Using Prenuptial Agreements as a Means to Avoid Transmutation of Separate Property

New York Law Journal

Reading up on decisions of interest, including those published in this Journal, is part and parcel of keeping current on the law. In the context of matrimonial law, specifically with respect to the drafting or prenuptial agreements, the Second Department’s recent decision in Rosen v. Rosen, 2021 Slip Op 01278 (2d Dep’t 2021) is worth far more than a passive read. In fact, the decision is arguably worth printing out, filing in your office (or virtual office), and re-reading each and every time the matrimonial practitioner is tasked with drafting a prenuptial agreement that will invariably define the various connotations of what constitutes each party’s “separate property.”

At their core, prenuptial agreements are designed to accomplish certainty in the event of what matrimonial lawyers term a “Termination Event,” “Dissolution Event,” or “Termination of the Marriage.” And while prenuptial agreements are accorded the same benefits bestowed by the law of contracts, time and again we find ourselves in the midst of litigation involving prenuptial agreements and/or reading decisions of interest involving challenges to the enforceability of prenuptial agreements and disputes as to the meaning of their terms.

A cursory Internet search reveals the unending opinions ranging from legal professionals to wedding magazines on the subject of whether or not couples need a prenuptial agreement (e.g., has either party been married before, does either party have a child or children, is one party or both parties wealthy). This article is not intended to offer another of such opinions and in fact, this author is of the view that across the board edicts about who needs or does not need a prenuptial agreement are short-sighted.

Each couple’s circumstances are unique to that couple, which is why the notion of using a “form” prenuptial agreement that you can generate in 10-15 minutes time on the Internet is a potentially treacherous route to follow if as and when you are contemplating a prenuptial agreement. The Rosen decision is an excellent example of why, for the drafter of the prenuptial agreement, excruciating attention to detail and continuously asking “will a Judge know how to interpret this clause” is critical.

In Rosen, four years prior to marriage, the husband incorporated Airline Software, Inc. (Airline) to market and support various programs developed by him and his company, Gordon S. Rosen Associates, Inc. (GSRAI). The husband’s programs he developed were known as the Airline Resource Management System (ARMS). In 2004, 19 years after the date of marriage, Airline changed its name to Airframe Systems, Inc. (Airframe). The husband also incorporated Aviation Software, Inc. (Aviation) and ASI Scanning, Inc. during the marriage (ASI).

Aside from providing that the husband’s separate property included shares of stock in Airline and GSRAI, the prenuptial agreement provided that:

the [wife] waived all rights to the [husband’s] separate property, as well as to any property that the [husband] may in the future purchase or exchange with the proceeds of his separate property. The [wife] also waived her right to any increase in value of the [husband’s] separate property in which the [husband] presently had an interest or in which he may have an interest acquired as a result of a sale or exchange of his separate property.

The trial court’s distributive award to the wife included the sum of $363,644.74, “representing 30% of the value of the [husband’s] interest in ASI.” On appeal, the Second Department found that the trial court erred in determining that ASI was marital property and in awarding the wife a percentage thereof:

It is undisputed that the [husband’s] interest in Airline, which was later renamed Airframe, constituted separate property. Through an assignment and licensing agreement, Airline transferred the source code, programs, and trade secrets to Aviation. Aviation operated from 2004 through 2011. ASI was incorporated as a sales and marketing company in 2006. All operations were transferred from Aviation to ASI.

Airline is the [husband’s] separate property. Since Airline exchanged its operations … with Aviation, and Aviation thereafter exchanged its operations with ASI, the [wife] waived all rights to the value of the [husband’s] interest in ASI.

In Rosen, the “property acquired in exchange for separate property” clause was used by the Second Department to neatly connect the dots and fulfill the plain language of the parties’ prenuptial agreement. The reason this author urges that Rosen be kept on file is that not every prenuptial agreement negotiation will lend itself to leaving the “property acquired in exchange for separate property” clause with the result in Rosen. Specifically, once the drafter, at the client’s request, begins to tinker with the “property acquired in exchange for separate property” clause, all bets may well be off. Nowhere might this be more pertinent than in the case of limited liability companies owning real estate.

Consider a Rubik’s cube. To start, before marriage, your client’s single-member LLC owns Building A (red), Building B (green), Building C (white), Building D (blue), Building E (yellow) and Building F (orange). Your client owns equity in each Building, and receives distributions resulting from each property’s operations. If you now twist the Rubik’s Cube to mix the colors, but leave the “property acquired in exchange for separate property” clause untarnished, then Rosen should still apply. However once you begin making exceptions (e.g., your client’s equity interests remain separate, but income received is marital, or to make this even more complicated—your client wants to exclude 1031 like-kind exchanges from an “exchange”), then be sure to ask if the now upended “property acquired in exchange for separate property” provision has a realistic chance of being enforced—or understood—as your client intends. Because despite your best intentions, Rosen may not be able to save the day.

“Using Prenuptial Agreements as a Means to Avoid Transmutation of Separate Property,” by Alan R. Feigenbaum was published in the New York Law Journal on May 19, 2021.

Reprinted with permission from the May 19, 2021, edition of the New York Law Journal © 2021 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited.