[ Update 11 Feb 2014 -- Peter Hoffman Indicted For Fraud -- http://www.hollywoodreporter.com/thr-esq/movie-producer-peter-hoffman-charged-679077 ]
The creditor, Jonesfilm, held judgments totaling nearly $1 million against the debtor, Peter Hoffman, and some of his companies, including Seven Arts Pictures Inc., which is apparently traded over-the-counter as a penny stock. (SAPX:OTC US)
When Jonesfilm learned that Hoffman was using several Louisiana LLCs, Jonesfilm registered its judgment in the U.S. District Court for the Eastern District of Louisiana, and began collection efforts there. That Court entered charging orders against those LLCs, which included a provision requiring Hoffman and his companies to produce their financial statements, tax returns, and K-1s. Hoffman just ignored the charging orders.
A few months later, the Court ordered Hoffman's Louisiana companies to garnish any funds that they held on behalf of Hoffman and his other debtor companies. The Court then ordered Hoffman's Louisiana companies to answer interrogatories regarding the garnished funds.
One of Hoffman's companies, Leeway, initially responded to the interrogatories by claiming that it held no funds for Hoffman or Seven Arts Pictures. But a few months later, Leeway admitted that it had actually held nearly $175,000 for Hoffman and Seven Arts Pictures, but transferred those funds away to Hoffman personally, two of Hoffman's debtor companies, and Hoffman's CPAs. Leeway's excuse was remarkable, in that Leeway claimed that it had never known that it was holding or had transferred Hoffman's funds, but rather that those funds had been wrongfully transferred without authorization by an employee seeking to cover up her embezzlement scheme. Notably, Leeway's response was signed by the one person who was all of Leeway's VP, secretary, director, bookkeeper, recordkeeper, and manager -- Hoffman's wife, Susan.
Justifiably outraged, Jonesfilm moved to hold Hoffman and Seven Arts Pictures in contempt of court for failing to comply with the charging orders (which would have intercepted distributions to Hoffman and Seven Arts Pictures). The Court instead immediately ordered Hoffman and Leeway to deliver the $175,000 to the Court immediately, and referred the contempt issue to a U.S. Magistrate Judge for further consider. And consider the matter the U.S. Magistrate Judge did, finding that Hoffman and Seven Arts Pictures had disobeyed the charging order by failing to cough up the funds or the required financial statements and tax documents.
Acting upon this, the U.S. District Court then held Hoffman and Seven Arts Pictures in contempt, and ordered them to deliver the $175,000 to Jonesfilm, as well as to provide Jonesfilm with complete financial statements and tax returns and other information. The U.S. District Court also awarded $21,357 in attorney's fees to Jonesfilm. Hoffman and his companies appealed -- and were shot down by the Fifth Circuit which affirmed everything.
Hoffman's appeal was based on his claim that the U.S. District Court, sitting in Louisiana, had no personal jurisdiction over him, since he resided only in California, and were therefore void from the outset.
He was wrong, mostly from his own doings. As the Court noted:
It was fair to subject Hoffman to suit in Louisiana. He has held himself out as a resident of the state, and the burden on him is minimal seeing as much of his business is done in the state and he owns residences there. Jonesfilm seeks to satisfy its outstanding judgments against Hoffman using his Louisiana property, which gives Louisiana an interest in the outcome of this litigation.
It was thus on these facts quite easy for the Fifth Circuit to pin Louisiana jurisdiction on Hoffman.
Strike One.
Next, Hoffman whined about having to produce tax returns, claiming that they should have been protected from discovery to protect his financial privacy and for other reasons. Whether or not this might have been a good defense against pre-judgment discovery, it was a quick loser post-judgment:
The scope of postjudgment discovery is very broad to permit a judgment creditor to discover assets upon which execution may be made. [] When a judgment creditor seeks information regarding a judgment debtor's financial position, the relevance of the tax returns to a judgment creditor is virtually presumed. [] A judgment debtor opposing production of relevant material would be required to show that other sources exist from which the information" sought could be obtained. [Internal quotations and citations omitted]
Since Hoffman could not prove that the information in the tax returns was otherwise available to Jonesfilm, he wholly failed on his burden of proof on this issue.
