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Commingling and the Separate Property Presumption Upon Divorce
2005 National Legal Research Group, Inc.

A recent Illinois opinion reached a split result on an interesting issue involving commingled marital and separate property. The dissent is most consistent with the plain language of the Illinois statute, but the majority opinion is most consistent with good policy, and with the general rule in other states.

In In re Marriage of Mouschovias, ___ Ill. App. 3d ___, 831 N.E.2d 1222 (2005), the parties were divorced after a sixteen-year marriage. Five days before the parties were married, the husband opened an investment account. The balance in the account on the date of marriage was not stated, but it was very small. During the marriage, a much larger body of marital funds was deposited into the account. There were no significant withdrawals. The question at issue was the classification of the balance in the account on the date of divorce.

The court's treatment of the issue was heavily influenced by the tortured history of Illinois' equitable distribution statute. Immediately after the statute was passed, the Illinois courts adopted the doctrine of unitary property, the rule that a single asset cannot contain both marital and separate interests. In re Marriage of Smith, 86 Ill. 2d 518, 427 N.E.2d 1239 (1981). Unitary property was a classic equitable distribution blunder, and it was reversed by statute only three years after it was adopted. 750 Ill. Comp. Stat. Ann. 5/503(c) (Westlaw 2005). Section 5/503(c) began by reaffirming that each asset must be either all marital or all separate property a very strange beginning for a statute which was intended to reach the exact opposite result. The statute then created a right to reimbursement, equal in many cases to the value created by the estate which did not receive the asset itself. For example, if equal amounts of marital and separate property were used to acquire an asset, 5/503(c) insists that the entire asset is marital property but then gives the separate estate a right of reimbursement equal to the value added with marital funds on the facts, 50% of the present value of the asset. The end result is to overturn unitary property, but the manner of operation can fairly be called baroque.

The specific statutory provision at issue in Mouschovias provided:

(1) When marital and non-marital property are commingled by contributing one estate of property into another resulting in a loss of identity of the contributed property, the classification of the contributed property is transmuted to the estate receiving the contribution, subject to [the right of reimbursement]; provided that if marital and non-marital property are commingled into newly acquired property resulting in a loss of identity of the contributing estates, the commingled property shall be deemed transmuted to marital property, subject to the provisions of paragraph (2) of this subsection.

750 ILCS 5/503(c)(1). Thus, when contributions of one character are made to an existing asset, the contributions transmute into the same character as the existing asset, subject to the right of reimbursement. The statute applies equally to both preexisting marital and preexisting nonmarital property. Thus, when marital contributions are made to separate property, the marital contributions transmute into separate property subject only to the right of reimbursement.

As applied to preexisting separate assets, 5/503(c)(1) is one of the most strikingly inequitable provisions in the entire law of equitable distribution. In equitable distribution theory generally, when marital and separate funds are mixed, the mixture is marital unless a partial separate interest is successfully traced by the party who claims it. Not only does 5/503(c)(1) insist that the mixture is separate property, but it does not even permit the nonowning spouse to trace the marital contributions.

Section 5/503(c)(1) can be explained, though not justified, as an extreme overreaction to unitary property. Before the statute was passed, the entire mixture at issue would have been automatically marital property, even if the separate assets were worth millions of dollars and the marital contributions were comparatively small. This was a terrible rule of law; the case for changing it was compelling. The obvious proper rule, looking back with twenty years of hindsight, is to recognize both marital and separate interests in the mixture, if the factual burden of tracing is met. Illinois law veered from one extreme to the other, changing the mixture from all marital property under unitary property, to all separate property under 5/503(c).

On the facts of Mouschovias, the investment account at issue was created with a nominal balance five days before the marriage. Substantial marital funds were then added to the account. Applying the statute as written, marital and separate funds were commingled by contributing one category of property to the other; the separate contribution existed first; the mixture was entirely separate property.

The trial court nevertheless classified the entire balance as marital property, and, by a 2-1 margin, the Illinois Court of Appeals affirmed. The court stated:

[W]e conclude the two funds were properly classified as marital. "[P]roperty acquired before the marriage" constitutes nonmarital property. 750 ILCS 5/503(a)(6) (West 2002). "Property," however, must have some identity, some integrity. A mere receptacle (a bucket?), owned by a party before the marriage, into which he places marital property, is not sufficient to invoke the rule that "contributing one estate of property into another resulting in a loss of identity of the contributed property" transmutes the classification of the contributed property to that of the estate receiving the contribution. 750 ILCS 5/503(c)(1) (West 2002). . . .

