The failure of a prenuptial agreement to specify that earnings during the marriage were separate propertywarranted a breach-of-contract recovery as part of a distribution on divorce when those earnings used to pay sparate liabilities. So held Supreme Court New York County Justice Laura E. Drager in her January 15, 2014 decision in R.B. v. M.I (New York Law Journal published decision).

Once again, the focus of the court’s attention was on the import of a prenuptial provision that limited marital property to that held jointly by the parties.

In Zinter v. Zinter, Saratoga County Supreme Court Justice Thomas D. Nolan, Jr., last month held it was unconscionable for a prenuptial agreement to give the husband  power to control whether earnings and other after-marriage acquired property would be placed into joint or indiviual accounts, and thus marital or separate property (see, my March 17, 2014 blog post).

Here, the Justice Drager held that whether pproperty was owned jointly or individually at the commencement of the divorce action did not end the inquiry, if a breach of contract claim arising during the marriage is viable.

In R.B., the husband (53) and wife (51) parties were married on January 31, 2004. A daughter was born in 2005. The parties held a bachelors degree from private universities. Each party had an established career when they married. At the time of the marriage, the wife held assets worth approximately $2,497,678, including a cooperative apartment in Manhattan that became the marital residence. The wife had no liabilities. The husband had assets worth $1,600,891 and liabilities of $149,000 for a net worth of $1,451,891.

At the time of trial the husband earned a base salary of $170,000 annually. plus a discretionary bonus of up to $25,500 , working in computer application sales. By the time this action was commenced, the Husband’s separate assets were worth approximately $712,000, including funds received from the sale of his separate property farm house. By the time of trial, the Husband’s assets consisted of $263,000 in three retirement accounts.

The wife had been employed in fashion merchandising earning $125,982. She held various jobs between January 2007 and December 2008. The wife had not been employed since 2009. By the time action was commenced, the wife held approximately $1,068,184 in separate property accounts and, in addition, still owned her separate property apartment.

Nine days before their marriage, the parties signed a prenuptial agreement. Both waived spousal maintenance, and identified and expanded the definition of separate property; constricting the definition of marital property.

The prenuptial agreement provided that neither party “shall acquire any interest in the separate property of the other by reason of the marriage, or by reason of any contribution of either party’s earnings during the marriage.” The parties further agreed that separate property included “property that might otherwise be characterized as marital or community property subject to equitable distribution or division in the State of New York or any other jurisdiction.” The prenuptial agreement further limited each parties’ respective rights in equitable distribution to property acquired during the marriage owned jointly by the parties and to any gifts from one party to the other.

The parties had further agreed that all liabilities attributable to their respective separate property “shall be the sole and exclusive liability of that party and shall be paid from such party’s separate property.” The agreement identified property subject to equitable distribution, i.e. marital property, as any real or personal property acquired during the marriage “that is held or owned jointly” and any gifts given by one party to the other.

During the marriage, the parties were careful not to commingle their separate assets. They maintained individual bank accounts and brokerage accounts. They each deposited their earnings into their respective separate bank accounts. They agreed informally that each would pay the expenses for their respective separate property residences including, inter alia, mortgage payments, carrying costs, maintenance fees, taxes, cable, electric, utilities, telephone, and insurance.

However, on several occasions at the wife’s request, the husband paid the carrying costs for the wife’s Manhattan apartment. In addition, the husband paid for homeowners’ insurance that covered the Manhattan apartment.

By the terms of the prenuptial agreement and by their conduct during the marriage, the parties purposefully preserved the separate nature of their respective assets. The parties kept their financial assets separate to such an extent that, when this action was commenced, the only marital property consisted of personalty, including certain furniture, jewelry, furnishings and clothing given to the husband by the wife. Thus, there was in fact almost no marital property to distribute.

The action was tried before Special Referee Louis Crespo to hear and report. The matter was now before Justice Drager on the husband’s motion to reject certain of the Referee’s made in the Referee’s report. The wife cross-moved to confirm the Referee’s Report .

Without first identifying what property held by the parties constituted marital property, the Referee concluded that the wife should receive 60 percent and the husband 40 percent of the value of any marital property.

Included among the Referee’s recommendations was that the wife be allowed to recoup a portion of the payments the husband made towards his separate property house using income earned during the marriage. The Referee correspondingly recommended a distribution to the husband of 40 percent of $24,253 paid by the husband for carrying costs of the wife’s separate property apartment in Manhattan. The Referee also recommended that the wife receive a distributive award of 60 percent of a $50,000 failed investment made by the husband.

The husband objected. He claimed that the prenuptial agreement contemplated the use of his earnings for this purpose without those funds being converted into marital property.

The court modified the Referee’s recommendations concluding that he did not properly identify the marital property subject to distribution and misapplied the precedent set forth in Mahoney-Buntzman v. Buntzman, 12 N.Y.3d 415 (2009).

Justice Drager began her analysis by noting the first step in the determination of equitable distribution was to identify what constitutes marital and separate property. DRL §§236B (1)(d); (4)(b); (5). Here, the prenuptial agreement “expanded the definition of separate property by excluding from marital property any increase in the value of separate property as a result of the marriage or the contribution of earnings to such property.”

Indeed, the Court stated that “marital property” only comes into existence upon the commencement of a divorce action. Typically, a court can only distribute marital assets remaining when the action was commenced and cannot distribute funds that were spent during the marriage. Under Mahoney-Buntzman, courts should not look back at the decisions made during the marriage before either party was anticipating the end of the marriage; when there was no fraud or concealment. This applied even to decisions that resulted in the reduction of marital assets. Courts should also not attempt to adjust for the fact that payments out of separate property may have benefitted both parties, or even the nontitled spouse exclusively. Courts should not second-guess the economic decisions made during the course of a marriage, but rather should equitably distribute the assets and obligations remaining once the relationship is at an end.