Strike Two.
Turning to the meat of the controversy, Hoffman and his companies argued first that they could not be held in contempt because the $175,000 had been embezzled by the errant employee. The problem with this excuse was that there will little proof of this, other than that Hoffman's companies had filed a police report and sent a letter to their bank about the alleged embezzlement, but there was no other proof that any such thing had actually occurred.
Hoffman next argued that he personally could not be responsible for the failure of Leeway to deliver the $175,000 as ordered by the Court, because he was not subject to the garnishment order.
Wrong again, as the Fifth Circuit explained:
Orders granting injunctions bind "the parties' officers, agents, servants, employees, and attorneys" and "other persons who are in active concert" with them or with the parties. Fed R. Civ. P. 65(d)(2) .
Hoffman was therefore subject to the garnishment order in two ways. First, he served as director, officer, bank statement recipient, bank signatory, keeper of the books, and manager of Leeway. Second, he acted "in active concert" with Leeway, because he personally, or companies of which he was CEO, or his CPAs, received every penny of the garnished funds from Leeway.
As this court recognized in Waffenschmidt, "[a]n injunction binds not only the parties subject thereto, but also nonparties who act with the enjoined party." In that case, the district court enjoined MacKay, and all persons acting in concert with him, from transferring any funds received from the Waffenschmidts. [] MacKay was ordered to deposit certain funds with the court, which he was unable to do because he had transferred them to nonparties, in violation of the injunction. [] The court found two of the nonparties in contempt, and imposed fines in the amounts received, because they were agents or employees of MacKay and acted "in active concert" with him by receiving the funds. [] We upheld the fines, finding that the court had not clearly erred when it held that they received the money with knowledge of the injunction. [Internal quotations and citations omitted]
Strike Three.
But having lost on the merits, Hoffman's companies attempted to appeal the award of attorney's fees, but lost that too -- with the Fifth Circuit going on to note that:
It has not escaped our notice that Hoffman, SAP, and Leeway openly defied the district court's order. They appealed it but failed to ask the court to stay the order pending appeal. Adding to their, especially Hoffman's, ongoing demonstration of contempt for the judicial process, they failed to "comply promptly with the order pending appeal," as was their obligation absent a stay.15 After nearly a year, the district court held them in contempt again, for disobeying the order. Hoffman, SAP, and Leeway would be wise to fulfill their obligations to the court without delay.
The End of the Fifth Circuit's Opinion was Footnote 15, which stated ominously:
15. Maness v. Meyers, 419 U.S. 449, 458–59 (1975) ("Persons who make private determinations of the law and refuse to obey an order generally risk criminal contempt even if the order is ultimately ruled incorrect.").
ANALYSIS
There is a serious misconception by planners that by "limiting" a creditor's remedy to a charging order, the creditor is left effectively neutered and powerless to proceed further against the debtor's interest in an LLC or partnership. This Opinion demonstrates the dangers of that thinking.
As has been related many times in many court opinions and scholarly articles, a charging order only creates a lien against the debtor/member's economic interest, i.e., right to distributions from the entity. This does not mean that the Court is prohibited from issuing ancillary orders. To the contrary, a Court can and usually will beef up the charging order with all sorts of provisions requiring the entity to not make surreptitious distributions to the debtor by way of loans, salary, management fees, or the like, as well as requiring the entity to provide in-depth financial information about the entity and its operations so that the entity's assets and activities may be monitored.
While different states have different limitations on what form these other provisions might take, in general they tend to be very broad and very pro-creditor, as here. The are several effects of such provisions:
First, as here, the disclosure of financial information allows the creditor to determine if the entity is acting essentially as trustee for the debtor, and holding assets which really don't belong to the entity at all. Since such assets are not the entity's assets, they are -- as in this case -- available to be garnished by creditors. Folks who attempt to "park" money in an entity while creditors are circling often just end up exposing the entity to liability too.
