TURNING ASSET PROTECTION INTO ASSET COLLECTION: A CREDITOR'S VIEW

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1 TURNING ASSET PROTECTION INTO ASSET COLLECTION: A CREDITOR'S VIEW MELISSA LANGA Bove & Langa P.C. Ten Tremont Street Suite 600 Boston MA [email protected] MELISSA LANGA is the managing shareholder in the Boston law firm of Bove & Langa, PC. She has built her practice guiding individuals, families, business owners, and charitable organizations in designing and implementing customized tax-efficient structures to meet their particular estate planning, business, and charitable needs. Melissa is an adjunct professor at Boston University Law School s Graduate Tax Program and a Fellow of the American College of Trust and Estate Counsel. She is a founder of the Boston chapter of the London based Society of Trust and Estate Practitioners (STEP Boston); and is Co- Chair of the ABA's Asset Protection Planning Committee. Melissa has been honored by the Boston Estate Planning Council as its 2014 Estate Planner of the Year. In addition to her professional activities, Melissa is a member of the Board of Directors of Boston's SpeakEasy Stage Company where she chairs the Governance Committee; is a member of the Board of Trustees of The Brookline Community Foundation; and is a member of the President s Advisory Committee of Colby-Sawyer College (NH). She has participated as a writer and lecturer at programs presented by many organizations including the Notre Dame Tax Institute, the American Bar Association, ALI-ABA, the Massachusetts Society of Certified Public Accountants, the Boston Bar Association, and the Massachusetts Bar Association. Melissa has been recognized in the field of Trusts and Estates as a New England Super Lawyer; a Best Lawyers in America; and one of the Top Women Attorneys In Massachusetts. ACKNOWLEDGMENT Today s presentation is based upon a longer article I presented at the Notre Dame Tax Institute. That presentation, and this one, would not have been possible without the hard work of the associates at Bove & Langa. Their contributions were invaluable; the errors remain mine.

2 TURNING ASSET PROTECTION INTO ASSET COLLECTION: A CREDITOR'S VIEW NEW HAMPSHIRE ESTATE PLANNING COUNCIL MAY 13, 2015 INTRODUCTION A court judgment is just a piece of paper until an execution or levy attaches to the debtor s property, and a transfer occurs in satisfaction of the debt. This presentation focuses on the strategies available to an unsecured creditor faced with a debtor whose estate plan has been crafted with modern asset protection features. ESTATE PLANS WITH ASSET PROTECTION ELEMENTS Asset protection is not a new concept. For as long as humans have walked upright clever minds have developed methods to protect assets. Castle moats protected wealth from jealous neighbors. Laws of primogeniture protected the wealth of eldest sons from siblings. Since the industrial age corporations, and in modern times limited liability companies, are used to encourage entrepreneurship, to permit a person to run a business without fear of placing personal assets at risk. State sponsored asset protection takes the form of laws to protect a person s home, retirement benefits, and insurance. Perhaps it is simply the unalterable march of time which brings us to today, when what has become known as asset protection planning is a concept considered, if not implemented, in every estate plan. To understand how an asset protection 2

3 infused estate plan might be vulnerable to attack by an unsecured creditor 1, let s begin by taking a brief look at an estate plan which contains asset protection elements. HARRY AND WANDA DINERO Wanda and Harry Dinero are married and live in Massachusetts. They think about moving to Florida, but just can t see themselves as Red Sox fans in Tampa Bay Ray s territory. They have two grown children. Wanda is a former hedge fund manager, who now sits on various corporate and non-profit boards. She has a $5 million IRA, most of it as a result of a 401(k) rollover, with Harry named as the beneficiary, and her irrevocable New Hampshire domestic asset protection trust, one of the first such trusts in NH, named as the contingent beneficiary. Harry is a real estate developer with a plethora of ongoing projects in various stages of completion, with a total net worth upwards of $20 million. Each project is contained within its own single member Massachusetts limited liability company (LLC), with the single member of each LLC being a Delaware LLC. The sole member of the Delaware LLC is Harry s irrevocable Delaware domestic asset protection trust. The sole member was Harry, but he created and funded the DE trust last year on advice of counsel. Wanda and Harry have a $3 million dollar Boston principal residence they bought in 1975, owned as tenants by the entirety and protected by a homestead. They also have a $7 million home on Martha s Vineyard, also owned tenants by the entirety with a recorded homestead declaration. They have a $5 million life insurance policy with about $400,000 of cash value, Harry is the insured, and an irrevocable fully discretionary spendthrift trust administered in Massachusetts has been the owner and beneficiary of the policy since its inception. Wanda and the children are the beneficiaries of the insurance trust, and Wanda s sister is the trustee. They also have $17 million in investments and liquid assets. About half is divided between the NH trust ($4 million) and the DE trust ($4 million), and the rest was transferred by Wanda to a Cook Islands irrevocable trust five years ago when it looked as if one of Harry s deals was going to create a large liability. The Cook Islands trustee established a single member Nevis LLC, and the assets were transferred to the Nevis LLC where they are held in an 1 Going forward, all references to creditor will mean an unsecured creditor unless otherwise noted. Further, assume the creditor is not a super creditor who are often granted special rights. Typical super creditors include the U.S. government; spouses; and children. Victims of violent crimes or extreme torts may also have special creditor status. 3

