Take-Away: A trustee that assists an individual in asset protection strategies needs to protect itself against potential future claims of the individual’s creditors as ‘aiding and abetting’ the voidable transaction. Anyone who works with a debtor should seriously consider obtaining an affidavit of solvency from the debtor, as protection more for the service provider than for the debtor.

Background: Michigan, like many states, has adopted the Uniform Voidable Transaction Act. That Act makes a transaction, i.e. a transfer of assets,  voidable if it was engaged in to delay, defraud or hinder the individual’s creditor’s effort to get paid. While the Uniform Voidable Transaction Act is primarily directed at the debtor’s actions to hide assets from collection, its broad scope and definition of a transfer transaction can be extended to others who assist the debtor, i.e. they aid and abet; they conspire; they wrongfully interfere with;  the debtor’s creditors in their efforts to collect their claims. A recent ‘non-decision’ by a federal judge raises anxiety with regard to the potential liability of a third-party [think attorney, trustee, CPA] who assists the debtor with estate planning transactions that can expose that third-party liable to the debtor’s creditors.

Kruse v Repp, 2021 WL 2451230 (S.D. Iowa, June 15, 2021)

Overview: As mentioned, this is a ‘non-decision.’ It means that the litigation got settled, but only after the federal judge ruled that the defendants’ motions for summary judgement were denied, and creditor-plaintiff’s claims against the attorney who assisted the debtor and the debtor’s bank could go to a jury trial. It is the claims that could have been submitted to the jury against the attorney and bank that indicate the broad exposure third-parties may face when they assist a debtor in his/her ‘asset-protection’ transactions, often explained away (not!) as ‘customary estate planning.’

Facts: Steve Weller ran his car into Christiana Kruse’s car, causing her serious personal injuries. Christina sued Steve. Steve had a $500,000 auto insurance limit. Steve admitted liability for the accident. A ultimately jury awarded Christina a judgement for $2.5 million against Steve.

Shortly before Christina’s jury trial, Steve made cash gifts to his family members. In addition, with the advice of another attorney, Steve transferred his farm into an LLC where he and his son were members. With the assistance of Steve’s long-time local bank, Steve refinanced his farm assets, obtained additional loans pledging collate security, and gave the bank liens against LLC and personal assets. The bank, like the attorney,  was aware of Steven’s pending lawsuit, his lack of sufficient liability insurance, that Steve had admitted liability, and that with the ultimate $2.5 million personal injury judgment against him, Steve was insolvent.

A second lawsuit was then filed by Christina against Steve under Iowa’s version of the Uniform Voidable Transactions Act, to set aside many of the transfers that Steve made on the eve of the personal injury trial, including the cash gifts, the funding of the LLC, and the bank refinancing and liens it placed against Steve and the LLC’s assets. Christina won a second judgment to set aside and avoid those transfers that rendered Steve insolvent.

A third lawsuit was then filed by Christina against Steve’s lawyer who assisted him in forming the LLC and transferring his farm to the LLC (“for estate planning”), the lawyer’s law firm, and Steve’s long-time local bank lender.  Christina brought these claims, in part, due to the additional expenses that she had to incur to set aside Steve’s voidable transactions. Several claims were made against these third-parties by Christina, including: (i) conspiracy to defraud, knowing that the defendants knew, or should have known, that the transactions that they assisted Steve with would ultimately be fraudulent transfers, and thus they had aided and abetted Steve to perpetuate the fraud by way of encumbering his assets.

I’ll skip the long litany of acts, admissions, and financing transactions that the judge referred to when denying the defendants’ motions for summary judgment to dismiss Christina’s claims against them. It is the scope of these claims that would have been presented to the jury in Christina’s third lawsuit which no doubt prompted the ‘estate planning’ lawyer, law firm, bank, and individual bank lenders to settle Christina’s claims against them.

Claims: Christina’s multiple claims against Steve’s ‘estate planning’ attorney, his law firm, and Steve’s bank lenders, all of which were permitted to proceed to a jury trial, no doubt got their attention:

  • Aiding and Abetting Liability: With respect to the local bank [First State] potential liability to the plaintiff [Kruse], the judge noted: “The structuring of the 2016 refinancing and circumstances surrounding those transactions, coupled with evidence supporting Bank’s knowledge of Weller’s [the debtor] unlawful intent, generate disputed issues of material fact from which a reasonable factfinder could infer First State was motivated, at least in part, to further Weller’s illegal efforts.” The judge insinuated that the bank’s refinancing facility was little more than a thinly-disguised device for the Steve to equity-strip his assets to the detriment of Christina. “Prejudice may be shown were a debtor such as Weller encumbers property to strip equity from the asset and create the appearance of over-securitization to discourage or otherwise attempt to lower the value produced at a judicial sale.”
  • Tortious Interference with the Creditor’s Collection Rights: As for Christina’s claims against Steve’s attorney and his law firm, the judge observed: A creditor has a legally-protected property right to the property of the judgement debtor…There was evidence that Repp [the ‘estate planning’ attorney] intended to and did interfere with Kruse’s [the plaintiff] interests in Weller’s [the debtor’s] property through his planning, and that First State [the bank] did the same thing through its encumbrances of Weller’s property in the refinancing and the subsequent mortgage loanBut the tortiousness of Repp’s conduct is not judged by whether an LLC was a good fit for Weller in a vacuum; at issue here is whether such transfer -in light of what Repp know when forming the LLC and transferring Weller’s only significant assets out of his hands- were appropriate at all under the circumstances… Although there is undoubtedly a public interest in enabling Iowa attorneys to provide sound legal advice to members of their community, this maxim does not hold true if the attorney’s representation knowingly furthers his client’s fraud… If Plaintiffs are successful in proving to a jury that Repp was more than a mere scrivener, tort liability is appropriate.”

A tortious interference claim can result in a punitive or exemplary damage award. As an intentional tort, the recovery for an intentional act would likely not be covered by a conventional errors and omissions insurance policy, meaning that a defendants [the lawyer, law firm, or bank] would additionally be out-of-pocket for their own attorney’s fees and expenses to defend such a claim.

  • Conspiracy to Tortiously Interfere with Collection Rights: A conspiracy claim, like a tortious interference claim, can justify an award of punitive damages which might be as high as ten times the compensatory damages the creditor sustains, e.g. the legal fees incurred to set-aside the voidable transfers of assets to the LLC, or the liens placed on Steve’s assets. This, too, was a separate claim the judge permitted to be submitted to the jury.
  • Civil RICO Damages: For a civil RICO claim, Christian had to offer minimal evidence that the defendants were in conduct of an enterprise through a pattern of racketeering activity. Mailings or wires, including phone calls and e-mails, must be a part of the scheme for over more than one year. The defendants must either have conducted or participated in the enterprise’s affairs on some level, working to further a common purpose, even if not all defendants were involved equally in the activity towards that common purpose. The judge noted in denying the ‘estate planning’ attorney’s motion for summary judgment: “It is unlawful to undertake a transaction with actual intent to hinder, delay, or defraud any creditor of the debtor… Repp [the ‘estate planning’ attorney] admitted he knew Kruse [the injured plaintiff] was a protected creditor at the time he assisted Weller [the debtor] in forming Weller Farms [the LLC] and transferring his real estate to the entity less than two months before the personal injury trial….From this a reasonable factfinder could conclude Repp’s legal services were intended to accomplish the aims of his client, and that those aims were Weller’s fraudulent purpose to hide his assets from Kruse. Disputed material facts surround Repp’s intent  in rendering his professional services preclude summary judgment. Repp’s position that he shared no unlawful purpose and only assisted Weller with ‘general asset protection’ is a question for the jury.

A civil RICO judgment provides for treble damages. Once the creditor’s damages are identified, they are automatically multiplied by a factor of 3.

Observations: Those service providers who work with debtors should seriously consider asking the debtor to provide an Affidavit of Solvency. The thought is that such an Affidavit is not intended to protect the debtor in the event of a creditor attack, since the affidavit would probably amount to hearsay of the debtor and would likely be excluded in evidence. Instead, the purpose of the Affidavit is to protect the planner and others who are involved with the debtor’s planning, like estate planners, trust companies and banks, from being implicated in post-claim planning. Asking for an Affidavit of Solvency has been successful in the past to protect an estate planner from both civil liability and ethical sanctions.

In addition, it probably safe to say that the estate planning defense when claims of voidable transactions are made is seldom accepted by judges. Rhetorically, why would any debtor engage in estate planning when their creditor possesses a claim in excess of the debtor’s net worth?  There is no point in engaging in the planning at that juncture. All of which probably explains why judges do not embrace the proverbial defense raised by debtors, or their advisors, “this was done for estate planning purposes.”

Conclusion: The types of claims that can be made against those who assist debtors in frustrating their creditors are becoming more and more sophisticated. Add to that the exposure to punitive damage awards and the possibility of treble damages and more advisors should consider, at a minimum, asking their client for an Affidavit of Solvency.