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Post by Sapphire Capital on Sept 19, 2012 23:56:34 GMT 4
Bradford v. IRS, 8/6/1986, 796 F2d 303
US-CT-APP-9, [86-2 USTC P9602], Robert W. Bradford, Petitioner-Appellant v. Commissioner of Internal Revenue, Respondent-Appellee , Assessment for tax deficiency: Failure to pay estimated tax.–, (Aug. 6, 1986)
[86-2 USTC P9602] Robert W. Bradford, Petitioner-Appellant v. Commissioner of Internal Revenue, Respondent-Appellee (CA-9), U.S. Court of Appeals, 9th Circuit, 85-7410, 8/6/86, 796 F2d 303, Affirming the Tax Court, 49 TCM 105, Dec. 41,615(M), TC Memo 1984-601
Penalties, civil: Fraud.–A penalty for fraud due to underpayment of tax was sustained. The taxpayer’s failure to file returns and to report substantial business income, dealing with cash, filing of false W-4 forms, and other types of tax avoidance behavior, all supported the tax court’s finding of fraud. BACK REFERENCES: 86FED P5533.4741
[Code Sec. 6654] Assessement for tax deficiency: Failure to pay estimated tax.–The tax court’s assessment for tax deficiency and failure to pay estimated tax was upheld. All projections of income made by the IRS were found to be reasonable, and the taxpayer failed to substantiate any claims for expenses. BACK REFERENCES: 86FED P5542.30 Robert W. Bradford, Chula Vista, Calif., for petitioner-appellant. Nancy G. Morgan, Department of Justice, Washington, D.C. 20530, for respondent-appellee.
Before CHOY, HUG, and WIGGINS, Circuit Judges.
Opinion
HUG, Circuit Judge:
Robert Bradford appeals from a Tax Court decision upholding in part an assessment by the Commissioner for tax deficiency, fraud, and failure to pay estimated tax for the tax years 1973-1977.
I.
Facts
In 1972, Bradford and several other individuals founded the Committee for Freedom of Choice in Cancer Therapy, Inc. (the “Committee”), which began as a legal defense fund for a California physician who had been arrested for dispensing laetrile, but which quickly became involved in a number of other activities, including seminars, political action, and the lawsuit which led to the legalization of laetrile, Rutherford v. United States, 429 F.Supp. 506 (W.D. Okla. 1977). The Committee’s records consisted mainly of a series of ledgers, with little supporting documentation of income or expenses. In 1973, Bradford formed a partnership with J. Franklin Salaman to smuggle laetrile into the United States and arrange for its distribution around the country. Bradford claims that this partnership had two purposes, first, to make laetrile available to cancer patients in this country, and second, to provide funds for the Committee`s activities. Bradford was arrested on smuggling charges in late 1975, and he and Salaman were later convicted of the charges and sentenced to probation and a fine. After laetrile was legalized in 1977, Bradford and Salaman formed Cyto-Pharma U.S.A. to handle their import operations; that partnership was dissolved in late 1977. Almost all of Bradford’s and Salaman’s operations were conducted on a cash basis.
Although the laetrile smuggling generated a considerable amount of income, Bradford’s 1973 tax return showed only his employment income. He did not file tax returns for the years 1974-1977. The Commissioner ultimately assessed Bradford $1,784,316 in tax deficiencies, $891,673 for fraud under 26 U.S.C. S6653(b) (1982), and $98,001 for failure to file estimated taxes under 26 U.S.C. S6654 (1982), for a total of $2,773,990. While the Tax Court upheld the imposition of the tax deficiencies and the penalties, it found that Salaman was equally responsible for the partnerships’ tax liabilities and made appropriate adjustments in its judgment to reflect this determination. Bradford appeals the Tax Court’s judgment.
We affirm.
This case essentially presents two issues: (1) was the Tax Court correct in upholding the deficiency assessment, and (2) was the Tax Court’s finding of fraud clearly erroneous?
II.
Deficiency Assessment
“In an action to collect taxes, the government bears the burden of proving that the taxes are owing . . . . Once the government introduces its assessment of tax due, a presumption usually arises that the assessment is correct.” Adamson v. Commissioner [84-2 USTC P9863], 745 F.2d 541, 547 (9th Cir. 1984) (citation omitted). This presumption must have some factual basis, id. that is, the Government must produce “some substantive evidence . . . demonstrating that the taxpayer received unreported income.” Delaney v. Commissioner [84-2 USTC P9813], 743 F.2d 670, 671 (9th Cir. 1984) (citation omitted); Adamson, 745 F.2d at 547. Once the Government has done so, “the taxpayer must establish by a preponderance of the evidence that the determination is arbitrary or erroneous.” Delaney, 743 F.2d at 671. See also Rapp v. Commissioner [85-2 USTC P9750], 774 F.2d 932, 935 (9th Cir. 1985); Larsen v. Commissioner [85-2 USTC P9537], 765 F.2d 939, 941 (9th Cir. 1985); United States v. Stonehill [83-1 USTC P9285], 702 F.2d 1288, 1293, 1294 (9th Cir. 1983), cert. denied, 465 U.S. 1079 (1984).
Here Bradford freely admits that he received unreported income from his laetrile-smuggling operations. He contests the Commissioner’s deficiency assessment essentially on three grounds: first, he argues that the Commissioner improperly used a “weighed average” unit cost rather than one fixed unit cost in computing the costs of goods sold. Second, he claims that the Commissioner did not adequately take into account his expenses in connection with the Committee’s activities. Third, he contends that the Commissioner improperly increased the tax assessments for 1976 and 1977 by extrapolating sales figures from a record of three months’ sales and from information developed through Food and Drug Adminstration (“FDA”) surveillance of his laetrile-importing activities. The Commissioner argues, in essence, that because Bradford dealt mostly in cash and kept inadequate records and supporting documentation, his attempt to reconstruct Bradford’s income and expenses was reasonable, given the circumstances.
In a recent series of cases, this court has reiterated its long-standing approach to the type of situation presented by Bradford’s appeal, where the taxpayer kept inadequate records or no records at all, and then relied mainly on testimony to challenge the Commissioner’s reconstruction of income and deductions or assessments. Adamson v. Commissioner [84-2 USTC P9863], 745 F.2d 541 (9th Cir. 1984); Keogh v. Commissioner [83-2 USTC P9539], 713 F.2d 496 (9th Cir. 1983); United States v. Stonehill [83-1 USTC P9285], 702 F.2d 1288 (9th Cir. 1983). All three cases reach the same result, which was explained in Adamson as follows:
Where the government has introduced evidence linking the taxpayer to the illegal activity, the taxpayer should not be allowed to avoid paying taxes simply because he keeps incomplete records. The absence of tax records cannot automatically deprive the Commissioner of a rational foundation for the income determination. As the Fifth Circuit recognized in Webb v. C.I.R. [68-1 USTC P9341], 394 F.2d 366, 373 (5th Cir. 1968):
[T]he absence of adequate tax records does not give the Commissioner carte blanche for imposing Draconian absolutes . . [However,] such absence does weaken any critique of the Commissioner’s methodology.
Arithmetic precision was originally and exclusively in [the taxpayer's] hands, and he had a statutory duty to provide it . . . . [H]aving defaulted in his duty, he cannot frustrate the Commissioner’s reasonable attempts by compelling investigation and recomputation under every means of income determination. Nor should he be overly chagrined at the Tax Court’s reluctance to credit every word of his negative wails.
Adamson, 745 F.2d at 548; see also Keogh, 713 F.2d at 502; Stonehill, 702 F.2d at 1296.
As to Bradford’s first contention, concerning the computation of cost of goods sold, Bradford’s own records show a fluctuation in the prices he paid for laetrile; thus, the “weighted average” approach used by the Commissioner to compute the cost of goods sold appears, if anything, more reasonable than Bradford’s “single unit cost” method.
Bradford’s second contention is that the Tax Court should have permitted the deduction of expenses he contends he paid on behalf of the Committee in conducting the seminars because the seminars promoted the sales of laetrile. Even if we were to make the doubtful assumption that these expenses could somehow be deducted as his personal business expenses, Bradford had the burden of producing evidence to support these claimed expenses. Rapp v. Commissioner [85-2 USTC P9863], 774 F.2d 932, 935 (9th Cir. 1985). There was no substantiation for these expenses other than the reports of the Committee’s activities, some brief summaries and vague testimony of Committee members, and Bradford’s own testimony.
Bradford further argues that the Tax Court improperly excluded his Exhibit 99, which was apparently a summary of his testimony as to his claimed expenditures on the Committee’s behalf. The Tax Court’s evidentiary decisions are reviewed for an abuse of discretion. Keogh, 713 F.2d at 499. Contrary to Bradford’s assertion, a review of the transcript shows that the tax judge did, in fact, allow Bradford to testify about this issue and allowed into evidence all of the other exhibits offered by Bradford to support his claims. The exclusion of the summary was not an abuse of discretion. The Tax Court’s finding that Bradford had failed to establish his entitlement to the expenses or deductions was adequately supported by the record. See id. at 502.
Bradford’s third contention questions the Commissioner’s increased assessments for tax years 1976 and 1977. For 1976, he argues that the Commissioner’s extrapolation of his annual income from a receipt book covering the last three months of the year was improper because it did not adequately consider the time, such as weekends and holidays, when Bradford was not engaged in smuggling laetrile, and other factors which may have affected the income generated by Bradford’s operations. Our review of the record convinces us that the Commissioner’s extrapolation did take these factors into consideration. Thus, as in Keogh, 713 F.2d at 502, we reject Bradford’s arguments that the 1976 income projections were unreasonable.
For 1977, the Commissioner determined Bradford’s income by extrapolating the total sales of laetrile from a sample generated by the FDA surveillance of Bradford’s activities. Bradford argues that this extrapolation is inaccurate because it did not take into account the time that he was on trial for laetrile smuggling and, thus, presumably not then involved in the laetrile operations. This argument is meritless. The figures were derived from surveillance of shipments that occurred during Bradford’s trial on the smuggling charges, and the Commissioner presented independent evidence in the form of receipts, also contemporaneous with the trial, which support the income projections. The Tax Court’s finding that Bradford had failed to show that the Commissioner’s assessment was unreasonable was not clearly erroneous.
III.
Civil Fraud Penalty
The Commissioner also assessed penalties for civil fraud under 26 U.S.C. S6653(b), which provides that “[i]f any part of any underpayment . . . of tax . . . is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment.”
“In the context of the 50 percent penalty of section 6653, fraud is intentional wrongdoing on the part of the taxpayer with the specific intent to avoid a tax known to be owing.” Conforte, 692 F.2d at 592 (citing Powell v. Granquist [58-1 USTC P9223], 252 F.2d 56, 60 (9th Cir. 1958)). The Commissioner must prove fraud by clear and convincing evidence, I.R.C. S7454(a); Stone v. Commissioner [Dec. 30,767] 56 T.C. 213, 220 (1971), but intent can be inferred from strong circumstantial evidence, Spies v. United States [43-1 USTC P9243], 317 U.S. 492, 499 63 S. Ct. 364, 368, 87 L.Ed. 418 (1943); Powell, 252 F.2d at 61; Stone, 56 T.C. at 223-24.
Akland v. Commissioner [85-2 USTC P9593], 767 F.2d 618, 621 (9th Cir. 1985) The Tax Court’s finding of fraud is factual and should be reversed only if this panel is “left with the definite and firm conviction . . . that there is no clear and convincing evidence of fraud.” Id. (citations omitted). See also Considine v. United States [82-2 USTC P9537], 683 F.2d 1285, 1286 (9th Cir. 1982).
Because fraudulent intent is rarely established by direct evidence, this court has inferred intent from various kinds of circumstantial evidence. These “badges of fraud” include: (1) understatement of income, see, e.g. Grudin v. Commissioner [76-1 USTC P9445], 536 F.2d 295, 296 (9th Cir. 1976); Ruark v. Commissioner [71-2 USTC P9699], 449 F.2d 311, 313 (9th Cir. 1971); Bahoric v. Commissioner [66-2 USTC P9535], 363 F.2d 151, 153-54 (9th Cir. 1966); Estate of Rau v. Commissioner [62-1 USTC P9339], 301 F.2d 51, 54-55 (9th Cir.), cert. denied, 371 U.S. 823 (1962); Factor v. Commissioner [60-1 USTC P9551], 281 F.2d 100, 129 (9th Cir. 1960), cert. denied, 364 U.S. 933 (1961); Cohen v. Commissioner [59-1 USTC P9388], 266 F.2d 5, 12 (9th Cir. 1959); Powell v. Granquist [58-1 USTC P9223], 252 F.2d 56, 61 (9th Cir. 1958); (2) inadequate records, see, e.g., Bahoric, 363 F.2d at 154; Factor, 281 F.2d at 129; Cohen, 266 F.2d at 12; Powell, 252 F.2d at 61; (3) failure to file tax returns, see, e.g., Factor, 281 F.2d at 129; Powell, 252 F.2d at 61; (4) implausible or inconsistent explanations of behavior, see, e.g., Bahoric, 363 F.2d at 153; Factor, 281 F.2d at 129; Baumgardner v. Commissioner [58-1 USTC P9170], 251 F.2d 311, 321 (9th Cir. 1957); (5) concealing assets, see, e.g., Ruark, 449 F.2d at 312-13; Powell, 252 F.2d at 61; and (6) failure to cooperate with tax authorities, see, e.g., Ruark, 449 F.2d at 313; Powell, 252 F.2d at 61.
The following facts support a finding of fraud: (1) Bradford engaged in illegal activities; (2) he failed to file returns for four consecutive years; (3) he failed to report substantial business income, his salary from Stanford, and the gain on the sale of his residence, all of which he knew constituted taxable income; (4) he dealt in cash to avoid scrutiny of his finances; (5) he filed false W-4′s; (6) he made efforts to conceal his laetrile distribution activities; (7) he failed to make estimated tax payments; (8) he failed to cooperate with the revenue agent during the audit examination; and (9) he failed to maintain adequate records.
The Tax Court’s finding that fraud had been established by clear and convincing evidence was adequately supported by the record.
The judgment is AFFIRMED.
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Post by Sapphire Capital on Sept 19, 2012 23:57:44 GMT 4
C. F. TRUST, INCORPORATED; ATLANTIC FUNDING CORPORATION, Plaintiffs-Appellees, v. FIRST FLIGHT LIMITED PARTNERSHIP, Defendant-Appellant, and BIRCHWOOD ORGANIZATION, INCORPORATED; BIRCHWOOD HOLDINGS GROUP, INCORPORATED; MARYLAND AIR INDUSTRIES, INCORPORATED; PVD LIMITED PARTNERSHIP; OCCOQUAN LIMITED PARTNERSHIP; CARNETT COMMERCIAL INVESTORS, INCORPORATED; BARRIE M. PETERSON; BARRIE M. PETERSON, Trustee; NANCY A. PETERSON; SCOTT PETERSON; DOE ENTITIES 1-10, Defendants.
No. 01-1753
UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT
338 F.3d 316; 2003 U.S. App. LEXIS 15013
June 4, 2002, Argued
July 29, 2003, Decided
SUBSEQUENT HISTORY: Costs and fees proceeding at, Petition denied by C.F. Trust, Inc. v. First Flight Ltd. P’ship, 2005 U.S. Dist. LEXIS 4232 (E.D. Va., Mar. 16, 2005)
PRIOR HISTORY: [**1] Appeal from the United States District Court for the Eastern District of Virginia, at Alexandria. T. S. Ellis, III, District Judge. (CA-99-1742-A).
C.F. Trust, Inc. v. First Flight Ltd. P’ship, 140 F. Supp. 2d 628, 2001 U.S. Dist. LEXIS 3569 (E.D. Va., 2001)
DISPOSITION: Affirmed.
CASE SUMMARY
PROCEDURAL POSTURE: The federal appellate court had certified the following two questions to the Virginia Supreme Court: (1) Would Virginia recognize a claim for outsider reverse veil-piercing under the facts of the case? (2) If the answer to (1) was yes, what standards had to be met before Virginia would allow reverse veil-piercing of the limited partnership? The Supreme Court of Virginia accepted the certification request and answered both questions.
OVERVIEW: Defendant limited partnership appealed from an order declaring the limited partnership the alter ego of defendant individual and thereby making the limited partnership’s assets subject to judgments entered against the individual. The federal appellate court previously held that the district court had properly exercised jurisdiction over the post-judgment alter ego claims of plaintiffs and that those claims constituted an existing liability sufficient to support a veil piercing claim under Virginia law. However, the federal appellate court found it “uncertain” whether Virginia law would permit outsider reverse veil piercing against a limited partnership and, if so, what standards would have to be met before Virginia would permit such a claim. Regarding the certified questions, the Virginia Supreme Court answered that Virginia did recognize the concept of outsider reverse piercing and that this concept could be applied to a Virginia limited partnership. Further, when determining whether reverse piercing of a limited partnership was appropriate, a court had to consider the same factors that it considered when determining whether traditional veil piercing should be permitted.
OUTCOME: The federal appellate court affirmed the judgment of the district court.
CORE TERMS: piercing, partnership, veil, outsider, innocent, alter ego, injustice, answered, veil-piercing
LexisNexis(R) Headnotes
Business & Corporate Law > Corporations > Shareholders > Disregard of Corporate Entity > General Overview
Business & Corporate Law > Limited Partnerships > Management Duties & Liabilities
Virginia does recognize the concept of outsider reverse piercing and that this concept can be applied to a Virginia limited partnership.
Business & Corporate Law > Limited Partnerships > Formation
Business & Corporate Law > Limited Partnerships > Management Duties & Liabilities
Civil Procedure > Justiciability > Exhaustion of Remedies > General Overview
When determining whether reverse piercing of a limited partnership is appropriate, a court must consider the same factors that it considers when determining whether traditional veil piercing should be permitted. Thus, although no single rule or criterion is dispositive, the litigant who seeks to disregard a limited partnership entity must show that the partnership sought to be pierced has been controlled or used by the debtor to evade a personal obligation, to perpetrate a fraud or a crime, to commit an injustice, or to gain an unfair advantage. The piercing of a veil is justified when the unity of interest and ownership is such that the separate personalities of the corporation and/or limited partnership and the individual no longer exist, and adherence to that separateness would create an injustice. When considering reverse veil piercing, a court must weigh the impact of such action upon innocent investors, and innocent secured and unsecured creditors, as well as the availability of other remedies the creditor may pursue.
Business & Corporate Law > Corporations > Shareholders > Disregard of Corporate Entity > General Overview
Business & Corporate Law > Limited Partnerships > Management Duties & Liabilities
Although in Virginia, unlike in some states, the standards for veil piercing are very stringent and piercing is an extraordinary measure, it is permitted in the most egregious circumstances.
COUNSEL: ARGUED: Russell James Gaspar, COHEN MOHR, L.L.P., Washington, D.C., for Appellant.
Harvey Alan Levin, BIRCH, HORTON, BITTNER & CHEROT, Washington, D.C., for Appellees.
ON BRIEF: Barbara A. Miller, BIRCH, HORTON, BITTNER & CHEROT, Washington, D.C.; James R. Schroll, BEAN, KINNEY & KORMAN, P.C., Arlington, Virginia, for Appellees.
JUDGES: Before WIDENER, WILLIAMS, and MOTZ, Circuit Judges. Judge Motz wrote the opinion, in which Judge Widener and Judge Williams joined.
OPINION BY: DIANA GRIBBON MOTZ
OPINION:
[*316] DIANA GRIBBON MOTZ, Circuit Judge:
In this diversity action, First Flight Limited Partnership appealed from the district court’s order declaring First Flight the alter ego of Barrie Peterson and thereby making First Flight’s assets subject to judgments entered against Peterson. We previously held that the district court had properly exercised jurisdiction over the post-judgment alter ego claims of C. F. [*317] Trust, Incorporated and Atlantic Funding Corporation and that those claims constituted an existing liability sufficient [**2] to support a veil piercing claim under Virginia law. See C. F. Trust, Inc. v. First Flight Ltd. Partnership, 306 F.3d 126, 133-34 (4th Cir. 2002).
However, we found it “uncertain” whether Virginia law would permit outsider reverse veil piercing against a limited partnership and, if so, what standards would have to be met before Virginia would permit such a claim. Id. at 141. Accordingly, after outlining the involved facts of this case and the legal issues they presented, we certified to the Supreme Court of Virginia, pursuant to Rule 5:42 of the Rules of the Supreme Court of Virginia, the following two questions:
1) Would Virginia recognize a claim for outsider reverse veil-piercing under the facts of this case?
2) If the answer to (1) is yes, what standards must be met before Virginia would allow reverse veil-piercing of the limited partnership? Id. (citing Va. Sup. Ct. R. 5:42(a)).
The Supreme Court of Virginia accepted our certification request and answered both questions. See C. F. Trust, Inc. v. First Flight Limited Parthershp, 266 Va. 3, 580 S.E.2d 806 (Va. 2003). It answered the first certified [**3] question in the affirmative, holding “that Virginia does recognize the concept of outsider reverse piercing and that this concept can be applied to a Virginia limited partnership.” Id. at 810.
With respect to the second question, the Supreme Court of Virginia explained: when determining whether reverse piercing of a limited partnership is appropriate, a court must consider the same factors” that it “considers when determining whether traditional veil piercing should be permitted.” Id. at 811. Thus, although “no single rule or criterion is dispositve, the litigant who seeks to disregard a limited partnership entity must show that the partnership sought to be pierced has been controlled or used by the debtor to evade a personal obligation, to perpetrate a fraud or a crime, to commit an injustice, or to gain an unfair advantage.” Id. The court further explained that “the piercing of a veil is justified when the unity of interest and ownership is such that the separate personalities of the corporation and/or limited partnership and the individual no longer exist, and adherence to that separateness would create an injustice.” Id.
The Supreme Court of Virginia also explained [**4] that when “considering reverse veil piercing” a court “must weigh the impact of such action upon innocent investors,” and “innocent secured and unsecured creditors,” as well as “the availability of other remedies the creditor may pursue.” Id. The court noted that in this case, however, “there are no innocent limited or general partners involved” and that “C.F. Trust and Atlantic Funding have exhausted all remedies available to them.” Id. at 811 nn.2-3.
In sum, the court concluded that although “in Virginia, unlike in some states, the standards for veil piercing are very stringent and piercing is an extraordinary measure” it “is permitted[] . . . in the most egregious circumstances, such as under the facts before this Court.” Id. (emphasis added).
In view of these answers to the certified questions, we affirm the judgment of the district court.
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Post by Sapphire Capital on Sept 19, 2012 23:59:03 GMT 4
Fleet v. TML Business Sales
65 F.3d 119, *; 1995 U.S. App. LEXIS 12704,
FLEET CREDIT CORPORATION, a Rhode Island Corporation, Plaintiff-Appellee, v. TML BUS SALES, INC., Applicant-Appellant.
No. 93-17218
UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT
65 F.3d 119; 1995 U.S. App. LEXIS 12704
May 11, 1995, Argued and Submitted, San Francisco, California, May 23, 1995, Filed
SUBSEQUENT HISTORY: [**1] The Publication Status of this Document has been Changed by the Court from Unpublished to Published September 1, 1995.
PRIOR HISTORY: Appeal from the United States District Court for the Northern District of California. D.C. No. CV-92-1410-WHO. William H. Orrick, Jr., District Judge, Presiding.
CASE SUMMARY
PROCEDURAL POSTURE: Appellant sought review of an order of the United States District Court for the Northern District of California that held that appellant could not secure a lien against bankrupt and that appellee was entitled to attorneys’ fees.
OVERVIEW: Appellant secured a judgment for more than $ 17 million against bankrupt for embezzlement and conversion of appellant’s funds. Appellee had obtained a judgment against bankrupt in the amount of $ 152, 276 plus interest. The district court subsequently determined that a new business was an alter ego of bankrupt and bankrupt’s conveyance of funds to this business was fraudulent. Therefore, appellee could reach the money in the business’s account. The court reversed the order of the district court that it had no right to a lien under Cal. Civ. Proc. Code § 708.410 because the federal action established that bankrupt had an interest in is alter ego’s account and appellant, as a judgment creditor, could take a lien even though bankrupt was not the plaintiff in this cause of action. The court found that the findings of fact established a fraudulent conveyance without any special circumstances attributable only to appellee and not to other similarly situated creditors. The court further found that appellant’s lien has priority of appellee’s attorneys’ fees because different liens upon the same property have priority according to the time of their creation.
OUTCOME: The court reversed the order because it established fraudulent conveyance without regard to any special circumstances attributable only to appellee and appellant had judgment creditor’s rights from earlier obtain judgment. Appellee attorneys’ fees did not have priority over appellant’ liens because different liens upon the same property have priority according to time of creation.
CORE TERMS: fraudulent conveyance, judgment debtor, judgment creditor, money judgment, alter ego, fraudulent transfer, plus interest, personally, defrauded, awarding, entitles, lien created, cause of action, pending action, notice of lien, conveyance, lawsuit, loaned, won
LexisNexis(R) Headnotes
Civil Procedure > Judgments > Entry of Judgments > Enforcement & Execution > Discovery of Assets
See Cal. Civ. Proc. Code. § 708.410.
Civil Procedure > Judgments > Entry of Judgments > Enforcement & Execution > Discovery of Assets
Cal. Civ. Proc. Code § 708.210 allows a judgment creditor to collect its money by suing a third person who has possession or control of property in which the judgment debtor has an interest.
Civil Procedure > Judgments > Entry of Judgments > Enforcement & Execution > Fraudulent Transfers
Civil Procedure > Remedies > Judgment Liens > General Overview
Contracts Law > Secured Transactions > Perfection & Priority > Priority > Liens
In California, other things being equal, different liens upon the same property have priority according to the time of their creation, except in cases of bottomry and respondentia. Cal. Civ. Code § 2897.
COUNSEL: Kendall M. Squires (On the Briefs), Bruce Sherman (Argued), San Diego, California, for the appellant.
Thomas E. Shuck, Ivanjack & Lambirth, Los Angeles, California, for the appellee.
JUDGES: Before: Alfred T. Goodwin, Cecil F. Poole and Andrew J. Kleinfeld, Circuit Judges. Opinion by Judge Kleinfeld.
OPINION BY: ANDREW J. KLEINFELD
OPINION: [*120] OPINION
KLEINFELD, Circuit Judge:
We decide a question of lien priorities arising out of a bankruptcy and a fraudulent conveyance.
I. Facts.
Berthold owned Taylor Bus Service, which filed chapter 11 bankruptcy. TML Bus Sales secured a judgment for more than $ 17 million against Berthold personally for embezzlement and conversion of TML’s funds. Fleet Credit obtained a default judgment against Berthold personally in the amount of $ 153,275.89 plus interest.
After the bankruptcy filing, two longtime friends and employees of Berthold’s [**2] incorporated Victory Enterprises as a Nevada Corporation. Taylor Bus Service emerged from the bankruptcy and received $ 1.9 million from the bankruptcy trustee. Taylor Bus loaned the $ 1.9 million to Victory, using falsified dates on documents to hide the true nature of the transaction. The district court found that the promissory note was a falsely dated instrument drafted to “disguise a fraudulent transfer.”
Victory deposited the $ 1.9 million into a Schwab brokerage account. Fleet believed that the money in the Schwab account really belonged to its judgment debtor, Berthold, and filed a lien against the Schwab account on March 30, 1992, in order to satisfy the judgment. Schwab refused to turn the money over to Fleet, because the account was Victory’s corporate account.
Fleet then filed this diversity suit in federal court. The court determined that Taylor Bus Service was an alter ego of Berthold, and Taylor Bus’s conveyance to Victory was a fraudulent conveyance, so Fleet could reach the money in Victory’s Schwab account:
The $ 1.9 million transfer to Victory was made ‘with actual intent to hinder, delay, or defraud’ Taylor’s and Berthold’s creditors. Cal. Civ. Code. § [**3] 3439.04(a)
* * *
The avoidance of the transfer to Victory effectively ‘revests’ in Taylor the property transferred. * * *
Berthold operated Taylor as an extension of himself. He personally directed the transfer of large sums of money, and did so for reasons that had nothing whatsoever to do with the operation of the corporate entity. Based on all the facts presented to the Court, it is clear beyond cavil that an inequitable result would follow were the Court to permit Berthold to shield himself with Taylor’s corporate form.
Meanwhile, TML sued Victory in state court to establish its own rights to the money in the Schwab account. The state court likewise held that Berthold’s creditor, TML, could reach the money in what is nominally Victory’s Schwab account.
TML filed a notice of lien in Fleet’s federal case, claiming a right under California Code of Civil Procedure § 708.410 to all amounts remaining after Fleet satisfied its state court judgment for $ 153,274.89 plus interest. Fleet moved for attorneys’ fees as well, as a priority ahead of TML’s lien. The district court held that TML could not secure a lien against Berthold at all, and Fleet was entitled to attorneys’ [**4] fees.
