Navigating Complex Asset Cases
This article will address complex and hidden asset cases in Virginia family law and divorce. The cases have been divided into the following sub-categories:
- Commingled Separate Property
- Vacation Homes or Investment Real Estate Interests
- Family Business Assets
- Interests in Closely-Held Corporations
- Stock Options and Stock Grants
- Complex Retirement Plans
- Financial Misconduct
- Spotting Hidden Assets
- Using Forensic Accounts and Business Valuation Experts
- Enforceability of Prenuptial Agreements
A. Commingled Separate Property
All property acquired by either party during the marriage (date of marriage to date of separation) is presumed to be marital. See, e.g., Dietz v. Dietz, 17 Va. App. 203 (1993). This presumption can be rebutted, however, upon proof that the property falls under the definition of separate property provided in Virginia Code section 20-107.3(A):
(i)all property, real and personal, acquired by either party before the marriage; (ii) all property acquired during them marriage by bequest, devise, descent, survivorship or gift from a source other than the other party; (iii) all property acquired during the marriage in exchange for or from the proceeds of sale of separate property, provided that such property acquired during the marriage is maintained as separate property; and (iv) that part of any property classified as separate pursuant to subdivision A 3.
The Code further provides that “[the] increase in value of separate property during the marriage is separate property, unless marital property or the personal efforts of either party have contributed to such increases and then only to the extent of the increases in value attributable to such contributions.”
So, what happens when separate property is commingled with other property? This can happen in four different ways:
- Separate property can be added to a marital property;
- Marital property can be added to a separate property;
- Separate and marital property can be commingled into new property; or
- Each party’s separate property can be commingled into new property.
Virginia Code section 20-107.3(A)(3)(d) provides that:
When marital property and separate property are commingled by contributing one category of property to another, resulting in the loss of identity of the contributed property, the classification of the contributed property shall be transmuted to the category of property receiving the contribution. However, to the extent the contributed property is retraceable by a preponderance of the evidence and was not a gift, such contributed property shall retain its original classification.
In this type of commingling the Court will apply a three-tier burden of proof. See, e.g., David v. David, 287 Va. 231 (2014). Let’s use a house owned by Abe and Danielle, Abe wants the home to be considered his part-separate property for post-separation contributions, and Danielle wants it to be considered all marital property. The first tier looks to the date of acquisition of the property as the classification date and applies the definition of separate property in Virginia Code section 20-107.3(A)(1) – was it separate when acquired? If not, the court presumes it is marital. In this case, Abe and Danielle acquired the house jointly during the marriage and so was marital property at acquisition. Part two then shifts the burden to Abe, who must now trace his separate contribution to the marital residence. He might do this by hiring an expert, showing the principal pay-down between the date of separation and date of trial, or providing documentation for any other reason he believes the property increased in value at a time when he was contributing separate property and efforts. If you stop here, the property is classified as hybrid and the court will determine the separate and marital components and divide appropriately. However, the third tier allows Danielle to come back and either show that the separate contributions of Abe were a gift (transmuting by intent the separate property into marital property), or that the increase in value of the marital residence was not due to Abe’s separate contributions or efforts. See David. If Danielle can show either of those (gift or no connection) then the property at the end of the analysis would be considered entirely marital; if not, it would be hybrid.
This burden shifting required by the statute was recently analyzed in David. In David, Husband owned an investment account before the marriage that was worth approximately $234,783.16. At the time of separation, the account had grown to $551,521.42. Throughout the marriage the husband researched, bought, sold, and reinvested stock in this account; he never contributed money from his income or any other marital asset into the account. At trial, the wife argued that the increase in the account value was marital since the increase occurred during the marriage and husband expended personal efforts to increase the value of the account during the marriage. Husband, of course, argued that the increase was separate since the account was separate to start with, and argued that wife had not shown his personal efforts caused the increase in the value of the account, so had not met her burden of proof. The Supreme Court of Virginia agreed with wife that once the non-owning spouse shows and increase in value and that there were personal efforts, the burden shifts to the owning spouse to rebut the presumption of a causal link.
You need to understand which burdens your client may have in court in order to properly advise them and develop case strategy – this case was a game changer in burden shifting in Virginia, so it is worth reading.
Virginia Code section 20-107.3 (A)(3)(e) provides that:
When marital property and separate property are commingled into newly acquired property resulting in the loss of identity of the contributing properties, the commingled property shall be deemed transmuted to marital property. However, to the extent the contributed property is retraceable by a preponderance of the evidence and was not a gift, the contributed property shall retain its original classification.
