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U.S. v. Kimball Case Supports the Use of a 541 Trust – Even Against IRS Lien

One of the simplest planning techniques to protect against claims from creditors, even the IRS, is to use a properly drafted irrevocable non self-settled trust. For generations, courts have found that these types of trusts will not be accessible by the creditors of the individual creating the trust.

In U.S. v. Kimball, Jr., 117 AFTR 2d 2016-811, (DC ME), 06/24/2016, the United States District Court District of Maine addressed two separate counts.  The first count was granted on summary judgment, resulting in a judgment of $1,090,700.05 in unpaid taxes and penalties against Mr. Kimball as an individual.  The second count was an attempt to have the tax lien attach to a trust that Mr. Kimball created. The Court denied the second count on summary judgment. In other words, the assets in the trust were safely protected from the tax lien.

The Court found that the trust was not the property of Mr. Kimball and the tax lien should not attach to the trust property.  Mr. Kimball created the trust naming his children as beneficiaries and himself as trustee.  The trust included flexible provisions, but the trust restricted any changes that would cause Mr. Kimball to become a beneficiary of the trust.  In the event of changes to the trust, the relevant property would go to the beneficiaries of the trust, and not to Mr. Kimball.

The type of trust used by Mr. Kimball was a non-self-settled trust.  This type of trust is a trust that does not name the settlor as a beneficiary, but instead the trust names a third party as the beneficiary of the trust (i.e. naming the settlor’s spouse or children as beneficiaries).  Because the trust is not “self-settled” the creditors of the settlor cannot reach into the trust, so long as there are no fraudulent transfers into the trust.

A powerful asset protection solution is to combine the asset protection benefits from using a non-self-settled trust with the flexibility provided by the grantor retaining a special power of appointment.  A special power of appointment is a tool that provides the settlor with a lot of flexibility while still protecting the trust from creditors’ claims. Court cases and statutes going back over 200 years have consistently held that a special power of appointment is not subject to creditors.  We have created such a trust with these unique characteristics.  We call our unique trust a 541 Trust.

A non-self-settled trust has provided an elegant and powerful solution for solid asset protection.  Asset protection does not need to be complicated and does not need to use a new and untested planning technique. When properly funded and operated correctly, a 541 Trust is one of the most efficient, flexible, and effective creditor protection strategies available.

We have perfected the 541 Trust to obtain the best in asset protection with the flexibility to adjust for changing circumstances.  There are generations of court cases demonstrating that it is extremely unlikely that a creditor will be able to access the assets in a 541 Trust.

Want to get the best in asset protection or learn more about the 541 Trust and why the Kimball Court, on summary judgement, denied the IRS’ attempt to attach a tax lien to the trust, please call us at 801-765-0279.

What is a Trust?

What is a Trust?

A trust is one of the most common estate planning techniques available.

While there are many different variations of trusts, they all share the same basic structure.

The creator of the trust is called the grantor who signs an agreement with a trustee who agrees to hold assets in trust for the grantor’s chosen beneficiaries. Sometimes the grantor and the trustee are the actually the same person.

Think of the trust like a bucket.

The grantor creates a bucket and puts assets into it, such as bank accounts and a home.

The trustee’s job is to hold the bucket handle and the assets “in trust” for the beneficiaries named by the grantor.

The trustee administers the trust according to the rules laid out by the grantor including how and when to take assets out of the bucket and give them to the beneficiaries.

The benefits of trusts can include:

probate avoidance
flexibility
cost savings
tax planning
privacy; and
peace of mind

Watch for other videos where I describe specific types of trusts in more detail.

As always you can call us 801-765-0279 for a free consultation.

What is a NING Trust?

A NING Trust has HUGE potential for state income tax savings. Watch this video see how it works and to learn how you could save state income tax.

NING Trust stands for Nevada Incomplete-gift Non-Grantor Trust

Here’s how it works

The Settlor establishes an irrevocable trust in a state which has no state income tax such as Nevada.

Contributions to the trust have no gift tax consequences and the trust files and pays its own income taxes. When the trust earns income it pays federal income tax but because it is established in Nevada it pays no state income tax on undistributed income.

Here’s an example:

A Utah resident transferred stock in the company he founded to a NING Trust. Some time later, the NING Trust sold that stock for $5 million dollars. The trust paid federal income tax but saved the 5% Utah income tax because it is a Nevada resident and taxpayer. That’s a savings of $250,000. A California resident would have saved or deferred up to $665,000 based on California’s current top tax bracket 13.3%.

The IRS approved this in a private letter ruling in 2013 (20131002). It is crucial that a NING Trust is properly drafted so that it provides the desired benefits.

McCullough Sparks has years of experience preparing this type of trust and have seen numerous clients save or defer millions in state income taxes.

Call 801-765-0279 for a free consultation to see if a NING Trust works for you.

Best Asset Protection Trust isnt an Asset Protection Trust

Could it be true that the best trust for asset protection isn’t even an asset protection trust? It may sound strange, but the legal precedent proves it to be true.

Whenever you hear the term “asset protection trust” it almost exclusively refers to a self-settled spendthrift trust. This where the settlor establishes and funds an irrevocable trust naming themself as a beneficiary. The trustee is an independent party who can make distributions from the trust to the settlor. So what does this mean? It means that the settlor can give money or assets to the independent trustee of an “asset protection trust” so future creditors can’t touch those assets. It also promises that the trustee can give the assets back to you at any time. This sounds pretty awesome right!

The problem is that self-settled trusts have historically provided zero asset protection in the United States. Generations of US laws have made it clear that your creditors can reach into a trust that you create if you are also the beneficiary.

This includes dozens of US court cases successfully attacking the assets of offshore asset protection trusts and none to the contrary.

Likewise, domestic self-settled asset protection trusts have failed in the only court cases to date.

So if quote Asset Protection Trusts have a dismal record in protecting assets, what is the solution?

The solution lies right in front of us. Generations of US legal precedent has made it perfectly clear that a non self-settled trust has ALWAYS worked. As opposed to creating a trust and naming yourself as the beneficiary, this trust names a third part as the beneficiary, such as the settlor’s spouse or children. Because the trust is not “self-settled” the creditors of the settlor cannot reach into the trust, so long as there are no fraudulent transfers into it.

We’ve also learned that a special power of appointment is a tool that provides infinite flexibility without subjecting a trust to creditors. Court cases and statutes going back over 200 years have consistently held that a special power of appointment is not subject to creditors, without exception.

We call this a 541 Trust because it is canonized in Section 541(b)(1) of the US Bankruptcy Code, as well as multiple other statutes and court cases nationwide dating back generations. The 541 Trust is superior to what are traditionally called Asset Protection Trusts because:

1. It works in all 50 states and in bankruptcy courts and has for over 200 years.
2. It works for any asset in any location.
3. It is proven by court cases for generations. We can actually show you court cases and other examples where our trusts were upheld.
4. It’s simple to understand, implement, and operate unlike the extremely complex structures associated with offshore trusts
5. It is infinitely flexible and can be modified at any time.
6. It is a fraction of the cost of an offshore trust structure and doesn’t have high annual maintenance charges or complex IRS reporting.

Nobody prepares this trust as well as we do. We pioneered it, we perfected it, and we have seen it succeed in every challenge. Some have criticized the 541 Trust but the legal precedent and the continued court support remains. It doesn’t matter what we say or what others say. The only thing that matters is what the courts say. The courts have spoken in favor of the 541 Trust over and over again.

So technically speaking, a 541 Trust isn’t an asset protection trust. It just happens to protect assets better than the types of trusts referred to as asset protection trusts.

CALL 801-765-0279 for more information

Common Questions You Might Have About Estate Planning

The topic of estate planning and creating a will can sometimes be a difficult subject to bring up, but it’s a very important topic to discuss with your loved ones, and with an experienced estate planning attorney. Estate planning, when done properly, can ensure that your affairs are handled properly after you pass on, that your family is taken care of, and the inheritance and property is shielded from unnecessary taxes and fines.

Do I Need a Will or a Trust?

Both wills and trusts can be commonly used estate planning tools, and you may want to have both depending on your situation. The main differences that you will find between the two are that wills are only effective after your death, whereas trusts can become effective immediately (or at a specified time in the future); wills are directives used to distribute property or appoint a legal representative after your death, whereas trusts can distribute property at any time prior to or after your death; wills cover all of your assets, whereas trusts only cover items that are specifically placed in the trust; and finally, wills are public documents while trusts can remain private if you choose. An experienced estate planning attorney can help you decide which is right for you.

How Important is Power of Attorney?

Granting someone “power of attorney” (POA) is a very important step in estate planning because it designates someone who can make legal decisions for you in the event you are unable to make them on your own. These can include financial decisions as well as medical or legal ones, so the person you appoint to this duty should be someone you trust and someone who knows what you would want. Without POA, these decisions could be left up a judge in the courts, who is likely a stranger and will have no idea what you would have wanted.

How Often Should I Update an Estate Plan?

The best answer to this question is: as often as you need to. While there is no set time frame for updating your documents, you should make sure to revisit them any time you have a significant life event take place. This might include things like:

  • Marriage or divorce
  • Additional children, whether by birth, adoption, or marriage
  • Death of a spouse
  • Significant changes to your assets
  • Relocation
  • Changes to tax laws, or the status of guardians, trustees, or executors

Since you may not know when the tax laws change, in the absence of any of the other events, it’s a good idea to visit with an estate planning attorney in Utah about once every five years to be sure yours is up to date.

What Happens if My Family Contests My Will?

The death of a family member can be a very difficult time, and sometimes other issues within the family spill over when settling an estate plan. Fortunately there are things you can do to protect the directives spelled out in your will, even in the face of a legal challenge after your death. Having a plan that is created and properly executed by an estate planning attorney is the best way to protect against this. It’s also helpful to discuss your wishes and plans with family members while you are alive to avoid surprises.

Estate planning can be complicated, so to answer all your questions and get started on your estate plan, call an experienced attorney today.

The 4 Most Important Assets to Protect in Your Estate

If you are thinking about how to protect your legacy, you have probably heard about and perhaps learned a little about estate planning in Utah. Many people are curious about what types of assets they should be protecting when they begin building an estate plan, and it’s important to get the right legal advice to help you protect your most valuable items and your overall net worth.

Customizing an Estate Plan

There is no clear-cut definition of exactly what assets you must protect with your estate plan, and it’s important that you work with an attorney that recognizes that each plan is unique and should be customized according to your individual financial situation, your assets, and your plan for the future. These plans can also help you define exactly how your heirs will receive their inheritance to avoid problems later down the road, and can take into account things like death, remarriage, divorce, lawsuits, and bankruptcy. Finally, your estate plan should be designed to avoid the hassle and unknowns associated with probate, prevent losses from gift or estate taxes, and carry out the transfer of your assets according to your wishes.

Four Assets to Protect

While every estate plan should be individualized, there are a few common assets and some traditional wealth accumulation that many people want to protect.

  • Retirement Accounts – If you have been saving money in an Individual Retirement Account (IRA), a 401(k), profit sharing, pension funds, survivor benefits, or any similar retirement account, you want to make sure that your heirs will be able to access this money after you are gone. If you have a significant amount of wealth that you have accumulated through similar investment accounts, it’s important to have an attorney that can help you understand the laws associated with transferring this wealth.
  • Your Home and Property – Another part of every estate is the family home, as well as any additional property, such as vacation homes, rental properties, and more. This is often one of the largest single assets in an estate, and should be protected and passed on to your heirs in the way that you would prefer.
  • Business Ownership or Income – When you own a business, it’s critical that you create an estate plan that takes into account these assets. Your family might want to continue to run the business for income, or they may prefer to sell it when you are gone, but either way you want to make sure that your surviving beneficiaries divide up the ownership or profits from that business (or sale of the business) in the way that you envisioned.
  • Heirlooms – Finally, you should consider any valuable family heirlooms that you might want to pass along to your beneficiary (or beneficiaries) after you pass away. In some cases these things might have specific monetary value, while in other situations they will carry more emotional value, but either way you want to ensure that they are in the right hands when your estate is divided.

While this is not necessarily a comprehensive list of all the assets you might want to protect, these four are essential items to address during estate planning. Talk to an attorney today to find out more and get started customizing your own estate plan.

SEC v Greenberg – Offshore Trust Contempt

 

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
v.
KEITH GREENBERG, Defendant.

(SEC v Greenberg)

Case No. 00-09109-CV-HURLEY/HOPKINS.
United States District Court, S.D. Florida.
May 21, 2015.

ORDER ADOPTING THE REPORT AND RECOMMENDATION OF MAGISTRATE JUDGE, AND HOLDING DEFENDANT KEITH GREENBERGIN CONTEMPT

DANIEL T.K. HURLEY, District Judge.

THIS CAUSE comes before the Court upon the Report and Recommendation [ECF No. 67] of Magistrate Judge James M. Hopkins on Plaintiff Securities and Exchange Commission’s Application for an Order to Show Cause Why Defendant KeithGreenberg Should Not Be Held In Contempt of Court [ECF No. 27].

BACKGROUND

A. FINAL JUDGMENT

In 2002, the Court entered Final Judgment of $5,915,346 against Defendant KeithGreenberg.[1] Through default, Greenberg admitted to violating the Securities Act and the Securities Exchange Act, as well as regulations promulgated thereunder.[2]The Final Judgment is comprised of a civil penalty of $100,000, disgorgement of $3,828,000, and prejudgment interest of $1,987,346.[3]

By 2010, Greenberg had paid nothing.[4] In late 2010, the SEC learned thatGreenberg lived an “extravagant lifestyle.”[5] On August 11, 2011, Defendant paid $114,592.35 to the SEC,[6] following the sale of a condominium. The SEC applied the payment to Greenberg’s civil penalty.[7] Greenberg paid nothing further.

By September 13, 2013, Greenberg owed the SEC $6,883,580.48.[8] Interest accrued at $288 a day.[9] On November 26, 2013, the SEC moved the Court for an Order to Show Cause Why Defendant Keith Greenberg Not Be Held in Contempt of Court.[10] In March 2014, Greenberg began paying $2,500 to $3,750 a month.[11]

The Court granted the SEC’s Motion to Show Cause on November 26, 2013, and referred the Motion to Magistrate Judge James M. Hopkins for an evidentiary hearing.[12] The Magistrate held three such hearings on October 15, 2014, October 16, 2014, and November 3, 2014, at which he admitted into evidence both testimony and exhibits.[13] This is what he found:

B. FINDINGS OF FACT

Mrs. Elise Greenberg created the Elise Trust in 1996.[14] From 1996 to 2011, KeithGreenberg’s efforts grew the Elise Trust from $1 million to $6-7 million in assets.[15]

The Elise Trust owns a condominium in Miami, Florida.[16] The Greenbergs lease this condominium from the Elise Trust.[17]

The Raintree Development Irrevocable Trust owns a house in Goldens Bridge, New York.[18] The Greenbergs lease this house from the Raintree Trust.[19]

At both their condominium in Miami and their house in New York, the Greenbergs have access to two luxury vehicles and a golf membership, all paid for by the Trusts.[20]

Braintree Properties, LLC is a New York company.[21] Braintree makes money by investing in medical centers.[22] From June 2006 to September 2011, Braintree paid $2,151,753 of the Greenbergs’ personal expenses.[23]

Greenberg was a consultant for the consulting firm, J.D. Keith, LLC.[24] J.D. Keith had a contract with a medical firm paying $10,000 a month for 22 months.[25]Between 2004 and 2006, the medical firm also personally paid Greenberg $83,000.[26]

In 2006, Braintree sold some of its medical centers to the medical firm.[27] Because of accounting issues, a dispute arose, and Braintree and the medical firm entered into a settlement agreement.[28] Under the agreement, the medical firm agreed to payGreenberg $600,000 personally over five years, provide him a $38,400 automobile expense, and reimburse him for entertainment and travel expenses.[29] These payments were made payable to the firm J.D. Keith in the amount of $635,538.[30]Greenberg used this money from J.D. Keith to pay his personal expenses.[31]

Vantage Beach Holdings, LLC was formed in 2010.[32] The Elise Trust owns and funds Vantage Beach.[33] Vantage Beach has recently replaced Braintree in paying the Greenbergs’ personal expenses.[34]

Together, the Raintree Trust, Braintree, J.D. Keith, and Vantage Beach are known as “the Entities.”

Before the Court entered Final Judgment in 2002, the Greenbergs owed more than $2,000,000 to the IRS.[35] By 2005, that amount totaled $7,750,000.[36] From 2006 to 2008, the Greenbergs made partial payments to the IRS by withdrawing funds from the Entities.[37] The IRS has written off $5 million and as of October 2014, the Greenbergs owed the IRS $675,000.[38]

DISCUSSION

A. CONTEMPT STANDARD

A court may enforce a final judgment of disgorgement, including prejudgment interest and civil penalties, through its contempt power.[39] To hold a defendant in contempt, the plaintiff must prove by “clear and convincing” evidence that the defendant violated the final judgment.[40] This requires proving that “(1) the allegedly violated order was valid and lawful; (2) the order was clear and unambiguous; and (3) the alleged violator had the ability to comply with the order.”[41]

If the plaintiff proves its prima facie case, the defendant may assert his “present inability to comply” as a defense.[42] To assert this defense, the defendant must prove “that he has made `in good faith all reasonable efforts'” to comply with the final judgment.[43] If he does so, the burden shifts to the plaintiff to prove the defendant’s “ability to comply.”[44]

B. REPORT AND RECOMMENDATION

The Magistrate concluded that Greenberg had the ability to comply with the Final Judgment, but that he did not. Accordingly, the Magistrate recommends thatGreenberg be held in contempt. He also recommends that:

Defendant shall be incarcerated until such time as he satisfies the Judgment to the greatest extent he is able, or provides evidence that he has taken all reasonable efforts to comply with the Judgment yet is unable to make any payment.[45]

The Court must review the Report and Recommendation’s legal conclusions, as well as those objected to portions, de novo.[46] It must be satisfied that there is “no clear error on the face of the record.”[47] Upon this review, the Court will overruleGreenberg’s objections, sustain the SEC’s, and adopt the Report and Recommendation.

OBJECTIONS

A. OBJECTION 1: “HAD THE ABILITY TO PAY”

Greenberg objects to the Report & Recommendation, arguing that the Magistrate considered Greenberg’s past, not present, ability to comply with the Final Judgment. According to Greenberg, the Court must look only to his present ability to comply. Defendant objects as follows:

The Magistrate Judge committed legal error by misapplying the legal standard for civil contempt holding: “In this case, the only issue in dispute is whether Defendant had, at some point since the Judgment was entered in 2002, the ability to pay some or all of that Judgment.” Having misstated the criteria, the Magistrate Judge erroneously concluded that the SEC had met its burden “. . . to show, clearly and convincingly, that Defendant had the ability to pay.”[48]

Greenberg is partly correct as what issues are in dispute, but the Magistrate Judge did not err. The SEC’s burden is to prove that Greenberg “had the ability to comply” with the Final Judgment. The burden then shifts to Greenberg to prove his “present inability to comply.” According to Greenberg, “the Magistrate Judge points to no proof, much less clear and convincing proof, of Mr. Greenberg’s present ability to comply.”[49] Such proof, however, is not the SEC’s burden. The burden is onGreenberg to prove his present inability to comply—only then does the burden shift to the SEC to prove a present ability. The Eleventh Circuit states the requirements follows:

A party seeking civil contempt bears the initial burden of proving by clear and convincing evidence that the alleged contemnor has violated an outstanding court order. Once a prima facie showing of a violation has been made, the burden of production shifts to the alleged contemnor, who may defend his failure on the grounds that he was unable to comply. The burden shifts back to the initiating party only upon a sufficient showing by the alleged contemnor. The party seeking to show contempt, then, has the burden of proving ability to comply.[50]

Because the SEC proved Defendant had the ability to comply, the SEC satisfied its burden. The Magistrate did not apply the wrong legal standard, and appropriately concluded that the SEC had proved its prima facie case for contempt. Greenberg’sfirst objection is overruled.

B. OBJECTION 2: “PRESENT ABILITY TO COMPLY”

Next, Greenberg objects to the Report and Recommendation, arguing that the recommended incarceration is unconstitutionally punitive. If Greenberg cannot comply with the Final Judgment, then incarceration would be criminal, not civil, contempt. Greenberg would have `no keys to his prison.’[51] The question, then, is whether Greenberg proved his “present inability to comply.” “Present” means from the time of the contempt hearing to the time of the contempt citation.[52] The Magistrate reviewed Greenberg’s arguments on this question, and, based on his findings, concluded each was wanting.

First, the Magistrate found that Greenberg used the Entities to pay his personal expenses. Had he wished, the Magistrate concluded, Greenberg could also use the Entities to pay his Final Judgment.[53] Second, the Magistrate concluded thatGreenberg should have asked the Elise Trust whether it would sell one of its cars, or rent one of its homes, to allow Greenberg to pay his Final Judgment. The Magistrate found “it to be beyond belief” that the Elise Trust would not, if it were asked, “agree to a compromise” to avoid Greenberg’s contempt.[54] Third, the Magistrate found that Greenberg withdrew money from the Entities to pay the IRS. Defendant, the Magistrate concluded, could do same for the SEC.[55] Finally, the Magistrate concluded that Greenberg’s monthly payments, compared to the findings of his “lavish lifestyle,” were insufficient to show his good faith to comply with the Final Judgment.[56] Upon de novo review, the Court not only agrees with the Magistrate’s conclusions, but finds additional support for them in the record. The record shows that although Greenberg has no “assets,” not even a personal bank account,[57] the Entities have become his piggy bank.

For example, Braintree purchased a Miami condominium for Greenberg in his own name.[58] Braintree paid to renovate the condominium, Braintree made its mortgage payments, and Braintree paid the condominium fees.[59] Vantage Beach, the Entity which replaced Braintree in paying Greenberg’s personal expenses, listsGreenberg as the sole checking account signatory.[60] From 2011 to 2012, Vantage Beach paid to renovate the Greenbergs’ condominium.[61] Furthermore, the Raintree Trust, which owns the Greenbergs’ New York home, has no accounting records and has not filed any tax returns since 2010.[62] As Greenberg testifies: the Raintree Trust “is clearly a, you know, among other things an asset protection, you know, vehicle.”[63]

For these, and the reasons cited in the Report, the Magistrate correctly concluded that Greenberg could use some, or all, of the Entities to pay or make reasonable efforts to comply with his Final Judgment. Such efforts could include selling or renting the New York home, selling or renting the Miami condominium, terminating the lease on the luxury cars, terminating the golf memberships, and withdrawing funds from the Entities.

C. “100% OWNED BY THE ELISE TRUST”

The SEC makes one objection to the Report and Recommendation. It objects to the finding that Braintree is “100% owned by the Elise Trust.” Because ownership of Braintree is immaterial to the Court’s present order, it will sustain the SEC’s objection and leave this question unresolved.[64]

CONCLUSION

Accordingly, it is hereby

ORDERED and ADJUDGED that:

1. The Report and Recommendation of Magistrate Judge James M. Hopkins [ECF No. 67] is ADOPTED in its entirety and incorporated herein by reference.

2. Plaintiff Securities and Exchange Commission’s Objections to Magistrate’s Report and Recommendation [ECF No. 68] are SUSTAINED.

3. Defendant Keith Greenberg’s Objections to the Magistrate’s Report [ECF No. 69] are OVERRULED.

4. Defendant Keith Greenberg is in CONTEMPT OF THIS COURT. It is hereby further ORDERED that:

a. Keith Greenberg shall surrender to the custody of the U.S. Marshal’s Office for the Southern District of Florida, located at the Paul G. Rogers Federal Building and U.S. Courthouse, 701 Clematis St., West Palm Beach, Florida, 33401, by 12:00 p.m. on Monday, June 1, 2015.

b. The U.S. Marshals Service SHALL REQUEST designation from the Bureau of Prisons for the nearest appropriate federal facility to West Palm Beach, Florida, for Defendant Keith Greenberg’s further incarceration.

c. The U.S. Marshals Office for the Southern District of Florida SHALL NOTIFY the Court of the fact of Keith Greenberg’s appearance or non-appearance on June 1, 2015.

d. Defendant Keith Greenberg SHALL REMAIN incarcerated until such time that he has complied with the conditions set forth in the 2002 Final Judgment, or provides evidence that he has made in good faith all reasonable efforts to do so.

[1] Final J. on Disgorgement and Civil Penalties (Oct. 4, 2002) [ECF No. 26].

[2] Final J. of Permanent Inj. by Default Against Defs.’ Keith Greenberg and Coyote Consulting and Fin. Servs. (Apr. 4, 2002) [ECF No. 18].

[3] Final J. on Disgorgement and Civil Penalties [ECF No. 26].

[4] Mot. for Order to Show Cause at 2 [ECF No. 27].

[5] Id.

[6] Keith Greenberg Account, Motion for Order to Show Cause, Silberman Aff., Ex. D, [ECF No. 27-3].

[7] Id.

[8] Id.

[9] Id.

[10] [ECF No. 27].

[11] Id. at 2; see supra note 64

[12] [ECF No. 29].

[13] See [ECF Nos. 54, 57, 61].

[14] Report and Recommendation at 3 [ECF No. 67] [hereinafter R&R].

[15] R&R at 11; see note

[16] R&R at 5.

[17] Id.

[18] Id.

[19] Id.

[20] Id. at 4-5.

[21] Id. at 5.

[22] Id.

[23] Id.

[24] Id. at 6.

[25] Id. at 6-7.

[26] Id. at 6.

[27] Id.

[28] Id.

[29] Id.

[30] Id.

[31] Id. at 7.

[32] Id.

[33] Id.; Nov. 3, 2014 Hr’g 40:1-4.

[34] R&R at 7.

[35] Id. at 2; Def.’s Pre-Hr’g Br. at 4.

[36] R&R at 2; Def.’s Pre-Hr’g Br. at 4.

[37] R&R at 2; Def.’s Pre-Hr’g Br. at 4.

[38] R&R at 2.

[39] S.E.C. v. Solow, 682 F. Supp. 2d 1312, 1329-30 (S.D. Fla.) (Middlebrooks, J.), aff’d, 396 Fed. App’x 635 (11th Cir. 2010).

[40] Newman v. Graddick, 740 F.2d 1513, 1525 (11th Cir. 1984).

[41] Georgia Power Co. v. N.L.R.B., 484 F.3d 1288, 1291 (11th Cir. 2007)

[42] E.g., CFTC v. Wellington Precious Metals, Inc., 950 F.2d 1525 (11th Cir. 1992).

[43] Id.

[44] Id.

[45] R&R at 16.

[46] Fed. R. Civ. P. 72(b)(3); 28 U.S.C. § 636(b)(1)(C); LeCroy v. McNeil, 397 Fed. App’x 664 (11th Cir. 2010).

[47] Fed. R. Civ. P. 72 advisory committee’s notes (1983); Macort v. Prem, Inc., 208 Fed. App’x 781, 784 (11th Cir. 2006).

[48] Greenberg Objection at 8 (quoting R & R at 8-9).

[49] Id. at 10.

[50] CFTC v. Wellington Precious Metals, Inc., 950 F.2d 1525, 1529 (11th Cir. 1992) (citations omitted).

[51] There are two types of coercive contempt. With civil contempt, “the contemnor is able to purge the contempt and obtain his release by committing an affirmative act.” Int’l Union, United Mine Workers of Am. v. Bagwell, 512 U.S. 821, 844, (1994) (internal quotation omitted). Civil contempt coerces compliance: the contemnor “carries the keys of his prison in his own pocket.” Id.(citation omitted) (internal quotation marks omitted). With criminal contempt, “the contemnor cannot avoid or abbreviate the confinement through later compliance.” Criminal contempt is punitive: “the defendant is furnished no key.” Id. at 830 (internal quotation marks omitted) (citation omitted).

[52] The Eleventh Circuit’s “present” standard derives from the Second Circuit, which held that a defendant could not be held in contempt because “at the time of the contempt citations . . . he did not have the present ability to comply with the court’s order.” United States v. Wendy, 575 F.2d 1025, 1031 (2d Cir. 1978), cited in United States v. Koblitz, 803 F.2d 1523, 1527 (11th Cir. 1986), cited inJordan v. Wilson, 851 F.2d 1290, 1292 n.2 (11th Cir. 1988), quoted in McGregor v. Chierico, 206 F.3d 1378, 1382 (11th Cir. 2000), cited in Riccard v. Prudential Ins. Co., 307 F.3d 1277, 1296 (11th Cir. 2002), quoted in F.T.C. v. Leshin, 618 F.3d 1221, 1232 (11th Cir. 2010). And the Supreme Court, when reviewing a defendant’s “present inability to comply with the order in question,” looks to “the showing made by [the defendant] at the [contempt] hearing.” United States v. Rylander, 460 U.S. 752, 757 (1983).

[53] R&R at 11.

[54] R&R at 11.

[55] Id. at 12.

[56] Id. 13.

[57] Nov. 3, 2014 Hr’g 150:5-8 (“Q: Do you have any available assets to satisfy the existing judgment? A: No, only, only the income that I hope to continue to make to try to continue to satisfy the judgment.”); R&R at 3.

[58] Pl.’s Closing Ar., Exhs. 5, 6.

[59] Nov. 3, 2014 Hr’g 70:24-71:2; 72:2-24; Pl.’s Closing Ar., Ex. 56, at Bates No. FR 00001800.

[60] Pl.’s Closing Ar., Ex. 41.

[61] Nov. 3, 2014 Hr’g 40:5-14

[62] Id. 106:10-16.

[63] Id. 108:17-18.

[64] See infra note 11.

 

2012 Tax Law Means You May Need to Amend Your Revocable Trust

In 2012 Congress passed The American Taxpayer Relief Act, a new tax law that included 2 major changes.

  1. Estate/Gift Tax Exemption increased to $5 million each (adjusted for inflation). The individual exemption for 2015 is $5.43 million.
  2. The Estate Tax Exemption was made portable between spouses.

While both of these changes are beneficial they triggered a need to update most estate plans that were created prior to the 2012 law (and some trusts created after 2012). Revocable trusts created for a married person prior to 2012 likely have an outdated allocation formula.

Under the new law this old formula is now inapplicable and can have negative consequences. The old formula requires the funding of a bypass trust after the first spouse dies and re-titling assets.  Under the new portability laws, this is no longer necessary. If a trust isn’t properly updated it could result in the following consequences:

  • Excess administrative costs
  • Extra income tax return each year
  • All trust assets must be re-titled (real property, accounts, etc.)
  • Higher tax rates
  • Additional exposure to the 3.8% surtax
  • Loss of step-up in income tax basis on the death of the second spouse

We recommend that every revocable trust for a married couple that was created prior to 2012 be amended to include a more efficient allocation formula.

With our amendment we will simplify the trust formula so that it will not require re-titling of assets. It also limits exposure to higher tax rates and the 3.8 surtax on investment income, and may reduce the number of tax returns.  Our updated formula provides additional flexibility while simplifying administration and capturing the tax benefits of the new law.  We are unique in providing a formula that provides all possible tax benefits without requiring a re-titling of all of your assets after the death of a spouse.

Call us at 801-765-0279 for a free review of your revocable trust.

Corporate Minute Book: What should be included?

Maintaining corporate records and observing corporate formalities is critical for a corporate entity in Utah and other jurisdiction.  Among other benefits and protections, maintaining proper records can help justify a higher value a buyer might consider paying for the business, help prevent fraud and maintain regulatory compliance, and help reduce the risk of veil piercing. The “minute book” is the complete record of corporate governance.

Corporate minutes preserve official records of all actions taken at meetings of shareholders, directors or committees.[1] As a sample of the type of documents to include in the minute book of a corporation in Utah, the book should include documentation of all governance actions and discussions, including, in part, the following records[2]:

  • Articles of Incorporation (file stamped copy) and any amendments
  • Corporate bylaws and any subsequent amendments
  • Shareholder records
    1. Shareholder action appointing board of directors
    2. All shareholder actions by meeting
    3. All shareholder action by written consent
    4. All written communications to the shareholders
  • Board of Directors records
    1. Board approval of company organizational documents and establishment of basic operations
    2. Minutes of regularly held meetings of the board of directors signed by the Secretary of the corporation for important matters, such as:
      • Approving salaries of officers and other executives
      • Appointing the officers of the corporation
      • Establishing corporate policies and procedures
      • Unanimous written consents approving actions taken between meetings by the board
  • Reference Documents:
    1. Tax ID Number
    2. List of current officers and directors with their contact information
    3. List of all current shareholders with their contact information
    4. Tax filings
    5. Accounting records
    6. Financial records available for request by shareholders
    7. Copy of most recent annual report filed with the State of Utah
    8. Foreign jurisdiction authorizations and filings

Courts have found grounds for veil piercing upon a corporation’s failure to follow corporate formalities and to maintain proper records.[3] On the other side, maintaining proper corporate records generally might reduce the risk of veil piercing.[4] Courts will generally consider the totality of the facts and circumstances in considering whether to pierce a corporate veil. To reduce the risk of having the corporate veil pierced, corporations should maintain proper corporate minutes of meetings of shareholders, board of directors, and committees.

[1] Chapin v. Cullis, 299 N.W. 824 (1941).

[2] Utah Code Section 10a-16-1601.

[3] E.g., Quaglino Tobacco & Candy Co. v. Barr, 519 So. 2d 200 (La. Ct. App. 1987).  In Quaglino Tobacco & Candy Co. v. Barr, a Louisiana appellate court affirmed the piercing of the corporate veil to reach a corporation’s shareholder under the alter ego doctrine.[3]  In that case, the trial record showed that: (1) the corporation did not generate or maintain corporate minutes or documents; (2) there were no corporate resolutions authorizing the shareholder to enter into contracts on behalf of the corporation, and the shareholder regularly acted on behalf of the corporation; and (3) the shareholder operated and ran the business without proper corporate authority). Id.at 201.

[4] E.g., United States v. Fid. Capital Corp., 920 F.2d 827, 838 (11th Cir. 1991) (holding that the corporate veil should not be pierced upon fniding that the president did not commingle funds and the “corporate records and forms were scrupulously maintained.”   See also, Commercial Escrow Co. v. Rockport Rebel, Inc., 778 S.W.2d 532, 540–41 (Tex. Ct. App. 1989) (finding no alter ego where, among several other factors weighing in the defendants’ favor, there was no record evidence showing that corporate records and minutes did not exist).

Piercing the Corporate Veil: Corporate Formalities and Business Records

Corporations are generally treated to be a separate entity from its owners.[1]  However, the owners of a corporation (i.e. shareholders) might be held personally responsible for the debts of the corporation. Generally, this can happen when a court allows creditors to “pierce the corporate veil.”  A common deficiency that might lead to piercing the veil is the failure to follow corporate formalities.

Small businesses are less likely to follow corporate formalities.  These entities are more at risk of having the corporate veil pierced.  Corporations should comply with all contractual and statutory formalities, including, in part:

  • Hold annual meetings of directors and shareholders;
  • Keep accurate and detailed “minutes” that document the decisions and issues addressed during a meeting;
  • Adopt and maintain company bylaws;
  • Make sure that the officers, agents, directors, and shareholders abide by the bylaws;
  • Ensure the formation documents were properly filed and recorded;
  • Renew the entity and update the public record on a timely basis to avoid any lapse in registration; and
  • Maintain separate accounts and do not commingle the entity’s financial assets with the owners’ personal assets or make them available for personal use.

Following the formalities of a corporation is important to defend against an attack that tries to pierce the corporate veil.  Ultimately, a court might consider various factors when determining to pierce the corporate veil, such as evaluating whether:  (1) a corporation was engaged in fraud or promotes injustice; (2) an entity was inadequately capitalized; (3) an entity is an alter ego of another individual or group of individuals; and (4) an entity fails to follow corporate formalities.

If your company is at risk, you might consider having a qualified attorney assist in completing the corporation’s annual minutes.  In some cases a complete legal audit might prove beneficial to indentify vulnerabilities and additional risks from failing to maintain proper formalities.

[1] E.g., United States v. Bestfoods, 524 U.S. 51, 55-56 (1998).

Who Needs Asset Protection?

asset-protection-page

We are often asked when asset protection is necessary or helpful. Some believe asset protection might only be helpful once you accumulate millions of dollars in assets. This isn’t always true. We help many wealthy clients, but we also assist clients with only a few hundred thousand dollars in assets who want to protect those assets against outside liabilities.

Liability can arise for anyone. The risk of liability might come from driving a car, operating a business, being sued for professional malpractice, suffering economic downturns, engaging in bad investment deals, being subject to lawsuits, entering bankruptcy, and other similar risks. The key is to assess your specific situation and determine how to protect against those risks.

Here is a quick list of individuals who might benefit from some type of asset protection:

  • Professions with high liability risk (i.e. physician, dentist, attorney, accountant, engineer, and other similar professions)
  • Business Owners
  • Property Owners
  • Individuals who are close to retirement and want to protect retirement savings while still engaging in business ventures and other activities that might put retirement savings at risk.
  • Individuals who have accumulated substantial equity in real property, savings, or investments which with individual needs or wants to protect.

There are many ways to protect your assets such as maintaining liability insurance, using business entities for your business (corporations, LLCs, etc.), creating irrevocable trusts, and various other strategies. No two situations are exactly alike and everyone has different goals and risk tolerance. Finding the right solution to reach your goal is important.

We generally recommend that clients obtain adequate insurance coverage that frequently exceeds the minimum requirements. We can then analyze your situation and the available options to determine a plan that is unique to your situation.

Timing is important. It is essential to consider asset protection before a claim or liability arises. You can greatly reduce your risk exposure by implementing a plan before you are facing a claim or liability.

Hopefully, you will never need to test your asset protection plan. In any case, you will want the peace of mind and comfort of knowing that your plan will work and your assets are protected.  We provide a free consultation to help you determine the most effective and appropriate asset protection strategy for your situation.

IRS Private Letter Ruling 201310002 – NING Trust

The IRS Private Letter Ruling below approved the intended income tax treatment of a Nevada Incomplete Non-grantor Trust (NING Trust). It confirmed the intent of the grantor that the NING Trust was a Nevada resident for income tax purposes which results in no state income tax to the trust. This provides huge potential for income tax savings. 

Date: November 7, 2012

Refer Reply To: CC:PSI:B04 – PLR-120843-12

Re: * * *
LEGEND:

Date 1 = * * *
Grantor = * * *
Trust = * * *
Trustee = * * *
Son 1 = * * *
Son 2 = * * *
Son 3 = * * *
Son 4 = * * *

Dear * * *:

This letter responds to correspondence, dated October 12, 2012, and prior correspondence, requesting rulings under §§ 671, 2501, and 2514 of the Internal Revenue Code.

The facts submitted and representations made are as follows. On Date 1, Grantor created an irrevocable trust (Trust) for the benefit of himself and his issue, Son 1, Son 2, Son 3, and Son 4, and their issue. A corporate trustee (Trustee) is the sole trustee. During Grantor’s lifetime, Trustee must distribute such amounts of net income and principal to Grantor and his issue as directed by the Distribution Committee and/or Grantor, as follows: (1) At any time, Trustee, pursuant to the direction of a majority of the Distribution Committee members, with the written consent of Grantor, shall distribute to Grantor or Grantor’s issue such amounts of the net income or principal as directed by the Distribution Committee (Grantor’s Consent Power); (2) At any time, Trustee, pursuant to the direction of all of the Distribution Committee members, other than Grantor, shall distribute to Grantor or Grantor’s issue such amounts of the net income or principal as directed by the Distribution Committee (Unanimous Member Power); and (3) At any time, Grantor, in a nonfiduciary capacity, may, but shall not be required to, distribute to any one or more of Grantor’s issue, such amounts of the principal (including the whole thereof) as Grantor deems advisable to provide for the health, maintenance, support and education of Grantor’s issue (Grantor’s Sole Power). The Distribution Committee may direct that distributions be made equally or unequally and to or for the benefit of any one or more of the beneficiaries of Trust to the exclusion of others. Any net income not distributed by Trustee will be accumulated and added to principal. The Distribution Committee is initially composed of Grantor and Sons 1 through 4. The Distribution Committee will cease to exist upon Grantor’s death.

Trust provides that at all times at least two “Eligible Individuals” must be members of the Distribution Committee. An “Eligible Individual” means a member of the class consisting of the adult issue of Grantor, the parent of a minor issue of Grantor, and the legal guardian of a minor issue of Grantor. A vacancy on the Distribution Committee must be filled by the eldest of Grantor’s adult issue other than any issue already serving as a member of the Distribution Committee, or if none of Grantor’s issue not already serving as a member of the Distribution Committee is an adult, then the legal guardian of the eldest minor issue shall serve, or if such minor issue does not have a legal guardian, then the parent of such minor issue. If at any time fewer than two Eligible Individuals are members of the committee, the Distribution Committee shall be deemed not to exist.

Trustee, pursuant to the direction of the Distribution Committee, shall, at any time or times prior to or upon the distribution date, distribute to the trustee or trustees of any one or more qualified trusts such amounts of the net income and/or principal of Trust (including the whole thereof) as the Distribution Committee determines. Any such distribution shall be added to the principal of such qualified trust and disposed of in accordance with the terms of such qualified trust. No distribution or transfer may be made to a qualified trust unless made pursuant to the direction of the Distribution Committee.

Upon Grantor’s death, the remaining balance of Trust shall be distributed to or for the benefit of any person or persons or entity or entities, other than Grantor’s estate, Grantor’s creditors, or the creditors of Grantor’s estate, as Grantor may appoint by will. In default of the exercise of this limited power to appoint (Grantor’s Testamentary Power), the balance of Trust will be distributed, per stirpes, to Grantor’s then living issue in further trust. If none of Grantor’s issue is then living, such balance shall be distributed, per stirpes, to the then living issue of Grantor’s deceased father.

You have requested the following rulings:

  1. During the period the Distribution Committee is serving, no portion of the items of income, deductions, and credits against tax of Trust shall be included in computing the taxable income, deductions, and credits of Grantor under § 671.
  2. The contribution of property to Trust by Grantor is not a completed gift subject to federal gift tax.
  3. Any distribution of property by the Distribution Committee from Trust to Grantor will not be a completed gift subject to federal gift tax, by any member of the Distribution Committee.
  4. Any distribution of property by the Distribution Committee from Trust to any beneficiary of Trust, other than Grantor, will not be a completed gift subject to federal gift tax, by any member of the Distribution Committee.

RULING 1
Section 671 provides that where it is specified in subpart E of Part I of subchapter J that the grantor or another person shall be treated as the owner of any portion of a trust, there shall then be included in computing the taxable income and credits of the grantor or the other person those items of income, deductions, and credits against tax of the trust which are attributable to that portion of the trust to the extent that such items would be taken into account under chapter 1 in computing taxable income or credits against the tax of an individual.

Section 672(a) provides that, for purposes of subpart E, the term “adverse party” means any person having a substantial beneficial interest in the trust which would be adversely affected by the exercise or nonexercise of the power which he possesses respecting the trust.

Sections 673 through 677 specify the circumstances under which the grantor is treated as the owner of a portion of a trust.

Section 673(a) provides that the grantor shall be treated as the owner of any portion of a trust in which the grantor has a reversionary interest in either the corpus or the income therefrom, if, as of the inception of that portion of the trust, the value of such interest exceeds 5 percent of the value of such portion.

Section 674(a) provides, in general, that the grantor shall be treated as the owner of any portion of a trust in respect of which the beneficial enjoyment of the corpus or the income therefrom is subject to a power of disposition, exercisable by the grantor or a nonadverse party, or both, without the approval or consent of any adverse party.

Section 674(b) provides that § 674(a) shall not apply to the power in § 674(b)(5) regardless of by whom held. Section 674(b)(5)(A) describes a power to distribute corpus to or for a beneficiary provided that the power is limited by a reasonably definite standard which is set forth in the trust instrument.

Section 674(b)(3) provides that § 674(a) shall not apply to a power exercisable only by will, other than a power in the grantor to appoint by will the income of the trust where the income is accumulated for such disposition by the grantor or may be so accumulated in the discretion of the grantor or a nonadverse party, or both, without the approval or consent of any adverse party.

Under § 675 and applicable regulations, the grantor is treated as the owner of any portion of a trust if, under the terms of the trust agreement or circumstances attendant to its operation, administrative control is exercisable primarily for the benefit of the grantor rather than the beneficiary of the trust.

Section 676(a) provides that the grantor shall be treated as the owner of any portion of a trust, whether or not he is treated as such owner under any other provision of part I, subchapter J, chapter 1, where at any time the power to revest in the grantor title to such portion is exercisable by the grantor or a nonadverse party, or both.

Section 677(a) provides, in general, that the grantor shall be treated as the owner of any portion of a trust, whether or not he is treated as such owner under § 674, whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be (1) distributed to the grantor or the grantor’s spouse; (2) held or accumulated for future distribution to the grantor or the grantor’s spouse; or (3) applied to the payment of premiums on policies of insurance on the life of the grantor or the grantor’s spouse.

Section 678(a) provides that a person other than the grantor shall be treated as the owner of any portion of a trust with respect to which: (1) such person has a power exercisable solely by himself to vest the corpus or the income therefrom in himself, or (2) such person has previously partially released or otherwise modified such a power and after the release or modification retains such control as would, within the principles of §§ 671-677, inclusive, subject a grantor of a trust to treatment as the owner thereof.

Based solely on the facts submitted and representations made, we conclude an examination of Trust reveals none of the circumstances that would cause Grantor to be treated as the owner of any portion of Trust under §§ 673, 674, 676, or 677. Because none of the other Distribution Committee members has a power exercisable solely by himself to vest Trust income or corpus in himself, none shall be treated as the owner of any portion of the Trust under § 678(a).

We further conclude that an examination of Trust reveals none of the circumstances that would cause administrative controls to be considered exercisable primarily for the benefit of Grantor under § 675. Thus, the circumstances attendant on the operation of Trust will determine whether Grantor will be treated as the owner of any portion of Trust under § 675. This is a question of fact, the determination of which must be deferred until the federal income tax returns of the parties involved have been examined by the office with responsibility for such examination.
RULINGS 2 AND 3
Section 2501(a)(1) provides that a tax is imposed for each calendar year on the transfer of property by gift during such calendar year by any individual, resident or nonresident. Section 2511(a) provides that the tax imposed by § 2501 applies whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.

Section 25.2511-2(b) of the Gift Tax Regulations provides that a gift is complete as to any property, or part thereof or interest therein, of which the donor has so parted with dominion and control as to leave in the donor no power to change its disposition, whether for the donor’s own benefit or for the benefit of another. But if upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete, or may be partially complete and partially incomplete, depending upon all the facts in the particular case. Accordingly, in every case of a transfer of property subject to a reserved power, the terms of the power must be examined and its scope determined.

Section 25.2511-2(b) also provides an example where the donor transfers property to another in trust to pay the income to the donor or accumulate it in the discretion of the trustee, and the donor retains a testamentary power to appoint the remainder among the donor’s descendants. The regulation concludes that no portion of the transfer is a completed gift. However, if the donor had not retained a testamentary power of appointment, but instead provided that the remainder should go to X or his heirs, the entire transfer would be a completed gift.

Section 25.2511-2(c) provides that a gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title in himself or herself. A gift is also incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed or ascertainable standard.

Section 25.2511-2(e) provides that a donor is considered as himself having a power if it is exercisable by him in conjunction with any person not having a substantial adverse interest in the disposition of the transferred property or the income therefrom.

Section 25.2511-2(f) provides that the relinquishment or termination of a power to change the beneficiaries of transferred property, occurring otherwise than by death of the donor, is regarded as the event which completes the gift and causes the gift tax to apply.

Section 25.2511-2(g) provides that if a donor transfers property to himself as trustee (or to himself and some other person, not possessing a substantial adverse interest, as trustees), and retains no beneficial interest in the trust property and no power over it except fiduciary powers, the exercise or nonexercise of which is limited by a fixed or ascertainable standard, to change the beneficiaries of the transferred property, the donor has made a completed gift and the entire value of the transferred property is subject to the gift tax.

Section 25.2511-2(e) does not define “substantial adverse interest.” Section 25.2514-3(b)(2) provides, in part, that a taker in default of appointment under a power has an interest that is adverse to an exercise of the power. Section 25.2514-3(b)(2) also provides that a coholder of a power is considered as having an adverse interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself, his estate, his creditors, or the creditors of his estate.

In Estate of Sanford v. Commissioner, 308 U.S. 39 (1939), the taxpayer created a trust for the benefit of named beneficiaries and reserved the power to revoke the trust in whole or in part, and to designate new beneficiaries other than himself. Six years later, in 1919, the taxpayer relinquished the power to revoke the trust, but retained the right to change the beneficiaries. In 1924, the taxpayer relinquished the right to change the beneficiaries. The court stated that the taxpayer’s gift is not complete, for purposes of the gift tax, when the donor has reserved the power to determine those others who would ultimately receive the property. Accordingly, the court held that the taxpayer’s gift was complete in 1924, when he relinquished his right to change the beneficiaries of the trust. A grantor’s retention of a power to change the beneficial interests in a trust causes the transfer to the trust to be incomplete for gift tax purposes, even though the power may be defeated by the actions of third parties.Goldstein v. Commisisoner, 37 T.C. 897 (1962). See also Estate of Goelet v. Commissioner, 51 T.C. 352 (1968).

In this case, Grantor retained the Grantor’s Consent Power over the income and principal of Trust. Under § 25.2511-2(e), a donor is considered as himself having a power if it is exercisable by him in conjunction with any person not having a substantial adverse interest in the disposition of the transferred property or the income therefrom. The Distribution Committee members are not takers in default for purposes of § 25.2514-3(b)(2). They are merely coholders of the power. The Distribution Committee ceases to exist upon the death of Grantor. Under § 25.2514-3(b)(2), a coholder of a power is only considered as having an adverse interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself, his estate, his creditors, or the creditors of his estate. In this case, the Distribution Committee ceases to exist upon Grantor’s death. Accordingly, the Distribution Committee members do not have interests adverse to Grantor under § 25.2514-3(b)(2) and for purposes of § 25.2511-2(e). Therefore, Grantor is considered as possessing the power to distribute income and principal to any beneficiary himself because he retained the Grantor’s Consent Power. The retention of this power causes the transfer of property to Trust to be wholly incomplete for federal gift tax purposes.

Grantor also retained the Grantor’s Sole Power over the principal of Trust. Under § 25.2511-2(c), a gift is incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries. In this case, Grantor’s Sole Power gives Grantor the power to change the interests of the beneficiaries. Accordingly, the retention of the Grantor’s Sole Power causes the transfer of property to Trust to be wholly incomplete for federal gift tax purposes.

Further, Grantor retained Grantor’s Testamentary Power to appoint the property in Trust to any person or persons or entity or entities, other than Grantor’s estate, Grantor’s creditors, or the creditors of Grantor’s estate. Under § 25.2511-2(b) the retention of a testamentary power to appoint the remainder of a trust is considered a retention of dominion and control over the remainder. Accordingly, the retention of this power causes the transfer of property to Trust to be incomplete with respect to the remainder in Trust for federal gift tax purposes.

Finally, the Distribution Committee possesses the Unanimous Member Power over income and principal. This power is not a condition precedent to Grantor’s powers. Grantor’s powers over the income and principal are presently exercisable and not subject to a condition precedent. Grantor retains dominion and control over the income and principal of Trust until the Distribution Committee members exercise their Unanimous Member Power. Accordingly, this power does not cause the transfer of property to be complete for federal gift tax purposes. See Goldstein v. Commissioner, 37 T.C. 897 (1962); Estate of Goelet v. Commissioner, 51 T.C. 352 (1968).

Accordingly, based on the facts submitted and the representations made, we conclude that the contribution of property to Trust by Grantor is not a completed gift subject to federal gift tax. Any distribution from Trust to Grantor is merely a return of Grantor’s property. Therefore, we conclude that any distribution of property by the Distribution Committee from Trust to Grantor will not be a completed gift subject to federal gift tax, by any member of the Distribution Committee. Further, upon Grantor’s death, the fair market value of the property in Trust is includible in Grantor’s gross estate for federal estate tax purposes.
RULING 4
Section 2514(b) provides that the exercise or release of a general power of appointment created after October 21, 1942, shall be deemed a transfer of property by the individual possessing such power.

Section 2514(c) provides that the term “general power of appointment” means a power which is exercisable in favor of the individual possessing the power (possessor), the possessor’s estate, the possessor’s creditors, or the creditors of the individual’s estate.

Section 25.2514-1(c)(1) provides, in part, that a power of appointment is not a general power if by its terms it is exercisable only in favor of one or more designated persons or classes other than the possessor or his creditors, or the possessor’s estate or the creditors of the estate.

Section 2514(c)(3)(A) provides, that in the case of a power of appointment created after October 21, 1942, if the power is exercisable by the possessor only in conjunction with the creator of the power, such power is not deemed a general power of appointment.

Section 2514(c)(3)(B) provides, that in the case of a power of appointment created after October 21, 1942, if the power is not exercisable by the possessor except in conjunction with a person having a substantial interest in the property subject to the power, which is adverse to the exercise of the power in favor of the possessor, such power shall not be deemed a general power of appointment. For purposes of § 2514(c)(3)(b), a person who, after the death of the possessor, may be possessed of a power of appointment (with respect to the property subject to the possessor’s power) which he may exercise in his own favor shall be deemed as having an interest in the property and such interest shall be deemed adverse to such exercise of the possessor’s power.

Section 25.2514-3(b)(2) provides, in part, that a coholder of a power has no adverse interest merely because of his joint possession of the power nor merely because he is a permissible appointee under a power. However, a coholder of a power is considered as having an adverse interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself, his estate, his creditors, or the creditors of his estate. Thus, for example, if X, Y, and Z held a power jointly to appoint among a group of persons which includes themselves and if on the death of X the power will pass to Y and Z jointly, then Y and Z are considered to have interests adverse to the exercise of the power in favor of X. Similarly, if on Y’s death the power will pass to Z, Z is considered to have an interest adverse to the exercise of the power in favor of Y.

The powers held by the Distribution Committee members under the Grantor’s Consent Power are powers that are exercisable only in conjunction with the creator, Grantor. Accordingly, under § 2514(c)(3)(A), the Distribution Committee members do not possess general powers of appointment by virtue of possessing this power. Further, the powers held by the Distribution Committee members under the Unanimous Member Powers are not general powers of appointment. As in the example in § 25.2514-3(b)(2), the Distribution Committee members have substantial adverse interests in the property subject to this power. Accordingly, any distribution made from Trust to a beneficiary, other than Grantor, pursuant to the exercise of these powers, the Grantor’s Consent Power and the Unanimous Member Powers, are not gifts by the Distribution Committee members. Instead, such distributions are gifts by Grantor.

Based upon the facts submitted and representations made, we conclude that any distribution of property by the Distribution Committee from Trust to any beneficiary of Trust, other than Grantor, will not be a completed gift subject to federal gift tax, by any member of the Distribution Committee. Further, we conclude that any distribution of property from Trust to a beneficiary, other than Grantor, will be a completed gift by Grantor.

Except as specifically ruled herein, we express no opinion on the federal tax consequences of the transaction under the cited provisions or under any other provisions of the Code. Specifically, we express no opinion on the trust provisions permitting Trustee to distribute income or principal to trustees of other qualified trusts (decanting).

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

Sincerely yours,

Lorraine E. Gardner
Senior Counsel, Branch 4
Office of Associate Chief Counsel
(Passthroughs and Special
Industries)

Transferable Offshore Trust Fails

Some asset protection promoters tout a transferable offshore trust strategy which begins onshore in the U.S. and shifts offshore at the first sign of duress. Such strategies initially hold assets in a U.S. entity or domestic asset protection trust (DAPT) and then shift or transfer to an offshore jurisdiction when the client is under duress.

An Ohio judge recently froze the assets of a limited partnership that was owned by a Cook Islands Trust.  The asset protection promoter had told the client they could shift the partnership interests offshore at the first sign of duress.  This is the same asset protection strategy and the same failing result as in the Indiana Investors case.  (See Indiana Investors, LLC v. Hammon-Whiting Medical Center, LLC No. 45D02-0807-CT-201 (Lake Superior Court, Lake County, Indiana); Indiana Investors v. Victor Fink, No. 12-CH-02253 (Circuit Court of Cook County, Illinois, Chancery Division), Victor Fink transferred assets to a Cook Islands trust provided by one of the popular asset protection providers found on the internet who claimed that the control could be shifted offshore in the event of duress.  The plaintiffs were able to obtain temporary restraining orders which prevented the trustees and protectors from shifting the control to the offshore  trustee (South Pac Trust International, Inc.) and the bank accounts were all frozen.)

The weakness of this strategy is not only proven by court cases, but it is emphasized by experts in the field of asset protection.  In fact, some are calling the this strategy legal malpractice.

Jay Adkisson had this to say about the asset protection strategy of shifting assets from a domestic entity to an offshore trust (FAPT) when under duress: “It is, quite arguably, malpractice for a planner to leave unencumbered U.S. assets owned by [a] FAPT, directly or indirectly, in the U.S. and within reach of creditors.”

Gideon Rothschild said, ” This seems to be the typical structure employed by many lawyers. They tell the clients they can keep the assets in the US in an FLP that you control and then upon an event such as a lawsuit the trustee is informed that he should take necessary steps to cause the FLP to be liquidated. In fact many of these structures will also have a US co-trustee so they don’t even have to file Form 3520 until US trustee resigns. I’ve told such settlors that this is a recipe for disaster. Not only will it expose the assets to what is happening in this case – the US court’s jurisdiction and attachment orders – but could also put the settlor in jail for contempt since he, as the GP, will have to take the steps needed to move the account offshore at a time when the clouds have already formed. That is why I will only settle foreign trusts where the client has liquid assets that he is willing to place offshore from day one. Otherwise, one needs to use other (domestic) strategies.”

 

TrustCo case shows importance of timing in asset protection.

The most important factor in almost every asset protection case is the timing between the time the assets were transferred and the time of the creditor’s claim.  In TrustCo Bank v. Mathews, the court held that a plaintiff was barred from bringing a fraudulent transfer claim because the statute of limitations had run.  Susan Mathews signed a personal guaranty in 2006.  A few months later she transferred stock to a couple of Delaware asset protection trusts.   The plaintiffs brought a fraudulent transfer claim against the trusts on March 1, 2013 and the court ruled that the claim was barred because the statute of limitations on fraudulent transfers had run.  This case is interesting because the transfer actually occurred after Susan had incurred an obligation.  Because the transfer occurred after the obligation, the transfer probably would have been voidable as a fraudulent transfer if not for the statute of limitations.  In other words, the planning worked only because of the timing between the date of the transfer and the date of the fraudulent transfer action.

What is a 541 Trust®?

The 541 Trust® is the name used by our law firm to refer to an irrevocable trust we use. It is built upon a foundation of generations of proven legal precedent. It is a domestic irrevocable non-self-settled trust carefully designed to provide the best asset protection while at the same time affording maximum flexibility. The trust is not a new school of thought nor is it based on foreign laws. We have carefully researched generations of legal precedent right here in the U.S. to find what has always worked and we design our trusts in compliance.

It is universally accepted that assets owned by you are within reach of your creditors. Likewise it is universally accepted that, absent a fraudulent transfer, assets not owned by you cannot be reached by your creditors. So if asset protection is a key goal in your estate planning, you must somehow remove the assets from your ownership. The best way to remove assets from your ownership is through the use of a properly crafted irrevocable trust. Because our trusts are drafted in compliance with U.S. laws, and are supported by generations of legal precedent, they provide the best possible protection.

Public policy and generations of legal precedent have been clear that you cannot settle a trust for your own benefit and at the same time shield the trust assets from your potential creditors. Offshore Trusts and Domestic Self-Settled Asset Protection trusts (DAPTs) are self-settled, which is a fatal chink in the supposed armor of these types of trusts. Don’t take our word for it though. Even though some states and offshore jurisdictions purport to allow self-settled asset protection trusts it is important to see what the courts have made clear. The only court cases dealing with Offshore Trusts or DAPTs have shown that they fail to protect the assets.[i] The Uniform Trust Code states that a creditor of a settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.[ii] In other words, if a settlor who is also a beneficiary has access to trust cash, property, vehicles, etc., so does a creditor, It is hard to argue that an Offshore Trust or a DAPT is the best solution based on their dismal record when challenged.

However, generations of legal precedent have made clear that the only type of trust which has withstood the test of time as a proven method of asset protection is a non-self-settled trust, aka a third party trust. This means that the settlor of the trust creates the trust for beneficiaries other than him/herself.[iii] Yes, you understood this correctly. Despite an abundance of promotion and marketing, self-settled trusts (DAPTs and Offshore Trusts) have zero wins when challenged in court. The only trusts which have withstood court challenges and Bankruptcies are non-self-settled trusts.

Our 541 Trust® protects assets from a person’s potential future liabilities by removing the assets from the person’s legal ownership. Rather than employing new strategies which have not been tested, or those which rely on the laws of foreign jurisdictions, this trust is designed using methods which have withstood the test of time in the U.S. legal system. The 541Trust™ has been successfully tested in lawsuits, bankruptcy, and IRS audits. The 541 Trust® has been proven to work better than offshore trusts and other asset protection strategies. Frankly, the name of the trust is of little importance. The important part of the trust is its craftsmanship. Our years of experience and dedication to building trusts upon a tried and tested legal foundation is the key value to our trusts. After all, what good is a trust if it fails when challenged? Our opinion, or the opinions of others, are of little importance if the courts don’t agree. The legal precedent speaks for itself.

For more information call 801-765-0279


 

[i] In re Mortensen, Battley v. Mortensen, (Adv. D.Alaska, No. A09-90036-DMD, May 26, 2011), Waldron v. Huber (In re Huber), 2013 WL 2154218  (Bk.W.D.Wa., Slip Copy, May 17, 2013), Dexia Credit Local v. Rogan  624 F. Supp 2d 970 (N.D.Ill. 2009), 11 U.S.C. 548(e), More offshore self-settled trust cases HERE.

[ii] Uniform Trust Code Section 505, Restatement (Second) of Trusts Section 156(2), and Restatement (Third) of Trusts Section 58(2).

[iii] “By establishing an irrevocable trust in favor of another, a settlor, in effect, gives her assets to the third party as a gift.  Once conveyed, the assets no longer belong to the settlor and are no more subject to the claims of her creditors than if the settlor had directly transferred title to the third party.” In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002).

See also:

Better Than an Offshore Trust

Better Than a DAPT

Don’t Self-Settle for Inadequate Asset Protection

Law and Precedent Supporting the 541 Trust®

IRS Approved NING Trust provides Substantial Tax Savings

For many years, we have helped clients reduce income taxes by using a Nevada trust often referred to as a “NING Trust” (Nevada Incomplete Gift Non-Grantor Trust). In PLR 20131002, the IRS approved this concept by ruling that the trust qualified as a complex trust for income tax purposes and that gifts to the trust were incomplete for federal gift tax purposes. In other words, a person can transfer assets of unlimited value to a NING Trust without gift tax consequences. The income of the NING Trust is taxed at the trust level and does not flow through to the grantor. Because Nevada has no state income tax there is huge potential for income tax savings. Here are three examples of how a NING trust can save taxes:

A California resident can avoid the 13.3% California tax on investment assets or capital gains. For example, assume a California resident establishes a properly structured [NING] trust and contributes a $20 million stock portfolio that produces 8% taxable income per year. Over a period of 10 years, the California income tax saved could be $2,500,000. Over 20 years, the compounded savings from not paying California income tax could be $8,500,000. (See Gordon Schaller & The 13.3% Solution: of DINGs, NINGs, WINGs and Other ThINGs, LISI Estate Planning Newsletter #2191 (February 5, 2014)).

As another example, we have a client who placed his stock into a NING trust prior to a sale of his company. When the stock was sold by the NING trust, the client saved over $5,000,000 in state capital gains taxes. Later, when the trustee terminated the trust and distributed the assets back to the client, the client was not required to pay state capital gains tax on the distribution because the state does not tax capital gains distributed from a nonresident trust.

As a third example, a professional athlete transferred the majority of his investment portfolio to a NING trust. The athlete pays federal and state tax on his W-2 earnings and on the investments he holds outside of the NING trust. The athlete is not required to pay state tax on the investment income earned by the trust, and this allows the trust to grow free of state income tax.

Call 801-765-0279 for more information or click HERE to email us.

The information and examples above are provided as general information and may not be used as tax advice for any particular situation. Each person should seek individualized tax advice for their own situation.

Don’t Self-Settle for Inadequate Asset Protection

Don’t Self-Settle for Inadequate Asset Protection

Why Self-Settled Asset Protection Trusts Don’t Protect Assets

By: Randall Sparks, JD LL.M. and Lee S. McCullough, III, JD MAcc

Click HERE for pdf verison

Self-Settled Asset Protection Trusts are all the rage. They come in two main flavors: (1) The Domestic Asset Protection Trust (“DAPT”) and (2) the Offshore Trust, aka Foreign Asset Protection Trust (“FAPT”).  To boost in-state trust business, about a dozen states have passed or are actively improving their self-settled asset protection trust statutes … and that number is growing. Although self-settled trusts are heavily promoted by asset protection attorneys across the county, all of the relevant court cases indicate that if asset protection is your goal, you should find a more viable option.

If self-settled trusts are inadequate for asset protection, why do attorneys go to such lengths to sell them?  The answer is simple: Money. Asset protection promoters market them heavily promising maximum protection and make big profits in the process. They do this despite zero court authority in existence that upholds self-settled asset protection trusts.  Promoters also ignore the many court cases showing that self-settled trusts simply don’t afford the promised asset protection benefits.

What is a Self-Settled Asset Protection Trust?

There are three parties to any trust agreement: (1) a Settlor, who creates the trust and funds it with assets, (2) a Trustee, who holds legal title to the assets in trust for the beneficiaries, and (3) the Beneficiaries, who are eligible to receive benefits from the trust.  In most trusts, the Settlor and Beneficiary are different people.  In a self-settled trust, the Settlor is also a Beneficiary.  In concept, the idea is incredible: contribute any amount of property to the trust and while creditors can’t touch it, you can enjoy it as much as you want.  The reality is that these arrangements just don’t work as advertised.

Public policy has long been clear that you cannot settle a trust for your own benefit and at the same time shield the trust assets from your potential creditors. The Uniform Trust Code states that a creditor of a settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.[1] In other words, if a Settlor/Beneficiary has access to trust cash, property, vehicles, etc., so does a creditor.

Offshore jurisdictions were the first to market self-settled trusts by promising protections in a foreign jurisdiction that is not bound by the laws of the United States.  In 1997, Alaska was the first state to enact a DAPT statute.  Since then, over a dozen United States jurisdictions have enacted DAPT statutes. However, creditor attorneys have developed successful techniques to pierce these trusts.  By frequently siding with creditors in these cases, courts have rebuffed the zeal of offshore and domestic jurisdictions to establish and promote self-settled trusts as superior asset protection tools.

Court Cases Defeating Domestic Asset Protection Trusts (DAPTs)

When it comes to self-settled trusts, there is an elephant in the room and that elephant has a name: Bankruptcy.  In states that don’t recognize self-settled trusts, a debtor’s interest in a self-settled trust is subject to bankruptcy.[2] The Mortensen case made clear that Federal Bankruptcy Law can even defeat a self-settled trust in states that recognize, protect, and advocate self-settled trusts.[3] In Mortensen, an Alaska resident created a self-settled trust under Alaska’s DAPT statute under ideal circumstances: he was solvent and there were no judgments against him. Several years later he ended up in a bankruptcy court sitting in Alaska. The court applied Federal Bankruptcy Law instead of Alaska law ruling that the trust assets were reachable by the creditors in the bankruptcy under Section 548(e) of the Federal Bankruptcy Code.[4]

Another problem with a DAPT is a potential lawsuit arising in a state that does not recognize or protect self-settled trusts.  In Dexia Credit Local v. Rogan, the Seventh Circuit Court ruled that despite the debtor’s trust having been created in a DAPT state, Illinois law applied instead.[5]  Another huge blow to DAPTs came on May 17, 2013 in Waldron v. Huber where, among other things, Washington State law applied rather than Alaska law where the DAPT was formed.[6] The result was that the trust assets were not protected.  Based on the Dexia Credit and Huber cases, one shouldn’t expect that a self-settled trust will be upheld in a state that does not allow them.  Numerous other cases indicate that a court can apply the law of the state where the court is located and not recognize the laws of the state where an entity was formed.[7]

If self-settled trusts don’t work in bankruptcy and don’t protect against laws of DAPT unfriendly states, then you can just avoid declaring bankruptcy and avoid contacts outside of your DAPT friendly state, right?  Not so fast. Unfortunately, even if you are careful not to get sued in the wrong state and manage to avoid voluntary bankruptcy, your creditors could file an involuntary bankruptcy petition against you. The court cases and the bankruptcy code have shown that even though a self-settled trust is created pursuant to a DAPT statute, the trust is still vulnerable.

Court Cases Defeating Offshore Trusts, aka Foreign Asset Protection Trusts (FAPTs)

Many asset protection promoters claim that offshore trusts are impermeable, in contrast to the absence of a single court case to support their claims.  Why do they sell a product that has such an abominable record?  It’s a calculated risk that the resulting liability of a few failed trusts that are actually challenged will be vastly overshadowed by those that are never tested. In other words, they know that the majority of their clients will never get sued or go bankrupt. For those who are sued or face bankruptcy however, if the trust is self-settled, its assets are not protected.

Although promoters of FAPTs claim foreign laws protect you because the trust is not subject to the jurisdiction of U.S. Courts, there are many court cases showing how offshore trusts fail. For example, it is well established that an offshore trust cannot protect onshore assets.[8]  Numerous other cases show that even though a court in the United States may not have jurisdiction over the FAPT, they have jurisdiction over the debtor and can order the debtor to repatriate the trust assets or face incarceration for contempt.  In In re Lawrence the debtor was jailed for over six years for refusing to repatriate assets, in Bank of America v. Weese the debtors paid settlement of over $12,000,000 in order to avoid incarceration, and in U.S. v. Plath the debtor was held in contempt for refusing to obey the court order to disclose details about offshore accounts despite the fact that there was no fraudulent transfer.[9] These are just a few lowlights of the long list of failed FAPT strategies.

For a time, offshore trust peddlers used US v. Grant as the one court case that supported their strategy, because it was the single case where a court did not hold the debtor in contempt.  The purported steel bulwark of the Grant opinion came crashing down when, in the Spring of 2013, a Florida court ruled against the very strategy FAPT promoters touted, dealing a huge blow to the offshore asset protection industry.[10] In Grant, Raymond Grant created two self-settled trusts offshore (FAPTs), one for his own benefit and one for the benefit of his wife.  Raymond funded both FAPTs at a time when he was solvent and had no known claims against him, once again ideal circumstances.  Years later, Raymond died and the IRS obtained a $36 million dollar judgment against Raymond’s wife Arline.  The U.S. moved to hold Arline in contempt of court for failing to repatriate the assets in the offshore trusts to pay the tax liability.  Initially, the court refused to do so because Arline had never exerted control or received benefits from these trusts.  But later when it was proven that Arline had received funds from the trust through her children’s accounts, the court issued a permanent injunction prohibiting Arline and her children from ever receiving any benefits from the trusts.  Ultimately a very expensive “asset protection” strategy kept the assets protected from creditors, but also out of reach of those the trust was created to benefit. If your goal is to protect assets from both creditors and yourself, an offshore trust may be a great fit. If, however, you seek any self-settled benefits at all, look elsewhere.

Solution – Non-Self-Settled Trust

The alternative to the self-settled trust is simple, remove the one aspect of the trust that creates all of its vulnerability; make the trust non-self-settled. A non-self-settled trust, aka third party trust, has the support of state and federal statutes, the federal bankruptcy code, and an overwhelming number of court cases. Since the Settlor is not a beneficiary, the creditors of the Settlor cannot reach the trust assets, even in bankruptcy.[11]  A properly drafted third party trust can still benefit the settlor without disrupting the asset protection.  The settlor could potentially benefit from the trust through a spouse who is a beneficiary. For example, the settlor could live in a trust owned residence free from rent so long as the spouse is a beneficiary.[12] The settlor could be an income only beneficiary and still protect the trust principal.[13] The settlor could also maintain flexibility by appointing a trust protector or through the use of a special power of appointment.

If the trust has discretionary spendthrift language, the assets are also shielded from the creditors of the beneficiaries. If Raymond Grant had created a non-self-settled discretionary spendthrift trust for his wife Arline, instead of creating the two FAPTs that failed, the assets would have been protected from the IRS judgment and Arline and other trust beneficiaries could still have benefitted from the trusts. For example, the trust could have purchased a home for Arline to live in and paid Arline’s credit card bills.[14]

If true asset protection is the goal, consumers and especially promoters should remember the old adage that pigs get fat and hogs get slaughtered. The court cases make it clear that a non-self-settled trust provides proven asset protection, whereas a self-settled trust lays out the welcome mat, flips on the light,  and leaves the front door wide open to creditors. If you self-settle, you settle for an inferior trust.


[1] Uniform Trust Code Section 505, Restatement (Second) of Trusts Section 156(2), and Restatement (Third) of Trusts Section 58(2).

[2] Federal Bankruptcy Code 11 U.S.C. 541. See also In re Simmonds, 240 B.R. 897 (8th Cir. BAP (Minn.) 1999).

[3] In re Mortensen, Battley v. Mortensen, (Adv. D.Alaska, No. A09-90036-DMD, May 26, 2011).

[4] 11 U.S.C. 548(e).

[5] Dexia Credit Local v. Rogan  624 F. Supp 2d 970 (N.D.Ill. 2009).

[6] Waldron v. Huber (In re Huber), 2013 WL 2154218  (Bk.W.D.Wa., Slip Copy, May 17, 2013).

[7] American Institutional Partners, LLC v. Fairstar Resources, Ltd. (where Utah law applied against a Delaware-formed LLC), 2011 WL 1230074 (D.Del., Mar. 31, 2011), Malone v. Corrections Corp. Of Am., 553 F.3d 540, 543 (7th Cir. 2009) (a district court in diversity applies the choice-of-law rules of the state in which it sits).

[8] In re Brooks, 217 B.R. 98 (D. Conn. Bkrpt. 1998) (where the offshore trust was disregarded because it was self-settled and the onshore assets were seized).

[9] In re Lawrence, 279 F.3d 1294 (11th Cir. 2002), Bank of America v. Weese, 277 B.R. 241 (D.Md. 2002), and U.S. v. Plath, 2003-1 USTC 50,729 (U.S. District Court, So. Dist. Fla. 2003).

[10] US v. Grant, 2013 WL 1729380 (S.D.Fla., April 22, 2013).

[11] Uniform Trust Code Section 505, Restatement (Second) of Trusts Section 156(2) and Restatement (Third) of Trusts Section 58(2), In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002), Shurley v. Texas Commerce Bank, 115 F.3d 333 (5th Cir. 1997).

[12] Revenue Ruling 70-155, Estate of Allen D. Gutchess, 46 T.C. 554 (1966), PLR 9735035.

[13] In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002).

[14] United States v. Baldwin, 391 A.2d 844 (1978) or U.S. v. O’Shaughnessy, 517 N.W.2d 574 (1994) (where the trust assets were not subject to tax lien because the trust was not self-settled).

California Court Throws Out Case Against Our Trust – Client Very Satisfied

On June 19, 2012, the Superior Court for the State of California for the County of Los Angeles sustained our motion to dismiss a lawsuit by Wilmington Capital LLC against The Big Whale Trust (an irrevocable trust created by McCullough Sparks).

The grantor had funded the trust with cash and real estate prior to the time the liability was incurrred. The grantor’s spouse and children were the trustees and beneficiaries of the trust. The trustees had made several distributions to the grantor’s spouse, but the grantor was not a beneficiary and the grantor had personally received no benefits from the trust.

Wilmington Capital LLC sued the trust because it had been unable to collect against the grantor and the grantor’s spouse. Wilmington Capital LLC had no evidence to claim that the trust was invalid, that the transfers to the trust were fraudulent, or that the grantor was the alter ego of the trust. Wilmington Capital LLC argued that they should have access to the trust because the grantor had retained a special power of appointment over the trust.

Because California law protects the assets of an irrevocable non self-settled discretionary trust (even when the grantor retains a special power of appointment), our client was able to have the case summarily dismissed without incurring significant legal fees.

The Big Whale Trust is a perfect illustration of the best way to create, fund and operate an asset protection trust. Copies of the court pleadings (including our Memorandum of Points and Authorities) are available upon request.

Bankruptcy Court – Our Trust Protects Client’s Home and Trust Assets

In 2009, our client, Todd H., transferred his home and some cash to one of our carefully drafted irrevocable trusts at a time when they were solvent and had no foreseeable liability problems.  Todd’s wife was the trustee, and his wife and children were the beneficiaries.  In 2010, Todd’s business went downhill along with the rest of the US economy.  In 2011, Todd’s small business went bankrupt and he was also forced into personal bankruptcy.  The transfer of the home to the trust was fully disclosed to the bankruptcy court, but the bankruptcy court excluded the trust and its assets pursuant to the federal bankruptcy code which provides that this type of trust is excluded from the bankruptcy estate.  After losing everything else they owned in the bankruptcy,  Todd’s family continues to live in the paid-off home that is owned by the trust.

When do courts allow a trust to be pierced as an alter ego?

One way to attack an irrevocable trust is to prove that the trust is the alter ego of the grantor because the trust is operated in a manner so that it has no separate existence from the grantor. Some courts describe this as the grantor “exercising such control that the trust has become a mere instrumentality of the owner.” In re Vebeliunas, 332 F.3d 85 (2nd Cir. 2003).

In WILSHIRE CREDIT CORPORATION v. KARLIN, 988 F.Supp. 570 (1997), Allan and Mary Rozinsky established an irrevocable trust for their children and transferred their home to the trust. The Rozinskys paid rent equal to the amount of the mortgage, insurance, and monthly expenses. For a time, the trust also owned a beach home that the Rozinskys rented from the trust. The trustees were close friends and relatives who admitted that most of their decisions were made at the direction of the Rozinskys.

After a time, the Rozinskys became unable to make the rent payments and they issued promissory notes to the trust in the amount of the delinquent rent, although no payments were made on the promissory notes. The court held that under Maryland law, alter-ego will only apply where necessary to prevent fraud, and because no fraudulent transfer had occurred, the creditors could not reach the trust assets despite the control exerted by the settlors.

In UNITED STATES v. EVSEROFF, No. 00-CV-06029 (E.D.N.Y. April 30, 2012), Jacob Evseroff established an irrevocable trust and transferred his primary residence to it after having received notice of a tax deficiency of over $700,000.  A series of family friends served as the trustees of the trust.  Evseroff did not pay rent to the trust for the privilege of living in the residence, but he did pay the mortgage and expenses as he had when he owned the home.  The trust never assumed the mortgage and it was never listed on the flood or fire insurance on the home.

The court held that a plaintiff may pierce the veil of a trust, under the laws of New York, if the plaintiff can show that “(1) the owner exercised such control that the corporation has become a mere instrumentality of the owner, who is the real actor; (2) the owner used this control to commit a fraud or ‘other wrong’; and (3) the fraud or wrong results in an unjust loss or injury to the plaintiff.”  Because the transfers to the trust were found to be fraudulent, and because the facts indicated that Evseroff had dominated the trust, the court allowed the government to collect against the assets of the trust.

Lessons learned from these cases: (1) don’t wait until you have a liability problem to transfer assets to an asset protection trust, (2) appoint a trustee who will take control of the trust, and (3) don’t allow a person other than the trustee to control or dominate the trustee or engage in transactions with the trust on terms that are not commercially reasonable in an arms-length transaction.

 

Wilshire Credit v. Karlin – Irrevocable Trust Protects Home Despite Partial Rent Payments

988 F.Supp. 570 (1997)

WILSHIRE CREDIT CORPORATION, Plaintiff,
v.
Stanley KARLIN, et al., Defendants.

No. Civ.A. AW 96-943.

United States District Court, D. Maryland, Southern Division.

December 8, 1997.

571*571 William A. Isaacson, Washington, DC, for Wilshire Credit Corp.

Yale L. Goldberg, Bethesda, MD, M. Michael Cramer, Benjamin A. Klopman, Rockville, MD, for Stanley Karlin, Robert Dawson.

MEMORANDUM OPINION

WILLIAMS, District Judge.

I

Presently before the Court are cross-motions for summary judgment. In ruling on the motions, the Court has considered the briefs of the parties, the arguments of counsel at a hearing in open court, and the entire record.

572*572 II

Allan and Mary Rozansky (hereinafter sometimes “the Rozanskys”, and “the settlors”) established a trust for the benefit of their two minor children on July 21, 1982. The children, and any other future lineal descendants of the Rozanskys, are the sole beneficiaries of the trust. The trustees are Stanley Karlin, a former neighbor of the Rozanskys, and Robert Dawson, Mary Rozansky’s brother. The trust vests the trustees with discretion to distribute funds for the benefit of the beneficiaries during the life-time of the settlors.[1] Upon the death of the settlors, the trust is to be distributed equally among the beneficiaries so long as they are at least 25 years old. Because the trustees hold legal title and the beneficiaries hold equitable title to the trust, the Rozanskys have no remaining legally recognizable property interest. The trust is irrevocable, and cannot be modified in any fashion by either settlor.

When the trust was created, its sole asset was the home of the Rozanskys. The Rozanskys retained a life estate, but transferred the remainder interest to the trust. In 1992, the trust purchased the Rozanskys life estate for $50,000. Thus, the trust owns a complete interest in the home (subject to its mortgage). The settlors are tenants of the trust, and pay “rent” which covers the cost of the monthly mortgage, insurance, and other related expenses. The trustee Karlin, who authorized the transaction, concedes that the decision to purchase the life estate was made at the direction of the Rozanskys. No alternative investments were considered and no one other than the Rozanskys was consulted respecting the prudence of the investment. In setting the rent to be paid by the settlors, Karlin never took into account any factor other than the fact that the payment would equal the monthly mortgage.

In 1994, the trust acquired a $695,000 beach home in Delaware which the Rozanskys used for vacations. Karlin, the trustee who authorized the purchase, again did so at the request of the settlors. Karlin had never seen the home before the transaction. The trust also purchased furniture for the beach home for $20,000. Because the trust did not have cash assets, the purchase was financed by refinancing the mortgage on the existing home. The Rozanskys’ rent payments were increased to match the increased mortgage payments. These actions were all taken at the direction of the settlors.

In 1995, the beach home was sold. This action was taken because Karlin was told by the Rozanskys that they could not afford to pay the rent on the two homes. The Rozanskys themselves found the realtor and handled the sale of the beach home; the trustees never spoke with the realtor. The beach house was finally sold for approximately the same price as its initial purchase, excluding realtor fees and other closing costs. After the sale, the trust held a cash balance of approximately $144,000.

Since the sale of the beach home, the Rozanskys have defaulted on rental payments owed to the trust. The Rozanskys have executed promissory notes to the trust. However, the notes provided no date of repayment, and thus far no repayment has been made. The trust has dissipated the $144,000 in cash making mortgage payments. Thus, the trust has accumulated no investment or cash assets for the benefit of the children. The only money the trust has ever paid for the support of the children was a summer camp bill of less than one thousand dollars. According to the trustees, at no time has any of the property belonging to the trust been disbursed to the Rozanskys. According to Trustee Karlin, major decisions regarding the management of the trust property were made with the benefit of independent professional advice. The trustees admit that certain of the acts taken on behalf of the trust were undertaken at the direction of the settlors. While the trustees appear to have acted at times at the direction of the Rozanskys, the Plaintiff makes no allegation that the Rozanskys’ conveyances of the property held by the trust were fraudulent.

Plaintiff, the successor in interest to a creditor of the Rozanskys, secured a stipulated 573*573 judgment against them on July 16, 1990, in the amount of approximately $1.7 million.