II. Analysis.
TML appeals the determination that it had no right to a lien under the applicable statute and asks us to find that, if it did have a right to secure a lien, its lien was superior to Fleet’s as to the amount of attorneys’ fees. We reverse, and hold that TML did have a lien, behind Fleet’s lien for the amount of its earlier judgment, but ahead of Fleet’s lien for attorneys’ fees.
TML obtained a $ 17 million, and Fleet a $ 153,000, judgment against Berthold in state court. Berthold hid $ 1.9 million in an account at Charles Schwab. His alter ego corporation loaned the money to another corporation in a fraudulent conveyance designed [*121] to keep the money away from creditors, as established by findings of fact after trial. The Schwab account was in the name of the second corporation, so for Berthold’s creditors to get it, they had to penetrate two layers of fraud, the alter ego corporation, and the fraudulent conveyance. Fleet did so, in federal court, and TML established substantially the same thing in state court. The attorneys’ fees of Fleet at issue are those Fleet won in the federal court case establishing the fraudulent conveyance and alter ego, not the earlier [**5] case establishing Berthold’s debt to Fleet of $ 153,000.
The district court concluded that because Berthold did not obtain a judgment in its favor in the fraudulent conveyance action in federal court in which TML sought to assert its lien, TML could not assert a lien on Berthold’s interest. We read the California statute differently, and conclude that TML’s motion for an order enforcing its lien should have been granted. We review this question of California law de novo, Ravell v. United States, 22 F.3d 960, 961 n.1 (9th Cir. 1994).
The statute at issue reads:
(a) A judgment creditor who has a money judgment against a judgment debtor who is a party to a pending action or special proceeding may obtain a lien under this article, to the extent required to satisfy the judgment creditor’s money judgment, on both of the following:
(1) Any cause of action of such judgment debtor for money or property that is the subject of the action or proceeding.
(2) The rights of such judgment debtor to money or property under any judgment subsequently procured in the action or proceeding.
Cal. Code. Civ. P. § 708.410.
Subsection (2) entitles TML to a lien for the amount of [**6] its judgment even though Berthold did not have a cause of action which was the subject of the lawsuit, because the action established that Berthold had an interest in the Schwab account for purposes of awarding his interest to creditors defrauded by his alter ego corporation and fraudulent conveyance. The first subsection lets a judgment creditor take a lien when the judgment debtor sues a third party for money. The second subsection broadens the judgment creditor’s rights, so that it can take a lien where the proceeding establishes that the judgment debtor has an interest in money or property, even though the judgment debtor was not the plaintiff. If there were doubt about this reading, it would be resolved by the legislative history. In the Legislative Committee Comment, immediately following the statute, the section is interpreted as follows:
A lien under this article reaches the judgment debtor’s right to money under the judgment in the pending action or proceeding as permitted by former law [referring to the superseded section 688.1]. See Abatti v. Eldridge, 103 Cal. App. 3d 484, 163 Cal. Rptr. 82 (1980). The lien also reaches any right of the judgment debtor to property [**7] under the judgment.
Cal. Code Civ. P. § 708.410 Legislative Committee Comment – Assembly 1982 Addition (emphasis added).
Fleet urges that the fraudulent conveyance lawsuit did not establish a right in Berthold to anything, because the district court’s conclusion of law number 14 in its July 9, 1993, order sets aside the fraudulent transfer to the second corporation only to the extent necessary to satisfy Fleet’s claim. The findings of fact, however, establish that the conveyance was fraudulent, and the first corporation an alter ego, without regard to any special circumstances attributable only to Fleet and not to other similarly situated creditors. This is not to say that Berthold could take the money for himself under the judgment. Whether he would be entitled to any excess, or Victory could keep it, would be adjudicated only in the event (an impossibility in the facts of this case) that a surplus remained after satisfying the liens of the creditors defrauded. The findings of fact establish Berthold’s right to the Schwab account insofar as his right is subject to claims of creditors defrauded by his alter ego corporation and fraudulent transfer.
Fleet sued under California [**8] Code of Civil Procedure § 708.210, which allows a judgment creditor to collect its money by suing a [*122] third person who has possession or control “of property in which the judgment debtor has an interest . . . .” The district judge correctly analyzed the case when he said “Fleet nevertheless may recover its judgment out of the Schwab One account by establishing that the money in that account belongs to Berthold.” (CR 178 at 16)(emphasis added). Abatti, 163 Cal. Rptr. at 85, establishes that a judgment debtor does not have to be a plaintiff in a subsequent suit for its judgment creditor to obtain a lien in that suit. Berthold got a right to funds and under these circumstances, the statute permitted TML to secure a lien under § 708.410.
Fleet argues that even if TML is entitled to a lien, its attorneys’ fees obtained in the fraudulent conveyance suit have priority over TML’s lien. TML argues that the court erred in awarding TML attorneys’ fees at all in the fraudulent conveyance suit. We conclude that TML’s lien has priority over Fleet’s attorneys’ fees, so we need not reach the question of whether the court erred in awarding Fleet attorneys’ fees. TML’s lien will exhaust the [**9] account.
Fleet was a judgment creditor based on its state court judgment for $ 153,000 with interest on the judgment until paid. The later federal court judgment in the fraudulent conveyance case, not the state court judgment which made Fleet a judgment creditor for $ 153,000, awarded Fleet the $ 79,000 in attorneys’ fees at issue.
Fleet’s lien based on its state court suit arose upon filing, and was for the amount of the judgment in that suit. In re Kerr, 185 Cal. App. 3d 130, 229 Cal. Rptr. 610, 611 (Cal.Ct.App. 1986). TML won a money judgment against Berthold in state court in 1989, and filed a notice of lien in this action on July 15, 1993, before Fleet requested an amendment to the July 9 order so it could get fees, and three months before those fees were awarded.
In California, “other things being equal, different liens upon the same property have priority according to the time of their creation, except in cases of bottomry and respondentia.” Cal. Civ. Code § 2897. This first in time, first in right rule controls. Fleet was first in time for $ 153,000, but TML was first in time for $ 17 million as against Fleet’s subsequent $ 79,000 lien for its attorneys’ fees judgment obtained in the federal [**10] fraudulent conveyance action. The lien established when a judgment creditor files a suit under § 708.410, is “a lien for the amount required to satisfy the money judgment . . . .” Cal. Code Civ. P. § 697.010 (emphasis added), n1 unless otherwise stated by statute. There is no statute altering that equation, so Fleet’s initial filing only entitled it to a lien for the amount of its money judgment, not its fees. “A lien created by statute is limited in operation and extent by the terms of the statute, and can arise and be enforced only in the event and under the facts provided for in the statute. . . . The lien cannot be extended by the courts to cases not provided for. . . .” 51 Am. Jur.2d § 38 at 176-77.
- – - – - – - – - – - – - – Footnotes – - – - – - – - – - – - – - -
n1 See also Cal. Code of Civ. P. §§ 697.540(a), 708.410(a), which also allow liens, but only to satisfy the amount of a prior money judgment.
- – - – - – - – – - – - End Footnotes- – - – - – - – - – - – - -
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No exception to the first in time, first in right rule entitles Fleet to augment its lien by subsequent awards, so the first lien created takes priority. [**11] Roseburg Loggers, Inc. v. U.S. Plywood-Champion Papers, Inc., 14 Cal. 3d 742, 122 Cal. Rptr. 567, 572-73, 537 P.2d 399 (1975). As between TML’s lien and Fleet’s lien, if any, for the $ 79,000 in subsequently awarded attorneys’ fees, TML’s lien is first in time.
Because we find that under California law TML was entitled to a lien and that lien had priority over Fleet’s right to obtain attorneys’ fees, we do not reach TML’s claim that no award of fees was permissible under California Code of Civil Procedure § 708.290.
Fleet has obtained the money from the Schwab account, pursuant to the district court judgment. Our decision entitles TML to all that is left after Fleet’s $ 153,274.89 lien plus interest. TML has requested an award of interest on the money which Fleet obtained in excess of its state court judgment with interest, and which should have been paid to TML, from the time the money was [*123] distributed to Fleet. Its entitlement is not governed by 28 U.S.C. § 1961, for the time between the distribution to Fleet and entry of the judgment in district court pursuant to this decision, because TML was entitled to a priority with respect to the Schwab account during that period, not a money judgment against Fleet. [**12] The district court shall determine whether interest is payable for some or all of the time between the distribution to Fleet and the judgment based on this decision, and in what amount, under the principle stated in the Restatement of Restitution § 156 or other applicable law.
REVERSED.
ORDER
The memorandum decision filed May 23, 1995, is redesignated as an authored opinion by Judge Kleinfeld with modification.
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Post by Sapphire Capital on Sept 20, 2012 0:00:18 GMT 4
Floyd v. Kansas 151 F.3d 1295, *; 1998 U.S. App. LEXIS 18366, **; 98-2 U.S. Tax Cas. (CCH) P50,631; 82 A.F.T.R.2d (RIA) 5574 GREGORY F. FLOYD and DENISE D. FLOYD, doing business as Medical Information Services; HAROLD DEAKINS and LYNNE DEAKINS, doing business as K and L Computers; RHONDA SIPPEL, doing business as Statbilling; JERRY NEVONEN, doing business as Network Facilities; WILLIAM MUTH, doing business as Electronic Billing Services; JACKIE RAY, doing business as Medical Billing Service; THOMAS PERRY, doing business as TurboClaim, Plaintiffs – Appellants, v. INTERNAL REVENUE SERVICE of the United States of America; STATE OF KANSAS ex rel. Carla Stovall, Attorney General; 12424 ABERDEEN, JOHNSON COUNTY, KANSAS, a certain piece of real estate, Defendants – Appellees. GREGORY F. FLOYD, DENISE D. FLOYD, doing business as Medical Information Services; HAROLD DEAKINS, LYNNE DEAKINS, doing business as K and L Computers; RHONDA SIPPEL, doing business as Statbilling; JERRY NEVONEN, doing business as Network Facilities; WILLIAM MUTH, doing business as Electronic Billing Services; JACKIE RAY, doing business as Medical Billing Service; THOMAS PERRY, doing business as TurboClaim, Plaintiffs – Appellees, and INTERNAL REVENUE SERVICE of the United States of America, Defendant – Appellee, v. STATE OF KANSAS ex rel. Carla Stovall, Attorney General, Defendant – Appellant, and 12424 ABERDEEN, JOHNSON COUNTY, KANSAS, a certain piece of real estate, Defendant. No. 96-3166, No. 96-3215 UNITED STATES COURT OF APPEALS FOR THE TENTH CIRCUIT 151 F.3d 1295; 1998 U.S. App. LEXIS 18366; 98-2 U.S. Tax Cas. (CCH) P50,631; 82 A.F.T.R.2d (RIA) 5574; 1998 Colo. J. C.A.R. 4282 August 10, 1998, Filed COUNSEL: Edward A. McConwell (Laura L. McConwell with him on the brief), McConwell Law Offices, Overland Park, KS, for Gregory F. and Denis D. Floyd, Harold and Lynne Deakins, Rhonda Sippel, Jerry Nevonen, William Muth, Jackie Ray and Thomas Perry. Martin J. Peck, Special Assistant Attorney General, Wellington, KS, for the State of Kansas. Theodore M. Doolittle (Kenneth L. Greene with him on the briefs), Department of Justice, Washington, D.C., for the Internal Revenue Service. JUDGES: Before HENRY, and LUCERO, Circuit Judges, and MILES-LaGRANGE, District Judge. * * The Honorable Vicki Miles-LaGrange, United States District Judge for the Western District of Oklahoma, sitting by designation. OPINION BY: LUCERO OPINION: [*1296] LUCERO, Circuit Judge. Thomas Bridges and his associated companies are in debt to three parties: the Internal Revenue Service (“IRS”), the State of Kansas, and a group of private judgment-creditors, the “Floyd plaintiffs.” These three parties sought judicial resolution [**2] of the priority of their claims to the assets of Bridges and his companies. Following a bench trial, the District Court for the District of Kansas held that the IRS claims primed those of the other two parties, and that, as to the remaining assets, Kansas took priority over the Floyd plaintiffs. The district court’s holding was premised in part on the IRS’s position that one of Bridges’s companies was his alter ego. Because we find that the district court erred in accepting the IRS’s alter ego argument, we reverse and remand. In 1991, Thomas Bridges founded two corporations, Network Billing Centers, Inc. (“NBC”) and Med-Net Technologies, Inc. (“Med-Net”), both in the business of licensing and developing computer software. Bridges, who was the sole shareholder and director of these companies, had complete control over them. Bridges’s salary from NBC was paid into the account of Thomas Marketing, Inc. (“TMI”), another corporation founded and controlled by him and of which he was the sole shareholder and director. The IRS’s claims against Bridges and his associated companies date from Bridges’s failure to pay personal income tax in 1984. The IRS first filed a Notice of Federal [**3] Tax lien against Bridges in 1990. In 1993, the IRS filed additional tax liens against Bridges as a result of his failure to pay personal income tax between 1988 and 1991. The following year, the IRS filed two tax liens against Med-Net for failing to pay employment taxes for the second and third quarters of 1993. Kansas’s claims are based on a pre-judgment attachment of Med-Net, NBC, and TMI accounts following the filing of an action by the State against Bridges, Med- Net, and NBC under the Kansas Consumer Protection Act (“KCPA”). Kansas won this action in late March 1994, obtaining judgment for just under $ 1 million. The Floyd plaintiffs’ claim is based on their successful suit against Bridges, NBC, and Med-Net for fraud and breach of contract. They secured judgment in early March 1994. These three creditors dispute their priority to two groups of assets: first, some $ 179,000, which constitutes proceeds from the sale of a house in Lenexa, Kansas, held in the registry of the United States District Court for the District of Kansas pursuant to a settlement between the three creditors; second, some $ 84,000 from the Med-Net, NBC, and TMI accounts attached by Kansas, which is held in [**4] the registry of the District Court of Johnson [*1297] County. n1 n1 The total amount seized was approximately $ 155,000. This sum was reduced pursuant to an agreement in August 1994 between the Floyd plaintiffs and the State to around $ 84,000. The Lenexa house was purchased using primarily Med-Net funds in 1992. Bridges’s daughter, Brooke Bridges McBride, filed an affidavit of equitable interest in the property with the register of deeds in Johnson County; legal title was apparently to pass from the construction company to McBride pursuant upon full payment under a contract for deed. n2 Both Bridges and McBride lived in the house. n2 The handwritten version of this contract listed Bridges and McBride as purchasers. A typed version prepared the same day lists only McBride. The district court determined Bridges had his name removed because he did not want the IRS to put a lien on the house. In April 1994, after obtaining judgment against Bridges, Med-Net, and NBC under the KCPA, Kansas filed another state court action, which was subsequently joined by the Floyd plaintiffs, alleging that McBride had received the house through a fraudulent conveyance from Med-Net and NBC. Shortly thereafter, the Floyd plaintiffs unsuccessfully attempted to collect on their judgment against Bridges, Med-Net, and NBC by garnishing McBride, arguing that Med-Net held its interest in her name. To resolve their claims to the house, Kansas, McBride, and the Floyd plaintiffs entered into a settlement whereby the house was to be sold, with the bulk of the proceeds to be contested among the competing creditors. After filing a lien against the house naming McBride as Bridges’s nominee, the IRS subsequently joined this settlement, and the house was sold. II The district court accepted the IRS’s arguments that Med-Net was Bridges’s alter ego and that McBride held the house as Bridges’s nominee. With one exception, therefore, the federal tax liens had been filed against Bridges and Med-Net before either of the other creditors had secured their judgments against Bridges and his associated companies. [**6] n3 Consequently, acting on the principle that priority for purposes of federal law is governed by the common-law principle that ‘the first in time is the first in right,’” United States v. McDermott, 507 U.S. 447, 449, 123 L. Ed. 2d 128, 113 S. Ct. 1526 (1993) (quoting United States v. New Britain, 347 U.S. 81, 85, 98 L. Ed. 520, 74 S. Ct. 367 (1954)), the district court held that the IRS’s claims to the house proceeds primed the claims of both Kansas and the Floyd plaintiffs. Because the IRS’s claims, which amounted to some $ 186,000, exhausted the sale proceeds entirely, the district court did not determine the relative priority of the other two creditors’ claims to the house. n3 The exception is the federal tax lien filed against Med-Net for its failure to pay employment taxes for the third quarter of 1993. The IRS does not appeal the district court’s holding that both Kansas and the Floyd plaintiffs’ claims have priority over this claim. The district court further held that [**7] the remaining $ 7,000 still owing to the IRS should be satisfied from the seized bank accounts, of which it concluded some $ 136,000 was traceable to Bridges and his alter ego Med-Net. As to the remaining bank account funds, the district court found that the State perfected its attachment lien when it won a favorable judgment in its KCPA suit. Because the State perfected its interest in the funds before the Floyd plaintiffs executed their judgment liens against those same funds, the district court concluded that Kansas had priority over the Floyd plaintiffs to whatever funds remained. Kansas and the Floyd plaintiffs both appeal. III Federal tax liens only arise in property as to which the defaulting taxpayer has rights of ownership. See United States v. Wingfield, 822 F.2d 1466, 1472 (10th Cir. 1987). State law determines such rights. See United States v. Central Bank of Denver, 843 F.2d 1300, 1303-04 (10th Cir. 1988). Federal law then determines the priority of competing liens against a taxpayer’s property. See Aquilino v. United States, 363 U.S. 509, 514, 4 L. Ed. 2d 1365, 80 S. Ct. 1277 (1960). [*1298] Both Kansas [**8] and the Floyd plaintiffs argue that Bridges had no rights to the Lenexa house, thus placing that property beyond the reach of the tax liens filed by the IRS against Bridges. More specifically, the Floyd plaintiffs argue that the house was properly owned by Med-Net, and because Med-Net was not Bridges’s alter ego, the house is properly claimable only by Med-Net creditors. Kansas, for its part, argues that Bridges fraudulently conveyed the house to McBride, leaving him without a valid claim to the property under state law. The district court determined that Med-Net was the alter ego of Bridges based on Pemco, Inc. v. Kansas Dep’t of Revenue, 258 Kan. 717, 907 P.2d 863 (Kan. 1995). If we accepted Pemco as the controlling authority in this case, we would review that determination deferentially. See G.M. Leasing Corp. v. United States, 514 F.2d 935, 939 (10th Cir. 1975) (district court’s finding of alter ego status “presumptively correct and must be left undisturbed on appeal unless . . . clearly erroneous”), rev’d in part on other grounds, 429 U.S. 338 (1977). And were we to do so, we would conclude that the evidence before the [**9] district court manifestly supported its conclusion that the “relationship” between Bridges and Med-Net was “so intimate,” Bridges’s “control” over Med-Net “so dominating,” and “the business and assets of the two are so mingled that recognition of [Med-Net] as a distinct entity would result in an injustice to third parties.” Pemco, 907 P.2d at 867 (quoting Doughty v. CSX Transp., Inc., 258 Kan. 493, 905 P.2d 106, 111 (Kan. 1995)). We also would not find error in the district court’s conclusion that crediting Med-Net with a separate corporate identity would sanction Bridges’s unjust evasion of his federal tax liability. But Pemco does not appropriately govern this case. The Pemco court considered a parent company’s request to be treated as a single unit with its corporate subsidiary for sales tax purposes. Ultimately, the court refused that request because “a corporation, having chosen the legal form in which to exist and do business, should not be permitted to pierce its own corporate veil to gain a tax advantage.” Id. 907 P.2d at 866. That rule does not speak to the case of an outside entity–here, the IRS–seeking [**10] to pierce the corporate veil. True, Pemco does recite Kansas’s “substantial case law authorizing the piercing of a corporate veil if to do otherwise would work an injustice on third parties.” Id. at 867. Those precedents, however, are inapplicable here because they consider the “standard” veil-piercing situation, in which corporate creditors seek to disregard the corporate form in order to hold stockholder assets liable for the corporation’s debts. In this case, we are presented with the reverse phenomenon because the IRS seeks to pierce Med-Net’s veil and use corporate assets to satisfy the obligations of an individual stockholder. Cf. Towe Antique Ford Found. v. IRS, 999 F.2d 1387, 1390 (9th Cir. 1993) (“Ordinarily, courts are called upon to apply the alter ego doctrine in cases where a party seeks to hold an individual liable for a business entity’s debts.”); Cascade Energy & Metals Corp. v. Banks, 896 F.2d 1557, 1575 (10th Cir. 1990) (stating that reverse-piercing theory employed by district court “led to the peculiar result of holding the corporation liable for the debts or torts of its controlling shareholder rather than the [**11] other way around”) (emphasis added). The IRS’s claims, in which an outside party seeks to meld the stockholder and the corporation into one, represent a “variant” on the usual “reverse-piercing” claim, in which an insider asserts that theory. See Cascade, 896 F.2d at 1575 n.17; see also Gregory S. Crespi, The Reverse Pierce Doctrine: Applying Appropriate Standards, 16 J. Corp. L. 33, 37- 38 (1991) (“Crespi”) (distinguishing between inside and outside reverse-piercing claims). The Floyd plaintiffs urge us to reject this outside reverse veil-piercing theory, at least where third-party corporate creditors would thereby be harmed. The government counters that numerous cases recognize such a practice in the federal taxation context. See No. 96-3166, IRS’s Br. at 30 (citing, e.g., Towe, 999 F.2d at 1390-91). But the question of whether Med-Net can be found to be Bridges’s alter ego for purposes of reverse veil-piercing must be answered by state law, [*1299] see Towe, 999 F.2d at 1391; Terrapin Leasing, Ltd. v. United States, 1981 U.S. App. LEXIS 14617, No. 79-1086, 1981 WL 15490, [**12] at *2 (10th Cir. Apr. 6, 1981), and none of the authorities cited by the government are drawn from that body of jurisprudence. Nor does the taxation context of the government’s claim dictate the outcome here. The IRS should be viewed as any other creditor seeking to pierce a corporate veil that is allegedly defrauding it of its legitimate claim.” Terrapin, 1981 WL 15490, at *2. In fact, there are significant reasons to resist application of the alter ego doctrine in this case. The IRS has presented no authority suggesting that Kansas does or would recognize an outside reverse-piercing claim, and our own review of Kansas law provides no authoritative support for that proposition. See Cascade, 896 F.2d at 1577 (holding that, absent a clear statement” by state supreme court adopting outside reverse-piercing theory, federal court will not reverse pierce). n4 n4 The Kansas courts did once apply a variant of reverse piercing–but only in a jurisdictional context. In Farha v. Signal Cos., 216 Kan. 471, 532 P.2d 1330, modified, 217 Kan. 43, 535 P.2d 463 (Kan. 1975), the Supreme Court of Kansas upheld a finding of personal jurisdiction against a corporation, which was not otherwise reachable under the Kansas long-arm statute, on the grounds that its co-defendant parent corporation transacted business within the state. While that decision contains alter ego and veil-piercing language, it does not contain any indication whatsoever that the subsidiary’s assets were reachable as a result of the parent’s substantive liability. As in personam jurisdiction can be asserted whenever a defendant has those “minimum contacts” with the forum state that will satisfy “‘traditional notions of fair play and substantial justice,’” International Shoe Co. v. Washington, 326 U.S. 310, 316, 90 L. Ed. 95, 66 S. Ct. 154 (1945) (quoting Milliken v. Meyer, 311 U.S. 457, 463, 85 L. Ed. 278, 61 S. Ct. 339 (1940)), the Farha decision is best understood as limited to the jurisdictional context; these jurisdictional standards should not be presumed to translate into substantive corporate law. In addition, “the reverse-pierce theory presents many problems.” Id. In Cascade, we noted two. First, the theory “bypasses normal judgment-collection procedures whereby judgment creditors attach the judgment debtor’s shares in the corporation and not the corporation’s assets.” Id. Second, third parties may be unfairly prejudiced if the corporation’s assets can be attached directly. Although in Cascade our particular concern was with non-culpable third-party shareholders of the corporation being unfairly prejudiced, no greater culpability should attach to the third-party corporate creditors harmed by reverse-piercing in this case. See id. (“‘ necessary element of the [alter ego] theory is that the fraud or inequity sought to be eliminated must be that of the party against whom the doctrine is invoked, and such party must have been an actor in the course of conduct constituting the abuse of corporate privilege–the doctrine cannot be applied to prejudice the rights of an innocent third party.’”) (quoting 1 William Meade Fletcher et al., Fletcher Cyclopedia of the Law of Private Corporations § 41.20, at 413 (1988 Supp.)) (emphasis added); see also [**14] Hamilton v. Hamilton Properties Corp., 186 B.R. 991, 1000 (Bankr. D. Col. 1995) (“The reverse piercing theory is an aberration which, if invoked, would prejudice . . . the rightful creditors of the corporation whose assets are subsumed for the benefit of the creditors of the individual. What of the creditors of [the corporation] who relied on its separate corporate existence in doing business with it?”); Cargill, Inc. v. Hedge, 375 N.W.2d 477, 479 (Minn. 1985) (holding that in considering propriety of reverse pierce, “also important is whether others, such as a creditor or other shareholders, would be harmed by a pierce”).
There are reasons beyond those identified in Cascade to deny an alter ego claim of this kind. For one thing, the prospect of losing out to an individual shareholder’s creditors will unsettle the expectations of corporate creditors who understand their loans to be secured–expressly or otherwise–by corporate assets. Corporate creditors are likely to insist on being compensated for the increased risk of default posed by outside reverse-piercing claims, which will reduce the effectiveness of the corporate form as a means [**15] of raising credit. Furthermore, as Judge Learned Hand suggested in what may be the earliest case to consider such a claim, outside reverse piercing is only appropriate in the rare case of a subsidiary dominating its parent. See Kingston Dry Dock Co. v. [*1300] Lake Champlain Transp. Co., 31 F.2d 265, 267 (2d Cir. 1929); see also Crespi at 67 (“Kingston stands for the proposition that the highly unusual circumstance of a subsidiary dominating its parent is a virtual prerequisite for finding the kind of unity that would allow an outside[] reverse pierce . . . .”); id. at 57, 65-66. Here, the premise of the IRS’s position is that the effective subsidiary–Med-Net–was the dominated party, which makes it hard, if not impossible, to argue for forfeiture of its assets through a reverse pierce. Additionally, disregard of the corporate form is an equitable remedy. See McKinney v. Gannett Co., 817 F.2d 659, 666 (10th Cir. 1987). As a consequence, it is appropriately granted only in the absence of adequate remedies at law. See 1 William Meade Fletcher et al., Fletcher Cyclopedia of the Law of Private Corporations § 41.25, at [**16] 653 (perm. ed. rev. vol. 1990). In cases where a corporation has been dominated by a controlling stockholder, an agency or aiding and abetting theory may suffice to hold the corporation liable for the actions of that stockholder. See Crespi at 65. Standard judgment collection procedures may also suffice to cover shareholder liability without expanding equitable theories of corporate liability. See Cascade, 896 F.2d at 1577. And, in taxation cases, the transfer of an economic benefit to a shareholder may be reachable for tax purposes as a constructive dividend, again obviating the need for the more drastic remedy of corporate disregard. See generally 10 Jacob Mertens, Jr. et al., The Law of Federal Income Taxation § 38B.33 (1991).
We recognize that the problems associated with reverse-piercing may be viewed as less serious in cases where a corporation is controlled by a single shareholder–there are, for instance, no third-party shareholders to be unfairly prejudiced by disregarding the corporate form. Should the Kansas courts consider adopting the doctrine of reverse-piercing, that factor may well influence the terms of any rule they ultimately adopt. [**17] Consequently, we stress that in reciting the litany of problems associated with the doctrine, we should not be understood as seeking to dictate or influence the law of corporations in Kansas. Rather, we seek only to lend additional weight to Cascade’s federal law conclusion that, in the absence of a clear statement of Kansas law by the Kansas courts, we will not assume that such a potentially problematic doctrine already has application in that state. See Cascade, 896 F.2d at 1577.
IV
The lion’s share of the district court’s analysis of this complex litigation is premised on its finding that Med-Net was Bridges’s alter ego. The district court’s conclusion that McBride held title to the house as Bridges’s nominee depends on its underlying finding that Bridges purchased the house through his alter ego Med-Net. Similarly, the determination of priority to the bank account proceeds assumes that the IRS satisfies the bulk of its claims by means of the proceeds from the sale of the house. If that latter determination is undone, then the IRS’s claims to the bank account funds, or the resolution of the other parties’ claims to the house proceeds, may impact the [**18] district court’s determination that Kansas would receive the bulk of the bank account funds.
