No Credit for Negative Equity

The Issue
The married parties own a home or other real estate that has an appraised value that is lower than the amount of secured debt owed on the home.  This is often referred to as being "upside down" on your home.  If one spouse keeps the property in the divorce, can they request a credit against other savings or assets for their assumption of this negative equity?

The Apparent Answer
There is no currently published (or unpublished) court of appeals or supreme court decisions in Michigan directly addressing this relatively new phenomenon.  It appears that the circuit court judges are not willing to grant the party that assumes this potential liability a credit against other assets.  There are several potential reasons behind these decisions.

1. The parties are both still liable on the note or underlying debt.  Even if there is a hold-harmless or indemnification clause, if the party that takes the house then walks away and stops paying, the note holder (bank) can still sue both parties on the debt.  The divorce judgment cannot force the bank to remove one of the parties from the liability associated with the same and if the parties owe more money on the home than it is worth, in most cases the bank won't agree to remove one name or allow refinancing.  So the party that does not keep the house may still be sued on the liability despite the divorce judgment and the hold harmless clause may be useless if the spouse that kept the house is "uncollectable".  Finally, if this situation occurs and the spouse that kept the house was given additional property to credit them for this liability, then the other spouse is facing a double loss, the loss of the property and getting sued for the deficiency by the bank.
2. The court believes that there is greater value to the party that keeps the house than the appraised value.  The court looks at the holder's value of the property rather than the appraised value.  The court thinks that if the person is willing to keep the house despite this apparent negative equity that it must be worth more to that person than the general home buying public, perhaps due to the children's school, some amenities in the house or the party really just doesn't want to move.
3. The court may look at the house like the stock market, the value is down now but it will go up.  If one party wants to keep the house, then they must bear the risk of loss as well as the potential benefit of gain.

There are likely other reasons that the courts have not wanted to grant a credit for the negative equity, but these are some potential reasons.

Solutions to the Negative Equity Issue

1. The parties can sell the house and come to the table with money from joint funds for the deficiency between the proceeds from the sale and the overall debt.
2. One party can keep the house and then agree to sell it in a set number of years to wait and see if the market goes up and then divide either the debt or the gain.  The parties must then decide what will happen if the spouse responsible for paying the debt defaults and how to handle the payment of taxes and the deductions for payment of the mortgage.
3. The parties could short sell the home.  In a short sale, one of the parties will have to include the difference between the sale price and the debt as income on their tax returns.  The parties must work out a mechanism to share the taxes on this reported income.
4. Finally, both parties could walk away from the home, allow the foreclosure and both will potentially face the bank filing a complaint against them to collect the deficiency in the future.  

These are only some potential ways of dealing with this solution.  The parties divorce lawyer must be creative but practical as there are several potential pitfalls in this evolving area of divorce law.

DIVORCE AND COLLAPSE OF THE REAL ESTATE MARKET

DIVORCE JUDGMENT LANGUAGE
On April 7, 2011, the Michigan Court of Appeals decided a case that dealt with the interplay of the real estate market collapse and judgments of divorce. In the case of Neill /f/k/a Schmoke v Schomke, Docket No. 294878, unpublished, the husband agreed in the consent divorce judgment to a provision where he would pay his wife the amount of $1,074,000 for her share of the value of the marital home upon the sale of the home or after five years from the entry of the judgment. Further, the judgment stated that this sum would become a money judgment after five years.

COLLAPSE OF THE REAL ESATE MARKET
The house did not sell, not only that, the Defendant lost the home in foreclosure before the expiration of the five year period. His former wife then executed upon the money judgment and sought payment of the $1,074,000. The reality of the situation is that the real estate market in Michigan collapsed and most people, regardless of their intelligence, did not foresee the devastating extent of this collapse. The defendant in this case is a doctor and a well-educated and intelligent person whom like most here did not foresee this collapse.

The trial court took this problem into consideration and decided basically that due to the collapse of the real estate market that it would not be fair to force the Defendant to pay this full amount. The flip side of this argument whether it is fair to the ex-wife in this situation where she bargained for and contracted for an exact amount of money for her share of the home.

