Marital Property and the Nature of Law

Yesterday I read Batlan v. Bledsoe (In re Bledsoe) and afterward couldn’t help but spend a long time thinking about marital property and the nature of law. Bledsoe is a bankrtupcy case, but it relates to marital property law in Oregon, which is not a community property state (as my state of California is). That may or may not be important.

Before I get to the part that really made me think, I should probably explain some of the basic legal doctrines in play, in case you are interested enough to be reading this, but not interested enough to enroll in a law school.

First, divorce. People generally accumulate property. They also like to marry each other. So no one should be surprised that people frequently marry each other and continue accumulating property. But everybody knows that people also get divorced, which generally means they want to go their separate ways and take all their accumulated stuff. So, naturally, the stuff has to be divided.

In community property states, like California, property accumulated by the spouses during marriage, which we call the “community estate,” with a few exceptions, must be divided equally between them when they divorce—also with a few exceptions. In other states, however, like Oregon, the property must be divided equitably, which is supposed to provide more wiggle room for judges presiding over divorce cases. There are other methods of division, depending on the state and the history of its marital property laws, but the important thing to remember is that when people divorce, their stuff has to go somewhere.

Now, bankruptcy. Under the Bankruptcy Code, which is a federal law, not a state law, when a person files a bankruptcy petition, a trustee is charged with gathering up the “bankruptcy estate.” The bankruptcy estate includes everything the debtor (the person who filed the petition) owns, with some exceptions and exemptions. In cases under chapter 7 of the Bankruptcy Code, also known as “liquidation” cases, a big part of the trustee’s job is to sell everything in the bankruptcy estate and use that money to pay off creditors of the debtor. The more stuff the trustee can sell, the more the trustee gets paid, which means the trustee has an incentive to scoop up as much property into that bankruptcy estate as possible.

Congress has given bankruptcy trustees a lot of power. For example, the trustee can look back through the period covering two years before the bankruptcy petition is filed and root out “fraudulent transfers.”  There are a couple ways to make a fraudulent transfer: by transfering property to another person with the intent to “hinder, delay, or defraud” a creditor, or by transfering property for less than a “reasonably equivalent value.” If the debtor made such a transfer while insolvent, or the transfer made the debtor insolvent, or the debtor intended or expected to incur debts beyond his or her ability to pay, and in a couple other circumstances, the trustee can “avoid” that transfer by filing a lawsuit against the person who received the property and demanding return of the property, so it can be included in the bankruptcy estate. The idea is that we don’t want people going out and transferring all their favorite assets to Cousin Joe, filing for bankruptcy to have their debts wiped out, and then getting their stuff back from Cousin Joe and going along their merry way while their creditors get shafted.

The trustee can also avoid transfers that are “voidable under applicable law,” which includes transfers that would be void under state law.

With all that in mind, here is what happened in Bledsoe. Husband and wife lived in Oregon. Husband filed for divorce. Wife refused to participate in the proceeding, so the court could not have “a meaningful trial” to determine how to make an “equitable division” of their property. In the procedural equivalent of throwing up its hands in frustration with an intransigent litigant, the Oregon court just decided to treat wife like a defaulting defendant (i.e., one that doesn’t bother to show up at all) and enter a default judgment of dissolution. Husband received a lot of property, but wife received very little. The trustee in the later bankruptcy action said that husband received stuff valued at $93,737, while wife received stuff valued at only $788. (Note: This is why it is never a good idea to ignore court papers or fail to participate in a lawsuit in which you are a party, including a divorce case.)

Not surprisingly, since the vast majority of bankrupcty petitions filed by ordinary people are the result of being decimated by a divorce or unexpected and uninsured medical expenses, about a year after the divorce judgment, wife filed for bankruptcy.

Maybe you see what’s coming. The trustee, trying to beef up wife’s bankruptcy estate, looked back over the past two years and saw this divorce judgment. Poor husband, who was probably glad to escape from a non-starting divorce case with a sizable chunk of assets, suddenly found himself at the defendant-y end of a lawsuit filed by the trustee. The trustee made two arguments. First, either the hugely unequal judgment violated the Uniform Fraudulent Transfer Act in Oregon law, or it was a fraudulent transfer because wife did not receive “reasonably equivalent value” for her property claims in the divorce case. (He did not argue that wife intentionally obtained an unfair judgment with the purpose of hindering, delaying, or defrauding her creditors.)

The bankruptcy court disagreed, so the trustee started up the appellate ladder by seeking review from the federal district court. It also disagreed with the trustee, so he took his argument to the 9th Circuit Court of Appeals.

The 9th Circuit affirmed the lower courts in a short, well-written opinion. First, the divorce judgment cannot be attacked under state law because Oregon requires a showing of “extrinsic fraud” to attack a judgment, even when the attack is based on the Uniform Fraudulent Transfer Act. In the unhelpful words of the Oregon Supreme Court, quoted by the 9th Circuit, “Extrinsic fraud consists of collateral acts not involved in the fact finder’s consideration of the merits of the case.” In real life, extrinsic fraud means doing something dishonest to keep another person from asserting his or her rights in court. Nobody in Bledsoe believed that husband did anything like that in the divorce case, so this argument went nowhere.

