©1998 by
Glen L. Rabenn

The California State Supreme Court's recent decision in Marriage of Walrath clarifies how the courts are to handle those situations where a spouse uses his or her separate funds to buy a jointly held asset, which is subsequently refinanced or sold. With the holding in this decision, married people will have to re-think how they deal with each other in the investment of their separate funds. It also poses new challenges to Family Law attorneys in protecting the separate property interests of their clients in dissolution actions.

The Facts

When Gilbert and Gladys Walrath were married on January 11, 1992, Gilbert owned a property in Lucerne, California. In June, 1992, the mortgage on the Lucerne property was refinanced and titled was deeded by Gilbert to both of them as joint tenants. At the time of the refinancing, the property had a fair market value of $228,000 and a mortgage balance of $82,000, yielding equity of $146,000. At a later, unspecified date, Gladys used $20,000 of her separate property funds to reduce the indebtedness on the property.

In 1993, the Walraths again refinanced the property, borrowing an additional $180,000. The loan proceeds were used for different things: $60,000 was used to reduce the encumbrance on the Lucerne property; $62,000 was used to pay off the mortgage on a community real property in Nevada; $40,500 was used to acquire and improve real property in Utah; $16,000 was deposited into a joint savings account. The record was silent with regard to the remaining $1,500 of the loan proceeds.

In the Superior Court

After the Walraths separated and the dissolution action was filed, Gilbert asserted that he was entitled reimbursement under Family Code §2640(b), which provides as follows:

"In the division of the community estate under this division, unless a party has made a written waiver of the right to reimbursement or has signed a writing that has the effect of a waiver, the party shall be reimbursed for the party's contributions to the acquisition of the property to the extent the party traces the contributions to a separate property source. The amount reimbursed shall be without interest or adjustment for change in monetary values and shall not exceed the net value of the property at the time of the division."

Gilbert claimed that his original separate property contribution of $146,000 should be traced to the Nevada and Utah properties and the joint savings account. Gladys, on the other hand, argued that any reimbursement to either party could only come from the Lucerne property. This was significant because, at the time of the dissolution, the equity in the Lucern property was only $1,000.

The trial judge sided with Gladys and held that the Gilber and Gladys should each be reimbursed from the remaining equity in the Lucerne property only. Because the equity was minuscule, the court held that what little equity existed should be divided between the Walraths in proportion to their separate property contributions. This meant that, of the $1,000 equity, Gilbert was to get $810. The equity in the other real properties and the funds on deposit in the joint account were held to be 100% community property and, for that reason, had to be equally divided between the Walraths.

In the District Court of Appeal

Gilbert appealed, claiming that Family Code §2640(b) did not limit the reimbursement to the first asset acquired with the separate property of the contributing spouse. Rather, so Gilbert contended, his separate property contribution should be transferrable from the Lucerne property to the ultimate destinations of those funds. The Court of Appeal for the First District, however, sided with Gladys in In re Marriage of Walrath (1997) 51 CA 4^th 1504, 60 CR 162. .

The panel concluded that, in enacting former Civil Code §§4800.1 and 4800.2, the predecessor to Family Code §2640, the Legislature intended that the asset acquired jointly by the parties with the separate property of one or both of them was, itself, community property. Thus, it concluded, any proceeds from a refinancing must assume the character of their source. The Court further observed that, if Gilbert had intended to retain his separate property contribution through successive assets, he surely would have taken steps to do just that. Clearly not a man who takes "no" for an answer, Gilbert took his cause to the California State Supreme Court.

The Historical Context

After deliberating the issue for three months following oral argument, the Court unanimously overturned the District Court of Appeal, holding that the reimbursement could be traced to successive assets. The decision, authored by Justice Brown, with concurrence by Justices George, Mosk, Werdegar and Chin, starts its analysis with a review of the genesis of former Civil Code §4800.1. Prior to 1983, a line of decisions had developed the rule that a spouse contributing separate property to the acquisition of a jointly-held asset, would be entitled to a pro tanto share of the equity in the asset if the contributing spouse could prove that there was an agreement or understanding to the effect with the other spouse. In re Marriage of Lucas (1980) 27 Cal.3d 808.

Fearing that Lucas would engender the type of pillow-talk testimony that was made extinct by the advent of no-fault divorce, the Legislature enacted former Civil Code Section 4800.1, which became effective on January 1, 1984. That statute, which was incorporated into Family Code §2460(b), gave something to the separatizing spouse and, simultaneously took something away. The statute made it easier for the separate property portion of the community asset to be recognized by simply requiring a tracing of the community property back to its separate property source. No longer was it necessary for the separatizing spouse to offer evidence of an understanding or an agreement. On the other hand, under the statute, the separatizing spouse would only be entitled to be reimbursed for the amount of the separate property contribution. Unlike under the Lucas rule, where the separatizing spouse was entitled to a proportionate share of the equity, the return to that spouse was now strictly limited to reimbursement; any remaining equity was deemed community property.

