Ponzi Schemes, Settlement Agreements and the Mutual Mistake

The plaintiff ex-husband in Simkin is an attorney at a high-powered New York law firm. His ex-wife holds a high position at a New York university. They were married in 1973, separated in 2001 and divorced in the summer of 2006. Because of the extended length of their marriage, they treated most of their assets as marital assets, to be divided roughly equally. This they thought they had done by dividing up the marital homes, cars and other property between them. However, one of the “assets” the husband received in the deal was an account with Bernard Madoff Investment Securities.

At the time of the parties' agreement, they both believed the Madoff account to be worth $5.4 million. However, in December 2008, Bernard Madoff was arrested for securities fraud and it soon became clear that about $18 billion dollars that individuals, corporations and investment groups thought they held in accounts with his firm did not exist.

Because the Madoff account had gone to the husband, he claimed in Simkin that he had been required to give up good assets worth $2.7 million (half of $5.4 million) in order to get the account in the property settlement. He therefore sought return of an unspecified amount from his ex-wife. In January 2010, Supreme Court, New York County (Saralee Evans, J.), granted the wife's motion to dismiss pursuant to Civil Practice Law & Rules (CPLR) ' 3211. The court, seeing this case as involving an asset that had value at the time of contracting but later lost its value, stated: “Here, the claim of mistake is opaque, stating simply that the account at issue did not exist. There is no assertion, however, that at the time of the agreement the account could not be redeemed for value.” The court concluded that the Simkin case was no different from any other case in which an asset loses value after the divorcing parties settle, and it was compelled to adhere to New York precedent favoring the finality of such agreements. See, e.g., Greenwald v. Greenwald, 164 AD2d 706, 721 (1991), lv denied 78 NY2d 855 (1991) (post-trial depreciation of two investment accounts did not entitle husband to new trial because “post trial changes in value may not be used to reallocate the distribution of marital assets to strike a more equitable balance”).

The Appeal

On appeal, the wife again argued that her ex-husband had taken the risk that the Madoff account would decrease in value after the agreement was signed. She noted that in the parties' contract each of them had acknowledged “that the property he or she is receiving or retaining pursuant to this Article represents a fair and reasonable share of the marital property.” In addition, the plaintiff husband had agreed to release “any and all claims to or upon the property of [defendant] ' whether now owned or hereafter acquired or received, to the end that she shall have free and unrestricted right to dispose of her property now owned or hereafter acquired or received, free from any claim or demand of [plaintiff].”

The husband argued, however, that the parties had entered into their agreement under the burden of a mutual mistake: that they both thought that the plaintiff had an account with the Madoff firm, when in fact no such account ever existed. Although this theory did not fly with the lower court, the appellate court was more sympathetic.

The First Department noted first that, when ruling on motions to dismiss, courts must “afford the pleadings a liberal construction, take the allegations of the complaint as true and provide plaintiff the benefit of every possible inference” (EBC I Inc. v. Goldman, Sachs & Co., 5 NY3d 11, 19 (2005)).” The trial court, however, made a conclusion as to a fact (concerning the assumptions on which the parties relied in dividing their property), deciding the issue in the wife's favor. This was error. Supreme Court also should not have relied on the wife's argument that her ex-husband could have expected the Madoff account to increase in value above the $5.7 million it was allegedly worth at the time the settlement agreement, as his motivations and reasoning were not germane to a motion to dismiss; again, the lower court was required at that point in the proceedings to treat the allegations in the complaint as true.

More to the point, the appellate court determined Supreme Court missed the gist of plaintiff's claim completely: that there was, in fact, no Madoff account in existence, either when the settlement agreement was made or at any time thereafter. However, both parties mistakenly believed that it did exist. Noted the First Department, “[O]n Madoff's own admission there were no accounts within which trades were made on behalf of investors.” Instead, when “investors” sought to withdraw money from their “accounts,” Madoff paid them with money coming in from new investors. The husband here was not simply trying to recoup a loss in the value of an asset that occurred after the agreement was made, he was trying to fix an agreement that was faulty at its inception. This being the case, his suit should have been allowed to go forward.

