In this latest installment of our rags-to-riches-to-rags series, our Debtor, Georges Marciano, as the co-founder of Guess, at one point had a net worth of $170 million, and his Trust in 2008 had a "book value" of $360 million.
However, by 2011, Marciano had lost a counterclaim lawsuit for defamation and was placed into involuntary bankruptcy in California, where the Court ordered him to turn over his property and file schedules of assets.
At first, Marciano filed blank, unsigned schedules. Then, after the Bankruptcy Trustee started chasing his IRA account, Marciano amended his schedule to list just the IRA account, and as an exempt asset. Not impressed, the Bankruptcy Court held that the account was property of the estate and Marciano's claim of exemption was made in bad faith.
Then, there were the debtor examinations. Marciano blew off three scheduled debtor examinations, and then missed the fourth on the grounds that he had back problems that made it "medically inadvisable" for him to fly on commercial aircraft back to California. That didn't stop Marciano from actually flying back to California for visits, without notifying the Bankruptcy Trustee so that he could be examined.
Threatened with contempt, Marciano finally filed his schedules, listing just over $2.3 million in assets. The Bankruptcy Trustee argued that these schedules were "incomplete and inadequate", and failed to account for Marciano's former wealth.
For his part, Marciano -- who had since moved to Montreal -- blamed the Bankruptcy Trustee for seizing his assets, which "made it impossible for him to accurately inventory his assets". The Bankruptcy Trustee had followed Marciano to Montreal and seized a collection of expensive watches, a rare diamond known as the "Chloe Diamond", stock certificates, and legal documents showing Marciano's ownership in various entities.
On December 5, 2011, the Court held Marciano in contempt, but ruled that he could purge the contempt by filing complete and accurate schedules of his assets, turning the assets over to the Trustee, and allowing an inspection of exempt assets.
Shortly thereafter, on December 31, 2011, Marciano filed new schedules that listed pretty much the same property that he had listed before -- but this time claiming that the property was never real his property.
Tired of his shenanigans, on January 13, 2012, the Bankruptcy Court issued a bench warrant for Marciano's arrest. The Bankruptcy Court found that Marciano had failed to turn over his assets to the Bankruptcy Trustee, and failed to allow an inspection of his exempt assets. Marciano then appealed the Bankruptcy Court's Order to the U.S. District Court for the Central District of California, which gave us this Opinion.
The District Court noted that civil contempt is meant to coercive future activity, as opposed to criminal contempt which seeks to punish past bad behavior. Because civil contempt is coercive, it is said that the party in contempt "carries the keys of his prison in his own pockets" because he can purge the contempt simply by complying with the Court's orders.
However, if it is impossible for a party to comply with a Court's orders, then the party is normally excused from compliance -- this is known as the "impossibility defense" to a civil contempt charge.
As held in the landmark Ninth Circuit opinion in FTC v. Affordable Media, 179 F.3d 1228, 1239 (9th Cir. 1999) (a/k/a "the Anderson decision" after the names of the debtors in that case), the creditor must first show by clear and convincing evidence that the debtor violated a court order. If so, then the debtor must show by clear and convincing evidence that compliance was impossible.
What this means, as a practical matter, is that the debtor must effective prove a negative by clear and convincing evidence (a very high standard), which is that there was no way that the debtor could possibly comply with the Court's order. Or as the District Court in Marciano stated:
The facts of Affordable Media make it particularly relevant to this appeal. In that case, two defendants had been held in contempt for failure to repatriate assets held by a foreign asset protection trust that they had created. The defendants argued that compliance was impossible because the law governing the trust did not allow for repatriation. The Ninth Circuit rejected this argument, noting that the defendants' "inability to comply with the district court's repatration order is the intended result of their own conduct." Id. at 1239. The Circuit expressed doubt that impossibility could ever be a valid defense where the claimed impossibility resulted from the contemnor's efforts to hide assets in a foreign trust. The Court further instructed that a contemnor faces an "especially high" burden of proving impossibility in this context, and that courts should be "especially chary" of such claims. Id. at 1241.
Turning to Marciano's specific assets, the Court first addressed Marciano's collection of expensive watches. The watch collection was initially seized by the Bankruptcy Trustee, but later returned to Marciano after he won an appeal on a procedural issue. In his schedules, Marciano denied that either he or his trust owned the watches -- although his trust had arranged an appraisal of the watches in 2009 for insurance purposes.
