The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By Linda J. Ravdin, Esq.
Pasternak & Fidis, P.C.,Bethesda, MD
There was a time when a premarital agreement was thought to be appropriate only for the rich. Courts enforced premarital agreements determining property rights at death, but agreements that determined spousal property and support rights at divorce were generally not enforceable. Things have changed. The past 40 years has seen a substantial increase in the number of couples entering into premarital agreements. Two contributing factors stand out:
The divorce revolution. Beginning in the early 1970s, states began to modernize their divorce laws to allow for no-fault divorce and for equitable division of property. It became easier to divorce, creating opportunities for serial marriages and complicated family relationships. The advent of equitable distribution of property at divorce, and the expansion of the definition of property to new forms of wealth, such as pension benefits and the goodwill of a business or professional services practice, enlarged the pool of assets subject to division at divorce. As a result, both the transactional costs of divorce – legal fees; expert witness fees – and the financial stakes went up dramatically. This created an incentive for many more persons considering marriage — not just the wealthy — to also consider a premarital agreement.
Prior to 1970, courts generally refused to enforce premarital agreements that determined financial rights at divorce. Such agreements were thought to destabilize the institution of marriage by encouraging divorce. Posner v. Posner, 233 So.2d 381 (Fla. 1970), changed all that. The Florida Supreme Court held that a premarital agreement that was fairly made should be enforced at divorce. Other state courts followed Florida's lead.
The availability of easy divorce, the high cost of divorce, and the ability to predetermine by contract spousal rights at both death and divorce gave persons considering marriage a compelling reason to seek a premarital agreement. Many have done so. As one court observed: "A person who enjoys a financial position that places him [or her] in the top one percent of all income-earning Americans, will be reluctant to marry when modern divorce law (including some parameter for judicial caprice) places both his [or her] property and his [or her] future income at jeopardy." Gant v. Gant, 329 S.E.2d 106, 113-114 (W.Va. 1985).
Since 1970 all states have permitted parties contemplating marriage to enter into a premarital agreement that determines property rights when the marriage ends. The majority of states also permit parties to completely waive all rights to alimony after divorce or to fix alimony at a predetermined level far below what a court would award in the absence of agreement. In the 40 years since Posner, both the law and practice of premarital agreements has evolved and it is evolving still. Historically, courts played a larger role in insuring substantive fairness in the terms of premarital agreements. Over time, that role has diminished. In the majority of states, a fair process is sufficient for validity. The agreement need not be substantively fair.
The UPAA. In 1983, the National Conference of Commissioners on Uniform State Laws (NCCUSL) created the Uniform Premarital Agreement Act (UPAA). The UPAA has been adopted in 27 states (although several have modified the criteria for validity in important ways). A number of other states use criteria for validity similar to that of the UPAA. The threshold requirement for validity of any premarital agreement is voluntariness. Put another way, the agreement must not have been the product of fraud, duress or undue influence. In addition, under the UPAA, if, and only if, the terms of the agreement are unconscionable, there must have been fair and adequate financial disclosure or an express, voluntary waiver of disclosure. Most non-UPAA states also require fair financial disclosure or an express waiver.
The UPAA creates criteria for validity that focus almost exclusively on the process leading to execution. The terms of the agreement need not be fair. In fact, the terms can be quite harsh from the perspective of the economically disadvantaged party. In adopting the UPAA, NCCUSL rejected allowing a judge to consider whether the terms of the agreement were fair to the weaker party at execution or remain fair at enforcement. The majority of states' laws allow parties to a premarital agreement to completely waive alimony at divorce, or to predetermine an amount that may be quite low relative to the needs of the recipient or the ability of the payor to pay. These laws also allow parties to agree in advance to an allocation of property rights at death or divorce that is extremely unfavorable to one spouse. In other words, the agreement need not be substantively fair. Allowing a substantive fairness review would have made enforceability less predictable since the agreement would be vulnerable to the arguably subjective sense of fairness of a given judge. The emphasis on process reflects NCCUSL's choice to create predictability of enforcement even at the expense of substantive fairness. This is consistent with general contract law principles. (In a minority of states a judge may consider whether a premarital agreement is substantively fair at divorce and may refuse to enforce all or part of the agreement to achieve substantive fairness.)
Experience of the last 30 years. The debate over the appropriate criteria for validity of premarital agreements has continued among academics. Many have been critical of the UPAA. See, e.g., Judith Younger, "Lovers' Contracts in the Courts: Forsaking the Minimum Decencies," 13 Wm and Mary J. of Women and L. 349 (Winter 2007). In courts in the majority of states, however, judges have readily upheld premarital agreements that created or perpetuated significant economic disparities and, in many cases, left a weaker spouse without adequate resources when the marriage ended at death or divorce. They have done so even when the process leading to execution left little opportunity for a weaker party to obtain legal advice or engage in meaningful negotiation.
