Posts tagged with "fraudulent transfer"

Several Different Legal Theories May Allow Creditors To Reach a Debtor’s Assets Held in Trust

In a recent case before the United States District Court for the Eastern District of New York, the United States government sought to collect delinquent taxes by accessing assets held in a trust established for the benefit of the taxpayer’s children. The current case was remanded to the District Court by the United States Court of Appeals for the Second Circuit after the Second Circuit reversed an earlier District Court ruling on the same matter. On remand, the District Court ruled that the government may collect against all assets held by the trust.

Between 1978 and 1982, the taxpayer invested in a series of tax shelters that generated deductions that were later disallowed by the Internal Revenue Service (IRS).  In December 1990, after being audited, the taxpayer received notification that he owed over $227,000 in taxes and penalties.  This amount was later corrected.  In January 1992, the taxpayer received a notice of deficiency indicating that he had accrued more than $700,000 in tax liability.  The taxpayer challenged the IRS calculation of his tax liability in a petition to the United States Tax Court.  In November 1992, the Tax Court entered judgment against the taxpayer in the amount of $209,113 in taxes and penalties, and $560,000 in interest.

In June 1992, the taxpayer established a trust, naming a series of family friend and business associates as the trustees and naming his two sons as the beneficiaries.  In the same month, he transferred approximately $220,000 to the trust and in October 1992 he transferred his primary residence, valued at $515,000, to the trust.  The taxpayer received no consideration and there was no evidence the trust assumed the individual taxpayer’s mortgage obligations. Pursuant to the transfer agreement, the taxpayer was allowed to live in the residence and was responsible for the expenses of the residence, including the mortgage and property taxes.  At the time of the transfer, the mortgage was scheduled to be paid off in five years; however, the transfer agreement did not specify an end date for the taxpayer’s occupancy.

At the bench trial held in 2005, the government advanced several theories for recovering assets from the trust, all of which were rejected by the District Court. The government appealed.  In 2008, the United States Court of Appeals for the Second Circuit reversed the judgment and remanded the case.  In its remand order, the Second Circuit directed the District Court to reconsider its findings with respect to whether the conveyances by the taxpayer to the trust were actually fraudulent, whether the trust held property as the taxpayer’s nominee and whether the trust was the taxpayer’s alter ego.

According to New York law, every conveyance made with “actual intent, as distinguished from intent presumed in law, to hinder, delay or defraud” one’s creditors is fraudulent as to both present and future creditors.  N.Y. Debtor and Creditor Law § 276.  The primary issue is the intent of the debtor in making the conveyance, not the actual financial status of the debtor at the time of the conveyance.  The requisite intent required by this section does not need to be proven by direct evidence; it may be inferred from circumstances surrounding the allegedly fraudulent transfer.  Factors, known as “badges of fraud,” that a court may consider in determining fraudulent intent include: lack or inadequacy of consideration; close relationship between the transferor and the transferee; debtor’s retaining possession, benefit or use of the property; series of transactions after incurring the debt; the transferor’s knowledge of the creditor’s claim and the inability to pay it; the financial condition of the debtor before and after the transfer; and the shifting of assets to a corporation wholly owned by the debtor.  See Steinberg v. Levine, 6 A.D.3d 620 (N.Y. 2004); In re Kaiser, 722 F.2d 1574, 1582–83 (2d Cir.1983) (citations omitted).  To support a fraudulent conveyance finding, the creditor must have suffered some actual harm; however, actual harm may be found if the debtor depletes or diminishes the value of the assets of the debtor’s estate available to the creditors.  Lippe v. Bairnco Corp., 249 F.Supp.2d 357, 375 (S.D.N.Y. 2003)

