Interspousal Fiduciary Duties

Recently, the California Court of Appeal affirmed its stance that the court will presume that undue influence took place if there is a transmutation of property from community to separate.

Explanatory Aside #1: California has a community property system whose origins arise from Visigothic Spain. Community property is generally defined as “all property, real or personal, wherever situated, acquired by a married person during the marriage while domiciled in [California] . . . ” except as otherwise provided by statute. Family Code Sec. 760. Separate property of a married person includes property owned before the marriage; acquired by gift, bequest, devise, or descent; rents, issues, or profits of the foregoing property. Family Code Sec. 130, 770(a). One of the consequences of this system for divorce are as follows: community property is subject to equal division between the spouses on dissolution of marriage or legal separation; separate property is not subject to that division. Family Code Sec. 2550.

Explanatory Aside #2: Spouses can change the character of an asset, from community to separate property, through transmutation. Transmutation of property must be in writing by an express declaration by the spouse whose interest in the property is being adversely affected that a change in characterization of ownership is being made. (In re Marriage of Holtemann (2008) 166 Cal.App.4th 1166, 1172.)

So, here’s the story: Husband inherited a lot of property from his family (inheritance = separate property). Husband and Wife went to make an estate plan. The estate planning attorney explained a key tax aspect to changing the character of assets from separate to community: community property gets a full step up in basis.

Explanatory Aside #3: A full step up in basis is a huge tax advantage upon the death of one spouse. Here’s what it means: the surviving spouse won’t pay taxes on the increase in value of the property while the other spouse was alive. The asset will be valued on the date of death of the surviving spouse. So, let’s say Husband inherited property worth $50M, the spouses executed a valid transmutation, the property increased in value to $75M by the time Husband died. The property is treated as if Wife herself purchased it for $75M.

Back to the Story: Husband executed a transmutation specifying that “all property owned by them, regardless of the record state of title . . . is intended to be held by them as their community property in which each has a present equal and existing interest.” And they specified that it was intended to be a valid transmutation under Family Code Sec. 852 and that they “understood that they were giving away a one-half interest in any property that might be traceable to an inheritance or gift.” (In re Marriage of Lico, Unpublished Opinion, District 1, Division 1 (Filed May 4, 2012).)

The Wife filed a petition for dissolution of marriage. Pursuant to Family Code Sec. 721, “a husband and wife are subject to the rules governing fiduciary relationships — a relationship that imposes the highest duty of good faith and fair dealing on each spouse. Neither may take any unfair advantage of the other.” (In re Marriage of Kieturakis (2006) 138 Cal.App.4th 56, 84.) Family Code Sec. 721 functions by setting up a presumption that, when one spouse gains an advantage over the other, there was undue influence. Put another way, “where one spouse admittedly secures an advantage over the other, the confidential relationship [marriage] will bring into operation a presumption of the use and abuse of that relationship by the spouse obtaining the advantage.” (In re Marriage of Haines (1995) 33 Cal.App.4th 277, 296.) Undue influence will abrogate the transmutation.

When the presumption of undue influence (use and abuse) arises, it’s then up to the advantaged spouse to show that the other spouse’s decision was freely made, with full knowledge of the facts, with a complete understanding of the consequences. Husband freely and voluntarily executed a document explaining that the character of the asset would change from separate to community. Wife didn’t do anything to mislead Husband. There was no evidence of Wife’s actual undue influence.

But “the influence which the law presumes to have been exercised by one spouse over the other is not an influence caused by any act of persuasion or importunity, but is that influence which is super-induced by the relation between them, and generated in the mind of the one by the confiding trust which he has in the devotion and fidelity of the other.” (In re Marriage of Starr (2010) 189 Cal.App.4th 277, 283) (internal quotation marks and citation omitted) The court explained: Husband did not have his own attorney and their shared attorney lacked expertise in family law matters. The evidence, then, supported the trial court’s conclusion that Husband did not fully appreciate the consequences of the transaction.

The result is somewhat odd: If Wife had died before Husband, Husband would not likely be arguing that the transmutation was invalid. That would have left him on the hook for taxes on the increase in value of the property since he inherited it, not just since Wife died. But since divorce, not death, took place, Husband and Wife became adversaries. So, it was Wife’s burden, then, to persuade the court that Husband fully appreciated the consequences of the transaction.

If you’re an estate planning attorney, this is something to keep in mind when advising clients on a transmutation.