Classification of Debts Upon Divorce
National Legal Research Group, Inc.)
Very few equitable distribution statutes expressly require the court to classify debts. Nevertheless, the strong general rule is that only marital debts should be divided. If debts are not classified, then the parties must share any debt incurred during the marriage. But there are clearly some sorts of debts which should not be shared. Gambling debts, excessive living expenses, and unreasonable investments are only a few of many potential examples. Just as some types of property acquired during the marriage should generally be retained by one spouse (e.g., gifts, inheritances), some types of debt incurred by one spouse should be charged to that spouse alone.
"In most states, a marital debt is any debt incurred during the marriage for the joint benefit of the parties or for a valid marital purpose." Ketchum v. Ketchum, 2003 WL 21134713, at *6 (Ohio Ct. App. 2003); see also, e.g., Nieboer v. Nieboer, 816 So. 2d 1259 (Fla. Dist. Ct. App. 2002); McGuire v. McGuire, 11 Neb. App. 433, 652 N.W.2d 293 (2002); Hickum v. Hickum, 320 S.C. 97, 463 S.E.2d 321 (Ct. App. 1995); Bchara v. Bchara, 38 Va. App. 302, 563 S.E.2d 398 (2002).
It is important to understand that the notions of joint benefit and marital purpose do not require that every debt benefit both spouses. In every marriage, both parties spend marital funds and incur marital debts for their own sole benefit. For example, the wife may buy a dress which only she will wear; the husband may buy new golf clubs which only he will use. Nevertheless, in the great majority of situations, both of these debts will be marital. What has happened is that the parties have agreed, implicitly if not expressly, that each of them will be permitted to use a certain amount of marital funds for his or her sole benefit. So long as these expenditures are consistent with one another and with the general marital standard of living, no one would contend that they are improper. For purposes of classifying debts, an obligation which is consistent with the established marital standard of living is incurred for joint benefit, even if it technically benefits only one spouse alone.
Volumes of cases have been written on the subject of which debts are and are not incurred for a marital purpose. This article will cover only a few highlights from the recent cases.
Debts incurred in the process of producing marital property are always marital debts. When a marital business enterprise succeeds and earns income, the income is clearly marital. But those who share the gain must also share the pain. The debts of a marital business are therefore marital debts. See McCleary v. McCleary, 2002 WL 31875127 (Md. 2002) (error to treat debts of marital business as nonmarital debts) (published opinion not yet released in A.2d); In re Marriage of Holden, 81 S.W.3d 217, 224 (Mo. Ct. App. 2002) (rejecting wife’s argument that husband’s business debt could not be considered).
This result is true even if the business fails and produces nothing but debt, so long as the business was operated in good faith and failed despite the best efforts of the operating spouse. E.g., In re Collins, 875 S.W.2d 643 (Mo. Ct. App. 1994) (wife was properly ordered to pay debt incurred by husband’s failed business, where husband had started business in good faith); Sien v. Sien, 889 P.2d 1268 (Okla. Ct. App. 1994) (farm debts were marital even though they resulted from unsuccessful operation by husband; husband acted in good faith). The leading case nationwide, which occurred in the context of dissipation but which is otherwise on point, is Goldman v. Goldman, 275 N.J. Super. 452, 646 A.2d 504 (App. Div. 1994).
Business and investment debts are nonmarital if the business was not operated in good faith. The most common example is unreasonable investment or gambling debts. See Keathley v. Keathley, 76 Ark. App. 150, 61 S.W.3d 219 (2001) (husband forged wife’s name on credit card applications, and incurred debt on cards for purposes of gambling). But cf. In re Marriage of Williams, 84 Wash. App. 263, 927 P.2d 679 (1996) (gambling consistent with the overall marital standard of living is not materially different from any other expenditure for entertainment). For other cases, see Lawson v. Lawson, 288 A.D.2d 795, 732 N.Y.S.2d 753 (2001) (husband borrowed money to start new business without wife’s consent, and business had substantial negative net worth at time of divorce), and Gadomski v. Gadomski, 245 A.D.2d 579, 664 N.Y.S.2d 886, 888 (1997) (husband lost 25% of parties’ net worth in "rash and unreasonable" investments in "penny stocks"). The clear trend is to find a nonmarital purpose only where the business is clearly unreasonable.
The same principles apply to income tax obligations. "Income tax liability incurred during the marriage is one of the accepted costs of producing marital income, and thus, we hold that income tax liability should generally be treated as a marital debt." Meints v. Meints, 258 Neb. 1017, 1023, 608 N.W.2d 564, 569 (2000). This is true regardless of whether the obligation is paid on time or late. "Even if the taxes are overdue, the principle behind the rule is the same, and the underlying tax liability would ordinarily be a marital debt." 258 Neb. at 1023-24, 608 N.W.2d at 569.