III

A.

The parties have filed cross-motions for summary judgment. Summary judgment is appropriate where there is no genuine dispute of material fact and when the moving party is entitled to judgment as a matter of law. Fed.R.Civ.P. 56(c); Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250, 106 S.Ct. 2505, 2511, 91 L.Ed.2d 202 (1986). The evidence of the non movant is to be believed and all justifiable inferences drawn in his favor, but a party cannot create a genuine dispute of material fact through mere speculation or compilation of inferences. Runnebaum v. NationsBank of Md., N.A., 123 F.3d 156, 164 (4th Cir.1997) (citing Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 106 S.Ct. 2505, 2513-14, 91 L.Ed.2d 202 (1986); Beale v. Hardy, 769 F.2d 213, 214 (4th Cir.1985))

B.

In this action, Plaintiff seeks to recover the assets of the trust as satisfaction of the debt of the Rozanskys. The defendant trust moves for summary judgment, arguing simply that a creditor of the settlors of the trust has no valid claim to the res of the trust. Plaintiff has filed a cross-motion for summary judgment, arguing that because the uncontradicted evidence clearly shows that the Rozanskys have so dominated the trust that it is effectively their “alter ego,” this Court should equitably disregard the trust and treat its assets as those of the Rozanskys.

The Plaintiff’s argument is as follows: “Under Maryland law, where an entity is a mere `creature’ of another party, the entity may be treated as the alter ego of the dominating party.” In support of this position, Plaintiff cites three cases that conclude, essentially, that courts will equitably disregard a corporate form where such disregard is necessary to prevent fraud or to enforce a “paramount equity.” Colandrea v. Colandrea, 42 Md.App. 421, 428, 401 A.2d 480 (1979) (tort claim for fraud may be had against sole shareholder of corporation); Bart Arconti & Sons v. Ames-Ennis, 275 Md. 295, 312, 340 A.2d 225 (1975) (corporate entity may be disregarded to prevent fraud).

Under Maryland law, the question of whether a party exerts sufficient “dominion” and “control” over a corporation to warrant the conclusion that the corporation is a “mere instrumentality” of another turns on the facts of the particular case. As one court explained, “(T)he corporate entity is disregarded … wherein it is so organized and controlled, and its affairs are so conducted, as to make it merely an instrumentality, agency, conduit, or adjunct of another corporation. The control necessary to invoke what is sometimes called the `instrumentality rule’ is not mere majority or complete stock control but such domination of finances, policies and practices that the controlled corporation has, so to speak, no separate mind, will or existence of its own and is but a business conduit for its principal.” Dixon v. Process Corporation, 38 Md.App. 644, 653, 382 A.2d 893 (1978). The Plaintiff here argues that, because the trust operated exclusively at the command of the Rozanskys, it must be concluded that the trust was so dominated and controlled by the settlors that it was nothing more than the settlors’ instrumentality.

However, Plaintiff cites no Maryland case, and the Court’s research has revealed no Maryland authority, supporting the application of this corporate “alter ego” principle to a trust. The Plaintiff does point to several federal cases where courts have applied the corporate “alter ego” doctrine to trusts. In William L. Comer Family Equity Trust v. U.S., 732 F.Supp. 755 (E.D.Mich.1990), aff’d., 966 F.2d 1455 (6th Cir.1992), the court acknowledged that it had “uncovered no precedent analyzing the `alter ego’ theory of property ownership in the context of a trust,” but reasoned that “cases involving corporate entities provide appropriate guidance.” Id. at 759. The court went on to explain that “where a corporation is a mere agent or instrumentality of its shareholders or a device to avoid legal obligations, the corporate entity can be ignored.” Id. By parity of logic, where a trust “is a mere agent or 574*574 instrumentality” of another party, the trust may similarly be disregarded. Id. Other federal courts have accepted the view that the corporate “alter ego” doctrine may be applied to trusts. E.g., F.P.P. Enterprises v. U.S., 830 F.2d 114, 118 (8th Cir.1987); Loving Saviour Church v. U.S., 728 F.2d 1085, 1086 (8th Cir.1984); U.S. v. Boucher, 735 F.Supp. 987, 988 (D.Col.1990).

The cases make clear, however, that whether a court is to equitably exercise the “alter ego” doctrine as to a particular entity must be determined in accordance with the law of the forum state. See Loving Saviour Church, 728 F.2d at 1086 (applying South Dakota law); Comer Trust, 732 F.Supp. at 759 (applying Michigan law).

The scant authority pertinent to the inquiry appears to suggest that, under Maryland law, a settlor’s access to the trust res will not defeat an otherwise valid trust. In United States v. Baldwin, 283 Md. 586, 391 A.2d 844 (1978), the government sought to impose a tax lien on the assets of a trust established by the settlor before he incurred his tax liability. The trust was irrevocable, but the settlor maintained the right to receive the income from the investments and other personalty of the trust during his lifetime. While the trustee was a third party bank, the settlor maintained the right to name himself as trustee. The Court concluded that “the settlor of an irrevocable trust, reserving to himself only the right to receive, during his lifetime, the income from the investments and other personalty of the trust does not have such an estate in the corpus thereof as constitutes `property and rights to property’ under Maryland law,” and thus the lien could not be attached. Id. at 595-596, 391 A.2d 844.

This seems to be the consistent rule of Maryland law. In Mercantile Trust Co. v. Bergdorf & Goodman, 167 Md. 158, 173 A. 31 (1934), the court explained that “[w]ith the ownership of the corpus in the [beneficiary] remaindermen, even though possession may be delayed or defeated by the will of the donor, there being no evidence of fraud in the inception of the trust, and none in the instrument creating it, the corpus cannot be attached to satisfy the creditors of the settlor.” Id. at 166, 173 A. 31. Similarly, after reviewing the relevant precedent, the U.S. Claims Court found “no assumption by the Maryland courts that the wife may be deemed merely the husband’s alter ego for purposes of insulating property from a settlor’s creditors in a non-fraudulent conveyance transaction.” Estate of German v. U.S., 7 Cl.Ct. 641, 645 (1985), citing Watterson v. Edgerly, 40 Md.App. 230, 388 A.2d 934 (1978). Likewise, in the present case the Rozanskys retain no ownership interest in the corpus of the trust benefitting their children and there is no allegation of fraud in the establishment of the trust;[2] accordingly, it is logical to conclude that, under Maryland law, the trust res is beyond the reach of the Rozanskys’ creditors.

Further, even assuming that the “alter ego” doctrine were applicable to properly established trusts in Maryland, the Plaintiff has not offered an adequate basis for invoking “alter ego” principles here. Again, there is no allegation of any fraud on the part of the Rozanskys in conveying the property to the trust; Plaintiff merely contends that the Rozanskys should not be able to evade their legal obligations through a trust device that they dominate and control. Concededly, this argument finds support in the out-of-state authority referred to by Plaintiff. “[W]here [a] corporation is a mere agent or instrumentality of its shareholders or a device to avoid legal obligations, the corporate entity may be ignored.” Comer Trust, 732 F.Supp. at 759. The Maryland courts, however, have adopted a somewhat different view of the “alter ego” doctrine.

In Arconti, the Maryland Court of Appeals acknowledged that “although the courts will, in a proper case, disregard the corporate entity,” it appears that such a “proper case” may only be found “where it is necessary to prevent fraud or enforce a paramount equity.” Arconti, 275 Md. at 310, 340 A.2d 225. 575*575 Notably, the Arconti court specifically overruled a lower court’s determination that the “alter ego” doctrine may be applied “in order to prevent evasion of legal obligations.” Id. at 311-312, 340 A.2d 225. Thus, in Arconti, even though three corporations commingled equipment, operated from a single place of business, permitted one corporation to become dormant as the two other corporations improved, and made personal loans and transferred insurance policies to the principals, the “alter ego” doctrine could not be applied to hold the dominant corporations and principals liable for the obligations of the indebted corporation because there was no showing of fraud.

Similarly, even assuming the general applicability of the “alter ego” doctrine to trusts in Maryland, there can be no application of the doctrine in this case. There has been no showing of fraud here. While Plaintiff generally avers that the Rozanskys have “fraudulently shelter[ed] assets from their creditors,” there has been no contention that the property held by the trust was fraudulently conveyed. While it is true that a settlor cannot place assets in trust for the settlor’s own benefit in order to frustrate his or her own creditors, in absence of a fraudulent conveyance of the property, the property becomes an asset of the trust when conveyed; non-beneficiary settlors no longer have assets to shield. Inasmuch as the only “fraudulent” conduct of the Rozanskys is the domination of the trust while failing to honor legal obligations, this does not warrant the application of the “alter ego” doctrine under Maryland law. Arconti, 275 Md. at 311-312, 340 A.2d 225.[3] Indeed, even in the out-of-state cases relied upon by the Plaintiff, in every instance the “alter ego” doctrine was applied in concert with an allegation of a fraudulent conveyance. See, e.g., F.P.P. Enterprises, 830 F.2d at 118 (affirming conclusion that “the trusts were shams and fraudulent conveyances”); Loving Saviour Church, 728 F.2d at 1086 (applying “alter ego” as an alternative to conclusion that “the property transfers to the church were a sham”); Boucher, 735 F.Supp. at 988 (government argues alternatively that “the trusts are void as fraudulent conveyances, or that the trusts are the settlor’s alter egos”); Comer Family Trust, 732 F.Supp. at 760 (relying on “indicia of improper transfers” in applying “alter ego” doctrine).

It is apparently true that the trustees have at times acted at the behest of the Rozanskys, though they are under no legal obligation to do so.[4] Nonetheless, to the extent that the trust was properly created and the property properly transferred to it, the Court must conclude that the trust res is now beyond the reach of the Rozanskys’ creditors, notwithstanding Plaintiff’s prayer for equitable application of the “alter ego” doctrine. Further, even assuming “alter ego” principles apply to trusts in Maryland, Plaintiff here points to no fraudulent conduct other than the fact that the Rozanskys have “controlled” the trust while failing to pay their debts. It seems clear that under Maryland law, the evasion of legal obligations does not warrant the invocation the of “alter ego” doctrine. Accordingly, Plaintiff has no legal claim to the assets of the trust.

576*576 IV

For the reasons set forth, the Defendants’ motion for summary judgment must be granted, and Plaintiff’s cross-motion for summary judgment must be denied.

[1] The trust document also vests the trustees with the power to “mortgage, lease, … [or] borrow on … any and all of the funds and properties of the Trust.”

[2] It is interesting to note that the conveyance into the trust of the Rozanskys’ life estate interest in the property occurred in 1992, two years after the judgment was entered. Nonetheless, Plaintiff makes no allegation that this subsequent conveyance was fraudulent.

[3] It is true that “alter ego” principles may be invoked to “enforce a paramount equity” as well as to prevent fraud. However, the enforcement of “a paramount equity” rationale appears to be of limited application in Maryland. See Travel Committee v. Pan Am., 91 Md.App. 123, 158, 603 A.2d 1301 (1992) (“Notwithstanding its hint that enforcing a paramount equity might suffice as a reason for piercing the corporate veil, the Court of Appeals to date has not elaborated upon the meaning of the phrase or applied it in any case of which we are aware”). In any event, the Court concludes that principles of fundamental equity and fairness do not compel the invalidation of a trust for the benefit of minor children, in favor of creditors of the settlor, simply because the trust’s third-party trustees may have been less than diligent in the discharge of their duties.

[4] Indeed, the trustees do so at their own peril. It is black letter law that the trustees of a trust owe a duty of loyalty to the beneficiaries of the trust. “Even if a trustee has no personal stake in a transaction, the duty of loyalty bars him from acting in the interest of third parties at the expense of the beneficiaries.” Trustees of Employees Retirement System of Baltimore v. Baltimore, 317 Md. 72, 109, 562 A.2d 720 (1989). It does not appear, however, that a creditor of the settlor has standing to bring a claim of breach of fiduciary duty against the trustees. See Parish v. Md. & Va. Milk Producers, 261 Md. 618, 277 A.2d 19 (1971) (suggesting that a “fiduciary relationship” is necessary to give “former members the right to maintain this action”).

Shurley v. Texas Commerce Bank, 115 F.3d 333 (5th Cir. 1997)

Shurley Shurley v. Texas Commerce Bank, 115 F. 3d 333 (5th Cir 1997) Bankr. L. Rep. P 77,423, 11 Tex.Bankr.Ct.Rep. 259 In The Matter of Billy R. SHURLEY and Jane Bryant Shurley, Debtors. Billy R. SHURLEY and Jane Bryant Shurley, Appellants, v. TEXAS COMMERCE BANK–AUSTIN, N.A. and Texas Commerce Bank–San Angelo, N.A., Appellees. In The Matter of Billy R. SHURLEY and Jane Bryant Shurley, Debtors. Billy R. SHURLEY and Jane Bryant Shurley, Appellants, v. TEXAS COMMERCE BANK–SAN ANGELO, N.A., Texas Commerce Bank–Austin, N.A. and Dennis Elam, Trustee, Appellees. In The Matter of Billy R. SHURLEY and Jane Bryant Shurley, Debtors. William H. ARMSTRONG, II, Appellant, v. TEXAS COMMERCE BANK–SAN ANGELO, N.A., Dennis Elam, Trustee, and Texas Commerce Bank–Austin, Appellees. Nos. 96-50137, 96-50138. United States Court of Appeals, Fifth Circuit. June 20, 1997. John P. Higgins, Michael Lee Rush, Higgins & Rush, Dallas, TX, for Shurley Appellants. Eric Jay Taube, Hohmann, Werner & Taube, Austin, TX, Mitchell Dodd Savrick, Hohmann, Werner & Taube, Austin, TX, for Texas Commerce Bank–Austin. Stanley M. Johanson, University Of Texas Law, Austin, TX, Henry H. McCreight, Jr., Houston, TX, for Texas Commerce Bank–San Angelo in No. 96-50137. Michael A. Wren, McGinnis, Lochridge & Kilgore, Austin, TX, Shannon H. Ratliff, Austin, TX, Scott Davis Moore, Joseph & Moore, Austin, TX, for William H. Armstrong. John Lloyd Hopwood, Houston, TX, Stanley M. Johanson, Austin, TX, Henry H. McCreight, Jr., Houston, TX, for Texas Commerce Bank–San Angelo in No. 96-50138. Michael G. Kelly, The McMahon Law Firm, Odessa, TX, for Trustee. James Alfred Carter, W. Truett Smith, Smith, Carter, Rose, Finley & Griffis, San Angelo, TX, for amicus curiae. Appeals from the United States District Court for the Western District of Texas. Before REAVLEY, JOLLY and BENAVIDES, Circuit Judges. REAVLEY, Circuit Judge: 1 The question here is to what extent the assets of a spendthrift trust settled by a bankruptcy debtor and others are included in the debtor’s bankruptcy estate. The bankruptcy and district courts held that the entirety of the debtor’s interest in the trust is property of the bankruptcy estate. We limit the estate to the property contributed to the trust by the debtor. BACKGROUND 2 In 1965 M.D. Bryant, Ethel Bryant, Anne Bryant Ridge, and Jane Bryant Shurley created a trust under Texas law. M.D. and Ethel Bryant were husband and wife. Anne Bryant Ridge and Jane Bryant Shurley are their daughters. The trust is known as the “M.D. Bryant Family Trust” or the “Bryant Family Trust.” 3 The parents and daughters contributed real property to the trust. The property consisted of ranches owned by the family, including one owned by Shurley. Shurley contributed approximately 11,000 acres of raw land from the south of a west Texas ranch (her contribution herein the “Marfa ranch”).1 The trust agreement states that the property contributed by the parents “represents two-thirds (2/3) of the total value of all of said real property to be contributed and that the value of that portion of said real property to be contributed by [the two daughters] each represents (1/6) of the total value of all of said real property to be contributed.” 4 The trust agreement provided that additional property could be added to the trust at a later date. According to Shurley the vast bulk of the corpus of the trust came through pourover provisions in the parents’ wills, which were executed at the same time the trust agreement was executed. She claims that the Marfa ranch represents only two percent of the value of the total assets of the trust. The parents died in 1967 and 1971. 5 Under the trust agreement, while the parents were alive, two-thirds of the income generated by the trust was distributed to the parents and one-sixth of the income was distributed to each of the daughters. Upon the death of one parent, the income was distributed equally among the living parent and the daughters. Upon the death of the second parent, the two daughters each received half of the income if both were living at the time. The agreement has provisions for the children and other descendants of the daughters to receive income from the trust and distribution of its assets upon final termination of the trust. 6 In 1992, Shurley and her husband filed for bankruptcy under Chapter 7 of the Bankruptcy Code. Since Shurley’s parents were deceased at the time, she and her sister each had a one-half interest in the income from the trust. The Marfa ranch was still held by the trust. Two bank creditors and the bankruptcy trustee brought an adversary action, seeking a declaratory judgment that Shurley’s interest in the trust was property of the bankruptcy estate. After a trial, the bankruptcy court entered a judgment declaring that Shurley’s “entire interest in the [trust], being an undivided 50 percent interest in the principal assets and income of the [trust], is property of the Chapter 7 bankruptcy estate.” In its memorandum opinion it enjoined the trustee of the trust “from disbursing any beneficial interest previously held by Mrs. Shurley to anyone other than” the bankruptcy trustee.2 Shurley and the trustee of the trust3 appealed to the district court, which affirmed. This appeal followed. DISCUSSION 7 We review the bankruptcy court’s factual findings under the clearly erroneous standard, and we review its legal conclusions de novo.4 8 Under section 541 of the Bankruptcy Code5 a bankruptcy estate is created at the commencement of the bankruptcy case. Section 541(a)(1) states that “[e]xcept as provided in subsections (b) and (c)(2) of this section, all legal or equitable interests of the debtor in property as of the commencement of the case” is included in the estate. Subsection (c)(2) states the exclusion relevant here: “A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.” 9 Section 541(c)(2) excludes “spendthrift trusts” from the bankruptcy estate if such a trust protects the beneficiary from creditors under applicable state law.6 “In general, a spendthrift trust is one in which the right of the beneficiary to future payments of income or capital cannot be voluntarily transferred by the beneficiary or reached by his or her creditors.”7 10 The Bryant Family Trust agreement vests in the trustee authority over the trust assets. Among other powers vested in the trustee, the agreement provides: 11 The trustee (and his successors) shall have full power and authority: to manage, handle, invest, reinvest, sell for cash or credit, or for part cash and part credit, convey, exchange, hold, dispose of, lease for any period of time, whether or not longer than the life of the trust, improve, repair, maintain, work, develop, operate, use, mortgage, or pledge all or any part of the funds…. The trustee shall have full power to determine the manner in which expenses are to be borne and in which receipts are to be credited as between principal and income, and also to determine what shall constitute income or net income and what shall constitute corpus and principal…. [B]eneficiaries shall have no right or power to transfer, assign, convey, sell or encumber said trust estate and interest therein, legal or equitable, during the existence of these trusts. 12 The agreement expressly provides that trust assets cannot be reached by creditors of the beneficiaries.8 13 By vesting control of the trust in the trustee, denying the beneficiaries control over the trust, and denying creditors of the beneficiaries access to trust assets, the trust agreement qualifies as a spendthrift trust under Texas law. For two reasons, however, the bankruptcy court concluded that the trust assets are not beyond the reach of creditors under state law. The first reason, which we reject in part, is that spendthrift trust protection under state law does not extend to a trust settled by the beneficiary herself. The second reason, which we reject, is that Shurley exercised sufficient control over the trust to make the assets subject to her creditors. 14 A. The Self-Settlor Rule and its Consequences 15 The bankruptcy court’s principal reason for holding that Shurley’s interest in the trust is property of the bankruptcy estate is that she was one of the original settlors of the trust. We have recognized that a beneficiary’s interest in a spendthrift trust is not subject to claims of creditors under Texas law “[u]nless the settlor creates the trust and makes himself beneficiary.”9 The rationale for this “self-settlor” rule is obvious enough: a debtor should not be able to escape claims of his creditors by himself setting up a spendthrift trust and naming himself as beneficiary. Such a maneuver allows the debtor, in the words of appellees, to “have his cake and eat it too.” As one Texas court has explained:Public policy does not countenance devices by which one frees his own property from liability for his debts or restricts his power of alienation of it; and it is accordingly universally recognized that one cannot settle upon himself a spendthrift or other protective trust, or purchase such a trust from another, which will be effective to protect either the income or the corpus against the claims of his creditors, or to free it from his own power of alienation. The rule applies in respect of both present and future creditors and irrespective of any fraudulent intent in the settlement or purchase of a trust.10 16 The novel issue presented here is whether the entirety of a beneficiary’s interest in a spendthrift trust is subject to creditors’ claims where the trust is only partially self-funded by the beneficiary. There is no compelling Texas authority on this issue, but we conclude that on these facts Texas courts would surely hold that the partially self-funded spendthrift trust is only partially subject to creditors’ claims. 17 Allowing creditors to reach only the self-settled portion of the trust is consistent with the other long-standing rule of Texas law that a settlor should be allowed to create a spendthrift trust that shields trust assets from the beneficiary’s creditors. “Spendthrift trusts have long been held valid by Texas courts.”11 The bankruptcy court’s ruling ignores the wishes of Shurley’s parents, the primary settlors of the trust, and the state’s policy of respecting their expectations. “Spendthrift trusts are not sustained out of consideration for the beneficiary. Their justification is found in the right of the donor to control his bounty and secure its application according to his pleasure.”12 Allowing creditors to reach only that portion of the trust contributed by Shurley would further the policy of allowing her parents to create a spendthrift trust for the benefit of Shurley that is protected from her creditors, while giving effect to the exception for self-settled trusts. At least one court from another jurisdiction agrees with this this approach,13 and we believe that Texas courts would do the same. Accordingly we hold that the property which Shurley herself contributed to the trust–the Marfa ranch–is not protected from creditors under state law and is therefore property of the bankruptcy estate, but that all other assets of the trust are not property of the estate.14 18 We so hold despite Shurley’s “power of appointment” granted by the trust agreement. Under the agreement each sister has a right to allocate assets of the trust to specified beneficiaries. The agreement states that the sisters “shall each have a special power of appointment over an adjusted one-half (1/2) of the trust assets, to appoint such adjusted one-half (1/2) of the assets of said trust to and among their children and lineal descendants…. Neither [daughter] can appoint assets to herself, her creditors, her estate, or the creditors of her estate.” If a daughter does not exercise her power of appointment, the trust agreement provides that her interest shall be distributed in equal shares “to her children and lineal descendants, and to the lineal descendants of a deceased child, per stirpes.” Shurley represents on appeal that she has not exercised her special power of appointment because she is content with the trust’s distribution provisions for her descendants. 19 This power of appointment does not alter our conclusion that the Marfa ranch is property of the bankruptcy estate. The Bankruptcy Code expressly excludes such a power of appointment from the bankruptcy estate, since section 541(b)(1) provides that property of the estate does not include “any power that the debtor may exercise solely for the benefit of an entity other than the debtor.” However, while the power of appointment to others does not become property of the estate under § 541(b)(1), the property which became part of the bankruptcy estate under the Code upon the commencement of the bankruptcy case now belongs to that estate and is controlled by the bankruptcy trustee. Regardless of how Shurley might indicate that trust assets should be divided upon her death, the Marfa ranch now belongs to the bankruptcy estate, and her designation of beneficiaries is irrelevant. The bankruptcy estate will be divided among creditors according to the Code, regardless of Shirley’s appointment of assets under the trust agreement. 20 The exercise of the power of appointment under the trust agreement is analogous to a will, and has no more effect on the property of the bankruptcy estate and creditor priorities than a garden-variety will of the debtor. With an ordinary will, the heirs only receive the stipulated items of the property that were owned by the testator. Stated more simply, a testator can only give away that which was hers. Here, the Marfa ranch no longer belongs to Shurley; it is property of the bankruptcy estate. 21 Shurley argues that she only has a life estate in the Marfa ranch and other trust assets in the form of an equitable interest in the income from the trust assets during her life, and that creditors therefore cannot reach the corpus of the trust even if it is self-settled. She is correct that absent distributions of corpus at the discretion of the trustee or a premature termination of the trust (discussed below), the trust agreement only provides her with an income interest in the trust assets, with the remainder going to other beneficiaries. Shurley cites authority that even when a settlor creates a trust for herself, creditors can only reach trust assets to the extent of the settlor’s interest.15 22 The issue here–whether the creditors can reach only Shurley’s income from the Marfa ranch or the ranch itself–does not turn on whether the Shurley’s interest in the trust is “equitable,” since the Bankruptcy Code defines property of the bankruptcy estate to include “all legal or equitable interests of the debtor in property.”16 Resolution of this question turns on whether creditors can reach the trust corpus under state law, regardless of how the interest is characterized. 23 We conclude that under Texas law creditors can reach not only Shurley’s income from the Marfa ranch but the ranch itself, in light of Bank of Dallas v. Republic National Bank of Dallas.17 In Bank of Dallas, the debtor settled a trust with spendthrift language for the benefit of herself and her children. The debtor was to receive the net income of the trust during her lifetime, with the remainder going to her children or other beneficiaries named in her will. The trust agreement further provided that “[w]henever the trustee determines that the income of the Settlor from all sources known to the trustee is not sufficient for her reasonable support, comfort, and health and for reasonable support and education of Settlor’s descendants, the trustee may in its discretion pay to, or use for the benefit of, Settlor or one or more of Settlor’s descendants so much of the principal as the trustee determined to be required for those purposes.” 24 The court held that “where a settlor creates a trust for his own benefit, and inserts a spendthrift clause, it is void as far as then existing or future creditors are concerned, and they can reach his interest under the trust by garnishment.”18 It further held that income from the trust was subject to creditor claims, and that “the interest of [the debtor] in the trust is such that the corpus may be reached by her creditors.”19 25 The court considered the Restatement (Second) of Trusts § 156 (1959), which provides: 26 (1) Where a person creates for his own benefit a trust with a provision restraining the voluntary or involuntary transfer of his interest, his transferee or creditors can reach his interest. 27 (2) Where a person creates for his own benefit a trust for support or a discretionary trust, his transferee or creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit. 28 The court also looked to comment e of this section, which states that “[w]here by the terms of the trust a trustee is to pay the settlor or apply for his benefit as much of the income or principal as the trustee may in his discretion determine, his transferee or creditors can reach the maximum amount which the trustee could pay to him or apply for his benefit.” Applying these rules the court held that the creditor could reach the corpus of the trust, even though the debtor only had a life interest in the trust. 29 By this reasoning the creditors are able to reach the self-settled asset of the trust in our case, namely the Marfa ranch. The trust agreement states that “[i]f the trustee determines that the net income of said trust is insufficient to maintain and support any of the beneficiaries of said trust or their children and lineal descendants in their accustomed manner of living, taking into account, however, such beneficiary’s income from all other sources, the trustee may use so much of the corpus of said trust as the trustee sees fit to make up such deficiency.” This language is even broader than the language of the trust agreement in Bank of Dallas, since in our case the trustee can make grants of trust corpus to support the beneficiaries’ or their descendants’ “accustomed manner of living,” while in Bank of Dallas the trustee was limited to making such distributions to support the beneficiary’s “reasonable support, comfort, and health” and the reasonable support and education her descendants. If anything, the former term grants even more discretion to the trustee than the latter. Accordingly we conclude that the creditors in our case can reach the corpus of the trust under Texas law as to that property–the Marfa ranch–contributed by Shurley to the trust, and that the ranch is therefore property of the estate. 30 The court in Bank of Dallas also quoted comment c to § 156, which states that “[i]f the settlor reserves for his own benefit not only a life interest but also a general power to appoint the remainder by deed or will or by deed only or by will alone, the creditors can reach the principal of the trust as well as the income.” In Bank of Dallas the debtor apparently had a general power to appoint the remaining trust assets by will, while in our case Shurley and her sister have a special power of appointment, meaning that the trust document limits the choice of recipients of appointed assets to the sisters’ descendants. We do not see this factual distinction as significant. Comment c was only one of three comments to § 156 (comments c, d, and e) quoted by the court in Bank of Dallas, and § 156 itself, as we read it, states than any self-settled support or discretionary trust is subject to creditor claims up to “the maximum amount which the trustee under the terms of the trust could pay to” the beneficiary. We cannot fathom why the court would have reached a different result if the debtor had had a special rather than a general power of appointment. Before even mentioning the Restatement, the court stated without qualification that, under Texas law, “where a settlor creates a trust for his own benefit, and inserts a spendthrift clause, it is void as far as then existing or future creditors are concerned, and they can reach his interest under the trust by garnishment.”20 31 A similar result was reached in State v. Nashville Trust Co.21 The debtor was the beneficiary of a spendthrift trust holding real estate. The debtor built a mansion on the property. The court held that the debtor had self-settled the trust to the extent of the improvements he had made, and that the property was therefore subject to the creditor’s claim to the extent of the debtor’s improvements. The debtor argued that even if he “can be held to have contributed to the trust property, enhanced its value, and to that extent created a spendthrift trust for his own benefit, only his interest in such enhancement, i.e. his life estate in such enhancement, may be subjected and that the remainder interest of his children … may not be subjected for any debt of his.”22 The court rejected this argument, reasoning that the debtor’s children “could only be donees or volunteers and could take no benefits under such transfer as against his creditors. So we think the chancellor did not err against defendants in decreeing that the [creditor] had a right to subject the land for the amount by which its value had been enhanced by reason of the improvements.”23 The court held that the creditor was entitled to a lien on the trust property for the value of the debtor’s improvements, and that the creditor was “entitled to a sale of the land, if necessary, to enforce the lien.”24 32 Shurley argues that creditors cannot reach the corpus of the trust because of our decisions in In re Goff, 706 F.2d 574 (5th Cir.1983) (Goff I), and In re Goff, 812 F.2d 931 (5th Cir.1987) (Goff II ). In Goff I we held that the debtor’s Keogh plan, a pension trust under the ERISA statute,25 was not a spendthrift trust excluded from the bankruptcy estate under Bankruptcy Code § 541(c)(2) because it was self-funded. We stated that “[t]he general rule is well established that if a settlor creates a trust for his own benefit and inserts a ‘spendthrift’ clause, restraining alienation or assignment, it is void as far as creditors are concerned and they can reach the settlor’s interest in the trust.”26 33 In Goff II, a creditor claimed that its recorded judgment against the debtor gave it a statutory lien against the property held in the pension trust, and that it therefore had a secured bankruptcy claim. The bankruptcy trustee argued that the claim was unsecured. We held that the claim was unsecured, because under Texas law a judgment lien only attaches to real property in which the debtor has legal title, and the debtor only had equitable title to the real property in the trust. We stated that “[t]he trust remains valid; only the spendthrift clause is void, allowing creditors to reach the property held in trust by garnishment.”27 Goff II did not, as appellants argue, hold that creditors cannot reach the corpus of a self-funded trust with an invalid spendthrift clause. It held only that a judgment lien against the debtor did not create a secured claim against the assets of the trust. We have cited Goff II for the proposition that “[a] creditor can reach the trust assets” of a trust funded by the debtor-beneficiary.28 As with the Bryant Family Trust, the trust in question (1) contained a spendthrift clause, (2) provided the debtor with a life interest in the income, with the remainder going to other beneficiaries, and (3) provided that the trustee could invade the corpus of the trust for the debtor’s support, maintenance and welfare. 34 Shurley points out that when she made the original contribution of the Marfa ranch to the trust, it was subject to a note and lien. She argues that this lien should affect our analysis, but we disagree. There is no dispute that Shurley was the owner of the ranch when she conveyed it to the trust, even if it was encumbered with a lien. The note and lien may have affected the value of the property at the time the trust was funded, but they did not affect ownership of the property. When determining the property of the estate, the Bankruptcy Code looks to the debtor’s property “as of the commencement of the case.”29 It makes no more sense to look to the value of the ranch at the time of the creation of the trust than in does to look to the value of any other property of the debtor on the date of acquisition. If the debtor owns stock, bonds, real estate or other property, the original value or cost basis of those assets is irrelevant to the bankruptcy matter of defining the estate. Accordingly a lien on the ranch at the time of the trust’s creation does not alter our conclusion that the ranch is property of the bankruptcy estate. The ranch might have appreciated or depreciated in value for any number of reasons since 1965, including the balance on the note, but it is still property of the bankruptcy estate. 35 Shurley argues that there was no proof by appellees that she had any equity in the ranch at the time of creation of the trust, reasoning that she could not be a self-settlor if the property she contributed was worthless. Assuming that Shurley is legally correct–that a settlor’s contribution to a trust of real property in which she had no equity at the time of the trust’s creation does not fall within the self-settlor rule–the bankruptcy court found that she had equity in the property at the time of the creation of the trust in 1965.30 This fact finding is not clearly erroneous. Shurley purchased the ranch from her parents in 1950 for $131,366.64 and assumed a $50,000 balance on the note.31 The balance on the note was only $23,000 when the property was conveyed to the trust.32 Moreover, in the trust agreement itself, Shurley as a signatory represented that “the value of that portion of said real property to be contributed by [Shurley and her sister] each represents (1/6) of the total value of all of said real property to be contributed.” This declaration is an admission by Shurley that the property she contributed had some value, exceeding the balance on the note, since the trust assumed the note. B. Beneficiary Control 36 The bankruptcy court concluded that “[e]ither substantial control or self-settlement may operate to invalidate protective trust provisions.”33 It found that Shurley exercised too much control over the trust to qualify as the beneficiary of a spendthrift trust. We find none of the reasons given persuasive.34 37 First, the court found that “Mrs. Shurley, in conjunction with her father during his life, had the power to revoke, alter, or amend the Trust document, or distribute the Trust assets back to the settlors.”35 We disagree. The agreement provides that “M.D. Bryant (the father) with the concurrence of either Settlor Anne Bryant Ridge or Settlor Jane Bryant Shurley, shall have the right at any time during his lifetime to revoke, alter and amend said trust and distribute the assets of said trust to the Settlors in the same proportion as the original contributions by each of said Settlor, taking into account any adjustment under paragraph (b).” The power to revoke or amend the trust was vested in the father, not the daughters. Shurley had no authority to alter the trust. She only had the authority to prevent her father from doing so, and only if she and her sister vetoed the change. At most therefore she and her sister in combination had the power to ensure the perpetuation of the trust. Further, this power lapsed upon the death of the father in 1967. We find no authority that such a limited power rendered the trust subject of creditor claims against the beneficiaries. 38 Second, the bankruptcy court noted that the agreement provided that Shurley had the right to petition three “special trustees” for the partial or complete termination of the trust. The agreement provides for the appointment of certain named special trustees, including a state judge, after the death of the parents. It states that “[u]pon application made by either daughter … or both, showing that termination would best serve the intended purpose of the trust, such Special Trustees shall in their sole and absolute discretion have the power and authority by unanimous consent to terminate in whole or in part and from time to time the trust or trusts established hereunder.” Again, this provision does not vest in Shurley the power to terminate or alter the trust. It only authorizes her to request such a change from special trustees, who have “in their sole and absolute discretion” the authority to alter the trust. Even absent such a provision, Shurley, like all Texas trust beneficiaries, had a statutory right to seek judicial modification or termination of the trust if “compliance with the terms of the trust would defeat or substantially impair the accomplishment of the purposes of the trust.”36 No court has ever held that such a statutory right renders a spendthrift trust subject to creditor claims. 39 Third, the bankruptcy court noted Shurley’s special power of appointment. This provision merely gave the daughters the authority to allocate trust assets to their descendants. It grants no authority to the daughters to allocate assets to themselves. As explained above, the Bankruptcy Code expressly excludes such a power of appointment from the bankruptcy estate. Section 541(b)(1) of the Code provides that property of the estate does not include “any power that the debtor may exercise solely for the benefit of an entity other than the debtor.” 40 Aside from the terms of the trust agreement, the bankruptcy court found that Shurley had exercised de facto control over the trust. The court found: 41 Outside the Trust document, the Shurleys also manipulated Trust assets and governed the initial Trustee, Bryant Williams. The Shurleys were regularly able to obtain unrestricted corpus distributions and loans. While the Trust provides for such distributions, the liberality and circumstances under which they were requested and granted suggested a domination by M.D. Bryant, Mrs. Shurley and Mrs. Watkins of Mr. Williams. Only recently had any corpus distribution request been denied, and only recently had the successor Trustee, Mr. Armstrong, started to make only “loans,” to the exclusion of corpus distributions. Indeed, in the early days of the Trust, the initial Trustee, on behalf of the Trust, executed promissory notes as a comaker for the Shurleys. Part of the malleability of Bryant Williams may have arisen either from his fear of being replaced for failing to abide by the wishes of Mrs. Shurley and Mrs. Watkins, or from his close relationship with the family. While M.D. Bryant, the Shurleys and the Watkines may not have held all of the puppet strings to Mr. Williams, they held enough of them to exert the control necessary to defeat the Trust’s protective attributes.37 42 Shurley strongly denies that the evidence at trial supported these findings, arguing for example that there is no evidence that the first trustee ever made a single distribution of trust corpus or a single loan to Shurley or any other beneficiary. Appellees argue that in addition to the above-quoted findings, Shurley, among other things, “used the Trust income to induce extensions of credit to herself and her husband,” and “engaged in ‘trustee shopping’ to help further her control of the trust assets.”Even if these findings are taken as undisputed, they do not establish control by the daughters over the trust assets sufficient to make the trust subject to their creditors. The fact that the trustees liberally bestowed trust assets on the daughters, by itself, does not establish de facto control by the daughters over the affairs of the estate. The daughters were after all two of the principal beneficiaries of the trust, and distributions of the wealth of the the trust to the daughters is entirely consistent with its apparent purpose. The agreement provides that the trustee was not limited to distributing income generated from the corpus of the trust. As discussed above, it expressly authorized the trustee to make distributions from the trust corpus “[i]f the trustee determines that the net income of said trust is insufficient to maintain and support any of the beneficiaries of said trust or their children and lineal descendants in their accustomed manner of living….” It also expressly authorized the trustee to “loan money to … and otherwise deal with any and all persons” including “the beneficiaries of this trust.” 43 As one Texas decision has explained in denying a creditor’s claim against assets held by a spendthrift trust: 44 the purpose of such a trust is not defeated by the fact that the trustee is authorized in his discretion to apply a part of the corpus of the fund to the use of the beneficiary in accordance with the terms of the trust. Neither is the purpose of such trust defeated by the fact that the trustee is authorized or even required to turn the entire trust fund or property over to the beneficiary absolutely at some fixed time in the future.38 45 Appellees did not establish that loans or grants from the trust to the daughters, on their face consistent with the purpose and language of the trust, amounted to de facto control of the trust by the daughters. Further, the fact that the beneficiary of a spendthrift trust may have behaved as a spendthrift only shows the prescience of the settlors, and should not defeat the protective features of the trust. Appellees’ focus on the behavior of Shurley as beneficiary is misplaced, since as explained above, spendthrift trusts are not shielded from creditors “out of consideration for the beneficiary. Their justification is found in the right of the donor to control his bounty and secure its application according to his pleasure.”39 C. Whether the Trust Is an Annuity 46 By separate appeal Shurley argues that the bankruptcy court erred in denying her summary judgment motion urging that her interest in the trust is an “annuity” exempt from creditors under Texas law. 47 Under Texas law and Bankruptcy Code § 522, Texas debtors may elect either state or federal exemptions from creditors.40 Shurley’s claims that her interest in the trust is an annuity exempt from creditors under Tex. Ins. Code Ann. art. 21.22 (Vernon Supp.1997), which provides an exemption for “all money or benefits of any kind, including policy proceeds and cash values, to be paid or rendered to the insured or any beneficiary under any policy of insurance or annuity contract issued by a life, health or accident insurance company, including mutual and fraternal insurance, or under any plan or program of annuities and benefits in use by an employer or individual.” The emphasized language was added by a 1993 amendment to the statute, after Shurley filed for bankruptcy. 48 This argument fails for two reasons. First, her interest in the trust was not issued by an insurance company or employer, so the only conceivable claim of exemption is that her interest is part of a “plan or program of annuities and benefits in use by an … individual.” The reference to an individual was added to the statute after the bankruptcy filing. In determining exemptions we must apply the law in effect at the time the debtor entered bankruptcy.41 Although Texas exemption laws are liberally construed,42 the exemption Shurley claims simply did not exist at the commencement of her bankruptcy case. We cannot agree with Shurley that the 1993 amendment merely “clarified” legislative intent insofar as it added a reference to non-employer annuities that are not issued by insurance companies.43 The statute plainly did not apply to such annuities prior to the amendment. 49 Second, we do not believe that Shurley’s trust interest can be characterized as an annuity in any event. One Texas court has described an annuity as a “a form of investment which pays periodically during the life of the annuitant or during a term fixed by contract rather than on the occurrence of a future contingency.”44 We have cited this same definition with approval.45 While all annuities do not make payments in fixed, predetermined amounts,46 we do not believe that the term extends to a trust where future payments are highly contingent on the future circumstances of the beneficiaries. The trust agreement provides that the trustee “may” make distributions of trust corpus if he determines that such distributions are needed to “maintain and support any of the beneficiaries or their children or lineal descendants in their accustomed manner of living.” Any such good faith determination by the trustee is “final and binding on all interested parties.” Such distributions were in fact made. By design, such distributions are tied to contingencies unknown at the time of the creation of the trust, and are not consistent with the concept that an annuity makes payments without regard to “the occurrence of a future contingency.”47 In addition, under terms of the trust agreement discussed above, payments to Shurley were contingent on (1) the death of her parents, since her interest increased on the death of one parent and increased again on the death of the second parent, (2) whether the father, with the consent of either sister, chose to terminate the trust, and (3) whether the special trustees terminated the trust. 50 Further, Shurley’s argument simply proves too much, since if her interest in the trust is an annuity, then all beneficiaries of self-settled trusts could make the same argument, as long as the trust agreement called for periodic payments to the settlor for life or a fixed term. We cannot accept that the Texas legislature intended this result, which would reject the universally recognized rule, and one codified by Texas statute, that a settlor cannot create his own spendthrift trust and shield its assets from creditors. If the legislature had intended this result, it would have repealed Tex. Prop.Code Ann. § 112.035(d), which provides that “[i]f the settlor is also a beneficiary of the trust, a provision restraining the voluntary or involuntary transfer of his beneficial interest does not prevent his creditors from satisfying claims from his interest in the trust estate.” CONCLUSION 51 In summary, we conclude that the Marfa ranch and income generated therefrom is property of the estate.48 The judgment is reversed and the case is remanded for further proceedings consistent with this opinion. 52 REVERSED and REMANDED. 1 The briefs indicate that the “Marfa Ranch” also refers to a larger tract of land out of which came the acreage Shurley contributed to the trust. In this opinion the “Marfa ranch” means only that acreage owned by Shurley and conveyed to the trust in 1965, together with any mineral interests she may have owned and conveyed to the trust 2 In re Shurley, 171 B.R. 769, 789 (Bankr.W.D.Tex.1994) 3 For convenience, appellants Shurley and the trustee of the trust are sometimes collectively referred to as Shurley 4 In re Herby’s Foods, Inc., 2 F.3d 128, 130-31 (5th Cir.1993) 5 11 U.S.C. § 541 6 Patterson v. Shumate, 504 U.S. 753, 762, 112 S.Ct. 2242, 2248, 119 L.Ed.2d 519 (1992) (noting legislative history that § 541(c)(2) “continues over the exclusion from property of the estate of the debtor’s interest in a spendthrift trust to the extent the trust is protected from creditors under applicable State law.”); In re Moody, 837 F.2d 719, 722-23 (5th Cir.1988) (“A beneficiary’s interest in a spendthrift trust is excluded from his bankruptcy estate by 11 U.S.C. § 541(c)(2), if state law and the trust so provide.”) 7 Id. at 723 8 The agreement states: “The interest of the beneficiaries in the trust estate and the increase and proceeds thereof, both legal and equitable, so long as the same are held in trust, shall not be subject in any manner to any indebtedness, judgment, judicial process, creditors’ bills, attachment, garnishment, execution, receivership, charge, levy, seizure or encumbrance, of or against said beneficiaries; nor shall the interest of the beneficiaries in said trust be in any manner reduced or affected by any transfer, assignment, conveyance, sale, encumbrance, act, omission or mishap, voluntary or involuntary, anticipatory or otherwise of said beneficiaries….” 9 Id. at 723. See also Daniels v. Pecan Valley Ranch, Inc., 831 S.W.2d 372, 378 (Tex.App.–San Antonio 1992, writ denied) (“In Texas, a settlor cannot create a spendthrift trust for his own benefit and have the trust insulated from the rights of creditors.”); Tex. Prop.Code Ann. § 112.035(d) (“If the settlor is also a beneficiary of the trust, a provision restraining the voluntary or involuntary transfer of his beneficial interest does not prevent his creditors from satisfying claims from his interest in the trust estate.”) 10 Glass v. Carpenter, 330 S.W.2d 530, 533 (Tex.Civ.App.–San Antonio 1959, writ ref’d n.r.e.) 11 Moody, 837 F.2d at 723 12 Hines v. Sands, 312 S.W.2d 275, 279 (Tex.Civ.App.–Fort Worth 1958, no writ) 13 In re Johannes Trust, 191 Mich.App. 514, 479 N.W.2d 25, 29 (1991) (“[The self-settlor’s] creditors can reach the assets of the trust and compel payment in the maximum amount that would be in the trustee’s discretion with respect to that portion of the assets that came from [the self-settlor], but not with respect to any portion of the trust that came from other individuals, particularly petitioner.”) 14 We note that the Marfa ranch was still held by the trust when Shurley commenced her bankruptcy case. If the ranch had been sold, prior to the bankruptcy filing, this case would be more complicated. We would still hold that some portion of Shurley’s interest in the trust was self-settled and therefore property of the estate, but would have to engage in a further analysis of (1) how to value the self-settled portion of the trust, through tracing of assets or some other method of calculating Shurley’s proportionate contribution to the trust relative to the other settlors’ contributions, and (2) who should have the burden of proof on this issue 15 E.g., Fordyce v. Fordyce, 80 Misc.2d 909, 365 N.Y.S.2d 323, 328 (N.Y.Sup.Ct.1974) (“Even in the case of a self-settled trust, creditors can only reach the interest the settlor retained for himself.”) 16 11 U.S.C. § 541(a)(1) 17 540 S.W.2d 499 (Tex.Civ.App.–Waco 1976, writ ref’d n.r.e.) 18 Id. at 501 19 Id. at 501-02 20 Bank of Dallas, 540 S.W.2d at 501 21 28 Tenn.App. 388, 190 S.W.2d 785 (1944) 22 Id. 190 S.W.2d at 791 23 Id. at 792 24 Id. at 799 25 29 U.S.C. §§ 1001 et seq 26 Goff I, 706 F.2d at 587. The principal holding of the case–that a qualified ERISA pension plan is not excluded from the bankruptcy estate because the federal ERISA statute is not “applicable nonbankruptcy law” under Bankruptcy Code § 541(c)(2)–was expressly overruled in Patterson, 504 U.S. at 757 n. 1, 112 S.Ct. at 2246 n. 1 (citing Goff I ) 27 Goff II, 812 F.2d at 933 28 In re Latham, 823 F.2d 108, 111 (5th Cir.1987) 29 11 U.S.C. § 541(a)(1) 30 Shurley, 171 B.R. at 778-79 n. 5 31 Shurley paid only $200 down for the ranch, and executed 25 separate promissory notes to her parents, which were annually forgiven by the parents 32 The note was subsequently paid off by the trust 33 Shurley, 171 B.R. at 782 34 We assume without deciding that the court was legally correct in concluding that “substantial control” can render a spendthrift or other protective trust subject to creditor claims. We note however that we do not believe that appellees have cited any Texas authority for this proposition 35 Id. at 783 36 Tex. Prop.Code Ann. § 112.054 (Vernon 1995) 37 Shurley, 171 B.R. at 783 38 Adams v. Williams, 112 Tex. 469, 248 S.W. 673, 679 (1923) 39 Hines v. Sands 312 S.W.2d 275, 279 (Tex.Civ.App.–Fort Worth 1958, no writ) 40 In re Walden, 12 F.3d 445, 448 (5th Cir.1994) 41 Walden, 12 F.3d at 449 n. 7. In so holding, Walden was interpreting the same state statute at issue here, Insurance Code art. 21.22 42 Id. at 448 43 We assume without deciding that Shurley is correct that an annuity under the current statute can be issued by an entity other than an insurance company. But see art. 21.22(6) (“For purposes of regulation under this code, an annuity contract issued by a life, health, or accident insurance company, including a mutual company or fraternal company, or under any plan or program of annuities or benefits in use by an employer or individual, shall be considered a policy or contract on insurance.”). Texas, like all states, comprehensively regulates insurers and insurance policies 44 Steves & Sons, Inc. v. House of Doors, Inc., 749 S.W.2d 172, 175 (Tex.App.–San Antonio 1988, writ denied) (quoting In re Howerton, 21 B.R. 621 (Bankr.N.D.Tex.1982)) 45 In re Young, 806 F.2d 1303, 1306 (5th Cir.1987) (quoting Howerton ) 46 With a variable annuity, “payments to the purchaser vary with investment performance.” NationsBank of North Carolina, N.A. v. Variable Annuity Life Ins. Co., 513 U.S. 251, 254, 115 S.Ct. 810, 812, 130 L.Ed.2d 740 (1995) 47 Steves & Sons, 749 S.W.2d at 175 48 Income from the ranch belongs to the estate because the Bankruptcy Code defines property of the estate to include “[p]roceeds, product, offspring, rents, or profits of or from property of the estate.” 11 U.S.C. § 541(a)(6)

In re Jane McLean Brown – 11th Circuit Discusses Asset Protection of Non-Self-Settled Trusts

IN RE: Jane McLean BROWN

IN RE: Jane McLean BROWN, Debtor. Deborah Menotte, Plaintiff-Appellant, v. Jane McLean Brown, Defendant-Appellee.

No. 01-16211.

— August 28, 2002 Before EDMONDSON, Chief Judge, and BLACK and COX, Circuit Judges.

Morris Gary Miller,Adorno & Zeder, P.A., West Palm Beach, FL, for Plaintiff-Appellant.David Lloyd Merrill, Cohen, Conway, Copeland, Copeland, Paiva & Merrill, P.A., Fort Pierce, FL, for Plaintiff-Appellee.

This case involves a Chapter 7 bankruptcy debtor seeking to exclude her interest in a trust from the bankruptcy estate.   The trust, which was created by the debtor prior to insolvency, was established to provide income to the debtor for her lifetime with the remainder ultimately being given to several charities.   Based on the presence of a spendthrift clause prohibiting assignment or alienation, the debtor contends her interest in the trust is exempt from her bankruptcy estate.   Alternatively, the debtor contends her interest is exempt because the trust qualifies as a support trust.   Having created the trust for her own benefit, however, the debtor cannot shield her interest in the trust from her creditors.   This interest, consisting of a yearly income stream from the trust assets, is not exempt from the debtor’s bankruptcy estate.   The corpus of the trust, however, is not likewise subject to the claims of the debtor’s creditors.

I. BACKGROUND

A. Establishment of the Trust

Appellee Jane McLean Brown (Appellee), the debtor in the bankruptcy case giving rise to this appeal, suffers from chronic alcoholism.   In 1993, her mother died, leaving her an inheritance of approximately $250,000.   In order to protect the inheritance from her own improvidence, Appellee decided to place the money into an irrevocable trust which would pay her a monthly income for life.   On August 11, 1993, Appellee executed the trust agreement, entitled Irrevocable Charitable Remainder Unitrust Agreement (ICRUA).

Under the ICRUA, Appellee is entitled to receive an annual amount equal to 7% of the net worth of the trust, valued as of the first day of each taxable year.   The payments are due in monthly installments.   Appellee, who is unemployed, lives off of the monthly payments flowing from the ICRUA.   Appellee is the only beneficiary currently entitled to receive income payments under the trust.

As a trust beneficiary, Appellee’s only rights are to receive the 7% income payments.   Although Appellee also serves as trustee, her powers are generally limited to directing investment decisions.   She does not have the discretion to invade the trust corpus or to alter the amount of payments made to the trust beneficiaries.   Furthermore, Appellee is prohibited from assigning or otherwise alienating her interest in the trust by virtue of a “spendthrift” clause contained into the ICRUA:

To the extent permitted by law, no beneficiary shall have any power to dispose of or to charge by way of anticipation any interest given to her, and all sums payable to any beneficiary shall be free and clear of her debts, contracts, dispositions and anticipations, and shall not be taken or reached by any legal or equitable process in satisfaction thereof.

See Article IV of the ICRUA.

Upon Appellee’s death, the 7% yearly trust income payments will be made to her daughter for life.1  At the daughter’s death, the corpus of the trust will pass to four charities listed in the ICRUA.   Although the ICRUA expressly reserves Appellee’s right to designate substitute or additional charitable beneficiaries by testamentary instruction, the right of redesignation is limited to substituting or adding other charities meeting certain Internal Revenue Code qualifications.2

B. Chapter 7 Bankruptcy

On February 4, 1999, Appellee filed a voluntary petition for Chapter 7 bankruptcy.   Appellant Deborah Menotte (Appellant) was appointed as the Chapter 7 trustee.   In her bankruptcy petition, Appellee listed secured and unsecured claims totaling $110,023.53.   Although Appellee acknowledged her interest in the ICRUA, no value for the interest was included as part of her asset calculation.3  Rather, Appellee claimed her interest in the trust was exempt from the bankruptcy estate.   Appellant objected, arguing self-funded trusts are not insulated from the claims of creditors.

On July 26, 2000, the bankruptcy court overruled Appellant’s objection to the claimed exemption.   Based on the presence of the spendthrift clause, the bankruptcy court concluded Appellee’s interest in the trust could not be attached by her creditors.   As an additional ground for exemption, the bankruptcy court indicated the trust also qualified as a support trust, which is a type of trust established to provide for a beneficiary’s needs.   The bankruptcy court rejected Appellee’s alternative argument that her interest in the trust constituted an exempt annuity.

On November 8, 2001, Appellant filed an appeal to the United States District Court for the Southern District of Florida.   On appeal, Appellant argued the bankruptcy court erred in finding the ICRUA was exempt from the bankruptcy estate as either a spendthrift trust or a support trust.   The district court affirmed in part, finding the ICRUA was exempt from the bankruptcy estate based on its spendthrift provision.   Although it did not need to reach the bankruptcy court’s other ground for exemption, the district court indicated the trust likely would not qualify as a support trust because the ICRUA provided for payment of a fixed sum to Appellee each year regardless of the amount needed for her support.   Having not been raised on appeal, the issue of whether the trust qualified as an exempt annuity was not addressed by the district court.4  This appeal followed.

II. STANDARD OF REVIEW

In bankruptcy appeals, legal determinations of the bankruptcy court and the district court are subject to de novo review.  Bush v. JLJ, Inc. (In re JLJ, Inc.), 988 F.2d 1112, 1116 (11th Cir.1993).

III. DISCUSSION

An estate in bankruptcy consists of all interests in property possessed by the debtor at the time of her bankruptcy filing.  11 U.S.C. § 541(a)(1) (1994).   Where there is a restriction on transfer of the debtor’s interests under applicable non-bankruptcy law, however, such restriction remains effective even in bankruptcy.  11 U.S.C. § 541(c)(2).   As a result, spendthrift and support trusts are excluded from a debtor’s bankruptcy estate to the extent they are protected from creditors under applicable state law.5  The state law applicable in this case is the law of the State of Florida.   We will examine in turn whether the ICRUA qualifies as either a spendthrift trust or a support trust under Florida law.

A. The ICRUA as a Spendthrift Trust

In Florida, trusts containing valid spendthrift provisions are protected from the reach of creditors, so long as the beneficiaries cannot exercise dominion over the trust assets.   See generally Waterbury v. Munn, 159 Fla. 754, 32 So.2d 603, 605 (Fla.1947) (en banc) (recognizing the validity of spendthrift trusts);  Croom v. Ocala Plumbing & Elec. Co., 62 Fla. 460, 57 So. 243, 244-45 (Fla.1911) (holding creditors could reach trust property, despite presence of spendthrift clause, where the beneficiaries possessed absolute control over the property).   Where a trust is self-funded by a beneficiary, however, there is an issue as to whether the trust’s spendthrift provision is valid as against creditors of the settlor-beneficiary.   We conclude it is not, and the beneficiary’s interest is subject to alienation by her creditors.

1. Validity of the ICRUA’s Spendthrift Provision as Against Appellee’s Creditors

Spendthrift trusts are defined under Florida law as “those trusts that are created with a view of providing a fund for the maintenance of another, and at the same time securing it against his own improvidence or incapacity for self-protection.”  Croom, 57 So. at 244 (emphasis added);  see also Waterbury, 32 So.2d at 605 (“A spendthrift trust is one that is created with the view of providing a fund for the maintenance of another, and at the same time securing it against his own improvidence or incapacity for self protection.”).

As impliedly recognized by the definition of spendthrift trusts set forth in Croom, Florida law will not protect assets contained within a spendthrift trust to the extent the settlor creates the trust for her own benefit, rather than for the benefit of another.6  See In re Witlin, 640 F.2d 661, 663 (5th Cir. Unit B 1981) (holding, under Florida law on spendthrift trusts, debtor’s interest in his Keogh plan was not exempt from his bankruptcy estate where the debtor was both the beneficiary and the settlor of the plan); 7  In re Wheat, 149 B.R. 1003, 1004-05 (Bankr.S.D.Fla.1992) (holding, under Florida law on spendthrift trusts, debtor’s deferred compensation plan was not exempt from his bankruptcy estate where it was self-funded);  In re Williams, 118 B.R. 812, 815 (Bankr.N.D.Fla.1990) (holding, under Florida law on spendthrift trusts, debtor’s interests in his employer’s thrift plan was not exempt from his bankruptcy estate where it was self-settled);  John G. Grimsley, Florida Law of Trusts § 15-5(b) (4th ed.   1993) (“A settlor cannot create for himself a spendthrift trust to avoid creditors.”);   55A Fla. Jur.2d Trusts § 78 (2000) ( “The trustee and the sole beneficiary cannot be one in the same under spendthrift trust law.   A settlor cannot create a spendthrift trust for his or her own benefit.”).

This limitation comports with the common law of trusts.8  See, e.g., Restatement (Second) of Trusts § 156(1) (1959) (“Where a person creates for his own benefit a trust with a provision restraining the voluntary or involuntary transfer of his interest, his transferee or creditors can reach his interest.”);   George Gleason Bogert & George Taylor Bogert, Trusts & Trustees § 223 (rev.2d ed.   1992) (“If a settlor creates a trust for his own benefit and inserts a spendthrift clause, it is void as far as then existing or future creditors are concerned, and they can reach his interest under the trust.”);   Erwin N. Griswold, Spendthrift Trusts § 474 (1936) (“A spendthrift trust created by a person for his own benefit is invalid against creditors.”);   II Austin Wakeman Scott, The Law of Trusts § 114 (3d ed.   1967) (“It is to be noticed that the beneficial interest reserved to the settlor is for some purposes treated differently from a beneficial interest created in a third person.   Thus, although a beneficial interest created in a third person may be inalienable by him and not subject to the claims of his creditors, a beneficial interest reserved to the settlor himself can be alienated by him or reached by his creditors even though it is otherwise provided by the terms of the trust.”).   Self-settled trusts may be reached by creditors, even if the settlor was solvent at the time of the trust’s creation and no fraud was intended.   See Scott, supra, at § 156 (“It is immaterial that in creating the trust the settlor did not intend to defraud his creditors.   It is immaterial that he was solvent at the time of the creation of the trust.   It is against public policy to permit a man to tie up his own property in such a way that he can still enjoy it but can prevent his creditors from reaching it.”).

In this case, Appellee is a beneficiary of a self-settled spendthrift trust.   In 1993, Appellee inherited $250,000 from her mother.   To protect the inheritance from her own squandering, Appellee established a charitable trust under which she retained the right to receive a 7% income for life.   Appellee purportedly was not insolvent at the time the trust was established;  nor is there evidence Appellee intended to defraud her creditors.   Nevertheless, Appellee is both the settlor and a beneficiary of the trust.   Consequently, the spendthrift clause contained in the trust is ineffective as against Appellee’s creditors.9

2. Interest Reachable by Appellee’s Creditors

When a settlor creates a trust for her own benefit and inserts a spendthrift clause, the entire spendthrift clause is void as to her creditors.   See Bogert § 223 (“The entire spendthrift clause, both as to voluntary and involuntary alienation, is void.   The creditors can reach the settlor-beneficiary’s interest.”).   In the absence of a valid spendthrift provision, a beneficiary’s interest in a trust is a property right which is liable for the beneficiary’s debts to the same extent as her legal interests.   See generally Grimsley § 8-3 (“Where the beneficiary’s equitable interest is vested in him without restraint on alienation, the interest is transferable by him and subject to claims of his creditors.”);  Bogert § 193 (“If the trust is active the creditor of the beneficiary can subject the latter’s interest in the trust to the satisfaction of the debt, either in law or equity, unless a statute or a valid spendthrift provision prevents this result.”).

As with any other property right, a trust beneficiary’s right to receive income for life is an interest which may be alienated or subject to attachment by her creditors.   See generally Blair v. Comm’r of Internal Revenue, 300 U.S. 5, 13-14, 57 S.Ct. 330, 333-34, 81 L.Ed. 465 (1937) (holding that in absence of a valid restraint on alienation, the interest of a trust beneficiary to income for life was present property which could be assigned to others);  Bradshaw v. Am. Advent Christian Home & Orphanage, 145 Fla. 270, 199 So. 329, 332-33 (Fla.1940) (holding that in absence of a restraint on alienation, income stream granted to orphanage as trust beneficiary was subject to the claims of the orphanages’ creditors).

Where the only interest a settlor has retained for herself under a trust is the right to income for life, it is solely this interest which her creditors can reach.10  See II Scott § 156 (“Where the only interest which the settlor has created for himself under the trust is a right to the income for life or for some other period, it is this interest alone which his creditors can reach, unless the creation of the trust was a disposition in fraud of his creditors.”);   see also In re Goff, 812 F.2d 931, 933 (5th Cir.1987) (indicating creditors of settlors-beneficiaries were limited to attaching whatever interest the settlors retained under the trust and, therefore, could not obtain a lien on real property conveyed into the trust because settlors’ interest was equitable rather than legal);  Bogert § 223 (“If the settlor creates a trust for the settlor for life, with a restraint on voluntary or involuntary alienation of his interest, and with a remainder interest in others at his death, his creditors can reach his life interest but not the remainder, unless he has also reserved a general power of appointment.”);   Griswold § 475 (indicating creditors could reach a settlor’s life interest, but not the remainder if vested in another).11  As illustrated in the Restatement (Second) of Trusts:

A transfers property to B in trust to pay the income to A for life and to pay the principal on A’s death to C.   By the terms of the trust it is provided that A’s interest under the trust cannot be transferred or reached by his creditors.   A can transfer his interest;  his creditors can reach his interest.

Restatement (Second) of Trusts § 156 cmt. a, illus. 1.

This result makes sense.   Although the spendthrift provision of a trust is void as against a settlor-beneficiary’s creditors, the trust itself remains valid.   See, e.g., In re Goff, 812 F.2d at 933 (holding spendthrift provision was void as against creditors based on self-settlement, but trust itself was valid);  Liberty Nat. Bank v. Hicks, 173 F.2d 631, 634-35 (D.C.Cir.1948) (holding settlor-beneficiary was bound by terms of trust, even though its spendthrift provision was ineffective as against his creditors);  see also 76 Am.Jur.2d Trusts § 128 (1992) (“[W]here there is a provision in the terms of the trust imposing restraint on the transfer by a beneficiary of his interest and the provision is illegal, the provision fails, but the whole trust does not fail, since provisions like this can ordinarily be separated from other provisions without defeating the purpose of the settlor in creating the trust.”).   Thus, although a settlor-beneficiary’s creditors are not bound by a trust’s spendthrift clause, the assets subject to attachment are circumscribed by the trust agreement.

By establishing an irrevocable trust in favor of another, a settlor, in effect, gives her assets to the third party as a gift.   Once conveyed, the assets no longer belong to the settlor and are no more subject to the claims of her creditors than if the settlor had directly transferred title to the third party.   Where the settlor retains a right to income payments, however, there is a limited interest created in favor of the settlor.   It is this limited interest, and not the entire trust assets, which may be attached by the settlor’s creditors:

Life interest in settlor with remainder over to a named or designated person.   The settlor may reserve to himself only the income from the property transferred during his life and may by the transfer give a vested remainder after his death to some named person or persons.   This situation arises in the following typical case:  A conveys property to T on trust to pay the income to A during A’s life, with restraints against anticipation, assignment, and the rights of creditors, and with a further provision that on the death of A the property shall be conveyed to B. Such a conveyance creates in B a present vested remainder, and if the transfer is not a fraudulent conveyance, the interest of B can not, of course, be reached for A’s debts.   The remainder may be to a class, as to the children of the settlor.   It may likewise be contingent until the death of the settlor.   In any of these cases, if the settlor has reserved no power over the remainder, and the transfer is not fraudulent, the conveyance of the remainder constitutes a present gift and is just as much beyond the reach of creditors as any other completed gift.

Griswold § 475.

In this case, Appellee transferred assets of $250,000 into a charitable trust.   The transfer was irrevocable, and the charities listed in the trust became vested in the corpus of the trust, subject only to divestment through redesignation of other charitable remaindermen.   Appellee retained no rights to the trust principle.   In establishing the ICRUA, however, Appellee granted herself an interest in the trust in the form of a right to receive 7% income from the trust for life.   As a result, Appellee’s income stream is subject to the reach of her creditors.12  The corpus of the trust, having irrevocably been conveyed to the trust for the benefit of others, is not likewise subject to the claims of her creditors.

B. The ICRUA as a Support Trust

In addition to claiming the ICRUA’s spendthrift provision is effective against her creditors, Appellee asserts the trust is exempt from her bankruptcy estate as a support trust.  “A support trust is one where the trustee is directed to pay to the beneficiary only so much income or principal, or both, as is necessary for the beneficiary’s support and education.”  In re McLoughlin, 507 F.2d 177, 185 (5th Cir.1975).   Support trusts, by their nature, are non-transferrable.  Id.;  see also Bogert § 229 (“If a trustee is directed to pay or apply trust income or principal for the benefit of a named person, but only to the extent necessary to support him, and only when the disbursements will accomplish support, the nature of the interest of the beneficiary makes it not transferable and not subject to the claims of creditors.”).

As an initial matter, the structure of the ICRUA is not in the form of a support trust.   Nowhere in the ICRUA is there a mention of payments by the trustee for the support of Appellee.   Although the monthly income payments are used by Appellee for her own support, the ICRUA does not limit disbursements to that effect.   Rather, the trustee is merely obligated to pay 7% of the value of the trust to Appellee each year.   The trustee may not pay Appellee more than the 7% income if her needs exceed that amount;  likewise, the trustee may not limit payments to less than the 7% income.   Appellee is entitled to the income payments regardless of need and may dispose of the funds as she chooses.   The ICRUA, therefore, does not constitute a support trust.

Even if the ICRUA qualified as a support trust, Appellee’s interest in the trust would not be shielded from her creditors.   As with the ICRUA’s spendthrift provision, a support trust created by a settlor for her own benefit is ineffective as against her creditors.   See Restatement (Second) of Trusts § 156(2) (“Where a person creates for his own benefit a trust for support or a discretionary trust, his transferee or creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit.”);   II Scott § 156.1 (“The policy which prevents a person from creating a spendthrift trust for his own benefit also prevents his creating a trust under which his creditors are precluded from reaching the income or principal which is to be applied for his support.”).

IV. CONCLUSION

When establishing the ICRUA, Appellee made an irrevocable charitable gift of the trust corpus.   By including the right to receive income payments for life, Appellee retained a portion of the assets for herself.   Whatever interest Appellee retained is her own property, subject to the claims of her creditors.   Accordingly, Appellee’s right to an income stream is not exempt from her bankruptcy estate and may be reached by her creditors.   The corpus of the trust, however, may not be reached by Appellee’s creditors.

AFFIRMED IN PART and REVERSED IN PART.

FOOTNOTES

1.    The income payments to Appellee’s daughter will be due under the ICRUA as long as the daughter survives Appellee, unless Appellee revokes and terminates the interest of the daughter through testamentary instruction.   If the daughter’s interest is revoked and terminated, the ICRUA will treat the daughter as having predeceased Appellee.

2.    The ICRUA states any charity serving as a beneficiary under the trust must qualify as an organization described in 26 U.S.C. §§ 170(b)(1)(A), 170(c), 2055(a), 2522(a) (1994).

3.   Appellee’s interest in the ICRUA was assigned a value of “0.00.”

4.    On appeal to this Court, Appellee argues the ICRUA is exempt from her bankruptcy estate as an annuity.   This issue, however, was not raised before the district court;  nor was it raised by Appellant as an issue on appeal to this Court.   Whether the ICRUA qualifies as an exempt annuity, therefore, is not properly before the Court.   See generally Depree v. Thomas, 946 F.2d 784, 793 (11th Cir.1991) (“We have long held that an issue not raised in the district court and raised for the first time in an appeal will not be considered by this court.”).

5.    See Lichstrahl v. Bankers Trust (In re Lichstrahl), 750 F.2d 1488, 1490 (11th Cir.1985) (stating the term “applicable nonbankruptcy law” in 11 U.S.C. § 541(c)(2) refers to state spendthrift trust law), abrogated on other grounds by Patterson v. Shumate, 504 U.S. 753, 112 S.Ct. 2242, 119 L.Ed.2d 519 (1992);  see also Rep. of the Comm’n on the Bankr.Laws of the U.S., H.R. Doc. No. 93-137, at 193 (1973) (discussing recommendations to change the bankruptcy laws to include spendthrift trusts within a debtor’s bankruptcy estate).

6.    This principle is not unique to Florida law.   See, e.g., John Hancock Mut. Life Ins. Co. v. Watson (In re Kincaid), 917 F.2d 1162, 1166-67 (9th Cir.1990) (stating Oregon and Massachusetts laws hold a “settlor cannot create a spendthrift trust for his own benefit”);  Herrin v. Jordan (In re Jordan), 914 F.2d 197, 199-200 (9th Cir.1990) (applying Washington law and holding trust funded by beneficiary’s personal injury settlement was not excludable from his bankruptcy estate as a valid spendthrift trust);  Dzikowski v. Edmonds (In re Cameron), 223 B.R. 20, 24 (Bankr.S.D.Fla.1998) (“It is axiomatic that under New York Law, self-settled trusts are void against both present and future creditors and a debtor may not avoid his creditors, or future creditors, by placing his property in trust for his own benefit.”);  In re Spenlinhauer, 182 B.R. 361, 364-65 (Bankr.D.Me.1995) (applying Maine law and holding settlor-beneficiary’s interest in trust was not protected from creditors), aff’d, 101 F.3d 106 (1st Cir.1996);  Jensen v. Hall (In re Hall), 22 B.R. 942, 944 (Bankr.M.D.Fla.1982) (applying Ohio law and holding creditors could reach settlor-beneficiary’s interest in spendthrift trust);  Speed v. Speed, 263 Ga. 166, 430 S.E.2d 348, 349 (Ga.1993) (applying Georgia law, and holding spendthrift provision in trust created by quadriplegic husband from his insurance benefits was not enforceable where the husband was both settlor and beneficiary);  Bank of Dallas v. Republic Nat’l Bank of Dallas, 540 S.W.2d 499, 501-02 (Tex.App.1976) (applying Texas law, and holding settlor who created spendthrift trust and made herself a beneficiary thereof could not protect her interest in the trust from her creditors).

7.    In Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th Cir.1981) (en banc), this Court adopted as binding precedent all decisions of the former Fifth Circuit handed down prior to close of business on September 30, 1981.

8.    Sources setting forth the common law of trusts frequently are cited by Florida courts for guidance regarding construction of spendthrift and other trusts.   See, e.g., Bacardi v. White, 463 So.2d 218, 222 (Fla.1985) (citing Restatement (Second) of Trusts regarding spendthrift trusts);  Waterbury, 32 So.2d at 605 (citing Bogert’s Trusts & Trustees and Griswold’s Spendthrift Trusts regarding spendthrift trusts);  Gilbert v. Gilbert, 447 So.2d 299, 301 (Fla.App.1984) (citing Scott’s The Law of Trusts regarding spendthrift trusts).

9.    The fact that Appellee cannot exercise dominion over the trust assets is irrelevant to this analysis.   The issue of self-settlement is separate from the issue of control, and either can serve as an independent ground for invalidating a spendthrift provision.   See, e.g., In re Spenlinhauer, 182 B.R. at 363 (declining to address beneficiaries’ control over trust where the trust was self-settled and, therefore, the spendthrift provision was ineffective on that basis alone);  In re Wheat, 149 B.R. at 1004 (“However, the Debtor’s degree of control is irrelevant in this case since one cannot create a spendthrift trust for oneself in Florida.”);  Walro v. Striegel (In re Walro), 131 B.R. 697, 701 (Bankr.S.D.Ind.1991) (holding self-settlement prevented agreement from qualifying as a spendthrift trust, although beneficiary did not have any control over assets).Although some cases appear to intertwine the issues of self-settlement and control, those cases are distinguishable because their facts supported invalidity of the spendthrift trusts at issue under both grounds.   See, e.g., Fehlhaber v. Fehlhaber, 850 F.2d 1453, 1455 (11th Cir.1988) (citing In re Witlin and other cases for the proposition that a settlor who creates a trust for his own benefit cannot protect his interest under the trust from his creditors, but also stating a settlor who exercises dominion over the trust cannot protect the trust from creditors);  Lawrence v. Chapter 7 Trustee (In re Lawrence), 251 B.R. 630, 641-42 (Bankr.S.D.Fla.2000) (invalidating spendthrift provision where trust was self-settled and the beneficiary exercised control over the trust), aff’d, 279 F.3d 1294 (11th Cir.2002);  In re Cattafi, 237 B.R. 853, 855-56 (Bankr.M.D.Fla.1999) (same).   In those cases, there was no need to address the issues as separate grounds for invalidation.

10.    Some limited exceptions to this general rule exist which do not apply in this case.   For example, creditors of a settlor-beneficiary who has reserved only a right to income may reach both the income and the corpus of a trust if the trustee has discretion to invade the corpus for the benefit of the settlor.   See, e.g., Miller v. Ohio Dept. of Human Servs., 105 Ohio App.3d 539, 664 N.E.2d 619, 621 (Ohio App.1995) (holding entire amount of trust was available to Medicaid even though settlor was given only income for life, where the trustee in his discretion could expend the principal on her behalf).   Likewise, creditors may reach the corpus of a trust where the beneficiary is given not only an income stream for life, but also the ability to designate remaindermen.   See, e.g., Bank of Dallas, 540 S.W.2d at 502 (holding income as well as corpus of an irrevocable spendthrift trust created by the settlor for her and her children’s benefit was subject to garnishment by creditors where the settlor received all the income from the corpus and held a general power of appointment exercisable at death);  Restatement (Second) of Trusts § 156 cmt. c (“If the settlor reserves for his own benefit not only a life interest but also a general power to appoint the remainder by deed or will or by deed alone or by will alone, his creditors can reach the principal of the trust as well as the income.”).   In this case, the trustee of the ICRUA does not have discretion to invade the corpus of the trust for Appellee’s benefit.   Additionally, Appellee does not have a general power of appointment regarding remaindermen;  rather, her right to redesignation is strictly limited to substituting other Internal Revenue Code qualified charities.

11.    See also Greenwich Trust Co. v. Tyson, 129 Conn. 211, 27 A.2d 166, 173-74 (Conn.1942) (“While we have found few cases dealing with a situation where the settlor of the trust, after reserving to himself the income for life, creates vested indefeasible interests, to take effect at his death, we have found none which subjects such interests to the demands of the settlor’s creditors, and on principle there is no question that the creditors cannot reach those interests.   Over them the settlor has no dominion, and his creditors have no more right to reach them than they would any interests in property formerly owned by him which has passed into the ownership of another.”);  Henderson v. Sunseri, 234 Ala. 289, 174 So. 767, 770 (Ala.1937) (holding settlor’s creditors could only reach the income stream reserved to the settlor, and not the remainder which was vested in the settlor’s children);  Dillon v. Spilo, 275 N.Y. 275, 9 N.E.2d 864, 866 (N.Y.App.1937) (holding settlor’s reserved life estate was subject to reach by her creditors, but not the remainder of the trust);  Egbert v. De Solms, 218 Pa. 207, 67 A. 212, 212-13 (Pa.1907) (holding settlors’ creditors could reach income from trust which was reserved for settlors’ benefit, but could not reach the remainder of the trust which was vested in the settlors’ children).

12.    Likewise, her interest vests in her bankruptcy trustee.   See II Scott § 147.1 (“Where a beneficiary of a trust becomes bankrupt, his interest under the trust vests in the trustee in bankruptcy, unless either by the terms of the trust or by statute there is a restraint on the alienation of his interest.   If his interest is assignable by him or if his creditors can reach it, it vests in the trustee in bankruptcy.”).

BLACK, Circuit Judge:

Fairstar: Utah Court Ignores State of Filing for Charging Order Purposes

American Institutional Partners, LLC v. Fairstar Resources, Ltd., 2011 WL 1230074 (D.Del., Mar. 31, 2011)

United States District Court,

D. Delaware.

AMERICAN INSTITUTIONAL PARTNERS, LLC, et al., Plaintiffs,

v.

FAIRSTAR RESOURCES LTD., and Goldlaw Pty Ltd., Defendants.

C.A. No. 10–489–LPS.

March 31, 2011.

Theodore Allan Kittila, Esq. of Elliot Greenleaf, Wilmington, DE, for Plaintiffs.

David E. Wilks, Esq. of Wilks, Lukoff & Bracegirdle, LLC, Wilmington, DE, for Defendants.

MEMORANDUM OPINION

STARK, District Judge.

*1 Pending before the Court is the Motion to Dismiss or Transfer Venue filed by defendants Fairstar Resources LTD (“Fairstar”) and Goldlaw PTY, LTD (“Goldlaw”) (collectively, “Defendants”). (D.I.4) Plaintiffs American Institutional Partners, LLC (“AIP”), AIP Lending, LLC (“Lending”), AIP Resort Development, LLC (“AIP RD”), Peninsula Advisors, LLC (“Peninsula”), and Mark Robbins (“Robbins”) (collectively, “Plaintiffs”) oppose the motion. (D.I.7) For the reasons discussed below, the Court will grant in part and deny in part Defendants’ motion.

I. BACKGROUND

A. The Parties

AIP, Lending, Peninsula, and AIP RD are limited liability companies organized under the laws of Delaware. (Am.Coml.¶ 3–6) AIP is the holder of 100% of the membership interest in and the managing member of Lending, and also is the holder of 55% of the membership interest in and manager of AIP RD. ( Id. ¶¶ 3, 16) Robbins is the manager of AIP, holder of 100% of the membership interest in and the managing member of Cavalion Group LLC (“Cavalion”)-a Delaware limited liability company which holds 100% of the membership interest in Peninsula-and former owner of 49% of the membership interest in and current manager of Seven Investments LLC, a Utah LLC which, in turn, holds 100% of the membership interests in AIP. ( Id. ¶¶ 7, 14)

Fairstar is a diversified exploration company organized under the laws of Australia, with its principal place of business in Osborne Park, Western Australia. (D.I. 4 at 9; Am. Compl. ¶ 8 ) Goldlaw is a corporation also organized under the laws of Australia, with its principal place of business in Osborne Park, Western Australia. (D.I. 4 at 9) Plaintiffs allege that Goldlaw is controlled by Fairstar. (Am.Compl.¶ 9) Fairstar and Goldlaw are judgment creditors of AIP, AIP Lending, and Robbins. (D.I. 4 Ex. B ¶ 2)

B. Out–of–State Proceedings

This dispute stems from litigation in a Utah state court. Defendants brought an action in the Third Judicial District of Utah against AIP, Lending, and Robbins (“the Utah Action”), in which Defendants prevailed.FN1 The Utah court entered judgment for Defendants in the amount of $2,296,651.38 and, upon Defendants’ request, issued numerous charging orders over various corporate interests held by Robbins.FN2 (D.I. 4 at 13; Am. Compl. Ex. C) FN3 The orders charge the various companies with payment of the unsatisfied judgment plus interest, attorney fees, and costs, as well as order the foreclosure and constable sale of the corporate interests to satisfy the judgment. (D.I. 4 Ex. A; D.I. 7 Ex. B) The Utah court specified the constable sales would result in payment to Defendants’ counsel in the Utah Action, and buyers would acquire all rights in a purchased company if AIP, Lending, or Robbins was the company’s sole member. ( Id.)

FN1. The Utah Action is captioned Fairstar Resources Ltd. and Goldlaw Pty. Ltd. v. American Institutional Partners, LLC, AIP Lending, LLC, and Mark Robbins, Civil No. 080916464.

FN2. The record contains thirty charging orders. (D.I. 4 Ex. A; D.I. 7 Ex. B) Neither party specifies the total number of charging orders entered by the Utah court.

FN3. The Complaint in this action appears in the record only as an attachment to Defendants’ Motion to Dismiss or Transfer. (D.I. 4 Ex. A) The Court, therefore, will cite to the Complaint in this manner, with no reference to a specific docket item number.

The record contains three objections filed by AIP, Lending, and Robbins to some of these charging orders, dated March 18, 2009, April 2, 2009, and May 22, 2009, respectively. (D.I. 4 Ex. F) In all three, AIP, Lending, and Robbins raised, among other things, the same contention: that Delaware law applies to the charging proceedings because the charged corporations are Delaware entities. ( Id.) AIP, Lending, and Robbins also filed a motion on May 16, 2010 for stay of the constable sales pending resolution of the instant action. (D.I. 4 Ex. G) The Utah court issued three orders in response. The first is dated April 16, 2009 (“the April 16 Order”) and denied objections to the constable sale of Peninsula. (D.I. 4 Ex. E) The court stated “that Utah law applies to all execution proceedings in this matter, including the foreclosure of a member’s interest in a limited liability [company], whether such company is domestic or foreign.” ( Id.) In the second, dated April 23, 2009 (“the April 23 Order”), the court summarily denied an objection to the sale of interests in Cavalion. ( Id.) Finally, in a June 4, 2010 order (“the June 4 Order”), the Utah court denied a motion to stay the pending constable sales until the resolution of the instant action, finding that the court had already ruled on arguments raised by AIP, Lending, and Robbins, including the assertion that Delaware law controlled the proceedings. (D.I. 4 Ex. H)

*2 A series of related litigations are also taking place in other states concerning the sale of a Utah ski resort known as The Canyons (“the Canyons Actions”). (Am.Compl.¶ 17) Peninsula has been involved in several of these actions, including one in the Colorado state courts (“the Colorado Action”). FN4 (D.I. 7 at 2) Fairstar and Goldlaw are not parties to the Canyons Actions. (D.I. 4 at 6) Plaintiffs, however, assert that Defendants have taken control of Peninsula’s actions in the Colorado Action, going so far as to sue Robbins. (D.I. 7 at 4)

FN4. The Colorado Action is captioned Vail Resorts, Inc. v. Peninsula Advisors, Case No. 07 CV 7264. (D.I.7 at 2)

C. Procedural History

Plaintiffs filed suit in the Delaware Court of Chancery on May 14, 2010, seeking a declaratory judgment that Defendants’ foreclosures upon Plaintiffs’ membership interests in eight Delaware limited liability companies (“the Subject LLCs”),FN5 which took place in Utah pursuant to a Utah court’s charging orders, are invalid under Delaware law, and a declaration of the identity of the members and managers of the Subject LLCs. (Am.Compl.¶¶ 25–28, 34–37) Plaintiffs also requested an injunction to prevent Defendants from obtaining confidential and privileged documents through assertion of membership and managerial interests in the Subject LLCs. ( Id. ¶¶ 2, 30–32) Defendants removed the action to this Court on June 4, 2010. (D.I.2) Defendants filed their Motion to Dismiss or Transfer Venue on July 13, 2010. (D.I.4) Plaintiffs filed their Opposition on August 12, 2010, and Defendants filed their Reply on August 25, 2010.