Let’s look at Abe and Danielle again – this time they bought the house during the marriage with income they saved, and by cashing out a premarital separate IRA of Abe’s. At first glance, the property was bought during the marriage with marital and separate funds, and therefore the property is marital. The burden then shifts to Abe to trace out his separate contribution and show what the current value of that contribution would be. Then Danielle gets to argue Abe’s contribution was a gift, or rebut his valuation. This case gets much harder when the house is sold, and the funds distributed into other marital assets.
Robbins v. Robbins, 48 Va. App. 466 (2006), dealt with the problem of tracing separate property as it weaves it way through multiple marital assets. In Robbins, husband had an interest in a medical practice he bought with marital and separate assets that was partially sold off at various times through the marriage, with the resulting funds being placed into marital accounts. Though his interest in the marital practice started at approximately 60/40 marital/separate, husband first argued that he had sold off his marital portions only, and the remaining interest at the time of trial was 93/7 separate/marital. The Court rejected this analysis since husband offered no proof of his “contemporaneous intent” to sell marital shares only. Husband then argued that each withdrawal should be considered pro rata marital/separate. The Court again rejected this argument, as pro rata does not show actual intent, which is required to show that separate property was maintained as separate. Without proof of actual contemporaneous intent on the part of husband, the court had to treat the marital shares as persisting, and the separate shares as being sold. The court used the following analogy to help with this concept:
[C]onsider a jar filled with 100 marbles. Fifty red ones came from separate sources, the remaining blue ones from marital sources. Husband sells the red marbles and puts the sales proceeds into another wholly separate asset. The jar of marbles, now all blue, would then be a wholly marital asset with no remaining separate component. The inverse would be true if husband sold all the blue marbles and used the proceeds for marital expenses, leaving the jar of marbles (now all red) an entirely separate asset. But if he sold 50 marbles taken from the jar at random and used the proceeds for both marital and separate purposes, we would presume the worst (at least from his point of view): that the remaining 50 marbles are all blue, not one red, and each subject to equitable distribution as the entire jar of marbles has been transmuted into marital property.
Robbins at 478.
What the Robbins case means is that where separate property has been commingled with marital property for each new transfer or commingling, there must be a complete tracing of the separate property including the contemporaneous intent that the separate portion, though commingled with marital, be maintained as separate. This is a high burden for any client, and best practice is to have your clients keep separate property separate, and in the same account, throughout the course of the marriage.
The same analysis and burdens apply when tracing separate property retitled into the joint names of the parties (under Virginia Code section 20-107.3(A)(3)(f)) and where the separate property of each party is commingled (under Virginia Code section 20-107.3(A)(3)(g)). Let’s say Abe and Danielle buy a house the day after they are married with money each has saved during the engagement. In this example, the home would first be considered marital, since it was acquired during the marriage. Then Abe and Danielle would each have the burden of tracing his or her individual separate components. If each successfully traces his or her separate property in the house, then the other party has the burden to prove such separate component was intended as a gift. Often, the best way to deal with the fact pattern in Robbins is to recognize simultaneously settlement of such assets in a percentage other than 50-50 is warranted, the likelihood of the failure to trace the separate property, and the unfairness of treating the asset as if it were a typical marital asset.
B. Vacation Homes or Investment Real Estate Interests
The tracing rules relating to marital/separate/hybrid property apply as well to vacation homes and investment real estate interests. A more interesting question in cases with rental real estate tends to be: which real estate property should I steer my client toward or away from. And that question often hinges on taxation. Rental properties can be depreciated down to zero, so the value upon a regular (non Starker/1031) sale, may be entirely taxable. And the tax may include federal, state and the 3.8% net investment income tax. The total approaches 30%. And, under Arbuckle v. Arbuckle, 22 Va. App. 362 (1996), the recipient cannot treat the tax as real unless the property is being sold. So, it is sometimes wise, rather than receive post-divorce a future tax problem, to sell the asset now. Or, it may be wise to keep a seemingly-similar asset that has no meaningful present or future tax problem, and let the other party receive the asset with the future tax problem.
From a tax perspective, whether a vacation home is an investment real estate interest depends largely on how much personal use the owner(s) make of it. If the property is rented less than 15 days per annum, it is a vacation home in the eyes of the IRS. The rental income from a vacation home (14 days or fewer) is excluded from income. However, the expenses associated with the vacation home are non-deductible, except for mortgage interest, taxes and casualty losses. A vacation home is not depreciated.
