Florida Asset Protection Law Seminar

ASSET PROTECTION WHEN THE WOLF IS AT THE DOOR:
WHAT WORKS AND WHAT DOESN’T WORK?
By: Jonathan Alper, Esq. and Lawrence Kosto, Esq.

Presented at the Florida Bar’s Annual Wealth Protection Conference
May 13, 2011

Fort Lauderdale, Florida

I. DEBTORS’ PROPOSED ASSET PROTECTION SOLUTIONS

  1. Buy a new and bigger house
    1. The best asset protection available after Havoco case, and the only reliable “cure” for last minute lawsuit problems.
    2. Creditor can obtain an equitable lien on homestead if debtor acquired funds by fraud or egregious conduct. See recent bankruptcy cases which discuss standards for equitable lien. In re Mazon, 387 B.R. 641 (2008); In re Gosman, 362 B.R. 549 (2008); In re McClung, 327 B.R. 690 (2005).
    3. For equitable lien, the creditor must trace the funds obtained by wrongdoing into the purchase or improvement of the homestead.
    4. Homestead investment is usually not a complete solution because debtor needs liquidity for living expenses.
  2. Debtors’ family law solutions:
    1. Debtor divorces non-debtor spouse, and the debtor gives non-exempt assets to non-debtor spouse as part of a formal divorce settlement.
    2. Some family planning variations include:
      1. Debtor marries current boyfriend/girlfriend, and they enter into a pre-nuptial agreement. Each spouse retains their own attorney and provides financial disclosures. The pre-nup provides the debtor consideration for his transfer to his new spouse of non-exempt assets. The pre-nup provides, for example, that debtor titles assets tenants by entireties in consideration for non-debtor waiving certain marital rights such as alimony and support. Non-debtor spouse obtains half interest in debtor’s property instead of marital right.
      2. Debtors presently married can enter into a post-nup agreement with similar planning provisions.
    3. Potential problems with debtors’ family planning strategies. Marital agreements require detailed financial disclosure so debtor is doing the creditor’s work by providing full and accurate financial statement which may be subject to creditor discovery.
      1. Debtor may waive evidentiary privilege with spouse by introducing the issue in defense of collection.
      2. If debtor really wanted to be married, he would be married already. Debtor needs to consider personal and legal consequences of marriage. Marriage gives new spouse an interest in all of the debtor’s property including, but not limited to, an elective share.
      3. Marriage and agreement makes the non-debtor spouse a material witness in collection proceedings, and drags the non-debtor spouse in to the debtor’s problems.
      4. A marital agreement could be attacked under fraudulent transfer laws as a sham arrangement designed to hinder and delay creditors. Creditor would argue that there was insufficient consideration for debtor’s transfer of non-exempt assets. Facts could indicate that the non-debtor spouse does not possess enough separate assets or marital rights to provide adequate present value consideration for the receipt of debtor’s non-exempt assets.
  3. Debtor strategies to prevent bank account garnishment
    1. Debtor withdraws all money from financial accounts in cash.
      1. Problem: debtor may have to provide credible explanation under oath of what he did with the cash.
      2. Large cash withdrawals be accounted for as having been spent on normal expenses or gambled away.
    2. Debtor changes banks so creditor is not aware of money location. Move accounts to banks located in other states.
      1. Debtor may want to change banks immediately after disclosing all financial accounts in initial discovery responses.
      2. Using an out-of-state bank with no Florida branches requires creditor to domesticate judgment in another state and comply with the foreign state’s garnishment procedures.
    3. Possible creditor efforts to chase money in foreign banks
      1. Can creditor use Florida writ to garnish foreign bank account?
      2. Because Florida courts lack jurisdiction over foreign bank, the debtor could argue that such writ is an abuse of process and is unethical.
      3. Creditor argues to court that debtor’s movement of money constitutes fraudulent transfer because debtor has no legitimate reason to move to bank accounts in other states other than avoidance of execution. Creditor could seek injunction against debtor in Florida court prohibiting future transfers of money out of current foreign bank. Creditor can then domesticate judgment in state where debtor’s account last located.
      4. Creditor could petition a Florida court to order the debtor to move money back to original bank in Florida. Issue is whether there is legal basis to compel a debtor to return property to state when creditor has no lien or other interest in the property.
  4. Debtors preference transfers to “friendly creditors”
    1. Friendly creditors include family, friends or business partners who have made bona fide loans to the debtor which debtor is obligated to repay.
    2. Two ways for debtor to protect assets through friendly creditors:
      1. Debtor transfers his non-exempt assets to preferred creditor to satisfy debt.
      2. Debtor gives preferred creditor a security interest in non-exempt assets. Adversary creditor is left in second position making collection more difficult.
      3. Security interest does not preclude levy, but it does drain equity available to judgment creditor.
      4. Proper legal documents needed to perfect security including a security agreement and mortgage or UCC1.
      5. Preferred creditor should initiate a request for additional security because he feels insecure about repayment in light of the debtor’s other potential creditors and possible insolvency.