In addition to avoiding the fallout of sordid marital discussions in trial courts, the Court observed that the Legislature was also concerned about the intrinsic unfairness of a rule that would cause a forfeiture of the contributing spouse's separate property. Quoting from the comments to the original legislation that was passed in 1983, the Court observed that, in enacting Civil Code §4800.1, the Legislature wanted to,

". . . avoid the inequity that may result in a case where property taken in joint tenancy form is divided equally between the spouses despite a showing that one spouse contributed a substantial portion of separate funds to the acquisition."

Interpretation of the Statute

After making its observations about the intent of the Legislature, the Court went on to interpret Family Code §2640(b). It started its analysis by considering the meaning of the phrase,

". . . the party shall be reimbursed for the party's contributions to the acquisition of the property" (emphasis added)

In its now-over turned decision, the District Court of Appeal limited the term to the asset initial acquired by the separate property contribution. The Supreme Court, however, saw no justification in imposing such a limited definition of the term. In fact, the Court felt that the legislation anticipated such an outcome.

 "We conclude that the phrase "the property" in section 2640 includes not only the specific community property to which the separate property is originally contributed, but also any other community property that is subsequently acquired from the proceeds of the initial property, and to which the separate property contribution can be traced. Nothing in the language of the statute precludes this result. Indeed, it is apparent that in providing for reimbursement "to the extent the party traces the contributions to a separate property source," section 2640 envisions some tracing. More significantly, the only exceptions to the statutory reimbursement right are a signed written waiver or a signed writing that has the effect of a waiver."

In support of this interpretation, the Court observed that the statute itself provides that the only circumstance where reimbursement will not be permitted is where,

". . . a party has made a written waiver of the right to reimbursement or has signed a writing that has the effect of a waiver." (Family Code §2640(b))

The Court was also impressed with the fact that, after having its handiwork declared unconstitutional, the Legislature attempted to redraft it so as to avoid the constitutional infirmity. As originally drafted, Family Code §4800.1 and its companion 4800.2 applied to,

"(a) Proceedings commenced on or after January 1, 1984. [¶ ] (b) Proceedings commenced before January 1, 1984, to the extent proceedings as to the division of the property are not yet final on January 1, 1984." (Stats. 1983, ch. 342, § 4, p. 1539.)

In two separate decisions, the Supreme Court held these provisions to be unconstitutional because they tended to impair vested property rights. In re Marriage of Buol (1985) 39 Cal.3d 751, 763-764; In re Marriage of Fabian (1986) 41 Cal.3d 440, 448-451. The Legislature immediately responded, in 1986 and 1987, by enacting urgency legislation which, it hoped, would address the Court's concerns expressed in Buol  and Fabian. In re Marriage of Heikes (1995) 10 Cal.4th 1211, 1223-1225.) Ultimately, however, the Court declared these amendments to also be constitutionally infirm. (Heikes at 10 Cal.4th at p. 1223.)

Even though it had thwarted the Legislature on two separate occasions over ten years, the fact that the Legislature attempted to legislate around the constitutional problems with Family Code §§4800.1 and 4800.2 was not lost on the Court.

" Indeed, the importance of this reimbursement right to the Legislature is apparent by that body' s express response to In re Marriage of Lucas, and its repeated attempts to make the statute constitutionally retroactive."

The Court further believed its holding was supported by the "vested" nature of the contributing spouse's separate property. Analogizing to its rulings in Buol and Fabian, the Court concluded that if the pre-1994 property rights of a separatizing spouse were vested, that spouse's property rights should be no lest vested in this context. "It would be incongruous to hold such a significant property interest exists only in the original property to which the separate property contribution is made.

The third prong of the Court's opinion rested on what it termed "important policy considerations."

1. Avoidance of Ongoing Negotiations

By encouraging spouses to freely contribute their separate property assets to benefit the community, permitting the tracing to extend to subsequent assets, alleviates the need for spouses to negotiate with each other during marriage regarding continuing reimbursement rights. This interpretation of Family Code §2640, the Court held, ". . . protects the general expectations of most people in marriage, i.e., that spouses will be reimbursed for significant monetary contributions to the community should the community dissolve."

2. Avoiding of Unfairness

Reversing the District Court of Appeal's ruling avoids unfairness. The Court stated that the lower court's interpretation would result in the ". . . fortuitous difference in the treatment of spouses who have retained the same separate property assets originally contributed as opposed to spouses who have converted the contributed property into other assets."