The rule is different, however, to the extent that a late payment by one spouse alone increases the total amount due. Thus, any interest and penalty are normally the separate debts of the spouse responsible for the late payment. See Killough v. Killough, 72 Ark. App. 62, 32 S.W.3d 57 (2000) (trial court properly awarded husband the entire interest and penalty component of tax obligation); Meints; Lekutanaj v. Lekutanaj, 234 A.D.2d 429, 651 N.Y.S.2d 154 (1996) (debt for unpaid taxes for last year of marriage was marital obligation; penalties and interest were husband’s separate obligation). At least one court has applied the same rule to other types of penalties. See Clark v. Clark, 324 N.J. Super. 587, 737 A.2d 189 (Ch. Div. 1999) (wife faced state-required insurance surcharge after conviction for driving while intoxicated; surcharge was a nonmarital debt). Where both parties share the responsibility for the late payment, any interest and penalty are marital obligations. See In re Dunseth, 260 Ill. App. 3d 816, 633 N.E.2d 82 (1994) (wife was aware of husband’s failure to file and benefited from an excessive lifestyle permitted by nonpayment of taxes).
One of the most interesting areas of law in recent years is the classification of debts incurred to pay living expenses after separation. During the marriage, debts incurred for living expenses are of course marital. E.g., DiOrio v. DiOrio, 751 A.2d 747 (R.I. 2000). Debts incurred to pay unreasonable expenses beyond the normal standard of living are nonmarital, regardless of when incurred. See Goodman v. Goodman, 8 S.W.3d 289 (Tenn. Ct. App. 1999) (debt incurred for living expenses was partly excessive; error to treat entire obligation as a nonmarital debt); Mathew v. Palmer, 8 Neb. App. 128, 589 N.W.2d 343 (1999) (credit card debt incurred by voluntarily unemployed husband after separation "to continue his indolent activity" was nonmarital); cf. Harbour v. Harbour, 227 A.D.2d 882, 643 N.Y.S.2d 969 (1996) (wife spent $35,985 for a new wardrobe after separation; finding dissipation).
The hard issue is funds spent for normal living expenses after the separation of the parties. There is law holding that all debts incurred to pay living expenses are marital, regardless of when incurred. See Fuchs v. Fuchs, 276 A.D.2d 868, 714 N.Y.S.2d 381 (2000) (debt incurred for post-separation living expenses was marital, stressing that amount of debt incurred by each party was roughly equal).
But this rule reached an unjust result in states in which the date of classification is the date of separation or the date of filing that is, in states which treat post-separation or post-filing (hereinafter post-classification) income as separate property. In those states, if debts incurred to pay post-classification living expenses are uniformly marital, then the parties are encouraged to pay their living expenses with marital debt, while hoarding separate post-classification income for their own benefit. Such an incentive is bad policy. Post-classification living expenses should normally be paid with post-classification income.
It is equally unjust, however, to hold that post-classification living expenses are never a marital debt. In a significant number of divorce cases, the husband leaves the wife because of his own misconduct and refuses thereafter to support her. Eventually, the wife can get temporary spousal support. But until the court gives an order, the wife must live off of her own income. If she cannot meet her basic support needs, she is literally forced to live off of marital funds. Even if she can meet her own basic needs, there is no reason why she should be forced to live at less than the marital standard of living. She is surely entitled to that level of support (or as close to it as the parties can afford) when the court makes its temporary support order. It is hard to see why she would act improperly by consuming marital funds to live at that level before the court has the opportunity to make an actual award. (To avoid undue linguistic complexity, this paragraph assumes that a wealthy husband has left a less-wealthy wife, but the same rules of course apply when the parties’ sex roles are reversed.)
The best rule, therefore, is that post-classification living expenses must be paid first from post-classification income. If a spouse incurs debt to pay living expenses, when post-classification income is available to pay the same expenses, the debt should be treated as nonmarital. Once post-separation income is exhausted, the parties should be allowed to incur marital debt (or to spend marital property without a finding of dissipation) so long as the living expenses involved are within the marital standard of living. Expenses above the marital standard of living, of course, are excessive and always nonmarital.
Only one case has considered this issue in the context of a marital debt. In Howell v. Howell, 31 Va. App. 332, 523 S.E.2d 514 (2000), the parties had established the practice of living beyond their incomes and paying off each year’s debt with the husband’s year-end bonus. After separation, the husband failed to pay off that year’s debt with the bonus he received after separation. The court held that the debt not paid off was marital and was properly allocated to the husband. The result suggests that, by failing to pay post-separation living expenses first from his post-separation bonus, the husband acted improperly.
Most of the discussion of post-separation living expenses occurs in the context of dissipation that is, whether a party acted improperly by spending a marital asset to pay those expenses. But no one contends that the result should vary, depending upon whether the party spent a marital asset or incurred a marital debt. In both cases, the marital nature of the purpose is the key question.
For cases holding in the dissipation context that post-classification living expenses are not a marital purpose unless post-classification income has been consumed first, see In re Marriage of Frey, 258 Ill. App. 3d 442, 630 N.E.2d 466 (1994) (husband dissipated assets by using marital savings for post-separation living expenses; noting that husband had not shown how he used his post-separation income); Parker v. Parker, 996 P.2d 565 (Utah Ct. App. 2000) (wife withdrew over $100,000 from bank accounts during separation even though her income exceeded her expenses by $2,000 per month); Holland v. Holland, 1999 WL 262433 (Fairfax County, Va., Cir. Ct. Mar. 3, 1999) (the best policy discussion); and Preiss v. Preiss, 238 Wis. 2d 368, 617 N.W.2d 514 (Ct. App. 2000) (husband’s use of marital funds to establish post-separation household was dissipation where husband could have paid the same expenses from post-classification income).
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