ALLOCATION OF PERSONAL INJURY AND WORKERS’ COMPENSATION PROCEEDS IN A DIVORCE: COLORADO’S UNUSUAL APPROACH

The following article by Philip E. Kay appeared in TrialTalk Magazine (Sept.-Oct. 2013):

To fully understand Colorado’s approach to allocating personal injury and workers’ compensation proceeds in a divorce, it is important to have a basic understanding of how property is generally allocated in a divorce.  Pursuant to Colorado’s Dissolution of Marriage Act, Colorado is an “equitable distribution” state whereby the court has authority to divide the parties’ marital property, regardless of fault,  in such proportions as the court deems just after considering all relevant factors, including (a) the contribution of each spouse to the acquisition of the marital property, including the contribution of a spouse as homemaker; (b) the value of the property set apart to each spouse; (c) the economic circumstances of each spouse at the time the division of property is to become effective, including the desirability of awarding the family home or the right to live therein for reasonable periods to the spouse with whom any children reside the majority of the time; and (d) any increases or decreases in the value of the separate property of the spouse during the marriage or the depletion of the separate property for marital purposes.  To identify and divide the parties’ marital property, the court must engage in a multi-step process.

First, the court must determine whether a spouse’s interest in something constitutes “property” at all.  The term “property” is interpreted broadly, and includes “everything that has an exchangeable value or which goes to make up wealth or estate.”  However, interests that are merely speculative are mere expectancies and do not constitute “property.”  For example, a spouse’s interest in a pension plan is “property” subject to division in a divorce, while the rights of a beneficiary in a discretionary trust are not.

Second, the court must determine whether the property is marital or separate.  Subject to certain limited exceptions, all property acquired by either spouse during the marriage is presumed to be marital property except the following, which are considered the party’s separate property: (a) property acquired by gift, bequest, devise, or descent; (b) property acquired in exchange for property acquired prior to the marriage or in exchange for property acquired by gift, bequest, devise, or descent; (c) property acquired by a spouse after a decree of legal separation; and (d) property excluded by valid agreement of the parties.  Property acquired by either spouse prior to the marriage or after the decree of separation or dissolution is entered is the party’s separate property.

Third, the court sets apart to each spouse his or her “separate property.”

Fourth, the court determines the value of each item of marital property.

Fifth, the court divides the parties’ marital property in such proportions as the court deems just after considering all the relevant factors set forth above.

General Approaches to Allocation of Personal Injury and Workers’ Compensation Proceeds in a Divorce

In most jurisdictions, including Colorado, property acquired by a spouse before the marriage or after the parties’ final separation or divorce is considered that spouse’s separate property.  Thus, it is generally agreed that proceeds received for pre-marriage or post-divorce injuries are the injured spouse’s separate property.  The below discussion deals with proceeds received for injuries occurring during the marriage.

U.S. jurisdictions take three general approaches to allocating personal injury and workers’ compensation proceeds in a divorce for injuries occurring during the marriage.

The “Unitary” Approach

A very small minority of states take the “unitary” approach whereby personal injury and workers’ compensation proceeds resulting from injuries occurring during the marriage are entirely the separate property of the injured spouse.

The “Mechanistic” Approach

A larger minority of states take the “mechanistic” approach whereby personal injury and workers’ compensation proceeds resulting from injuries occurring during the marriage are entirely marital property.   Most of these courts look to the statutory language defining marital property and reason that since personal injury and workers’ compensation proceeds resulting from injuries occurring during the marriage are not expressly excluded from the definition of marital property, they are marital property, even if the purpose of the proceeds is to compensate the injured spouse for entirely personal losses such as pain and suffering.

The “Analytic” Approach

The majority of states take the “analytic” approach whereby the determination of whether personal injury and workers’ compensation proceeds resulting from injuries occurring during the marriage are marital or separate property depends on the loss that the proceeds are intended to compensate for.  Each component of the recovery or settlement must be examined to determine the loss for which the component is intended to compensate, and the proceeds, or a part thereof, are considered marital property to the extent the loss for which the proceeds are intended to compensate is a loss to the marital estate.  Examples include proceeds intended to compensate for the injured spouse’s lost wages during the marriage or medical expenses incurred during the marriage.  Proceeds compensating for losses other than to the marital estate, such as future (post-divorce) lost earnings and medical expenses and noneconomic damages such as pain and suffering, are considered the injured spouse’s separate property.   Proceeds compensating a spouse for loss of consortium are also considered that spouse’s separate property.

To the extent a personal injury or workers’ compensation recovery or settlement is not differentiated into components or categories indicating the loss that each part of the proceeds is intended to compensate, most “analytic” jurisdictions hold that the spouse claiming that the proceeds, or a part thereof, is his or her separate property bears the burden of proving his or her claim.