The District Court found that the taxpayer was well aware of his tax liabilities and other potential demands on his assets when he transferred his residence and $220,000 to the trust in 1992.  Evidence of the taxpayer’s conduct at the time of the transfers supported the court’s finding that the taxpayer acted with the intention to hinder or delay collection of his assets. The taxpayer retained the benefits of ownership of the residence after it was transferred to the trust for no consideration.  His payments of mortgage and other property-related expenses, in lieu of rent, were the type of payments that would be made by a property owner, not a renter.  Much of the taxpayer’s net worth consisted of cash, which he was continually transferring among bank accounts held by family and close associates, as well as withdrawing to hold in an office safe. These transfers and withdrawals made it difficult for the IRS to locate and value the taxpayer’s assets.  The District Court also found that the transfers of cash and real estate to the trust unambiguously caused the requisite actual harm to his creditors by reducing the assets that the taxpayer had available to satisfy his tax debt and reducing the value of his readily accessible assets well below the amount of his tax debt.  After the transfers, the IRS would have had to collect between fifty and ninety percent of his remaining assets to satisfy his tax debt.  As a result of this analysis, the District Court found that the taxpayer’s intent to evade the IRS collection efforts was substantial and sufficient on its own; therefore, the court concluded that the taxpayer’s transfer of the residence and $220,000 to the trusts was actually fraudulent within the definition of New York law.  The remedy for fraudulent conveyance is that the creditor may collect upon the fraudulently conveyed property.  Therefore, the District Court held that the government may collect against the assets in the trust on this basis.

The nominee theory focuses on the relationship between the taxpayer and the property to determine whether a taxpayer has engaged in a legal fiction, for federal tax purposes, by placing legal title to property in the hands of another while, in actuality, retaining all or some of the benefits of being the property’s true owner. Richards v. United States, 231 B.R. 571, 578 (E.D.Pa.1999).  The overall objective of the nominee analysis is to determine whether the debor retained the practical benefits of ownership while transferring legal title.  Id. The critical consideration is whether the taxpayer exercised active or substantial control over the property.  Factors examined by the court include: (1) whether inadequate or no consideration was paid by the nominee; (2) whether the property was placed in the nominee’s name in anticipation of a liability while the transferor remains in control of the property; (3) where there is a close relationship between the nominee and the transferor; (4) whether they failed to record the conveyance; (5) whether the transferor retains possession; and (6) whether the transferor continues to enjoy the benefits of the transferred property.  Giardino v. United States, No. 96–CV–6348T, 1997 WL 1038197, at *2 (W.D.N.Y. Oct.29, 1997).  A nominee finding can be made even where there is no intent to defraud creditors or hinder collection efforts.  Where a nominee relationship is found, the government may access only the property held on the taxpayer’s behalf by the nominee and not all the property of the nominee.

The District Court found that the trust was the taxpayer’s nominee with respect to the residence only, and not with respect to the $220,000. The taxpayer had a close relationship with the trustees and the trust paid no consideration for the transfer of the residence. There was no evidence in the transfer agreement that the trust prevented the taxpayer from benefitting from the use and occupancy of the residence as much as when he held legal title to it.  The District Court found the evidence that the taxpayer made some payments relating to the property to be insufficient evidence to rebut the inference that he was the de facto owner of the property.  The payments that the taxpayer made in exchange for his occupancy were precisely those that an owner would make.  Once the mortgage was paid off, the taxpayer was only responsible for upkeep and expenses for the property; therefore, the trust received no net return from this asset.  The District Court considered that, were the trust acting as the owner of the property, it would have sought market rental rates that would have exceeded the taxpayer’s payments.  Therefore, the District Court found that the trust held the residence as the taxpayer’s nominee and that the government could recover the taxpayer’s debts against the residence under a nominee theory.

The alter ego theory differs from the nominee theory because the nominee theory focuses on the taxpayer’s control over and benefit from the actual property, while the alter ego theory emphasizes the taxpayer’s control over the entity that holds the property.  The alter ego doctrine arose from the law of corporations and allows the creditor to disregard the corporate form (also known as “piercing the corporate veil”) by either using an individual owner’s assets to satisfy a corporation’s debts or using the corporation’s assets to satisfy the individual owner’s debts.  Although the New York Court of Appeals has never held that the alter ego theory may be applied to reach assets held in trust, the District Court found no policy reason not to extend the application of veil piercing to trusts.  The policy behind piercing the corporate veil is to prevent a debtor from using the corporate form to unjustly avoid liability, which applies equally to trusts.  Therefore, the District Court held that the alter ego theory could be applied to the trust in the instant case.

