Attorney Mark E. Schlussel ended up owing his former partner in a non-legal business, Terrace Dillard, about $500,000 on a judgment arising from the dissolution of the business. The judgment was entered in 2008 in Arizona, and domesticated the following year in Michigan.
At his debtor's examination, Mark admitted to having owned a company called M&A Enterprises ("M&A"), which employed and paid Mark a salary to provide consulting services. This company, which apparently had no assets, was transferred by Mark to his wife, Rose Lynn Dillard, in 2004.
Mark also produced his personal income tax returns, beginning with tax year 2004. Those returns showed that Mark had earned substantial income between 2004 and 2008, which Mark claimed to have spent in its entirety.
Mark testified that he and Rose had monthly expenses of approximately $18,000 per month, but wobbled on where that money came from, or into which account it went.
In 2011, Dillard brought a fraudulent transfer action against Mark, Rose Lynn, M&A and Mark's law practice, under Michigan's Uniform Fraudulent Transfer Act ("MUFTA"). Dillard alleged that Mark had transferred moneys to M&A accounts over which Rose Lynn had signatory capacity. Dillard also alleged that Mark had transferred the cash value of a life insurance policy to Rose Lynn.
Among the Defendants' affirmative defenses were that the funds alleged to have been fraudulently transferred "were used for customary living expenses."
When Rose Lynn was deposed, she admitted to receiving $26,000 in deposits from Mark, but claimed that she used the money to pay their living expenses. Rose Lynn also admitted that Mark after Dillard garnished Mark's personal checking account, he quit depositing checks into that account and instead deposited his checks into the M&A accounts controlled by Rose Lynn.
Rose Lynn further testified that all the money that Mark deposited into the M&A accounts was used to pay their living expenses.
Defendants moved for summary judgment against Dillard, which was granted by the trial court on the grounds that all the funds that Mark transferred to Rose Lynn were exempt because they were used to pay household expenses.
Dillard appealed, thus setting up for the Michigan Court of Appeals to decide whether there is a "living expenses" defense to a fraudulent transfer.
That court, in a very well-crafted Opinion, said no:
That the Schlussels used the transferred funds to pay their personal "living" expenses does not defeat Dillard's MUFTA claims.
The Court first verified that the facts supported a Dillard's fraudulent transfer, finding that Mark intended to defeat Dillard's collection rights by depositing checks into the M&A accounts controlled by his wife (a statutory "insider"). The Court then turned to trial court's finding that because Rose Lynn spent the moneys on living expenses, Mark's transfers to her were "reasonable" and thus there could not be any fraudulent transfer between Mark and Rose Lynn:
Three fundamental legal errors undercut the circuit court's ruling.
First, once a creditor establishes the presence of multiple badges of fraud, he or she has established a fact question regarding actual intent.
Second, by ignoring the factors supporting Mark's actual intent to fraudulently transfer his earnings and instead crediting the Schlussels' claim that they merely intended to pay expenses rather than to hinder Dillard's collection efforts, the circuit court invaded the province of the fact finder.
Third, "reasonably equivalent value" received by a transferee is not a defense to a claim brought under sec. 4(1)(a). Receipt of "reasonably equivalent value" may present an obstacle to avoidance of transfers challenged under sec. 4(1)(a), but it does not cleanse the transfers of their fraud. In other words, the consideration exchanged for an intentionally fraudulent transfer may limit the creditor's remedy, but it does not negate the fraudulent transfer claim itself. "[T]he determination that the transfer is fraudulent is conceptually distinct from the avoidance of the transfer, which is, in turn, separate and distinct from a recovery based upon the avoidance of a transfer." In re Cohen, 199 BR 709, 716 (CA 9, 1996). And here, Rose Lynn exchanged no value for the transfers, completely defeating defendants' argument.
Fraudulent transfer law operates largely on the principle of "reasonably equivalent value", meaning that the Court will look to see what the debtor got back in exchange for what the debtor transferred. Here, Mark didn't get anything for transferring money to Rose Lynn, and so there was no "reasonably equivalent value" present.