Another View

Two judges (Karla Moskowitz and Luis A. Gonzalez) dissented, in large part because the parties' agreements appeared to seek a fair distribution of the marital assets, not necessarily an equal distribution. In fact, in only one respect did the agreement speak of equalizing the distribution of any of the couple's assets; that was when it stated that the husband would transfer to his wife's retirement account an additional $368,000 “[t]o equalize the difference in value between the Husband's Retirement Accounts and the Wife's Retirement Accounts” as “the parties have agreed to divide the value of such accounts equally.” Other than that one item, the parties agreed on specific distributions of particular assets. Notably, under the terms of the contract, each party retained title to assets held in his or her name alone. One of these assets, the Madoff account, was held in the husband's name alone during the marriage and was thus his after divorce. The Madoff account was not specifically identified in the contract, any more than were several other assets held by the parties in their separate names. Presumably because the plaintiff husband is the monied spouse and a partner in a presitigeous New York law firm, the dissent seemed incredulous that he was taken advantage of by this method of distribution: “One would think that [the plaintiff] would not have signed an agreement in which he waived equitable distribution if the parties had agreed to divide each particular asset equally. The parties were certainly capable of discussing equal division of specific property. They did so with respect to only one asset, the retirement accounts.” The dissent continued: “In total disregard for clear Court of Appeals precedent, the complaint, under the guise of a 'mistake,' seeks to rewrite the agreement between the parties. [The plaintiff] received exactly what he bargained for, including sole title to a house in Scarsdale. To require [the defendant] to give back any of the $6.25 million would result in a serious windfall to [the plaintiff], who received valuable consideration in exchange for this payment and, notably, does not suggest that he give back half the house or commence spousal support payments.”

Conclusion

Is the Simkin majority right? Richard D. Emery, who represented the ex-wife, thinks not, and says his client plans to appeal. “The point” he said, is, “When is a deal a deal? This clearly is a divorce deal which was a deal in 2006, not to be reopened later on.”

Certainly, the court's decision could open up a can of worms, encouraging other unhappy divorced parties to try to re-open their cases. The ruling is limited to permitting re-litigation only when an asset the parties thought they owned turns out to be illusory, but the situation in Simkin can hardly be an isolated case. The recent economic crisis exposed the prevalence of Ponzi schemes, and certainly other recently divorced couples have been similarly affected ' not to mention those who will be defrauded in future financial transactions. But when is a deal a deal?

On the other hand, although the Simkin plaintiff's plight is not an overly sympathetic one ' he is, after all, a high-powered attorney who received many valuable assets under the parties' settlement agreement ' the importance of the precedent this case could set should not be discounted. Just suppose that the plaintiff were the non-monied spouse, married for over 30 years, who took from the settlement table only a sham investment account. Should the court say, “You got what you bargained for,” and turn the litigant away?

Janice G. Inman is Editor-in-Chief of this newsletter.

During the current economic downturn, many people have unfortunately discovered that they have been the victims of sharp dealers and their Ponzi schemes. That means that some divorced couples and their attorneys now have one more thing to worry about. Now that an asset that went to one party has been found to be valueless, that settlement agreement that seemed so fair three years ago may no longer look so equitable. Can anything be done for the ex-spouse who finds himself stuck with a phantom asset?

In a dismissal of a suit, granted by State Supreme Court last year, the answer to that question was, “No.” However, the Appellate Division, First Department, took the case up and went the other way, finding that a man who took an account managed by Bernard Madoff as part of his share of the marital estate may seek to recover some of the “good” marital assets from his ex-wife. Simkin v. Blank, 3016, NYLJ 1202477009087, at *1 (App. Div., 1st, Decided January 4, 2011) (Gonzalez, P.J., Tom, Andrias, Catterson, Moskowitz, JJ.).

An Agreement

The plaintiff ex-husband in Simkin is an attorney at a high-powered New York law firm. His ex-wife holds a high position at a New York university. They were married in 1973, separated in 2001 and divorced in the summer of 2006. Because of the extended length of their marriage, they treated most of their assets as marital assets, to be divided roughly equally. This they thought they had done by dividing up the marital homes, cars and other property between them. However, one of the “assets” the husband received in the deal was an account with Bernard Madoff Investment Securities.

At the time of the parties' agreement, they both believed the Madoff account to be worth $5.4 million. However, in December 2008, Bernard Madoff was arrested for securities fraud and it soon became clear that about $18 billion dollars that individuals, corporations and investment groups thought they held in accounts with his firm did not exist.

Because the Madoff account had gone to the husband, he claimed in Simkin that he had been required to give up good assets worth $2.7 million (half of $5.4 million) in order to get the account in the property settlement. He therefore sought return of an unspecified amount from his ex-wife. In January 2010, Supreme Court, New York County (Saralee Evans, J.), granted the wife's motion to dismiss pursuant to Civil Practice Law & Rules (CPLR) ' 3211. The court, seeing this case as involving an asset that had value at the time of contracting but later lost its value, stated: “Here, the claim of mistake is opaque, stating simply that the account at issue did not exist. There is no assertion, however, that at the time of the agreement the account could not be redeemed for value.” The court concluded that the Simkin case was no different from any other case in which an asset loses value after the divorcing parties settle, and it was compelled to adhere to New York precedent favoring the finality of such agreements. See, e.g., Greenwald v. Greenwald , 164 AD2d 706, 721 (1991), lv denied 78 NY2d 855 (1991) (post-trial depreciation of two investment accounts did not entitle husband to new trial because “post trial changes in value may not be used to reallocate the distribution of marital assets to strike a more equitable balance”).

