Possible implications of CFTC v. Walsh for divorced couples in bankruptcy

Here at Shenwick & Associates, clients with a variety of marital statuses seek our bankruptcy counsel–single, married, in the process of divorce, filing individually or jointly. Each variation requires the analysis and creativity of sophisticated bankruptcy counsel to avoid potential pitfalls in the process.

On June 23, 2011, in CFTC v. Walsh, the New York State Court of Appeals ruled that a woman could keep proceeds from a divorce agreement, even though those proceeds were the ill-gotten gains of a financial fraud perpetrated by her former husband. In February 2009, federal authorities arrested Stephen Walsh and his business partner Paul Greenwood. According to an article on the case in the New York Times, they were charged with defrauding investors of more than $550 million in a 13 year Ponzi scheme. Although the government did not accuse Ms. Schaberg (the wife of Mr. Walsh) of participating in a crime, they still sought to recover the money she received from her husband in her divorce settlement agreement.

The Court of Appeals ruled that 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. Ms. Schaberg's lawyer argued that once the couple had divided their marital property and signed a divorce settlement agreement, the government could not force her to disgorge what were her rightful proceeds.

Similar principles may also apply in personal bankruptcy and buttress the argument that marital property divided by a divorcing couple, pursuant to a divorce decree in New York State, would not be subject to fraudulent conveyance or other "clawback" actions by a Bankruptcy Trustee if a spouse filed for chapter 7 bankruptcy after the divorce proceeding.

Accordingly, let's assume that a couple with two young children were having marital problems, the husband has substantial debts, cash and stock and the couple owns a house that has appreciated in value. The couple decides that as part of their divorce, the husband will deed the house to his wife and transfer a substantial amount of the stock and cash to his wife pursuant to the divorce decree for support and maintenance. The husband then waits three months and files for Chapter 7 bankruptcy to liquidate his debts and obtain a discharge.

Following the Court of Appeals' holding in CFTC v. Walsh, a Bankruptcy Trustee should not be able to challenge the transfer of the house and assets to his ex-wife, thereby making those assets non-exempt or unreachable by the husband's creditors or the Bankruptcy Trustee. Clients with questions regarding bankruptcy and divorce should contact Jim Shenwick.

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NYT: Court Says Ex-Wife May Retain Ponzi Scheme Money

By PETER LATTMAN

J.B. Nicholas/Bloomberg News

The Ponzi schemes that came to light during the depths of the financial crisis have spawned various lawsuits seeking to claw back money from divorce agreements.

Now, in one case, a court has said: Hands off.

On Thursday, New York’s highest court ruled that a woman could keep proceeds from a divorce agreement, even if those proceeds were the ill-gotten gains of a financial fraud perpetrated by her former husband.

The decision is a blow to the federal government, which is seeking to force the woman to disgorge what it says are millions of dollars in stolen money.

“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,” said Judge Victoria A. Graffeo, writing for the New York State Court of Appeals.

The federal appeals court in Manhattan, which had asked the New York State court for guidance on the case, is now expected to prevent the federal government from seizing the woman’s assets.

Thursday’s ruling could also affect other divorce cases, like some involving victims of Bernard L. Madoff’s huge Ponzi scheme.

The New York State Court of Appeals is hearing a case brought by a man seeking to rescind his divorce settlement with his ex-wife because a large chunk of the marital proceeds were in a Madoff account.

The husband, Steven Simkin, kept much of his money with Mr. Madoff after the divorce; his wife, Laura Blank, received cash. After losing the bulk of his assets in the Madoff fraud, Mr. Simkin now wants to rewrite their divorce agreement.

In Massachusetts, a Madoff victim has also sued his ex-wife to revise their separation pact. A family court judge dismissed the lawsuit this month, and the plaintiff’s lawyer has appealed.

Thursday’s ruling in New York involves Janet Schaberg, 55 years old, the former wife of Stephen Walsh, a former executive at WG Trading, a commodities firm in Greenwich, Conn.

In February 2009, federal authorities arrested Mr. Walsh and his business partner, Paul Greenwood, on charges that they had defrauded investors of more than $550 million in a 13-year Ponzi scheme.

Mr. Greenwood pleaded guilty last year; Mr. Walsh is fighting the case.

Although the government did not accuse Ms. Schaberg of having any knowledge or participation in the scheme, lawyers at the Securities and Exchange Commission and the Commodity Futures Trading Commission went after her money, saying that much of it was ill-gotten proceeds from her former husband’s fraud.

In August 2009, a federal judge agreed with the government, freezing most of Ms. Schaberg’s assets, including $7.6 million in cash.

Ms. Schaberg, who divorced Mr. Walsh in 2007 after 25 years of marriage, appealed the judge’s order.

Her lawyer, Steven Kessler, argued that once she and Mr. Walsh had divided their marital property and signed a divorce settlement agreement, the government could not force her to disgorge what were her rightful proceeds.

In an unusual request, the federal appeals court asked New York state’s highest court for guidance on the divorce-law issues instead of a ruling.

The case, Judge Graffeo wrote, raised “difficult policy questions” that required the court to weigh the competing interests of returning stolen property to its rightful owners against the innocent former spouse of the defrauder.

In ruling for Ms. Schaberg, the court made an analogy between Ms. Schaberg and her divorce settlement proceeds and any person who unknowingly receives tainted money in a business transaction. For instance, the government could not seize stolen money from an architect whom a thief had paid to build his home.

