before the marriage; a post nuptial agreement rearranging the couple’s property rights after they have married; or a written agreement transmuting a particular asset to some form of ownership other than community property.
The fraudulent transfer quagmire
California marital property law gets even more complicated when you consider fraudulent transfer law.
Fraudulent transfer laws are centuries-old legal concepts that say one cannot transfer property without getting adequate value in return. Whether you intend to frustrate your creditors or you make a gift or a bargain sale, your creditors can sue to unwind the transaction.
The word “fraudulent” in the law doesn’t require dishonest intent. Gifts to charity are, after all, “fraudulent transfers” at law because the donor doesn’t get anything but a good feeling in return. It’s just that most charitable gifts are made by people well able to pay their bills with the funds they still have.
Under California fraudulent transfer laws (the Uniform Voidable Transfer Act), creditors have four years to challenge a transfer by someone who owes them money (and sometimes, even longer). So instead of lodging assets safely in the hands of a third party, the person making a fraudulent transfer opens that person up to being sued by the transferor’s creditors.
Put your business in the name of your brother or your buddy and two things will generally happen: a nasty lawsuit against your friend and the rupture of that relationship.
So, the take-away here is that changing the way title is held during marriage can be tricky when creditors are disadvantaged.
It’s not so simple
What I want you to walk away with is the understanding that simply changing the title to a community property asset does not, without more, make the asset the separate property of one spouse.
Nor does keeping your funds and business operations separate from your spouse defeat the presumptions of community property.
In the context of debtor-creditor rights, the presumption that wealth acquired during marriage is community property, with all of its exposure to creditors, is powerful. The presumption is overcome only with well thought out, clear, written instruments signed by both spouses.
The greater the value of the assets in question, the more important it becomes to do transmutation right.