To pierce the corporate veil in New York, a plaintiff must show that “(1) the owner exercised such control that the corporation has become a mere instrumentality of the owner, who is the real actor; (2) the owner used this control to commit a fraud or ‘other wrong’; and (3) the fraud or wrong results in an unjust loss or injury to the plaintiff.” Babitt v. Vebeliunas,332 F.3d 85, 91–92 (2d Cir.2003) (citations omitted); see also Wm. Passalacqua Builders, Inc. v. Resnick Developers S. Inc., 933 F.2d 131, 138 (2d Cir.1991).  With respect to analyzing the taxpayer’s control over the trust, the relevant factors can be drawn by analogy from the corporate context.  In analyzing the alter ego question as it relates to a corporation, courts consider factors such as the absence of formalities, the amount of business discretion displayed by the allegedly dominated corporation, whether the related corporations deal with the dominated corporation at arm’s length and whether the corporation in question had property that was used by other of the corporations as if it were its own. Vebeliunas,332 F.3d  at 91 n.3 (citation omitted).

The District Court that the trust was an alter ego of the taxpayer.  The trust formalities were so poorly observed as to give rise to the inference that the trust was not a bona fide independent entity. Between 1992 and 1998, the trust did not record the taxpayer’s payment of expenses for the residence as income and, during this period, the trust did not claim the mortgage interest deduction for the residence.  The individual taxpayer remained as the named beneficiary of the flood and fire insurance policies of the residence.  The accounting work for the trust was performed by a business associate of the taxpayer as a professional courtesy.  The trust tax statements were sent directly to the taxpayer instead of to the trustees. The District Court also found that the manner in which the trust was managed also demonstrate that it was an extension of the taxpayer because there was little evidence that the trustees were actively involved in managing the trust or its assets.  Having trustees play an active role in managing the trust is an important factor in deciding whether to respect the form of a trust because active involvement of trustees would support the separate existence of a trust. Dean v. United States, 987 F.Supp. 1160, 1165 (W.D.Mo.1997).  Finally, the taxpayer demonstrated his domination of the trust by controlling its property to a high degree.

Once the District Court found that the taxpayer controlled the trust, the next steps were to determine whether he used that control to commit a fraud or a wrong against the government, in its capacity as a creditor, and whether that wrong resulted in an unjust loss.  The court found these elements to be plainly satisfied by the facts and its previous findings with respect to actual fraudulent conveyance and the nominee doctrine.  Therefore, the District Court concluded that the existence of the trust as a separate entity was a legal fiction. Under the alter ego theory, the government may collect against all assets held by the trust as if they were held by the taxpayer himself.

Therefore, the District Court held that the government may proceed to collect against all the assets held by the trust that the taxpayer established for benefit of his sons in order to satisfy his delinquent tax liabilities.

Should you have any questions relating to trusts and other personal asset protection issues, please do not hesitate to contact Attorney Susan Maya, at SMaya@Mayalaw.com or 203-221-3100, and Attorney Russell Sweeting, at RSweeting@Mayalaw.com or 203-221-3100, in the Maya Murphy office in Westport, Fairfield County, Connecticut.

United States v. Evseroff, 00-CV-06029 KAM, 2012 WL 1514860 (E.D.N.Y. Apr. 30, 2012)

Uniform Fraudulent Transfer Act Applies to Property Distributed by a Divorce Decree

In a case before the Connecticut Supreme Court, Canty v. Otto, 41 A.3d 280 (Conn. 2012), the former wife of a convicted felon appealed a trial court ruling granting prejudgment relief to the administratrix of a homicide victim’s estate by challenging the administratrix’s right to recover against her as a creditor under the Uniform Fraudulent Transfer Act (“UFTA”). The Supreme Court affirmed the trial court ruling.