ALI Principles of the Law of Family Dissolution. In 2002 American Law Institute published its Principles of the Law of Family Dissolution: Analysis and Recommendations. The ALI Principles sought to change the law regarding the criteria for validity of premarital agreements in two respects. First, the ALI Principlespropose significantly greater procedural safeguards. Most importantly, they recommend that the agreement be signed at least 30 days before the wedding and that if one party is not represented by counsel, that he or she is advised to obtain independent advice. Further, if one party is not represented, the agreement should state the nature of the rights being waived in language understandable by an adult of ordinary intelligence with no legal training. Further, the party seeking to uphold the agreement would have the burden to prove that the other party consented to the agreement and that his or her consent was informed and not under duress. Second, the ALI Principles would allow a judge at divorce (but not at death) to consider whether enforcement of the agreement would work a substantial injustice and, if so, refuse to enforce part or all, even when the agreement was executed voluntarily, with full financial disclosure, and with the advice of independent counsel.
The ALI Principles never gained support in any state legislature nor has any court adopted them as a standard for enforcement. Nevertheless, the ALI Principles serve as a guide to best practices for lawyers. Moreover, the Principles advocate a uniform standard for the creation and enforcement of marital agreements. A marital agreement is an agreement executed after marriage, not incident to a marital separation or divorce, to determine spousal rights at death or in the event of divorce. The current law regarding the enforceability of such agreements is a hodgepodge. Thus, the ALI Principles made an important contribution by proposing standards for validity of this type of agreement.
A New Uniform Act. In 2010, NCCUSL constituted the Premarital and Marital Agreements Committee (PMAA Committee). Professor Barbara A. Atwood, University of Arizona College of Law, is the Chair. Professor Brian Bix, University of Minnesota School of Law, is the Reporter. The Committee was charged to consider and develop a uniform act governing marital agreements. It was also charged with the task of reconsidering the UPAA. Because these two types of agreements serve similar functions it was inevitable that the standards for validity and permissible scope of these agreements would need to be evaluated together. The PMAA Committee submitted a draft Premarital and Marital Agreements Act for a first reading and discussion at the Annual Meeting of NCCUSL in July 2011. Following input from Commissioners at that meeting, the Committee will make some revisions and the draft Uniform PMAA will be presented for adoption at the 2012 Annual Meeting.
The draft Uniform PMAA, to the extent adopted by state legislatures, will be a significant development in the law governing premarital and marital agreements. In developing the draft PMAA, the Committee made several key decisions. First, the Committee decided to treat both types of agreements the same with regard to criteria for validity and permissible scope. Second, the Committee decided that the criteria for enforcement should be the same whether the marriage ended at death or divorce. Third, the Committee agreed that a new uniform act should retain the UPAA's emphasis on process and predictability of enforcement, and, therefore, rejected a role for judges to consider substantive fairness except under limited circumstances. However, the Committee also felt that the standards by which the process was judged should be raised so as to enhance procedural fairness for weaker parties and, it is hoped, expand the opportunity for such parties to obtain legal advice and negotiate the terms.
The key terms of the draft UPMAA are in Section 9, Enforcement. Section 9 provides that a premarital or marital agreement is not enforceable if the challenging party proves any of the following: he or she did not execute the agreement voluntarily; the agreement was unconscionable when it was executed; the party did not receive fair financial disclosure, did not waive such disclosure, and did not have constructive knowledge of the other party's financial affairs; the party did not have access to independent counsel and the other party was represented; if unrepresented, the agreement did not include a statement in plain language of the rights the challenging party would otherwise have at the end of marriage, by death or divorce, and the effect of the agreement on those rights.
Importantly, the draft PMAA requires access to independent counsel when the other party had a lawyer. Such a requirement should encourage more proponents to present a proposed premarital agreement well enough in advance of the wedding to enable the other party to seek counsel. Plain language advice is an alternative, but this puts a significant burden on the lawyer for the proponent to make sure such advice is adequate. The complexities of the law of divorce should be a deterrent as the adequacy of the advice will certainly come under attack and in some cases the attack will succeed. Both the lawyer and his or her client will be better served by independent counsel for the other party. The agreement need not be substantively fair at execution, but it will be unenforceable if it was unconscionable.
The draft PMAA would permit a judge – at divorce or after the death of a spouse – to determine whether to limit enforcement when enforcement would result in the other party becoming eligible for need-based public assistance. This differs from the UPAA. Under the UPAA, a court may only refuse enforcement of an alimony waiver to prevent a spouse from going on public assistance. Alimony is only available at divorce; thus, in its present form the UPAA offers no protection for a widow or widower who may become impoverished as a result of a waiver of rights. Moreover, either at divorce or after death, under the draft PMAA, a court may refuse enforcement of the provisions for disposition of property to prevent a spouse from going on welfare. Thus, the court would have broader power to prevent a spouse from suffering severe economic hardship.
Conclusion.The law governing premarital agreements may change to enhance both procedural and substantive fairness for economically weaker parties. This will inevitably mean that some agreements that would be upheld under prior law will be considerably more vulnerable if the law changes. This development need not be alarming, however. Lawyers practicing in this field can protect their clients by following best practices (assuming the client cooperates):
For more information, in the Tax Management Portfolios, see Ravdin, 849 T.M., Marital Agreements.
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