I previously wrote about this case when it was then at the Bankruptcy Court level in an article at http://onforb.es/Q3dmH0 entitled "Kendall: Distress Debtor's Late Transfers Set Aside As Fraudulent Transfers In Bankruptcy". The case was then appealed to the 10th Circuit Bankruptcy Appellate Panel, which issued its own lengthy opinion that shed light on some important other issues as set forth below.
Here are the basic facts: Debtor owned a printing company ("Printing Company") and 82.4% of a real estate investment company ("Land Company"). The Land Company leased property to the Printing Company for the latter's operations. Debtor's Wife is a physician, and she owned a skin care company ("Wife's Company").
Wife settled the "J.K. Family Trust" ("Offshore Trust") in the Cook Islands, naming her mother as a trustee. The Adversary Complaint filed in the case indicates that the Cook Islands Trust Company was the other trustee.
When Debtor decided to build his Printing Company's building on the Land Company's land in 2005, the Debtor borrowed heavily -- eventually taking out $5.2 million in loans, with the Printing Company as the primary debtor, and Debtor as the personal guarantor. Of this amount, $3.85 million went to a new printing press that turned out to be defective, and eventually caused the Printing Company to fail.
While the Printing Company was failing, the Debtor tried to work out his loans with the Bank, and the Bank worked with him until 2009 when the Printing Company stopped paying altogether. Even then, the Bank was apparently ready to try to restructure the loans, but then the Bank itself failed, and the FDIC took over as its receiver. The FDIC immediately sold the Bank's loans to Creditor, which wasn't interested in helping the Debtor with a work-out, and instead (we are still in 2009) commenced collection proceedings against both the Printing Company and the Debtor.
In the meantime, and obviously concerned about his personal guarantee on the loans, Debtor was desperately trying to get his personal assets out of his name. In 2008, Debtor transferred his personal residence, which he owned outright from a previous marriage, to his Wife for no consideration. A couple of months later, Debtor transferred $125,000 to his Wife, again for no consideration. In 2009, Debtor had his Land Company transfer another $210,000 to Wife's Company, which was documented as a "loan" but no loan payments were ever made.
Sensing that she too might have troubles brewing as a result of these transfers, Wife then settled the "J.K. Family Trust" ("Offshore Trust") in the Cook Islands, naming her mother as a trustee. Wife transferred the deed to the personal residence that she received from Debtor into the Offshore Trust, and also transferred the stock in Wife's Company to the Offshore Trust.
To get out from under the liability on his personal guarantee and to stop the Creditor's state court collection action, Debtor then voluntarily filed for Chapter 7 bankruptcy relief, only three months after Wife settled the Offshore Trust.
A Trustee was appointed, and -- not at all surprisingly under these facts -- the Trustee immediately brought an Adversary Action against Wife and the Offshore Trust to avoid all the transfers by Debtor to his Wife, and to recover the assets. The Adversary Action alleged fraudulent transfers under both Bankruptcy Code section 548 and the Colorado Uniform Transfer Act.
For his part, Debtor attempted to argue that trial that he was solvent at the time of the transfers, by claiming that the values of his stock in the Printing Company and the Land Company exceeded the $5.2 million liability that he had from the loan guarantees. The Debtor and his Wife put up experts who testified these businesses had high values, and the Trustee put up an expert that testified they had low values.
The Court believed the Trustee's expert, and held that the Debtor was insolvent at the time of the transfers, but even beyond that the Debtor had an intent to defraud his creditor at the time the transferred were made, i.e., the Trustee established both actual and constructive fraudulent transfers to the satisfaction of the Court.
Debtor and Wife then appealed to the Bankruptcy Appellate Panel ("BAP") of the U.S. Tenth Circuit Court of Appeals -- and lost. The BAP affirmed the Bankruptcy Court's findings in every particular.
