Saturday, November 8, 2014

On Prenuptial Agreements

I write a fair amount of pre-nuptial agreements and my clients often have difficulty with same requests from me. I decided it would be beneficial if I explain them in my blog.

Following is a list of common issues:

First, I always ask to disclose all property and debt of each party and it always surprises me when people resist the disclosure. One of many questions is “why do I need to show what I have?”

 Second, I always schedule a meeting to explain terms of the agreement and I always ask my clients to read the agreement closely and ask me questions on everything they did not understand. Some people follow that advice, majority however do not. They also tend not to listen during our meeting. That concerns me.

Third, I always recommend that their fiancé hired an independent counsel before signing the agreement. Unfortunately I cannot force them to hire one. I wish I could though.

Why am I so concerned about the items on the list? Here is why: in a recent appellate case In re the Marriage of Kaye, which was unpublished, Division One upheld trial court’s decision to invalidate the parties’ prenuptial agreement on the grounds of substantive and procedural unfairness. Meaning they said the agreement was invalid because the parties did not provide full disclosure of the assets, they did not understand terms of their agreement and the wife did not have an attorney for the agreement review and thus did not fully understand the terms of the agreement.

From legal point of view, when analyzing enforceability of prenuptial agreement, the court undertakes a two-prong test:

1.      The court determines if the agreement is substantively fair. If it is fair, then the agreement is enforceable.

2.      If the court finds that the agreement is not fair, the court checks if it was procedurally fair when executed. The term “procedurally fair” means:

a.       Both spouses made full disclosure of the amount, character, and value of the property; and

b.      The agreement was freely entered into on independent advice from counsel with full knowledge by both spouses of their rights.

 “Substantive fairness” means that the agreement fairly provides for the spouse not seeking enforcement of the agreement, including (1) the proportional benefit between the parties; (2) restrictions on the creation of community property; (3) prohibitions on the distribution of separate property upon dissolution; (4) the economic means of each spouse; (5) preclusion of common law and statutory rights to both community and separate property under dissolution; (6) limitation on inheritance; (7) prohibitions on awards of maintenance, and (8) limitations on the accumulation of separate property.

The court in our case found the agreement both substantively and procedurally unfair. On substantive unfairness the court held:

“In the context of the parties’ economic means at the time of execution, these paragraphs [the court referred to specific paragraphs in the agreement] limited the accumulation of community property and disproportionally benefited Karl. When Barbara and Karl married, Barbara owned modest property assets. Her primary source of income was the salary she earned working for a local bank. Conversely, Karl owned substantial property assets and various real estate investments, stocks, and bonds that generated his primary source of income. He had not worked for years, and there was no expectation that he would work during the marriage. By its terms, the agreement essentially ensured that Karl’s property would always remain separate. … Karl’s substantial property assets and its proceeds remained his separate property even if those assets increased in value or became commingled with community assets. Any community funds that directly benefited separate property would be deemed a gift. There was no requirement that a party be reimbursed for community or separate funds gifted to the other party.”

In addition, the agreement prevented accumulation of community property and “it ensured that Karl would retain and interest in half of Barbara’s salary or any asset obtained with the proceeds of her salary. Further, no other clause in the agreement expressly designates any assets as community property. By the agreement’s terms, the only sources of community property are wages, salaries, and employment benefits – assets and only Barbara was expected to contribute when the signed the agreement.”

The court also analyzed other provisions of the agreement and found it to be substantively unfair. “Given the parties’ economic circumstances at the time of execution, the agreement disproportionally favors Karl, restricts the creation of community property, prohibits the distribution of separate property upon dissolution, limits inheritance rights, and precludes statutory rights upon dissolution or death.”

It would have been ok, if the agreement was procedurally fair though. In this case, the court held that the agreement was procedurally unfair because (1) neither party understood what was in the agreement, and (2) Barbara did not receive independent legal advice.

 Even though a person is not required to seek legal counsel, when the agreement is substantively unfair courts routinely find that legal advice is necessary because otherwise a party is “ill equipped to identify its [agreement’s] patently unreasonable terms on her own.”

That is the main point, both parties will benefit if they have reasonable time to review proposed agreement, go over each and every provision with their attorney, and both parties have an attorney to review that agreement.

My recommendation is always to have an attorney review proposed prenuptial agreement, and always make sure that you understand all provisions of the agreement.