Opinion ID: 152985
Heading Depth: 2
Heading Rank: 2

Heading: The Preliminary Injunctions

Text: The SEC and CFTC proceed against Schaberg as a relief defendant. A relief defendant is a person who holds the subject matter of the litigation in a subordinate or possessory capacity as to which there is no dispute. SEC v. Colello, 139 F.3d 674, 676 (9th Cir.1998), quoting SEC v. Cherif, 933 F.2d 403, 414 (7th Cir.1991). Such a person may be joined in a securities enforcement action to aid the recovery of relief, provided she has no ownership interest in the property which is the subject of litigation. SEC v. George, 426 F.3d 786, 798 (6th Cir.2005) (internal quotation marks omitted); see also SEC v. Cavanagh, 445 F.3d 105, 109 n. 7 (2d Cir.2006)( Cavanagh II ); Cherif, 933 F.2d at 414. District courts have the power to order disgorgement from a relief defendant upon a finding that she (1) is in possession of ill-gotten funds and (2) lacks a legitimate claim to those funds. SEC v. Cavanagh, 155 F.3d 129, 136 (2d Cir.1998) ( Cavanagh I ). To obtain a preliminary injunction freezing the assets of such a relief defendant, the agencies must demonstrate only that they are likely ultimately to succeed in disgorging the frozen funds. Id.; see also SEC v. Unifund SAL, 910 F.2d 1028, 1041 (2d Cir.1990) (holding that the SEC need not show the likelihood of a recurring violation of securities law to obtain an injunction freezing the assets of a named defendant, since such an injunction aims only to preserve the SEC's opportunity to collect funds.) We review a grant of a preliminary injunction freezing assets for abuse of discretion. Cavanagh I, 155 F.3d at 132. A district court necessarily abuses its discretion if it applies legal standards incorrectly or relies upon clearly erroneous findings of fact, or proceeds on the basis of an erroneous view of the applicable law. Register.com, Inc. v. Verio, Inc., 356 F.3d 393, 398 (2d Cir.2004) (internal quotation marks, citations and brackets omitted). Schaberg contends primarily that the district court erred in determining as a matter of law that she lacked a legitimate claim to the frozen funds, and therefore that an injunction was authorized under Cavanagh I. [4] She claims instead that she acquired her assets pursuant to the separation agreement she executed with Walsh in their divorce proceedings, and that by executing this agreement she became a good faith purchaser for value of the assets. Therefore, she asserts, she has a legitimate claim and her assets are not subject to disgorgement in the action against her ex-husband. We agree with Schaberg that if she received her assets only when they were transferred to her pursuant to the separation agreement and if she is a good faith purchaser for value, then her assets are immune from disgorgement. District courts may only require disgorgement of the assets of a relief defendant upon a finding that she lacks a legitimate claim. See Cavanagh I, 155 F.3d at 136; accord Janvey v. Adams, 588 F.3d 831, 834 & 835 n. 2 (5th Cir.2009); SEC v. Ross, 504 F.3d 1130, 1144 (9th Cir.2007); CFTC v. Kimberlynn Creek Ranch, Inc., 276 F.3d 187, 191-92 (4th Cir.2002); Cherif, 933 F.2d at 414 n. 11. While we have not developed explicit guidelines for what qualifies as a legitimate claim, we have held that the receipt of property as a gift, without the payment of consideration, does not create a legitimate claim sufficient to immunize the property from disgorgement. See Cavanagh I, 155 F.3d at 137; see also George, 426 F.3d at 798 (holding that a relief defendant must disgorge a diamond ring given to her as a gift because the money used to buy it was obtained through fraud). While we have not directly addressed the issue, our sister courts of appeal have held that relief defendants who have provided some form of valuable consideration in good faith in return for proceeds of fraud are beyond the reach of the district court's disgorgement remedy. See Janvey, 588 F.3d at 834-35 (holding that creditors whose loans were repaid by defendant in SEC enforcement action had sufficient legitimate ownership of the funds so as to preclude being treated as relief defendants); [5] Kimberlynn Creek Ranch, 276 F.3d at 192 ([R]eceipt of funds as payment for services rendered to an employer constitutes one type of ownership interest that would preclude proceeding against the holder of the funds as a [relief] defendant.). On this basis, we conclude that if Schaberg truly is a good faith purchaser for value of the assets in her possessiona question of New York state law, see Butner v. United States, 440 U.S. 48, 55, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979) (As a general rule, [p]roperty interests are created and defined by state law.)her assets would not be subject to disgorgement in a proceeding against her former husband. Schaberg's argument that she holds her assets as a good faith purchaser for value proceeds in two steps: first, she argues that the district court erred in focusing its analysis on transfers of investor funds to her checking accounts over the course of her marriage. These transfers, she contends, were not to her, but rather to her and Walsh together, and the money, even after the transfers, was not her individual property, but rather part of the marital estate. Schaberg asserts that this money was transferred to her only by the separation agreement she executed with Walsh. Second, Schaberg contends that because she relinquished valuable claims to the Walsh marital estate in this negotiated and arms-length separation agreement, she holds whatever she derived from the agreement as a good faith purchaser for value. Evaluating Schaberg's argument involves addressing two substantial questions of New York state law.
