You Have a Fiduciary Duty to Your Spouse if You Own Bitcoin in California
A lawyer explanation’s of In re Marriage of DeSouza, (2020) 54 Cal. App. 5th 25
Some quick context here so that we can all track how this issue came before the court: Erica and Francis were a married couple in San Francisco County who initiated divorce proceedings in 2013. As part of the divorce, Erica served Francis with a petition for dissolution of marriage along with a restraining order that prohibited Francis from “[t]ransferring, encumbering, hypothecating, concealing, or in any way disposing of any property, real or personal, whether community, quasi-community, or separate, without the written consent of the other party or an order of the court, except in the usual course of business or for the necessities of life” After this restraining order was already issued, Francis tried to purchase $45,000 worth of Bitcoin on Mt. Gox, but ultimately never received the bitcoins and lost all the funds in the process. Now that’s some real laser eyes ladies and gentlemen!
Francis then asked his friend “Wences Casares,” to purchase approximately 558.32 bitcoins from Mt. Gox for $99,451. Casares being the loyal friend that he is purchases the bitcoins for Francis and also throws in an additional 5 bitcoins as a gift. Wences sends the 563.32 bitcoins to Francis’ digital wallet. We’ll call these the Wences coins. Francis then goes to another friend, “Khaled Hassounah” and has him purchase another 498.89 bitcoins from Mt. Gox for $44,940 at the time. We’ll call these the Hassounah coins. While Mr. Hassounah purchased the coins, he ultimately never sent the coins to Francis so they remained on Mt. Gox. Francis transfers Wences coins back and forth between wallets several times over the course of a year.
Some readers may already know of the historic fall of Mt. Gox. For those that don’t, essentially Mt. Gox becomes the subject of investigation by the United States for failure to comply with federal regulations and then falls victim to hackers who steal thousands of bitcoins off of the exchange. Mt. Gox then files for bankruptcy and most would go on to lose thousands of bitcoins worth millions of dollars. At the time, it was a major blow to the cryptocurrency community as a whole. Francis himself loses the 498.89 bitcoins that had been left on the exchange by Mr. Hassounah. The Hassounah coins are gone forever!
Before we continue, it’s worth noting a little about how divorce court works in California. Whenever a couple gets divorced, the court will have both individuals complete several schedule of all of their assets and debts. Francis filed his preliminary schedule in February 2014. He completed his final one in July 2016. On both schedules, he disclosed that he had ownership of 1,062.21 bitcoins. However, he fails to disclose that the 498.89 Hassounah coins were left on Mt. Gox and now unaccessible.
In divorce court, the judge will then hold a hearing to try the property issues and make a determination on what property belongs to the community (marital estate). The marital estate property will then be split equally amongst the parties. Erica and Francis have their property hearing in 2017 and the judge rules that the bitcoins Francis purchased belonged to the community and will be split equally among Erica and Frances. When Erica goes to collect her share of the bitcoins, Francis discloses that 498.89 of the Hassounah coins were on Mt. Gox and are unrecoverable. He then comes clean that also failed to disclose that he bought the bitcoins using his friends as proxies. (Why not at this point, right?) Francis claims that he now only has access to 613.53 of the bitcoins as a result of the Mt. Gox bankruptcy.
Erica and her attorney go to the court and ask for an emergency order transferring half of the 613.53 bitcoins from Francis to her. Erica also argues that additional remedies should be ordered to her under the California Family Code for his failure to disclose all the material information about the bitcoin investments. The court approves Erica’s motion and orders that Francis send her half of the Wences coins and orders Francis to show cause as to why he shouldn’t have to send Erica an additional 224.34 bitcoins (which would have reflected her share of the Hassounah coins), pay for her attorneys fees and pay for her court costs pursuant to to California Family Code sections 721 and 1100.
Let’s dive in to some important legal principles that apply to those married in California.
Under California Family Code section 721, a married spouse can use the couple’s funds to enter into transactions with those outside the marriage. This means one spouse can use marital funds to invest in cryptocurrency without any issues. However, the spouse using the marital funds is held under the general rules governing fiduciary relationships. This means the person using the marital funds has a duty of good faith and fair dealing on each spouse, and neither shall take any unfair advantage of the other. This is the same duty imposed on nonmarital business partners. This means the other spouse may inspect the books of the transaction, render all information concerning the transaction, and provide accounting to the other spouse. The investing spouse must hold oneself out as a trustee with respect to any profits that derived from the transaction. Francis could not simply have turned a profit from bitcoin using marital funds and not acted as a trustee, on behalf of Erica, any profit he made from the investment.
