By Donald A. Hayes, Attorney at Law
The downturn in the real estate market has created new legal issues concerning what the divorce court will do to divide distressed real estate. One type of distressed real state comes to mind: “upside down property” where the mortgage balances exceeds the fair market value.
The question becomes should a party requesting that he or she be awarded an upside down property in the division of community property receive a credit for the property’s negative equity, or only receive the property at zero value.
When the entire estate is positive, but the real property is upside down, the Court is required to make a mathematically equal division of the parties’ community property assets and liabilities pursuant of the mandates of FC §2550.
When the entire estate is negative, Family Code 2622 (b) gives the court the discretion to the extent the community debts exceed total community assets, to assign the excess debt as the court deems just and equitable. In this situation the Court clearly can award an upside down property to one party at a zero value; or it may award it at a negative value.
Central to the analysis is the concept of recourse debt vs. non-recourse debt. In California a purchase money mortgage secured by a deed of trust with a power of sale on a principal residence is non-recourse debt. This means in the event of a default the lender must resort to the security and has no recourse against the borrower who defaults on the loan. In this situation the Court would likely award the property to that spouse at a zero value
On the other hand if upside down property includes an upside down second trust deed mortgage, it may be considered a recourse debt since the lender could seek recovery against the borrower by filing a lawsuit in the event of default. Under this analysis the asset may be awarded to a spouse at a negative value by giving credit for the negative equity.
There are other situations where recourse debt can arise, such as vehicle and equipment loans, and if there is a an overall estate with positive value, then the court should award the asset with negative equity along with that asset for purposes of an equal division of community property.