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    The Lawletter Blog

    FAMILY LAW UPDATE: Transfers for Grossly Inadequate Consideration: Gift or Sale?

    Posted by Gale Burns on Mon, Jun 18, 2012 @ 11:06 AM

    June 19, 2012

    Brett Turner, Senior Attorney, National Legal Research Group

    In Sfreddo v. Sfreddo, 59 Va. App. 471, 720 S.E.2d 145 (2012), the husband and his brother worked for Triple S, a corporation owned by their mother.  In 2004, the mother decided to give the business to her two sons.  To accomplish this goal, she let each of them purchase 200 shares for par value, which was $1 per share.  The husband's shares therefore cost $200.  The corporation then entered into an agreement to redeem the mother's shares, leaving the sons as sole owners of the company.  "[H]usband, his mother, and his brother all testified they understood the transferring of the company to the brothers to constitute a gift."  Id. at 478, 720 S.E.2d at 149.

    The corporation was not valued at the time when the husband bought his shares, but a one-half interest owned by another relative of the husband's had been redeemed one year earlier for $1.5 million.  At divorce in 2011, the husband's one-half interest in the corporation was worth $1.636 million.  The $200 paid by the husband was therefore only a small fraction of the total net worth of his 50% interest.

    Upon divorce, the wife argued that the husband's entire interest in Triple S was acquired by purchase during the marriage and that it was therefore marital property.  The husband argued that his interest was a gift, as the consideration paid was nominal compared to the value of the stock transferred.  The trial court held that the husband's mother had intended to make a gift, but it found insufficient evidence that the corporation had intended to make a gift.  It therefore treated the husband's stock as marital property.

    On appeal, the Virginia Court of Appeals reversed.  The trial court had held that the husband's mother had intended to make a gift.  The corporation had three directors, the mother, the husband, and his brother, and all three had signed the corporate minutes approving the purchase of stock by the husband and his brother.  There was no evidence that the intent of the husband and his brother was any different from the intent of the mother.  Also, "[t]he vast disparity between sale price and value clearly manifests the board's intent to gift."  Id. at 483, 720 S.E.2d at 151.

    If all three directors had donative intent, then the corporation necessarily had donative intent.  Indeed, under the trial court's approach, it is not clear how one could ever prove that a corporation intended to make a gift.  "[T]he trial court's conclusion that there was not a corporate intent to gift the shares to husband and his brother was plainly wrong and unsupported by the evidence."  Id. at 482, 720 S.E.2d at 151.

    The question remained whether a gift was disproven by the uncontested fact that the husband had paid $200 for his shares.  The court of appeals held that the $200 was not consideration at all:

    "To constitute consideration, a performance or a return promise must be bargained for." Restatement (Second) of Contracts § 71(1) (1981). In a comment, the Restatement elucidates this by stating: "[A] mere pretense of bargain does not suffice, as where there is a false recital of consideration or where the purported consideration is merely nominal. In such cases there is no consideration. . . ." Id. cmt. b. In a comment to another section, the Restatement again explains: "Disparity in value, with or without other circumstances, sometimes indicates that the purported consideration was not in fact bargained for but was a mere formality or pretense. Such a sham or 'nominal' consideration does not satisfy the requirement of § 71." Id. § 79 cmt. d. Moreover, the Restatement provides an illustration highly relevant for this case: "In consideration of one cent received, A promises to pay $600 in three yearly installments of $200 each. The one cent is merely nominal and is not consideration for A's promise." Id. illus. 5.

    Id. at 489‑90, 720 S.E.2d at 154‑55.  "We hold that where nominal consideration and the surrounding circumstances of a contract demonstrate a gift rather than a bargained for sale occurred, the court should find the transaction constitutes a gift."  Id. at 491‑92, 720 S.E.2d at 155‑56.

    The court was clearly correct in holding that the great majority of the stock transferred to the husband was acquired by gift.  All three directors of the corporation—the mother, the husband, and the brother—intended to make a gift.  The price paid was only a small portion of the value of the stock trasferred.

    Yet it is possible to question the court's holding that all of the stock was acquired by gift.  The mother did require the husband to pay $200, and there was no proof that the $200 was paid with separate funds.  When property is sold at less than fair market value, with intent to make a gift, the transaction is treated as part sale and part gift for income tax purposes.  I.R.C. § 2512.  The better rule is to treat it as part sale and part gift for equitable distribution purposes as well.  See generally 1 Brett R. Turner, Equitable Distribution of Property § 5:36 (3d ed. 2005).

    On the facts of Sfreddo, the author would have held that $200 of the stock was acquired by gift.  Assuming that the stock was worth $1.5 million at the time of sale, that would have created a marital interest of .013% ($200 divided by $1.5 million), with a value at the time of divorce of $218 (.013% times $1.636 million).

    An additional marital asset worth only $218 was trivial, of course, and the result reached by the Sfreddo court is therefore substantially correct.  But the difference might be larger in a case where the transferee pays a larger portion, such as 25% or 50%, of the value of the transferred interest.  Sfreddo provides support in this sort of case for ignoring a marital contribution much larger than $200.  The court expressly stated that its holding was limited to the facts, so perhaps the court would find a partial sale when the amount of consideration paid is more substantial.  But the simpler and cleaner approach is to find a partial sale whenever consideration is paid, so that the marital estate receives proportional credit for any marital funds, however small, which were contributed to the acquisition of the property.

    Topics: legal research, family law, Brett turner, Sfreddo v. Sfreddo, Va. Ct. Appeals, shares transfer, inadequate consideration, gift or sale, part sale and part gift for tax and equitable dist

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