Liabilities In a Divorce

General rules regarding whether a debt should be included in the marital estate

The question of whether or not to include a debt in a marital estate is a function of the reason the debt was incurred and when it was incurred. There are three general rules in considering whether or not a debt should be included in the marital estate:

  • Debts incurred to supply necessities are part of the marital estate.
  • Debts to provide luxuries which are incurred prior to the date of separation are part of the marital estate.
  • Debts to provide luxuries which are incurred after the date of separation are not part of the marital estate.

These rules are from an economic viewpoint, not a legal viewpoint. The underlying theory deals with the changes in economic entities that occur during divorce. In marriage there is a single economic unit, the married couple. The economic assumption is that this single entity is making economic decisions that have the approval of both parties. Consequently, any debt that is incurred can be assumed to be the result of a combined economic decision and therefore appropriately included in the marital estate. However, the separation of the couple creates two economic entities instead of one. It can no longer be assumed that the economic decisions of the parties to incur debt are in accord.

Under this theory, it could be assumed that no debt incurred by either party after the separation would be included in the marital estate. However, separation of a married couple, more often than not, creates an economic disparity between the parties. That is, one party will usually have more resources than the other. The party without resources may have to incur debt in order to live. From an economic standpoint, it is not necessarily that the resources do not exist to support both parties, it is that there is an economic imbalance between the parties that creates the debt. It follows then that the debts incurred for the support of either party after separation should be the responsibility of both parties.

Luxuries

Debt that is incurred for goods and services that are not necessary to live are considered luxuries. Whether or not these items are included in the marital estate is a matter of timing. If the debt was incurred prior to the separation, an assumption is made that incurring the debt had the approval of both parties and the debt is included in the marital estate. If the debt was incurred after the date of separation, an assumption is made that the there was not a mutual agreement to incur the debt and the debt is excluded from the marital estate.

Local rules, regulations and case law may counter economic principle. For example, a jurisdiction can mandate a date of valuation (date of separation, filing or other arbitrary date) stating that any debt incurred prior to this date is marital and any after is not. Some jurisdictions may have a default valuation date of the date of the divorce which is rarely altered. This means that anything that happens to the finances of the couple prior to the divorce is marital. Understandably, this type of provision will normally necessitate review by the court of numerous transactions to ensure equitability of the debts included in marital estates. Case law on when debts (and property) are part of marital estate can produce curious and confusing precedent. In addition, jurisdictions can vary remarkably on the principles that are applied even from county to county within the same state.

Exceptions to the general rules

After the general rules are applied, exceptions to the rules may come into play. Exceptions can be generated by attempts to maintain equity in the valuation of the marital estate or as tools of negotiation.

The following are some examples where departure from the rules was warranted, valuable, or a matter of survival:

  • The husband incurred a Visa bill of $3,500 associated with a ring purchased for his girlfriend before the couple separated. It could not be contended by anyone that the decision to incur the debt was a mutual decision by the couple even if the amount was incurred before the separation. The debt was excluded from the marital estate.
  • After the separation, the husband took the entire family (including his estranged wife) to Disneyland, incurring significant credit card debt. Since the amount was a luxury and incurred by one party the rule would indicate that the amount should be excluded from the marital estate. However, the couple decided that the luxury had been incurred for the benefit of the entire family and it was included in the debts of the marital estate.
  • The husband incurred credit card bills of $7,500 for a hunting trip to Alaska. As the amount was incurred before the separation, the wife concurred that the trip was a mutual economic decision of the couple and that the amount should be included in the marital estate. However, presentation of the credit card statements as part of the normal construction of the marital estate indicated that the husband had traveled with a female companion. The husband agreed to the exclusion of the debt.
  • As a part of estate planning, a husband had transferred his interest in the couple’s house to his wife. Immediately after the separation, the wife arranged a line of credit against the house in the amount of $20,000. Over a period of weeks she lost the entire $20,000 to local casinos. Technically, and under the general economic rules, the amount should have been excluded from the marital estate. However, the husband recognized that if the debt was not paid, the remaining equity in the house would be lost. Instead, the husband used the presence of the debt in the marital estate to negotiate terms and conditions of settlement. These included treatment of the wife’s gambling addiction and the establishment of a payment schedule to distribute the marital estate in regular (monthly) payments instead of a lump sum settlement.