4 investment account. Wanda, Harry, and the two children are the beneficiaries of the Cook Islands Trust. The trust is fully discretionary, and no Dinero family member has ever asked for a distribution. It gives them peace of mind knowing not all of their wealth is tied up in the U.S. economy. A Swiss law firm serves as the protector of the trust. Harry and Wanda routinely request and receive distributions from the NH trust and the DE trust. Harry also receives mandatory annual income distributions from a $1 million spendthrift trust created and funded by his deceased father, and sometimes the trustee exercises its discretion to make a principal distribution. He has a lifetime and testamentary special power of appointment over the trust. Harry and Wanda generally pay their debts as they come due. INVOLUNTARY BANKRUPTCY Involuntary Bankruptcy And The Dinero Family: Here, a Dinero a creditor may be itching to get into bankruptcy court, where it could seek to apply an extended ten (10) year statute of limitations against the trust structure. But even if a petition was successful, the fact that the Dinero family generally pays its debts when due may operate to deny relief. If the facts were different, and the creditor had a premonition that the Dineros were making transfers currently to defeat a creditor s claim, or there was a preference that needed to be set aside and the clock was ticking, then the risk of the involuntary petition might be worthwhile. 2 Involuntary Bankruptcy - Creditor Checklist: Confirm the bankruptcy laws grant an advantage not otherwise available. Due diligence confirms your fellow petitioning creditors will be good partners in the suit. Substantiate there is not a bona fide dispute as to liability or amount. Confirm the debtor is not paying its debts. Review whether the debtor will be unable to prove bad faith. Be ready to accept award of legal fees and costs. 2 Even so, commentators warn against the inherent headaches involved in multi-party litigation where in the single creditor claim is now being litigated with two co-creditor-plaintiffs. 4

5 TENANTS BY THE ENTIRETY Tenants By The Entirety And The Dinero Family: Wanda and Harry Dinero claim to hold two Massachusetts properties as tenants by the entirety: their Boston residence, worth $3 million, and a home on Martha s Vineyard worth $7 million. A creditor may want to collect against both properties. Is the debt jointly owed by both spouses? First, and simplest, a creditor may reach property held as tenants by the entirety if the debt is jointly owed by Harry and Wanda. If the debt is owed only by Harry, the creditor must review other possible alternatives. Is the ownership as tenancy by the entirety effective? To collect on Harry s debt from the Boston and Martha s Vineyard properties, the creditor s first step should be to look for an argument that the properties are not held as tenants by the entirety. In Massachusetts, to be effective, tenancy by the entirety must be created in a deed to the married couple, with the express term as tenants by the entirety in the deed. Also, to gain the benefit of statutory protection against creditors, the property must be the debtor s principal residence. 3 Assuming the statute applies, only the Boston property (their principal residence) would qualify for tenancy by the entirety protection. However, in Massachusetts, property purchased prior to February 11, 1980 and held continuously as tenants by the entirety without intervening deeds will be subject to the prior, common law rule. 4 What is the result of the tenancy by the entirety? Assuming that there has been an intervening deed or declaration to the Boston residence since February 11, 1980, the statute will apply. Even so, it will not protect the Boston residence against a lien for Harry s debt. The creditor may place a lien on the property but may not enforce it until and unless the tenancy by the entirety is broken, leaving Harry as the owner of all or a portion of the property s value. If Harry dies before Wanda, the tenancy will be broken but Harry will have no interest in the property, and the lien will become unenforceable. On the other hand, if the pre-1980 common law rule applies, 3 M.G.L. c Coraccio v. Lowell Five Cents Sav. Bank, 612 N.E.2d 650, (Mass. 1993). 5

6 Wanda s creditors cannot attach the Boston residence at all, but Harry s creditors may be able to lien the property and dispossess Harry and Wanda of it. 5 After dispossession, the property remains subject to Wanda s survivorship right, even in the hands of the creditor, until either Harry s or Wanda s death. If Wanda survives Harry, the creditor will lose all interest in the property. 6 Tenancy By The Entirety - Creditor Checklist: Ideally, confirm that the debt is joint debt. If only one spouse signed for the debt, consider whether it may be characterized as joint debt under state law, for example by application of marital agency, or if the borrowed funds were used by both spouses. If the debt is from only one spouse, confirm that the property qualifies to be held as tenants by the entirety in that state and there are no failures or errors in the property title. Carefully review all nuances of state law, including the applicability of prior law. If the property already has been sold or transferred, review the law to confirm whether or not the property or its proceeds remain inaccessible to creditors. HOMESTEAD BANKRUPTCY ALERT: The 2005 Federal Bankruptcy Act was enacted in part to curb abuses with regard to the homestead protection. It was not uncommon (for example) to hear of a debtor relocating to Florida and investing in an expensive home to take advantage of the unlimited Florida homestead exemption. Now, the debtor s domicile for purposes of applying a state s exemptions, including homestead, is the place in which the debtor s domicile has been located for the last 730 days immediately preceding the date of the filing of the petition. However, if the debtor s domicile has not been located at a single state for such 730-day period, then the debtor s domicile shall be the place in which the debtor s domicile was located for 180 days immediately preceding the 730-day period (i.e. 731 to 910 days prior to the petition date). Furthermore, if the debtor s domicile has not been located in a single state for such 180-day period, then the debtor s domicile shall be the place in which the debtor s domicile was located for the 5 Coraccio v. Lowell Five Cents Sav. Bank, 612 N.E.2d 650, (Mass. 1993). 6 Id. 6

