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Equitable Distribution and Divorce and the Clean Hands Doctrine
© 2005 National Legal Research Group, Inc.
When dividing property, should the court consider the fact that one or both spouses has committed misconduct against a third person? The relevant decisions reach disparate results.
A good entry point into the discussion is the recent New York case of Bernstein v. Bernstein, 18 A.D.3d 683, 795 N.Y.S.2d 733 (2005). The husband in Bernstein transferred property to a third person for the purpose of defrauding creditors. The wife argued that the husband should not be awarded any of the property so conveyed. The court agreed on the law, but disagreed on the facts:
Where jointly-held property is transferred for the purpose of defrauding creditors, the transferor may not then share in the value of the transferred asset for purposes of equitable distribution (see Bullaro v. Bullaro, 231 A.D.2d 666, 648 N.Y.S.2d 46; Langdon v. Langdon, 138 A.D.2d 358, 525 N.Y.S.2d 649; see also Hasegawa v. Hasegawa, 290 A.D.2d 488, 736 N.Y.S.2d 398). Nevertheless, where the plaintiff expressly acknowledged that she knowingly encouraged and benefitted from the transfer, the asset properly was subject to equitable distribution to the defendant (see Vasquez v. Zambrano, 196 A.D.2d 840, 602 N.Y.S.2d 29; see also Walker v. Walker, supra).
795 N.Y.S.2d at 734-35.
The Bernstein court gave very few facts about the transfer at issue. If the property remained in the hands of a third party, it was not property owned by either party, and therefore technically not marital property at all. There is certainly nothing objectionable in the rule that the husband cannot share in the value of an asset which the parties no longer own.
If the conveyance occurred in anticipation of divorce, the asset can be treated as marital property under a dissipation theory. See generally Brett R. Turner, Equitable Distribution of Property 6.30 (2d ed. 1994 & Supp. 2004). Since the wife benefited from the transfer, this sort of transfer was not involved on the facts of Bernstein.
Authority exists in some states for awarding the transferring spouse little or no part of any asset hidden or conveyed away for the express purpose of defrauding the other spouse. E.g., Sands v. Sands, 442 Mich. 30, 497 N.W.2d 493 (1993) (proper to award wife 100% of such an asset, although 100% award was not legally required); Hasegawa v. Hasegawa, 290 A.D.2d 488, 489, 736 N.Y.S.2d 398, 400 (2002) ("[T]he defendant, who admitted taking part in the transfer notwithstanding the temporary restraining order, and with the admitted purpose of preventing the plaintiff from obtaining equitable distribution of marital property, may not obtain equitable relief with unclean hands"); Bell v. Bell, 540 N.W.2d 602 (N.D. 1995) (where husband dissipated single largest marital asset and refused to pay court-ordered child support to any of the mothers of his various children, including the wife, proper to award wife 100% of the divisible estate); In re Marriage of Coyle, 671 N.E.2d 938, 946 (Ind. Ct. App. 1996) (rejecting wife's argument that "the only way in which a trial court can fairly compensate a party for the waste or misuse is to 'restore the dissipated asset to the marital estate'" (quoting the wife's brief); trial court's award was not erroneous merely because its deviation from equality was greater than the amount dissipated).
The above cases reach the correct result. If the law of burglary merely required a captured thief to return the stolen property, and did not impose a penalty upon him, the result would be an increase in the frequency of burglary; the worst case scenario following any attempted burglary would be restoration of the status quo ante, so that burglary would be essentially risk-free. For exactly the same reason, it is important to impose a penalty upon spouses who are caught in the course of an intentional and malicious effort to steal marital property, beyond restoration of the status quo ante, in order to ensure that dissipation is not a risk-free activity.
But the law of dissipation is complicated, and there are many ways in which a spouse can dissipate property unintentionally. In particular, the fact that a court deems an expenditure of marital funds to be improper in hindsight does not necessarily mean that the expenditure was made with evil intent. Where evil intent is absent, the courts have generally refused to make a penalizing award. See Hanaway v. Hanaway, 208 Mich. App. 278, 527 N.W.2d 792 (1995) (declining to apply Sands where no fraudulent intent was present); In re Marriage of Gerhart, 318 Mont. 94, 98, 78 P.3d 1219 (2003) (trial court did not err by accepting husband's explanation that failure to disclose stock plan was inadvertent).
