Recent Developments in Asset Protection Law - September 2011

Meiselman v. Hamilton Farm Golf Club LLC, 2011 WL 3859846 (D.N.J., Not for Publication, Sept. 1, 2011).

This case involves a golf course that was hit with refund claims by a number of its members, and transferred assets away by a purported refinancing. The case is very interesting in how the court interpreted the UFTA against the fact that the members' rights to a refund had not yet vested:

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Defendants assert that Plaintiffs are not present creditors because their right to a refund vests in thirty years. * * * However, the UFTA protects creditors with "unmatured" claims, so Plaintiffs qualify as "creditors" even without an immediate right to payment.

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This is very important, because sometimes debtors will want to make transfers before some obligation ripens -- such as a personal guarantee that the debtor suspects may be called. But, because "claim" includes unmatured claims, the fraudulent transfer laws may still apply.

And therein lies yet another potential landmine for asset protection planners -- and why asset protection planning against existing personal guarantees and other unmatured claims is usually just as bad an idea as attempting to avoid an existing and matured claim.

Full Opinion at http://www.goo.gl/ItkC0

In re Shirley, 2011 WL 4054773 (Bkrtcy.E.D.Tenn., Slip Copy, Sept. 12, 2011).

Right after the H&W debtors were told by the bank that their $4.45 million in outstanding loans would not be modified -- do I even need to continue? -- debtors started transferring properties out of their name, by gifting or selling interests to variously their living trust and the mother of one of the debtors, to the latter ostensibly by a note obligation "for reasonably equivalent value".

Later, the couple filed for bankruptcy and then H died (which probably confused the availability of the assets in the living trust), and the bank initiated an adversary proceeding to bring the assets back into the debtor estate.

Suffice it to say that the bank was successful in getting the transfers set aside, but the opinion is very well written and gives a detailed explanation of what constitutes both actual fraud and constructive fraud on creditors, as well as about the definition of what constitutes "reasonably equivalent value".

One very interesting issue is that the court would not admit the debtors evidence of the contemporaneous value of the assets at the time of the transfer, which was a spreadsheet prepared by one of the debtors to show solvency (presumably the spreadsheet was excluded on hearsay grounds although the court doesn't explain this -- I've had very similar "Affidavits of Solvency" kicked out when representing creditors).

The court's discussion of the timing of the transfer was also very interesting, and should be a lesson for those persons who have something bad happen and then immediately initiate a bunch of planning -- a Kremlin-sized bright red flag all by itself:

"Most telling to the court is the timing of the transfers, one day prior to the March 28, 2009 maturity date of the BankEast Note, and the haste with which the General Warranty Deed, Memorandum of Trust, and Quit Claim Deed were recorded, especially in light of the Debtors' stated intention that they wanted to keep the properties in their family."

The court also gave its version of "reasonably equivalent value" as:

[T]he proper focus is on the net effect of the transfers on the debtor's estate, the funds available to the unsecured creditors. As long as the unsecured creditors are no worse off because the debtor, and consequently the estate, has received an amount reasonably equivalent to what it paid, no fraudulent transfer has occurred."

Students of fraudulent transfer law will recognize this as a variant of the "utility to creditors" definition that is included in the official comments to the UFTA, and as a definition which potentially guts many transfers made to defeat creditors even if they facially appear to satisfy the "reasonably equivalent value" test that recurs throughout the UFTA.

Anyhow, an interesting opinion that is well worth the time to read.

Full Opinion at http://www.goo.gl/ASpHB

In re Schofield-Johnson, LLC, 2011 WL 4433653 (Bkrtcy.M.D.N.C., Slip Copy, Sept. 22, 2011).

This case involves the Husband who won a $1,000,000 award, and had the check deposited into his wife's name. Husband then then fought with the IRS over whether the award was taxable or not, and he lost to the IRS.

After Husband lost, Wife set up an LLC "for the dual purposes of protecting assets against any potential malpractice claims ([Wife] is a physician) and developing family land." Into this new LLC, Wife contributed the settlement proceeds.

The IRS simply levied directly on the new LLC, and Husband and Wife screamed bloody murder because Husband had absolutely no ownership interest in the LLC. Husband then filed for bankruptcy to try to wash out the IRS and claimed that he had no assets.

The IRS won on the dual grounds that Wife was simply acting as Husband's nominee, and also Husband's transfer to Wife and her transfer into the LLC was a fraudulent transfer.