In early 2007, the local and state police began to investigate the former wife’s husband in connection with the disappearance of a woman with whom he had been involved outside of the marriage.  In mid-April, the husband transferred $8,000 from a joint marital account to an account that was held solely in his wife’s name.  Within a week of the transfer, the police found the remains of the missing woman on a Connecticut property that was co-owned by the husband and his son.  After this discovery, the husband and wife went together to the Department of Motor Vehicles to transfer title to a jointly owned vehicle solely to the wife, and traveled to Massachusetts to transfer title in residential property to the wife.  The husband made these transfers without valuable consideration.  Within a week of completing the property transfers, the wife contacted an attorney to file a dissolution action, which was commenced the same day and filed within a week.  Pursuant to the dissolution action, a notice of lis pendens was filed against the husband’s interest in two Connecticut properties.  Afterward, the estate of the deceased woman commenced a wrongful death action against the husband.  In May 2007, the state arrested him and charged him with one count of murder and two counts of tampering with physical evidence.

In June 2007, after a full hearing on the wrongful death action, the administratrix of the deceased woman’s estate obtained a prejudgment order against the husband in the amount of $4.5 million.  During this hearing, the trial court found probable cause to believe that the former wife did not truly intend to divorce her husband but rather intended to conspire with him to obtain a judgment of dissolution that would shield his assets from the victim’s estate. The trial court also found that the husband transferred assets shortly before the commencement of the dissolution action with specific intent to defraud his creditors, among which was the estate of the deceased.  Finally, the court found that the former husband had encouraged and facilitated his former wife’s institution of a dissolution action against him and did not seriously contest those proceeding in order to ensure that most or all of his assets could not be reached by the deceased’s estate in the wrongful death action.

The administratrix moved to intervene in the couple’s dissolution action to assert her rights as a creditor of the husband; the motion was denied and later dismissed on appeal.  In June 2008, the trial court issued a judgment of dissolution which included the division of marital property.  The former wife received all of the real property, and the former husband received an automobile, some shares of stock and the remaining balance of his retirement funds.  The former husband was convicted of murder in November 2008.

After the judgment in the wrongful death hearing, the administratrix filed an action against the former wife to recover against her under the UFTA and applied for a prejudgment remedy. In February 2010, the trial court hearing the motion for a prejudgment remedy concluded that there was probable cause to show that the assets transferred from the husband to the wife through the dissolution action were fraudulent actions.  In doing so, that court adopted the prior decision of the trial court, concluded that a dissolution judgment would be subject to a claim under the UFTA and awarded a prejudgment remedy in the amount of $670,000.  The former wife filed a motion for reconsideration in which she alleged that the amount of the prejudgment remedy was higher than the amount alleged to have been transferred. In April 2010, the trial court issued a memorandum of decision in which it agreed with the former wife that her one-half interest in the marital property could not be the subject of a fraudulent transfer and reduced the amount of the prejudgment remedy to $552,000.

The former wife appealed.  She contended that the administratrix, as a creditor of her debtor spouse, cannot collect the debt from her, the non-debtor spouse, by bringing an action under the UFTA, Conn. Gen. Sta. §§ 52-552a et seq.  The former wife first claimed that the distribution of marital assets in a dissolution decree was an equitable determination as to which portion of the marital estate each party was entitled and not a transfer as defined in the UFTA.  The former wife alleged that characterizing the distribution as a transfer and allowing the administratrix to bring a claim under the UFTA would disturb the distribution that was carefully crafted by the trial court and would create further complications for distributing marital property.  Second, the former wife alleged that the trial court’s determination that the dissolution was undertaken with actual intent to hinder, delay or defraud the estate of Smith was clearly erroneous and was not supported by evidence in the record.  Finally, the former wife alleged that the administratrix was improperly attempting to obtain a modification of a marital property distribution, which was prohibited under Connecticut law governing the assignment of property pursuant to a dissolution decree and modification of such judgments.

