Answers to Winter 2014
California Bar Exam Questions

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Winter 2014 Bar Question 2

Community Property

  Question
 

Hank and Wendy are residents of California.  Hank is a teacher and Wendy is an accountant.

In 2008, Hank and Wendy married.  After their wedding, Wendy’s mother deeded them a house as joint tenants.  They moved into the house and used their earnings to furnish it in a lavish style, including an antique mirror in the entryway. One day, Hank gave the mirror to a friend who had admired it on a visit to the house.

In 2012, Wendy purchased a small office building where she established her own accounting  practice.    She  paid  for  the  building  with  funds  saved  from  her earnings during her marriage and took title in her name alone.

In 2013, Hank and Wendy separated.  Hank told Wendy that the house was henceforth her separate property and she said, “O.K.”

After the separation, Wendy’s income from the accounting practice tripled and she remodeled the office building with her increased earnings.  Without Hank’s knowledge, she then sold the building to Bob, who did not know that she was married.

In 2014, Wendy initiated dissolution proceedings.

1.  What are Wendy’s rights, if any, as to the antique mirror?  Discuss.

2.  What are Hank’s and Wendy’s rights, if any, as to the following:
a)  The house? Discuss.

b)  The accounting practice?  Discuss. c)  The office building? Discuss.
Answer according to California law.

 
Answer

Community Property
Question 2, Winter 2014

1. Mirror
The character of property follows its source. Property acquired with community property is community property. Here, H and W bought a mirror with when they were married. Therefore, the mirror is community property.

H Gave Mirror to a Friend — Gift of Community Property by One Spouse
Furnishings of the community home are accorded special protection against disposal by one spouse. Because things in the home are central to the marital community, these objects may not be conveyed by one of the spouses without the consent of the other spouse. The nonconsenting spouse may void the gift at any time.
Here, H gave the antique mirror in the couple’s home to a friend. H conveyed community property furnishings without W’s consent.
W may void the conveyance, and the mirror would be returned to the community.
Alternatively, W may seek an accounting and reimbursement from H for the value of the mirror. The mirror is community property, and each spouse is entitled to half its value.

2a). House
Property acquired during marriage is community property. Here, W’s mother gave H and W the house after their wedding. Therefore the house is CP.

Joint Tenancy Title
When real property has been conveyed to a married couple, there is a strong presumption that it was intended to be their marital property. Joint tenancy title conflicts with community property character, in that joint tenancy has a right of survivorship. In contrast. community property can be left by will to whomever the decedent spouse designates.
Because community property characterization is preferred, the court will not find the joint tenancy title controlling unless the grantor’s intent is absolutely clear. This requires that the title state not only that it is “joint tenancy,” but also contain the words, “with right of survivorship.”
Here, W’s mother simply used the words, “as joint tenants.” This is not enough to overcome the presumption that the character is community property. Therefore, the house is community property.

H Told W the House Was Her Separate Property — Transmutation
Changing the character of an asset requires a writing. Here, H verbally told W that the house would be W’s separate property in the future. This is ineffective to change the house’s character.
Therefore, the house remains community property.
Therefore, H and W each have a right to half the value of the house.

2b). Accounting Practice
Earnings during marriage are community property, but when a spouse works for herself, she may not take a salary. If she does, the community property is deprived of the spouse’s earnings. To calculate the community’s share, it is necessary to know whether the seed money for the business was community property or separate property.

If seed money was W’s separate property. When a spouse works in her own business funded by her separate property, a portion of the appreciation of the business is awarded to the community property in lieu of earnings. We are not told the character of the seed money for the accounting practice. If it was W’s separate property, the accounting used to determine the community’s award is either Van Camp or Pereira.
Van Camp is used when the appreciation of the business is due to the nature of the economy or the type of business. In that case, the community property is awarded what that spouse might have been paid as an employee for similar work. The remainder is the worker’s separate property.
Pereira is used when the appreciation of the business is due to the skills, efforts or talents of the spouse who is working in the business. In that case, the separate property is awarded the initial investment plus a reasonable interest rate, as if the capital had been invested. The remainder of the profits are community property.
Here, an accountancy practice is a professional business. Success depends largely on the skill of the spouse who is the accountant. So the Pereira accounting would apply, and W would be awarded the initial seed money and a reasonable interest rate for the years she practiced while H and W were married. The community property would be awarded the remainder.