However, the district court’s opinion need not inexorably unravel with our holding here because the IRS also brought a constructive dividend claim. That claim, if adjudged successful, might lead to the same conclusion as to the ownership of the house and the court’s subsequent determinations flowing therefrom. The district court did not rule as to whether Med-Net’s purchase of the house was a constructive dividend to Bridges. As the record on appeal contains no indication that the facts relevant to a constructive dividend determination are undisputed, we cannot decide this question as a matter of law, and it must instead be resolved in the first instance by the trial court below. Cf. Dolese v. United States, 605 F.2d 1146, 1153 (10th Cir. 1979). We are therefore obliged to remand for further proceedings.
REVERSED and REMANDED for further proceedings consonant with the views herein expressed.
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Post by Sapphire Capital on Sept 20, 2012 0:02:53 GMT 4
U.S. 9th Circuit Court of Appeals
Appeal No. 98-16378
FEDERAL TRADE COMMISSION,
Plaintiff-Appellee,
v.
AFFORDABLE MEDIA, LLC,
Defendant,
and
DENYSE LINDA ALYCE ANDERSON;
MICHAEL K. ANDERSON,
Defendants-Appellants.
Case Below: CV-98-00669-LDG (RLH)
Appeal from the United States District Court for the District of Nevada
Lloyd D. George, District Judge, Presiding
Argued and Submitted January 13, 1999–San Francisco, California
Filed June 15, 1999
Before: Charles E. Wiggins, A. Wallace Tashima, and Barry G. Silverman, Circuit Judges.
Opinion by Judge Wiggins
COUNSEL
Pamela J. Naughton and Michael P. McCloskey, Baker & McKenzie, San Diego, California, for the defendants-appellants.
Michael S. Fried, Federal Trade Commission, Washington, D.C., for the plaintiff-appellee.
OPINION
WIGGINS, Circuit Judge:
A husband and wife, Denyse and Michael Anderson, were involved in a telemarketing venture that offered investors the chance to participate in a project that sold such modern marvels as talking pet tags and water-filled barbells by means of late-night television. Although the promoters promised that an investment in the project would return 50 per cent in a mere 60 to 90 days, the venture in fact was a Ponzi scheme, which eventually unraveled and left thousands of investors with tremendous losses. When the Federal Trade Commission brought a complaint against the telemarketing duo, they claimed that they were simply innocent dupes rather than a modern day telephonic Bonnie and Clyde.
While the investors’ money was lost in the fraudulent scheme, the Andersons’ profits from their commissions remained safely tucked away across the sea in a Cook Islands trust. When the Commission brought a civil action to recover as much money as possible for the defrauded investors, the Andersons advanced two incredible propositions. First, they claimed that they should retain the 45 percent commissions they received for their role in the fraud, even though they acknowledged that the investors were defrauded. They claimed this entitlement because they merely sold the toxic investments that fueled the scheme and propped up the duplicitous house of cards. Second, the Andersons claimed that they were unable to repatriate the assets in the Cook Islands trust because they had willingly relinquished all control over the millions of dollars of commissions in order to place this money overseas in the benevolent hands of unaccountable overseers, just on the off chance that a law suit might result from their business activities. The learned district court was skeptical of both arguments and choose to grant the Commission its requested preliminary relief.
An old adage warns that a fool and his money are easily parted. This case shows that the same is not true of a district court judge and his common sense. After the Andersons refused to comply with the preliminary injunction by refusing to return their illicit proceeds, the district court found the Andersons in civil contempt of court. The Andersons appealed. We have jurisdiction under 28 U.S.C. S1292(a)(1) and we affirm.fn1
fn1 We also grant the Commission’s motion to strike the materials contained in the first tab of Appellants’ Supplemental Excerpts of Record. These materials are declarations, executed in September 1998, months after the district court issued the preliminary injunction and found the Andersons in contempt of court. We, therefore, order these materials stricken. See Kirshner v. Uniden Corp. of Am. , 842 F.2d 1074, 1078 (9th Cir. 1988) (striking portions of excerpts of record that were “neither filed with the district court, considered by the court, nor even before the court when it entered the order that [appellant] now challenges on appeal”).
I
Sometime after April 1997, Denyse and Michael Anderson became involved with The Sterling Group (“Sterling”). Sterling sold such imaginative products as the “Aquabell,” a water-filled dumbbell, the “Talking Pet Tag,” and a plastic wrap dispenser known as “KenKut” by means of late-night television commercials broadcast between the hours of 11:00 p.m. and 4:00 a.m. The Andersons formed Financial Growth Consultants, LLC (“Financial”) to serve as the primary telemarketer of media units, an investment that afforded purchasers the opportunity to receive a portion of the profits generated from the sales of Sterling’s outlandish products. Financial’s telemarketers thereupon set about locating prospective investors in the media unit scheme.
The media units sold for $5,000. Each media unit entitled the investor to participate in the sale of Sterling’s products from 201 of the late-night commercials. Each product sold for $20.00. The investor would receive $7.50 for each product sold during his 201 commercials, up to a maximum of five products per commercial. According to Financial’s telemarketers, the investors would likely receive $37.50 per commercial (from five products sold during each commercial) for a total of $7,537.50–an astronomical fifty percent return in sixty to ninety days. Financial, for its part, would receive forty-five percent of the investor’s $5,000.00 investment, an amount that the Andersons assert is the industry standard.
It appears that Financial’s telemarketers were especially skilled at marketing the media units. Financial may have raised at least $13,000,000 from investors in the media-unit scheme, retaining an estimated $6,300,000 in commissions for itself. Perhaps unsurprisingly to those not involved in the media-unit project, it turned out that Sterling could not sell enough Talking Pet Tags and Aquabells to return the promised yields to the media-unit investors. Instead, it appears that Sterling used later investors’ investments to pay the promised yields to earlier investors–a classic Ponzi scheme.
On April 23, 1998, the Federal Trade Commission (the “Commission”) filed a complaint in the United States District Court for the District of Nevada, charging the Andersons, Financial, and others with violations of the Federal Trade Commission Act (the “Act”) and the Telemarketing Sales Rule for their participation in a scheme to telemarket fraudulent investments to consumers. Upon motion by the Commission, the district court issued an ex parte temporary restraining order against the defendants.fn2 After hearings on April 30 and May 8, 1998, the district court entered a preliminary injunction against the defendants, which incorporated the provisions of the temporary restraining order. Both the temporary restraining order and the preliminary injunction required the Andersons to repatriate any assets held for their benefit outside of the United States.
fn2 The temporary restraining order prohibited the Andersons, the other defendants, and their agents from making false or misleading statements in connection with the marketing of investments or destroying or otherwise failing to maintain their business records. It also froze the defendants’ assets and required the defendants to provide a financial statement to the Commission’s counsel. In addition, it required any financial institutions in possession of the defendants’ assets to preserve the assets and provide the Commission’s counsel information about the assets. Finally, it required the defendants to repatriate all assets outside of the United States to the territory of the United States.
In July, 1995, the Andersons had created an irrevocable trust under the law of the Cook Islands. The Andersons were named as co-trustees of the trust, together with AsiaCiti Trust Limited (“AsiaCiti”), a company licensed to conduct trustee services under Cook Islands law. Apparently, the Andersons created the trust in an effort to protect their assets from business risks and liabilities by placing the assets beyond the jurisdiction of the United States courts. As discussed more fully below, the provisions of the trust were intended to frustrate the operation of domestic courts, by removing the Andersons as trustees and preventing AsiaCiti from repatriating any of the trust assets to the United States if a so-called “event of duress” occurred.
In response to the preliminary injunction, the Andersons faxed a letter to AsiaCiti on May 12, 1998, instructing AsiaCiti to provide an accounting of the assets held in the trust and to repatriate the assets to the United States to be held under the control of the district court. AsiaCiti thereupon notified the Andersons that the temporary restraining order was an event of duress under the trust, removed the Andersons as cotrustees under the trust because of the event of duress, and refused to provide an accounting or repatriation of the assets. The trust assets were therefore not repatriated to the United States and the Andersons have provided only limited information to the district court and the Commission regarding the trust assets.
On May 7, 1998, the Commission moved the district court to find the Andersons in civil contempt for their failure to comply with the temporary restraining order’s requirements that they submit an accounting of their foreign assets to the Commission and to repatriate all assets located abroad. At a hearing on June 4, 1998, the district court found the Andersons in civil contempt of court for failing to repatriate the trust assets to the United States and failing to provide an accounting of the trust’s assets. The district court, however, continued the hearing until June 9, then until June 11, and finally until June 17, in an effort to allow the Andersons to purge themselves of their contempt. In attempting to purge themselves of their contempt, the Andersons attempted to appoint their children as trustees of the trust, but AsiaCiti removed them from acting as trustees because the event of duress was continuing. At the June 17 hearing, the district court indicated that it believed that the Andersons remained in control of the trust and rejected their assertion that compliance with the repatriation provisions of the trust was impossible. At the close of the June 17 hearing, the district judge ordered the Andersons taken into custody because they had not purged themselves of their contempt. The Andersons timely appealed the district court’s issuance of the preliminary injunction and finding them in contempt. We affirm the district court.fn3
fn3 Subsequent to the Andersons’ appeal to this court, but prior to oral argument, the district court ordered the Andersons released from custody. In its Release Order, filed December 22, 1998, the district court ordered the Andersons released but found that they remain in contempt of court. Because they remain in contempt, their appeal of the court’s order finding them in contempt has not been rendered moot, even though they are no longer in custody.
II
The first issue in the Anderson’s appeal concerns the district court’s issuance of the preliminary injunction. This court only subjects a district court’s order regarding preliminary injunctive relief to “limited review.” Does 1-5 v. Chandler, 83 F.3d 1150, 1152 (9th Cir. 1996). We will reverse a district court’s issuance of a preliminary injunction only if the district court abused its discretion by basing its decision on an erroneous legal standard or on clearly erroneous factual findings. See id. Based on the record, we find that the district court did not abuse its discretion in issuing the preliminary injunction.
Section 13(b) of the Act allows a district court to grant the Commission a preliminary injunction “pon a proper showing that, weighing the equities and considering the Commission’s likelihood of ultimate success, such action would be in the public interest.” 15 U.S.C. S 53(b). Section 13(b), therefore, “places a lighter burden on the Commission than that imposed on private litigants by the traditional equity standard; the Commission need not show irreparable harm to obtain a preliminary injunction.” FTC v. Warner Communications, Inc., 742 F.2d 1156, 1159 (9th Cir. 1984). Under this more lenient standard, “a court must 1) determine the likelihood that the Commission will ultimately succeed on the merits and 2) balance the equities.” Id. at 1160.
A. Likelihood of Success on the Merits
In its complaint, the Commission alleged that: (1) the Andersons and Financial violated Section 5(a) of the Act by representing that consumers were highly likely to earn returns of 25 percent or more on their investments within a period of 90 days even though these consumers were not likely to earn such returns; and (2) the Andersons and Financial violated Section 310.3 of the Telemarketing Sales Rule, 16 C.F.R. S 310.3(a)(2)(vi), by misrepresenting a material aspect of the investors’ investment opportunity by misrepresenting the return the investors were likely to earn. In granting the preliminary injunction, the district court found a “substantial likelihood that the Commission will ultimately succeed” in establishing that the Andersons and their company had violated these provisions and were likely to violate these provisions in the future. Preliminary Injunction, entered and served May 22, 1998, at 2. The Andersons do not deny that the Sterling enterprise was a Ponzi scheme. Instead, the Andersons challenge the district court’s order by claiming that the Commission will not succeed in holding them personally liable for their involvement in the scheme. This contention lacks merit; the Commission has made a sufficient showing to justify preliminary injunctive relief.
The Andersons claim that the Commission will not succeed on the merits in holding them personally liable for restitution for any deceptive practices of Financial. Their contention reveals a crucial misunderstanding regarding the requisite factual showing in order to obtain preliminary, as compared to permanent, injunctive relief. Once the correct standard is applied, it becomes abundantly clear that the district court did not abuse its discretion in finding that the Commission had made a sufficient showing that it will likely succeed in holding the Andersons personally liable for Financial’s misconduct.
[1] Individuals are personally liable for restitution for corporate misconduct if they “had knowledge that the corporation or one of its agents engaged in dishonest or fraudulent conduct, that the misrepresentations were the type upon which a reasonable and prudent person would rely, and that consumer injury resulted.” FTC v. Publishing Clearing House, Inc., 104 F.3d 1168, 1171 (9th Cir. 1996). The knowledge requirement can be satisfied by showing that the individuals had actual knowledge of material misrepresentations, [were] recklessly indifferent to the truth or falsity of a misrepresentation, or had an awareness of a high probability of fraud along with an intentional avoidance of the truth.
Id.fn4 The Commission, however, “is not required to show that a defendant intended to defraud consumers in order to hold that individual personally liable.” Id.
fn4 The Commission claims that knowledge or reckless indifference is not necessary for disgorgement, as compared to restitution. The Commission bases this claim upon cases dealing with the Commodity Futures Trading Commission. This argument has been proffered by the Commission before and this Circuit has declined to reach the issue. See, e.g., FTC v. Pantron I Corporation, 33 F.3d 1088, 1103 (9th Cir. 1994). We will not decide today whether the Act allows the Commission to obtain disgorgement, without regard to the defendant’s mental state, because we believe that the Commission has made a sufficient showing of reckless indifference to obtain preliminary injunctive relief.
The Andersons concede that reckless indifference is legally sufficient to impose personal liability on principals for corporate wrongdoing. Instead of challenging the legal standard applied by the district court, they challenge the court’s factual findings. In its preliminary injunction, the district court found “substantial evidence that [the Andersons] were at least recklessly indifferent to the deceptive profit representations of the telemarketers” who worked for Financial and its independent sales offices. Preliminary Injunction, entered and served May 22, 1998, at 2. The Andersons assert that the district court’s “finding of reckless indifference is based on clearly erroneous findings of fact.” Appellants’ Opening Brief at 27. In making this assertion, the Andersons reveal a fundamental misunderstanding of the factual showing necessary to support a district court’s preliminary injunction (as compared to a permanent injunction) as well as confusion regarding the appropriate legal standards for imposing personal liability on principals for corporate misconduct.
In reviewing a preliminary injunction, our review is significantly constrained because of the state of the record available for our review. This constraint is especially limiting when we are asked to review the district court’s factual findings that serve as the basis for a preliminary injunction. We have explained these limitations in another case in which we had to review a district court’s issuance of a preliminary injunction:
We begin by identifying how little we can assist in the final resolution of the critical issues before the district court. Until a permanent injunction is granted or denied, we are foreclosed from fully reviewing the important questions presented. . .. Review of factual findings at the preliminary injunction stage is, of course, restricted to the limited and often non-testimonial record available to the district court when it granted or denied the injunction motion. The district court’s findings supporting its order granting or denying a permanent injunction may differ from its findings at the preliminary injunction stage because by then presentation of all the evidence has been completed. Then too, our determination whether its subsequent findings are clearly erroneous may differ from our view taken at the preliminary stage.
Zepeda v. INS, 753 F.2d 719, 723-724 (9th Cir. 1985) (emphasis added). Recognizing the limitations we face, and applying the appropriately deferential level of scrutiny to the district court’s findings, the Andersons’ contentions can be dealt with without any difficulty.
[2] The Andersons claim that the district court’s finding of reckless indifference was clearly erroneous because they had conducted extensive due diligence before becoming involved with Sterling. The district court was skeptical of the Andersons’ claim because extensive due diligence likely would have brought to light the scheme’s fraudulent nature.fn5 More importantly, the Andersons’ assertion evidences a clear misunderstanding of the relevant standard for personal liability on the part of corporate principals for corporate misconduct. The extent of an individual’s involvement in a fraudulent scheme alone is sufficient to establish the requisite knowledge for personal restitutionary liability. See FTC v. Sharp , 782 F. Supp. 1445, 1450 (D. Nev. 1991); FTC v. Amy Travel Service, Inc., 875 F.2d 564, 574 (7th Cir. 1989) (“Also, the degree of participation in business affairs is probative of knowledge.”) The Andersons’ control of Financial, the chief telemarketer of Sterling and the media units, establishes strong evidence of the Andersons’ knowledge. See Sharp, 782 F. Supp. at 1450 (“Here, Hall was a principal in, and president of MEHA, the chief broker of White Rock mines. Hall was deeply involved in the marketing of White Rock for around two and a half years. Thus, there is strong evidence that Hall knew his representations were false.”).
fn5 The district court found the Andersons’ due diligence efforts to be extremely deficient. See Opinion and Order, entered and served May 22, 1998, at 2-3. The only reliable information concerning actual sales by Sterling was obtained five months after the Andersons began selling the media units for Sterling. Nor did the Andersons conduct continuing diligence efforts to ensure that the media units were profitable investments rather than the Ponzi scheme that they proved to be. Id. Although the Andersons emphasize what they feel were adequate due diligence efforts, they fail to respond in any way to the specific deficiencies noted by the district court. Our review of the record indicates that there is more than sufficient evidence to support the district court’s findings and nothing approaching what would be necessary for us to conclude that the district court’s findings were clearly erroneous, given the level of deference afforded a district court’s findings in connection with a preliminary injunction.
[3] Even though the Andersons claim to have relied on their due diligence efforts, ample evidence, at least for preliminary injunctive relief, supports the district court’s conclusion that in light of their central involvement in the media unit scheme the Andersons were at a minimum recklessly indifferent to the truth of the representations Financial was making regarding the profit potential of the media unit investments. See id; see also Pantron I Corporation, 33 F.3d at 1104 (“Given the overwhelming evidence that no scientific support existed for the product’s efficacy claims, Lederman could not have failed to know that the scientific support claims were false unless he intentionally avoided the truth.”).
[4] The district court found that the promised yields on the media unit investments were so extraordinary that the Andersons should have been suspicious of the investment scheme. The Andersons claim that the district court miscalculated the promised yield on the media units. Instead of the 1000% annualized yield that the district court found would be necessary to earn the promised returns to the investors, they claim that under a profit-margin per-item analysis, the media units only had to yield a more modest 50% return in 60 to 90 days in order to deliver the promised yields–an annualized return of 200% to 300%. The Andersons seem to believe that these more modest returns on the media unit investments were so reasonable that they were not required to conduct more extensive due diligence. Perhaps the Andersons’ telemarketers were able to convince their victims that Sterling could sell enough water-filled barbells and talking pet name tags to deliver 50% returns on their investments in 60 to 90 days, but the Andersons have failed to convince us that the district court erred in finding that experienced business persons like the Andersons should have conducted greater due diligence efforts before representing to potential investors that the investment would yield 50% returns in a mere 60 to 90 days. Consequently, we cannot conclude, at least at this preliminary stage of the proceeding, that the district court clearly erred when it found that “[t]he Andersons had experience in the investment business, and should have been highly suspect of promises of such yields [on the media unit investments]. Yet they fell woefully short in verifying the legitimacy of the venture they were promoting.” Opinion and Order, entered and served May 22, 1998, at 2. Therefore, we find that the Commission has shown a sufficient likelihood of succeeding in holding the Andersons personally liable for the actions of Financial to warrant preliminary relief.
B. Balance of the Equities
The Andersons also argue that the district court ignored the hardships borne by the Andersons and Financial because of the issuance of the preliminary injunction. This argument ignores the fact that the district court released monies to pay Inter Com’s operating expenses,fn6 to pay Inter Com’s employees, and to pay for the Andersons’ living expenses and attorneys’ fees. Therefore the burden of the preliminary injunction, although not insubstantial, is not as great as the Andersons claim. We find that the district court did not clearly err in balancing the equities involved in this case.
fn6 When the temporary restraining order was granted, the Andersons had already discontinued their involvement with Sterling. They were operating a new telemarketing company, Inter Com, in the same office in which they had operated Financial.
[5] Under this Circuit’s precedents,”when a district court balances the hardships of the public interest against a private interest, the public interest should receive greater weight.” FTC v. World Wide Factors, Ltd., 882 F.2d 344, 347 (9th Cir. 1989); see also Warner Communications, Inc., 742 F.2d at 1165. Obviously, the public interest in preserving the illicit proceeds of the media unit-scheme for restitution to the victims is great.
Incredibly, the Andersons assert that “the district court did not find that there was a likelihood of asset dissipation.” Appellants’ Reply Brief at 7. This astounding assertion is made even in light of the clear finding of the district court that “[t]here is a substantial likelihood that, absent the continuation of the asset freeze, the Enjoined Defendants will conceal, dissipate, or otherwise divert their assets, thereby defeating the possibility of the Court granting effective final relief in the form of equitable monetary relief for consumers. ” Preliminary Injunction, entered and served May 22, 1998, at 2. Given the Andersons’ history of spiriting their commissions away to a Cook Islands trust, which was intentionally designed to frustrate United States courts’ powers to grant effective relief to prevailing parties, the district court’s finding regarding the likelihood of dissipation is far from clearly erroneous.
[6] Based on our review of the record, the district court did not clearly err in balancing the equities in this case simply because the court concluded that the important public interest in preserving the Andersons’ steep commissions from the Ponzi scheme was more important than the private interests, the harm to which was minimized by the district court’s release of monies to pay particular expenses. Therefore, we find that the Commission has adequately shown that the balance of the equities warrants preliminary injunctive relief.
C. Mootness
[7] The Andersons also contend that their cessation of sales for Sterling mooted the need for injunctive relief. In making this contention, the Andersons exhibit a startling misunderstanding of the nature of the preliminary relief that the district court actually granted. At a minimum, the Andersons’ cessation of sales has no bearing on the need to repatriate the assets they have secreted off to the Cook Islands. More importantly, however, their argument mischaracterizes the law to such a degree that they are advocating a legal proposition that is precisely opposite the rule established by our precedents. As such, we conclude that the Commission’s need for injunctive relief has not become moot.
The Andersons’ first difficulty arises from their misunderstanding of the preliminary relief that the district court actually granted the Commission. The preliminary injunction contains both a prohibitory component and a mandatory component. In relevant part, the prohibitory component prohibited the Andersons from (1) engaging in certain types of business practices, (2) destroying any of their financial records, or (3) dissipating any of their assets. In relevant part, the mandatory component of the preliminary injunction required the Andersons to (1) prepare and deliver financial reports to the Commission’s counsel, and (2) transfer to the United States all funds and assets held in foreign countries. While the Andersons’ cessation of sales might possibly effect the need to restrain them from engaging in prohibited business practices, it could in no way affect the need to have the Andersons repatriate their assets from the Cook Islands. Therefore, the Andersons’ cessation of sales for Sterling has not rendered moot the Commission’s need for the mandatory component of the preliminary injunction.
The Andersons also appear to misunderstand the legal significance of their voluntary cessation of sales for Sterling in terms of the prohibitory aspect of the preliminary injunction. The Andersons contend that “[v]oluntary cessation of an unlawful course of conduct precludes the issuance of an injunction if there is no cognizable danger of recurrent violations.” Appellants’ Opening Brief at 28. Contrary to the Andersons’ assertion, however, it is actually well-settled “that an action for an injunction does not become moot merely because the conduct complained of was terminated, if there is a possibility of recurrence, since otherwise the defendant’s would be free to return to [their] old ways. ” FTC v. American Standard Credit Systems, Inc. 874 F. Supp. 1080, 1087 (C.D. Cal. 1994) (quoting Allee v. Medrano, 416 U.S. 802, 811 (1974)) (internal citations omitted) (emphasis added).
In part, the Andersons’ misunderstanding may involve a misunderstanding of the difference between the effect of the perpetrator’s conduct, as compared to the victim’s conduct, on the need for injunctive relief. The difference is that the victim can moot her need for injunctive relief by her own conduct, but the alleged wrongdoer can not moot the need for injunctive relief as easily. This confusion becomes apparent from the cases upon which the Andersons rely. If an employee leaves the employ of an employer, she can not obtain injunctive relief to prevent her former employer from engaging in future retaliation in the workplace. See Taylor v. Resolution Trust Corp., 56 F.3d 1497, 1502 (D.C. Cir. 1995). It would obviously be a different case if an employer claimed that an injunction to prevent future retaliation against current employees was no longer necessary because the employer had stopped retaliating against its employees in the workplace.
It is possible, of course, that a defendant’s conduct can moot the need for injunctive relief, but the “test for mootness in cases such as this is a stringent one.” United States v. Concentrated Phosphate Export Ass’n., Inc., 393 U.S. 199, 203 (1968). The reason that the defendant’s conduct, in choosing to voluntarily cease some wrongdoing, is unlikely to moot the need for injunctive relief is that the defendant could simply begin the wrongful activity again: “Mere voluntary cessation of allegedly illegal conduct does not moot a case; if it did, the courts would be compelled to leave `[t]he defendant . . . free to return to his old ways.’ ” Id. (quoting United States v. W.T. Grant Co., 345 U.S. 629, 632(1953)).
[8] The Andersons contend that they have satisfied their burden because “[t]he FTC did not offer any admissible evidence that the Andersons were likely to repeat any wrongful conduct.” Appellants’ Opening Brief at 28. This asserted failure on the part of the Commission, however, is not sufficient to satisfy the Andersons’ burden of establishing that the need for injunctive relief has become moot as a result of their own conduct.fn7 The standard for the voluntary cessation exception to mootness is “whether the defendant is free to return to its illegal action at any time.” Public Utilities Comm’n of California v. Federal Energy Regulatory Comm’n, 100 F.3d 1451, 1460 (9th Cir. 1996). In order to meet their burden, the Andersons must show that “subsequent events [have] made it absolutely clear that the allegedly wrongful behavior cannot reasonably be expected to recur.” Norman-Bloodsaw v. Lawrence Berkeley Laboratory, 135 F.3d 1260, 1274 (9th Cir. 1998) (internal quotation omitted); cf. Lindquist v. Idaho State Bd. of Corrections, 776 F.2d 851, 854 (9th Cir. 1985) (A case may become moot as a result of voluntary cessation of wrongful conduct only if “interim relief or events have completely and irrevocably eradicated the effects of the alleged violation.”). The Andersons allege nothing that would suggest that it is “absolutely clear” that their wrongful activities are not reasonably likely to recur. Because they have failed to satisfy their burden, we can not conclude that the need for injunctive relief is moot solely because of the Andersons’ cessation of their unlawful conduct.
fn7 Because the Andersons have failed to satisfy their burden of proving that they are not likely to resume engaging in illegal telemarketing activities, we do not decide today the merits of the Andersons’ assertion that the Commission has failed to “offer any admissible evidence that the Andersons were likely to repeat any wrongful conduct. ” Nevertheless, we do note that one of the Andersons’ complaints about the preliminary injunction is that it disrupted the operations of the Andersons’ new telemarketing project, Inter Com. According to the Andersons, Inter Com is involved with pre-paid residential telephone service rather than the sale of media units. Inter Com apparently is involved with Tel Com Plus, which was subject to at least one state cease and desist order. At this point, the factual record is insufficient for us to decide whether the Andersons’ involvement in another fraudulent telemarketing scheme could provide a sufficient independent basis for the prohibitory aspect of the preliminary injunction.
In light of our conclusions regarding the Andersons’ various challenges to the propriety of the district court’s granting the Commission preliminary injunctive relief, we conclude that the district court did not abuse its discretion in issuing the preliminary injunction, based on the factual record available at such a preliminary stage of the proceeding.
III
The next issue on appeal is the district court’s finding the Andersons in contempt for refusing to repatriate the assets in their Cook Islands trust.fn8 We review a district court’s civil contempt order for an abuse of discretion. Hilao v. Estate of Marcos, 103 F.3d 762, 764 (9th Cir. 1996). We review the district court’s findings of fact in connection with the civil contempt adjudication for clear error. Reliance Ins. Co. v. Mast Constr. Co., 84 F.3d 372, 375 (10th Cir. 1996). We review a district court’s findings in connection with rejecting an impossibility defense for clear error. See Fortin v. Commissioner of Mass. Dep’t of Pub. Welfare, 692 F.2d 790, 797 (1st Cir. 1982) (affirming contempt order when district court’s finding that compliance was not impossible was not clearly erroneous). Based on the record before us, we find that the district court did not abuse its discretion in holding the Andersons in contempt.
fn8 We have interlocutory appellate jurisdiction over the district court’s adjudication of civil contempt where it is incident to an appeal from a preliminary injunction. See Diamontiney v. Borg, 918 F.2d 793, 796-97 (9th Cir. 1990).
The standard for finding a party in civil contempt is well settled:
The moving party has the burden of showing by clear and convincing evidence that the contemnors violated a specific and definite order of the court. The burden then shifts to the contemnors to demonstrate why they were unable to comply.
Stone v. City and County of San Francisco, 968 F.2d 850, 856 n.9 (9th Cir. 1992) (citations omitted).
