What is the Operation of Law?
What is ‘Operation of Law’?
Generally, the basic concept of operation of law is that it is a method by which an act of the state, rather than an act of an individual or corporation, transfers rights and obligations from one entity to another. Operation of law varies by jurisdiction and may be based on statute, constitution or judicial action.
Operation of law may pertain to a variety of matters, such as divorce matters, where, for example, a divorce is finalized (and gained its legal effect) upon entry of a final judgment, even if the order is in violation of court rules or procedures. In short , the execution of the order gives its vitality and legal operation to the rights and obligations contained in that order.
It may be useful to consider the term "operation of law" in contrast with the voluntary acts of individuals. For example, when a person or entity takes an action to transfer property, their act is a voluntary transfer. When the state takes action to transfer the property (e.g., merger by operation of law) it is an involuntary transfer. An involuntary transfer is necessary to distinguish it from a consequence of an individual’s voluntary actions, which has the same effect, i.e., a transfer of property. By using this term, courts and attorneys may be able to save time when filing pleadings and orders with the Courts and avoid arguing the voluntariness of a particular action or transfer.
Common Scenarios where the Operation of Law is Involved
There are numerous instances where operation of law comes into play. One of the most common is when real property is transferred. As discussed above, a deed will operate by the law to transfer real property, in the absence of a contrary intent as to time. In other words, if the grantor did not include "upon recordation" or "upon delivery" in the granting clause of the deed, the law will presume that the deed transfers the real property upon recordation.
Another example is the termination of a contract. For instance, a contract may have an explicit provision stating the circumstances under which it will terminate, such as the failure of a party to meet a condition precedent. A contract, however, may terminate by operation of law in the event that someone dies. The death of a party to a contract may terminate the performance of the contract if the contract (a) depends on the continued existence of that person, or (b) if performing the contract would make anyone else’s performance substantially more difficult. An example would be the contract between a singer and a record label that may terminate by operation of law in the event the singer dies. However, the contract would not terminate by operation of law if a singer dies but his or her heirs can still perform properly under the contract without making it substantially more difficult.
Another example of operation of law is the creation of liens. Under the circumstances described above, when a party becomes indebted to another party, the creditor can file a document with the county recorder’s office and thereby obtain a lien against the real property of the debtor. The lien would arise by operation of the law, without the creditor needing to record any other instrument.
Inheritance also brings into play operation of law. An heir may inherit property of a decedent by operation of state law (or federal law in the case of federal estate tax liens).
Legal Effects and Repercussions
In legal terms, the operation of law is most commonly used in the context of determining the applicability of laws to new scenarios (i.e. legislation) or as a result of the dissolution of a legal entity, resulting in the application of laws and regulations to the assets, liabilities, shareholders and the like. It is not necessary that the private parties to a contract expressly outline or define the effect of the statute which triggers the operation of law or in any way refer to the event. The mere enactment, implementation, or expiration of a statute or governmental rule is virtually always sufficient to trigger the operation of law. The operation of law usually occurs when the parties would not reasonably expect the law to operate in this way, and therefore it can have devastating effects for a party to a contract. Careful consideration must be given to the drafting of final determinations to CCAA plans of arrangement, particularly where these results in the alteration of contractual rights and obligations. In particular, attention should be paid to the vesting of assets in a company as of the date of the bankruptcy or trade when assets of the insolvent is transferred to the trustee or receiver, respectively. Legal advisers should consider the remainder of the contract, mitigation of damages, and other related areas of law when advising on the operation of law, particularly with regard to the potential remedies.
How the Operation of Law Applies to Contracts
Operation of law may change the parties to a contract. A merger of the parties by one party merging into the other is one example of how operation of law alters a contract. When Party A merges into Party B under a statute, Party A ceases to exist and its liabilities are taken on by Party B. The result is that all contracts with Party A remain in full force and effect with Party B (as the successor company) as the counterparty. See, e.g., In re Vitro S.A.B. de C.V., 701 F.3d 581, 591 (5th Cir. 2012) (holding that assets acquired from debtor by buyer as a result of operation of law upon debtor’s sale of assets were "property of the estate" under section 363(f) of the Bankruptcy Code); 15 William Meade Fletcher et al., Cyclopedia of the Laws of Private Corporations § 6999 (West 2012) (applying the same principle to distinguish between a statutory merger and a common law consolidation).