FN5. The eight Subject LLCs are AIP, AIP Lending, AIP RD, Peninsula, Cavalion, Smarthedge, LLC, Talisker Canyons Acquisition Co., LLC, and Pelican Equity, LLC. (Am.Compl.¶ 21)

Plaintiffs also filed a Motion for a Temporary Restraining Order and Preliminary Injunction on August 24, 2010, on which it requested to be heard. (D.I.10) The Court held a teleconference on the emergency motion on August 26, 2010, during which the Court denied the motion. This ruling was memorialized in a written Order issued on August 30, 2010. (D.I.14)

The Court held oral argument on the motion to dismiss or transfer on November 5, 2010. See Hr’g Tr., November 5, 2010 (D.I.15) (hereinafter “Tr.”).

D. The Parties’ Contentions

By their motion, Defendants seek dismissal of the complaint on the grounds that: (1) pursuant to Federal Rule of Civil Procedure 12(b)(2), this Court lacks personal jurisdiction over them because the Delaware implied consent statute, 6 Del. C. § 18–109(a) (“the Implied Consent Statute”), is inapplicable, and exercising personal jurisdiction would fail to comport with Due Process; (2) pursuant to Federal Rule of Civil Procedure 12(b)(6), the Complaint fails to state a claim on which relief can be granted because the Rooker–Feldman doctrine precludes this Court from considering Plaintiffs’ claims; and (3) pursuant to Federal Rule of Civil Procedure 12(b)(6), the Complaint fails to state a claim on which relief can be granted because, under the doctrine of res judicata, a decision by a Utah state court bars Plaintiffs’ claims. (D.I. 4 at 4–9, 10–11, 15–16) In the alternative, Defendants seek a transfer of venue pursuant to 28 U.S.C. § 1404(a) to the United States District Court for the District of Utah. (D.I. 4 at 17–20)

*3 Plaintiffs respond that Defendants are subject to personal jurisdiction under the Implied Consent Statute and that Defendants have minimum contacts with Delaware, making the exercise of personal jurisdiction proper under the Due Process Clause. (D.I. 7 at 6–11) They argue, in the alternative, that this Court has jurisdiction pursuant to 6 Del. C. § 18–110(a), which gives Delaware courts jurisdiction to determine who is entitled to serve as a manager of a Delaware limited liability company. ( Id at 11–14) They also contend that neither res judicata nor the Rooker–Feldman doctrine bar their claims. ( Id. at 16–22) Finally, Plaintiffs assert that a transfer of venue to Utah is inappropriate. ( Id. at 23–24)

II. LEGAL STANDARDS

A. Motion to Dismiss Pursuant to Rule 12(b)(2)

Federal Rule of Civil Procedure 12(b)(2) directs the Court to dismiss a case when it lacks personal jurisdiction over the defendant. Determining the existence of personal jurisdiction requires a two-part analysis. First, the Court analyzes the long-arm statute of the state in which the Court is located. See IMO Indus., Inc. v. Kiekert AG, 155 F.3d 254, 259 (3d Cir.1998). Next, the Court must determine whether exercising jurisdiction over the defendant in this state comports with the Due Process Clause of the Constitution. See id. Due Process is satisfied if the Court finds the existence of “minimum contacts” between the non-resident defendant and the forum state, “such that the maintenance of the suit does not offend traditional notions of fair play and substantial justice.” Int’l Shoe Co. v. Washington, 326 U.S. 310, 316 (1945) (internal quotation marks omitted).

Once a jurisdictional defense has been raised, the plaintiff bears the burden of establishing, by a preponderance of the evidence and with reasonable particularity, the existence of sufficient minimum contacts between the defendant and the forum to support jurisdiction. See Provident Nat’l Bank v. Cal. Fed. Sav. & Loan Ass’n, 819 F.2d 434, 437 (3d Cir.1987); Time Share Vacation Club v. Atl. Resorts, Ltd., 735 F.2d 61, 66 (3d Cir.1984). To meet this burden, the plaintiff must produce “sworn affidavits or other competent evidence,” since a Rule 12(b)(2) motion “requires resolution of factual issues outside the pleadings.” Time Share, 735 F.2d at 67 n. 9; see also Philips Elec. N. Am. Corp. v. Contec Corp., 2004 WL 503602, at *3 (D.Del. Mar. 11, 2004) (“After discovery has begun, the plaintiff must sustain [its] burden by establishing jurisdictional facts through sworn affidavits or other competent evidence.”).

If no evidentiary hearing has been held, a plaintiff “need only establish a prima facie case of personal jurisdiction.” O’Conner v. Sandy Lane Hotel Co., 496 F.3d 312, 316 (3d Cir.2007). A plaintiff “presents a prima facie case for the exercise of personal jurisdiction by establishing with reasonable particularity sufficient contacts between the defendant and the forum state.” Mellon Bank (E.) PSFS, Nat. Ass’n v. Farino, 960 F.2d 1217, 1223 (3d Cir.1992). On a motion to dismiss for lack of personal jurisdiction, “the plaintiff is entitled to have its allegations taken as true and all factual disputes drawn in its favor.” Miller Yacht Sales, Inc. v. Smith, 384 F.3d 93, 97 (3d Cir.2004). A court is always free to revisit the issue of personal jurisdiction if it later is revealed that the facts alleged in support of jurisdiction are in dispute. See Metcalfe v. Renaissance Marine, Inc., 566 F.3d 324, 331 (3d Cir.2009).

B. Motion to Dismiss Pursuant to Rule 12(b)(6)

*4 Evaluating a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) requires the Court to accept as true all material allegations of the complaint. See Spruill v. Gillis, 372 F.3d 218, 223 (3d Cir.2004). “The issue is not whether a plaintiff will ultimately prevail but whether the claimant is entitled to offer evidence to support the claims.” In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1420 (3d Cir.1997) (internal quotation marks omitted). Thus, the Court may grant such a motion to dismiss only if, after “accepting all well-pleaded allegations in the complaint as true, and viewing them in the light most favorable to plaintiff, plaintiff is not entitled to relief.” Maio v. Aetna, Inc., 221 F.3d 472, 481–82 (3d Cir.2000) (internal quotation marks omitted).

However, “[t]o survive a motion to dismiss, a civil plaintiff must allege facts that ‘raise a right to relief above the speculative level on the assumption that the allegations in the complaint are true (even if doubtful in fact).’ ” Victaulic Co. v. Tieman, 499 F.3d 227, 234 (3d Cir.2007) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007)). While heightened fact pleading is not required, “enough facts to state a claim to relief that is plausible on its face” must be alleged. Twombly, 550 U.S. at 570. A claim is facially plausible “when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Ashcroft v. Iqbal, ––– U.S. ––––, 129 S.Ct. 1937, 1949 (2009). At bottom, “[t]he complaint must state enough facts to raise a reasonable expectation that discovery will reveal evidence of [each] necessary element” of a plaintiff’s claim. Wilkerson v. New Media Tech. Charter Sch. Inc., 522 F.3d 315, 321 (3d Cir.2008) (internal quotation marks omitted). “[W]hen the allegations in a complaint, however true, could not raise a claim of entitlement to relief, this basic deficiency should … be exposed at the point of minimum expenditure of time and money by the parties and the court.” Twombly, 550 U.S. at 558 (internal quotation marks omitted). Nor is the Court obligated to accept as true “bald assertions,” Morse v. Lower Merion Sch. Dist., 132 F.3d 902, 906 (3d Cir.1997) (internal quotation marks omitted), “unsupported conclusions and unwarranted inferences,” Schuylkill Energy Res., Inc. v. Pa. Power & Light Co., 113 F.3d 405, 417 (3d Cir.1997), or allegations that are “self-evidently false,” Nami v. Fauver, 82 F.3d 63, 69 (3d Cir.1996).

C. Motion to Transfer Venue Pursuant to 28 U.S.C. § 1404(a)

Under appropriate circumstances, transfer of a case from one federal court to another is authorized by 28 U.S.C. § 1404(a). Section 1404 provides: “For the convenience of parties and witnesses, in the interest of justice, a district court may transfer any civil action to any other district or division where it might have been brought.” 28 U.S.C. § 1404(a). The burden of demonstrating that such a transfer is appropriate rests with the moving party. See Jumara v. State Farm Ins. Co., 55 F.3d 873, 879 (3d Cir.1995). In evaluating such a motion, courts consider a nonexclusive list of six private factors and six public factors articulated in Jumara:

*5 (1) plaintiff’s foram preference as manifested in the original choice;

(2) the defendant’s preference;

(3) whether the claim arose elsewhere;

(4) the convenience of the parties as indicated by their relative physical and financial condition;

(5) the convenience of the witnesses-but only to the extent that the witnesses may actually be unavailable for trial in one of the fora;

(6) the location of books and records (similarly limited to the extent that the files could not be produced in the alternative forum);

(7) the enforceability of the judgment;

(8) practical considerations that could make the trial easy, expeditious, or inexpensive;

(9) the relative administrative difficulty in the two fora resulting from court congestion;

(10) the local interest in deciding local controversies at home;

(11) the public policies of the fora; and

(12) the familiarity of the trial judge with the applicable state law in diversity cases.

Id. at 879–80.

In considering a motion to transfer venue and determining “whether, on balance, the litigation would more conveniently proceed and the interests of justice be better served by a transfer to a different foram,” it bears emphasis that “the plaintiff’s choice of venue should not be lightly disturbed.” Id. at 879. Hence, “unless the balance of convenience of the parties is strongly in favor of defendant, the plaintiff’s choice of forum should prevail.” Shutte v. Armco Steel Corp., 431 F.2d 22, 25 (3d Cir.1970) (internal quotations omitted). “Because a plaintiff’s choice of forum is accorded substantial weight and venue is transferred only if the defendant truly is regional (as opposed to national) in character, a defendant has the burden of establishing that the balance of convenience of the parties and witnesses strongly favors the defendant. Therefore, defendants [seeking transfer] must prove that litigating in Delaware would pose a unique or unusual burden on their operations.” L’Athene, Inc. v. Earthspring LLC, 570 F.Supp.2d 588, 592 (D.Del.2008) (internal citations and quotation marks omitted).

III. DISCUSSION

A. Personal Jurisdiction

Plaintiffs bear the burden of adducing facts which, at a minimum, “establish with reasonable particularity” that personal jurisdiction exists over Defendants. See Provident Nat’l Bank, 819 F.2d at 437. Plaintiffs assert two bases for exercising personal jurisdiction over Defendants. First, Plaintiffs rely on the Implied Consent Statute. Second, they rely on 6 Del. C. § 18–110(a), a provision that gives Delaware courts jurisdiction to determine who is entitled to serve as manager of a Delaware limited liability corporation. Under either basis, the exercise of personal jurisdiction must also comport with the Due Process Clause of the Constitution. See IMO Indus., 155 F.3d at 259; PT China LLC v.. PT Korea LLC, 2010 WL 761145, at *5 (Del. Ch. Feb. 26, 2010) (“Even if one is served pursuant to § 18409(a), personal jurisdiction must still be consistent with due process.”). This requirement is met, Plaintiffs advert, because Defendants have the requisite minimum contacts with Delaware.

*6 The Court concludes that Plaintiffs have made an adequate showing under the Implied Consent Statute to justify the exercise of personal jurisdiction over Fairstar, and that with respect to Fairstar the requirements of Due Process are satisfied. However, no adequate showing has been made for Goldlaw. Also, asserting personal jurisdiction over either Defendant pursuant to § 18–110(a) would be inappropriate.

1. Implied Consent Statute

Delaware’s Implied Consent Statute provides a basis for exercising personal jurisdiction over an out-of-state citizen who is a manager, or participates in the management, of a Delaware limited liability company. The provision states:

(a) A manager … of a limited liability company may be served with process in the manner prescribed in this section in all civil actions or proceedings brought in the State of Delaware involving or relating to the business of the limited liability company … whether or not the manager … is a manager … at the time suit is commenced…. Such service as a manager … shall signify the consent of such manager … that any process when so served shall be of the same legal force and validity as if served upon such manager … within the State of Delaware…. As used in this subsection (a) …, the term “manager” refers (i) to a person who is a manager as defined in § 18–101(10) of this title and (ii) to a person, whether or not a member of a limited liability company, who, although not a manager as defined in § 18–101(10) of this title, participates materially in the management of the limited liability company; provided however, that the power to elect or otherwise select or to participate in the election or selection of a person to be a manager as defined in § 18–101(10) of this title shall not, by itself, constitute participation in the management of the limited liability company.

6 Del. C. § 18–109 (emphasis added).

Defendants argue that the Implied Consent Statute is inapplicable because the Complaint does not involve or relate to the business of the Subject LLCs. FN6 (D.I. 4 at 4) Defendants emphasize that, while the complaint alleges they are purporting to act as managers, the Implied Consent Statute applies only to actual managers or entities actually participating in management. (Id) If Plaintiffs are correct (i.e., Defendants are wrongfully exercising management rights), Defendants argue, the basis for jurisdiction under the Implied Consent Statute (material participation in management) “falls out” of the case, making jurisdiction improper. ( Id.)

FN6. This argument is unpersuasive. “An action involves or relates to the business of an LLC if: (1) the allegations against the manager focus centrally on his rights, duties and obligations as a manager of a Delaware LLC; (2) the resolution of this matter is inextricably bound up in Delaware law; and (3) Delaware has a strong interest in providing a forum for disputes relating to the ability of managers of an LLC formed under its law to properly discharge their respective managerial functions.” Vichi v. Koninklijke Philips Elecs. N.V., 2009 WL 4345724, at *8 (Del. Ch. Dec. 1, 2009) (internal quotation marks omitted). A dispute regarding the identity of the proper members and managers of an LLC clearly relates to the business of that LLC. See Cornerstone Techs., LLC v.. Conrad, 2003 WL 1787959, at *12 (Del. Ch. Mar. 31, 2003) (“Clearly, the question of whether [one of the defendants] was properly removed as a manager, CEO, and President of the Companies relates to the business of the Companies…. [T]he issue as to who owns what part of [the Companies] … is related in some respect to the management disputes underlying this case—i.e., it relates to the business of the Companies…. In view of the importance of these issues to the capital structure and control of closely-held Delaware LLCs, they obviously relate to the business of those Companies and fall within the literal terms of § 18–109.”).

Defendants also assert that Plaintiffs’ factual claims are insufficient to establish jurisdiction under the Implied Consent Statute. In the Complaint, Plaintiffs assert that Defendants have acted as managers of Peninsula, one of the Subject LLCs, in two ways. First, Defendants’ counsel in Utah—who does not represent them here—sent a letter to Peninsula’s former counsel in Utah—who does not represent Peninsula here—on April 20, 2010, demanding that the latter turn over all files related to its representation of Peninsula.FN7 (D.I. 7 Ex. A) Second, Plaintiffs allege that Defendants, purportedly acting on behalf of Peninsula, have made filings in the Colorado Action reversing Peninsula’s prior litigating positions. ( Id. ¶ 19)

FN7. This demand was renewed in an August 16, 2010 letter, spurring Plaintiffs to file the motion for a temporary restraining order and preliminary injunction discussed above in Section I.C.

*7 Defendants contend that the April 20, 2010 letter was not sent on Defendants’ behalf and does not represent Defendants as Peninsula managers. (D.I. 4 at 5) Defendants also emphasize that they never executed on any membership interest in Peninsula, although Fairstar admits to owning 100% of the membership interest in Cavalion, which is the sole member of Peninsula and which appointed Peninsula’s sole manager. ( Id. at 6) Given what Defendants characterize as “limited activity” related to Peninsula, Defendants assert they could not have orchestrated Peninsula’s reversal of positions in the Colorado Action. ( Id. at 7)

In response, Plaintiffs argue that the Implied Consent Statute applies when a defendant participates materially in management, whether or not the participation is proper. (D.I. 11 at 7) The Court agrees. The statute indicates that a manager is subject to personal jurisdiction “whether or not the manager … is a manager … at the time suit is commenced.” 6 Del. C. § 18–109(a). Undoubtedly, this provision contemplates the situation where a former manager, who is no longer a manager at the start of the suit, is being sued. However, the language also encompasses actions against purported managers who may never have been actual managers. At this stage, the Court need not decide the propriety of Defendants’ alleged assertion of managerial interests. Instead, the Court is merely concluding that Defendants’ alleged assertion of managerial interests is sufficient to justify haling Defendants into a Delaware court, as Plaintiffs have established with reasonable particularity that Defendants materially participated in management of the Subject LLCs, making personal jurisdiction proper under the Implied Consent Statute.

Plaintiffs rely on four factual allegations to establish material participation in management: (1) Fairstar’s assertion of a 100% ownership interest in Cavalion, which owns Peninsula, and the accompanying power to appoint managers of both entities; (2) Defendants’ Utah counsel’s demand for Peninsula documents; (3) Defendants’ alleged court filings on behalf of Peninsula in the Colorado Action; and (4) Fairstar’s filings in a bankruptcy proceeding in the United States Bankruptcy Court for the District of Utah (the “Utah Bankruptcy Proceeding”).FN8 Fairstar’s asserted ownership interest FN9 is a sufficient basis for jurisdiction only if the ownership interest, or the accompanying power to appoint managers, equates to material participation in management. Generally, an ownership interest does not (by itself) imply managerial control—a point the statute makes explicitly. See 6 Del. C. § 18–109(a); see also Fisk Ventures, LLC v. Segal, 2008 WL 1961156 (Del. Ch. May 7, 2008) (finding no material participation in management where member had right to appoint two of five managers, and entity he owned was member with power to appoint third manager); Nolu Plastics, Inc. v. Ledingham, 2005 WL 5654418 (Del. Ch. Dec. 17, 2005) (finding no material participation in management where defendant had right to elect manager of LLC); Palmer v. Moffat, 2001 WL 1221749 (Del.Super.Ct. Oct. 10, 2001) (finding three members were not managers even though members were authorized to appoint majority of managers). But Defendants have done more than just own Cavalion and, through it, Peninsula. Here, Fairstar, as sole owner of Cavalion, appointed Cavalion’s sole manager. (D.I. 4 Ex. C ¶ 4) Further, Cavalion, which wholly owns Peninsula, has appointed Peninsula’s sole manager. ( Id.) The only case addressing the issue of material participation in management in the context of a sole member/sole manager LLC—which, as best as this Court can discern from the record, is the situation here—is a ruling from this District, in which personal jurisdiction was exercised. See Christ v. Cormick, 2007 WL 2022053 (D.Del. July 10, 2007) (holding that defendant materially participated in management by forming LLC in Delaware and serving as sole initial member). FN10 Although an entity that wholly owns an LLC and appoints its sole manager likely participates materially in its management, the corporate structures of Cavalion and Peninsula are not clearly established in record.

FN8. The Utah Bankruptcy Proceeding and the motion brought by Fairstar in that proceeding were first brought to the attention of the Court at the hearing held on November 5, 2010. ( See Tr. at 18–20) Defendants did not object to the Court’s consideration of this evidence. ( See id. at 44–45)

FN9. Defendants emphasize, at great length, that Fairstar has acquired a membership interest in Cavalion, but not in Peninsula. (D.I. 11 at 5–8) While it is true Cavalion is not a party to this action, Cavalion is one of the Subject LLCs for which Plaintiffs request a declaration. (Am.Compl.¶ 21) Therefore, if Plaintiffs establish that Defendants participated in Cavalion’s management, personal jurisdiction is proper under the Implied Consent Statute.

FN10. Plaintiffs also argue that there was an interim period prior to the appointment of the Cavalion manager when Fairstar served as the corporation’s sole member and manager. (D.I. 7 at 9) This interim period, Plaintiffs assert, is sufficient to warrant jurisdiction under the Implied Consent Statute. ( Id.) Given the Court’s above finding, the Court need not address this unestablished interim period.

*8 Plaintiffs offer more to justify the exercise of personal jurisdiction. Plaintiffs allege facts that support a finding of material participation in management by Fairstar (e.g., the allegation that Defendants directed the mailing of the demand letter and the Colorado Action filings that switched Peninsula’s litigating positions). Defendants’ Utah counsel, Mr. David Walquist, is an employee of Kirton & McConkie, the law firm that made the demand for the Peninsula documents. (D.I. 4 Ex. E, Ex. H) At this stage, the Court must construe disputed facts in favor of Plaintiffs and, thus, draw the inference that Fairstar retained Kirton & McConkie to represent its newly acquired entities, Cavalion and Peninsula (which it owns through Cavalion). See Metcalfe, 566 F.3d at 330 (“[A] court is required to accept the plaintiff’s allegations as true, and is to construe disputed facts in favor of the plaintiff.”). Plaintiffs also point to action by Fairstar in the Utah Bankruptcy Proceeding. ( See Tr. at 18–20) Fairstar filed a motion in that proceeding in which it asserted that it acquired all membership interest in AIP RD and appointed AIP RD’s manager. See Memorandum in Support of Ex Parte Joint Motion of Fairstar Resources Ltd. and Petitioning Creditors AD Capital, LLC and Lockhart & Munroe for Order Pursuant to Bankruptcy Rule 1007(d) Directing Moving Parties to Prepare and File the Debtor’s Statements and Schedules by August 13, 2010 at 2, In re AIP Resort Dev. LLC, Bankruptcy Case No. 10–25027 (Bankr.D.Utah July 15, 2010). Notably, Fairstar stated that AIP RD failed to make a required filing because Fairstar—not AIP RD—lacked the necessary information to prepare the filing. Id. at 4 (“The Debtor’s Statements and Schedules and the List of 20 Largest Creditors were not filed by the Debtor [AIP RD] within the deadlines outlined in Bankruptcy Rule 1007 because the financial information needed to prepare the Statements and Schedules and this List was not in the possession or control of Fairstar, which now holds all of the membership interests in the Debtor [AIP RD].”). Assuming the document demand and Colorado Action filings were made at the behest of Fairstar, along with Fairstar’s 100% ownership interest in Cavalion and the accompanying authority to designate its sole manager, as well as Fairstar’s representations in the Utah Bankruptcy Proceeding, the Court finds the exercise of personal jurisdiction over Fairstar proper.

With respect to Goldstar, however, the only basis Plaintiffs assert for exercising personal jurisdiction over Goldlaw is an unsubstantiated contention that Fairstar controls Goldlaw. (Am.Compl.¶ 9) This allegation is insufficient to support the inference that Goldlaw was behind the document demand or court filings in the Colorado Action and the Utah Bankruptcy Proceeding. The inferential gap is simply too large. Plaintiffs, therefore, have failed to justify the exercise of personal jurisdiction over Goldlaw under the Implied Consent Statute.

2. 6 Del. C. § 18–110(a)

*9 Plaintiffs argue, in the alternative, that jurisdiction is proper under 6 Del. C. § 18–110(a), a provision that grants Delaware courts jurisdiction to determine the rightful managers of a Delaware limited liability company. (D.I. 7 at 11) If personal jurisdiction over Defendants is lacking, Plaintiffs ask that the Court drop them from the case, realign the parties, and exercise jurisdiction under § 18–110(a). ( Id. at 12) This realignment would be much more extensive than the realignment that occurred in the authorities Plaintiffs cite. Plaintiffs want Defendants dropped completely from the case and AIP, AIP Lending, AIP RD, and Peninsula realigned as defendants, turning the action into a dispute between Robbins and the LLCs over his ouster as member and manager. This does more than realign the parties; it changes the entire theory of the case.

The three cases Plaintiffs cite involve realigning parties to determine if there is complete diversity of citizenship, allowing the federal courts to assess whether they had subject matter jurisdiction. See Indianapolis v. Chase Nat’l Bank, 314 U.S. 63, 69 (1941); Employers Ins. v. Crown Cork & Seal Co., 905 F.2d 42, 46 (3d Cir.1990); Polak v. Kobayashi, 2005 WL 2008306 (D.Del. Aug. 22, 2005). The Court finds these cases to be inapposite. Given the case Plaintiffs chose to file, the changes Plaintiffs request simply ask too much.

3. Due Process Analysis

Fairstar asserts that it lacks minimum contacts with Delaware. (D.I. 4 at 8 ) The accused conduct, Fairstar contends, was the execution of the Utah judgment, which occurred in Utah and was not action directed at Delaware. ( Id.) The only ties Fairstar has to Delaware are the membership interests it gained through the foreclosure sales. ( Id.) Fairstar emphasizes that it is an Australian company, which has transacted no business in Delaware and has no offices, employees, telephones numbers, or bank accounts here. ( Id.) Plaintiffs respond that Fairstar purposefully availed itself of Delaware law by acquiring the management interest in Delaware LLCs through the foreclosure sales. (D.I. 7 at 10) The Court agrees with Plaintiffs.

Fairstar, by foreclosing on Delaware LLCs and taking ownership rights in them, has purposefully availed itself of Delaware law. Fairstar cannot be surprised it has been haled into a Delaware court for a dispute over the governance of these Delaware LLCs. See Cornerstone Techs. v. Conrad, 2003 WL 1787959, at *13 (Del. Ch. Mar. 31, 2003) (holding that due process requirements were met because defendant purposefully availed himself of Delaware law and cannot be surprised to face lawsuit in Delaware). There is nothing unfair or unjust about exercising personal jurisdiction over Fairstar. See PT China, 2010 WL 761145, at *8 n. 44 (finding that exercise of personal jurisdiction over Chinese individual comported with due process, fairness, and substantial justice because individual submitted himself to jurisdiction by taking management position in Delaware LLC, and claims asserted related to his obligations as manager). Since Plaintiffs’ claims involve the management rights of Peninsula, among other Delaware LLCs, they relate to Fairstar’s obligation as a member who participates materially in management. Due process requirements are, thus, satisfied. See id. (finding due process requirements satisfied for specific claim because it pertained to defendant’s rights, duties, and obligations as manager of Delaware LLC); Palmer, 2001 WL 1221749, at *4 (“The Court finds that [the defendant] could reasonably have anticipated being subject to Delaware jurisdiction under these circumstances to answer for his actions as a manager and that exercise of jurisdiction would not offend traditional notions of fair play and substantial justice.”); Assist Stock Mgmt. LLC v.. Rosheim, 753 A.2d 974, 981 (Del. Ch.2000) (finding exercise of personal jurisdiction proper under Due Process Clause “because: (1) the allegations against [defendant] Rosheim focus centrally on his rights, duties and obligations as a manager of a Delaware LLC; (2) the resolution of this matter is inextricably bound up in Delaware law; and (3) Delaware has a strong interest in providing a forum for disputes relating to the ability of managers of an LLC formed under its law to properly discharge their respective managerial functions”) (internal quotation marks omitted).

B. Failure to State a Claim

1. Res Judicata

*10 When deciding whether a party’s claim is precluded by a prior state court judgment, this Court must give the judgment “the same preclusive effects” that a court from “the state in which the judgment was entered[ ] would.” Turner v. Crawford Square Apartments III, L.P., 449 F.3d 542, 548 (3d Cir2006). The Court, therefore, applies the law of Utah, the state where the allegedly preclusive orders were issued. In Utah, for a claim to be precluded by a prior ruling, (1) “both cases must involve the same parties or their privies;” (2) “the claim that is alleged to be barred must have been presented in the first suit or be one that could and should have been raised in the first action;” and (3) “the first suit must have resulted in a final judgment on the merits.” Snyder v. Murray City Corp., 73 P.3d 325, 332 (Utah 2003).

Defendants argue these three elements are met. (D.I. 4 at 15–17) First, AIP, AIP Lending, Robbins, Fairstar, and Goldlaw were all parties to the Utah Action; and AIP RD and Peninsula, Defendants assert, are privies of AIP and Robbins, as they have identical legal interests. ( Id. at 15) Second, Defendants contend that Plaintiffs raised the same issue in the Utah Action: whether Delaware law controlled and prohibited the constable sales. ( Id. at 16) Finally, the April 16 Order and the April 23 Order were substantive rulings qualifying as final judgments on the merits. ( Id. at 17)

Plaintiffs counter that Peninsula and AIP RD were neither parties nor privies to the Utah Action, relying on the bedrock principle of a corporation’s separate legal existence. (D.I. 7 at 18) Defendants respond that the parties have identical interests and represent the same legal rights, making them privies under Utah law, (D.I. 11 at 15) Plaintiffs also contend that the April 16 Order has no bearing on this litigation since it denied an objection to a charging order on Peninsula, but Defendants never executed on that order. (D.I. 7 at 16) Defendants argue that the April 16 Order extended beyond the charge on Peninsula; the Utah court ruled that Utah law, not Delaware law, applied to all execution proceedings in the Utah Action. (D.I. 11 at 12) Even assuming Utah law—specifically Utah Code Ann.1953 § 48–2c–l 103(6)—controls, Plaintiffs advert, Defendants’ assertion of control over Peninsula is still improper. (D.I. 7 at 17)

Finally, Plaintiffs argue the claims here are broader than those resolved in the April 16 Order and the April 23 Order. ( Id. at 19) Those orders decided whether the constable sales in Utah should proceed. Here, Plaintiffs want a declaration of the proper members and managers of the Subject LLCs subsequent to those sales, and a ruling that Defendants have no right to demand the production of Peninsula files. ( Id.)

In the June 4 Order, the Utah court denied a stay of the foreclosure sales pending resolution of this action. ( Id. at 20) Plaintiffs assert this ruling in no way validates the foreclosures. ( Id.) Defendants disagree, pointing to the Utah court’s statement that it was denying the motion because the court had “already ruled on the issues presented,” reincorporating the prior ruling that Utah law controls, under which the charging orders are proper. (D.I. 11 at 13)

*11 Plaintiffs do not challenge the finality of the April 16 Order, April 20 Order, or June 4 Order. (D.I. 7 at 15–21). Only the first and second elements of claim preclusion are in dispute.

a. Same parties or privies

Under Utah law, a privy is “a person so identified in interest with another that he represents the same legal right.” Searle Bros. v. Searle, 588 P.2d 689, 691 (Utah 1978). “Thus, privity depends mostly on the parties’ relationship to the subject matter of the litigation.” Press Pub. Ltd. v. Matol Botanical Intern. Ltd., 37 P.3d 1121, 1128 (Utah 2001) (internal citations omitted). In Press Publishing, the Supreme Court of Utah found that affiliates and subsidiaries of an entity, Matol Botanical International Ltd. (“MBI”), were its privies because, in a prior bankruptcy proceeding, the sister corporations had defended MBI in their affiliate capacity. Also, the causes of action in the earlier bankruptcy proceeding “stem[med] from the same alleged conduct, obligations, and legal theory.” Id. But in a more recent case, the Utah Supreme Court emphasized that, to comport with Due Process requirements, a finding of privity for claim preclusion as opposed to issue preclusion—between corporate affiliates requires “additional findings establishing the appropriateness of the transfer” of judgment. See Brigham Young Univ. v. Tremco Consultants, Inc., 110 P.3d 678, 686–88 (Utah 2005). The parties must have a relationship that “is sufficiently close to justify preclusion,” which cannot be based on corporate affiliation alone. Id. at 688. A theory such as alter ego or veil piercing must be established to ensure the “substantive precepts of corporate law” are respected. Id. (“In cases involving liability between and among corporations, findings of alter ego or a piercing of the corporate veil, for example, could suffice to establish the appropriateness of extending or transferring the liability of one corporate entity to another…. Absent such a finding, however, liability cannot be imposed upon the second entity without displacing substantive precepts of corporate law.”).

Although language in Press Publishing, which Defendants cite (D.I. 11 at 15), implies a finding of privity was made based on an entity’s status as an affiliate, putting it at odds with BYU, an examination of the facts there reveals no tension. MBI originally filed suit against Press Publishing Ltd. (“Press”) for breach of contract. Press responded with counterclaims of misappropriation against MBI and various affiliates and subsidiaries. Press Publishing, 37 P.3d at 1123. As part of its misappropriation claims, Press argued that the counterclaim-defendants acted “in concert and as agents and alter egos” to carry out a scheme to destroy Press, and there was no distinctness among any of them. Id. at 1124. MBI then dropped its breach of contract claim, leaving only Press’ counterclaims, and the MBI affiliates moved to dismiss the counterclaims as being barred by a prior bankruptcy ruling. Id. at 1126. MBI was a party to that bankruptcy proceeding and the affiliates argued they were MBI’s privies. Id. In response, Press argued the affiliates were not alter egos of MBI, the complete opposite of its prior assertion. Id. The Supreme Court of Utah held that the affiliates were privies because of their status as sister corporations, their defense of MBI (as affiliates) in one of the bankruptcy proceedings, and the fact that the two causes of action arose from the same conduct, obligations, and legal theory, all of which combined to create an identity of legal interests between the parties. Id. at 1128. The court emphasized that MBI’s “attempt to retract its previous allegation of privity” based on an alter-ego theory was disingenuous, indicating it was holding MBI to its earlier position. Id. The Press Publishing ruling, therefore, involved an assertion (and perhaps establishment) of an alter ego theory, meeting the requirement clarified in BYU.

*12 Here, Defendants raise no basis to disregard the separate legal existence of AIP RD and Peninsula, and in fact argue the separate existence is “beside the point.” (D.I. 11 at 15) They merely rely on the ownership interests the parties to the Utah Action have in AIP RD and Peninsula, citing authority from the Tenth Circuit and the Southern District of New York. ( Id. at 16) But in Utah “additional findings establishing the appropriateness of the transfer” of judgment are required, which Defendants have failed to present. The claims brought by AIP RD and Peninsula, therefore, are not barred.

Since the remaining Plaintiffs were parties to the Utah Action, the Court must turn to the second requirement for claim preclusion with regard to their claims.

b. Claim presented, or should have been presented, in the first suit

In Utah, for purposes of claim preclusion, “[c]laims or causes of action are the same as those brought or that could have been brought in the first action if they arise from the same operative facts, or in other words from the same transaction.” Mack v. Utah State Dep’t of Commerce, Div. of Sec., 221 P.3d 194, 203 (Utah 2009). The Utah Supreme Court stated in Mack that it has “moved toward the transactional theory of claim preclusion espoused by the Restatement (Second) [of Judgments]” and moved away from requiring the causes of action to “rest on the same state of facts” or that the necessary evidence be of the “same kind or character.” FN11 Id. In Press Publishing, the same claims were involved because the causes of action “stem[ed] from the same alleged conduct, obligations, and legal theory” as those in the prior proceeding. 37 P.3d at 1128.

FN11. Plaintiffs rely on the “sameness of evidence” rationale, arguing Defendants have attempted to control Peninsula only after the Utah rulings, and Plaintiffs could not have raised claims based on these future facts. (D.I. 11 at 20) In making this argument, Plaintiffs rely on Macris & Assocs., Inc. v. Neways, Inc., 16 P.3d 1214 (Utah 2000). But, in Mack, the Utah Supreme Court explained that the holding in Macris turned on a transactional theory; there was no preclusion because the claims arose from different transactions. See Mack, 221 P.3d at 203–04.

This action and the Utah Action involve one transaction: the constable sales of the Delaware LLCs. In the Utah Action, AIP, Lending, and Robbins challenged the future sales preemptively through objections that resulted in the April 16 Order and April 20 Order. Here, these entities challenge the consummated sales after-the-fact by requesting a declaration that Defendants do not own any interest in the Subject LLCs, are not entitled to any property owned by the Subject LLCs, and are not members or managers of the Subject LLCs. (Am.Compl.¶¶ A, B, D, E) Granting relief requires a finding that the sales were invalid. The challenge is based on Delaware law, making it identical to the challenge raised in the Utah Action. The Utah court resolved this claim in the April 16 Order by holding that Utah law controlled; this holding was later incorporated into the June 4 Order.FN12

FN12. Plaintiffs emphasize the fact that the April 16 Order was a challenge to a charging order that was never executed on, but the Utah court clearly incorporated its holding there into the June 4 Order, leaving no doubt as to the finality of the holding. (D.I. 4 Ex. H)

Plaintiffs also challenge acts by Defendants which Plaintiffs argue are attempts to control Peninsula (the document demand, the Colorado Action filings, and the Utah Bankruptcy Proceeding filing). But they do so by requesting an injunction. To issue the injunction, the Court must find that the foreclosure sales are void. The claim is based, somewhat, on conduct occurring after the Utah rulings, but it is still premised on the same transaction: the constable sales. Plaintiffs argue that even under Utah law, Defendants could gain no managerial rights in Peninsula. (D.I. 7 at 17) Plaintiffs have progressed from challenging the acquisition of membership rights under Delaware law to challenging the acquisition of managerial rights under Utah law. Although this claim was not raised in the Utah Action, it “could and should have been.” When Plaintiffs received the unfavorable ruling refusing to stop the sales, they could and should have asked the Utah court for a declaration (as they do here) clarifying the rights Defendants would acquire through the sales. If they had done this, they would have asked a Utah court (not a Delaware court) for a ruling under Utah law.

2. Rooker–Feldman Doctrine

*13 The Rooker–Feldman doctrine, by removing subject matter jurisdiction, prevents district courts from reviewing and rejecting state court decisions in federal actions brought by the party that lost in the state forum. See Turner v. Crawford Square Apartments III, L.P., 449 F.3d 542, 547 (3d Cir.2006). The scope of this doctrine, however, is very narrow. See id. (“[T]he [Supreme] Court … [has] emphasized the narrow scope of the Rooker–Feldman doctrine, holding that it ‘is confined to cases of the kind from which the doctrine acquired its name: cases brought by state-court losers complaining of injuries caused by state-court judgments rendered before the district court proceedings commenced and inviting district court review and rejection of those judgments.’ “) (quoting Exxon Mobil Corp. v. Saudi Basic Indus. Corp., 544 U.S. 280, 284 (2005)). In fact, “a district court is not divested of subject-matter jurisdiction simply because a party attempts to litigate in federal court a matter previously litigated in state court. Id.

Here, Plaintiffs raise issues not presented in the Utah Action (i .e., the challenge under Utah law and the challenge to the demand for Peninsula documents). They request a declaration of corporate rights in the aftermath of the Utah rulings. They do not seek a stay of the sales—the remedy prayed for in Utah-or damages for harm caused by the denial of a stay; this action is not framed as an appeal of the Utah ruling. See 18B C. Wright & A. Miller, Federal Practice and Procedure § 4469.1 (2d ed. 2010) (“The most obvious occasions to apply Rooker–Feldman principles arise in the occasional actions that are expressly framed as attempted appeals from a state-court judgment to a federal district court.”). When, as here, additional claims are asserted in the federal forum, the Rooker–Feldman doctrine is no bar, even if the claims contradict a legal conclusion made by the state court. See Exxon Mobil Corp., 544 U.S. at 1527 (“If a federal plaintiff presents some independent claim, albeit one that denies a legal conclusion that a state court has reached in a case to which he was a party, then there is jurisdiction and state law determines whether the defendant prevails under principles of preclusion.”) (internal citations omitted). The Rooker–Feldman doctrine is, therefore, inapplicable.

C. Transfer of Venue

Since the claims asserted by AIP RD and Peninsula against Fairstar survive the analysis above, the Court must consider Defendants’ request to transfer venue to the District of Utah. Defendants’ request arises pursuant to 28 U.S.C. § 1404(a), which permits transfer of “any civil action to any other district or division where it might have been brought.” Venue is proper in the District of Utah under 28 U.S.C. § 1391(a)(2) because it is the “judicial district in which a substantial part of the events … giving rise to the claim occurred,” namely, the constable sales. No party contends venue is improper in Delaware. See 28 U.S.C. § 1391. Since two proper venues have been identified, the Court must consider the factors identified by the Third Circuit in Jumara v. State Farm Insurance Co., 55 F.3d 873, 879 (3d Cir.1995). Having done so, the Court concludes that Defendants have failed to meet the high burden imposed on them by the law of this Circuit, which requires a showing that convenience and fairness strongly favor transfer.

*14 Specifically, the Court makes the following findings with respect to each of the Jumara factors, (i) Plaintiffs have clearly manifested their preference for Delaware as a forum by filing the Amended Complaint in this jurisdiction, (ii) Defendants prefer an alternative forum: the District of Utah. The Court notes that Defendants are Australian companies with their principal places of business in Osborne Park, Western Australia. (D.I. 4 at 9) The only tie to Utah the Court can discern from the record is Defendants’ choice to file the Utah Action there, presumably because that is where AIP and Lending have their principal places of business. (D.I. 4 Ex. B. ¶ 3) FN13 This connection is weaker than Defendants’ tie to this forum: their asserted ownership (and possible managerial) interest in various Delaware LLCs, (iii) Plaintiffs’ claim did arise in Utah. The basis for their claims are the foreclosure sales through which Defendants executed on the Subject LLCs, which occurred in Utah pursuant to Utah law and a Utah court’s charging orders.

FN13. Defendants’ Utah counsel states in an affidavit attached to Defendants’ motion that he “personally entered the Plaintiffs’ AIP LLC, AIP Lending, and Peninsula’s principal place of business which was located in Utah.” (D.I. 4 Ex. B ¶ 3) Plaintiffs do no challenge this assertion.

(iv) The record contains little information about the physical and financial conditions of the parties,FN14 and nothing about the convenience of litigating in Utah as opposed to Delaware. (v) Although some witnesses reside in Utah, there is no indication that any witness would be unavailable in Delaware. The convenience of witnesses is not, therefore, highly pertinent. (vi) While Defendants assert that documentary evidence is located in Utah, they do not suggest it would be difficult to produce this evidence in Delaware. Hence, these considerations do little to offset the heavy weight afforded to Plaintiffs’ choice of forum, as they show no unusual burden presented by litigation in Delaware. See, e.g., Tsoukanelis v. Country Pure Foods, Inc., 337 F.Supp.2d 600, 604 (D.Del.2004) (“This court … has denied motions to transfer venue when the movants were unable to identify documents and witnesses that were unavailable for trial.”); Wesley–Jessen Corp. v. Pilkington Visioncare, Inc., 157 F.R.D. 215, 218 (D.Del.1993) (“[T]echnological advances have substantially reduced the burden of having to litigate in a distant forum.”).

FN14. The Court notes that on March 18, 2011, a suggestion of bankruptcy was filed in this case informing the Court that AIP filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code, 11 U.S.C § 11, in the United States Bankruptcy Court for the District of Delaware. (D.I.16)

(vii) There is no suggestion that a judgment would be unenforceable in either District. (viii) Defendants argue that practical considerations such as ease and expense of trial favor transfer to Utah because evidence and witnesses are located there. But shipment and travel costs for proceeding in Delaware are not compared to those for litigating in Utah, providing no indication of the weight this factor should be given.

(ix) Notwithstanding the heavy caseload carried by the judges in this District, and the ongoing judicial vacancy, the Court is not persuaded that administrative difficulties due to court congestion favor transfer. See Textron Innovations, Inc. v. The Taro Co., 2005 WL 2620196, at *3 (D.Del. Oct. 14, 2005) (“[T]he court is not persuaded that any disparity in court congestion, to the extent there is any, will be so great as to weigh strongly in favor of a transfer.”).

*15 (x) Both venues have a local interest in deciding the controversy and (xi) public policy considerations favoring resolution there. Delaware clearly has a substantial interest in resolving lawsuits pertaining to the ownership and control of Delaware LLCs. Also, when Defendants executed on Delaware LLCs, they were fully cognizant of the possibility of being sued here. By taking ownership, Defendants “received the benefits of Delaware incorporation” and cannot now complain that they have been sued here. See Auto. Techs Int 7, Inc. v. Am. Honda Motor Co. Inc., 2006 WL 3783477, at *2 (D.Del. Dec. 21, 2006). That being said, Utah has a significant local interest also. The Subject LLCs are registered to do business in Utah and have their principal places of business there. This dispute requires an examination of the implications of a Utah court’s ruling and constable sales that took place in Utah. Since both Delaware and Utah can assert significant local interests and public policy concerns related with this lawsuit, this factor favors neither venue.

Finally, (xii) a district judge in the District of Utah undoubtedly has more occasion to apply Utah law than a district judge here. But there is no reason to believe that this Court is unable to render an informed ruling under Utah law. Further, application of Delaware law is likely also required, as the action is brought under a provision of Delaware corporate law. Hence, this final factor favors neither venue.

At bottom, this analysis turns on a balance between the first and third factors: the great weight given to the Plaintiffs’ choice of forum and the origin of the claim in Utah. The Court concludes that the latter factor does not outweigh the presumption that a case should be litigated in the forum chosen by the plaintiff. Defendants have failed to meet the heavy burden of demonstrating that another forum clearly would be more convenient or otherwise more fair. Therefore, Defendants’ motion to transfer venue will be denied.

IV. CONCLUSION

For the reasons set forth above, Defendants’ motion to dismiss or transfer venue is GRANTED IN PART and DENIED IN PART. The claims against defendant Goldstar are dismissed for lack of personal jurisdiction. The claims asserted by AIP, Lending, and Robbins are barred under the doctrine of claim preclusion and, thus, dismissed. Defendants’ motion to transfer venue is DENIED. This suit will proceed as an action by AIP RD and Peninsula against Fairstar.

ORDER

At Wilmington, this 31st day of March 2011, for the reasons set forth in the Memorandum Opinion issued this date, IT IS HEREBY ORDERED that:

1. The Motion to Dismiss or Transfer Venue (D.I.4) filed by Defendants Fairstar Resources Ltd. and Goldlaw Pty Ltd. is GRANTED to the extent it challenges personal jurisdiction over Goldlaw Pty Ltd. and to the extent it asserts the claims of American Institutional Partners LLC, AIP Lending LLC, and Mark Robbins are barred under the doctrine of claim preclusion, and DENIED to the extent it challenges personal jurisdiction over Fairstar Resources Ltd., asserts the claims of Peninsula Advisors LLC and AIP Resort Development LLC are barred by the doctrine of claim preclusion or the Rooker–Feldman doctrine, and requests transfer of venue to the United States District Court for the District of Utah.

*16 2. The Clerk of Court is directed to DISMISS American Institutional Partners LLC, AIP Lending LLC, Mark Robbins, and Goldlaw Pty Ltd. This action will proceed as Peninsula Advisors LLC and AIP Resort Development LLC against Fairstar Resources Ltd.

In re Mortensen: Self-Settled Trusts Don’t Work in Bankruptcy

Battley v. Mortensen, Adv. D.Alaska, No. A09-90036-DMD, May 26, 2011.UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF ALASKAIn re: Case No. A09-00565-DMD THOMAS WILLIAM MORTENSEN,Debtor.Chapter 7

Filed On

5/26/11

KENNETH BATTLEY, Plaintiff,

v.

ERIC J. MORTENSEN, ROBIN MARIE MULLINS, MARY MARGARET MORTENSEN-BELOUD, in their capacities as trustees of the Mortensen Seldovia Trust, and THOMAS W. MORTENSEN, in his individual capacity,

Defendants.

Adv. No. A09-90036-DMD

HON. DONALD MacDONALD IV, United States Bankruptcy Judge

MEMORANDUM DECISION

Kenneth Battley, chapter 7 trustee, has brought this adversary proceeding to set aside a transfer of real property as a fraudulent conveyance. It is a core proceeding under 28 U.S.C. sec. 157(b)(2)(H). Jurisdiction arises under 28 U.S.C. sec. 1334(b) and the district court’s order of reference. Trial was held on March 21 – 23, 2012. I find for the plaintiff.

Factual Background

Thomas Mortensen, the debtor and one of the defendants herein, is a self- employed project manager. He has a master’s degree in geology but has not worked in that field for 20 years. He manages the environmental aspects of construction projects. Mortensen has contracted with major oil companies for work in the past.

In 1994, Mortensen and his former wife purchased 1.25 acres of remote, unimproved real property located near Seldovia, Alaska.FN1 They paid $50,000.00 cash for the purchase. The parties divorced in 1998. Mortensen received his former wife’s interest in the property. Subsequently, improvements were made to the property. A small shed was placed on the parcel in 2000 and some other small structures were built on it from 2001 through 2004. There is power to the property along with a well and septic system. The debtor transferred the property to a self-settled trust on February 1, 2005. The transfer of this property is the focal point of the current dispute.

FN1 Mortensen testified that he accesses the property by taking a boat from Homer to Seldovia, then driving about 7 miles down an old logging road out of Seldovia and, finally, switching to a narrower footpath or ATV trail to reach the parcel.

Mortensen’s divorce was a contested proceeding. In 1998, when the court divided the parties’ assets and liabilities, Mortensen argued that the Seldovia property had been purchased with an inheritance and was to remain his sole and separate property. The court rejected his argument. It found that Mortensen wasn’t credible on the issue,FN2 and that the property was joint marital property.FN3 Nonetheless, Mortensen received the Seldovia property. He also received $61,581.00 from his wife’s SBS account, another $24,000.00 in cash from the refinance of the couple’s home and other miscellaneous personal property. In total, Mortensen received assets of $164,402.00 in the divorce.FN4

FN2 Pl.’s Ex. 13 at 8, para. 36.

FN3 Id. at 12, para. 66.

FN4 Id. at 13, para. 17.

Mortensen was not liable for any debt arising out of the marital estate. His ex- wife received the family home. She assumed an encumbrance against the home and was obligated to remove Mortensen’s name from a $78,000 obligation encumbering the home.FN5

FN5 Id. at 14, para. 84.A.

There was no credit card debt described in the courts findings and conclusions and no credit card debt was to be assumed by either party to the divorce.FN6

FN6 Pl.’s Ex. 13.

In June of 2004, Mortensen filed a motion to impose child support against his ex-wife.FN7 Despite a joint custody arrangement, he asked for an increase in child support due to a decrease in his income. After the superior court granted his uncontested request, Mortensen’s former spouse filed a Rule 60(b) motion. He filed an opposition to the motion on July 30, 2004. In his opposition, Mortensen stated:

FN7 Exhibit 12.

The property settlement and other expenses of the divorce drove me deeply into debt. After the divorce my debt continued to increase due to the ongoing legal expenses and the time required from profitable work in order to respond to two more years of repeated motions from the defendant. The defendant continued with motion practice for two years after the divorce ended. The defendant did not cease the motion practice until Judge Shortell told her in 2000 that he would consider awarding me attorney’s fees if she persisted in filing frivolous motions. Saddled with debt and with increasing competition in my shrinking business market I have not recovered from the financial carnage of the divorce.FN8

FN8 Pl.’s Ex. 9 at 15.

Mortensen’s income fluctuated substantially from year to year after the divorce. His 1999 income tax return was not placed into evidence. At a hearing held in state court on December 22, 2004, Mortensen revealed his annual income from 2000 through 2004. His net income in 2000 was $32,822.00.FN9 He also cashed out an annuity for $102,023.18 that year. In 2001, Mortensen had net income of $16,985.00.FN10 In 2002, his annual income dipped to $3,236.00.FN11 2003 yielded income of $13,185.00.FN12 Mortensen’s 2004 income was about the same” as 2003.FN13 Prior to the divorce, Mortensen had averaged $50,000.00 to $60,000.00 a year in net income.FN14

FN9 Pl.’s Ex. 4 at 24:22.

FN10 Id. at 24:20.

FN11 Id. at 24:16.

FN12 Id. at 21:25 – 22:6.

FN13 Pl.’s Ex. 4 at 24:25.

FN14 The superior court found that Mortensen earned $54,000.00 in 1994, $57,000.00 in 1995, $46,500.00 in 1996, and $62,690.00 in 1997. His estimated income for 1998 was between $53,360.00 and $69,000.00. Exhibit 13, page 5, paragraph 13.

Mortensen didn’t reveal his interest in establishing an asset protection trust at the hearing in December of 2004. Mortensen had heard about Alaska’s asset protection trust scheme in casual conversation. He researched the topic and, using a template he had found, drafted a document called the “Mortensen Seldovia Trust (An Alaska Asset Preservation Trust).” Mortensen then had the trust document reviewed by an attorney. He said only minor changes were suggested by the attorney.

The express purpose of the trust was “to maximize the protection of the trust estate or estates from creditors’ claims of the Grantor or any beneficiary and to minimize all wealth transfer taxes.”FN15 The trust beneficiaries were Mortensen and his descendants. Mortensen had three children at the time the trust was created.

FN15 Def.’s Ex. A at Mortenson 0006.

Mortensen designated two individuals, his brother and a personal friend, to serve as trustees. His mother was named as a “trust protector,” and had the power to remove and appoint successor trustees and designate a successor trust protector. She could not designate herself as a trustee, however. The trustees and Mortensen’s mother are named defendants in this adversary proceeding.

The trust was registered on February 1, 2005.FN16

FN16 Def.’s Ex. B.

As required by AS 34.40.110(j), Mortensen also submitted an affidavit which stated that: 1) he was the owner of the property being placed into the trust, 2) he was financially solvent, 3) he had no intent to defraud creditors by creating the trust, 4) no court actions or administrative proceedings were pending or threatened against him, 5) he was not required to pay child support and was not in default on any child support obligation, 6) he was not contemplating filing for bankruptcy relief, and 7) the trust property was not derived from unlawful activities.FN17

FN17 Def.’s Ex. C.

On February 1, 2005, Mortensen quitclaimed the Seldovia property to the trust, as contemplated in the trust document.FN18 Per the trust, this realty was “considered by the Grantor and the Grantor’s children to be a special family place that should not be sold and should remain in the family.”FN19 To facilitate this purpose, the trustees of the trust were requested, but not directed, to maintain and improve the Seldovia property “in the trust for the benefit, use and enjoyment of the Grantor’s descendants and beneficiaries.”FN20

FN18 Def.’s Ex. D. The quitclaim deed was recorded in the Seldovia Recording District on February 3, 2005. Id.

FN19 Def.’s Ex. A at Mortensen 0009.

FN20 Id.

The Seldovia property was worth roughly $60,000.00 when it was transferred to the trust in 2005. Mortensen’s mother sent him checks totaling $100,000.00 after the transfer. Mortensen claims this was part of the deal in his creation of the trust; his mother was paying him to transfer the property to the trust because she wanted to preserve it for her grandchildren. This desire is corroborated by notes his mother included with the two $50,000.00 checks she sent to him. The first check, No. 1013, was dated February 22, 2005, and referenced the Seldovia Trust, which had been registered just three weeks earlier.FN21 A short, handwritten note from Mortensen’s mother, bearing the same date stated:

FN21 Def.’s Ex. E at Mortensen 0079.

Enclosed is my check #1013 in the amount of fifty thousand dollars, as we have discussed, to pay you for the Seldovia property that you have put into the trust for my three special “Grands”!

In the next few weeks there will be a second check mailed to you in the amount of fifty thousand dollars, making a total of $100,000.00.

What a lot of fun memories have been made there!FN22

FN22 Id. at Mortensen 0080.

Mortensen’s mother wrote him a second check on April 8, 2005.FN23 This check also referenced the Seldovia Trust. It was accompanied by a typewritten note which said, “Here we go with the second and final check for the Seldovia property in the amount of fifty thousand dollars, totaling in all $100,000.00, as we have been talking about.”FN24

FN23 Id. at Mortensen 0087.

FN24 Id. Mortensen 0088.

Mortensen says he used the money his mother sent him to pay some existing debts and also put about $80,000.00 of the funds into the trust’s brokerage account as “seed money” to get the trust going and to pay trust-related expenses, such as income and property taxes. There was no promissory note for the money he lent to the trust. Mortensen said these funds were invested, some profits were made, and he was repaid “pretty much” all of the loan within about a year’s time.

Mortensen says the Seldovia property is recreational property. It was used primarily by him and his three children, but other family members also used it. Before the trust was created, Mortensen had lived on the property the majority of the time, and he says he could have exempted it from creditors’ claims as an Alaska homestead if he had retained it rather than placing it in the trust. In support of this contention, he has provided copies of his 2004 Alaska voter registration application,FN25 his 2003 fishing certificate,FN26 his 2004 Alaska PFD application (filed in 2005),FN27 a January, 2005, jury summons,FN28 and his Alaska driver’s license,FN29 which all indicate that he resided in Seldovia when the trust was created.

FN25 Def.’s Ex. I.

FN26 Def.’s Ex. J.

FN27 Def.’s Ex. K.

FN28 Def.’s Ex. L.

FN29 Def.’s Ex. M.

Mortensen’s financial condition has deteriorated since the establishment of the trust. His income has been sporadic.FN30 He used the cash he received from his mother and his credit cards to make speculative investments in the stock market and to pay living expenses. His credit card debt ballooned after the trust was created. In 2005, total credit card debt ranged from $50,000.00 to $85,000.00.FN31 When he filed his petition in August of 2009, Mortensen had over $250,000.00 in credit card debt. The $100,000.00 he received from his mother has been lost.

FN30 Mortensen had total income of $63,197.00 in 2005; $24,430,00 in 2006; $50,040.00 in 2007; $24,887 in 2008; and $6,142.00 in 2009.

FN31 Mortensen’s statements and other evidence regarding the amount of his credit card debt at the time of the creation of the trust have been inconsistent.

Mortensen claims that he was always able to make at least the minimum monthly payment on his credit card debts until he became ill in April of 2009. He needed immediate surgery and was hospitalized for almost two weeks. His illness required a long period of convalescence. Mortensen says he tried to return to work but was on pain medication which made him “fuzzy.” He lost several work contracts while he was recovering. He first considered filing bankruptcy in early August, 2009.

Mortensen filed his chapter 7 petition on August 18, 2009. He owned no real property at the time of filing, but his Schedule B itemized personal property with a value of $26,421.00. He scheduled no secured or priority claims. General unsecured claims totaled $259,450.01, consisting of $8,140.84 in medical debt and $251,309.16 in credit card debt on 12 separate credit cards. His interest in the Seldovia Trust was not scheduled, but Mortensen disclosed the creation of the trust on his statement of financial affairs. His monthly income was listed as $4,221.00, consisting of $321.00 in child support and the balance as income from the operation of his business as a geologist and permits consultant. Mortensen indicates that he expected his income to decrease due to his ongoing health issues and the increasingly unfavorable market conditions for his profession. His itemized monthly expenses totaled $5,792.00, which exceeded his income by more than $1,500.00. Expenses included $1,350.00 for rent, $600.00 for “income and FICA tax obligations, not withheld,” and $1,650.00 for expenses from the operation of his business.

Analysis

The trustee alleges that Mortensen failed to establish a valid asset protection trust under Alaska’s governing statutes because Mortensen was insolvent when the trust was created on February 1, 2005. Under A.S. 34.40.110(j)(2), the settlor of an Alaskan asset protection trust must file an affidavit stating that “the transfer of the assets to the trust will not render the settlor insolvent.”FN32 “Insolvent” is not defined in Alaska’s asset protection trust statute or in any cases arising thereafter. The trustee applies the Bankruptcy Code’s definition of insolvency found in 11 U.S.C. sec. 101(32), which provides that the term “insolvent” means:

(A) with reference to an entity other than a partnership and a municipality, financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair evaluation, exclusive of –

(i) property transferred, concealed, or removed with intent to hinder, delay, or defraud such entity’s creditors; and

(ii) property that may be exempted from property of the estate under section 522 of this title;FN33

FN32 AS 34.40.110(j)(2).

FN33 11 U.S.C. sec. 101(32)(A).

While there is no indication that Alaska would adopt a similar definition in the trust statute, other states have adopted a similar approach.FN34 I conclude that insolvency is established for purposes of Alaska’s asset protection trust law if the debtor’s liabilities exceed its assets, excluding the value of fraudulent conveyances and exemptions. Here, the applicable exemptions will be determined under state rather than federal law, because this court is applying Alaska law to determine if the trust was correctly established. The federal exemption statutes have no role in making that determination.

FN34 See 37 AM.JUR. 2D Fraudulent Conveyances and Transfers secs. 20, 21 (1964).

The trustee contends that the $100,000.00 received from Mortensen’s mother was a gift and cannot be considered as an asset in making a determination of solvency. I respectfully disagree. Mortensen and his mother had an oral agreement for the creation of a trust for the benefit of Ms. Mortensen-Belound’s grandchildren. Mortensen was to place the Seldovia property in trust and in return, his mother promised to pay him $100,000.00. Mortensen performed his end of the bargain. Based on his mother’s promise, he transferred the Seldovia property to an irrevocable trust on February 1, 2005.FN35 His partial performance took the agreement outside the statute of frauds.FN36 As noted in sec. 90(1) of the Restatement (Second) of Contracts:

(1) A promise which the promisor should reasonably expect to induce action or forbearance on the part of the promisee or a third person and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise. The remedy granted for breach may be limited as justice requires.FN37

FN35 Article 13 of the trust states that it is an irrevocable trust. See Def.’s Ex. A at Mortensen 0043.

FN36 Martin v. Mears, 602 P.2d 421, 428-429 (Alaska 1979).

FN37 Restatement (Second) of Contracts sec. 90 (1981).

Ms. Mortensen-Belound’s promise of payment should reasonably have been expected to induce action on the part of Mortensen and it did induce such action. The promise was binding on Ms. Mortensen-Belound and the proper remedy for a breach would have been payment of $100,000.00. Justice could have been avoided only by enforcement of the promise because Mortensen’s creation of the trust was irrevocable. Justice would not require limitation of a remedy for breach because the damages are clearly liquidated. It is proper to include the $100,000.00 in Mortensen’s balance sheet to determine solvency as a contract right existing as of February 1, 2005.

Mortensen prepared a balance sheet on March 8, 2010, which reconstructs his financial status as of February 1, 2005.FN38 This balance sheet shows that Mortensen had $153,020.00 in assets as of February 1, 2005. Some of those assets may have been exempt. He had a brokerage account designated as “ML SEP” for $3,606.00. This may be a form of pension plan that is exempt under AS 09.38.017. His other liquid assets may be exempt in the sum of $1,750.00 under A.S. 09.38.020 as it existed in 2005. The only other exemption for Mortensen would have been for an automobile in the amount of $3,750.00. After deductions for exemptions, Mortensen had assets totaling $143,914.00.

FN38 Pl.’s Ex. 21; Def.’s Ex. G.

Mr. Mortensen’s balance sheet lists liabilities totaling $49,711.00 as of February 1, 2005.FN39 This sum may be low. At his sec. 341 creditors’ meeting held on September 24, 2009, Mortensen testified that he owed roughly $85,000.00 on credit cards at the time the trust was created.FN40 Using either figure, however, Mortensen was solvent at the time he created the trust. The trust was created in accordance with Alaska law.

FN39 Id.

FN40 Pl.’s Ex. 2 at 6.

Battley seeks judgment against Mortensen under 11 U.S.C. sec. 548(e), which contains a ten-year limitation period for setting aside a fraudulent transfer. Section 548(e) provides:

(e)(1) In addition to any transfer that the trustee may otherwise avoid, the trustee may avoid any transfer of an interest of the debtor in property that was made on or within 10 years before the date of the filing of the petition, if –

(A) such transfer was made to a self- settled trust or similar device;

(B) such transfer was by the debtor;

(C) the debtor is a beneficiary of such trust or similar device; and

(D) the debtor made such transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made, indebted.FN41

FN41 11 U.S.C. sec. 548(e)(1).

Section 548(e) was added to the Bankruptcy Code in 2005, as part of the Bankruptcy Abuse Prevention and Consumer Protection Act.FN42 Section 548(e) “closes the self-settled trusts loophole” and was directed at the five states that permitted such trusts, including Alaska.FN43 Its main function “is to provide the estate representative with an extended reachback period for certain types of transfers.”FN44 However, the “actual intent” requirement found in sec. 548(e)(1)(D) is identical to the standard found in sec. 548(a)(1)(A) for setting aside other fraudulent transfers and obligations.FN45

FN42 Pub. L. No. 109-8, sec. 1042 (2005).

FN43 5 COLLIER ON BANKRUPTCY para. 548.10[1], [3][a] n.6 (N. Alan Resnick & Henry J. Sommer eds., 16th ed.).

FN44 Id., para. 548.10[2].

FN45 11 U.S.C. sec. 548(a)(1)(A), (e)(1)(D), see also 5 COLLIER ON BANKRUPTCY para. 548.10[3][d].

Mortensen’s trust, established under AS 34.40.110, satisfies the first three subsections of sec. 548(e) – the Seldovia property was transferred to a self-settled trust, Mortensen made the transfer, and he is a beneficiary of the trust. The determinative issue here is whether Mortensen transferred the Seldovia property to the trust “with actual intent to hinder, delay, or defraud” his creditors.FN46

FN46 11 U.S.C. sec. 548(e)(1)(D).

Mortensen says he did not have this intent when he created the trust and that he simply wanted to preserve the property for his children. Battley counters that Mortensen’s intent is clear from the trust language itself. The trust’s stated purpose was “to maximize the protection of the trust estate or estates from creditors’ claims of the Grantor or any beneficiary and to minimize all wealth transfer taxes.”FN47 Mortensen argues that the trust language cannot be used to determine intent because Alaska law expressly prohibits it. Under Alaska law, “a settlor’s expressed intention to protect trust assets from a beneficiary’s potential future creditors is not evidence of an intent to defraud.”FN48 But is this state statutory provision determinative when applying sec. 548(e)(1)(D) of the Bankruptcy Code?

FN47 Def.’s Ex. A at Mortenson 0006.

FN48 AS 34.40.110(b)(1).

Ordinarily, it is state law, rather than the Bankruptcy Code, which creates and defines a debtor’s interest in property.FN49

FN49 Butner v. United States, 440 U.S. 48, 55 (1979).

Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding.FN50

FN50 Id.

Here, Congress has codified a federal interest which requires a different result. Only five states allow their citizens to establish self-settled trusts.FN51 Section 548(e) was enacted to close this “self-settled trust loophole.”FN52 As noted by Collier:

[T]he addition of section 548(e) is a reaction to state legislation overturning the common law rule that self-settled spendthrift trusts may be reached by creditors (and thus also by the bankruptcy trustee.)FN53

FN51 In addition to Alaska, Delaware, Nevada, Rhode Island and Utah permit the creation of self-settled trusts.

FN52 5 COLLIER ON BANKRUPTCY para. 548.10[1], citing H.R. Rep. No. 109-31, 109th Cong., 1st Sess. 449 (2005) (statement of Rep. Cannon).

FN53 5 COLLIER ON BANKRUPTCY para. 548.10[3][a] (footnotes omitted).

It would be a very odd result for a court interpreting a federal statute aimed at closing a loophole to apply the state law that permits it. I conclude that a settlor’s expressed intention to protect assets placed into a self-settled trust from a beneficiary’s potential future creditors can be evidence of an intent to defraud. In this bankruptcy proceeding, AS 34.40.110(b)(1) cannot compel a different conclusion.

To establish an avoidable transfer under sec. 548(e), the trustee must show that the debtor made the transfer with the actual intent to hinder, delay and defraud present or future creditors by a preponderance of the evidence.FN54 Here, the trust’s express purpose was to hinder, delay and defraud present and future creditors. However, there is additional evidence which demonstrates that Mortensen’s transfer of the Seldovia property to the trust was made with the intent to hinder, delay and defraud present and future creditors.

First, Mortensen was coming off some very lean years at the time he created the trust in 2005. His earnings over the preceding four years averaged just $11,644.00 annually.FN55 He had burned through a $100,000.00 annuity which he had cashed out in 2000. He had also accumulated credit card debt of between $49,711.00 to $85,000.00 at the time the trust was created. He was experiencing “financial carnage” from his divorce. Comparing his low income to his estimated overhead of $5,000.00 per month (or $60,000.00 per year), Mortensen was well “under water” when he sought to put the Seldovia property out of reach of his creditors by placing it in the trust.

FN54 Consolidated Partners Inv. Co. v. Lake, 152 B.R. 485, 488 (Bankr. N.D. Ohio 1993).

FN55 See the discussion herein regarding Mortensen’s income during this time, at pp. 4 – 5.

Further, when Mortensen received the $100,000.00 from his mother he didn’t pay off his credit cards. Rather, he transferred $80,000.00 into the trust after paying a few bills and began speculating in the stock market. He had a substantial credit card debt due to AT&T, approximately $15,200.00,FN56 which was not paid in 2005. This debt had increased to $19,096.00 by the time he filed his bankruptcy petition.FN57 In 2005, Mortensen also owed Capital 1 approximately $6,350.00 in credit card debt.FN58 This debt had bumped up to$7,525.00 when he filed for bankruptcy.FN59 He had a Discover card with a balance of $12,588.00 as of Feb. 1, 2005.FN60 He owed Discover $11,905.00 when he filed bankruptcy.FN61

FN56 Pl.’s Ex. 23.

FN57 Pl.’s Ex. 18 at 13. Citibank took over AT&T”s credit card business. It is listed as a creditor in the debtor’s bankruptcy schedules for a loan with the same account number as the AT&T debt.

FN58 Pl.’s Ex. 24 at 12.

FN59 Pl.s Ex. 18 at 14.

FN60 Pl.’s Ex. 25.

FN61 Pl.’s Ex. 18 at 13.

Mortensen claims he paid these accounts off on a number of occasions and then re-borrowed against them. I can find no evidence of such pay-offs in the documentary evidence and I don’t believe Mortensen. Nor do I believe that the trust repaid Mortensen the $80,000 in 2006. If that had been the case, Mortensen wouldn’t have needed to borrow another $29,000.00 on his credit cards.FN62 I conclude that Mortensen’s transfer of the Seldovia property and the placement of $80,000.00 into the trust constitutes persuasive evidence of an intent to hinder, delay and defraud present and future creditors.

FN62 Pl.’s Ex. 44 shows an increase of about $29,000.00 in credit card debt from February 1, 2005 through December 31, 2006.

Mortensen alleged that the purpose of the trust was to preserve the Seldovia property for his children. Yet he used the trust as a vehicle for making stock market investments. In 2005, the trust had capital gains of nearly $7,000.00.FN63 In 2006, the trust had capital gains of over $26,000.00.FN64 In 2007, the trust had capital gains of $6,448.00.FN65 In 2008 and 2009 the trust had either no capital gain income or experienced losses.FN66 The trust also made a car loan to one of Mortensen’s acquaintances. These activities had no relationship to the trust’s alleged purpose.

FN63 Def.’s Ex. S.

FN64 Def.’s Ex. T.

FN65 Def.’s Ex. U.

FN66 Def.’s Exs. V and W.

The bottom line for Mr. Mortensen is that he attempted a clever but fundamentally flawed scheme to avoid exposure to his creditors. When he created the trust in 2005, he failed to recognize the danger posed by the Bankruptcy Abuse Protection and Consumer Protection Act, which was enacted later that year. Mortensen will now pay the price for his actions. His transfer of the Seldovia property to the Mortensen Seldovia Trust will be avoided.

The trustee has asked for costs and attorney’s fees. His costs will be awarded.

However, under the American Rule, attorney’s fees are generally not recoverable for litigating federal issues absent an agreement or specific statutory authority.FN67 This avoidance action is brought under a provision of the Bankruptcy Code and raises federal issues. The trustee is not entitled an award of attorney’s fees against the defendants.

FN67 Alyeska Pipeline Service Co. v. Wilderness Society, 421 U.S. 240 (1975).

Conclusion

The transfer of the Seldovia property from Thomas Mortensen to the Mortensen Seldovia trust will be avoided, pursuant to 11 U.S.C. sec. 548(e). The trustee will be awarded his costs but denied attorney’s fees. An order and judgment will be entered consistent with this memorandum.

SEC v. Jamie Solow, 2010 WL 303959 (S.D. FL., Jan 22, 2010)

Debtor Found in Contempt of Court for Refusing to Repatriate Funds from Offshore Trust

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF FLORIDA

CASE No.06-81041-CIV-MIDDLEBROOKS/JOHNSON

SECURITIES AND EXCHANGE COMMISSION,

Plaintiff,

vs. JAMIE SOLOW,

Defendant, ____________________________________/

ORDER DENYING DEFENDANT’S MOTION TO DISMISS

This Cause comes before the Court on Defendant’s Motion to Dismiss (DE 27), filed April 16, 2007. The Court has reviewed the record and is fully advised in the premises.

I. Plaintiff’s Complaint

Plaintiff Securities and Exchange Commission (“SEC”) brought a five-count amended complaint against Defendant Jamie Solow (“Solow”) on April 2, 2007. The SEC alleges that Solow 1) violated Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 promulgated thereunder; 2) violated Section 17(a) of the Securities Act of 1933 (“Securities Act”); 3) aided and abetted violations by Archer Alexander Securities Corp. (“Archer”) of Section 17(a) of the Exchange Act; 4) aided and abetted Archer’s violations of Section 15(c)(3) of the Exchange Act and Rule 15c3-1 thereunder; and 5) aided and abetted Archer’s violations of Section 17(a) of the Exchange Act and Rule 17a-5(a)(2) thereunder.

These alleged violations stem from Solow’s practice of trading in new issues of inverse floating rate collateralized mortgage obligations (“inverse floaters”). Inverse floaters are defined by the National Association of Securities Dealers (“NASD”) as high-risk investments suitable to sophisticated investors. See NASD Notice to Members 93-73.

The Complaint alleges that Archer had in place various policies regarding the trading of inverse floaters, and that Solow intentionally disregarded these policies. One of these policies required Solow to trade on a riskless principal basis, which means that when a dealer receives a purchase order from a customer, he purchases the requested security in a transaction that is proximate in time to the customer’s order. Archer’s policies allegedly required Solow to have a willing buyer in place for any security that he purchased. Plaintiff SEC alleges that Archer’s CEO discussed this restriction with Solow on more than one occasion.

Another Archer policy allegedly required Solow to get authorization from the CEO before entering into any specific transaction or trade. After obtaining this pre-approval, Solow was required to fax trade tickets to Archer and the clearing firm. The complaint alleges that Archer did not follow these procedures, purchasing inverse floaters for settlement one to two months after the trade date. It is claimed that these improper trades committed Archer to proprietary positions without its knowledge or approval. It is further alleged that Solow falsified trade tickets to make it appear that his transactions conformed to Archer’s policies. As a result of these alleged improprieties, Archer submitted inaccurate reports required by the securities laws.

The Complaint also alleges fraudulent sales of unsuitable securities, claiming that Solow did not tell his risk-averse retail customers that he was investing for them in high-risk inverse floaters. Plaintiff claims that Solow actually told risk-averse customers that the inverse floaters were in fact a suitable investment. He allegedly told customers that government sponsored enterprises, such as Fannie Mae, guaranteed the principal on such investments. However, this guarantee applies only if the positions are held to maturity, and interest rate changes could extend the maturity date into the future.

As a basis for the claims for violating the books and records, net capital, and FOCUS report filing requirements, Plaintiff argues that Defendant’s improper conduct caused Archer to violate these rules. His alleged concealment of his improper inverse floater trades resulted in Archer’s general ledger not reflecting these positions. As a result, Archer’s net capital computations were inaccurate throughout 2003, and it continued to do business while undercapitalized. This also resulted in Archer filing inaccurate FOCUS reports.

II. Legal Analysis

A motion to dismiss is appropriate when it is demonstrated “beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.” Conley v. Gibson, 355 U.S. 41, 45-46 (1957). For the purpose of the motion to dismiss, the complaint is construed in the light most favorable to the plaintiff, and all facts alleged by the plaintiff are accepted as true. Hishon v King & Spaulding, 467 U.S. 69, 73 (1984). Regardless of the alleged facts, however, a court may dismiss a complaint on a dispositive issue of law. Marshall County Bd. of Educ. v. Marshall County Gas Dist., 992 F.2d 1171, 1174 (11th Cir. 1993).

As fraud claims are a part of this action, Plaintiff’s complaint must also satisfy the provisions of Fed. R. Civ. P. 9(b).1 However, when considering the question of whether or not a pleading of fraud is alleged with adequate particularity in a securities law context, a court must not read Rule 9(b) of the Federal Rules of Civil Procedure to abrogate the notice pleading requirements of the Federal Rules of Civil Procedure. See Friedlander v. Nims, 755 F.2d 810, 813 (11th Cir. 1985), see also SEC v. Physicians Guardian, 72 F. Supp. 2d 1342, 1352 (M.D.Fla. 1999).

A. Claims for Fraudulent Inverse Floater Trading

A violation occurs under Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder when there is (1) a misrepresentation or omission, (2) that was material, (3) which was made in the offer and sale of a security [Section 17(a)(1)] or in connection with the purchase or sale of securities [Section 10(b) and Rule 10b-5], (4) scienter, and (5) the involvement of interstate commerce, the mails, or a national securities exchange. See SEC v. Gane, 2005 U.S. Dist. LEXIS 607, 28-29 (S.D. Fla. 2005), citing 15 U.S.C. § 77q(a)(1) (2004); 15 U.S.C. § 78j(b) (2004); see also United States SEC v. Corporate Rels. Group, Inc., 2003 U.S. Dist. LEXIS 24925, at *24 (M.D. Fla. 2003); see also SEC v. Monarch Funding Corp., 192 F.3d 295, 308 (2d Cir. 1999)(noting that essentially the same elements are required under Section 17(a) and Rule 10b-5).

For the first claim, violations of section 10(b) and rule 10b-5, Defendant argues that the complaint fails to sufficiently allege material misrepresentations or omissions and fails to detail how Solow falsified trade tickets. However, plaintiff is correct in its argument that the complaint alleges multiple instances of potential fraud, including dates and the nature of the alleged omissions. See Amd. Comp. ¶¶ 30a-e, 32 a-c, 43 a-d. This level of specificity satisfies both Rule 12(b)(6) and Rule 9(b), as the Amended Complaint provides clear notice and sufficient particularity. The Defendant could discern that the SEC is claiming that he engaged in material omissions by disregarding Archer’s policies and secretly buying the inverse floaters, all while allegedly knowing that he was violating these policies. His alleged failure to ask for the required approval and alleged falsification of trade tickets is enough to sustain Plaintiff’s claim at the pleading stage, where I treat all of Plaintiff’s allegations as true.

I reach the same result as to the claim of unsuitable investment recommendations. The elements of an unsuitability claim brought under the antifraud provisions are (1) that the securities purchased were unsuited to the buyer’s needs; (2) that the defendant knew or reasonably believed the securities were unsuited to the buyer’s needs; (3) that the defendant recommended or purchased the unsuitable securities for the buyer anyway; (4) that, with scienter, the defendant made material misrepresentations (or, owing a duty to the buyer, failed to disclose material information) relating to the suitability of the securities; and (5) that the buyer justifiably relied to its detriment on the defendant’s fraudulent conduct. See Brown v. E.F. Hutton Group, Inc., 991 F.2d 1020, 1031 (2d Cir. 1993).

The Amended Complaint alleges that Solow knew inverse floaters were risky investments, due to that description in the NASD notice, and that he also knew from the account forms that many of his customers were risk averse. Plaintiff has listed specific examples of the customers there were allegedly placed in unsuitable investments. Additionally, the complaint alleges that Solow made misleading statements to these investors, telling them that the securities were a good investment, that GSE’s like Fannie Mae guaranteed the principal, and that he could manage these inverse floaters in any interest rate environment. These plead facts, when accepted as true, are adequate to sustain the claim pursuant to the test noted above.

Defendant’s primary argument on these claims is based upon a factual inquiry. He argues that it is simply not possible to buy an inverse floater and settle it on the same day as the purchase, and that the practice he engaged in is common in the industry. Solow also states that Archer and its CEO had to know about his practices, because it constituted a substantial portion of their revenue. However, as noted, these are factual disputes, and while they may prove useful to Solow’s defense, they are inappropriate at the motion to dismiss phase.

B. Aiding and Abetting Claims

Liability for aiding and abetting a securities violation occurs “if some other party has committed a securities law violation, if the accused party has general awareness that his role was part of an overall activity that is improper, and if the accused aider-abettor knowingly and substantially assisted the violation.” Rudolph v. Arthur Andersen & Co., 800 F.2d 1040, 1045 (11th Cir. 1986).

Here the complaint alleges in the facts section that Archer committed books and records violations, along with violations of net capital and FOCUS reporting requirements. Plaintiff states that Solow had an awareness that his role was part of improper activity, as he was concealing trades and falsifying trade tickets. The SEC addresses the knowledge prong by alleging that because Solow was a registered representative of Archer, he was required to know of Archer’s obligations to maintain accurate books and records. All of these facts in the complaint give adequate notice to Solow of the basis for the claims, and they are sufficient at the motion to dismiss stage.

Again, Solow’s primary argument for dismissal of these claims is factual in nature. He contends that while he was a registered agent, he did not have knowledge of Archer’s obligations under the reporting rules, or whether Archer was complying with these regulations. Such alleged facts, if true, would certainly be critical at a later stage of the proceedings. However, at this stage I am bound to accept all of Plaintiff’s well-plead facts as true. My review of the amended complaint and the relevant case law leads to the conclusion that Plaintiff has stated viable claims with the requisite particularity.

Accordingly, it is

ORDERED AND ADJUDGED that Defendant’s Motion to Dismiss (DE 27) is DENIED.

DONE AND ORDERED in Chambers at West Palm Beach, FL, this 10th day of May 2007.

DONALD M. MIDDLEBROOKS
UNITED STATES DISTRICT JUDGE

Herring v. Keasler

Using LLCs for Asset Protection

Herring v. Keasler, 150 NC App 598 (01-1000) 06/04/2002

NO. COA01-1000
NORTH CAROLINA COURT OF APPEALS
Filed: 4 June 2002

MAX HERRING, as assignee of

BRANCH BANKING & TRUST CO.,
Plaintiff,

v .     Wake County
No. 94 CVS 7235
BENNETT M. KEASLER, JR.,
Defendant.

Appeal by plaintiff from order filed 16 May 2001 by Judge Jack W. Jenkins in Wake County Superior Court. Heard in the Court of Appeals 14 May 2002.
Michael W. Strickland & Associates, P.A., by Nelson G. Harris, for plaintiff-appellant.Hunton & Williams, by John D. Burns, for defendant-appellee.GREENE, Judge.

Max Herring (Plaintiff), as assignee of Branch Banking & Trust Company (BB&T), appeals an order filed 16 May 2001 enjoining Plaintiff from seizing or selling Bennett M. Keasler, Jr.’s (Defendant) membership interests in various limited liability companies.
On 3 January 1996, BB&T obtained a default judgment (the judgment) against Defendant and his wife in the amount of $29,062.57 plus interest.   (See footnote 1) On 12 December 2000, BB&T assigned its interest in the judgment to Plaintiff, and Plaintiff obtained awrit of execution against Defendant on 19 March 2001. Subsequently, on 19 April 2001, Defendant filed an emergency motion seeking an order to restrain Plaintiff from attempting to have Defendant’s membership interests in several limited liability companies seized and sold. In Defendant’s affidavit, he stated he had a 20% membership interest in several limited liability companies, “including River Place I, LLC; River Place II, LLC; River Place III, LLC[;] and River Place IV, LLC [(collectively, the LLCs)], which were created for the purpose of developing real estate in Wake County, North Carolina.”
In an order dated 20 April 2001, the trial court temporarily restrained Plaintiff from seeking the seizure and sale of Defendant’s membership interests in the LLCs. Thereafter, Plaintiff filed a motion on 23 April 2001 seeking an order under N.C. Gen. Stat. § 1-362 directing Defendant’s membership interests in the LLCs be sold and the proceeds applied towards the judgment. Pending the sale of Defendant’s membership interests in the LLCs, Plaintiff requested an order directing any distributions and allocations of those interests to be applied towards the satisfaction of the judgment (charging order). On 16 May 2001, the trial court filed an order: enjoining Plaintiff from seeking the seizure or sale of Defendant’s membership interests in the LLCs; denying Plaintiff’s motion, insofar as he sought to have Defendant’s membership interests in the LLCs sold or transferred; and granting Plaintiff’s motion for a charging order. With respect to the charging order, the trial court directed: Defendant’smembership interests in the LLCs to be charged with payment of the judgment, plus interest; the LLCs to deliver to Plaintiff any distributions and allocations that Defendant would be entitled to receive on account of his membership interests in the LLCs; Defendant to deliver to Plaintiff any allocations and distributions he would receive; and Plaintiff to not obtain any rights in the LLCs, except as those of an assignee and under the respective operating agreement.