Tracing Method

The Court's unanimity in setting forth its interpretation of Family Code §2640 did not survive the debate over what tracing method is appropriate. Instead, the panel broke into three factions over the issue.

The majority, consisting of five justices, took the position that the Legislature's intention would be honored by first determining the percentage of the loan proceeds that are traceable to Gladys' and Gilbert's respective separate property contributions. This ratio would then be applied to the assets that were acquired with the proceeds on the loan that was taken out on the first property. Coining a new term, the Court held that this tracing method would fulfill the Legislature's intent to protect he contributing spouse's separate property.

In arriving upon the approach the majority also sought to adhere to what it divined as the legislature's intentions in its 1983-1984 session.

". . . the legislative intent to permit full reimbursement for separate property contributions indicates that separate property contributions receive greater protection from depreciation than the community' s interest, provided only that any appreciation in the value of a community asset above the amount of the separate property contributions to that asset belongs to the community."

With this concept in mind, the majority first tackled how to divide the de minimus equity in the Lucerne property. The equity in this property was found to be only $1,000, resulting from the $180,000 refinancing and a weak real estate market. The majority affirmed the trial court's order that this remaining equity be divided in proportion to the original separate property investments of the parties; i.e. 88% to Gilbert and 12% to Gladys. Thus, Gilbert and Gladys were respectively awarded $880 and $120.

The Court then engaged in some simple arithmetic to determine how the equities in the subsequently-acquired assets were to be allocated. The majority first observe that, as of the date of the first refinancing, the Lucerne property ad equity of $146,000, which was stipulated to be Gilbert's separate property. Gladys later contributed $20,00 of her own separate property to the Lucerne property. Thus, the majority concluded, when Gilbert and Gladys borrowed $180,000 on the property, $146,000 or 81% of that sum was Gilbert's separate property and $20,000 or 14% was the separate property of Gladys. The remainder of the loan proceeds - $14,000 - was confirmed as their community property.

Once they determined the Walraths' respective separate property percentage interests in the Lucerne property, the majority simply applied those percentages to the assets that were acquired with the loan proceeds. For example, of the $40,500 used to acquire and improve the Utah property, Gilbert and Gladys were ordered to be reimbursed $32,805 (81%) and $4,555 (11%), respectively. The remaining $3,240 was the community property portion of the equity. The majority stressed that it would not approve any approach that would enable a spouse to "randomly seek reimbursement from any asset through which his or her separate property contribution has passed."

Finally, the majority dealt with the task of allocating the $180,000 loan on the Lucerne property. Citing (Lezine v. Security Pacific Financial Services, Inc. (1996) 14 Cal.4th 56, 64, In re Marriage of Fonstein (1976) 17 Cal.3d 738, 748 and In re Marriage of Barnert (1978) 85 Cal.App.3d 413, 420, the majority held that the loan was to be equally allocated between the parties. At oral argument, Gladys apparently had proposed that she be charged with only 12% of the loan, in proportion to her separate property contribution. The majority felt that such an approach would be contrary to its conclusion that,

". . . the legislative intent to permit full reimbursement for separate property contributions indicates that such contributions receive greater protection from depreciation than the community' s interest, provided only that any appreciation in the value of a community asset above the amount of the separate property contributions to that asset belongs to the community."

In her concurring and dissenting opinion Justice Kennard endorsed the Majority's ruling on the notion of following the separate property contributions to successive assets. However, the justice parted ways with the majority's tracing formula, based on her concern that it was not sufficiently ". . . protective of the separate property reimbursement right." Under the approach suggested by Justice Kennard, when the original asset that was acquired with separate property is refinanced, and the proceeds used to acquire other assets, the spouse contributing separate property may obtain reimbursement from each such subsequent asset. However, the reimbursement, according to Justice Kennard, cannot exceed the amount of the loan proceeds invested in that asset.

In support of her approach, the justice set forth a hypothetical in which the husband contributes $50,000 to property A, resulting in $100,000 equity. Later, the couple borrows $50,000 on that property and uses the loan proceeds to buy property B. At the dissolution, property A is worthless and property B has equity of $50,000. Justice Kennard observed that the majority's approach would limit the husband's reimbursement to $25,000, that being 50% of the investment in property B. In her hypothetical, Justice Kennard would permit the husband to elect to obtain reimbursement from either property. The only limitation on the election would be that the husband could not be reimbursed more than $50,000 from property B.

Justice Kennard cited certain policy considerations as being the basis of her approach.

"The majority' s approach is thus more complex, because it requires a determination of the equity value of Property A at the time of refinancing and an apportionment of the loan proceeds, and it is less protective of spouses' separate property reimbursement rights, because it permits those rights to be diluted when funds invested in one asset are later withdrawn through refinancing and spread among other community assets. Spouses may be hesitant to diversify their investments in this manner if they understand that the result will be a substantial weakening of their ability to obtain reimbursement for separate property contributions."