If a transfer of marital property is rescinded by the court for fraud upon a third party, the property returns to the marital estate. If the nontransferring spouse consented to the transfer, which was the fact situation in Bernstein, the parties are equally guilty, and it seems reasonable to ignore their misconduct. Indeed, the wife in Bernstein positively "encouraged" the transfer. 795 N.Y.S.2d at 735. For other cases finding equal guilt on the facts, see In re Marriage of Dunseth, 260 Ill. App. 3d 816, 633 N.E.2d 82 (1994) (wife was aware of husband's failure to file, and benefited from an excessive lifestyle permitted by nonpayment of taxes); and Whitehead v. Whitehead, 836 P.2d 814 (Utah Ct. App. 1993) (dividing tax liens between parties; husband had filed improper return, but wife knew of the improprieties and both parties jointly benefited from the illegal tax savings).
The hardest cases are those in which property was transferred to defraud a third party, and the nontransferring spouse did not consent to the conveyance. Authority exists holding that the transferring spouse in this situation should receive no share of the asset:
The trial court should have denied equitable distribution of the marital residence to the husband under the "clean hands" doctrine since Domestic Relations Law 236(B)(5)(d) requires that the court do equity by considering "any other factor which the court shall expressly find to be just and proper". This doctrine precludes equitable distribution of the marital residence because the husband testified that on the advice of a "lawyer friend", he transferred the marital residence to the wife in 1983, in order to protect the property from his judgment creditors[.]
Bullaro v. Bullaro, 231 A.D.2d 666, 648 N.Y.S.2d 46, 46 (1996).
The trial court properly denied equitable distributive relief to the defendant husband under the clean hands doctrine, since Domestic Relations Law 236(B)(5)(d)(13) requires the court to do equity by considering "any other factor which the court shall expressly find to be just and proper" (cf., Scheinkman, Practice Commentary, McKinney Cons. Laws of N.Y., Book 14, Domestic Relations Law, C236B:14, at 236). That doctrine serves as a disability to the defendant husband because he admitted that in 1977 he had transferred the marital residence into the wife's sole ownership in order to avoid his creditors' claims to that residence. Furthermore, he avoided filing for bankruptcy until 1979 so that his creditors could not seek to have the transfer set aside. Clearly, his conduct with respect to the marital residence was immoral and wrongful and the trial court properly refused to permit the defendant husband to share in this asset as a matter of public policy in order to protect the integrity of the court.
Langdon v. Langdon, 138 A.D.2d 358, 525 N.Y.S.2d 649, 649-50 (1988); see also Sheridan v. Sheridan, 247 N.J. Super. 552, 589 A.2d 1067 (Ch. Div. 1990) (refusing to divide funds allegedly acquired from illegal activity).
The result reached in the above cases is harsh and unjustified. When the transfer at issue is made for the purpose of defrauding a third party, the third party has the right to sue the transferring spouse and recover appropriate damages. The transferring spouse therefore already faces significant potential liability. By definition, the defrauded party's cause of action gives that party fair and sufficient compensation for any injury inflicted by the transfer. To impose an additional penalty upon the transferring spouse in the divorce action is to impose an unfair double liability. If two transferors commit the exact same misconduct imposing the same harm upon identical third parties, and only one is engaged in divorce proceedings, that transferor will end up with substantially more liability, even though the acts of misconduct and the resulting damage are identical. There is no reasonable basis for providing that additional damages must be paid by the transferor who is engaged in divorce proceedings.
In addition, the result of Bullaro and Langdon is to increase the recovery of the nontransferring spouse, who is by definition not involved in the fraudulent transfer. (If the nontransferring spouse were involved, no relief would be granted in the divorce case. E.g., Bernstein.) Granted that a double recovery is appropriate, however, why should the additional recovery go to the nontransferring spouse? Bullaro and Langdon award an unfair double recovery to a claimant who has suffered no actual injury from the fraudulent transaction.
It is certainly appropriate, of course, that the transferring spouse hold the nontransferring spouse harmless from any liability arising from the misconduct. The courts have not hesitated to hold that criminal and civil penalties of all sorts are the sole responsibility of a spouse who unilaterally incurred them. See Killough v. Killough, 72 Ark. App. 62, 32 S.W.3d 57 (2000) ( interest and penalty component of tax obligation); In re Marriage of Hageshenas, 234 Ill. App. 3d 178, 600 N.E.2d 437 (1992) (liability for husband's breach of fiduciary duty in small business); Tambone v. Tambone, 162 S.W.3d 1, 2 (Mo. Ct. App. 2004) ($500 penalty imposed against husband by divorce court for wrongfully increasing balance on line of credit against marital home; "sanctions imposed against one party should not be attributable against the party who was harmed"); Clark v. Clark, 324 N.J. Super. 587, 737 A.2d 189 (Ch. Div. 1999) (state-required insurance surcharge after conviction for driving while intoxicated). But no basis exists for increasing the nontransferor's recovery in the divorce case, solely because of misconduct committed by the transferor against a third party, who is perfectly capable of enforcing his or her rights if any actual injury was inflicted by the transfer.