      6. This tool probably does not work in bankruptcy where Code gives bankruptcy trustee ability to set aside payments or interests given to insiders for antecedent debts within one year of bankruptcy filing.
    3. Creditor attacks on preferential loan payments.
      1. Creditor could argue that loan from insider was not real or that loan was a fraudulent loan. See F.S. 726.201.
      2. Challenge the debtor’s debt repayment as a fraudulent transfers pursuant to. F.S. 726.106. 13 Fla. Jur 2d Creditors’ Rights § 221. Challenge requires creditor show that payment to insider was made when debtor was insolvent and that the insider had reason to know of insolvency.
      3. Apply the common law theory of improper preference of inside creditor. See Tampa Drug Co. v. Duncan, 109 So. 302 (Fla 1926).
    4. Debtor can freely pay friendly creditors who are not insiders. Debtor can choose to prefer one unrelated creditor over adversarial creditors.
  5. Transfers of assets to debtor’s partnerships or LLC
    1. The creditor remedy is limited to charging lien against distributions, if any, from a limited partnership or LLC.
    2. Must be multi-member LLC. Partnerships should have two or more limited partners.
    3. Creditor can challenge as fraudulent conversion of title to avoid, hinder, or delay collection of debt.
    4. Debtor asserts that contribution of cash or personal property to the business entity was for adequate consideration in the form of LLC or limited partnership interests.
    5. The contribution of non-exempt assets to a business entity best works where there are unrelated business “partners” who benefit from the increased protection against debtor’s creditors. The LLC and partnership charging lien remedy is designed to protect the non-debtor partner. An existing or newly added non-debtor partner might want to initiate formation of the LLC/partnership in order to protect his own interest in the business assets.
  6. Debtor transfers non-exempt assets to business entity formed in foreign states with more favorable protection laws
    1. Some states’ laws expressly provide that the charging lien as sole creditor remedy to execute upon LLC interests regardless of the number of members, and some states provide the charging lien is the sole remedy to execute upon debtor’s stock in multi-stockholder corporations.
    2. Conflict of law issue is whether a Florida court would restrict a Florida creditor to the collection tools provided in foreign state under the foreign state’s laws where the creditor is executing a Florida judgment against Florida debtor. Foreign state laws govern internal matters of a foreign entity, but the general rule is that collection law is based on location of debtor.
  7. Equity stripping of debtor’s non-exempt assets
    1. Debtor draws cash from existing secured lines of credit to drain equity from the pledged non-exempt assets.
    2. Pre-existing lien in favor of arms-length creditor helps defend fraudulent transfer allegation.
    3. Does not prevent creditor levy or foreclosure on the asset pledged as security, but this tool removes most equity in advance.
    4. Debtor will have to explain under oath what he did with the additional loan proceeds.
    5. Creditor response
      1. The creditor will examine debtor regarding disposition of cash borrowed. Creditor may challenge debtor’s uses of loan proceeds as fraudulent transfer or conversion.
      2. Creditor tries to make debtor provide explanation that is not credible to undermine believability on all issues.
      3. Creditor probably will not foreclose on encumbered assets unless to harass debtor.
    6. Debtor risks increasing amount of debt for which he is most likely personally liable to repay.
  8. Variation of equity stripping: debtor offers friendly lender non-exempt assets to secure pre-existing unsecured debt
    1. Many creditors have borrowed money for personal or business use from banks or other financial institutions with unsecured loans or lines of credit where debtor’s prior relationship with bank or personal financial strength made security unnecessary.
    2. Debtor pledges security interest in non-exempt assets to bank in order to secure previously unsecured loan.
    3. Security provided bank less vulnerable to fraudulent transfer allegation than security given to insider or family member for similarly unsecured, or under secured, debt.
    4. Debtor must consider the bank a preferred or friendly creditor because grant of valuable security will compel debtor to pay this loan or lose asset to bank rather than to judgment creditor. Debtor risks the friendly bank becoming adversarial after having pledged valuable unencumbered assets.
    5. Security given to bank does not preclude judgment creditor levy. Judgment creditor can still force property sale even though creditor is junior position.
    6. Offering unsolicited security may worry bank who could reduce borrower’s lending ability even though debtor has made prior loans safer for bank.
  9. Planning for debtor’s future inheritance
    1. Judgment creditor can garnish a bequest from an estate or or life insurance proceeds payable to the debtor.
    2. Inheritance by debtor spouse subsequently conveyed to tenants by entireties may be a fraudulent transfer because the inheritance was given to the debtor spouse individually.
    3. Solution:
      1. Parent should amend will or trust to provide that debtor’s inheritance is held in spendthrift trust with discretionary distributions. Debtor may serve as the trustee of his own spendthrift trust. Requests to other heirs and beneficiaries are not changed.
      2. Parents amendment of their own estate planning documents is not a fraudulent transfer by debtor even if after judgment.