__________________________________
The dispositive issue is whether N.C. Gen. Stat. § 57C-5-03 permits a trial court to order a judgment debtor’s membership interest in a limited liability company seized and sold and the proceeds applied towards the satisfaction of a judgment.
Generally, a trial court may order any property, whether subject or not to be sold under execution (except the homestead and personal property exemptions of the judgment debtor), in the hands of the judgment debtor or of any other person, or due to the judgment debtor, to be applied towards the satisfaction of [a] judgment.N.C.G.S. § 1-362 (2001). North Carolina General Statutes § 57C-5- 03, however, provides that with respect to a judgment debtor’s membership interest in a limited liability company, a trial court “may charge the membership interest of the member with payment of the unsatisfied amount of the judgment with interest.” N.C.G.S. § 57C-5-03 (2001). This “charge” entitles the judgment creditor “to receive . . . the distributions and allocations to which the [judgment debtor] would be entitled.” N.C.G.S. § 57C-5-02 (2001). The “charge” “does not dissolve the limited liability company or entitle the [judgment creditor] to become or exercise any rights of a member.” Id. Furthermore, because the forced sale of a membership interest in a limited liability company to satisfy a debt would necessarily entail the transfer of a member’s ownership interest to another, thus permitting the purchaser to become a member, forced sales of the type permitted in section 1-362 are prohibited. See N.C.G.S. § 57C-3-03 (2001) (except as provided in the operating agreement or articles of organization, consent of all the members of a limited liability company required to “[a]dmit any person as a member”).
In this case, despite Plaintiff’s attempts to have Defendant’s membership interests in the LLCs seized and sold, his only remedy is to have those interests charged with payment of the judgment under N.C. Gen. Stat. § 57C-5-03. Accordingly, the trial court did not err in ordering that the judgment be satisfied through the application of the distributions and allocations of Defendant’s membership interests in the LLCs and in denying Plaintiff’s motion to have Defendant’s membership interests seized and sold.
Affirmed.
Judges HUDSON and BIGGS concur.

 


Footnote: 1

The judgment as to Defendant’s wife was subsequently vacated.

Olmstead v. Federal Trade Commission, No. SC08-1009, FL Sup. Ct. (24 june 2010)

Charging Order Provision does Not Protect Interest in a Single-Member LLC

Supreme Court of Florida

_____________

No. SC08-1009

____________

SHAUN OLMSTEAD, et al.,
Appellants,

vs.

FEDERAL TRADE COMMISSION,
Appellee.

[June 24, 2010]

CANADY, J.

In this case we consider a question of law certified by the United States Court of Appeals for the Eleventh Circuit concerning the rights of a judgment creditor, the appellee Federal Trade Commission (FTC), regarding the respective ownership interests of appellants Shaun Olmstead and Julie Connell in certain Florida single-member limited liability companies (LLCs). Specifically, the Eleventh Circuit certified the following question: “Whether, pursuant to Fla. Stat. § 608.433(4), a court may order a judgment-debtor to surrender all ̳right, title, and interest‘ in the debtor‘s single-member limited liability company to satisfy an outstanding judgment.” Fed. Trade Comm‘n v. Olmstead, 528 F.3d 1310, 1314 (11th Cir. 2008). We have discretionary jurisdiction under article V, section 3(b)(6), Florida Constitution.

The appellants contend that the certified question should be answered in the negative because the only remedy available against their ownership interests in the single-member LLCs is a charging order, the sole remedy authorized by the statutory provision referred to in the certified question. The FTC argues that the certified question should be answered in the affirmative because the statutory charging order remedy is not the sole remedy available to the judgment creditor of the owner of a single-member limited liability company.

For the reasons we explain, we conclude that the statutory charging order provision does not preclude application of the creditor‘s remedy of execution on an interest in a single-member LLC. In line with our analysis, we rephrase the certified question as follows: “Whether Florida law permits a court to order a judgment debtor to surrender all right, title, and interest in the debtor‘s single- member limited liability company to satisfy an outstanding judgment.” We answer the rephrased question in the affirmative.

I. BACKGROUND

The appellants, through certain corporate entities, “operated an advance-fee credit card scam.” Olmstead, 528 F.3d at 1311-12. In response to this scam, the FTC sued the appellants and the corporate entities for unfair or deceptive trade practices. Assets of these defendants were frozen and placed in receivership. Among the assets placed in receivership were several single-member Florida LLCs in which either appellant Olmstead or appellant Connell was the sole member. Ultimately, the FTC obtained judgment for injunctive relief and for more than $10 million in restitution. To partially satisfy that judgment, the FTC obtained—over the appellants‘ objection—an order compelling appellants to endorse and surrender to the receiver all of their right, title, and interest in their LLCs. This order is the subject of the appeal in the Eleventh Circuit that precipitated the certified question we now consider.

II. ANALYSIS

In our analysis, we first review the general nature of LLCs and of the charging order remedy. We then outline the specific relevant provisions of the Florida Limited Liability Company Act (LLC Act), chapter 608, Florida Statutes (2008). Next, we discuss the generally available creditor‘s remedy of levy and execution under sale. Finally, we explain the basis for our conclusion that Florida law permits a court to order a judgment debtor to surrender all right, title, and interest in the debtor‘s single-member LLC to satisfy an outstanding judgment. In brief, this conclusion rests on the uncontested right of the owner of the single- member LLC to transfer the owner‘s full interest in the LLC and the absence of any basis in the LLC Act for abrogating in this context the long-standing creditor‘s remedy of levy and sale under execution.

A. Nature of LLCs and Charging Orders

The LLC is a business entity originally created to provide “tax benefits akin to a partnership and limited liability akin to the corporate form.” Elf Altochem North Am., Inc. v. Jaffari, 727 A.2d 286, 287 (Del. 1998). In addition to eligibility for tax treatment like that afforded partnerships, LLCs are characterized by restrictions on the transfer of ownership rights that are related to the restrictions applicable in the partnership context. In particular, the transfer of management rights in an LLC generally is restricted. This particular characteristic of LLCs underlies the establishment of the LLC charging order remedy, a remedy derived from the charging order remedy created for the personal creditors of partners. See City of Arkansas City v. Anderson, 752 P.2d 673, 681-683 (Kan. 1988) (discussing history of partnership charging order remedy). The charging order affords a judgment creditor access to a judgment debtor‘s rights to profits and distributions from the business entity in which the debtor has an ownership interest.

B. Statutory Framework for Florida LLCs

The rules governing the formation and operation of Florida LLCs are set forth in Florida‘s LLC Act. In considering the question at issue, we focus on the provisions of the LLC Act that set forth the authorization for single-member LLCs, the characteristics of ownership interests, the limitations on the transfer of ownership interests, and the authorization of a charging order remedy for personal creditors of LLC members.

Section 608.405, Florida Statutes (2008), provides that “[o]ne or more persons may form a limited liability company.” A person with an ownership interest in an LLC is described as a “member,” which is defined in section 608.402(21) as “any person who has been admitted to a limited liability company as a member in accordance with this chapter and has an economic interest in a limited liability company which may, but need not, be represented by a capital account.” The terms “membership interest,” “member‘s interest,” and “interest” are defined as “a member‘s share of the profits and losses of the limited liability company, the right to receive distributions of the limited liability company‘s assets, voting rights, management rights, or any other rights under this chapter or the articles of organization or operating agreement.” § 608.402(23), Fla. Stat. (2008). Section 608.431 provides that “[a]n interest of a member in a limited liability company is personal property.”

Section 608.432 contains provisions governing the “[a]ssignment of member‘s interest.” Under section 608.432(1), “[a] limited liability company interest is assignable in whole or in part except as provided in the articles of organization or operating agreement.” An assignee, however, has “no right to participate in the management of the business and affairs” of the LLC “except as provided in the articles of organization or operating agreement” and upon obtaining “approval of all of the members of the limited liability company other than the member assigning a limited liability company interest” or upon “[c]ompliance with any procedure provided for in the articles of organization or operating agreement.” Id. Accordingly, an assignment of a membership interest will not necessarily transfer the associated right to participate in the LLC‘s management. Such an assignment which does not transfer management rights only “entitles the assignee to share in such profits and losses, to receive such distribution or distributions, and to receive such allocation of income, gain, loss, deduction, or credit or similar item to which the assignor was entitled, to the extent assigned.” § 608.432(2)(b), Fla. Stat. (2008).

Section 608.433—which is headed “Right of assignee to become member”—reiterates that an assignee does not necessarily obtain the status of member. Section 608.433(1) states: “Unless otherwise provided in the articles of organization or operating agreement, an assignee of a limited liability company interest may become a member only if all members other than the member assigning the interest consent.” Section 608.433(4) sets forth the provision— mentioned in the certified question—which authorizes the charging order remedy for a judgment creditor of a member:

On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the limited liability company membership interest of the member with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of such interest. This chapter does not deprive any member of the benefit of any exemption laws applicable to the member‘s interest.

C. Generally Available Creditor’s Remedy of
Levy and Sale under Execution

Section 56.061, Florida Statutes (2008), provides that various categories of real and personal property, including “stock in corporations,” “shall be subject to levy and sale under execution.” A similar provision giving judgment creditors a remedy against a judgment debtor‘s ownership interest in a corporation has been a part of the law of Florida since 1889. See ch. 3917, Laws of Fla. (1889) (“That shares of stock in any corporation incorporated by the laws of this State shall be subject to levy of attachments and executions, and to sale under executions on judgments or decrees of any court in this State.”). An LLC is a type of corporate entity, and an ownership interest in an LLC is personal property that is reasonably understood to fall within the scope of “corporate stock.” “The general rule is that where one has any ̳interest in property which he may alien or assign, that interest, whether legal or equitable, is liable for the payment of his debts.‘” Bradshaw v. Am. Advent Christian Home & Orphanage, 199 So. 329, 332 (Fla. 1940) (quoting Croom v. Ocala Plumbing & Electric Co., 57 So. 243, 245 (Fla. 1911)).

At no point have the appellants contended that section 56.061 does not by its own terms extend to an ownership interest in an LLC or that the order challenged in the Eleventh Circuit did not comport with the requirements of section 56.061. Instead, they rely solely on the contention that the Legislature adopted the charging order remedy as an exclusive remedy, supplanting section 56.061.

D. Creditor’s Remedies Against the Ownership
Interest in a Single-Member LLC

Since the charging order remedy clearly does not authorize the transfer to a judgment creditor of all an LLC member‘s “right, title and interest” in an LLC, while section 56.061 clearly does authorize such a transfer, the answer to the question at issue in this case turns on whether the charging order provision in section 608.433(4) always displaces the remedy available under section 56.061. Specifically, we must decide whether section 608.433(4) establishes the exclusive judgment creditor‘s remedy—and thus displaces section 56.061—with respect to a judgment debtor‘s ownership interest in a single-member LLC.

As a preliminary matter, we recognize the uncontested point that the sole member in a single-member LLC may freely transfer the owner‘s entire interest in the LLC. This is accomplished through a simple assignment of the sole member‘s membership interest to the transferee. Since such an interest is freely and fully alienable by its owner, section 56.061 authorizes a judgment creditor with a judgment for an amount equaling or exceeding the value of the membership interest to levy on that interest and to obtain full title to it, including all the rights of membership—that is, unless the operation of section 56.061 has been limited by section 608.433(4).

Section 608.433 deals with the right of assignees or transferees to become members of an LLC. Section 608.433(1) states the basic rule that absent a contrary provision in the articles or operating agreement, “an assignee of a limited liability company interest may become a member only if all members other than the member assigning the interest consent.” See also § 608.432(1)(a), Fla. Stat (2008). The provision in section 608.433(4) with respect to charging orders must be understood in the context of this basic rule.

The limitation on assignee rights in section 608.433(1) has no application to the transfer of rights in a single-member LLC. In such an entity, the set of “all members other than the member assigning the interest” is empty. Accordingly, an assignee of the membership interest of the sole member in a single-member LLC becomes a member—and takes the full right, title, and interest of the transferor— without the consent of anyone other than the transferor.

Section 608.433(4) recognizes the application of the rule regarding assignee rights stated in section 608.433(1) in the context of creditor rights. It provides a special means—i.e., a charging order—for a creditor to seek satisfaction when a debtor‘s membership interest is not freely transferable but is subject to the right of other LLC members to object to a transferee becoming a member and exercising the management rights attendant to membership status. See § 608.432(1), Fla. Stat. (2008) (setting forth general rule that an assignee “shall have no right to participate in the management of the business affairs of [an LLC]”).

Section 608.433(4)‘s provision that a “judgment creditor has only the rights of an assignee of [an LLC] interest” simply acknowledges that a judgment creditor cannot defeat the rights of nondebtor members of an LLC to withhold consent to the transfer of management rights. The provision does not, however, support an interpretation which gives a judgment creditor of the sole owner of an LLC less extensive rights than the rights that are freely assignable by the judgment debtor. See In re Albright, 291 B.R. 538, 540 (D. Colo. 2003) (rejecting argument that bankruptcy trustee was only entitled to a charging order with respect to debtor‘s ownership interest in single-member LLC and holding that “[b]ecause there are no other members in the LLC, the entire membership interest passed to the bankruptcy estate”); In re Modanlo, 412 B.R. 715, 727-31 (D. Md. 2006) (following reasoning of Albright).

Our understanding of section 608.433(4) flows from the language of the subsection which limits the rights of a judgment creditor to the rights of an assignee but which does not expressly establish the charging order remedy as an exclusive remedy. The relevant question is not whether the purpose of the charging order provision—i.e., to authorize a special remedy designed to reach no further than the rights of the nondebtor members of the LLC will permit—provides a basis for implying an exception from the operation of that provision for single- member LLCs. Instead, the question is whether it is justified to infer that the LLC charging order mechanism is an exclusive remedy.

On its face, the charging order provision establishes a nonexclusive remedial mechanism. There is no express provision in the statutory text providing that the charging order remedy is the only remedy that can be utilized with respect to a judgment debtor‘s membership interest in an LLC. The operative language of section 608.433(4)—”the court may charge the [LLC] membership interest of the member with payment of the unsatisfied amount of the judgment with interest”— does not in any way suggest that the charging order is an exclusive remedy.

In this regard, the charging order provision in the LLC Act stands in stark contrast to the charging order provisions in both the Florida Revised Uniform Partnership Act, §§ 620.81001-.9902, Fla. Stat. (2008), and the Florida Revised Uniform Limited Partnership Act, §§ 620.1101-.2205, Fla. Stat. (2008). Although the core language of the charging order provisions in each of the three statutes is strikingly similar, the absence of an exclusive remedy provision sets the LLC Act apart from the other two statutes. With respect to partnership interests, the charging order remedy is established in section 620.8504, which states that it “provides the exclusive remedy by which a judgment creditor of a partner or partner‘s transferee may satisfy a judgment out of the judgment debtor‘s transferable interest in the partnership.” § 620.8504(5), Fla. Stat. (2008) (emphasis added). With respect to limited partnership interests, the charging order remedy is established in section 620.1703, which states that it “provides the exclusive remedy which a judgment creditor of a partner or transferee may use to satisfy a judgment out of the judgment debtor‘s interest in the limited partnership or transferable interest.” § 620.1703(3), Fla. Stat. (2008) (emphasis added).

“[W]here the legislature has inserted a provision in only one of two statutes that deal with closely related subject matter, it is reasonable to infer that the failure to include that provision in the other statute was deliberate rather than inadvertent.” 2B Norman J. Singer & J.D. Shambie Singer, Statutes and Statutory Construction § 51:2 (7th ed. 2008). “In the past, we have pointed to language in other statutes to show that the legislature ̳knows how to‘ accomplish what it has omitted in the statute [we were interpreting].” Cason v. Fla. Dep‘t of Mgmt. Services, 944 So. 2d 306, 315 (Fla. 2006); see also Horowitz v. Plantation Gen. Hosp. Ltd. P‘ship, 959 So. 2d 176, 185 (Fla. 2007); Rollins v. Pizzarelli, 761 So. 2d 294, 298 (Fla. 2000).

The same reasoning applies here. The Legislature has shown—in both the partnership statute and the limited partnership statute—that it knows how to make clear that a charging order remedy is an exclusive remedy. The existence of the express exclusive-remedy provisions in the partnership and limited partnership statutes therefore decisively undermines the appellants‘ argument that the charging order provision of the LLC Act—which does not contain such an exclusive remedy provision—should be read to displace the remedy available under section 56.061.

The appellants‘ position is further undermined by the general rule that “repeal of a statute by implication is not favored and will be upheld only where irreconcilable conflict between the later statute and earlier statute shows legislative intent to repeal.” Town of Indian River Shores v. Richey, 348 So. 2d 1, 2 (Fla. 1977). We also have previously recognized the existence of a specific presumption against the “[s]tatutory abrogation by implication of an existing common law remedy, particularly if the remedy is long established.” Thornber v. City of Fort Walton Beach, 568 So. 2d 914, 918 (Fla. 1990). The rationale for that presumption with respect to common law remedies is equally applicable to the “abrogation by implication” of a long-established statutory remedy. See Schlesinger v. Councilman, 420 U.S. 738, 752 (1975) (” ̳[R]epeals by implication are disfavored,‘ and this canon of construction applies with particular force when the asserted repealer would remove a remedy otherwise available.”) (quoting Reg‘l Rail Reorganization Act Cases, 419 U.S. 102, 133 (1974)). Here, there is no showing of an irreconcilable conflict between the charging order remedy and the previously existing judgment creditor‘s remedy and therefore no basis for overcoming the presumption against the implied abrogation of a statutory remedy.

Given the absence of any textual or contextual support for the appellants‘ position, for them to prevail it would be necessary for us to rely on a presumption contrary to the presumption against implied repeal—that is, a presumption that the legislative adoption of one remedy with respect to a particular subject abrogates by implication all existing statutory remedies with respect to the same subject. Our law, however, is antithetical to such a presumption of implied abrogation of remedies. See Richey; Thornber; Tamiami Trails Tours, Inc. v. City of Tampa, 31 So. 2d 468, 471 (Fla. 1947).

In sum, we reject the appellants‘ argument because it is predicated on an unwarranted interpretive inference which transforms a remedy that is nonexclusive on its face into an exclusive remedy. Specifically, we conclude that there is no reasonable basis for inferring that the provision authorizing the use of charging orders under section 608.433(4) establishes the sole remedy for a judgment creditor against a judgment debtor‘s interest in single-member LLC. Contrary to the appellants‘ argument, recognition of the full scope of a judgment creditor‘s rights with respect to a judgment debtor‘s freely alienable membership interest in a single-member LLC does not involve the denial of the plain meaning of the statute. Nothing in the text or context of the LLC Act supports the appellants‘ position.

III. CONCLUSION

Section 608.433(4) does not displace the creditor‘s remedy available under section 56.061 with respect to a debtor‘s ownership interest in a single-member LLC. Answering the rephrased certified question in the affirmative, we hold that a court may order a judgment debtor to surrender all right, title, and interest in the debtor‘s single-member LLC to satisfy an outstanding judgment.

It is so ordered.

QUINCE, C.J., and PARIENTE, LABARGA, and PERRY, JJ., concur.
LEWIS, J., dissents with an opinion, in which POLSTON, J., concurs.

NOT FINAL UNTIL TIME EXPIRES TO FILE REHEARING MOTION, AND IF FILED, DETERMINED.

LEWIS, J., dissenting.

I cannot join my colleagues in the judicial rewriting of Florida‘s LLC Act. Make no mistake, the majority today steps across the line of statutory interpretation and reaches far into the realm of rewriting this legislative act. The academic community has clearly recognized that to reach the result of today‘s majority requires a judicial rewriting of this legislative act. See, e.g., Carter G. Bishop & Daniel S. Kleinberger, Limited Liability Companies: Tax and Business Law, ¶ 1.04[3][d] (2008) (discussing fact that statutes which do not contemplate issues with judgment creditors of single-member LLCs “invite Albright-style judicial invention”); Carter G. Bishop, Reverse Piercing: A Single Member LLC Paradox, 54 S.D. L. Rev. 199, 202 (2009); Larry E. Ribstein, Reverse Limited Liability and the Design of Business Associations, 30 Del. J. Corp. L. 199, 221-25 (2005) (“The situation in Albright theoretically might seem to be better redressed through explicit application of traditional state remedies than by a federal court trying to shoehorn its preferred result into the state LLC statute. The problem . . . is that no state remedy is appropriate because the asset protection was explicitly permitted by the applicable statute. The appropriate solution, therefore, lies in fixing the statute.” (emphasis supplied)); Thomas E. Rutledge & Thomas Earl Geu, The Albright Decision – Why an SMLLC Is Not an Appropriate Asset Protection Vehicle, Bus. Entities, Sept.-Oct. 2003, at 16; Jacob Stein, Building Stumbling Blocks: A Practical Take on Charging Orders, Bus. Entities, Sept.-Oct. 2006, at 29. (stating that the Albright court “ignored Colorado law with respect to the applicability of a charging order” where the “statute does not exempt single- member LLCs from the charging order limitation”). An adequate remedy is available without the extreme step taken by the majority in rewriting the plain and unambiguous language of a statute. This is extremely important and has far- reaching impact because the principles used to ignore the LLC statutory language under the current factual circumstances apply with equal force to multimember LLC entities and, in essence, today‘s decision crushes a very important element for all LLCs in Florida. If the remedies available under the LLC Act do not apply here because the phrase “exclusive remedy” is not present, the same theories apply to multimember LLCs and render the assets of all LLCs vulnerable.

I would answer the certified question in the negative based on the plain language of the statute and an in pari materia reading of chapter 608 in its entirety. At the outset, the majority signals its departure from the LLC Act as it rephrases the certified question to frame the result. The question certified by the Eleventh Circuit requested this Court to address whether, pursuant to section 608.433(4), a court may order a judgment debtor to surrender all “right, title, and interest” in the debtor‘s single-member limited liability company to satisfy an outstanding judgment. The majority modifies the certified question and fails to directly address the critical issue of whether the charging order provision applies uniformly to all limited liability companies regardless of membership composition. In addition, the majority advances a position with regard to chapter 56 of the Florida Statutes that was neither asserted by the parties nor discussed in the opinion of the federal court.

Despite the majority‘s claim that it is not creating an exception to the charging order provision of the statute for single-member LLCs, its analysis necessarily does so in contravention of the plain statutory language and general principles of Florida law. The LLC Act inherently displaces the availability of the execution provisions in chapter 56 of the Florida Statutes by providing a remedy that is intended to prevent judgment creditors from seizing ownership of the membership interests in an LLC and from liquidating the separate assets of the LLC. In doing so, the LLC Act applies uniformly to single- and multimember limited liability companies, and does not provide either an implicit or express exception that permits the involuntary transfer of all right, title, and interest in a single-member LLC to a judgment creditor. The statute also does not permit a judgment creditor to liquidate the assets of a non-debtor LLC in the manner allowed by the majority today. Therefore, under the current statutory scheme, a judgment creditor seeking satisfaction must follow the statutory remedies specifically afforded under chapter 608, which include but are not limited to a charging order, regardless of the membership composition of the LLC.

Although this plain reading may require additional steps for judgment creditors to satisfy, an LLC is a purely statutory entity that is created, authorized, and operated under the terms required by the Legislature. This Court does not possess the authority to judicially rewrite those operative statutes through a speculative inference not reflected in the legislation. The Legislature has the authority to amend chapter 608 to provide any additional remedies or exceptions for judgment creditors, such as an exception to the application of the charging order provision to single-member LLCs, if that is the desired result. However, by basing its premise on principles of law with regard to voluntary transfers, the majority suggests a result that can only be achieved by rewriting the clear statutory provisions. In effect, the majority accomplishes its result by judicially legislating section 608.433(4) out of Florida law.

For instance, the majority disregards the principle that in general, an LLC exists separate from its owners, who are defined as members under the LLC Act. See §§ 608.402(21) (defining “member”), 608.404, Fla. Stat. (2008) (“[E]ach limited liability company organized and existing under this chapter shall have the same powers as an individual to do all things necessary to carry out its business and affairs . . . .”). In other words, an LLC is a distinct entity that operates independently from its individual members. This characteristic directly distinguishes it from partnerships. Specifically, an LLC is not immediately responsible for the personal liabilities of its members. See Litchfield Asset Mgmt. Corp. v. Howell, 799 A.2d 298, 312 (Conn. App. Ct. 2002), overruled on other grounds by Robinson v. Coughlin, 830 A.2d 1114 (Conn. 2003). The majority obliterates the clearly defined lines between the LLC as an entity and the owners as members.

Further, when the Legislature amended the LLC requirements for formation to allow single-member LLCs, it did not enact other changes to the provisions in the LLC Act relating to an involuntary assignment or transfer of a membership interest to a judgment creditor of a member or to the remedies afforded to a judgment creditor. Moreover, no other amendments were made to the statute to demonstrate any different application of the provisions of the LLC Act to single- member and multimember LLCs. For example, the LLC Act generally does not refer to the number of members in an LLC within the separate statutory provisions. The Legislature is presumed to have known of the charging order statute and other remedies when it introduced the single-member LLC statute. Accordingly, by choosing not to make any further changes to the statute in response to this addition, the Legislature indicated its intent for the charging order provision and other statutory remedies to apply uniformly to all LLCs. This Court should not disregard the clear and plain language of the statute.

In addition, the majority fails to correctly set forth the status of a member in an LLC and the associated rights and interests that such membership entails. An owner of a Florida LLC is classified as a “member,” which is defined as

any person who has been admitted to a limited liability company as a member in accordance with this chapter and has an economic interest in a limited liability company which may, but need not, be represented by a capital account.

§ 608.402 (21), Fla. Stat. (2008) (“Definitions”) (emphasis supplied). Therefore, to be a member of a Florida LLC it is now necessary to be admitted as such under chapter 608 and to also maintain an economic interest in the LLC. Moreover, a member of an LLC holds and carries a “membership interest” that encompasses both governance and economic rights:

“Membership interest,” “member‘s interest,” or “interest” means a member‘s share of the profits and the losses of the limited liability company, the right to receive distributions of the limited liability company‘s assets, voting rights, management rights, or any other rights under this chapter or the articles of organization or operating agreement.

§ 608.402(23), Fla. Stat. (2008) (emphasis supplied). This provision was adopted during the 1999 amendments, which was after the modification to allow single- member LLCs. See ch. 99-315, § 1, at 4, Laws of Fla. In stripping the statutory protections designed to protect an LLC as an entity distinct from its owners, the majority obliterates the distinction between economic and governance rights by allowing a judgment creditor to seize both from the member and to liquidate the separate assets of the entity.

Consideration of an involuntary lien against a membership interest must address what interests of the member may be involuntarily transferred. Contrary to the view expressed by the majority, a member of an LLC is restricted from freely transferring interests in the entity. For instance, because an LLC is a legal entity that is separate and distinct from its members, the specific LLC property is not transferable by an individual member. In other words, possession of an economic and governance interest does not also create an interest in specific LLC property or the right or ability to transfer that LLC property. See § 608.425, Fla. Stat. (2008) (stating that all property originally contributed to the LLC or subsequently acquired is LLC property); see also Bishop, supra, 54 S.D. L. Rev. at 226 (discussing in context of federal tax liens the fact that “[t]ypically, a member is not a co-owner and has no transferable interest in limited liability company property”) (citing Unif. Ltd. Liab. Co. Act § 501 (1996), 6A U.L.A. 604 (2003)). The specific property of an LLC is not subject to attachment or execution except on an express claim against the LLC itself. See Bishop & Kleinberger, supra, ¶ 1.04[3][d].

The interpretation of the statute advanced by the majority simply ignores the separation between the particular separate assets of an LLC and a member‘s specific membership interest in the LLC. The ability of a member to voluntarily assign his, her, or its interest does not subject the property of an LLC to execution on the judgment. Under the factual circumstances of the present case, the trial court forced the judgment debtors to involuntarily surrender their membership interests in the LLCs and then authorized a receiver to liquidate the specific LLC assets to satisfy the judgment. In doing so, the trial court ignored the clearly recognized legal separation between the specific assets of an LLC and a member‘s interest in profits or distributions from those assets. See F.T.C. v. Peoples Credit First, LLC, No. 8:03-CV-2353-T-TBM, 2006 WL 1169677, *2 (M.D. Fla. May 3, 2006) (ordering the appellants to “endorse and surrender to the Receiver, all of their right, title and interest in their ownership/equity unit certificates” of the LLCs for the receiver to liquidate the assets of these companies). The majority approves of this disregard by improperly applying principles of voluntary transfers to allow creditors of an LLC member to attack and liquidate the separate LLC assets.

Additionally, the transfer of a membership interest is restricted by law and by the internal operating documents of the LLC. Although a member may freely transfer an economic interest, a member may not voluntarily transfer a management interest without the consent of the other LLC members. See § 608.432(1), Fla. Stat. (2008). Contrary to the view of the majority, in the context of a single-member LLC, the restraint on transferability expressly provided for in the statute does not disappear. Unless admitted as a member to the LLC, the transferee of the economic interest only receives the LLC‘s financial distributions that the transferring member would have received absent the transfer. See § 608.432(2), Fla. Stat. (2008); see also Bishop & Kleinberger, supra, ¶ 1.01[3][c]. Consequently, a member may cease to be a member upon the assignment of the entire membership interest (i.e., transferring all of the following: (1) share of the profits and losses of the LLC, (2) right to receive distributions of LLC assets; (3) voting rights, (4) management rights, and (5) any other rights). See §§ 08.402(23), 608.432(2)(c), Fla. Stat. (2008). Furthermore, a transferring member no longer qualifies under the statutory definition of “member” upon a transfer of the entire economic interest. See § 608.402(21), Fla. Stat. (2008) (defining “member” as a person who has an economic interest in an LLC). However, unless otherwise provided in the governing documents of the entity (i.e., the articles of incorporation and the operating agreement), the pledge or granting of “a security interest, lien, or other encumbrance in or against, any or all of the membership interest of a member shall not cause the member to cease to be a member or to have the power to exercise any rights or powers of a member.” § 608.432(2)(c), Fla. Stat. (2008) (emphasis supplied). Accordingly, a judgment or a charging order does not divest the member of a membership interest in the LLC as the member retains governance rights. It only provides the judgment creditor the economic interest until the judgment is satisfied.

Whether the LLC Act allows a judgment creditor of an individual member to obtain this entire membership interest to exert full control over the assets of the LLC is the heart of the underlying dispute. Neither the Uniform Limited Liability Company Act nor the Florida LLC Act contemplates the present situation in providing for single-member LLCs but restricting the transferability of interests. This problematic issue is not one solely limited to our state, though our decision must be based solely on the language and purpose of the Florida LLC Act. Thus, in my view, this Court must apply the plain meaning of the statute unless doing so would render an absurd result. In contrast, the majority simply rewrites the statute by ignoring those inconvenient provisions that preclude its result.

Legislative Intent With Regard to the Rights of a Judgment Creditor of a Member

I understand the policy concerns of the FTC and the majority with the inherent problems in the transferability of both governance and economic interests under the LLC Act because the plain language does not contemplate the impact of a judgment creditor seeking to obtain the entire membership interest of a single- member LLC and to obtain the ability to liquidate the assets of the LLC. The Florida statute simply does not create a different mechanism for obtaining the assets of a single-member LLC as opposed to a multimember LLC and, therefore, there is no room in the statutory language for different rules.

However, I decline to join in rewriting the statute with inferences and implications, which is the approach adopted by the majority. This Court generally avoids “judicial invention,” as accomplished by the majority, when the statute may be construed under the plain language of the relevant legislative act. See Bishop & Kleinberger, supra, ¶ 1.04[3][d]. In construing a statute, we strive to effectuate the Legislature‘s intent by considering first the statute‘s plain language. See Kasischke v. State, 991 So. 2d 803, 807 (Fla. 2008) (citing Borden v. East- European Ins. Co., 921 So. 2d 587, 595 (Fla. 2006)). When, as it is here, the statute is clear and unambiguous, we do not “look behind the statute‘s plain language for legislative intent or resort to rules of statutory construction to ascertain intent.” Daniels v. Fla. Dep‘t of Health, 898 So. 2d 61, 64 (Fla. 2005). This is especially applicable in the instance of a business entity created solely by state statute.

If the statute had been written as the majority suggests here, I would agree with the result requested by the FTC. However, the underlying conclusion lacks statutory support. By reading only self-selected provisions of the statute to support this result, the majority disregards the remainder of the LLC Act, which destroys the isolated premise that the charging order provision only applies to multimember LLCs and that other statutory restrictions do not exist.

Additionally, exceptions not found within the statute cannot simply be read into the statute, as the majority does by holding that single-member LLCs are an implicit exception to the charging order provision. The remedy provided to the FTC by the federal district court and approved by the majority in this instance— that a judgment creditor of a single-member LLC is entitled to receive a surrender and transfer of the full right, title, and interest of the judgment debtor and to liquidate the LLC assets—is not provided for under the plain language of the LLC Act without judicially writing an exception into the statute.

Judgment Creditor Can Charge the Debtor Member’s Interest in the LLC
With Payment of the Unsatisfied Judgment

As a construct of statutory creation, an LLC is an entity separate and distinct from its members, and thus the liability of the LLC is not directly imputed to its members. In a similar manner, the liability of individual members is not directly imposed separately upon the LLC.

Although a member‘s interest in an LLC is considered to be personal property, see § 608.431, Fla. Stat. (2008), and personal property is generally an asset that may be levied upon by a judgment creditor under Florida law, see § 56.061, Fla. Stat. (2008), there are statutory restrictions in the LLC context. Any rights that a judgment creditor has to the personal property of a judgment debtor are limited to those provided by the applicable creating statute.

The appellants contend that if a judgment creditor may seek satisfaction of a member‘s personal debt from a non-party LLC, the plain language of the LLC Act limits the judgment creditor to a charging order. See § 608.433(4), Fla. Stat. (2008). A charging order is a statutory procedure whereby a creditor of an individual member can satisfy its claim from the member‘s interest in the limited liability company. See Black‘s Law Dictionary 266 (9th ed. 2009) (defining term in the context of partnership law). It is understandable that the FTC challenges the charging order concept being deemed a remedy for a judgment creditor because, from the creditor‘s perspective, a charging order may not be as attractive as just seizing the LLC assets. For example, a creditor may not receive any satisfaction of the judgment if there are no actual distributions from the LLC to the judgment creditor through the debtor-member‘s economic interest. See Elizabeth M. Schurig

& Amy P. Jetel, A Shocking Revelation! Fact or Fiction? A Charging Order is the Exclusive Remedy Against a Partnership Interest, Probate & Property, Nov.-Dec. 2003, at 57, 58. The preferred creditor‘s remedy would be a transfer and surrender of the membership interest that is subject to the charging order, which is a more permanent remedy and may increase the creditor‘s chances of having the debt satisfied. See id.

The application of the charging order provision, including its consequences and implications, has been hotly debated in the context of both partnership and LLC law because of the similarities of these entities. The language of the charging order provision in the Revised Uniform Limited Partnership Act (1976), as amended in 1985, is virtually identical to that used in the Uniform Limited Liability Company Act, as well as in the Florida LLC Act. See §§ 608.433(4), 620.153, Fla. Stat. (2008). The Uniform Limited Partnership Act of 2001 significantly changed this provision by explicitly allowing execution upon a judgment debtor‘s partnership interest. See Schurig & Jetel, supra, at 58. However, the Florida Partnership Act provides that a charging order is the exclusive remedy for judgment creditors. See § 620.8504(5), Fla. Stat. (2008) (stating the charging order provision provides the “exclusive remedy by which a judgment creditor of a partner or partner‘s transferee may satisfy a judgment out of the judgment debtor‘s transferable interest in the partnership”). In the context of partnership interests, Florida courts have also determined that a charging order is the exclusive remedy for judgment creditors based on the straightforward language of the statute. See Givens v. Nat‘l Loan Investors L.P., 724 So. 2d 610, 612 (Fla. 5th DCA 1998) (holding that charging order is the exclusive remedy for a judgment creditor of a partner); Myrick v. Second Nat‘l Bank of Clearwater, 335 So. 2d 343, 345 (Fla. 2d DCA 1976) (substantially similar). The Florida LLC Act has neither adopted an explicit surrender-and-transfer remedy nor does it include a provision explicitly stating that the charging order is the exclusive remedy of the judgment creditor. The plain language of the charging order provision only provides one remedy that a judgment creditor may choose to request from a court and that the court may, in its discretion, choose to impose. See § 608.433(4), Fla. Stat. (2008).

To support its conclusion that charging orders are inapplicable to single- member LLCs, the majority compares the provision in the partnership statute that mandates a charging order as an exclusive remedy to the non-exclusive provision in the LLC Act. The exclusivity of the remedy is irrelevant to this analysis. By relying on an inapplicable statute, the majority ignores the plain language of the LLC Act and the other restrictions of the statute, which universally apply the use of a charging order to judgment creditors of all LLCs, regardless of the composition of the membership. The majority opinion now eliminates the charging order remedy for multimember LLCs under its theory of “nonexclusivity” which is a disaster for those entities.

Plain Meaning of the Statute’s Actual Language

The charging order provision does not act as a reverse-asset shield against the creditors of a member. Instead, the LLC Act implements statutory restrictions on the transfer and assignment of membership interests in an LLC. These restrictions limit the mechanisms available to a judgment creditor of a member of any type of LLC to obtain satisfaction of a judgment against the membership interest. Specifically, section 608.433(4) grants a court of competent jurisdiction the discretion to enter a charging order against a member‘s interest in the LLC in favor of the judgment creditor:

608.433. Right of assignee to become member.—

  1. Unless otherwise provided in the articles of organization or operating agreement, an assignee of a limited liability company interest may become a member only if all members other than the member assigning the interest consent.
  2. An assignee who has become a member has, to the extent assigned, the rights and powers, and is subject to the restrictions and liabilities, of the assigning member under the articles of organization, the operating agreement, and this chapter. An assignee who becomes a member also is liable for the obligations of the assignee‘s assignor to make and return contributions as provided in s. 608.4211 and wrongful distributions as provided in s. 608.428. However, the assignee is not obligated for liabilities which are unknown to the assignee at the time the assignee became a member and which could not be ascertained from the articles of organization or the operating agreement.
  3. If an assignee of a limited liability company interest becomes a member, the assignor is not released from liability to the limited liability company under ss. 608.4211, 608.4228, and 608.426.
  4. On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the limited liability company membership interest of the member with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of such interest. This chapter does not deprive any member of the benefit of any exemption . . . .

§ 608.433, Fla. Stat. (2008) (emphasis supplied).

The majority asserts that the placement of the charging order provision
within the section titled “Right of assignee to become member” mandates that the provision only applies to circumstances where the interest of the member is subject to the rights of other LLC members. There is absolutely nothing to support the notion that the Legislature‘s placement of the charging order provision as a subsection of section 608.433, instead of as a separately titled section elsewhere in the statute, was intended to unilaterally link its application only to the multimember context. For instance, the Revised Uniform Limited Liability Company Act, unlike the Florida statute, places the charging order provision as a separately titled section within the article that discusses transferable interests and rights of transferees and creditors. See Unif. Ltd. Liab. Co. Act § 503 (revised 2006), 6B U.L.A. 498 (2008). Other states have also adopted a statutory scheme that places the charging order remedy within a separate provision specifically dealing with the rights of a judgment creditor. See Conn. Gen. Stat. § 34-171 (2007). Thus, the majority‘s interpretation would again fail by a mere movement of the charging order provision to a separately titled section within the Act.

In contrast to the majority, my review of this provision begins with the actual language of the statute. In construing a statute, it is our purpose to effectuate legislative intent because “legislative intent is the polestar that guides a court‘s statutory construction analysis.” See Polite v. State, 973 So. 2d 1107, 1111 (Fla. 2007) (citing Bautista v. State, 863 So. 2d 1180, 1185 (Fla. 2003)) (quoting State v. J.M., 824 So. 2d 105, 109 (Fla. 2002)). A statute‘s plain and ordinary meaning must be given effect unless doing so would lead to an unreasonable or absurd result. See City of Miami Beach v. Galbut, 626 So. 2d 192, 193 (Fla. 1993). Here, the plain language establishes a charging order remedy for a judgment creditor that the court may impose. This section provides the only mechanism in the entire statute specifically allocating a remedy for a judgment creditor to attach the membership interest of a judgment debtor. In the multimember context, the uncontested, general rule is that a charging order is the appropriate remedy, even if the language indicates that such a decision is within the court‘s discretion. See Myrick, 335 So. 2d at 344. As the Second District explained:

Rather, the charging order is the essential first step, and all further proceedings must occur under the supervision of the court, which may take all appropriate actions, including the appointment of a receiver if necessary, to protect the interests of the various parties.

Id. at 345. Without express language to the contrary, the discretionary nature of this remedy applies with equal force to single- and multimember LLCs, which the majority erases from the statute.

Nevertheless, the certified question before us is not the discretionary nature of this remedy but whether a court should even apply the charging order remedy to single-member LLCs. The majority rephrases the question certified to this Court as not considering whether an exception to the charging order provision should be implied for single-member LLCs. In doing so, the majority unjustifiably alters and recasts the question posited by the federal appellate court to fit the majority‘s result. The convoluted alternative presented by the majority is premised on a limited application of a charging order without express language in the statutory scheme to support this assertion.

Here, the plain language crafted by the Legislature does not limit this remedy to the multimember circumstance, as the majority holds. Further, exceptions not made in a statute generally cannot be read into the statute, unless the exception is within the reason of the law. See Cont‘l Assurance Co. v. Carroll, 485 So. 2d 406, 409 (Fla. 1986) (“This Court cannot grant an exception to a statute nor can we construe an unambiguous statute different from its plain meaning.”); Dobbs v. Sea Isle Hotel, 56 So. 2d 341, 342 (Fla. 1952) (“We apprehend that had the legislature intended to establish other exceptions it would have done so clearly and unequivocally. . . . We cannot write into the law any other exception . . . .”). Thus, without going behind the plain language of the statute, at first blush, the statute applies equally to all LLCs, regardless of membership composition.

The distinction asserted by the FTC is clearly inconsistent with the plain language of section 608.434 with regard to the proper method for a judgment creditor to reach the interest of a member in a LLC in that a complete surrender of the membership interest and the subsequent liquidation of the LLC assets are not contemplated by the LLC Act. The majority‘s interpretation that the charging order remedy only applies to multimember LLCs can only be given effect if the plain language of this provision renders an absurd result, which it does not.

The purpose of creating the charging order provision was never limited to the protection of “innocent” members of an LLC. Moreover, when amending the LLC Act to permit single-member LLCs, the Legislature did not also amend the assignment of interest and charging order provisions to create different procedures for single- and multimember LLCs. The appellants argue that this indicates a manifestation of legislative intent; however, it appears more likely that our Legislature, as with many other states, had not yet contemplated the situation before us. Even so, the appropriate remedy in this circumstance is not for this Court to impose its speculative interpretation, but for the Legislature to amend the statute to reflect its specific intention, if necessary. When interpreting a statute that is unambiguous and clear, this Court defers to the Legislature‘s authority to create a new limitation and right of action. Here, the actual language of the statute does not distinguish between the number of members in an LLC. Thus, the charging order applies with equal force to both single-member and multimember LLCs, and the assignment provision of section 608.433 does not render an absurd result.

The majority purports to base its analysis on the plain language of the statute. However, the FTC and a multitude of legal theorists agree that the plain language of the statute does not support this result. See e.g., Bishop & Kleinberger, supra, ¶ 1.04[3][d]; Bishop, supra, 54 S.D. L. Rev. at 202; Ribstein, supra, 30 Del. J. Corp. L. at 221-25; Rutledge & Geu, supra, Bus. Entities, Sept.- Oct. 2003 at 16; Stein, supra, Bus. Entities, Sept.-Oct. 2006 at 28. All authorities recognize that the sole way to achieve the result desired by the FTC and the majority is to ignore the plain language of the statute. No external support exists for the majority‘s bare assertions.

Rights of an Assignee

The plain language of section 608.433(4) applies the charging provision to the judgment creditor of both a single-member and multimember LLC. The next analytical step is to determine what rights that charging order provision grants the judgment creditor. To the extent that a membership interest is charged with a judgment, the plain text of the statute specifically provides that the judgment creditor only possesses the rights of an assignee of such interest. See § 608.433(4), Fla. Stat. (2008) (“To the extent so charged, the judgment creditor has only the rights of an assignee of such interest.”).

To determine the rights of an assignee of such an interest, we look to section 608.432, which defines these rights. To divine the intent of the Legislature, we construe related statutory provisions together, or in pari materia, to achieve a consistent whole that gives full, harmonious effect to all related statutory provisions. See Heart of Adoptions, Inc. v. J.A., 963 So. 2d 189, 199 (Fla. 2007) (quoting Forsythe v. Longboat Key Beach Erosion Control Dist., 604 So. 2d 452, 455 (Fla. 1992)). The FTC asserts that the rights delineated in this section render an absurd result when applied to single-member LLCs; however, the FTC ignores that the same rule applies even if only a part of a member‘s interest is needed to satisfy a debt amount. Further, an assignee is entitled solely to an economic interest and is not entitled to governance rights without the unanimous approval of the other members or as otherwise provided in the articles of incorporation or the operating agreement.

The plain reading of this provision does not establish the judgment creditor as an assignee of such interest, only that to the extent of the judgment amount charged to the economic interest, the judgment creditor has the same rights as an assignee. Though section 608.433(4) directs that the judgment creditor has only the rights of an assignee of such interest, as provided in section 608.432, it is important to clarify that the judgment creditor does not become an assignee; the language merely indicates that the judgment creditor‘s rights do not exceed those of an assignee.

This clear distinction can be seen when considering the voluntary and involuntary nature of these different interests—an assignment is generally a voluntary action made by an assignor, whereas a charging order is clearly an involuntary assignment by a judgment debtor. For that reason, the majority formulates a false conclusion that section 404.433(1) provides a foundation for the bare assertion that a charging order is inapplicable in the context of a single- member LLC. Exploiting this false foundation, the majority asserts a result that is unsupportable when considered in pari materia with the entirety of the statutory scheme.

The question before this Court requires articulation of a general principle of law that applies to all types of judgments, whether less than, equal to, or greater than the value of a membership interest, and to all types of LLCs. Reading section 608.433(4) and 608.432 together, a judgment creditor may be assigned a portion of the economic interest, depending on the amount of the judgment. This provision contemplates that a charging order may not encompass a member‘s entire membership interest if the judgment is for less than the available economic distributions of an LLC. For instance, if the LLC membership interest here were worth more than the $10 million judgment, it would be unnecessary under this provision to transfer the full economic interest in the LLC to satisfy the judgment. Further, a member does not lose the economic interest and membership status unless all of the economic interest is charged to the judgment creditor. See § 608.432(2)(c), Fla. Stat. (2008). Thus, if the judgment were for less than the value of either the membership interest or the assets in the LLC, the members could transfer a portion of their economic interest and still retain their membership interest, in that they would still hold an economic and governance interest in the LLC. The FTC would then only have the right to receive distributions or allocations of income in an amount corresponding to satisfaction of a partial economic interest. Regardless of the amount of the interest assigned, the judgment creditor does not immediately receive a governance interest. See § 608.432(1), (2), Fla. Stat. (2008).

In such a circumstance, the result contemplated by the FTC does not come to pass—the single member maintains his, her, or its membership rights because a member only ceases to be a member and to have the power to exercise any governance rights upon assignment of all of the economic interest of such member. See id. The majority disregards this factual possibility and considers only the application of the statutory scheme in the context of a judgment that is equal to or greater than the value of the membership interest. Under the majority‘s interpretation of the statute, a judgment creditor could force a single-member LLC to surrender all of its interest and liquidate the assets specifically owned by the LLC, even if the judgment were for less than the assets‘ worth.

Alternative Remedies

Currently, the plain language of the statute provides additional remedies to the charging order provision for judgment creditors seeking satisfaction on a judgment that is equal to or greater than the economic distributions available under a charging order—(1) dissolution of the LLC, (2) an order of insolvency against the judgment debtor, or (3) an order conflating the LLC and the member to allow a court to reach the property assets of the LLC. First, upon the issuance of a charging order that exceeds a member‘s economic interest in an LLC for satisfaction of the judgment, dissolution may be achieved because the remaining member ceases to possess an economic interest and governance rights in the LLC following the assignment of all of its membership interest. See § 608.432(2)(c), Fla. Stat. (2008) (“Assignment of member‘s interest”). The statutory provision with regard to the assignment of a member‘s interest provides, in relevant part:

(2) Unless otherwise provided in the articles of organization or operating agreement:
….

(c) A member ceases to be a member and to have the power to exercise any rights or powers of a member upon assignment of all of the membership interest of such member. Unless otherwise provided in the articles of organization or operating agreement, the pledge of, or granting of a security interest, lien, or other encumbrance in or against, any or all of the membership interest of a member shall not cause the member to cease to be a member or to have the power to exercise any rights or powers of a member.

Id. (emphasis supplied). This demonstrates a clear and unambiguous distinction between a voluntary assignment of all the interest and the granting of an encumbrance against any or all of the membership interest. Because a “member” is defined as an actual or legal person admitted as such under chapter 608, who also has an economic interest in the LLC, it is the assignment of all of that economic interest that divests the member of his, her, or its status and power. Thus, if the charging order is only for a part of the economic interest held by the judgment debtor, the statute does not require that the member cease to be a member. See §§ 608.402(21), 608.432(2)(c), Fla. Stat. (2008). If, on the other hand, the charging order is to the extent that it requires a surrender of all of the member‘s economic interest, in that circumstance, the member ceases to be a member under section 608.432(2)(c). In the case of a member-managed LLC, this would leave the LLC without anyone to govern its affairs. However, within the manager-managed LLC context, the manager would remain in a position to direct the LLC and distribute any profits according to any governing documents.

This provision need not be limited to single-member LLCs. For example, if the appellants had entered into a multimember LLC, that entity would be subject to the same statutory construction issues as a single-member LLC. Once the FTC obtained a judgment against a member of the multimember LLC, a charging order would be lodged against that member‘s interest. In that circumstance, though there may be charging orders against separate membership interests, in essence the same divestiture of the membership interest would occur if the judgment was for all of each member‘s economic interest.

It is important to note, however, if an LLC becomes a shell or legal fiction with no actual governing members, the LLC shall be dissolved under section 608.441. The dissolution statute provides:

(1) A limited liability company organized under this chapter shall be dissolved, and the limited liability company‘s affairs shall be concluded, upon the first to occur of any of the following events:

(d) At any time there are no members; however, unless otherwise provided in the articles of organization or operating agreement, the limited liability company is not dissolved and is not required to be wound up if, within 90 days, or such other period as provided in the articles of organization or operating agreement, after the occurrence of the event that terminated the continued membership of the last remaining member, the personal or other legal representative of the last remaining member agrees in writing to continue the limited liability company and agrees to the admission of the personal representative of such member or its nominee or designee to the limited liability company as a member, effective as of the occurrence of the event that terminated the continued membership of the last remaining member; or

….
(4) Following the occurrence of any of the events specified in this section which cause the dissolution of the limited liability company, the limited liability company shall deliver articles of dissolution to the Department of State for filing.

§ 608.441(1)(d), (4), Fla. Stat. (2008) (emphasis supplied). A dissolved LLC continues its existence but does not carry on any business except that which is appropriate to wind up and liquidate its business and affairs under section 608.4431. Once dissolved, the liquidated assets may then be distributed to a judgment creditor holding a charging order. See § 608.444(1), Fla. Stat. (2008).

The judgment creditor may also seek an order of insolvency against the individual member, in which instance that member ceases to be a member of the single-member LLC, and the member‘s interest becomes part of the bankruptcy estate. In Florida, the commencement of a bankruptcy proceeding also terminates membership within an LLC. See §§ 608.402(4), 608.4237, Fla. Stat (2008). The decisions advanced by the FTC involved bankruptcies of the judgment debtor, and the rights of a judgment creditor in a bankruptcy are substantially different than the rights of a judgment creditor generally. See In re Modanlo, 412 B.R. 715 (Bankr. D. Md. 2006), aff‘d, No. 06-2213 (4th Cir. 2008); In re Albright, 291 B.R. 538, 539 (Bankr. D. Colo. 2003). Upon commencement of a bankruptcy proceeding, a bankruptcy estate includes all legal or equitable property interests of the debtor.

An LLC membership interest is the personal property of the member. Therefore, when a judgment debtor files for bankruptcy, or is subject to an order of insolvency, the judgment debtor effectively transfers any membership interest in an LLC to the bankruptcy estate. In this context, it is reasonable for the bankruptcy courts to construe the LLC Act to no longer require a charging order because the judgment debtor has passed the entire membership interest to the bankruptcy estate, and the trustee stands in the shoes of the judgment debtor, who is now seeking reorganization of its assets. See, e.g., In re Albright, 291 B.R. at 541. The majority refuses to even acknowledge any of these approaches.

This bankruptcy context is distinguishable from the general case of a judgment creditor seeking to execute upon the assets of an LLC because the judgment may not meet or exceed the economic interest remaining in the LLC. Thus, the Albright bankruptcy situation should not alter our determination that the plain language of the statute applies the charging order provision to both single- and multimember LLCs. This may be a more complicated procedure than to allow a court to simply “shortcut” and rewrite the law and enter a surrender-and-transfer order of a member‘s entire right, title, and interest in an LLC as the majority accomplishes today. However, it is the method prescribed by the statute. Although the procedures created by the statute may involve multiple steps and legal proceedings, they are not absurd or irreconcilable with chapter 608 as a whole.

A Charging Order, in and of Itself, Does Not Entitle a Judgment Creditor to
Seize and Dissolve a Florida LLC

Based on the plain language of the statute and the construction of chapter 608 in pari materia, I would answer the certified question in the negative: A court may not order a judgment debtor to surrender and transfer outright all “right, title, and interest” in the debtor‘s single-member LLC to satisfy an outstanding judgment. If a judgment creditor wishes to proceed against a single-member LLC, it may first request a court of competent jurisdiction to impose a charging order on the member‘s interest. If the judgment creditor is concerned that the member is constraining distribution of assets and incomes, the creditor may seek judicial remedies to enforce proper distribution. In addition, if the economic interest so charged is insufficient to satisfy the judgment, the judgment creditor may move through additional proceedings: (1) seek to dissolve the LLC and to have its assets liquidated and subsequently distributed to the judgment creditor; (2) seek an order of insolvency against the judgment debtor, in which case the trustee of the bankruptcy estate will control the assets of the LLC, or (3) request a court to pierce the liability shield to make available the personal assets of the company to satisfy the personal debts of its member. This plain reading of chapter 608 may create additional steps for judgment creditors and judgment debtors to satisfy, as characterized by the federal district court in this case. However, only the Legislature, as the architects of this statutorily created entity, has the authority to provide a more streamlined surrender of these rights, not the judicial branch through selective reading and rewriting of the statute. As enacted, the plain meaning of the statute is unambiguous and does not require “judicial invention” of exceptions that are clearly not provided in the LLC Act. If the Legislature wishes to make either an exception to the charging order provision for single-member LLCs or to provide additional remedies to judgment creditors, it may do so through an amendment of chapter 608.

Accordingly, I would answer the certified question in the negative. Under Florida law, a court does not have the authority to order an LLC member to surrender and transfer all right, title, and interest in an LLC and have LLC assets liquidated without first going through the statutory requirements created by the Legislature.

POLSTON, J., concurs.

Certified Question of Law from the United States Court of Appeals for the
Eleventh Circuit – Case Nos. 06-13254-DD and 03-02353-CV-T-17-TBM

Thomas C. Little, Clearwater, Florida,

for Appellant

William Blumenthal, General Counsel, John F. Daly, Deputy General Counsel and John Andrew Singer, Attorney, Federal Trade Commission, Washington, D.C.,

for Appellee

Daniel S. Kleinberger, Professor, William Mitchell College of Law, St. Paul, Minnesota,

As Amicus Curiae

In re Hicks

In re: James Tillman HICKS, Jr., a/k/a J. T. Hicks, Jr., a/k/a Sonny Hicks, Debtor; Benjamin C. ABNEY, Trustee, Plaintiff v. James Tillman HICKS, Jr., the Citizens and Southern National Bank, and Lois Reagan Hicks, Defendants

Case No. 80-01342A, Adversary No. 81-1877A

UNITED STATES BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF GEORGIA ATLANTA DIVISION 

22 B.R. 2431982 Bankr. LEXIS 3653

July 26, 1982

COUNSEL:  [**1]  Benjamin C. Abney, Esq., Carr, Abney, Tabb & Schultz, N.W., Atlanta, Georgia, for Plaintiff.

 

Jeffrey Starnes, Esq., Conyers, Georgia, (attorney for James Tillman Hicks, Jr.).

 

C. R. Vaughn, Jr., Esq., Vaughn & Barksdale, Conyers, Georgia, (attorney for C&S National Bank and Lois Reagan Hicks).

 

JUDGES: W. Homer Drake, United States Bankruptcy Judge.

 

OPINION BY: DRAKE

 

OPINION

[*244]  ORDER

This case is before the Court on the plaintiff’s Complaint for Declaratory Relief to determine what interest, if any, the debtor may have in certain property held in trust pursuant to his father’s will.  The plaintiff alleges that the interest held by the debtor is a vested remainder and that the debtor held this interest when he filed his bankruptcy petition. If this interest exists, it would be part of the estate of the debtor under 11 U.S.C. § 541(a)(5)(A).  In re McLoughlin, 507 F.2d 177 (5th Cir. 1975). The defendants contend that the interest which the debtor has under his father’s will is contingent and not vested.  The parties have filed Motions for Summary Judgment and submitted briefs in support thereof.

The will in question is that of James Tillman Hicks, Sr., the debtor’s father.  Mr.  [**2]  Hicks, Sr. died May 29, 1970, almost ten years prior to the time the debtor filed his petition in bankruptcy on April 24, 1980.  The Citizens and Southern National Bank (“C&S”) and Lois Reagan Hicks are trustees of the residuary trust created pursuant to Item V of the Last Will and Testament of J. T. Hicks, Sr.  Lois Reagan Hicks, who was the wife of J. T. Hicks, Sr., and the mother of the debtor, is currently alive. She was given a life estate and the power of appointment which enabled her to direct the trustee to turn over any of the corpus of the trust to any descendant of J. T. Hicks, Sr. or to pay any income from the trust to any descendants of J. T. Hicks, Sr.  Lois Reagan Hicks has not exercised this power of appointment.

The power of appointment held by Lois Reagan Hicks gives her total discretion as to the division of the trust corpus among the descendants of J. T. Hicks, Sr.  The  [*245]  vesting of the debtor’s interest in the estate is contingent upon one of two events.  The first is the exercise of the power of appointment by Lois Reagan Hicks.  The plaintiff contends that this Court should find a vested interest in J. T. Hicks, Jr.  Essentially, that would require [**3]  the Court to compel Mrs. Hicks to exercise her power of appointment. Section 36-602 of the Ga. Code states that: “Equity may not compel a party, having a discretion, to exercise the power of appointment;”.  Based on Ga. Code § 36-602, this Court finds that it cannot compel the exercise of a discretionary power of appointment.  See also In re McLoughlin, supra.

Lois Reagan Hicks was given a life estate in the trust created under the will of J. T. Hicks, Sr.  Under Georgia law, when a will creates a life estate for the widow, the remainder interest does not vest in the remaindermen until the death of the life tenant, and the estates of the remaindermen who predecease the life tenant are not entitled to an interest in the estate.  Ruth v. First National Bank of Atlanta, 230 Ga. 490, 197 S.E.2d 699 (1973). Accordingly, the interest created in the children of J. T. Hicks, Sr. is a contingent remainder. The Ruth case illustrates the second way by which J. T. Hicks, Jr.’s interest could vest, i.e. J. T. Hicks, Jr. would have to survive the life tenant, Lois Reagan Hicks.  Because the estate created in the children is a contingent remainder, it is not property of the [**4]  debtor’s estate under 11 U.S.C. § 541(a)(5)(A) and therefore it is not subject to the claim of the trustee in bankruptcy. Thornton v. Scarborough, 348 F.2d 17, 22 (1965).

In a recent case, the Fifth Circuit Court of Appeals held that under Georgia law, a father’s will created contingent remainders in his children who are required to survive a mother – life tenant because until her death, her survivors were unascertained persons.  In re McLoughlin, 507 F.2d 177, 182 (1975). Since Lois Reagan Hicks is in life and was alive at the time the debtor filed his bankruptcy petition, the beneficiaries of the trust cannot be ascertained, and their interests are contingent. Id. at 181. Because the interest created in the debtor is a contingent remainder, it is non-transferrable under Georgia law.  Id. at 181.

Therefore, for the above-stated reasons, the debtor’s interest in J. T. Hicks, Sr.’s will is a contingent remainder and is not subject to the claim of the trustee in bankruptcy as property of the estate under the ambit of 11 U.S.C. § 541. The plaintiff’s Motion for Summary Judgment is hereby denied and the defendants’ Motion for Summary Judgment is granted.

IT IS SO [**5]  ORDERED.

At Atlanta, Georgia, this 26 day of July, 1982.

W. HOMER DRAKE, UNITED STATES BANKRUPTCY JUDGE

In re Knight

In re: JAMES EDWARDS KNIGHT, Debtor.

CASE NO. 91-30264-BKC-RAM CHAPTER 7

UNITED STATES BANKRUPTCY COURT FOR THE SOUTHERN DISTRICT OF FLORIDA

164 B.R. 3721994 Bankr. LEXIS 192Bankr. L. Rep. (CCH) P75,78930 Collier Bankr. Cas. 2d (MB) 16187 Fla. L. Weekly Fed. B 381

 February 22, 1994, Decided

CASE SUMMARY:

PROCEDURAL POSTURE: A creditor filed an objection to a debtor’s claim of exemption with respect to his interests in trusts created by his parents. The court considered the issue to be whether the trust interests were property of the bankruptcy estate under 11 U.S.C.S. § 541.

OVERVIEW: The debtor’s mother’s trust named him and his sister as beneficiaries after his mother’s life estate. His father’s trust had been divided into two parts at the father’s death. His mother held absolute discretion over the funds in Part A. The provisions in Part B were the same as in the mother’s trust. There were no spendthrift provisions in the trusts. The parties stipulated that the father’s Part A trust was not property of the bankruptcy estate. The court held that the fact that the debtor’s interests in the Part B trust and his mother’s trust were contingent upon his surviving her did not prevent them from being included in the bankruptcy estate. Section 541(a)(1) evidenced a congressional intent to include all legally recognizable interests, including contingent interests. The contingent nature of the debtor’s interests went to a determination of the value to be includible in the estate. The trusts could be modified only with the consent of the debtor, and the court assumed for purposes of valuation that he would not elect to terminate his own interest.

OUTCOME: The court held that the debtor’s interests in his mother’s trust and in the Part B trust created by his father were property of the bankruptcy estate.

LexisNexis(R) Headnotes

 

Bankruptcy Law > Estate Property > Content

[HN1] Section 541(a)(1) of the Bankruptcy Code11 U.S.C.S. § 541(a)(1), defines property of the estate broadly to include all legal and equitable interests of the debtor in property as of the commencement of the case. Unlike the Bankruptcy Act, the Code has eliminated a requirement that the debtor be able to transfer the interest or that his creditors by some means must be able to reach it. By including all legal interests without exception, Congress indicated its intention to include all legally recognizable interests although they may be contingent and not subject to possession until some future time.

Bankruptcy Law > Case Administration > Examiners, Officers & Trustees > Postpetition Transactions

Estate, Gift & Trust Law > Estates Created by Trusts & Wills > Future Interests > General Overview

Estate, Gift & Trust Law > Trusts > Beneficiaries > General Overview

[HN2] For purposes of valuing a beneficiary’s future interest in the corpus of a trust, a court assumes that a beneficiary would not elect to terminate his or her own interest.

 

Bankruptcy Law > Estate Property > Content

Estate, Gift & Trust Law > Estates Created by Trusts & Wills > Future Interests > General Overview

Estate, Gift & Trust Law > Trusts > General Overview

[HN3] The discretionary right to invade principal affects the value of a debtor’s interests as beneficiary of trusts but it does not render them worthless. Similarly, the fact that the debtor must outlive the life beneficiary in order to obtain his share of the trust principal also does not immunize the interest from becoming property of the estate.

 

Estate, Gift & Trust Law > Estates Created by Trusts & Wills > General Overview

Estate, Gift & Trust Law > Trusts > Spendthrift Trusts > Exclusion From Bankruptcy Estate

Real Property Law > Estates > Present Estates > Life Estates

[HN4] A contingent remainder is an interest that is alienable and subject to seizure under applicable New York law. Absent any spendthrift provisions which would exclude the interest under 11 U.S.C.S. § 541(c)(2), the debtor’s interests, a 50 percent remainder interest in a trust subject to a life tenancy, are alienable interests that pass to the bankruptcy trustee upon the filing of a bankruptcy case.

 

Bankruptcy Law > Estate Property > Content

[HN5] There is a material difference between an interest which may be unilaterally extinguished by a grantor and an interest which may be defeated by some condition subsequent. In the former case, there is no interest of value which passes to the estate. In the latter, the value is affected by the possibility of future events which may reduce or eliminate the interest, but the interest has value as of the petition date which can and does pass to the Trustee.

COUNSEL:  [**1]  For GIAC Leasing: Robert L. Young, Esq., CARLTON, FIELDS, WARD, EMMANUEL, SMITH & CUTLER, P.A., Orlando, Florida.

For Debtor: Leslie G. Cloyd, Esq., ACKERMAN, BAKST, CLOYD & SCHERER, P.A., West Palm Beach, Florida.

JUDGES: MARK

OPINION BY: ROBERT A. MARK

OPINION

[*373] SUPPLEMENTAL MEMORANDUM OPINION DETERMINING ESTATE’S INTEREST IN TRUSTS

The Debtor in this Chapter 7 case scheduled certain property described as contingent unvested interests in various trusts. These trust interests were scheduled as exempt. GIAC Leasing Corporation (“Creditor”) filed an objection to the claim of exemption. Although framed as an objection to exemptions because of the form in which the Debtor listed these interests, the issue is whether the trust interests are property of the estate.

After consideration of the arguments presented in written memoranda and in oral argument and after review of the trust documents, the Court scheduled a hearing on October 20, 1993, to announce its ruling. This Supplemental Memorandum Opinion incorporates and supersedes the findings and conclusions stated on the record on that day.

The Court concludes that the Debtor’s interests in the Dorothy E. Knight Trust and Part B of the Charles E. Knight Trust are [**2]  property of the estate; the Debtor’s interest in Part A of the Charles E. Knight Trust is not estate. property.

 

FACTUAL BACKGROUND

The Debtor, James Edwards Knight, is the son of Charles E. Knight and Dorothy E. Knight. The interests at issue are the Debtor’s interest in the Dorothy E. Knight Trust (the “Dorothy Trust”) established on October 1, 1937 and the Debtor’s interest in the Charles E. Knight Trust (the “Charles Trust”) established on January 2, 1946. Upon the death of Charles, the Charles Trust was divided into Part A and Part B as described below.

The Dorothy Trust

The Dorothy Trust terminates upon the death of Dorothy who was 90 years old as of the petition date. At her death, under Section 4 of the trust, the principal will be distributed equally to the Debtor and his sister, if they are alive. If the Debtor predeceases his mother, his share will be distributed to his children.

Since 1965, the Debtor’s sister and Dorothy have served as co-trustees of the trust. Prior to the filing of his Chapter 7 case, the Debtor had been receiving some income distributions from this trust pursuant to Section 3, which provides that income “may be paid from time to time in equal [**3]  or unequal proportions” to Dorothy, the Debtor or his sister.

[*374]  Two other provisions of the trust are relevant to the Court’s analysis. First, the trust may be amended only by the consent of all three trustees. Second, Section 12 of the trust grants the trustees the right to invade principal during Dorothy’s lifetime “in the discretion of the trustees.” According to a supplemental letter submitted by Debtor’s counsel on May 19, 1992, the Dorothy Trust has a value of approximately $ 885,000.00.

The Charles Trust

The Charles Trust, created in 1946 and amended in 1965, was divided, by its terms, into two parts when Charles died. The Debtor, his sister and Dorothy are also co-trustees of this trust.

Dorothy is entitled to receive all of the income from the Part A Trust during her life. At her death, the principal of the Part A Trust will be distributed pursuant to a power of appointment exercisable by Dorothy in her will. The Creditor concedes that the Debtor has no present or future interest in Part A of the Charles Trust, since Dorothy has absolute discretion as to naming him as a beneficiary.

Part B of the Charles Trust is at issue. The Charles Part B Trust provides for Dorothy to [**4]  receive income during her lifetime with the principal to be distributed equally to the Debtor and his sister if they are alive, just like the principal of the Dorothy Trust. Also like the Dorothy Trust, Section 12 of the Charles Part B Trust provides for invasion of the principal during Dorothy’s lifetime. Unlike the invasion of principal provision in the Dorothy Trust, the provisions in the Charles Part B Trust are both more specific and mandatory as follows:

Section 12. Payments By the Trustees.

During the lifetime of CHARLES E. KNIGHT the Trustees shall pay and distribute any portion of this Trust as CHARLES E. KNIGHT may direct by notice in writing to the Trustees. Further, the Trustees shall pay and distribute unto CHARLES E. KNIGHT and/or DOROTHY E. KNIGHT at any time during the duration of this Trust so much of the principal thereof as shall be necessary to keep and maintain CHARLES E. KNIGHT and/or DOROTHY E. KNIGHT in the standard of living to which he and/or she may be accustomed, and/or to provide for his and/or her medical care.

 

The Charles Part B Trust had a value of $ 1,545,000 as of May 19, 1992.

DISCUSSION

[HN1] Section 541(a)(1) of the Bankruptcy Code defines [**5]  property of the estate broadly to include “all legal and equitable interests of the debtor in property as of the commencement of the case.” Unlike the Bankruptcy Act, the Code has eliminated a requirement that the debtor be able to transfer the interest or that his creditors by some means must be able to reach it.  In re Ryerson, 739 F.2d 1423 (9th Cir. 1984). By including all legal interests without exception, Congress indicated its intention to include all legally recognizable interests although they may be contingent and not subject to possession until some future time.  Id. at 1425citing H.R. Rep. No. 595, 95th Cong., 1st Sess. 175-76 (1977), reprinted in 1978 U.S. Code Cong. & Ad. News 5963, 6136.

The Debtor argues that he has no vested right to any portion of the principal of the Dorothy Trust unless three contingencies occur: (1) The Debtor survives Dorothy; (2) Dorothy does not amend the trust interest so as to exclude the Debtor as a beneficiary; and (3) the trustees do not consume the entire principal by paying it to Dorothy or other beneficiaries as they may in their discretion do under Section 12 of the  [**6]  trust instrument. The Debtor similarly argues that he has no right to the principal of the Charles Part B Trust unless he survives his mother and the corpus is not consumed by distributions to Dorothy during her lifetime.

The Debtor is wrong as to Dorothy’s unilateral ability to amend the Dorothy Trust to eliminate his interest. Dorothy certainly has absolute discretion as to the Charles Part A Trust, but she may not amend the Dorothy Trust to exclude the Debtor without the consent of the other trustees. The Debtor’s consent to his exclusion post-petition would constitute an unlawful post-petition transfer of property of the estate under § 549 of the  [*375]  Code. Moreover, [HN2] for purposes of valuing a beneficiary’s future interest in the corpus of a trust, the Court assumes that a beneficiary would not elect to terminate his or her own interest.

The trustees in their discretion could distribute principal and consume some or all of the trust principal in both the Dorothy Trust and the Charles Part B Trust prior to Dorothy’s death. [HN3] This discretionary right to invade principal affects the value of the interests but it does not render them worthless. Similarly, the fact that the Debtor must  [**7]  outlive Dorothy in order to obtain his share of the trust principal also does not immunize the interest from becoming property of the estate. See In re Kreiss, 72 Bankr. 933 (Bankr. E.D.N.Y. 1987) (debtor’s contingent remainder interest in trust was property of the estate). In short, the Debtor’s interests in the Dorothy Trust and the Charles Part B Trust had value as of the petition date and are therefore property of the estate.

Three well reasoned bankruptcy cases support the Court’s conclusion.  In re Newman, 88 Bankr. 191 (Bankr. C.D.Ill. 1987)In re Kreiss, 72 Bankr. 933 (Bankr. E.D.N.Y. 1987)In re Dias, 37 Bankr. 584 (Bankr. D.Idaho 1984).

In Kreiss, the debtor held a 50% remainder interest in a trust subject to a life tenancy. The court held that this equitable interest, [HN4] a contingent remainder, is an interest that is alienable and subject to seizure under applicable New York law. The same reasoning would apply to both trust interests in this case. Absent any spendthrift provisions which would exclude the interests under § 541(c)(2), the Debtor’s interests [**8]  in both the Dorothy Trust and Charles Part B Trust are alienable interests that passed to the bankruptcy trustee upon the filing of this bankruptcy case.

In Newman, the Debtor trust beneficiary was entitled to distribution of the trust principal at the age of 50. The court observed that the broad definition of property of the estate in § 541 includes interests that are strictly contingent. 88 Bankr. at 192citing In re Brown, 734 F.2d 119, 123 (2d Cir. 1984). The court held that the debtor’s interest in the trust was property of the estate. As in this case, the contingency merely affects the value of the property interest; it does not prevent the property from becoming property of the estate.  Newman, 88 Bankr. at 192.

In Dias, the court had to determine whether the debtor’s one-third equitable interest in the corpus of a trust was property of the estate. The debtor, who was 23 when the petition was filed, was entitled to her share when she reached age 25. The court noted that the debtor’s interest, though contingent or subject to divestment, was alienable by her on the petition date. The  [**9]  court found that the contingency reduced the value of the interest but that “the interest was not so remote or speculative as to have no value,” 37 Bankr. at 587, and was thus property of the estate.

The cases and arguments relied upon by the Debtor either interpret the more restrictive definition of property under the Bankruptcy Act or are old state court decisions finding certain property interests to be beyond the reach of creditors under state law. See e.g., In re Martin, 47 F.2d 498 (7th Cir. 1931)Howbert v. Cauthorn, 100 Va. 649, 42 S.E. 683 (1902)Kenwood Trust & Savings Bank v. Palmer, 285 Ill. 552, 121 N.E. 186 (1918)1

 

1    Under the broad definition of property of the estate in § 541 of the Bankruptcy Code, it no longer is necessary for an interest to be transferable or leviable to become property of the estate. Nevertheless, under Florida law, even uncertain future interests in land or other property may be alienated and may be subject to execution. See Richardson v. Holman, 160 Fla. 65, 33 So. 2d 641 (Fla. 1948)Croom v. Ocala Plumbing and Electric Company, 62 Fla. 460, 57 So. 243 (Fla. 1911).

[**10]  The Debtor’s reliance on In re Hicks, 22 Bankr. 243 (Bankr. N.D.Ga. 1982) is also misplaced. In that case, the trust instrument gave the debtor’s mother a power of appointment giving her absolute discretion in determining whether the debtor would receive any portion of the trust corpus. As of the bankruptcy filing, the debtor’s mother had not exercised the power of appointment. The court found that it could not compel the exercise of a discretionary power of appointment  [*376]  and held that the debtor had no interest that passed to the bankruptcy trustee.

The facts and holding in Hicks are consistent with the facts and holding here as to the Charles Part A Trust. As in Hicks, Mrs. Knight has the power of appointment as to the corpus of the Part A Trust. As such, the Debtor’s interest in the Part A Trust is too remote to have value and does not constitute property of the estate. 2

 

2    The Hicks decision also supports this Court’s holding that the potential income distributions from the Dorothy Trust are not property of the estate since the Debtor has no ability to compel payment of these discretionary distributions. See also, In re Dias, 37 Bankr. at 586, in which the court held that discretionary support distributions were not property of the estate.

[**11]  The facts in Hicks are readily distinguishable from the facts presented in the Dorothy Trust and Charles Part B Trust. [HN5] There is a material difference between an interest which may be unilaterally extinguished by a grantor and an interest which may be defeated by some condition subsequent. In the former case, there is no interest of value which passes to the estate. In the latter, the value is affected by the possibility of future events which may reduce or eliminate the interest, but the interest has value as of the petition date which can and does pass to the Trustee.

There is language in Hicks suggesting that a contingent remainder is not property of the estate.  22 Bankr. at 245. While Hicks is correct on its facts because the interest there was subject to a discretionary power of appointment just like the interest in the Charles Part A Trust here, this court does not accept Hicks as authority that all contingent interests are excluded from the estate. Such an overly broad proposition would be inconsistent with § 541 of the Code and contrary to the holdings in Newman, Kreiss and Diascited favorably by the Court.

Other cases cited [**12]  by the Debtor dealing with contingent trust interests have ruled against the trustee on § 541(c)(2) grounds, finding that the interest was subject to enforceable spendthrift provisions.See, e.g., In re Davis, 110 Bankr. 573 (Bankr. M.D.Fla. 1989)Horsley v. Maher, 89 Bankr. 51 (D.S.D 1988). There are no spendthrift provisions in the Knight Trusts that would trigger application of the § 541(c)(2) exception.

 

VALUE OF ESTATE’S INTEREST

The possibility of divestment does not render the trust interests without value as of the filing date. The possibility of divestment by virtue of the Debtor predeceasing Dorothy and the possibility of reduction in the trust corpora, by virtue of distributions prior to her death, do affect the value of the interests. Thus, the estate is not entitled to simply receive one half of the principal of each trust as of the filing date. Instead, the value which passes to the estate is the hypothetical value of the trust interests if they had been seized by creditors or sold by the Debtor as of the date of his Chapter 7 petition. See In re Dias, supra, 37 Bankr. at 587.  [**13]  If the parties are unable to agree on the value of the trust interests, the Court will conduct a further evidentiary hearing.

 

CONCLUSION

The Court has analyzed the trust interests in this case in view of the broad scope of § 541 and the absence of any spendthrift restrictions which would protect the interests from passing to the trustee upon the filing of the bankruptcy case. The Court has also distinguished between interests that are so remote as to be without value because, for example, they depend upon the exercise of a power of appointment, and interests such as the ones here, in which the Debtor is a named beneficiary whose rights may be affected by the occurrence of some future conditions.

The trust interests here are of sufficient certainty to render the interests property of the estate. Thus, the Debtor’s interests in the Dorothy Trust and the Charles Part B Trust are deemed to be property of the estate subject to liquidation by the Trustee. The Debtor’s interest in the income from the Dorothy Trust and his potential interest in the Charles Part A Trust are too remote to have value and are thus not property interests which the Trustee may administer.

A separate order will [**14]  be issued in accordance [*377]  with this Opinion. 3

 

3    Pursuant to findings and conclusions announced on the record on October 20, 1993, the Court entered its Order Determining Certain Trust Interests to be Property of the Estate on November 10, 1993. The Debtor’s Motion for Rehearing of that Order is denied in a separate Order entered in conjunction with this Supplemental Opinion.

DATED, this 22nd day of February, 1994.

ROBERT A. MARK, U.S. Bankruptcy Judge

Cooley v. Cooley

Mary Paula Cooley v. Timothy Cooley

No. 10445

Appellate Court of Connecticut

32 Conn. App. 152; 628 A.2d 608; 1993 Conn. App. LEXIS 338

March 22, 1993, Argued

July 20, 1993, Decided

PRIOR HISTORY: [***1] Action for the dissolution of a marriage, and for other relief, brought to the Superior Court in the judicial district of Hartford-New Britain at Hartford and tried to the court, Goldstein, J.; judgment dissolving the marriage and granting certain other relief, from which the plaintiff appealed and the defendant cross appealed to this court.

DISPOSITION: Reversed in part; further proceedings.

CASE SUMMARY:

PROCEDURAL POSTURE: In an action for the dissolution of a marriage, and for other relief, brought to the Superior Court in the judicial district of Hartford-New Britain at Hartford (Connecticut) and tried to the court, judgment was granted dissolving the marriage and granting certain other relief. Plaintiff wife appealed and defendant husband cross-appealed.

OVERVIEW: The wife appealed, claiming that the trial court improperly (1) excluded her from a share in a trust, (2) ordered nonmodifiable, time limited periodic alimony, and (3) ordered financial awards. The husband cross appealed, claiming that the trial court improperly (1) assigned the principal of a trust and (2) apportioned personal property. On appeal, the court held that because the husband, having only a limited power of appointment, had no interest, beneficial or otherwise, in the appointive assets of one trust, no portion of those assets could be included in the marital estate. The trial court properly refused to order the husband to exercise his limited power of appointment and properly concluded that the wife was not entitled a share of the one trust. The court found that the financial awards were within the parameters of the trial court’s broad discretion and made in accordance with the law and the evidence. Lastly, for nearly the same reasons that the court concluded that the wife was not entitled to a share in the one trust, it concluded that she as not entitled to a share in a second trust.

OUTCOME: The court reversed the judgment as to the financial orders and remanded the case for further proceedings.

LexisNexis(R) Headnotes

Civil Procedure > Appeals > Standards of Review > De Novo Review

Estate, Gift & Trust Law > Trusts > Interpretation

[HN1] The issue of intent as it relates to the interpretation of a trust instrument is to be determined by examination of the language of the trust instrument itself and not by extrinsic evidence of actual intent. The construction of a trust instrument presents a question of law to be determined in the light of facts that are found by the trial court or are undisputed or indisputable. Where the issue presented concerns the court’s legal conclusion regarding intent of the settlor as expressed solely in the language of the trust created, a reviewing court must decide that issue by determining de novo whether that language supports the court’s conclusion.

Estate, Gift & Trust Law > Trusts > Interpretation

[HN2] A reviewing court cannot rewrite a trust instrument. The expressed intent must control, although this is to be determined from reading the instrument as a whole in the light of the circumstances surrounding the settlor when the instrument was executed, including the condition of the estate, the relations to family and beneficiaries, and their situation and condition. The construing court will put itself as far as possible in the position of the settlor, in the effort to construe any uncertain language used by the settlor in such a way as shall, conformably to the language, give force and effect to the settlor’s intention. But the quest is to determine the meaning of what the settlor said and not to speculate upon what he/she meant to say.

Estate, Gift & Trust Law > Trusts > Beneficiaries > General Overview

[HN3] A power of appointment is a power of disposition given to a person over property not his own by some one who directs the mode in which that power shall be exercised by a particular instrument. The donor does not vest in the donee of the power title to the property, but simply vests in the donee power to appoint the one to take the title. The appointee under the power takes title from the donor, and not from the donee of the power. The ultimate beneficiary really takes from the person who created the power, the donee of the power acting as a mere conduit of the former’s bounty.

Estate, Gift & Trust Law > Trusts > Beneficiaries > General Overview

Governments > Fiduciary Responsibilities

[HN4] A power of appointment is general if it is exercisable in favor of any one or more of the following: the donee of the power, the donee’s creditors, the donee’s estate, or the creditors of the donee’s estate. Any other power of appointment is a nongeneral one. As a matter of both common law doctrine and the practicalities of the situation, the donee of a nongeneral power is not the owner of the appointive assets. The donee is in a fiduciary position with reference to the power and cannot derive personal benefit from its exercise. The donee’s creditors have no more claim to the appointive assets than to property which the donee holds in trust. It is immaterial whether or not the donee exercises the power. The situation differs where the donee possesses a general power of appointment. Where a general power has been created, the donee is substantially in the position of an owner.

