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Divorce, Marital Duties, and Digital Assets

Jun 10, 2022 | Divorce/Marital Dissolution

By Bennett Reichard, Law Clerk

In recent years there has been a dramatic increase in the usage and prevalence of digital assets such as cryptocurrency and non-fungible tokens (“NFT”).  A forecast, created by research firm Insider Intelligence, found that by the end of 2022, more than 10% of Americans will own some form of cryptocurrency.  Furthermore, total NFT sales in 2021, growing at over 21,000%, reached a record high of $17.6 billion.  All of this is to say that digital assets can no longer be ignored, especially as they relate to the equitable separation of property in a divorce.

What are Digital Assets?

Digital assets are a relatively new concept originating with the creation of the internet.  Beginning as a way to track and transfer real dollars through services like online banking, PayPal, and eventually Venmo, this asset class has evolved into uniquely digital property without any attachment to the physical world.  Modernly, “Digital Assets” primarily refers to cryptocurrency and NFTs.  Cryptocurrency is defined as a “decentralized digital money that’s based on blockchain technology.”  Put simply, cryptocurrency is a type of currency existing solely on the internet without attachment to any physical representation or traditional currency.  An NFT is a similar type of technology but instead of representing money digitally, they represent real-world objects like art and music.

Are there Potential Problems with Digital Assets in Divorce?

One of the most important aspects of any divorce proceeding is determining what assets each party owns and how much those assets are worth.  Traditional forms of assets like real property, cash, or cars can be physically identified and traced through title or other records to find out the identity of the owner.  Digital assets on the other hand, are “owned” in the blockchain and are accessed using blockchain “keys” rather than true identities.  This means that spouses can attempt to hide their digital assets with more ease than they could hide a physical one.  In fact, cryptocurrency “wallets” can even be stored on flash drives making identification of these digital assets potentially very challenging.

Valuation of Digital Assets

Another modern problem facing divorce litigants is how to divide digital assets given their rapidly fluctuating value.  Whether it is Bitcoin or an NFT, valuations change day to day by incredibly significant margins making valuation during a divorce very troublesome.  For example, if one spouse, who owns 10 Bitcoin valued at $30,000 each on March 1 but $50,000 each on April 1, initiates a divorce on March 1, which valuation does the court look to when dividing the asset?  While at separation the divorcing spouse owned $300,000 worth of Bitcoin, his or her investment had grown by $200,000 one month into the divorce proceedings.  Is the other spouse entitled to half of $300,000, $500,000, or neither?  Because digital assets are relatively new, the courts have little published case law to use as precedent to answer these questions.  Ken Maynard, a Divorce Financial Specialist, in an interview with DailyCoin explained that “the files that we’re working on for families who have cryptocurrency, assets are to be valued on the date of separation.”  But to answer a problem like the example above, Maynard said any “increase can be considered income that goes to the child and spousal support.”  This is just one explanation as to how divorce litigants can solve their digital asset valuation problem but we will be on the lookout for new case law or legislation that addresses this very issue.

Case Law on Cryptocurrency:

While the advent of digital assets occurred very recently, there is a growing field of case law on the subject.  In a recent case, In re Marriage of Souza decided in 2020, the California Court of Appeals was given an opportunity to look at one spouse hiding cryptocurrency during a divorce and examine the incredibly significant effects that decision had.  In January 2013 Erica Souza filed a dissolution of marriage against her husband Francis.  This filing prevented Francis from completing a number of financial transactions, but most importantly, from transferring or concealing any property, community or separate.  In April 2013 Francis completed two different transactions, by which he spent approximately $150,000 purchasing Bitcoin separately from a friend and business associate.  Francis received only roughly 500 of the 1,062 Bitcoins he expected to but when it came time to file his preliminary schedule of assets and debts for the divorce, 1,000 Bitcoins were listed.  After their dissolution judgment was entered in 2017, Erica attempted to obtain her half of the community property in Bitcoin.  It was at this time that Francis informed her that half of his Bitcoin was tied up in the bankruptcy of the Bitcoin exchange he had used to purchase them.  In fact, he only possessed 613 of the 1,062 Bitcoins he had listed on his Schedule of Assets and Debts.  Erica then moved for an order to compel Francis to transfer her full interest of community property in Bitcoin at once.  Importantly, due to the meteoric rise of Bitcoin’s price, the community investment of roughly $150,000 had appreciated to be worth approximately $13.5 million all of which the husband was trying to conceal.

The primary issue in the Souza trial was whether Francis breached his spousal fiduciary duty primarily by concealing his purchases of Bitcoin.  The court defined this duty as encompassing the time period after separation and obligating each spouse to create “accurate and complete” disclosures of assets of which the other spouse has an interest.  To determine if Francis breached his fiduciary duty the court was tasked with determining if his failure to inform Erica of his Bitcoin purchases was “material.”  In this context, materiality is shown as information that would affect the other party’s decision-making if they knew of such information.  Here the court determined that an investment potentially worth millions of dollars was substantial enough that Erica likely would have acted differently had she known the true nature of the Bitcoin.

In re Marriage of Souza is but the first in what is expected to be a long string of future cases deciding issues regarding and surrounding digital assets.  The court will need to continue to examine digital assets in divorce proceedings and specifically how to identify and value such property.  Here the court “valued” the Bitcoin by referring solely to the actual number of Bitcoins held by Francis which was static but in cases involving purchases and sales of digital assets, the court will have to determine how to value these novel transactions.

 

 

 

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