Recently, my partner, Matt Kenefick, obtained a large judgment
here in California against an Arizona resident. The desert rat
refused to pay up voluntarily, hiding behind Arizona's unique
and highly protective community property laws. The problem Matt
faced was that only one spouse had been involved in the nefarious
scheme to separate our client from its money.
Matt ultimately collected from the Arizona judgment debtor, but
the difficulties he faced are worth highlighting for those of us
who normally do business in states other than Arizona.
Lenders: Beware of the
Arizona "Two-Dollar Bankruptcy"
by Matthew Kenefick
Lenders commonly rely upon form documentation when making a
loan, often assuming that the form complies with the ever-changing
law governing the deal. As we all know, a mistake in documentation
can result in serious collection issues if the loan goes into
default. If the defaulting obligation is secured by a personal
guaranty given by an Arizona resident, or if the guaranty has to be
enforced in Arizona, there may be enforcement problems.
For many years, an Arizona individual debtor could place his or
her future wages and commingled community property assets outside
of the reach of his or her creditors simply by getting married.
Thus, getting married in Arizona has been colloquially referred to
as a "two-dollar Bankruptcy." The term-of-art
"two-dollar Bankruptcy" refers to initial cost of an
Arizona marriage license, which was at one time two dollars.
Although the scope of the "two-dollar Bankruptcy" has
been significantly narrowed though legislative and case law
developments, its protection continues in certain contexts. One of
these contexts is personal guaranties. Under Arizona law, both
spouses must execute a personal guaranty to bind the marital
community. See Ariz. Rev. Stat. § 25-214(c)(2); Rackmaster
Systems, Inc. v. Maderia, 193 P.3d 314 (Ariz. App. 2008). This
limitation has been extended to non-Arizona resident debtors in the
context of Arizona enforcement proceedings (see Phoenix Arbor
Plaza Ltd. v. Dauderman, 785 P.2d 1215 (Ariz. App. 1989)) and
Arizona debtors in the context of non-Arizona enforcement
proceedings (see G.W. Equipment Leasing, Inc. v. Mt. McKinley
Fence Co., 982 P.2d 114 (Wash. App.1999)). Thus, under Arizona
law, if only one spouse executes a personal guaranty, only that
spouse's separate marital property is subject to the claims
arising under that guaranty. Since most assets acquired and income
earned after the formation of a marriage are deemed community
property, under such circumstances there will be a much smaller
universe of assets upon which a lender can enforce its guaranty
So, what is a lender to do? Stop doing business with Arizona
residents? Obviously not. Require both spouses to execute a
personal guaranty in all states, even when it is not needed to bind
the marital community -- also a bad idea since that may kill
certain deals. The practical solution is for lenders to require
execution of a personal guaranty by both spouses in an Arizona
marital community and to include in that guaranty a choice of
non-Arizona law and a waiver (by both spouses) of the protections
of Arizona community property law. If the lender cannot get both
spouses to execute the personal guaranty, then this should be taken
into consideration in the underwriting process. It may be
permissible under Reg. B to require both spouses to sign loan
documents, including guaranties, in community property states, such
It is also worth noting that Arizona is not the only state with
protective community property laws. Furthermore, in states such as
Arizona, the failure to name both spouses as defendants in certain
types of actions can preclude enforcement of any resulting judgment
against marital community assets. See, e.g., Ariz. Rev. Stat.
§ 25-215(D)(10); Spudnuts, Inc. v. Lane, 676 P.2d 669, 670
(Ariz. App. 1984). It is therefore a good idea to become familiar
with the community property laws of the state in which your
borrower, guarantor, or debtor resides both when entering into a
transaction and when commencing legal proceedings to enforce
The lesson here is to check for local laws when doing deals
outside your home state. We here in California have our share of
legal issues that must be addressed, many in the context of making,
restructuring and enforcing commercial and real estate loans. JMBM
can help you through the patchwork quilt of well-intentioned but
often troublesome laws that affect your ability to collect on loans
made to Californians or secured by California real property.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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Overseas Shipping Group ("Overseas") recently sued its former attorneys, a prominent New York-based law firm, for legal malpractice in drafting credit agreements that resulted in the company incurring an estimated $463 million in tax liability.