United States: Lenders: Beware Of The Arizona "Two-Dollar Bankruptcy

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 claims. 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 as Arizona. 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 claims. 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.