Case of the Mistaken (Illusory) Investment
posted by Lawrence Cunningham
Can a spouse rescind a divorce settlement contract if it turns out that the valuation assigned to assets the spouse retained in exchange for a cash payment to the other was inflated due to fraud by a third party?
Several years ago, Husband, a prominent New York real estate attorney at a large firm, and Wife, entered into a contract as part of an uncontested divorce. In the negotiations, the two listed their marital assets, including several homes, and divided them roughly fifty-fifty.
The homes aside, it appeared that the couples’ total assets to split amounted to $13.2 million. The agreement apparently provided that Husband would retain these assets, in their extant form, in exchange for making a cash payment to Wife in the amount of $6.6 million.
It turns out, several years later, that the value of these other assets was overstated by $5.4 million. That portion of the assets are actually worth zero, because they were held in an investment account managed by Bernard Madoff, whose fund turned out to be a Ponzi scheme.
According to the New York Daily News, Husband seeks rescission and reformation of that part of the contract, along with restitution from Wife in the amount of $2.7 million (half the amount of the original valuation of that account). Can he? What grounds are available to do so?
Mutual mistake? That would require concluding that Husband and Wife were both mutually mistaken about a fundamental assumption of the contract, whose risk was neither foreseeable nor allocated by the contract. Is this likely?
It would seem unlikely that a mere change in the market value of appraised property would justify rescission under this doctrine. Suppose that the settlement payment was also based, in part, on the appraised value, at the time of contract formation, of an art collection.
The fact that the art collection probably has declined in value in the several years since contract formation would not provide a basis for rescission under mutual mistake. The relevant basic assumption would be that the art collection existed and was authentic, not that its value would never change.
In contrast, perhaps, in the case of the fraudulent investment account, the assumption is not that its value would never change, but that it existed and was not a mere fraud-induced illusion. Which seems more likely as the basic assumption of the contract?
Unilateral mistake? This would require concluding that Husband was unilaterally mistaken as to the legitimacy of the account that turned out to be fraudulent. Unilateral mistake may be a ground for rescission and reformation when the mistake concerns a matter of computational, mathematical or clerical error, something objectively true or false, as opposed to errors of judgment. Is a mistaken assumption that a fraudulent account is a legitimate one more nearly a clerical error or an error of judgment?
Fraud, somehow? The common law slogan is fraud vitiates all contracts. Does that apply here? Neither Husband nor Wife has engaged in any fraudulent activity. To what extent may a third party’s fraud provide a basis to vitiate contracts between others?
Anything else? Should special rules apply to a divorce settlement agreement? Is it important to know more about the background of the parties and their divorce proceedings and settlement negotiations? Would those factors bear on the question of whether one or the other should or did bear the risk of third party fraud or related mistake?