The Appeal

On appeal, the wife again argued that her ex-husband had taken the risk that the Madoff account would decrease in value after the agreement was signed. She noted that in the parties' contract each of them had acknowledged “that the property he or she is receiving or retaining pursuant to this Article represents a fair and reasonable share of the marital property.” In addition, the plaintiff husband had agreed to release “any and all claims to or upon the property of [defendant] ' whether now owned or hereafter acquired or received, to the end that she shall have free and unrestricted right to dispose of her property now owned or hereafter acquired or received, free from any claim or demand of [plaintiff].”

The husband argued, however, that the parties had entered into their agreement under the burden of a mutual mistake: that they both thought that the plaintiff had an account with the Madoff firm, when in fact no such account ever existed. Although this theory did not fly with the lower court, the appellate court was more sympathetic.

The First Department noted first that, when ruling on motions to dismiss, courts must “afford the pleadings a liberal construction, take the allegations of the complaint as true and provide plaintiff the benefit of every possible inference” ( EBC I Inc. v. Goldman, Sachs & Co. , 5 NY3d 11, 19 (2005)).” The trial court, however, made a conclusion as to a fact (concerning the assumptions on which the parties relied in dividing their property), deciding the issue in the wife's favor. This was error. Supreme Court also should not have relied on the wife's argument that her ex-husband could have expected the Madoff account to increase in value above the $5.7 million it was allegedly worth at the time the settlement agreement, as his motivations and reasoning were not germane to a motion to dismiss; again, the lower court was required at that point in the proceedings to treat the allegations in the complaint as true.

More to the point, the appellate court determined Supreme Court missed the gist of plaintiff's claim completely: that there was, in fact, no Madoff account in existence, either when the settlement agreement was made or at any time thereafter. However, both parties mistakenly believed that it did exist. Noted the First Department, “[O]n Madoff's own admission there were no accounts within which trades were made on behalf of investors.” Instead, when “investors” sought to withdraw money from their “accounts,” Madoff paid them with money coming in from new investors. The husband here was not simply trying to recoup a loss in the value of an asset that occurred after the agreement was made, he was trying to fix an agreement that was faulty at its inception. This being the case, his suit should have been allowed to go forward.

Another View

Two judges (Karla Moskowitz and Luis A. Gonzalez) dissented, in large part because the parties' agreements appeared to seek a fair distribution of the marital assets, not necessarily an equal distribution. In fact, in only one respect did the agreement speak of equalizing the distribution of any of the couple's assets; that was when it stated that the husband would transfer to his wife's retirement account an additional $368,000 “[t]o equalize the difference in value between the Husband's Retirement Accounts and the Wife's Retirement Accounts” as “the parties have agreed to divide the value of such accounts equally.” Other than that one item, the parties agreed on specific distributions of particular assets. Notably, under the terms of the contract, each party retained title to assets held in his or her name alone. One of these assets, the Madoff account, was held in the husband's name alone during the marriage and was thus his after divorce. The Madoff account was not specifically identified in the contract, any more than were several other assets held by the parties in their separate names. Presumably because the plaintiff husband is the monied spouse and a partner in a presitigeous New York law firm, the dissent seemed incredulous that he was taken advantage of by this method of distribution: “One would think that [the plaintiff] would not have signed an agreement in which he waived equitable distribution if the parties had agreed to divide each particular asset equally. The parties were certainly capable of discussing equal division of specific property. They did so with respect to only one asset, the retirement accounts.” The dissent continued: “In total disregard for clear Court of Appeals precedent, the complaint, under the guise of a 'mistake,' seeks to rewrite the agreement between the parties. [The plaintiff] received exactly what he bargained for, including sole title to a house in Scarsdale. To require [the defendant] to give back any of the $6.25 million would result in a serious windfall to [the plaintiff], who received valuable consideration in exchange for this payment and, notably, does not suggest that he give back half the house or commence spousal support payments.”

Conclusion

Is the Simkin majority right? Richard D. Emery, who represented the ex-wife, thinks not, and says his client plans to appeal. “The point” he said, is, “When is a deal a deal? This clearly is a divorce deal which was a deal in 2006, not to be reopened later on.”

Certainly, the court's decision could open up a can of worms, encouraging other unhappy divorced parties to try to re-open their cases. The ruling is limited to permitting re-litigation only when an asset the parties thought they owned turns out to be illusory, but the situation in Simkin can hardly be an isolated case. The recent economic crisis exposed the prevalence of Ponzi schemes, and certainly other recently divorced couples have been similarly affected ' not to mention those who will be defrauded in future financial transactions. But when is a deal a deal?

On the other hand, although the Simkin plaintiff's plight is not an overly sympathetic one ' he is, after all, a high-powered attorney who received many valuable assets under the parties' settlement agreement ' the importance of the precedent this case could set should not be discounted. Just suppose that the plaintiff were the non-monied spouse, married for over 30 years, who took from the settlement table only a sham investment account. Should the court say, “You got what you bargained for,” and turn the litigant away?

Janice G. Inman is Editor-in-Chief of this newsletter.