Discussing the tracing formula adopted by the majority, Justice Baxter expressed concern that,

". . . their method of doing so unfairly insulates portions of the "community estate," and even of assets specifically traceable to the original contribution, from full participation in the burden of reimbursement."

Justice Baxter also took exception to Justice Kennard's approach, which Justice Baxter felt did not go far enough in protecting the separate property contribution. Both approaches, Justice Baxter concluded, were based on the faulty assumption that reimbursement could be derived only from assets to which the separate property contribution could be traced. Instead, he felt that reimbursement should be made from the community estate as a whole.

Comment and Some Unanswered Questions

1. Legislative Intent

All of the justices concur with regard to the Legislature's intent in creating the current statutory scheme. They conclude that the Legislature's prime concern was that the separate property of the contributing spouse had to be protected. This approach ignores that fact that, when it enacted form Civil Code sections 4800.1 and 4800.2, the legislature elected not to limit the types of assets to which the community could acquire an interest. As California Family Law Report observed in its "Review of 1983 California Family Law Legislation,"

"At the same time, the bill expands another aspect of Lucas - the presumption that property acquired During the marriage and held in joint tenancy is community - not only beyond single-family residences, but also beyond the real estate. AB 26 includes all property acquired during the marriage in joint tenancy." 1984 CFLR 2333

The position of the Court, thus, begs the question, if the legislature was primarily concerned about enabling a spouse to retain his/her separate property, why did it elect to expand the definition of community property? When Civil Code sections 4800.1 and 4800.2 (which were dubbed "anti-Lucas") were enacted, it was widely understood within the Family Law community, that the legislature was concerned with eliminating the "pillow-talk" evidence that was inherent in proving a Lucas agreement or understanding.

2. Different Facts, Different Outcome?

One has to wonder, if the Lucern property had substantial equity and the subsequently acquired assets had been depleted, would the Supreme Court have rule as it did. Of course, this decision would never have been necessary had the Lucern property contained sufficient equity to repay Mr. Walrath for his separate property contribution.

If the majority did, in fact, intend that its approach was to be literally applied, consider the following scenario in which the initial property has sufficient equity, but the separatizing spouse is not permitted to seek reimbursement from it: The parties purchase property A for $100,000, using $50,000 of the husband's separate property for a down payment. After two years the property has diminished to a fair market value of only $50,000. The parties then refinance the entire equity and invest it I property B. Five years pass and now Property A has regained its value to the point where it's fair market value is $50,000. Property B, on the other hand, has depreciated to $50,000. So, the community estate has two properties of equal value and which spouse ends up with which property does not appear to be a crucial decision.

However, suppose that Property A has some other quality such as an ocean view or a putting green, that makes it more desirable to the husband. Under the approach adopted by the Court majority, even though Property A now has sufficient equity to be the source or reimbursement, the husband would only be permitted to be reimbursed from Property B. Under the minority approaches of Justices Kennard and Baxter, the husband would be permitted to elect which property would be the source of his reimbursement.

3. Family Law Practice Post-Walrath

The tracing process is now, more than ever, a fixture in marital property litigation. With the Walrath decision, spouses are now put on notice that, if they can substantiate the tracing of their original separate property investment, regardless of how many years, sales and refinances have intervened, they will be reimbursed their contributions. But, time and transactions tend to stretch tracings thin. Over the years of a marriage records can be lost and destroyed (by accident or otherwise).

The spouse who claims that he/she made a separate contribution to a jointly-held asset must be counseled to maintain al relevant documents, such as escrow statements, canceled checks and bank statements. In the usual course of Family Law practice, however, seperatizers come to their attorneys well after the fact. If adequate records have not been maintained the damage, from that spouse's point of view, will already have been done. But, all might not be lost.

The attorney who takes on a case for the spouse claiming the reimbursement should immediately initiate discovery to establish the tracing trail. Time is often of the essence in these cases, because financial institutions do not retain their records indefinitely. In fact, most banks retain records for not more than six to seven years. If the claim for reimbursement involves real property, the records of the escrow companies should be the subject of discovery efforts early in the case. Such companies often destroy their files, either as a matter of office procedure or because they simply go out of business.

4. Legislative Action

Perhaps, after fourteen years, it is time for the Legislature to clarify, refine or simply reconfigure this entire area. For reasons set forth above, the Court has concluded that the Legislature's overriding concern in enacting former Civil Code Section 4800.1 and 4800.2 was to protect the separate property of the contributing spouse. However, to this writer such an intention is not all that obvious. A case can certainly be made in support of the notion that, in 1993, the Legislature was equally concerned with avoiding the resurrection of pre-no-fault testimony in the state's Family Law courts.