The temporary restraining order required the Andersons, in relevant part, to “transfer to the territory of the United States all funds, documents and assets in foreign countries held either: (1) by them; (2) for their benefit; or (3) under their direct or indirect control, jointly or singly.” Temporary Restraining Order, entered and served April 23, 1998, at 8. These provisions were continued in the preliminary injunction. See Preliminary Injunction, entered and served May 22, 1998, at 9. It is undisputed that the Andersons are beneficiaries of an irrevocable trust established under the laws of the Cook Islands. The Andersons do not dispute that the trust assets have not been repatriated to the United States. Instead, the Andersons claim that compliance with the temporary restraining order is impossible because the trustee, in accordance with the terms of the trust, will not repatriate the trust assets to the United States.
[9] A party’s inability to comply with a judicial order constitutes a defense to a charge of civil contempt. See United States v. Rylander, 460 U.S. 752, 757(1983) (“While the court is bound by the enforcement order, it will not be blind to evidence that compliance is now factually impossible. Where compliance is impossible, neither the moving party nor the court has any reason to proceed with the civil contempt action.”). The Andersons claim that the refusal of the foreign trustee to repatriate the trust assets to the United States, which apparently was the goal of the trust, makes their compliance with the preliminary injunction impossible.
[10] Although the Andersons assert that their “inability to comply with a judicial decree is a complete defense to a charge of civil contempt, regardless of whether the inability to comply is self-induced,” Appellants’ Reply Brief at 12 (emphasis added), we are not certain that the Andersons’ inability to comply in this case would be a defense to a finding of contempt. It is readily apparent that the Andersons’ inability to comply with the district court’s repatriation order is the intended result of their own conduct–their inability to comply and the foreign trustee’s refusal to comply appears to be the precise goal of the Andersons’ trust.fn9 The Andersons claim that they created their trust as part of an “asset protection plan.” See Appellant’s Opening Brief at 36. These “o called asset protection trusts are designed to shield wealth by moving it to a foreign jurisdiction that does not recognize U.S. judgments or other legal processes, such as asset freezes.” Debra Baker, Island Castaway, ABA Journal, October 1998, at 55. The “asset protection” aspect of these foreign trusts arises from the ability of people, such as the Andersons, to frustrate and impede the United States courts by moving their assets beyond those courts’ jurisdictions:
Perhaps most importantly, situs courts typically ignore United States courts’ demands to repatriate trust assets to the United States. A situs court will not enforce a United States order from a state court compelling the turnover of trust assets to a creditor that was defrauded under United States law, or assets that were placed into a self-settled spendthrift trust.
James T. Lorenzetti, The Offshore Trust: A Contemporary Asset Protection Scheme, 102 Com. L. J. 138, 143-144 (1997).Because these asset protection trusts move the trust assets beyond the jurisdiction of domestic courts, often times all that remains within the jurisdiction is the physical person of the defendant. Because the physical person of the defendant remains subject to domestic courts’ jurisdictions, courts could normally utilize their contempt powers to force a defendant to return the assets to their jurisdictions. Recognizing this risk, asset protection trusts typically are designed so that a defendant can assert that compliance with a court’s order to repatriate the trust assets is impossible:
Another common issue is whether the client may someday be in the awkward position of either having to repatriate assets or else be held in contempt of court. A well-drafted [asset protection trust ] would, under such a circumstance, make it impossible for the client to repatriate assets held by the trust. Impossibility of performance is a complete defense to a civil contempt charge.
Barry S. Engel, Using Foreign Situs Trusts For Asset Protection Planning, 20 Est. Plan. 212, 218 (1993).
fn9 The Andersons’ trust created the circumstances in which a foreign trustee would refuse to repatriate assets to the United States by means of so-called duress provisions. Under the trust agreement, an event of duress includes “[t]he issuance of any order, decree or judgment of any court or tribunal in any part of the world which in the opinion of the protector will or may directly or indirectly, expropriate, sequester, levy, lien or in any way control, restrict or prevent the free disposal by a trustee of any monies, investments or property which may from time to time be included in or form part of this trust and any distributions therefrom.” Trust Agreement at 3. Upon the happening of an event of duress, the trust agreement provides that the Andersons would be terminated as co-trustees, so that control over the trust assets would appear to be exclusively in the hands of a foreign trustee, beyond the jurisdiction of a United States court:
Notwithstanding any other provision contained in this deed any trustee hereof shall automatically cease to be a trustee upon the happening of an event of duress within the territory where such trustee is . . . resident (in the case of an individual) and upon ceasing to be a trustee pursuant to this clause such trustee shall be divested of title to the property of this trust which shall automatically vest in the remaining or continuing trustee (if any) located in a territory not having an event of duress and the form for administration of this trust shall notwithstanding any other provision in this deed be deemed to be the place of residence or incorporation (if a corporation) of such continuing trustee.
Trust Agreement at 17 (emphasis added).
[11] Given that these offshore trusts operate by means of frustrating domestic courts’ jurisdiction, we are unsure that we would find that the Andersons’ inability to comply with the district court’s order is a defense to a civil contempt charge. We leave for another day the resolution of this more difficult question because we find that the Andersons have not satisfied their burden of proving that compliance with the district court’s repatriation order was impossible. It is well established that a party petitioning for an adjudication that another party is in civil contempt does not have the burden of showing that the other party has the capacity to comply with the court’s order. See NLRB v. Trans Ocean Export Packing, Inc., 473 F.2d 612, 616 (9th Cir. 1973). Instead, the party asserting the impossibility defense must show “categorically and in detail” why he is unable to comply. Id.; See also Rylander, 460 U.S. at 757 (“It is settled, however, that in raising this defense, the defendant has a burden of production.”).
[12] In the asset protection trust context, moreover, the burden on the party asserting an impossibility defense will be particularly high because of the likelihood that any attempted compliance with the court’s orders will be merely a charade rather than a good faith effort to comply. Foreign trusts are often designed to assist the settlor in avoiding being held in contempt of a domestic court while only feigning compliance with the court’s orders:
Finally, the settlor should be aware that, although his trust will probably prove unassailable by domestic creditors, he may face minor hassles while defending his trust in court. In particular, if a creditor attacks an offshore trust in United States court, the settlor may face contempt of court orders during the proceedings. . . . [T]here is a possibility that the court will . . . order the settlor to collect his assets from the trust and turn them over to the court. If the settlor does not comply with these orders, a court may hold him in contempt. However, there are ways around such a conflict. . . . [T]he settlor could comply with the court order and `order’ his trustee to turn over the funds, knowing full well that the trustee will not comply with his request. Thereby, the settlor would technically comply with the court’s orders, escape contempt of court charges, and still rest assured that his assets will remain protected.
James T. Lorenzetti, The Offshore Trust: A Contemporary Asset Protection Scheme, 102 Com. L. J. 138, 158 (1997). With foreign laws designed to frustrate the operation of domestic courts and foreign trustees acting in concert with domestic persons to thwart the United States courts, the domestic courts will have to be especially chary of accepting a defendant’s assertions that repatriation or other compliance with a court’s order concerning a foreign trust is impossible. Consequently, the burden on the defendant of proving impossibility as a defense to a contempt charge will be especially high.
[13] Given these considerations, we cannot find that the district court clearly erred in finding that the Andersons’ compliance with the repatriation order was not impossible because the Andersons remain in control of their Cook Islands trust. In finding the Andersons in civil contempt, the district court rejected the Andersons’ impossibility defense, specifically finding that the Andersons “in the judgment of the Court [and] from the evidence that I’ve heard are in control of this trust.” Transcript of June 17, 1998 Hearing Regarding Plaintiff’s Motion for Civil Contempt, p. 30. Because we only review a district court’s findings in connection with rejecting an impossibility defense for clear error, we will treat the district court’s finding that the Andersons were in control of their trust as a finding of fact, subject only to the clearly erroneous standard of review. Based upon the record before us, we find that the district court’s finding that compliance with the repatriation order was possible because the Andersons remain in control of their trust was not clearly erroneous.
The Andersons claim that they have “demonstrated to the district court `categorically and in detail’ that they can not comply with the repatriation section of the preliminary injunction.” Appellants’ Reply Brief at 13. The district court was not convinced and neither are we. While it is possible that a rational person would send millions of dollars overseas and retain absolutely no control over the assets, we share the district court’s skepticism. The district court found, notwithstanding the Andersons’ protestations, that
As I look at the totality of the scheme of what I see before me at this time, I have no doubt that the Andersons can if they wish to correct this problem and provide the means of putting these funds in a position that they can be accountable if the final determination of the Court is that the funds should be returned to those who made these payments.
Transcript of June 9, 1998 Hearing Regarding Plaintiff’s Motion for Civil Contempt, p. 18.
We cannot say that this finding was clearly erroneous. The Andersons had previously been able to obtain in excess of $1 million from the trust in order to pay their taxes. Given their ability to obtain, with ease, such large sums from the trust, we share the district court’s skepticism regarding the Andersons’ claim that they cannot make the trust assets subject to the court’s jurisdiction.
Moreover, beyond this general skepticism concerning the Andersons’ lack of control over their trust, the specifics of the Andersons’ trust indicate that they retained control over the trust assets. These offshore trusts allow settlors, such as the Andersons, significant control over the trust assets by allowing the settlor to act as a co-trustee or “protector” of the trust. See Debra Baker, Island Castaway, ABA Journal, October 1998, at 56 (“Further, an offshore trust, may allow settlors to maintain significant control over their assets. Trusts can include co-trustees in the United States to watch over the actions of the foreign trustees, and settlors can name anyone, including themselves, as `protectors’ to oversee the trustees and veto their actions if necessary.”). When the settlors retain this type of control, however, they can jeopardize the asset protection scheme because they will be subject to a U.S. court’s personal jurisdiction and be forced to exercise their control to repatriate the assets. See id. (“If litigation is threatened, the protector and the co-trustee can resign so that no one within the personal jurisdiction of a federal or state court has control over the assets of the trust.”).
[14] The district court’s finding that the Andersons were in control of their trust is well supported by the record given that the Andersons were the protectors of their trust. A protector has significant powers to control an offshore trust. See Gideon Rothschild, “Establishing and Drafting Offshore Asset Protection Trusts,” 23 Est. Plan. 65, 70 (1996) (“The use of a trust protector or advisor is common among foreign trusts. This person . . . has the power to replace trustees and veto certain actions by the trustees.”). A protector can be compelled to exercise control over a trust to repatriate assets if the protector’s powers are not drafted solely as the negative powers to veto trustee decisions or if the protector’s powers are not subject to the anti-duress provisions of the trust. See id. (“The protector’s powers should generally be drafted as negative powers and subject to the anti-duress provisions to protect against an order compelling the protector to exercise control over the trust.”). The Andersons’ trust gives them affirmative powers to appoint new trustees and makes the anti-duress provisions subject to the protectors’ powers,fn10 therefore, they can force the foreign trustee to repatriate the trust assets to the United States.
fn10 For example, the trust provides the protectors with discretion to conclusively determine that an event of duress has not occurred: “For the purpose of determining whether an Event of Duress has occurred pursuant to paragraph (c) and paragraph (d) of this clause (1)(a)(vi) of this Deed, the written certificate of the Protector to that effect shall be conclusive.” Trust Agreement at 3 (emphasis added).
[15] Perhaps the most telling evidence of the Andersons’ control over the trust was their conduct after the district court issued its temporary restraining order ordering the repatriation of the trust funds. The Andersons sent a notice to the foreign trustee, ordering it to repatriate the trust assets because the district court had issued a temporary restraining order. The foreign trustee removed the Andersons from their positions as co-trustees and refused to comply with the repatriation order. After the Andersons claimed that compliance with the repatriation provisions of the temporary restraining order was impossible, the Commission revealed to the court that the Andersons were the protectors of the trust. The Andersons immediately attempted to resign as protectors of the trust. This attempted resignation indicates that the Andersons knew that, as the protectors of the trust, they remained in control of the trust and could force the foreign trustee to repatriate the assets.fn11
fn11 Although we have concentrated on the Andersons’ capacity as protectors of the trust to support the district court’s finding that the Andersons remain in control of the trust, we have not considered whether other facts might support the Andersons’ continuing control over the trust, regardless of who is the protector of the trust. The Andersons attempted to resign their position as protectors and that attempt appears to have failed. If the Andersons have in fact resigned their position as protectors, they may still remain in control of the trust. We have not resolved this issue at this time because the Andersons have conceded that they are the protectors of the trust.
The Andersons contend that even though they are the protectors of the trust, it is impossible for them to repatriate the trust assets. The Andersons’ argument, that “[t]here is a misstep in the FTC’s logic,” Appellants’ Reply Brief at 17, ignores the fact that they bear the burden of proving impossibility, not the Commission. Their pointing to a few provisions of the trust, alone,fn12 is insufficient to carry their burden or to establish that the district court’s finding that they remain in control of their trust was clearly erroneous.fn13 Because we see no clear error in the district court’s finding that the Andersons remain in control of their trust and could repatriate the trust assets, the district court did not abuse its discretion in holding them in contempt. We, therefore, affirm the district court’s finding the Andersons in contempt. Given the nature of the Andersons’ so-called “asset protection” trust, which was designed to frustrate the power of United States’ courts to enforce judgments, there may be little else that a district court judge can do besides exercise its contempt powers to coerce people like the Andersons into removing the obstacles they placed in the way of a court. Given that the Andersons’ trust is operating precisely as they intended, we are not overly sympathetic to their claims and would be hesitant to overly-restrict the district court’s discretion, and thus legitimize what the Andersons have done.
fn12 The district court excluded evidence that the Andersons claimed supported their impossibility defense. The Andersons did not challenge this evidentiary ruling at all until their Reply Brief. Accordingly, we will not consider the propriety of the district court’s exclusion of the Andersons’ evidence concerning impossibility. See All Pacific Trading, Inc. v. Vessel M/V Hanjin Yosu, 7 F.3d 1427, 1434 (9th Cir. 1993). Moreover, what little the Andersons say in their Reply Brief cannot be considered an adequate argument challenging the district court’s evidentiary ruling. From the Andersons’ meager assertions, it is unclear what their challenge to the district court’s ruling would be.
fn13 The provisions of the trust also make clear that the Andersons’ position as protectors gives them control over the trust. In provisions of the trust agreement that the Andersons conveniently fail to reference, the trust agreement makes clear that the Andersons, as protectors, have the power to determine whether or not an event of duress has occurred: “For the purpose of determining whether an Event of Duress has occurred pursuant to paragraph (c) and paragraph (d) of this clause (1)(a)(vi) of this Deed, the written certificate of the Protector to that effect shall be conclusive.” Trust Agreement at 3 (emphasis added). Moreover, the very definition of an event of duress that the Andersons assert has occurred makes clear that whether or not an event of duress has occurred depends upon the opinion of the protector: “The issuance of any order, decree or judgement of any court or tribunal in any part of the world which in the opinion of the Protector will or may directly or indirectly, expropriate. . . .” Trust Agreement at 3 (emphasis added). Therefore, notwithstanding the provisions of the trust agreement that the Andersons point to, it is clear that the Andersons could have ordered the trust assets repatriated simply by certifying to the foreign trustee that in their opinion, as protectors, no event of duress had occurred.
AFFIRMED.
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Post by Sapphire Capital on Sept 20, 2012 0:07:44 GMT 4
UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF ALASKA In re: Case No. A95-00200-DMD ) ) Chapter 11 SANFORD WAYNE BROWN and ) CARROL A. BROWN, ) ) Debtors. ) ______________________________ ) ) Bancap No. 95-3072 VICKEY HIGASHI, ) Adversary No. A95-00200-002-DMD ) Plaintiff, ) ) v. ) ) SANFORD WAYNE BROWN and ) CARROL A. BROWN, ) ) Defendants. ) ______________________________ )
MEMORANDUM DECISION
This is an action by a judgment creditor to determine the validity of certain trusts in which the debtors have an interest. This is a core proceeding in accordance with 28 U.S.C. § 157(b)(2)(B), (E) and (O). I find for the plaintiff.
Background
The defendant, S. Wayne Brown, is a certified public accountant and successful businessman. In late 1989 and 1990, he and his wife Carrol created a series of self-settled trusts. One of these trusts was called the "CAW Family Trust." This trust was formed in the United States and governed by American law. The defendants have acted as trustees of this trust and admit that its trust assets are property of their bankruptcy estate. Two other trusts were formed during this same time period. These trusts were named the "Leones Company" and "American International Retail." Each of these trusts expressly declares that it was executed in the country of Belize and is to be interpreted and construed under the laws of Belize, formerly known as British Honduras. They are common law TOP 4 ABR 280 business trusts, also known as Massachusetts trusts. Both incorporate features found in corporations and trusts. Each trust document provided for the establishment of an irrevocable trust controlled by a trustee who could make discretionary distributions of trust property. The defendant S. Wayne Brown signed the trust documents through an attorney-in-fact in Belize. One Gregory McDonald was the "creator" of the trust. A trust certificate for 100 trust units was executed in favor of Mr. Brown for each trust. Trust certificates are similar to shares of stock. Mr. Brown, through his attorney-in-fact, immediately amended the trust certificates such that 50 were issued in his favor and 50 in favor of his wife in each trust. Immediately upon formation of the Leones Company, the defendants S. Wayne and Carrol A. Brown became the president and secretary, respectively, oFRCVCT f the trust.
The assets of the American International Retail trust are insignificant. That trust has an undocumented loan of about $11,000 payable from a Washington manufacturing firm. The trust currently has about $8,100 in cash and no other business assets. Mr. Brown initially placed $25,000 in the trust.
The Leones Company trust has substantial assets. It owns a Merrill Lynch whole life insurance policy on defendant S. Wayne Brown with a net cash value as of July 31, 1995, of $202,897.91. The policy was purchased for $200,000 in October of 1990. The trust also owns a Merrill Lynch annuity with a cash value as of July 31, 1995, of $148,831. The annuity was purchased for $100,000 in October of 1990.
There has been no business activity in Belize by either American International Retail or the Leones Company. All communication between the Leones Company and Merrill Lynch has been done by Mr. Brown. The funds utilized to purchase the annuity and the life insurance policy came from Mr. Brown. None of the funds were ever placed in the hands of the trustee, George A. Griffith, nor have any of the trust assets ever been controlled by Mr. Griffith.
The defendants filed for chapter 11 relief on March 31, 1995, after the plaintiff had obtained a judgment against them and their business corporation, Nome Commercial Company, for approximately $1.4 million. The judgment is on appeal to the Alaska Supreme Court. The defendants have submitted a joint chapter 11 plan for themselves and Nome Commercial TOP 4 ABR 281 Company. The plan initially went to hearing on confirmation on January 23, 1996. The confirmation hearing has been continued pending resolution of this proceeding.
Analysis
11 U.S.C. § 541(c)(2) excludes transfers of the debtors' beneficial interest in a trust from the bankruptcy estate when a transfer restriction is enforceable under "applicable non-bankruptcy law." For example, the debtors' interest in a pension trust arising under the Employment Retirement Income Security Act of 1974 (ERISA), is exempt from the estate under applicable non-bankruptcy law. Patterson v. Shumate, 504 U.S. 753 (1992); In re Conner, 73 F.3d 258 (9th Cir. 1996).
The trusts at issue here are not governed by ERISA or any other federal law. Ordinarily, this court would turn to Alaska law to determine whether or not trust assets are included in the bankruptcy estate. In re Anderson, 2 A.B.R. 82 (Bankr. D. Alaska 1991); In re Daniel, 771 F.2d 1352, 1360 (9th Cir. 1985), cert. denied, 475 U.S. 1016 (1986); In re Kincaid, 917 F.2d 1162, 1166 (9th Cir. 1990). Although both the American International Retail and the Leones Company trust documents specifically provide that the instruments are governed by the laws of Belize, under Alaska conflict of law principles, it is inappropriate to apply the law of Belize to this controversy. The driving force behind this bankruptcy and the cause of the debtors' current financial problems is Vickey Higashi's tort judgment for $1.4 million. Because this case is an outgrowth of that controversy, it should be governed by tort conflicts of law principles. In determining whether or not the trust assets are property of the estate, this court faces the same issues that would confront a state court in post-judgment execution proceedings concerning the trusts. As such, the application of tort conflict of law principles is clearly warranted.
Two tests have evolved over time to determine the proper choice of law in tort cases. The first is the "lex loci delicti" rule. Under this older rule, the law of the place of the wrong was uniformly applied to all tort cases. In later cases, however, the place of injury alone was not the controlling factor. Armstrong v. Armstrong, 441 P.2d 699, 701 (Alaska 1968). Alaska has now adopted a FRCVCT second test, "the most signifi- TOP 4 ABR 282 cant relationship" test, for conflicts of law questions. It requires the court to consider:
(a) the place where the injury occurred, (b) the place where the conduct causing the injury occurred, (c) the domicil[e], residence, nationality, place of incorporation and place of business of the parties, and (d) the place where the relationship, if any, between the parties is centered.
These contacts are to be evaluated according to their relative importance with respect to the particular issue.
Restatement (Second) of Conflict of Laws, § 145, as quoted in Ehredt v. DeHavilland Aircraft Co. of Canada, 705 P.2d 446, 453 (Alaska 1985)(footnotes omitted).
Applying this test to the current conflict, I conclude as follows: (1) the injury occurred in Nome, Alaska, entirely within the state; (2) the place where the conduct causing the injury occurred was in Nome, Alaska; (3) Vickey Higashi was a citizen of the state of Alaska at the time of the injury, and the Browns had an ownership interest in Nome Commercial Company, although they were residents of the state of Washington just prior to the tortious conduct; (4) the place where the relationship between the parties was centered was Alaska. Since the parties' most significant relationship is with Alaska, Alaska law should determine the outcome of this controversy.
There are other reasons for applying Alaska law in this case. The relevant policies of the forum state and the non-forum state are relevant factors in choosing the applicable rule of law. Restatement (Second) of Conflicts of Laws, § 6 (1971). The relevant policies of the state of Alaska will not be served by applying the laws of Belize. Alaska statutes specifically provide for the invalidation of fraudulent transfers, including transfers to trusts. A.S. 34.40.010 - 34.40.130. Belize, on the other hand, appears to actively encourage such transactions. It does not even have a fraudulent conveyance law. Rather, trusts in Belize are immune from attack from creditors even when created by fraudulent transfers. Moreover, the trusts can be self-settled. As noted by one author:
TOP 4 ABR 283 C. But Belize is Best.
The Cook Islands adopted at least some version of fraudulent conveyance law; Belize (the former British Honduras) did not even try.
In 1992, Belize adopted a new Trusts Act, a copy of which is appended to this paper. Section 7(6) is quite clear:
(6) Where a trust is created under the law of Belize, the court shall not vary it or set it aside or recognize the validity of any claim against the trust property pursuant to the law of another jurisdiction or the order of a court of another jurisdiction in respect of -- (a) the personal and proprietary consequences of marriage or the termination of marriage;
(b) succession rights (whether testate or intestate) including the fixed shares of spouses or relatives; or
(c) the claims of creditors in an insolvency.
(Emphasis added.)
Section 7(7) provides that the preceding Section 7(6) "shall have effect notwithstanding the provisions of section 149 of the Law of Property Act, section 42 of the Bankruptcy Act and the provisions of the Reciprocal Enforcement of Judgments Act."
Section 12 provides for the establishment of spendthrift trusts, and Section 12(4) specifically allows the settlor to establish a spendthrift trust with herself as beneficiary.
Thomas M. Mayer, Sheltering Assets in 1994: Real Estate Workouts and Bankruptcies 1994, Prac. L. Inst. 383, 446 (1994).
The policies underlyFRCVCT ing the current law of Belize are diametrically opposed to the fundamentals of Alaskan and American fraudulent transfer law. Belize is a popular trust jurisdiction precisely because it allows the types of fraudulent transfers that are unenforceable in America.
Under these circumstances, application of the law of Belize to the case at bar would be inappropriate. Alaska is the state with the most significant relationship to the controversy. Fundamental policies of TOP 4 ABR 284 Alaskan and American law will not be served by applying the laws of Belize. This case will be decided based on Alaskan and American law, not on the law of a foreign jurisdiction which actively solicits U.S. funds to insulate Americans from their creditors.
Alaska law prohibits fraudulent transfers. A.S. 34.40.010 provides that transfers made with the intent to hinder, delay or defraud creditors are void. A.S. 34.40.110 provides that transfers made in trust for the benefit of the person making the transfer are void against existing and subsequent creditors. I find the initial transfer to the Leones Company business trust to be fraudulent and void for several reasons.
The transfer of funds that created the Leones Company was made to hinder, delay or defraud future creditors. The fact that the trusts were established in Belize, a country notorious for its anti-creditor policies(1), rather than Alaska or Washington, indicates an intent to hinder, delay or defraud on the part of the defendants. Further, one of the express purposes for creation of the trust listed by the trustee was the protection of "assets from liability." However, the defendants' retention of control over the Merrill Lynch policies is the primary reason I find their transfers to the Leones Company trust fraudulent. Since the inception of the policies in 1990, Mr. Brown has retained complete control over trust assets. Neither Gregory McDonald, the "creator" of the trust or George Griffith, the trustee, has ever exercised any control over trust assets. They haven't even signed a trust document since the inception of the trust in 1989. The checks sent to Merrill Lynch originated with Mr. Brown and never passed through the hands of the supposed trustee. The Browns retain the ability, as trust officers, to instantly obtain all cash from the Merrill Lynch policies without interference from the trustee. I conclude that the Leones Company trust is simply a sham. The true substance and business of this trust is to avoid creditors and nothing more.
The Browns contend that establishment of the Leones Company trust was simply an estate planning device. If estate planning was the only TOP 4 ABR 285 consideration, however, their needs could easily have been addressed through American wills or trusts. Mr. Brown is a shrewd businessman. As such he sought to shield his assets from exposure to creditors through use of friendly foreign jurisdiction. Dramshop liability, for instance, is a problem for Alaskan liquor store and bar owners. A.S. 04.21.020 allows only limited immunity to such owners. When minors are allowed to purchase liquor or when a "drunken" person is served, owners may be liable for the damages that result, which can be catastrophic. The Browns' principal business, Nome Commercial Company, is engaged in the sale of liquor. Although it had liability insurance in 1989, damages from a personal injury claim could exceed policy limits. I find that avoidance of such liability claims to future creditors was a major consideration in the establishment of the trust.
The transfer creating the Leones Company trust is also invalid because it violates the provisions of A.S. 34.40.110, which provides:
A deed of gift, a conveyance, or a transfer or assignment, oral or written, of goods and chattels or things in action made in trust for the person making the deed, conveyance, transfer, or assignment is void as against the creditors, existing or subsequent, of the person.
The Browns' October 1990 transfer of funds to Merrill Lynch Pearce Fenner & Smith to create an annuity and life insurance policy for the Leones Company is void against Vickey Higashi, a subsequent creditor.
Statute of Limitations and Other Defenses
The Leones Trust was created in January of 1989. Transfers for the benefit of the Leones trust were made to Merrill Lynch Life Insurance Company on October 5, 1990. The Browns have failed to produce copies of checks that would detail the precise dates and amounts of payments. Alaska does not have a specific statute of limitations for fraudulent transfers. This court adopts the holding of Judge Ross in In re Ferrara (Barstow v. Ferrara, et. al.), 3 ABR 472, 491 (Bankr. D. Alaska 1994), which followed the March 12, 1992, ruling of District Judge Singleton in Battley v. Stanton, Case No. A91-0161-Civil. The six-year period contained in AS 09.10.050 is the applicable limitation period for a fraudulent transfer action. In this instance, the limitation period for TOP 4 ABR 286 setting aside the fraudulent transfers commenced upon rendition of the state court judgment on February 10, 1995. Austin v. Fulton Insurance Company, 444 P.2d 536, 539 (Alaska 1968); 37 Am Jur 2d Fraudulent Conveyance § 196 (1968). This action was filed July 19, 1995, well within the limitation period. The statute of limitations provides no defense to the Browns.
The Browns allege that Vickey Higashi has no standing to file a complaint regarding the trusts because she will be paid in full under the plan and the trusts are an "abstract issue." I disagree. The Browns seek to cramdown a $1.4 million tort claim. The plan must be proposed in good faith and be fair and equitable with respect to Vickey Higashi's claim. 11 U.S.C. § 1129(a)(3) and § 1129(b)(1). Determination of the validity of the trusts is a key issue in deciding whether the case meets the confirmation requirements of the Code. It would be very unfair and inequitable, for example, for the Browns to retain all liquid assets while forcing Ms. Higashi to accept non-liquid assets in satisfaction of her claim. If the liquid assets were held in a valid trust, their differentiation in treatment could be warranted. Determination of the validity of the trusts is a significant factor for evaluating the confirmability of the plan.