7 longest period during the 180-day period. If there is a tie (i.e. 90 days in two states), then the default is the 2009 federal exemption of $20, BANKRUPTCY ALERT: One a debtor in bankruptcy establishes domicile, a second hurdle must be overcome. If the homestead property was acquired within 1215 days (about 3 years and 4 months) of filing for bankruptcy, the exempt amount cannot exceed $125,000. BANKRUPTCY ALERT: It has been held that a state cannot define state bankruptcy exceptions inconsistent with federal law, and federal bankruptcy law protects pre-petition debts. Thus, the Massachusetts homestead exemption was applied in bankruptcy to a pre-existing debt. In re Weinstein, 164 F.3d 677 (1 st Cir. 1999). Homestead and the Dinero Family: Here, a creditor will notice that Wanda and Harry have declared homestead on their primary residence in Boston, as well as on their Martha s Vineyard vacation home. Under the Massachusetts statute, Wanda and Harry may only declare homestead with respect to their primary residence - Boston. So the homestead on the vacation home does no good. But does it do harm? It might. Local law provides that a declaration of homestead voids a previously filed homestead. If the Martha s Vineyard declaration was declared after the Boston declaration, a creditor would argue that Harry and Wanda intended to release the Boston homestead, an argument which finds support in the statute. If successful, Harry and Wanda would only receive the automatic Massachusetts $125,000 worth of protection, and (after the tenancy by the entirety is destroyed when one of them dies) the remaining $2.875 million will be available to satisfy a judgment. If faced with this argument, Harry and Wanda would respond that the Martha s Vineyard declaration is simply ineffective, as Martha s Vineyard is not their primary residence. If the Boston declaration was made after the Martha s Vineyard declaration, and the Boston declaration was made prior to any lien being placed on the property, then such homestead will effectively protect up to $500,000 worth of equity in the Boston residence (or $1 million if Harry and Wanda are both age 62 or over and have filed elder homestead declarations) USC 522(b)(3) and 11 USC 522(d)(1) 7

8 Homestead Creditor s Checklist: Confirm the property is a residence under applicable law. Review whether the debtor occupies the property as a principal residence. Does debtor s equity in the home exceed the protected amount? If the relevant law protects limited acreage, does the debtor s land exceed such acreage? If the applicable law requires that a homestead declaration be recorded, is the language required by the law contained in the recorded document? Review whether the homestead has been revoked by a subsequent homestead filing. Does the debtor use the property for commercial as well as residential purposes? If so, analyze whether the statute protects mixed-use property. Determine if applicable law requires homestead to be re-filed after refinancing or whether the law automatically subordinates estates of homestead to mortgages. Determine if applicable law requires both spouses to sign a conveyance regarding the real estate for it to be applicable or enforceable against both spouses. Could it be argued that the funds used to purchase or improve the home were a fraudulent transfer? Was the debt incurred prior to the declaration of homestead (if the homestead is not automatic)? Does the relevant law require the declarant to state declarant s marital status? If yes, was the marital status properly disclosed, and does the amount of the protection vary based on whether the declarant is single or married? Is there an exclusion of certain debts under the relevant law and, if yes, does this debt qualify for such an exclusion? If the debtor spouse dies, for whom do the benefits continue and for how long under the applicable law? Has the debtor transferred the property into a revocable trust? If yes, does the statute uphold protection, require (or even allow) the trustees to declare homestead? If the home has been sold or destroyed, are the proceeds protected? 8