The stated basis for Bullaro and Langdon is that the division of illegally acquired property harms the "integrity" of the court. This basis is questionable. Assume that a spouse obtains $1 million in cash from operating an illegal and immoral business. Failure to divide the $1 million will not advance any policy against illegal activity. On the contrary, failure to divide the $1 million will defeat the policy against illegal activity, by allowing the spouse who committed the misconduct to retain it. Nothing is gained by an across-the-board refusal to divide funds which are actually present before the court. In many situations, the net effect of such refusal is to reward illegal conduct.
The situation is not materially different if the $1 million is awarded entirely to the innocent spouse. It is likely that some of the victims of the illegal enterprise will discover that the husband is responsible for their loss, and will bring civil actions against him to recover damages. If the $1 million is awarded to the innocent spouse, the victims' civil actions are likely to be frustrated by the fact that the husband is no longer able to pay an award of $1 million in damages. The just result is clearly to keep the $1 million available to pay compensation to the victims, but this result cannot be accomplished if the funds are awarded entirely to the innocent spouse.
Another problem with the Bullaro/Langdon rationale is that it is too easy to find misconduct when none actually exists. Under those cases, divorcing spouses have every rationale to accuse one another of criminal misconduct. If some technically criminal act can be found, the divorce court then imposes an arbitrary penalty. At no point does the court consider the interests of the victims, who may not exist or who may not be sufficiently injured to make the misconduct at issue meaningful. The effect is sometimes to encourage witch hunts for relatively minor acts of misconduct.
A good example is the practice of some physicians of transferring assets to family members, in order to protect themselves from potential malpractice judgments. If a malpractice judgment is actually issued in an amount which exceeds the physician's insurance coverage, and a malpractice plaintiff actually seeks to reach the physician's assets to satisfy a judgment, then these conveyances are improper and those who make them should be penalized. But it is not right to penalize a transferor for making a fraudulent conveyance without a victim. If no malpractice plaintiff actually exists, there is no victim and no significant misconduct. To award one spouse thousands of dollars of additional marital property, merely because the other spouse committed conduct which might have defrauded a judgment creditor who does not exist, seeking damages for malpractice which never occurred, is fundamentally unjust.
There is admittedly some utility in encouraging physicians not to make fraudulent conveyances. But most of these conveyances are not made with evil intent. An unreasonable fear of malpractice liability pervades the modern medical community, and some neutral financial experts are advising physicians to conceal assets with a frequency way out of proportion to the actual likelihood of malpractice liability beyond policy limits. A physician who accepts ill-considered financial advice is not in the same position as one who deliberately hides assets to avoid clear liability to a known plaintiff with an existing and valid claim.
Moreover, if discouraging fraudulent conveyances is good policy, it is good policy regardless of whether the physician-transferor is engaged in divorce proceedings. If fraudulent conveyances by physicians are actually inflicting harm upon malpractice plaintiffs and the author finds little hard evidence that this is the case then the law should take measures to penalize all physicians who make such conveyances, and not merely those who are unfortunate enough to be engaged in divorce proceedings. Even if the remedy is reasonable, it is being applied arbitrarily to a small subset (divorce litigants) of the physicians who actually make such transfers.
The best policy is to ignore illegal activity against third parties entirely when dividing marital property. For example, in the course of holding that marital funds obtained through tax evasion were marital property, another New York court held:
Viewing marriage as an economic partnership, we are in agreement with the proposition that spouses should share losses as well as profits, liabilities as well as assets incurred in the pursuit of marital wealth. Upon settling the accounts of the spouses, it should make no difference that wealth was acquired through unlawful means where, as here, the innocent spouse benefits therefrom. Since most, if not all, of the cash generated by the husband prior to the commencement of the action through his tax evasion scheme was apparently used to purchase and renovate 990 Fifth Avenue, and is thus reflected in the valuation assigned to that property, the wife should share in the financial liability arising out of the crime.