II. EFFECTIVE COLLECTION TOOLS AND HOW TO DEAL WITH THEM

  1. Creditor levy upon debtor’s household furniture and personal items
    1. Creditor can ask debtor to describe furniture and other house contents during deposition
    2. Creditor can require house inspection or an immediate levy of known personal property.
    3. Works best with joint marital debtors where entireties protection unavailable.
    4. May not be financially rewarding for creditor because of sheriff fees, storage costs, and auction fees, but this tool can intimidate debtors.
    5. Sentimental value of assets often produces settlements.
    6. Embarrassment of creditor coming to residence motivates debtor to settle debt.
  2. Levy upon stock in debtor’s primary operating corporate business
    1. By levy upon debtor’s stock in closely held corporation the creditor can take control of business in which debtor has majority ownership.
    2. Stock levy enables creditor can interfere with operations of business where debtor is minority stockholder. Non-debtor partner may encourage debtor’s settlement.
    3. Remedy limited against debtor professional business due to ownership restrictions.
    4. Levy upon debtor’s leases of business premises when lease is in debtor’s individual name. Lease and improvements are assets subject to levy even though debtor is liable to make payments.
    5. Taking lease closes down debtor’s business operations.
  3. Garnishment of debtor’s salary from closely held business
    1. Wages of a head of household are exempt from garnishment.
    2. Cases have held that payments to a debtor from the debtor’s own business is in nature of profit distributions rather than salary exempt from head of household garnishment. Brock v. Westport Recovery Corporation, 832 So.2d 209 (Fla. 4th DCA 2009). While this is a matter of State law, the Court decision relies on In re Harrison, 216 B.R. 451 (Bkrtcy.S.D.Fla. 1997) and In re Manning, 163 B.R. 380 380 (Bkrtcy.S.D.Fla. 1994), both of which are Southern District of Florida Bankruptcy Court decisions.
    3. These cases seem to focus on a label being placed on the monies paid as wages, and the issue as to whether the monies are paid as “earnings for personal” service, and then requiring that the amounts be dictated by an arm’s length employment agreement In re Harrison, 216 B.R. 451 (Bkrtcy.S.D.Fla. 1997). If there is a written employment agreement, and debtor could show that it is a regular payment made every month for the same amount, and evidence were presented from a competing business, that the wages were reasonable for the position the owner maintains running the business, then debtor could distinguish himself from this line of cases.
    4. Penetrate closely held business as debtor’s alter ego where debtor is paying his personal expenses from business account.
  4. Examination of debtor in court before judge
    1. Proceedings supplementary permits debtor examination in court. F.S. 56.29(2).
    2. Subpoena can require debtor to bring assets to court.
    3. Debtor less likely to evade judge’s questions.
    4. Judge can order immediate turnover of assets or other equitable remedies.