The first prong of Schaberg's argument is that the district court erred in concluding that she received money separately while she was married, since this money was jointly held marital property. As she notes, New York Domestic Relations Law (DRL) § 236 defines marital property as all property acquired by either or both spouses during the marriage and before the execution of a separation agreement or the commencement of a matrimonial action, regardless of the form in which title is held. See Musso v. Ostashko, 468 F.3d 99, 105 (2d Cir.2006) (explaining that, since marriage is an economic partnership, New York law provides that all its proceeds should be divided equitably upon dissolution). Although the money was held in an account in her name, she maintains, it was heldand usedfor the benefit of the marital estate, to pay expenses that were not hers alone, but of the marital unit. Accordingly, she asserts that it was only when pursuant to the execution of a separation agreement with Walsh in 2006 she was permitted to retain the remaining funds in her checking accounts, that the funds were transferred from the marital estate, a transfer which could serve to give rise to a legitimate claim. [6] In opposition, the agencies contend that the monies misdirected from investor accounts to Schaberg's checking accounts never became marital property, and accordingly could not be transferred from the marital estate to Schaberg by means of the separation agreement. They argue that DRL § 236 implicitly extends the marital estate only to property obtained lawfully. If the proceeds of the fraud never became part of the marital estate, Schaberg could not have acquired them in her separation agreement, and her only claim to ownership would be based on receipt of the funds while she was married. Under Cavanagh I, this receipt of the funds without consideration would be insufficient to defeat the agencies' disgorgement claim. We agree with Schaberg that a separation agreement can serve as a conveyance from the marital estate to divorcing individuals within the meaning of New York Real Property Law § 290(3), which defines conveyance to include every written instrument, by which any estate or interest in real property is created. See FDIC v. Malin, 802 F.2d 12, 17 (2d Cir. 1986). Accordingly, if the funds at issue were part of the marital estate, her agreement with Walsh did create an interest in the funds for her individually. See id. We are unable to determine, however, whether DRL § 236 defines marital property to include the proceeds of fraud. On the one hand, the plain language of the statute suggests that marital property should include such assets; Section 236(B)(1)(c) defines marital property as all property acquired by either or both spouses during the marriage and before... the commencement of a matrimonial action, regardless of the form in which title is held. No New York authority supports the agencies' contention that the word acquired implicitly includes a requirement of lawfulness. Furthermore, New York courts are clear that the term marital property is to be broadly construed, see Price v. Price, 69 N.Y.2d 8, 511 N.Y.S.2d 219, 222, 503 N.E.2d 684, 687 (1986), and that the law favors the inclusion of property within the marital estate, see Burns v. Burns, 84 N.Y.2d 369, 618 N.Y.S.2d 761, 763, 643 N.E.2d 80, 82 (N.Y.1994). [7] On the other hand, a lower court decision in New York suggests that the New York Court of Appeals might not extend § 236's definition of marital property to include any assets misappropriated from investor funds over the course of the Walshes' marriage. In a divorce proceeding between a couple that jointly operated an unlawful loansharking enterprise, a New York Supreme Court held that the proceeds of an illegal business are not marital property. LaPaglia v. LaPaglia, 134 Misc.2d 1030, 514 N.Y.S.2d 317, 318 (Sup.Ct. Kings Cnty.1987). The court reasoned that, as a matter of public policy, the fruits of a criminal enterprise are not subject to equitable distribution. Id. Furthermore, we believe that since New York has no binding authority on this question, the New York Court of Appeals may be swayed by persuasive authority from other states. The Supreme Court of Colorado has held that the marital estate does not include proceeds of fraud. See In re Marriage of Allen, 724 P.2d 651 (Colo. 1986). In Allen, an employer sued its employee to recover embezzled funds and then sued the employee's ex-wife to recover that portion of the embezzled funds that she received pursuant to a property settlement agreement executed in their divorce. The ex-wife argued that she was entitled to keep the assets of the fraud, because she was a good faith purchaser for value by virtue of the settlement agreement. The court, however, rejected this argument, finding that [t]he property was never truly a marital asset and should never have been subject to the Allens' property division negotiations. Id. at 659. The court concluded that there was no reason to enhance a spouse's interest in misappropriated property merely because the marriage is later dissolved. Id. Similarly, a New Jersey court has held that illegally obtained funds were not properly subject to equitable division. See Sheridan v. Sheridan, 247 N.J.Super. 552, 589 A.2d 1067, 1071 (Ch. Div.1990). Since the New York Court of Appeals has not been presented with a case similar to Allen, we are uncertain how it would address the issue of whether the proceeds of fraud can be considered marital property. Accordingly, we certify this question to that Court: Does marital property within the meaning of New York Domestic Relations Law § 236 include the proceeds of fraud?