Second, the 9th Circuit held that an unequal division of property in a divorce is not a fraudulent conveyance so long as it follows “a regularly conducted contested proceeding”—which includes a default judgment entered in a divorce where there is “no suggestion of collusion, sandbagging, or indeed any irregularity in the dissolution proceedings.” In other words, the federal bankruptcy court does not get to swoop down from on high and reexamine the judgments of a state divorce court.

That’s all well and good, but you may be thinking what Justice Diarmuid O’Scannlain was thinking: Wait, how is a division of property in a divorce a transfer at all? In his concurring opinion agreeing with the result but not the reasoning of the majority, he wrote:

In this case, the debtor, [wife], received an award from the Oregon court judgment that dissolved her marriage to [husband]. That was the “property received.” But what was the property transferred, and who owned it before? In a sense, the married couple once owned the entirety of the marital res [which is just Latin for "thing" or "object"—"the marital res" is "the marriage," sort of the way a corporation is a "legal person," but in a property sense instead of a "person" sense], over which [wife] no longer had any claim; but, of course, the married couple no longer existed after the divorce. Thus, to speak of a transfer fits uncomfortably with the reality of what happens in a divorce proceeding.

I believe it makse more sense to say that both spouses owned the property before dissolution, but that, because they were getting divorced, the dissolution judgment assigned the assets of the marital res to each spouse individually as the state court found to be equitable. That is to say, a dissolution judgment determines, for the first time, what each spouse owns on an individual bases. Therefore, the debtor ex-spouse does not transfer or receive anything, because there is no transfer for fraudulent conveyance purposes. A divorce court simply determines that, in equity, each ex-spouse owns a certain share of the marital res.

In footnote, O’Scannlain also points out that, under Oregon law, a judgment in a marital dissolution case is “a partitioning of jointly owned property.” “In other words,” he continues, “the married spouses jointly owned the whole, but after divorce individually own only a part. . . . Because the partition is equitable and therefore not always 50/50 . . . it is unclear ex ante [Latin for "beforehand"] how much each spouse owns individually. The dissolution judgment answers that question.”

That got me thinking about California law. We have a community property regime, which Oregon does not, but do the property divisions in our divorce judgments follow the same or a similar theory? Here is how the California Court of Appeal for the Fourth Appellate District explained our system in In re Marriage of Hillerman (1980) 109 Cal.App.3d 334:

The interest of each spouse in the assets of the marital community [is] “present, existing and equal” during the continuance of the marriage. Upon dissolution each spouse possesses an equal and absolute right to one-half of the community property. The division of community property by the court merely distributes that which each party already owns by virtue of the marriage relationship.

Same thing? In context, because of the precedent relied on by the majority in Bledsoe, Justice O’Scannlain was concerned with comparing the function of the court in a judgment of dissolution to the function of a foreclosure sale. A foreclosure sale, he points out, has the function of “value discovery,” or determining how much money the property is worth, while a property division in a judgment of dissolution is about ownership, not value. That is probably still true in California, even with our equal-division rule, but it often doesn’t seem like that in practice, when divorce cases often require value determinations and appraisals before the court can make an equal division.

But the problem of spouses’ ownership rights against the marital res or the community estate snaps to the fore when you file a petition for dissolution of marriage in California. As soon as you get that petition served on the opposing party, several “automatic temporary restraining orders” spring into effect, and one of them prevents either party from “transferring income and or concealing or disposing of any property real or personal whether it be community or quasi community or separate property without the other parties written consent or Court order except in the usual course of business or for the necessities of life.” That restraining order makes a lot of sense: we don’t want a sudden free-for-all, with each spouse running around and snatching up assets to keep them from going to the other one.

Aside from the practical value of the order, however, the underlying theory is interesting, too. If both spouses have “present, existing, and equal” interests in the community estate during the marriage, but only by virtue of their being a married couple, then, as Justice O’Scannlain points out, once they separate and cease being a married couple—because even though legal marital status is not terminated until after the judgment is entered, “the marriage” ends on the date of separation—then that community estate is left hanging out there without a clear owner. The former spouses are now outside the marriage, even though they still do not have the legal status of “unmarried individuals,” so their property claims against the community estate become what I suppose might be called “unliquidated claims,” or claims without a specific value. That would seem true even though we require an equal division in California because we don’t typically just divide every individual asset in half. We generally have to determine the value of each asset, then see if we can divvy up the assets equally, sometimes with one person receiving more stuff and then being ordered to make an “equalization payment” to the other spouse to make up for the excess. A spouse may not know from the outset exactly how much he or she will receive in the final division of property. Saying that his or her share wil be “equal” to that of the other party does not mean much.

But then wouldn’t that mean a judgment of dissolution adjudicating those claims and dividing the marital property be a determination not just of ownership but also of value? While Justice O’Scannlain makes a persuasive argument that divorce judgments are about ownership, not value, I am not convinced the theory is bulletproof. (He may not be, either.)

None of this really matters in practice, either for dissolving marriages or for deciding avoidance actions in later bankruptcy proceedings. But the fact that what seems to me like theoretical indeterminacy in the law does not prevent a court like the 9th Circuit coming to what is clearly the right result is, in my view, evidence that “law” does not “go all the way down.” By that I mean that it may be impossible to come up with a consistent, unambiguous set of rules that can be reduced to—or derived from—any universal, underlying principles. We can only do what works. Meanwhile, creative people like the trustee in Bledsoe will always probe the deep waters of legal theory looking for uneven spots to grab hold of and anchor. It’s a fascinating process.