Colorado’s Unusual Approach to Allocating Personal Injury and Workers’ Compensation Proceeds in a Divorce

Regardless of whether a particular jurisdiction has adopted the unitary, mechanistic or analytic approach, almost all jurisdictions apply the same approach to the allocation of both personal injury and workers’ compensation proceeds.  Colorado is unusual in that it applies the mechanistic approach to allocating personal injury proceeds in a divorce, but applies the analytic approach to allocating workers’ compensation proceeds in a divorce.  How Colorado applies the mechanistic and analytic approaches, and the rationale behind this bifurcated approach, is explained below.

Colorado’s Allocation of Personal Injury Proceeds in a Divorce:  The Mechanistic Approach

Colorado is one of the minority jurisdictions that follow the mechanistic approach to the allocation of personal injury proceeds in a divorce.  In Colorado, personal injury proceeds are classified as marital or separate based solely on the timing of the injury.  Proceeds compensating for an injury that occurred during the marriage, even if such proceeds are intended to compensate for purely personal losses such as pain and suffering, are entirely marital property subject to equitable distribution by the court in a dissolution action.  The rationale for this approach is based on a strict interpretation of the Dissolution of Marriage Act, under which all property acquired during a marriage is presumed to be marital unless it falls under one of the four exceptions to marital property set forth at C.R.S. 14-10-113(2) (discussed above), and personal injury proceeds are not included as an exception to marital property under the statute.

The presumption that personal injury proceeds for injuries occurring during the marriage are entirely marital property subject to equitable distribution by the court also applies if the injured spouse has not actually received the proceeds prior to the date of dissolution, but has only received a settlement offer which he or she has accepted.

The presumption even applies to unliquidated personal injury claims for which no suit has been filed and no settlement offer has been received.  Obviously, the court may have difficulty valuing and dividing an unliquidated personal injury claim which has no cash value, no loan value, no redemption value, no lump sum value, no value realizable after death, and no known settlement value.  While these factors may affect valuation, they do not affect the classification of the claim as marital. Since the value of an unliquidated personal injury claim is unknown, the court may award each spouse a percentage share of any future benefits received.  In determining the percentage share to be awarded to each spouse, the court should consider the actual effect that the injury had on the marital estate such as lost marital income, medical expenses, and the inability to meet marital obligations such as maintenance and child support.  The trial court should make specific factual findings supporting its division of an unliquidated personal injury claim.

Since the court has authority to divide the parties’ marital property in such proportions as the court deems just after consideration of all relevant factors, the court may consider the injured spouse’s physical condition and injury-related expenses in arriving at an equitable distribution of the parties’ property as a whole, which includes the proceeds of the injured spouse’s personal injury settlement or recovery.  Thus, despite the marital nature of the personal injury proceeds, a disproportionate award as a whole in favor of the injured spouse based on that spouse’s physical limitations and related expenses is within the court’s discretion.

Colorado recognizes one limited exception to the general rule that personal injury proceeds for injuries occurring during the marriage are entirely marital property.  In Colorado, the rights of a beneficiary in a discretionary trust are not considered “property” at all, marital or separate.  Such rights constitute an “expectancy” interest only, and as such are not “property” within the meaning of C.R.S. §14–10–113.  Income from a discretionary trust is likewise not property subject to division, but is instead considered a “gift” under C.R.S. §14–10–113(2)(a) and is thus not divisible in the divorce.  The injured spouse’s placement of personal injury proceeds into an irrevocable discretionary trust over which the injured spouse has no control effectively removes the proceeds from the marital estate, as long as the placement of the proceeds into the trust is not done for an “improper purpose” amounting to dissipation of the property.  The court may, however, consider the injured spouse’s expectancy interest in the trust as an “economic circumstance” in arriving at an equitable distribution of the parties’ marital property.  Thus, the non-divisibility of personal injury proceeds placed into a discretionary trust may be more illusory than real.  Even so, the attorney representing the injured spouse should determine whether a legitimate purpose exists for placing the proceeds in an irrevocable discretionary trust since this may insulate the proceeds from a claim by the other spouse.  Regardless of whether the proceeds are divisible in the divorce, the injured spouse’s income from such a trust is includable in that spouse’s “gross income” for purposes of determining child support.

An unresolved issue in Colorado is whether personal injury proceeds compensating an injured spouse for injuries occurring during the marriage would still be classified as entirely marital property if the other spouse caused the injuries and was the defendant in the personal injury action.  In Colorado, an injured party may sue his or her spouse in tort for personal injuries caused by the conduct of the defendant spouse (although such an action must be brought separately from the dissolution action).  Since the proceeds in such a case would not fall under any of the statutory exceptions to marital property set forth at C.R.S. 14-10-113(2), they are technically marital property subject to distribution back to the tortfeasor spouse.  Possibly the court faced with this situation would award the proceeds entirely to the injured spouse under the “wide discretion [afforded] to a trial court in dividing marital property to accomplish a just result,” especially if the defendant spouse intentionally injured his or her spouse.  But would the divorce court award the entirety of the personal injury proceeds to the injured spouse if the injuries occurred as a result of the defendant spouse’s negligent as opposed to intentional conduct?  Would the divorce court make such an award if it left the defendant spouse without adequate (or any) resources to support himself or herself, or resulted in the defendant spouse’s insolvency?  These questions remain unanswered in Colorado.

