Lawyers Can Face Severe Consequences For Helping a Client With a Fraudulent Conveyance

Courts in a number of states have specifically held that lawyers can violate applicable disciplinary rules by facilitating fraudulent conveyances.  This can result in an attorney being suspended or even disbarred. 

This is one of the reasons that an attorney must conduct a certain amount of due diligence about a new client before agreeing to assist that client with his or her asset protection planning.  Also, at times you may think your asset protection attorney is being overly cautious about transferring some of your assets.  Keep in mind that if it later appears that your attorney helped facilitate a fraudulent conveyance, the lawyer can face severe consequences. 

None of this should impact appropriate asset protection planning.  There are many circumstances under which you are free to transfer and/or retitle your assets.  The procedures followed by your asset protection attorney are not only necessary to protect the attorney - - they are likely to ultimately be in your best interest as well.

Ohio Court Pierces Corporate Veil and Holds Transfers to Shareholder Were Fraudulent

A recent decision by the Ohio Court of Appeals (Second District) held that the City of Springfield, Ohio was entitled to “pierce the corporate veil” of the defendant corporation in order to reach the shareholder’s assets.  The court further held that transfers totaling about $900,000 to its shareholder (proceeds from the corporation’s sale of real property) were fraudulent conveyances pursuant to §1336 of the Ohio Revised Code.

This case was decided in June of 2013, but only recently published in the September 16, 2013 edition of the Ohio State Bar Association Report.

Forming a corporation, trust or other entity in and of itself does not automatically protect assets.  How the entity is operated (and how and when various transfers are made) also needs detailed attention.  The trial court in this case paid particular attention to the timing of the transfers in finding that they were fraudulent.

At a minimum, this new Ohio decision is another reminder that simply forming a corporation, trust or other entity is not enough for asset protection.  You need to pay close attention to how that entity is operated (and how and when various asset transfers are made).

 

Bankruptcy Trustee has 10 Years to Challenge Transfer to a DAPT

A number of states have enacted Domestic Asset Protection Trust (DAPT) legislationOhio may soon join those states.  These statutes authorize what are known as "self settled" trusts.  This essentially means that the person setting up the trust is also one of its beneficiaries.  Thus, the person setting up the trust is attempting to protect some of his or her own assets (in addition to possibly protecting the assets for one or more other beneficiaries).

As I have noted in other posts, there is still not a single reported court decision in the United States that specifically upholds this kind of trust.  This is one of the reasons that I have been advising my clients not to put too large of a percentage of their assets into a DAPT.

Another significant consideration is that a bankruptcy trustee can challenge a conveyance to a DAPT within 10 years of the time it is made.  While 11 U.S.C. §548(a)(1) provides a general two year time frame in which a trustee can challenge alleged fraudulent conveyances, section (e)(1) provides a 10 year period with respect to self-settled trusts.

One of the goals of asset protection planning is to make sure that you do not end up in bankruptcy.  But it is obviously impossible to know in advance whether a future bankruptcy might be necessary.  Thus, 11 U.S.C. §548(e)(1) should be a very important consideration in deciding how much to contribute to a DAPT (and whether to form one in the first place).

Disclaiming an Inheritance can Constitue a Fraudulent Conveyance

Transferring an asset under certain circumstances can constitute a fraudulent conveyance.  Refusing to accept an asset can also constitute a fraudulent conveyance.

Let's say that you owe a creditor a significant amount of money.  You then learn that you have received a substantial inheritance.  If you take the inheritance it will go to the creditor.  So you decide to disclaim the inhertiance so that it can go to another family member.  In most states, that disclaimer will be deemed a fraudulent conveyance.  This all depends on state law; but the majority view seems to be that the creditor will be able to successfully reach those funds.

This is why multi-generational asset protection planning can be very important (just like multi-generational estate planning).  If the person leaving the inheritance had left it in a trust (with the right kind of provisions) it probably could have been protected.

It is important to keep in mind that many state fraudulent transfer laws are broad enough to encompass disclaiming certain assets as well as transferring certain assets.