If, by contrast, at the other end of the vacation home—rental property spectrum, the property is both (a) rented more than 14 days per year and (b) not used for personal use more than the greater of (i) 14 days per year or (ii) 10% of the rental days, then the property is classified as a rental. Rental allows an allocation of expenses based upon rental and personal use, and allows a deductible loss of up to $25,000 per annum, subject to complete phase-out at $150,000 AGI.
In the middle of the spectrum (rented at least 15 days per year, but use is more than the greater of 14 days per year or 10% of the rental use) is usually an undesirable place, called mixed use, which is taxed like a hobby. Expenses are allocated (between personal and rental) and allowed, but only to the amount of gross income. Losses in excess of gross income cannot be deducted this year (but can be carried forward).
Note that real estate professionals are not subject to the loss limitations, however, the requirements to be a real estate professional are consistent with near-full-time employment in real estate.
Many investment real estate interests are interests in closely-held real estate holding corporations, which are discussed in D below (along with marketability and minority shareholder discounts), though real estate interests are typically much easier to value. Virginia Courts have long found that an appropriate value for real estate holding companies is the net asset value of the company (e.g., total value of the real estate less liabilities). See, e.g., Bosserman v. Bosserman, 9 Va. App. 1 (1989). It is debatable whether a court may apply a marketability or minority shareholder discount to the net asset value.
It is important to remember that courts must value the interest based on intrinsic value to the parties – meaning that without a foreseeable sale or transfer, the court will ordinarily not apply a marketability or minority shareholder discount. However, if there is a foreseeable sale or transfer, the value of the interest may be affected if the owning spouse provides credible (typically expert) testimony on why and how his or her share should be discounted. Such discount could be based on the “upside of the real estate, down side of the real estate, the number of other owners, magnitude, income characteristics, control or lack of control, form of ownership, sometimes partition ability, finance ability, and the overall marketability of the fractional interest.” Patel v. Patel, 61 Va. App. 714 (2013).
Whether or not a sale or transfer is foreseeable, the Court should consider the illiquid character of a minority interest in investment real estate, along with all the other factors contained within Virginia Code section 20-107.3(E), in determining the proper distribution of marital property.
In Bosserman, the husband and his two brothers each owned a 1/3 interest in a real estate holding company. The Court of Appeals upheld the trial court’s finding that the value of Husband’s interest was 1/3 of the net assets of the real estate holding company (value of the properties less credible liabilities), and upheld the trial court’s refusal to discount the property given husband’s failure to meet his burden of proof regarding the discount.
In Patel, the Court of Appeals similarly upheld the trial court finding that the real estate interest was worth the net assets (in this case, real estate value plus cash reserves in the company less debt), and upheld the trial court’s decision not to discount Husband’s value since there was no foreseeable sale or transfer. Instead, the trial court properly considered the illiquid nature of Husband’s real estate investments in dividing the marital estate by awarding Husband 60% of the marital estate.
C. Family Business Assets
Clients who work in a family business have a much greater ability to influence the structure of compensation, benefits, and work schedule. This includes structuring the receipt of family business assets. It is imperative at the beginning that you think of how the matter will look at the end – specifically, how will these assets be classified and divided – in advising your clients on their family business assets. Let’s take one example of a family business that owns real property.
Sue and Jane are married. Sue works for her family business, Sky Slide Zip lines. Sue may have an interest in this closely held corporation (D below), stock options (E below), or an unusual retirement benefit (F below) – but for now let’s look at how to structure another perk she may receive from the business. As part of the business model, Sky Slide owns a lot of real estate – both developed (with zip lines, concession stores, and old time photo booths) and undeveloped – which is intended to create additional income and assets for the business and family members.
Assume for purposes of this section, Sue’s parents each own 50% of Sky Slide. A typical way for Sue to acquire a controlling interest in Sky Slide is to buy the interest at discounted rates. The result of acquisition, however, is that the interest acquired during the marriage is marital, if acquired with marital or hybrid funds, and the compensation is marital.
For family law purposes, a better way to structure this particular type of transaction for Sue would be for the owners of Sky Slide (family members) to annually gift Sue individually with a fractional interest in each piece of real property or in each holding company (LLC interest). Such gift would be considered Sue’s separate property, as well as any income derived therefrom (through sale or lease), (or the large extent) provided Sue’s work did not increase the value thereof. Though any income would be considered for the purposes of spousal support, the property itself would not be divided; and if Sue chose to sell the property or her portion of it, there would be no additional income to consider for support purposes. In addition, Sue’s parents, for example, may, via this transfer, avoid estates and gift tax if their estate exceeds $5.49million (2017) or the annual gifts, and there will be no income tax or gift income if their combined annual gift is less than $28,000 (2017).