Family Law > Marital Termination & Spousal Support > Spousal Support > Obligations > Periodic Support

[HN5] One purpose of limiting the duration of an alimony award is to provide an incentive for the spouse receiving support to use diligence in procuring training or skills necessary to attain self-sufficiency. If the time period for the periodic alimony is logically inconsistent with the facts found or the evidence, it cannot stand. The trial court must consider all of its financial orders as a cohesive unit. The trial court need not make a detailed finding justifying its award of time limited alimony, but the record must indicate the basis for that award, and there must be sufficient evidence supporting the award for the particular duration established.

Family Law > Marital Termination & Spousal Support > Spousal Support > Obligations > Rehabilitative Support

[HN6] The court has great discretion in domestic relations cases, and a reviewing court will give great weight to the financial awards because of the trial court’s opportunity to observe the parties and the evidence. Although time limited alimony awards are essentially rehabilitative in purpose, there may be other valid reasons for awarding such alimony. The particular length of time needed for alimony can sometimes be established by predicting when future earnings, based on earning capacity as known at the time of the dissolution, will be sufficient for self-sufficiency.

Civil Procedure > Appeals > Standards of Review > Abuse of Discretion

Family Law > Marital Termination & Spousal Support > Spousal Support > General Overview

[HN7] A reviewing court is limited to determining whether the trial court abused its discretion in making financial awards.

COUNSEL: Joel M. Ellis, with whom was Catherine P. Klingerman, for the appellant-appellee (plaintiff).

Robert B. Hempstead, for the appellee-appellant (defendant).

JUDGES: Daly, Foti and Landau, Js. The other judges concur.

OPINION BY: FOTI

OPINION

[*153] [**610] This is an appeal from a judgment rendered in a dissolution of marriage action. The plaintiff withdrew her complaint after the defendant filed a cross complaint. She now appeals, claiming that the trial court improperly (1) excluded her from a share in a trust, (2) ordered nonmodifiable, time limited periodic alimony, and (3) ordered financial awards. The defendant has cross appealed, claiming that the trial court improperly (1) assigned the principal of a trust and (2) apportioned personal property. We reverse the trial court’s [***2] judgment in part.

The parties were married on September 13, 1972, in Hartford. At the time of the dissolution, they had one minor child, a daughter born March 19, 1975. The prior marriage of each party ended in divorce. The defendant has three adult sons from his first marriage, which ended in 1972; he pays $ 7800 annually in alimony to his former spouse. Beginning in 1974, the defendant’s three sons changed their residence from that of their mother to that of the parties for respective periods of three, five and two years. The plaintiff took an active role in raising the defendant’s sons.

The defendant graduated from Yale, and from Wharton School of Finance with a masters degree in business administration. The parties met when they were both employed at the same stock brokerage firm and eventually developed a relationship that led to marriage. [*154] The defendant later worked for another stock brokerage firm, until he became a bank trust officer and vice president for investments. In August 1982, with the plaintiff’s support, the defendant began working as a chartered financial analyst. When he left the bank he earned about $ 39,000; during the next few years his [***3] salary was about $ 20,000 to $ 25,000. He has had significant trust income to cushion the income loss. Since 1986, the defendant has been employed as an independent contractor-salesperson for an investment advisory firm. He is paid on a commission basis, but has had expectations of an equity position with this firm.

The plaintiff stopped working in 1974 when she became pregnant. She organized a local chapter of The Samaritans, Inc., in 1985. In 1988, she received a masters degree in pastoral ministry from St. Joseph College and began work as a part-time assistant photographer, earning $ 100 a week. She has been employed as a personal financial planner since August, 1989, and is now an independent contractor-salesperson, earning commissions for financial planning and selling various financial products. She expects her income to reach $ 20,000 in a few years when she has built a client base, and thereafter to reach between $ 30,000 and $ 40,000.

During his first marriage, the defendant had a drinking problem. His alcoholism also surfaced in this marriage about 1975 and became a significant factor that eventually doomed the relationship. Although he was a functioning alcoholic [***4] who maintained employment, the defendant’s illness transformed him into a distant family figure. After a confrontation with his children and the plaintiff in December, 1981, the defendant stopped drinking and joined Alcoholics Anonymous (AA) in June, 1982. He believes that during his alcoholic period the plaintiff assumed a dominant role in the marital [*155] and parental relationship and was unable to accept him as an equal partner when he became a recovered alcoholic in 1982.

The parties could not agree on therapists, or Al-Anon, or about the defendant’s alcoholism. The defendant initially went to AA five nights a week. He later reduced the number of sessions, but could spend up to four nights a week at AA, which meant he was out of the house for up to fifty-eight hours a week. The loss of family time became a problem for the parties. By 1985, the marriage was in difficulty; divorce proceedings were initiated in 1988. In November, 1990, the trial court rendered a judgment dissolving the marriage and entered financial orders.

[**611] I

The Appeal

A

The plaintiff first claims that the trial court improperly excluded her from sharing in a trust. The defendant’s [***5] deceased mother set up two trusts in August, 1975, referred to as the “Timothy Trust” and the “Paula Trust.” The trustee of each is an independent bank and both are spendthrift trusts. See General Statutes § 52-321. 1 The plaintiff’s claim relates to the Paula Trust. (Paula is the plaintiff.)

1 General Statutes § 52-321 provides: “Except as provided in sections 52-321a and 52-352b:

“(a) If property has been given to trustees to pay over the income to any person, without provision for accumulation or express authorization to the trustees to withhold the income, and the income has not been expressly given for the support of the beneficiary or his family, the income shall be liable in equity to the claims of all creditors of the beneficiary.

“(b) Any creditor of the beneficiary who has secured a judgment against the beneficiary may bring an action against him and serve the trustees with garnishee process, and the court to which the action is returnable may direct the trustees to pay over the net income derived from the trust estate to the judgment creditor, as the income may accrue, until the creditor’s debt is satisfied.

“(c) The court having jurisdiction over the fund may make such an order for payment pursuant to subsection (b) when the beneficiary is a nonresident of this state, as well as when the beneficiary is a resident, but in the case of a nonresident beneficiary notice shall be given to the nonresident of the action against him as provided in section 52-87. The nonresidence of the beneficiary shall not deprive the court of authority to make such an order.

“(d) If any such trust has been expressly provided to be for the support of the beneficiary or his family, a court of equity having jurisdiction may make such order regarding the surplus, if any, not required for the support of the beneficiary or his family, as justice and equity may require.

“(e) The defendant trustee in any such action shall be entitled to charge in the administration account of the trust such expenses and disbursements as the court to which the action is brought determines to be reasonable and proper.”

[***6] [*156] The Paula Trust was funded in 1975. At that time, the defendant’s mother gifted equal amounts to her four sons. The defendant’s allocation was placed in the Paula Trust. Between the time that the trust was funded and April, 1990, its appreciation was $ 667,848.

During the “initial period” of the Paula Trust, the trust provides that the trustee in its discretion can pay out the annual net income and principal for the care, maintenance and support of the plaintiff as long as she remains married to the defendant. Subject to the plaintiff’s needs, the trustee in its discretion can pay out any remaining income and principal for the maintenance, support and education of the defendant’s children (his three sons and the parties’ daughter). 2 In the [*157] event the marriage terminates, the trustee in its discretion can pay out the annual income and principal solely for the defendant’s children, though not necessarily equally.

2 We note with concern that the trial court did not appoint counsel for the parties’ daughter, who did not reach majority until March 19, 1993; General Statutes § 46b-54 (b); the interests of the minor child and those of the defendant’s three sons were unrepresented throughout this action even though, as secondary beneficiaries under both the Paula Trust and the Timothy Trust, their interests may have been adverse to those of the parties.

We also find troubling the absence of the trustee, Connecticut National Bank, which owes a fiduciary duty to all of the persons whose interests may be affected by the financial orders in this dissolution action. We recognize, however, that because of our disposition of this appeal the trustee may no longer be a necessary party.

[***7] During the initial period, the trust instrument confers on the defendant a limited power to appoint, during his lifetime or by his will, all or any part of the trust principal for the benefit of the plaintiff or his three brothers or any of them.

The trust instrument expressly provides that no interest in the trust, while in the possession of the trustee, shall be subject to the debts, contracts, liabilities, engagements or torts of any beneficiary. The Paula Trust is still in its initial period.

The trial court refused to order that the plaintiff share in the appreciation of the Paula Trust. The court found that, under [**612] article eleventh of the trust instrument, 3 she ceased to be a beneficiary upon the filing of this dissolution action, and, therefore, the defendant’s limited power to appoint to her had ceased.

3 Article eleventh provides in pertinent part: “DEFINITION OF TERMS . . . For purposes of this Indenture, the initiation of any legal proceeding by either said Timothy Cooley or said Paula D. Cooley for either a divorce or a legal separation shall constitute the termination of their marriage and the status of said Paula D. Cooley as a beneficiary hereunder shall terminate upon the filing of such papers.”

[***8] The plaintiff disagrees. She recognizes that, pursuant to article first, § (a), during the initial period the trustee may pay her income and principal only “so long as she shall be married to said Timothy Cooley.” She contends, however, that because the initial period of the trust has not terminated, the defendant still has a limited power to appoint to her. She points out that under article second of the Paula Trust, the “initial period” terminates [*158] only upon one of five occurrences, none of which, undisputedly, has happened. 4 She also points out that article first, § (b), provides that “[a]nything herein to the contrary notwithstanding” the defendant may appoint, during his lifetime or by will, all or any part of the trust principal to her or his brothers, or any of them, but not to himself. The plaintiff argues that by this language, the defendant may exercise his power to appoint to her at any time during his life or by his will, even after the marriage terminates, as long as the “initial period” of the trust has not ceased. She claims that the trial court improperly concluded that, pursuant to article eleventh, she ceased to be both an income beneficiary [***9] and a beneficiary of the defendant’s power of appointment upon her filing of a dissolution action.

4 Article second provides:

“TERMINATION OF INITIAL PERIOD OF TRUST

“The initial period of the trust hereby created shall terminate upon the happening of whichever of the following events shall first occur:

“(a) The remarriage of Susan Cooley, the former wife of said Timothy Cooley.

“(b) The death of said Susan Cooley.

“(c) The death of said Timothy Cooley.

“(d) The termination of the marriage of said Paula D. Cooley to said Timothy Cooley if no issue of said Timothy Cooley shall then be living.

“(e) The death of the last survivor of the issue of said Timothy Cooley living at the time of execution of this Indenture if his marriage to said Paula D. Cooley shall previously have terminated.

“Upon such termination of the initial period of the trust, the Trustee shall set out any balance of the Trust Estate not appointed by an effective exercise of the power of appointment contained in Paragraph FIRST (b) hereof, as it is then constituted, under Paragraph THIRD hereof if said Timothy Cooley shall then be living, or if he is not then living, the Trustee shall set out the same under Paragraph FOURTH hereof if said Paula D. Cooley shall then be living and unremarried, and shall have been married to him at the time of his death. If said Paula D. Cooley is not then living and unremarried, or if she was not married to said Timothy Cooley at the time of his death, the Trustee shall set out the Trust Estate under Paragraph FIFTH hereof.”

[***10] We agree with the plaintiff that, under the terms of the trust, termination of the parties’ marriage appears [*159] not to have affected her position as a possible appointee. We disagree, however, with her contention that the court improperly excluded her from a share in the trust corpus.

[HN1] “The issue of intent as it relates to the interpretation of a trust instrument . . . is to be determined by examination of the language of the trust instrument itself and not by extrinsic evidence of actual intent.” Heffernan v. Freedman, 177 Conn. 476, 481, 418 A.2d 895 (1979). The construction of a trust instrument presents a question of law to be determined in the light of facts that are found by the trial court or are undisputed or indisputable. See Connecticut National Bank & Trust Co. v. Chadwick, 217 Conn. 260, 266, 385 A.2d 1189 (1991). Since the issue presented concerns the court’s legal conclusion regarding intent of the settlor as expressed solely in the language of the trust she created, we must decide that issue by determining de novo whether that language supports the court’s conclusion. See Canaan National Bank v. Peters, 217 Conn. 330, 335, 586 [***11] A.2d 562 (1991).

[**613] [HN2] “[W]e cannot rewrite . . . a trust instrument. The expressed intent must control, although this is to be determined from reading the instrument as a whole in the light of the circumstances surrounding the . . . settlor when the instrument was executed, including the condition of [her] estate, [her] relations to [her] family and beneficiaries, and their situation and condition. ‘The construing court will put itself as far as possible in the position of the . . . [settlor], in the effort to construe . . . [any] uncertain language used by [her] in such a way as shall, conformably to the language, give force and effect to [her] intention.’ . . . But ‘[t]he quest is to determine the meaning of what the . . . [settlor] said and not to speculate upon what [she] meant to say.'” (Citations omitted.) Connecticut Bank & Trust Co. v. Lyman, 148 Conn. 273, 278-79, 170 A.2d 130 (1961).

[*160] In its articulation, the trial court properly concluded that article eleventh terminates the plaintiff’s status as an income beneficiary of the trust upon the filing of divorce papers. The court determined that an inconsistent result would [***12] be possible if it found that even after a divorce the plaintiff remained an appointee under the defendant’s limited power of appointment, with access to the trust corpus. The trial court found this interpretation would be contrary to a harmonious reading of all sections of the trust. The court discerned that the settlor was concerned with the impact of divorce on her proposed gift to her son, and that she desired to protect and preserve the trust from financial claims arising from a dissolution. These intentions are strongly evidenced by the great lengths to which the settlor went to protect the trust assets from claims by the defendant’s first wife, Susan Cooley. The trust instrument also evinces an intent by the settlor to limit the distribution of the trust principal to a very narrow group of persons. Under article sixth, § (c), for instance, in the event that any legal action to enforce a claim against the defendant by his first wife results in a determination that any part of the trust estate may be taken to satisfy such claim, the trustee is directed to terminate the trust as to that part and pay the portion to the defendant’s brothers, the settlor’s other sons; the plaintiff [***13] was not to be a recipient under this provision. Also significant is that the trust’s initial period does not end upon the termination of the parties’ marriage “with issue living.” Under that circumstance, the defendant himself still has no access to trust assets for his own benefit, again evincing the settlor’s intent to shield the assets from the effects of a dissolution judgment. The trust instrument, read as a whole, strongly suggests an intent on the part of the settlor that the plaintiff’s status as a recipient under the trust would change upon termination of the marriage.

[*161] Nevertheless, the phrase “anything herein to the contrary notwithstanding” contained in article first, § (b), appears to preserve the defendant’s power to appoint to the plaintiff even after her filing of divorce papers. While this phrase injects uncertainty into the trust instrument, we need not resolve that uncertainty. We conclude that, even if the language of the trust were crystal clear as to the settlor’s intent that the plaintiff maintain her status as an appointee even after termination of the marriage, the trial court’s decision not to award her a portion of the Paula Trust was proper.

[***14] General Statutes § 46b-81 gives the trial court the power in a dissolution action to “assign to either the husband or wife all or any part of the estate of the other.” A limited power of appointment is not a part of the marital estate that can be awarded in a dissolution action, however.

[HN3] “A power of appointment is a power of disposition given to a person over property not his own by some one who directs the mode in which that power shall be exercised by a particular instrument. . . . The donor does not vest in the donee of the power title to the property, but simply vests in the donee power to appoint the one to take the title. The appointee under the power takes title from the donor, and not from the donee of the power. . . . The ultimate beneficiary really takes from the person who created the power, the donee of [**614] the power acting as a mere conduit of the former’s bounty.” (Citations omitted; internal quotation marks omitted.) Linahan v. Linahan, 131 Conn. 307, 324, 39 A.2d 895 (1944).

Under the terms of the Paula Trust, the defendant was the donee of only a limited or nongeneral power of appointment. [HN4] “(1) A power of appointment is general if it is exercisable [***15] in favor of any one or more of the following: the donee of the power, the donee’s creditors, [*162] the donee’s estate, or the creditors of the donee’s estate. (2) Any other power of appointment is a nongeneral one.” 2 Restatement (Second), Property § 11.4 “Donative Transfers” (1986). “As a matter of both common law doctrine and the practicalities of the situation, the donee of a nongeneral power is not the owner of the appointive assets. The donee is in a fiduciary position with reference to the power and cannot derive personal benefit from its exercise. The donee’s creditors have no more claim to the appointive assets than to property which the donee holds in trust. It is immaterial whether or not the donee exercises the power.” Id., § 13.1, comment (a). The situation differs where the donee possesses a general power of appointment. “Where . . . a general power has been created, the donee is substantially in the position of an owner.” Id. Because the defendant, having only a limited power of appointment, has no interest, beneficial or otherwise, in the appointive assets of the Paula Trust, no portion of those assets may be included in the marital estate.

Nor can the [***16] appointive assets be included in the marital estate by virtue of the plaintiff’s status as the object of the power of appointment given to the defendant. “An object of a power of appointment has an interest analogous to a contingent future interest in the property subject to the power . . . .” Id., § 11.2, comment (d). As one of the possible objects of the defendant’s power, the plaintiff possesses no more than a mere expectancy; her receipt of principal from the trust is wholly contingent upon the defendant’s exercising his discretion to appoint to her. Even if the marriage had continued, the plaintiff’s expectancy might never have been realized if, for example, the defendant had elected to appoint the entire corpus of the Paula Trust to one of his brothers. The plaintiff had no vested right at any [*163] time to the trust corpus that would permit its inclusion in the marital estate. See Rubin v. Rubin, 204 Conn. 224, 231, 527 A.2d 1184 (1987) (future property that is a “mere expectancy” is not subject to division in a divorce action).

Finally, because a limited power of appointment such as the defendant’s is not, itself, an asset of the donee; Supreme Colony [***17] v. Towne, 87 Conn. 644, 648, 89 A. 264 (1914); it may be neither assigned nor delegated. The trial court properly refused to order the defendant to exercise his limited power of appointment and properly concluded that the plaintiff was not entitled a share of the Paula Trust.

B

The plaintiff next claims that the trial court’s award of nonmodifiable, time limited periodic alimony was clearly erroneous. 5

5 As part of the court’s award, the plaintiff received a lump sum payment of over $ 100,000 as well as the marital residence valued at $ 225,000 subject to a mortgage of approximately $ 30,000. She was awarded alimony of $ 45,000 payable over four years, ending December 7, 1994, plus two additional years at $ 1 per year.

“The issue of time limited alimony has been considered by this court in a number of cases. See Watson v. Watson, 20 Conn. App. 551, 568 A.2d 1044 (1990); Sunbury v. Sunbury, [13 Conn. App. 651, 538 A.2d 1082 (1988)]; O’Neill v. O’Neill, 13 Conn. App. [***18] 300, 536 A.2d 978, cert. denied, 207 Conn. 806, 540 A.2d 374 (1988); Louney v. Louney, 13 Conn. App. 270, 535 A.2d 1318 (1988); Markarian v. Markarian, 2 Conn. App. 14, 475 A.2d 337 (1984). In each of these cases, we stated that [HN5] one purpose of limiting the duration of an alimony award [**615] is to provide an incentive for the spouse receiving support to use diligence in procuring training or skills necessary to attain self-sufficiency. See Markarian v. Markarian, supra, 16.

[*164] “In these cases, we reviewed whether there was sufficient evidence to support the trial court’s finding that the spouse should receive time limited alimony for the particular duration established. If the time period for the periodic alimony is logically inconsistent with the facts found or the evidence, it cannot stand. O’Neill v. O’Neill, supra.” Henin v. Henin, 26 Conn. App. 386, 391-92, 601 A.2d 555 (1992).

The trial court must consider all of its financial orders as a cohesive unit. Brash v. Brash, 20 Conn. App. 609, 614, 509 A.2d 44 (1990). The trial court need not make a detailed finding justifying its award of time limited alimony, [***19] but the record must indicate the basis for that award, and there must be sufficient evidence supporting the award for the particular duration established. Mathis v. Mathis, 30 Conn. App. 292, 293, 620 A.2d 174 (1993); Ippolito v. Ippolito, 28 Conn. App. 745, 751-52, 612 A.2d 131, cert. denied, 224 Conn. 905, 615 A.2d 1047 (1992).

Our review of the record in this case indicates that the trial court considered a number of the criteria set out in General Statutes § 46b-82 in exercising its discretion to award time limited alimony, including the length of the marriage, the causes of the dissolution, the age, health, station, occupation, amount and sources of income, along with the vocational skills, employability, estate and needs of the parties. We recognize that the trial court did not explicitly address each criteria. [HN6] The court has great discretion in domestic relations cases; Savage v. Savage, 25 Conn. App. 693, 695, 596 A.2d 23 (1991); and a reviewing court will give great weight to the financial awards because of the trial court’s opportunity to observe the parties and the evidence. Holley v. Holley, 194 Conn. 25, 29, 478 A.2d 1000 (1984). [***20] While the trial court did not specifically address rehabilitative alimony, the record supports the court’s conclusion that the plaintiff is not in need of [*165] training or further education in order to obtain the skills necessary to attain self-sufficiency. See Wolfburg v. Wolfburg, 27 Conn. App. 396, 400, 606 A.2d 48 (1992). “Although time limited alimony awards are essentially rehabilitative in purpose, there may be other valid reasons for awarding such alimony.” Roach v. Roach, 20 Conn. App. 500, 506, 568 A.2d 1037 (1990). “The particular length of time needed for alimony can sometimes be established by predicting when future earnings, based on earning capacity as known at the time of the dissolution, will be sufficient for self-sufficency.” Wolfburg v. Wolfburg, supra.

The evidence in the record as to the plaintiff’s education, ability and vocational skills, and the absence of any evidence of physical or mental restrictions, reasonably lead to a conclusion that she will resume a successful business career in a relatively short period of time. We conclude that neither placing a time limit on the alimony nor ordering that its duration be nonmodifiable [***21] was logically inconsistent with these factors.

C

The plaintiff’s final claim is that the trial court improperly awarded the lump sum and periodic alimony and the division of property.

[HN7] As a reviewing court, we are limited to determining whether the trial court abused its discretion in making financial awards. Barnes v. Barnes, 190 Conn. 491, 494-95, 460 A.2d 1302 (1983). To conclude that the trial court abused its discretion, we must first find that the court either incorrectly applied the law or could not reasonably have concluded as it did. Wolfburg v. Wolfburg, supra, 398. Here, the court made clear that it intended to set a greater share of the marital estate to the plaintiff than to the defendant and that one of the difficulties in this matter was to produce an equitable dissolution judgment in a deteriorating financial market. [*166] We have reviewed the record and the evidence in this [**616] case and conclude that the financial awards are within the parameters of the trial court’s broad discretion and made in accordance with the law and the evidence.

II

The Defendant’s Cross Appeal

A

The defendant first claims that the trial court improperly [***22] ordered him to exercise his limited power of appointment to appoint to the plaintiff one half of the appreciation of the Timothy Trust. We agree with the defendant.

At the time the defendant’s mother set up the Paula Trust in 1975, she also set up another trust. That trust was funded in 1985 after the defendant’s mother died. The trust property was divided into four equal portions for the defendant and his three brothers; the defendant’s portion is referred to as the Timothy Trust.

Article third, § (a), of the Timothy Trust provides that the trustee, in its discretion, can pay out so much of the annual net income and principal as the trustee deems advisable for the defendant’s care, maintenance and support. Thereafter, the trustee can distribute to the defendant’s four children, not necessarily equally, so much of the balance of the income and principal as the trustee deems advisable for their maintenance, support and education. Article third, § (b), provides that the defendant in his sole discretion may appoint all or any part of the principal of the Timothy Trust, “in trust or otherwise, to or for the benefit of any person, persons or charitable organizations, or any of [***23] them, except himself, his estate, his creditors or the creditors of his estate.” If, at death, the defendant has not exercised [*167] this limited power as to all of the principal of the trust, the balance will be divided equally among his four children.

The trial court determined that because the Timothy Trust did not exclude the plaintiff as a possible beneficiary of the power of appointment and the plaintiff is not a creditor, she should share in the appreciation of the trust principal. As ordered, this would give the plaintiff 50 percent of the difference between the trust’s funding value of $ 237,826 and its market value at the close of business on December 1, 1990, the accounting date nearest to the date of judgment. For nearly the same reasons that we concluded that the plaintiff is not entitled to a share in the Paula Trust, we conclude that she is not entitled to a share in the Timothy Trust.

As we noted earlier in this opinion, a limited power of appointment such as the defendant’s is not an asset of the defendant that can be assigned or transferred. Supreme Colony v. Towne, supra, 648-49. The power does not confer on the defendant any title to or interest [***24] in the appointive property. Bankers Trust Co. v. Variell, 143 Conn. 524, 528, 123 A.2d 874 (1956). Unlike a general power, which in some contexts is deemed to be the equivalent of ownership over the appointive assets, a limited power confers on the donee none of the beneficial enjoyment of the property. Nor does the plaintiff have more than a mere expectancy in the trust property. Rubin v. Rubin, supra.

The plaintiff recommends that we cast aside the common law principle that appointive property is not an asset of the donee and that we recognize an equitable power in the trial court to reach the appointive assets and include them in the marital estate. She urges us to employ “a common sense notion that such powers over wealth should be deemed the equivalent of property subject to a court’s control in a dissolution proceeding.” [*168] The plaintiff relies on a doctrine applicable to general powers, “that property of a third person, not owned by a [donee] but over which he had and has exercised a general power of appointment, is deemed in equity to be charged with the payment of the debts of the donee to the extent that his own estate is insufficient to [***25] satisfy them . . . . and while doubts have often been expressed as to the soundness of the reasons underlying [this doctrine] and the logical difficulties involved have been noted, it has been generally adopted [**617] and applied in appropriate cases. . . . The doctrine is purely one of equity. ‘On no theory of hard fact is the property appointed the property of the donee of the power. But very early equity grafted onto these bald facts a principle of fair dealing. That principle was founded on the idea that a man ought to pay his debts if he could. Equity assumed as a matter of good conscience and sound morals that a man in debt could not honestly have meant to give property to his friends or relatives to the exclusion of his creditors, when he could give it to anybody he chose. . . . This is another of numerous illustrations of the application by courts of “fundamental ethical rules of right and wrong” to the complicated affairs of mankind.'” State ex rel. Beardsley v. London & Lancashire Indemnity Co., 124 Conn. 416, 427-28, 200 A. 567 (1938). In keeping with this principle, the plaintiff also urges us to treat the assets subject to the defendant’s limited [***26] power of appointment as they might be treated under the transfer and succession tax laws if they were subject to a general power of appointment in the defendant. By this analysis, she contends, the appointive assets would be includable in the marital estate and would be subject to distribution by the trial court.

The plaintiff’s position has an obvious flaw: While this equitable principle may apply to general powers of appointment, the power possessed by the defendant [*169] under the Timothy Trust was only a limited power. Although the plaintiff acknowledges this important distinction, she urges us to ignore it. We decline to do so.

We earlier underscored the important difference between a general and a limited or nongeneral power of appointment. Again we point out that the nature of this power is such that the defendant, himself, can derive no personal benefit from its exercise. While it is certainly possible, as the plaintiff proposes, that the defendant can indirectly benefit from the power by appointing to persons — his brothers, for instance — who might turn the money back over to the him, we cannot and will not base our decision on such speculation. The trust [***27] instrument specifically provides that the power may not be exercised for the benefit of the defendant himself, his estate, his creditors, or the creditors of his estate. Financial awards made in a dissolution proceeding are, by their very nature, a benefit to one party and an obligation to another.

Moreover, while the class of appointees under the Timothy Trust is broader than that under the Paula Trust, the trust instrument expressly excludes creditors from the class of appointees. Contrary to the trial court’s statement that the plaintiff is not a creditor, the judgment in this dissolution action established the plaintiff’s status as that of a judgment creditor. See Urrata v. Izzillo, 1 Conn. App. 17, 18, 467 A.2d 943 (1983) (former spouse is a judgment creditor pursuant to a judgment for alimony and child support); see also McAnerney v. McAnerney, 165 Conn. 277, 287, 334 A.2d 437 (1973); 2 Restatement (Second), Property § 13.7 “Donative Transfers,” (1986) Reporter’s note 4 (as a result of divorce, spousal claims established in divorce proceedings entitle spouse to same rights against appointive assets as would be available to a creditor). The plaintiff is [***28] thus no longer a permissible appointee.

[*170] We therefore conclude that the trial court improperly ordered the defendant to exercise his limited power of appointment under the Timothy Trust in favor of the plaintiff. 6

6 The defendant also, as part of this claim on his cross appeal, alleges that the trial court incorrectly calculated the amount of the lump sum payment awarded to the plaintiff. Because of our disposition of the first issue on his cross complaint we find it unnecessary to address this.

B

The defendant next claims that the trial court abused its discretion in apportioning personal property between the parties. Specifically, he claims that the court failed to consider written proposals submitted by the parties and incorrectly applied the criteria ordinarily relevant to apportionment.

[**618] Because our resolution of the defendant’s first claim requires that we remand the case to the trial court for a reconsideration of all the financial orders; Sunbury v. Sunbury, 210 [***29] Conn. 170, 175, 553 A.2d 612 (1989); we need not address this issue.

The judgment is reversed as to the financial orders and the case is remanded for further proceedings consistent with this opinion.

Dean v. United States – Irrevocable Trust Protects Against Federal Tax Lien

987 F.Supp. 1160

Joanne R. DEAN, et al., Plaintiffs,
v.
UNITED STATES of America, Defendant.

No. 96-0652-CV-W-5.

United States District Court, W.D. Missouri, Western Division.

December 4, 1997.

Page 1161

Edward J. Essay, Colorado Springs, CO, for Plaintiffs.

Anita L. Mortimer, U.S. Atty’s Office, Kansas City, MO, Carol E. Schultz, U.S. Dept. of Justice, Tax Div., Civil Trial Section, Washington, DC, for Defendant.

ORDER

LAUGHREY, District Judge.

This case was tried to the Court on November 4 and 5, 1997. Plaintiffs, as the Trustees of the George and Catherine Irrevocable Trust, assert that a wrongful levy was made on trust assets by the Internal Revenue Service (“IRS”). The government claims that the levy was proper because George and Catherine Mossie are delinquent taxpayers and the George and Catherine Irrevocable Trust is merely the alter ego of these delinquent taxpayers. The trustees claim that the trust is not the alter ego of George and Catherine Mossie, therefore, the seizure of trust property by the IRS was wrongful and the property should be returned to the trust.

The Court makes the following findings of fact and conclusions of law.

FINDINGS OF FACT

1. In 1950, George W. Mossie married Catherine P. Mossie.

2. In 1967, George W. Mossie and Catherine P. Mossie separated and lived apart from one another and continue to do so. During this separation, the Mossies continued to perform their respective functions in the various family businesses and were amicable in their relationship with each other.

3. Prior to their separation, the Mossies had four children, Tom Mossie, Joanne R.

Page 1162

Mossie (Dean), Janet A. Mossie and Linda L. Mossie.

4. In 1987, the Mossies decided to equally divide part of the real property owned in their individual names. The division was done because of their long-term separation and upon the advice of their estate planning counsel. On February 23, 1987, deeds were prepared and the property was conveyed into their respective 1987 revocable trusts.

5. In September of 1987, George W. Mossie was severely injured in an automobile accident and thereafter underwent multiple surgeries which rendered him disabled. In 1988, Catherine P. Mossie suffered a life-threatening illness from which she was not expected to recover. She also had surgery in 1989. Because of these illnesses, George and Catherine Mossie decided to transfer their assets into an irrevocable trust for the sole benefit of their children. This was done on advice of their estate planning counsel.

6. In November of 1989, the Mossies executed the George and Catherine Irrevocable Trust (hereinafter 1990 Irrevocable Trust) naming Joanne Mossie Dean and Janet A. Mossie as the trustees. The following assets were to be transferred into the irrevocable trust.

a. 20,000 shares of Summit Structural Steel.

b. Fifteen duplex units, which had been acquired in 1975 in the name of George and Tom Mossie.

c. Lake investment property which was used for family vacations.

7. The foregoing assets were not transferred into the trust until December 4, 1990. The delay was caused by the ill health of George and Catherine Mossie.

8. When the Mossies transferred their assets into the trust on December 4, 1990, they did not know that their 1988 tax return was being audited by the IRS. At that time, they did not know that they would be assessed back taxes by the IRS. Eventually, the IRS audited the Mossies’ 1987, 1988, 1989, and 1990 jointly-filed tax returns and did assess back taxes against them.

9. At the time the assets were transferred into the 1990 Irrevocable Trust, the Mossies had a net worth sufficient to cover their current liabilities and the tax liability that was eventually assessed against them by the IRS.

10. After a proceeding in the United States Tax Court to determine the tax deficiency owed by the Mossies for their jointly-filed returns for tax years 1987, 1988, 1989, and 1990, the IRS assessed back taxes and penalties against the Mossies in the amount of $281,093.95.

11. On February 8, 1993, the Internal Revenue Service assessed a trust fund recovery penalty in the amount of $109,125.71 against George W. Mossie, Tom Mossie and Summit Structural Steel, relating to the unpaid employment taxes withheld from the wages of the employees of Summit Structural Steel pursuant to I.R.C. § 6672. This assessment was made against George W. and Tom Mossie because they were persons required to collect and truthfully account for and pay over to the United States the federal social security and income taxes withheld from the wages of the employees of Summit Structural Steel, Inc., for the taxable quarter ending June 30, 1992.

12. On May 4, 1994, two additional real estate holdings were transferred into the 1990 Irrevocable Trust.

a. The west 70 feet of Lot 2, Highway Lane Addition, a subdivision in Lee’s Summit, Missouri.

b. Lot 85, Braeside Addition, a subdivision in Lee’s Summit, Jackson County, Missouri, also known as 311 Lincolnwood.

c. Log 4, Ziegler Addition, a subdivision in Lee’s Summit, Jackson County, Missouri.

These properties were titled in the name of Alamo Real Estate Company, a company owned by George and Catherine Mossie, which was dissolved in 1994 because of financial difficulty.

13. In 1995, notices of a federal tax lien were filed with the Recorder of Deeds for Jackson County, Missouri, and Morgan County, Missouri, against property held in the names of Joanne R. Dean and Janet A. Mossie, as co-trustees of the 1990 Irrevocable Trust. These liens were levied against

Page 1163

the trustees as the nominees or alter egos of George W. Mossie and Catherine P. Mossie.

14. The 1990 Irrevocable Trust is not the nominee or alter ego of delinquent taxpayers George W. Mossie and Catherine P. Mossie.

15. The assets of the 1990 Irrevocable Trust are controlled by the Plaintiff trustees and not George W. Mossie and Catherine P. Mossie.

a. Except for a brief period at the beginning of the trust when Catherine Mossie used old checks to pay for rental property expenses, all trust checks are signed by the trustees. Catherine Mossie used the old checks because she did not want to waste them.

b. All deeds and other transfer documents are signed by the trustees.

c. All tax returns are executed by the trustees.

d. All promissory notes are executed by the trustees.

e. All management decisions concerning the trust and its property are made by the trustees, not Catherine or George Mossie.

16. George and Catherine Mossie do receive some benefits from the trust.

a. The trustees permit Catherine Mossie to live at 311 Lincolnwood Drive, which has been the family home for the last 33 years. Catherine Mossie does not pay rent to live at 311 Lincolnwood Drive. Catherine Mossie does pay the utilities at 311 Lincolnwood Drive.

b. The trust also provides a car to Catherine Mossie and George Mossie which is available for their personal use.

c. The trustees would permit George and Catherine Mossie to stay at the family vacation home, but only Catherine has gone there since 1990 and only once or twice.

17. George Mossie did not significantly benefit when the trust loaned $275,000 to Summit Structural Steel to pay employment taxes and penalties for the period ending June 30, 1992. At the time of the loan, the majority shareholder of Summit Structural Steel was the 1990 Irrevocable Trust, and the minority shareholder was Tom Mossie. When the employment taxes of Summit Structural Steel were paid off, the trust and Tom Mossie, as owners of the corporation, were the primary beneficiaries. It would be illusory to say that the loan was, therefore, for the benefit of George Mossie merely because he was also liable as an officer of the corporation.

18. George and Catherine Mossie receive no money from the trust except reimbursement for minimal expenses incurred on behalf of the trust and for gasoline and auto maintenance.

19. George and Catherine Mossie have provided benefits to the trust.

a. Catherine Mossie presently manages fifteen duplex rental units which are owned by the trust. She also managed the units when they were owned by her husband and her son. She receives no compensation from the trust for her management of the rental units. She received no compensation for managing the rental property when it was owned by her husband and son.

b. Catherine Mossie is the bookkeeper for the trust and is not paid for this service.

c. George Mossie infrequently helps with the rental units by picking up parts needed for repairs.

20. After the transfer of the rental units to the trust, Catherine Mossie’s responsibilities were decreased and were assumed by the trustees. Tom Mossie and the trustees now are actively involved in the maintenance, cleaning and repair of the rental units. The trustees make the ultimate management decisions concerning the rental property.

21. Other than to recommend the bank and to introduce the trustees to the bank officers, neither George nor Catherine Mossie helped the trustees to get a loan from the LaMonte Bank to pay employment taxes owed by Summit Structural Steel.

CONCLUSIONS OF LAW

Pursuant to § 6321 and 6322 of the Internal Revenue Code (26 U.S.C., “the Code”) a tax lien in favor of the United States attaches to all properties and rights to property of a delinquent tax payer from the date the tax liability is assessed. Glass City Bank of Jeanette, Pa. v. United States, 326

Page 1164

U.S. 265, 267-68, 66 S.Ct. 108, 110-11, 90 L.Ed. 56 (1945). The federal tax lien continues until the tax liability is fully satisfied or becomes unenforceable due to lapse of time. 26 U.S.C. § 6322; Guthrie v. Sawyer, 970 F.2d 733, 735 (10th Cir.1992).

The United States may also file tax liens against property held by a third party, (i.e., person other than the taxpayer) where the third party is the nominee or alter ego of the taxpayer. When such a lien has been filed, the United States may levy upon the property. See, e.g., G.M. Leasing Corp. v. United States, 429 U.S. 338, 350-51, 97 S.Ct. 619, 627-28, 50 L.Ed.2d 530 (1977); F.P.P. Enters. v. United States, 830 F.2d 114, 117-18 (8th Cir.1987); Loving Saviour Church v. United States, 728 F.2d 1085, 1086 (8th Cir. 1984).

A third party who claims an interest in the property seized by the government may challenge the seizure in a wrongful levy action in the United States District Court pursuant to Code § 7426. In such an action, the initial burden is on the Plaintiff to prove (1) an interest in the property and (2) the tax assessment is for taxes owed by another taxpayer. The burden then shifts to the government to produce substantial evidence showing a nexus between the property and the taxpayer. The Plaintiff has the ultimate burden of proving that the levy was wrongful and should be overruled. Xemas, Inc. v. United States, 689 F.Supp. 917, 922 (D.Minn. 1988), aff’d, 889 F.2d 1091 (8th Cir.1989), cert. denied, 494 U.S. 1027, 110 S.Ct. 1472, 108 L.Ed.2d 610 (1990).

It appears that state law controls the question of whether a third party is the alter ego of the taxpayer. Aquilino v. United States, 363 U.S. 509, 513, 80 S.Ct. 1277, 1280, 4 L.Ed.2d 1365 (1960); Morgan v. Comm’r of Internal Revenue, 309 U.S. 78, 82, 60 S.Ct. 424, 426, 84 L.Ed. 585 (1940). “[I]n the application of a federal revenue act, state law controls in determining the nature of the legal interest which the taxpayer had in the property … sought to be reached by statutes.” Id. at 82, 60 S.Ct. at 426. While Aquilino and Morgan seem to clearly indicate that state law controls in a wrongful levy case such as this, there has been confusion over the issue. It appears that some federal courts have considered more than state law to determine whether a third-party is the alter ego of the taxpayer, e.g., James E. Edwards Family Trust by Edwards v. United States, 572 F.Supp. 22, 24-25 (D.N.M. 1983); Loving Saviour Church, 728 F.2d at 1086; Valley Finance, Inc. v. United States, 629 F.2d 162 (1980) (“Given the diversity of corporate structures and the range of factual settings in which unjust and inequitable results are alleged, it is not surprising that no uniform standard exists for determining whether a corporation is simply the alter ego of its owner.” Id. at 172.) One court has held, however, that the question of whether state or federal law controls is of little importance because the standards are so similar. “The issue under either state or federal law depends upon who has ‘active’ or ‘substantial control.'” Shades Ridge Holding Co., Inc. v. United States, 880 F.2d 342 (11th Cir.1989). While the Court believes that Aquilino and Morgan require application of state law in this case, the Court’s conclusion would be the same even if the additional factors suggested by the government and considered in other federal cases were also taken into account.

While the Missouri courts have never considered the alter ego doctrine in the context of a trust, the doctrine has been applied in the corporate context where an effort is being made to pierce the corporate veil. Collet v. American Nat’l Stores, Inc., 708 S.W.2d 273, 283 (Mo.App.1986). In such cases, the Missouri courts use a three-part test. An individual will be deemed to be the alter ego of a corporation when:

1) The individual completely dominates and controls the finances, policy and business practice of the other corporation.

2) Such control was for an improper purpose such as “fraud or wrong, or … unjust act in contravention of [a third parties’] legal rights.”

3) The alter ego’s control of the corporation caused injury to the third party. National Bond Finance Co. v. General Motors Corp., 238 F.Supp. 248, 256 (W.D.Mo. 1964), aff’d, 341 F.2d 1022 (8th Cir.1965); K.C. Roofing Center v. On Top Roofing, Inc., 807 S.W.2d 545 (Mo.App.1991). The alter

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ego doctrine, however, will only apply where a corporation has “no separate mind, will or existence of its own.” Thomas Berkeley Consulting Eng’r, Inc. v. Zerman, 911 S.W.2d 692, 695 (Mo.App.1995).

Because there is no Missouri law applying the alter ego doctrine to trusts, the court assumes that the same standard applied in the corporate context would be applied to trusts. At a minimum, Missouri law would require a showing that the alter ego of the trust so dominated it that the trust had “no separate mind, will or existence of its own.” Thomas Berkeley, 911 S.W.2d at 695. Applying this standard to the 1990 Irrevocable Trust, it is clear that the trust is not the alter ego of George and Catherine Mossie.

Like thousands of aging adults, George and Catherine Mossie created a trust for the benefit of their children, making it irrevocable as their health deteriorated. They did not rely on a mail order product peddled by tax protesters. They set up their trust with an estate planner from a sophisticated law firm. They executed the documents necessary to transfer the legal title of their assets to the trust, and, other than a brief period when Catherine Mossie wrote checks for the rental property using old personal checks rather than trust checks, the trustees executed all documents requiring signatures by the owner of the trust property. Tax returns were executed by the trustee. Checks were signed by the trustees. The trustees decided how to spend trust assets, when to make repairs on the rental property, and the rent to be paid by tenants. The trustees borrowed and repaid money in the name of the trust. In other words, the legal control of the trust assets has consistently been exercised by the trustee, not the taxpayer. These trusts were not a sham and did “coincide with economic reality.” F.P.P. Enters., 830 F.2d at 117. Also see James Edwards Family Trust, 572 F.Supp. at 24. While it is true that there is a family relationship between the trustees and the taxpayers, the taxpayers had forever given up the right to control the disposition of the trust property and whatever advice the taxpayer gives to the trustee can be ignored. The government minimizes the importance of legal title and legal control, but the ancient law of trust is grounded in just such distinctions.

The government is correct that practical control is an important consideration, but the Court finds that the balance weighs in favor of the taxpayer on this question as well. After the trusts were created, the behavior of the trustees and settlors changed. The trustees made the decisions about the assets and also became more actively involved in the cleaning, maintenance and rental of the duplexes. While Catherine Mossie continues to be involved in the maintenance of the rental property, it is clear that she does not control the decision-making. George Mossie is no more involved in the rental property than any parent who occasionally helps their children with business advice or runs an errand for them to pick up supplies. It is not unusual for parents to continue to help their children, even after the parents’ assets are placed in trust. Indeed, even where a parent’s assets are transferred in fee simple presently to the children, most parents continue to help. Indeed, even if parents have never transferred any property to their children, parents help children with their property. That is how families do function and should function. It would substantially undermine trust law if such behavior was sufficient to characterize the settlor as the alter ego of the trust and negate the validity of the trust.

The trust does not support George and Catherine Mossie. They receive no money from the trust except reimbursement for minimal expenses incurred on behalf of the trust. It is true that they both drive cars owned by the trust for their personal use and Catherine Mossie lives in the family home. But these facts alone are insufficient to characterize the trust as the alter ego of the taxpayers. A beneficiary of the trust could sue the trustees for failing to comply with a term of the trust, but small deviations from the trust are not enough to invalidate the whole trust.

The government attempted to show that the $275,000 loan made to Summit Structural Steel, Inc. was for the benefit of George Mossie because he was chairman of the board and, in that capacity, was liable for the

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past-due employment taxes of the corporation. Tom Mossie, however, owned 49 per cent of the stock of Summit Structural Steel and, as president of the corporation and a stockholder, was also liable for the employment taxes. More importantly, the trust owned 51 per cent of the stock and would be directly liable if the taxes were not paid. Any benefit to George Mossie under these circumstances is illusory and is certainly not enough evidence that the trust had “no separate mind, will, or existence of its own.” Thomas Berkeley, 911 S.W.2d at 695.

The fact that the trustee’s parents were permitted to use the family vacation property is de minimis given that they had little or no contact with the vacation property, did not use it even when it was in their own name and such sharing would be expected. It is also significant that at the time the property was placed in trust, the taxpayers had sufficient assets to meet their tax liability and to provide for their own personal expenses. There is no evidence that the trust was created for an improper purpose.

The cases cited by the government in support of their argument that the alter ego doctrine is applicable to this case are not persuasive because they are factually distinguishable. The government’s authority falls into two categories. The first group of cases involve trusts established by or with the assistance of tax protestors. The so-called “family” trusts give the settlor complete access to the trust property so that the settlor can use it for self-support. This is because the trustee is completely controlled by the settlor. Loving Saviour Church, 728 F.2d at 1086. (The taxpayer transferred all assets to a trust and the trust transferred the assets to a church which was established and controlled by the taxpayer. The taxpayer/settlor received all his support from the church which received all the income from the taxpayer’s chiropractic practice); F.P.P. Enters. 830 F.2d at 117 (The trust lacked the essential elements of a trust. The trust failed to identify beneficiaries and the taxpayer, not the trustee, exercised control over the trust property. The taxes on the trust property and the expenses paid to maintain the trust property were deducted from the personal income tax of the taxpayer.)

In the second group of cases cited by the government, corporations have been found to be the alter ego of the taxpayer because the taxpayer controls the corporate entity. Wilcox v. United States, 983 F.2d 1071 (6th Cir.1992) (Table); 1992 WL 393581 (unpublished per curium opinion) (The corporation and trust were the alter ego of taxpayer/anesthesiologist because the taxpayer commingled corporate, individual and pension property and as the only shareholder and officer of the corporation and as the only trustee of the pension had complete control over the disposition of corporate and pension property. Wolfe v. United States, 798 F.2d 1241 (9th Cir.1986), cert. denied, 482 U.S. 927, 107 S.Ct. 3210, 96 L.Ed.2d 697 (1987) (Wolfe was deemed to be the alter ego of corporation/taxpayer because Wolfe was the sole shareholder of the corporation and, as the director and president of the corporation, made all corporate decisions without consulting with the other directors. Corporate expenses, including personnel costs, were paid from a sole proprietorship operated by Wolfe and all income of the corporation was put into the sole proprietorship’s bank account); Ames Investment, Inc. v. United States, 819 F.Supp. 666 (E.D.Mich.1993), aff’d, 36 F.3d 1097, 1994 WL 529863 (6th Cir.1994) (A corporation was formed to purchase and manage real estate. The first property purchased was a house which was used as the personal residence of the taxpayer who was a shareholder and director of the corporation. This house was the most valuable asset of the corporation. It was never rented or used as an office. There were never any corporate meetings and there was no capitalization of the corporation or any profit from the corporation.)

The common thrust of all these cases is that the alter ego doctrine will apply when the delinquent taxpayer is really in control of the corporation or trust and so dominates it that the corporation or trust form exists, but there is no substance to it. As already discussed, the 1990 Irrevocable Trust is a valid trust instrument, created for a valid purpose, comports with economic reality, and the trustees, in most aspects, have respected the terms of the trust. To permit the alter ego doctrine to apply in such a case would require

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an expansion of the alter ego doctrine which the Court is unwilling to do without clearer direction from Congress or the Missouri courts. The Court, therefore, finds that the levies by the IRS against the assets of the George and Catherine Irrevocable Trust of December 4, 1990, was unlawful. The property seized by the IRS pursuant to the levies shall be returned to the trustees and all tax liens related to the unlawful levies shall be released. The Plaintiffs’ request for damages and attorneys’ fees is denied.

One troubling aspect of this case is the fact that the family home was deeded to the trust but Catherine Mossie has continued to control and occupy the home since the formation of the trust. The trustees acknowledged at trial that they and the Mossies have always understood that Catherine Mossie would continue to occupy the house until her death. Catherine Mossie also holds a deed of trust against the house which secures a promissory note in favor of Catherine Mossie. That promissory note is in default and has been since the property was transferred into trust. Catherine Mossie has the beneficial interest in the property during her lifetime and holds the key to the legal title at any time that she chooses to foreclose on the property. While it is true that the trust holds legal title until foreclosure, effectively Catherine Mossie controls the future disposition of the family home. While an argument could be made that the house was never a part of the trust, even though legal title was transferred to it, the government has insisted during this litigation that the house was properly placed in trust and is subject to the trust. The government’s position, therefore, forecloses a finding that the house is subject to the IRS levy because it is the property of the delinquent taxpayer, Catherine Mossie, not the property of the trust. The Court’s decision in this case, however, does not preclude the IRS from levying on property owned by Catherine Mossie, such as the promissory note and deed of trust on the property at 311 Lincolnwood. The only issue before this Court, however, is whether the levy by the IRS against the assets of the trust was wrongful. The Court has rejected the government’s argument that the 1990 Irrevocable Trust is the alter ego of George and Catherine Mossie and, therefore, the IRS levy on the trust property was wrongful and the trust property must be returned to the trust and the liens released from the trust property.

CONCLUSION

Accordingly, it is hereby ORDERED that:

1. Judgment be entered in favor of Plaintiff trustees.

2. The property of the 1990 Irrevocable Trust which has been seized by the IRS to satisfy the tax liability of George and Catherine Mossie shall be returned to the trustees.

3. The 1995 tax liens filed with the Recorder of Deeds for Jackson County, Missouri, and Morgan County, Missouri, against property held in the name of Joanne R. Dean and Janet A. Mossie as co-trustees of the 1990 Irrevocable Trust shall be forthwith release.

4. The Plaintiffs’ request for damages and attorneys’ fees is denied.

Evseroff – alter-ego applied to a trust

U.S. v. Evseroff, No. 00-CV-06029 (E.D.N.Y., April 30, 2012).
UNITED STATES OF AMERICA, Plaintiff,
v.
JACOB EVSEROFF, ET AL., Defendants.
No. 00-CV-06029 (KAM).
United States District Court, E.D. New York.
April 30, 2012.
MEMORANDUM & ORDER
KIYO A. MATSUMOTO, District Judge.
This case arises out of efforts by the United States (the “government”) to collect taxes owed by Jacob Evseroff (“Evseroff”) by accessing assets currently held by a trust that Evseroff established in 1992 for the benefit of his two sons (the “Trust”). The United States argues that Evseroff’s attempts to transfer various pieces of his own property to the Trust should not frustrate the government’s collection efforts under several legal theories. A bench trial was held before Judge David G. Trager on November 7 and 8, 2005, and a post-trial order was entered on September 27, 2006 that rejected the government’s claims, holding that the Trust property could not be used to satisfy Evseroff’s tax debts (the “Post-Trial Order”).
The government appealed the Post-Trial Order, and on March 21, 2008, the United States Court of Appeals for the Second Circuit reversed and remanded. In its remand order, the Second Circuit directed the district court to reconsider its findings regarding whether certain conveyances by Evseroff to the Trust were actually fraudulent and whether the Trust was Evseroff’s alter ego or held property as his nominee. For the reasons discussed below, the government may collect on all property held by the Trust.
BACKGROUND
This case has been discussed in several prior opinions. See United States v. Evseroff, No. 00-CV-6029, 2001 WL 1571881 (E.D.N.Y. Nov. 6, 2001) (entering judgment on the judgment of the United States Tax Court regarding Evseroff’s tax liability) (“Evseroff I”); United States v. Evseroff, No. 00-CV-6029, 2002 WL 1973196 (E.D.N.Y. July 8, 2002) (allowing Evseroff to designate an expert to testify as to the value of his assets and ordering that interest on Evseroff’s tax debts continue to accrue) (“Evseroff II”); United States v. Evseroff, No. 00-CV-6029, 2003 WL 22872522 (E.D.N.Y. Sept. 30, 2003) (denying the government’s summary judgment motion on its claim to access the Trust’s assets) (“Evseroff III”); Evseroff v. United States, No. 03-CV-0317, 2004 WL 3127981 (E.D.N.Y. Sept. 22, 2004) (rejecting Evseroff’s claim under the Taxpayer Bill of Rights) (“Evseroff IV”); United States v. Evseroff, No. 00-CV-6029, 2006 WL 2792750 (E.D.N.Y. Sept. 27, 2006) (finding, after a bench trial, that the government could not access assets held by the Trust) (“Evseroff V” or the Post-Trial Order). It is assumed that the reader has some familiarity with these decisions and, therefore, the relevant facts and procedural history are described only as necessary below.
Evseroff’s tax liability arose primarily from his decision to invest in a series of tax shelters between 1978 and 1982 that generated deductions which were later disallowed by the Internal Revenue Service (“IRS”). Evseroff III, 2003 WL 22872522, at *1.[1] Evseroff was first notified that he had outstanding tax liabilities in December 1990, when he received a letter from the IRS after being audited. This letter indicated that he owed $227,282 in taxes and penalties. Evseroff V, 2006 WL 2792750, at *1. Evseroff received another letter from the IRS in January 1991, and the parties stipulated that, as of December 6, 1990, Evseroff owed $647,549.40 in back taxes and accrued interest. Id. In January of 1992, the IRS sent Evseroff a notice of deficiency indicating that he had accrued more than $700,000 in tax liability. Id. at *2.
Also in January of 1992, Evseroff met with an attorney to set up the Trust. Id. It is unclear whether Evseroff first met with the attorney about the Trust before or after receiving the January 1992 letter from the IRS. Id. In April 1992, Evseroff challenged the IRS’s calculation of his tax liabilities in a petition to the United States Tax Court. Id. In June 1992, the Trust was created, with Evseroff’s sons as the named beneficiaries. Evseroff III, 2003 WL 22872522, at *2. Also in June 1992, Evseroff transferred approximately $220,000 to the Trust (“the $220,000”). Id. In October 1992, Evseroff transferred his primary residence, located at 155 Dover Street in Brooklyn (“the Dover Street Residence”), to the Trust. Id. In November of 1992, the Tax Court entered judgment against Evseroff in the amount of $209,113 in taxes and penalties and $560,000 in interest. Evseroff V, 2006 WL 2792750, at *2.
The particulars of the transfer of the Dover Street Residence are set forth here in detail. Evseroff received no consideration for the deed transferring the Dover Street residence to the Trust. (See Deposition of Jacob Evseroff dated February 7 and 21, 2002 (“J. Evseroff Dep.”), Ex. 12 (the “Transfer Agreement”).)[2] Pursuant to the Transfer Agreement[3], Evseroff was allowed to live in the house and pay the expenses as he had before. (Id.) Evseroff did not pay the Trust any cash rent, but he was responsible for the expenses of the Dover Street Residence, such as the mortgage and taxes on the property. (Id.) Moreover, the Transfer Agreement specified no end date after which Evseroff’s right to live in the Dover Street Residence expired. (Id.) There is no evidence that the Trust assumed Evseroff’s mortgage obligations. The Transfer Agreement did not give Evseroff the power to sell the home, id., and Evseroff never attempted to do so, Evseroff V, 2006 WL 2792750, at *4. The fair market value of the Dover Street Residence in 1992 was $515,000. (United States (“Gov’t”) Ex. 6 at 5; ECF No. 190, Defendant’s Post-Remand Memorandum of Law (“Evseroff Mem.”) at A-1.) In 1995, the payments on the mortgage were $1,044 per month. (ECF No. 186-3, United States’ Post-Remand Supplemental Memorandum (“Gov’t Mem.”) at 3; Evseroff Mem. at A-3.) In 1992, the mortgage was scheduled to be paid off in approximately five years. (Tr. at 91-93; Evseroff Mem. at A-3.)
With respect to the management of the Trust, a series of Evseroff family friends and business associates served as trustees. Evseroff III, 2003 WL 22872522, at *9. There is little evidence that they were actively involved in managing the Trust or its assets. Indeed, one trustee appears to have believed that he had no responsibilities until Evseroff’s death. (Transcript of Deposition of Barry Schneider dated January 3, 2002 (“Schneider Dep. Tr.”) at 20.) The accounting work for the Trust was performed by Frederick Blumer, an accountant who also performed accounting work for Evseroff and Evseroff’s law firm. Evseroff III, 2003 WL 22872522, at *3. The accountant was not paid for his work on behalf of the Trust, which he did as a professional courtesy to Evseroff. Id. The Trust’s tax returns took Blumer between one-half hour and an hour to prepare. (Transcript of Deposition of Frederick Blumer dated February 21, 2002 (“02/21/02 Blumer Dep. Tr.”) at 39.) The Trust’s tax statements were apparently never even sent to the trustees, and instead were sent directly to Evseroff. Evseroff III, 2003 WL 22872522, at *3, *11.
Between 1992 and 1998, the Trust did not record Evseroff’s payment of expenses for the Dover Street Residence as income.[4] (02/21/02 Blumer Dep., Exs. 1-7.) The Trust also did not claim the mortgage interest deduction for the Dover Street Residence between those years, though it did claim the deduction for real estate taxes between 1994 and 1998. (Id.) Indeed, the Trust never assumed the mortgage for the Dover Street Residence. (Gov’t Mem. at 3; Evseroff Mem. at A-2, A-3.) Evseroff also remained the named beneficiary of the flood and fire insurance policies on the Dover Street Residence. (J. Evseroff Dep., Exs. 32-33; Evseroff Mem. at A-7.)
Several other facts bear generally on Evseroff’s financial affairs. For one, Evseroff had a wife from whom he had been separated for eleven years at the time he created the Trust. Evseroff III, 2003 WL 22872522, at *2 n.3. Evseroff would later state that one of his reasons for setting up the Trust was to ensure that his two sons, rather than his estranged wife, received the benefit of his estate. Id. at *2. Additionally, he purchased a home in Florida in September of 1991. Evseroff V, 2006 WL 2792750, at *2-3. He apparently believed that the Florida home could not be seized by the IRS. Id. at *2.
Starting in 1997, Evseroff moved his funds around from place to place and, at one time, had his sons hold money for him rather than establishing a bank account. Id. at *3; Evseroff III, 2003 WL 22872522, at *5-6. Further, Evseroff admitted that he kept personal funds in his law firm checking account and wrote checks on the account to pay for some personal expenses because he was concerned that the IRS would seize funds from his personal checking account. (Tr. at 72-73, 82-85; see also J. Evseroff Dep., Ex. 28.)
Evseroff’s financial situation at the time of his transfer of the Dover Street Residence and the $220,000 to the Trust is difficult to discern with precision. Two points, however, are clear: (1) Evseroff was technically solvent after these transfers despite his tax debts, and (2) Evseroff’s readily accessible assets[5] were insufficient to satisfy his tax debt.
First, with regard to Evseroff’s solvency, the court found in its Post-Trial Order that on October 18th, 1992 — just ten days after Evseroff transferred the Dover Street Residence to the Trust — Evseroff’s tax liabilities totaled $770,530.64. Evseroff V, 2006 WL 2792750, at *2-3. Evseroff’s total assets, after and excluding the two transfers involving the Dover Street Residence and the $220,000, could be reasonably estimated at anywhere between $847,342[6] to $1,422,646.[7] See id. at *3-5. Thus, as of October 18, 1992, he had assets valued somewhere between $76,811 and $652,115 over and above his tax liabilities. See id. Regardless of where within that range the value of Evseroff’s assets actually fell, the results of the fraudulent transfer, nominee, and alter ego analyses would be the same.
Second, with regard to Evseroff’s readily accessible assets, those assets were insufficient to satisfy Evseroff’s tax liabilities. In the Post-Trial Order, the court identified two readily accessible assets in Evseroff’s possession: his $230,000 Florida residence and his $75,575 law practice. See id. at *3-4. The court did not find Evseroff’s retirement accounts to be readily accessible because the government could be delayed in its efforts to collect future distributions from the $355,304 in Evseroff’s retirement accounts.[8] Id. at *5 n.7. In addition, the court heard evidence that Evseroff moved his cash assets from one account to another and hid them in his law practice checking account, with his sons, and in his sons’ businesses in an effort to prevent the United States from collecting his cash assets. Evseroff V, 2006 WL 2792750, at *3; (see Tr. at 72-73, 82-85; J. Evseroff Dep., Ex. 28; 02/21/02 Blumer Dep., Ex. 19). Thus, considering only Evseroff’s readily accessible assets, the law practice and the Florida residence, those assets would be worth considerably less than Evseroff’s tax debt. The value of Evseroff’s law practice and Florida Residence totaled a mere $305,575, which was almost $465,000 less than his tax debt. See Evseroff V, 2006 WL 2792750, at *3.
At the bench trial held before The Honorable David G. Trager on November 7 and 8, 2005, the government pressed three theories for recovering assets from the Trust: (1) that Evseroff transferred assets to the Trust through constructively fraudulent conveyances; (2) that Evseroff transferred assets to the Trust through actually fraudulent conveyances; and (3) that the Trust was Evseroff’s alter ego/nominee. Id. at *4-7.
Evseroff claimed that his motivation in setting up the Trust was estate planning. Id. at *2. At the time that Evseroff started the process of setting up the Trust, he was 68 years old and had a wife from whom he had been separated. Id. at *2-3. He testified that he set up the Trust so that (1) his sons would get the benefit of his estate, (2) his estranged wife would not receive a portion of his assets, and (3) he could avoid the estate tax. Id. at *2. The government, by contrast, argued that his motive in setting up the Trust was to avoid his outstanding tax debts.
In the Post-Trial Order, Judge Trager noted that Evseroff’s motives were mixed, specifically that:
At trial, it became apparent that Evseroff had mixed motives in establishing the Trust: he was concerned about his separated wife taking a share of his estate, he wished to provide for his two unmarried sons who were living with him and he was concerned about the government’s potential collection efforts. All of these motives were present. If the issue were decided today, based on all that happened in the interim, it is clear that his tax problems would be the predominate concern. However, when these events occurred, the separation from his wife and need for estate planning based on this separation was much more at the forefront of his life.
Id. at *3. With respect to the government’s legal arguments, the Post-Trial Order found that the property transfers to the Trust were neither constructively nor actually fraudulent, based primarily on the fact that Evseroff was still solvent, despite his tax debts, after transferring both the Dover Street Residence and the $220,000 to the Trust. Id. at *5-6. The Post-Trial Order also rejected the government’s claim that the Trust was either Evseroff’s alter ego or that it held property as his nominee. Id. at *6-7. With respect to the latter two findings, the Post-Trial Order reasoned that Evseroff’s creation of the Trust was not primarily motivated by his desire to avoid the government’s collection efforts. Id. at *7. The Post-Trial Order also noted that there was no evidence that Evseroff had used or controlled any of the money in the Trust, id., and that he was solvent at the time of the transfers, id. at *6. Finally, the Post-Trial Order discussed the fact that Evseroff provided valuable consideration to the Trust in exchange for the use of the Dover Street Residence in that he paid the mortgage and other expenses related to the property. Id. at *7.
The government appealed and the Second Circuit reversed and remanded by summary order. United States v. Evseroff, 270 F. App’x 75 (2d Cir. 2008) (summary order).[9] Regarding the actual fraud finding, the Second Circuit held that a finding that the transfers did not leave Evseroff insolvent did not preclude a finding that the transfers constituted actually fraudulent conveyances. Id. at 77. On remand, the Second Circuit directed the district court to consider both whether Evseroff intended to defraud the government and also whether he intended to hinder or delay its collection efforts. Id.
In analyzing the alter ego and nominee issues, the Second Circuit instructed that “the critical issue in resolving a nominee or alter ego claim is not motive, but control.” Id. The Second Circuit further noted that, if Evseroff controlled the trust, this court should then determine “whether Evseroff used this control to commit fraud or other wrongful conduct, such as whether he ever used the trust for his benefit rather than the benefit of his two sons.” Id. at 78. In order to determine whether Evseroff used control of the Trust to commit wrongful conduct, the Second Circuit suggested that this court consider factors such as (1) how the payments made by Evseroff for the Dover Street Residence’s expenses compared to the value of the house, and (2) how the payments were treated by the relevant entities for accounting and tax purposes. Id.
DISCUSSION
I. Fraudulent Conveyance
On remand, the government argues that Evseroff’s transfers of the Dover Street Residence and the $220,000 to the Trust represent fraudulent conveyances under a theory of actual fraud. Under New York law, “[e]very conveyance made and every obligation incurred with actual intent, as distinguished from intent presumed in law, to hinder, delay, or defraud either present or future creditors, is fraudulent as to both present and future creditors.” N.Y. Debt. & Cred. Law sec. 276. As this section indicates, a conveyance may be fraudulent whether a debtor intends to actually “defraud” a creditor or merely intends to “hinder or delay” their collection efforts.
“The requisite intent required by this section need not be proven by direct evidence, but may be inferred from the circumstances surrounding the allegedly fraudulent transfer.” Steinberg v. Levine, 774 N.Y.S.2d 810, 810 (N.Y. App. Div. 2d Dep’t 2004) (citation omitted); see also Capital Distributions Servs., Ltd. v. Ducor Exp. Airlines, Inc., 440 F. Supp. 2d 195, 204 (E.D.N.Y. 2006) (citing Steinberg). Whether a conveyance is fraudulent “is ordinarily a question of fact,” Grumman Aerospace Corp. v. Rice, 605 N.Y.S.2d 305, 307 (N.Y. App. Div. 2d Dep’t 1993), and a creditor must prove his case by “clear and convincing evidence.” Lippe v. Bairnco Corp., 249 F. Supp. 2d 357, 374 (S.D.N.Y. 2003) (quoting HBE Leasing Corp. v. Frank, 48 F.3d 623, 639 (2d Cir. 1995)).
In determining whether Evseroff had the requisite fraudulent intent, it is necessary to examine a series of factors that are generally referred to as “badges of fraud.” Capital Distributions Servs., 440 F. Supp. 2d at 205 (quoting Steinberg, 774 N.Y.S.2d at 810).
These badges of fraud include lack or inadequacy of consideration, family, friendship, or close associate relationship between transferor and transferee, the debtor’s retention of possession, benefit, or use of the property in question, the existence of a pattern or series of transactions or course of conduct after the incurring of debt, and the transferor’s knowledge of the creditor’s claim and the inability to pay it. . . .
Steinberg, 774 N.Y.S.2d at 810 (citations omitted). A court may also consider “the financial condition of the party sought to be charged both before and after the transaction in question . . . . [and the] shifting of assets by the debtor to a corporation wholly controlled by him. . . .” In re Kaiser, 722 F.2d 1574, 1582-83 (2d Cir. 1983) (citations omitted).
Based on the clear and convincing evidence in the record, factual findings in the Post-Trial Order establish that both conveyances at issue were actually fraudulent. As noted above, the Post-Trial Order found that Evseroff’s motives for creating the Trust were mixed: he was concerned with estate planning and with avoiding collection by the IRS and a claim by his estranged wife. Evseroff V, 2006 WL 2792750, at *3. The Post-Trial Order also found that Evseroff did not receive consideration for the transfer of $220,000 of personal funds to the trust. Evseroff V, 2006 WL 2792750, at *2, *5. Nor did he receive consideration for the transfer of the Dover Street Residence other than a rental agreement with the Trust allowing him to reside in the home in exchange for his payment of operating and maintenance expenses in lieu of rent. Id. at *4. Further, the court found that Evseroff was solvent after the transfers. Id. at *6. Nothing has been presented that contradicts these findings.
Nevertheless, neither the fact that Evseroff had mixed motives in establishing the Trust nor the fact that he was solvent after he made the transfers absolves him of liability. The primary issue is his intent — not his actual financial status. See N.Y. Debt. & Cred. Law sec. 276; see also Grumman Aerospace Corp., 605 N.Y.S.2d at 307 (finding that a cause of action predicated upon sec. 276 “may lie even where fair consideration was paid and where the debtor remains solvent”). Although there must be some actual financial harm to a creditor to support a fraudulent conveyance finding, a debtor need merely “deplete or otherwise diminish the value of the assets of the debtor’s estate remaining available to creditors” to be liable. Lippe, 249 F. Supp. 2d at 375 (citations omitted).
By making the transfers of the Dover Street Residence and the $220,000 to the Trust, Evseroff unambiguously caused the requisite actual harm to his creditors by reducing the assets he had available to satisfy his tax debt and reducing the value of his readily accessible assets well below the amount of his tax debt. As noted above, at the time of the conveyances, Evseroff’s tax liabilities totaled $770,530.64. See Evseroff V, 2006 WL 2792750, at *3. As discussed previously, Evseroff’s total assets after and excluding the two transfers could reasonably be estimated at anywhere from $847,342 to $1,422,646 — leaving him somewhere between $76,811 and $652,115 over and above his tax debts if all of his assets are included. As such, the IRS would have had to collect somewhere between half and ninety percent of Evseroff’s total assets in order to satisfy his tax debts. This would be a difficult task — particularly given evidence in the record that Evseroff was not inclined to cooperate with collection efforts.[10] And if one includes only Evseroff’s readily accessible assets, the transfers reduced the value of Evseroff’s remaining assets to $305,575 — well below the amount of his tax liability. At the very least, the transfers made collection efforts much more difficult.
Moreover, Evseroff’s financial picture was even less favorable than the snapshot of the amount he owed the IRS in 1992 would suggest. That federal tax debt was not the only potential demand on his assets. Evseroff was sixty-eight at the time he created the Trust, and, as he testified at trial, he was getting ready to retire. (Tr. at 38-39, 187-88.) Although Evseroff’s assets exceeded his tax liability, his assets were not so substantial as to guarantee that he would not outlive them. Moreover, Evseroff’s IRS debt would continue to accrue interest to the extent that he did not pay it down. Evseroff was also aware that he might need to make payments to his estranged wife should they divorce, and he wished to provide as substantial an inheritance as possible to his two sons. These probable demands on his assets, combined with his tax debt, exceeded the assets he had available after the transfers.
Evseroff was well aware of his financial difficulties, including his tax liabilities, when he transferred the assets to the Trust. In December 1990 — more than a year before he first met with his attorney to set up the Trust — Evseroff received an IRS estimate that he owed $227,282, not including interest. Evseroff V, 2006 WL 2792750, at *1. Just a few weeks later, in January 1991, he received another letter from the IRS reflecting a total liability that he inaccurately estimated at $800,000. Id. In January 1992, he received an IRS letter indicating that he had a liability of more than $700,000. Id. at *2. Although it is not clear whether Evseroff had received the January 1992 letter at the time that he first met with an attorney to establish the Trust, he had received the January 1991 letter. Moreover, Evseroff certainly had received the January 1992 letter at the time that he actually conveyed the $220,000 in cash and the Dover Street Residence to the Trust in June and October of 1992 respectively. The other demands on his assets — such as his family obligations — were also undoubtedly apparent to him at that time. It is therefore reasonable to conclude that Evseroff knew that he was jeopardizing his ability to pay his taxes when he conveyed the Dover Street Residence and the $220,000 to the Trust.[11]
In addition to the evidence of Evseroff’s financial situation, evidence of Evseroff’s conduct at the time he made the transfers further supports a finding that he intended to hinder or delay collection of his assets, particularly his tax debt. For one, he engaged in a “pattern or series of transactions or course of conduct after the incurring of debt” that establish his intent to impair, handle, or delay the IRS’s ability to collect his tax debts when he made the relevant conveyances. Steinberg, 774 N.Y.S.2d at 810. Around the time that Evseroff established the Trust in 1992, he purchased a Florida home that he appears to have thought could not be seized by the IRS. Evseroff V, 2006 WL 2792750, at *2. Five years thereafter, in 1997, Evseroff also moved his funds from place to place and, on one occasion, had his son hold money for him rather than establishing a bank account. Id. at *3; Evseroff III, 2003 WL 22872522, at *5-6. Although these suspicious movements of funds did not occur until 1997 — about five years after Evseroff transferred the Dover Street Residence and the $220,000 to the Trust — they nonetheless shed light on Evseroff’s general intent in conveying assets to the Trust because they show additional attempts to avoid paying a known tax debt.
These monetary transactions in 1997 are particularly significant because the IRS could only collect his assets to the extent that it could find them. Much of Evseroff’s net worth consisted of cash. If the IRS could only reliably collect on Evseroff’s readily accessible assets, it would only have access to $305,575 — almost $465,000 less than his tax debt in 1992. Thus, Evseroff’s movement of cash assets to avoid collection in combination with his earlier conveyances of the $220,000 and the Dover Street Residence made collection efforts much more difficult.
Finally, Evseroff’s intent to shield his assets from the IRS’s collection is demonstrated by the fact that he retained the benefits of ownership of the Dover Street Residence after he transferred it to the Trust for no consideration. As noted above, Evseroff continued to live in the residence after the transfer. Evseroff argues that he was, in fact, renting the residence from the Trust, as evidenced by the Transfer Agreement that obligated him to pay certain expenses in lieu of rent, (Evseroff Mem. at 4; J. Evseroff Dep., Ex. 12), and that his ability to live in the house was limited by the fact that the trustees had the power to sell the house at any time, (Evseroff Mem. at A-2). But neither of these arguments is persuasive.
As discussed infra Part II, Evseroff’s post-transfer payment of the mortgage and other expenses related to the property in lieu of rent were the type of payments that an owner of property would make, not those that a renter would make. Additionally, although the trustees nominally had the power to remove Evseroff from the Dover Street Residence, there was no evidence that they would actually utilize that power because, as discussed more fully infra Part III, Evseroff dominated the Trust to such a degree that it was not a bona fide entity, but merely an extension of Evseroff. Among other things, the trustees were his friends and business associates, and at least one trustee was unaware of any duties he had as a trustee. (Schneider Dep. Tr. at 19-20.) Although the Trust could have removed Evseroff from the Dover Street Residence, as a practical matter, Evseroff’s enjoyment of the residence was secure, allowing him to enjoy use and occupancy of the Dover Street Residence as an owner would, given the lack of evidence that either Evseroff or the Trust ever tried to rent or sell the property. See Evseroff V, 2006 WL 2792750, at *4.
Evseroff’s de facto ownership of the Dover Street Residence is further demonstrated by the fact that Evseroff received no consideration for transferring the Dover Street Residence to the Trust. (J. Evseroff Dep., Ex. 12.) The lack of consideration to Evseroff indicates that Evseroff was not relinquishing any rights to the property in exchange for which he would be paid. And because his sons were the beneficiaries of the Trust, the transfer allowed Evseroff to ensure that they would receive the Dover Street Residence upon his passing, as they would have had he remained the owner of the property.[12]
Evseroff responds that his true intention was not to avoid paying his taxes to the United States, but rather to engage in estate planning — primarily by ensuring that his assets passed to his two sons rather than to his estranged wife on his passing. The Post-Trial Order found that Evseroff’s estate planning motive was but one of his motives in addition to protecting the assets from the IRS and his estranged wife at the time that he created the Trust, Evseroff V, 2006 WL 2792750, at *3, and there is no reason to question that finding. Nonetheless, even if Evseroff was motivated to create the Trust, in part, by his desire to provide an inheritance for his sons and shield his assets from his wife, his intent to evade the IRS’s collection effort was substantial and sufficient on its own. Evidence in the record, as discussed above, demonstrates Evseroff’s intent to shield his assets specifically from the government’s collection efforts. Moreover, the IRS was seeking to collect much more than Evseroff’s wife was likely to obtain in a divorce settlement as she did not seek a settlement during the years of their separation. Thus, Evseroff’s intent to evade, hinder, delay, and frustrate the IRS’s collection efforts was sufficient to cause him to transfer the assets to the Trust, regardless of any additional motive that he might have had. Accordingly, Evseroff’s transfer of the Dover Street Residence and the $220,000 to the Trust was fraudulent as provided by New York Debtor and Creditor Law sec. 276. See Capital Distributions Servs., 440 F. Supp. 2d at 204 (noting that the remedy for a fraudulent conveyance is that the creditor may collect upon the fraudulently conveyed property).[13]
II. Nominee
The government also argues that it should also be able to collect upon the Dover Street Residence and the $220,000 because Evseroff is the real owner of both. Though both assets are legally held by the Trust, the government argues that the Trust merely holds them as Evseroff’s nominee.[14] “Under the nominee doctrine, an owner of property may be considered a mere `nominee’ and thus may be considered to hold only bare legal title to the property.” United States v. Snyder, 233 F. Supp. 2d 293, 296 (D. Conn. 2002).
The nominee theory focuses
on the relationship between the taxpayer and the property . . . to discern whether a taxpayer has engaged in a sort of legal fiction, for federal tax purposes, by placing legal title to property in the hands of another while, in actuality, retaining all or some of the benefits of being the true owner.
Richards v. United States (In re Richards), 231 B.R. 571, 578 (E.D. Pa. 1999). As distinct from the government’s claim that Evseroff’s conveyances were actually fraudulent, a nominee finding can be made even where there was no intent to defraud creditors or hinder collection efforts. In re Richards, 231 B.R. at 579-80 (finding that a trust held assets as a taxpayer’s nominee even when the conveyance of the property to the trust was not fraudulent). Rather than intent, the nominee theory focuses on control. Id.
The nominee theory also differs from the alter ego theory in that the nominee theory focuses on the taxpayer’s control over and benefit from the property while the alter ego theory emphasizes the taxpayer’s control over the entity that holds the property.[15] Compare In re Richards, 231 B.R. at 579 (discussing the nominee theory and noting that “the critical consideration is whether the taxpayer exercised active or substantial control over the property”), and United States v. Stonier, No. 88 N 993, 1994 WL 395644, at *4 (D. Colo. Feb. 28, 1994) (listing five factors for making a nominee determination, three of which relate to the transferor’s control over or benefit from the property), with Babitt v. Vebeliunas (In re Vebeliunas), 332 F.3d 85, 91-92 (2d Cir. 2003) (discussing the alter ego theory and noting that an individual must control the corporation for alter ego liability to attach); and Dean v. United States, 987 F. Supp. 1160, 1166 (W.D. Mo. 1997) (collecting cases and stating that “the common thrust . . . is that the alter ego doctrine will apply when the delinquent taxpayer is really in control of the corporation or trust and so dominates it that the corporate or trust form exists, but there is no substance to it”).
Where a nominee relationship is found, the government may access only the property held on the taxpayer’s behalf by the nominee, not all property of the nominee. See In re Richards, 231 B.R. at 580; see also Giardino v. United States, No. 96-CV-6348T, 1997 WL 1038197, at *2 (W.D.N.Y. Oct. 29, 1997) (“[T]he government has the authority to seize or levy on the property of the taxpayer held by the nominee in order to collect the tax liabilities of the taxpayer.” (emphasis added) (citations omitted)).
In determining whether a taxpayer’s property is held by a nominee, courts examine:
(1) whether inadequate or no consideration was paid by the nominee; (2) whether the property was placed in the nominee’s name in anticipation of a lawsuit or other liability while the transferor remains in control of the property; (3) whether there is a close relationship between the nominee and the transferor; (4) whether they failed to record the conveyance; (5) whether the transferor retains possession; and (6) whether the transferor continues to enjoy the benefits of the transferred property.
Giardino, 19libu97 WL 1038197, at *2 (citation omitted); LiButti v. United States, 968 F. Supp. 71, 76 (N.D.N.Y 1997); see also In re Richards, 231 B.R. at 579 (considering these factors as well as whether the transferor spent personal funds maintaining the property). As noted above, “the critical consideration is whether the taxpayer exercised active or substantial control over the property.” In re Richards, 231 B.R. at 579 (citation omitted). The government bears the burden of proving that the taxpayer’s property is held by a nominee.[16]
In the instant case, the Trust held the Dover Street Residence, but not the $220,000, as Evseroff’s nominee. Turning first to the Dover Street Residence, an examination of the factors listed above demonstrates that the Trust was Evseroff’s nominee. Considering the first factor, the Trust paid no consideration to Evseroff for the property. (J. Evseroff Dep., Ex. 12.) Evidence in the record indicates that the second factor is satisfied in that the Trust was created and the property was transferred in anticipation of Evseroff’s liability to the IRS and possibly his estranged wife, and Evseroff remained in possession and control of the Dover Street Residence. The third factor is also satisfied in that Evseroff had a close relationship with the trustees, having selected close friends and associates to manage the Trust. Evseroff III, 2003 WL 22872522, at *9.
As for the fifth and sixth factors, there is substantial evidence in the record that Evseroff retained and enjoyed possession and control of the Dover Street Residence, even after title was legally transferred to the Trust. Despite the transfer, Evseroff retained possession of the Dover Street Residence and benefitted from it as though he were an owner: he continued to live in the Dover Street Residence without paying rent although he continued to pay the mortgage and other expenses necessary to operate and maintain the property, including taxes, water, sewer charges, utilities, fuel, and insurance (J. Evseroff Dep., Ex. 12); he remained the named beneficiary of the flood and fire insurance policies (J. Evseroff Dep., Exs. 32-33; Evseroff Mem. at A-7); and there is no evidence that the Trust ever officially assumed the mortgage for the Dover Street Residence nor did the Trust claim the mortgage interest deduction between 1992 and 1998 (see 02/21/02 Blumer Dep., Exs. 1-7; Evseroff Mem. at A-2, A-3). Furthermore, there is no evidence that the Trust ever took any action that would have interfered with Evseroff’s enjoyment of the property: his rental agreement had no set end date (J. Evseroff Dep., Ex. 12) and there is no evidence that the Trust ever contemplated selling or renting the property to anyone other than Evseroff. These facts all indicate that Evseroff retained possession and benefitted from his use and occupancy of the Dover Street Residence much as he had when he held legal title to it. Cf. In re Richards, 231 B.R. at 580.
In response, Evseroff argues that the Trust was not his nominee with regard to the Dover Street Residence because: (1) his status was that of a renter rather than that of an owner, as demonstrated by the fact that he paid the mortgage and upkeep costs on the property in lieu of rent;(2) he only had a license to the property, and therefore could have been evicted at any time; and (3) he did not act like an owner in that he never tried to sell the property. None of these arguments is persuasive.
With regard to Evseroff’s first argument, the mere fact that Evseroff made some payments relating to the property does not rebut the inference that he was the de facto owner of the property. See City View Trust v. Hutton, No. 98-CV-1001-B, 1998 WL 1031525, at *10 (D. Wyo. Nov. 02, 1998). The payments Evseroff made in exchange for his occupancy of the property — taxes, insurance, water and the mortgage — were precisely those that an owner of the property would make. The Trust did not claim Evseroff’s payments between 1992 and 1998 as income, the Trust’s tax returns were prepared by Evseroff’s accountant and sent to Evseroff rather than the Trust, and the Trust did not claim mortgage interest deductions but did claim real estate tax deductions between 1994 and 1998. Evseroff III, 2003 WL 22872522, at *3, *11; (see 02/21/02 Blumer Dep. Tr. at 39, Exs. 1-7). Indeed, payment of upkeep costs for a property has been specifically identified as a factor favoring a nominee finding. In re Richards, 231 B.R. at 579. Thus, the inference that the Trust was merely his nominee is a strong one.
Moreover, the payments that a renter would have made on the Dover Street Residence would have differed greatly from those that Evseroff made. Although Evseroff made mortgage payments for about five years after the inception of the purported lease, after that he was only responsible for the property’s upkeep and expenses. (Tr. at 91-93; J. Evseroff Ex. 12.) Therefore, after the mortgage was paid off, the Trust received no net return on the Dover Street Residence. Were the Trust truly the owner, it would have sought to receive market rental rates, which would likely have exceeded the mere cost of maintaining the property. Furthermore, even for the term where Evseroff was paying for both the mortgage and the upkeep of the property, those combined payments were still low in comparison to the property’s fair market value in 1992 of $515,000.
Evseroff’s argument that he was merely a licensee who could have been evicted from the property at any time fares no better. According to Evseroff, because the agreement allowing him to live in the Dover Street Residence did not contain an end date, it did not constitute a lease under New York law. (Evseroff Mem. at 9.) Instead, Evseroff contends that the agreement was a mere license, revocable at any time. (Id.)
Even assuming that Evseroff is correct regarding the legal status of the agreement, it would provide little support for his argument that he did not exercise active control over the property. Given Evseroff’s control over the Trust, see infra Part III, there was no realistic prospect that his possession and enjoyment of the Dover Street Residence would be challenged. A merely theoretical possibility that the transferor could be evicted does nothing to rebut a nominee finding. See City View Trust, 1998 WL 1031525, at *10.
Finally, Evseroff’s argument that he did not act like an owner in that he never tried to sell the property and never attempted to use it as collateral for a loan is not enough to avoid a nominee finding given the evidence discussed above. See Evseroff, 270 F. App’x at 78 (citing LiButti v. United States, 107 F.3d 110, 119 (2d Cir. 1997)). Many property owners neither use their property as collateral (apart from their mortgage) nor attempt to sell their property. Thus, the fact that Evseroff has not attempted to sell the Dover Street Residence and has not pledged it as collateral does little to refute that he was acting as the de facto owner of the property. Accordingly, the Trust plainly holds the Dover Street Residence as Evseroff’s nominee and the United States may therefore recover against the Dover Street Residence under a nominee theory.
The government, however, has not shown that the Trust holds the $220,000 as Evseroff’s nominee. Indeed, only a few thousand dollars have ever been distributed by the Trust, and that money went towards paying taxes owed by the Trust, namely, income taxes on interest earned by the Trust and real estate taxes in specific years for the Dover Street Residence. (See Tr. at 61; J. Evseroff Dep. Tr. at 126-27; 02/21/02 Blumer Dep., Exs. 1-7.) There is no evidence that those funds were distributed at Evseroff’s direction. And even if they were, the distribution benefitted the Trust significantly more than it benefitted Evseroff.[17]
The overall objective of the nominee analysis is to determine whether the debtor retained the practical benefits of ownership while transferring legal title. See In re Richards, 231 B.R. at 578. The most important factors in the nominee analysis center on the transferor retaining possession of the property and deriving benefits from it. See id. at 579. Given that the money held by the Trust has remained substantially unused by Evseroff, he has neither retained possession nor derived benefit from the funds.
The government responds by emphasizing Evseroff’s control over the funds. According to the government, the fact that the Trust’s cash has remained undistributed demonstrates Evseroff’s control of the funds because Evseroff did not want the funds to be distributed. (Gov’t Mem. at 4 (citing Tr. at 61; J. Evseroff Dep. Tr. at 126-27).) The fact that the Trust’s retention of the funds was consistent with Evseroff’s wishes, however, is of minimal evidentiary value without some evidence that Evseroff controlled the funds by actions intended to ensure that the Trust funds would not be distributed. In that regard, there is no evidence that Evseroff intervened to prevent any disbursements that would have been made if the Trust really were the owner of the $220,000. Absent any evidence that Evseroff actively tried to control the Trust funds, the government has failed to prove by a preponderance of the evidence that Evseroff was a nominee of the funds.
III. Alter Ego
Finally, the government argues that it should be able to reach the assets held in the Trust because the Trust is Evseroff’s alter ego.
The alter ego doctrine arose from the law of corporations and allows a creditor to disregard the corporate form (also known as “piercing the corporate veil”) either by using an owner’s assets to satisfy a corporation’s debt or by using the corporation’s assets to satisfy the individual’s debt. See State v. Easton, 647 N.Y.S.2d 904, 908-09 (N.Y. Sup. Ct. Albany Cnty. 1995). The essence of the alter ego theory is that the entity in question really has no separate existence — it is merely a tool of someone or something else. See Bridgestone/Firestone v. Recovery Credit Servs., 98 F.3d 13, 17-18 (2d Cir. 1996).[18]
Although the New York Court of Appeals has never held that the alter ego theory may be applied to reach assets held in a trust, In re Vebeliunas, 332 F.3d at 90-91; Winchester Global Trust Co. v. Donovan, 880 N.Y.S.2d 877 (Table), 2009 WL 294685, at *9-10 (N.Y. Sup. Ct. Nassau Cnty. Feb. 4, 2009) (noting the lack of precedent but finding that veil piercing applies to trusts), there is no policy reason why veil piercing would apply only to corporations but not to trusts. The policy behind corporate veil piercing is to prevent a debtor from using the corporate legal form to unjustly avoid liability. See Wm. Passalacqua Builders, Inc. v. Resnick Developers S. Inc., 933 F.2d 131, 138 (2d Cir. 1991). That policy applies equally to trusts. Cf. Winchester Global Trust, 2009 WL 294685, at *9-10. Moreover, there is some precedent indicating that the alter ego doctrine also applies to trusts. See Evseroff, 270 F. Appx. at 77-78; see also Dean, 987 F. Supp. at 1165; Katz v. Alpert, 919 N.Y.S.2d 148, 148 (N.Y. App. Div. 1st Dep’t 2011); Winchester Global Trust, 2009 WL 294685, at *9-10. Accordingly, for the reasons below, the alter ego theory will be applied to the Trust.
To pierce the veil in New York, a plaintiff must show that “(1) the owner exercised such control that the corporation has become a mere instrumentality of the owner, who is the real actor; (2) the owner used this control to commit a fraud or `other wrong’; and (3) the fraud or wrong results in an unjust loss or injury to the plaintiff.” In re Vebeliunas, 332 F.3d at 91-92 (citations omitted); see also Wm. Passalacqua Builders, 933 F.2d at 138 (noting that the alter ego theory and the three factor test discussed above “are indistinguishable . . . and should be treated as interchangeable” (citation omitted)).
With regard to the question of Evseroff’s control over the Trust, the relevant factors can be drawn by analogy from the corporate context. In analyzing the alter ego question as it relates to a corporation, courts consider factors such as “the absence of . . . formalities . . ., the amount of business discretion displayed by the allegedly dominated corporation . . ., whether the related corporations deal with the dominated corporation at arms length .. . [and] whether the corporation in question had property that was used by other of the corporations as if it were its own.” In re Vebeliunas, 332 F.3d at 91 n.3 (citation omitted). Though these factors require adaptation as applied to a trust, they nonetheless provide some guidance in determining the issue of control. In particular, they indicate that it is necessary to examine whether the Trust’s formalities were observed, whether the Trust exercised its own discretion and made its own decisions as an entity, and whether it dealt with Evseroff at arms length or whether Evseroff effectively controlled the Trust’s property.
These factors all indicate that Evseroff dominated the Trust. Trust formalities were so poorly observed as to give rise to an inference that the Trust was not a bona fide entity. To be sure, a trust instrument was prepared, tax returns were filed on behalf of the Trust, and trustees were appointed. The Trust, however, did not book the payments Evseroff made in lieu of rent as income between 1992 and 1998 on its tax returns. (See 02/21/02 Blumer Dep., Exs. 1-7.) The Trust never officially assumed the mortgage for the Dover Street Residence. (See Gov’t Mem. at 3; Evseroff Mem. at A-2, A-3.) Thus, the Trust did not claim the mortgage interest deduction for the Dover Street Residence between 1992 and 1998 — although it did claim the deduction for real estate taxes between 1994 and 1998. (See 02/21/02 Blumer Dep., Exs. 1-7.) Instead, Evseroff paid the mortgage interest and, for some years, paid real estate taxes and claimed the deductions. (Tr. at 50-51; see Gov’t Mem. at 3, 5.) Evseroff remained the named beneficiary of the flood and fire insurance policies on the Dover Street Residence. (J. Evseroff Dep., Exs. 32-33; Evseroff Mem. at A-7.) Finally, Evseroff’s accountant prepared the Trust’s tax returns as a professional courtesy to Evseroff, spent only half an hour to prepare them, and sent the Trust returns to Evseroff rather than the trustees. Evseroff III, 2003 WL 22872522, at *3, *11; (02/21/02 Blumer Dep. Tr. at 36-39). All of the above evidence demonstrates both that there was little substance to the Trust and that it was merely an extension of Evseroff.
The manner in which the Trust was managed also demonstrates that it was merely an extension of Evseroff. Though trustees were appointed, there is little evidence that they played an active role in making decisions for the Trust. One apparently believed that he had no Trust responsibilities until Evseroff’s death. (Schneider Dep. Tr. at 20.)
Having trustees play an active role in managing the trust is an important factor in deciding whether to respect the form of a trust. See Dean, 987 F. Supp. at 1165. Moreover, active involvement of trustees of the sort that would support the separate existence of a trust looks very different than the minimal involvement present here. See id.[19] Accordingly, the trustees’ lack of substantial control over the Trust is an important point in favor of the government.
Similarly, Evseroff also evinced his domination of the Trust by controlling its property to a high degree. As discussed supra Part II, Evseroff acted as the owner of the Dover Street Residence. He made the same payments that an owner would make and had a similar degree of practical control over and enjoyment of the property as an owner would have. Although Evseroff’s domination of the $220,000 in the Trust appears to have been more limited, see supra Part II, that fact does not undermine the significant countervailing evidence that Evseroff dominated the Trust. In 1992, when Evseroff transferred the assets into the Trust, the Dover Street Residence was worth approximately $515,000, making it by far the Trust’s most valuable asset. Evseroff’s control over the Dover Street Residence establishes a high degree of dominance over Trust property, further evincing his dominance over the Trust. Thus, it is clear that Evseroff had the requisite degree of control over the Trust to support an alter ego finding.
Because Evseroff controlled the Trust, it is necessary to determine whether he used that control to commit a fraud or wrong against the government, and whether that wrong resulted in an unjust loss. In re Vebeliunas, 332 F.3d at 91-92. On the facts presented here, these elements are plainly satisfied. As noted above, Evseroff essentially used the Trust to shield his assets from attack by those with potential claims upon them, including the government. Moreover, given the potential claims on Evseroff’s assets, and his demonstrated ability to shield his liquid assets from collection through a series of transfers, see Evseroff V, 2006 WL 2792750, at *3, Evseroff’s use of the Trust undoubtedly caused damage to the government by hindering its collection of taxes. Indeed, the government’s continuing difficulties collecting Evseroff’s taxes are evidence of the damage caused.
As a result, the government may collect against all assets held by the Trust. The essence of the alter ego theory is that the existence of the Trust as a separate entity is a fiction — in fact the Trust is Evseroff. See Claudio v. United States, 907 F. Supp. 581, 587-88 (E.D.N.Y. 1995) (“`The courts will look beyond the fiction of corporate entity and hold two corporations to constitute a single unit in legal contemplation, where one is so related to, or organized, or controlled by, the other as to be its mere agent, instrumentality, or alter ego.'” (citation omitted)); see also Austin Powder Co. v. McCullough, 628 N.Y.S.2d 855, 857 (N.Y. App. Div. 3d Dep’t 1995) (noting that where an “alter ego” finding is made “the corporate form may be disregarded to achieve an equitable result”). Based on the court’s determination that the Trust is but an alter ego of Evseroff, its assets should be subject to collection just as if they were held by Evseroff. Moreover, there appears to be no reason why it would be inequitable for the government to collect on all assets held by the Trust on the facts of this case. Accordingly, all of the Trust’s assets are subject to collection.
CONCLUSION
For the foregoing reasons, the government may proceed to collect against all assets held by the Trust established by Evseroff. The Clerk of the Court is respectfully requested to enter judgment in favor of the United States and to close the case.
So ordered.
[1] The IRS also assessed additional liabilities based on Evseroff’s 1991, 1992, and 1996 tax returns. Evseroff III, 2003 WL 22872522, at *6.
[2] All deposition transcripts and exhibits referenced herein were admitted into the trial record, subject to relevance objections. (See Transcript of Trial held on November 7 and 8, 2005 (“Tr.”) at 86-87.)
[3] The Transfer Agreement also appears to transfer a Florida residence owned by Evseroff to the Trust in October 1992. (See J. Evseroff Dep., Ex. 12.) It appears, however, that title to the Florida residence remained with Evseroff, see Evseroff V, 2006 WL 2792750, at *3, and thus the transfer of the Florida residence to the Trust apparently never took place. In any case, the status of the Florida residence is not material to the outcome here. The government does not claim that such a residence was fraudulently conveyed. Moreover, if the Florida residence had been conveyed to the Trust, it would only further indicate the weakness of Evseroff’s financial condition after the two conveyances at issue here and thereby support the legal conclusions detailed below.
[4] The record does not contain information on this point for years after 1998.
[5] For the reasons described below, Evseroff’s pension fund and tax assets may not be readily accessible to the United States.
[6] This figure includes $230,000 for Evseroff’s Florida residence, $75,575 for his law practice, and $541,767 for a Citibank account, which may be a pension account. See Evseroff V, 2006 WL 2792750, at *3-4.
[7] This figure includes $230,000 for Evseroff’s Florida residence, $75,575 for his law practice, $308,304 for a Citibank pension account, $47,000 for a Republic Bank Keogh account, an estimated $220,000 in savings accounts or money market accounts, and $541,767 for a different Citibank account, which may have been a pension account. See Evseroff V, 2006 WL 2792750, at *3-4. This figure does not include the $577,000 cash amount that Evseroff listed in response to the government’s first interrogatories (see Gov’t Ex. 6, at 5), which may be duplicative of the accounts listed above, see Evseroff V, 2006 WL 2792750, at *3, *5.
[8] As of the beginning of 1992, Evseroff’s retirement accounts consisted of a Citibank pension account valued at $308,304 and a Republic Bank Keogh account valued at $47,000. See Evseroff V, 2006 WL 2792750, at *3. Neither party has established whether the Citibank account containing $541,767 was a retirement account or another type of account, and thus whether it was readily accessible. Id. at *6.
[9] The government appealed only the actual fraud and nominee/alter ego findings; it did not appeal the constructive fraud finding. Evseroff, 270 F. App’x at 77.
[10] The government argues that Evseroff’s pension funds should be excluded from the calculation of his assets because they were, at the very least, more difficult to collect. It is true that pension funds receive substantial protection from creditors under state law. Cf. Pauk v. Pauk, 648 N.Y.S.2d 134, 135 (N.Y. App. Div. 2d Dep’t 1996); 31 Am. Jur. 2d Exemptions sec. 198 (2009). There is little impediment, however, to the immediate collection of pension funds by the IRS. The IRS has broad powers to access a taxpayer’s assets notwithstanding protections available for pension funds under state law. See 26 U.S.C. sec. 6334(a),(c) (1992) (noting that “[n]otwithstanding any other law of the United States . . . no property or rights to property shall be exempt from levy other than the property specifically made exempt by subsection (a),” which does not exempt retirement accounts like Evseroff’s). Moreover, “[s]tate law define[s] the nature of the taxpayer’s interest in the property, but the state-law consequences of that definition are of no concern to the operation of the federal tax law.” United States v. Nat’l Bank of Commerce, 472 U.S. 713, 723 (1985) (holding that state laws governing creditors’ rights did not impair the IRS’s levy power); see also Jacobs v. IRS (In re Jacobs), 147 B.R. 106, 108-09 (Bankr. W.D. Pa. 1992) (holding that the IRS could levy on a pension fund protected from creditors under state law). Indeed, the IRS can levy upon and force the immediate liquidation of an IRA where the taxpayer can withdraw his funds. Kane v. Capital Guardian Trust Co., 145 F.3d 1218, 1221-24 (10th Cir. 1998) (noting that the IRS stands in the shoes of the taxpayer for levy purposes (citations omitted)). As Evseroff apparently had the ability to withdraw and use his pension funds (see Tr. at 96-97), the government likely could have accessed the funds as well. Accordingly, the pension funds should not be categorically excluded from consideration in Evseroff’s asset total. Furthermore, even if the IRS were unable to collect from Evseroff’s pension funds, it would not affect the result reached here.
[11] Evseroff argues in his post-remand submission that he was acting in good faith because he believed that the IRS had accepted his offer to settle his tax liabilities for approximately $110,000 in 1993 (the “initial offer in compromise”). See Evseroff IV, 2004 WL 3127981, at *1; (Evseroff Mem. at 5, 21-22.) The evidence of this purported settlement, however, was not admitted at trial and will not be considered except as discussed here.
Prior to trial, the government indicated that it could prove that this alleged settlement was fraudulent and, indeed, had done so in another action. See Evseroff IV, 2004 WL 3127981, at * 1; see also Evseroff III, 2003 WL 22872522, at *4. The government also represented that it had evidence of a series of other offers in compromise that Evseroff submitted. (See Tr. at 24-26.) The government argued that these other offers were in bad faith and designed to delay collection efforts. (See id.) Evidence of these other offers in compromise would, however, have been extremely time-consuming to present.
In a pre-trial evidentiary ruling, the court held that Evseroff could not introduce evidence of the initial offer in compromise unless the government introduced evidence of the other offers in compromise. (See Tr. at 23-26, 193-94.) As the government never sought to introduce evidence regarding the other offers in compromise, the door was not opened to Evseroff to present evidence regarding the initial offer in compromise.
Evseroff claims that the door was opened to the evidence of the initial offer in compromise because the government relied on evidence regarding Evseroff’s actions after the transfers to the Trust. The evidentiary ruling, however, did not specify that this sort of evidence would open the door to evidence regarding the offer in compromise. Moreover, post-transfer evidence is commonly and properly offered as evidence of intent in fraudulent conveyance cases. Cf. Steinberg, 774 N.Y.S.2d at 810 (noting that a debtor’s retention of control after the legal transfer of the property supports a finding of an actually fraudulent conveyance). Even apart from the evidentiary ruling, the government’s post-transfer evidence would not open the door to the offer in compromise evidence Evseroff wishes to present and it will not be considered. By contrast, the court will consider the government’s evidence of Evseroff’s post-transfer actions to the extent it is relevant to Evseroff’s intent.
[12] Although Evseroff’s transfer of the Dover Street Residence does not bear directly on the $220,000 transfer, the fact that the two transfers were made at around the same time indicates that Evseroff’s intent regarding the $220,000 transfer was the same as that regarding the Dover Street Residence.
[13] If these assets have been damaged or disbursed, a money judgment may also be available. Capital Distributions Servs., 440 F. Supp. 2d at 204 (citations omitted). Additionally, the creditor is generally entitled to recover reasonable attorney’s fees. Id. (citing N.Y. Debt. & Cred. Law. sec. 276-a).
[14] The nominee and alter ego issues have generally been discussed together in the prior opinions and filings in this case. As discussed later in this decision, however, there are relevant analytical differences between the two theories.
[15] Although some authority discerns little practical difference between the nominee and alter ego theories, see United States v. Engels, No. C98-2096, 2001 WL 1346652, at *6 (N.D. Iowa. Sept. 24, 2001), for reasons discussed below, the differences between the nominee and alter ego theories are relevant in this case.
[16] The parties dispute whether the government must prove that the Trust is held by Evseroff’s nominee by a preponderance of the evidence or clear and convincing evidence. Because I find that the government’s proof satisfies either standard with regard to the Dover Street residence and fails to satisfy either standard with regard to the $220,000, I need not resolve this dispute.
[17] The government argues that the distribution to pay the real estate taxes for the Dover Street Residence benefitted Evseroff because he had a contractual duty to the Trust to pay those taxes. The government, however, ignores the fact that the distribution also benefitted the Trust. The Trust, as owner of the property, had an independent duty to pay taxes on the residence. N.Y. Real Prop. Tax Law sec. 926(1) (“The owner of real property . . . shall be personally liable for the taxes levied thereon.”); id. sec. 304(2) (Although a renter may have an interest in the real property that makes the renter subject to personal tax liability, “[n]othing in this subdivision shall relieve the owner of real property from the obligation for paying all taxes due on the real property under his ownership or vitiate the sale of said real property for unpaid taxes or special ad valorem levies.”). Therefore, the fact that the Trust distributed Trust funds to pay taxes for the Dover Street Residence does not provide sufficient evidence to prove that the funds were being used to benefit Evseroff, and not the Trust.
[18] As with the nominee issue, the parties dispute whether the government must prove that the Trust was Evseroff’s alter ego by a preponderance of the evidence or clear and convincing evidence. Because I find that the government’s proof satisfies either standard, I need not resolve this dispute.
[19] The Dean court respected the legal form of a trust as established by two parents for the benefit of their children against IRS collection efforts when, among other things:
[O]ther than a brief period . . ., the trustees executed all documents requiring signatures by the owner of the trust property. Tax returns were executed by the trustee. Checks were signed by the trustees. The trustees decided how to spend trust assets, when to make repairs on the rental property, and the rent to be paid by tenants. The trustees borrowed and repaid money in the name of the trust. In other words, the legal control of the trust assets has consistently been exercised by the trustee, not the taxpayer.