The Browns claim that Higashi's failure to join George A. Griffith, the supposed trustee of the Leones Company and the American International Retail trusts, warrants dismissal for failure to join an indispensable party. Again, I disagree. When the Browns have in fact dominated and controlled the trusts from their inception, Griffith is merely a figurehead. Higashi's failure to name him as a party is meaningless when he had no control over the trust assets at any time. The Browns are the real parties in interest and have been given proper notice of these proceedings.
American International Retail and CAW Family Trust
I find that the American International Retail trust was created by the Browns for the same reasons as the Leones Company. Its assets are property of the bankruptcy estate.
The CAW Family trust is not really at issue in these proceedings. The Browns concede that the assets of the trust are property of the TOP 4 ABR 287 estate. The Browns' California rental home is also property of the estate, as it was never transferred to any trust.
Conclusion
The Belizean trusts established FRCVCTwand controlled by the Browns were created by fraudulent transfers. As such, the assets of these trusts are property of the bankruptcy estate. The assets of the CAW Family trust are also property of the estate, along with the Browns' California rental home. An order and judgment consistent with this decision will be entered.
DATED: March 11, 1996.
BY THE COURT DONALD MacDonald IV United States Bankruptcy Judge
1. TOP 4 ABR 284 The policies of Belize and other offshore jurisdictions are discussed at length by Elena Marty-Nelson, in Offshore Asset Protection Trusts: Having Your Cake and Eating It Too, 47 Rutgers L. Rev. 11 (1994).
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Post by Sapphire Capital on Sept 20, 2012 0:37:46 GMT 4
In re: ASHLEY ALBRIGHT
UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF COLORADO
In re: ASHLEY ALBRIGHT
SSN 358-56-9118, Debtor, Case No. 01-11367
ABC, Chapter No. 7, 2003 Bankr. LEXIS 291
April 4, 2003, Decided
DISPOSITION:
Trustee’s Motion to appoint Bob Karls as real estate broker for the Trustee granted.
COUNSEL: For Ashley Albright, Debtor: James H. Hahn, Greenwood Village, CO. Harvey Sender, Trustee: Charles F. McVay, Denver, CO.
JUDGES: A. Bruce Campbell, U.S. Bankruptcy Judge.
OPINION BY: Bruce Campbell, U.S. Bankruptcy Judge.
OPINION:
OPINION AND ORDER ON MOTION TO ALLOW TRUSTEE TO TAKE ANY AND ALL NECESSARY ACTIONS TO LIQUIDATE PROPERTY OWNED BY WESTERN BLUE SKY LLC
THIS MATTER is before the Court on the (1) Motion to Allow Trustee to Take Any and All Necessary Actions to Liquidate Property Owned by Western Blue Sky LLC (“Motion to Liquidate”); (2) Motion to Appoint and Compensate Bob Karls as Real Estate Broker to the Trustee; and (3) Debtor’s Response to Trustee’s Motion to Retain Realtor and Liquidate LLC Property. Following a hearing on February 4, 2003, the parties agreed to submit the matter on briefs.
Ashley Albright, the debtor in this Chapter 7 case (“Debtor”), is the sole member and manager of a Colorado limited liability company named Western Blue Sky LLC. n1 The LLC owns certain real property located in Saguache County, Colorado (the “Real Property”). The LLC is not a debtor in bankruptcy.
n1 The Debtor initiated this case on February 9, 2001, under Chapter 13. It was converted to Chapter 7 by the Debtor on July 19, 2001.
The Chapter 7 Trustee contends that because the Debtor was the sole member and manager of the LLC at the time she filed bankruptcy, he now controls the LLC and he may cause the LLC to sell the Real Property and distribute the net sales proceeds to his bankruptcy estate. n2 The Debtor maintains that, at best, the Trustee is entitled to a charging order n3 and cannot assume management of the LLC or cause the LLC to sell the Real Property.
n2 If the Trustee is entitled to control of the LLC, he could, presumably, as an alternative, dissolve the LLC, distribute its property to his bankruptcy estate, and then sell the property himself. The Trustee has not asserted any alter ego theory and has not attempted to pierce the veil of the LLC. n3 The Debtor further asserts that because the LLC is “non-profit” pursuant to its operating agreement, no distribution of “profit” will ever be made and thus the value of this interest is zero. This argument erroneously assumes that a member of a Colorado limited liability company’s distribution rights are limited only to “profits.” They are not. Colo. Rev. Stat. § 7-80-102(10)(“Membership interest means a member’s share of the profits and losses of a limited liability company and the right to receive distributions of such company’s assets.”) See also Colo. Rev. Stat. § 7-80-702(1).
Pursuant to the Colorado limited liability company statute, the Debtor’s membership interest constitutes the personal property of the member. Upon the Debtor’s bankruptcy filing, she effectively transferred her membership interest to the estate. See 11 U.S.C. § 541(a). n4 Because there are no other members in the LLC, the entire membership interest passed to the bankruptcy estate, and the Trustee has become a “substituted member.” n5
n4 11 U.S.C. § 541(a)(1) provides, in relevant part: “The commencement of a case … creates an estate. Such estate is comprised of … all legal or equitable interests of the debtor in property as of the commencement of the case.”
n5 Colo. Rev. Stat. § 7-80-702 provides (emphasis added): (1) The interest of each member in a limited liability company constitutes the personal property of the member and may be transferred or assigned. However, if all of the other members of the limited liability company other than the member proposing to dispose of his or its interest do not approve of the proposed transfer or assignment by unanimous written consent, the transferee of the member’s interest shall have no right to participate in the management of the business and affairs of the limited liability company or to become a member. The transferee shall only be entitled to receive the share of profits or other compensation by way of income and the return of contributions to which that member would otherwise be entitled.
(2) A substituted member is a person admitted to all the rights of a member who has died or has assigned his interest in a limited liability company with the approval of all the members of the limited liability company by unanimous written consent. The substituted member has all the rights and powers and is subject to all the restrictions and liabilities of his assignor; except that the substitution of the assignee does not release the assignor from liability to the limited liability company under section 7-80-502.
Section 7-80-702 of the Limited Liability Company Act requires the unanimous consent of “other members” in order to allow a transferee to participate in the management of the LLC. n6 Because there are no other members in the LLC, no written unanimous approval of the transfer was necessary. Consequently, the Debtor’s bankruptcy filing effectively assigned her entire membership interest in the LLC to the bankruptcy estate, and the Trustee obtained all her rights, including the right to control the management of the LLC. n7
n6 This reading of § 7-80-702 is reinforced in Colo. Rev. Stat. § 7-80-108(3)(a). Section 108 sets forth the effect of an operating agreement and what provisions are non-waivable. Section 108(3) states that “unless contained in a written operating agreement or other writing approved in accordance with a written operating agreement, no operating agreement may [...] vary the requirement under section 7-80-702(1) that, if all of the other members of the limited liability company other than the member proposing to dispose of the member’s interest do not approve of the proposed transfer or assignment by unanimous written consent, the transferee of the member’s interest shall have no right to participate in the management of the business and affairs of the limited liability company or to become a member.” Colo. Rev. Stat. § 7-80-108(3)(a). The clause “other than the member proposing to dispose of the member’s interest” confirms that the “other members” identified in § 7-80-702 does not include the transferee.
n7 Under Colo. Rev. Stat. § 7-80-702, supra, the result would be different if there were other non-debtor members in the LLC. Where a single member files bankruptcy while the other members of a multi-member LLC do not, and where the non-debtor members do not consent to a substitute member status for a member interest transferee, the bankruptcy estate is only entitled to receive the share of profits or other compensation by way of income and the return of the contributions to which that member would otherwise be entitled. Thus, Mountain States Bank v. Irwin, 809 P.2d 1113 (Colo. App. 1991); Union Colony Bank v. United Bank of Greeley National Association, 832 P.2d 1112 (Colo. App. 1992) and Prefer v. Pharmnetrx LLC, 18 P.3d 844 (Colo.. App. 2000), cited by the parties, are distinguishable as they relate to multi-partner or member entities.
The Debtor argues that the Trustee acts merely for her creditors and is only entitled to a charging order against distributions made on account of her LLC member interest. n8 However, the charging order, as set forth in Section 703 of the Colorado Limited Liability Company Act, exists to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose, or from having to accept a creditor of another member as a co-manager. A charging order protects the autonomy of the original members, and their ability to manage their own enterprise. In a single-member entity, there are no non-debtor members to protect. The charging order limitation serves no purpose in a single member limited liability company, because there are no other parties’ interests affected. n9
n8 Colo. Rev. Stat. § 7-80-703 provides: Rights of creditor against a member. On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the membership interest of the member with payment of the unsatisfied amount of the judgment with interest thereon and may then or later appoint a receiver of the member’s share of the profits and of any other money due or to become due to the member in respect of the limited liability company and make all other orders, directions, accounts, and inquiries which the debtor member might have made, or which the circumstances of the case may require. To the extent so charged, except as provided in this section, the judgment creditor has only the rights of an assignee of the membership interest. The membership interest charged may be redeemed at any time before foreclosure. If the sale is directed by the court, the membership may be purchased without causing a dissolution with separate property by any one or more of the members. With the consent of all members whose membership interests are not being charged or sold, the membership may be purchased without causing a dissolution with property of the limited liability company. This article shall not deprive any member of the benefit of any exemption laws applicable to the member’s membership interest.
n9 The harder question would involve an LLC where one member effectively controls and dominates the membership and management of an LLC that also involves a passive member with a minimal interest. If the dominant member files bankruptcy, would a trustee obtain the right to govern the LLC? Pursuant to Colo. Rev. Stat. § 7-80-702, if the nondebtor member did not consent, even if she held only an infinitesimal interest, the answer would be no. The Trustee would only be entitled to a share of distributions, and would have no role in the voting or governance of the company. Notwithstanding this limitation, 7-80-702 does not create an asset shelter for clever debtors. To the extent a debtor intends to hinder, delay or defraud creditors through a multi-member LLC with “peppercorn” comembers, bankruptcy avoidance provisions and fraudulent transfer law would provide creditors or a bankruptcy trustee with recourse. 11 U.S.C. § § 544(b)(1) and 548(a).
The Colorado limited liability company statute provides that the members, including the sole member of a single member limited liability company, have the power to elect and change managers. n10 Because the Trustee became the sole member of Western Blue Sky LLC upon the Debtor’s bankruptcy filing, the Trustee now controls, directly or indirectly, all governance of that entity, including decisions regarding liquidation of the entity’s assets.
n10 See Colo. Rev. Stat. § 7-80-402 and § 7-80-405.
Because of the Court’s ruling herein, the Debtor may be entitled to a claim for her contributions made to preserve an asset of this bankruptcy estate based on post-petition mortgage payments on the Real Property. The parties were asked to brief the issue, but the Debtor has not formally asserted such a claim. Therefore, the Court does not rule on the issue at this time.
Based on the foregoing, it is hereby:
ORDERED that the Trustee, as sole member, controls the Western Blue Sky LLC and may cause the LLC to sell its property and distribute net proceeds to his estate. Alternatively, the Trustee may elect to distribute the LLC’s property to [*9] the bankruptcy estate, and, in turn, liquidate that property himself; and it is
FURTHER ORDERED that the Trustee’s Motion to appoint Bob Karls as real estate broker for the Trustee is hereby granted; and it is
FURTHER ORDERED that the Debtor may file a claim, subject to objection in the regular course of this case, for her expenditures made to preserve an asset of this estate based on post-petition mortgage or other payments made by the Debtor.
DATED: 4-4-03
BY THE COURT:
A. Bruce Campbell
U.S. Bankruptcy Judge
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Post by Sapphire Capital on Sept 20, 2012 0:38:57 GMT 4
In re: Ehmann 2005 WL 78921 (Bankr.D.Ariz. 01/13/2005) Only the Westlaw citation is currently available. United States Bankruptcy Court, D. Arizona. In re Gregory Leo EHMANN, Debtor. Louis A. Movitz, Trustee, Plaintiff, v. Fiesta Investments, LLC, Defendant. No. 2-00-05708-RJH. Adversary No. 04-00956. Jan. 13, 2005. John J. Hebert, Phoenix, AZ, for Debtor. OPINION DENYING DEFENDANT’S MOTION TO DISMISS COUNT I RANDOLPH J. HAINES, Bankruptcy Judge. *1 The Court here concludes that because the operating agreement of a limited liability company imposes no obligations on its members, it is not an executory contract. Consequently when a member who is not the manager files a Chapter 7 case, his trustee acquires all of the member’s rights and interests pursuant to Bankruptcy Code 1 §§ 541(a) and (c)(1), and the limitations of §§ 365(c) and (e) do not apply. Procedural Background Plaintiff Louis A. Movitz (“Trustee”) is the Chapter 7 Trustee for the estate of Debtor Gregory L. Ehmann (“Debtor”). The Trustee has sued Defendant Fiesta Investments, LLC (“Defendant” or “Fiesta”), an Arizona limited liability company of which the Debtor was a member when his bankruptcy case was filed. The Trustee’s suit seeks a declaration that the Trustee has the status of a member in Fiesta, a determination that the assets of Fiesta are being wasted, misapplied or diverted for improper purposes, and an order for dissolution and liquidation of Fiesta or the appointment of a receiver for Fiesta. Fiesta has moved to dismiss the complaint. The Court understood Fiesta’s motion as directed to Count II of the complaint to be based solely on an argument that the Court lacks subject matter jurisdiction, which this Court has already denied. The motion to dismiss Count I rests more on substantive law, arguing essentially that the Trustee has no rights with respect to Fiesta other than the right to receive a distribution that might have been made to the Debtor if and when Fiesta decides to make such a distribution. Such a motion to dismiss should be granted only if the Court concludes that the Trustee could prove no set of facts that would entitle him to any remedy other than simply waiting to see if Fiesta should ever decide to make a distribution. Background Facts The Trustee’s complaint identifies Fiesta as an Arizona limited liability company that was formed in approximately 1998 by the Debtor’s parents, Anthony and Alice Ehmann. At the time it was formed, it had two assets, a 17% interest in City Leasing Co. Ltd. and 25% interest in Desert arms LLC. Shortly after this bankruptcy case was filed, however, City Leasing was liquidated and as a result of that liquidation Fiesta received cash distributions in the amount of approximately $837,000 in the summer of 2000. Fiesta is still receiving regular quarterly distributions of cash from its other asset, Desert Farms. The Trustee’s complaint stems from the fact that although no formal distributions have been declared or paid to members, and certainly not to the Debtor, substantial amounts of cash have flowed out of Fiesta to or for the benefit of other members, including $374,500 in loans to members or to corporations owned or controlled by members, a $42,500 payment to one member, and $124,000 paid to another member to redeem his interest. In response to the Trustee’s demand for information and distributions, the managing member of Fiesta, the Debtor’s father, responded that he had created “Fiesta a few years ago to remove assets from our estate for estate tax purposes, and to accumulate investments for the benefit of our children after our deaths …. [W]e see no reason to accede to the wishes of any member or assignee of any member which runs contrary to our original goals.” Yet the outflow of over half a million dollars does not seem to be consistent with the original goal “to accumulate investments for the benefit of our children after our deaths.” The Parties’ Arguments *2 While the parties disagree on several relevant legal principles, a dispute that is absolutely central to the motion to dismiss is whether the Trustee’s rights are governed by Bankruptcy Code § 541(c)(1) or by § 365(e)(2). In a very general sense, the latter provision, if applicable, permits the enforcement of state and contract law restrictions on the Trustee’s rights and powers, whereas the former provision, if applicable, would render such restrictions and conditions unenforceable as against the Trustee. Because § 541 applies generally to all property and rights that the Trustee acquires, whereas § 365 applies more specifically to executory contract rights, the answer to this question hinges on whether the Trustee is asserting a property right or an executory contract right. The Trustee’s complaint does not expressly seek to exercise any rights under an executory contract, nor does it identify the Fiesta Operating Agreement as being an executory contract, but merely attaches it as an exhibit. Indeed, as Fiesta notes, the deadline for the Trustee to have assumed or rejected an executory contract has long since passed. 2 In its motion to dismiss, Fiesta relies heavily on various provisions of the Fiesta Operating Agreement which provide that in the event a trustee acquires a member’s interests, such action shall not dissolve the company or entitle “any such assignee to participate in the management of the business and affairs of the company or to exercise the right of a Member unless such assignee is admitted as a Member ….” Operating Agreement ¶ 7.2. “Such an assignee that has not become a Member is only entitled to receive to the extent assigned the share of distributions … to which such Member would otherwise be entitled with respect to the assigned interest.” Id. Fiesta further notes that such limitations on the rights of assignees of members’ interests in LLCs are specifically authorized by state law, Arizona Revised Statutes (“A.R.S.”) § 29-732(A). Fiesta also argues that the Trustee is akin to a judgment creditor, and that A.R .S. § 29-655(c) provides that a charging order is the exclusive remedy by which a judgment creditor of a member may satisfy a judgment out of the member’s interest in an LLC. Nowhere in its motion to dismiss, however, does Fiesta argue that the Operating Agreement creates an executory contract between Members and the LLC, that § 365(e)(2) renders such provisions on which Fiesta relies enforceable against the Trustee, or that § 541(c)(1) is for some other reason inapplicable. In reply, Fiesta relies on § 365(e) to maintain that the state and contract law restrictions are enforceable against the Trustee notwithstanding § 541(c)(1). Nowhere, however, does Fiesta ever establish, much less even attempt to demonstrate, that the Trustee’s complaint seeks to enforce rights under an executory contract. To the contrary, Fiesta simply assumes or flatly asserts that the Trustee’s rights hinge entirely on an executory contract: “In the case at bar, there is no dispute that if the Operating Agreement is considered as a partnership agreement it is an executory contract.” Fiesta Reply at 6. And yet the very case that Fiesta cites after making that assertion itself concluded that a partnership relationship may include both an executory contract and a nonexecutory property interest in the profits and surplus. Cutler v. Cutler (In re Cutler), 165 B.R. 275, 280 (Bankr.D.Ariz.1994)(Case, B.J.). *3 If a partnership relation entails both executory contract rights and nonexecutory property rights, then it would seem to necessitate a threshold determination of which kind of rights are at issue for the particular kind of relief a Trustee seeks with respect to a partnership or LLC. Before reaching that issue, however, it may be fruitful first to examine whether the Fiesta Operating Agreement even includes any executory contract rights. Legal Analysis Although the Bankruptcy Code contains no definition of an executory contract, the Ninth Circuit has adopted the “Countryman Test”: “ contract is executory if ‘the obligations of both parties are so far unperformed that the failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other.’ ” 3
While Fiesta undoubtedly owes many obligations to its members pursuant to the Operating Agreement, for the contract to be executory there would also have to be some material obligation owing to the company by the member. Moreover, such member’s obligation must be so material that if the member did not perform it, Fiesta would owe no further obligations to that member. As noted above, in its briefing on the motion to dismiss Fiesta has not attempted to demonstrate that the Operating Agreement is in fact an executory contract, much less to demonstrate exactly what material obligation is owed to the company by its members. Moreover, the founding member’s statement of the purposes for which the company was formed suggests that it is very likely there are no such obligations. The purpose was twofold: to remove assets from the parents’ estates for estate tax purposes, and to accumulate investments for the benefit of their children after their deaths. One would certainly not expect the children-members to have any obligations with respect to satisfaction of that first goal, which was a unilateral act by the parents, and it is highly unlikely the children-members undertook any obligations with respect to the second goal, any more than would an ordinary prospective heir.
This suspicion is borne out by a close reading of the Operating Agreement itself. It imposes many obligations on the managers, but as noted above the manager is the Debtor’s father, not the Debtor. Article V is entitled “Rights and Obligations of Members,” but in fact it identifies only rights and no obligations. It (1) limits members’ liability for company debts, (2) grants members the right to obtain a list of other members, grants members the right to approve by majority vote the sale, exchange or other disposition of all or substantially all of the company’s assets, (4) grants the members rights to inspect and copy any documents, (5) grants members the same priority as to return of capital contributions or to profits and losses, and (6) grants the permissible transferee of a member’s interests the right to require the company to adjust the basis of the company’s property and the capital account of the affected member. In short, the Article of the Operating Agreement that is partially titled “Obligations of Members” reveals that members have no obligations to the company.
*4 In the entire Agreement, the only provision where members, who are not managers, agree to do anything is Article 7.4, which provides in part that “Each member agrees not to voluntarily withdraw from the company as a member ….” It is now questionable in the Ninth Circuit whether such an agreement merely to refrain from acting is sufficient, standing alone, to create an executory contract. 4 But we need not go that far to resolve this issue, because the sentence in which each member agrees not to voluntarily withdraw goes on to say: “nd each Member further agrees that if he attempts to withdraw from the Company in violation of the provisions of this paragraph, he shall receive One Dollar ($1 .00) in payment of his interest in the Company and the remaining portion of such Member’s interest shall be retained by the Company as liquidated damages.” This reveals that what at first may have appeared as a mandatory obligation is in fact merely an option, which gives each member the option of withdrawing if he is willing to accept $1.00 for his interest. But under Helms, such an unexercised option is not an executory contract. 5
As demonstrated by the excellent analysis in Smith, 6 it is facile to assume that all partnership agreements are executory contracts. Closer analysis reveals that if there are no material obligations that must be performed by the members of a limited liability company or the limited partners in a limited partnership, then the contract is not executory and is not governed by Code § 365 . 7 This case is therefore unlike others that have expressly found “an obligation to contribute capital” and other “continuing fiduciary obligations among the partners that make this [Partnership] Agreement an executory contract.” 8
In the absence of any obligation on the part of the member, it is difficult to see where an executory contract lies. This is consistent with the whole purpose of Fiesta. It was created simply as a way to reduce the estate tax liabilities that might otherwise have been incurred upon the death of the parents and the distribution of their estate to their heirs. Indeed, as King Lear suggests, the irrevocable transfer of the parents’ assets to Fiesta and the irrevocable gift of membership interests in Fiesta to their children probably creates even less obligations on the children than the ordinary filial obligations morally felt by most expectant heirs. Moreover, not only do there not appear to be any obligations imposed upon members by the Fiesta Operating Agreement, but there are certainly none with respect to either receipt of a distribution or proper management of the company by its managers. Members do not have to do anything to be entitled to proper management of the company by the managers. The Trustee’s complaint does not involve the Debtor’s lone arguable obligation not to voluntarily withdraw. Because there are no obligations imposed on members that bear on the rights the Trustee seeks to assert here, the Trustee’s rights are not controlled by the law of executory contracts and Bankruptcy Code § 365. Consequently the Trustee’s rights are controlled by the more general provision governing property of the estate, which is Bankruptcy Code § 541.
*5 Code § 541(c)(1) expressly provides that an interest of the debtor becomes property of the estate notwithstanding any agreement or applicable law that would otherwise restrict or condition transfer of such interest by the debtor. All of the limitations in the Operating Agreement, and all of the provisions of Arizona law on which Fiesta relies, constitute conditions and restrictions upon the member’s transfer of his interest. Code § 541(c)(1) renders those restrictions inapplicable.
This necessarily implies the Trustee has all of the rights and powers with respect to Fiesta that the Debtor held as of the commencement of the case. It therefore appears that the Trustee may be able to prove a set of facts that would entitle the Trustee to some remedy. The appropriate remedy might include a declaration of the Trustee’s rights, redemption of the Debtor’s interest, 9 appointment of a receiver to operate the partnership in accordance with its purposes and the members’ rights, 10 or dissolution, wind up and liquidation. Consequently Fiesta’s motion to dismiss must be denied.
Footnotes
FN1. Unless otherwise indicated, all chapter, section, and rule references are to the Bankruptcy Code, 11 USC §§ 101-1330, and to the Federal Rules of Bankruptcy Procedure, Rules 1001-9036.
FN2. The bankruptcy case was filed as a voluntary Chapter 7 on May 26, 2000. Bankruptcy Code § 365(d)(1) provides that in a Chapter 7 case, an executory contract is deemed rejected unless assumed or rejected by the Trustee within 60 days after the filing of the case. In response, the Trustee argues that he is not a mere assignee of the Debtor’s membership interest, but rather acquired all of the Debtor’s right, title and interest pursuant to § 541(a). He argues, further, that the Trustee took the Debtor’s rights free of certain conditions and restrictions that would otherwise devalue the asset in the hands of any other assignee, pursuant to § 541(c)(1).
FN3. Unsecured Creditors’ Comm. v. Southmark Corp. (In re Robert L. Helms Constr. and Dev. Co., Inc.), 139 F.3d 702, 705 (9th Cir.1998), quoting Griffel v. Murphy (In re Wegner), 839 F.2d 533, 536 (9th Cir.1988), and citing Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 MINN. L.REV. 439, 460 (1973).
FN4. In the case where the Ninth Circuit first expressly adopted the Countryman test, it held that such an agreement to refrain from acting may be sufficient to make a contract executory: “Because of the exclusive nature of the license which Fenix received, Select-A-Seat was under a continuing obligation not to sell its software packages to other parties. Violation of this obligation would be a material breach of the licensing agreement.” Fenix Cattle Co. v. Silver (In re Select-ASeat Corp.), 625 F.2d 290, 292 (9th Cir.1980)(decided under the prior Bankruptcy Act). That decision was legislatively repealed in 1984 by the adoption of § 365(n). More recently, the en banc decision in Helms, supra note 3, reformulated the test in a way that focuses only on affirmative performance: “The question thus becomes: At the time of filing, does each party have something it must do to avoid materially breaching the contract?” 139 F.3d at 706. And the Andrews/Westbrook analysis, as thoroughly explained in In re Bergt, 241 B.R. 17, 21-36 (Bankr.D.Alaska 1999), demonstrates that it makes no sense to determine the “executoriness” of a contract if its assumption would impose no administrative liability on the estate, because the avoidance of such administrative liability when it exceeds the contractual benefits is the sole reason for executory contract law.
FN5. Helms, supra note 3, at 705.
FN6. Samson v. Prokopf (In re Smith), 185 B.R. 285, 292-93 (Bankr.S.D.Ill.1995) (a majority of courts that have found limited partnership agreements to be executory contracts “have either accepted the executory contract characterization summarily or have dealt with limited partnership agreements under which the limited partner has continuing financial obligations to the partnership.”).
FN7. See, e.g., In re Garrison-Ashburn, L.C., 253 B.R. 700, 708- 09 (Bankr.E.D.Va.2000) (there is no executory contract and § 365 does not apply to an operating agreement that imposes no duties or responsibilities on its members, but merely provides for the structure of the management of the entity); Smith, supra note 6, at 291-95 (limited partnership agreement was not executory as to a limited partner/debtor who had no material obligations to perform; the Chapter 7 trustee steps into the shoes of the debtor and may exercise debtor’s right to dissolve the partnership).
FN8. Calvin v. Siegal (In re Siegal), 190 B.R. 639, 643 (Bankr.D . Ariz.1996)(Case, J.), citing In re Sunset Developers, 69 B.R. 710, 712 (Bankr.D.Idaho 1987). See also Summit Invest. and Dev. Corp. v. Leroux, 69 F.3d 608 (1st Cir.1995)(§ 365 applies to general partner debtors who have duties and obligations to limited partnership); Broyhill v. DeLuca (In re DeLuca), 194 B.R. 65 (Bankr.E.D.Va.1996)(§ 365 applies to debtors who were managers of limited liability company with ongoing duties and responsibilities; because debtors’ personal identity and participation were material to the development project, the § 365(e)(2) exception to assumption applies); In re Daugherty Constr., Inc., 188 B.R. 607, 612 (Bankr.D.Neb.1995)(operating agreements are executory contracts because there are material unperformed and continuing obligations among the members, including participation in management and contributions of capital).
FN9. As noted above, Fiesta has already redeemed one member’s interest for $124,000. That suggests that it has the power to do so, that redemption of a member’s interest is not contrary to Fiesta’s interests or purposes, and that $124,000 might be an appropriate value for the Debtor’s interest. Because the schedules filed in this case reflect priority and unsecured debts of less than $70,000, such a remedy might entirely satisfy the Trustee while simultaneously avoiding any disruption of the partnership or any conflict with the purposes for which it was created.
FN10. Although § 105(b) provides that “a court may not appoint a receiver in a case under this title,” the precise language of that provision and case law make clear that it applies only to the administrative bankruptcy “case,” not to an adversary proceeding. A “case” is what is commenced by the filing of a petition, e.g., § 301, whereas a “proceeding” is commenced by a summons and complaint, Bankruptcy Rules 7001 & 7004. The provision was added simply because the Code “has ample provision for the appointment of a trustee when needed.” S.Rep. No. 989, 95th Cong.2d Sess. 29 (1978). Consequently § 105(b) “does not prohibit the appointment of a receiver in a related adversary proceeding if otherwise authorized and appropriate.” 2 LAWRENCE P. KING, COLLIER ON BANKRUPTCY ¶ 105.06, at 105-84.7 (15th Ed.2004). Accord, Craig v. McCarty Ranch Trust (In re Cassidy Land and Cattle Co.), 836 F.2d 1130, 1133 (8th Cir.1988); In re Memorial Estates, Inc., 797 F.2d 516, 520 (7th Cir.1986)(“The power cut off by section 105(b) of the Bankruptcy Code is the power to appoint a receiver for the bankrupt estate, that is, a receiver in lieu of a trustee.”).