California Family Code section 1100 elaborates on this duty further:“Each spouse shall act with respect to the other spouse in the management and control of the community assets and liabilities in accordance with the general rules governing fiduciary relationships which control the actions of persons having relationships of personal confidence as specified in section 721, until such time as the assets and liabilities have been divided by the parties or by a court. This duty includes the obligation to make full disclosure to the other spouse of all material facts and information regarding the existence, characterization, and valuation of all assets in which the community has or may have an interest and debts for which the community is or may be liable, and to provide equal access to all information, records, and books that pertain to the value and character of those assets and debts, upon request.”
The court found that this fiduciary duty with respect to cryptocurrency investments follows the spouse even after the marriage has been dissolved up until the time the cryptocurrency is divided and both spouses go on their merry way. This duty requires the investing spouse to disclose all the cryptocurrency that belongs or might belong to the marital estate, and its value, and then to account for the management of that cryptocurrency, revealing any material changes in the marital estate as a whole. According to the appellate court, these duties of transparency placed on the investing spouse discourages unfair dealing and empowers the non-investing spouse to take action in exercising their rights to bring a claim against the investing spouse.
Section 1101 of the California Family Code allows a spouse to bring a claim against the other for any breach of a fiduciary duty that impairs the spouse’s interest in the marital estate. The remedy for breaching a fiduciary duty owed to the spouse includes “an award to the other spouse of 50 percent, or an amount equal to 50 percent, of any asset undisclosed or transferred in breach of the fiduciary duty plus attorney’s fees and court costs.”
Francis makes two big retorts here:
First, Francis argues that his failure to fully inform Erica about the bitcoin investments was not “material” within the meaning of the code because even if Erica knew where the coins were being stored and how he purchased them, it would not have affected her decision making in the least. The court did not agree with Francis. The court determined that because Mt. Gox has gone bankrupt and the 498 Hassounah coins were tied up in the bankruptcy, and most likely gone at this point, Erica suffered a massive lost because she would never be able to access her share of the coins. Had Francis disclosed that he was buying bitcoins through proxies from Mt. Gox, Erica would have had the ability to object to her share being on the failed exchange and/or asked the court to prevent Francis from buying them all together with the marital funds.
Francis tried to argue that Erica never took an active role in the couple’s finances and as a result would have never done anything to protect her interest in the bitcoin investments. He even presented evidence that even after their separation, Erica agreed to his request to invest $50,000 of the estate into a friend’s start-up company. The court rejected this argument holding that this does not mean Erica would not protect her financial interest after lawyering up, filing for divorce, and serving Francis with a restraining order that prevented him from making these kinds of unilateral financial decisions.
Ultimately the court concludes that Francis breached his fiduciary duty when he purchased the bitcoins in 2013 despite the restraining order preventing him from doing so. The fact that Mt. Gox went bankrupt and the Hassounah coins were gone “substantially impaired” Erica’s interest in the lost coins because she will never see be able to access them. The court determined his failure to disclose such information was material.
Francis then argued that even if he did fail to disclose the material information about the bitcoin investment, and lost some bitcoins as a result, his failure to disclose did not impair Erica’s interest in the investment because they were still able to access the Wences bitcoins, which earned $3.45 million dollars for the marital estate and greatly enriched Erica as a result. The old “yea but are you poor?” argument. The court was quick to shut this down by finding “the financial success of one undisclosed investment does not erase the harm to the community estate, . . . occasioned by a separate undisclosed transaction.
In the end, Francis ended up paying Erica half of the Wences bitcoins. He also had to send her 224.34 bitcoins, which represents half of the Hassounah bitcoins he lost.
Hopefully, most of those reading this have very successful and happy marriages. For the nearly 50% that don’t, there is something to be drawn from this case. Cryptocurrencies like any other asset or investment are subject to the laws of your jurisdiction. California is a community property state. Property belongs to the community. Upon dissolution, spouses divide the property equally. And just like entering into any other business partnership, both spouses are bound to the same fiduciary duties in the management and control of the marital assets and liabilities even after the dissolution of the marriage. Buying bitcoins through proxies and backdoor dealings, did not help Francis skirt the fiduciary duties he owed to his spouse. When you hold cryptocurrency in California, you are bound to the same fiduciary duties as Francis.