Law and Precedent Supporting the 541 Trust®

STATEMENT OF THE LAW

Our 541 Trust® is built on two irrefutable legal principles:

1.         With respect to an irrevocable trust, a creditor of the settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit (Essentially, if the trust is self-settled, it is vulnerable).   See Uniform Trust Code Section 505; RESTATEMENT (SECOND) OF TRUSTS Section 156(2) and RESTATEMENT (THIRD) OF TRUSTS Section 58(2).  This principle has been adopted in hundreds of cases throughout the country and many states have enacted statutes with this identical language.  For example, see Alabama Code Section 19-3B-505; Ariz. Rev. Stat. Ann. §14-7705; Cal. Prob. Code § 15304; Ga. Code Ann. § 53-12-28(c); Florida Trust Code Section 736.0505(b); Ind. Code Ann. § 30-4-3-2; Kan. Stat. Ann, §33-101; La. Rev. Stat. Ann.§2004(2); Michigan Code Section 7506(c)(2), Mo. Ann. Stat. § 456.080.3(2); Mont. Code Ann. § 72-33-305; N.Y. Civ. Prac. L. & R. § 5205(c); Ohio Code Section 5805.06; Okla. Stat. Ann. tit. 60, §175.25G; Pennsylvania Code Title 20 §7745; R.I. Gen. Laws § 18-9.1-1; Tex. Prop. Code Ann. §112.035(d); Utah Code Section 75-7-505(b); Virginia Code Section 55-545.05 ); W. Va. Code §36-1-18 (1985); Wis. Stat. Ann. §701.06(1).

2.         A settlor can retain a special power of appointment without subjecting the trust to the claims of creditors.  See RESTATEMENT (THIRD) OF PROPERTY: WILLS AND OTHER DONATIVE TRANSFERS Section 22.1; US Bankruptcy Code Section 541(b)(1), California Probate Code Section 681; Delaware Code Section 3536; Georgia Code Section 23-2-111; New York Code 10-7.1; Also see cases set forth below.

APPLICATION OF LAW TO THE 541 TRUST®

The 541 Trust® is an irrevocable trust that includes the following features:

1.         The settlor is not a beneficiary and no distributions can be made to or for the settlor’s benefit.

2.         The settlor retains a “special power of appointment” which allows the settlor to change the trustees, the beneficiaries, or the terms of the 541 Trust® at any time (except that the assets cannot be distributed to or for the settlor’s benefit).  In addition, the settlor can appoint assets to any other person at any time.

Creditors have no claim against the 541 Trust® because no distributions can be made for the settlor’s benefit.  The cases and statutes set forth below show that these powers of appointment do not give creditors any claim against the 541 Trust®.  There are no statutes, cases, secondary sources or commentaries to the contrary.

COURT CASES

In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002) Defendant funded irrevocable trust and retained an income interest and a special power of appointment over principal.  11th Circuit analyzes creditor’s access to an irrevocable trust.  The trust principal was not included in the defendant’s bankruptcy estate.  To read the case, follow this link: In re Jane McLean Brown

In Estate of German, 7 Cl. Ct. 641 (1985) (85-1 USTC Par 13,610 (CCH)) – Assets of an irrevocable trust were not subject to the creditors of the settlor despite the fact that the trustees and beneficiaries had power to appoint the assets to the settlor.

Shurley v. Texas Commerce Bank, 115 F.3d 333 (5th Cir. 1997) – 5th Circuit Court holds that the portion of the trust that was not self-settled is not included in the bankruptcy estate, and assets subject to a special power of appointment are excluded from the bankruptcy estate.  To read this case, click  Shurley v. Texas Commerce Bank                           

In re Hicks, 22 B.R. 243 (Bankr. N.D.Ga.1982) – A court cannot compel the exercise of a special power of appointment and the assets of the trust were not included in the bankruptcy estate of a permissible appointee.  To read this case, click In-re-Hicks

In re Knight, 164 B.R. 372 (Bankr.S.D.Fla.1994) – The interest of a contingent beneficiary was included in the bankruptcy estate, but the interest of a permissible appointee of a power of appointment was too remote to be property and was not included in the bankruptcy estate.
To read this case, click In re Knight

In re Colish, 289 B.R. 523 (Bankr.E.D. N.Y. 2002) – The interest of a contingent beneficiary was included in the bankruptcy estate.  The court distinguished this from Knight and Hicks where the interest of a permissible appointee under a power of appointment was not included.
To read this case, click Colish-v-United-States

Cooley v. Cooley, 628 A.2d 608 (1993) – A special power of appointment is not a part of the marital estate that can be awarded in a divorce action.  As one of the possible objects of the defendant’s power, the plaintiff possesses no more than a mere expectancy.
To read this case, click Cooley-v-Cooley

 Cote v. Bank One, Texas, N.A., No. 4:03-CV-296-A, 2003 WL 23194260 (N.D. Tex. Aug. 1, 2003) – Permissible appointee is not an “interested person” with standing to sue the trust.  This is relevant because if the permissible appointee has no standing to sue the trust, neither should a creditor of a permissible appointee.

Avis v. Gold, 178 F.3d 718 (1999) – Permissible appointee had no interest which could be included in the bankruptcy estate, or to which an IRS tax lien could attach, prior to the time the power was exercised in favor of the debtor.

Horsley v. Maher, U.S. Bankruptcy Ct. Case No. 385-00071 (1988) – debtor was a permissible appointee of Trust A and a beneficiary of Trust B.  Trust A was not included in the bankruptcy estate because “the debtor holds no interest in Trust A.”  The assets of Trust B were included in the bankruptcy estate.

U. S. v. O’Shaughnessy, 517 N.W.2d 574 (1994) – Assets subject to discretionary special power of appointment not subject to tax lien

Spetz v. New York State Dep’t of Health, 737 N.Y.S. 2d 524 (Sup. Ct. Chautauqua Co, Jan. 15, 2002) – New York Supreme Court holds that special power of appointment does not cause trust assets to be taken into account for purposes of Medicaid qualification

Verdow v. Sutkowy, 209 F.R.D. 309 (N.D.N.Y. 2002) – Assets subject to special power of appointment not taken into account for purposes of Medicaid qualification

United States v. Baldwin, 391 A.2d 844 (1978) – Assets subject to special power of appointment not subject to tax lien
            
Estate of Ballard v. Commissioner, 47 BTA 784 (1942), aff’d, 138 F.2d 512 (2nd Cir. 1943) – Assets of trust not included in husband’s estate merely because wife had the power to return the assets to the husband.

Kneeland v. COMMISSIONER OF INTERNAL REVENUE, 34 BTA 816 – Board of Tax Appeals (1936) – Assets of trust not included in husband’s estate merely because wife had the power to return the assets to the husband.

Helvering v. Helmholz, 296 US 93 (Supreme Court 1935) – Assets of trust not included in wife’s estate merely because the beneficiaries had the power to terminate the trust and return the assets back to the wife.

Price v. Cherbonnier, 63 Atl 209 (1906) – Creditors of the donee of a special power of appointment cannot reach the assets subject to the power.

Gilman v. Bell, 99 Ill. 194 (1881) – Assets subject to power of appointment not subject to claims of creditors.

Jones v. Clifton, 101 US 225 (1879) – Assets subject to power of appointment not subject to claims of creditors.

Holmes v. Coghill, 33 Eng. Rep 79 (1806) – Assets subject to power of appointment not subject to claims of creditors.

_______________________________________________________________________________

For an excellent summary of the law supporting this kind of trust (from an unrelated law firm), see Asset Protection Planning with Trusts – A Practical Overview by Alexander A. Bove, Jr. published in Journal of Practical Estate Planning (CCH Inc., April-May 2002).

Building a Better Asset Protection Trust/ as published in Estate Planning Magazine

Estate Planning Journal (WG&L)
Volume 38, Number 01, January 2011
Use ‘Powers’ to Build a Better Asset Protection Trust, Estate Planning Journal, Jan 2011

 

Use ‘Powers’ to Build a Better Asset Protection Trust

A creatively drafted special power of appointment can be used to increase flexibility, asset protection, and anonymity of a trust.

Author: LEE S. McCULLOUGH, III, ATTORNEY

LEE S. McCULLOUGH, III practices exclusively in the areas of estate planning and asset protection in Provo, Utah. He also teaches estate planning as an adjunct professor at the J. Reuben Clark Law School at Brigham Young University

An asset protection trust can provide a person with security and peace of mind by ensuring that some assets are protected against future potential liabilities. State and federal laws support the use of an asset protection trust that is designed and funded in an ethical manner. Fraudulent transfer laws prevent the use of an asset protection trust to hinder, delay, or defraud a creditor.

For the past several decades, most asset protection trusts have been based on the concept of a self-settled trust. 1 Historically, the general rule has been to deny asset protection to a self-settled trust. 2 This began to change when laws were passed in offshore jurisdictions, such as the Cook Islands and the Isle of Man, which protect the assets in a self-settled trust. Beginning with the Alaska Trust Act in 1997, 13 states now offer some degree of asset protection for a self-settled trust:

(1) Alaska.

(2) Colorado.

(3) Delaware.

(4) Hawaii.

(5) Missouri.

(6) Nevada.

(7) New Hampshire.

(8) Oklahoma.

(9) Rhode Island.

(10) Missouri.

(11) Tennessee.

(12) Utah.

(13) Wyoming.

Although this concept has dominated the discussion and the practice of designing asset protection trusts, it is not the only option. The special power of appointment, an old reliable tool, can be implemented to replace and improve on the concept of a self-settled trust.

The special power of appointment is perhaps the most powerful and unappreciated tool in estate planning and asset protection. While most estate planners regularly use special powers of appointments to add flexibility to trust documents, most fail to recognize many of the most powerful uses of this tool. Whether designing a trust solely to protect against potential creditors, or to protect against estate taxes as well, a special power of appointment can be used to build a better asset protection trust.

Powers of appointment are nothing new

The concept of a power of appointment has been a part of the English common law for hundreds of years. This concept is well recognized in all 50 states and in the federal tax laws. 3 Although some minor variations in the law pertaining to powers of appointment have occurred over time, the basic principles, which form the basis of this article, have never varied. These basic principles are summarized below.

Key terminology. Familiarity with the following terms is crucial to an understanding of the strategies discussed below:

A power of appointment is a power that enables the donee of the power, acting in a nonfiduciary capacity, to designate recipients of beneficial ownership interests in the appointive property. 4The “donor” is the person who created the power of appointment.The “donee” is the person on whom the power is conferred (and who may exercise the power).The “permissible appointees” or “objects” are the persons for whom the power may be exercised.An “appointee” is a person to whom an appointment has been made.A “taker in default of appointment” is a person who will receive the property if the power is not exercised. 5

A power of appointment is “general” to the extent that the power is exercisable in favor of the donee, the donee’s estate, or the creditors of the donee or the donee’s estate, regardless of whether the power is also exercisable in favor of others. 6 A power that is not general is referred to as a “special” or “nongeneral” power of appointment.

Basic rules pertaining to asset protection and estate tax inclusion. Property that is subject to a presently exercisable general power of appointment is generally subject to the creditors of the donee because it is a power that is equivalent to ownership. 7 On the other hand, property subject to a special power of appointment is exempt from claims of the donee’s creditors. 8 The donee of a special power of appointment is not considered to have a property interest in the property subject to the power because it cannot be exercised for the economic benefit of the donee. 9 Because the donee has no property interest, the property subject to the power of appointment is not included among the property of the donee for purposes of judgment collection, bankruptcy, 10 divorce, Medicaid eligibility, estate tax inclusion, 11 or other determinations that involve the property of the donee.

Similarly, a permissible appointee (including the donor) has no property interest in a power of appointment. 12 Any attempt to include the interest of a permissible appointee for purposes of judgment collection, bankrupty, divorce, Medicaid eligibility, estate tax inclusion, or other determinations that involve the property of the donee would be a logical and practical impossibility because most special powers of appointment include everyone in the world as a permissible appointee, except for the donee, the donee’s estate, and the creditors of the donee and the donee’s estate.

Replacing the self-settled asset protection trust

An irrevocable trust with a special power of appointment that includes the donor as a permissible appointee (referred to herein as a “special power of appointment trust”) can be used to replace and improve on the concept of a self-settled asset protection trust. Both the self-settled asset protection trust and the special power of appointment trust can be designed so that gifts to the trust are incomplete for gift tax purposes 13—and thus not subject to gift tax at the time of the initial transfer. Both of these trusts can also be designed as a grantor trust for income tax purposes so that income from the trust is taxed to the settlor. If the tax treatment for these two trusts is the same, and the ability to benefit the settlor is the same, what is the difference between a self-settled asset protection trust and a special power of appointment trust?

The pros and cons of these two alternatives may be summarized as follows:

(1) No case law supports the asset protection provided by a self-settled asset protection trust because the statutes that allow asset protection for a self-settled trust are relatively new and untested. On the other hand, the inability of a creditor of a permissible appointee to reach the assets of a special power of appointment trust is supported by centuries of common law that is consistent throughout all 50 states in addition to federal bankruptcy courts. 14 In addition, the asset protection provided by a special power of appointment trust is supported by the logical and practical impossibility of ascribing trust liability for all permissible appointees when that class includes every person on earth other than the donee, the donee’s estate, and the creditors of the donee and the donee’s estate.

(2) The common law rule, followed by the majority of states, is that the assets of a self-settled trust are available to the claims of the settlor’s creditors. 15 Many commentators believe that a state that does not grant asset protection for self-settled trusts will not uphold the laws of a state that does grant asset protection for self-settled trusts, because doing so would violate the first state’s public policy. 16 The asset protection provided by a special power of appointment trust is not dependent on the state where the parties reside or the state where the matter is adjudicated.

(3) Many commentators question whether a self-settled asset protection trust will hold up in a bankruptcy court. At least two bankruptcy courts have held that the recognition of an offshore self-settled trust would offend federal bankruptcy policies. 17 A person who files bankruptcy is typically required to disclose any trust in which he or she is included as a beneficiary. In addition, the 2005 changes to the Bankruptcy Code have created a new ten-year limitations period for transfers to self-settled trusts that are meant to hinder, delay or defraud creditors. 18 Even if a bankruptcy court is unable to bring the assets of a self-settled trust into the bankruptcy estate, the court could dismiss the debtor’s case and deny the debtor a discharge under the bankruptcy laws. In contrast, the special power of appointment trust should be irrelevant to a bankruptcy proceeding because the settlor has no beneficial interest in the trust.

(4) Many of the state statutes that grant some form of asset protection for a self-settled trust also include exceptions that allow creditors to seize the assets of a self-settled trust for child support, alimony, transfers made within certain time periods, government creditors, bankruptcy, or certain torts. 19 In contrast, no statutory exceptions allow a creditor of a permissible appointee to reach the assets of a special power of appointment trust.

(5) Plaintiff’s attorneys, creditors, and government agencies often ask if a person is a beneficiary of a trust in order to determine whether the trust assets may be attached or taken into account for various purposes. This opens the trust up to inspection and evaluation by an adverse party, and it may affect a person’s eligibility for certain programs or benefits. The special power of appointment trust is immune to this kind of scrutiny because the settlor is not a beneficiary, and most every person in the world is a permissible appointee.

(6) A self-settled trust governed by the laws of an exotic and foreign jurisdiction often carries with it a negative stigma and a perception of wrongdoing. Upon learning that a person is a beneficiary of a self-settled trust in a foreign jurisdiction, judges, juries, and government agencies are likely to view the person as a criminal who is attempting to avoid the law. In contrast, a special power of appointment trust established in a domestic jurisdiction for the benefit of a person’s family has the appearance of an ordinary measure established by a law-abiding citizen for estate planning purposes.

(7) The self-settled asset protection trust requires the appointment of a trustee or co-trustee in one of the jurisdictions where self-settled trusts are allowed (with some jurisdictions requiring the use of a corporate trustee 20); the special power of appointment trust does not require the appointment of a corporate trustee or a trustee that is located in a certain jurisdiction.

(8) One may argue that the self-settled trust is safer than the special power of appointment trust because the trustee has a fiduciary duty to the beneficiaries and this ensures that the trustee will not distribute the assets to the wrong people. 21 However, if the trustee has a discretionary power to sprinkle assets among the potential beneficiaries, there is still a chance that the trustee will not distribute the assets according to the wishes of the settlor. The settlor of a special power of appointment trust could use the following measures to ensure that the donee of the power does not exercise it inappropriately:

The settlor could appoint one or more co-donees who are required to act together.The settlor could limit the class of permissible appointees.The settlor could appoint a trust protector with power to approve or veto the exercise of a power of appointment.The settlor could grant a trust protector the power to remove and replace a donee.

To illustrate the differences between a self-settled asset protection trust and a special power of appointment trust, consider the following example:

Scenario 1. Dawn creates a self-settled asset protection trust naming her brother as the trustee. She names herself, her spouse, and her children as the beneficiaries. She gives her brother the power to withhold distributions or to sprinkle distributions among the beneficiaries as he determines in his sole and absolute discretion. Dawn funds her self-settled asset protection trust at a time and in a manner that is not considered a fraudulent transfer.

Scenario 2. Michael creates a special power of appointment trust naming his brother as the trustee. Michael names his spouse and children as the beneficiaries, but he does not include himself as a potential beneficiary. He gives his brother the same power to withhold distributions or to sprinkle distributions among the beneficiaries as he determines in his sole and absolute discretion. Michael also gives his brother a special power of appointment to appoint assets to any person other than himself, his estate, or the creditors of himself or his estate. Michael funds his special power of appointment trust at a time and in a manner that is not considered a fraudulent transfer.

In both scenarios, the brother of the settlor has power to withhold assets or sprinkle assets among the spouse and children of the settlor. In both scenarios, the brother of the settlor can transfer all, part, or none of the assets of the trust to the settlor at any time and for any reason.

Now assume that both Dawn and Michael are sued, and a judgment is entered against them. The creditor’s attorneys will ask both Dawn and Michael if either is the beneficiary of any trust. Michael will correctly answer that he is not a beneficiary of a trust. Even if creditors discover that Michael once created a trust, they will have no claim on the trust because Michael is not included as a beneficiary. Dawn, on the other hand, will have to reply that she is the beneficiary of a self-settled trust, and her creditors will then commence an examination of the trust and an attempt to confiscate its assets.

Improving an intentionally defective grantor trust

An intentionally defective grantor trust is a trust that is excluded from the settlor’s estate for gift and estate tax purposes but whose income is attributed to the settlor for income tax purposes. The name comes from the fact that the settlor intentionally includes a “defect” in the trust document that causes the income to be taxable to the settlor (or “grantor”). The purpose of an intentionally defective grantor trust is to protect assets from estate taxes in addition to protecting assets from the potential future creditors of the settlor. An intentionally defective grantor trust is typically used to own life insurance or other appreciating assets. In order to ensure that the assets of the trust are not included in the settlor’s estate, the settlor is not included as a beneficiary of an intentionally defective grantor trust.

The concept of an intentionally defective grantor trust can be greatly improved if the settlor grants a special power of appointment allowing a donee to appoint assets to any person other than the donee, the donee’s estate, or the creditors of the donee or the donee’s estate. The grant of a special power of appointment to a non-adverse party is one way to cause an irrevocable trust to be treated as a “grantor trust” for income tax purposes. 22 This power allows the donee potentially to appoint the assets of the trust back to the settlor. The donee should not be a person who is also a beneficiary of the trust, or the exercise of a special power of appointment may result in a taxable gift. 23 The fact that the settlor and the settlor’s spouse are included as permissible appointees is insufficient to cause the trust assets to be included in their taxable estate because most everyone in the world is a permissible appointee. 24

Example. Sarah and John both create an intentionally defective grantor trust, and both transfer significant assets to the trust by gift and by sale in order to remove the assets from their taxable estates. Sarah’s trust also includes a special power of appointment allowing her brother to appoint assets to any person other than himself, his estate, or the creditors of the brother or his estate. If the estate tax is repealed, if Sarah falls on hard times, or if she decides that she does not want her children to receive a large inheritance, Sarah’s brother can simply appoint the assets to her at any time. John’s trust does not include this special power. Thus, he has no way to benefit from the assets in the trust, and the trustee has no power to give them back to him.

This option to return assets to the settlor may be especially useful if Congress eventually increases the estate tax exemptions while maintaining the step-up in basis for property included in a decedent’s taxable estate. The special power of appointment that is included in Sarah’s trust would allow her brother to appoint sufficient assets back to her to take full advantage of the step-up in basis at her death to the extent of her available estate tax exemption.

Conclusion

Although a special power of appointment is an old familiar tool, it may be used in creative ways to add greater flexibility, greater asset protection, and greater anonymity to a trust. In fact, it may accomplish what was otherwise impossible in that it allows a person to make an irrevocable gift without giving up the possibility that the assets that were given might be returned.

1

A “self-settled” trust is one in which the settlor is included as a beneficiary of the trust.
2

See RESTATEMENT (SECOND) OF TRUSTS, section 156.
3

See RESTATEMENT OF PROPERTY sections 318-369 (1940), RESTATEMENT (SECOND) OF PROPERTY: DONATIVE TRANSERS sections 11.1-24.4 (1986), RESTATEMENT (THIRD) OF PROPERTY: WILLS AND OTHER DONATIVE TRANSFERS (Tentative Draft No. 5, 2006) section 17.1, and IRC Section 2041.
4

RESTATEMENT (THIRD) OF PROPERTY: WILLS AND OTHER DONATIVE TRANSFERS (Tentative Draft No. 5, 2006) section 17.1.
5

Id. at section 17.2.
6

Id. at section 17.3.
7

Id. at section 17.4.
8

Id. at section 22.1.
9

See RESTATEMENT (THIRD) OF TRUSTS section 56 comment b (2003).
10

See 11 U.S.C. section 541.
11

See Sections 2041 and 2514.
12

See RESTATEMENT (THIRD) OF PROPERTY: WILLS AND OTHER DONATIVE TRANSFERS (Tentative Draft No. 5, 2006) Section 17.2. Also see In re Hicks, 22 BR 243 (Bkrptcy. DC Ga., 1982) and In re Knight, 164 BR 372 (Bkrptcy. DC Fla., 1994).
13

A transfer to a trust is “incomplete” for gift tax purposes if the settlor retains a power to veto distributions proposed by the trustee. See Reg. 25.2511-2(c).
14

Supra note 12.
15

Supra note 2.
16

A trust is generally governed by the law of the jurisdiction designated in the trust agreement unless that jurisdiction’s law is contrary to a strong public policy of the jurisdiction having the most significant relationship to the matter at issue. See Uniform Trust Act section 107 and Restatement (Second) of Conflict of Laws sections 273 and 280.
17

See In re Portnoy, 201 B.R. 698, and In re Brooks, 217 B.R. 98.
18

11 U.S.C. section 548(e).
19

See Utah Code 25-6-14, Delaware Code Section 3573, Oklahoma Statutes Title 31, section 11.
20

See Utah Code 25-6-14; Oklahoma Statutes Title 31, section 11.
21

By definition, a trustee has a fiduciary duty to the beneficiaries of a trust, while a donee of a power of appointment acts in a nonfiduciary capacity and has no duty to the beneficiaries or permissible appointees. See RESTATEMENT (THIRD) OF PROPERTY: WILLS AND OTHER DONATIVE TRANSFERS (Tentative Draft No. 5, 2006) section 17.1.
22

See Section 674.
23

See Reg. 25.2514-1(b)(2).
24

Section 2042(2) provides that a reversionary interest could cause the trust assets to be included in the settlor’s estate if the value of the reversionary interest immediately before the insured’s death exceeds 5% of the value of the trust. Because the special power of appointment is exercisable in the donee’s absolute discretion, the value of the reversionary interest is less than 5% of the value of the trust. See Reg. 20.2042-1(c)(3). If it can be shown that the settlor and the donee had an express or implied understanding that distributions would be made to the settlor, then the assets of the trust could possibly be included in the settlor’s estate under Section 2036(a)(1).

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Olmstead v. Federal Trade Commission, No. SC08-1009, FL Sup. Ct. (24 june 2010)

Charging Order Provision does Not Protect Interest in a Single-Member LLC

Supreme Court of Florida

_____________

No. SC08-1009

____________

SHAUN OLMSTEAD, et al.,
Appellants,

vs.

FEDERAL TRADE COMMISSION,
Appellee.

[June 24, 2010]

CANADY, J.

In this case we consider a question of law certified by the United States Court of Appeals for the Eleventh Circuit concerning the rights of a judgment creditor, the appellee Federal Trade Commission (FTC), regarding the respective ownership interests of appellants Shaun Olmstead and Julie Connell in certain Florida single-member limited liability companies (LLCs). Specifically, the Eleventh Circuit certified the following question: “Whether, pursuant to Fla. Stat. § 608.433(4), a court may order a judgment-debtor to surrender all ̳right, title, and interest‘ in the debtor‘s single-member limited liability company to satisfy an outstanding judgment.” Fed. Trade Comm‘n v. Olmstead, 528 F.3d 1310, 1314 (11th Cir. 2008). We have discretionary jurisdiction under article V, section 3(b)(6), Florida Constitution.

The appellants contend that the certified question should be answered in the negative because the only remedy available against their ownership interests in the single-member LLCs is a charging order, the sole remedy authorized by the statutory provision referred to in the certified question. The FTC argues that the certified question should be answered in the affirmative because the statutory charging order remedy is not the sole remedy available to the judgment creditor of the owner of a single-member limited liability company.

For the reasons we explain, we conclude that the statutory charging order provision does not preclude application of the creditor‘s remedy of execution on an interest in a single-member LLC. In line with our analysis, we rephrase the certified question as follows: “Whether Florida law permits a court to order a judgment debtor to surrender all right, title, and interest in the debtor‘s single- member limited liability company to satisfy an outstanding judgment.” We answer the rephrased question in the affirmative.

I. BACKGROUND

The appellants, through certain corporate entities, “operated an advance-fee credit card scam.” Olmstead, 528 F.3d at 1311-12. In response to this scam, the FTC sued the appellants and the corporate entities for unfair or deceptive trade practices. Assets of these defendants were frozen and placed in receivership. Among the assets placed in receivership were several single-member Florida LLCs in which either appellant Olmstead or appellant Connell was the sole member. Ultimately, the FTC obtained judgment for injunctive relief and for more than $10 million in restitution. To partially satisfy that judgment, the FTC obtained—over the appellants‘ objection—an order compelling appellants to endorse and surrender to the receiver all of their right, title, and interest in their LLCs. This order is the subject of the appeal in the Eleventh Circuit that precipitated the certified question we now consider.

II. ANALYSIS

In our analysis, we first review the general nature of LLCs and of the charging order remedy. We then outline the specific relevant provisions of the Florida Limited Liability Company Act (LLC Act), chapter 608, Florida Statutes (2008). Next, we discuss the generally available creditor‘s remedy of levy and execution under sale. Finally, we explain the basis for our conclusion that Florida law permits a court to order a judgment debtor to surrender all right, title, and interest in the debtor‘s single-member LLC to satisfy an outstanding judgment. In brief, this conclusion rests on the uncontested right of the owner of the single- member LLC to transfer the owner‘s full interest in the LLC and the absence of any basis in the LLC Act for abrogating in this context the long-standing creditor‘s remedy of levy and sale under execution.

A. Nature of LLCs and Charging Orders

The LLC is a business entity originally created to provide “tax benefits akin to a partnership and limited liability akin to the corporate form.” Elf Altochem North Am., Inc. v. Jaffari, 727 A.2d 286, 287 (Del. 1998). In addition to eligibility for tax treatment like that afforded partnerships, LLCs are characterized by restrictions on the transfer of ownership rights that are related to the restrictions applicable in the partnership context. In particular, the transfer of management rights in an LLC generally is restricted. This particular characteristic of LLCs underlies the establishment of the LLC charging order remedy, a remedy derived from the charging order remedy created for the personal creditors of partners. See City of Arkansas City v. Anderson, 752 P.2d 673, 681-683 (Kan. 1988) (discussing history of partnership charging order remedy). The charging order affords a judgment creditor access to a judgment debtor‘s rights to profits and distributions from the business entity in which the debtor has an ownership interest.

B. Statutory Framework for Florida LLCs

The rules governing the formation and operation of Florida LLCs are set forth in Florida‘s LLC Act. In considering the question at issue, we focus on the provisions of the LLC Act that set forth the authorization for single-member LLCs, the characteristics of ownership interests, the limitations on the transfer of ownership interests, and the authorization of a charging order remedy for personal creditors of LLC members.

Section 608.405, Florida Statutes (2008), provides that “[o]ne or more persons may form a limited liability company.” A person with an ownership interest in an LLC is described as a “member,” which is defined in section 608.402(21) as “any person who has been admitted to a limited liability company as a member in accordance with this chapter and has an economic interest in a limited liability company which may, but need not, be represented by a capital account.” The terms “membership interest,” “member‘s interest,” and “interest” are defined as “a member‘s share of the profits and losses of the limited liability company, the right to receive distributions of the limited liability company‘s assets, voting rights, management rights, or any other rights under this chapter or the articles of organization or operating agreement.” § 608.402(23), Fla. Stat. (2008). Section 608.431 provides that “[a]n interest of a member in a limited liability company is personal property.”

Section 608.432 contains provisions governing the “[a]ssignment of member‘s interest.” Under section 608.432(1), “[a] limited liability company interest is assignable in whole or in part except as provided in the articles of organization or operating agreement.” An assignee, however, has “no right to participate in the management of the business and affairs” of the LLC “except as provided in the articles of organization or operating agreement” and upon obtaining “approval of all of the members of the limited liability company other than the member assigning a limited liability company interest” or upon “[c]ompliance with any procedure provided for in the articles of organization or operating agreement.” Id. Accordingly, an assignment of a membership interest will not necessarily transfer the associated right to participate in the LLC‘s management. Such an assignment which does not transfer management rights only “entitles the assignee to share in such profits and losses, to receive such distribution or distributions, and to receive such allocation of income, gain, loss, deduction, or credit or similar item to which the assignor was entitled, to the extent assigned.” § 608.432(2)(b), Fla. Stat. (2008).

Section 608.433—which is headed “Right of assignee to become member”—reiterates that an assignee does not necessarily obtain the status of member. Section 608.433(1) states: “Unless otherwise provided in the articles of organization or operating agreement, an assignee of a limited liability company interest may become a member only if all members other than the member assigning the interest consent.” Section 608.433(4) sets forth the provision— mentioned in the certified question—which authorizes the charging order remedy for a judgment creditor of a member:

On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the limited liability company membership interest of the member with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of such interest. This chapter does not deprive any member of the benefit of any exemption laws applicable to the member‘s interest.

C. Generally Available Creditor’s Remedy of
Levy and Sale under Execution

Section 56.061, Florida Statutes (2008), provides that various categories of real and personal property, including “stock in corporations,” “shall be subject to levy and sale under execution.” A similar provision giving judgment creditors a remedy against a judgment debtor‘s ownership interest in a corporation has been a part of the law of Florida since 1889. See ch. 3917, Laws of Fla. (1889) (“That shares of stock in any corporation incorporated by the laws of this State shall be subject to levy of attachments and executions, and to sale under executions on judgments or decrees of any court in this State.”). An LLC is a type of corporate entity, and an ownership interest in an LLC is personal property that is reasonably understood to fall within the scope of “corporate stock.” “The general rule is that where one has any ̳interest in property which he may alien or assign, that interest, whether legal or equitable, is liable for the payment of his debts.‘” Bradshaw v. Am. Advent Christian Home & Orphanage, 199 So. 329, 332 (Fla. 1940) (quoting Croom v. Ocala Plumbing & Electric Co., 57 So. 243, 245 (Fla. 1911)).

At no point have the appellants contended that section 56.061 does not by its own terms extend to an ownership interest in an LLC or that the order challenged in the Eleventh Circuit did not comport with the requirements of section 56.061. Instead, they rely solely on the contention that the Legislature adopted the charging order remedy as an exclusive remedy, supplanting section 56.061.

D. Creditor’s Remedies Against the Ownership
Interest in a Single-Member LLC

Since the charging order remedy clearly does not authorize the transfer to a judgment creditor of all an LLC member‘s “right, title and interest” in an LLC, while section 56.061 clearly does authorize such a transfer, the answer to the question at issue in this case turns on whether the charging order provision in section 608.433(4) always displaces the remedy available under section 56.061. Specifically, we must decide whether section 608.433(4) establishes the exclusive judgment creditor‘s remedy—and thus displaces section 56.061—with respect to a judgment debtor‘s ownership interest in a single-member LLC.

As a preliminary matter, we recognize the uncontested point that the sole member in a single-member LLC may freely transfer the owner‘s entire interest in the LLC. This is accomplished through a simple assignment of the sole member‘s membership interest to the transferee. Since such an interest is freely and fully alienable by its owner, section 56.061 authorizes a judgment creditor with a judgment for an amount equaling or exceeding the value of the membership interest to levy on that interest and to obtain full title to it, including all the rights of membership—that is, unless the operation of section 56.061 has been limited by section 608.433(4).

Section 608.433 deals with the right of assignees or transferees to become members of an LLC. Section 608.433(1) states the basic rule that absent a contrary provision in the articles or operating agreement, “an assignee of a limited liability company interest may become a member only if all members other than the member assigning the interest consent.” See also § 608.432(1)(a), Fla. Stat (2008). The provision in section 608.433(4) with respect to charging orders must be understood in the context of this basic rule.

The limitation on assignee rights in section 608.433(1) has no application to the transfer of rights in a single-member LLC. In such an entity, the set of “all members other than the member assigning the interest” is empty. Accordingly, an assignee of the membership interest of the sole member in a single-member LLC becomes a member—and takes the full right, title, and interest of the transferor— without the consent of anyone other than the transferor.

Section 608.433(4) recognizes the application of the rule regarding assignee rights stated in section 608.433(1) in the context of creditor rights. It provides a special means—i.e., a charging order—for a creditor to seek satisfaction when a debtor‘s membership interest is not freely transferable but is subject to the right of other LLC members to object to a transferee becoming a member and exercising the management rights attendant to membership status. See § 608.432(1), Fla. Stat. (2008) (setting forth general rule that an assignee “shall have no right to participate in the management of the business affairs of [an LLC]”).

Section 608.433(4)‘s provision that a “judgment creditor has only the rights of an assignee of [an LLC] interest” simply acknowledges that a judgment creditor cannot defeat the rights of nondebtor members of an LLC to withhold consent to the transfer of management rights. The provision does not, however, support an interpretation which gives a judgment creditor of the sole owner of an LLC less extensive rights than the rights that are freely assignable by the judgment debtor. See In re Albright, 291 B.R. 538, 540 (D. Colo. 2003) (rejecting argument that bankruptcy trustee was only entitled to a charging order with respect to debtor‘s ownership interest in single-member LLC and holding that “[b]ecause there are no other members in the LLC, the entire membership interest passed to the bankruptcy estate”); In re Modanlo, 412 B.R. 715, 727-31 (D. Md. 2006) (following reasoning of Albright).

Our understanding of section 608.433(4) flows from the language of the subsection which limits the rights of a judgment creditor to the rights of an assignee but which does not expressly establish the charging order remedy as an exclusive remedy. The relevant question is not whether the purpose of the charging order provision—i.e., to authorize a special remedy designed to reach no further than the rights of the nondebtor members of the LLC will permit—provides a basis for implying an exception from the operation of that provision for single- member LLCs. Instead, the question is whether it is justified to infer that the LLC charging order mechanism is an exclusive remedy.

On its face, the charging order provision establishes a nonexclusive remedial mechanism. There is no express provision in the statutory text providing that the charging order remedy is the only remedy that can be utilized with respect to a judgment debtor‘s membership interest in an LLC. The operative language of section 608.433(4)—”the court may charge the [LLC] membership interest of the member with payment of the unsatisfied amount of the judgment with interest”— does not in any way suggest that the charging order is an exclusive remedy.

In this regard, the charging order provision in the LLC Act stands in stark contrast to the charging order provisions in both the Florida Revised Uniform Partnership Act, §§ 620.81001-.9902, Fla. Stat. (2008), and the Florida Revised Uniform Limited Partnership Act, §§ 620.1101-.2205, Fla. Stat. (2008). Although the core language of the charging order provisions in each of the three statutes is strikingly similar, the absence of an exclusive remedy provision sets the LLC Act apart from the other two statutes. With respect to partnership interests, the charging order remedy is established in section 620.8504, which states that it “provides the exclusive remedy by which a judgment creditor of a partner or partner‘s transferee may satisfy a judgment out of the judgment debtor‘s transferable interest in the partnership.” § 620.8504(5), Fla. Stat. (2008) (emphasis added). With respect to limited partnership interests, the charging order remedy is established in section 620.1703, which states that it “provides the exclusive remedy which a judgment creditor of a partner or transferee may use to satisfy a judgment out of the judgment debtor‘s interest in the limited partnership or transferable interest.” § 620.1703(3), Fla. Stat. (2008) (emphasis added).

“[W]here the legislature has inserted a provision in only one of two statutes that deal with closely related subject matter, it is reasonable to infer that the failure to include that provision in the other statute was deliberate rather than inadvertent.” 2B Norman J. Singer & J.D. Shambie Singer, Statutes and Statutory Construction § 51:2 (7th ed. 2008). “In the past, we have pointed to language in other statutes to show that the legislature ̳knows how to‘ accomplish what it has omitted in the statute [we were interpreting].” Cason v. Fla. Dep‘t of Mgmt. Services, 944 So. 2d 306, 315 (Fla. 2006); see also Horowitz v. Plantation Gen. Hosp. Ltd. P‘ship, 959 So. 2d 176, 185 (Fla. 2007); Rollins v. Pizzarelli, 761 So. 2d 294, 298 (Fla. 2000).

The same reasoning applies here. The Legislature has shown—in both the partnership statute and the limited partnership statute—that it knows how to make clear that a charging order remedy is an exclusive remedy. The existence of the express exclusive-remedy provisions in the partnership and limited partnership statutes therefore decisively undermines the appellants‘ argument that the charging order provision of the LLC Act—which does not contain such an exclusive remedy provision—should be read to displace the remedy available under section 56.061.

The appellants‘ position is further undermined by the general rule that “repeal of a statute by implication is not favored and will be upheld only where irreconcilable conflict between the later statute and earlier statute shows legislative intent to repeal.” Town of Indian River Shores v. Richey, 348 So. 2d 1, 2 (Fla. 1977). We also have previously recognized the existence of a specific presumption against the “[s]tatutory abrogation by implication of an existing common law remedy, particularly if the remedy is long established.” Thornber v. City of Fort Walton Beach, 568 So. 2d 914, 918 (Fla. 1990). The rationale for that presumption with respect to common law remedies is equally applicable to the “abrogation by implication” of a long-established statutory remedy. See Schlesinger v. Councilman, 420 U.S. 738, 752 (1975) (” ̳[R]epeals by implication are disfavored,‘ and this canon of construction applies with particular force when the asserted repealer would remove a remedy otherwise available.”) (quoting Reg‘l Rail Reorganization Act Cases, 419 U.S. 102, 133 (1974)). Here, there is no showing of an irreconcilable conflict between the charging order remedy and the previously existing judgment creditor‘s remedy and therefore no basis for overcoming the presumption against the implied abrogation of a statutory remedy.

Given the absence of any textual or contextual support for the appellants‘ position, for them to prevail it would be necessary for us to rely on a presumption contrary to the presumption against implied repeal—that is, a presumption that the legislative adoption of one remedy with respect to a particular subject abrogates by implication all existing statutory remedies with respect to the same subject. Our law, however, is antithetical to such a presumption of implied abrogation of remedies. See Richey; Thornber; Tamiami Trails Tours, Inc. v. City of Tampa, 31 So. 2d 468, 471 (Fla. 1947).

In sum, we reject the appellants‘ argument because it is predicated on an unwarranted interpretive inference which transforms a remedy that is nonexclusive on its face into an exclusive remedy. Specifically, we conclude that there is no reasonable basis for inferring that the provision authorizing the use of charging orders under section 608.433(4) establishes the sole remedy for a judgment creditor against a judgment debtor‘s interest in single-member LLC. Contrary to the appellants‘ argument, recognition of the full scope of a judgment creditor‘s rights with respect to a judgment debtor‘s freely alienable membership interest in a single-member LLC does not involve the denial of the plain meaning of the statute. Nothing in the text or context of the LLC Act supports the appellants‘ position.

III. CONCLUSION

Section 608.433(4) does not displace the creditor‘s remedy available under section 56.061 with respect to a debtor‘s ownership interest in a single-member LLC. Answering the rephrased certified question in the affirmative, we hold that a court may order a judgment debtor to surrender all right, title, and interest in the debtor‘s single-member LLC to satisfy an outstanding judgment.

It is so ordered.

QUINCE, C.J., and PARIENTE, LABARGA, and PERRY, JJ., concur.
LEWIS, J., dissents with an opinion, in which POLSTON, J., concurs.

NOT FINAL UNTIL TIME EXPIRES TO FILE REHEARING MOTION, AND IF FILED, DETERMINED.

LEWIS, J., dissenting.

I cannot join my colleagues in the judicial rewriting of Florida‘s LLC Act. Make no mistake, the majority today steps across the line of statutory interpretation and reaches far into the realm of rewriting this legislative act. The academic community has clearly recognized that to reach the result of today‘s majority requires a judicial rewriting of this legislative act. See, e.g., Carter G. Bishop & Daniel S. Kleinberger, Limited Liability Companies: Tax and Business Law, ¶ 1.04[3][d] (2008) (discussing fact that statutes which do not contemplate issues with judgment creditors of single-member LLCs “invite Albright-style judicial invention”); Carter G. Bishop, Reverse Piercing: A Single Member LLC Paradox, 54 S.D. L. Rev. 199, 202 (2009); Larry E. Ribstein, Reverse Limited Liability and the Design of Business Associations, 30 Del. J. Corp. L. 199, 221-25 (2005) (“The situation in Albright theoretically might seem to be better redressed through explicit application of traditional state remedies than by a federal court trying to shoehorn its preferred result into the state LLC statute. The problem . . . is that no state remedy is appropriate because the asset protection was explicitly permitted by the applicable statute. The appropriate solution, therefore, lies in fixing the statute.” (emphasis supplied)); Thomas E. Rutledge & Thomas Earl Geu, The Albright Decision – Why an SMLLC Is Not an Appropriate Asset Protection Vehicle, Bus. Entities, Sept.-Oct. 2003, at 16; Jacob Stein, Building Stumbling Blocks: A Practical Take on Charging Orders, Bus. Entities, Sept.-Oct. 2006, at 29. (stating that the Albright court “ignored Colorado law with respect to the applicability of a charging order” where the “statute does not exempt single- member LLCs from the charging order limitation”). An adequate remedy is available without the extreme step taken by the majority in rewriting the plain and unambiguous language of a statute. This is extremely important and has far- reaching impact because the principles used to ignore the LLC statutory language under the current factual circumstances apply with equal force to multimember LLC entities and, in essence, today‘s decision crushes a very important element for all LLCs in Florida. If the remedies available under the LLC Act do not apply here because the phrase “exclusive remedy” is not present, the same theories apply to multimember LLCs and render the assets of all LLCs vulnerable.

I would answer the certified question in the negative based on the plain language of the statute and an in pari materia reading of chapter 608 in its entirety. At the outset, the majority signals its departure from the LLC Act as it rephrases the certified question to frame the result. The question certified by the Eleventh Circuit requested this Court to address whether, pursuant to section 608.433(4), a court may order a judgment debtor to surrender all “right, title, and interest” in the debtor‘s single-member limited liability company to satisfy an outstanding judgment. The majority modifies the certified question and fails to directly address the critical issue of whether the charging order provision applies uniformly to all limited liability companies regardless of membership composition. In addition, the majority advances a position with regard to chapter 56 of the Florida Statutes that was neither asserted by the parties nor discussed in the opinion of the federal court.

Despite the majority‘s claim that it is not creating an exception to the charging order provision of the statute for single-member LLCs, its analysis necessarily does so in contravention of the plain statutory language and general principles of Florida law. The LLC Act inherently displaces the availability of the execution provisions in chapter 56 of the Florida Statutes by providing a remedy that is intended to prevent judgment creditors from seizing ownership of the membership interests in an LLC and from liquidating the separate assets of the LLC. In doing so, the LLC Act applies uniformly to single- and multimember limited liability companies, and does not provide either an implicit or express exception that permits the involuntary transfer of all right, title, and interest in a single-member LLC to a judgment creditor. The statute also does not permit a judgment creditor to liquidate the assets of a non-debtor LLC in the manner allowed by the majority today. Therefore, under the current statutory scheme, a judgment creditor seeking satisfaction must follow the statutory remedies specifically afforded under chapter 608, which include but are not limited to a charging order, regardless of the membership composition of the LLC.

Although this plain reading may require additional steps for judgment creditors to satisfy, an LLC is a purely statutory entity that is created, authorized, and operated under the terms required by the Legislature. This Court does not possess the authority to judicially rewrite those operative statutes through a speculative inference not reflected in the legislation. The Legislature has the authority to amend chapter 608 to provide any additional remedies or exceptions for judgment creditors, such as an exception to the application of the charging order provision to single-member LLCs, if that is the desired result. However, by basing its premise on principles of law with regard to voluntary transfers, the majority suggests a result that can only be achieved by rewriting the clear statutory provisions. In effect, the majority accomplishes its result by judicially legislating section 608.433(4) out of Florida law.

For instance, the majority disregards the principle that in general, an LLC exists separate from its owners, who are defined as members under the LLC Act. See §§ 608.402(21) (defining “member”), 608.404, Fla. Stat. (2008) (“[E]ach limited liability company organized and existing under this chapter shall have the same powers as an individual to do all things necessary to carry out its business and affairs . . . .”). In other words, an LLC is a distinct entity that operates independently from its individual members. This characteristic directly distinguishes it from partnerships. Specifically, an LLC is not immediately responsible for the personal liabilities of its members. See Litchfield Asset Mgmt. Corp. v. Howell, 799 A.2d 298, 312 (Conn. App. Ct. 2002), overruled on other grounds by Robinson v. Coughlin, 830 A.2d 1114 (Conn. 2003). The majority obliterates the clearly defined lines between the LLC as an entity and the owners as members.

Further, when the Legislature amended the LLC requirements for formation to allow single-member LLCs, it did not enact other changes to the provisions in the LLC Act relating to an involuntary assignment or transfer of a membership interest to a judgment creditor of a member or to the remedies afforded to a judgment creditor. Moreover, no other amendments were made to the statute to demonstrate any different application of the provisions of the LLC Act to single- member and multimember LLCs. For example, the LLC Act generally does not refer to the number of members in an LLC within the separate statutory provisions. The Legislature is presumed to have known of the charging order statute and other remedies when it introduced the single-member LLC statute. Accordingly, by choosing not to make any further changes to the statute in response to this addition, the Legislature indicated its intent for the charging order provision and other statutory remedies to apply uniformly to all LLCs. This Court should not disregard the clear and plain language of the statute.

In addition, the majority fails to correctly set forth the status of a member in an LLC and the associated rights and interests that such membership entails. An owner of a Florida LLC is classified as a “member,” which is defined as

any person who has been admitted to a limited liability company as a member in accordance with this chapter and has an economic interest in a limited liability company which may, but need not, be represented by a capital account.

§ 608.402 (21), Fla. Stat. (2008) (“Definitions”) (emphasis supplied). Therefore, to be a member of a Florida LLC it is now necessary to be admitted as such under chapter 608 and to also maintain an economic interest in the LLC. Moreover, a member of an LLC holds and carries a “membership interest” that encompasses both governance and economic rights:

“Membership interest,” “member‘s interest,” or “interest” means a member‘s share of the profits and the losses of the limited liability company, the right to receive distributions of the limited liability company‘s assets, voting rights, management rights, or any other rights under this chapter or the articles of organization or operating agreement.

§ 608.402(23), Fla. Stat. (2008) (emphasis supplied). This provision was adopted during the 1999 amendments, which was after the modification to allow single- member LLCs. See ch. 99-315, § 1, at 4, Laws of Fla. In stripping the statutory protections designed to protect an LLC as an entity distinct from its owners, the majority obliterates the distinction between economic and governance rights by allowing a judgment creditor to seize both from the member and to liquidate the separate assets of the entity.

Consideration of an involuntary lien against a membership interest must address what interests of the member may be involuntarily transferred. Contrary to the view expressed by the majority, a member of an LLC is restricted from freely transferring interests in the entity. For instance, because an LLC is a legal entity that is separate and distinct from its members, the specific LLC property is not transferable by an individual member. In other words, possession of an economic and governance interest does not also create an interest in specific LLC property or the right or ability to transfer that LLC property. See § 608.425, Fla. Stat. (2008) (stating that all property originally contributed to the LLC or subsequently acquired is LLC property); see also Bishop, supra, 54 S.D. L. Rev. at 226 (discussing in context of federal tax liens the fact that “[t]ypically, a member is not a co-owner and has no transferable interest in limited liability company property”) (citing Unif. Ltd. Liab. Co. Act § 501 (1996), 6A U.L.A. 604 (2003)). The specific property of an LLC is not subject to attachment or execution except on an express claim against the LLC itself. See Bishop & Kleinberger, supra, ¶ 1.04[3][d].

The interpretation of the statute advanced by the majority simply ignores the separation between the particular separate assets of an LLC and a member‘s specific membership interest in the LLC. The ability of a member to voluntarily assign his, her, or its interest does not subject the property of an LLC to execution on the judgment. Under the factual circumstances of the present case, the trial court forced the judgment debtors to involuntarily surrender their membership interests in the LLCs and then authorized a receiver to liquidate the specific LLC assets to satisfy the judgment. In doing so, the trial court ignored the clearly recognized legal separation between the specific assets of an LLC and a member‘s interest in profits or distributions from those assets. See F.T.C. v. Peoples Credit First, LLC, No. 8:03-CV-2353-T-TBM, 2006 WL 1169677, *2 (M.D. Fla. May 3, 2006) (ordering the appellants to “endorse and surrender to the Receiver, all of their right, title and interest in their ownership/equity unit certificates” of the LLCs for the receiver to liquidate the assets of these companies). The majority approves of this disregard by improperly applying principles of voluntary transfers to allow creditors of an LLC member to attack and liquidate the separate LLC assets.

Additionally, the transfer of a membership interest is restricted by law and by the internal operating documents of the LLC. Although a member may freely transfer an economic interest, a member may not voluntarily transfer a management interest without the consent of the other LLC members. See § 608.432(1), Fla. Stat. (2008). Contrary to the view of the majority, in the context of a single-member LLC, the restraint on transferability expressly provided for in the statute does not disappear. Unless admitted as a member to the LLC, the transferee of the economic interest only receives the LLC‘s financial distributions that the transferring member would have received absent the transfer. See § 608.432(2), Fla. Stat. (2008); see also Bishop & Kleinberger, supra, ¶ 1.01[3][c]. Consequently, a member may cease to be a member upon the assignment of the entire membership interest (i.e., transferring all of the following: (1) share of the profits and losses of the LLC, (2) right to receive distributions of LLC assets; (3) voting rights, (4) management rights, and (5) any other rights). See §§ 08.402(23), 608.432(2)(c), Fla. Stat. (2008). Furthermore, a transferring member no longer qualifies under the statutory definition of “member” upon a transfer of the entire economic interest. See § 608.402(21), Fla. Stat. (2008) (defining “member” as a person who has an economic interest in an LLC). However, unless otherwise provided in the governing documents of the entity (i.e., the articles of incorporation and the operating agreement), the pledge or granting of “a security interest, lien, or other encumbrance in or against, any or all of the membership interest of a member shall not cause the member to cease to be a member or to have the power to exercise any rights or powers of a member.” § 608.432(2)(c), Fla. Stat. (2008) (emphasis supplied). Accordingly, a judgment or a charging order does not divest the member of a membership interest in the LLC as the member retains governance rights. It only provides the judgment creditor the economic interest until the judgment is satisfied.

Whether the LLC Act allows a judgment creditor of an individual member to obtain this entire membership interest to exert full control over the assets of the LLC is the heart of the underlying dispute. Neither the Uniform Limited Liability Company Act nor the Florida LLC Act contemplates the present situation in providing for single-member LLCs but restricting the transferability of interests. This problematic issue is not one solely limited to our state, though our decision must be based solely on the language and purpose of the Florida LLC Act. Thus, in my view, this Court must apply the plain meaning of the statute unless doing so would render an absurd result. In contrast, the majority simply rewrites the statute by ignoring those inconvenient provisions that preclude its result.

Legislative Intent With Regard to the Rights of a Judgment Creditor of a Member

I understand the policy concerns of the FTC and the majority with the inherent problems in the transferability of both governance and economic interests under the LLC Act because the plain language does not contemplate the impact of a judgment creditor seeking to obtain the entire membership interest of a single- member LLC and to obtain the ability to liquidate the assets of the LLC. The Florida statute simply does not create a different mechanism for obtaining the assets of a single-member LLC as opposed to a multimember LLC and, therefore, there is no room in the statutory language for different rules.

However, I decline to join in rewriting the statute with inferences and implications, which is the approach adopted by the majority. This Court generally avoids “judicial invention,” as accomplished by the majority, when the statute may be construed under the plain language of the relevant legislative act. See Bishop & Kleinberger, supra, ¶ 1.04[3][d]. In construing a statute, we strive to effectuate the Legislature‘s intent by considering first the statute‘s plain language. See Kasischke v. State, 991 So. 2d 803, 807 (Fla. 2008) (citing Borden v. East- European Ins. Co., 921 So. 2d 587, 595 (Fla. 2006)). When, as it is here, the statute is clear and unambiguous, we do not “look behind the statute‘s plain language for legislative intent or resort to rules of statutory construction to ascertain intent.” Daniels v. Fla. Dep‘t of Health, 898 So. 2d 61, 64 (Fla. 2005). This is especially applicable in the instance of a business entity created solely by state statute.

If the statute had been written as the majority suggests here, I would agree with the result requested by the FTC. However, the underlying conclusion lacks statutory support. By reading only self-selected provisions of the statute to support this result, the majority disregards the remainder of the LLC Act, which destroys the isolated premise that the charging order provision only applies to multimember LLCs and that other statutory restrictions do not exist.

Additionally, exceptions not found within the statute cannot simply be read into the statute, as the majority does by holding that single-member LLCs are an implicit exception to the charging order provision. The remedy provided to the FTC by the federal district court and approved by the majority in this instance— that a judgment creditor of a single-member LLC is entitled to receive a surrender and transfer of the full right, title, and interest of the judgment debtor and to liquidate the LLC assets—is not provided for under the plain language of the LLC Act without judicially writing an exception into the statute.

Judgment Creditor Can Charge the Debtor Member’s Interest in the LLC
With Payment of the Unsatisfied Judgment

As a construct of statutory creation, an LLC is an entity separate and distinct from its members, and thus the liability of the LLC is not directly imputed to its members. In a similar manner, the liability of individual members is not directly imposed separately upon the LLC.

Although a member‘s interest in an LLC is considered to be personal property, see § 608.431, Fla. Stat. (2008), and personal property is generally an asset that may be levied upon by a judgment creditor under Florida law, see § 56.061, Fla. Stat. (2008), there are statutory restrictions in the LLC context. Any rights that a judgment creditor has to the personal property of a judgment debtor are limited to those provided by the applicable creating statute.

The appellants contend that if a judgment creditor may seek satisfaction of a member‘s personal debt from a non-party LLC, the plain language of the LLC Act limits the judgment creditor to a charging order. See § 608.433(4), Fla. Stat. (2008). A charging order is a statutory procedure whereby a creditor of an individual member can satisfy its claim from the member‘s interest in the limited liability company. See Black‘s Law Dictionary 266 (9th ed. 2009) (defining term in the context of partnership law). It is understandable that the FTC challenges the charging order concept being deemed a remedy for a judgment creditor because, from the creditor‘s perspective, a charging order may not be as attractive as just seizing the LLC assets. For example, a creditor may not receive any satisfaction of the judgment if there are no actual distributions from the LLC to the judgment creditor through the debtor-member‘s economic interest. See Elizabeth M. Schurig

& Amy P. Jetel, A Shocking Revelation! Fact or Fiction? A Charging Order is the Exclusive Remedy Against a Partnership Interest, Probate & Property, Nov.-Dec. 2003, at 57, 58. The preferred creditor‘s remedy would be a transfer and surrender of the membership interest that is subject to the charging order, which is a more permanent remedy and may increase the creditor‘s chances of having the debt satisfied. See id.

The application of the charging order provision, including its consequences and implications, has been hotly debated in the context of both partnership and LLC law because of the similarities of these entities. The language of the charging order provision in the Revised Uniform Limited Partnership Act (1976), as amended in 1985, is virtually identical to that used in the Uniform Limited Liability Company Act, as well as in the Florida LLC Act. See §§ 608.433(4), 620.153, Fla. Stat. (2008). The Uniform Limited Partnership Act of 2001 significantly changed this provision by explicitly allowing execution upon a judgment debtor‘s partnership interest. See Schurig & Jetel, supra, at 58. However, the Florida Partnership Act provides that a charging order is the exclusive remedy for judgment creditors. See § 620.8504(5), Fla. Stat. (2008) (stating the charging order provision provides the “exclusive remedy by which a judgment creditor of a partner or partner‘s transferee may satisfy a judgment out of the judgment debtor‘s transferable interest in the partnership”). In the context of partnership interests, Florida courts have also determined that a charging order is the exclusive remedy for judgment creditors based on the straightforward language of the statute. See Givens v. Nat‘l Loan Investors L.P., 724 So. 2d 610, 612 (Fla. 5th DCA 1998) (holding that charging order is the exclusive remedy for a judgment creditor of a partner); Myrick v. Second Nat‘l Bank of Clearwater, 335 So. 2d 343, 345 (Fla. 2d DCA 1976) (substantially similar). The Florida LLC Act has neither adopted an explicit surrender-and-transfer remedy nor does it include a provision explicitly stating that the charging order is the exclusive remedy of the judgment creditor. The plain language of the charging order provision only provides one remedy that a judgment creditor may choose to request from a court and that the court may, in its discretion, choose to impose. See § 608.433(4), Fla. Stat. (2008).

To support its conclusion that charging orders are inapplicable to single- member LLCs, the majority compares the provision in the partnership statute that mandates a charging order as an exclusive remedy to the non-exclusive provision in the LLC Act. The exclusivity of the remedy is irrelevant to this analysis. By relying on an inapplicable statute, the majority ignores the plain language of the LLC Act and the other restrictions of the statute, which universally apply the use of a charging order to judgment creditors of all LLCs, regardless of the composition of the membership. The majority opinion now eliminates the charging order remedy for multimember LLCs under its theory of “nonexclusivity” which is a disaster for those entities.

Plain Meaning of the Statute’s Actual Language

The charging order provision does not act as a reverse-asset shield against the creditors of a member. Instead, the LLC Act implements statutory restrictions on the transfer and assignment of membership interests in an LLC. These restrictions limit the mechanisms available to a judgment creditor of a member of any type of LLC to obtain satisfaction of a judgment against the membership interest. Specifically, section 608.433(4) grants a court of competent jurisdiction the discretion to enter a charging order against a member‘s interest in the LLC in favor of the judgment creditor:

608.433. Right of assignee to become member.—

  1. Unless otherwise provided in the articles of organization or operating agreement, an assignee of a limited liability company interest may become a member only if all members other than the member assigning the interest consent.
  2. An assignee who has become a member has, to the extent assigned, the rights and powers, and is subject to the restrictions and liabilities, of the assigning member under the articles of organization, the operating agreement, and this chapter. An assignee who becomes a member also is liable for the obligations of the assignee‘s assignor to make and return contributions as provided in s. 608.4211 and wrongful distributions as provided in s. 608.428. However, the assignee is not obligated for liabilities which are unknown to the assignee at the time the assignee became a member and which could not be ascertained from the articles of organization or the operating agreement.
  3. If an assignee of a limited liability company interest becomes a member, the assignor is not released from liability to the limited liability company under ss. 608.4211, 608.4228, and 608.426.
  4. On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the limited liability company membership interest of the member with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of such interest. This chapter does not deprive any member of the benefit of any exemption . . . .

§ 608.433, Fla. Stat. (2008) (emphasis supplied).

The majority asserts that the placement of the charging order provision
within the section titled “Right of assignee to become member” mandates that the provision only applies to circumstances where the interest of the member is subject to the rights of other LLC members. There is absolutely nothing to support the notion that the Legislature‘s placement of the charging order provision as a subsection of section 608.433, instead of as a separately titled section elsewhere in the statute, was intended to unilaterally link its application only to the multimember context. For instance, the Revised Uniform Limited Liability Company Act, unlike the Florida statute, places the charging order provision as a separately titled section within the article that discusses transferable interests and rights of transferees and creditors. See Unif. Ltd. Liab. Co. Act § 503 (revised 2006), 6B U.L.A. 498 (2008). Other states have also adopted a statutory scheme that places the charging order remedy within a separate provision specifically dealing with the rights of a judgment creditor. See Conn. Gen. Stat. § 34-171 (2007). Thus, the majority‘s interpretation would again fail by a mere movement of the charging order provision to a separately titled section within the Act.

In contrast to the majority, my review of this provision begins with the actual language of the statute. In construing a statute, it is our purpose to effectuate legislative intent because “legislative intent is the polestar that guides a court‘s statutory construction analysis.” See Polite v. State, 973 So. 2d 1107, 1111 (Fla. 2007) (citing Bautista v. State, 863 So. 2d 1180, 1185 (Fla. 2003)) (quoting State v. J.M., 824 So. 2d 105, 109 (Fla. 2002)). A statute‘s plain and ordinary meaning must be given effect unless doing so would lead to an unreasonable or absurd result. See City of Miami Beach v. Galbut, 626 So. 2d 192, 193 (Fla. 1993). Here, the plain language establishes a charging order remedy for a judgment creditor that the court may impose. This section provides the only mechanism in the entire statute specifically allocating a remedy for a judgment creditor to attach the membership interest of a judgment debtor. In the multimember context, the uncontested, general rule is that a charging order is the appropriate remedy, even if the language indicates that such a decision is within the court‘s discretion. See Myrick, 335 So. 2d at 344. As the Second District explained:

Rather, the charging order is the essential first step, and all further proceedings must occur under the supervision of the court, which may take all appropriate actions, including the appointment of a receiver if necessary, to protect the interests of the various parties.

Id. at 345. Without express language to the contrary, the discretionary nature of this remedy applies with equal force to single- and multimember LLCs, which the majority erases from the statute.

