The Consequences of Refinancing During Marriage

RAMIFICATIONS OF REFINANCES DURING MARRIAGE

For a married couple, refinancing has many ramifications relating to their respective positions under California community property law. These fall into three main categories: 1) matters affected by the form of title to the property after refinance; 2) characterization and disposition of the loan proceeds received in the refinance; and 3) liability for the resulting debt. Because of space limitations, it is impossible to provide a full, substantive analysis of the myriad issues within each of these categories. Thus, the purpose of this article is to furnish a thorough overview that will enable a practitioner to parse any given refinance situation to determine the issues extant and the law necessary to resolve them. To assist the reader in this regard, the author has included a flowchart, which should prove useful when reading this article, and in the future when confronted with a situation involving a refinance. This article is organized to follow the chart, left to right.

Form of Title After Refinance - Separate Property of One Spouse

This section addresses situations where post-refinance title is taken in the name of one spouse alone. In a majority of these cases, title is already in the name of the "owner" spouse prior to refinance. In such cases, the title company will require the other spouse to execute an Interspousal Transfer Deed or a Quitclaim deed to allow the owner spouse to retain sole title. In rare instances, pre-refinance joint title may be deeded by the both spouses to one of them as that spouse's separate property. In any case, if title to the subject property is taken in the name of one of the spouses as his or her separate property, two issues are raised. First, what effect does the deed have on actual ownership of the property? Second, how does replacement of the old loan with a new loan affect "Moore/Marsden" calculations?

Evidence Code §662 provides that: "The owner of the legal title to property is presumed to be the owner of the full beneficial title." Moreover, this presumption can only be rebutted by "clear and convincing" proof." Thus, when title to refinanced property has been taken in the name of one spouse alone, that spouse will surely invoke the §662 presumption to claim the property as his or her separate property in a subsequent dissolution proceeding.

But, what if the other spouse asserts community property ownership, claiming that he or she signed the deed because of duress or undue influence exerted by the owner spouse? According to Marriage of Haines (1995) 33 Cal.App.4th 277, a rebuttable presumption of undue influence arises in such circumstances. This presumption conflicts with the §662 presumption. Haines resolved the conflict by holding that application of §662 is improper when it conflicts with the presumption of undue influence stemming from the family law fiduciary duty statutes, e.g. Family Code §721. Thus, after a refinance, a non-owner spouse who executed a deed waiving any interest in the property can avoid the Evidence Code §662 presumption by showing undue influence per Haines.

In some cases, the non-owner spouse may be judicially estopped from claiming a breach of fiduciary duty. See, Marriage of Dekker (1993) 17 Cal.App.4th 842. However, the non-owner spouse still has a right to rebut the §662 presumption by clear and convincing proof. A typical example is where property acquired with community funds is placed in the name of one of the spouses alone to protect against the "bad credit" of the other spouse. While it is obvious that there is no undue influence or breach of fiduciary duty between the parties, it is also clear that there is no intent of a gift by the spouse whose name has been omitted from the deed. In such a case, the omitted spouse will be able to show the true facts and circumstances, which would constitute the "clear and convincing proof" necessary to rebut Evidence Code §662.

Assuming that the property is deemed to be the separate property of the title-holding spouse, the focus moves to the "Moore/Marsden" milieu. The Moore/Marsden rule is applicable when the community begins to participate in an ongoing separate property purchase. Marriage of Moore (1980) 28 Cal.3d 366; Marriage of Marsden (1982) 130 Cal.App.3d 426.

The usual Moore/Marsden situation arises where a spouse owns property before marriage and is paying a mortgage. After marriage, the community makes the monthly payments on the pre-existing mortgage. In other words, the community begins to participate in the original, ongoing separate property purchase. In such situations, the Moore/Mardsen rule provides the community with a pro tanto interest based on the sum of two components: the actual principal reductions made by the community on the original loan, and a percentage of the post-marital appreciation. The percentage to be applied to the post-martial appreciation is the community's principal reductions divided by the purchase price. To review a fully annotated basic Moore/Marsden calculation, go to http://www.yourmanfriday.com/downloads.htm.