Debtor and Wife argued that the Bankruptcy Court seriously erred when it listened to the Trustee's expert, who valued the Printing Company based on liquidation value, rather than Debtor's and Wife's experts who used a "going concern" value. But the BAP didn't really care whether the Debtor was technically solvent or not at the time he made the transfers:
Appellants misunderstand the significance of Debtor's alleged solvency.
Assuming for purposes of argument that [Printing Company] should have been valued on a going concern basis and that it would result in a determination that Debtor was solvent, such a change in the facts does not necessarily change the results in this case. Debtor's solvency at the time he made the transfers does not, in and of itself, prevent the bankruptcy court from determining the transfers were actually or constructively fraudulent. Insolvency is only one of the eleven badges of fraud typically considered by bankruptcy courts in analyzing whether a transfer is actually fraudulent because it meets the sec. 548(a)(1)(A) statutory requirement of intent to hinder, delay, or defraud creditors. Further, insolvency is only one type of "fragile financial condition" that satisfies the sec. 548(a)(1)(B) statutory requirements.24 Therefore, Appellants' allegations of error, even if true, do not require that the bankruptcy court's decision be reversed.
The crux of the decision was that no matter how hard Debtor and Wife tried to make technical arguments about value, the totality of the circumstances made crystal clear that Debtor was trying to stiff his Creditor on the personal guarantee by transferring his assets to Wife.
The BAP summarized the most important circumstances as:
In this case, the bankruptcy court found that Trustee had established, at least in part, seven of the eleven badges of fraud. In addition to its conclusion that Debtor was insolvent at the time of the transfers, the bankruptcy court also found that:
1) the transfers from Debtor (in his individual capacity or as the alter ego of [Printing Company and Land Company]) were to an insider, i.e., Wife (in her individual capacity or as the alter ego of [Wife's Company]);
2) Debtor retained possession or control of the property after transfer with respect to the marital residence;
3) Debtor was inconsistent and inattentive in his disclosure of the transfers;
4) there was pending or threatened litigation against Debtor at the time of the [transfer to Wife's Company];
5) Debtor received no consideration in exchange for any of the transfers; and
6) the [transfer to Wife's Company] occurred around the time that Debtor ceased operation of [Printing Company], and therefore he knew or should have known he would be liable on [Printing Company]'s debt obligations to Bank because of his personal guarantees of the loans.
All this was bad, but what really hurt was that Wife then took the assets and transferred them to the Offshore Trust:
And not insignificantly, following Debtor's transfers of the residence and cash to Wife and Laskin, Wife then transferred ownership of the residence and Laskin to the Family Trust. Again, the Family Trust was settled by Wife shortly before Debtor filed bankruptcy, named Wife as beneficiary and Mother as trustee, and is an offshore trust formed under the laws of the Cook Islands, a jurisdiction popular for its aggressive asset protection legislation.
To make the latter point about the Cook Islands being "popular for its aggressive asset protection legislation", in a footnote the BAP referenced text from an asset protection treatise,
See generally 2 Asset Protection: Domestic & Int'l L. & Tactics sec. 20.6 (Duncan E. Osborne).
The BAP then moved on to discuss the Debtor's intent, noting that:
In analyzing actual intent to hinder, delay, or defraud, we focus on the debtor's state of mind, and not on either the debtor's solvency or transferee's culpability. Actual intent is, of course, difficult to prove so courts analyze the circumstances surrounding a transfer to determine whether intent can be inferred.
As stated, the circumstances made clear that the Debtor made the transfers to stiff his creditor, whatever his other stated excuses for the transfers. As to constructive fraud, the BAP stated that it was not necessary for the Trustee to prove that Debtor was technically insolvent under Bankruptcy Code section 548, but instead the Trustee need only meet a much lesser standard that Debtor was in a "fragile financial condition" at the time of the transfers, which Debtor would be a kind characterization of the mess Debtor was in at the time.