It is here that Mark tried to play another card, claiming that his transfers to Rose Lynn were for really for "estate planning purposes" and not to cheat Dillard out of enforcing the judgment. But the Court noted that at best this was an issue for the fact-finder, and thus not suitable for summary judgment, though the Court itself was quite skeptical:
Footnote 8. Mark also asserts that he transferred M & A to his wife for "estate planning purposes," thereby negating any fraud. Record evidence substantiates that the transfer was made for estate preservation, as are most fraudulent transfers to insiders. To the extent that one's intent to keep one's money corresponds with "estate planning," the fact finder may decide to credit Mark's contention. Nevertheless, the transfer bears many indicia of actual fraud, and these indicia are not cleansed by Mark's claim that he was merely planning his "estate." Mark admitted as much during his creditor's exam when he offered that he transferred M & A to his wife for "[e]state planning purposes, I wanted to get things in her name, not my name." Whether placing a straw corporation regularly drained of assets in Rose Lynn's name was accomplished for purposes unrelated to hindering, delaying or defrauding Dillard is for the fact finder to determine.
There are two basic types fraudulent transfer, what are known as "actual fraudulent transfers" (the intent-based test of Section 4 of the UFTA) and "constructive fraudulent transfers" (the insolvency-based test of Section 5 of the UFTA).
The Court noted that while "reasonably equivalent value" was an important consideration, it was not the sine qua non of an actual fraudulent transfer claim. Instead, the Court focuses on the intent of the debtor in making the transfer -- did the debtor make the transfer with the intent of defeating the collection rights of his creditors?
Thus, the transfer could be for "reasonably equivalent value" and still satisfy the "actual fraudulent transfer" test under Section 4 of the UFTA, if the debtor had the intent to cheat his creditors.
Where "reasonably equivalent value" might come into play in an actual fraudulent transfer case is where the transferee claims the "good faith transferee defense" (section 8 of the UFTA) which basically has two elements: (1) the transferee didn't know the debtor was in financial trouble, and (2) the transferee gave "reasonably equivalent value" in exchange for what we received from the debtor.
This last point is where the Schlussel's came a'cropper, since Rose Lynn didn't pay Mark anything in exchange for what he transferred to her:
Rather, MCL 566.38(1) provides that "[a] transfer ... is not voidable under section 4(1)(a) against a person who took in good faith and for a reasonably equivalent value...." In other words, transferees who have exchanged "reasonably equivalent value" for a transfer are protected from the avoidance remedy—they can keep that which they paid for. This makes good sense. If Mark exchanged his law firm check for a car, the dealer who sold him the vehicle would not be subject to avoidance of the transfer, because the dealer gave value in exchange. In other words, the MUFTA protects good faith purchasers for value. But neither Rose Lynn nor M & A gave anything in exchange for the transfers, rendering sec. 8 inapplicable. Because the transfers of Mark's money were entirely gratuitous as to Rose Lynn and M & A, the Schlussels cannot avoid liability by interposing a "reasonably equivalent value" defense, and the circuit court erred by applying this remedy provision as a legal bar to Dillard's actual intent claim.
The Court then turned to whether Mark's transfers to Rose Lynn were constructive fraudulent transfers under Section 5 of the MUFTA. A constructive fraudulent transfer claim is easy to measure, since it only has two black-and-white tests: (1) Was the debtor insolvent at the time of the transfers, or did the transfer render the debtor insolvent? and (2) Did the debtor receive "reasonably equivalent value" in exchange for the transfer?
Intent does not play a role in a constructive fraudulent transfer case, but instead the Court looks to the cold, hard economic facts of the situation.
Here, the Schlussels tried to argue that Mark received "reasonably equivalent value" for what he paid to Rose Lynn, because the money was eventually spent on their household expenses. The Court didn't buy it:
This argument finds no support in case law, or in the logic or language of the MUFTA.
The Court then engaged in a discussion of what constitutes "value", noting that:
"Value" is to be determined in light of the purpose of the Act to protect a debtor's estate from being depleted to the prejudice of the debtor's unsecured creditors. Consideration having no utility from a creditor's viewpoint does not satisfy the statutory definition.
* * *
Indirect, noneconomic benefits that preserve a family relationship do not provide reasonably equivalent value. [] Thus, any promise made by Mark to support his wife, or to pay their joint household expenses, has no bearing here.
[citations omitted]
Proving living expenses to his family, while it might sound nice, simply didn't equate with anything like "reasonably equivalent value" that Dillard could enforce her judgment against. The key, said the Court, is that what the debtor got back have the same "commercial value" as what the debtor transferred -- and of course spent "living expenses" have no commercial value at all.