A refinance of the subject property wreaks havoc with the Moore/Marsden calculation because the new loan is based upon the value of the property at refinance, not the original purchase price of the property. Unless the purchase price is adjusted, the Moore/Marsden calculation will implode because the principal reductions on the new loan can almost always eventually exceed the original purchase price. This is also true when the refinance has taken place before the marriage. Perhaps the most perplexing problem occurs when there are multiple refinances during the marriage with the property remaining in the name of the owner spouse. Because the loan proceeds exceed to total accrued equity, the question begged is how to allocate the erosion. This is a very complex area, which will not be explored further here. Suffice it to say that when calculating the community's Moore/Marsden interest in refinanced property, the "purchase price" should be increased to equal the value at the time of the refinance, and any pre-existing Moore/Marsden interest should be rolled forward into the calculation subject to erosion caused by the liability of the community loan proceeds.

Form of Title After Refinance - Joint Title

It is assumed that the reader has a working knowledge of the transmutation rules set forth in Family Code §852 and the type of "writing" required to support a transmutation as articulated in Estate of MacDonald (1990) 51 Cal.3d 262, and its progeny. The question begged in this context is whether the joint deed resulting after the refinance will suffice as the "writing" supporting a transmutation from separate property to community property. This question was resolved in Estate of Bibb (2001) 87 Cal.App.4th 461. In that case the court held that a grant deed signed by a husband transferring his separate property interest in real property to himself and his wife as joint tenants satisfied the "express declaration" requirement of Family Code §852(a).

One might ask, why do I need to worry about a transmutation under §852 and Bibb when I simply can use the community property presumption of Family Code §2581 (discussed below) to obtain the same result? The answer is that §2581 (and §2640) apply only in dissolution actions, and cannot be applied in a probate case. Hence, if there is a refinance of separate property, after which title is taken in both names, and thereafter the spouse who owned the property dies, the surviving spouse can claim that the property was transmuted to community property. Remember, in such a circumstance the surviving spouse cannot rely on §2581; neither can representatives of the deceased spouse assert a reimbursement claim based upon §2640.

If the change in title from separate to joint takes place in a refinance occurring after January 1, 1984, the tandem of Family Code §§2581 and §2640 (formerly C.C. §§4800.1 and 4800.2) will apply. Under §2581, property taken by spouses in joint title is presumed to be community property absent a writing to the contrary or a clear statement on the face of the deed that the property is separate property, not community property. To alleviate the potential harshness of the §2581 presumption, §2640 provides a right of reimbursement to a party who contributes his or her separate property to the "acquisition." In the context of a refinance, the "acquisition" is the newly-minted community property stemming from the joint deed, and the separate property contribution is the interest held by the former owner spouse.

According to Marriage of Perkal (1988) 203 Cal.App.3d 1198, the amount of the §2640 reimbursement is the owner spouse's equity in the property at the time of the refinance, which is the value of the property at the time of refinance less the encumbrances on the property at that time. However, that is not always the end of the story. If the community has made payments on the subject property prior to the refinance, it has accrued a pro tanto interest under the Moore/Marsden rule. The value of that Moore/Marsden interest is included in the equity at the time of refinance and thus must be deducted from the gross equity to determine the proper §2640 reimbursement due to the owner spouse.

Characterization of Loan Proceeds - Generally

In every refinance during marriage the parties borrow money. In some transactions no money is actually realized, such as a case where the old loan is paid off by the funds realized from the new loan, the sole goal being a lower interest rate on the new loan. However, in many cases the new loan is greater than the balance of the old loan, and excess funds are available after the old loan is paid off. Because these excess loan proceeds can be used to purchase real or personal property, or to improve property, the characterization of such loan proceeds is a crucial issue in a subsequent dissolution action.

If the post refinance form of title is joint, then there is little question that the loan proceeds will be deemed community, and the reader should follow the "CP, Grinius" line of the chart. The more interesting question is the character of post-refinance loan proceeds when the form of title remains in the name of the owner spouse. In such cases it is inevitable that the non-owner spouse will execute some sort of deed waiving any interest in the property. The question begged is whether that deed can be used to argue that the spouse also waived any community interest in the loan proceeds. There are two competing lines of cases in this area.

Characterization of Loan Proceeds - Community Property

According to Marriage of Grinius (1985) 166 Cal.App.3d. 1179, loan proceeds received during marriage are presumed to be community property. This presumption may only be rebutted by a showing that in granting the loan, the lender relied "solely" on the separate property of the owner spouse. It is very difficult to make such a showing, largely because the owner spouse is required to list and verify his or her income (community property) in the loan application; often the other spouse's income is also included, as well as other assets that are community property. And, many times the other spouse actually signs the loan application. In view of these typical circumstances, it can hardly be said that the lender was relying "solely" on the separate property of the owner spouse.

When the loan proceeds are found to be community, any assets that are purchased with those proceeds are presumed to be community.

