California is what is known as a community property state . This means that any money or property acquired over the course of a marriage or registered domestic partnership by either spouse presumed to belong equally to both spouses, with a few minor exceptions, such as money or property acquired as a gift or inheritance.
That being said, what happens when one spouse takes more than 50% of the community assets they share with the other spouse without taking any steps to transmute the character of said assets? That is the question around which this case hinges.
In this case, our client’s mother and stepfather got married in their senior years with each already having their own set of children. After around 12 years of marriage, the spouses created a joint trust to hold their assets, which consisted primarily of a real property, stocks, and cash.
Our client’s stepfather entered the marriage with a residence he owned as his separate property. However, when he and our client’s mother created their joint trust, he signed a deed expressly transferring this separate property into the name of the joint trust.
Along with the primary trust document, the spouses also signed a document referred to as a Letter of Intent and Declaration of Gift. This letter essentially stated that any property in the trust that was not specifically designated as either of the spouse’s separate property would be regarded as their community property.
They further clarified in the letter that if any questions should arise surrounding the character of assets, that the assets in question should be considered a gift from one trustor to the other “in consideration of their mutual love and affection.”
The aforementioned Letter of Intent would play a crucial role in the disputes that would unfold following the spouses’ deaths.
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Our Client’s Bombshell Discovery: Mother and Stepfather’s Joint Trust Is Virtually Unfunded
Our client came to our firm for help after learning that despite the considerable wealth her mother and stepfather had amassed during their lifetimes, their joint trust appeared to be virtually unfunded after her stepfather’s death.
Our client at one time had enjoyed a close relationship with her stepfather. As a result, he had shared with her that he and her mother intended to leave all their children (except one who had been expressly disinherited) equal shares of their joint trust. He had also discussed his success with investments over the years. For this reason, it was shocking for our client to discover that her stepfather had transferred most of the assets from the joint trust into his own trust that provided for only his children and great-grandchildren, and for none of his late wife’s children.
Needless to say, our client was aware that something wasn’t right about this scenario, and she wanted Keystone’s assistance to get to the bottom of what had transpired with the joint trust.
Does a Temporary Separation Automatically Create Separate Property?
After more than two decades of marriage, our client’s mother started to experience cognitive decline due to Alzheimer’s disease. At this time, disputes arose between our client’s sister and her stepfather about how best to treat her mother’s illness. The sister wished to use a holistic approach, whereas the stepfather wished to use traditional medicine.
Eventually, the dispute between our client’s sister and stepfather reached a breaking point, leading to the filing of a marital dissolution (divorce) proceeding. This, however, did not seem to be the desire of our client’s mother, but rather the desire of her sister.
After the dissolution proceeding was filed, the stepfather created new bank accounts in only his name. As an avid stock trader, he developed the practice of selling certain stocks that were owned by the joint trust and investing half the proceeds from the sales in new stocks held his name individually.
Our client’s mother moved in with our client’s sister in Oregon. Nevertheless, the mother and stepfather had continued to regularly communicate. A few years after the dissolution proceeding was filed, the stepfather picked up our client’s mother in a limousine from her residence in Oregon, went to the airport, and flew her back to Southern California.
After discovering what happened, our client’s sister called the police to alert them of her mother’s potential kidnapping by her husband; however, when the police confronted the couple at the airport, our client’s mother confirmed that she had wanted to reunite with her husband, so the police left the two alone.
Soon after this event, the marital dissolution proceeding was dismissed. What this meant for the stepfather was that none of the assets he’d accumulated during the separation were his separate property, since the divorce had never been finalized.
Does Placing Community Property in a “Separate Property Trust” Make It Separate?
Almost a year after reuniting with our client’s mother, her stepfather created his own trust, which he referred to as his separate property trust — presumably to create confusion surrounding the true character of the assets it held. This trust would name only his children and great-grandchildren as trust beneficiaries, and disinherit all of his wife’s children, including our client.
Around this same time, our client’s mother’s cognitive impairment had become so severe that she was unable to meaningfully communicate. The stepfather ostensibly took advantage of her lack of competence by funding his trust with their community assets without her knowledge.
At one point, he even signed a deed transferring the residence he previously had transferred into the joint trust into his own trust. To effectuate the transfer, he signed the deed as trustee of the joint trust and as the power of attorney for his wife, who also had been a trustee of the joint trust. He either disregarded or did not consider the inherent conflict of interest in his decision.
Eventually, our client’s mother died. A few years later, her stepfather died as well. The damage, however, had already been done, with most of the spouses’ joint assets now being held by the stepfather’s “separate” trust, which was being managed by the client’s stepsister, who also happened to be a co-trustee of the joint trust along with our client.