. . . A party should not be allowed to defeat the fundamental concept that all property acquired during the marriage is marital property by opening a checking account in his name and placing a meager amount in that account before the marriage, then depositing all his paychecks into that account after the marriage.

831 N.E.2d at 1227.

When a brokerage account is established during a marriage with nonmarital funds and marital funds are later added to that account, you do not have a situation where one estate of property is contributed "into another resulting in a loss of identity of the contributed property." 750 ILCS 5/503(c)(1) (West 2002). Instead, you have a situation where "marital and non[ ]marital property are commingled into newly acquired property resulting in a loss of identity of the contributing estates." 750 ILCS 5/503(c)(1) (West 2002); In re Marriage of Davis, 215 Ill.App.3d 763, 770, 159 Ill.Dec. 375, 576 N.E.2d 44, 48-49 (1991). There is not a loss of identity by one estate; there is a loss of identity by both estates. In that situation, "the commingled property shall be deemed transmuted to marital property." 750 ILCS 5/503(c)(1) (West 2002). Unlike, for example, the situation where $100,000 of nonmarital funds are used to purchase a residence and then $100,000 of marital funds are used over the years to maintain the residence, it makes little difference whether $100,000 in marital funds are placed in an account before or after $100,000 of nonmarital funds are placed in that account. The exact same asset has been contributed by each estate, and the result is newly acquired property, not a loss of identity of the contributed property while the receiving property maintains its identity.

Id. at 1227-28. This second passage clearly suggests that if a $100,000 separate property account exists for years, and $100,000 in marital funds are added "later" even twenty or thirty years later the post-contribution account is "newly acquired property," even though the account has existed for years. This result stands the language of the statute on its head. An account which has existed for years, under the same account number, with a substantial separate balance, cannot with any degree of intellectual honesty be called a "newly acquired" asset.

This criticism is not meant as a defense of the statute. On the contrary, the majority's reasoning is a convincing argument that the statute is bad policy. As a matter of statutory construction, however, the holding is wrong. The account was not a "mere receptacle"; it was an asset, with an existing premarital balance. The marital contributions did not create a new asset; they improved an existing asset. It is terribly unfair to hold that a very large marital deposit is controlled by a very small preexisting separate balance; it is wrong to allow the concept of marital property to be defeated so easily. Nevertheless, that is the result which the statute requires. A bank account is property even if it has only nominal value, or indeed no value at all. The remedy for the problem is to fix the statute, not to misconstrue it.

The dissenting opinion made precisely this argument:

We have a duty to apply the clear provisions of section 503(c)(1) without reading into the statute any exceptions or limitations regardless of whether we think the statute is a bad idea in a given case. See Eads v. Heritage Enterprises, Inc., 204 Ill.2d 92, 114, 272 Ill.Dec. 585, 787 N.E.2d 771, 783 (2003). Nowhere does the statute say it is inapplicable to accounts used to pay household expenses. Nowhere does the statute say it is inapplicable to nonmarital accounts that began with a low balance and grew during the marriage because of marital contributions.

The contributions of marital funds had no effect on the identity of the Portfolio account. The marital deposits lost their identity, but the Portfolio account remained the same account with the same account number, the same investment company, the same shareowner, and the same contractual terms. The number of shares changed, but not the essential identity of the account. The Portfolio account is Telemachos's nonmarital property, subject to reimbursement to the marital estate for contributions that are retraceable by clear and convincing evidence, including Telemachos's earned income. See 750 ILCS 5/503(a)(7), (c) (West 2002). The crystal-clear language of sections 503(a)(6) and (c)(1) admits of no other conclusion.

Id. at 1236 (Appleton, J., dissenting).

Moreover, in its haste to ignore the unwise but clear language of the statute, the majority missed a better path for reaching the same result. The entire account at issue was separate property under 5/503(c)(1), but 5/503(c)(1) is expressly subject to the right of reimbursement. In relevant part, 5/503(c)(2) provides:

When one estate of property makes a contribution to another estate of property, or when a spouse contributes personal effort to non-marital property, the contributing estate shall be reimbursed from the estate receiving the contribution notwithstanding any transmutation; provided, that no such reimbursement shall be made with respect to a contribution which is not retraceable by clear and convincing evidence, or was a gift, or, in the case of a contribution of personal effort of a spouse to non-marital property, unless the effort is significant and results in substantial appreciation of the non-marital property.