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Post by Sapphire Capital on Sept 20, 2012 0:41:29 GMT 4
In re: Turner
335 B.R. 140 (Bkrpt. N.D. Cal 2005)
United States Bankruptcy Court, N.D. California.
In re Stephen Brian TURNER, etc., Debtor.
John T. Kendall, Chapter 7 Trustee, Plaintiff,
v.
Susana C. Turner, et al., Defendants.
Ah Beng Yeo and E.A. Martini, Plaintiffs,
v.
Stephen Brian Turner, M.D., etc., Defendant.
Bankruptcy No. 02-44874TK.
Adversary Nos. 02-7273 AT, 02-7298 AT.
Dec. 5, 2005.
Timothy Carl Aires, Aires Law Group, Newport Beach, CA, for Plaintiffs Ah Beng Yeo and E.A. Martini.
Chris Kuhner, Kornfield, Paul & Nyberg, Oakland, CA, for Plaintiff John T. Kendall.
Drew Henwood, Law Offices of Drew Henwood, San Francisco, CA, Herman A.D. Franck, Law Offices of Herman Franck, Sacramento, CA, for Defendant Susana Turner.
MEMORANDUM OF DECISION AFTER TRIAL
LESLIE TCHAIKOVSKY, Bankruptcy Judge.
The two above-captioned adversary proceedings were consolidated for trial. The Court conducted a trial on most of the claims asserted on March 8, 9, and 10, 2005. 1 At the conclusion of the trial, the Court took the claims under submission. It deferred rendering a decision pending receipt of the above-captioned debtor’s (the “Debtor”) tax returns. Pursuant to the Court’s direction, the parties filed closing briefs on or about November 7, 2005. Having considered the evidence and argument presented by the parties, the Court finds and concludes as set forth below.
No. 02-7298 AT for a later trial, if necessary.
SUMMARY OF FACTS
The Debtor graduated from medical school in or about 1980. The Debtor and Susana Turner (“Susana”) were married on February 16, 1981. After five years of post-graduate work, the Debtor began practicing medicine. Some time during the 1980s, a complaint about the Debtor’s professional conduct was lodged with the Medical Board of California, Department of Consumer Affairs. Thereafter, the Debtor was placed on probation and permitted to practice medicine only on certain conditions.
In November 1991, the Debtor and Susana acquired title to and began living in a residence located in Alameda County, California (the “Home”). The deed by which they acquired title was recorded shortly thereafter. In 1994, while the Debtor was still practicing medicine on probation, he was convicted of a misdemeanor based on an incident involving a patient. This second incident ultimately led to a license revocation proceeding and to the Debtor’s surrender of his medical license. Thereafter, the Debtor supported himself and his family by performing paramedical examinations for insurance companies.
In 1994, the Debtor attended a seminar on “asset protection” given by Robert Matthews (“Matthews”). At the conclusion of the seminar, Matthews referred the Debtor to a tax attorney knowledgeable about “asset protection.” The attorney provided the Debtor with a form of document entitled Declaration of Trust (the “GG Trust Declaration”) which the Debtor and Susana signed but did not record. The GG Trust Declaration purported to establish a Bahamian Trust and declared that certain of the Debtor’s and Susana’s assets, including the Home, were held in trust for the Debtor’s and Susana’s three children.
Beginning in the Spring of 1995, the Debtor engaged in conduct with respect to the plaintiffs Ah Beng Yeo and E.A. Martini (the “Plaintiffs”) that was ultimately found by a jury to be tortious. At about the same time, the Debtor met with Matthews in Ventura to discuss the subject of “asset protection.” The Debtor showed Matthews a transmutation agreement, purporting to change the character of the Home to Susana’s separate property (the “Transmutation Agreement”) and the GG Trust Declaration as evidence of what efforts he had made previously to “protect” his assets. Matthews advised the Debtor about some of the disadvantages of holding real property in an offshore trust. They discussed the use of limited liability companies to “protect” assets.
In September 1997, the Plaintiffs filed a lawsuit (the “Tort Action”) against the Debtor and in August 1998 obtained a money judgment (the “Judgment”). At about the same time, at the Debtor’s direction, Matthews created a Nevada limited liability company named Real Investment Capital Holdings LLC (“RICH LLC”) and a Nevada corporation named Proset Enterprises, Inc. (“Proset”).2 In publicly filed documents, the GG Trust was identified as the 99 percent owner and Proset was identified as the 1 percent owner of RICH LLC. Alfred Cheung, Susana’s brother, a resident of Hong Kong, was identified as Proset’s President and Secretary.
In March 1998, after the Civil Action was filed but before the Judgment was entered, Susana and the Debtor executed a grant deed (the “1998 Deed”), transferring title to the Home to RICH LLC. The 1998 Deed was recorded in April 1998. On March 16, 1999, approximately seven months after the Judgment was entered, the Debtor, acting on behalf of RICH LLP, executed a deed of trust in favor of Proset (the “Proset Deed of Trust”), encumbering the Home to secure a line of credit. The Proset Deed of Trust was recorded on March 18, 1999.3 The Debtor is identified in the Proset Deed of Trust as the managing partner of RICH LLC.
In October 1999, the Plaintiffs filed a fraudulent transfer action against the Debtor and Susana.4 On May 31, 2001, the Plaintiffs obtained a writ of execution and attempted to execute the writ against the Home. In June 2001, the Debtor prepared a dissolution petition for Susana in which she sought to dissolve her marriage to the Debtor. In the petition, the Debtor and Susana stipulated that the Home (which had previously been transferred to RICH LLC) should be “confirmed” as Susana’s separate property. A dissolution judgment (the “Dissolution Judgment”) was entered in September 2001. Notwithstanding their divorce, the Debtor and Susana both continue to live in the Home and file joint tax returns, identifying themselves as married.
On December 27, 2001, RICH LLC executed a deed, transferring title to the Home to Susana (the “2001 Deed”).5 The 2001 Deed was recorded the same day.6 On September 10, 2002, less than one year after the recordation of the 2001 Deed, the Debtor filed a petition seeking relief under chapter 7 of the Bankruptcy Code, thereby commencing this case.
DISCUSSION
As noted above, the trial addressed claims asserted in two adversary proceedings: (1) A.P. No. 02-7273 AT (the “Fraudulent Transfer Action”) and (2) A.P. No. 02-7298 AT (the “Objection to Discharge Action”). The Fraudulent Transfer Action was filed by the Plaintiffs in state court in October 1999. It was removed to this court when the Debtor filed his chapter 7 bankruptcy petition in September 2002. Pursuant to Rule 6009 of the Federal Rules of Bankruptcy Procedure, the Trustee took over the prosecution of this action. The Plaintiffs filed the Objection to Discharge Action in the bankruptcy court after the Debtor filed his chapter 7 bankruptcy petition. They remain the plaintiffs in that action. The Court will address each action in turn.
A. FRAUDULENT TRANSFER ACTION
The Fraudulent Transfer Action asserts four claims for relief. The first two claims seek to avoid the various pre-petition transfers of the Home by the Debtor as actually and constructively fraudulent pursuant to bankruptcy and state law. Section 548 of the Bankruptcy Code permits a trustee to avoid a transfer of an interest of the debtor in property that is actually or constructively fraudulent provided it was made within one year of the bankruptcy filing. See 11 U.S.C. § 548.
Section 544(b) of the Bankruptcy Code permits a trustee to avoid a transfer that would have been avoidable by an unsecured creditor under applicable state law provided that there is such a creditor with a claim against the bankruptcy estate. See 11 U.S.C. § 544(b). Section 3439 et seq. of the California Civil Code permits a creditor to avoid the transfer of an “asset” of the debtor that is actually or constructively fraudulent that is made within four years prior to the date the avoidance action is filed. See Cal. Civ.Code §§ 3439.07, 3439.09. “Asset” is defined to include only the unencumbered, nonexempt value of the property transferred. See Cal. Civ.Code § 3439.01(a).
Both bankruptcy law and California law define an actually fraudulent transfer as one made with “actual intent to hinder, delay, or defraud a creditor.” See 11 U.S.C. § 548(a)(1)(A); Cal. Civ.Code § 3439.04(a)(1). Both bankruptcy law and California law define a transfer that is constructively fraudulent, in essence, as one for which the debtor does not received reasonably equivalent value and which is made when the debtor is insolvent or which renders the debtor insolvent. See 11 U.S.C. § 548(b); Cal. Civ.Code § 3439.05. In sum, despite their similarities, the right to avoid a fraudulent transfer under the Bankruptcy Code differs from the right to avoid a fraudulent transfer under California law in two significant respects.
First, the “reach back” period under the Bankruptcy Code is only one year. The “reach back” period under California law is four years or, in the case of “actual fraud,” if later, one year after the transfer could reasonably have been discovered. See Cal. Civ.Code § 3439.09(a). Second, under the Bankruptcy Code, the entire transfer is avoided. Under California law, only the transfer of the “asset” is avoided.
In the first claim for relief, the Trustee seeks to avoid all of the transfers referred to above as actually fraudulent under both 11 U.S.C. § 548 and Cal. Civ.Code § 3439 et seq. In the second claim for relief, the Trustee seeks to avoid all of the transfers referred to above as constructively fraudulent under both 11 U.S.C. § 548 and Cal. Civ.Code § 3439 et seq. In the third claim for relief, the Trustee seeks a determination that, despite the numerous transfers, the Debtor retained his equitable interest in the Home at the time he filed his bankruptcy petition. Thus, he seeks a determination that the Home is property of the Debtor’s bankruptcy estate. In the fourth claim for relief, he seeks turnover of the Home.
The evidence presented at trial persuaded the Court that all of the transfers in question were made with actual intent to hinder, delay, or defraud creditors. Actual intent must generally be established by reference to external circumstances. California fraudulent transfer law has codified some of the types of circumstances commonly found to indicate actual intent to defraud. Several of these “badges of fraud” are present here.7 The Court was also persuaded that the Debtor received no consideration for any of the transfers and that they rendered the Debtor insolvent.
The Court did not believe the Debtor’s and Susana’s testimony that the transfer reflected by the Transmutation Agreement was made to restore marital harmony and to give Susana a sense of financial security. It was obvious to the Court that the Debtor exerted complete control over the disposition of the Home both before and after the execution of the Transmutation Agreement. However, the transfer reflected by the Transmutation Agreement is irrelevant because, as noted above, in 1998, Susana transferred her separate property interest in the Home to RICH LLC pursuant to the 1998 Deed. The Debtor obviously considered the GG Trust Declaration as not having effected a transfer because he did not bother to have any document executed by the trustee of the GG Trust, transferring title back to the Debtor and Susana (or to Susana alone) before he and Susana executed the 1998 Deed.
During the pre-trial motion stage of the proceeding, the Court viewed the 1998 Deed as the critical transfer for fraudulent transfer purposes. Because this transfer occurred more than one year before the filing of the Debtor’s bankruptcy petition, the Court assumed that the Trustee’s remedies were limited to avoidance of the “asset” transferred pursuant to the 1998 Deed. As a result, at the Court’s direction, Susana and the Trustee each called appraisers as expert witnesses to testify as to the unencumbered, nonexempt value of the Home at the time of the 1998 transfer.
Susana’s appraiser testified that the Home had no “asset” value at that time. The Trustee’s appraiser testified that the Home had approximately $7,700 in unencumbered, nonexempt value. Although both appraisers were competent and credible, the Court found the Trustee’s appraiser methodology more reasonable. Thus, if the Trustee were forced to rely on California fraudulent transfer avoidance law, the Court would grant the Trustee a judgment avoiding the transfer of the Home to the extent of $7,700. However, based on the testimony at trial and further analysis of the series of transfers persuades the Court that the critical transfer is reflected by the 2001 Deed.
The evidence presented persuaded the Court that RICH LLC and Proset were the Debtor’s alter egos. The Debtor admitted that these entities were created and their relationship structured to maximize the protection of his assets: i.e., the Home. “Asset protection” is not illegal and is honored by the law if done for a legitimate purpose. For example, an individual may do business through a corporation or limited liability company and will not be held personally liable for the debts of the entity. The assets of the corporation or limited liability company will not be considered the assets of the individual interest holder. However, an entity or series of entities may not be created with no business purpose and personal assets transferred to them with no relationship to any business purpose, simply as a means of shielding them from creditors.
Under such circumstances, the law views the entity as the alter ego of the individual debtor and will disregard it to prevent injustice. Under similar facts, a trial court found that the corporation created by a judgment debtor to hold his assets was the judgment debtor’s alter ego. This finding was noted with approval by the Ninth Circuit Court of Appeals. See Fleet Credit Corp. v. TML Bus Sales, Inc., 65 F.3d 119, 120 (9th Cir.1995). In Fleet, the trial court found that Berthold, the judgment debtor, had operated a corporation: …as an extension of himself. He personally directed the transfer…and did so for reasons that had nothing whatsoever to do with the operation of the corporate entity…. t is beyond cavil that an inequitable result would follow were the Court to permit Berthold to shield himself with Taylor’s corporate form. Id. at 120.
Moreover, in Fleet, as here, Berthold caused his alter ego corporation to make a further fraudulent transfer.
The Court of Appeals noted that: “for Berthold’s creditors to get… [Berthold's assets], they had to penetrate two layers of fraud, the alter ego corporation, and the fraudulent conveyance.” Id. at 121. Thus, the fraudulent transfer by the alter ego corporation could be treated as a fraudulent transfer by Berthold. Id. at 121-22.
Thus, the only relevant transfer to be avoided is the transfer reflected by the 2001 Deed: i.e., by the Debtor (through his alter ego, RICH LLC) to Susana. The Court has received no evidence of the value of the “asset” transferred pursuant to the 2001 Deed. However, because this transfer occurred within one year of the bankruptcy filing, there is no need to reopen the evidence for this purpose. The Trustee is entitled to avoid the transfer in its entirety under 11 U.S.C. § 548(a).
The avoidance of this transfer causes the interest in the Home to revert to RICH LLC which, as discussed above, the Court views as the Debtor’s alter ego. Because the Debtor and Susana were divorced before the bankruptcy was filed, the avoidance of the transfer reflected by the 2001 Deed causes the entire interest in the Home to reverts to the Debtor as his separate property. Thus, the Home is property of the Debtor’s bankruptcy estate in its entirety. As a result, the Trustee is also entitled to a judgment on his fourth claim for relief: i.e., for turnover of the Home pursuant to 11 U.S.C. § 542.
B. DENIAL OF DISCHARGE CLAIM
The Denial of Discharge Action seeks denial of the Debtor’s discharge under 11 U.S.C. § 727(a)(2), (4), and (5). Section 727(a)(2) of the Bankruptcy Code provides, in pertinent part, that an individual chapter 7 debtor may not obtain a discharge if “the debtor, with intent to hinder, delay, or defraud a creditor…has transferred… or concealed… (A) property of the debtor, within one year before the date of the filing of the petition; or (B) property of the estate, after the date of the filing of the petition.” The transfer of the Home by RICH LLC to Susana pursuant to the 2001 Deed occurred within one year of the bankruptcy filing. As discussed above, the Court finds and concludes that RICH LLC was the Debtor’s alter ego and that the transfer reflected by the 2001 Deed was made with actual intent to hinder, delay, or defraud the Plaintiffs.
Thus, the Debtor’s discharge should be denied based on 11 U.S.C. § 727(a)(2).
The Debtor’s discharge should also be denied under 11 U.S.C. § 727(a)(4). Section 727(a)(4) provides, in pertinent part, that an individual chapter 7 debtor may not obtain a discharge if “the debtor knowingly and fraudulently, in or in connection with the case(A) made a false oath or account….” The Court concludes that the Debtor knowingly and fraudulently made several false oaths on the Debtor’s Schedules of Assets and Liabilities (the “Debtor’s Schedules”) and Statement of Financial Affairs (the “SOFA”). Both documents were signed by the Debtor under penalty of perjury.
First, the Court views as a knowing and false oath the Debtor’s omission of any reference to his interest in the Home. Schedule A of the Debtor’s Schedule of Assets and Liabilities (the “Debtor’s Schedules”) asked the Debtor to list any interest in real property and to describe the nature of the interest. The Court was persuaded that, notwithstanding the numerous paper transfers of his interest in the Home, at the time he filed his bankruptcy petition, the Debtor retained an equitable interest in the Home. He failed to list that interest on Schedule A.
In addition, item 10 on the Debtor’s SOFA directed him to list any transfers of property other than in the ordinary course of business within one year prior to the bankruptcy filing. As discussed above, the Court views the 2001 Deed as a transfer by the Debtor. The Debtor failed to list this transfer and marked the box indicating that there were no such transfers. The Court views this omission and mark as a knowing and fraudulent false oath.
Second, Schedule B of the Debtor’s Schedules, item 12, asked the Debtor to list any interests in incorporated or unincorporated businesses. As discussed above, the Court was persuaded that the Debtor was the equitable owner of RICH LLC and Proset at the time he filed his bankruptcy petition. The Debtor failed to list these interests and instead checked the space in the column indicating that he had no interest in any incorporated or unincorporated business. The Court also views this omission and mark as a knowing and fraudulent false oath.
Third, Schedule I and J required the debtor to list his income and expenses at the time the bankruptcy petition is filed. On Schedule I, the Debtor identified himself as divorced. He listed a monthly income of $5,000 and, on Schedule J, listed expenses of $5,106, the largest item being an alimony payment of $4,657. This was inconsistent with the Debtor’s sworn statements in his tax returns for that year in two respects. As noted above, in their tax returns, filed jointly notwithstanding their prior divorce, the Debtor and Susana identified themselves as married. Not surprisingly, they also listed no alimony payment.
Although the Court believes that the Debtor’s and Susana’s divorce was effected for fraudulent purposes, they are nonetheless divorced. Thus, the Debtor’s false statement under oath concerning his marital status is the one made on his tax returns, not the one made on Schedule I. However, based on the evidence presented, the Court finds and concludes that the Debtor’s statement on Schedule J that his monthly expenses included an alimony payment of $4,675 was a knowing and fraudulent false statement. Susana testified credibly that the Debtor did not pay her alimony of $4,675 a month. Instead, he simply gave her money when she asked for it. The Court is persuaded that this false statement, standing alone, warrants denial of the Debtor’s discharge.
Finally, 11 U.S.C. § 727(a)(5) of the Bankruptcy Code provides, in pertinent part, that an individual chapter 7 debtor may not obtain a discharge if “the debtor has failed to explain satisfactorily, before determination of denial of discharge…any loss of assets or deficiency of assets to meet the debtor’s liabilities….” The Plaintiffs failed to present sufficient evidence to meet their burden of establishing a claim for denial of the Debtor’s discharge under this subsection.
CONCLUSION
With respect to the Fraudulent Transfer Action:
1. With respect to the First Claim for Relief, the Trustee is entitled to a judgment declaring that RICH LLC and Proset were alter egos of the Debtor and avoiding the transfer of the Home to Susana pursuant to the 1998 Deed as an actually fraudulent transfer under 11 U.S.C. § 548(a)(1)(A).
2. Alternatively, with respect to the Second Claim for Relief, the Trustee is entitled to a judgment avoiding the Home to Susana pursuant to the 1998 Deed as a constructively fraudulent transfer under 11 U.S.C. § 548(a)(1)(B).
3. With respect to the Third Claim for Relief, the Trustee is entitled to a judgment declaring that, at the time he filed his bankruptcy petition, the Debtor retained his equitable interest in the Home.
4. With respect to the Fourth Claim for Relief, the Trustee is entitled to a judgment ordering turnover of the Home to the Trustee.
With respect to the Denial of Discharge Action:
1. The Plaintiffs are entitled to a judgment denying the Debtor’s discharge pursuant to 11 U.S.C. § 727(a)(2) and (4). Their claim for denial of the Debtor’s discharge pursuant to 11 U.S.C. § 727(a)(5) will be dismissed with prejudice.
2. The second claim for relief, seeking to except the Plaintiffs’ Judgment from the Debtor’s discharge, is dismissed as moot.
Counsel for the Trustee is directed to submit a proposed form of judgment in accordance with this decision.
FN1. The Court severed the dischargeability claim asserted in A.P.
FN2. The Debtor and Matthews continue to maintain a business relationship. Matthews owns a company with an office in Las Vegas that serves as the resident agent for the RICH LLC and Proset, as well as for numerous other companies. In addition, for a small annual payment, the Debtor serves as the “nominee” president for at least six limited liability companies formed by Matthews for other clients who do not wish their names to be listed in a public filing. The public filing does not reveal that the Debtor is not a bona fide officer of the companies.
FN3. The Debtor testified at trial that there was never any draw on the line of credit. As a result, the Proset Deed of Trust did not secure any debt. Moreover, there was no credible testimony at trial that Proset ever had the ability to answer a draw. No credible evidence was provided that either Proset or the GG Trust, Proset’s interest holder, had any assets other than their interest the Home. The Debtor testified vaguely that the GG Trust had held investments which generated income. The Court did not believe him.
FN4. After the Debtor filed his bankruptcy petition, this action was removed to the bankruptcy court and was designated A.P. No. 02-7273 AT. Thus, it is one of the two above-captioned adversary proceedings. As fraudulent transfer actions belong to the bankruptcy estate, the Trustee has assumed the prosecution of this proceeding in place of the Plaintiffs. See Fed. R. Bankr. Proc. 6009.
FN5. The Court has not been provided with a copy of the 2001 Deed. However, the Court assumes that the Debtor signed the 2001 Deed on behalf of RICH LLC.
FN6. The Dissolution Judgment had no legal effect on Susana’s interest in the Home. Prior to the entry of the Dissolution Judgment, Susana had transferred her separate property interest in the Home, acquired pursuant to the Transmutation Agreement, to RICH LLC.
FN7. For example, all of the transfers were to insiders; the Debtor retained possession and control of the Home after the all of the transfers; the Debtor had been sued before most of the transfers; no consideration was received for the transfers; and the Debtor was rendered insolvent by the transfers. See Cal. Civ.Code § 3439.04(b).
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Post by Sapphire Capital on Sept 20, 2012 0:42:42 GMT 4
Koh v. Inno-Pacific Holdings, Ltd.
54 P.3d 1270 (Wash.App.Div.1 10/07/2002)
Synopsis
Inno-Pacific Holdings, Ltd. is a Singapore public corporation with its principal place of business in Singapore. Inno- Pacific employed Kay Yew Koh to conduct business activities on its behalf in California. Koh sued Inno- Pacific for wrongful termination in California, and prevailed. In post-judgment discovery, Koh learned that Inno-Pacific owned a 50 percent interest in Sawyer Falls, a limited liability company, registered under the laws of the state of Washington as a domestic limited liability company. Sawyer Falls has an agent in Washington and owns 478 acres of undeveloped real property in Washington. However, Sawyer Falls registered as its principal place of business an address in Malaysia and represents that its main office, officers, employees, books, and records are located in Malaysia.
Koh obtained a charging order against Inno’s interest in Sawyer Falls. Inno moved to quash the charging order stating that the court lacked personal jurisdiction. The court held that Washington’s Limited Liability Company Act clearly allows him to reach Inno-Pacific’s interest in Sawyer Falls through a validly entered foreign judgment and charging order entered in Washington by a court of competent jurisdiction. A charging order entered here against the property interest is permissible.
Opinion
Koh v. Inno-Pacific Holdings, Ltd., 54 P.3d 1270 (Wash.App.Div.1 10/07/2002)
Washington Court of Appeals
No. 47991-1-I
114 Wash.App. 268, 54 P.3d 1270, 2002.WA.0001445
October 07, 2002
KAY YEW KOH, APPELLANT, v. INNO-PACIFIC HOLDINGS, LTD., RESPONDENT.
Appeal from Superior Court of King County Docket No: 002223285 Judgment or order under review Date filed: 12/18/2000 Judge signing: Hon. Robert Alsdorf
* * *
The opinion of the court was delivered by: Grosse, J.
Concurring: William W. Baker, Walter E. Webster
PUBLISHED OPINION
Normally, personal property is found, for purposes of levy or attachment, where it is physically located or where the owner resides. The interest of a member in a limited liability company is personal property. Therefore, once it has been determined by a court of competent jurisdiction that a defendant is a debtor of the plaintiff, an action to realize on that debt in Washington, where the defendant has a property interest in a limited liability company, is proper whether or not Washington would have had jurisdiction to determine the existence of the debt as an original matter.
FACTS
Inno-Pacific Holdings, Ltd. (Inno-Pacific) is a Singapore public corporation with its principal place of business in Singapore. Inno- Pacific employed Kay Yew Koh (Koh) to conduct business activities on its behalf in California. Koh sued Inno- Pacific for wrongful termination in California, and prevailed receiving a money judgment against Inno-Pacific in the amount of $240,000 (Singapore dollars). Inno-Pacific had appeared through counsel to defend itself against Koh’s claim.
In post-judgment discovery, Koh learned that Inno-Pacific owned a 50 percent interest in Sawyer Falls, a limited liability company, registered under the laws of the state of Washington as a domestic limited liability company. Sawyer Falls has an agent in Washington and owns 478 acres of undeveloped real property in Washington as a long-term development project.
However, Sawyer Falls registered as its principal place of business an address in Malaysia and represents that its main office, officers, employees, books, and records are located in Malaysia.
Two years after the California judgment, Koh obtained a charging order in King County Superior Court against Inno-Pacific’s interest in Sawyer Falls. Inno-Pacific filed a motion to quash the charging order based on lack of personal jurisdiction and lack of in rem jurisdiction, but did not contest the validity of the California judgment. The trial court quashed Koh’s charging order holding that the ‘Court lacks jurisdiction over Defendant’s membership interest in Sawyer Falls because the membership interest as personal property is located outside the state of Washington.’ Koh appeals.
DISCUSSION
Preliminary to the issue of jurisdiction is the location of Inno- Pacific’s interest in Sawyer Falls. Clearly, Inno-Pacific’s interest in Sawyer Falls is personal property to Inno-Pacific.*fn1 Inno-Pacific argues that an entity’s interest in a limited liability company exists where the entity resides, in this case in Singapore. Thus, Inno-Pacific concludes that Washington courts have no jurisdiction over its personal property interest in Sawyer Fal ls. Koh counters that an entity’s interest in a limited liability company is located where that company is formed.
Koh’s position is the more accurate. The touchstone of Inno-Pacific’s argument regarding jurisdiction is In re Estate of Grady.*fn2 That case does stand for the proposition that personal property is located where the owner is domiciled. Unquestionably, that is true for purposes of taxation.
However, that proposition does not preclude jurisdiction over personal property where it is found.*fn3 Certainly the language of the statute appears to reflect that a partnership interest is located where the partnership is formally organized:
On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the limited liability company 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 the limited liability company interest. This chapter does not deprive any member of the benefit of any exemption laws applicable to the member’s limited liability company interest.*fn4
Washington’s Limited Liability Company Act is modeled substantially upon the Uniform Limited Liability Company Act, which was in turn based upon the Uniform Partnership Act and the Revised Uniform Partnership Act, adopted in full or in part by various states.*fn5 Therefore, although the comments to the Uniform Limited Liability Company Act, the Uniform Partnership Act, and the Revised Uniform Partnership Act do not directly discuss this issue, we can look to the few cases that do address the location of a partnership interest under one of these uniform acts.
In Rankin v. Culver, 16 years after Pennsylvania’s enactment of its version of the Uniform Partnership Act, the Supreme Court of Pennsylvania analyzed whether a creditor could attach the partnership interest of a nonresident debtor when the partnership was organized and doing business in Pennsylvania.*fn6 The Rankin court found that an interest of a partner in firm assets is personalty and subject to foreign attachment. Further, the court held that a partnership doing business in Pennsylvania constituted a property interest in Pennsylvania to those who owned an interest in the partnership, thus a writ of foreign attachment on the partnership interest was valid.*fn7
In Federal Deposit Insurance Corporation v. Birchwood Builders, Inc., a plaintiff received a judgment in New York and learned that the debtor, a New York resident, owned 40 percent of a partnership organized in New Jersey under that state’s version of the Uniform Partnership Act.*fn8 The partnership owned a tract of vacant land in New Jersey, although it earned no income. The plaintiff attempted to attach the partnership interest through a charging order in New Jersey. Although the New Jersey court did not discuss in detail the location of the partnership interest, it determined that even though the owner of the partnership interest resided in New York, the partnership was incorporated in New Jersey and thus the interest was subject to attachment in New Jersey.*fn9
These cases illustrate at the least that where a partnership organizes under the laws of a state, the partnership interest is located within that state. Here, Sawyer Falls is registered under the laws of the State of Washington, maintains an office and registered agent in Washington, and owns a parcel of property in Washington. Therefore, the partnership interest is located here.