Operation of law may also result in the death of a contract. Some contracts include anti-assignment clauses that state that the contract terminates if either party becomes insolvent or transfers its assets (i.e., through assignment, succession, or delegation) without the other party’s consent. E.g., International Turbine Service Inc. v. Aeroenergy Holdings, Inc., No. 4:2011-cv-00207, 2011 U.S. Dist. LEXIS 33585, at *17 (S.D. Tex. Mar. 29, 2011). These clauses do not, however , work to prevent a contract from being created. Instead, they only prevent a transfer of rights under an existing contract. See, e.g., PPG Indus. v. Conn. Landmark Ins. Co., 678 So. 2d 1008, 1010 (Fla. Dist. Ct. App. 1996) (noting that the anti-assignment provision did not preclude the insured from acquiring a policy). Thus, a contract may be created upon operation of law, but the contract may also be terminated upon operation of law.
A contract can be deemed to have been breached upon operation of law. For example, some agreements provide for an event of default if a receiver is appointed for a party. See, e.g., In re W & A Holdings Corp., 569 B.R. at 764 (discussing the automatic appointment of a receiver under Texas law upon the entry of a final judgment or an order appointing a liquidator or receiver). Once a receiver is appointed, the receivership can affect the parties’ obligations under an agreement. Sometimes a court will order a receivership where the underlying relationship is highly interdependent. E.g.., In re Campbell, 284 B.R. 431, 438 (Bankr. E.D. Pa. 2002) (approving a receivership upon holding that the business was "one comprised of a profusion of interdependent and dependent relationships"). Thus, courts may find that a receiver’s authority when appointed by operation of law can be broad in order to preserve the parties’ contractual obligations.
Key Similarities and Differences Between Operation of Law and Judicial Action
In some situations, the distinction between a change to the beneficial owner of an interest in a PFP investment and a change to the interest itself may be difficult to discern. A good way to conceptualize this distinction is to consider what actions are or can be taken against the ownership interest to affect the change in the beneficial owner. The distinction can be illustrated by comparing the change to investment by operation of law (i.e., a change resulting from an automatic, co-ownership provision in the governing document that results from the death of a co-owner or divorce or a restructuring or reorganization) to the manifestation of a change in investment implemented by a court order, warrant, lien, levy or execution upon the interest. In contrast, the former is beyond the control of the PFP investment and its manager and is not implemented pursuant to a judicial order, while the latter is a deliberate judicial action to enforce or satisfy a judgment, levy, or lien claimed against a property interest.
Commonly Asked Questions Regarding the Operation of Law
1. When does operation of law apply?
"Operation of law" applies in two scenarios: first, when an interest in property is created or transferred from one owner to another through the filing of a deed, declaration, or other written instrument. And second, it applies when the meaning of a covenant or contract term between parties changes for some reason other than direct actions of the parties; for example, when the law, equity or a third party affects the enforcement or obligation to perform the covenant or term.
2. Is operation of law limited to property transactions, or does it also apply to contracts and agreements?
Operation of law is not exclusive to property transactions; it also applies to certain contracts and agreements. In fact, many decisions from the California appellate courts confirm that operation of law is intended to apply broadly and not just limited to property transactions.
3. Does operation of law apply to any agreement, such as one between two parties with no relation to real property?
Not necessarily. Courts are often hesitant to find that a deed, declaration, or other document has been extinguished, changed or terminated by operation of law unless there is a clear intent expressed in the deed or declaration to do so, or unless there are clear statutory provisions or a specific case providing for the application of the doctrine to that particular situation. So any individual situation must be closely examined for the facts of the case, the specific terms and language of the deed or declaration at issue, and the purpose of the doctrine.
4. What are some examples where operation of law has been applied by the courts?
The most common example in California decisions where operation of law has been applied to extinguish the rights of a homeowners association to collect on an assessment lien is when the declaration of covenants, conditions and restrictions ("CC&R’s") at issue contain a provision stating that an action to enforce the lien can be brought "within a reasonable time" after a periodic delinquency occurs . In that situation, the court often holds that, because the CC&R’s did not specify a certain period of time for the court to address the adjustment in the rights and obligations of parties, the court will not review the case to determine whether or not a reasonable time has passed; rather, the court will treat the adjustment in the rights and obligations of the parties as having occurred, and will decline to exercise its jurisdiction.
Other examples include cases where the court has applied the doctrine to determine the effect of a change in the legal description of a parcel of real property used in a deed, declaration or other written instrument.
5. Does the operation of law doctrine apply to:
a. Liens?
Generally, the court will not consider the specific terms and conditions of a lien when determining whether operation of law extinguished the lien.
b. Court orders?
Generally, the court will not consider court orders when determining whether operation of law extinguished the underlying rights of a homeowners association to collect on an assessment lien or assessmenT. Examination of the particular facts of the case, and the associations governing documents at issue, specific court orders involved and the current state of the law is required.
6. What is the most common misconception about operation of law?
That, absent any specific wording in the deed, declaration or other written instrument, operation of law cannot apply to extinguish a right, or create a new obligation. This is not true. The decision discussed above makes it clear that the rule is meant to be applied liberally to the particular facts and circumstances without being restricted solely to property transactions.