Nevertheless, the certified question before us is not the discretionary nature of this remedy but whether a court should even apply the charging order remedy to single-member LLCs. The majority rephrases the question certified to this Court as not considering whether an exception to the charging order provision should be implied for single-member LLCs. In doing so, the majority unjustifiably alters and recasts the question posited by the federal appellate court to fit the majority‘s result. The convoluted alternative presented by the majority is premised on a limited application of a charging order without express language in the statutory scheme to support this assertion.

Here, the plain language crafted by the Legislature does not limit this remedy to the multimember circumstance, as the majority holds. Further, exceptions not made in a statute generally cannot be read into the statute, unless the exception is within the reason of the law. See Cont‘l Assurance Co. v. Carroll, 485 So. 2d 406, 409 (Fla. 1986) (“This Court cannot grant an exception to a statute nor can we construe an unambiguous statute different from its plain meaning.”); Dobbs v. Sea Isle Hotel, 56 So. 2d 341, 342 (Fla. 1952) (“We apprehend that had the legislature intended to establish other exceptions it would have done so clearly and unequivocally. . . . We cannot write into the law any other exception . . . .”). Thus, without going behind the plain language of the statute, at first blush, the statute applies equally to all LLCs, regardless of membership composition.

The distinction asserted by the FTC is clearly inconsistent with the plain language of section 608.434 with regard to the proper method for a judgment creditor to reach the interest of a member in a LLC in that a complete surrender of the membership interest and the subsequent liquidation of the LLC assets are not contemplated by the LLC Act. The majority‘s interpretation that the charging order remedy only applies to multimember LLCs can only be given effect if the plain language of this provision renders an absurd result, which it does not.

The purpose of creating the charging order provision was never limited to the protection of “innocent” members of an LLC. Moreover, when amending the LLC Act to permit single-member LLCs, the Legislature did not also amend the assignment of interest and charging order provisions to create different procedures for single- and multimember LLCs. The appellants argue that this indicates a manifestation of legislative intent; however, it appears more likely that our Legislature, as with many other states, had not yet contemplated the situation before us. Even so, the appropriate remedy in this circumstance is not for this Court to impose its speculative interpretation, but for the Legislature to amend the statute to reflect its specific intention, if necessary. When interpreting a statute that is unambiguous and clear, this Court defers to the Legislature‘s authority to create a new limitation and right of action. Here, the actual language of the statute does not distinguish between the number of members in an LLC. Thus, the charging order applies with equal force to both single-member and multimember LLCs, and the assignment provision of section 608.433 does not render an absurd result.

The majority purports to base its analysis on the plain language of the statute. However, the FTC and a multitude of legal theorists agree that the plain language of the statute does not support this result. See e.g., Bishop & Kleinberger, supra, ¶ 1.04[3][d]; Bishop, supra, 54 S.D. L. Rev. at 202; Ribstein, supra, 30 Del. J. Corp. L. at 221-25; Rutledge & Geu, supra, Bus. Entities, Sept.- Oct. 2003 at 16; Stein, supra, Bus. Entities, Sept.-Oct. 2006 at 28. All authorities recognize that the sole way to achieve the result desired by the FTC and the majority is to ignore the plain language of the statute. No external support exists for the majority‘s bare assertions.

Rights of an Assignee

The plain language of section 608.433(4) applies the charging provision to the judgment creditor of both a single-member and multimember LLC. The next analytical step is to determine what rights that charging order provision grants the judgment creditor. To the extent that a membership interest is charged with a judgment, the plain text of the statute specifically provides that the judgment creditor only possesses the rights of an assignee of such interest. See § 608.433(4), Fla. Stat. (2008) (“To the extent so charged, the judgment creditor has only the rights of an assignee of such interest.”).

To determine the rights of an assignee of such an interest, we look to section 608.432, which defines these rights. To divine the intent of the Legislature, we construe related statutory provisions together, or in pari materia, to achieve a consistent whole that gives full, harmonious effect to all related statutory provisions. See Heart of Adoptions, Inc. v. J.A., 963 So. 2d 189, 199 (Fla. 2007) (quoting Forsythe v. Longboat Key Beach Erosion Control Dist., 604 So. 2d 452, 455 (Fla. 1992)). The FTC asserts that the rights delineated in this section render an absurd result when applied to single-member LLCs; however, the FTC ignores that the same rule applies even if only a part of a member‘s interest is needed to satisfy a debt amount. Further, an assignee is entitled solely to an economic interest and is not entitled to governance rights without the unanimous approval of the other members or as otherwise provided in the articles of incorporation or the operating agreement.

The plain reading of this provision does not establish the judgment creditor as an assignee of such interest, only that to the extent of the judgment amount charged to the economic interest, the judgment creditor has the same rights as an assignee. Though section 608.433(4) directs that the judgment creditor has only the rights of an assignee of such interest, as provided in section 608.432, it is important to clarify that the judgment creditor does not become an assignee; the language merely indicates that the judgment creditor‘s rights do not exceed those of an assignee.

This clear distinction can be seen when considering the voluntary and involuntary nature of these different interests—an assignment is generally a voluntary action made by an assignor, whereas a charging order is clearly an involuntary assignment by a judgment debtor. For that reason, the majority formulates a false conclusion that section 404.433(1) provides a foundation for the bare assertion that a charging order is inapplicable in the context of a single- member LLC. Exploiting this false foundation, the majority asserts a result that is unsupportable when considered in pari materia with the entirety of the statutory scheme.

The question before this Court requires articulation of a general principle of law that applies to all types of judgments, whether less than, equal to, or greater than the value of a membership interest, and to all types of LLCs. Reading section 608.433(4) and 608.432 together, a judgment creditor may be assigned a portion of the economic interest, depending on the amount of the judgment. This provision contemplates that a charging order may not encompass a member‘s entire membership interest if the judgment is for less than the available economic distributions of an LLC. For instance, if the LLC membership interest here were worth more than the $10 million judgment, it would be unnecessary under this provision to transfer the full economic interest in the LLC to satisfy the judgment. Further, a member does not lose the economic interest and membership status unless all of the economic interest is charged to the judgment creditor. See § 608.432(2)(c), Fla. Stat. (2008). Thus, if the judgment were for less than the value of either the membership interest or the assets in the LLC, the members could transfer a portion of their economic interest and still retain their membership interest, in that they would still hold an economic and governance interest in the LLC. The FTC would then only have the right to receive distributions or allocations of income in an amount corresponding to satisfaction of a partial economic interest. Regardless of the amount of the interest assigned, the judgment creditor does not immediately receive a governance interest. See § 608.432(1), (2), Fla. Stat. (2008).

In such a circumstance, the result contemplated by the FTC does not come to pass—the single member maintains his, her, or its membership rights because a member only ceases to be a member and to have the power to exercise any governance rights upon assignment of all of the economic interest of such member. See id. The majority disregards this factual possibility and considers only the application of the statutory scheme in the context of a judgment that is equal to or greater than the value of the membership interest. Under the majority‘s interpretation of the statute, a judgment creditor could force a single-member LLC to surrender all of its interest and liquidate the assets specifically owned by the LLC, even if the judgment were for less than the assets‘ worth.

Alternative Remedies

Currently, the plain language of the statute provides additional remedies to the charging order provision for judgment creditors seeking satisfaction on a judgment that is equal to or greater than the economic distributions available under a charging order—(1) dissolution of the LLC, (2) an order of insolvency against the judgment debtor, or (3) an order conflating the LLC and the member to allow a court to reach the property assets of the LLC. First, upon the issuance of a charging order that exceeds a member‘s economic interest in an LLC for satisfaction of the judgment, dissolution may be achieved because the remaining member ceases to possess an economic interest and governance rights in the LLC following the assignment of all of its membership interest. See § 608.432(2)(c), Fla. Stat. (2008) (“Assignment of member‘s interest”). The statutory provision with regard to the assignment of a member‘s interest provides, in relevant part:

(2) Unless otherwise provided in the articles of organization or operating agreement:
….

(c) A member ceases to be a member and to have the power to exercise any rights or powers of a member upon assignment of all of the membership interest of such member. Unless otherwise provided in the articles of organization or operating agreement, the pledge of, or granting of a security interest, lien, or other encumbrance in or against, any or all of the membership interest of a member shall not cause the member to cease to be a member or to have the power to exercise any rights or powers of a member.

Id. (emphasis supplied). This demonstrates a clear and unambiguous distinction between a voluntary assignment of all the interest and the granting of an encumbrance against any or all of the membership interest. Because a “member” is defined as an actual or legal person admitted as such under chapter 608, who also has an economic interest in the LLC, it is the assignment of all of that economic interest that divests the member of his, her, or its status and power. Thus, if the charging order is only for a part of the economic interest held by the judgment debtor, the statute does not require that the member cease to be a member. See §§ 608.402(21), 608.432(2)(c), Fla. Stat. (2008). If, on the other hand, the charging order is to the extent that it requires a surrender of all of the member‘s economic interest, in that circumstance, the member ceases to be a member under section 608.432(2)(c). In the case of a member-managed LLC, this would leave the LLC without anyone to govern its affairs. However, within the manager-managed LLC context, the manager would remain in a position to direct the LLC and distribute any profits according to any governing documents.

This provision need not be limited to single-member LLCs. For example, if the appellants had entered into a multimember LLC, that entity would be subject to the same statutory construction issues as a single-member LLC. Once the FTC obtained a judgment against a member of the multimember LLC, a charging order would be lodged against that member‘s interest. In that circumstance, though there may be charging orders against separate membership interests, in essence the same divestiture of the membership interest would occur if the judgment was for all of each member‘s economic interest.

It is important to note, however, if an LLC becomes a shell or legal fiction with no actual governing members, the LLC shall be dissolved under section 608.441. The dissolution statute provides:

(1) A limited liability company organized under this chapter shall be dissolved, and the limited liability company‘s affairs shall be concluded, upon the first to occur of any of the following events:

(d) At any time there are no members; however, unless otherwise provided in the articles of organization or operating agreement, the limited liability company is not dissolved and is not required to be wound up if, within 90 days, or such other period as provided in the articles of organization or operating agreement, after the occurrence of the event that terminated the continued membership of the last remaining member, the personal or other legal representative of the last remaining member agrees in writing to continue the limited liability company and agrees to the admission of the personal representative of such member or its nominee or designee to the limited liability company as a member, effective as of the occurrence of the event that terminated the continued membership of the last remaining member; or

….
(4) Following the occurrence of any of the events specified in this section which cause the dissolution of the limited liability company, the limited liability company shall deliver articles of dissolution to the Department of State for filing.

§ 608.441(1)(d), (4), Fla. Stat. (2008) (emphasis supplied). A dissolved LLC continues its existence but does not carry on any business except that which is appropriate to wind up and liquidate its business and affairs under section 608.4431. Once dissolved, the liquidated assets may then be distributed to a judgment creditor holding a charging order. See § 608.444(1), Fla. Stat. (2008).

The judgment creditor may also seek an order of insolvency against the individual member, in which instance that member ceases to be a member of the single-member LLC, and the member‘s interest becomes part of the bankruptcy estate. In Florida, the commencement of a bankruptcy proceeding also terminates membership within an LLC. See §§ 608.402(4), 608.4237, Fla. Stat (2008). The decisions advanced by the FTC involved bankruptcies of the judgment debtor, and the rights of a judgment creditor in a bankruptcy are substantially different than the rights of a judgment creditor generally. See In re Modanlo, 412 B.R. 715 (Bankr. D. Md. 2006), aff‘d, No. 06-2213 (4th Cir. 2008); In re Albright, 291 B.R. 538, 539 (Bankr. D. Colo. 2003). Upon commencement of a bankruptcy proceeding, a bankruptcy estate includes all legal or equitable property interests of the debtor.

An LLC membership interest is the personal property of the member. Therefore, when a judgment debtor files for bankruptcy, or is subject to an order of insolvency, the judgment debtor effectively transfers any membership interest in an LLC to the bankruptcy estate. In this context, it is reasonable for the bankruptcy courts to construe the LLC Act to no longer require a charging order because the judgment debtor has passed the entire membership interest to the bankruptcy estate, and the trustee stands in the shoes of the judgment debtor, who is now seeking reorganization of its assets. See, e.g., In re Albright, 291 B.R. at 541. The majority refuses to even acknowledge any of these approaches.

This bankruptcy context is distinguishable from the general case of a judgment creditor seeking to execute upon the assets of an LLC because the judgment may not meet or exceed the economic interest remaining in the LLC. Thus, the Albright bankruptcy situation should not alter our determination that the plain language of the statute applies the charging order provision to both single- and multimember LLCs. This may be a more complicated procedure than to allow a court to simply “shortcut” and rewrite the law and enter a surrender-and-transfer order of a member‘s entire right, title, and interest in an LLC as the majority accomplishes today. However, it is the method prescribed by the statute. Although the procedures created by the statute may involve multiple steps and legal proceedings, they are not absurd or irreconcilable with chapter 608 as a whole.

A Charging Order, in and of Itself, Does Not Entitle a Judgment Creditor to
Seize and Dissolve a Florida LLC

Based on the plain language of the statute and the construction of chapter 608 in pari materia, I would answer the certified question in the negative: A court may not order a judgment debtor to surrender and transfer outright all “right, title, and interest” in the debtor‘s single-member LLC to satisfy an outstanding judgment. If a judgment creditor wishes to proceed against a single-member LLC, it may first request a court of competent jurisdiction to impose a charging order on the member‘s interest. If the judgment creditor is concerned that the member is constraining distribution of assets and incomes, the creditor may seek judicial remedies to enforce proper distribution. In addition, if the economic interest so charged is insufficient to satisfy the judgment, the judgment creditor may move through additional proceedings: (1) seek to dissolve the LLC and to have its assets liquidated and subsequently distributed to the judgment creditor; (2) seek an order of insolvency against the judgment debtor, in which case the trustee of the bankruptcy estate will control the assets of the LLC, or (3) request a court to pierce the liability shield to make available the personal assets of the company to satisfy the personal debts of its member. This plain reading of chapter 608 may create additional steps for judgment creditors and judgment debtors to satisfy, as characterized by the federal district court in this case. However, only the Legislature, as the architects of this statutorily created entity, has the authority to provide a more streamlined surrender of these rights, not the judicial branch through selective reading and rewriting of the statute. As enacted, the plain meaning of the statute is unambiguous and does not require “judicial invention” of exceptions that are clearly not provided in the LLC Act. If the Legislature wishes to make either an exception to the charging order provision for single-member LLCs or to provide additional remedies to judgment creditors, it may do so through an amendment of chapter 608.

Accordingly, I would answer the certified question in the negative. Under Florida law, a court does not have the authority to order an LLC member to surrender and transfer all right, title, and interest in an LLC and have LLC assets liquidated without first going through the statutory requirements created by the Legislature.

POLSTON, J., concurs.

Certified Question of Law from the United States Court of Appeals for the
Eleventh Circuit – Case Nos. 06-13254-DD and 03-02353-CV-T-17-TBM

Thomas C. Little, Clearwater, Florida,

for Appellant

William Blumenthal, General Counsel, John F. Daly, Deputy General Counsel and John Andrew Singer, Attorney, Federal Trade Commission, Washington, D.C.,

for Appellee

Daniel S. Kleinberger, Professor, William Mitchell College of Law, St. Paul, Minnesota,

As Amicus Curiae

Colish v. United States

In re Jerrie S. COLISH, Debtor. Jerrie S. Colish, Plaintiff, v. United States of America, Department of Treasury Internal Revenue Service, Defendant. United States of America, Third-Party Plaintiff, v. Jerrie S. Colish, Third-Party Defendant.United States Bankruptcy Court, E.D. New York.289 B.R. 523Bankruptcy No. 197-14664-608. Adversary Nos. 197-1399-608, 00-01633-608.Oct. 23, 2002.

Wendy J. Kisch, Batholomew Cirenza, Department of Justice, Tax Division, Washington, D.C., for United States.

Gary C. Fischoff, Fischoff and Associates, Garden City, NY, for Debtor, Plainttiff and Third-Party Defendant.

DECISION AND ORDER

CARLA E. CRAIG, Bankruptcy Judge.

This matter comes before the Court on the complaint of Jerrie S. Colish (“Colish” or “Debtor”) to have his debt to the Intertnal Revenue Service (“Government”) for his assessed federal income tax liabilities for years 1987 through 1992 declared dischargeable under 11 U.S.C.  523(a)(1) and, additionally, on the complaint of Government seeking a determination that Debtor’s Chapter 7 discharge should be revoked pursuant to 11 U.S.C.  727(d)(2).

Procedural History

On April 29, 1997, Debtor filed a voluntary petition under Chapter 7 of the United States Bankruptcy Code (11 U.S.C.) and was granted a discharge of all dischargeable debts on August 19, 1997.

On August 8, 1997, Colish filed a complaint (Govt.Ex. R1.) to commence an adversary proceeding, wherein he requested that the Court issue an order declaring his assessed federal income tax liabilities for years 1986 through 1993 dischargeable under 11 U.S.C.  523(a)(1). On September 30, 1999, the Honorable Laura Taylor Swain, to whom this case was then assigned, determined that Debtor’s 1993 assessed federal income tax liabilities were non-dischargeable priority liabilities pursuant to 11 U.S.C.  507(a)(8)(A)(ii). In the Matter of Jerrie S. Colish, 239 B.R. 670 (Bankr.E.D.N.Y.1999). Hence, the only years for which dischargeability is still in dispute are tax years 1987 through 1992.

Subsequently, on October 26, 2000, the Government commenced an adversary proceeding seeking the revocation of Debtor’s Chapter 7 discharge pursuant to 11 U.S.C.  727(d)(2) on the grounds that Debtor failed to disclose on Schedule B of the bankruptcy petition his remainder interest in a trust established by his father and that Debtor, additionally, failed to disclose and surrender to the Chapter 7 Trustee cash and other property distributions he received from the trust upon the maturing of his remainder interest. (Govt.Ex. S1.) On January 17, 2001, the Court denied the Government’s motion to consolidate both adversary proceedings, but ordered that the two adversary proceedings be tried jointly. Consequently, on September 4 and 5 of 2001 and November 20, 2001, the above-entitled adversary proceedings were tried simultaneously. At the conclusion of the trial, the Court directed the parties to file post-trial briefs.

This Court has considered thoroughly all submissions, evidence, and arguments relating to this matter, and the decision rendered herein reflects such consideration.

Jurisdiction

This Court has jurisdiction over these proceedings pursuant to 28 U.S.C.  151, 157 and 1334, and both these adversary proceedings are core proceedings pursuant to 28 U.S.C.  157(b)(2)(I) and (b)(2)(J).

Facts

Debtor’s Work Experience and Education

Debtor is an attorney who holds a Juris Doctor (J.D.) degree from the University of Miami Law School and Masters of Law (LL.M.) degree in taxation from the University of Miami Law School. (T1 63.) 1 In addition to his legal education, Debtor has a “Series 7” license to sell variable securities and a license to sell life insurance products. (JPTO 2  5 (4).)

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1. References to T1 refer to the September 4, 2001 transcript. References to T2 refer to the September 5, 2001 transcript. References to T3 and T4 refer to the morning and afternoon transcripts from November 30, 2001.

2. References to “JPTO” are to the Joint Pre-Trial Order approved by the Court on September 4, 2001.

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Debtor has substantial work experience in both private legal practice and in the sale of securities. From 1979 through October of 1985, Debtor practiced law, advising clients on federal tax issues and corporate and partnership formations. (JPTO  7.) Later, from 1985 to 1987, Debtor was hired by Equityline Securities as its vice president and general counsel, and worked in sales, marketing, analysis, due diligence and wholesaling. (JPTO  9.)

After an extensive period of time working as an independent wholesaler of securities, from October of 1987 through November 1994 (JPTO ╤ 10.), Debtor was employed by a Wall Street securities firm, D.H. Blair, as a retail sales broker, from late 1994 to late 1996. (JPTO  10.) Subsequently, starting in late 1996 and through the time of trial, Debtor has worked with a venture capital firm, Spencer Trask. (T1 at 67.)

At the time of trial, Debtor resided in a rented 4-bedroom apartment in Brooklyn, New York and had resided there since June 1993. (JPTO ╤ 32) From 1988 to 1993, Debtor resided in a rented apartment in Pennsylvania. Debtor leased a 1986 Buick Skylark from 1986 to 1991. (JPTO  31.)

Debtor’s Expenses and Lifestyle

From 1986 to 1998, other than normal living expenses, Debtor’s expenses mainly consisted of: 1) child support payments pursuant to a marriage settlement agreement, 2) tuition payments for private school education for his four children, and 3) charitable contributions and gifts made to his ex-wife and friends.

Pursuant to a marriage settlement agreement (“Agreement”), dated March 28, 1988, Debtor and his wife became legally separated. Debtor has four children. Under the terms of the Agreement, Debtor agreed to pay $375 per month, per child as support. (Debtor’s Ex. 2  7.) The Agreement further provides increases in the amount of support annually in the amount of “one-half of the excess of his net income from all sources over Sixty-Thousand ($60,000) Dollars” and that child support in no instance shall exceed $600 per month per child. (Debtor’s Ex. 2  7.) However, the $600 maximum allowance per month per child apparently could be modified “provided that the needs of the children . . . require more.” Furthermore, pursuant to  8 of the Agreement, Debtor was to pay for his children’s college expenses provided that he was financially able to do so. 3 Nothing in the Agreement required the Debtor to fund the cost of private elementary or secondary school education.

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3. Debtor and his former wife agreed:

to contribute to the reasonable cost of undergraduate college education …debtor’s obligation is conditioned on: 1) his being consulted with respect to the choice of educational institutions…, and 2) upon the children making application for any financial aid [Debtor] deems appropriate, and 3) upon [debtor’s] financial ability to pay.

Paragraph 8, Marriage Settlement Agreement, Debtor’s Exhibit 2, at 6.

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Nevertheless, beginning in 1986 and continuing on through 1999, Debtor paid for his children’s private school education. (T1 at 113, 124.) Although all four chil╜dren graduated from Abrams Hebrew Academy in Yardley, Pennsylvania, one daughter attended boarding school (T2 at 45, 76) and one son went to public high school for two years. (T1 at 124.) The tuition at the private schools amounted to $16,000 in 1986, and steadily rose throughout the period at issue, reaching $33,000 in 1992. The tuition remained relatively constant from 1992 to 1997 at $33,000, before increasing substantially in 1998 to $48,500 due to one of Debtor’s children attending college. 4

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4. In 1998, Debtor’s oldest daughter began attending Philadelphia College of Science and Textiles, a private school in Philadelphia, Pennsylvania. See Trial Transcript (9/5/01) at 42.

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Furthermore, commencing in 1989 and continuing through 1998, Debtor made charitable contributions. (T2 at 20-21.) The contributions varied significantly from year to year, ranging from a low of $1,774 in 1997 to a high of $15,962 in 1993. (Govt. Ex. D3 through D12.)

In addition, Debtor gave substantial sums of money to close friends and his ex-wife. In 1998, Debtor gave his ex-wife $12,500. (Govt. Ex. PP; T2 93.) It was initially given as a loan, but later the Debtor forgave the loan, and it became a gift. (T2 at 93.) Debtor also felt responsible for the losses incurred by three friends who had invested and lost money on Debtor’s advice. (T1 at 182-183.) As a result, Debtor gave three $20,000 nonrecourse loans each to the three friends. 5 Repayment was solely conditioned on the successful investment of the loans. (T1 at 182-183.)

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5. One $20,000 check was returned.

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Tax Return Filings: 1987-1998

On October 12, 1988, Debtor filed late his federal income tax return for the 1987 tax year in which he made a payment of $2,302 through employer withholding. (Govt.Ex A1 A2.) His return reflected that he owed tax in the amount of $11,675, inclusive of interest and penalties, thus leaving a deficiency of $9,373. Id .

On April 15, 1989, Debtor timely filed his federal income tax return for the 1988 tax year in which he failed to make any payment. His return reflected that he owed tax in the amount of $6,579, inclusive of interest and penalties, thus leaving a deficiency in such amount. Id.

On March 18, 1991, Debtor filed late his federal income tax return for the 1989 tax year in which he made estimated payments of $3,250. His return reflected that he owed tax in the amount of $27,315, inclusive of penalties and interest, leaving a deficiency of $24,065. Id.

On June 3, 1991, Debtor timely filed his federal income tax return for the preceding year in which he made estimated payment of $100. His return reflected that he owed tax in the amount of $25,050, inclusive of interest and penalties, leaving a deficiency of $24,950. Id .

On April 10, 1992, Debtor timely filed his federal income tax return for the preceding year in which he did not make any payments. His return reflected that he owed tax in the amount of $16,207, inclusive of interest and penalties, leaving a deficiency in such amount. Id.

On April 15, 1993, Debtor timely filed his federal income tax return for the preceding year in which he made an estimated payment of $11,310. His return reflected that he owed tax in the amount of $27,042, leaving a deficiency of $15,732. Id.

On April 15, 1994, Debtor timely filed his federal income tax return for the preceding year in which he failed to make any payment. His return reflected that he owed tax in the amount of $38,913. Id.

On April 15, 1995, Debtor timely filed his federal income tax return for the preceding year in which he made an estimated payment of $9,250. His return reflected that he owed tax in the amount of $25,462, inclusive of interest and penalties, leaving a deficiency of $16,212. Id.

On April 15, 1996, Debtor timely filed his federal income tax return for the preceding year, and made a payment of $28,936 through employer withholding. His return reflected that he owed tax in the amount of $26,611, inclusive of interest and penalties, leaving an overpayment of $2,770, which was credited to his 1986 tar liability. Id.

On April 27, 1997, Debtor timely filed his federal income tax return for the preceding year, and made a payment of $27,009 through employer withholding. His return reflected tax in the amount of $12,516, inclusive of interest and penalties, leaving an overpayment of $14,493, which was credited to his 1986 tax liability. Id.

On June 25, 1998, Debtor filed late his federal income tax return for the preceding year, and made a payment of $20,826, through employer withholding. His return reflected tax in the amount of $12,324, inclusive of interest and penalties, leaving an overpayment of $8,502. Id.

On October 19, 1999, Debtor filed late his federal income tax return for the preceding year reporting no tax liability. On February 1, 2000, Debtor filed an Amended Return and made a $8,671 estimated payment as well as a $573 payment through employer withholding. His return reflected that he owed tax in the amount of $88,028, leaving a deficiency of $84,744. Id.

Serial Offers in Compromise

On April 30, 1992, Debtor submitted his first offer-in-compromise to the Government wherein he sought to compromise his tax liabilities for years 1986 through 1991, totaling $78,319, plus interest and penalties based on “doubt as to collectability” by offering to make future estimated tax payments and by paying $12,500. (Govt.Ex. F1.) The offer was amended on June 10, 1992 and again on April 5, 1993. (Govt.Ex. F2.) Under the revised offer, Debtor offered to pay $12,916 to compromise total reported tax liabilities of $85,241 for tax years 1987 through 1992. (Govt.Ex. F2.) On December 2, 1993, the Government rejected Debtor’s first offer, as amended, based on Debtor’s statement to the Government that the funds were no longer available. (Govt.Ex. F4.)

On April 20, 1994, Debtor submitted his second offer-in-compromise, seeking to pay only $12,500 for his total reported unpaid liabilities of $123,464 for tax years 1987 through 1993. (Govt.Ex. C.) The Debtor was, in effect, submitting the same amount as previously offered but attempting to satisfy an additional tax year as well. The Government determined that the Debtor actually had over $119,447 in net equity from which to collect outstanding tax liabilities of $130,780. (See attachment to Govt. Ex. G3.) As a result, the Government formally rejected that offer on August 19, 1994, after determining that a much larger amount was collectible by the it. (Govt.Ex. G2.)

On September 15, 1994, Debtor submitted his third offer-in-compromise, which was amended on May 18, 1995. (Govt.Ex. H1.) As amended, Debtor offered to pay $20,000 to compromise total reported lia╜bilities of $147,64. (Govt.Ex. H2.) The Government rejected Debtor’s offer by letter dated June 22, 1995, and afforded him the opportunity to protest the decision. Debtor’s final offer was rejected by letter on May 14, 1997 because a larger amount was deemed collectible. (Govt.Ex. H6.)

The Mannie S. Colish Trust

Mannie S. Colish, Debtor’s father, established the Mannie S. Colish Trust (“Trust”) on October 25, 1979. (Govt.Ex. W, X1, X2, Y.) The Trust provided a life estate interest to Lorraine S. Colish, Debt╜or’s mother, and equal vested remainder interests to Debtor and his sister, Julie Colish. Mannie Colish died on January 11, 1981. (T1 at 140.) Upon his father’s death, Debtor learned that he was a beneficiary of the Trust. (Govt.Ex. W, X1, X2, Y.) The Trust provided that Lorraine Col╜ish had a testamentary power of appointment, which permitted her, by her last Will and Testament, to divest either re╜mainder interest in the Trust. (Govt.Ex. W, X1, X2, Y.)

At the time of filing the bankruptcy petition, Debtor failed to disclose his remainder interest in the Trust in schedules filed with this Court. (Govt. Ex. P, Sch. “B”, lines 18, 19; T1 at 145.) The Government contends that it only became aware of Debtor’s interest in the Trust during settlement negotiations with the Debtor for adversary proceeding no. 97-1399, after which it commenced an adversary proceeding to revoke Debtor’s discharge pursuant to 11 U.S.C.  727(d)(2). (T4 at 18-19.)

On December 20, 199 7, Lorraine Colish died and the Debtor became entitled to collect his remainder interest. (T1 at 140-141; Ex. AA.) Subsequently, from January 1998 through June 1998, Debtor received cash and other property distributions from the Trust, totaling $718,000. (T1 at 142.) As part of the distributions, Debtor received $479,631 from a land contract held by the Trust. (T1 at 165-1661; Govt. Ex. 00.) On January 13, 1998, Debtor wire-transferred his share of these proceeds from his Citizens Bank account in Flint, Michigan to an account he maintained with Chase Bank in New York. (T1 at 169.) Next, Debtor transferred $450,000 from the Chase account to a savings account opened at Citibank. ( Id. ) On January 27, 1998 Debtor transferred $200,000 from the Citibank savings account into Citibank checking account and $245,335 into a 7-day CD. (T1 at 170.) Debtor then transferred $100,000 of the $200,000 in the Citibank checking account to a personal account at Spencer Trask (held by Schroeder Bank). (T1 at 184.)

On March 23, 1998, Debtor created a Nevada Limited Partnership, Phoenix Samson Associates, L.P. in which Debtor was named a general partner and limited partner, holding a 96% interest of the partnership and the Jerrie Saul Colish Irrevocable Children’s Trust (“Irrevocable Trust”), a limited partner, holding the other 4% interest. (Govt. Ex. J; T1 at 180.) Debtor funded the partnership with cash and property valued at $740,625, including his Spencer Trask account, his newly opened Citibank accounts, numerous stock warrants, various general and limited partnership interests acquired from the Trust and extensive personal property. 6 Of the contributed funds, Debtor treated $711,000 (96% interest in partnership) as coming from himself and the other $29,625 coming from the Irrevocable Trust. However, the entire amount clearly came from Debtor’s interest in the Trust. (T1 at 160-161.)

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6. The debtor contributed several items of personal property, including furniture, household items, clothing, furs, jewelry, musical instruments, silverware, china, crystal, paintings, books, collectibles, electronic audio and video equipment, computers, appliances and other property. (T1 at 157-180, Ex. J.)

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Discussion

Pursuant to 11 U.S.C.  523(a)(1)(C), Debtor’s 1987 through 1992 Assessed Federal Income Tax Liabilities Are Non-Dischargeable

A discharge in bankruptcy does not discharge debtor of all debts.

523(a)(1)(C) provides in relevant part:

Section 523. Exceptions to Discharge

(a) A discharge under  727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual Debtor from any debt-

(1) for a tax or customs duty-

(C) with respect to which Debtor made a fraudulent return or willfully attempted in any manner [italics to highlight] to evade or defeat such tax.

The two exceptions to dischargeability in  523(a)(1)(C) are to be read in the disjunctive. “Nondischargeability under 523(a)(1)(C) is not limited to finding a fraudulent return.” In re Fernandez, 112 B.R. 888, 891 (Bankr.N.D.Ohio 1990); In re Tudisco, 183 F.3d 133 (2d Cir.1999). Therefore, in order to prevail, the Government must prove that the Debtor either made a fraudulent return or the Debtor willfully attempted to evade or defeat payment of taxes. In re Lilley, 152 B.R. 715, 720 (Bankr.E.D.Pa.1993); In re Griffith, 161 B.R. 727 (Bankr.S.D.Fla.1993).

At issue in Adversary Proceeding No. 197-1399 is whether Debtor willfully attempted in any manner to evade or defeat payment of taxes for tax years 1987 through 1992. The Second Circuit has recently held that the “willfulness exception consists of a conduct element (an attempt to evade or defeat taxes) and a mens rea requirement (willfulness).” In re Tudisco, 183 F.3d 133, 136 (2d Cir. 1999).

The burden of proof is the ordinary civil standard; the government must show by a preponderance of the evidence that the claim should be excepted from discharge. Grogan v. Garner, 498 U.S. 279, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991); Langlois v. United States, 155 B.R. 818, 820 (N.D.N.Y.1993). We also bear in mind that exceptions to discharge are construed in favor of the Debtor. In re Birkenstock, 87 F.3d 947, 951 (7th Cir.1996).

The Second Circuit has recently declined to decide whether more than a simple nonpayment of taxes is required to satisfy  523(a)(1)(C)’s conduct requirement or whether  523(a)(1)(C) “encompasses both acts of commission as well as culpable omissions.” In re Tudisco, 183 F.3d at 137 (quoting Bruner v. United States (In re Bruner), 55 F.3d 195, 200 (5th Cir.1995) (holding that  523(a)(1)(C) “encompasses both acts of commission as well as culpable omissions”)). However, the Second Circuit, in Tudisco, has joined the majority of the courts in holding that a failure to pay a known tax duty is, at a minimum, “relevant evidence which a court should consider in the totality of conduct to determine whether . . . the debtor willfully attempted to evade or defeat taxes.” Dalton v. IRS, 77 F.3d 1297, 1301 (10th Cir.1996). Nonpayment of tax coupled with concealment of assets or income, or a pattern of failure to file returns is sufficient to establish conduct aimed at “evading or defeating taxes.” See, e.g., In re Tudisco , 183 F.3d 133 (nonpayment of tax, failure to file and submission of false affi╜davit to employer intended to establish exemption from withholding), In re Birkenstock, 87 F.3d 947 (nonpayment of tax, failure to file, creation of shell trust); Dalton v. Internal Revenue Service, 77 F.3d 1297 (concealing assets and underestimating ownership interest in property on bankruptcy schedule).

The Second Circuit has interpreted “willfully” for purposes of  523(a)(1)(C) to require that debtor’s attempts to avoid his tax liability be undertaken “voluntarily, consciously or knowingly, and intentionally.” In re Tudisco, 183 F.3d 133, 137 (2d Cir.1999) (quoting Dalton, 77 F.3d at 1302).

Because direct proof of intent is rarely found, courts look to circumstantial evidence to determine debtor’s intent. Such evidence may include evidence outside the tax years in question, “if sufficiently related in time and character to be probative.” In re Birkenstock, 87 F.3d at 951 (quoting United States v. Birkenstock, 823 F.2d 1026, 1028 (7th Cir.1987)).

In the case at bar, there are a number of facts which, when taken together, show that the Debtor intended to evade or defeat taxes. Debtor, an attorney with an LL.M. in tax, despite the knowledge that he was required to pay estimated taxes and to fully pay his tax liabilities by April 15th of each year (T1 at 137), did not pay his federal income taxes for thirteen years, except to the extent tax was withheld by his employers, and his tax obligation has accumulated over this period, resulting in total tax liabilities to date of $228,277.60. (Govt.Ex. A1-A2.) Debtor failed to fully pay his tax liabilities for tax years 1986 through 1998, with the exception of tax years 1995 through 1997 when his employer was withholding taxes from his wages. (Govt. Ex. C, D9-D11; T1 at 131-32. )

Second, Debtor failed to timely file returns for tax years 1986, 1987, 1989, 1996, 1997 and 1998. It was only from tax years 1990 through 1995 that Debtor timely filed his tax returns. However, during this period, Debtor was negotiating three separate offers-in-compromise with the IRS and was required to comply with Internal Revenue Service Regulations, which included timely filing returns as a condition of acceptance of the offers-in-compromise. Moreover, Debtor attempted to thwart or at the very least delay the collection of his tax liabilities by filing serial offers-in-compromise from 1990 to 1995. In re Myers, 216 B.R. 402 (6th Cir. BAP 1998) (finding that  523(a)(1)(C)’s modifying phrase “in any manner” is “broad enough to encompass attempts to thwart the payment of taxes”). The undisputed evidence shows that Debtor, an intelligent, highly educated tax attorney who was familiar with the offer-in-compromise process, succeeded in delaying the Government’s collection efforts for more than five years by submitting offers which were clearly too low in relation to the tax obligations owed. 7 In addition, Debtor knew that, while the offers were pending, he could forestall collection of all tax liabilities under consideration, which permitted him to delay filing bankruptcy and seeking discharge of his taxes. (Govt. Ex. F1-G1 (╤ 4), H1, H2 (╤ 7(d)).)

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7. Under Debtor’s offer, as revised, he was to pay only $12,916 to compromise total reported unpaid liabilities of $85,241 for the tax years 1987 through 1992 (Govt.Ex. C). Based on Debtor’s reported income, this was not a legitimate offer.

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Third, Debtor, aware of his remainder interest at the time of filing the bankruptcy petition, failed to disclose this interest to this Court despite the fact that Schedule B explicitly asked whether Debtor had any contingent or future interests at the commencement of the case. Debtor’s failure to list his remainder interest in the Trust prevented the Government from asserting a secured claim position based on tax liens that had attached to all of Debtor’s property.

As the Government pointed out at trial, had the Debtor reported his remainder interest in the bankruptcy schedules, even if he had reported the value as zero, the Trustee and the Government would have had an opportunity to inquire as to its value and the Government would have asserted a secured claim on this interest, permitting the Government to receive the value of the remainder interest at the time the interest matured post-petition. (T3 at 47-54.) As a general matter, federal tax liens survive bankruptcy and, to the extent that they are secured by the liened property, they remain enforceable against the liened property, despite the fact that the underlying obligations are dischargeable. See, e.g., In. re Isom 901 F.2d 744 (9th Cir.1990); In re Dillard, 118 B.R. 89 (Bankr.N.D.Ill.1990); U.S. v. Alfano, 34 F.Supp.2d 827 (E.D.N.Y.1999). The omis╜sion further enabled the Debtor to receive $718,000 in distributions, which he chan╜neled to various accounts and ultimately a limited partnership in Nevada in an at╜tempt to conceal his assets from the Government and thwart the collection of his tax obligations.

Fourth, Debtor did not even fully pay his $88,000 tax liability for the 1998 tax year when he received over $718,000 in distributions from the Trust, nor did he even make any effort to pay his tax obligations owed for prior years.

Debtor argues that an inference of intent to evade or defeat taxes should not be drawn from these facts, for the following reasons.

First, Debtor contends that he did not pay his 1998 tax obligations because he had future obligations, and because he was attempting to reach a settlement with the Government on prior taxes. (T1 at 114-115, and at 118-119.) The existence of future obligations is no excuse not to pay current tax obligations, In re Haesloop, 2000 WL 1607316 (Bankr.E.D.N.Y.2000), and it is not clear how a desire to reach a settlement on prior taxes would preclude payment of current taxes. Additionally, Debtor argues that the reason he did not pay his prior tax obligations when he received the Trust distributions was that he thought these prior taxes were discharged already. However, this is a weak argument, as Debtor knew that his 1994 tax liability was a priority tax liability and did not attempt to challenge it in his complaint for Adversary Proceeding No. 197-1399. (Govt.Ex. R1.)

Second, Debtor argues that the reason he did not pay his taxes each year was because, by the time April 15 came around each year, he did not have enough money on hand to pay his taxes. (T1 at 9, 102, 109-110.) This argument fails to convince this Court. Debtor did have the funds to pay his tax liabilities. The evidence shows that Debtor could have easily paid his tax obligations had he spent less money on tuition payments, gifts, charitable contributions and child support payments in excess of his obligations under the court-ordered arrangement with his ex-wife. From 1986 to 1999, Debtor spent $420,000 on tuition payments, spent approximately $62,725 on excess child support payments, made charitable contributions in the amount of $68,389, gave gifts to his ex-wife and close friends totaling $72,500 and made highly speculative investments in which he lost $269,000. In comparison, Debtor accumulated total tax liabilities of $288,277.60 of which a significant portion, if not all, could have been paid within a reasonable amount of time had Debtor refrained from spending all his money on the above-listed discretionary expenses. In a recent case, under a similar set of facts, the Debtor, an attorney, channeled money that could have been used for his tax liabilities to personal expenses, such as paying his daughter’s “Ivy League” education, maintaining a country house and paying his wife’s tax liabilities. In re Haestoop, 2000 WL 1607316 (Bankr.E.D.N.Y.2000). In that case, the court found that had debtor made reasonable adjustments to his standard of living he could have easily paid his tax debt in full and held that the debtor willfully attempted to evade or defeat his tax obligations within the meaning of  523(a)(1)(C). The fact that the debtor’s income, in Haesloop, was $275,000 per year and Debtor’s income, on average during the relevant period, was $67,000 per year, makes no difference. Had Debtor refrained from spending more than half his income on discretionary expenses such as private education and excess child support payments, he would have easily been able to pay his tax obligations within a reasonable period of time.

Furthermore, this Court rejects Debtor’s related argument that he led a frugal modest lifestyle and that he was faced with “Hobson’s Choice” between payments of his tax obligations on the one hand, and financial contributions and support to his family on the other. (Debtor’s Post-Trial Memorandum of Law, at 5.) Courts have held that a debtor has willfully evaded his taxes under  523(a)(1)(C) where he had the wherewithal to pay his tax obligations but chose to apply his income to discretionary expenses such as private education for his children and financial support to his family members. In re Haesloop, 2000 WL 1607316, In re Wright, 191 B.R. 291, 295 (S.D.N.Y.1995) (debtor spent “thousands of dollars” on tuition payment for Ivy League education for his children, paid substantial credit card charges of wife and daughter, and helped support his brother and mother); In re Eleazar, 271 B.R. 766 (Bankr.D.N.J.2001) (debtor paid substantial credit card debt of his family member). Debtors do not owe a duty to supply their children with nonessential luxuries such as private education absent some evidence that the debtor’s children would not be served by a public school education. In re Griffieth, 209 B.R. 823, 828 (Bankr. N.D.N.Y.1996).

Debtor claims that as an Orthodox Jew he has an obligation to send his chil╜dren to Jewish day schools. (T1 at 113.) While there is no case directly addressing whether a debtor has a constitutional right to send his children to religious school, courts have held that a debtor does not have a constitutional right to make charitable contributions under the free exercise clause of the First Amendment. In re Griffieth, 209 B.R. 823, 828 (Bankr. N.D.N.Y.1996), Church of Lukumi Babalu Aye., Inc. v. Hialeah, 508 U.S. 520, 113 S.Ct. 2217, 124 L.Ed.2d 472 (1993). This Court sees no basis for finding a right, constitutional or otherwise, to pay religious school tuition in preference to tax obligations.

If this Court were to permit every debtor to receive a discharge of his or her tax liabilities every time a debtor decided to spend income on discretionary personal expenses at the expense of tax obligations, claiming that he or she was faced with conflicting monetary obligations, then  523(a)(1)(C) would be meaningless. In this case, Debtor had the wherewithal to pay his taxes had he not spent most of his income on discretionary expenses and taken affirmative steps, after receipt of distributions from his father’s trust, to place his assets beyond the reach of creditors.

This is not a case where Debtor was ignorant of his tax obligations. Indeed, like the debtors in Haesloop and Wright, Debtor, an intelligent attorney with an LL.M. in tax, clearly knew he had a duty to pay his tax obligations and voluntarily and consciously chose to ignore these obligations. At trial, the Debtor testified that “the IRS came at the bottom of his list along with three or four hundred thousand worth of other creditors” (T3 at 24) because they didn’t “scream loud enough” (T3 at 24) and that he would pay “whichever creditors were yelling the loudest” (T2 at 16) and that his “landlord, car payments and child support payments” were timely made so that his “ex-wife wouldn’t yell at me.” (T2 at 16.)

Section 523(a)(1)(C) renders nondischargeable attempts in any manner to evade or defeat a tax. The totality of the Debtor’s conduct here constitutes a scheme of willful evasion and conduct to defeat the payment of his tax liabilities.

In conclusion, the Court, having considered the totality of Debtor’s conduct, finds that Plaintiff willfully attempted to evade or defeat his tax obligations within the meaning of  523(a)(1)(C) of the U.S. Bankruptcy Code. Accordingly, the principal amount of Debtor’s outstanding tax debt and the interest and penalties hereon, for each of the tax years in dispute, 1987 through 1992, are non-dischargeable.

Pursuant to 11 U.S.C  727(d)(2), Debtor’s Discharge Should Be Revoked

Section 727(d)(2) of the United States Bankruptcy Code (11 U.S.C.) provides in pertinent part:

(d) On request of the trustee, a creditor, or the United States trustee, and after notice and hearing, the court shall revoke a discharge granted under subsection (a) of this section if-

(2) the debtor acquired property that is property of the estate, or became entitled to acquire property of the estate, and knowingly and fraudulently failed to report the acquisition of or entitlement to such property, or to deliver or surrender such property to the trustee.

The burden of proof under  727(d)(2) is preponderance of the evidence, and not, as Debtor’s counsel argues, the clear and convincing standard. Although this Court, in In re Kirschner, 46 B.R. 583 (Bankr.E.D.N.Y.1985), held that the appropriate standard in a  727(d)(1) case was clear and convincing evidence, the U.S. Supreme Court in Grogan v. Garner, 498 U.S. 279, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991), applied the preponderance of evidence standard to dischargeability issues under 11 U.S.C. ╖523. Several other courts have subsequently applied the preponderance of evidence standard to discharge revocation proceedings under 11 U.S.C.  727 because similar considerations of intent are involved in both provisions. See, e.g., In re Serafini, 938 F.2d 1156 (10th Cir.1991); In re Bowman, 173 B.R. 922 (9th Cir. BAP 1994); In re Sylvia, 214 B.R. 437, 440 (Bankr.D.Conn. 1997); In re Barr, 207 B.R. 168 (Bankr. N.D.Ill.1997); In re Trost, 164 B.R. 740 (Bankr.W.D.Mich.1994); In re Wolfson, 139 B.R. 279 (Bankr.S.D.N.Y.1992).

The Government contends that Debtor’s remainder interest in the Trust was property of the estate at the time of the filing of the petition, and should have been disclosed on Schedule “B”. (Plaintiffs Post-Trial Brief, at 40.) In addition, the Government asserts that Debtor failed to report acquisitions of cash from and maturing of Debtor’s remainder interest to the Court or the Trustee. (Plaintiffs Post-Trial Brief, at 40.) In response, Debtor advances two arguments. First, he contends that his interest in the Trust was both subject to a discretionary power of appointment by the income beneficiary, Lorraine Colish, and also non-assignable and thus was not property of the estate. (Debtor’s Post-Trial Memorandum of Law, at 10-14.) Second, he argues that he relied on his attorney’s advice in not listing his remainder interest in the Trust in the schedules of his bankruptcy petition, and therefore that his failure to disclose the interest in his bankruptcy filing was not “knowing and fraudulent”. (Debtor’s Post-Trial Memorandum of Law, at 10-14.)

Both Debtor’s counsel and the Government agree that the scope of property of the estate under  541 of the U.S. Bankruptcy Code includes “all legal or equitable interests of the debtor in property as of the commencement of the case”. 11 U.S.C.  541. This provision has been broadly construed. In re Yonikus, 996 F.2d 866, 869 (7th Cir.1993) (“every conceivable interest of the debtor, future, nonpossessory, contingent, speculative, and derivative, is within the reach of  541”). Although  541 defines the scope of the property of the estate, applicable state law determines the issue of whether debtor has a legal or equitable interest in property. Butner v. United States, 440 U.S. 48, 54, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979).

Both parties also agree that since the Trust was established in Michigan, Michigan law applies. Under Michigan law, the trustee holds legal title to the corpus and the beneficiaries hold the equitable interest. In re Page, 239 B.R. 755, 763 (Bankr.W.D.Mich.1999). In the case at bar, the Trust provided that testator’s wife, Lorraine Colish, would be the income beneficiary of the Trust assets during her life, and Debtor and his sister, Julie Colish, had remainder interests in the trust assets which would mature on the death of Lorraine Colish. The Trust contained two provisions which are of particular importance in this case. First, Section 5B.3(d) of the Trust provides that Lorraine Colish had a special power to appoint, only by specific reference in her Will, the trust assets to any of testator’s children or their descendants as she would determine in her sole discretion 8 . Second, Section 7.4 of the Trust contains a clause which essentially prevents the assignment or transfer of the beneficiary’s interest in the trust’s principal and income to his beneficiaries unless the trustee determines that such transfer is in the best interest of the beneficiary.

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8. Section 5B.3(d) of the trust states: “Spouse’s Special Power. My spouse shall have special testamentary power of appointment to appoint outright, in a trust or otherwise, with such estates, powers, limitations or conditions as she shall determine, to any one or more of my children or to their descendants (…) such amounts as my spouse, in my spouse’s sole discretion shall determine, provided this power shall not be exercised for the purpose of discharging my spouse’s legal obligations. ( . . . ) This power shall only be exercisable only by specific reference thereto in my spouse’s will.”

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Debtor relies on two cases, In re Knight, 164 B.R. 372 (Bankr.S.D.Fla.1994), and In re Hicks, 22 B.R. 243 (Bankr. N.D.Ga.1982), for the proposition that where an interest is subject to a testamentary special power of appointment, the potential beneficiary does not have an interest that would be property of the estate. (Debtor’s Post-Trial Memorandum of Law, at 10-13.) In Knight, the debtor scheduled certain property as contingent unvested interests in trusts and the issue was whether these trust interests were included as property of the estate. Debtor’s parents established two separate trusts, the Dorothy Trust and the Charles Trust, which was later divided into Charles A trust and Charles B Trust. The Dorothy Trust provided that upon the death of Dorothy, the life beneficiary, the trust principal would be distributed equally to debtor and his sister, if they were alive. The Charles A Trust provided that Dorothy would receive all her income from this trust during her life and also permitted Dorothy, by power of appointment exercisable by Dorothy alone and in her sole discretion, to name debtor or his sister as beneficiaries. The court held that debtor’s interest in the Charles A Trust was too remote to have value and did not constitute property of the estate. In re Knight, 164 B.R. at 376. However, the debtor’s interest in the Dorothy Trust was held to be property of the debtor’s estate, despite the existence of contingencies, which the court acknowledged reduced the actual value of the interest.

In Hicks, the debtor alleged that he had a vested remainder interest in his father’s trust. Debtor’s father died ten years prior to debtor’s filing of his bankruptcy petition and debtor’s mother was given a life estate in the residuary trust as well as a power of appointment, which enabled her to direct the trustee to turn over the trust assets to any descendant of her late husband. As of the bankruptcy filing date, the mother had not exercised her power of appointment and was still alive. The court held that debtor’s interest would only vest upon the occurrence of two contingencies: 1) the mother’s exercise of the power of appointment naming debtor as beneficiary and 2) the debtor surviving his mother. The court reasoned that it could not compel debtor’s mother to exercise her power of appointment naming him as beneficiary and further that under Georgia law, the debtor’s interest would only vest on the death of the mother, the life tenant. In re Hicks, 22 B.R. at 245.

The case at bar is distinguishable from the above cases. First, unlike Knight, the debtor in this case was actually named as a beneficiary under the Trust and was to receive 50% of the trust assets upon the death of the life beneficiary, Lorraine Colish. (Govt. Ex. W, X1, X2, Z1 and Z2.) In contrast, in Knight, the Charles A Trust did not provide that debt╜or was to receive the principal or income upon the death of the life beneficiary (unlike the Charles Part B Trust and the Dorothy Trust, which were held to be property of the estate), but merely permitted the life beneficiary to name any descendant of the testator upon her death, pursuant to the power of appointment. Second, Lorraine Colish, unlike the life beneficiaries in both Knight and Hicks, actually did exercise her power of appointment in her Last Will, prior to the filing of the bankruptcy petition. On January 8, 1985, Lorraine Colish executed a Last Will and Testament under ITEM XVII in which she refrained from exercising any power of appointment that she may have had at the time of her death. (Govt.Ex. CC1) Further, on October 29, 1997, she executed a First Codicil to her Last Will and Testament in which she did not change ITEM XVII in the Last Will. (Govt.Ex. CC2.) Consequently, the Debtor’s argument that the Court could not compel the .life tenant to refrain from divesting Debtor of his interest in the Trust or to name him as beneficiary is unavailing: in this case there was no need to do so. Third, the court in Hicks placed emphasis on the fact that under Georgia law, the debtor’s interest would only vest on the death of the life tenant, who happened to be still alive at the time of the filing of the bankruptcy petition. Here, in contrast, although the life beneficiary was still alive at the time of the bankruptcy filing, the Debtor’s interest had already vested, because under Michigan law, as the Government properly notes, a remainderman’s interest vests at the time of the death of the testator, not the life tenant. (United States Post-Trial Brief, at 43.) In re Hurd’s Estate, 303 Mich. 504, 6 N.W.2d 758, 760 (1942) (listing cases in support of the long-standing preference for vested estates); In re Childress Trust, 194 Mich. App. 319, 486 N.W.2d 141, 143 (1992).

For these reasons, this Court concludes that Debtor’s interest in the Trust was not too remote or speculative to not be included in the property of the estate. Furthermore, although subject to possible divestment by the life beneficiary, Debtor’s interest was a vested remainder interest. Even if Debtor’s interest was found to be a contingent remainder interest, this alone would not preclude it from being property of the estate, provided the interest was not circumscribed by a spendthrift provision. See, e.g., In re Neuton, 922 F.2d 1379 (9th Cir.1990) (fact that debtor’s interest in trust was contingent on surviving life tenant did not preclude it from being property of estate); In re Dias, 37 B.R. 584, 586-587 (Bankr.D.Idaho 1984) (a beneficial interest is an equitable interest under  541(a)(1) despite the fact that at the time of filing petition it was contingent).

Debtor further argues that pursuant to both Section 7.4 of the Trust and  541(c)(2) of the U.S. Bankruptcy Code, his interest in the Trust was non-assignable and not reachable by his creditors and thus should not be included in the property of the estate. 9

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9. ═  541(c)(2) states in relevant part:

(c)(1) Except as provided in paragraph (2) of thus subsection, an interest of the debtor in property becomes property of the estate. . .notwithstanding any provision in any agreement, transfer instrument, or applica╜ble nonbankruptcy law

(c)(2) A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.

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Michigan law recognizes the validity of restrictions on the transfer of beneficial interests in spendthrift trusts. In re Edgar Estate, 137 Mich.App. 419, 357 N.W.2d 867 (1984). The United States Supreme Court has ruled that in accordance with the plain meaning of  541(c)(2), property is excluded from the estate when 1) debtor has a beneficial interest in a trust, 2) there is restriction on the transfer of such interest, and 3) the restriction is enforceable under applicable nonbankruptey law. Patterson v. Shumate, 504 U.S. 753, 757-758, 112 S.Ct. 2242, 119 L.Ed.2d 519 (1992).

This Court finds that the spendthrift provision in the Trust constitutes a valid spendthrift provision. Under Michigan law, the provisions of the trust instrument must demonstrate grantor’s intent to “provide a fund for the maintenance of the beneficiary and at the same time to secure the fund against his improvidence or incapacity.” In re Barnes, 264 B.R. 415 (Bankr.E.D.Mich.2001) (quoting Black’s Law Dictionary). In the case at bar, the main purpose of the spendthrift clause was to provide a source of income for the testator’s wife, Lorraine, and secure the fund against any improvidence or incapacity of the wife or other beneficiaries by delegating complete control over the distribution of the funds to the trustee. 10 As a result, in the case at bar, Debtor’s vested remainder interest in the spendthrift trust would be excluded from the estate pursuant to  541(c)(2), were it not for the effect of federal tax law.

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10. The spendthrift clause clearly states that the principal and income of the trust are to be free from interference of the creditors of any beneficiary and not subject to assignment or anticipation by any beneficiary unless the trustee determines this to be in the best interest of the beneficiary. See Section 7.4 of the Trust (Creditor’s Clause).

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The Bankruptcy Code recognizes federal tax law as “applicable nonbankruptcy laws” for purposes of enforcing a  541(c)(2) exemption. Patterson, 504 U.S. at 758-759, 112 S.Ct. 2242 (“Plainly read, the provision encompasses any relevant nonbankruptcy law, including federal law”); United States v. Dallas National Bank, 152 F.2d 582, 585 (5th Cir.1945) (holding that Internal Revenue statutes are federal laws). It is well-settled that courts draw from “Federal tax lien law as a source of ‘applicable nonbankruptcy’ law that overrides any state law restriction on the Government’s reaching the debtor’s rights.” In re Lyons, 148 B.R. 88, 93 (Bankr.D.D.C. 1992); see, e.g., Bank One v. United States, 80 F.3d 173, 176 (6th Cir.1996) (“Under the great weight of federal authority, however, such restraints on alien╜ation [referring to spendthrift provisions in a trust] are not effective to prevent a federal tax lien from attaching under 26 U.S.C.  6321.”) Section 6321 of the Internal Revenue Code (26 U.S.C.) provides that “if any person liable to pay a tax neglects or refuses to pay the same after demand, the amount shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.” 26 U.S.C.  6321; United States v. National Bank of Commerce, 472 U.S. 713, 719-20, 105 S.Ct. 2919, 86 L.Ed.2d 565 (1985) (the language of  6321 is broad and is reflective of a congressional intent to “reach every interest in property that a taxpayer may have”). Thus, although the spendthrift clause prevented creditors of the Debtor from reaching his remainder interest in the Trust, the United States’ federal tax lien can be satisfied against any income distributions of the Trust provided that the liens attached to Debtor’s property prior to the Debtor’s bankruptcy filing, the liens were properly filed federal tax liens and Debtor’s remainder interest constitutes a legal or equitable right defined as “property” or “rights to property” subject to attachment under federal law. Jones v. Internal Revenue Service, 206 B.R. 614, 621 (Bankr.D.D.C.1997) (observing that certain property has “a split personality by remaining property of the estate for purposes of federal tax claims even though it is not property of the estate for purposes of other creditors’ claims”); In the Matter of Orr, 180 F.3d 656 (5th Cir.1999) (holding that federal tax liens attached to future distributions from the spendthrift trust at the time of the creation of the lien, which predated and survived the bankruptcy, and not at the time that each distribution was made).

In this case, the United States filed Notices of Federal Tax Liens for each of the years 1987 through 1993, thereby making each of those liabilities secured claims in the Chapter 7 case. (Govt.Ex. A1, A2.); 11 U.S.C.  506(a). Generally, the federal tax lien arises at the time the assessment is made and continues until the liability is satisfied or becomes unenforceable by reason of lapse of time. 26 U.S.C.  6332; United States v. City of New Britain, 347 U.S. 81, 74 S.Ct. 367, 98 L.Ed. 520 (1954) (describing federal tax lien as general lien when attached at the time of assessment to all of the taxpayer’s property, was thus perfected). Furthermore, under Michigan law, a debtor’s interest in a spendthrift trust, be it contingent or remainder, is “property” or “rights to property” under 26 U.S.C.  6321. Bank One v. United States, 80 F.3d at 175. In addi╜tion, the Government’s lien on the property of the taxpayer, when taxpayer fails to pay taxes after assessment, notice and demand, attaches to all property and rights to taxpayer’s property, including property subsequently acquired by taxpayer. 26 U.S.C.A.  6321, 6322.

As a result, the federal tax liens attached to Debtor’s vested remainder interest in the Trust at the time of the creation of the liens, which predated the bankruptcy, and the liens attached to Debtor’s af╜ter-acquired property, namely the matur╜ing of Debtor’s remainder interest and the resulting distributions from the Trust post-discharge.

The only question remaining before this Court is whether Debtor knowingly and fraudulently failed to report to the Court or surrender to the Chapter 7 Trustee his remainder interest in the Trust and the cash and other property distributions he received from the maturing of his remainder interest pursuant to  727(d)(2) of the U.S. Bankruptcy Code. 11

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11. Although there is disagreement whether Section 727(d)(2) applies only to post-petition entitlement or receipt of property or whether it applies to both pre-petition property and post-petition property, this issue does not affect this Court’s analysis because the debtor’s pre-petition remainder interest in the Mannie S. Colish Trust actually matured, and the proceeds of the trust were distributed to him, after his discharge in bankruptcy. Compare In re Argiannis, 183 B.R. 307 (Bankr.M.D.Fla. 1995), In re Puente, 49 B.R. 966, 968 (Bankr. W.D.N.Y.1985) (holding that Section 727(d)(2) applies only to entitlement or acquisition of post-petition property) with In re Barr, 207 B.R. 168 (Bankr.N.D.Ill.1997) (holding that  727(d)(2), by its plain reading, is not limited to property acquired post-peti╜tion, but extends to property acquired prepetition).

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To find the requisite degree of fraudulent intent under  727(d)(2), the court must find the debtor knowingly intended to defraud, or engaged in such reckless behavior as to justify the finding of fraud. In re Puente, 49 B.R. 966, 969 (Bankr.W.D.N.Y.1985). The requisite fraudulent intent or recklessness may be proven by evidence of the debtor’s awareness of the omitted asset and by showing that the debtor knew that failure to list the asset could seriously mislead the trustee or creditors or that the debtor acted so recklessly in not reporting the asset that fraud is implied. 4 Collier on Bankruptcy ╤ 727 .15[4] (1992). As direct evidence of the debtor’s intent can rarely be found, the courts have relied on the inferences drawn from a course of conduct and all surrounding circumstances in finding fraudulent in╜tent. Matter of Reed, 700 F.2d 986, 991 (5th Cir.1983) (debtor’s whole pattern of conduct supports the court’s finding of fraudulent intent); In re Kindorf, 105 B.R. 685, 689 (Bankr.M.D.Fla.1989) (in determining debtor’s actual intent, court considered all circumstances, including debtor’s systematic transfer of excess of $143,000 to his wife, comprising his salary, income from partnership interest and gifts from parents, as well as debtor’s failure to disclose the existence of a Swiss bank account in his schedules in which he held a substantial sum), In re Yonikus, 974 F.2d 901, 905 (7th Cir.1992).

In the case at bar, Debtor became aware of his remainder interest in his father’s estate soon after his father’s death on January 11, 1981. (T1 at 140.) On December 20, 1997, Debtor’s mother, Lorraine Colish, died. Despite knowledge of his remainder interest in the trust, debtor failed to disclose his interest in the schedules filed with this Court. Rather, Debtor, on Schedule “B” of the bankruptcy petition, expressly denied possessing any “future” interest or any “contingent and non contingent interests in estate of a decedent …or trust.” (Gov. Ex. P. Declaration Concerning Debtor’s Schedules.) Debtor testified that he “didn’t read the particular item[s] concerning future interest, life estates, contingent and noncontingent interest in estates” and that “had [he] read that, [he] would have never signed this petition.” (T1 at 147.) Furthermore, Debtor claims that he told his attorney, William Bryk, about his interest in the Trust and that he decided not to disclose such interest on Schedule B of the bankruptcy petition upon ad-vice of counsel. (T1 at 148.) These explanations are not credible and, in addition, lack merit.

It is well established that the advice of counsel is a complete defense to a charge of fraud where a full and fair disclosure of the facts is made. Jones v. Gertz, 121 F.2d 782, 784 (10th Cir.1941); In re Topper, 229 F.2d 691 (3rd Cir.1956); In re Stone, 52 F.2d 639 (D.N.H.1931). However, the reliance must be in good faith and any protection based on reliance on debtor’s counsel will only act as a pro╜tection to the extent the reliance was reasonable. In re Weber, 99 B.R. 1001, 1018 (Bankr.D.Utah 1989).

In Jones, the debtor was to provide architectural services on certain public construction contracts but later filed bankruptcy because he did not have suffi╜cient funds to pay his necessary travel expenses to supervise the work. Debtor was owed a small sum from Adams County and the City of Walden ($461 and $95 respectively), which he assigned to a bank and a finance corporation. Debtor relied on his attorney who did not list the sums on his schedules because he thought the “assignments conclusive” and the debtor had no interest in the fund. The court held that debtor failed to list the fund because he honestly believed that there was nothing “coming to him from the assignments” rather than because he wanted to defraud the creditors. Jones v. Gertz, 121 F.2d at 784. In Topper, the debtor had no assets at the time he filed bank╜ruptcy or after his discharge was denied. In re Topper, 229 F.2d at 692. Although debtor owed money to a few- retail accounts, and two small loan companies, he only listed the debt owed to his landlord. As explanation, debtor said he only wished to discharge the debt to the landlord but that he intended to pay his other creditors. The court found that debtor had little to gain from the omission because debtor did not have any assets, and held that there was an absence of fraudulent intent necessary for denial of discharge due to false oath under Title 18 U.S.C.A. Section 152. In a more recent case, the debtor’s attorney failed to list certain debts on the bankruptcy petition because he was either co╜fused about the questions, or because he considered the debts to be family-related and of no value. In re Ellingson, 63 B.R. 271, 275-276 (Bankr.N.D.Iowa 1986). However, debtor and his attorney promptly amended the schedules after they learned of their errors at the first creditors meeting. Id . at 276. The court held that creditors had failed to show that material omissions from the schedules were made with fraudulent intent pursuant to 11 U.S.C. Section 727.

The case at bar is clearly distinguishable from the above cases. Unlike the debtor in Topper, who had no assets before and after the discharge, Colish concealed his interest in the Trust despite the near certainty that he would eventually come into possession of large monetary distributions. Similarly, the sums owed to the debtor in Jones pale in comparison to the distributions from the Trust, and, in addition, the debtor in Jones had actually assigned his interest in these funds to other entities, unlike Colish. Had the Debtor taken a similar approach to the debtor in Ellingson and voluntarily divulged his remainder interest in the Trust subsequent to his discharge, and prior to dissipating the Trust proceeds, this Court might have been more sympathetic to Debtor’s pleas of mistake and reliance on counsel. However, the Government only became aware of Debtor’s interest in the Trust during settlement negotiations with the Debtor for Adversary Proceeding No. 97-1399. (T4 at 18-19.) At trial, Debtor and his attorney, Mr. Bryk, submitted conflicting testimony concerning whether Debtor’s trust interest was divulged to Mr. Bryk. Debtor testified that he disclosed his re╜mainder interest to Mr. Bryk and Mr. Bryk told him he did not need to report such interest. (Tl at 148.) In contrast, Debtor’s attorney, Mr. Bryk, testified that he never discussed a family trust nor did he remember the debtor informing him about any interest in a trust (T2 at 99-101 and T2 at 102, 103.) Attorney Bryk further testified that he typically made inquiries concerning items 18 and 19 of Schedule “B” (concerning future interests and interests in trusts). (T2 at 100.) It is unlikely that an attorney who considers himself a specialist in consumer bankruptcy law, and who has represented debtors in over one hundred cases (some involving substantial tax liabilities) would expose himself to malpractice liability by not listing Debtor’s interest in a trust in the petition. (T2 at 103.) Given the conflicting testimony, this Court chooses to give credence to Mr. Bryk’s testimony, especially in light of Debtor’s conduct subsequent to receiving distributions from the Trust in January.

On January 13, 1998, Debtor received nearly $500,000 from the sale of land pertaining to the Trust and immediately thereafter engaged in a series of unex╜plained transfers and reallocation of these funds to several banks and accounts. (T1 at 169.) From January 1998 through December 1998, Debtor received distributions from the Trust totaling approximately $713,000. In addition, in March, 1998, Debtor created a Nevada Limited Part╜nership which he named Phoenix Samson Associates, L.P. and into which he transferred his Spencer Trask account, his newly opened Citibank accounts, various partnership interests in his father’s Trust as well as practically all his personal property, all totaling $740,625. 12 (Govt. Ex. J.) When asked at trial why he created this partnership in Nevada and why he transferred virtually all his property into it, Debtor replied that he was concerned about potential suits from clients. (T1 at 155.) This explanation is dubious at best. The Debtor’s testimony in this regard was glib and lacking in credibility. Moreover, given the Debtor’s history with the Internal Revenue Service, detailed above, any assertion that this convoluted series of transfers was not motivated in substantial measure by an intent to frustrate the Government’s collection efforts defies credulity. In addition, the fact that Debtor did not pay his pending taxes for prior years nor even fully pay his 1998 taxes, when he received the distributions from the Colish Trust, provides additional support for an inference of fraudulent intent. Debtor’s claims that he did not read the schedules carefully, and relied on his attorney’s ad╜vice are ultimately not credible in light of Debtor’s conduct and the fact that Debtor is an attorney, with an LL.M. in tax, and a sophisticated businessman.

************

12. His personal property included: “All furniture, household items, clothing, furs jewelry, musical instruments, silverware, china, crystal, paintings, antiques, books, collectibles, electronic audio and video equipment, computers, telephones, appliances, and all other personal property…” (T1 157-180, Govt. Ex. J.)

************

Based on all the circumstances described above, this Court finds that the Government has carried its burden of proof under the preponderance of evidence standard enunciated in Grogan v. Garner and that Debtor knowingly and fraudulently failed to report to the Court or surrender the Chapter 7 Trustee his remainder interest in the Trust and the cash and other property distributions he received from the maturing of his remainder interest pursuant to  727(d)(2) of the U.S. Bankruptcy Code.

Conclusion

For all of the foregoing reasons, the United States has sustained its objection to the Debtor’s discharge pursuant to  727(d)(2). Accordingly, Debtor’s discharge is REVOKED. Furthermore, the United States has sustained its objection to the dischargeability of Debtor’s outstanding tax debt for each of the tax years in dispute, 1987 through 1992, pursuant to  523(a)(1)(C). Accordingly, Debtor’s outstanding tax debt, and interest and penalties thereon, for the tax years 1987 through 1992, are non-dischargeable.

IT IS SO ORDERED.

Why the Our Trust is Better than an FLP or LLC

Our Trust is better than a family limited partnership (“FLP”) or LLC for the following reasons:

Criteria FLP or LLC Our Trust
Confidentiality An ownership interest in an FLP or LLC must be disclosed on the financial statements and tax return of each family member who owns an interest.  This subjects the interest to scrutiny and attack in the event any family member is subject to a lawsuit, divorce, bankruptcy, or review by a government agency, including a review for eligibility for student loans or grants or other assistance. Our trust requires no disclosure by any family member on financial statements or tax returns.  Our trust is not discoverable through discovery of tax returns, or through a bankruptcy questionnaire.
Ownership  If you own something, then you can lose it in a lawsuit, divorce, bankruptcy, or a proceeding with a government agency.  Each family member who has ownership in an FLP or LLC, has an asset that could be jeopardized. Neither you nor any family member has any vested ownership interest in the trust.  Therefore, you have no asset that can be pursued or taken into account if you are sued, divorced, bankrupt, or subject to an examination by a government agency.
Flexibility After you have given ownership away to family members, their ability or willingness to return the ownership is limited by gift tax laws, fraudulent transfer laws, and changing attitudes, wants and needs.  If your child becomes estranged from you, or subject to a divorce or bankruptcy, there may be no way for you to take their ownership away. Our trust includes a power (called a “special power of appointment” or “re-write power”) which allows the terms, conditions,  and potential beneficiaries or distributees to be changed at any time.  If a family member is estranged from you or under financial attack, the special power of appointment can be used to remove the family member from the trust, and then reinstate them at a later date.
Case Law  Most states allow a creditor to foreclose and become the owner of an interest in an FLP or LLC.  Some states limit the remedy of a creditor to a charging order.  Some states allow a court to give a creditor a broad charging order that gives the creditor a right to an accounting or other directions and requirements against an FLP or LLC.  All states allow a minority interest holder to enforce minority rights and fiduciary duties to ensure that the assets are managed for the benefit of all stake holders.  Most charging orders result in a settlement payment to buy the creditor out at a reduced value.  Most people do not enjoy having to buy a creditor out of their FLP or LLC. Because no one has a vested interest in the trust, neither do their creditors.  For a listing of cases supporting the asset protection provided by our trust, see Law and Precedent Supporting the Trust.
Tax and Family Complexities You are required to file a partnership tax return for an FLP or LLC each year.  You are also required to give each family member who owns an interest in an FLP or LLC a k-1 which indicates the portion of income attributed to their interest.  This means that they cannot file their taxes until the partnership return is complete, and they may want to be reimbursed for their portion of the income each year.  It also means that family members and in-laws are entitled to information about the assets, activities and income of the partnership.  This can create significant tax complexities and family complexities.  Our trust results in NO extra tax returns.  Family members don’t even need to know about the existence of the trust, except to the extent you choose to tell them.

How to Attack an Asset Protection Trust and How to Defend Against Such an Attack

By Lee S. McCullough, III

 

            If you read all the asset protection cases, you will find that there are really only three ways to attack a well crafted asset protection trust: (1) you can attempt to prove that the transfers to the trust were fraudulent transfers, (2) you can attack a self-settled asset protection trust by using the laws of a state or jurisdiction that doesn’t recognize self-settled trusts, or (3) you can attack the trust based on several related theories referred to as reverse veil piercing, alter-ego, constructive trust, or the sham transaction theory.  For purposes of this article, the third category will be referred to as “veil piercing.”

Fraudulent Transfers

It is easy to completely avoid and prevent an attack based on a fraudulent transfer theory.  You simply transfer your assets to your asset protection trust in advance of a problem.
For example, in Albee v. Krasnoff,[1] Mr. Krasnoff was a fifty percent owner of an investment partnership with hundreds of investors.  Mr. Krasnoff conveyed a home to an irrevocable trust for his wife.  Five years later it was discovered that Mr. Krasnoff’s partner had embezzled money from the partnership.  All the investors lost money and sued the partnership as well as Mr. Krasnoff and his partner.  The investors argued that the transfer to the trust was fraudulent because it occurred after the investment had been made, but the court ruled that the transfer was not fraudulent because it was done for estate planning purposes and Mr. Krasnoff had no knowledge of the fraud or the potential claim when the transfer was made.
In another court case called, In the Matter of Damrow,[2] the court examined two separate transfers by the same person, and the court found that one of them constituted a fraudulent transfer, and the other did not.  When the first transfer was made, in January of the year 2000, Mr. Damrow had guaranteed significant loans to several lenders, but he was not behind on payments.  When the second transfer was made, in November of 2001, Mr. Damrow was behind on payments and several creditors had initiated collection activities.  The court found that the second transfer was fraudulent because Mr. Damrow was insolvent when he made it, and the first transfer was not fraudulent because he was not insolvent when the first transfer was made.
If you make a transfer with actual intent to hinder, delay, or defraud a creditor, or if you make a transfer at a time and under circumstances that appear to be a fraudulent transfer, then a creditor can obtain a judgment against the trust regardless of how well the trust is designed and drafted.  Countless court cases make it unmistakably clear that no asset protection trust, domestic or offshore, can be relied upon to protect assets if the transfers are made at a time and under circumstances that are likely to result in a fraudulent transfer.
Even if you do have a current lawsuit or judgment against you, you may be able to make a transfer to an asset protection trust that is not a fraudulent transfer if you retain sufficient assets in your name to satisfy the pending judgment.  The test that is used to determine if a transfer is fraudulent is based on your specific facts and circumstances.  If you have any question whether a transfer could be considered fraudulent, you should consult legal counsel regarding your specific situation.
In summary, the best way to defend against a fraudulent transfer attack is to create and fund your asset protection trust at a time when you are not insolvent, the transfer does not render you insolvent, you have no judgments against you, you are not behind on payments, and you have no reason to believe that substantial liabilities or judgments are imminent.  If you do so, the fraudulent transfer attack is avoided and you can move on to the next phase of the analysis.


Self-Settled Trusts

The common law rule in the United States has always been that if a settlor is also a beneficiary of a trust, the settlor’s creditors can reach the maximum amount which the trustee can pay to the settlor.  (See Restatement (Second) of Trusts, Section 156 and Uniform Trust Code Section 505).  Over the past thirty years, several domestic and offshore jurisdictions have passed statutory laws providing that the assets of a self-settled trust (a trust in which the settlor is also a beneficiary) are protected from creditors.  Almost all offshore and domestic asset protection trusts are based on these new laws which provide asset protection for a self-settled trust.
If you create a self-settled asset protection trust in a supportive jurisdiction, a creditor could attack your trust by arguing that the law of a different jurisdiction applies.  For example, if you create a Delaware asset protection trust, a creditor from New York may argue that New York law applies instead of Delaware law because the offense occurred in New York and the offended party is a resident of New York.  Because the laws of the State of New York do not allow a debtor to protect assets in a self-settled trust, the New York courts could potentially allow a New York resident to obtain a judgment against the trust.  Similarly, it is possible that a federal court (including a bankruptcy court) could refuse to recognize the laws of a jurisdiction that provides asset protection for a self-settled trust.  Because domestic self-settled asset protection trusts have only been around for 13 years, there are no court cases on this issue at the present time.  There are however, two federal bankruptcy cases where the bankruptcy court has refused to recognize the self-settled trust laws of a foreign jurisdiction because it is against the policy of the federal bankruptcy courts.[3]
In the Portnoy case cited above, Judge Brozman of the Federal Bankruptcy court said, “I think it probably goes without saying that it would offend our policies to permit a debtor to shield from creditors all of his assets because ownership is technically held in a self-settled trust.”[4]
In Dexia Credit Local v. Rogan,[5] Dexia sued Peter Rogan for fraud, conspiracy, and other torts and obtained a judgment against him for $124,000,000.  Rogan had established a trust under Bahamian law which protects the assets of a self-settled trust from the creditors of the grantor.  The Illinois court said that it would not honor the laws of a jurisdiction where doing so would violate the public policy of the State of Illinois.
You can avoid an attack based on a self-settled trust theory by simply not using a self-settled trust.  If you create an irrevocable trust for your spouse and children and you are not included as a beneficiary, the risk of an attack based on a self-settled trust theory is completely eliminated.
There are other ways that you can potentially receive benefits from a trust without being included as a beneficiary.  For example, you could receive a salary for managing companies owned by a trust.  Or, the trust could provide distributions to your spouse, which your spouse could later transfer to you as a gift or allow you to enjoy as a collateral benefit of being married to a wealthy spouse.  Another option is to grant your spouse or some other person a special power of appointment.  This is a power to appoint the assets of a trust to anyone except for the person who holds the power (or their estate or their creditors).  The special power of appointment could be used to provide benefits to you if necessary, even though you are not a beneficiary of the trust.  Many statutes and cases support the fact that a special power of appointment does not create creditor rights.[6]
In summary, you can avoid an attack based on a self-settled trust theory by not using a self-settled trust.  However, this creates other risks because it means that you are left out as a beneficiary.  The best way to solve this problem is to include a special power of appointment in the trust, and design a system of trustees and trust protectors that ensures that no person has power to abuse the trust.
Veil Piercing
The only other way to attack an asset protection trust is to argue that the trust is not to be respected as a separate legal entity from the debtor.  This attack is often referred to as reverse veil piercing, alter-ego, constructive trust, or the sham transaction theory.  There are many court cases discussing and applying these theories to determine if a creditor can pierce an irrevocable trust.
For example, in Dean v. United States,[7] George and Catherine Mossie established an irrevocable trust for the benefit of their children for estate planning purposes.  They transferred assets to the trust on December 4, 1990.  At the time the transfer was made, they were not aware that their tax return from 1988 was being audited.  Later the IRS, audited all their returns from 1987 to 1990 and assessed back taxes and penalties against the Mossies in the amount of $281,093.95.  The IRS placed a federal tax lien on the assets of the trust by claiming that it was the alter-ego of the Mossies, and the trustees sued to have the lien removed.
It is interesting to note the following facts pertaining to the alter-ego analysis:
1.         Except for a brief period at the beginning of the trust when Catherine Mossie used her personal checking account to pay rental expenses for the trust property, all trust checks were signed by the trustees and not the Mossies.
2.         All deeds, transfer documents, tax returns, and promissory notes pertaining to the trust were signed by the trustees.
3.         All management decisions concerning the trust were made by the trustees.
4.         The trustees did allow Catherine Mossie to live in a home owned by the trust without rent.
5.         The trust owns a car which it makes available for the personal use of George and Catherine Mossie.
6.         The trust owns a vacation home which it has made available to Catherine without rent, once or twice.
7.         George and Catherine Mossie have received no money from the trust, except for reimbursement for nominal trust expenses paid by the Mossies.
8.         The trustees were two of the Mossie’s four daughters.
The court recited the general rule for applying the alter-ego doctrine which is that a separate entity will be respected unless it was so dominated that it had “no separate mind, will or existence of its own.”  The court found that the Mossies had established the trust for legitimate estate planning purposes and that the legal control of the trust assets had shifted to the trustees.  It is true that the trustees had allowed the Mossies to receive some collateral benefits from the trust but the court said that is how families do function and should function and small deviations from the trust are not enough to invalidate the whole trust.  In the end, the court ordered the IRS to return the trust property to the trustees and release the tax liens against the trust property.
Another example is the case called, In re Vebeliunas.[8]  In the Vebeliunas case, a wife established an irrevocable trust for her husband (the “debtor”), naming herself as the sole trustee.  The court found that the creditor was not able to pierce the veil of the trust, despite the following facts: (1) the debtor was indicted for fraud, (2) the debtor filed for bankruptcy to obtain relief from his creditors, (3) the bankruptcy court sought to have the debtor declared the alter ego of the trust and to have the trust assets treated as part of debtor’s bankruptcy estate, (4) the debtor’s family received and retained rent proceeds from trust, (5) the debtor and his family lived on property owned by the trust without paying rent to the trust; (6) the debtor granted easements on property owned by the trust, (7) the debtor and his wife deducted from their personal tax returns real estate taxes and interest expenses relating to the trust, (8) the debtor granted mortgages on property owned by the trust, (9) the debtor pledged the trust property in order to obtain bail in his criminal case; and (10) the debtor represented to several banks that his revocable trust owned the property which was actually owned by the irrevocable trust.  Although the debtor probably pushed the limits of dominion and control over the trust in this case, this case illustrates the fact that a court will generally uphold an irrevocable trust as a separate and distinct legal entity unless the debtor exerts so much dominion over the trust that it has no separate identity.
Similarly, in Miller v. Kresser,[9] a mother created a trust for her son and named another son as the trustee.  The beneficiary son was sued for over $1,000,000.  The trial court found that the beneficiary son exerted significant control over the trust by taking money out without the trustee’s knowledge, dominating investment decisions, and keeping possession of the trust checkbook.  The Florida 4th District Court of Appeals upheld the creditor protection provided by the trust even though “the facts in this case are perhaps the most egregious example of a trustee abdicating his responsibilities . . . the law requires that the focus must be on the terms of the trust . . . and the trust did not give the beneficiary any authority whatsoever to manage or distribute trust property.”
By reciting these cases, I am not by any means recommending abuse of a trust arrangement, but I do think these cases demonstrate the fact that a court will generally uphold the separate existence of a trust, just as they generally uphold the separate existence of a corporation, unless the facts are so egregious as to indicate a total disregard of the legal entity so that it becomes the alter-ego of the debtor.
The solution to avoiding these attacks is really quite simple: (1) the trustee should demonstrate control over the trust and abide by the terms of the trust instrument, (2) the presence of an independent trustee is not required, but it goes a long way to show that the trust is a separate legal entity from the grantor or the beneficiaries, (3) the grantor and beneficiaries should not exert so much control or dominion so that they appear to be the owners of the trust assets, (4) the benefits of the trust should be reserved for the beneficiaries, and (5) transactions with the trust should be on the same terms as would be expected between unrelated parties.
Another way to defend against the veil piercing type of attack is to locate the trust in a state with greater asset protection laws.  Currently, the best states are Nevada, Alaska, and South Dakota.  A person in any state can create a trust in one of these locations by appointing a trustee in the state where they want the trust to be located.  Consider the language of these Nevada Statutes which are designed to protect against a veil piercing attack:
NRS 163.4177  Factors which must not be considered exercising improper dominion or control over trust.  If a party asserts that a beneficiary or settlor is exercising improper dominion or control over a trust, the following factors, alone or in combination, must not be considered exercising improper dominion or control over a trust:

1.  A beneficiary is serving as a trustee.

2.  The settlor or beneficiary holds unrestricted power to remove or replace a trustee.

3.  The settlor or beneficiary is a trust administrator, general partner of a partnership, manager of a limited-liability company, officer of a corporation or any other manager of any other type of entity and all or part of the trust property consists of an interest in the entity.