9 RETIREMENT BENEFITS In Patterson v. Shumate the Supreme Court ruled that the ERISArequired anti-alienation clause in a qualified pension plan is an enforceable restriction on transfer within the meaning of 11 U.S.C. Section 541(c)(2). 8 Bankruptcy Alert: The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ( BAPCPA ) expanded debtor protection to include IRAs and Roth IRAs. 9 In bankruptcy, qualified plans, rollover IRAs from qualified plans, 403(b) and 457 plans are exempt without dollar limitation, though notably rollover IRAs whose source of funds are SEP and SIMPLE IRAs do not qualify for the unlimited rollover protection an odd result. 10 Traditional and Roth IRAs are exempt up to $1 million in the aggregate for all such accounts, which as of April 2013 is adjusted for inflation to $1,245, Courts remain divided as to whether BAPCPA extends to inherited IRAs. Some courts deny protection in bankruptcy because an inherited IRA becomes immediately payable to the beneficiary and loses its status as a retirement benefit. 12 In contrast, some courts have found that transfers creating the inherited IRA do not result in a loss of eligibility despite receiving different treatment in other respects under the Internal Revenue Code. 13 Retirement Plans and the Dinero Family: Here, a creditor will seek to attach Wanda s $5 million IRA, most of which is a 401(k) rollover. To the extent Wanda can trace the IRA and its corresponding earnings to the 401(k), such amounts could be fully exempt, though required minimum distributions will be available to Wanda s creditors once they land in her pocket Patterson v. Shumate, 504 U.S. 753, 112 S. Ct (1992). 9 Bankruptcy Law Impact on IRAs and Qualified Retirement Plans, Natalie Choate, Steve Leimberg s Employee Benefits and Retirement Planning Newsletter (April 26, 2005). 10 As such, as one consolidates retirement accounts as he moves from job to job, it is wise to document the source of funds and consider segregating rollovers whose sources are qualified plans (or 403(b) or 457 plans) from IRAs and Roth IRAs. 11 The amount protected is adjusted for inflation every three years. In can also be increased if justice so requires. 11 U.S.C. 522(n). 12 For no protection see: In re Kirchen, 344 BR. 09 (Bankr. S.D. Tex. 2007); In re Jarboe, 365 B.R. 717, 2007 Bankr. LEXIS 1147 (Bankr. S.D. Tex. 2007); In re Sims, 241 B.R. 467, (Bankr. N.D. Okla. 1999); In re Greenfield, 289 B.R. 146, (Bankr. S.D. Cal. 2003); In re Kirchen, In re Taylor, 2006 WL (Bankr. C.D. Ill. May 9, 2006). 13 For protection see: In re Thiem, 107 A.F.T.R.2d (RIA) 529 (Bankr. D. Ariz. 2011); In re Nessa, 426 B.R. 312 (BAP 8th Cir. 2010); Chilton v. Moser, 444 B.R. 548, 552 (E.D.Tex.2011). See also Creditor Protection for IRAs: A shift in favor of debtors has started to occur, Michelle Ward & Mark Merric, Trust & Estates (June, 2012). 14 At present, the author knows of no case that has sanctioned the unscrambling of a rollover IRA that combines different types of original source pension funds. 9

10 The creditor should argue that the IRA was tainted when the 401(k) proceeds were merged with funds emanating from contributions to Traditional and/or Roth IRAs, and that such tainting renders the entire IRA (in excess of the state limitation) susceptible. Even if Wanda is able to protect the entire 401(k) portion of the IRA, then to the extent that the account emanates from contributory IRAs and similar accounts, Wanda s (non-bankruptcy) exemption will be limited to deposits equal to 7% of her total income in the preceding five years. Excess deposits will not be protected. If Wanda dies and Harry survives her, then Harry effectuates a spousal rollover, the same protections should be afforded to Harry. If Harry then dies (or if Harry predeceases Wanda), the spendthrift protections of the fully discretionary New Hampshire Domestic Asset Protection Trust (DAPT) should be sufficient to prevent a creditor of a trust s beneficiary from attacking his or her interests in the trust, although the fully discretionary nature of the DAPT will most likely cause an acceleration of the IRA distribution. Retirement Benefits Creditor s Checklist: Review whether plan is protected under ERISA. If not protected by ERISA, review relevant statute to determine if IRA account value exceeds the statute s threshold (if any). Determine if debtor has reached an age of required minimum distributions. Determine if the debtor has disclaimed any beneficial interest. Does the statute protect IRA assets and distributions, or only the assets? Does the statue protect only as much as is necessary for owner and dependents? Review age, earning ability, dependents, and other assets/liabilities of owner. If the account is a rollover IRA, determine source of funds. Exemption may not be unlimited due to source(s). Is the type of retirement account explicitly listed in the statute? Determine if and to what extent the statute s protection extends to a debtor-beneficiary. If the source of the funds was a 401(k), determine if the 401(k) was a solo 401(k), then determine if protections are afforded or limited with respect to such a plan under the statute. 10

11 Is the IRA an inherited IRA? No entitled to the protection of a participant. Clark v. Rameker, 573 U.S. ; 134 S. Ct. 678 (2014) INSURANCE BANKRUPTCY ALERT: There are three sections in the Bankruptcy Code pertaining to the exemption of certain interests in life insurance policies. The first two exemptions concern the debtor as the owner of a policy, whereas the third concerns the debtor as a beneficiary of a policy. The first exempts term life insurance policies, owned by the debtor, that have not yet matured. 15 The second exempts up to $8,625 of the debtor s aggregate interest in an unmatured policy, provided that the insured is either the debtor or an individual of whom the debtor is a dependent (including a spouse). 16 Basically, only $8,625 of a policy s cash value is exempt. The third exempts the debtor as the beneficiary of a policy to the extent the proceeds are reasonably necessary for the support of the debtor and any dependent of the debtor. 17 Moreover, the debtor must have been a dependent of the insured (including a spouse) at the time of the insured s death. 18 Insurance and the Dinero Family: Here, as you will recall, we have a $5 million life insurance policy with about $400,000 of cash value, Harry is the insured, and an irrevocable fully discretionary spendthrift trust administered in Massachusetts has been the owner and beneficiary of the policy since its inception. Wanda and the children are the beneficiaries of the insurance trust, and Wanda s sister is the trustee. How the creditor would attack the policy is instructive in that many of the questions the creditor must ask are applicable to other jurisdictions. First, a creditor may argue that the entire policy, or at least a part of it, was paid for using funds that were subject to fraudulent transfers. Assuming Harry funded premium payments every year by gifting cash to the trust and utilizing his annual exclusion amounts, a court may agree with a creditor claiming that some or all of such transfers were fraudulently made, either with the actual intent to hinder, delay or defraud his creditors or with the requisite criteria constituting constructive fraud U.S.C. 522(d)(7) U.S.C. 522(d)(8) and 104(b) U.S.C. 522(d)(11)(C) 18 Id. 11