Mortensen Case Highlights Fraudulent Conveyance Issues

A recent decision by the United States Bankruptcy Court for the District of Alaska (In Re: Thomas Mortensen, Case No. A09-00565-DMD) is clearly worth reading -- for a discussion of fraudulent conveyances, Alaska asset protection trusts, applicable statutes of limitations, and a variety of other asset protection topics.  I will likely comment on this recent case in several different posts, but here is a quick initial summary.

U.S. Bankruptcy Judge Donald MacDonald IV held that a transfer by Thomas Mortensen of real estate into an Alaska asset protection trust was a fraudulent conveyance.  The Judge found that there was persuasive evidence of an intent to hinder, delay and defraud present and future creditors. The Bankruptcy Judge voided the transfer of real estate to the trust as a fraudulent conveyance.

There are numerous lessons to be taken from this court decision and here are just two of them --

  • Transferring assets when you are insolvent is likely to constitute a fraudulent conveyance.  While Mortensen was found to be solvent at the time of the real estate transfer, his own testimony from a child support action was used against him in the bankruptcy proceeding. In a child support proceeding against his ex-wife, Mortensen took the position that his divorce had thrown him into heavy debt.  This is simply a reminder that whatever you say in one court case can obviously be used against you in another!
  • Think carefully about choosing the trustee of a trust.  Mortensen named his brother and a personal friend as trustees of his Alaska asset protection trust, and named his mother as a "trust protector."  All of these individuals were named as defendants by the Chapter 7 Bankruptcy Trustee in his adversary action against Mortensen.  While it is perfectly appropriate in many instances to name family members as trustees or trust protectors, you need to consider that these individuals can sometimes be dragged into litigation.

Many court decisions are difficult to read, but the Mortensen case is fairly easy to follow.  It is useful reading for anyone interested in some of the more technical aspects of fraudulent conveyances and other asset protection issues.

 

Asset Protection Planning is Often Possible After You Have Creditor Issues

It is clearly better to engage in asset protection planning before you have any creditor issues.  But planning after a lawsuit has been filed -- or even after a judgment has been entered against you -- is frequently possible.

State fraudulent transfer statutes vary in a number of respects.  But as a general rule, a conveyance is voidable (i) if there is intent to improperly prevent a current creditor from collecting against you or (ii) if the transfer would make you insolvent.  See for example Section 1336.04 of the Ohio Revised Code

Stated another way, you are not always prevented from transferring assets just because there is a lawsuit or judgment pending against you.  For example, lets say that you have a net worth of $1 million and a judgment against you for $10,000.  As long as you have no other known creditor issues, that $10,000 judgment does not prevent you from protecting the other 99% of your assets.

Again, it is clearly better to engage in asset protection planning before any creditor issues arise.  But trasnferring assets after a lawsuit has been filed or even after a judgment has been entered may, under many circumstances, still be appropriate and advisable.

Statute of Limitations for Fraudulent Transfers

The statute of limitations relating to a fraudulent transfer can vary significantly from jurisdiction to jurisdiction.  In Ohio, Section 1336.09 of the Ohio Uniform Fraudulent Transfer Act provides that a claim for relief must generally be brought within four years after a transfer was made.  But even if that period has expired, a claim may be brought within one year after the transfer was (or reasonably could have been) discovered by a claimant.

Some other states and certain foreign jurisdictions (such as the Cook Islands) have much shorter statutes of limitation.  This is one of the considerations involved in choosing a jurisdiction for a domestic asset protection trust or an offshore trust.

Many jurisdictions (including Ohio) consider when a claimant reasonably could have known about a transfer.  For this reason, it is sometimes advisable to provide some sort of public notice of a transfer of assets.  Many clients mistakenly think that asset protection involves hiding assets.  That is not the case.  It is not always advisable to provide public notice of an asset transfer, but sometimes it is.  This can be done in a number of ways, such as filing a deed, a UCC financing statement, or some other public notice that a transfer of assets has occured.

Creditors Have Many Options Once They Have a Judgment Against You

An article in the September 20, 2009 Business section of the Cleveland Plain Dealer contains a good summary of the various remedies available to a creditor who has a judgment against you.  Cleveland Plain Dealer columnist Sheryl Harris is discussing a $3,000 judgment obtained in a small claims court in Rocky River, Ohio; but the alternatives she outlines would be just as applicable to a $3 million judgment in Ohio and many other states.