In light of that policy, Justice rejected a recommendation of the Referee that would have had the husband bear the burden of a losing investment made with the use of marital earnings. The Wife was entitled to no recoupment of a portion of this investment as marital waste.

However, Justice Drager held Mahoney-Buntzman was not applicable to bar a recoupment to the wife of the husband’s use of marital earnings to pay the mortgage on his separate property farm house. Here, the prenuptial agreement addressed that issue: each party was responsible for payment of liabilities attributable to their separate property from their separate assets. According to the wife, the mortgages on the husband’s separate-property farm house were paid from the income he earned during the marriage and, therefore, she was entitled to recoup some part of those payments.

The husband acknowledged those payments, but argued that the prenuptial agreement provided for equitable distribution only of property “that is held or owned jointly by the parties.” The husband claimed that as the parties’ respective earnings were not held or owned jointly by the parties, they were separate property. By the parties’ mutual agreement, the husband claimed, they deposited their earnings in their separate bank accounts from which they paid their separate liabilities.

Justice Drager agreed with the Referee that the parties’ earnings were marital property, but only as a matter of contract interpretation, not Equitable Distribution.

Each party’s separate property assets were listed in the Prenuptial Agreement. The party’s earnings were not listed as separate assets, nor does the agreement state that income earned by either party during the marriage was to be considered separate property.

Moreover, Justice Drager ruled that the fact that the parties deposited their earnings into separate bank accounts did not convert the income into separate property if it was earned during the marriage.

The Husband offered no evidence to support his argument that the parties agreed that their earnings would be treated as separate property. In the absence of a specific agreement to treat earnings as separate property, the Court concluded that such income did not constitute separate property.

Rather, Justice Drager noted the husband’s argument would negate the provision in the agreement that separate property liabilities were to be paid from separate assets. The court should “adopt an interpretation which gives meaning to every provision of a contract.” In order to give meaning to the provision that separate property liabilities be paid with separate assets, it was appropriate for the wife to receive a share of the mortgage payments made on the Husband’s farm house during the marriage.

[T]he Wife’s right to this recoupment results from the parties’ contract. The court, therefore finds that the Wife is more appropriately entitled to a recoupment of 50 percent of the marital income used to pay the mortgage on the Husband’s country home.

Justice Drager noted that an adjustment of the amount owed to the wife might be necessary due to the tax deduction taken by the parties on their joint returns for interest and real estate taxes attributable to the $152,332 paid by the husband on this property. To the extent that the parties’ benefitted from such deductions, the wife’s “distribution” should be reduced by 50 percent of the value of such deductions.

Although neither party objected to the Referee’s recommendation that the Husband receive an award of $9,710.20 representing 40 percent of the maintenance payments he made for the Wife’s apartment during the marriage (the Referee generally awarded the wife 60% and the husband 40% of marital property), the Court found it appropriate to make new findings consistently applying the analysis set forth above. The husband will receive a distribution of 50 percent of the maintenance payments he made for the wife’s separate apartment during the marriage, less 50 percent of any tax benefit received by the parties for these maintenance payments.

After the conclusion of the hearing, the husband learned that he had developed cancer. After treatment, the cancer recurred and spread. The husband asked the court to consider this medical prognosis and reduce his distribution obligation. Justice Drager noted that under the equitable distribution law, the court would be free to consider the Husband’s medical prognosis in awarding a distribution of marital property [DRL §236B(5)(d)(2)].

However, while Justice Drager was sympathetic to the Husband’s medical circumstance, the distributive award being made by the Court resulted from the terms of the parties’ prenuptial agreement. Thus, the Court was constrained from reducing the award on equitable grounds.

Comment: First, calling the recoupment a “distribution,” may lead to confursion. Justice Drager appears to have declared that there had been a breach of contract for which damages were appropriate. Presumably, neither party actually pleaded a breach of contract cause of action.

If the husband wrongfully used his marital earnings to pay separate liabilities, then in theory the result should be the restoration of the funds. However, the funds came from the husband’s separate account. The parties’ agreement declared that the funds in the husband’s separate account as of the commencement of the divorce action, when (according to the Court) marital property first comes into existence, were the husband’s separate property.

If all marital earnings were marital property, then contributions to the separate retirement assets were marital, subject to recoupment.

Justice Drager held that in order to give meaning to the provision that separate property liabilities be paid with separate assets, it was necessary to hold that earnings, not listed as a separate asset, be recognized as marital. The wife’s recovery was not, then to be a recoupment of that marital property (Mahoney-Bunztman), but damages.

The husband could have chosen to have his earnings be on there way to becoming marital property by depositing them into a jointly-held account. The wife could have made the same choice. She did not. Both parties had knowledge of what they were doing with earnings. Neither party objected during the marriage. Instead they chose to deposit them into their separate accounts. The logical extension of this analysis is to have prohibited the parties from doing so: the prenuptial agreement prohibited the parties from putting earnings on the path to separate property status. That extension, though, would run afoul of the agreement provision that neither party “shall acquire any interest in the separate property of the other by reason of the marriage, or by reason of any contribution of either party’s earnings during the marriage.”

Wendy Parmet of Parmet & Greenblatt LLC, of Manhattan, represented the husband. Laurie McPherson of The McPherson Firm, PC, of Manhattan, represented the wife.