To try to get around this result, Mark argued that some of the money that he transferred to Rose Lynn was eventually used by her to pay the couple's other creditors. But these later payments didn't create "reasonably equivalent value" at the time of the transfers:
Record evidence substantiates that Mark received no contemporaneous value from Rose Lynn for the transfers made to her. Any "value" came later, indirectly, when Rose Lynn used the money to pay other creditors. However, "value" obtained from the checks down the road is simply inconsequential under the MUFTA. Judge Posner has explained:
[W]e think the inquiry should stop at the first stage of the analysis, that is, should stop after it is determined that the transfer was not supported by consideration. If it was gratuitous, the fact that some or for that matter all of it may later have seeped back to the debtor does not legitimize the transfer.... A compelling reason for stopping at the first stage is that the seeping back of the transferred money or property to the transferor is strong evidence of actual fraud by him. It is one thing to make a gift; it is another to transfer money to someone whom you expect to retransfer it to you; the inescapable implication is that you are parking your money in a place where you hope your creditors won't know to look.
[citing The Nostalgia Network v. Lockwood, 315 F3d 717, 720 (CA 7, 2002) (citations omitted).]
This brought the Court back to the defendants' primary argument, which was that the expenditure of the transferred funds on living expenses somehow created an absolute defense to fraudulent transfer liability. If there was any doubt that such did not constitute a defense under the MUFTA, the Court squashed that doubt:
[C]ommon sense dictates that spending money on oneself or one's spouse does not automatically trump a fraudulent transfer claim. If it did, the MUFTA would be a useless waste of ink and paper, as every debtor would simply transfer any cash in his possession to a covert account, spend it freely, and thereby avoid liability on a court-entered judgment. The circuit court's ruling would freely permit a debtor and his spouse to avoid liability for an otherwise fraudulent transfer simply by spending the money on themselves. Our Supreme Court long ago condemned this reasoning in a similar case, in which the creditor-plaintiff claimed that the debtor-defendants had placed their property "under cover of the wife with intent to thereby keep the same away from the creditors of the husband." [] The Court affirmed a judgment in the plaintiff's favor, concluding with this colorful language:
Subsequent accumulations, being those of the husband, are not covered by the skirts of the wife. Defendants have treated such subsequent accumulations as belonging to the husband up to the point where creditors try to step in. The transparent screen of the ownership of the wife offers no insurmountable hurdle to the law. []
The MUFTA is not so easily circumvented.
[Internal quotations omitted]
Instead of hiding assets by his transfers to Rose Lynn, the Court wrote, Mark should have just taken his payments from his law firm, which would have been subject to the 25% federal limitation on wage garnishment under 15 USC § 1673(a)(1). That way, Mark could have lawfully protected 75% of his paycheck, but instead he tried to protect 100% by secreting funds with Rose Lynn -- and so may end up instead with a judgment against him and Rose Lynn for 100% of it. (The phrase "pigs get fat, hogs get slaughtered" comes to mind here).
The Court in a footnote likewise called into question whether the large amounts the Schlussels attributed to "living expenses" were reasonable:
Footnote 9. Even were it relevant, the "reasonableness" of the Schlussels' expenses also constitutes a question of fact. Simply put, whether the hundreds of thousands of dollars that flowed from Mark into the M & A Consulting account represented an amount reasonably necessary for the Schlussels' support represents a question of fact. That the Schlussels "ordinarily" spent $250,000–$275,000 per year on themselves does not mean that this sum was "reasonable." Contrary to the circuit court's ruling, the Schlussels' "ordinary" living expenses are meaningless under the MUFTA. Rather, the issue is the reasonableness of the consideration received for the transfer from the perspective of the creditor. Nt'l L Investors, LP v. Robinson, 98 SW3d 781, 784 n. 2 (Tex App, 2003):
Indeed, if the legitimacy of a conveyance was determined from the perspective of the debtor, it is questionable whether any transfer could ever be considered fraudulent viz his creditors. No doubt the debtor could always divine some explanation for transferring the property as he did, even though his creditors are left with nothing to satisfy the debt. He could always divine some subjective benefit which may be valueless to the creditor.
In the end, the Court held that summary judgment was not appropriate as to Mark's cash value life insurance policy that Mark transferred from M&A to Rose Lynn. Mark had argued that because M&A owned the policy, and it was not a debtor, that it could not have fraudulently transferred the policy to anyone. But the Court held that the trial court should first have determined whether this policy really constituted Mark's property, and not M&A's property.
Thus, the Court reversed the summary judgment, and remanded the case back to the trial court for further proceedings -- suggesting in footnote 10 that it might be appropriate for the trial court to either appoint a receiver or impose a constructive trust as necessary to recoup assets.
