Mr. Evgeny Freidman was in deep financial distress. Having personally guarantee $31.5 million in loans by Citibank to his companies, Freidman faced the loss of his cab companies and personal insolvency. Worse, Freidman's companies had pledged their cab medallions (read: licenses) to Citibank as collateral for the loans.
But Citibank was only one of Freidman's problems, as another of his companies owed money to Capital One. On August 14, 2014, Freidman signed an affidavit wherein he confessed to the Capital One liability for nearly $8.5 million. For whatever reason, Capital One did not immediately reduce the liability to a judgment.
In December of 2014, Freidman's financial pigeons with Citibank came home to roost, as his companies missed payments on the loans and they went into default. These defaults triggered Freidman's personal guarantees as well.
Citibank sued Freidman and his companies in New York state court on March 5, 2015. And this is where the case starts to get really interesting.
Soon after Citibank sued him, Freidman found himself in the offices of New York attorney Michael Zimmerman, seeking advice on "estate planning and asset protection". Zimmerman assisted Freidman in creating four trusts, with Freidman's business attorneys as the domestic trustees:
The Kelly Funding Trust (Cook Islands);
The Birkin Funding Trust (Cook Islands);
The Evelyn Funding Trust (Belize); and
The Lindy Funding Trust (Nevis).
Into these four trusts went Freidman's interests in some 28 entities, being LLCs and corporations that owned his personal resident and various real estate investments in the United States, plus his two New York residences.
On May 19, 2015, the New York Court granted a Seizure Order in favor of Citibank, which was finally entered on June 12, 2015. But three days later, June 15, 2015, the New York Appellate Division granted Freidman and his companies a temporary stay, later modified on July 14, 2015, to require that the defendants post a $50 million bond.
About this same time, on July 10, 2015, Capital One finally entered a Judgment by Confession against Freidman for the nearly $8.5 million which Freidman owed that company.
Of course, no $50 million bond was posted. Instead, on July 22, 2015, Freidman's companies that owed on the Citibank loans filed for Chapter 11 bankruptcy reorganization. This triggered the automatic stay of the bankruptcy court. A week later, on July 29, 2015, Freidman's companies removed the New York state court action to federal court.
On November 5, 2015, at the request of Citibank, the Bankruptcy Court issue a Temporary Restraining Order (TRO) to restrain Freidman and his companies from further transferring assets. A week later, the Bankruptcy Court was advised that the domestic U.S. trustees the four Freidman trusts had all resigned, and two Russian individuals had become the successor trustees.
Finally, on November 30, 2015, the Bankruptcy Court held an evidentiary hearing on Citibank's motion for an Order of Attachment against the assets of Freidman and his companies, and which lead to the Opinion that I shall next relate. According to the Opinion, "Freidman also testified, providing testimony that, on the whole, lacked credibility."
The Bankruptcy Court was basically faced with two questions:
First, was Citibank entitled to an Order of Attachment under these facts?
Second, could the Order of Attachment extend to secure the real estate that Freidman transferred to the four trusts?
As a preliminary note, in the context, an "Attachment" basically means that property is taken from the debtor or other third-party and either held by the so-called "levying officer" (usually the local Sheriff) or the creditor, pending the final outcome of the case. The goal is to protect the property from being disposed of or sold by a debtor who thinks he will probably lose the case.
Since real estate cannot be moved, at least without enormous expense (I picture some debtor digging up the acre that his McMansion sits on and putting it on a barge to the Cook Islands), an Attachment against real estate simply means that a copy of the Order is filed with the county recorder, and this clouds the title and keeps it from being sold.
Now back to our regularly-scheduled case.
Was Citibank entitled to an Order of Attachment?
To win an Order of Attachment required Citibank to prove several things, primarily that Citibank was ultimately going to win a judgment against Freidman and his companies. Cases involving loans and personal guarantees are pretty easy for creditors, since all they have to prove is that the loans went into default unpaid (they did), and that triggered the personal guarantee (it did). Point to Citibank.
But Citibank also had to prove that Freidman and his companies were trying to dispose of their assets; in other words, commit a fraudulent transfer. Citibank argued that the surrounding circumstances clearly demonstrated that Freidman was trying cheat Citibank's right to collect on its (future) judgment. These surrounding circumstances, said Citibank, satisfied the so-called "badges of fraud" that the courts look to for the purposes of determining whether a debtor is trying to cheat creditors.
The Court noted a basic precept of fraudulent transfer law, which is that:
Because fraudulent acts are as varied as the fish in the sea, any list of the badges of fraud would be non-exhaustive.