Even if Schaberg's separation agreement served to transfer the marital assets to her individual ownership, our analysis still requires a second step: we must determine whether this transfer made Schaberg a good faith purchaser for value according to the terms of New York Debtor and Creditor Law (DCL) § 278. This inquiry also presents a substantial issue of New York state law, and thus we certify a second question to the New York Court of Appeals. DCL § 278 provides that a creditor whose claim has matured may have a conveyance set aside against any person, other than a good faith purchaser for value, defined as a purchaser for fair consideration without knowledge of the fraud. Schaberg contends that she meets this definition because the assets were transferred to her without notice of their source, and she paid fair consideration, which is defined by DCL § 272 as given when in exchange for ... property, ... as a fair equivalent therefor, and in good faith, property is conveyed or an antecedent debt is satisfied. Schaberg argues that she paid fair consideration because, in return for the receipt of her property in the agreement, she agreed that she would never ... seek through court proceedings or otherwise a distributive award or an award of equitable distribution with respect to any other property acquired by her husband over the course of their marriage. [8] Schaberg relies upon FDIC v. Malin, 802 F.2d 12 (2d Cir.1986). In Malin, we held that a judgment creditor could not set aside as fraudulent under DCL § 278 a conveyance of a house from a husband, Leonard Malin, to his wife, Phyllis Malin, in a separation agreement. We determined that Phyllis's interest in the house was protected, since it was transferred to her before the date of the creditor's judgment lien, she had no notice of the fraud, and she paid fair consideration for the property according to the terms of DCL § 272. Id. at 18-19. Our determination that Phyllis paid fair consideration turned on the findings that the separation agreement represented a bargained for exchange in which the wife relinquished rights and remedies otherwise conferred by law, thereby freeing her husband from his antecedent obligation to provide maintenance and child support. Id. at 19-20. Schaberg contends that her relinquishment of any further claims on the marital estate in the bargained-for exchange effected by her separation agreement is indistinguishable from Phyllis Malin's, and thus that Malin provides binding precedent holding that she is a good faith purchaser for value of the assets she possesses pursuant to the separation agreement. Schaberg is wrong, however, in her assertion that it is impossible to distinguish her relinquishment of claims to future distributions of her marital property from the valuable consideration paid by Phyllis Malin. In Malin, it was the transfer of property from Leonard to Phyllis that the plaintiff sought to rescind as fraudulent, since, it was contended, that transfer was effected so that the house would not be subject to a claim by the FDIC as a creditor. No party in Malin contended that the house itself represented the proceeds of fraud. Rather, in that case, both the property that was transferred and the property to which Phyllis Malin relinquished her future claims was property in which the couple indisputably already had a legitimate interest. By contrast, in her separation from Walsh, Schaberg relinquished future claims to an equitable distribution of marital property thatit is allegedconsisted almost entirely of the proceeds of fraud. Schaberg did not have a legitimate claim to the property while she was married to Walsh, and the issue in contention is whether the transfer to her individually served to create a legitimate interest where none existed before. We are uncertain whether, under DCL § 272, a spouse pays fair consideration by relinquishing in good faith claims to funds in which she in fact has no legitimate interest. On the one hand, New York law holds that the focus of the good faith inquiry is on the subjective intent of the transferee. In re Sharp Int'l Corp., 403 F.3d 43, 54 n. 4 (2d Cir.2005); see also Morse v. Howard Park Corp., 50 Misc.2d 834, 272 N.Y.S.2d 16, 22-26 (Sup.Ct. Queens Cnty. 1966). Since there is no reason to question Schaberg's good faith in relinquishing her claim to what she believed was a legitimate interest in a substantial fortune, this inquiry strengthens Schaberg's argument that she is a good faith purchaser for value under DCL § 272. On the other hand, DCL § 272 requires that in order to attain the status of good faith purchaser for value the transferee must confer to the transferor a fair equivalent, a term that implies that the transferee must convey property in which she has a legitimate interest. A New York court has held that a fair equivalent is not given when a wife relinquishes a claim to maintenance and child support of only minimal economic value. Century Ctr., Ltd. v. Davis, 100 A.D.2d 564, 473 N.Y.S.2d 492, 493-94 (2d Dep't 1984). We have similarly held that the surrender of contingent future claims fails to satisfy the statute's requirement that the transferee confer a fair equivalent. HBE Leasing Corp. v. Frank, 61 F.3d 1054, 1059-60 (2d Cir.1995) (holding that the relinquishment of future claims to marital property in a prenuptial agreement is insufficient to serve as fair consideration under DCL § 272, since before the marriage one spouse has only a contingent right to support from the other). Both of these instances are analogous to the case at bar, but in neither case are the situations similar enough to provide us with a rule of decision. We have discovered no New York authority that addresses whether a fair equivalent is paid when a transferee in good faith relinquishes claims to property of substantial value, but these claims are later determined to be illegitimate. Accordingly, we certify a second question to the New York Court of Appeals: Does a spouse pay fair consideration according to the terms of New York Debtor and Creditor Law § 272 when she relinquishes in good faith a claim to the proceeds of fraud?