Under this statute, when marital funds were contributed to the account at issue in Mouschovias, the marital estate acquired a right to reimbursement. The marital funds became separate funds, but the right to reimbursement exists "notwithstanding any transmutation," so long as the contribution at issue is traceable and was not a gift.

The statute imposes various obstacles which burden the right to reimbursement, but none seems unavoidable under the facts of Mouschovias. There was no serious dispute that the marital contributions had been proven on the facts. The clear and convincing evidence standard is often an enormous problem it is bad enough to require that marital property be traced, but to require tracing by an enhanced burden of proof is indefensible but the court recited no evidence suggesting that no marital contributions were made. There was likewise no evidence suggesting that the marital contributions were a gift. Even if the court had to stretch the clear and convincing evidence standard downward to find that the burden was met, such stretching would be vastly more defensible than the majority's conclusion that a premarital bank account is not "property." The proper course of action in Mouschovias would have been to hold that the entire account was separate property, but then order the husband to pay substantial reimbursement back to the marital estate. This was as close to an equitable result as the Illinois statute permitted.

By brushing past the reimbursement provisions of 5/503(c)(2), the dissent in Mouschovias may discourage future courts from using those provisions aggressively to avoid the unusual and inequitable classification rule set forth in 5/503(c)(1). The dissent was correct that the account was separate property but the marital estate had a countervailing right to reimbursement, almost equal in amount to the value of the account itself. This result admittedly makes the classification of the account hollow but 5/503(c)(2) was designed to overrule unitary property, e.g., In re Marriage of Brown, 127 Ill. App. 3d 831, 469 N.E.2d 612 (1984), and therefore to make 5/503(c)(1) hollow in many cases. This strange result is the inevitable effect of a statute which codifies unitary property ( 5/503(c)(1)) only for the purpose of overruling it ( 5/503(c)(2)).

Outside of Illinois, there is a general consensus solution to the problem which so vexed the court in Mouschovias. When marital and separate funds are mixed together, regardless of whether the marital or separate contribution was made first, the entire mixture is presumptively marital property. The spouse who made the separate contributions can establish a partial separate interest by proving the nature and amount of the separate contributions. E.g., Schmitz v. Schmitz, 88 P.3d 1116 (Alaska 2004); Lilly v. Lilly, 107 N.C. App. 484, 420 S.E.2d 492 (1992); Von Raab v. Von Raab, 26 Va. App. 239, 494 S.E.2d 156 (1997). Unless active marital efforts caused the asset to increase in value after the contributions were made, the marital and separate interests in the same asset ultimately have the same ratio as the underlying marital and separate contributions. E.g., Schmitz; In re Marriage of Walrath, 17 Cal. 4th 907, 72 Cal. Rptr. 2d 856, 952 P.2d 1124 (1998); In re Marriage of Gilmore, 943 S.W.2d 866 (Mo. Ct. App. 1997). See generally Brett R. Turner, Equitable Distribution of Property 5.23 (2d ed. 1994 & Supp. 2004). If that spouse is unable to prove the nature and amount of the separate contributions, the entire account is marital property. Where significant withdrawals from the account have been made during the marriage, a more difficult problem in mixed destination tracing is presented; that issue is outside the scope of this article. For detailed treatment, see Turner, supra, 5.23, and Brett R. Turner, Tracing Separate Property Through a Commingled Bank Account, 12 Divorce Litigation 229 (2000).

Finally, this entire issue demonstrates once again the importance of recognizing partial marital and separate interests in the same asset. Episodes of commingling like the one at issue in Mouschovias are very common; most separate property is commingled to some extent with at least minor amounts of marital property. This is fundamentally why unitary property was a blunder; it assumes that separate property will normally remain separate, when in fact twenty years of nationwide experience have shown that separate property is normally subject to at least minor commingling.

If complete preservation of separate property is the exception, and a lesser or greater amount of commingling is the norm, then dual-classification jurisdictions logically must recognize partial marital and separate interests in the same asset. If the legislature truly believes that minor episodes of commingling should cause complete transmutation, it should abandon separate property altogether and retreat to an all-property system, for the benefit of excluding only pristinely kept separate property does not justify the administrative burdens of the classification process. If the legislature believes that a reasonably identifiable separate value should be preserved for the owning spouse, absent a gift to the marital estate and that is demonstrably the position most legislatures have taken then partial separate interests functionally must be recognized, for that is the form in which the great majority of all separate property is ultimately found. In the real world, pure, pristine, 100% separate property is a comparatively rare beast.