Here, the Court examined six of the traditional badges of fraud:
- Did Freidman transfer the assets without adequate consideration? Freidman simply made gifts of his assets to his trusts, without any consideration at all. Badge to Citibank.
- Did Freidman make the transfers to "insiders", i.e., family, friends and other close associates with whom Freidman had a pre-existing relationship? The beneficiaries of the four trusts were Freidman himself, his children and his parents. Badge to Citibank.
- Did Freidman have the right to benefit from or use the property? Freidman's trusts were written so that he could continue to live in or use the property upon any terms that the trustees saw fit. Moreover, Freidman kept management control over the properties to himself, and never actually transferred to the trustees his signatory control over the investment accounts into which the rents and like for the properties were paid. Moreover, as is so common in these cases, the trustees upon examination testified that they little knowledge of the trusts' assets or their investment activities. For his part, Freidman testified that he had intended to yield control of the trust assets to the trustees, but just hadn't gotten around to it yet in the last half-year. Badge to Citibank.
- What was Freidman's financial condition at the time of the transfers? You'd think that Freidman would just waive the white flag here, since he had just defaulted on his personal guarantee for tens of millions of dollars. But no, Freidman claimed -- apparently with a straight face -- that even after he made the transfers he was in "robust financial shape" and had a net worth of $130 million as late as June 2015. But here, Freidman ran afoul of a concept in fraudulent transfer law known as "utility to creditors", which essentially requires that the value of an asset is measured through the eyes of a creditor, not a debtor. Thus:
It is not necessary to find that Freidman was rendered insolvent by these transfers in order to conclude that the transfers were made with intent to defraud creditors or to frustrate the enforcement of a judgment. What is telling is that, by these transfers, Freidman appears to have sought to convey all of his property against which a judgment creditor could readily execute.
Freidman maintains that his Statement of Financial Condition dated June 30, 2015 ("2015 SFC") demonstrates that even after the transfers he was in robust financial shape. [] 2015 SFC lists a net worth of almost $130 Million. [] However, even a cursory analysis shows that, notwithstanding this purported net worth, Freidman retains few assets from which a potential judgment creditor might readily recover.
The Court noted that $85 million of Freidman's supposed $130 million in assets were in the form of taxi medallions which were largely illiquid, and Freidman had so many of them that if a creditor attempted to liquidate them, it would flood the market and drive down prices to nearly nothing -- even assuming that so many buyers could be found.
Indeed, this is where an earlier affidavit submitted by Freidman came back to haunt him with his own words:
The impact of a fire sale liquidation of so many medallions would likely cause a massive devaluation of all N.Y. City medallions, resulting in more defaults by other taxi operators and perhaps cause a collapse of the entire industry.
So, the tax medallions were of little utility to Citibank. Freidman's next biggest asset was approximately $35 million in interests in his own companies, which were of dubious value because Freidman was the manager of these companies, and their value was largely based on Freidman's self-assessment of his own management skills. This lead the Court to conclude:
However, any value attributable to his management, his market share, or the superiority of the integrated operation he has built, is precisely the type of value that would disappear when a judgment creditor tried to sell these companies. Thus, just as in the case of the NYC Medallions, the net worth that Freidman purports to demonstrate by virtue of his ownership of the Management Companies is not something that can be valued highly from the perspective of a creditor seeking to realize on collateral.
That left Freidman with just two assets: $2 million in Swiss bank accounts, and two residences in France worth $14 million. The residences would also be difficult for a creditor to collect upon, and Freidman's own words again hurt him as to the value of the Swiss bank accounts as he testified that he didn't know how much money was still in them.
The Court thus summarized:
Thus, is appears that Freidman has transferred substantially all of his assets available for execution by a judgment creditor to the Trusts. Much is made by Defendants of the fact that in connection with the creation of the Trusts, Freidman signed affidavits attesting that the transfers would not render him insolvent. [] (Such self-serving affidavits are entitled to little, if any, weight and do not contradict the overwhelming circumstantial and documentary evidence that show that these transfers were undertaken to remove valuable assets from the reach of potential judgment creditors.
Badge of Fraud to Citibank.
- Did Freidman engage in transactions to defeat his creditors? And 6. Do the surrounding circumstances show that Freidman intended to defeat his creditors? The Court first noted that "fraudulent intent is rarely susceptible to direct proof", which is legalize for saying that a debtor will rarely if ever admit to having made a fraudulent transfer. Instead, the law in Anglo-American jurisprudence has been ever since Farmer Twyne claimed that he didn't make a fraudulent transfer of sheep to defraud his creditors, and lost in 1601, is the Court can instead look to the surrounding circumstances to determine the debtor's real intentions. That is what the Court here next proceeded to do.