The Court was not impressed:
Given these facts, the Court concludes that the bankruptcy court did not clearly err in rejecting Marciano's contention that it was impossible to turn over the watch collection. Marciano's admission in the November Schedules that the watch collection was his personal property, together with the evidence that the collection was appraised by the Georges Marciano Trust and the undisputed fact that the collection was in his possession, provides substantial evidence to support the bankruptcy court's conclusion that the collection was Marciano's personal property. The only evidence that the collection was not Marciano's property was his own statement in the December Schedules that he was merely holding it for another unnamed entity. As such, the bankruptcy court did not clearly err in rejecting Marciano's contrary argument.
Similarly, Marciano had "dozens of vehicles, ranging in value from $2,300 to $200,000" scattered from Los Angeles to Montreal -- his schedules listed some of his cars as "address unknown". But most of the cars were moved to Canada post-petition, and Marciano did not offer any evidence that he did not own them -- again, he just gave his word (for what that was worth, i.e., nothing).
But it is here that we see one of the most interesting comments by the Court, in response to Marciano's (unsupported) assertion that he had sold the cars and no longer had the ability to turn them over to the Bankruptcy Trustee:
Even if Marciano's assertions of post-petition transfer were to be believed, the bankruptcy court would have a substantial basis to find that these transfers were an attempt to avoid turnover—in other words, a "self-created" impossibility. As Affordable Media instructs, Marciano faces an "especially high" burden of proving impossibility in this context. 179 F.3d at 1241. As such, this Court concludes that the bankruptcy court did not clearly err in rejecting his defense.
Now on to the Chloe Diamond, valued at $16 million, which Marciano claimed that he gave to his daughter in 2007. The problem was that Marciano had previously claimed that he owned the diamond until 2009 and then transferred it into a trust to hold until his daughter was married. Again, Marciano's own trust had the diamond appraised for insurance purposes in 2009 thus exploding his claim that he gifted it to his daughter in 2007. Thus, the Court held that Marciano still owned the Chloe Diamond and it was contemptuous for his not to return it to the Court.
Finally, the Court found that Marciano had not made a reasonable effort to allow the Bankruptcy Trustee to inspect his exempt property.
The net result of these findings is that the U.S. District Court affirmed the issuance of the bench warrant for Marciano, and undoubtedly this is not the last we will hear of this case.
ANALYSIS
It would be easy enough to dismiss this as yet another in a long line of "bad facts" cases. But to do so would be to overlook the Court's important analysis of the so-called "Impossibility Defense" to contempt charges.
To give an example of how the Impossibility Defense is supposed to work, let say that Farmer Joe builds a barn on Neighbor Pete's land. The Court enters an Order requiring Farmer Joe to tear down the barn within 30 days. However, before Farmer Joe can comply, the nearby river floods thus preventing anybody from going near the barn. In that case, Farmer Joe can assert "impossibility", i.e., it was impossible for him to tear down the barn because of the flood.
Indeed, the Impossibility Defense is at the core of asset protection as it relates to offshore trusts, with the idea being that the inevitable refusal of the offshore trustee to return the debtor's assets to the U.S. would make it "impossible" for the Debtor to comply with a turnover order, and thus the debtor could not be held in contempt.
Although it has had very little success in actual application, the Impossibility Defense is much talked about in asset protection circles. But the Marciano opinion reminds us just how difficult it is for a debtor to successfully assert the Impossibility Defense.
The problem for debtors is that the burden of proof is on them to demonstrate impossibility, i.e., that there was no reasonable way for them to comply. In other words, debtors are effectively required to prove a negative -- something which is very difficult even in the best of situations. This is made exponentially more difficult if the Court determines that the facts giving rise to the impossibility were "self-created". In that event, the burden becomes so high as to become insurmountable for all practical purposes.
That is why the "Impossibility Defense" is so difficult to prove, and will be successful only in the rarest of circumstances, that it is simply not reasonable to rely upon it as a defense to contempt. It follows that any asset protection strategy that relies upon the successful application of the Impossibility Defense is an inherently flawed strategy, and should be avoided. At best, it is a longshot -- and who wants to bet their assets on a longshot?
CITE AS
In re Marciano, 2013 WL 180057 (C.D.Cal., Jan 17, 2013). http://goo.gl/XUgg7
This article at http://onforb.es/WcfG2m and http://goo.gl/JCxtl
