DON’T STAY TOGETHER FOR THE KIDS…DO IT FOR THE ASSET PROTECTION: PART I THE BASICS
By Bradley Pack
The Ninth Circuit recently held that a California-based bank with a judgment arising out of a guaranty signed by only one spouse (the husband) of a married couple residing in Arizona could enforce its judgment against the husband’s interest in a co-op apartment in California. While this may seem like a “common sense” result, the holding was surprising in light of what many seasoned Arizona practitioners simply took for granted: that if a husband and wife are domiciled in Arizona, a guaranty signed by only one spouse cannot be enforced against any interest in anything that would constitute community property under Arizona law. The outcome highlights the need for prospective lenders and guarantors alike to understand just how Arizona community property law affects creditors’ rights to enforce guarantees signed by only one spouse—and how the outcome can change when the laws of other states with some connection to the transaction conflict with Arizona law. This series of posts explores those issues. Today’s post covers the basics.
Arizona is a community property state, which means that absent a valid pre- or post-martial agreement, essentially all property and income (except for gifts and inheritances) acquired by a married couple domiciled in Arizona becomes part of a pot of assets known as community property. A.R.S. § 25-211. All other property (e.g., property owned by either spouse prior to marriage) is the separate property of one spouse or the other. A.R.S. § 25-213. Community property can be divided only upon divorce, annulment, legal separation, or death of one of the spouses. If a creditor is barred from collecting its claim from the community, it cannot recover anything from the community property pot. Many spouses who have been married for a long period of time have no separate property; everything they own and all of their income is community property. Thus, if a lender is prohibited from collecting from the community property, it may never be able to collect anything as long as the couple stays married.
Fortunately, the general rule in Arizona is that both spouses have equal power to bind the community to debts. A.R.S. § 25-214(B). Thus, if Big Bank makes a $500,000 loan to Henry Husband and Henry defaults, a judgment for the loan balance would be enforceable against the community property owned by Henry Husband and his spouse Wilma Wife (let’s assume she kept her ironic maiden name for purposes of this example). Big Bank could collect on its judgment by garnishing Henry’s salary, Wilma’s salary, or any other non-exempt property Henry and Wilma acquired after their marriage.
But there are several exceptions to the rule that either spouse may bind the community. One of these exceptions is that “joinder of both spouses is required” to bind the community to “[a]ny transaction of guaranty, indemnity or suretyship.” A.R.S. § 25-214(C)(2). Arizona courts have interpreted this to mean that “the community is not bound by any guaranty that is not signed by both spouses, even though the guaranty was for a business that benefitted the marital community.” Vance-Koepnick v. Koepnick, 197 Ariz. 162, 163, ¶ 5 (App. 1999). While a non-signing spouse can “ratify” a guaranty signed only by their partner after the fact, the evidence of such a ratification must be very clear (such as signing a written ratification agreement), and “cannot be inferred merely from the marital community’s receipt of benefits under that transaction.” All-Way Leasing, Inc. v. Kelly, 182 Ariz. 213, 217 (App. 1994).
So let’s assume that instead of making its $500,000 loan directly to Henry Husband, Big Bank loans $500,000 to his business, Henry’s Hot Dogs, Inc. Henry signs a personal guaranty of Hot Dogs’ debt, but Wilma does not. Several years later, Hot Dogs’ once thriving business has been decimated by a sudden shift in market demand away from heavily processed cured meats toward soy-based alternatives. Henry reacts by abandoning his wiener empire and taking a job as Chief Operating Officer at Thomas’s Tofurkey Corp., where he received a meaty $200,000 signing bonus and a $400,000 annual salary.
But what about the Bank? Assuming it can obtain a judgment against Henry on its guaranty, could it garnish his salary or the bank account into which he deposited the signing bonus? Unfortunately for the Bank, the answer under these facts is no. Because Wilma did not sign the guaranty, none of Henry and Wilma’s community property can be touched. Even though the Bank’s loan to Hot Dogs might have benefitted Henry and Wilma’s marital community (for example, by enabling Hot Dogs to operate and generate profits during its healthy years that fed Henry and Wilma’s lavish lifestyle), the lack of a guaranty signed by Wilma precludes any enforcement of the guaranty against the community property—truly, the “wurst case” scenario for the Bank.
The lesson here is simple, but it’s one that many lenders (particularly those based outside of Arizona) have learned the hard way. To bind a married couple’s community property to a guaranty in Arizona, both spouses must sign the guaranty. Otherwise, as long as that couple stays married (and each of them stays alive), collection is going to be limited to the signing spouse’s separate property, of which there may be little or none.
On the other hand, this is only true for couples who were married and domiciled in Arizona at the time the guaranty was signed, who remain in Arizona when the lender seeks to collect, and who keep all of their property in Arizona. What happens if that couple’s most valuable asset is their vacation home in Miami? What happens if a single person signs a guaranty and then gets married? What happens when a married person signs a guaranty outside of Arizona and then moves here? And what if one of them happens to be a former All-Pro defensive tackle whose nickname suggests you should think twice before trying to collect anything from him, regardless of your legal rights? Those questions and more will be answered in our next post.
About the Author
Bradley Pack is a shareholder with Engelman Berger. His practice includes representing lenders and borrowers in connection with loan disputes, workouts, insolvency, and bankruptcy matters; commercial litigation; and civil appeals.
Disclaimer: This blog is not legal advice and is only for general, non-specific informational purposes. It is not intended to cover all the issues related to the topic discussed. If you have a legal matter, the specific facts that apply to you may require legal knowledge not addressed by this blog. If you need legal advice, consult with a lawyer.
