Since the beginning of the Great Recession, family law attorneys have struggled with what to do with property with negative equity (i.e. where the mortgages against the property are greater than its value). If the parties weren’t candidates for (or weren’t interested in) a short sale or foreclosure, inevitably one spouse took the property, and the accompanying negative equity, as part of his or her share of the marital estate. The spouse taking the underwater property invariably argued that he/she should receive credit for the negative equity (that is to say a correspondingly larger share of other assets). While the spouse walking away from the property (and the debt) engaged in a more metaphysical inquiry as to how “real” this negative equity was after all. Speaking purely anecdotally, the arguments of the metaphysically dubious spouses seemed to be carrying the day when the real estate market rebounded. Underwater properties were listed as having no value rather than giving the spouse receiving the property credit for taking an asset with negative value. Thankfully, home sales picked up, prices rose, and negative equity ceased to be an issue for most divorcing spouse.
Fast forward to yesterday. Five years after the economic collapse (and with home prices rebounding) the Court of Appeals finally gave us our answer—sort of. In its unpublished decision in Middendorf v. Middendorf, A12-1949 (Minn. App. Oct., 28, 2013), the Court reversed a district court’s assignment of a $0 value to an underwater property.
The facts are as follows: At trial, the parties agreed that the encumbrances against a property exceeded its value by approximately $25,000. Appellant was awarded the property. Despite the negative equity, the Court did not assign a negative value, instead raising its own metaphysical concerns about the “reality” of the negative equity:
Awarding [appellant] the … [Property] with negative equity could result in [appellant] letting the property go into foreclosure, and still incurring the benefit from the property award. Moreover, if the housing market recovers, the property value of the … [Property] may increase thus resulting in an inequitable division of marital property.
The district court then valued the property at $0. The Court of Appeals harbored relatively fewer doubts, and reversed. Observing that courts “are hesitant to speculate about the future value of property,” the Court found the assignment of a $0 value to clearly erroneous and held that the district court had overstated the property awarded to appellant by $25,000.
The decision here is particularly interesting because the appellate court’s holding runs directly contrary to the prevailing attitudes and arguments of the past five years.
Of course, it would be easy to read too much into this decision. First, it’s unpublished. For what that’s worth. Second, perhaps the error lies in the district court’s reasoning rather than the outcome. What if the Court correctly valued the property but declined to equally divide the overall marital estate? Would it make a difference if the parties lacked enough additional property to make up for the negative equity? It may be that the error in Middendorf is one of valuation rather than actual property division.
Who knows. What should be clear is that for those couples who still find themselves in a negative equity situation, the landscape just changed.