12 Another appealing argument is the lack of an insurable interest. In order to receive protection under the insurance exemption statute in Massachusetts, the owner of the policy must have an insurable interest in the insured (debtor). 19 Insurable interest is typically defined under state law, and a fairly typical definition looks to whether a person can reasonably expect the insured to provide an economic benefit to the person while the insured lives, or conversely the person can expect to experience economic loss if the insured died. Does the irrevocable life insurance trust, the true owner of the policy, have an insurable interest in the insured? Not many planners gave this issue much thought until a 2006 case held a trust did not have an insurable interest. 20 Here, however, regardless of whether the trust did or did not have an insurable interest, because the trust is not the debtor, such an argument would not likely work. Insurance Creditor s Checklist: Identify applicable state law, and relevant exemption statute Identify type of insurance policy term or permanent in order to determine if there is any cash value o Does relevant exemption statute or case law differentiate between protection of policy proceeds vs. policy cash value? Identify type of interest(s) debtor has in the policy: owner, insured, beneficiary o If the debtor is all 3, the exemption probably does not apply o If the debtor is only the beneficiary, determine if applicable law exempts creditors of a debtor-beneficiary Even if debtor is not the beneficiary, identify who the beneficiary is o Can the beneficiary designation be changed by the owner? o Is the designated beneficiary a member of a protected class? o Has the beneficiary designation been changed (if so, limited number of jurisdictions, like Massachusetts, require that the original designation has not been altered) Determine if any exceptions to protection under the exemption apply o Requisite time the debtor s interest in the policy has been met, o Child support, o Alimony, o Miscellaneous obligations of support, and o Fraudulent transfer 19 M.G. L. Chap Chawla v. Transamerica Occidental Life Ins. Co., 440 F.3d 639, 2006 WL (4 th Cir. March 7, 2006), aff'g in part, vac'g in part, 2005 WL (E.D. Va. Feb. 3, 2005) 12

13 Look for large, single premium policies Determine when policy was purchased If not single premium, find when most recent premium was paid FRAUDULENT TRANSFERS BANKRUPTCY ALERT: The Bankruptcy Code permits the trustee in bankruptcy to avoid any transfer made within a certain time period before the filing of the bankruptcy petition. The 2005 Bankruptcy Act increased the avoidance period to two years (up from one year). A special ten year avoidance period applies to self-settled trusts or similar devices which is discussed when we look at domestic asset protection trusts and foreign situs asset protection trusts. Fraudulent Transfer and The Dinero Family: A gratuitous transfer rendering the transferor insolvent is a fraudulent transfer pursuant to the constructive fraud provisions of the UFTA. For the creditor to prove insolvency, a typical balance sheet analysis can be used. To determine whether a transfer made either Wanda or Harry insolvent the following calculation is made: First, the creditor would add together all assets that are reachable by the creditor. Then the creditor would add together all the known liabilities with all reasonably anticipated liabilities. Then, subtract the second from the first. If the result is a positive number, say, $1 million, then the client has $1 million of assets that may be transferred without the transfer being deemed a fraudulent transfer. If the result is a negative number, you have an insolvent client. 21 Fraudulent Transfer Creditor s Checklist: Identify applicable state law, and, if more than one, choose most creditor friendly. Identify applicable fraudulent transfer law: UFTA, UFCA, Bankruptcy Code, Common Law. Identify statute of limitations. Identify type of creditor: present or future (i.e., predictable subsequent creditors ). Identify type of fraud 21 U.S. v. Evseroff, 2006 WL (E.D.N.Y.); 98 A.F.T.R.2d , USTC 50,222 (transfer of assets to trust immediately before judgment not a fraudulent transfer because transfer did not render the transferor insolvent). 13

