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    The Lawletter Blog

    FAMILY LAW: Proceeds of Fraud as Marital Property

    Posted by Gale Burns on Wed, Feb 29, 2012 @ 16:02 PM

    The Lawletter Vol 36 No 8

    Brett Turner, Senior Attorney, National Legal Research Group

    Steven Walsh and Janet Schaberg were divorced in New York in 2006.  They had a substantial marital estate, which they divided in a property settlement agreement.  Given the size of her property award, Schaberg agreed to waive maintenance.

    Several years after divorce, a federal investigation revealed that Walsh had been engaged in a long-standing scheme to defraud investors in various funds he managed.  In fact, much of the parties' marital estate was a product of Walsh's fraud.

    Two federal agencies, the Commodity Futures Trading Commission and the Securities and Exchange Commission (hereinafter "the agencies"), filed suit in federal court, seeking to recover the proceeds of Walsh's fraud not only from Walsh, but also from Schaberg.  The Second Circuit held that the agencies could recover the proceeds from Schaberg if she "lacks a legitimate claim" to the funds.  Commodity Futures Trading Comm'n v. Walsh, 618 F.3d 218, 225 (2d Cir. 2010).

    Schaberg, who had been entirely unaware of Walsh's wrongdoing, argued that she had such a legitimate claim under New York state marital property law.  Because state law was involved, the Second Circuit certified two questions to the New York Court of Appeals:  (1) whether "marital property" can ever include the proceeds of fraud, and (2) if so, whether the wife nevertheless had an obligation to return the funds because she had not paid fair consideration for them in good faith.

    In a 2011 opinion, the New York court answered both questions.  Commodity Futures Trading Comm'n v. Walsh, 951 N.E.2d 369 (N.Y. 2011).  It answered the first question with a yes, holding that the proceeds of fraud can constitute marital property.  They are certainly property acquired during the marriage through the active, if dishonest, efforts of the guilty spouse.  They belong to the guilty spouse unless and until the victims take legal action to recover them.  If a postdivorce attempt to recover the proceeds of fraud retroactively erases those funds from the marital estate, property-division judgments will never be final, and the policy of finality of judgments is very strong.  The court therefore held that the proceeds of fraud can constitute marital property.

    The second question defied a simple and easy answer.  The agencies argued that the wife had acquired her share of the proceeds of fraud in exchange for waiving her interest in the husband's share of the proceeds of fraud.  The New York court agreed that fair "consideration cannot be predicated on a spouse's relinquishment of a claim to a greater share of the proceeds of fraud."  Id. at 377.  In other words, fair consideration must be something beyond an interest in the proceeds of fraud themselves.

    But looking at the facts, the court saw that the wife had paid consideration not directly tied to the husband's fraud.  To begin with, she had waived maintenance.  Maintenance would be related to the husband's fraud to the extent that the husband's income had been fraudulently earned, but he had worked honestly before commencing his fraudulent activities and probably had a positive earning capacity arising from legal activities.  Second, the wife had also waived her interest in the former marital home, which she alleged had been acquired before the husband's fraudulent activities began.  Third, she had waived her right to inherit from the husband.  Even if these waivers were not fair consideration for all of the wife's property award, they may well have been fair consideration for part of it.  The court therefore held that to the extent the wife had paid fair consideration, she should be permitted to keep her share of the proceeds of fraud.

    The Second Circuit subsequently remanded the case back to the federal district court to determine the extent to which Schaberg had paid fair consideration for the proceeds of fraud.  Commodity Futures Trading Comm'n v. Walsh, 658 F.3d 194 (2d Cir. 2011).  There are no further opinions available at this date.

    Topics: legal research, family law, Brett turner, The Lawletter Vol 36 No 8, fraud proceeds as marital property, illegal funds belong to guilty spouse, wife's share was exchange for waiver of mainte, fair consideration

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