IMPORTANCE OF THE SPECIFIC LANGAUGE IN THE DIVORCE JUDGMENT
The Michigan Court of Appeals reversed this decision. The court paid a lot of attention to the exact wording of the judgment which stated that the amount due would become a money judgment. The appellate court found that due to this specific language particularly that after five years the amount would become a money judgment, the judgment was not subject to modification except in very limited circumstances.

The appellate court decided that it would be more unfair to the ex-wife to modify the amount of money due to her from the ex-husband as they both made a strategic decision to settle the matter and that he should not be relieved from his bad decision merely because his assessment of the consequences was incorrect. So it would appear that the court held the Defendant to his bad bargain and looked more to contract law in enforcing the judgment than it did to the traditional equitable or fairness arguments that would otherwise control in a divorce matter.

One last note of interest in the decision itself, was that the trial court believed the collapse of the real estate market in Michigan was an extraordinary circumstance that should allow revision of the judgment, the appellate court stated that while the “downturn was unfortunate” it could not be characterized as “entirely unforeseeable or extraordinary”. So despite the fact that it appears the extent of the collapse of the market is historically unique in this part of the country, the court still decided that people should have somehow been prepared for this potential when drafting the judgment of divorce.

COMPARE TO PRENUPTIAL AGREEMENTS
The court treated this judgment the way that the courts appear to be treating prenuptial agreements. The court favors enforcing the contractual provisions without attempting to balance the equities of the situation. Just as the courts have strongly trended toward enforcement of prenuptials as written without attempting to rebalance the equities between the parties, so here the court held the defendant to his bargain without attempting to rebalance the burden between these parties. Ten years ago, it is my belief that the outcome of this case would have been different and that this is an example of the ascendancy of contract law in the area of matrimonial law.

LESSONS LEARNED
There are a number of lessons one may learn from this case. First, every word and phrase in a judgment of divorce must be drafted and reviewed with care. If the use of the term “money judgment” was avoided, there may have been a different outcome in this case. Second, that the term foreseeable is very narrow when viewed in the eyes of the court and applied to divorce judgments. Finally, the court continues to rely more and more upon contractual principles in the area of matrimonial and appears to be moving away from equitability or fairness to both parties. From prenuptials to judgments of divorce, one must be very careful when drafting these agreements as the courts will enforce them as written.

Save Your Marriage, Be Nice to Your Spouse

I deal with divorcing couples all the time.  No-one wants to get divorced, but by the time they get to me, the relationship is typically over.  Do not take your marriage or your relationship for granted.  Here are some suggested thoughts on trying to make your spouse happy, which in turn should make for a better relationship and hopefully avoid the disastrous consequences that can be a result of a relationship turned bad.

Try taking a weekend trip somewhere that your spouse wants to go or visit.  It does not have to be "Dutch Amish Country" but just get out of the house.  Maybe even a local hotel with a swimming pool and sauna.  Have the grandparents watch the kids or hire a babysitter to watch them overnight.

Take your spouse to an event that they would enjoy.  Maybe try the Detroit Opera House for your wife or a Red Wings game for your husband.  Go see a movie together and indulge with a big tub of popcorn.  Then stay the night out somewhere.

Next time you disagree with your spouse, maybe let them have the final word.  You are sometimes better off not saying everything that you think.  The instant gratification of telling your spouse that they are an idiot often results in serious negative consequences that are just not worth it.  We all act like idiots sometimes, your spouse will figure it out.  You don't have to point out all of their errors or shortcomings.

Try to be as supportive as possible.  Listen to what they tell you when they are complaining about something.  You do not have to offer a solution, you just have to listen and act like you care (because you do of course care about them). 

Say something nice to your spouse about them.  We all have to deal with difficulties and people that are trying to cause problems for us, when we come home we as spouses should attempt to be there for our partners.  A kind word here and there really helps and who doesn't like to hear nice things about themselves.\

Don't worry if you feel that you are the only one that is trying to please the other person.  Hopefully they will come around after some persistent niceness and caring on your part.  Even if you feel like you are doing all the accommodating of the other person's feelings, it may be worth it.  Like my dad says, life is hard but the alternative is worse.

Good luck, be nice.