Capasso v. Capasso, 129 A.D.2d 267, 517 N.Y.S.2d 952, 968 (1987). Under Capasso, public policies involving illegally obtained funds become relevant only after the guilty spouse is actually found liable in criminal or civil proceedings. "Of course, it hardly need be said that the wife should not have to share in the $500,000 fine to which the husband was sentenced. Nor should she have to share in any civil fraud or other penalties imposed by IRS on account of the acts charged in the indictment." 517 N.Y.S.2d at 968. By limiting policy concerns involving illegal behavior to cases in which misconduct is proven in an action brought by the actual victim, the court avoided the risks inherent in allowing the innocent spouse to benefit from the guilty spouse's illegal activity.
A Massachusetts court made similar comments in the course of holding that all illegal gambling losses are not necessarily misconduct as a matter of law:
"Conduct" that has harmed the marriage or the marital estate may be viewed negatively, and considered as a factor that would diminish that spouse's equitable share of marital property. However, it is conduct having an adverse impact on the marriage or the marital estate, not simply conduct that is in some other sense considered "good" or "bad," that is to be weighed. An equitable division of marital property is intended to effect fairness between the parties in light of all of the circumstances, not to punish "bad" behavior or enforce the criminal laws. See Putnam v. Putnam, 5 Mass.App.Ct. 10, 15-16, 358 N.E.2d 837 (1977) (order transferring property may not be justified "purely on the basis of the blameworthy conduct of one of the spouses"). See also Davisson v. Davisson, 12 Mass.App.Ct. 420, 424, 425 N.E.2d 762 (1981) ("matters such as custody support and alimony are not affected by . . . the relative moral rectitude of the spouses"). Thus, the fact that a spouse's "conduct" during the marriage included unlawful conduct, and that the marital estate is less valuable as a result of that unlawful conduct, is but one circumstance, not necessarily determinative in itself, for a judge to consider in equitably distributing property pursuant to 34. See Jones v. Jones, 942 P.2d 1133, 1140 (Alaska 1997) (illegal nature of husband's gambling "is not of central importance" to determination whether his gambling was "an unreasonable depletion of marital assets").
Kittredge v. Kittredge, 441 Mass. 28, 803 N.E.2d 306, 314-15 (2004) (footnotes omitted). The court added in a footnote:
For example, a spouse who is a scofflaw with respect to parking and traffic restrictions may, over the course of a long marriage, incur a large total of fines and expenses the "unlawful" nature of that spouse's driving habits does not compel the judge to tally up those fines and expenses and treat them as dissipation. A spouse's failure to make timely payment of taxes, improper disposal of hazardous waste, running a red light and striking another vehicle, or failure to carry workers' compensation insurance for his or her employees would all be examples of "unlawful" conduct that could result in significant fines, civil judgments, and legal fees. If all wrongful or unlawful conduct by a spouse that resulted in additional expenditures had to be treated as dissipation of marital assets, determinations of the equitable division of marital property would routinely be bogged down in uncovering and quantifying the financial ramifications of prior misconduct committed by either spouse.
803 N.E.2d at 315 n.12.
To similar effect is a Maryland decision in which the husband claimed that inherited assets should be treated as separate property because the wife fraudulently omitted them from her mother's estate tax return:
Appellant argues that because appellee failed to include some items on her mother's estate tax return, she should be precluded from considering these items to be nonmarital property. We shall quickly dispose of this argument as we find it to be wholly without merit.
Appellee testified below that she believed that the items did not have to be listed on the estate tax return. She thought that she had done the right thing, but stated that she would correct it if she had made a mistake. . . .
Given the evidence before it, the trial court clearly was justified in finding that these assets indeed were inherited property. We reject appellant's argument that the rules of equity or estoppel should preclude these assets from being treated as nonmarital property. Appellant has presented no law that suggests that a failure to list property on a tax return destroys the inherited status of the property.
Merriken v. Merriken, 87 Md. App. 522, 590 A.2d 566, 577 (1991).
In short, the law already imposes sufficient criminal and civil penalties upon spouses who commit misconduct against third persons. Awarding illegally acquired property to the innocent spouse does not help the victims of such activity. On the contrary, it may hurt them by making the proceeds of illegal activity unavailable to pay restitution. Such a division may hurt the guilty spouse, but the guilty spouse remains subject to the normal criminal and civil remedies available to the victims. An award of damages to the innocent spouse is therefore an unfair imposition of double liability. Finally, even if double liability is for some reason deemed appropriate, it is arbitrary to impose such liability only upon guilty persons who are married and engaged in divorce proceedings, and not upon guilty persons who are unmarried or married but not engaged in divorce proceedings. In dividing marital property, the divorce courts should leave deterrence of misconduct against third parties to the existing provisions of criminal and civil law adopted for that express purpose.
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