Finally, that Debtor had made the transfers left him unable to meet his obligations, or as the BAP put it:
In this case, the bankruptcy court not only found Debtor to be insolvent at the time he made the three transfers, but also that he was engaged in a business for which the remaining property was an unreasonably small capital, and that he knew or should have known that, upon KPC's default on its obligations to Bank, it would be impossible for him to pay them.40 Therefore, even assuming Appellants' claims of error regarding valuation of [Printing Company] and its impact on Debtor's solvency have merit, those claims are not sufficient to reverse the bankruptcy court's conclusion that the transfers were constructively fraudulent because the Trustee also established existence of the alternative fragile financial conditions set forth in the statute.
The BAP thus affirmed the lower Bankruptcy Court judgment, and the Wife and the Offshore Trust lost.
ANALYSIS
The first point that should be made here is that the Debtor engaged in nothing like asset protection planning, but instead just in good old fraud on the creditor. Any schmuck can make fraudulent transfers; to the contrary, asset protection is all about avoiding having a transfer characterized as a fraudulent transfer.
As I have previously explained in depth at http://onforb.es/WBVO8p, persons who have entered into personal guarantees are basically DOA in terms of creditor planning. When a person enters into a personal guarantee they have basically pledged the totality of their wealth to back a debt. They can't later attempt to take chips off the table when the cards start to turn up bad, by way of transferring assets away to others.
That is exactly what the Debtor tried to do here, and that is exactly what didn't work. The only thing that the Debtor accomplished is that he proved to the whole world that his word isn't worth the paper it is printed on, and he dragged his Wife into the mess so that she is now tainted as a sordid wrongdoer too.
Next, filing for voluntary bankruptcy relief after engaging in fraudulent transfers was probably the dumbest thing the Debtor could have done. The transfers were sure to be determined to be fraudulent transfers under at least Bankruptcy Code section 548, if not also under Colorado's Uniform Fraudulent Transfer Act, and not only would the transfers be unwound but now the Debtor must also risk the Trustee seeking to make the Creditor's claim non-dischargeable, or even seek to have the Debtor's entire discharge disallowed on the basis of misconduct.
Thus, by making these transfers and then seeking relief in bankruptcy, the Debtor may very well have accomplished the very difficult task of turning claims that were dischargeable into nondischargeable claims -- Kudos!
Bankruptcy is a meat grinder for Debtors. If a Debtor is cooperative and acts in good faith, the Debtor's assets are marshaled for the benefit of creditors, and the Debtor gets a discharge. But if the Debtor is not cooperative or has not acted in good faith, such as by making fraudulent transfer, the Debtor can lose his discharge -- but the marshaling of the Debtor's assets still goes on. Yes, the Courts will often state that the primary purpose of bankruptcy is to give a discharge to the Debtor, but it is to be noted that the marshaling of the Debtor's assets occurs whether the Debtor receives a discharge or not.
Moreover, Debtors should not be confident of avoiding a fraudulent transfer even if they were not in financial distress or otherwise met the technical requirements for avoiding a constructive fraudulent transfer. As the BAP repeatedly pointed out, the constructive fraud issue was a non sequitur (in English, it meant nothing) because the circumstances of the transfers clearly indicated the Debtor's intent to dodge his Creditor by the old tried-and-failed strategy of giving assets to his Wife. If a Debtor makes a transfer with the intent to defeat a Creditor, then the transfer is a fraudulent transfer -- end of story. This is a simple concept, but one which even many long-experienced asset protection planners often flub or can never get their minds around.
It is here that the simple appearance of a Cook Island Trust in the fact-pattern was the final nail in the Debtor's fraudulent transfer coffin. The BAP did not analyze the Cook Island Trust, or its terms. The BAP did not give comity to the Cook Islands, or its laws. Instead, the BAP simply looked at the subsequent transfers by Wife to the Cook Islands Trust as a bright red flag that something was seriously amiss.
