Are Illusory Agreements The New Trend?
Welcome to the adversarial world of family law.
Posted May 27, 2017
I’m increasingly being asked to review premarital and marital agreements, and divorce settlement agreements that are illusory in nature. Illusory agreements are “not real and based on illusion.” Most of the time, corporate entities are used to create such an illusion.
For example, the owner of the corporation(s) might agree to the creation of community or marital property and for spousal support. However, the agreement excludes perquisites and/or fringe benefits and retained earnings for such purposes.
Ron J. Anfuso, CPA/ABV explains perquisites as follows:
“It is common that a significant portion of the income generated from employment or by a self-employed business owner comes in the form of perquisites or ‘perks.’...
Self-employed business owners, on the other hand, control the amount and nature of their perquisites, usually as a result of writing off personal expenses as business expenses for tax purposes. Medical and automobile expenses are common expenses that often fall into the perquisite category.
The proper determination and analysis of perks can affect the property division if one or both of the parties owns a business (i.e. when a business valuation must be performed) and for gross cash flow available for support....
Perquisite testing is a complex issue, but the existence of perquisites can mean a significant adjustment to cash flow available for support. The practicing family law attorney should be familiar with the common types of perquisites and their affect on business valuation and gross cash flow available for support.”
As far as retained earnings are concerned, Investopedia defines them as follows:
“Retained earnings refer to the percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business, or to pay debt. It is recorded under shareholders’ equity on the balance sheet.”
Meanwhile, in his article Divorcing Women: Don’t Forget These Marital Assets, Jeff Landers states the following with regard to retained earnings:
“This refers to the portion of corporate income that is retained by the corporation rather than paid out as dividends to shareholders. If your husband owns a business, this is one of many things to watch out for.”
The reason it’s important to watch out for such things is because of what Landers calls “SIDS (Sudden Income Deficit Syndrome) once divorce proceedings start,” which also includes the business paying its owner’s personal expenses.
What’s most offensive is that such tactics are no longer limited to situations in which divorce is underway. Instead, people are providing their fiancés and spouses with agreements which set the stage for such maneuvering from the outset. Moreover, by excluding perquisites and/or fringe benefits and retained earnings from the creation of community or marital property and income available for spousal support, there’s really nothing to watch out for should a divorce occur because that ship essentially sailed at the time the premarital or marital agreement was signed.
In one particular case, after explaining my concerns regarding the complete exclusion of perquisites and/or fringe benefits and retained earnings, I said, “If all perquisites and retained earnings are off limits, such game-playing cannot be addressed by my client because a court would not have jurisdiction over the issue.”
The opposing counsel who drafted the agreement responded as follows:
“game playing? what are you talking about?
We are trying to avoid potential litigation issues in the future. When was the last time you saw the inside of a family law courtroom? It’s probably been a while hasn’t it? Well it’s not pleasant. Our PMA is trying to avoid any and all issues regarding the business. if you consider that ‘game playing’ I don’t know what to tell you....
We are unwilling to negotiate [concerns regarding perquisites and retained earnings]. it’s OFF LIMITS."
Such things might be non-negotiable and “OFF LIMITS”, but generating an agreement that contains provisions that appear real and are nothing more than smoke and mirrors speaks volumes about what to expect from the relationship itself and the spouse-to-be responsible for the creation of such an agreement. After all, the exclusion of such things gives the owner of the corporations full control over whether or not to increase retained earnings or pay more (or all) salary to him/herself as perquisites and/or fringe benefits.
Sometimes the complexities involved have led me to insist that my client also retain a corporate attorney to assist me in navigating the treacherous waters created by attorneys for whom the practice of law is nothing more than a game to be won, even when it involves the creation of premarital agreements, which set the tone for future marriages. In fact, I received the following email from one such attorney:
“Welcome to the adversarial world of family law.”
Adversarial is defined as “involving or characterized by conflict or opposition.”
I may be a bit unusual, but I don’t believe that divorces need to be handled in a process or manner that creates or increases whatever conflict already exists, and I certainly don’t believe that the drafting and negotiation of premarital agreements should be handled in such a manner.
For what it’s worth, I received the following email from one corporate attorney I involved to assist me in navigating my client through treacherous waters:
“FYI, you were rightly concerned about relying on ****. My **** expert agreed and listed several other problems. @@@@ needs to have a personal guarantee from her fiancé for a certain amount of money, of which his pension could be a source, but she cannot rely on it per se.”
In cases I’ve mediated, I’ve seen one spouse try to get the other to waive their interest in community/marital property in exchange for very generous spousal support provisions. However, among other things, the spouse offering such generous support owns multiple corporations and could experience “sudden income deficit syndrome” anytime thereafter and seek to significantly reduce the amount of spousal support, while their then ex-spouse would have few, if any, resources with which to protect themselves.
If you’re wondering whether such an agreement was formalized in a mediation conducted by me and in which no attorneys were involved, the answer is “No”. I emailed the agreement to the clients in draft form along with the following statement:
“As I mentioned in our last mediation session, I will not put this document into final form unless and until I know for certain that you have each consulted with separate counsel who is knowledgeable in the field of family law in California. You may not be involved in selecting the consulting attorney that your spouse retains for this purpose, regardless of how such costs will be paid.”
Shortly thereafter, I was advised that the matter had fallen out of mediation, and could not have been more pleased.
Then, there was the self-employed accountant who owned his own business and was understating his income by half. Understanding how to read financial forms, in my capacity as the mediator, I kept asking him to explain why I was misreading them to reflect double his stated income. After a great many explanations that made no sense, the accountant finally admitted that I wasn’t misreading the financial forms. Mind you, that significantly impacted child support, spousal support, and property division, among other things. Again, neither party had attorneys involved.
I am well aware that, as the Certified Family Law Specialist who welcomed me to “the adversarial world of family law” told me, “[my] opinion doesn’t carry much weight in this community.”
However, as I explained to him, “Just because I no longer litigate doesn’t mean I’m stupid. Please don’t confuse the two.”
Moreover, just because I don’t respect or appreciate aggressive lawyering doesn’t mean that I’m not assertive.
“There is a difference between being aggressive and being assertive. A lawyer can be assertive without being aggressive and obtain superior results for their clients regardless of the process involved.”
As it turns out, my undergraduate degree in economics/business, background in corporate law, and continuing education with regard to financial investigation didn’t suddenly leave my brain by virtue of the fact that I no longer litigate.
I can’t even imagine how many attorneys and mediators fail to catch these issues. Furthermore, I wonder just how many mediators don’t think it’s their job to catch such things.
From my perspective, legally competent people making informed decisions can agree to anything they want, as long as it is legal and not otherwise in violation of public policy.
If you have legal representation, one would hope that you are making informed decisions - at least with regard to the terms of your agreement. I’ve been around the block enough to know that most lawyers don’t provide their clients with sufficient information from which to make informed decisions regarding legal process and approach.
If you don’t have legal representation and you’re working with a mediator, what’s their perception of “informed consent”? Do they believe that a mediator should be involved in the parties’ “informed consent”, and if so, to what degree? How does their perception of client self-determination impede such “informed consent”? And, to what degree does the mediator even have the knowledge base to ensure such “informed consent”, assuming they believe they should be involved in such things?
I’ll conclude by saying “caveat emptor”, which is Latin for “let the buyer beware.”