Another option for these facts might be the creation of a family limited partnership. Mother and father might gift Sue $28,000 per annum (the limit of the annual exclusion), and with a part of that annual $28,000 Sue can acquire in her sole name, and as separate property, an ever-increasing share of Sky Slide.
This example illustrates how thoughtfully advising your clients can create separate property, adhere closer to the client’s (and their family’s) intent with the business and business assets, and protect family assets from needlessly being divided at death or in a divorce.
D. Interests in Closely Held Corporations
One of the more complex issues in dealing with interests in a closely held corporation is figuring out how to value that interest based on the intrinsic value to the parties. Since the company is not publicly traded, there is not an immediately clear value for that interest. Instead, you will likely have to hire a business valuation expert (I below), who will value the corporation using the following four components: tangible assets (e.g., capital account, furniture, computers); intangible assets (e.g., accounts receivable, patents, trademarks); organizational goodwill (e.g., the value associated with the brand name and company); and personal goodwill (e.g., the value in the company associated with a particular person). If the business is started during the marriage (or more accurately: if the interest in the business is derived during the marriage) with marital property, then the value of each component except personal goodwill of the opposing party is likely marital property; personal goodwill is considered separate property. See, e.g., Howell v. Howell, 31 Va. App 332 (2000).
Once you have the value of a company, you need to consider whether any marketability or minority owner discounts apply. In Bosserman v. Bosserman, 9 Va. App. 1 (1989), the Virginia Court of Appeals looked at a case where there were restrictions placed on the sale of shares in a closely held corporation. The Court determined that such shareholder agreements must be considered by the court, but are not dispositive in and of itself. There may be several other factors the Court can look to in determining what – if any – discount to apply. These include, but are not limited to, “the nature, size and purpose of the corporation; the type and nature of its assets; the terms of the restrictions or transfer provisions; the nature and existence of escape clauses; optional provisions for valuation; and any circumstances which could affect the corporation, the stockholders or their relationship.” Bosserman at 7. Once a Court determines a marketability discount should apply, then the Court has many other options for valuing the corporation other than a value based on the four components above or the value provided in the shareholder agreement (if any) including, but not limited to: rate of return on investment, fair market value of corporate assets, and value to shareholder of benefits derived from the corporation. Id. However, for a marketability discount to apply there must be a plan to sell the interest; a Court will not award a marketability discount where there is no foreseeable transfer or sale of that interest. See, Howell at 345.
For minority owners, their interest in a closely held corporation may be further discounted in an equitable distribution hearing due to being held captive by the majority owner’s whims. However, where a company has no majority owner, there will probably not be any minority owner discount applied. Id. Further, the burden is on the minority owner spouse to show how, why, and how much his or her interest should be reduced due to minority status. Bosserman at 17. Without such testimony (usually required through an expert), no discount will be given. Id. In this regard, control your expert business valuator: he may want to apply minority and marketability discounts simply because they are typical in his business and he does not know Howell and Bosserman.
Remember: just because the Court does not discount an interest in a closely held corporation due to marketability or minority shareholder status, does not mean the Court will divide the interest equally. The Court may instead distribute the interest unequally (or, if not jointly titled, award an unequal monetary award) to effectively discount the interest. See, e.g., Arbuckle v. Arbuckle, 22 Va. App. 362, (1996).
E. Stock Options and Stock Grants
Virginia courts have determined that stock options and stock grants can be treated in divorce as a deferred compensation plan pursuant to Virginia Code section 20-107.3(G). See, e.g., Dietz v. Dietz, 17 Va. App. 203 (1993), Schuman v. Schuman, 282 Va. 443 (2011). However, the classification of any stock option or grant can be complicated since you will need to know the following 5 attributes – none of which is dispositive – in determining the marital portion of the stock option: when were the options granted; when did/do they vest; when did/do they become exercisable; what – if any – restrictions are there; and what are the options or grants for (past work, future work, both, recruitment, etc.)? Only after determining the answer to each of those questions, and looking at them together, can you figure out whether the stock options or grants are marital, separate, or hybrid.
Let’s use Paul and Mary as an example. In the easiest case, Paul and Mary get married, then Paul receives stock options for future work at the same company, the options eventually vest and are exercisable upon Paul’s retirement. The parties separate after the options vest but before Paul’s retirement, and are interested in obtaining the fairest resolution for their case. In this example, even though Paul cannot exercise his options until retirement – which may be several years into the future – the stock options were granted during the marriage and completely earned (vested) during the marriage. Therefore, Paul’s stock options – whether or not exercised or exercisable at the time of divorce – are entirely marital and can be divided equally under Virginia Code section 20-107.3(G).
