I have been asked several times recently what steps a person can take to protect their assets. A skilled attorney should be well-versed in the process of asset protection planning. Our office routinely advises small-business owners on the options that Utah law offers to protect assets. Almost all small-business owners must personally guarantee bank loans and leases when starting out a business. Exemption planning is crucial if you want to embark on the all-American adventure of starting your own business. So what rights do people have in protecting their assets? The answer is not as clear as you think. Because the information is crucial for those considering starting their own business, lets address it here:
First of all, it is important to understand Utah laws around exemptions.
Exemptions, in general
Utah law provides its citizens certain “exemptions” in property. The Utah Exemptions Act is found in Utah Code Ann. (U.C.A.) § 78B-5-501.
Utah law defines exempt property as “protected” and exemption as “protection from subjection to a judicial process to collect an unsecured debt.” See U.C.A. § 78B-5-502(3).
Therefore, property that is covered under the Utah Exemptions Act are protected from subjection to judicial process to collect an unsecured debt.
Exemptions are also important for those who may consider obtaining bankruptcy relief or protection in the future. The bankruptcy code is found in Title 11 of the United States Code. When an individual files for bankruptcy all of their property becomes property of the “bankruptcy estate.” See 11 U.S.C. 541(a). The bankruptcy estate consists of “all legal or equitable interests of the debtor in property” Once property of the bankruptcy estate, the property will be distributed to the debtor’s creditors. See 11 U.S.C. § 541(a)(1).
11 U.S.C. § 522(b)(1) states that an individual debtor (or petitioner) may exempt property from the bankruptcy estate that is either provided for under 11 U.S.C. § 522(d) or exemptions that are provided for under state law. 11 U.S.C. § 522(b)(2) states that a bankruptcy debtor cannot claim the exemptions under the bankruptcy code if the state law does not authorize it. Utah has opted out of the bankruptcy code exemptions, therefore, individuals proceeding through bankruptcy must utilize the exemptions provided for in the Utah Exemptions Act. See U.C.A. §78B-5-513.
Therefore, the best way to protect property, even if you are doing well and not in need of bankruptcy, is ensuring property is protected through the Utah Exemptions Act. This process is referred to as “exemption planning.” Bankruptcy Court judge, Joel T. Marker wrote an article in 2008 discussing the importance of exemption planning and converting non-exempt property to exempt property. The real challenge here is to ensure that this conversion is done in a way that is ethical and legal. Must of what follows is taken directly from Judge Marker’s article- because it has a lot of helpful information and case citations:
The analysis begins with the premise that “the conversion of non-exempt to exempt property for the purpose of placing the property out of the reach of creditors, without more, will not deprive the debtor of the exemption to which he would otherwise be entitled.” Marine Midland Bus. Loans, Inc. v. Carey, 938 F.2d 1073, 1076 (10th Cir. 1991). Carey first cites the legislative history for the proposition that exemption planning permits the debtor to make full use of the exemptions to which he is entitled under the law. Despite this, the Tenth Circuit then states that simple exemption planning can be found fraudulent when tested against the classic badges of fraud, such as whether the conversion was concealed or disclosed, whether the conversion took place “immediately before the filing of the bankruptcy petition,” and the monetary value of the assets converted. The Tenth Circuit ultimately affirmed the lower court’s determination that the debtor’s systematic liquidation of non-exempt assets to pay down the mortgage on her homestead did not rise to the level of fraud necessary to deny her discharge or her exemption. It is interesting to note that Congress addressed the conduct complained of in Carey when it enacted new section 522(o), which imposes a 10-year lookback to recover increases in homestead value relating to transfers of non-exempt assets “with the intent to hinder, delay or defraud a creditor.”