4.  The trustee is a person related by blood, adoption or marriage to the settlor or beneficiary.

5.  The trustee is the settlor or beneficiary’s agent, accountant, attorney, financial adviser or friend.

6.  The trustee is a business associate of the settlor or beneficiary.
NRS 163.418  Clear and convincing evidence required to find settlor to be alter ego of trustee of irrevocable trust; certain factors insufficient for finding that settlor controls or is alter ego of trustee of irrevocable trust.  Absent clear and convincing evidence, a settlor of an irrevocable trust shall not be deemed to be the alter ego of a trustee of an irrevocable trust. If a party asserts that a settlor of an irrevocable trust is the alter ego of a trustee of the trust, the following factors, alone or in combination, are not sufficient evidence for a court to find that the settlor controls or is the alter ego of a trustee:

1.  The settlor has signed checks, made disbursements or executed other documents related to the trust as the trustee and the settlor is not a trustee, if the settlor has done so in isolated incidents.

2.  The settlor has made requests for distributions on behalf of a beneficiary.

3.  The settlor has made requests for the trustee to hold, purchase or sell any trust property.

4.  The settlor has engaged in any one of the activities, alone or in combination, listed in NRS 163.4177.


Conclusion

In my experience, most properly designed asset protection trusts are never discovered in the first place.  If you are sued or subject to some kind of unexpected liability, the creditor will ask for your personal financial statements.  Because you have no ownership in the trust or its assets, they should not be included on your personal financial statements.  If your trust is funded more than two years before you file bankruptcy, the trust is usually not discovered through a typical bankruptcy proceeding.
Although an asset protection trust is not discovered in the majority of cases, one should never rely solely on secrecy to defend against every attack.  A sophisticated creditor can always get you under oath and ask enough of the right questions to discover the trust.  If that happens to you, you should always answer honestly and with confidence that your trust was established for appropriate purposes and that it will hold up on its own merits.  The best asset protection trust has the following characteristics: (1) it is funded in advance of a problem, (2) it is created for legitimate estate planning purposes, (3) it is an irrevocable trust that does not include the grantor as a beneficiary, (4) it includes an independent professional trustee in the State of Nevada (although it is possible to use a family member or friend in your home state as long as the parties respect the trust as a separate legal entity), and (5) it includes a special power of appointment which provides flexibility to the trust despite the fact that the trust is irrevocable.


[1] 566 SE 2d 455 (Ga.Ct. Appeals 2002).

[2] Case No. BK02-43392 (Bankr.Neb. 3/13/2007) (Bankr.Neb., 2007).

[3]  See In re Portnoy, 201 B.R. 698, and In re Brooks, 217 B.R. 98.

[4]  In re Portnoy at 700.

[5]  624 F. Supp. 2d 970 (N.D. Illinois 2009).

[6] See US Bankruptcy Code Section 541(b)(1), California Probate Code Section 681, Delaware Code Section 3536, In Estate of German, 7 Cl. Ct. 641 (1985) (85-1 USTC Par 13,610 (CCH), In re Hicks, 22 B.R. 243 (Bankr. N.D.Ga.1982), In re Knight, 164 B.R. 372 (Bankr.S.D.Fla.1994), RESTATEMENT OF THE LAW (SECOND) PROPERTY, Section 13.6.

[7]  987 F. Supp. 1160 (December 4, 1997).

[8]  332 f. 3D 85 (Ct. Appeals 2nd Cir. 2003).

[9]  2010 Fla. App Lexis 6152.

Asset Protection – Stories from the Trenches

We talk a lot of theory about asset protection, and everyone seems to have their own opinion about what works and what doesn’t.  These are some real-life experiences that have shaped my perspective:

1.  I worked for a law firm that set up a lot of family partnerships.  One client put a substantial amount of assets in his family partnership and made annual gifts to his children.  One child had financial problems and went bankrupt.  Because the child’s interest in the family partnership was included on her tax returns and among her assets, she had to include it as an asset on her bankruptcy questionnaire.  The bankruptcy trustee demanded an accounting from the partnership and a liquidation of the partnership interest for the benefit of the child’s creditors.  We insisted that the bankruptcy trustee was limited to a charging order, and the court agreed.  The bankruptcy trustee continued to monitor the dealings of the partnership and question the actions of the general partners to ensure that they were fulfilling their fiduciary duties to the partners and not simply using the partnership for their own benefit.  The client eventually negotiated a settlement and agreed to buy the child’s interest from the bankrutpcy trustee for a fourth of its real value.  Even though the client was able to buy the child’s share for pennies on the dollar, the client said, “I lost tens of thousands of dollars to my child’s bankruptcy, and you call that asset protection!”

2.  My friend from law school works for a law firm that is well known for promoting Cook Island Trusts.  He tells how one client formed a Cook Islands Trust and transferred millions of dollars to the trust.  Later, the client went bankrupt and failed to include the trust assets on his bankruptcy questionnaire.  The Bankruptcy Court reviewed the client’s tax returns and easily discovered the offshore trust. The Bankruptcy Court said this was bankruptcy fraud & ordered the client to turn over the assets of the trust.  The client claimed that he had no power to turn over the trust assets.  The Court did not believe the client and said that if the client disobeyed its order, the Court would send the client to jail for contempt of court and impose a fine of $10,000 per day until the money was turned over.  The client found a way to retrieve the money and threatened to sue the law firm for malpractice.  The lawyers were also accused of conspiracy to commit fraud.

3.  My client put $4,000,000 in a special power of appointment trust (“541 Trust®”) in 2004. In 2007, he entered into a business deal with a wealthy investor.  The client and the investor agreed to share the risks and the profits.  The deal went bad and they both lost all of the money that they had invested.  The investor sued my client for millions of dollars.  My client went to the pretrial conference and explained that he had no assets, and that if he lost the case, he would simply go bankrupt. The investor hired a private investigator who did an asset search and a review of his tax returns and found nothing. The case was dropped without going to trial and the assets continue under the protection of the 541 Trust®.  My client feels that he acted honestly because he funded the trust well in advance of the deal, the investor went into the deal with an accurate understanding of the risks involved, and my client had every right to set aside assets for the security of his family before entering into that deal.

4.  Another client set up a 541 Trust® in 2003. He was recently sued and he had to give an asset statement under penalties of perjury. He also had to give tax returns for the past 3 years and sign an affidavit that he had not made any transfers in the past 3 years.  The client answered everything honestly and the 541 Trust® and its assets were never discovered.

In the two cases described above, an offshore trust would have been easily discovered in a review of the client’s tax returns.  The offshore trust still may have worked, but it would have been frightening to explain and defend the offshore trust to the judge.

In my experience, the safest course is to do asset protection planning well in advance of a problem, do it in way that avoids any discovery, do it in a way that avoids tax problems or issues of any kind, do it in a way that can be easily amended, and do it in a way that is acceptable and defendable even if it is discovered.  That is why I think the 541 Trust® is the best asset protection solution.

IRREVOCABLE TRUSTS

IRREVOCABLE TRUSTS

by Lee S. McCullough, III

Updated April 25, 2012

 

Irrevocable trusts are an amazing tool with many uses and almost infinite varieties.  This article provides a summary of what these trusts are, how they work, and what some of the options and uses are.

I.  Typical Uses

a.         Asset Protection Trusts.  You can create an irrevocable trust to own cash or other assets that you want protected from creditors.  If the trust is designed correctly and if you give assets away to the trust at a proper time and in a correct manner, the assets can be protected from future creditors or liabilities that you may have.  If the trust is designed as an incomplete gift trust (described in more detail below), you can transfer unlimited amounts to the trust without any gift taxes or other taxes due on the transfer.  An irrevocable trust provides better asset protection than a family limited partnership or limited liability company because an irrevocable trust completely removes an asset from a person’s ownership, rather than simply limiting the remedies of a creditor to a charging order against a family limited partnership or a limited liability company.

b.         Trusts designed for Estate Tax Protection.  For large estates, or estates with highly appreciating assets, the irrevocable trust is often the best tool in an estate planner’s toolbox.  You can create an irrevocable trust to own assets that you don’t want included in your taxable estate.  If the trust is designed correctly and if the transfers that you make to the trust are done in a correct manner, the assets of the trust will not be included in your taxable estate.  For example, you could create an irrevocable life insurance trust to own life insurance policies on your life so that the death benefit is not included in your taxable estate.  Or you could give highly appreciating stock to an irrevocable trust to remove the stock from your taxable estate.  Or you could sell your business to an irrevocable trust so that the kids can inherit the business without paying estate tax.  Or you could start a new business or purchase a new property inside of an already existing irrevocable trust so that the business or asset is out of your estate from the time it is purchased.

c.         Estate Planning Objectives.  You can create an irrevocable trust to ensure that certain assets are set aside for the security of your family.  You can create an irrevocable trust to provide conditions that must be met in order for a person to receive an inheritance.  You can create an irrevocable trust to ensure that a cabin or ranch is preserved and held for certain purposes for a certain length of time.  You can create an irrevocable trust to see that your heirs do not receive too much money too soon or for the wrong purposes.

II.  What is an Irrevocable Trust?

a.         Names and Varieties.  There seems to be an infinite number of names and varieties of irrevocable trusts.  For example, an irrevocable trust may be known as a Dynasty Trust, an Asset Protection Trust, a Legacy Trust, an Irrevocable Life Insurance Trust, an Intentionally Defective Grantor Trust, an Alaska Trust, an Offshore Trust, or an IDIT.  One offshore trust may be designed to be included in a grantor’s estate and another may be designed to be excluded from the grantor’s estate.  One may be taxable to the grantor and another may be taxable to the trust or to the beneficiaries.

b.         Offices and Titles.  The person who creates the trust is called a settlor or, as used in this article, a “grantor.”  The person who controls and manages the trust is called the “trustee.”  The people who are eligible to receive benefits from the trust are called the “beneficiaries.”  The trustee duties may be divided among multiple trustees with different names such as the “Investment Trustee,” the “Qualified Trustee,” or the “Administrative Trustee.”  Some trusts create an office called a “Trust Protector” with power to remove and replace the trustee, or to otherwise ensure that the trust is operated in a manner that accomplishes its intended purposes.

c.         Meaning of the word “Irrevocable”.  If the trust provides that the grantor retains no power to amend or revoke the trust, then the trust is “irrevocable” in regards to the grantor.  This does not prevent a trustee from making distributions to the grantor’s spouse, children, or designated beneficiaries.  In some cases, it is possible for an irrevocable trust to allow the trustee to have discretion to make transfers back to the grantor, because this is done in the discretion of the trustee and the grantor retains no power to require the trustee to make distributions to the grantor.  It is also possible to grant a special power of appointment so that a person other than the grantor can essentially amend or re-write the trust or appoint the assets to any person; thus making an irrevocable trust amendable and revocable by a person other than the grantor.

d.         Control.  The grantor can exert control by placing restrictions, limitations or requirements in the trust document before it is executed.  After the trust is executed, the grantor should not retain or exercise any control or “incidents of ownership” over the trust, or all the purposes and benefits of trust could be jeopardized.  For this reason, it is important that the trust document be designed carefully according to the wishes of the grantor, that the trustees and protectors are chosen carefully, and that the drafter of the trust create sufficient flexibility to adapt to changes in the laws as well as changes in the circumstances of the grantor and the beneficiaries.  The best way for the grantor to retain control may be to contribute assets to an LLC of which the grantor is a manager, and then contribute the LLC interests to the trust.

e.         Trust Design and Drafting.  Designing and drafting an effective irrevocable trust requires years of training and experience, as well as time and effort to understand the wishes of the grantor and to anticipate the possible problems, concerns, and issues that may arise in the future.  It is impossible to design and draft an effective trust without a thorough knowledge of state laws, income tax laws, and gift and estate tax laws pertaining to trusts.  It is also impossible to create an effective trust without careful analysis and customization based on the wants and needs of each individual grantor.  Many problems are created when a person attempts to create their own trust using a generic software package, or when a general practice attorney attempts to create a trust without a knowledge of all the applicable laws or experience with trust design and drafting.

III.  Asset Protection Features of an Irrevocable Trust

a.         Which Laws Apply to an Irrevocable Trust?.  Trusts are governed by state laws, not federal laws; but some federal laws do have an effect on irrevocable trusts, including federal tax laws and federal bankruptcy laws.

The Uniform Trust Act provides that, “The meaning and effect of the terms of a trust are determined by: (1) the law of the jurisdiction designated in the terms unless the designation of that jurisdiction’s law is contrary to a strong public policy of the jurisdiction having the most significant relationship to the matter at issue; or (2) in the absence of a controlling designation in the terms of the trust, the law of the jurisdiction having the most significant relationship to the matter at issue.”[1]

A grantor can generally select the law that will govern the meaning and effect of the terms of the trust, even if the jurisdiction selected has no other connection to the trust.  The laws governing the administration of the trust are generally the laws of the state designated in the trust instrument or the laws of the state where the administration occurs.[2] It is also possible to design a trust so that the governing law will change as the location of the trustee is changed from one jurisdiction to another.

Because of this ability of a grantor to choose the state law that will govern the trust, many states have amended their laws to make them more competitive in order to attract business for their state.  Many attorneys engage in “forum shopping” in order to find the best available laws for their clients.

For example, a California resident may choose to create a South Dakota trust if they want the trust to last indefinitely and not be terminated by the California rule against perpetuities.  The California resident could create a trust document that states that the trust is governed by South Dakota law, and the California resident would then appoint a trustee located in South Dakota and meet any other requirements set forth under South Dakota law.

Why would you want to shop for better laws?  Most states do not allow a grantor to be included as a beneficiary of a trust without subjecting the assets of the trust to the creditors of the grantor.  Twelve states do allow asset protection for a “self-settled trust” (a trust that includes the grantor as a potential discretionary beneficiary).[3] In many states, it is probable that a creditor or ex-spouse of a beneficiary can compel distributions from a trust.[4] Several states specifically support the absolute discretion of a trustee in withholding distributions from a creditor or ex-spouse of a beneficiary.  Many states limit the duration of a trust, while others allow for unlimited duration or a duration lasting hundreds of years.  Some states have a state income tax on trust income, and others do not.

Although it is tempting to create a trust in a state with favorable laws, it is not completely reliable.  There is a chance that a court in your home state will recognize the laws of the state where you intend the trust to be located, but there is an equally good chance that a court in your home state will disregard the laws of the trust state and use their own laws.  There are not many cases on this issue and the outcome in your case may depend on many facts and circumstances.  Therefore, while it doesn’t hurt to establish a trust in a state with favorable laws, it should not be relied on as the basis for your asset protection plan.  It is better to create a trust that will hold up in any state.

b.        Using Irrevocable Trusts for Asset Protection.  Asset Protection is one of the main reasons that people forum shop for the most advantageous state laws.  Not only is asset protection important to many people in and of itself, but it is also a critical factor in keeping the assets of a trust outside of the taxable estate of the grantor and the beneficiaries.  The tax law actually relies on state asset protection laws to determine if a trust is includable in the grantor’s estate.  If creditors can reach the trust assets under applicable state law, then the assets are also included in the grantor’s taxable estate.[5]

Four states seem to stand out as the best states for asset protection in regards to irrevocable trusts.  Below, I have provided a summary of the advantages offered by these four states:[6]

1.         Alaska Trust Law.  These are some of the advantages of Alaska trust law:

a.        Creditor protection is allowed for certain self-settled trusts.

b.        A trustee’s ability to make or withhold discretionary distributions of income or principal is absolute.  In other words, a beneficiary or the creditor of a beneficiary is not able to force a distribution if it is left in the discretion of a trustee.

c.        A grantor may retain a power to veto distributions or a testamentary power of appointment without jeopardizing asset protection.

d.        The statute of limitations for a fraudulent transfer claim is four years for future creditors, or one year after discovery for past creditors.

e.        There are no significant exceptions for asset protection of a beneficial interest.

f.        The statute provides that express or implied understandings regarding distributions to a grantor are invalid.

g.        There is statutory support for a no-contest clause.

h.        The allowable duration of an Alaska trust is 1,000 years.

i.         Alaska has no state income tax.

2.         Nevada Trust Law.  These are some of the advantages of Nevada trust law:

a.        Creditor protection is allowed for certain self-settled trusts.

b.        A trustee’s ability to make or withhold discretionary distributions of income or principal is absolute.  In other words, a beneficiary or the creditor of a beneficiary is not able to force a distribution if it is left in the discretion of a trustee.

c.        A grantor may retain a power to veto distributions or a testamentary power of appointment without jeopardizing asset protection.

d.        The statute of limitations for a fraudulent transfer claim is two years for future creditors, or six months after discovery for past creditors.  Transfers are deemed discovered when reflected in a public record.

e.        There are no exceptions for asset protection of a beneficial interest.

f.        The allowable duration of a Nevada trust is 365 years.

g.        Nevada has no state income tax.

3.         Delaware Trust Law.  These are some of the advantages of Delaware trust law:

a.        Creditor protection is allowed for certain self-settled trusts.

b.        A trustee’s ability to make or withhold discretionary distributions of income or principal is absolute.  In other words, a beneficiary or the creditor of a beneficiary is not able to force a distribution if it is left in the discretion of a trustee.

c.        A grantor may retain a power to veto distributions, a testamentary power of appointment, or a power to replace a trustee with an unrelated and non-subordinate replacement, without jeopardizing asset protection.

d.        The statute of limitations for a fraudulent transfer claim is four years for future creditors, or one year after discovery for past creditors.

e.        There are no significant exceptions for asset protection of a beneficial interest.

f.        The statute provides that express or implied understandings regarding distributions to a grantor are invalid.

g.        There is statutory support for a no-contest clause.

h.        The allowable duration of a Delaware trust is unlimited for personal property and 110 years for real estate.

i.         There is no state income tax, except for trusts that accumulate income for Delaware residents.

4.         South Dakota Trust Law.  These are some of the advantages of South Dakota trust law:

a.        Creditor protection is allowed for certain self-settled trusts.

b.        A trustee’s ability to make or withhold discretionary distributions of income or principal is absolute.  In other words, a beneficiary or the creditor of a beneficiary is not able to force a distribution if it is left in the discretion of a trustee.

c.        A grantor may retain a power to veto distributions, a testamentary power of appointment, or a power to replace a trustee with an unrelated and non-subordinate replacement, without jeopardizing asset protection.

d.        The statute of limitations for a fraudulent transfer claim is four years for future creditors, or one year after discovery for past creditors.

e.        There are no significant exceptions for asset protection of a beneficial interest.

f.        The statute provides that express or implied understandings regarding distributions to a grantor are invalid.

g.        The allowable duration of a South Dakota trust is infinite.

h.        South Dakota has no state income tax.

In addition to the factors listed above, Nevada has two additional practical benefits.  First, the other top states require that some or all of the trust assets be deposited in the jurisdictional state, and Nevada does not.  Second, many states require that the jurisdictional trustee be a financial institution located in the jurisdictional state.  Using a financial institution as a trustee often creates significant cost, inconvenience and complexity for the grantor.  Nevada allows the jurisdictional trustee to be a resident individual.  While it is more convenient and less expensive to appoint an individual as the resident trustee, there is some risk that the trust will fail to qualify to be governed by the laws of a state if the individual fails to fulfill the responsibilities required by the statute or if a court determines that the individual is not qualified or capable of serving as a legitimate trustee.  It is critical to find a trustee who can ensure that the trust will hold up under attack, but without resulting in unnecessary cost, inconvenience or complexity.

The use of offshore irrevocable trusts is another issue that is beyond the scope of this article.  Suffice it to say that over 30 court cases in the last ten years have held that a self-settled offshore trust is void because it is against public policy.  Many of these cases have resulted in favorable settlements paid to a creditor, some exceeding the amount of money in the offshore trust.

c.        Other Factors for Protecting Assets using an Irrevocable Trust.  In addition to picking the best jurisdiction for an irrevocable trust, there are many other factors that must be present if an irrevocable trust is to succeed in protecting assets from the creditors of the grantor.  First, there are many essential issues involved in the drafting of an irrevocable trust that provides asset protection including careful design of spendthrift clauses, discretionary distribution clauses, ascertainable standards, powers of appointment, and more.  Most importantly, the transfer to an irrevocable trust must be done at a time and in a manner that it is ethical, legal, and appropriate.  When asset protection planning is done in an ethical and legal manner, it is generally very effective.  When asset protection planning is done in an unethical or illegal manner, judges often find ways to ensure that the planning is not effective in protecting assets.  A transfer made with actual intent to delay, hinder, or defraud creditors is called a fraudulent transfer.[7] If a creditor can prove that a fraudulent transfer has occurred, then they can pursue and attach the assets that were involved in the transfer.

IV.  Tax Treatment of Irrevocable Trusts

a.         Income Tax Treatment of Irrevocable Trusts.  All irrevocable trusts fall into one of three categories for income tax treatment: (1) grantor trusts which are taxable to the grantor, (2) simple trusts which are taxable to the income beneficiaries, and (3) complex trusts which are taxable to the trust itself, except to the extent that distributions are made, in which case the income flows out to the beneficiaries.

Complext trusts are in the highest income tax bracket.  Grantor trusts and simple trusts automatically avoid this problem because by definition the income is not taxable to the trust as long as it remains a grantor or simple trust.  A complex trust can avoid this problem by simply distributing all income by the end of each calendar year.

Most irrevocable trusts are intentionally designed to be taxed as a grantor trust.  A “grantor trust” is a trust that is treated as if it is owned by the grantor for federal income tax purposes because the grantor retains one or more of the powers described in Sections 670-678 of the Internal Revenue Code.  Thus, any income, deductions, or other tax attributes belonging to the trust, are allocated to the grantor.

Because the trust is considered the same as the grantor for federal income tax purposes, the following benefits can be realized from a grantor trust: (1) the trust is an eligible shareholder of an “S” corporation if the grantor would be an eligible shareholder,[8] (2) the trust can own a home and the grantor can receive all the tax benefits of home ownership, (3) the grantor can sell a life insurance policy to the trust without triggering the transfer for value rules or any other income tax consequences,[9] (4) the grantor can sell assets to the trust without recognizing capital gains on the sale and without reporting the sale on income tax returns,[10] (5) the grantor can pay the income taxes due on the earnings of the trust without it being considered a gift to the trust,[11] (6) interest payments between the trust and the grantor are not deductible to the payer nor are they interest income to the payee,[12] and (7) forgiveness of debt has no income tax consequences. These income tax benefits create many exciting estate planning opportunities, some of which are described in Section V below.

b.         Gift and Estate Tax Issues Pertaining to Irrevocable Trusts.  Irrevocable trusts can be designed so that transfers to the trust are incomplete gifts for gift tax purposes and the assets of the trust are included in the grantor’s taxable estate, or they can be designed to that transfers to the trust are complete gifts for gift tax purposes and the assets of the trust are not included in the grantor’s taxable estate.

If the grantor retains a power to veto distributions proposed by the trustee, this power is sufficient to cause gifts to the trust to be considered incomplete for gift tax purposes and the assets of the trust to be included in the grantor’s estate.[13] Under the laws of certain states, a grantor is allowed to retain a veto power without jeopardizing the asset protection offered by an irrevocable trust.  This allows a grantor to create and fund a trust that is protected from creditors, but transfers to the trust are not subject to gift taxes, even though the assets have a value far in excess of the gift tax exclusions and exemptions.

On the other hand, it is also possible to create an irrevocable trust that is not included in the grantor’s estate.  In order to keep a trust outside of the grantor’s estate, the grantor generally must not retain any use, possession, right to the income or other enjoyment, right to alter the use, possession or enjoyment, or other incidents of ownership over the property of the trust.[14]

c.         Generation Skipping Taxes and Irrevocable Trusts.  The purpose of the generation skipping tax is to prevent a person from avoiding the estate tax at multiple generations by making transfers to individuals who are two or more generations removed from the grantor.  The generation skipping tax rules are complex, but the basic principal pertaining to irrevocable trusts is quite simple – avoid the generation skipping tax at all costs.  In order to do this, the grantor must ensure that all transfers the trust are in the form of a gift that is covered by generation skipping tax exemption, or in the form of a loan or sale, which are not subject to the generation skipping tax.

For example, if I make a $1,000,000 gift to an irrevocable trust, I should file a gift tax return reporting that I am allocating my $1,000,000 lifetime gift tax exemption and $1,000,000 of my generation skipping tax exemption to the gift.  This ensures that the trust is 100% exempt for generation skipping taxes.  After the gift is made, I can make additional loans or sales to the trust without affecting the generation skipping tax treatment of the trust.  The trust can then make distributions to future generations without any generation skipping taxes.

d.         Structuring Sales to Irrevocable Trusts.  In order to ensure that a sale to an irrevocable grantor trust is effective in removing the assets of the trust from the taxable estate of the grantor, the following points should be considered:

1)         The trustees should open a bank account in the name of the trust and in its tax ID number.  The trustee should keep appropriate books and records for the trust and treat the trust as a separate legal entity for all purposes.

2.         The trustee located in the jurisdiction of choice should keep books and records for the state of jurisdiction, hold annual meetings for the trust, and any other requirements set forth by state law or other administrative actions which show that the trustee is a legitimate trustee and that the trust is truly being administered in the desired jurisdiction.

3.         There should be no express or implied understanding whereby it is shown that the grantor retains control or incidents of ownership over the trust or its assets.

4.         Any property being gifted or sold to the trust should be appraised or a value otherwise established and documented to prove that the sale was made for fair market value.

5.         Assets should be retitled, stock certificates reissued, and the owner and beneficiary of insurance policies should be changed in accordance with any sale.

6.         The trust should have some “seed money” or other capital equal to at least ten percent of the value of assets being sold to the trust, or the promissory note used in the purchase should be guaranteed by the beneficiaries.

7.         Any promissory note should accrue interest at a rate described in Sections 1274(d) and 7872 of the Internal Revenue Code.

8.         Some payments should be made on the note on a regular basis to prove that there is an intention to repay the note.

9.         An amortization schedule should be kept to track the payments and remaining balance on the promissory note.

10.       Tax reporting should correctly recognize the existence of the trust.  K-1s and 1099s should be issued to the trust.  The trust should file form 1041 and check the box indicating that it is a grantor trust.  The trustee should sign form 1041 on behalf of the trust.  The trustee should include an attachment with the tax return showing the income and other items which are attributable to the grantor, as described in the instructions for form 1041.

V. What are some practical uses of Irrevocable Trusts?

a.        Transfers to Incomplete Gift Trusts for Asset Protection.

Tim sold his business and ended up with $20,000,000 in cash.  Tim had no current creditors or liability concerns, but he wanted to put the money in a safe place so he could begin some new entrepreneurial activities without putting the money at risk.  Tim was not concerned about estate taxes because he was young, single, and he had many charitable interests that he wanted to benefit from his estate.  Tim created an irrevocable trust but retained a veto power over distributions so that transfers to the trust would be incomplete gifts for federal gift tax purposes.  Because there were no gift tax limits on the amount he could transfer, Tim was able to transfer the bulk of his funds to the trust without any tax consequences.  Tim chose to have the trust governed by the law of Nevada so that no one could compel the trustee to make distributions to the creditor of any beneficiary.  Tim’s trust gave the trustees discretion to make or withold distributions to the beneficiaries as determined by the trustees, subject to his veto power.  Tim used an Alaska trust company as one trustee, but he appointed his trusted CPA as the trustee with power over distributions.  Tim appointed his attorney and his brother as the trust protectors with power to remove and replace the trustees.  The trust protectors also had a special power of appointment, exercisable only with Tim’s consent, to appoint the trust assets to any person other than themselves, in order to provide maximum flexibility.  In order to keep the trust completely off of his personal financial statement and tax returns, Tim chose to have the trust pay its own income taxes.  The asset protection provided by this trust gave Tim enough peace of mind and security to allow him to take some personal risks on the new business ventures that he wanted to pursue.

b.        Gifts and Sales of Life Insurance Policies.

Mark owned a business that had a value in excess of the estate tax exemptions of he and his wife.  He also owned a $4,000,000 life insurance policy.  If Mark and his wife died while owning the policy, roughly half of the proceeds would go toward estate taxes on the policy itself!  If Mark gave the policy to an irrevocable grantor trust (such as a typical irrevocable life insurance trust or ILIT), there would be no estate tax on the policy proceeds, unless Mark died within three years of the transfer because of the three-year look-back rule found in Section 2041 of the Internal Revenue Code.

An even better plan would be for Mark to give cash to the irrevocable trust in an amount equal to the current value of the insurance policy.  A cash gift is not subject to the three year look back rule found in Section 2041 of the Internal Revenue Code.  The trust could then pay the cash to Mark to purchase the policy from him.  A sale of a policy is also not subject to the three-year look-back rule found in Section 2041 of the Internal Revenue Code.  This gift of cash followed by a sale of the policy is a tax-free method of removing all the life insurance from their taxable estate.  This way, the entire $4,000,000 could be used to pay estate taxes on other assets they have, or if there were no other taxable assets, the entire amount could benefit their children.

c.        Gifts and Sales of Appreciating Assets.

John was a California resident who owned 25% of the outstanding stock of a software company with tremendous potential for growth and income.  John wanted to remove the asset from his estate in order to protect the asset from estate taxes as well as potential future creditors.  John wanted to retain as much control and flexibility as possible.  He also wanted to provide for himself, his wife Susan, and their three children.  John had $800,000 in a bank account and a home worth $600,000.  He also had a life insurance policy with a cash value of $100,000 and a death benefit of $3,000,000.  The current value of his stock was $1,000,000.

John created an irrevocable trust under the laws of the State of Nevada.  The trust was designed as a “grantor” trust so that John would be treated as the owner of the trust for income tax purposes and all income and deductions would flow through to John.

John made a cash gift of $200,000 to the trust.  He filed a gift tax return reporting the gift and allocating gift tax exemption and generation skipping tax exemption to the gift, but no taxes were due.  John then sold his stock and his life insurance policy to the trust in exchange for a promissory note equal to the fair market value of the stock and the life insurance policy, which was $1,100,000.  There was no tax due on the sale because it was a sale from a grantor to a grantor trust.  The trust made regular payments to John on the note, using the cash that John had gifted to the trust and future earnings from the stock.  There were no tax consequences from the interest income on the note because it was a transaction between a grantor and a grantor trust.  Each year, the income from the earnings of the stock was allocated to John, and he paid the tax from personal funds, allowing the assets of the trust to grow without taxation.  This payment of income taxes on behalf of the trust had the economic effect of an annual gift to the trust, but no gift taxes were due.  Eventually, the company was sold and the trust received $15,000,000 in exchange for the stock.  The trust paid John the amount remaining on the promissory note and kept the other $14,000,000 in the trust, protected from future creditors or estate taxes.

As you can see, irrevocable trusts are very complex and powerful tools, to be used with caution and great care.  Because of the many varieties and options involved, the design and crafting of an irrevocable trust that accomplishes the purposes of a grantor is an exciting and interesting process.

Lee S. McCullough, III is a partner in the law firm of McCullough Sparks, exclusively focusing on estate planning and asset protection.  Lee is an adjunct professor, teaching estate planning at the J. Reuben Clark Law School at Brigham Young University.


[1] Uniform Trust Act Section 107.  Restatement (Second) of Conflict of Laws Sections 273, 280.

[2] Uniform Trust Act Section 108.

[3] Comparison of the Twelve Domestic Asset Protection Statutes, by David G. Shaftel, ACTEC Journal 293 (2009).

[4] State Third Party Discretionary and Spendthrift Trust Statutes, by Richard W. Nenno, Wilmington Trust Company (2008); Third Restatement of Trusts Sections 50 and 60.

[5] Treasury Regulation 20.2036-1(b); Rev. Rul. 76-103, 1976-1 CB 293.

[6] See Comparison of the Twelve Domestic Asset Protection Statutes, by David G. Shaftel, ACTEC Journal 293 (2009).

[7] Uniform Fraudulent Transfer Act Section 4(a)(1).

[8] Internal Revenue Code Section 1361(c)(2)(A)(i).

[9] Rev. Rul. 2007-13, 2007-11 I.R.B.

[10] Rev. Rul. 85-13, 1985-1 CB 184.

[11] Rev. Rul. 2004-64, 2004-2 CB 7.

[12] Rev. Rul. 85-13, 1985-1 CB 184.

[13] Treasury Regulation 25.2511-2(c).

[14] The many rules for keeping the assets of an irrevocable trust outside of the taxable estate of a grantor are beyond the scope of this Article; but see generally Sections 2036, 2038, 2042 of the Internal Revenue Code.

Advantages of a Life Cycle Buy Sell Agreement

The Life Cycle Buy Sell Agreement

The Life Cycle Buy Sell is a relatively new method for structuring a Buy Sell Agreement. Under traditional methods, owners must choose between company owned life insurance or cross-owned life insurance. Both of these methods have their advantages and disadvantages. The Life Cycle Buy Sell attempts to provide the advantages of both of these methods.

Description Company Owned

Life Insurance

Cross-Owned Life Insurance Life Cycle Buy Sell
Step-Up in Tax Basis for Surviving Owners No Yes Yes
Only One Policy Needed Per Owner Yes No Yes
Custom Allocation of Costs and Benefits No No Yes
Tax-Free Access to One’s Own Cash Values* No No Yes
Cash Values Protected from Company Creditors No Yes Yes
Cash Values Protected from Individual Creditors Yes No Yes
Retiring Owners Can Take Policy Without Triggering Transfer-For-Value Tax No No Yes
Avoid C-Corp. AMT Taxes on Death Benefit No Yes Yes

* Distributions are Tax-Free to Extent of Premiums Paid, then Tax-Free Policy Loans

– This page presents summary information and should not be taken as legal advice for any particular situation.  Clients should seek legal counsel pertaining to their individual situation.

 

by Lee S. McCullough, III

Ethical and Effective Asset Protection Planning

By Lee S. McCullough, III

When is it Ethically Appropriate to do Asset Protection Planning?

The law allows business owners to create corporations and other forms of business entities is to separate the personal assets of the owners from the liabilities of the business.  This type of planning is done every day, and most everyone would agree that there is nothing unethical about creating a corporation for this purpose.  Other situations where asset protection planning may be appropriate include the following:

  1. You want to separate the assets and liabilities of one business or property from the assets and liabilities of other businesses or properties.
  2. You come into some money and you want to set aside a rainy day fund to provide financial security for you and your family.
  3. Your are contemplating a new marriage or business partnership and you want to keep certain assets separate and protected from the new venture.
  4. You are asked to sign a personal guarantee, or take on joint and several liability with partners, and you want to limit the amount of assets you put at risk.
  5. You are willing to pledge sufficient assets to provide security for a new loan, but you don’t want to jeopardize more assets than are required by a lender.
  6. You want to discourage frivolous lawsuits, time consuming litigation, and expensive settlement payments by removing the incentive that comes with having “deep pockets.”

 

On the other hand, there are many situations where asset protection planning could be considered unethical or illegal.  Asset protection planning may be inappropriate in the following situations:

  1. Your business is going downhill and you desire to abscond with the remaining funds, default on your creditors, and file for bankruptcy.
  2. You want to give all your assets to your children, qualify for government assistance, and live off the government for the rest of your life.
  3. You have a desire to avoid your obligations, protect what you have, and shift your losses to your partners, lenders or others.
  4. You feel it is your constitutional right to refuse to pay taxes and to hide your income and assets from the government.
  5. You are contemplating divorce and you want to place some of the marital assets beyond the reach of your spouse.
  6. You have run a successful ponzi scheme and you can see that your time is running out.

 

It is interesting to note that when asset protection planning is done in an ethical and legal manner, it is generally very effective.  Also, when asset protection planning is done in an unethical or illegal manner, judges often find ways to ensure that the planning is not effective in protecting assets.  Consider the following recent cases that demonstrate these principals:

 

Lakeside Lumber Products, Inc v. Renee Evans, Dan R. Evans, et al., 2005 UT App 87 (Utah App. 02/25/2005).

In 1989, Dan and Renee Evans created a trust agreement that included a separate trust for Renee Evans and conveyed their home to this trust.  The trust agreement specifically provided that any property in that separate trust was the exclusive property of Renee Evans and that Dan

R. Evans waived all interests therein.

In 1996, Dan Evans personally guaranteed the debts of his company, E.S. Systems. In 1998, E.S. Systems filed for bankruptcy and a creditor, Lakeside Lumber Products, obtained a judgement against Dan Evans.  In 1999, Dan Evans filed for bankruptcy.

Lakeside Lumber Products filed a complaint against Dan and Renee Evans seeking to obtain an interest in the couple’s home.  The district court granted summary judgement to the Evans concluding that the transfer to the trust was not a fraudulent transfer and that there was no wrongful conduct on the part of the Evans in creating and funding the trust.  The appellate court affirmed this decision.

The creditors of Dan Evans were not able to reach the home titled in his wife’s trust for the following reasons:

  1. The transfer to the trust was done long before the debt was incurred, and long before a default or bankruptcy was anticipated.
  2. The transfer to the trust was motivated by appropriate reasons, including traditional estate planning motivations.
  3. A couple has a right to divide properties between themselves and to separate the assets of one spouse from the potential future liabilities of the other spouse.
  4. Renee Evans has a right to own property independent of her husband or any other person.
  5. The creditor had the opportunity to obtain appropriate security when it entered into business dealings with E.S. Systems and Dan R. Evans.
  6. Dan Evans did not hide assets, conceal information, or fail to use his personal assets to meet his obligations.

 

Because the court concluded that the Evans actions did not constitute “wrongful conduct,” the court upheld the asset protection planning done by Dan and Renee Evans.

 

In re Lawrence (S.D. Fla. December 12, 2006); In re Lawrence, 279 F.3d 1294 (11th Cir. 2002).

Stephan Jay Lawrence was a highly successful big stakes options trader.  When the stock market crashed in 1987, he found himself with more debt than assets.  He transferred $7,000,000 to an offshore trust two months before an arbitration settled his liabilities at $20,400,000.  A bankruptcy court found that the assets of the trust should be included in his bankruptcy estate.

The court ordered Mr. Lawrence to retrieve the assets from the offshore trust and Mr. Lawrence refused to do so, claiming that he had no control over the trust.  Mr. Lawrence was sentenced to jail for contempt of court on October 5, 1999 and remained in jail for six years because he continued to refuse to turn over the assets.  The court refused to give Mr. Lawrence a discharge in bankruptcy and the court continues to pursue collection from Mr. Lawrence.

Because the court determined that Mr. Lawrence had made a fraudulent transfer, and because the court determined that he “lied through his teeth” about his motivation for the transfer and his ability to retrieve the assets, the court found a way to make life very difficult for Mr. Lawrence.

 

Herring v. Keasler, 150 NC App 598 (01-1000) 06/04/2002.

Mr. Herring owed some money to a bank on a defaulted loan.  In 1996, the bank obtained a judgment in the local court but the bank did not pursue collection activities.  In 1999, Mr. Herring and some other unrelated parties formed several limited liability companies (LLCs) for the purpose of investing in real estate.  Mr. Herring transferred property to the LLCs in exchange for an interest in the LLCs.

In 2000, the bank assigned its claim to Mr. Keasler who attempted to collect on the judgement against Mr. Herring by foreclosing on his membership interests, selling them, and having the proceeds applied towards the satisfaction of the judgment.  The trial court denied the plaintiff’s request for the seizure or sale of Mr. Herring’s membership interests in the LLCs, but it granted the plaintiff’s motion for a charging order. The charging order provided that the LLCs must deliver to the plaintiff any distributions that Mr. Herring would be entitled to receive on account of his membership interests in the LLCs; but the plaintiff would not obtain any rights in the LLCs.

The attorney for the plaintiff had this to say, “The real problem with this decision is that it enables defendants to hide their assets from judgment creditors basically forever…. The decision takes assets that are potentially subject to execution and turns them into something you cannot get to. If you’re a member and manager of an LLC, you never have to give yourself a distribution or you don’t have to do it until the judgment runs out. [The defendant] owns at least seven or eight LLCs that were formed years after the judgment with his assets and I can’t get to them. If they were shares in a corporation, we could sell them.”

Presumably, the plaintiff was unable to get to the assets in the LLC for the following reasons:

  1. Mr. Herring received interests in the LLCs that were proportionate to the assets that he transferred.
  2. It appeared that Mr. Herring had good business reasons for making the transfers, in addition to protecting the assets from a creditor.
  3. The LLCs had other unrelated partners.  If Mr. Herring had owned 100% of the LLCs, the creditor may have been able to liquidate the LLCs.
  4. The LLCs were filed in a state whose laws did not allow foreclosure of an LLC interest.
  5. The operating agreements of the LLC must have included proper limitations and wording in order to keep the creditor from liquidating the interests in the LLC.

 

 

SEC v. Bilzerian, 131 F. Supp. 2d 10 (D.C. 2001).

In 1989, Paul Bilzerian was convicted of securities violations and sentenced to four years in prison. He filed for bankruptcy but it was determined that he owed $130,650,328 in a non-dischargeable debt.  Sometime between 1994 and 1999, Mr. Bilzerian transferred substantial assets to a complex structure involving partnerships and offshore trusts.  The court found that the transfer was made to purposefully insulate his assets from the reach of his creditors and ordered Mr. Bilzerian to turn over the assets that had been transferred.  When he refused to turn over the assets, the court sent him to jail until he complied.  After spending over a year in jail, he settled his claims with the government by paying over a substantial portion of his assets.

On February 5, 2002, the St. Petersburg Times reported, “After nearly a year in prison ­including some memorable days sharing a cell with a bullet-scarred buy named ‘Queenie’- Paul Bilzerian is back inside his family’s $5.7 million Tampa mansion.  The former corporate raider was freed from a maximum security lockup in Miami on January 16 after his wife, Terri Steffen, agreed to hand over millions of dollars in stock and other property to the federal Securities and Exchange Commission.”  Bilzerian said that his most recent stint in prison was “horrifying,” and “People just don’t understand how awful those places are.”

 

What are the Keys to Ethical and Effective Asset Protection Planning?

In determining whether asset protection planning is ethically appropriate, and whether it will be effective, there seem to be three critical factors that make or break an asset protection plan. The first factor is the timing.  The more time between the date when the plan is put in place and the date when the liability is incurred or the judgement is executed, the better.  The second critical factor is the purposes for the planning.  If your only purpose in doing a transaction is asset protection, it is not nearly as effective as if you have business purposes, estate planning purposes, or other valid purposes in addition to asset protection.  A third factor is proper documentation and operation of the entities involved in the plan.  In other words, if you don’t have the correct documentation and if you don’t operate things correctly, your asset protection plan will look more like a sham than a valid and enforceable business arrangement.

 

Lee S. McCullough, III, operates a private law practice in Provo, Utah, exclusively focusing on estate planning and asset protection. Lee is an adjunct professor, teaching estate planning at the J. Reuben Clark Law School at Brigham Young University.

Lakeside Lumber Products v. Evans

Using Marital Property Agreements for Asset Protection

Lakeside Lumber Products, Inc v. Renee Evans, Dan R. Evans, et al.,

2005 UT App 87 (Utah App. 02/25/2005)

COURT OF APPEALS OF UTAH

2005 UT App 87;2005 Utah App. LEXIS 71

Case No. 20010334-CA

Appeal from Second District, Farmington Department. The Honorable Jon M. Memmott.

Affirmed.

COUNSEL: Clinton J. Bullock, J. Jay Bullock, and Karen Bullock Kreeck, Salt Lake City, for Appellant.

Loren D. Martin, Salt Lake City, for Appellee.

JUDGES: Before Judges Billings, Bench, and Thorne.

OPINION: BENCH, Associate Presiding Judge:

Lakeside Lumber Products, Inc. (Lakeside) appeals the district court’s grant of summary judgment in favor of Dan R. and Renee Evans. We affirm.

 

BACKGROUND

In 1996, Dan Evans, in his capacity as manager of a limited liability company, E.S. Systems, executed a personal guarantee agreement in favor of Lakeside. Lakeside delivered goods to E.S. Systems, but E.S. Systems and Dan Evans failed to pay for the goods. In 1998, E.S. Systems filed for bankruptcy. Later that same year, Lakeside obtained a judgment against Dan Evans in Arizona. Dan Evans filed a petition for bankruptcy in 1999.

Lakeside brought the present action against Dan and Renee Evans in 1998, seeking to satisfy the Arizona judgment by obtaining an interest in the couple’s primary residence. Dan and Renee Evans had transferred the home to an intervivos trust several years earlier. In 1989, Dan and Renee Evans executed the DaRe Family Trust Agreement, which created three separate trusts: the DaRe Trust, the Daymond Trust, and the Revans Trust. The Evanses conveyed the home to the Revans Trust. Article II of the DaRe Family Trust Agreement, which outlines the terms of the Revans Trust, states that: “Property held as ‘The Revans Trust’ is the exclusive property of Renee Poulsen Evans and Daniel Raymond Evans hereby expressly waives all interests . . . therein.” Dan and Renee Evans were joint trustees under the DaRe Family Trust Agreement.

The DaRe Family Trust Agreement was amended in 1997. As part of the amendment process, Dan and Renee Evans executed a separate trust agreement for the Revans Trust, naming Renee Evans as the sole trustee. In addition, the couple filed a quitclaim deed as trustees, purporting to reconvey the home to the Revans Trust. The stated purpose of the quitclaim deed was “to reflect that Daniel R. Evans . . . no longer serves as a trustee.”

Lakeside’s complaint alleged that either the initial transfer to the trust or the subsequent amendment constituted a fraudulent transfer. Alternatively, Lakeside asked the district court to create a constructive trust in Lakeside’s favor because, in Lakeside’s view, Dan Evans continues to hold an interest in the home as a beneficiary and still has power to revoke the transfer under the Revans Trust.

After suit was filed, Dan and Renee Evans moved for summary judgment and Lakeside filed a cross-motion for summary judgment. In granting summary judgment in favor of Dan and Renee Evans, the district court concluded that the undisputed facts did not demonstrate that Dan Evans transferred the home to the trust with the intent to defraud his creditors. Further, the district court determined that the 1997 amendment to the trust agreement was not a transfer, but merely an addition to the trust agreement. With regard to the constructive trust claim, the district court held that the trust agreement did not give Dan Evans the power to revoke the transfer of the home. The district court stated that Dan Evans was a beneficiary of the Revans Trust, but refused to create a constructive trust in Lakeside’s favor. Lakeside appeals.

 

ISSUES AND STANDARDS OF REVIEW

Lakeside argues that the district court erred in rejecting its claims for fraudulent transfer and constructive trust, and in granting the Evanses’ motion for summary judgment.

“In reviewing a grant of summary judgment, we view the facts and all reasonable inferences drawn therefrom in the light most favorable to the nonmoving party.” Higgins v. Salt Lake County, 855 P.2d 231, 233 (Utah 1993). Summary judgment is proper when “there is no genuine issue as to any material fact” and “the moving party is entitled to a judgment as a matter of law.” Utah R. Civ. P. 56(c). Moreover, a district court’s interpretation of a “trust instrument is a question of law,” which we review for correctness. Jeffs v. Stubbs, 970 P.2d 1234, 1251 (Utah 1998).

 

ANALYSIS

I. Fraudulent Transfer

A. The 1989 Conveyance

Lakeside argues that the district court erred in concluding that the 1989 conveyance of the home to the trust was not fraudulent as a matter of law. Under the Uniform Fraudulent Transfer Act (the Act), the transfer of an asset “is fraudulent . . . if the debtor made the transfer . . . with actual intent to hinder, delay, or defraud any creditor.” Utah Code Ann. § 25-6-5(1) (1998). The existence of “fraudulent intent is ordinarily considered a question of fact, and may be inferred from the existence of certain indicia of fraud” enumerated in the Act. Territorial Sav. & Loan Ass’n v. Baird, 781 P.2d 452, 462 (Utah Ct. App. 1989) (citations and quotations omitted). Indicia of fraud “are facts having a tendency to show the existence of fraud, although their value as evidence is relative not absolute.” Id. (citations and quotations omitted). Under the Act, indicia of fraudulent intent include: “transfer . . . to an insider,” and “the debtor retaining possession or control of the property.” Utah Code Ann. § 25-6-5(2)(a), (b). Moreover, the Act provides that the enumerated indicia of fraud are to be considered “among other factors” in determining actual intent. Id. § 25-6-5(2).

With regard to the 1989 conveyance, Lakeside argues that two indicia of fraud are present: (1) Dan Evans transferred the home to an “insider”; and (2) Dan Evans has continued to reside in the home, effectively retaining control of the property. Assuming, without deciding, that Lakeside’s contentions are true, we conclude that these indicia of fraud, considered in conjunction with “other factors,” fail to create a triable issue of fact in this case. Crucial to our determination is the temporal remoteness of the 1989 conveyance to both the 1996 guarantee agreement and Dan Evans’s 1999 petition for bankruptcy. Lakeside has pointed to no facts suggesting that in 1989, or shortly thereafter, Dan Evans was insolvent or experiencing other financial difficulties. Likewise, there are no facts in the record that would suggest that the 1989 transfer was part of a larger scheme to defraud future creditors such as Lakeside. Based merely on the indicia of fraud cited by Lakeside–transfer to an insider and retaining control of the transferred property–a jury could not rationally conclude that Dan Evans transferred the property with an intent to defraud creditors.

Thus, the district court did not err in granting summary judgment on this issue.

8. The 1997 Trust Amendment

Lakeside contests the district court’s conclusion that the 1997 amendment to the trust was not a transfer, but simply a modification of the trust agreement. Under the Act, a transfer is defined as “every mode . . . of disposing of or parting with an asset or an interest in an asset.” Utah Code Ann. § 25-6-2(12) (1998).

At the time of their creation, the DaRe Trust, the Daymond Trust, and the Revans Trust were governed by a single trust agreement, entitled “the DaRe Family Trust.” Under the 1989 trust agreement, Dan and Renee Evans were both trustees of the Revans Trust. In 1997, the trust agreement was amended and a separate agreement for the Revans Trust was created. At that time, Dan and Renee Evans, as trustees, executed a quitclaim deed to the Revans Trust and named Renee Evans as the sole trustee.

 

We conclude that these actions did not effectuate a transfer within the meaning of section 25-6-2(12). Dan Evans did not part with an asset or an interest in an asset by signing the quitclaim deed as a trustee. The purpose of the amendment and the quitclaim deed was to reflect Dan Evans’s resignation as trustee. The district court did not err in determining that the 1997 amendment was not a transfer. Thus, the district court properly granted summary judgment in favor of Dan and Renee Evans on Lakeside’s fraudulent transfer claim.

II. Constructive Trust

Lakeside argues that the undisputed material facts justified the creation of a constructive trust in Lakeside’s favor. “A constructive trust is an equitable remedy which arises by operation of law to prevent unjust enrichment.” Ashton v. Ashton, 733 P.2d 147, 150 (Utah 1987). “The plaintiff in bringing a suit to enforce a constructive trust seeks to recover specific property.” Restatement of Restitution § 160 cmt. a (1937). Because Lakeside is seeking to recover specific property, Lakeside must show a nexus between the alleged wrongful conduct and the property that is the target of the constructive trust action. See Baltimore & Ohio R.R. Co. v. Equitable Bank, 77 Md. App. 320, 550 A.2d 407, 412 (Md. Ct. Spec. App. 1988) (“In order to impose a constructive trust as a matter of law specific funds must be ascertained as traceable to fraudulent or wrongful conduct.”); Restatement of Restitution § 160 cmt. b (“A constructive trust is imposed [*9] because the person holding title would profit by a wrong or would be unjustly enriched if he were allowed to keep the property.”); 76 Am. Jur. 2d Trusts § 207 (1992) (noting that imposition of a constructive trust requires that “specific identifiable property” be held by the defendant).

Lakeside contends that a constructive trust is an appropriate remedy because Dan Evans is either a beneficiary of the Revans Trust or has power to revoke the transfer of the home. However, even assuming these facts, a constructive trust can only be imposed if Lakeside can demonstrate a connection between wrongful conduct and the property. See Baltimore & Ohio R.R. Co., 550 A.2d at 412.

Lakeside argues that it can prevail on its constructive trust claim without a showing of wrongful conduct. Lakeside points to section 156 of the Restatement of Trusts, which provides that “where a person creates for his own benefit a trust[,] . . . creditors can reach his interest.” Restatement (Second) of Trusts § 156 (1959). The Restatement further provides that the creditor can reach the assets of a self-settled trust without showing fraudulent intent. See id., comment a. However, section 156 cannot be read to allow a creditor to reach assets of a self-settled trust under any theory of recovery, even where, as here, the theory urged by the creditor requires a showing of fraudulent or wrongful conduct. Section 156 merely states a general rule: A debtor’s interest in a self-settled trust is reachable to the same extent as the debtor’s non trust assets. Moreover, comment (a) of section 156 simply recognizes it is possible for a creditor to successfully reach self-settled trust assets without showing fraudulent intent, if the creditor pleads a proper theory of recovery. See Leach v. Anderson, 535 P.2d 1241, 1243 (Utah 1975) (citing the general rule that self-settled trusts are void against creditors and allowing a creditor to reach the assets of a self-settled trust under a statute that did not require a showing of fraudulent intent). Comment (a) does not suggest that a creditor’s obligation to prove all required elements of an established cause of action is altered when the creditor seeks to reach the assets of a self-settled trust. Thus, Lakeside cannot avoid its obligation to prove each element of its constructive trust claim simply by citing the Restatement of Trusts. If Lakeside desired to recover without having to prove fraudulent or wrongful conduct, it was incumbent upon Lakeside to plead such a theory.

Lakeside also cites Butler v. Wilkinson, 740 P.2d 1244 (Utah 1987), for the proposition that a judgment creditor can reach a debtor’s property via a constructive trust action. However, Butler is easily distinguished from the present case. In Butler, the Utah Supreme Court held that a constructive trust was necessary to permit judgment creditors to reach the proceeds resulting from a debtor’s fraudulent transfer where the judgment creditors had no other remedy. See id. at 1262.

In contrast to Butler, the present case does not involve a fraudulent transfer or other wrongful conduct. The debtor’s fraudulent transfer in Butler gave rise to the constructive trust; without the fraudulent transfer, a constructive trust would have been inappropriate. See id. Here, even if Dan Evans holds an interest in the Revans Trust, as Lakeside asserts, this fact alone does not give rise to a constructive trust in Lakeside’s favor absent a showing of fraud or other wrongdoing. While it is true that Dan Evans has failed to pay his debt to Lakeside, it does not follow that Lakeside can collect on the debt by imposing a constructive trust on the home. Thus, we affirm the district court’s conclusion that, as a matter of law, Lakeside cannot prevail on its constructive trust claim.

CONCLUSION

Accordingly, we affirm the district court’s order granting summary judgment in favor of Dan and Renee Evans and denying Lakeside’s cross-motion for summary judgment.

Russell W. Bench, Associate Presiding Judge

 

WE CONCUR:

Judith M. Billings,Presiding Judge

William A. Thorne Jr., Judge

Why You Can’t Rely on a Wyoming LLC for Asset Protection Purposes

For many years, asset protection planners have believed and promoted the idea that an out-of-state resident could take advantage of the strong charging order laws in another state by filing their LLC in that state.

  Recent cases show that this does not work.
In American Institutional Partners, LLC v. Fairstar Resources, Ltd., 2011 WL 1230074 (D.Del., Mar. 31, 2011), a Utah resident established several Delaware LLCs with the hope that they could take advantage of the better charging order statute in the State of Delaware.  When the Utah resident was sued in a state court in Utah, the Utah court stated “that Utah law applies to all execution proceedings in this matter, including the foreclosure of a member’s interest in a limited liability [company], whether such company is domestic or foreign.”  In other words, the Utah court used their own law and ignored the law of the state where the LLC was filed.

This means that you shouldn’t believe those who heavily advertise the use of a Wyoming LLC for asset protection purposes, because if you are sued in a state outside of Wyoming, the court will probably use their own law and you won’t get the benefits of a Wyoming LLC.

Mortensen Case Holds that Self-Settled Trusts Don’t Work in Bankruptcy (but Our Trust Will)

A self-settled trust is a trust in which the grantor is also included as a beneficiary.  Historically, all fifty states did not allow asset protection for a self-settled trust.
  In recent years, several states have passed laws allowing asset protection for a self-settled trust.  These states include Alaska, Nevada, Delaware, Tennessee, Utah, Hawaii, Missouri, New Hampshire, Oklahoma, Rhode Island, Wyoming and South Dakota.  Many have promoted self-settled trusts under the name of a “Domestic Asset Protection Trust,”an “Alaska Asset Protection Trust,” a “Nevada Asset Protection Trust,” etc.  As more and more cases show that offshore trusts can be attacked through the use of a contempt order, these “Domestic Asset Protection Trusts have become quite popular.However, a recent bankrupcty case (Battley v. Mortensen, Adv. D. Alaska, No. A09-90036-DMD, May 26, 2011) shows that self-settled asset protection trusts are ineffective at protecting assets from bankruptcy.  This is not a situation where bad facts make bad law.  This is a case where the debtor settled the trust when he was not insolvent, and it was done four years before the debtor filed for bankruptcy.The reason the self-settled asset protection trust failed is because of a new bankruptcy law (Section 548(e)(1)) which specifically applies to a self-settled trust.  This law allows the bankruptcy court to avoid any transfer made to a self-settled trust within ten years of the bankruptcy filing if the debtor made the transfer with actual intent to hinder, delay, or defraud any entity to which the debtor became indebted whether the debt occured before or after the transfer.It is important to note that the Mortensen case and Section 548(e)(1) have no affect on any trust in which the debtor is not a beneficiary; they only apply to self-settled trusts.  Thus, our trust continues to be the best asset protection trust available in or out of the US because it is supported by the federal bankruptcy code (See Section 541(b)(1)), the Uniform Trust Code (See Section 505), the Restatements of the Law (See RESTATEMENT (SECOND) OF TRUSTS Section 156(2)), and many statutes and court cases throughout the country.Click HERE to read the case.

Asset Protection Test Case

I had a client named Bill who was a wealthy physician.  In 2003, he created a 541 Trust® for his wife Jenny and their four children.

  He put $2,000,000 into the 541 Trust® where it was invested in income producing real estate.  In 2005, Bill died.  In 2007, Jenny married a successful real estate developer named Paul.  Paul needed a loan for a large project and the bank required both Paul and Jenny to guarantee the loan.  When the real estate market crashed in 2008 and 2009, the project failed.  The bank sued Paul and Jenny on their personal guaranty.  Paul and Jenny were both forced into bankruptcy.  The bankruptcy court declared that the 541 Trust® was not includible in the bankruptcy estate and that the creditors have no claim on the 541 Trust®.  The 541 Trust® is now Jenny’s only source of income.  The income and principal of the 541 Trust® is available to Jenny, but protected from her creditors or from a divorce.  When Jenny dies, the assets will be held for her children for life and they will receive the same asset protection.

Asset Protection for Doctors

Doctors have several unique characteristics that require specialized asset protection planning.  First, doctors cannot take advantage of the corporate shield that protects other business owners from the liabilities of their business.  In all fifty states, doctors are personally liable for malpractice claims regardless of whether their practice is operated within a corporation.   Second, malpractice insurance for many doctors is prohibitively expensive.  Many doctors choose to underinsure or even go without malpractice insurance due to the outrageous expense.  Third, a doctor’s most valuable assets often consist of accounts receivable and future earnings which are more difficult to protect than a current asset.
Because doctors have unique needs, they need a unique solution.  The best solution for a doctor consists of the following entities: (1) a professional corporation (taxed as an S corporation) to operate the medical practice, (2) a 541 Trust® to remove assets from the doctor’s personal ownership, (3) a Delaware LLC that is owned by the 541 Trust to own cash and other investments, and (4) an effective equity stripping plan that allows the Delaware LLC to put an enforceable lien on the doctor’s home, accounts receivable and other assets which are personally held by the doctor.  If you would like a diagram and detailed explanation of this plan, send me an email at  [email protected].
The purpose of the professional corporation is to save money on employment taxes and keep the employees and other non-malpractice liabilities separate from the doctor and his assets.  The purpose of the 541 Trust is to remove assets from the doctor’s personal ownership so they cannot be discovered or attached in a lawsuit or other legal proceeding.  The purpose of the Delaware LLC is to own and manage cash or other liquid assets. The purpose of the equity stripping plan is to ensure that the doctor’s home and accounts receivable cannot be attached by a third party.
This plan is simple to implement, easy to maintain, and impervious to attack if it is implemented in advance of a problem.  However, individual circumstances require individual plan design and this site should not be construed to create an attorney-client relationship or provide legal advice for any particular situation.  If you would like to discuss your situation, please give me a call.

Update of Recent Asset Protection Cases

This is a summary of important findings from recent asset protection cases:

1. In re Baldwin, 593 F.3d 1155 (10th Cir Ct. App. 2010). Bankruptcy trustee can avoid restrictions imposed by state law charging order statutes if a partnership agreement is not an executory contract. Also see In re Ehmann 2005 WL 78921 (Bankr.D.Ariz. 01/13/2005) which had similar facts and a similar holding.

From these cases we learn the following: (1) Partnership agreements and LLC operating agreements should be carefully designed to ensure that they constitute executory contracts, (2) Personal use assets should not be held by business entities (except for valid lease arrangements), (3) Entities should be structured for valid business purposes, (4) If possible, entities should include legitimate partners other than the debtors (and unrelated to the debtors if possible).

2. Shaun Olmstead vs. Federal Trade Commission, No. SC08-1009, June 24, 2010.  The Supreme Court of Florida held that Florida law permits a court to order a judgment debtor to surrender all right, title, and interest in the debtor‘s single-member limited liability company to satisfy an outstanding judgment. A charging order is not the sole remedy authorized by law.

From this case we learn the following: (1) Some states provide much better asset protection than others for LLCs and limited partnerships. Many states, including Florida, mention a charging order as one remedy but remain silent as to whether it is the sole remedy of a creditor. This case shows that this language is insufficient to ensure “charging order protection.” (2) As we have learned from previous cases, including In re Albright, 291 B.R. 538, 540 (D. Colo. 2003), you cannot rely on a single member LLC to provide charging order protection. This does NOT mean that a single member LLC cannot provide asset protection to the members against the inside liabilities of the LLC.

3. Miller v. Kresser, 2010 Fla. App Lexis 6152 (Fla. 4th DCA 2010); Wachovia Bank, NA v. Levin, 419 B.R. 297 (E.D.N.C. 2009) and In re: Coumbe, 304 B.R. 378 (2004). From these cases we learn that the good old fashioned asset protection provided by a spendthrift trust continues to be upheld by the courts. This protection is even greater when the trust is designed as a discretionary trust (see Wilson v. U.S., 140 B.R. 400 (N.D. Tex. 1992). Once again, this protection is even greater when supported by a state statute that provides that a beneficial interest is not a property right and that the discretion of a trustee is “absolute.”

4. Sweeney, Cohn, Stahl & Vaccaro v. Kane, No. 2002-04052 (N.Y. App.Div. 03/08/2004).  A New York resident attempted to protect a residence by placing it in a Florida corporation whose shares were owned as tenants by the entirety under Florida law.  The Supreme Court of the State of New York- Appellate Division, found that Florida law applied because the state of incorporation has the greatest interest in determining whether the corporate veil may be pierced.  The court allowed the creditor to attach the residence under a theory of “reverse-veil piercing.”

This case affirms the fact that the internal affairs of a corporation, including a potential piercing of the corporate veil, are governed by the laws of the state where the corporation is filed, regardless of the fact that the plaintiffs, the defendants, and the cause of action in the case, were all located in another state.  The case also reminds us not to put personal use assets in a corporate entity without a lease or other business purpose to justify such an arrangement.

Miller v. Kresser

In the recent case, Miller v. Kresser, 2010 Fla. App Lexis 6152 (Fla. 4th DCA 2010), a Florida Appeals court overturned the ruling of a lower court which allowed a creditor to reach the assets of a trust.

The lower court allowed the creditor to reach the assets of the trust because the beneficiary exerted significant control over the trust, the trustee was related to the beneficiary, and the trustee basically failed to perform the administrative duties expected of a trustee. The appeals court overturned that ruling and upheld the asset protection provided by the trust despite the fact that the trustee was not fulfilling his duties.

Lessons learned from this case:

1. Courts continue to uphold the asset protection provided by a spendthrift trust, even in cases where the operation of the trust is imperfect.

2. You can improve your chances of protecting trust assets by appointing an independent professional as the trustee instead of appointing a family member.

3. If you must appoint a family member as a trustee, appoint an independent professional as a co-trustee in order to add legitimacy to the trust.

4. A trustee who does very little administration and allows the beneficiary too much control over the trust will jeopardize the asset protection provided by the trust. The trustee should keep books and records, participate in regular meetings, make investment decisions, sign tax returns, and take part in the administration of the trust.

5. Distribution of income and principal should not be mandatory at any time, but should be left to the unfettered discretion of the trustee.

6. The trust should be located in a jurisdiction that supports the asset protection provided by an irrevocable spendthrift trust.

Death Hollow Done Right

As a sequel to my previous blog entry, I wanted to provide a report of our recent trip to Death Hollow.

The first day entails a 13 mile hike in soft desert sand without any water. Last time we did this hike we almost died of dehydration. This time we left at 3am and used headlamps to light our way. Not only did we enjoy the adventure of hiking through the desert at night, we arrived at our destination early, with plenty of water remaining in our packs. The decision to leave early and hike at night was right – dead right.

hh5hh4hh3

The second day requires swimming through icy water. This can be scary with shoes and a backpack. We threw ropes back to the younger boys so they could grab on if they got in trouble. This turned out to be unnecessary, but it was the right decision – dead right.

Late on the second day we found ourselves in the narrows when it started to rain. We decided to run down river and get to high ground to avoid a flash flood. No flood came on this day, but the decision to play it safe was right – dead right.

That night we slept in a cave that was sheltered from the storm outside. After we set up camp we found bear scat all over the place. We moved all the food away from our sleeping area, built a fire at the entrance to keep the bears away, and dried tons of wet firewood over the fire to give us extra fuel for a bonfire. Twice during the night we heard a large animal splashing in the river outside and we stoked up the fire really quick. The decision to prepare tons of firewood and keep the fire raging was right – dead right.

The next morning we were anxious to press on in order to get home on time, but it was raining and we decided it would be wise to wait out the storm. We witnessed a deluge of rain for five hours. Huge waterfalls poured off the canyon walls. The river rose and we watched the flash flood from the safety of our bear cave. The decision to wait out the storm was right – dead right.

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The storm passed and we finally started hiking at noon. We hiked as fast as we could to try to make it out before dark. When darkness came we pressed on with our headlamps walking down a river in the dark for four hours. We really wanted to make it to the end of the hike so we could call and let our families know we were safe, but we got lost in the darkness. We knew we were close to the parking lot but we couldn’t tell if we had passed it in the darkness, and we didn’t know which way to go. We really wanted to keep looking for the parking lot but we knew it was best to stay where we were until the morning so we didn’t get lost any further out of our way. That was the right decision – in fact, it was dead right. In the morning, we found the way and realized we never would have found it in the dark.

Death Hollow was a great adventure, one that we will never forget. I am grateful for the friends that made the trip so much fun, and for the wisdom, experience, and inspiration that helped us to make the right decisions and bring everyone home safely.

The Case for Specialization (and deep powder)

Last Saturday I went snowcat skiing with my dad and my brother. We had a marvelous time. But the most impressive part of the day was watching the guides who led us to the steepest and deepest powder runs while avoiding the dangers all around us. The guides have years of experience on the same mountains and they know exactly where the best powder is found and how to avoid the avalanches and other dangers which were apparent all around us. All day the snowcat climbed up ridges no wider than the snowcat itself with thousand foot drops on both sides. We skied along narrow ridges where the guides insisted that we stay directly on their tracks to avoid collapsing the rims on either side. In one large bowl thousands of yards across, the guides showed us how there was avalanche danger on the right, icy crusty snow on the left, and one perfect powder run down the middle. They had us ski between the tracks of one guide on the right and the tracks of another on the left so we could take advantage of the lightest and deepest powder the mountain had to offer.

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Powder skiing photography by John Dougall

These guides did not rely on generalized weather reports or general backcountry experience. They were focused on the specific conditions of each particular hillside at each specific moment in time. They knew which slopes got the most sun, which got most wind, which got the most snow, and how this would affect the safety and enjoyment of the skiers at any particular time. Because of their specific knowledge, they were able to provide a safer and better experience than we could ever do for ourselves.

This same principal applies equally well in many fields. I keep a specialist file in my office with the name and contact information of people who are the very best in their field of specialization. So if you ever need an expert in municipal bonds, or the taxation of stock options, or mediation, or bankruptcy (hopefully not), let me refer you to a specialist. By focusing on one specific area, a specialist can stay up on the latest developments, dangers, strategies and ideas. Just like the ski guides, we can show you where the dangers are, and where the good stuff can be found.

Living on the Edge

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Gooseberry Mesa is the greatest mountain bike trail on earth The trail involves sweet single track, endless slick rock playground, and breathtaking views. If you look east, you see the imposing cliffs of Zion National Park If you ride along the south or north edges of the mesa, the trail skirts sheer cliffs dropping hundreds if not thousands of feet to the valley floor At the end of the mesa is a narrow neck of rock, forty feet wide with a trail down the middle and cliffs on both sides Finally, the rock ends with sheer cliffs dropping off in front of you and on both sides A trip to Gooseberry Mesa is exhilarating, and refreshing to the soul.

The trail keeps you close enough to enjoy the view, but never puts you in danger of falling off the edge This is a good analogy for those of you who like to live on the edge I have many clients who get involved in aggressive tax planning, speculative investments, or high risk businesses Some push the limits too far and get burned; others live to play another day Sometimes it is luck that makes the difference; other times, a person is protected by taking precautionary measures that limit their exposure I recommend the following precautionary measures:

First, “Where no counsel is, the people fall: but in the multitude of counsellors there is safety” (Proverbs 11:14) A really good CPA not only helps you take advantage of every opportunity, but he also knows where to draw the line and when to push back when you get too greedy Before taking the plunge on a risky deal, I suggest you get several independent opinions from well qualified counselors.

Second, “He that maketh haste to be rich shall not be innocent” (Proverbs 28:20) If it sounds too good to be true, it probably is If it is that good, it is worth taking the time for some advance planning and due diligence.

Third, “He that walketh with wise men shall be wise: but a companion of fools shall be destroyed” (Proverbs 13:20) More important than any legal documents, tax opinions, or pro forma projections, is the character of the promoters.

Remember, a fine day at Gooseberry Mesa is made better by the fact that you are likely to survive, to do it again.

Death Hollow and Doing Difficult Things

My dad has been a scoutmaster all his adult life.  He has done 7 or 8 camping trips every year for over thirty years.  I asked him once, “What is the most memorable scout trip you ever did?”  He said the most memorable trip was Death Hollow because it was the most difficult.  He said that those who went will never forget it as long as they live.

And so it was, in June of 2007, that I took 22 boys and 9 men to a place called Death Hollow.  This is a deep, beautiful canyon, 33 miles long, and filled with obstacles of every kind.  Can you imagine hiking through thick forest with no trail, sandy riverbeds, endless cactus fields, deep narrows full of choke stones, beaver dams, swimming holes, waterslides, and lots of poison ivy, all in one trip?

My dad has been a scoutmaster all his adult life.  He has done 7 or 8 camping trips every year for over thirty years.  I asked him once, “What is the most memorable scout trip you ever did?”  He said the most memorable trip was Death Hollow because it was the most difficult.  He said that those who went will never forget it as long as they live.

And so it was, in June of 2007, that I took 22 boys and 9 men to a place called Death Hollow.  This is a deep, beautiful canyon, 33 miles long, and filled with obstacles of every kind.  Can you imagine hiking through thick forest with no trail, sandy riverbeds, endless cactus fields, deep narrows full of choke stones, beaver dams, swimming holes, waterslides, and lots of poison ivy, all in one trip?

The canyon changes every year depending on the water flows.  We took plenty of water for the first 11 miles, expecting to refill at a well marked spring.  But in June of 2007, the canyon was burning hot, and the spring was dry.  We all suffered from severe dehydration, but most of the boys made it to flowing water at the 13 mile mark.  I was with a small group that collapsed from dehydration.  We found a small pool of dirty water with a dead bird in it.  We filtered the water many times and attempted to drink.  But my body was so dehydrated I threw it up.  Six times I tried to drink and threw it up.  I knew I desperately needed water, but my body wouldn’t take it.  I thought I was going to die.  I prayed with a desperation and sincerity I never felt before in my life.  It was a long night, but I did finally keep the water down and recover my strength.

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In the morning we joyfully reunited with our friends and continued on our way.  The rest of the trip was challenging, adventurous, and thoroughly enjoyable.  We cherish the memories of Death Hollow the same way my dad’s troop did.  In fact, we came up with a new motto for our troop, “We do difficult things.”

It is no coincidence that the most difficult things in life are often the most rewarding.  The best business advice I ever heard is to find the thing that is so difficult that no one else wants to do it, and master that thing, and this will make you valuable.

My accounting professors at college said that the most complicated parts of the Internal Revenue Code are partnership special allocations and the generation-skipping transfer tax.  I made a special effort to learn these provisions and I found that this made me valuable at work because I knew things that were useful, but very few were willing to learn.

If I stay in my comfort zone, I am no more valuable to others tomorrow than I am today.  But if I take on the difficult process of continual education and improvement, I increase my ability to help myself and others.  I believe this applies in many fields of endeavor.  I suggest that you adopt our troop motto, “We do difficult things.”  Look around for difficult challenges that will stretch your capacity, and then do it and see what it does for you.  If you are unable to find a difficult challenge, we are planning another trip to Death Hollow this year, and you are welcome to come along!

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How to Avoid a Piercing of Your Corporate Veil

If you have one or more corporations or LLCs, this subject should be of importance to you. The general rule in every state is that a creditor of a corporation or LLC cannot reach the assets of the owners unless the owners have signed a personal guarantee, or unless the creditor can pierce the corporate veil.

Courts in every state generally uphold the liability protection offered by a corporation or LLC, and they rarely are willing to pierce the corporate veil. A two-part test has been developed by the Utah Supreme Court to assist in determining when to disregard a corporation or LLC. ”[I]n order to disregard the corporate entity, there must be a concurrence of two circumstances: (1) there must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist, viz., the corporation is, in fact, the alter ego of one or a few individuals; and (2) the observance of the corporate form would sanction a fraud, promote injustice, or an inequitable result would follow.” (Envirotech Corp. v. Callahan, 872 P.2d 487, 499 (Utah App. 1994)).

There are slight differences from state to state, but courts will typically look at the following factors to determine if a corporate veil can be pierced: (1) is there commingling of funds between the entities, (2) is the management the same, (3) is the ownership the same, (4) do the entities have separate bank accounts and accounting records, (5) do the entities have their own operating agreements, (6) is their a unity of purposes, assets, or operations, (7) does one entity exert dominion over the other, (8) is the entity undercapitalized for its operating needs, (9) is there a failure to fulfill corporate formalities, etc.

After reviewing applicable case law, the following are my tips to avoiding a piercing of your corporate veil:

  1. Each entity should have its own bank account, keep its own accounting records, collect its own income, and pay its own bills. It is possible to have another entity provide management services (such as collecting income and paying bills) if a written management agreement is in place and if proper allocations and reimbursements are made.
  2. Corporations should have an updated corporate book with bylaws, organizational meeting minutes, a stock ledger, updated stock certificates, and minutes of annual meetings of shareholders and directors. LLCs should have an operating agreement and they may strengthen their position by having resolutions or minutes of manager meetings although these are not required. Entities must be operated in accordance with the rules set forth in the bylaws or operating agreement.
  3. Related party transactions should be documented with written leases, promissory notes, purchase agreements, etc, and the terms should be typical of an arms-length transaction.
  4. Different entities should have differences in the identify of their officers, directors or managers. In a family setting, you could have one spouse manage one entity and another spouse manage another entity. After all, who could argue that a husband and wife have such a unity of interest that the separate personalities no longer exist and one is the alter ego of the other?
  5. Any use of assets, employers or resources of one entity by another entity should be compensated or reimbursed.
  6. Each entity should have sufficient capital to meet its operating needs.
  7. Each entity should have its own assets and resources which are allocated to its independent purposes.
  8. Most entities should have an annual meeting with an outside CPA and attorney to discuss tax and business planning issues, update corporate documents, review buy sell agreements and leases, check on asset titles and corporate renewals, and review the factors necessary to avoid a piercing of the corporate veil.

How to Protect Your Home

For most of us, protecting our home is paramount. We do this through the acquisition of homeowners insurance, fire insurance, flood insurance, personal liability insurance, burglar alarms, fire alarms, frightening dogs, and an assortment of high powered weapons. In addition to all the above, you should consider legal asset protection planning for your home.

I have a client who works in a high risk occupation. My client has a recurring nightmare that he will incur serious personal liability and have a sheriff come to his house with a judgment in hand, kick his family out, and attempt to take furnishings or other personal items from the house to satisfy the judgment. He wants to be sure that his wife and children don’t experience this kind of invasion of their peace, privacy and personal belongings, but what are his options?

These are a few of the common strategies for protecting a home:

Using Mortgages and Liens

Some people keep enough debt on the home so there isn’t much equity for a creditor to attack. A lack of equity may deter a creditor, but it results in a significant interest expense Others sign up for a home equity loan that results in a lien for the full amount of the credit line even if they don’t borrow any money. This gives the appearance of low equity, but it is only a smokescreen It may deter a lazy creditor, but it also may fail if a creditor discovers that no funds have been borrowed and there is equity in the home.

Separate Property Ownership for a Safer Spouse

If a couple has a safer spouse who is not likely to be sued, it is possible for the couple to sign a legal agreement whereby they agree to own property separately. If the couple has signed a prenuptial agreement, or a post-marital separate property agreement, the creditors of one spouse should not be able to reach the separate property of the other spouse (see Lakeside Lumber Products vs. Evans under “Important Articles, Cases and Rulings” on my website). This can be a safe and convenient strategy, and it allows a couple to retain all the tax advantages of home ownership. The only disadvantages are the risk of a suit against the safer spouse, and the risk in some states that you could be left at a disadvantage in the event of a divorce.

Using an Irrevocable Trust

The advantages of transferring a home to an irrevocable trust are: (1) the assets can be protected from the creditors of both spouses, (2) the couple can retain the tax advantages of home ownership, (3) the trust can serve other important purposes such as avoiding probate, avoiding estate taxes, and transferring assets to heirs according to your wishes. The disadvantages of an irrevocable trust include: (1) cost and complexity, (2) possible difficulty in later refinancing the home, and (3) the transfer must occur far before trouble occurs so it is not deemed to be a fraudulent transfer.

Renting from a Safer Entity

If you don’t own something, your creditors can’t take it away from you. I have some clients who rent their furnished house from a friendly landlord to ensure that the assets are protected from creditors. The obvious risk is that the landlord could kick you out, or he could jeopardize the home due to his own liabilities. It is best to structure a protected entity to own the home and collect rent from you for your future benefit. By paying full rental value for your home and personal property, you can transfer additional funds into a protected entity This option requires some cost, complexity, and tax planning, but if properly designed and managed, it can provide phenomenal peace of mind.

 

Tax Planning for Business Opportunities

I am an amateur outdoor photographer. To me, photography is all about capturing the opportunities when they come and before they leave To get the perfect photo, you simply have to be in the right place at the right time Consider the following photos:

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I have been to these places many times when the colors weren’t as brilliant, or the water wasn’t flowing, or the light wasn’t just right These photos are as good as they are because I was lucky to be in the right place at the right time.

Business opportunity planning is similar, in that you try to transfer a business to a Dynasty Trust or a Roth IRA at just the right time.

Consider these examples:

1. A young software developer established and funded a Self-Directed Roth IRA when his income was low enough for him to qualify, and at a time when he had an opportunity to purchase stock in his company for a very low price The Roth IRA bought the stock, the value grew exponentially, the company was sold, and the young guy walked away with $700,000 in a Roth IRA, never to be subject to income tax! That is what we call business opportunity planning.
2. One of my clients owned a huge commercial real estate center At a perfect time when values and interest rates were low, he sold the real estate to a Dynasty Trust Now he is 85 years old and he has $200,000,000 in a Dynasty Trust that can pass to future generations without estate tax.

Neither of these examples required a bending of the rules Both were made possible by a convergence of good timing, good thinking, and a quick and decisive response Both are very applicable to current conditions Right now we have historically low market values, historically low interest rates, and the opportunity for people of any income level to convert to a Roth IRA Now all you need is a legitimate and reliable once-in-a-lifetime business opportunity!

Advance Planning for the Sale of a Business

The best way to prepare for the sale of your business is to sell your stock to a grantor trust (often called a Dynasty Trust) In addition to other benefits, this will protect the appreciation of your stock from estate taxes as well as other potential creditors

If you want to provide incentive to key employees by promising them a portion of the proceeds from a sale of the business, a “profits interest” may be the most tax efficient way to do it A “profits interest” is simply an interest in the future profits of a partnership without any current equity or liquidation rights A profits interest can be granted without any income tax affect and it can allow an employee to receive long-term capital gains from the proceeds of a sale A profits interest can be designed with any kind of limits, restrictions, adjustments, vesting schedules or other specific features.

If you give an employee a bonus plan, this will result in ordinary income and employment taxes to the employee If you give an employee stock, this is ordinary income to the employee when it is received If you give an employee stock options, this will create ordinary income to the employee when the options are granted, or when they vest Incentive stock options result in AMT income instead of ordinary income, but the end result is almost equally negative Also, most of these options can’t be undone if the employee is terminated.

Consider this example of a profits interest Assume that you give your key employee a profits interest defined as 10% of the proceeds from the sale of the business, but only to the extent the proceeds exceed the current business value of $10,000,000, and only if the employee is not terminated for cause before the sale If the business sells for $15,000,000, the employee will receive $500,000 as a long term capital gain and pay $75,000 in taxes (using the current 15% federal rate) If the employee had received the same $500,000 as ordinary income, the employee would have paid $175,000 in taxes (assuming a 35% federal rate).

On the other hand, a sale to a grantor trust for an employee can accomplish the same result as a profits interest, with even greater control and flexibility And a sale to a grantor trust works just as well with a corporation as it does with a partnership or LLC If you are starting to get the impression that I attempt to solve all of life’s problems with a grantor trust, you may be on to something I haven’t found too many problems that can’t be solved with fresh air, duct tape, or a grantor trust!

Self Settled Trust not Included in Taxable Estate

PLR 200944002

PLR 200944002 Completed Gift Not in Estate

Dear * * *:

This responds to your authorized representative’s letter of January 15, 2009, requesting gift and estate tax rulings with respect to a trust.

The facts and representations submitted are as follows: Grantor proposes to create an irrevocable trust (Trust) for the benefit Grantor, his spouse and descendents. Trust will be initially funded with $X. Trust Company will serve as trustee.

Article Second, paragraph A of Trust provides, in part, that trustee will pay over the income and principal of