Griff’s Notes, January 20, 2022: The Ghosts of Divorces Past in Estate Planning
Tax, trusts and estates updates from around the country
Estate planning professionals rarely concern themselves with divorce property settlements, or the economics and equity behind them. And, while today’s case is not specifically about these issues, it illustrates how they may be applied at the death of a spouse.
If nothing else, today’s key takeaway is to always review a client’s prior divorce settlements if you are assisting them with an estate plan. There may be specific, contractual requirements in such settlement agreements which can create issues if disregarded.
Crain v. Crain, W.D. Ark, January 18, 2022
Central Issue: Effect of divorce property settlement agreement on decedent’s estate plan
Value Added Score: 8
Rule: When a divorce property settlement requires a portion of an estate to go to specific non-spousal heirs, and the decedent remarries, this creates contractual rights and equity rights which supersede tenancies by the entirety, joint tenancies and the elective share
Facts:
This was a lengthy, but interesting, case, if for no other reason than the first name of the decedent was Dude.
Long story short, Dude had four children from a prior marriage. Dude had divorced their mother many decades prior, and executed a divorce property settlement agreement under which he and the mother each contractually agreed to leave at least one-half of their respective estates to their children.
Dude soon thereafter remarried, but remained silent about the settlement agreement (including with his new wife). The children only knew about it through their mother. Both before and after the divorce, Dude had been a successful titan in the industry of manufacturing foam products, amassing a fortune of 9 figures.
But, when Dude died, his estate plan contained the traditional tax plan – creation of a bypass trust to shelter his remaining exclusion amount, with the balance to a marital trust for his second wife. The catch, however, was that Dude had used up his applicable credit during life, so no bypass trust was formed and everything went to the marital trust. The second wife had a power of withdrawal over the marital trust, and (while not stated in the opinion) probably used this as a reason to never open probate, never create or fund the marital trust, and instead take charge of all of Dude’s assets.
The children later came back almost three years after Dude’s death and sued his second wife in federal court, seeking their one-half of his estate.
Analysis
There was a lengthy analysis of Dude’s assets, how they were titled, and what they were worth. Significant value was assigned to an investment account, which held the balance of the proceeds of sale of Dude’s foam manufacturing company. (Notably, his children had been shareholders of this company at the time of sale, and he had purchased their stock in exchange for a note to facilitate such sale, but only paid one-third of each note – this was not at issue in the case, however).
Ultimately, the equitable remedy of a constructive trust was imposed on Dude’s assets, but significant analysis surrounded the question of whether tenancy by the entireties property belonged solely to the second wife as the surviving spouse. There were conflicting equitable views here, as the theory behind entireties property is that the married couple and surviving spouse are treated as one 100% owner instead of two separate 50% owners. But, the Court determined that the divorce property settlement essentially created a lien on property owned by Dude at the time of his second marriage, which such lien could extend not just to his 50% ownership but also to his second wife’s 50% ownership (since the lien existed at the time that the tenancy by the entireties was created).
There was also joint tenancy property, not held as husband and wife, which had to be explored as well.
While I will not summarize the District Court’s entire analysis, as it digs into the tracing of property from a restitution perspective, I did find it interesting that the Court analyzed the second wife’s economic and equitable contributions to joint assets. This is especially helpful for those who work with couples (married or not married) who own significant joint tenancy assets.
Much like a divorce court may analyze, the Court here was tasked with an equitable determination of what belonged to the second wife instead of just assuming a 50/50 split. For example, with Dude’s various business interests, the wife’s testimony of her contributions to the businesses during Dude’s 3-year period of incapacity before death (which was one-tenth of their 30-year marriage) entitled her to 10% of the businesses, with the remaining 90% being subject to the 50/50 split required.
Similarly, for various residences which were jointly titled, it was established that although Dude contributed most (if not all) of the purchase price, the wife had spent a significant amount of sweat equity in fixing up and/or designing such properties. Thus, her efforts rose to the level of 50% ownership notwithstanding her nominal financial contributions.
So, at the end of the day, the children and second wife had to engage in significant time and expense to trace and identity assets, especially since the second wife had sold some of those assets and given some to her son as well. For assets that were sold, the Court found that those were properly chargeable to the 50% of the Dude’s estate which would have gone to the second wife.
The zeitgeist of this case was a three-way tug of war in equitable remedies to consider here – constructive trust for the children, quantum meruit for the second wife, and laches (since the children took almost three years to bring their claims). On the latter point, the Court considered that this delay impacted the ability to identify and trace Dude’s assets. But, the Court also weighed the history of conduct of the parties. There was a significant investment account under which the children were named remainder beneficiaries of 80% of the account. This would have fully, if not significantly, satisfied Dude’s obligations to his children. But, the second wife later changed this from 80% to 40%, which is what precipitated this lawsuit.
Also relevant were the burdens of proof – the children had to show clear and convincing evidence of what was Dude’s, and the second wife had to rebut with clear and convincing evidence what was hers. You can imagine the reams of paperwork required, and if the second wife had not cooperated, one must question whether the children would have been able to establish their burden of proof. But, we don’t know the history of the parties’ conduct, other than the change to the beneficiary designation on the investment account noted above.
Takeaways
As noted above, if you are dealing with a client’s estate plan, always ask for any prior divorce settlement agreement. There could be obligations imposed on a divorced spouse’s estate, which must be addressed in the will or revocable trust.
You should also note that the legal ownership and titling for assets held as joint tenants, and as tenants by the entirety, may not align with the equitable ownership. Regardless of what the title says, contributions matter from both a monetary and labor perspective. But, equitable claims that existed before joint ownership could come in as well.
Now, what the court did not consider here (which could come in with a divorce court’s analysis) is opportunity cost, and how that affects equitable ownership.
It is also important to note that equity typically does not take into account intent, or actions or omissions. It simply places the parties back into the position they should have been in from the beginning if a contract or obligation had been fulfilled. Thus, even though the second wife had no knowledge of the divorce property settlement agreement, this does not mean that she escapes its effects. Innocence is not a factor. But, going the other way, unclean hands can come into play, and fortunately this was not a factor here.
While this seems like a worst-case scenario, I think it helps to consider the entire context of these issues in client conversations. If nothing, remember that joint tenancy between spouses in a blended family tends to be a recipe for disaster.
One must also consider the tax effects here - the assets going to the children as a result of this court settlement will likely be subject to estate tax. Tax apportionment should be a factor in a settlement like this, as well as a divorce property settlement, and the inequitable piece not considered by the Court is that the second wife will not take a 40% haircut on her share until her death. But, the kids will, and there is no relief for a marital property settlement.