If the seed money was community property: The Van Camp and Pereira formulas are not used when the seed money is community property. Instead the applicable rule is that character follows source. This means that profits from community property are community property. If the seed money was community property, the appreciation of accounting practice would be community property. W started the accounting practice at the same time she bought the office building, and she used community funds for the office building, so it is likely the accounting practice also was funded by community property. Therefore, CP was the likely source of funds. The entire value of the accounting practice is CP.

Conclusion
During marriage, the appreciation of the business is likely to be community property.

Appreciation After Permanent Separation — Reverse Pereira-Van Camp
The treatment of the appreciation from a business after permanent separation is subject to a different rule.

If the start-up capital was W’s separate property, the community has no further claim on the appreciation after permanent separation because earnings after permanent separation are W’s separate property.

If community property is the seed money for a business and one spouse continues to work in the business after permanent separation, the appreciation after permanent separation is characterized by one of the following:

Reverse Van Camp. If the main reason for the increase in the appreciation of the business can be attributed to the asset itself or to the nature of the economy, then the spouse working in the business is awarded a reasonable salary as separate property and the community property is awarded the remainder.

Reverse Pereira. If the main reason for the increase in the value of the business is due to the skills, efforts and talents of the business-operating spouse, then the community is awarded the return on investment, at a reasonable rate of return, and the remainder is awarded to the spouse who worked in the business.
We have already decided W’s efforts predominated so the Pereira test applies. Further evidence that this is the right rule is seen by W’s tripling the income to the accounting practice after they separated. This is unlikely to be due to the nature of the economy. Instead, it is more likely to be due to W’s skills. For these reasons, the court would apply the reverse Pereira formula to the appreciation after separation.
Under Reverse Pereira, the community would be awarded the return on investment.
All the rest of the appreciation since separation would be awarded to W as her separate property.

2c). Office Building
Title presumption. Property title is presumed to be its character. Here, W took title to the office building in her name alone. Thus it is presumed to be W’s separate property.

Exception: Self-Serving Title
Every spouse has equal management and control over community funds. However, when a spouse takes community property and uses it to acquire property and titles it as separate property, title is seen as self-serving. The court will ignore the title and look to the source of the funds.

Source of funds. Earnings during marriage are CP. W paid for the office building with funds saved from her earnings during marriage. Therefore, the source of funds for the office building is CP.
Therefore, the office building is community property.

Value Added to CP Office Building by W’s Separate Property
Where a spouse improves community property with her separate property, the money she added will be awarded back to her as SP. Here, W used appreciation from the accounting practice to improve the office building. Regardless of whether the initial capital for the business was her SP or community funds, the appreciation after permanent separation is W’s separate property.
There are two ways to calculate how much W’s separate property will be reimbursed.
The first and most common way is that the SP funds are called a gift to the CP, but the separate property is reimbursed the actual dollars she contributed.
The second permits a greater award to the separate property. The gift presumption can be overcome if, when she contributed the SP, W wrote a document memorializing her intent that the SP contribution retain its SP character. In that case, W would be awarded a pro rata share of the value of property, calculated by a fraction where the spouse’s SP contribution is the numerator and the total purchase price of the house is the denominator. This is multiplied by the current value of the property.
As far as we know, W did not write such a document.. Therefore, the court would reimburse W the actual dollars expended in remodeling, without appreciation. After deducting W’s reimbursement, the court would divide the value of the office building equally as community property.

Conveying Office Building to Bob
A conveyance of CP real property requires the written consent of both spouses. Here, W sold the office building to Bob without H’s knowledge. Since H did not know of the sale, he could not have provided written consent.
The nonconsenting spouse may void the conveyance up to a year after it is made. The time limit on voiding the sale is due to the need for title to real property to be settled. Here, W sold B the office building in 2013 and the dissolution proceedings began in 2014, so we do not know if W conveyed the building less than a year ago. If it was within a year, H can void the sale, with the following condition.
If the grantee was a bona fide purchaser without knowledge that the property was CP, the nonconsenting spouse voiding the conveyance must reimburse the grantee the purchase price. Here, the office building was titled as W’s separate property, and Bob did not know W was married. Therefore, Bob would be entitled to a refund of his purchase price from H.
If it has been more than a year since W sold the office building, H may request an accounting from W and reimbursement to the community of the value of the property that was misappropriated.

Conclusion
The office building is CP. Each spouse will be awarded half its value, after W has been reimbursed for the improvements she made from her separate property.

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