Divorce Law Beats Fraud, Maybe Contract

We’ve debated whether mutual mistake is a ground to rescind divorce settlements dividing marital property based on an account held with Madoff. The New York Court of Appeals will soon decide in the case of Simkin v. Blank.

As a matter of contract law, in my opinion, they should be rescindable, when people cannot reasonably be supposed to have allocated the risk that an account was fraudulent.

As I noted in Peter Lattman’s N.Y. Times story on the pending Simkin case, the real policy debate pits principles of contract law, about protecting party risk allocation, against principles of domestic relations law, where the finality of divorce settlements might warrant upholding even such mutually mistaken contracts.

The New York Court of Appeals today issued an opinion, CFTC v. Walsh, with clues about this balance. Today’s divorce settlement case involves an innocent spouse who received millions of dollars from an ex who allegedly committed a spectacular securities fraud (amounting to some $550 million).

Federal agencies want to recover the property from the innocent spouse. The defense: the millions counted as marital property and the settlement agreement makes it hers, even if fraudulently obtained and once belonging to innocent victims.

The Court thus weighed whether to privilege the public policy intended to restore stolen property to rightful owners or the one favoring finality of divorce settlement agreements.

The federal agencies thought you could split the baby: stress the finality of divorce settlements, but make a narrow exception for proceeds of certain kinds of fraudulent activity.

The Court noted how appealing the argument was, but rejected it, putting the finality of divorce agreements first.  Here is a flavor of the reasoning:

Ex-spouses have a reasonable expectation that, once their marriage has been dissolved and their property divided, they will be free to move on with their lives. To hold that the proceeds of fraud acquired by one spouse unbeknownst to the other cannot be subject to equitable distribution or conveyed through a settlement agreement as marital property would undermine one of the fundamental policies underlying the equitable distribution process, namely finality. The exception proposed by the [federal authorities] would effectively undo court orders and settlement agreements.

If divorce law warrants such priority over fraud law, it seems even easier to say that divorce law should get priority over contract law.  If so, in Simkin v. Blank, even if contract law’s doctrine of mutual mistake were compelling to rescind a divorce settlement, it would yield to the pro-finality policy of the domestic relations law. 

The only caveats stated in today’s opinion: the receiving spouse must indeed be innocent, having received the property in good faith on the basis of fair consideration. This is the “good faith purchaser for value” defense of commercial law, and the subject of the second half of today’s opinion.

The agencies denied the possibility of giving “fair consideration” for property obtained illegally, calling any such consideration supporting the divorce settlement “illusory.” Giving up claims to additional slices of fraudulent assets won’t do, the court agreed, noting that would be illusory and the proceeds recoverable despite the divorce settlement.

But, the court added, many other forms of consideration would count as “fair consideration” in divorce settlements, such as ceding claims to other assets, releasing claims or relinquishing child custody. That’s true even if the bulk of the consideration is giving up claims to additional fraud-tainted assets.

In short, claims of fraud victims warrant protection but so do those of innocent spouses making divorce agreements without knowledge of a spouse’s fraud. The court stressed that it will not enforce collusive divorce settlements, of course. But it didn’t probe exactly what sort of ignorance makes for an innocent spouse. Does burying one’s eyes and ears work?  

A dissenting judge would have held that an innocent spouse does not give “fair consideration” when settling a divorce in which the bulk of the consideration is giving up claims to additional amounts of fraud-tainted assets, even if you can point to other dribs and drabs of rights ceded or claims released.

The case now heads back to the federal courts, as this opinion addressed two certified questions raised in the federal fraud proceeding, brought by the CFTC and SEC.  CFTC v. Walsh, 618 F3d 218 (2d Cir.2010).

Hat Tip: Peter Lattman (N.Y. Times)

You may also like...