14 o Actual fraud Transfer with the intent to hinder, delay, or defraud Intent may be inferred using badges of fraud Present and future creditors may seek redress o Constructive fraud Transfer without receiving reasonably equivalent value and Made when debtor has unreasonably small capital compared to the business or transaction debtor is or is about to engage, Made when debtor is or is about to incur debts beyond the debtor s ability to pay such debts, or Made when debtor is insolvent or becomes insolvent thereby Present and future creditors may seek redress under the first 2 types of constructive fraud, but only present creditors may seek redress under the third type of constructive fraud o Fraud involving insiders: present creditors may seek redress for transfers by an insolvent debtor in satisfaction of prior debts to insiders who have reason to know of the debtor s insolvency Determine type of remedy to seek o Void the transfer o Attach the transferred asset (or other asset of transferee, if applicable) o Subject to applicable law, issuance of an injunction, appointment of a receiver, other relief which the circumstances justify Identify potential defenses o May depend on whether transfer was actual or constructive fraud o Actual fraud: transfer to good-faith transferee for reasonably equivalent value cannot be voided o Constructive fraud: transfer to good-faith transferee for value may be voided, but transferee is protected to the extent value was given, in the form of: A lien Enforcement of any obligation incurred Reduction in the amount of the liability LIMITED LIABILITY COMPANY BANKRUPTCY ALERT: The outside liability protection that LLCs offer against creditors may not be available against a trustee in Bankruptcy Court in the event the debtor voluntarily or involuntarily enters into Chapter 7 bankruptcy. A couple bankruptcy cases have held that the bankruptcy trustee is entitled to all the powers the debtor-member (or limited partner in the case of a partnership) would otherwise have, including the right to vote for dissolution of the LLC. 14

15 Limited Liability Companies and the Dinero Family: The Dinero family fact pattern involves six single-member LLCs the Delaware Holding LLC, four Massachusetts LLCs, and the Nevis LLC. The creditor s rights provisions contained in the Massachusetts LLC statute are based largely on the Uniform Limited Partnership Act of 1976, and, as such, do not stipulate that a charging order is a creditor s exclusive remedy. Consequently, a court in Massachusetts (generally considered a debtor friendly state) might order a foreclosure on the Delaware Holding LLC s membership interest in one or more of the Massachusetts LLCs, especially considering each such LLC has only one member the Delaware Holding LLC. Delaware, on the other hand, amended its LLC statute in 1995 in order to provide that a charging order is a creditor s exclusive remedy. 22 However unlikely it may be, a Delaware court could interpret the statute to apply only to multi-member LLCs, in which case a creditor of its member, the Delaware Domestic Asset Protection Trust (DAPT), could attempt to foreclose on the membership interest. Creditors of Harry or Wanda individually, however, would have the additional hoop of breaking through the DAPT in that situation, Harry and Wanda would have significant bargaining leverage if they preferred to enter settlement negotiations. Limited Liability Companies Creditor s Checklist: Identify applicable state law, and, if more than one, choose most creditor friendly. Identify type of creditor o Personal creditor of LLC member (trying to reach LLC s assets) o Creditor of LLC (trying to reach LLC member s personal assets) If creditor of LLC trying to reach LLC member s personal assets, an may exception apply: o Untimely filing of articles of organization, defective formation, misleading or false statements in articles of organization o Member s personal conduct (e.g., guaranteeing a loan or acting in tortious or criminal manner) caused the liability o Pierce the LLC veil look for certain common criteria: Disregard for the entity Commingling personal and business assets Undercapitalization Disregard for appropriate governance 22 Del. Code Ann. tit

16 If creditor of the LLC trying to reach member s personal assets, determine possible remedies: o Charging order o Foreclosure o Dissolution of LLC or transfer of LLC s assets For single-member LLCs, courts may be more willing to grant equitable relief, especially if provisions of LLC statute stipulating that charging order is exclusive remedy appear ambiguous THIRD PARTY SPENDTHRIFT TRUSTS BANKRUPTCY ALERT: The Bankruptcy Code broadly exempts a valid spendthrift trust from the bankruptcy estate. 11. U.S. C. 541(c)(2) provides that [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 Third Party Spendthrift Trusts and the Dinero Family: The life insurance trust is both a discretionary trust as well as a third party spendthrift trust, settled by Harry and of which Wanda and the children are beneficiaries. Assuming the governing law (in addition to it being the principal place of administration) is that of Massachusetts, then Article 5 of M.G.L. Ch. 203E applies. Section 501 provides that to the extent a beneficiary s interest is not subject to a spendthrift provision, the court may authorize a creditor or assignee of the beneficiary to reach the beneficiary s interest by attachment of present of future distributions to or for the benefit of the beneficiary or other means. So, if the trust s spendthrift provisions do not apply to the entire portion of a beneficiary s interest (unlikely), then a court could conceivably authorize a creditor to reach such portion of beneficiary s interest, except for the fact that the trust is also a discretionary trust. Assuming the trust is fully discretionary and the trustee is not required to distribute income or principal, then a creditor can only wait and see if, and what to what extent, a trustee does in fact make a distribution to a debtor-beneficiary, at which point such distributed principal or income, as the case may be, may be subject to the reach of the debtor-beneficiary s creditor. The creditor should look to the spendthrift trust established by Harry s father as Harry receives mandatory annual income distributions, which may be reachable by a creditor of Harry 16