Second, the ancillary provisions in a charging order basically seal off those assets from both the creditor and the debtor. Sure, the creditor cannot get those assets unless they are distributed, but the debtor cannot access them either. It then becomes a contest of "who can hold out the longest" and a surprising number of times it will be the creditor who can exercise unlimited patience while watching the debtor wither and die on the vine from the lack of cash flow that the entity would otherwise have provided to the debtor.
Another strategic misconception by debtors is that they have the same protection in post-judgment discovery that they have in pre-judgment discovery. As this Opinion and numerous others have made clear, the post-judgment discovery world is a very, very different alien world where the debtor has the burden of proving that the creditor can get the exact same information through some other avenue -- the practical upshot being that almost no important information is protectable by a debtor in post-judgment discovery.
Discovery protection relating to financial privacy and tax returns have a very limited existence, if they exist at all, in the post-judgment world. And, as here, a debtor who refuses to cooperate with discovery will likely face contempt charges, and often incarceration as well.
This is why asset protection planning that is based primarily on secrecy has a correspondingly limited usefulness. Anyone engaging in asset protection planning should presume that everything will see the light of day; if a plan cannot stand up to that light, then it is not much of a plan.
Do creditors abuse this broad discovery just to harass debtors? Of course they do, and the Courts do little to stop it. Because creditors are allowed to leave no stone unturned in the search for assets, and because Courts know that debtors will attempt to hide assets, creditors are allowed quite a few fouls before they are sent to the bench. What might shock the conscience in pre-judgment discovery is simply pro forma in post-judgment discovery.
Finally, this Opinion highlights that not only will debtors be subject to court orders, but also all entities to which the Court' orders are directed, and their officers and director, are subject to the court order relating to charging orders, garnishments, discovery and the like. There are rarely any "innocent soldiers just following orders" where a Court order has been disobeyed in the post-judgment world. A debtor or person helping the debtor who gets too cutesy with some technical legal argument -- or even a third-party subject to an order who just doesn't respond -- risk bringing down the wrath of the court.
So what should planners do?
First, as noted above, presume that everything will see the light of day and be defendable in that fashion. This means that the structure and transaction will be sound, and rationally explainable to the Court or a jury. The old saw, "If you can't explain it, then it probably doesn't work" applies with a special fervor here. The old military acronym KISS ("Keep It Simple Stupid") applies to asset protection planning which may have to be explained to a skeptical court. The more planning looks like normal, everyday planning, the more likely it is to pass muster. The more it looks like some exotic, complicated strategy, the less likely the court will stamp it with approval.
Second, the corollary to this is that you should not draft, and don't allow your clients to draft or send, documents that you don't want to see the light of day -- because they will. Similarly, don't have conversations that somebody would have to lie about, keeping in mind that debtor examinations can include hauling in third-parties. Note also that post-judgment examinations are a form of court hearing where the judge can immediately intervene to force an answer on the spot, as opposed to a deposition where a sensitive subject might be subject to weeks of litigation before being answered. It is much easier for a creditor to catch somebody in a lie in post-judgment proceedings than for a normal litigant pre-judgment.
The shorthand way to think about all this is simply: "Keep it honest." Just have the right intentions and do the right things from the outset, and then you will not have to worry about transparency. But if the planning and the ultimate plan are not transparent, then maybe you need re-think the process and the outcome.
CITE
Seven Arts Pictures, Inc. v. Jonesfilm, 2013 WL 599661 (5th Cir., Feb. 18, 2013). Full Opinion at https://chargingorder.com/opinion-2013-louisiana-jonesfilm-charging-order.html
FN1. Waffenschmidt v. MacKay, 763 F.2d 711, 717 (5th Cir.1985),
This article at http://onforb.es/WcgHcH and http://goo.gl/OhuzT