In Bank of Oklahoma, N.A. v. Boudrot, 287 B.R. 582 (Bankr. W.D. Okla. 2002), the bankruptcy court held that the debtors’ liquidation of their non-exempt savings accounts, in the amount of $54,000, and use of the proceeds to pay down the mortgage on their exempt homestead was such as to warrant denial of their discharge. Noting the lack of a coherent body of law on the subject, the court cited another source for the proposition that “fraud in bankruptcy planning appears to enjoy the same precise definition as pornography – the federal courts know it when they see it.” Id. at 585.
And in OTE Dev. USA, Inc. v. Warren (In re Warren), 512 F.3d 1241, 2008 U.S. App. LEXIS 248, Bankr. L. Rep. (CCH) P81,086 (10th Cir. Utah 2008) the court noted the debtor’s pattern of sharp dealing, consistent with “a scheme to liquidate each and every asset, no matter the loss, to prevent payment to his creditors.” The court stated that although “some pre-bankruptcy planning is appropriate,” there exists a “precarious balance” between the competing interests of debtors and creditors in pre-bankruptcy planning. The court was struck by the debtor’s animosity toward the creditor and found the debtor abused pre-bankruptcy planning because his purpose was to place assets out of the reach of the creditors.
A different approach is suggested in Murphey v. Crater, 286 B.R. 756 (Bankr. D. Ariz. 2002), which draws a rational distinction between transfers of assets that are truly fraudulent and those conversions of non-exempt assets to exempt assets that do not support a finding of fraudulent intent. The court held that unless the creditor that seeks to deny a debtor’s discharge based upon his pre-bankruptcy exemption planning shows some deception or concealment, an insider transaction, a fraudulent conveyance, a secretly retained possession or benefit, or debtor explanations that lack credibility, the presence of other badges of fraud that are not themselves intricately indicative of fraud (such as the timing of the transmutation or the amount at issue) are insufficient to shift to the debtor the burden of going forward, even if all of the debtor’s non-exempt assets are converted into exempt assets just after the debtor is sued and just before the debtor files for bankruptcy.
Given the express Congressional statement that conversion of “nonexempt property into exempt property before filing a bankruptcy petition…is not fraudulent as to creditors, and permits the debtor to make full use of the exemptions to which he is entitled under the law,” one could easily argue that factors relating to timing or the amount converted from non-exempt to exempt assets are policy matters that should be left to the legislature. For example, under BAPCPA (or here), Congress constrained the “Florida option” by imposing a 730-day residency requirement before allowing a debtor to claim the homestead of his new domicile, see § 522(b)(3)(A), and directly limited efforts to convert non-exempt assets into exempt homestead assets if made with the intent to hinder, delay, or defraud a creditor within ten years of the petition date, see section 522(o). The Utah Legislature has made similar policy determinations by providing for unlimited exemptions for individual retirement accounts, see Utah Code Ann. § 78B-5-505(1)(a)(xiv) and unmatured life insurance contracts contributed to such plans or contracts one year or more prior to bankruptcy or execution. Unfortunately, a rational policy argument is of small comfort to a client deciding whether to engage in otherwise lawful exemption planning, knowing that one risks offending a trustee or judge because one took advantage of an unlimited exemption shortly before filing a bankruptcy petition.
The Point – The Timing of Transfers
The Mathai v. Warren case cited above appears to outline the general rules around exemption planning, bankruptcy, and fraudulent intent in attempting to hide assets from creditors. The 10th Circuit recognized that “one of the more difficult issues in bankruptcy law is deciding when, if ever, an intent to defraud creditors can be shown by the debtor’s conversion of nonexempt assets to exempt assets.” Warren 512 F.3d at 1249. The Tenth Circuit has initially held “that the premise that ‘the conversion of non-exempt to exempt property for the purpose of placing the property out of the reach of creditors, without more, will not deprive the debtor of the exemption to which he otherwise would be entitled,’” Marine Midland Bus. Loans, Inc. v. Carey, 938 F.2d 1073, 1076 (10th Cir. 1991) (quoting Norwest Bank Nebraska, N.A. v. Tveten, 848 F.2d at 873-74 (8th Cir. 1988).