In Connecticut, the UFTA requires three elements for a creditor to claim recovery:  (1) the debtor made a transfer or incurred an obligation; (2) the transfer is made after the creditor’s claim arose; and (3) the debtor made the transfer with the actual intent to “hinder, delay or defraud” the creditor.  Conn. Gen. Stat. § 52–552e.  UFTA defines the term “transfer” very broadly, including “every mode … voluntary or involuntary…of disposing of or parting with an asset or an interest in an asset.” Conn. Gen. Stat. § 52-522b (12).   Such a transfer is fraudulent under the UFTA if the creditor’s claim arose before the transfer was made and the debtor made the transfer with requisite actual intent.  Conn. Gen. Stat. § 52-552e.

The Supreme Court concluded that the plain language of the UFTA supports the conclusion that distribution of property in a dissolution decree is a transfer under the UFTA.  The federal bankruptcy code defines “transfer,” 11 U.S.C. § 101(54)(D), using terminology similar to the UFTA, and bankruptcy courts characterize property settlements pursuant to divorce decrees as transfers of property.  The court further supported this conclusion with reference to the statute governing assignment of property and conveyance of title in dissolution actions, Conn. Gen. Stat § 46b-81, which uses terms such as “assign,” “pass title,” “vest title,” and “conveyance.”  Case law in other jurisdictions expressly rejects the allegation that characterizing the distribution of assets in a dissolution decree as a transfer would disturb the court’s equitable determination.  The Supreme Court agreed with the reasoning and policy considerations stated by the California Supreme Court: “[i]n view of this overall policy of protecting creditors, it is unlikely that the [l]egislature intended to grant married couples a one-time-only opportunity to defraud creditors by including the fraudulent transfer in [a marital separation agreement].” Mejia v. Reed, 74 P.3d 166 (Cal. 2003). Therefore, the court concluded that the distribution of property in the divorce decree was a transfer that could be subject to a UFTA claim.

The Connecticut UFTA sets forth a series of factors which a court may consider in determining “actual intent” to fraudulently transfer property.  Conn. Gen. Stat. § 52-522e(b).  These factors include whether the debtor retained possession or control over the property after the transfer, whether the debtor had been threatened with a suit before the transfer was made, whether the transfer was of substantially all the debtor’s assets, and whether the value of the consideration received by the debtor was reasonable equivalent to the value of the assets transferred.  A person’s intent to defraud is to be inferred from his conduct under the surrounding circumstances, and is an issue for the trier of fact to decide. State v. Nosik, 715 A.2d 673 (Conn. 1998).

In her application for prejudgment remedy, the administratrix alleged the conveyance of the Massachusetts property and the entire divorce proceeding were undertaken with intent to shelter assets; the timing of these acts, occurring so quickly after the husband became a suspect in the disappearance of the deceased, offered a reasonable inference of fraudulent intent.  According to Connecticut law, in a hearing on an application for prejudgment remedy, the trial court need only make a finding of probable cause, which is a bona fide belief in the existence of facts essential under law for the action. Based on the evidence in the record, the Supreme Court concluded that the trial court finding of probable cause was not an abuse of its discretion. Additionally, the Supreme Court concluded that the trial court properly determined that probable cause existed that the husband commenced the dissolution action with actual intent to hinder, delay or defraud the administratrix.  These findings, combined with the determination that the property settlement under the divorce decree constituted a transfer, permitted the administratrix to bring her claim for prejudgment relief against the former wife.

The Supreme Court additionally noted that the administratrix was not seeking to set aside the dissolution decree, but rather attach certain assets that were transferred to the former wife as a result of the decree.  A financial order is severable when it is not interdependent with other orders and is not improperly based on a factor that is linked to other factors.  Therefore, her claim was not an improper attempt to modify a court judgment in contravention of Connecticut law.

Therefore, Supreme Court determined that the trial court properly granted the administratrix’s application for a prejudgment remedy.

Should you have any questions relating to marital proceedings or personal asset protection issues, please do not hesitate to contact Attorney Susan Maya, at SMaya@Mayalaw.com or 203-221-3100, and Attorney Russell Sweeting, at RSweeting@Mayalaw.com or 203-221-3100, in the Maya Murphy office in Westport, Fairfield County, Connecticut.

written by Lindsey Raber, Esq.