Here are some slightly harder examples:
- What if Paul is granted stock options for future work after he and Mary are married; but the options vest during the parties’ separation or post-divorce? The Supreme Court of Virginia has ruled this is, as above, deferred compensation which is earned between the date of the stock option grant and the date of vesting – not simply on the date of vesting. Schuman. Therefore, the stock options are hybrid property and the proper equation for determining the marital portion in this example is akin to that of pension accounts: a fraction, with the numerator representing the number of months between the grant of stock options and the date of separation, and the denominator representing the number of months between the grant of stock options and the date of vesting.
- What if Paul is granted a stock option a year before he and Mary are married; 4 years into their marriage; and during their separation? Analyze each grant separately.
- Are the grants for work previously performed? If so, the stock option granted before the marriage is entirely separate property, and the fraction would be determined by the period of work the stock options are compensation for (e.g., if it’s compensation for the previous 5 years, and Paul and Mary were married 4 years before the grant, such grant would be approximately 4/5 marital and 1/5 separate) and not based on a vesting schedule, since there likely is no vesting schedule.
- If it’s for future work – figure out the vesting schedule and plug it into the bolded formula above.
- When is the exercise date? If the vesting date, same as above. If it is after the vesting date (such as retirement), and there are restrictions beyond the vesting date (such as continued employment), then you would use “earliest available exercise date” instead of “date of vesting” in the bolded formula above; if there are no restrictions, then you would simply use the bolded formula above.
- Are there any restrictions? For example, does any grant require Omar’s continued employment with his company? If so, the formula would be altered so that the denominator would be from the date of the grant of stock options to the date Omar is still required to perform for his company (e.g., retirement)
F. Complex Retirement Plans
Companies can pay for services performed in the past, in the current year, or in the future. Accordingly, each retirement plan is different. While most remuneration is payment for services performed contemporaneously, most is not all: each retirement plan is different. Therefore, in each case, you need to follow best practices to ensure you are protecting your client.
The first step in each case is to identify all retirement benefits. Retirement benefits can take any number of forms including, but not limited to, pensions, savings accounts, deferred compensation, and continued benefits. Each type can further be an ERISA qualified or non-qualified plan – the biggest difference, for purposes of distribution, is that a qualified plan can be divided via court order (QDRO, COAP, RBCO, etc.) whereas in a non-qualified plan the plan participant is responsible for dividing the benefit him or herself. It is very common for individuals to not know all of their retirement benefits, and certainly not to be familiar with the ins and outs of their retirement benefits (including plan names, whether non/qualified, distribution options, etc.). Because of that, it is very important that you work closely with the participant’s employer (and any former employer with whom he or she has a retirement benefit) to identify benefits and benefit types. You can work with the participant’s employer through a release (best way) or via subpoena duces tecum if the participant refuses to sign a release. We have all had cases where a party did not know the scope of his pension rights; in one of my cases the undisclosed pension was worth $1 million. The only reason we discovered it was that the subpoena duces tecum created a relationship between the company HR person and my associate.
Once you have identified each benefit and its marital component, you need to determine how each benefit can be divided: whether the plan requires a specific formula be used or specific value, whether the plan will compute gains/losses or if you have to do that, if there is any survivor annuity, whether you can do a separate interest or shared payment division, whether there are any tax consequences, what the deadlines are. You need to know all of these options and limitations before you negotiate. You will be able to get all of this information – often including a model QDRO for qualified plans – from the participant’s employer or the retirement benefit servicer.
Depending on the complexity of the retirement benefit now would be the time to bring in any expert. Tax experts can be helpful in figuring out how to divide assets in a tax-preferred way for your client; there are experts who draft QDROs and know the ins and outs of multiple types of accounts and may also be able to advise you on preferred options to meet your client’s needs.
