This case arises from a swimming pool that husband and wife Homeowners built in the year 2000. The Homeowners hired a general contractor, who itself hired Engineer (our defendant/debtor) to test the soil and prepare a soil report.
We'll come back to the swimming pool in a few paragraphs when we reach the year 2008, by which time the pool has cracked and a lawsuit has erupted.
Instead, let's move ahead only four years, to 2004, when Engineer started worrying that someday he might be sued by somebody (there is no evidence that he was thinking specifically of our Homeowners here).
Seeking asset protection, our future Engineer formed three trusts. Into one of the trusts (which we'll just call the "Trust") formed under Nevada law, the Engineer transferred the bulk of his worldly wealth. This wealth consisted of four properties, his bank accounts, certificates of deposit, and some vehicles. One of the properties was a valuable office building out of which the Engineer ran his business.
The transfers were admittedly without any consideration, i.e., they were outright gifts by the Engineer to the Trust. After these transfers, Engineer was "left personally with no assets worth more than $500" according to his own testimoney.
Critically, Engineer also admitted that his intent in transferring his office building to the Trust was for "asset protection" and so that "creditors could not go after any equity that [the Trust] owned in that property."
Engineer operated his business out of the same office building owned by the Trust, and the Trust didn't charge him any rentals. The Engineer had also transferred his personal residence into the Trust, and he and his family lived there, also rent-free.
Here, let me digress and say that the Trust wasn't much of an asset protection structure in the first place, being sort of what one would expect a do-it-yourselfer engineer to concoct by reading some stuff about asset protection on the internet and in Popular Mechanics, and then assembling legal structures without any real idea about how they were supposed to work. Think of it all as a kid who builds an airplane out of cardboard boxes, and "flies" it off the roof to a wholly predictable result, care of the Law of Gravity.
For instance, the Engineer made himself the "managing director" of the Trust (and his other trusts), and as the "managing director" he directly controlled all the Trust bank accounts, traded stocks, dealt with tenants, and paid his XM radio bill, credit cards, newspaper subscriptions, etc., etc., et stupidium. Engineer might as well have named Trust the "Alter Ego Trust" because that is what it amounted to.
The one saving grace to Engineer's scheme was that he was not the beneficiary of the Trust, but rather he named his brother as the sole beneficiary. So, at least it was not a self-settled spendthrift trust which are not respected for creditor purposes in California as to the settlor/beneficiary. Thus the Homeowners, to whom we shall now return, had to figure out how to bust the Trust and get at its assets.
By 2008, the pool was leaking and the Homeowners sued the contractor, the Engineer, and others involved in the project for negligence. Engineer settled with the Homeowners for $92,500 and the Homeowners awaited their check for the settlement payment.
It never came.
Frustrated, the Homeowners levied on the Engineer's office building, now titled in the name of the Trust. A couple of days before the Sheriff's sale of the office building, Engineer's buddy who was one of the trustees showed up and filed a third-party claim on behalf of the Trust, stating that the Trust was the true owner of the office building and the Engineer had no equity that could be sold.
For those of you who don't practice in the often alien legal world of post-judgment collections, a third-party claim is a claim by somebody that they -- not the debtor -- are the true owners of the property. Since it is not the job of our friendly but gun-toting Sheriff to make legal determinations as to who-owns-what, a third-party claim effectively gums up the works of any levy, and the Sheriff cancelled the sale of the office building. Score one for Engineer.
Homeowners then filed a petition to invalidate the Trust's third-party claim, and alleged that the Engineer's 2004 transfer of the office building to the Trust was a fraudulent transfer under the California Uniform Fraudulent Transfers Act ("UFTA"). Homeowners also claimed that the Trust was the alter ego of Engineer. Whereupon, the trial court held a bench trial wherein the Engineer was the sole witness. The trial court found that the Engineer was the alter ego of the Trust, and that the office building had been fraudulently transferred to the Trust.
Here is where it gets interesting from an asset protection planning perspective.
The Court's fraudulent transfer ruling was based on the Engineer's testimony that he transferred the office building "because soils engineers are frequently sued." Although there was no evidence that the Engineer transferred the office building to defeat the rights of the Homeowners specifically, or that Engineer even suspected they were having problems with their pool, the trial court found that the Homeowners "were reasonably foreseeable as future judgment creditors under the UFTA."
Stated differently, the trial court found that even though there was no existing "claim" at the time our Engineer made his transfers, the transfer was a fraudulent transfer because the Engineer made the transfers for the stated purpose of defeating the collection rights of unknown future claimants who might come along later.