Here are a few of the things a judgment creditor may be able to do:

  • Garnish your wages
  • Attach your bank accounts
  • File a lien against your home and/or other real estate that you own
  • Force a sale of your home and/or other real estate that you own
  • Attach your personal property

There are of course limits on these remedies.  A creditor can garnish only a certain percentage of your wages.  As I have discussed in other posts, a small portion of the equity in your home will be protected in Ohio pursuant to Ohio Revised Code Section 2329.66 (while states such as Florida and Texas protect almost all the equity in your home).  It may be possible for the creditor to seize the full amount of your bank accounts, up to the amount of the judgment against you.  Transferring assets after a judgment has been entered (or even after a lawsuit has started) will likely be a prohibited fraudulent conveyance under Ohio Revised Code Section 1336.04 and similar statutes in other states.

The situation that columnist Sheryl Harris is writing about sounds like one in which we would all be rooting for the creditor.  The creditor is trying to collect on a judgment against a roofing company that failed to make proper repairs.  In many cases, however, I am representing a potential debtor.  And in those situations I want to lawfully protect the assets of that person or entity to the greatest extent reasonably possible under applicable law. 

The Cleveland Plain Dealer article is a good reminder that while debtors have many rights, so do creditors.  Asset protection attorneys must have a thorough understanding of the rights of creditors.  When an attorney is working to protect your assets, he or she must be knowledgeable about the various techniques that can be used to seize those assets.

Fraudulent Conveyances

Asset protection planning generally involves transferring and/or re-titling some or all of your assets in order to better protect those assets from claims of creditors. Not surprisingly, however, there are statutory prohibitions against transferring your assets with the intent of avoiding your legal obligations. Whenever any assets are transferred or re-titled for protection purposes, it is critical to focus on applicable “fraudulent conveyance” laws, which give creditors the ability to void certain asset transfers in order to satisfy a judgment. Asset protection planners must have a thorough understanding of fraudulent conveyance laws.

The Ohio Uniform Fraudulent Transfer Act (Chapter 1336 of the Ohio Revised Code) is fairly typical of the statutes found in most other states. An examination the statute reveals how broadly a fraudulent conveyance is defined. Whether a conveyance is “fraudulent” under Ohio Revised Code Section 1336.04 depends on a variety of factors, including the following:

  1. Was the conveyance intended to hinder, delay, or defraud any creditor of the debtor?
  2. If the transfer was as sale, did the debtor receive a reasonably equivalent value in exchange for the asset that was transferred?
  3. Did the debtor know (or reasonably should have believed) that due to the transfer he would have debts beyond his ability to pay as they became due?

Whether a conveyance is “fraudulent” depends heavily on the “intent” of the person making the conveyance. Ohio Revised Code Section 1336.04 (B) says that in order to help determine that intent, consideration should be given to many different factors, including but not limited to:

  1. Whether the transfer was to an insider (like a family member or partner);
  2. Whether the debtor retained possession or control of the property transferred after the transfer;
  3. Whether there was a lawsuit pending or threatened;
  4. Whether the transfer made the debtor insolvent.

Whether or not a transfer is “fraudulent” is often a complicated issue that depends on a wide variety of factors. Other terms in the Ohio statute also frequently raise complicated questions. Debtors and creditors frequently argue about whether an asset was “transferred” at all. The term “transfer” is defined very broadly in Ohio Revised Code Section 1336.01(L) to include a direct or indirect, absolute or conditional, voluntary or involuntary method of disposing of an asset or an interest in an asset. The term “transfer” includes the payment of money, a release, a lease, creation of lien or other encumbrance. Exactly when a transfer occurs can be very important and may determine whether or not a creditor can reach a particular asset.   

Each state has its own fraudulent conveyance statutes. The Ohio statute discussed here is typical, but each applicable state law must be reviewed separately.

 

Fraudulent conveyance statutes do not make asset protection planning impossible. They are intended only to prevent improper transfers.  

 

In addition to the specific provisions of Ohio Revise Code Section 1336.04 (and/or any other applicable statute), debtors must also consider how certain transfers may be perceived by a judge who may try to “do justice” notwithstanding the words of the statute.