Now you are ready to negotiate. Remember that the receiving client can only be awarded up to 50% of the marital portion of any pension, deferred compensation, or retirement plan in court per Virginia Code section 20-107.3(G), but of course, in a negotiated agreement, may divide the benefit in any division, including going entirely to the non-owning spouse, if the plan does not prohibit the same. Also remember that a tax-deferred dollar is worth less than a current dollar. So, for example, a Roth IRA dollar is worth a dollar, but a 401(k) dollar may be worth seventy or eighty cents depending on the age and wealth of your client, as well as assumed unknown future tax rates. Be sure to check for any lapses in coverage – for example, if spousal support ends upon retirement, but the spousal support payor can choose to delay pension payments beyond his date of retirement, that can be a problem. Put protective language into the agreement so that if a benefit cannot be divided as written, then the parties will execute any additional appropriate documents to enforce the meaning and intent of their agreement. Talk to your client about shared payment (receiving a portion of their spouse’s pension if, as, and when received by their spouse) versus separate interest (having their own pension annuitized to their individual life and being able to have personal control over that account) and any survivor annuity options (likely will be an option with a shared payment, which will stop when the participant dies; but will not be an option with a separate interest, which will not be affected by the participant’s death).
Draft required documents. Once an agreement is reached, you can send court orders to the retirement account servicer for approval. This process can take over a month, which is another reason it is useful to have all the required information ahead of negotiation, so you can just plug-in and send. Ideally one would have form QDRO or other company approved language prior to negotiating the terms of the retirement division. After the Agreement, if the QDRO is not approved, you will have to rely upon the protective language you have included in the agreement to figure out how to get the account divided in an approved manner, which can be a very vulnerable position (n.b. be kind to opposing counsel, you may need that relationship).
Once approved, endorse any required order and send to court for entry along with the Final Order of Divorce; send any other required paperwork to the retirement account servicer (for non-qualified plans).
Once the Court has entered the order, send an original order to the account servicer immediately. For payees in retired status, you may have to send a QDRO within 30-60 days from the date of entry of the final order of divorce for it to be considered valid.
G. Financial Misconduct
Waste is the most common form of financial misconduct and is “the dissipation of marital funds in anticipation of divorce or separation for a purpose unrelated to the marriage and in derogation of the marital relationship at a time when the marriage was in jeopardy.” Booth v. Booth, 7 Va. App. 22 (1988).
Speak with your client, conduct discovery, and, depending on the scale of the missing money, consider hiring an expert. Let’s say Rebecca is your client and she suspects her husband, Victor, of wasting assets. In talking to your client you can get a picture of the opposing party – does he like to gamble, have any alcohol or drug issues, issues with fidelity, etc. If so, tailor your discovery requests to specifically seek documents and information about trips, paramours, gifts (including cash) for third parties, gambling locations, timing of the suspected waste, and any other specific areas of concern in your case.
When you receive discovery responses, assuming Victor has not highlighted his waste for you, you should start pouring over financial accounts. Are there any bank or investment accounts that have decreased significantly in value? Credit cards, HELOCs, or other lines of credit that has increased?
Rebecca has the initial burden of identifying the asset and wasted amount, showing that Victor was responsible for the decrease in value of that asset, and that the decrease happened at a time when the marriage was in jeopardy. The burden then shifts to Victor to show, by a preponderance of the evidence, that he spent the marital funds on a marital purpose. See, e.g., Smith v. Smith, 18 Va. App. 427 (1994), Clements v. Clements, 10 Va. App. 580 (1990). While Victor will probably not get away with just claiming he spent the money on “marital” or “joint” expenses, he may not be held accountable for the waste if he provides a detailed accounting of where the money went. See, e.g., Howell v. Howell, 31 Va. App. 332 (2000).
At this point you will need to determine if you plan to hire an expert to rebut any accounting Victor may come up with, or not. Have discussions with your expert (section I below) about the scope of the waste, what your expert’s timeline for completion would be. Also, be honest with yourself about whether your client has the resources to trace, or, if you are doing it sans expert, you have the resources (time, patience, skill) to trace the waste yourself or not. The tracing is not worth much if it is not an admissible summary. Weighing those issues, either you or the expert should begin to look at the identified accounts/statements and categorizing each expense. Rebecca is an invaluable resource here – you will need her constant input about when the marriage was in jeopardy, which accounts/time periods/transactions seem suspicious to her, and whether or not she accompanied Victor on any occasions in which he gambled/cheated/etc. (if so, those expenses are probably not waste). In this way, Rebecca will be able to narrow the scope for you and/or the expert to focus on and get the most bang for her buck.
H. Searching for and Spotting Hidden Assets
As with waste, the most important part of searching for and spotting hidden assets is talking to your client to determine whether a case is likely to have hidden assets or not. As above, this will include an analysis of the opposing party’s preferences (e.g., gambling or prostitutes) and habits (frugal or spendthrift), and whether the identified assets seem to match up with the parties’ income or not. A rule of thumb I use in cases of high income is that one might project a savings rate of 10% annual income. If there is no savings, where did the money go? For example, if Brandon comes in and tells you that his husband, Charlie, mysteriously stopped getting bonuses a couple of years ago; or there are large HELOC charges Brandon is unaware of though he and Charlie are typically frugal; or Charlie has a boyfriend in the Bahamas – you should be doing everything you can to search for hidden assets.