Discussion: Was There a Misappropriation of Trust Funds and Property by the Stepfather?
On the surface, community property laws may seem unjust. For instance, one spouse could be the breadwinner of the family and the other spouse could not work, but both spouses would still own any assets acquired over the course of their marriage or registered domestic partnership equally unless the adversely affected spouse were to sign a prenuptial or postnuptial agreement waiving their community property rights.
But in reality, community property laws are designed to promote fairness and protect spousal rights. They acknowledge the fact that non-earning spouses in a marriage take on other responsibilities that often times enable the earning spouse to have the time and resources to make a living, such as managing the family home, or raising children.
As discussed below, when community property rights are violated through misappropriation, there can be serious consequences. Had the husband in our case been alive, he would have been in for a rude awakening, as the court didn’t regard what he did as justified but as a misappropriation of trust funds and property.
What Is Misappropriation of Trust Funds and Property?
A misappropriation of trust funds and property is exactly what it sounds like: trust assets wrongfully being removed from a trust for purposes that are not in the best interests of the beneficiaries. When there is a misappropriation of trust funds by a trustee, it is considered trustee misconduct. If proven, it can lead to trustee removal or suspension, and a potential surcharge.
If the stepfather’s misappropriation of trust assets had been discovered when he’d been alive, he likely would have been removed as trustee of the joint trust and surcharged. He, however, managed to escape detection as a result of carrying out his fiduciary misconduct at a time when his wife had been severely mentally incapacitated.
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How Is Community Property Transmuted to Separate Property?
This Keystone case was complicated because the stepfather did partially own many of the assets he misappropriated, with at least one asset even having been his separate property prior to marriage. However, in California, it is much easier for separate property to become community property than for community property to become separate property.
For separate property to become community property, the asset simply needs to be commingled with community assets or be transmuted via a signed legal agreement specifically providing for transmutation. For example, if a spouse receives an inheritance from a grandparent during marriage (which would be considered separate property by default), but then places that inheritance in a joint bank account owned by both spouses, the inheritance may be considered commingled and become the community property of both spouses if it cannot be traced to a separate property source.
On the other hand, the only way for community property to become separate property is if the adversely affected spouse signs a community property transmutation agreement that waives their community property rights to the asset in question.
“The main question of this case was where did the assets of the separate property trust come from?” says Casey Reagan, a Senior Associate at Keystone. “If the assets could be traced to separate property, or were legitimately transmuted to separate property, then our client’s stepfather would have had the right to distribute them to beneficiaries of his choosing in his separate trust.”
Did the Letter of Intent and Declaration of Gift Constitute a Valid Transmutation Agreement?
The Letter of Intent our client’s mother and stepfather signed when executing their joint trust constituted a valid transmutation agreement in the eyes of the court. To transmute property, agreements need not use specific terminology, such as “community property,” “separate property” or “transmutation” for the document to be regarded as a valid transmutation agreement. Rather, according to California Court of Appeal case Safarian v. Govgassian, “the writing must reflect a transmutation on its face, and must eliminate the need to consider other evidence in divining its intent.”
In other words, because the spouses in this case both signed the Letter of Intent and Declaration of Gift and demonstrated their intent to transmute any property titled in the name of the trust to community property (except for the property both trustors designated in writing to be separate property), the document served as a valid agreement between the spouses to establish community ownership of all the assets in their joint trust — and it’s worth noting the spouses transferred title to all their assets into their joint trust, including the stepfather’s residence owned before marriage.
Could Each Spouse’s Separate Property Be Traced?
Even though the spouses expressed a clear desire to keep certain property separate in the Letter of Intent they signed, the spouses had been too vague in specifying which assets constituted their separate property for them to truly have any separate property interests.
Namely, in a document listing the alleged separate property, the stepfather had named “stocks and cash” as his separate property without identifying which stocks and how much cash he was referring to. A forensic accountant hired by Keystone’s client could not trace the stepfather’s separate property based on this document.
When it’s virtually impossible to distinguish between a spouse’s community and separate assets, the assets in question generally will be considered the spouses’ community property unless evidence can be provided to the contrary.
Did the Stepfather’s Trust Contain Any Separate Property?
As discussed extensively above, because the spouses had placed all their assets in the joint trust, and because their separate assets could not be traced, all their assets were considered community property. By extension, so were the assets in the stepfather’s trust, since they originated from the assets in the joint trust.
That, however, is not all. While the stepfather’s misappropriation of trust assets from the joint trust was in itself unlawful, he also, in so doing, breached his fiduciary duties to both his spouse and the beneficiaries of the joint trust by robbing them of assets they were entitled to.