Carried to its logical conclusion, this ruling means that a person cannot make transfers meant to take assets off the table against future claimants who might come along later -- which is arguably the very purpose of asset protection planning! In other words, if asset protection planning is not planning against future unknown creditors, then what is it?
Jointly appealing the decision, the Engineer and Trust argued that the fraudulent transfer laws are not meant to encompass claims against future, unknown creditors. Only if --and there was absolutely no evidence of this -- the Engineer had specifically intended to defeat the collection rights of Homeowners or some other existing creditors, they argued, could a fraudulent transfer action rightly prevail.
But in a very detailed analysis, the Court of Appeals rejected the notion that the UFTA is limited to only existing creditors:
The statute does not include the terms 'future creditor' or 'future potential creditors' . . . and does not require that, from the debtor's perspective, a creditor who challenges a transfer as fraudulent under the UFTA to have been reasonably foreseeable as the debtor's creditor before pursuing remedies under the UFTA. Furthermore, the statute does not require that the debtor intended to hinder, delay, or defraud the specific creditor who challenges a transfer of an asset as violative of the UFTA. On the contrary, section 3439.04, subdivision (a) provides that a current creditor can challenge a transfer as fraudulent, regardless whether that creditor had a claim at the time of the transfer, if that creditor can prove, inter alia, the transfer was made to hinder, delay, or defraud any creditor.
For support, the Court of Appeals dug out an obscure 1947 opinion [fn. 1] interpreting the California Uniform Fraudulent Conveyances Act ("UFCA" -- the predecessor to the modern UFTA), to find a fraudulent transfer as to the "future creditors" of a failing business:
Future creditors as well as present creditors are protected by the legislation relating to fraudulent conveyances. Such protection is extended . . . under the Uniform Fraudulent Conveyance Act . . . Appellants do not cite any legal authority showing the Legislature intended to change this unrestricted interpretation of "future creditors" with the passage of the UFTA in 1986.
Having thus held that a general intent by a debtor to defeat the rights of "future creditors" would satisfy the intent requirement of the UFTA, it was thus an easy thing for the Court of Appeals to next apply against him the Engineer's admission that he was trying to protect his assets against future lawsuits, i.e., future creditors, such that he had committed a fraudulent transfer. This was made easy for the Court of Appeals, since so many of the other elements of a fraudulent transfer claim were easily established, i.e., the transfer lacked reasonably equivalent value, was to an insider, etc.
Left grasping at straws, the Engineer and Trust also tried to argue that Nevada's UFTA should apply instead of California's UFTA, since the Trust was formed in Nevada. The Court of Appeals rejected this by pointing to the UFTA as being a uniform act, and ruled that the result in Nevada would not have been any different even if the Silver State's law were to apply instead.
Having found that the transfer of the office building to the Trust to be a fraudulent transfer, the Court of Appeals decided that it did not have consider the trial court's alter ego finding as to the Engineer and his Trust, and on that note affirmed the trial court's decision.
ANALYSIS
Before I go into the analysis of his opinion, I know that there are readers out there who will want to dismiss this as an "unpublished" decision and thus entitled to no weight whatsoever. I get that concern.
However, as a practical matter, unpublished decisions are ignored at great peril. There is little reason to believe that this particular appellate panel would reach a different legal conclusion in another case, one that is published, or even one on better facts.
While unpublished opinions cannot be cited by the parties to a lawsuit, that does not mean that judges and clerks do not read them and get guidance from them in the absence of other authorities. On numerous occasions, I've frequently seen courts recite text from unpublished opinions verbatim, without citation, but adopting that text as their own reasoning.
Yes, this decision is unpublished and thus carries no precedential value for future cases. But it is also out there for the reading, and is an indication of at least how this particular panel views this area of law.
Now on to the Monday morning quarterbacking.
I caveat my next remarks with the disclaimer that nobody has seen fitten to give me a black robe, and thus it is probably with the greatest arrogance that I hereby proclaim this decision to be wrongly decided.
This is not a case of a "future creditor" but rather an "existing creditor". Under the UFTA, a claim is very broadly defined as "a right to payment, whether or not the right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured."
Note that what is missing from that statutory definition is whether the claim is "known" or "unknown" -- it just doesn't matter for purposes of that definition.
Basically, a "claim" occurs whenever an event has happened to create a liability. Here, that event was the Engineer's alleged negligence in regard to his soil studies for the swimming pool -- and that negligence occurred, if at all, in 2000 when the pool was built, and four year before the Engineer made his transfers in 2004.
Thus, in 2004 the "claim" existed even if the Engineer didn't know about it. Homeowners were "present, existing creditors" not future ones. But even that parsing of terms should not matter in the context of these facts.
