A Negotiating Tool for Your Divorce Case: The Debt-to-Asset Ratio
In considering a spouse’s entitlement to support or an award of counsel fees, courts generally examine a number of factors, such as the richer spouse’s ability to pay, the dependent spouse’s financial need, the parties’ access to other financial resources and liquid assets, and whether they each exercised good faith or bad faith in the proceedings. A helpful way to interpret several of these factors is to examine the “Debt-to-Asset Ratio.”
The debt-to-asset ratio determines how much of each party’s assets are financed or encumbered by debt. As such, it provides a measure of the dependent spouse’s need for support compared to her access to valuable assets.
The data necessary to construct this ratio is readily available in the financial disclosures that parties are required to make as a part of the pretrial discovery process in a divorce action. Thus, in a New Jersey divorce, the necessary figures it can be found on the Case Information Statement that all parties are required to complete as part of the divorce process.
There are just three simple steps: First, calculate a spouse’s total debt. Then, calculate total assets. Then, divide total debt by total assets.
For example, assume that Wife’s total liabilities are $300,000, and her total assets are $500,000. The debt-to-asset ratio is 0.60 ($300,000 divided by $500,000). This means that for every 60 cents in total debt, the Wife has total assets of $1. If Husband has a ratio lower than 0.60, then his financial position is better.
The objective is to have a lower number because it is better not to owe too much money. Thus, in arguing alimony and child support motions, it is useful to note which party has the lower (better) debt-to-asset ratio. If Wife has a ratio of .60 and Husband has a ratio of .20, one might argue that the Husband has a stronger (more asset-rich) financial foundation and has a clear ability to pay more support.
In a jurisdiction in which the court will attempt to equalize the financial positions of the parties, one might argue that the Husband should pay enough money to the Wife to equalize both of their ratios at .40 – effectively giving them a comparable debt-to-asset balance.
Consider another scenario. On his Case Information Statement, an unemployed Husband reports total debt at $219,650. Having been dispossessed of his only real estate in a foreclosure action, the Husband counts $132,000 in personal assets. His debt-to-asset ratio is disquieting:
Debt / Asset = $219,650 / $132,000 = 1.66
The ratio indicates that for every $1.66 in debt, the Husband has only $1 in assets. His top-heavy or upside-down condition may very well help him to argue for alimony, spousal support, maintenance, or an award of counsel fees from a more financially secure Wife.
The ratio may also assist the Husband in arguing for a reassignment of assets as part of the divorce proceedings. In the scenario above, the Husband has only $1 worth of assets to cover every $1.66 of debt. If the Husband were to liquidate his assets – essentially selling everything to pay off his debt – he would be able to cover only about 60% of his obligations.
$1 / $1.66 = 0.6024
In this regard, Husband could argue that he should receive an award of additional assets. In a mathematically perfect world, for example, Husband could assert that an additional $87,650 in assets would bring his debt-to-asset ratio to 1:1; that is, exactly $1 of debt for every $1 of assets.
Debt / Asset = $219,650 / $132,000 + $87,650
= $219,650 / $219,650
In a more likely scenario, however, there could be insufficient assets to bring each party down to a ratio of 1, or there may be enough assets to lower each party’s ratio to a comparable number below 1.
Suppose that, at the time of their separation, Husband had debt of $219,650 and Wife had debt of $111,000. Husband had assets of $132,000 and Wife had assets of $121,000. In the divorce which ensues, the Husband contends that he is the dependent spouse and demands a financial and/or property distribution from his Wife. The Wife, in defense, points out that Husband walked away with $11,000 more in assets than she has. Let’s compare each party’s debt-to-asset ratio:
Husband: Debt/Asset= $219,650/$132,000=1.66
Here, it is evident that the Wife is not nearly as financially burdened as Husband. In the event of full liquidation, the Wife could cover her indebtedness because she has only 91 cents in debt for every dollar in assets. The disparity in the two ratios offers a negotiating opportunity to the Husband’s counsel. While it may not be appropriate to settle a divorce exclusively on the basis of the disparity in these ratios, the information produced by these ratios provides a useful bargaining tool. Consider two approaches:
APPROACH #1 — RE-ASSIGNING DEBT.
The Husband’s attorney could seek a payment of alimony or spousal support from Wife that would assist Husband in reducing his debt more quickly. Or, Husband’s attorney could argue that a particular debt should be reassigned from Husband to Wife in order to equalize (or nearly equalize) their debt-to-asset ratios.
For example, let’s say that Husband had been assuming responsibility for a $44,650 bank loan, among his other debts. Husband’s attorney could argue that this particular loan (which was marital in nature) should be shifted to Wife in order to apportion the parties’ debt commitments more equitably. If Wife agreed to assume responsibility for the $44,650 bank loan, the respective debt-to-asset ratios would be adjusted as follows:
Debt / Asset = $219,650-44,650 / $132,000
= $175,000 / $132,000
Debt / Asset = $111,000-$44,650 / $121,000
= $155,650 / $121,000
By reassigning the bank loan to Wife, Husband has lowered his debt-to-asset ratio to 1.32 while Wife has raised her ratio to 1.28. The ratios are now quite close, and with other minor adjustments between the parties, an equitable resolution of the divorce can be achieved.
APPROACH #2: RE-ASSIGNING ASSETS.
The second approach to equalizing or approximately balancing the ratios is to reassign assets from one spouse to the other. Using the original ratios for Husband and Wife provided above, let’s assume that there are no reassignable debts. However, Wife’s assets of $121,000 consist of a number of investments, two of which can be safely transferred without any penalties, fees or tax consequences. The two investments are valued at $16,000 each, for a total of $32,000. By transferring these investment assets to Husband, the parties will achieve somewhat more comparable debt-to-asset ratios:
Debt / Asset = $219,650 / $132,000 + $32,000
= $219,650 / $164,000
Debt / Asset = $111,000 / $121,000 – $32,000
= $155,650 / $89,000
While the ratios are not identical, the disparity between the parties has been significantly reduced. With other financial or equitable adjustments between the parties, the prospect of a fair settlement now seems much more achievable.
The debt-to-asset ratio, like the debt-to-equity ratio, is a common calculation on the corporate frontier. It is not, however, limited to business analysts and corporate lawyers. The debt-to-asset ratio provides a practical snapshot of a separated spouse’s financial condition. A ratio under 1 means that a majority of that spouse’s assets are financed through equity; a ratio greater than 1 means they are financed more by debt. The higher the ratio above 1, the more debt-leveraged the spouse.
Knowing this information can help a dependent spouse qualify for spousal support or for a redistribution of assets. It may also assist an obligor spouse in arguing that he is already too leveraged by debt to pay support or to relinquish any unencumbered property.
Like all ratios, however, the debt-to-asset comparison should not be considered in isolation. Rather, it should be used as one of several tools aimed at structuring a reasonable settlement, or as one of several devices to persuade a judge to enter a well-reasoned judgment.