One advantage of decades of experience in family law is the realization of how one might hide income or assets during a marriage, if one has access to certain kinds of employer-related benefits, including the following:
Life Insurance (e.g. split dollar)
Nonqualified deferred compensation
Executive Benefit Plans
Stock Options (NQSO and ISO)
Employee Stock Purchase Plans (ESPPS)
Phantom stock (shadow stock)
Stock Appreciation Rights (SAR)
Junior Class Shares
Flexible Spending Accounts (FSA)
Health Savings Account (HSA)
Transportation fringe benefits
An example of a dirty trick is to acquire, more than three years pre-separation, a deferred annuity, and to have the statements from the annuity company go directly to one’s work address. Say, for example, in 2013, Charlie intended to separate in 2017, when the last adopted child of the marriage was expected to finish college, and he bought with $500,0000 in 2013 dollars the right to receive $50,000 per year for the rest of his life, beginning in 2033. The $500,000 would be hidden, nothing would reveal its acquisition in tax returns, formal discovery would not likely catch it, and Charlie would likely get away with it.
One simply cannot catch all hiding. In most situations, good legal sleuthing starts with looking at all employment benefits for the spouse and all recent tax returns. From the latter, one might develop a list of financial institutions. A lawyer can do this with the help of Brandon, Charlie, Charlie’s employer, and a private investigator. Ask Brandon to provide you a list of each financial institution he can recall being associated with Charlie – has Charlie received SunTrust mail at home? Citibank? In discovery, ask Charlie to list each financial institution he has had any relationship with for the past 5 years. (Note: If you follow this up with a Motion to Compel in which Charlie represents and warrants that he has listed each institution in discovery, and post-divorce a hidden account is discovered, Brandon may be able to return to court and seek an equitable division of said account.) You can issue a subpoena duces tecum to Charlie’s employer seeking pay-related documents including any direct deposit directions (which may indicate Charlie is diverting some of his paycheck to a separate account). Lastly, private investigators may be able to determine (via property searches, public record databases, and other PI databases) additional assets (like real property) or financial institutions associated with Charlie.
Once you have a comprehensive(ish) list of Charlie’s financial institutions, it’s time to issue subpoenas duces tecum. For each financial institution, you should seek copies of statements, withdrawal and deposit slips, and front and back of checks. Then, dig in. Look for any accounts which were not initially disclosed in discovery; look for checks Charlie wrote from one account and cashed in an undisclosed account; look for transfers of money to unknown accounts; for credit card or other loan payments to institutions Charlie did not disclose in discovery; and for lots of money going to a specific unknown person or lots of cash withdrawals. Any of those clues will help lead you towards hidden assets in Charlie’s name or being held by a third party.
After you have a complete list of financial institutions, you should send a subpoena duces tecum to each institution for the relevant time period. This will provide documents for each account that existed during the relevant time period – whether or not it currently exists. In addition to statements, you should seek copies of checks, withdrawal slips, and deposit slips. These can provide clues as to any additional institutions Charlie may have a relationship with (for example, if he writes a check to himself from SunTrust, and deposits the check into a Bank of America account, you know to add Bank of America to the list). If there is any overlap between a hidden asset and the financial institutions uncovered in discovery, you will be able to find it.
I. Using Forensic Accountants and Business Valuation Experts
Forensic accountants and business valuation experts can be incredibly valuable – and incredibly expensive. For that reason, it’s imperative that you exercise judgment in determining whether the benefit is going to outweigh the costs. It is best practice to find the person you believe is the best forensic accountant and best business valuation expert and create a strong relationship with them so that they will tell you frankly whether their services will be worth it or not in any given case. “Best” necessarily includes honest as one of the criteria; technical skill is only good if the expected financial benefit to the client exceeds the financial cost to the client of the legal and expert fees.
Forensic accountants are the best way to prove financial misconduct, including waste, and hidden assets, which can require hours upon hours of tracing money from known accounts to unknown sources. This type of analysis can easily cost tens of thousands of dollars – so you will want to determine up front if yours is the type of case where there is a real threat (or known) misconduct or hidden assets; whether you have the information and documents available so that an expert will be able to prove misconduct and/or hidden assets; and the scope of misconduct or hidden assets. For example, if Frank thinks his wife Eliza is hiding money because she takes out $100 per week from the ATM, it is probably not worth hiring an expert, who will cost much more than the level of feared waste, which may not even be provable (if Eliza claims she spends the money on groceries, for example). Conversely, if Frank thinks Eliza makes $200,000 per year but only deposits $100,000 per year into their joint account, and Eliza’s paystubs indicate Frank is correct about her salary, then it likely is worth having an expert trace where the missing funds are going and try to reclaim those back into the marital estate.