By pointing out in its Opinion that the Cook Islands is "a jurisdiction popular for its aggressive asset protection legislation", the BAP is signaling that the death knell for the Cook Islands as anything like a legitimate asset protection jurisdiction has finally rung, if it had not rung in the numerous other court opinions considering the Cook Islands in the debtor misconduct context.
Courts, including the 10th Circuit as we see here, are now looking at trusts formed in the Cook Islands and concluding offhand that the Debtor (or, in this case, his Wife) had an intent to stiff creditors. Whatever slight nuances of Cook Islands law that some believe makes it a better trust jurisdiction than any of the other offshore debtor havens, the bad reputation of the Cook Islands now outweighs those perceived advantages by at least tenfold. Simply stated, it is time to start forming offshore trusts somewhere besides the Cook Islands, and to migrate trusts already there to other jurisdictions that do not carry the Cook Islands' serious taint with U.S. judges. Notably, court opinions where any special Cook Islands law made a difference in a case have simply failed to materialize -- if there are advantages to the Cook Islands (and I will leave this to others to mull over), those advantages haven't yet done anything for anybody. But it is an unavoidable fact that the Cook Islands' reputation has gone down the flusher with US. judges -- a Cook Islands trust will probably never beat the "bad tuna" smell test now.
To continue using the Cook Islands puts clients at risk of "guilt by association", whereby an honest intent will never be inferred, and a dishonest intent always presumed. Undoubtedly, however, some U.S. practitioners will continue to use the Cook Islands out of some combination of force-of-habit since they've never used any other place, and laziness in establishing trust and banking contacts elsewhere. But it is now borderline malpractice for asset protection planners to continue the using the Cook Islands, and maybe not even so borderline.
The Opinion does not tell us what relief was ultimately granted to the Trustee, but only that the Wife and the Offshore Trust were held liable for the fraudulent transfers.
Presumably, the Trustee will now simply be able to execute directly upon the personal residence, upon Wife, and upon Wife's Company (or garnishing Wife's wages) for the amounts that were transferred, without regard to who now holds title in the personal residence or Wife's Company.
This is another way of saying that offshore trusts are good for offshore assets, but those who hope to protect purely domestic assets by conveying their title into an offshore trust quite probably accomplishes nothing. Land in particular is ill-suited for protection by offshore trusts, since it cannot be moved to the Cook Islands or other any debtor haven (at least without astronomical expense), and, as here, all a court has to do is to rule that the transfer was fraudulent to give creditors a green light to collect against the domestic assets, and the laws of the Cook Islands are of no relevance in such a scenario.
Very simply, if one is going to attempt to protect their assets by offshore planning, then the assets actually have to be offshore. It is folly to believe that an offshore trust will protect domestic assets -- there is utterly no technical legal reason to believe that such will ever be the case, except in maybe the rarest of circumstances or against unsophisticated creditors (which will almost never include a Bankruptcy Trustee).
Simple as this sounds, too many debtors believe the ocean of false advertising on the internet or the promises of unscrupulous planners, and try to do the exact thing that Wife did here -- protect real estate and moneys held in her domestic bank accounts with an offshore trust. From an asset protection perspective, it is insanity, but in this case it was a bit of cumulative insanity since the Debtor's transfers were doomed to failure anyway, and she should have known better than to have gotten herself involved in this mess.
At the end of the day, this case stands as a bright example of what a distressed Debtor facing personal guarantees should not do -- try to take chips off the table to avoid the consequence of the guarantee. The 10th Circuit has made that crystal clear.
CITE AS
In re Kendall, 2013 WL 1890660 (10th Cir.BAP, Unpublished, May 7, 2013). Full Opinion at http://goo.gl/tTVQJ and case below: In re Kendall, 2012 WL 3202689 (Bkrtcy.D.Colo., Slip Copy, Aug. 6, 2012). Full Opinion at http://goo.gl/bkBTy and Forbes article at http://onforb.es/Q3dmH0 and http://goo.gl/0cLQh
This article at http://onforb.es/14eDpR6 and http://goo.gl/mlbVT
