In November 2018 we wrote about In re Brace, in which the Ninth Circuit Court of Appeals asked the California Supreme Court to decide whether the “form of title presumption” trumps the “community property presumption” when spouses take title to real property as joint tenants. To read our prior post, please click HERE.
On July 23, 2020, in a very thorough decision that will have a big impact on family, bankruptcy, and debtor-creditor law, the California Supreme Court answered the Ninth Circuit’s questions. The decision can be read HERE.
In sum: Property acquired by spouses with community funds on or after January 1, 1975, is presumed to be community property even if title to the property is taken in joint tenancy. The grant deed, in itself, is not sufficient to overcome the community property presumption. What is required to overcome the community presumption depends on whether the property was acquired before or after January 1, 1985.
Why does it matter when the property was acquired? In the 1970s, the California legislature enacted landmark reforms to the community property system. Those reforms, which went into effect on January 1, 1975, eroded prior rules that emphasized the manner in which title was held. Still, spouses could “transmute” property from community property to separate property (and vice versa) by an oral or written agreement or a common understanding between the spouses. However, effective January 1, 1985, new legislation provided that a transmutation is not valid unless it is made in writing and satisfies certain requirements.
This decision will have a huge impact in bankruptcy cases, especially chapter 7 cases, in which only one spouse files for bankruptcy.
Consider the following example: John and Jane own a house that they bought after they were married. The grant deed says that they took title as “John and Jane, husband and wife, as joint tenants.” The house is worth $500,000. Their mortgage is $300,000. John files a chapter 7 petition, but Jane does not join in. As is his right, John claims a $75,000 homestead exemption in the property.
Under a 2003 Ninth Circuit case called Summers, the chapter 7 trustee would not sell the house because it would not generate any funds for unsecured creditors. If she were to sell the house, about $35,000 would go to pay brokerage fees and closing costs, and $300,000 would go to the mortgage company. That leaves $165,000. Half of that would be paid to Jane for her one-half joint tenancy interest. That leaves $82,500. From that the trustee would pay John his $75,000 homestead exemption. That leaves $7,500. The trustee’s statutory fee for selling the property would exceed $7,500. Since a sale would generate nothing for unsecured creditors, the trustee would “abandon” it back to the debtor. John and Jane would keep the house, and creditors would receive nothing.
Now, under Brace, the trustee will sell the house because John’s bankruptcy estate includes all community property in which John had an interest when he filed for bankruptcy. See 11 U.S.C. § 541(a)(2). After paying costs of sale and the mortgage, the trustee will pay John his homestead exemption and the remaining $90,000 will be used to pay costs of administration (such as the trustee’s fee) and unsecured creditors. John and Jane will lose the house, and creditors will receive something on account of their claims.
As we predicted in our prior post, the California Supreme Court’s answer will have a significant impact on cases in which only one spouse files for bankruptcy. In many such cases, the answer makes it more likely that debtors’ houses will be sold and creditors will be paid.