Section 5/503(c)'s Younger Cousin: Va. Code Ann. 20-107.3(A)(3)

The language of the unusual Illinois statute construed in Mouschovias is mostly unique to Illinois. A version of that language exists, however, in one other state: Virginia.

The Virginia statute, like the Illinois statute, was designed to overrule an unwise court decision adopting unitary property. Smoot v. Smoot, 233 Va. 435, 357 S.E.2d 728 (1987). The Virginia drafters began with the Illinois language, but they modified it extensively. In Illinois, contributions which are retraceable and were not a gift generate a right to reimbursement. In Virginia, contributions which are retraceable and were not a gift generate a partial marital or separate interest a cleaner and much more intuitive result. The key provisions read as follows:

d.When marital property and separate property are commingled by contributing one category of property to another, resulting in the loss of identity of the contributed property, the classification of the contributed property shall be transmuted to the category of property receiving the contribution. However, to the extent the contributed property is retraceable by a preponderance of the evidence and was not a gift, such contributed property shall retain its original classification.

e.When marital property and separate property are commingled into newly acquired property resulting in the loss of identity of the contributing properties, the commingled property shall be deemed transmuted to marital property. However, to the extent the contributed property is retraceable by a preponderance of the evidence and was not a gift, the contributed property shall retain its original classification.

Va. Code Ann. 20-107.3(A)(3)(d), (e) (Westlaw 2005). The key phrase appearing in both subsections, providing that the "contributed property shall retain its original classification," clearly creates a partial ownership interest and not a mere right to reimbursement.

The Virginia statute retains, however, the same language providing that marital contributions to an existing separate asset transmute into separate property, unless the marital contributions are retraceable. Construing this language, the Virginia Court of Appeals held in a published decision that marital funds contributed to a separate property home transmuted into marital property unless they were retraceable and were not a gift. Thus, the marital contributions were presumed to be separate property. Moran v. Moran, 29 Va. App. 408, 413, 512 S.E.2d 834, 836 (1999) ("[T]hey commingled marital funds with separate property, resulting in the presumption that the marital funds were transmuted to separate property"). The majority in Mouschovias likewise accepted that marital contributions to a tangible asset, such as a home, remain separate.

Virginia has never considered marital contributions to an intangible asset in a published appellate opinion. An unpublished opinion, however, summarily held that marital contributions to an established separate investment account were presumed to transmute into separate property:

Wife's act of depositing marital funds, her earnings during the marriage, into her separately titled Wheat First brokerage account, which initially contained only her separate funds, resulted in the presumption that the marital funds were transmuted back into wife's separate property. See Moran v. Moran, 29 Va.App. 408, 413, 512 S.E.2d 834, 836 (1999).

Zalusky v. Zalusky, 2002 WL 31553133, at *3 (Va. Ct. App. 2002). This is the exact result advocated by the Mouschovias dissent. Zalusky's reliance upon Moran, which involved a tangible home, suggests that the court saw no reason to distinguish between tangible and intangible assets for purposes of the presumption. Unpublished Virginia Court of Appeals decisions lack precedential value, but they can be cited freely for whatever persuasive value they may have.

Note that both Moran and Zalusky found that the separate property presumption had been rebutted on the facts, so that the marital contributions at issue ultimately resulted in a partial marital interest. This is further evidence that the result reached by the Mouschovias majority could have been obtained by treating the account as separate property, and then awarding the marital estate a substantial right of reimbursement the Illinois equivalent of a partial marital interest.

While Virginia's construction of 20-107.3(A)(3)(d) is better than Illinois' construction of 5/503(c)(1), both statutes are unwise policy to the extent that they adopt a presumption that marital contributions transmute into separate property. The burden of tracing separate property should always be upon the owning spouse, regardless of whether the separate property or the marital property existed first. Like the Illinois statute, the Virginia statute was drafted as a measure to overturn unitary property, and, against that background, a desire to err on the side of limiting transmutation of separate property is understandable. Nevertheless, the law of both Illinois and Virginia would be improved if the relevant statutes were amended to provide that the spouse who asserts a separate property interest always carries the burden of tracing that interest by a preponderance of the evidence.

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