The Tenth Circuit in Carey focused very strongly on the timing of the property transfer.
the debtor liquidated almost his entire net worth of $ 700,000 and converted it to [exempt] property . . . on the eve of bankruptcy,” 848 F.2d at 876. Moreover, we said in Carey that “[a]ctions from which fraudulent intent may be inferred include situations in which a debtor . . . converts assets immediately before the filing of the bankruptcy petition,” 938 F.2d at 1077 (citations omitted); and we noted that “[o]ther indicia of fraud include: (1) that the debtor obtained credit in order to purchase exempt property; (2) that the conversion occurred after entry of a large judgment against the debtor; . . . and (4) that the conversion rendered the debtor insolvent,” id. at n.4 (brackets and internal quotation marks omitted). Emphasizing the scope of the trial court’s fact-finding discretion, we added: ” The cases . . . are peculiarly fact specific, and the activity in each situation must be viewed individually.” Warren 512 F.3d at 1249-1250 quoting Carey 848 F.2d at 876 and 939 F.2d at 1077
The Carey case does not provide much guidance as to was is necessary to show fraud. In Warren, the Tenth Circuit points to the badges of fraud as outlined in Mueller v. Redmond(In re Mueller), 867 F.2d 568 (10th Cir. 1989). In that case, the Tenth Circuit affirmed a ruling that a life-insurance policy claimed to be exempt had been acquired with fraudulent intent. It held that the bankruptcy court’s finding was supported by the following badges of fraud:
(1) the debtor was insolvent when he purchased the policy; (2) the policy was purchased one week prior to the filing of his petition in bankruptcy; (3) the debtor used his last non-exempt assets to make the acquisition; (4) the debtor had two other unencumbered life insurance policies; (5) although the debtor contended he purchased the last policy to provide for his daughter’s education, the named beneficiaries are the “then living children of the insured, and the then living children of any child of the insured who is not then living, per stirpes.” Id at 570
All indications point at the timing and intent behind the transactions. It appears in most cases, the bankruptcy debtors were transferring large amounts of assets just days before filing for bankruptcy. That appears to be the most crucial aspect of the analysis. It is also relevant to delve into the motive behind the transactions. If the intent is to defraud creditors then it may be possible to employee sanctions against the transferor.
Utah law also touches on this type of exemption planning in the Uniform Fraudulent Transfer Act found in U.C.A. § 25-6 et. seq.
U.C.A. § 25-6-5 states that a transfer is fraudulent if the debtor made the transfer or incurred an obligation:
(a) with actual intent to hinder, delay, or defraud any creditor of the debtor; or
(b) without receiving a reasonably equivalent value in exchange for the transfer or obligation; and the debtor:
(i) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or
(ii) intended to incur, or believed or reasonably should have believed that he would incur, debts beyond his ability to pay as they became due.
(2) To determine “actual intent” under Subsection (1)(a), consideration may be given, among other factors, to whether:
(a) the transfer or obligation was to an insider;
(b) the debtor retained possession or control of the property transferred after the transfer;
(c) the transfer or obligation was disclosed or concealed;
(d) before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;
(e) the transfer was of substantially all the debtor’s assets;
(f) the debtor absconded;
(g) the debtor removed or concealed assets;
(h) the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred;
(i) the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;
(j) the transfer occurred shortly before or shortly after a substantial debt was incurred; and
(k) the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.
Application to YOU
So what is the point of all of these laws and statutes? The point is that a skilled attorney should be able to analyze your personal situation and create a strategy, within the framework of the law, to allow you to protect your property. Our office takes the process of exemption planning very seriously and will work aggressively and ethically to give you the best advice and result possible. When meeting with an attorney, try and ensure that the attorney has a firm grasp of Utah exemptions and there applicability to your personal situation.
As always, our office offers a free 30 minute consultation. Call 801-781-2026 today.