The court said its decision to protect Ms. Schaberg, an innocent recipient of stolen funds, over the victims of the Ponzi scheme, was “rooted in New York’s concern for finality in business transactions.”

The decision emphasized that fraud victims could try to reclaim their stolen money if the former spouse was aware or participated in the crime.

Representatives for the S.E.C. and C.F.T.C. declined to comment.

New York divorce lawyers are divided on the decision. Michael D. Stutman, a divorce lawyer in Manhattan, is uninvolved in the Schaberg case, but along with three other lawyers, he submitted a brief that sided with the government.

“We disagree with the decision because someone in possession of stolen property should not be able to claim an ownership interest superior to the rightful owner,” Mr. Stutman said.

“Here, however, largely because she received ‘title’ to the ill-gotten gains through the divorce, she trumps the claims of people from whom the money was stolen,” he said.

Mr. Stutman also questioned the court’s emphasis on what it called New York’s “strong public policy of ensuring finality in divorce proceedings.”

He said other facets of divorce law — the amount of child and spousal support, as well as child-custody issues — are all subject to change based on newly discovered facts.

“Why is finality all of a sudden so sacred that you’re depriving victims of a fraud from access to their assets?” he asked.

Richard Emery, a lawyer for Ms. Blank, who is battling with her former husband in the New York case involving the Madoff fraud, applauded the ruling, calling it ”the right result for families and society.”

“The appeals court embraced the plight of a spouse who relies on the right to move on with her life after divorce,” Mr. Emery said. “This consideration trumps the interest of even the federal government.”

The Schaberg ruling

Copyright 2011 The New York Times Company. All rights reserved.

A California Bankruptcy Court Rejects U.S. Law Barring Same-Sex Marriage

By JOHN SCHWARTZ

A bankruptcy court in California has declared that the 1996 law barring federal recognition of same-sex marriage is unconstitutional, increasing pressure against the law.

“In this court’s judgment, no legally married couple should be entitled to fewer bankruptcy rights than any other legally married couple,” wrote Judge Thomas B. Donovan of the United States Bankruptcy Court for the Central District of California. In an unusual move, 19 other judges — nearly all of the 24 judges of the central district — also signed the decision.

The impact of the opinion could be limited, since the decision of the court is specific to the bankruptcy of the couple, Gene Douglas Balas and Carlos A. Morales. But the other judges’ signatures suggest that as a matter of policy they would rule similarly.

It is not the first blow to the law known as the Defense of Marriage Act. A federal judge in Boston declared the law unconstitutional last July, and that case is working its way through the legal system. The Department of Justice, however, is not driving that appeals process. In February, Attorney General Eric H. Holder Jr. announced in a letter to members of Congress that while the Obama administration would continue to enforce the law, it would no longer defend it in court and that classifications based on sexual orientation should be subjected to a tough legal test intended to block unfair discrimination.

Speaker John A. Boehner, Republican of Ohio, then announced that Congress would defend the law, and that it had hired former Solicitor General Paul Clement to argue on its behalf.

Mr. Balas and Mr. Morales cited Mr. Holder’s letter in their pleadings, and Judge Donovan quoted it approvingly in his 26-page opinion, and stated, “The Holder Letter demonstrates that DOMA cannot withstand heightened scrutiny.”

Mr. Balas and Mr. Morales were legally married under California law, and wanted to file jointly for bankruptcy. The trustee, the federal officials who oversee the bankruptcy process, moved to dismiss their petition under the Defense of Marriage Act. They then asked Judge Donovan to allow them to file jointly, and Monday’s decision was the result.

Adam Winkler, a professor at the law school at the University of California, Los Angeles, called the decision “a powerful statement about the status of gay rights today.” Professor Winkler said, “it shows the effect of Eric Holder’s letter in shaping legal decisions that came after it, almost as if it’s a precedent in the case.”

Mary Bonauto, the civil rights project director for Gay and Lesbian Advocates and Defenders, the group that brought the Massachusetts case, said she was not surprised to see another judge agree with the earlier decision, because the law “advances a blatant legal double standard.” Ms. Bonauto added, “In our system of justice, it’s the job of courts to call that out.”

One of those who signed Judge Donovan’s opinion, Judge Sheri Bluebond, said that a signing by other judges is “an unusual occurrence, but it is certainly not unprecedented.”

Judge Bluebond said bankruptcy judges signed on to their colleagues’ decisions when “threshold questions” were brought before one judge and the others in that district “so the bar would know where we stand,” and whether they would be able to file in those courts. While 20 judges signed the opinion and there are 24 in the Central District of California, Judge Bluebond said, “the fact that some judges did not sign on to it does not mean one way or another what their views on that issue are.”

“There could have been procedural reasons or just logistical reasons that they did not sign on,” she said.

It is unclear whether an appeal will be filed. Judge Donovan noted that the House Bipartisan Legal Advisory Group, which is leading the Congressional action, requested a brief delay in proceedings while it considered whether to intervene, but that “no further pleadings and no challenge” had ensued.

“The government’s nonresponse to the debtors’ challenges is noteworthy,” Judge Donovan wrote.

A spokesman for Mr. Boehner, Brendan Buck, said the ruling would not be appealed.

“Bankruptcy cases are unlikely to provide the path to the Supreme Court, where we imagine the question of constitutionality will ultimately be decided,” Mr. Buck said. “Obviously, we believe the statute is constitutional in all its applications, including bankruptcy, but effectively defending it does not require the House to intervene in every case, especially when doing so would be prohibitively expensive.”

Copyright 2011 The New York Times Company. All rights reserved.