And here's where we get to the really interesting part. A theory has floated around from time-to-time that a transfer to an LLC should not be a fraudulent transfer because the debtor received something back in exchange, i.e., the LLC units for like value. So what did the Court think of hte argument?

The Court finds that Victoria's receipt of 91% of the ownership of a company over which she had complete control and dominion does not constitute reasonably equivalent value for the assets.

So much for that theory, at least where the debtor directly or indirectly controls the entity (which makes perfect sense). However, in a different case where the debtor does not control the entity, the outcome might be different.

Anyhow, this Opinion is a good read on fraudulent transfers and how a creditor might bypass defenses by simply levying on the transferee entity.

Full Opinion at http://goo.gl/VphHg

In re Jevic Holding Corp., 2011 WL 4345204 (Bkrtcy.D.Del., Slip Copy, Sept. 15, 2011).

This case involves a trucking company that was failing, went through a refinancing, continued to fail, and then tried a restructuring, etc., but still eventually failed. While all of this was going on, some creditors saw their rights diminish through the financial hijinks, and eventually brought an adversary action that alleged fraudulent transfer and other theories.

This opinion is interesting for its lengthy and detailed commentary on the so-called theory of "collapsing fraudulent transfers", which is described thusly:

The Third Circuit has recognized the propriety of collapsing multiple transactions and treating them as one integrated transaction for the purpose of assessing a defendant's fraudulent transfer liability. * * * The collapsing concept is usually applied when a series of transactions actually comprise a single integrated transaction, notwithstanding the fact that the 'formal structure erected and labels attached' make them appear distinct. * * * [T]he Third Circuit explained that where a series of transactions were all "part of one integrated transaction," a court could look "beyond the exchange of funds" in one transaction and consider the " aggregate transaction."

As asset protection planning becomes more sophisticated, so must our understanding of collapsing fraudulent transfers, and thus why this opinion is a great read.

Full opinion at http://www.goo.gl/7Q7F8

In re Pitt Penn Holding Co., Inc., 2011 WL 4352373 (Bkrtcy.D.Del., Slip Copy, Sept. 16, 2011).

This is a very interesting case by a creditor of a company claimed to be a massive stock fraud against three educational institutions that were gift recipients of the company's stock through the company's profit-sharing plan benefiting its owners.

[Note: As a general matter, it is very easy for scam artists and securities fraudsters to make generous charitable donations to build their personal reputations and thus attract more investors, since of course it is not their money that they are donating -- don't ever let the fact that somebody is making generous charitable donations deceive you since they still might not be on the up and up.]

The creditor brought an adversary action for fraudulent transfer under the federal bankruptcy code sec. 544 as well as claims for unjust enrichment, and the schools moved to dismiss. In a nutshell, the creditor's fraudulent transfer claim survives the motion to dismiss, but the unjust enrichment claim does not. Getting to this result is an opinion that is chock-full of juicy fraudulent transfer issues, such as whether the stock had any value or whether any transfer took place -- this opinion could by itself be a lesson as to what constitutes a fraudulent transfer under the bankruptcy law provisions.

Full Opinion at http://www.goo.gl/XhpMI

In re Racsko, 2011 WL 4344300 (Bkrtcy.E.D.Tenn., Slip Copy, Sept. 14, 2011).

Sometimes debtors believe that so long as they give stuff to their kids, or to benefit their kids, all will be well despite any other circumstances. Such debtors couldn't be any more wrong.

Sharon Racsko won $100,000 from her ex-husband's retirement account in 2003. Later, she ran into financial trouble and only then set up the Poppy Family Trust to which she contributed various assets including the approximately $80,000 in after-tax dollars that she had been awarded from the retirement account. Under the trust, document she was designated " as Trustee of the Poppy Family Trust, granting her the right to change any beneficiary, amend any provision of the Trust, revoke the Trust in whole or in part, and withdraw any or all of the corpus, and also designates the Defendant's minor children as the sole beneficiaries of the Trust."

A year-and-a-half later, Sharon filed for bankruptcy and listed only a few assets -- but not the assets in the Poppy Family Trust. The court-appointed bankruptcy trustee then commenced an adversary action against Sharon, both in her individual capacity and as Trustee of the Poppy Family Trust, to recover transfers made to the Trust, including the retirement funds.

A fraudulent transfer case is usually pursued by a creditor down the both of two avenues: (1) actual fraud, meaning that the debtor had the intent to defraud creditors, and (2) constructive fraud, meaning that whether or not the debtor had the intent to defraud creditors, the totality of the circumstances indicate that is what took place.