17 upon Harry s receipt of such income (or principal at such times the trustee exercises its discretion to make a distribution of principal). Third Party Spendthrift Trusts Creditor s Checklist: Review the trust to determine if its terms require distributions of principal, income, or both. Review applicable spendthrift law or case law to determine existence of exception creditors. Note if there are different exception creditors for a discretionary trust and a third party spendthrift trust. If the trust is a discretionary trust and does not contain spendthrift language, review the standard, if any, to determine if distributions could be construed as compulsory. Where language commanding the trustee (e.g. shall distribute ) is coupled with language of discretion, consider arguing that settlor s intention was not to provide absolute discretion to the trustee. If the state has adopted a modified version of the UTC, determine which portions, if any, have been intentionally removed from the original UTC. Consider arguing that the absence of such provisions constitute legislative intent to broaden, not narrow, creditor s rights. Review the spendthrift statute of the state whose law governs the trust and the terms of the trust to determine if all, or only a portion, of the beneficiary s interest is subject to the spendthrift clause. Determine whether the spendthrift statute of the state whose law governs the trust make available to creditors amounts in excess of what is needed for the support of the beneficiary? Determine if there overdue distributions that should have been made in the past? If mandatory income distributions and debtor has died, review whether distribution must be made to debtor s estate. Does the trust require accumulated income to be added to principal? If the trust has Crummey (withdrawal) powers, argue that the lapsed powers make the trust self-settled by the beneficiary as to the portion funded by the lapsed powers. Argue that timing, amounts and patterns of distributions supports a determination that there is a prearrangement between the trustee and the debtor-beneficiary with regards to distributions. Was trust funded as result of a disclaimer by the debtor? Was trust funded as a result of a decanting? Was decanting permissible? Review the domicile history of the debtor to consider whether any trust asset originated in a community property jurisdiction rendering the trust partially self-settled. 17

18 DOMESTIC SELF-SETTLED SPENDTHRIFT TRUSTS BANKRUPTCY ALERT: Section 548(e) of the 2005 Bankruptcy Code grants a creditor ten years in which to attack a transfer to a self-settled trust or similar device, a significantly longer time than granted under any DAPT law, and a reason a creditor might consider an involuntary bankruptcy petition. The elements for a cause of action under 548(e) are: (1) there is a transfer within ten years of the filing of the bankruptcy petition; (2) the transfer is to a self-settled trust or similar device; (3) the transfer is by the debtor; (4) the debtor is a beneficiary of the self-settled trust or similar device; and (5) the debtor made the transfer with the actual intent to hinder, delay, or defraud any entity to which the debtor was or became indebted. 23 It is interesting to note that the inclusion of 548(e) actually supports the view that asset protection trusts are not against federal public policy. During Congressional deliberations, a New York Times editorial decried the protections afforded by domestic and offshore asset protection jurisdictions, and asserted that corporate executives involved in Enronlike transgressions would avoid the reach of the bankruptcy court by transferring funds to an offshore trust or to a trust within a protected domestic jurisdiction. In response, Senator Schumer proposed a $125,000 limit on self-settled spendthrift trusts (similar to the homestead limit). This was rejected in favor of a proposal by Senator Talent which added 548(e). Congress could have brought all asset protection trusts within the reach of the bankruptcy trustee and chose not to do so. Domestic Asset Protection Trusts and The Dinero Family: The New Hampshire DAPT was funded sometime shortly after enactment of the NH law (2009) so a future creditor might be coming up against the four year statute of limitations, while a pre-existing creditor would have an additional year from discovery of the trust. The creditor has more time regarding the Delaware DAPT. Although it appears clear that the intention of Harry and Wanda in settling the NH and DE trusts was asset protection (one of the bankruptcy code requirements), the facts do not look favorable for a creditor who wishes to invoke the ten year bankruptcy statute of limitations through an involuntary bankruptcy petition, since the Dineros routinely pay all debts as they come due. That said, if payment of those debts come from funds routinely distributed 23 The first reported case to discuss 11 U.S.C. 548(e) was In re Porco, 447 B.R. 590 (S.D. IL 2011). See ALEXANDER A. BOVE JR. & MELISSA LANGA In re Porco: Case of First Impression Interprets Similar Device for Purposes of Section 548(e) of Bankruptcy Code (Leimberg Information Services Asset Protection Planning No. 184 ( ). See also Battley v. Mortensen, 2011 WL (Bankr. D. Alaska May 26, 2011)(applying 548(e) to an Alaska domestic asset protection trust); In re Huber, 2013 Bankr. LEXIS 2038 (May 13, 2013) (discussing the application of 548(e) to an Alaska domestic asset protection trust) 18