That Freidman intended to defraud his creditors was apparent from the fact that he created and funded his trusts only shortly after being sued by Citibank, and the trusts were "in three different offshore locations." Moreover, Freidman appointed his attorneys to be the trustees, although they never really acted that way or even knew much about what they were supposed to do. And, all the time, Freidman himself retained direct control over the assets as the manager of the companies in which the assets were held.
This brings us to a phenomena known as the "Estate Planning Defense", i.e., that he wasn't thinking about creditors at all, but simply chose this point in time to get his affairs in order and dodge some estate taxes. And, as usual, for a debtor who is in financial distress, that defense once again flops:
Freidman asserts that he undertook these transfers simply for estate planning purposes, a proposition that strains credulity. From the perspective of an inquiry into the presence of the badges of fraud, it is difficult to imagine a more arresting chronology. These transfers occurred against the background of a suit by Citibank to recover in excess of $40 million dollars, and a confession of judgment entered by Capital One, which resulted in a judgment of almost $8.5 million dollars. It is impossible to conclude that the timing of the transfers is merely coincidence.
Another problem is that Freidman and his attorneys that had acted as the Trustees of the four trusts couldn't get their stories straight. Freidman testified that he didn't know why these Trustees suddenly resigned, their resignations surprised him, and he certainly didn't tell them to do that. But at least one of these former Trustees testified that they were fired by Freidman, and that Freidman stated at the time that he desired to replace the domestic Trustees with foreign Trustees.
Finally, Freidman argued that because the transfers were openly recorded and sent to creditors militated against the transfers to the four trusts being fraudulent transfers. But the court didn't buy it, point out that whatever Freidman did after the transfers did not mitigate his intent to cheat his creditors when he made the transfers in the first place.
Badge of Fraud to Citibank. The Court summarized this part of its opinion with "the badges of fraud are numerous and glaring", and thus held that the proof supported Citibank's claim that Freidman had committed fraudulent transfers.
Can Citibank Attach Property That Freidman No Longer Owns?
Freidman argued that the Bankruptcy Court could not attach the property that had been transferred to the four trusts, for the simple reason that Freidman no longer owned the property. Indeed, that is the general rule, but (general rules being generally inapplicable) courts may attach property that a debtor has fraudulently transferred.
And that is what the Court in this case did, which was to allow Citibank to attach all of the properties that were transferred to the four trusts.
ANALYSIS
First, as I seem to have to so frequently do in cases like this, I must caveat that this case is not about anything like legitimate asset protection planning, which does not seek to defraud or defeat the rights of anybody, but instead simply take chips off the table and transfers those chips to future generations.
To the contrary, the planning here is nothing more-or-less than a fraud on creditors -- an overt attempt to cheat Citibank out of its collection rights. There is very little here that is in the way of legitimate planning.
What we do have here is another example of where the so-called "estate planning defense" has flopped.
If an affluent person has no creditors, then doing estate planning makes sense on many levels, i.e., succession planning and federal estate and gift tax planning at least. Then, it is a good defense.
But if a person has substantial creditors, and is arguably insolvent, then the courts are simply not buying the "estate planning defense". It is no surprise, because the "estate planning defense" makes little sense when there is an insolvent defendant, largely because the debtor doesn't have an estate to plan for, but instead should be conserving his assets to satisfy creditors.
Another issue that comes up in this case is the extent to which a settlor (a/k/a the creator of the trust) retains control over assets that have been transferred to a trust. These days, it is quite popular to make the settlor the "investment advisor" and suchlike. As this case shows, that is probably not a good idea because of the fraudulent transfer issues that might later in arise if the settlor gets into trouble.
Finally, we see the problem with planning with real estate, which is that it is immovable. Foreign Asset Protection Trusts work because the assets are outside the jurisdiction of the U.S. courts. But domestic real estate will never be beyond the jurisdiction of the U.S. courts, and thus the main protection of an offshore trust does not apply.
As here, the U.S. courts have the power to look past the legal titling of real property in an offshore trust and determine that the real owner is some domestic person or entity. Thus, attempting to protect domestic real estate with an offshore trust is quite possibly asset protection malpractice per se.
Yet, we keep see folks attempting to do what is almost always a failure; go figure.
CITE AS
In re Hypnotic Taxi LLC, 2016 WL 145870 (Bk.E.D.N.Y., Jan. 12, 2016). http://goo.gl/EWgxRk
This article at http://onforb.es/1UxYjVf and http://goo.gl/rCV7pk