Likewise, business valuation experts can help you determine whether a business is worth valuing or not. For example, if Frank owns Frank Law, PLLC, which runs out of his home office and employs one paralegal, the majority of the business is likely personal goodwill and therefore Frank’s separate property. It may not be worth his wife, Eliza, spending tens of thousands of dollars on a business valuation expert to learn the law firm only has a marital value of a few thousand dollars. It is helpful to have a good relationship with a talented expert who would be willing to spend just a little time glancing over documents you already have and give you their honest opinion about (a) whether the expert will find anything; (b) how much may be missing; and (c) how much their effort and testimony will cost.
A good business valuator will know what to look for in determining whether a business is worth valuing or not, and guide you in that process. For example, signing a non-compete agreement often transmutes any personal goodwill an individual owner may have into organizational goodwill. Having a business valuator glance at a file and pick out that one, salient fact can make the difference in whether you decide to have a business evaluated or not.
J. Enforceability of Prenuptial Agreements
Pursuant to Virginia Code section 20-149 a premarital agreement signed by both parties shall be enforceable without consideration and become effective upon the marriage of the parties. Virginia Code section 20-151 provides that such agreements are unenforceable where a party did not enter the agreement voluntarily, the agreement is unconscionable (so uneven as to shock the conscious) plus has a disclosure problem, or the marriage is void.
In Derby v. Derby, 8 Va. App. 19 (1989), the Court of Appeals found a marital settlement agreement was invalid and unconscionable where the Husband signed over all of his interest in the parties’ real property, which constituted the majority of their marital estate. In analyzing the agreement, the Court stated that “unconscionability is more concerned with the intrinsic fairness of the terms of the agreement in relation to all attendant circumstances, including the relationship and duties between the parties.” Derby at 28. Such circumstances may include bad faith in the form of “concealments, misrepresentation, undue advantage, oppression on the part of the one who obtains the benefit, or ignorance, weakness of mind, sickness, old age, incapacity, pecuniary necessities, and the like, on the part of the other … .” Id. Here, the court invalidated an agreement where it was unconscionable in wife’s favor and wife took advantage of husband’s hope of reconciliation by concealing her new relationship and intent to proceed with divorce.
In considering whether a prenuptial agreement is voidable, the simplest and best approach, suggested by Derby, is to look for a combination of (1) a disparate/ unconscionable division and (2) an unfair process (duress, undue include, fraud, etc.). A disparate result itself is insufficient. Derby at 27.
Courts have refused to invalidate agreements where the business-man husband gave wife three valueless companies which later became valuable and there was no bad faith exhibited on the part of wife (Shenk v. Shenk, 39 Va. App. 161 (2002)); and where husband received 94% of the marital estate but there was no proof of bad faith on the part of husband (Galloway v. Galloway, 47 Va. App. 83 (2005)).
Conversely, Courts have invalidated agreements where the agreement was unconscionable against the wife and husband failed to disclose his assets (Chaplain v. Chaplain, 54 Va. App. 762 (2009)); and where the agreement was unconscionable against wife and bad faith factors were present (wife had 3rd grade education, health problems, and was on food stamps) (Sims v. Sims, 55 Va. App. 340 (2009)).
If you want almost to ensure your prenuptial agreement is considered enforceable, it is best practice to give each party an attorney, go through (at least informal) discovery, and to include the statutorily-required language in each agreement about disclosure, voluntariness, and understanding the agreement. With regard to disclosure the verbiage of the waiver ought to track 20-151(A)(1) and (2). I suggest the following (the bold is essential, the rest is not statutorily-required): “The parties are signing this Agreement voluntarily, and not under any duress, coercion or undue influence. While the parties have a romantic relationship and the emotional highs and lows attendant with such relationship, this Agreement was not created in the aftermath of, or as the result, of any overreaching or oppressive influence of any party or anyone.
This Agreement is not unconscionable. Each party was provided a fair and reasonable disclosure of the property or financial obligations of the other party; and/or each party does hereby, via the signing of this Agreement, voluntarily and expressly waive, in writing, any right to disclosure of the property or financial obligations of the other party beyond the disclosure provided within this Agreement.”
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