III. INVOLUNTARY BANKRUPTCY

  1. Debtor’s biggest concern because asset protection tools are less effective in bankruptcy court.
    1. In determining what one’s exemptions are in bankruptcy, one must determine whether the state or the federal bankruptcy exemption apply.
    2. 11 U.S.C. § 541 of the Bankruptcy Code defines property of the estate, and includes all legal or equitable interests of the debtor in property, as of the commencement of a bankruptcy case. Asset must first be part of the bankruptcy estate as a precursor to being exempted out of the estate under either Federal or State exemption statutes. See In re Corbi, 149 B.R. 325 (Bkrtcy.E.D.N.Y. 1993).
    3. 11 U.S.C. § 522(b)(1) of the bankruptcy Code authorizes states to opt out of the federal exemptions set forth in § 522(d) of the Bankruptcy Code. States can elect “to opt out of the federal scheme of exemptions in favor of state established exemptions.” Goldenberg v. Sawczak, 791 So.2d. 1078 (Fla. 2001). The state of Florida elected to opt out of the federal scheme by enacting § 222.20 prohibiting citizens of Florida from claiming as exempt any property listed in Section 522(d) of the Bankruptcy Code. Accordingly, a citizen of Florida is limited to the Florida exemptions, in lieu of those found in § 522(d).
  2. The difference between exemption planning in state court context and in a bankruptcy filing is substantial in two areas: namely, the debtor’s homestead exemption and the debtor’s exemption of employee pensions and IRAs.
    1. Florida’s homestead exemption is very generous. It is unlimited by value, so long as the homestead property is less than half an acre in the city, and 120 acres in the county. Fla. Const. art. X, § 4; Fla. Stat. §§ 222.01, 222.02 and 222.05. Conversely, the Federal Exemption as provided in the bankruptcy code is limited to $21,625 11 U.S.C. § 522(d)(2).
    2. Likewise, a debtor has an unlimited exemption with respect to an IRA outside of bankruptcy, whereas under 11 U.S.C. § 522(n) the IRA exemption is capped at $1,171,650.
    3. In 2005, Congress amended the bankruptcy code that for the first time limited Florida’s homestead exemption in certain instances. Under the 2005 Code amendments a debtor’s homestead exemption is capped if the homestead was acquired within the 1215 day period preceding the date of the filing of the petition. 11 U.S.C. § 522(p)(1). In such an instance, the exemption is capped at $146,450. For married couples, they are permitted to stack the exemption so that the cap is extended to $292,900 in a joint bankruptcy. In re Limperis, 370 B.R. 859 (Bkrtcy.S.D. Fla. 2007).
  3. Criteria for involuntary bankruptcy
    1. Number of creditors
      1. Under 11 U.S.C. § 303(b)(1), to initiate an involuntary bankruptcy, it requires 3 or more entities, each of which “hold a claim . . . that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount,” and an aggregate of claims of at least $14,425, where a Debtor has 12 or more creditors;
      2. If there are fewer than 12 creditors, a single creditor may file, provided said creditor’s claim is at least $14,425, and also that it is not contingent as to liability or the subject of a bona fide dispute as to liability or amount. 11 U.S.C. § 303(b)(2);
      3. An employee or insider may not bring an involuntary case. 11 U.S.C. § 303(b)(2);
      4. An involuntary petition by a single petitioning creditor, filed with knowledge of more than 12 creditors must be dismissed, In re Bock Transp., Inc., 327 B.R. 378 (B.A.P. 8th Cir. 2005); In re Caucus Distributors, Inc., 106 B.R. 890 (Bkrtcy.E.D.Va. 1989); In re Coppertone Communications, Inc., 96 B.R. 663 (Bkrtcy.W.D.Mo. 1989).