19 from the DAPTs upon request of Harry and/or Wanda, a creditor might be able to prove that a prearrangement as to distributions exists, and argue both that such prearranged distributions are really a mandatory income interest, or that the trusts are shams or alter egos of the Dinero family, or that DAPT jurisdictional law should not apply since substantial administration is not occurring within the DAPT jurisdiction. A creditor would also closely examine the Delaware LLC and the role played by the Delaware DAPT as it sole member. If in fact Harry was the manager of the DE with the Delaware DAPT assuming the role of a directed trustee then this would bolster an argument that Delaware law should not apply in a conflict of law situation. Domestic Asset Protection Trusts Creditor s Checklist: Review the domicile of the debtor and if domicile is outside the domestic asset protection state argue law of domicile applies. (Or law where transaction giving rise to the claim arose). Review whether the DAPT migrated to the DAPT jurisdiction from a jurisdiction more protective of creditor rights. Review location of DAPT assets for the purpose of in rem jurisdiction. Review presence of DAPT trustee in state of controversy for the purpose of personal jurisdiction. Review domicile of a trust protector, investment advisor, or other non-beneficiary trust power holder for purposes of jurisdiction over the DAPT trust. Review whether powers of a trust protector, investment advisor, or other non-beneficiary trust power holder are so great to render the local DAPT trustee s administrative duties insignificant. Review history of distributions for patterns and evidence of prearrangement. Determine whether a letter of wishes exists. Determine actual control exercised by the debtor renders DAPT an alter ego of the debtor. Determine funding schedule of trust for applicable cascading statute of limitations. 19

20 Review the elements required to trigger the application of the ten year statute of limitations under the Bankruptcy Code. Review whether a federal law has been breached to gain access to a deep pocket coplaintiff. FOREIGN SITUS SELF-SETTLED SPENDTHRIFT TRUSTS Foreign Situs Self-Settled Trust and the Dinero Family: Five years ago Wanda settled the Cook Islands trust, funded with $9 million of investments held in the Nevis LLC. As always, a preexisting creditor will have a different statute of limitations to attack the transfer than a future creditor, this is true even under Cook Islands law. And it will be important to determine where the trust s assets are invested foreign investments are more protective than U.S. investments but the correspondent bank issue will need to be explored if foreign bank accounts are held in the Nevis LLC. As to the LLC, inquiry will be made as to who is the manager of the Nevis LLC. If Wanda or Harry, sham trust or alter ego trust attacks might be possible. The fact that the Cook Islands trustee has not made any distributions can go both ways. If the creditor can show that no inquiry was ever made by the trustee as to beneficiary needs, or can show other evidence that the Cook Islands trustee was not performing as a true trustee, a court may be more willing to dismiss the trust as a sham. Finally, it may be that the creditor will simply ignore the foreign structure and focus on the U.S. assets. Most likely what the Dinero family hopes for. Foreign Situs Self-Settled Trust Creditor s Checklist: Obtain foreign counsel as soon as possible since in some jurisdictions it is possible for the debtor to conflict out many sources of legal assistance. Investigate whether there is a U.S. person fiduciary, such as a protector, to gain jurisdiction over the trust. Determine whether a civil contempt order is appropriate. Confirm whether there is a U.S. correspondent bank. Consider involuntary bankruptcy petition. Determine whether debtor s passport can be revoked by court order. Determine whether facts available to obtain a Mareava injunction. Determine if any assets held in the U.S. or invested in U.S. corporations. 20

21 THE LAWYER BANKRUPTCY ALERT: The lawyer s fee may be subject to a clawback attempt by the bankruptcy trustee. The law firm of Donlevy-Rosen & Rosen, P.A. proposed and implemented an offshore asset protection structure for a client and received $45,000 in fees and costs for its troubles. 24 The bankruptcy trustee claimed, among other things, that the transfer of legal fees was a fraudulent transfer, as the debtor was insolvent at the time of the transfer. Lucky for the lawyers, the firm could offer an affidavit of solvency signed by the client stating that she was solvent at the time the offshore structure was implemented. Testimony by the debtor-client to the contrary was not found credible by the bankruptcy court, who found that the debtor was solvent at the time of the transfers. 25 The Lawyer and the Dinero Family: To bring a strong claim against the lawyer(s) advising the Dinero family, the creditor should establish that the lawyer knew, or should have known, that the planning engaged in was a transfer designed to thwart payment to known creditors. At one point, it seems that Wanda transferred approximately $9 million to a Cook Islands irrevocable trust when it looked as if one of Harry s deals was going south. To seek damages from the Dineros attorney, it seems that a creditor would want to establish as many as possible of the following elements: 1) a creditor of Harry s Massachusetts or Delaware LLC is also a creditor of Harry (because Harry held all of his real estate projects inside LLCs); 2) Harry had an interest in the $9 million that Wanda transferred to the Cook Islands irrevocable trust five years ago; 3) the creditor was known to Harry and Wanda and the transfer to the Cook Islands trust was a fraudulent transfer as to that creditor; 4) the attorney knew all of this or had reason to know it and acted intentionally to defraud the creditor; and 5) the statue of limitations has not expired. The Lawyer Creditor s Checklist: Investigate whether lawyer was more than mere conduit, and whether lawyer engaged in clear misconduct. Determine whether applicable law (state law or bankruptcy law) grants or prohibits a cause of action against the lawyer or a clawback of fees. 24 In re Niroomand, 493 Fed Appx. 11, 12; 2012 U.S. App. LEXIS (11 th Cir. 2012)(unpublished opinion) 25 Id. at