By his own admission, the Engineer's transfers to the Trust were without reasonably equivalent value. The Engineer's transfers to the Trust left him with less than $500 in other assets -- which means that by the time one takes into account the $92,500 judgment (the value of a claim is determined retrospectively based on what the judgment turns out to be), the transfers left the Engineer insolvent.
Under Section 5(a) of the UFTA:
"A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation."
Thus, the Engineer's 2004 transfers to his Trust was a "technical fraudulent transfer" for which the Engineer's knowledge of the 2000 claim was irrelevant. When the Engineer transferred his property in 2004 to the Trust, those transfers were fraudulent transfers whether the Engineer had the best of intentions or the worst, since "intent" is not an element of a Section 5(a) fraudulent transfer claim.
The Section 5(a) fraudulent transfer finding was the correct route for the Court to find a fraudulent transfer, not to meander off into the "future or present creditor" morass on the back of a 1947 opinion of dubious application.
In the context of this case, Section 5(a) illustrates the perils of making transfers which lack reasonably equivalent value (i.e., gifts), and which leave the transferor dangerously close to insolvency. In such a case, as here, an unknown but then-existing claim could then technically renders the transferror insolvent under the UFTA.
This is exactly why transfers-for-value, i.e., sales, which do not change the transferor's balance sheet but instead simply replace one asset for another (such as a note for the value of whatever was transferred) are infinitely preferable forms of transfers where asset protection is any consideration.
But again, nobody has seen fitten to give me a black robe. The more prudent course for planners is to simply take this opinion at face value, even if it is unpublished, and even if it could have been better decided on either the UFTA section 5(a) grounds or on alter ego grounds.
Taking this opinion at face value, the lesson here is simple and commonsensical but is one that is often ignored by planners: Asset protection planning should rarely be undertaken in its own name or for that stated purpose.
If the Engineer here had not admitted that he put this structure in place for asset protection purposes, and to defeat the rights of future claimants who might sue him over soil studies gone bad, then the result might have been very different on this point.
There is rarely a need to announce to the world that something was done for asset protection purposes, to call something an "asset protection trust", to send an "asset protection" engagement letter, or any of the like. Yet, bad planners and do-it-yourselfers do it every day.
To the contrary, asset protection planning should almost exclusively be undertaken for some other purpose than creditor planning. [fn. 2] Do it for estate or succession planning reasons, do it for general business or financial planning reasons, do it for health reasons, do it because you're trying to look out for an heir, but don't state that you're doing it for creditor reasons.
Whatever is done for asset protection planning needs to do more than merely recite these words, but must reasonably work to accomplish these goals. Like tax shelters which only work when the tax benefits are "incidental" to the non-tax purposes of the transaction, asset protection planning is best done when the anti-creditor benefits are simply incidental (even if very effective) to the non-creditor purposes of the planning.
Had the Engineer heeded that simple advice, then he probably would not have suffered this ruling on these grounds. He probably would still have lost on other grounds, but stay with me here.
The practical truth is that the UFTA is poorly drafted. The Act is confusing to those of us who practice in the area regularly, and it can be easily misunderstood and misapplied by those courts which do not regularly face UFTA issues, i.e., non-bankruptcy courts.
The "future creditors" versus "present creditors" issue is among the most confusing UFTA issues. So, avoid creating fodder for litigation by giving creditors the chance to argue what amounts to a "transferred intent" argument -- an improper intent to defeat the rights of Creditor A now, can be transferred to Creditor B who comes along later.
Simply put, purge the two words "asset protection" from your documents, and tell your clients never to mutter those words or write or e-mail or fax or say anything like they did planning in case creditors came along later. It can't do any imaginable good, and (as here) it can certainly hurt. Even if you win later on appeal by arguing the technical merits of what "future creditors" really means (six figures in legal fees later) that was a dispute that was probably easily avoided in the first place by not creating evidence of intention to defeat the rights of creditors.
At the end of the day, that's what this opinion is really all about.
Kilker v. Stillman, 2012 WL 5902348 (Cal.App. 4 Dist., Unpublished, Nov. 26, 2012). Full Opinion at http://goo.gl/utZ5z
This article at http://onforb.es/UvzNal and http://goo.gl/jS8Sj
FN1. Severance v. Knight–Counihan Co., 29 Cal.2d 561, 567–568 (1947).
FN2. About the only place that one can safely mention that planning is being done for asset protection reasons in in the area of exemption planning, since exemptions by their very nature are meant to defeat the rights of creditors. But even then, in some states, one has to be wary of a "fraudulent conversion" claim, i.e., a claim that assets were wrongfully converted from non-exempt to exempt assets. The better practice is to just avoid the use of the term entirely whenever possible.