While most people are aware of the fact trustees owe fiduciary duties to beneficiaries, few are aware of the fact that spouses may also owe fiduciary duties, particularly if a decision they are making regarding community property could adversely affect their spouse.
When the stepfather went behind his wife’s back to transfer their community assets into his separate property trust (at a time when she was mentally incapacitated no less), he breached his fiduciary duties to his wife and created a presumption of undue influence in his acts.
In the same vein, the stepfather had breached his duties to the beneficiaries of the joint trust. The joint trust should have been funded with 50% of the community assets upon the death of our client’s mother; however, nearly all of the assets of that trust, which had a seven-figure value, had already been transferred to the stepfather’s separate trust.
Results: Return of Assets and Double Damages Awarded
Our client’s stepfather was substantially more financially savvy than our client’s mother. Additionally, he had been married three times before marrying our client’s mother and was well-versed in how community property and separate property work. The stepfather also signed a Certificate of Trust for his trust that served as direct evidence of the fact that he was aware he was funding his trust with community assets.
To prove our client’s case in court, our attorneys investigated the assets of the stepfather’s separate property trust by issuing numerous subpoenas to different banks and securing records from the spouses’ divorce proceeding to determine whether the assets of the couple’s joint trust had been misappropriated by our client’s stepfather. The stepfather had been an active stock trader, which meant that he had sold many stocks, with the proceeds from the sales having been used to purchase new stock. This made this process all the more complex.
After thoroughly examining these records, our attorneys determined that the assets comprising the stepfather’s trust had originally been accumulated during the spouses’ marriage, and therefore, technically belonged to the spouses’ joint trust as community property. The Letter of Intent the spouses signed along with the terms of the trust stated that all the assets in the joint trust were the couple’s community property, unless specifically designated as separate property. Since the spouses’ separate property could not be traced, all the assets in their joint trust should have been considered community property.
Still, the trustee of the stepfather’s trust, our client’s stepsister, did not agree to resolve the case when confronted with these facts. She instead argued that the assets of her father’s trust must have been his separate property, either due to the divorce proceedings or based on a separate property agreement created alongside her father and stepmother’s joint trust. She also refused to resign as co-trustee of the joint trust despite Keystone attorneys urging her to resign due to the conflict of interest the situation presented. Ultimately, she was removed as co-trustee of the trust following the court trial in the case.
The only conclusion Keystone’s attorneys could draw was that the stepfather knew exactly what he was doing when misappropriating property from the joint trust, and acted in bad faith.
There was no evidence to suggest our client’s mother ever had signed any legally valid documents waiving her community property rights to the assets the stepfather transferred into his trust. While a power of attorney had been used by the stepfather to sign a deed on behalf of our client’s mother to transfer their community residence into his trust, this was an improper usage of his power of attorney, and could even be considered .
Keystone attorneys presented this extensive evidence to the court over four days of trial. As a result of these factors, the court agreed with Keystone’s arguments and determined that not only did the spouses’ joint trust have a one-half interest in the assets of the stepfather’s trust, but that the joint trust should also be awarded, according to the standard established by California Probate Code section 859, double damages — which meant that the joint trust would receive all the assets in the stepfather’s trust.
Keystone’s extensive and careful preparation for trial helped the court reach the correct result, as justice prevailed for our client.
The Takeaway: Don’t Assume Your Spouse Has Your Best Interests at Heart
While the spouse’s love story in this case may have begun with both parties’ intentions being pure, that certainly is not how it ended.
Our client’s stepfather was a Casanova of sorts. After he and his wife separated, and his wife was moved to another state by her daughter, he showed up in a limousine at her doorstep to whisk her away back to California, where they would reignite their marriage. To his wife, our client’s stepfather likely was a hero.
Unfortunately, his romantic gestures were masking his deceitful intentions. As our client’s mother’s spouse, our client’s stepfather not only was supposed to be looking out for her best interests, but he had a duty of loyalty to her, which he flagrantly disregarded, and at a time when his wife was declining mentally due to Alzheimer’s.
Don’t get us wrong. We are not suggesting that you distrust your spouse, but that you simply pay close attention to your assets. Educate yourself on the basics of community property versus separate property, work with knowledgeable professionals like attorneys and accountants, and don’t sign any agreement without understanding its implications.
But if you are the beneficiary or trustee of a trust and suspect the trust’s assets have been misappropriated, you may be able to rectify those circumstances with legal assistance like what Keystone was able to provide for its client in this case. “I am pleased we were able to help our client recover all the assets her mother’s joint trust was entitled to,” said Casey Reagan. “The Court reached the right result in this case.”
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