Colorado’s Allocation of Workers’ Compensation Proceeds in a Divorce:  The Analytic Approach

In Colorado, workers’ compensation benefits are intended to indemnify an employee for loss of earnings, future diminished earning capacity, and medical expenses arising out of an occupational injury or disease.  Workers’ compensation injuries are classified as either partially or totally disabling and either temporary or permanent in nature.  Temporary disability benefits, whether partial or total, are intended to compensate an employee for loss of earnings from the date of injury until the employee’s condition has stabilized or the employee has commenced vocational rehabilitation.  Permanent disability benefits, whether partial or total, compensate for an employee’s diminution of future earning capacity as a result of a work-related physical or mental impairment.

In allocating workers’ compensation proceeds in a divorce, Colorado is one of the majority jurisdictions that follow the analytic approach.  Under this approach, the court must determine the element(s) of the loss being remedied.  Compensation for lost earning capacity and medical expenses incurred during the marriage is marital property subject to equitable division by the court.  Compensation for premarital or post-dissolution lost earning capacity or medical expenses is the injured spouse’s separate property.  This rule applies to liquidated and unliquidated workers’ compensation claims.

In adopting the analytic approach to the allocation of workers’ compensation proceeds in a divorce despite Colorado’s prior adoption of the mechanistic approach to the allocation of personal injury proceeds in a divorce, Colorado courts have focused on the unique purpose of workers’ compensation as a wage substitute to the injured employee.  Workers’ compensation constitutes the employee’s exclusive remedy against the employer for a work-related injury, and workers’ compensation benefits do not include recovery for pain, suffering, or monetary loss based on fault.  To hold that workers’ compensation benefits are marital property to be divided in a divorce even if the award compensates for the injured spouse’s post-dissolution diminished earning capacity or post-dissolution medical expenses would contravene the legislative intent, as reflected by C.R.S. 8-42-124(1), to ensure that workers’ compensation benefits are readily available to the injured employee as a wage substitute.

If the injured spouse’s unliquidated workers’ compensation claim is pending on the date of divorce and will likely include compensation for lost marital earnings or medical expenses, the court may reserve jurisdiction to apportion the marital interest upon receipt of the award.  On the other hand, if the only outstanding workers’ compensation claim on the date of divorce is for permanent disability benefits, the claim is not a marital asset because a permanent disability award compensates for future loss of earning capacity only.  That said, future workers’ compensation wage replacement benefits, temporary or permanent, may be considered by the court in determining the injured spouse’s ability to pay maintenance and child support.

If the injured spouse settles his or her workers’ compensation claim prior to the date of divorce, the question may arise whether any part of the settlement proceeds constitute compensation for post-dissolution, and thus non-marital, losses.  The burden of establishing that some or all of the proceeds are for post-dissolution losses is on the party seeking to establish a separate interest in the proceeds.  Absent a “clear indication” demonstrating what the settlement amount represented, there is no basis upon which a court can apportion the marital and non-marital portions of the proceeds.  The attorney representing the injured spouse would be well advised to delineate in the workers’ compensation settlement agreement the portions of the proceeds compensating for any pre- or post-dissolution losses along with the reasons supporting such a delineation, and should be prepared to present evidence (in the form of expert testimony or otherwise) supporting the delineation at the permanent orders hearing.

Conclusion

Colorado courts have taken the unusual approach of allocating personal injury proceeds in a divorce using the mechanistic approach while allocating workers’ compensation proceeds in a divorce using the analytic approach.  Although neither personal injury nor workers’ compensation proceeds fall under any of the exceptions to marital property set forth in the Dissolution of Marriage Act, Colorado views workers’ compensation as a special statutory benefit intended to provide the injured employee with a readily available wage substitute.  Personal injury proceeds have not been accorded the same statutory status.

If a spouse suffers a personal injury during the marriage, any personal injury proceeds received by the injured spouse are entirely marital property subject to equitable division by the court, regardless of the category of loss for which the proceeds are intended to compensate.  If a spouse suffers a work-related injury during the marriage, any workers’ compensation proceeds received by the injured spouse for lost earning capacity or medical expenses incurred during the marriage are marital property subject to equitable division by the court.  Any workers’ compensation proceeds received by the injured spouse for premarital or post-dissolution lost earning capacity or medical expenses are the injured spouse’s separate property.