Koh correctly asserts that Washington’s Limited Liability Company Act clearly allows him to reach Inno-Pacific’s interest in Sawyer Falls through a validly entered foreign judgment and charging order entered in Washington by a court of competent jurisdiction.*fn10 Nevertheless, Inno-Pacific argues, or appears to argue, that this apparent jurisdiction and authority should not be exercised because it offends the Constitution, citing Shaffer v. Heitner*fn11 and Hanson v. Denckla.*fn12 But, a careful look at those cases convinces us that jurisdiction does lie.
At first glance, the action here does appear to be the type of quasi in rem action described in the case of Hanson v. Denckla, a proceeding where the plaintiff seeks to apply property unrelated to the claim to the satisfaction of a judgment or claim against the defendant.*fn13 Clearly, Koh is attempting to apply the property of Inno-Pacific to a debt unrelated to that property. This type of quasi in rem jurisdiction was addressed in Washington in Ace Novelty Company v. M.W. Kasch Company and later addressed by the United States Supreme Court in Shaffer v. Heitner.*fn14
Ace Novelty involved a plaintiff that attempted to sue in Washington a Wisconsin company for a debt by attaching unrelated assets that the company allegedly owned in Washington. Shaffer involved a nonresident shareholder of a Delaware corporation who filed a motion in Delaware to attach the corporate stock of nonresident officers and directors to force them to appear for purposes of a different shareholder’s derivative suit. Both Ace Novelty and Shaffer held that this type of proceeding requires the same minimum contacts discussed in International Shoe Company v. State of Washington.*fn15 However, neither of the plaintiffs in those cases ha d obtained a valid foreign judgment, as Koh did here. This action is different. It involves action on a valid foreign judgment to obtain a charging order against the property of a judgment debtor. Here, it is registration of the foreign judgment in conjunction with the presence of the property that satisfies due process.
As the court in Shaffer notes, once a court of competent jurisdiction has determined that a defendant is a debtor of the plaintiff under the Full Faith and Credit Clause ‘there would seem to be no unfairness in allowing an action to realize on that debt in a State where the defendant has property, whether or not that State would have jurisdiction to determine the existence of the debt as an original matter.’*fn16 Therefore, because we have determined that the property exists in Washington and that Koh has a valid foreign judgment, our decision is simple. The Full Faith and Credit Clause and Washington’s Foreign Judgments Act allow Koh to register his California judgment and obtain a charging order against Inno-Pacific’s interest in Sawyer Falls.*fn17 There is no unfairness in allowing an action in this jurisdiction to realize on a valid California judgment. Indeed, such a result is required in order to give full faith and credit to the California judgment. The property is here. A charging order entered here against the property interest is permissible.
Reversed. Opinion Footnotes
*fn1 RCW 25.15.245(1).
*fn2 In re Estate of Grady, 79 Wn.2d 41, 483 P.2d 114 (1971).
*fn3 Hanson v. Denckla, 357 U.S. 235, 247, 78 S. Ct. 1228, 2 L. Ed. 2d 1283 (1958) (citing State Tax Comm’n of Utah v. Aldrich, 316 U.S. 174, 62 S. Ct. 1008, 86 L. Ed. 1358 (1942); Curry v. McCanless, 307 U.S. 357, 59 S. Ct. 900, 83 L. Ed. 1339 (1939)).
*fn4 RCW 25.15.255.
*fn5 6A Nat’l Conference on Comm’rs on Uniform State Laws, Business and Nonprofit Organizations and Associations Laws at 235, 401 (West 1995) (sec. 703 of 1976 Revised Uniform Limited Partnership Act; sec. 22 of 1916 Uniform Limited Partnership Act); see, e.g., The Charging Order Under the Uniform Partnership Act, 28 Wash. L. Rev, 1, 18 (Gose) 1953; Sherwood v. Jackson, 121 Cal. App. 354, 357, 8 P.2d 943 (1932); see, e.g., Ala. Code sec. 10-12-35 (1975); Conn. Gen. Stat. Ann. sec.. 34-30 (1961); Del. Code Ann. sec. 18-703 (2000); Haw. Rev. Stat. Ann. sec. 428-504 (1996); Ill. Comp. Stat. Ann. sec. 180/30-20 (1994); La. Code Ann. sec. 486A.504 (West 1998) (noting that the section is similar to sec. 504 of Uniform Partnership Act (1997)); Mont. Code Ann. sec. 35-8-705 (1993); N.J. Stat. Ann. sec. 42:1A-30 (2000) (modeled after sec. 504 of Uniform Partnership Act (1997)); Or. Rev. St. Ann. sec. 63.259 (1993); Pa. Cons. Stat. Ann. sec. 8345 (West 1988); S.C. Code Ann. sec. 33-44-504 (Law. Co-op. 1976); S.D. Codified Laws Ann. sec. 47-34A-504 (Michie 1998); Utah Code Ann. sec. 48-2c-1103 (1953); Vt. Stat. Ann. tit. 11, sec. 3074 (1995); Va. Code Ann. sec. 13.1-1041 (Michie 1991); see, e.g., former RCW 25.04.280 (1955), repealed by Laws of 1998, ch. 103, sec. 1308 (effective January 1, 1999).
*fn6 Rankin v. Culver, 303 Pa. 401, 154 A. 701 (1931).
*fn7 Rankin, 303 Pa. at 404.
*fn8 Fed. Deposit Ins. Corp. v. Birchwood Builders, Inc., 240 N.J. Super. 260, 263, 573 A.2d 182 (1990); N.J. Stat. Ann. sec. 42:1-24 (West 1990).
*fn9 Birchwood Builders, Inc., 240 N.J. Super. at 266.
*fn10 RCW 6.40.050; RCW 25.15.255.
*fn11 Shaffer v. Heitner, 433 U.S. 186, 97 S. Ct. 2569, 53 L. Ed. 2d 683 (1977).
*fn12 Hanson v. Denckla, 357 U.S. 235.
*fn13 See Hanson, 357 U.S. at 246 n.12.
*fn14 Ace Novelty Co. v. M.W. Kasch Co., 82 Wn.2d 145, 508 P.2d 1365 (1973); Shaffer, 433 U.S. 186.
*fn15 Int’l Shoe Co. v. Wash., 326 U.S. 310, 316, 66 S. Ct. 154, 90 L. Ed. 95 (1945); Ace Novelty Co., 82 Wn.2d at 150; Shaffer, 433 U.S. at 187-88.
*fn16 Shaffer, 433 U.S. at 210 n.36 (emphasis added).
*fn17 U.S. Const. art. IV, sec. 1; 28 U.S.C.A. sec. 1738; RCW 6.40.050. Other jurisdictions have come to similar conclusions using the reasoning and language of Shaffer. Ruiz v. Lloses, 233 N.J. Super. 608, 559 A.2d 866 (1989); Fine v. Spierer, 486 N.Y.S.2d 9, 109 A.D.2d 611 (1985)
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Post by Sapphire Capital on Sept 20, 2012 0:43:44 GMT 4
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
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Post by Sapphire Capital on Sept 20, 2012 0:45:28 GMT 4
Ruby Mountain Trust v Montana
No. 99-532
IN THE SUPREME COURT OF THE STATE OF MONTANA
2000 MT 166
RUBY MOUNTAIN TRUST, and
VIRGIL and LOUISE BATES,
Petitioners and Appellants,
v.
THE DEPARTMENT OF REVENUE
OF THE STATE OF MONTANA, and
THE STATE TAX APPEAL BOARD
OF THE STATE OF MONTANA,
Respondents and Respondents.
APPEAL FROM: District Court of the First Judicial District,
In and for the County of Lewis and Clark,
The Honorable Thomas C. Honzel, Judge presiding.
COUNSEL OF RECORD:
For Appellants:
Dana C. Christian, Livingston, Montana
For Respondents:
Roberta Cross Guns, Tax Counsel, Helena, Montana
Submitted on Briefs: January 13, 2000
Decided: June 22, 2000
Filed:
Clerk Justice William E. Hunt, Sr. delivered the Opinion of the Court.
In this appeal by Virgil and Louise Bates (the Bates) and the Ruby Mountain Trust (the Trust), we are asked to decide whether the District Court of the First Judicial District, Lewis and Clark County, correctly affirmed the decision of the State Tax Appeal Board (STAB) finding that the Trust did not qualify for treatment as a trust for tax purposes. We affirm.
FACTUAL AND PROCEDURAL BACKGROUND
The facts of this case are not in dispute. The Bates owned a 500-plus-acre family farm in Manhattan, Montana, that they transferred along with various buildings, livestock, and personal property to the Trust upon its creation on December 29, 1992. The Trust was created and structured according to a trust establishment “kit” that the Bates had previously purchased for $2,400 after attending a “financial planning” seminar in Billings.
Upon transfer of the Bates’ property, the Trust issued 100 certificates of beneficial interest to the Bates and their three children. The Bates received a two percent interest in the Trust, while the remaining ninety-eight percent interest was given to their children. The named “beneficiaries” of the Trust are the Bates’ children. The trustees are Gary and Joyce Thompson, neighbors of the Bates, and Val Bentley, who resides outside of Montana. The Bates themselves are characterized as “co-managers” of the Trust.
Though the Trust is captioned “irrevocable,” the trustees may terminate the Trust at any time provided that all of the holders of the units of beneficial interest agree. The Trust contains no distribution clause, however. Virgil testified that the certificates of beneficial interest proportionally represent, for purposes of distribution “[w]hatever the property’s worth.” If the Trust were terminated, the corpus presumably would be distributed on a pro-rata basis according to the certificates of beneficial interest issued to the Bates and their children.
Following its creation, the Trust hired Virgil in the position of “caretaker.” Under the terms of the caretaker’s agreement, the Trust pays him $20 an hour for his farming and management services. Additionally, the Bates are authorized as co-managers of the Trust to write checks against the Trust’s account up to $5,000 (excepting general trust operating expenses) without prior approval of the trustees. The Bates have also entered into a lease and rental agreement with the Trust, under which they lease farming equipment to the Trust and pay rent for continuing to reside in the farmhouse on the property. Further, the Trust has been paying the Bates’ debt obligations with respect to the farm.
Much of the Bates’ farm property that was transferred into the Trust was surveyed and subdivided into twenty-two plots of twenty-one acres each, leaving about sixty acres of undeveloped farmland. The Bates hired an independent appraiser to value the property, who calculated that with the addition of various improvements making the lots suitable for residential sale, the land transferred to the Trust had a fair market value of $1,420,000. The improved and developed lots were prepared for sale, advertised for sale, and ultimately sold by the Bates. The sales of these subdivided and developed parcels have generated income in excess of $1 million for the Trust.
The Bates did not pay a gift tax when they put the farm in trust. They claimed that since the transfer was in exchange for units of beneficial interest, it was not a gift. Nor did the Bates pay any self-employment taxes. Furthermore, when the Bates transferred the land into the Trust, they adopted the fair market value of the subdivided land as its basis. Of the total proceeds the Trust received for sale of the developed parcels, the Bates claimed that only $5,000 per beneficiary had been distributed while the remainder of the proceeds had been reinvested in the corpus of the Trust by means of improvements thereto. The Bates thus asserted that income from the sales of the lots was not taxable until such time as the proceeds were actually paid over to the beneficiaries.
In 1996, in conjunction with a nationwide investigation by the Internal Revenue Service (IRS) to identify legally questionable trust arrangements, the DOR undertook an audit of the Trust. Two primary income-generating activities were determined by the DOR to fall within the Trust: (1) farming and (2) the subdivision/selling of land. Specifically, the DOR identified a number of concerns in connection with the land-development activities of the Trust, including, among others, the issuance of certificates of beneficial interest to the Bates in exchange for the land, the degree of control retained by the Bates over the corpus of the Trust, and the Bates’ transfer of the property into the Trust at a “stepped-up” basis (i.e., the Bates’ fair market value appraisal conducted after the subdivision improvements).
In particular, the DOR took issue with the Bates’ claim of fair market value basis, asserting that the Bates were attempting to impermissibly avoid capital gains and other taxes by valuing the land transferred to the Trust at a stepped-up basis when it should have been valued at the Bates’ carry-over “book value” (i.e., the historical cost of the farmland to the Bates prior to the value-added subdivision improvements). Ultimately, the DOR issued an audit assessment to the Bates regarding the Trust for the tax years 1993 and 1994, disallowing the Trust for tax purposes and imputing any “business income” and expenses derived from the Trust to the Bates’ individual tax returns.
The Bates and the Trust appealed the DOR’s assessment in a timely manner. In April of 1997, a hearing was held before a DOR Administrative Hearing Examiner. The Bates argued that the Trust was not void for Montana tax purposes, and that the Bates should not be held personally liable for capital gains or other taxes on the income generated by the sale of the subdivision lots. The hearing examiner issued his decision on June 11, 1997, finding the Trust and the property transfer to the Trust void, and holding the Bates liable as individuals for the income and expenses associated with the sale of the developed parcels.
The Bates and the Trust then filed an objection to the hearing examiner’s decision, and the DOR’s Director reviewed the matter on briefs. A Final Agency Decision was issued on April 20, 1998, affirming the hearing examiner’s findings of fact, conclusions of law, and order. The Bates and the Trust timely appealed to STAB. Another hearing was held, and STAB issued its decision on November 19, 1998, again voiding the Trust for tax purposes and making the Bates individually liable for taxes on the income generated from the sale of their land. Subsequently, the Bates and the Trust separately filed petitions for judicial review, which were consolidated in the stipulated venue of the District Court.
The court issued its decision affirming STAB on June 9, 1999. The Bates and the Trust appeal.
DISCUSSION
Did the District Court correctly affirm STAB’s decision that the Trust was legally invalid and that the Bates therefore personally owe Montana taxes?
We review STAB’s decision in the same manner as the District Court. See § 2-4-704, MCA. Since the material facts of this case are not in dispute, the only disagreement between the parties is the legal question of the validity of the Trust. In reviewing questions of law, we simply ascertain whether the agency’s interpretation of the law is correct. Steer, Inc. v. Department of Revenue (1990), 245 Mont. 470, 474, 803 P.2d 601, 603.
The parties do not dispute that upon its creation, the Trust issued certificates of beneficial interest (also referred to as “units of beneficial interest” or “UBIs”) to the Bates and their children in exchange for the land and assets the Bates transferred to the Trust. Rather, the parties disagree as to the effect that the issuance of UBIs has on the validity of the Trust for tax purposes. The parties agree, however, that resolution of the trust-creation issue will resolve the tax issue. Thus, if the Trust is legally invalid, the Bates individually owe Montana capital gains and other taxes for the disputed tax years 1993 and 1994.
The Bates contend that they have complied with all legal formalities and that the Trust, being “personal” and “irrevocable” in nature, is a legitimate estate-planning vehicle which should be respected for tax purposes. Particularly, they assert that the Trust is not a legally invalid “business trust” simply because it operates a legitimate business endeavor while minimizing tax and personal liability. The DOR counters that there are several factors making the Trust an “abusive trust” under Montana and federal law. As such a “sham” entity, the DOR argues that the Trust should be disregarded for tax purposes and that any income derived from trust activities should be imputed to the individual tax returns of the Bates. We agree. Under the following analysis, we hold that the Trust does not qualify for treatment as a trust under Montana and federal law, and, therefore, that the Bates are personally liable for Montana taxes for the years in question.
The crux of this case is the application of § 72-33-108(4), MCA, which defines what constitutes a legitimate “trust” under Montana law. In pertinent part, the statutory definition provides that a trust does not include “business trusts providing for certificates to be issued to beneficiaries . . . .” Section 72-33-108(4), MCA (emphasis added). As the DOR principally contends, the issuance of certificates of beneficial interest or UBIs by the Trust is analogous to the issuance of stocks or shares by a corporation, thus taking such a “business trust” out from under the provisions of Title 72 of the Montana Code applicable to ordinary trusts. See also § 35-5-101, MCA (defining a “business trust” under Title 35 of the Montana Code applicable to corporations, partnerships, and associations).
The Bates cite legislative history applicable to § 72-33-108(4), MCA, arguing that the exclusionary definition of a “business trust” is meant to apply only to “big business” and not a “family irrevocable trust.” However, we agree with the DOR that the legislative history cited by the Bates, though not particularly illuminating, supports the rather straightforward proposition that an entity with objective indicia of a business organization (i.e., a partnership or corporation) is not to be regarded as a trust under Montana law.
Similarly, federal law refuses to recognize the validity of a business trust for tax purposes. In contrast to an ordinary trust, business trustsare not simply arrangements to protect or conserve the property for the beneficiaries. These trusts . . . generally are created by the beneficiaries simply as a device to carry on a profit-making business which normally would have been carried on through business organizations that are classified as corporations or partnerships under the Internal Revenue Code. 26 C.F.R. § 301.7701-4(b).
As the DOR indicates, federal law considers a business trust to be an “abusive trust.” The IRS recently issued Notice 97-24, warning state and federal agencies and taxpayers of the existence and promotion of certain types of “abusive trust arrangements” that allege to reduce or eliminate federal taxes. According to the Notice, these trust arrangements are abusive of the law and are not to be recognized as ordinary trusts. They are abusive in that they promise “tax benefits with no meaningful change in the taxpayer’s control over or benefit from the taxpayer’s income or assets.” Such an abusive trust arrangement often promises, inter alia, “reduction or elimination of income subject to tax; . . . a stepped-up basis for property transferred to the trust; the reduction or elimination of self-employment taxes; and the reduction or elimination of gift and estate taxes.”
One example of an abusive trust is a business trust, which is described in the Notice as an arrangement where, as here, property (usually a business) is transferred to the trust in exchange for units or certificates of beneficial interest. See, e.g., Markosian v. Commissioner of Internal Revenue (T.C. 1980), 73 T.C. 1235 (dentistry practice). Payments to holders of the UBIs, often characterized as “deductible distributions,” are claimed to largely reduce or eliminate the taxable income of the business trust. Additionally, there is claimed to be little or no income from self-employment on the theory that the taxpayer allegedly receives little to no income from the trustees’ management of the business property.
In Morrissey v. Commissioner of Internal Revenue (1935), 296 U.S. 344, 56 S.Ct. 289, 80 L.Ed. 263, the United States Supreme Court set forth the distinguishing characteristics of a business association or trust, as opposed to an ordinary trust. Analogous to this case, a considerable portion of the trust property at issue in Morrissey had been surveyed and subdivided into lots, and various residential improvements were made to the subdivided property to facilitate sales of the lots. See Morrissey, 296 U.S. at 360-61, 56 S.Ct. at 296, 80 L.Ed. at 272.
Morrissey instructs that this Court must look to the substance of the trust arrangement, not its form, in determining whether the entity constitutes an impermissible business trust or a legitimate ordinary trust. Thus, “the absence of particular [corporate] forms, or of the usual terminology of corporations, cannot be regarded as decisive.” Morrissey, 296 U.S. at 358, 56 S.Ct. at 295, 80 L.Ed. at 271. Rather, we look to whether the economic realities of the trust arrangement indicate that it is, in substance, “a medium for the carrying on of a business enterprise and sharing its gains,” thus making it analogous to a corporate organization. Morrissey, 296 U.S. at 359, 56 S.Ct. at 296, 80 L.Ed. at 271.
Hence, although a business trust may not have “directors” or “officers,” as in a corporate organization, the “trustees” may function in nearly the same manner as directors of a corporation for purposes of carrying on the business enterprise at issue. Morrissey, 296 U.S. at 358, 56 S.Ct. at 295, 80 L.Ed. at 272. Additionally, the earmarks of a business trust, not usually found in an ordinary trust, include the following characteristics: centralized management, continuity of life, transferability of interests, and limited personal liability. See Morrissey, 296 U.S. at 359, 56 S.Ct. at 296, 80 L.Ed. at 272. Ultimately, in a business trust, the relationship of the grantor to the property transferred does not differ in any material aspect before and after the creation of the trust. Markosian, 73 T.C. at 1243.
We concur with the DOR that the distinguishing features of a business trust are manifest in the Trust. First, the Bates’ transfer of property to the Trust was done in exchange for certificates of beneficial interest that are factually identical to shares or stocks issued by a business entity, particularly for purposes of identifying rights to distributable income. Thus, the UBIs held by the Bates effectively make them, along with their three children, “shareholders” in the Trust.
Second, these units of beneficial interest are easily transferred. The terms of the Trust require only the consent of one other disinterested beneficiary to effect such a transfer. Hence, similar to shares or stocks in a business entity, the UBIs are readily transferable.
Third, and importantly, the Bates continue to exercise substantial managerial discretion over the corpus of the Trust. The role of the “trustees” is somewhat vague, although they appear to function largely as an advisory board to the Bates, much like the directors of a business entity. Although the Bates point to the trust documents as indicating that the trustees have penultimate managerial authority over the business property, there is substantial evidence that the Bates made nearly all of the decisions relevant to the management of the property in the Trust, including both land-development and farming activities, and that the trustees simply “rubber-stamped” the Bates’ managerial decisions. Moreover, the Bates have the authority to write substantial checks against the Trust’s account without prior approval from the trustees. While the Bates pay nominal rent for continuing to reside in the farmhouse, there is no indication that they pay rent to the Trust for their continued use of the non-subdivided farmland. The weight of the evidence suggests that there has been little to no change in the Bates’ relationship to the assets they transferred into the Trust, and that the Bates’ business affairs have been conducted in substantially the same manner as prior to execution of the trust documents in 1992. In other words, “regardless of regularity of form as a matter of plutological reality, there [has been] no substantial change in economic ownership” here. Burde v. Commissioner of Internal Revenue (2d Cir. 1965), 352 F.2d 995, 1001.
Fourth, the Trust has a continuity of life more typical of a business entity. Trustees can be any person, provided that not more than 50% of the trustees are related to the Bates. Trustees can be replaced in a variety of ways akin to the directors of a corporation, including death, resignation, removal for cause, and the addition of another trustee. Furthermore, the Bates may personally appoint a “Protector” who can independently remove for cause and replace a trustee without unanimous consent of the other trustees.
Fifth, there is no personal liability for trust debts adhering to the Bates. Rather, all debt liability lies with the Trust property.
Lastly, as highlighted in IRS Notice 97-24, the Trust exhibits several of the distinguishing characteristics of an “abusive” business trust under federal law. Most important among these characteristics, the Bates accepted certificates of beneficial interest or UBIs in exchange for transferring their property into the Trust, and the property was transferred into the Trust at a stepped-up basis.
The Bates are correct in arguing that a taxpayer has a legal right to minimize or entirely avoid taxes by any means permitted by the law. See Gregory v. Helvering (1935), 293 U.S. 465, 469, 55 S.Ct. 266, 267, 79 L.Ed. 596, 599. However, when the form of the transaction has not, in fact, altered any cognizable economic relationships, that form will be disregarded and the tax law applied according to the substance of the transaction. Markosian, 73 T.C. at 1241 (citing Furman v. Commissioner of Internal Revenue (T.C. 1966), 45 T.C. 360). While we acknowledge that the Trust has some formal characteristics of an ordinary trust, we determine, on balance, that it is substantially a medium for the carrying on of the Bates’ farming and land-development enterprises; there has been little material change in economic ownership or reality before and after creation of the Trust.
Montana law does not recognize a “business trust” where, as here, certificates of beneficial ownership are issued to beneficiaries. Section 72-33-108(4), MCA. Therefore, since the Trust is void under Montana law, any transfer of property to the Trust is likewise void. The Trust must be disregarded for Montana tax purposes. We hold that the District Court correctly affirmed STAB’s order affirming the DOR’s assessment against the Bates personally.
Affirmed.
/S/ WILLIAM E. HUNT, SR.
We Concur:
/S/ J. A. TURNAGE
/S/ KARLA M. GRAY
/S/ TERRY N. TRIEWEILER
/S/ JAMES C. NELSON
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Post by Sapphire Capital on Sept 20, 2012 0:47:26 GMT 4
Strangi vs CIR
Albert Strangi v. Commissioner of Internal Revenue,
417 F.3d 468 (5th Cir. 07/15/2005)
ALBERT STRANGI, Deceased, Rosalie Gulig, Independent Executrix, Petitioner-Appellant,
versus COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
No. 03-60992
UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT
417 F.3d 468;2005 U.S. App. LEXIS 14497; 2005-2 U.S. Tax Cas. (CCH) P60,506;
96 A.F.T.R.2d (RIA) 5230
July 15, 2005, Filed
SUBSEQUENT HISTORY: As Revised: July 25, 2005.
PRIOR HISTORY: [*1] Appeal from a Decision of the United States Tax Court. Estate of Strangi
v. Comm’r, T.C. Memo 2003-145, 2003 Tax Ct. Memo LEXIS 144 (T.C., 2003)
COUNSEL: For ALBERT STRANGI, Deceased, Rosalie Gulig, Independent Executrix, Petitioner-
Appellant: George Tomas Rhodus, Norman Arthur Lofgren, Michael C Kelsheimer, Looper Reed
& McGraw, Dallas, TX.
For COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee: John A Nolet, Michael J Haungs, US Department of Justice Tax Division, Washington, DC; Charles Casazza, Clerk, US Tax Court, Washington, DC; Emily A Parker, Internal Revenue Service, Washington, DC; Jonathan S Cohen, US Department of Justice Tax Division Appellate Section, Washington, DC; Eileen J O’Connor, Assistant Attorney General, US Department of Justice, Washington, DC. For AMERICAN COLLEGE OF TRUST AND ESTATE COUNSEL, Amicus Curiae: Milford B Hatcher, Jr., Jones Day, Atlanta, GA. JUDGES: Before REAVLEY, JOLLY, and PRADO, Circuit Judges. OPINION BY: E. GRADY JOLLY OPINION: E. GRADY JOLLY, Circuit Judge: This case, which comes before us now for a second time, involves an assessment by the Commissioner of Internal Revenue of an estate tax deficiency against the Estate of Albert Strangi. Initially, the Tax Court held for the Estate. However, we remanded to the Tax Court, [*2] which reversed its prior holding and decided the case under I.R.C. § 2036(a). Section 2036(a) provides that transferred assets of which the decedent retained de facto possession or control prior to death are included in the taxable estate. The Tax Court held that Strangi retained enjoyment of the assets in question, and thus, that the transferred assets were properly included in the estate. The Estate now appeals that decision. We find no reversible error, and accordingly AFFIRM. I As failing health began to telegraph that the inevitable would occur, Albert Strangi transferred approximately ten million dollars worth of personal assets into a family limited partnership. Upon his death, Strangi’s Estate filed an estate tax return based on the value of his interest in that partnership, as opposed to the actual value of the transferred assets. The Internal Revenue Service issued a notice of a deficiency of $ 2,545,826 in estate taxes. Strangi’s Estate petitioned the Tax Court for a redetermination of the deficiency. After protracted litigation, the Tax Court found that Strangi had retained an interest in the transferred assets such that they were properly included [*3] in the taxable estate under I.R.C. § 2036(a), and entered an order sustaining the deficiency. Our review of the Tax Court’s decision requires an inquiry into the structure of the limited partnership established by Strangi and the extent to which he retained enjoyment of partnership assets. First, however, some account of antecedents is in order. A Albert Strangi died on October 14, 1994 in Waco, Texas. He was survived by four children from his first marriage: Jeanne, Rosalie, Albert Jr., and John (collectively, the “Strangi children”). Rosalie was married to Michael J. Gulig, a local attorney. In 1965, after divorcing his first wife, Strangi married Delores Seymour. Seymour had two daughters, Angela and Lynda, from a prior marriage (collectively, the “Seymour children”). In 1987, Strangi and Seymour both executed wills, naming one another as primary beneficiaries and the Strangi and Seymour children as residual beneficiaries. That same year, Seymour began to suffer from a series of medical problems. As a result, Strangi and Seymour decided to move their residence from Florida to Waco, Texas. To facilitate the relocation, Strangi executed a general power of [*4] attorney naming Gulig as his attorney-in-fact. In July 1990, Strangi executed a new will, naming the Strangi children as sole beneficiaries if Seymour predeceased him — i.e., cutting out the Seymour children. The new will designated Strangi’s daughter Rosalie and a bank, Ameritrust, as co-executors of the Estate. Seymour died in December 1990. In 1993, Strangi began to experience health problems. He had surgery to remove a cancerous mass from his back, was diagnosed with a neurological disorder called supranuclear palsy, and had prostate surgery. At this point, Gulig took over management of Strangi’s daily affairs. Gulig testified that, on several occasions between 1990 and 1993, he discussed his concerns regarding Strangi’s Estate with retired Texas probate Judge David Jackson, who was a personal friend. Gulig said that he felt “confident” that the Seymour children would either sue Strangi’s Estate or contest the will. He also claimed to have been concerned about “horrendous executor fees” that he believed Ameritrust would charge. Further, Gulig said he worried about the possibility of a tort claim by Strangi’s housekeeper for injuries she sustained in an accident while caring [*5] for Strangi. He testified that Judge Jackson advised him that his fears were “very valid” and that he “had to do something” to protect the Strangi Estate. B On August 11, 1994, Gulig attended a seminar provided by Fortress Financial Group, Inc., explaining the so-called “Fortress Plan”. The Fortress Plan was billed as a means of using limited partnerships as a tool for (1) asset preservation, (2) estate planning, (3) income tax planning, and (4) charitable giving. Fortress marketed the plan as a means of, among other things, “lowering the taxable value of your estate” by means of “well established court doctrines which recognize that the value of a limited partnership interest is worth less than the value of the assets owned by the limited partnership”. In brief, the plan instructed parties to “sell” their assets in exchange for an interest in a newly-created limited partnership. Because a partnership interest is worth less for tax purposes than a proportional share of the partnership’s assets — due to lack of direct control and non-liquidity — this “exchange” would reduce the taxable value of the estate. The next day, Gulig, acting under power of attorney on behalf of Strangi: [*6] (1) prepared the Agreement of Limited Partnership of the Strangi Family Limited Partnership (“SFLP”); (2) prepared and filed the Articles of Incorporation of Stranco, Inc. (“Stranco”); (3) transferred 98% of Strangi’s assets n1 – valued at $ 9,932,967 — to SFLP in exchange for a 99% limited partner interest; (4) transferred $ 49,350 of Strangi’s assets to Stranco in exchange for 47% of Stranco’s common stock; (5) facilitated the purchase of the remaining 53% of Stranco’s common stock by the four Strangi children for $ 55,650; (6) issued a check from Stranco for a 1% general partner interest in SFLP. [*7] The result of Gulig’s efforts was a three-tiered entity, with SFLP — and the roughly $ 10 million in assets Strangi had transferred into it — at the top. The SFLP partnership agreement provided that Stranco, which owned a 1% general partnership interest in SFLP, had sole authority to conduct SFLP’s business affairs. Strangi owned a 99% interest in SFLP, but was a limited partner, and thus had no formal control. Stranco itself was a Texas corporation. Strangi owned 47% of Stranco’s common stock; each of his four children owned a 13% share. Stranco’s articles of incorporation named Strangi and the four Strangi children as the initial board of directors. On August 17, the five met to execute the corporate bylaws, a shareholder agreement, and an authorization to employ Gulig as manager of Stranco. On August 18, Stranco made a corporate gift of 100 shares — a 1/4 of one percent stake — to the McLennan Community College Foundation. Gulig later testified that he understood that the gift would improve the asset protection features of the Stranco/SFLP structure. The implementation of the “Fortress Plan” was thus completed. Following Strangi’s death in October 1994, Gulig asked Texas [*8] Commerce Bank (“TCB”, a successor in interest to Ameritrust) to decline to serve as executor of the Estate. To that end, Gulig claims to have issued a “threat that no distributions would be made from SFLP to pay executor fees”. After receiving indemnification from the Strangi children, TCB agreed. Strangi’s will was admitted to probate in April 1995 with Rosalie Gulig as the sole executor. C Both prior to and after Strangi’s death, SFLP made various outlays, both monetary and in-kind, to meet his needs and expenses. In September and October of 1994, SFLP distributed $ 8,000 and $ 6,000, respectively, to Strangi. On both occasions, SFLP made proportional distributions — $ 80.81 and $ 60.61, to be precise — to its general partner, Stranco. The Commissioner suggests that these payments to Strangi were necessary because, after the transfer to SFLP, Strangi retained possession of only minimal liquid assets — i.e., two bank accounts with funds totaling $ 762. The Estate responds by noting that Strangi received a monthly pension of $ 1,438 and Social Security payments of $ 1,559, and that he retained over $ 187,000 in “liquefiable” assets, which consisted largely of various brokerage [*9] accounts. SFLP also distributed approximately $ 40,000 in 1994 to pay for funeral expenses, estate administration expenses, and various personal debts that Strangi had incurred. In 1995 and 1996, SFLP distributed approximately $ 65,000 to pay for Estate expenses and a specific bequest made by Strangi. Moreover, in 1995, SFLP distributed $ 3,187,800 to the Estate to pay federal and state inheritance taxes. The Estate notes that all of these disbursements were recorded on SFLP’s books and accompanied by pro rata distributions to Stranco. The Estate further notes that it repaid SFLP for the $ 65,000 “advance” in January 1997. In addition, prior to his death, Strangi continued to dwell in one of the two houses he had transferred to SFLP. The Estate notes that SFLP charged rent for the two months that Strangi remained in the house. Although the accrued rent was recorded in SFLP’s books, it was not actually paid until January 1997, more than two years after Strangi’s death. D In December 1998, the Internal Revenue Service issued a notice of deficiency to the Estate, asserting that it owed $ 2,545,826 in federal estate tax or, in the alternative, $ 1,629,947 in federal gift tax. The deficiency [*10] was attributable to the IRS’s determination that Strangi’s interest in SFLP was $ 10,947,343 — i.e., the actual value of the assets transferred — rather than the $ 6,560,730 that the Estate reported. n2 The Estate petitioned the Tax Court for a redetermination of the deficiencies. In the Tax Court, the Commissioner of Internal Revenue contended, inter alia, that (1) SFLP should be disregarded because it lacked economic substance and business purpose; (2) the partnership agreement was a restriction on the sale or use of the underlying [*11] property that should be disregarded for valuation purposes; (3) the fair market value of Strangi’s partnership interest was understated; and (4) if a discount was appropriate, Strangi had made a taxable gift on formation of SFLP to the extent the value of the property transferred exceeded the value of his partnership interest. Prior to trial, the Commissioner filed a motion for leave to amend his answer to include the alternative theory that, under I.R.C. § 2036(a), Strangi’s taxable estate should include the full value of the assets he transferred to SFLP and Stranco. The Tax Court denied the motion. After a two-day trial, the court held for the Estate, rejecting all of the Commissioner’s proffered reasons for inclusion of the assets. See Estate of Strangi v. Commissioner, 115 T.C. 478 (2000) (“Strangi”) I The Commissioner appealed, inter alia, the denial of the motion to amend his answer. This court affirmed in part and reversed in part, and remanded the case to the Tax Court with instructions that it either “set forth its reasons for … denial of the Commissioner’s motion for leave to amend” or “reverse its denial of the Commissioner’s [*12] motion, permit the amendment, and consider the Commissioner’s claim under § 2036″. Gulig v. Comm’r, 293 F.3d 279, 282 (5th Cir. 2002). On remand, the Tax Court opted to permit the amendment. The parties submitted additional briefs on the § 2036(a) issue and the Tax Court entered its opinion in May 2003, finding in favor of the Commissioner, and upholding the initially-assessed estate tax deficiency. See Estate of Strangi v. Commissioner, T.C. Memo 2003-145 (2003) (“Strangi II”). The Estate now appeals the decsion of the Tax Court. II The Strangi Estate advances two primary arguments. Both hinge on the application of I.R.C. § 2036(a) to the facts at hand. Section 2036(a) provides: The value of the gross estate shall include the value of all property to the extent of any interest therein which the decedent has at any time made a transfer (except in the case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which [*13] does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom. First, the Estate contends that the Tax Court erred in holding that Strangi retained “possession or enjoyment” of the property he transferred to SFLP or the right to designate who would possess or enjoy it. If Strangi did not retain such an interest, § 2036(a) does not apply. Second, the Estate contends that, even if Strangi retained possession or enjoyment of the assets, the Tax Court erred in holding that the transfer did not fall within the “bona fide sale” exception to § 2036(a). A The core of the Estate’s argument on appeal is that the Tax Court erred in concluding that Strangi retained possession or enjoyment of the assets he transferred to SFLP. It follows, the Estate contends, that the Tax Court erred in holding that the assets were includible in the taxable estate under § 2036(a). Section 2036(a) is one of several provisions of the Internal Revenue Code intended to prevent [*14] parties from avoiding the estate tax by means of testamentary substitutes that permit a transferor to retain lifetime enjoyment of purportedly transferred property. See Estate of Lumpkin v. Commissioner, 474 F.2d 1092, 1097 (5th Cir. 1973). Specifically, § 2036(a) provides that property transferred by a decedent will be included in the taxable estate if, after the transfer, the decedent retains either (1) “possession or enjoyment” of the transferred property; or (2) “the right . . . to designate the persons who shall possess or enjoy the property or the income therefrom”. A transferor retains “possession or enjoyment” of property, within the meaning of § 2036(a)(1), if he retains a “substantial present economic benefit” from the property, as opposed to “a speculative contingent benefit which may or may not be realized”. United States v. Byrum, 408 U.S. 125, 145, 150, 33 L. Ed. 2d 238, 92 S. Ct. 2382 (1972). IRS regulations further require that there be an “express or implied” agreement “at the time of the transfer” that the transferor will retain possession or enjoyment of the property. 26 C.F.R. § 20.2036-1(a). In the [*15] case at bar, the benefits retained by Strangi – including, for example, periodic payments made prior to Strangi’s death, the continued use of the transferred house, and the postdeath payment of various debts and expenses — were clearly “substantial” and “present”, as opposed to “speculative” or “contingent”. n3 As such, our inquiry under § 2036(a)(1) turns solely on whether there was an express or implied agreement that Strangi would retain de facto control and/or enjoyment of the transferred assets. The Commissioner does not suggest that any express agreement existed. Thus, the precise question before us is whether the record supports the Tax Court’s conclusion that Strangi and the other shareholders of Stranco — that is, the Strangi children — [*16] had an implicit agreement by which Strangi would retain the enjoyment of his property after the transfer to SFLP. n4 The Tax Court’s determination that an implied agreement existed is a finding of fact and is reviewed only for clear error. See Maxwell v. Commissioner, 3 F.3d 591, 594 (5th Cir. 1993). A factual finding is not clearly erroneous if it is plausible in light of the record read as a whole. See, e.g.United States v. Villanueva, 408 F.3d 193, 203 (5th Cir. 2005). [*17] As such, we will disturb the Tax Court’s findings of fact only if we are “left with the definite and firm conviction that a mistake has been made”. Otto Candies, L.L.C. v. Nippon Kaiji Kyokai Corp., 346 F.3d 530, 533 (5th Cir. 2003) (quoting Allison v. Roberts (In re Allison), 960 F.2d 481, 483 (5th Cir. 1992)). The Tax Court, in its memorandum opinion, presented a litany of circumstantial evidence to support its conclusion. The Estate responds that each of the factors cited by the court is either factually erroneous or irrelevant. We consider each of the evidentiary factors in turn. First, the Commissioner cites SFLP’s various disbursements of funds to Strangi or his Estate. The Estate responds that only two of the payments — those made in September and October 1994, totaling $ 14,000 — should be considered, because the remaining payments were made after Strangi’s death, and thus “were not as a consequence of anything Mr. Strangi did”. The Estate’s response misses the point. Certainly, part of the “possession or enjoyment” of one’s assets is the assurance that they will be available to pay various debts and expenses upon one’s death. n5 And [*18] that assurance is precisely what Strangi retained in this case. SFLP distributed over $ 100,000 from 1994 to 1996 to pay for funeral expenses, estate administration expenses, specific bequests and various personal debts that Strangi had incurred. These repeated distributions provide strong circumstantial evidence of an understanding between Strangi and his children that “partnership” assets would be used to meet Strangi’s expenses. n6 [*19] Second, the Tax Court found “highly probative” Strangi’s “continued physical possession of his residence after its transfer to SFLP”. The Estate responds by noting that SFLP charged Strangi rent on the home. As the Tax Court observed, although the rent charge was recorded in SFLP’s books in 1994, the Estate made no actual payment until 1997. Even assuming that the belated rent payment was not a post hoc attempt to recast Strangi’s use of the house, such a deferral, in itself, provides a substantial economic benefit. As such, the Tax Court did not err in considering Strangi’s continued occupancy of his home as evidence of an implied agreement. Third, both the Commissioner and the Tax Court point to Strangi’s lack of liquid assets after the transfer to SFLP as evidence that some arrangement to meet his expenses must have been made. As noted supra, Strangi transferred over 98% of his wealth to SFLP and afterward retained only $762 in truly liquid assets. The Estate counters that Strangi had over $ 187,000 in “liquefiable” securities, which could have been sold to meet expenses for the remainder of Strangi’s life — that is, for the twelve to twenty- four months he was expected to live [*20] after August 1994. Even this limited assertion seems dubious, however, when, as the Tax Court noted, Strangi averaged nearly $ 17,000 in monthly expenses over the two months between the creation of SFLP and his death. See Strangi II, T.C. Memo 2003-145. In sum, upon creation of SFLP, Strangi retained assets barely sufficient to meet his own living expenses for the low end of his life expectancy — that is, for about one year — assuming he was never required to pay rent, estate administration costs, outstanding personal debts, funeral expenses, or taxes. At the same time, Strangi began receiving substantial monthly payments out of SFLP’s coffers. Given these circumstances, we cannot say that the Tax Court clearly erred in holding that Strangi and his children had some implicit understanding by which Strangi would continue to use his assets as needed, and therefore retain “possession or enjoyment” within the meaning of § 2036(a)(1). n7 [*21] B The Estate next contends that, even if the assets transferred to SFLP do fall within the ambit of § 2036(a)(1), they should nonetheless be excluded from the taxable estate, based on the “bona fide sale” exception contained in § 2036(a). For the reasons set forth below, we disagree. Section 2036(a) provides an exception for any transfer of property that is a “bona fide sale for an adequate and full consideration in money or money’s worth”. The exception contains two discrete requirements: (1) a “bona fide sale”, and (2) “adequate and full consideration”. See Estate of Harper v. Commissioner, T.C. Memo 2002-121. Both must be satisfied for the exception to apply 1 We turn briefly to the “adequate and full consideration” requirement. This requirement is met only where any reduction in the estate’s value is “joined with a transfer that augments the estate by a commensurate . . . amount”. Kimbell, 371 F.3d 257, 262. Where assets are transferred into a partnership in exchange for a proportional interest therein, the “adequate and full consideration” requirement will generally be satisfied, so long as the formalities of the partnership entity are respected. [*22] n8 The Commissioner concedes that such has been the case here. As such, the adequate and full consideration prong of the exception is satisfied and the sole question before us is whether the transfer was a “bona fide sale”. 2 Thus, we turn our attention to the bona fide sale requirement. The term “bona fide”, taken literally, means “in good faith” [*23] or “without fraud or deceit”. See BLACK’S LAW DICTIONARY, 186 (8th ed. 2004). As we have previously observed, use of a “bona fide” standard often requires the courts to assess both the subjective intent of a party and the objective results of his actions. See, e.g. United States v. Adams, 174 F.3d 571, 576-77 (5th Cir. 1999). As we noted in Wheeler v. United States, however, Congress in 1976 removed a provision from the Internal Revenue Code that included within the taxable estate transfers “intended to take effect in possession or enjoyment” after the decedent’s death. 116 F.3d 749, 765 (5th Cir. 1997). We observed that Congress’s apparent purpose was to “eliminate factbound determinations hinging on subjective motive”. Id. (quoting Estate of Ekins v. Commissioner, 797 F.2d 481, 486 (7th Cir. 1986)). As such, since Wheeler, we have held that whether a transfer of assets is a bona fide sale under § 2036(a) is a purely objective inquiry. See Kimbell, 371 F.3d at 263-64. We have yet to definitively state, however, precisely what this “objective” inquiry entails. Relying on language from [*24] Wheeler, the Estate contends that the “objective” bona fide sale inquiry requires only that the transfer be for adequate and full consideration. n9 The exception to § 2036(a), however, already expressly requires that transfers be for “adequate and full consideration”. As such, the Estate’s interpretation of the exception would render the term “bona fide” superfluous, and must therefore be rejected. n10 We think that the proper approach was set forth in Kimbell, in which we held that a sale is bona fide if, as an objective matter, it serves a “substantial business [or] other non-tax” purpose. Id. at 267. As noted supra, Congress has foreclosed the possibility of determining the purpose of a given transaction based on findings as to the subjective motive of the transferor. Instead, the proper inquiry is whether the transfer in question was objectively likely to serve a substantial nontax purpose. n11 Thus, the finder of fact is charged with making an objective determination as to what, if any, non-tax business purposes the transfer was reasonably likely to serve at its inception. We review such a determination only for clear error. See [*26] Walker Intern. Holdings Ltd. v. Republic of Congo, 395 F.3d 229, 233 (5th Cir. 2004). The Estate proffered five discrete non-tax rationales for Strangi’s transfer of assets to SFLP. They are: (1) deterring potential tort litigation by Strangi’s former housekeeper; (2) deterring a potential will contest by the Seymour children; (3) persuading a corporate executor to decline to serve; (4) creating a joint investment vehicle for the partners; and (5) permitting centralized, active management of working interests owned by Strangi. The Tax Court rejected each of the rationales as factually implausible. In reviewing for clear error, we ask only whether the Tax Court’s findings are supported by evidence [*27] in the record as a whole, not whether we would necessarily reach the same conclusions. First, the Estate contends that Strangi transferred his assets to SFLP partly out of concern that his former housekeeper, Stone, might bring a tort claim against the Estate for injuries sustained on the job. The Tax Court, however, heard admissions by Gulig that Strangi had paid all of the medical expenses stemming from Stone’s injury and had continued to pay her salary during her absence from work. Still, the Estate contends, had Stone sued, she might have recovered a substantial amount for her pain and suffering. Although this possibility cannot be ruled out entirely, the evidence before the Tax Court suggests otherwise. Gulig testified, for example, that Stone and Strangi were “very close” and admitted that he had never inquired as to whether there was any evidence that Strangi actually caused Stone’s injury. Further, there is no evidence that Stone ever threatened to take any action. As such, the district court did not clearly err in finding that the transfer of assets into SFLP did not operate to deter Stone from bringing a tort claim against the Estate. Second, the Estate contends that [*28] SFLP served to deter a will contest by the Seymour children. The Tax Court concluded that “the Seymour claims were stale when the partnership was formed, and they never materialized”. Strangi I, 115 T.C. at 485. Further, although the Seymour children did retain counsel, Gulig admitted that prior to the creation of SFLP neither they nor their attorney ever contacted him in regard to Strangi’s will, and that no claim was ever made against the Estate. Although reasonable minds might differ on this point, the Tax Court’s factual conclusion — i.e., that the Seymour children either would not or could not have mounted a successful challenge to the will — is not clearly erroneous. Third, the Estate argues that SFLP deterred TCB, the corporate co-executor of Strangi’s will, from serving, thus saving the Estate a substantial amount in executor’s fees. The Estate presented Gulig’s testimony regarding a meeting with TCB and TCB’s subsequent declining to serve. Nonetheless, the Tax Court was unpersuaded, noting that it was “skeptical of the estate’s claims of business purposes related to executor and attorney’s fees”. See id. The Estate concedes that “the reason for [*29] which the corporate co-executor declined to serve[] is not reflected in the record”. Thus, although a finder of fact might infer a causal relationship between the existence of SFLP and TCB’s withdrawal, there is nothing clearly erroneous in the Tax Court’s refusal to do so. Fourth, the Estate contends that SFLP functioned as a joint investment vehicle for its partners. The Tax Court rejected this contention, noting that the contribution of the Strangi children, which totaled $ 55,650, was de minimis and thus properly ignored for purposes of the bona fide sale requirement. The Tax Court further concluded that, even if the contributions of the children were properly considered, SFLP never made any investments or conducted any active business following its formation. See Strangi I, 115 T.C. at 486. The Estate responds that ignoring a shareholder’s contribution as de minimis runs contrary to Kimbell, in which we noted that there exists “no principle of partnership law that would require the minority partner to own a minimum percentage interest in the partnership for . . . transfers to be bona fide”. 371 F.3d at 268. It is certainly true that [*30] the de minimis contribution of a minority partner is not, in itself, sufficient grounds for finding that a transfer of assets to a partnership is not bona fide. However, where a partnership has made no actual investments, the existence of minimal minority contributions may well be insufficient to overcome an inference by the finder of fact that joint investment was objectively unlikely. Such appears to have been the case here. Thus, it was not clear error for the Tax Court to reject the Estate’s “joint investment” rationale. Finally, the Estate contends that SFLP permitted active management of Strangi’s “working assets”. As a preliminary matter, it is undisputed that the overwhelming majority of the assets transferred to SFLP did not require active management. Some seventy percent of the transfer, for example, consisted of various brokerage accounts. As the Estate points out, however, this is not unlike the situation in Kimbell, where we reversed summary judgment for the Commissioner based in part on the transferor’s contribution of $ 438,000 In working oil and gas properties, which comprised approximately 11% of the overall transfer. See id. at 267. [*31] The Estate asserts that working assets — including real property and interests in real estate partnerships — comprise an approximately equal proportion of the transfer in this case, as in Kimbell. Assuming this to be an accurate characterization of Strangi’s contribution, this analogy misses the point. In Kimbell, we reviewed cross motions for summary judgment on the “bona fide sale” issue. In reversing the Tax Court, we noted that the Commissioner “raised no issues of material fact in its motion for summary judgment and challenged none of the taxpayer’s facts”. Id. at 268-69. Among the unchallenged facts was the taxpayer’s assertion that there had been significant active management of the transferred oil and gas properties. Id. at 267-68. By contrast, this case comes to us after a full trial on the merits. The Tax Court heard uncontested evidence that “no active business was conducted by SFLP following its formation”. Strangi I, 115 T.C. at 486. In short, although Strangi may have transferred a substantial percentage of assets that might have been actively managed under SFLP, the Tax Court concluded, [*32] based on substantial evidence, that no such management ever took place. From this, the Tax Court fairly inferred that active management was objectively unlikely as of the date of SFLP’s creation. As such, we cannot say that the Tax Court clearly erred in rejecting the Estate’s “active management” rationale. In sum, we hold that the Tax Court did not clearly err in finding that Strangi’s transfer of assets to SFLP lacked a substantial non-tax purpose. Accordingly, the “bona fide sale” exception to § 2036(a) is not triggered, and the transferred assets are properly included within the taxable estate. We therefore affirm the estate tax deficiency assessed against the Estate. C The Estate raises one final matter for our consideration. It contends that, even if the Tax Court did not err in holding the transferred assets includible under § 2036(a), it nonetheless abused its discretion in denying the Estate leave to amend its petition to include a computational offset, based on a time-barred income tax refund, under the doctrine of equitable recoupment. As such, the Estate requests that we remand the case to the Tax Court with instructions that it offset the assessed estate tax deficiency [*33] by $ 304,402 already paid in income taxes. The doctrine of equitable recoupment applies where the Commissioner brings a timely suit for payment of taxes owed and the taxpayer seeks to offset that amount by seeking a refund of an erroneously imposed tax, but the taxpayer’s claim is time-barred. Equitable recoupment allows the taxpayer to raise the time barred refund claim “in order to reduce or eliminate the money owed on the [Commissioner's] timely claim”. Estate of Branson v. Commissioner, 264 F.3d 904, 909 (9th Cir. 2001). The problem in this case, as the Tax Court points out, is that the Estate has adopted two inconsistent positions with respect to its equitable recoupment argument. To sustain a claim for equitable recoupment, the taxpayer must show, inter alia, that the refund sought is, in fact, timebarred. See Estate of Branson, 264 F.3d at 910 (citing Stone v. White, 301 U.S. 532, 538, 81 L.Ed. 1265, 57 S. Ct. 851, 1937-1 C.B. 224 (1937)). The Estate, however, currently has a separate action pending in the Western District of Texas, in which it contends that the disputed refund is not time-barred. Given this inconsistency, [*34] the Tax Court held that the Estate failed to show that the refund was time-barred, and denied its motion to amend. On appeal, the Estate argues only that this result is inequitable. Unfortunately, in so doing, it neglects to address the controlling legal issue here — i.e., whether the Tax Court erred in concluding that the refund was not time-barred, and thus not subject to equitable recoupment. In sum, because the Estate has failed to brief us on the underlying merits of the Tax Court’s ruling, it has likewise failed to show that the Tax Court abused its discretion in denying the motion to amend. III For the foregoing reasons, the decision of the Tax Court is AFFIRMED. Footnotes n1 The assets that Strangi transferred to SFLP included, inter alia, (1) brokerage accounts at Smith Barney and Merrill-Lynch valued at $ 7.4 million; (2) an annuity valued at $ 276,000; (3) two life insurance policies valued at a total of $ 70,000; (4) two houses in Waco; (5) a condominium in Dallas; (6) a commercial warehouse in Dallas; and (7) several limited partnership interests, valued at approximately $ 400,000. n2 The basis for the discrepancy in this case – and the primary rationale for the use of family limited partnerships generally — is the IRS’s practice of permitting discounts in the taxable value of an estate based on a lack of marketability or control of estate property. See 26 C.F.R. § 20.2031-1(b) (“The value of every item of property includible in a decedent’s gross estate . . . is its fair market value at the time of the decedent’s death . . .”). n3 See Byrum, 408 U.S. at 146-47 (A substantial present interest exists in “situations in which the owner of property divested himself of title but retained an income interest or, in the case of real property, the lifetime use of the property”.). n4 As the Tax Court explained, § 2036(a) includes within the taxable estate any asset that is not transferred “absolutely, unequivocally, irrevocably, and without possible reservations”. Strangi II, T.C. Memo 2003-145 (quoting Commissioner v. Estate of Church, 335 U.S. 632, 645, 93 L. Ed. 288, 69 S. Ct. 322, 69 S. Ct. 337, 1949-1 C.B. 212 (1945)). The controlling question for present purposes, then, is not whether Strangi actually kept any particular asset in his possession, but whether he received a general assurance that his assets would be available to meet his personal needs. n5 See 26 C.F.R. § 20.2036-1 (“The ‘use, possession . . . or other enjoyment of the transferred property’ is considered as having been retained by … the decedent to the extent that the use, possession . . . or other enjoyment is to be applied toward the discharge of a legal obligation of the decedent . . . .”); see also Ray v. United States, 762 F.2d 1361, 1363 (9th Cir. 1985)(considering use of transferred assets to pay transferor’s funeral expenses as supportive of finding that transferor retained possession or enjoyment under § 2036). n6 The Estate further contends that all of the above payments were “pro rata partnership distributions”, meaning that Stranco received cash disbursements in proportion to its 1% general partner interest in SFLP. The Tax Court characterized these payments as “de minimis”, insofar as they did not “in any substantial way operate to curb decedent’s ability to benefit from SFLP property”. Strangi II, T.C. Memo 2003-145. In short, although the importance of the pro rata distributions to the “implied agreement” inquiry is perhaps debatable, there is nothing clearly erroneous about the decision to assign them minimal weight. n7 Because we hold that the transferred assets were properly included in the taxable estate under § 2036(a)(1), we do not reach the Commissioner’s alternative contention that Strangi retained the “right . . . to designate the persons who shall possess or enjoy the property”, thus triggering inclusion under § 2036(a)(2). n8 As we observed in Kimbell, 371 F.3d at 266: The proper focus therefore on whether a transfer to a partnership is for adequate and full consideration is: (1) whether the interest credited to each of the partners was proportionate to the fair market value of the assets each partner contributed to the partnership, (2) whether the assets contributed by each partner to the partnership were properly credited to the respective capital accounts of the partners, and (3) whether on termination or dissolution of the partnership the partners were entitled to distributions from the partnership in amounts equal to their respective capital accounts. n9 In support of its contention, the Estate cites Wheeler for the proposition that “the only possible grounds for challenging the legitimacy of a transaction [under § 2036(a)] are whether the transferor actually parted with the [transferred property] and the transferee actually parted with the requisite adequate and full consideration”. 116 F.3d at 764. Our holding in Wheeler, however, was expressly limited to the narrow factual circumstances of an intra-family sale of a remainder interest in real property. See id. at 756. Although adequate consideration may suffice to show the absence of fraud or deceit where a real property interest is, in fact, transferred from one party to another, such is not the case where, as here, the purported transfer arguably deprives the transferor of literally nothing. [*25] n10 We recognize that the Estate’s proposed interpretation of § 2036(a) would yield a more uniform and predictable rule than the one set forth in Kimbell and here. Although we acknowledge the importance of predictability in the law governing estates and estate planning, it cannot be had at the expense of the plain language of the statute.
n11 Accord Merryman v. Commissioner, 873 F.2d 879, 881 (5th Cir. 1989) (“To determine whether economic substance is present, courts view the objective realities of the transaction or, in other words, whether what was actually done is what the parties to the transaction purported to do.”).
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