While the bankruptcy trustee could not prove actual fraud against Sharon, it could prove constructive fraud based largely on the fact that she made the transfers while in financial distress and that the transfers lacked " reasonably equivalent value" when made, i.e., Sharon did not get anything back from the transfers that would have been of any value to her then-existing creditors.

Sharon's defense was largely that the moneys were meant for her children's welfare and were spent for that purpose, including fees for private tuition, a car for her daughter, religious donations on behalf of the children, and to pay the mortgage. But none of this provides any exception to the fraudulent transfer laws.

In the end, the bankruptcy trustee argued something like, "Sharon was in financial distress when she made these transfers, and the circumstances indicate that she did it to keep the assets out of the hands of her creditors." Regardless of her good heart towards her children, this was a winning argument for the Trustee, and thus the Court required Sharon to turn over the retirement funds to the Trustee.

As an aside, having found that a fraudulent transfer took place, the odds are good that we will next read about Sharon losing her discharge in bankruptcy. A good intention to protect your children does not create any special right to mess around with the bankruptcy courts.

Indeed, the point of all this is that distressed creditors have no special right to benefit their children, either directly or through a trust, but must instead preserve their assets for the benefit of their creditors. To say it bluntly: creditors trump children. Sometimes people will ask me if they can continue to make regular contributions to the children's educational funds as they have for a number of years, even though they are financially distressed now -- and the answer is an emphatic "no".

But all of this also points to an old lesson in asset protection planning, which is that one must start early before they run into difficulty, and not wait until the creditors are knocking on the door. If Sharon had created and funded the Poppy Family Trust back in 2003 when she first received the funds, the odds are good that they would have been protected from creditors when later she ran into financial trouble in 2008, since the four-year Statute of Limitations under the Uniform Fraudulent Transfers Act would have run.

Instead, Sharon waited until the skies darkened to pull in her sails, but by then it was too late -- and thus too late for her children too.

Full Opinion at http://www.goo.gl/EBkhO

Bogosian v. All American Concessions, 2011 WL 4460362 (E.D.N.Y., Slip Copy, Sept. 26, 2011).

The United States Tennis Association contracted with Restaurant Associates to provide catering services at the 2005 U.S. Open. Restaurant Associates then subcontracted with All American, a Florida corporation, to provide beverages at U.S. Open concession stands, including providing employees for those stands.

All American was a sole shareholder corporation, with its owner and officer Marty Rosen serving all roles. Although the contract between Restaurant Associates and All American required the latter to obtain adequate insurance, it did not do so.

The employees brought a class action against the USTA, Restaurant Association and All American for unpaid wages. The case eventually settled, with Restaurant Association paying $92,000 and All American and Rosen declining to participate in the settlement.

So, Restaurant Association sued All American for indemnification of the $92,000 which was not contested by All American. But the Restaurant Association also sought to pierce the corporate veil as to Rosen, which was Rosen contested.

Sole shareholder corporations stand up poorly to veil piercing claims. While the veil does not always fail, it fails much more than enough such that one should not count on it for asset protection. In fact, one should presume that the corporate veil of a sole shareholder corporation (or a single-member LLC) will fail -- because that seems to be most often the result.

As with most sole shareholder corporations, the "corporate formalities" were minimally maintained, as would be expected with somebody is having shareholders meetings with only themselves. It didn't help Rosen's cause that he failed to produce documents in discovery, leading the court to suspect that he was covering up a bad paper trail.

But most importantly, All American was undercapitalized for its purpose, i.e., not sufficiently capitalized to pay its liabilities for this particular transaction:

Here, the undisputed record, including Rosen's own deposition testimony establishes that, at the time All American entered the Contract, All American lacked the ability to perform.

In this context, it meant that All American did not have the financial strength to indemnify Restaurant Associates even though it agreed to do so.

Had All American purchased insurance against such claims as agreed, then Restaurant Associates would have been made whole and All American would have been deemed to have been adequately capitalized, but Rosen was "penny wise and pound foolish" when it came to the insurance.

Because All American was effectively judgment-proof, it was thus proper for the court to pierce the corporate veil, and here the Court did exactly that to the tune of the $92,000 to indemnify Restaurant Associates.

But, some might say, isn't the whole purpose of a corporation to protect against "unlimited liability"? And if one is required to constantly add capital, doesn't that negate the "unlimited liability" protection of a corporation?

No. The term "unlimited liability" means liability in excess of appropriate capital for a particular transaction, not liability in excess of the capital that is minimally required by the state or the initial capitalization. As the court said here,

Entry into a transaction without the present ability or expectation of ability to perform is sufficiently wrongful for veil piercing purposes.