      5. Two party disputes are disfavored. See In re Axl Industries, Inc., 127 B.R. 482 (Bkrtcy.S.D.Fla. 1991) judgment aff’d in part, appeal dismissed in part, 977 F.2d 598 (11th Cir. 1992) (Court found it was proper to dismiss where the Debtor had virtually ceased to do business and the only significant asset was claim against third party, and case was it was a two party dispute.)
      6. That being said, single creditor cases have had some success. In re Concrete Pumping Service, Inc., 943 B.R. 627 (6th Cir. 1991) (Court found the Debtor was engaging in fraud, where the Debtor executed a security agreement covering almost all of its assets, just after a Judgment was entered.); Federal Financial Co. V. DeKaron Corp., 261 B.R. 61 (Bkrtcy.S.D.Fla. 2001) (Court reversed a dismissal of an involuntary case based on a per se rule, which provided a Debtor not its sole creditor could not be said to be not paying its debts “generally,” and accordingly, a single creditor could in fact, under some circumstances bring an involuntary petition. The theory being that a bankruptcy court would not involve itself in two party disputes that themselves could be readily adjudicated in state court. See In re Jr. Food Mart of Arkansas, Inc., 241 B.R. 423 (Bkrtcy.E.D.Ark. 1999).
      7. While two party disputes are disfavored, they are allowed to stand, where they are shown to have some basis to support it, where there remedy might be inadequate in State Court. See In re AMC Investors, LLC, 406 B.R. 478 Bkrtcy.D.Del. 2009) (Court found that involuntary petition was filed to seek appointment of trustee to investigate and possibly pursue claims against the companies officers and directors, and that the case spanned state and national boundaries.)
      8. For purposes of determining number of creditors, a creditor may include:
        1. Other business debts and judgment creditors
        2. Retail sales contracts
        3. Credit card balances
        4. Bills paid in full each month do not count
        5. Mortgage taxes
        6. Some attorney fees
        7. Petitioning judgment must hold a final liquidated judgment
        8. Debtor generally not paying debts when due
        9. Debtor’s non-payment of one large debt
        10. Is debtor insolvent?
        11. 1. Is creditor’s circumvention of debtor exemptions a proper purpose of involuntary bankruptcy?
  4. Are involuntary petitions common, and if not, why not?
    1. Threat of sanctions for petition incorrectly prepared, or for petition which court denies. 11 U.S.C. § 303(i)(1)(B) authorizes the court to grant judgment to a Debtor in an involuntary action, and against the Petitioner(s) following the dismissal of an involuntary petition of the petition is dismissed other than on consent of all petitioners and the alleged debtor and if the Debtor does not waive the right to judgment. These damages would be for costs or a reasonable attorney’s fees, 11 U.S.C. § 303(i)(1) (A) and (B), and where bad faith is found, “for — (A) any damages proximately caused by such filing; or (B) punitive damages.”
    2. Difficult to ascertain whether debtor qualifies based on number of debts.
    3. Cost and complexity of action
    4. Dilutes recovery among all creditors.
    5. More likely with one creditor because it is difficult to get other creditors to join in a petition against debtor with 12 creditors.
Jon Alper

About Jon Alper

Jon is an attorney focusing on bankruptcy and asset protection in Orlando, Florida.