A divorce designed for asset protection does not usually protect assets because courts can still find that transfers made according to a marital settlement agreement are fraudulent transfers.
Some clients ask me whether getting divorced and implementing a marital settlement agreement to divide property can help protect their assets from a judgment creditor. For example, a client may suggest that the couple execute a marital settlement agreement under which the debtor spouse transfers all their non-exempt property to their former non-debtor spouse.
Then, under the client’s plan, after the creditor either agrees to a favorable settlement or gives up its collection efforts, the spouses would remarry and reverse the asset transfers. The client would say that a state court’s approval of the marital settlement agreement prevents the creditor from challenging property transfers made according to the marital settlement agreement.
What Is a Fraudulent Transfer?
The Florida Uniform Fraudulent Transfer Act provides that courts may reverse transfers of assets that are found to be fraudulent as to judgment creditors. The Act provides, in part, that a transfer made is fraudulent, whether the claim arose before or after the transfer, if the debtor made the transfer without receiving reasonably equivalent value, and if the debtor believed that he would not have the ability to repay his debts.
The creditor remedy for a fraudulent transfer is either a reversal of the transfer so that the property reverts to the transferor or a money judgment against the transferee for the property’s value.
If a divorcing debtor spouse makes a fraudulent conveyance to their non-debtor ex-spouse, a creditor could ask for a money judgment against the non-debtor spouse.
Can a Court Find that the Divorce is Fraudulent?
Courts typically will not find that a divorce, by itself, is fraudulent as to judgment creditors.
Property settlements in divorce are governed by principles of equitable distribution. Property settlements that appear to be equitable and reasonably allocate assets between divorcing spouses are likely to be upheld even where a non-debtor spouse receives mostly non-exempt assets.
But, property settlement agreements that disproportionately convey marital assets to a non-debtor spouse when such unequal distribution cannot be justified under equitable principles can be undone under fraudulent transfer principles. Courts have found that unjustified unequal distributions of marital properties may be avoided as fraudulent conveyances.
How to Use Divorce for Asset Protection
A divorcing couple can protect their assets in the divorce from a judgment creditor by giving the exempt assets to the non-debtor spouse and the exempt assets to the debtor spouse.
If the married couple owns exempt assets, a marital settlement agreement can be designed to minimize challenges based on fraudulent transfer theory. The agreement could be structured so the debtor spouse receives mostly exempt assets in the settlement, such as the family homestead and annuities. In exchange, the non-debtor spouse may receive an equal amount of non-exempt assets such as investment real property and cash.
The settlement agreement would produce an equitable distribution based on the value of assets each spouse receives, but the allocation of specific assets would optimize the asset protection for the debtor spouse.
The designed divorce must appear to be a real divorce motivated by marital issues rather than a “fake divorce” designed to fool the creditors and the courts. For example, if the divorcing spouses continued to reside together in the family home as before, a court may find that the divorce and marital settlement is a scheme to defraud creditors, notwithstanding a family court’s divorce order.