If the community loan proceeds are used to make improvements, the following basic rules will apply.

• If the improver uses community loan proceeds to improve his or her own separate property, the theory of constructive trust will be applied on behalf of the community. The community will receive the greater of the amount contributed or the value added to the property as a result of the improvement. See, Marriage of Warren (1972) 28 Cal.App.3d. 777.

• If the improver uses community loan proceeds to improve the other spouse's separate property, the recent cases of Marriage of Wolfe, (2001) 91 Cal.App.4th 962 and Bono v. Clark (2002) 103 Cal.App.4th 1409 will apply, giving the community reimbursement rights and possibly a pro tanto interest. Prior to these cases being decided, the longstanding rule was that the improver intended a gift to the other spouse.

• If the improver uses community loan proceeds to improve community property, the value of the improvement will be reflected in the value of the asset, which is already community.

Characterization of Loan Proceeds - Separate Property

The "Grinus" line discussed above appears quite formidable. But is there an argument to be made that the execution of the quitclaim deed by the non-owner spouse acts as a waiver of any community interest in the loan proceeds? The answer is "yes" when the cases of Marriage of Stoner (1983) 147 Cal.App.3d 858 and Marriage of Branco (1996) 47 Cal.App.4th 1621 are carefully analyzed. The full analysis is too complex and lengthy to set forth in this article, however it can be accessed at: http://www.yourmanfriday.com/articles.htm

In short, Stoner held that a spouse executing a quitclaim deed waived any community interest in ownership of the property, loan proceeds realized in the transaction, and an accrued Moore/Marsden interest in the property. Branco, while rejecting the Stoner ruling as it pertained to a Moore/Marsden waiver, accepted the Stoner ruling as it applied to waiver of a community interest in the loan proceeds.

Thus, when there is a refinance of an owner spouse's property during marriage, and the non-owner spouse executes an Interspousal Transfer Deed or Quitclaim deed waiving any interest in the property, the owner spouse can argue that the resultant loan proceeds are separate. However, the community's Moore/Marsden interest, accrued and prospective, will not be waived.

As an aside, it should be noted that if one wishes to obtain a waiver of a Moore/Marsden interest by a non-owner spouse, a separate writing that meets the requirements of the transmutation statutes and cases discussed above must be executed by the non-owner spouse.

When the loan proceeds are found to be separate, any assets that are purchased with those proceeds are separate property. However, because these assets are acquired during marriage and presumed community, it is the separate property owner's burden to trace the separate property loan proceeds directly to the acquired assets. See, Marriage of Braud (1996) 45 Cal.App.4th 797.

If the separate property loan proceeds are used to make improvements, the following basic rules will apply.

• If the improver uses separate property loan proceeds to improve his or her own separate property, there is no problem. Generally, a separate property owner has an absolute right to use separate property to improve separate property.

• If the improver uses separate property loan proceeds to improve the other spouse's separate property, a gift is presumed, absent an agreement to the contrary.

• If the improver uses separate property loan proceeds to improve community property, he or she is entitled a reimbursement pursuant to Family Code §2640. Note that even though §2640 states that the reimbursement will be for the amount contributed, the holdings in Marriage of McNeill (1984) 160 Cal.App.3d 548 [overruled on unrelated grounds] and Marriage of Reilly (1987) 196 Cal.App.3d 1119, seem to indicate that if the cost of the improvement only increases the value of the improved property by an amount less than the contribution, the reimbursement should be limited to the value added, not the amount of the contribution. This makes sense because the pre-existing community equity should not be eroded by a separate property improvement.

Liability for Resulting Debt

Much to the surprise of lay persons and law students, Family Code §910 states that the community is liable for debts incurred by either party either before, or during marriage.

Assuming the loan proceeds are deemed community under the Grinius line, application of §910 makes perfect sense. The community is liable for the loan. However, the following paragraph presents a very real dilemma.

Suppose that a separate property owner successfully argues the Stoner/Branco line to establish that the proceeds of a post marital loan are his or her separate property. The owner spouse then uses the loan proceeds to improve his or her separate property. Any spouse has a right to use his or her own separate funds (here the loan proceeds) to improve his or her separate property. Yet, no one can deny that the community is liable for the entire loan under §910, with no right of reimbursement. The author knows of no community reimbursement right in such a scenario.

Conclusion

The analysis presented above shows that refinancing of property during marriage raises many complex issues, ranging from transmutation to liability for the resultant debt. We hope that by reading this article the reader has improved his or her ability to identify and resolve these issues.