A practical test that I have used over the years is that a corporation (or LLC, LP, etc.) must be sufficiently capitalized for its "O&O" meaning " Operations and Obligations".

This means that an entity should have at least the adequate capital for its foreseeable:

Operations: Has sufficient cash to carry on its ordinary and daily business activities

Obligations: Has sufficient assets to back its known liabilities.

Insurance can factor into this since insurance can go towards capitalization of unknown or unsuspected liabilities, and sometimes even indemnification claims of this type.

We have lately seen a rash of cases where the corporate veil was busted primarily for lack of adequate capitalization. Thus, business owners should take the time to analyze their O&O and make sure that they are now -- and continue to be -- adequately capitalized for whatever they are doing and whatever agreements they are entering.

Full Opinion at http://goo.gl/kQRr4

Marriage of Darian, Cal.App.4th Distr., Appeal No. G043746 (2011).

This case was won by fellow CAJP honorary member Raymond Goldstein, who is probably the best enforcer of family law judgments in California and perhaps nationwide.

Here, the debtor had a bunch of accounts and IRAs and tried to exempt them as a "private retirement plan" because ... uh ... he intended to use the money for retirement. But both the trial court and appellate court correctly rejected the debtor's claim for exemption because simply holding accounts was nothing like a "plan" set up by a private employer:

One kind of exempt private retirement plan is a "private retirement plan[]." (§ 704.115, subd. (a)(1).) At first blush, this is an "unhelpful tautological definition." (In Re Barnes (Bankr. E.D. Cal. 2002) 275 B.R. 889, 896 (Barnes).) FN2 Courts have straightened out the circularity by gleaning additional elements of an exempt plan. First, "section 704.115(a)(1) applies only to retirement plans set up by private employers, 'not by individuals acting on their own, outside of the employment sphere.'" (Simpson, supra, 557 F.3d at p. 1018.) Second, a plan is not "exempt merely by virtue of its name." (In re Bloom (9th Cir. 1988) 839 F.2d 1376, 1378 (Bloom).) It must be actually "used and designed for retirement purposes." (Ibid.; accord Yaesu, supra, 28 Cal.App.4th at p. 14.) These additional elements make sense because "the amount exemptible in a private retirement plan under section 704.115(a)(1) is unlimited," instead of being "limited to what is necessary to support a debtor." (Barnes, supra, 275 B.R. at pp. 896-897.) Without the "private employer" and "designed and used for retirement" requirements, debtors could shield their every penny by unilaterally dubbing their bank accounts "retirement plans." (See id. at p. 897.)

Full Opinion at http://www.goo.gl/6hJYg

U.S. v. Ellefsen, ___ F.3d ____, 2011 WL 3962844 (8th Cir., Sept. 9, 2011).

This opinion is what in my office we call a "Dumb Doctor Case" (a/k/a "DDC") which refers to a physician who does something stupid while thinking he or she is outsmarting everybody else. This opinion does not have any significant creditor-debtor aspects, but it is interesting and a good opinion to provide to those clients who are convinced that they can get away with offshore tax evasion if only it is sophisticated enough.

Here, an orthopedic surgeon and his business-manager brother got hooked up with James Quay and the Aegis Business Trust System, which was later to result in the criminal tax evasion convictions of probably most of their clients. Even before they committed to it, the surgeon's CPA went to a presentation and warned the surgeon:

"It seems to me that the promoters are relying on an elaborate chain of complex entities to conceal taxable income. They have concocted a series of transactions to cloak earned taxable income from rendering patient services in Carthage, Missouri into non-reported foreign source income and then arranging to lend or gift the money back to you. I am especially suspicious when I learned that they will provide you with a Visa card to access the money. They have also represented that you will have a power of attorney that will allow you to transfer funds at will. You will be earning the income by performing services and you will be enjoying the benefits of the income. Therefore it is reasonable that the I.R.S. could potentially look through this masquerade and say that it is taxable income to you regardless of the structure.

"I am asking that you consider the worst case scenario in which the I.R.S. takes the position that you are committing tax evasion. They have the power to assess huge penalties and interest, to prosecute you, to ruin your career, and seize your property. Is the risk worth it?"

Even with this advice, the surgeon and his brother went ahead with Aegis, and are now probably sleeping the floors of the prison hospital.

Another Dumb Doctor who thought he could save money on income taxes by outsmarting the system.

Full Opinion well worth reading at http://www.goo.gl/Kx3O3