ANALYSIS
Once again -- and this is getting to be a dead horse so often beaten that it hardly deserves mention -- we see that one cannot merely chant "estate planning defense" and a scheme to defeat creditors is somehow magically legitimized. Indeed, for the Schlussels to even argue that they made their transfers for estate planning purposes is particularly ridiculous for the reason that, with his unpaid debts, Mark effectively had no "estate" to worry about transferring.
This is a common theme by debtors who are in financial distress: They claim "estate planning" as their excuse for their planning, when they really have no meaningful estate at all. If they don't think the courts can't see through this charade, they're nuts. Nonetheless, debtors not having much of an estate persist in this defense though it is often a significant factor in toasting their credibility.
If somebody with a legitimate estate planning issue does planning well in advance of creditor difficulties, then they should normally be able to claim that they lacked the intent to defeat creditors because they had other significant motivations for their planning. That is a legitimate "estate planning defense", and must be contrasted with the assertion of that defense by somebody who doesn't have much if any of an estate to plan for, and has current creditors -- the defense will probably never fly in those latter circumstances.
The Court of Appeals in its opinion does an excellent job of blowing up the "living expenses" defense, and demonstrating that it doesn't even exist. No need to cover that again.
But what is worth covering again is the concept of "utility to creditors", which is that the very important element of "reasonably equivalent value" is always measured from perspective of creditors, and not the debtor. How the debtor measures the value that he got back from the transferee is totally irrelevant to anything.
Consider the debtor who prizes his aunt's oil painting of the debtor prized bull terrier. To the debtor, that painting is worth $1 million, and so when he pays his aunt $10,000 for it, he's getting it at a great bargain. But the true "reasonably equivalent value" is what the painting would garner at an auction -- more like $5. In such a case, there is no "reasonably equivalent value" for the $10,000 that the debtor transferred to his aunt, since it would only be worth $5 to creditors -- that is the painting's true value for fraudulent transfer purposes.
Now, in such a case, if the aunt were in good faith, meaning she didn't know that her nephew had creditor problems, then she would be a "good faith transferee" and entitled to assert that defense -- for the $5 value of the painting. In other words, the aunt would have to repay creditors $9,995 and keep the $5.
Where the concept of "utility to creditors" most often rears its ugly head is in those situations where the debtor is trying to convert a liquid asset that is readily available to creditors, into an illiquid asset of about the same book value that is of little value to creditors. These attempts fail because of "utility to creditors".
For example, it is lore in the asset protection world that if a debtor has liquid cash, the debtor can invest the cash into a Limited Liability Company (LLC) or Limited Partnership (LP), such that the debtor gets an interest that is subject to "charging order protection", which means that the creditor cannot get at the cash that was invested.
However, it is precisely this "charging order protection" that kills the "utility to creditors" of the LLC or LP interest that the debtor received in return for the cash. That interest certainly does not have the same "utility to creditors" as the debtor's cash did, and so there is no "reasonably equivalent value" for that transfer.
The "utility to creditors" problem seems to trip up most the CPAs and financial advisors who pretend to be asset protection planners, since (in their minds) there was a dollar-for-dollar transfer ($100 cash for a $100 LLC interest) such that "reasonably equivalent value" should be satisfied. In their world of dollars, that seems like the natural outcome, but in the legal world it is a huge mistake, since the $100 LLC interests does not have anything like the same "utility to creditors" as the $100 cash.
Finally, once again we see a debtor who outsmarts himself. As the Court of Appeals noted, if Mark had simply continued to take a salary from his law firm, the most Dillard (and other creditors) could garnish under federal law was 25% of Mark's "net disposable income", which is calculated after the deductions for taxes and FICA, etc., and minimal living expenses. Dillard probably would have gotten something (but, after all, respectable folks pay their debts), but Mark and Rose Lynn would have been able to legitimately cover the bulk of their living expenses.
As it is, it will likely be very difficult for the Schlussels to win at the trial court level, particularly after the Court of Appeals took the lower court to the fraudulent transfer woodshed and proclaimed it to be wrong about pretty much everything. But even beyond that, if a judgment is ultimately entered for the fraudulent transfer, then such might be difficult to discharge in bankruptcy -- a fraudulent transfer that backfires is not a pleasant thing to contemplate.
I'll bet that 75% of disposable income that Mark and Rose Lynn could have legitimately kept is starting to look pretty darn good about now.
CITE AS
Dillard v. Schlussel, 2014 WL 5361674 (Mich.App., Unpublished, Oct. 21, 2014). Full Opinion at http://goo.gl/Ke7ndc
This article at http://onforb.es/1tbCQX8 and http://goo.gl/g5eVIv
