Asset Protection Updates

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U.S. v. Evseroff, 2006 WL 2792750 (E.D. N.Y.), 98 A.F.T.R.2nd 2006-7034, 2007-1 USTC P. 50,222.

A New York federal district court’s flawed application of state fraudulent transfer law led it to rule in favor of a debtor, without regard for whether the debtor made the transfer with the actual intent to hinder, delay or defraud the creditor.

The Facts and the Court’s Decision

Between 1978 and 1982, Mr. Evseroff, a lawyer and former Assistant District Attorney in Kings County, New York, participated in a number of tax shelters on the recommendation of a friend who was an attorney and accountant. In December 1990, after an audit, Mr. Evseroff was informed by the IRS that he owed $227,282 in taxes and penalties.  A few weeks later, the IRS sent a letter with an updated amount owed, including interest, of several hundred thousand dollars more.

In September 1991, Mr. Evseroff purchased a retirement property in Florida for $230,000. This property was later seized by the government.  Several months after purchasing the retirement property, Mr. Evseroff received a notice of deficiency from the IRS indicating that he owed over $700,000.  Shortly thereafter, Mr. Evseroff met with an attorney about creating a trust.  He filled out a questionnaire for the attorney, but did not mention any of his tax problems.  Before the trust was executed, Mr. Evseroff filed a petition with the Tax Court challenging the notice of deficiency.  He executed the trust in June 1992, naming his sons as beneficiaries and a family friend as trustee.  The trust was funded between June and October 1992 with $220,000 in cash and his Brooklyn home. The Tax Court entered judgment in the amount of $769,113 in November 1992.

After a long journey through the courts, the case ended up in the federal district court for the Eastern District of New York for a bench trial in 2006 on the issues of (1) fraudulent transfer, based on constructive intent; (2) fraudulent transfer, based on actual intent; and (3) alter ego.

The government argued that Mr. Evseroff attempted to shield assets from the government by shifting money between accounts, having his sons hold money in lieu of establishing a bank account, and purchasing the Florida residence. Mr. Evseroff acknowledged that the tax liability was a consideration, but he claimed that his primary motivation for establishing and funding the trust was estate planning, particularly his worry that his estranged wife would take a substantial share of his estate if he died.

The court found that Mr. Evseroff was solvent at the time of the transfer. It went on to assert that “as a threshold issue, it must be determined whether the transfer rendered Evseroff insolvent.”  The court explained that:

“[I]t is hornbook law that ‘[a] conveyance cannot be fraudulent as to creditors if the debtor’s solvency is not affected thereby, that is, if the conveyance does not deplete or otherwise diminish the value of the assets of the debtor’s estate remaining available to creditors.’” Lippe v. Bairnco Corp., 249 F.Supp.2d 357, at 375 (S.D.N.Y.2003), (citing 30 N.Y. Jur.2d Creditors’ Rights & Remedies § 305 (2003)).

After finding that the government did not establish that Evseroff was insolvent at the time of the transfer to the Trust account, the court held, as a matter of law, that the government could not establish either constructive fraud or actual fraud.  The court acknowledged that “there is evidence that Mr. Evseroff had mixed motives in establishing the Trust,” but declined to pursue that angle further, because it held that actual fraud cannot be proved where a debtor is solvent after the transfer.

In September, 2006 the federal District Court for the Eastern District of New York found that (1) Mr. Evseroff’s transfers to the trust were not fraudulent transfers; and (2) that the trust is not Mr. Evseroff’s alter ego or nominee.

Huh??

For purposes of my commentary, I will assume that the court is correct in its holding that (1) Mr. Evseroff was solvent after any transfers he made to the trust; and that (2) the trust is not Mr. Evseroff’s alter ego or nominee. However, the court’s analysis of the issue of fraudulent transfer based on actual intent is clearly flawed.  Understandably, the government filed a Notice of Appeal on November 22, 2006.

New York is one of only seven states which have not adopted the Uniform Fraudulent Transfer Act (UFTA). New York’s fraudulent conveyance law is based on the 1918 Uniform Fraudulent Conveyance Act.  Nonetheless, the UFTA is derived from the UFCA, and the case law under both uniform acts is similar.

In the district court, the government argued that the creation and funding of the trust was constructively fraudulent under New York Debtor and Creditor Law § 273 or intentionally fraudulent under New York Debtor and Creditor Law §  276.  Section 273 provides that “[e]very conveyance made and every obligation incurred by a person who is or will be thereby rendered insolvent is fraudulent as to creditors without regard to his actual intent if the conveyance is made or the obligation is incurred without a fair consideration.” Section 276 provides that “[e]very conveyance made and every obligation incurred with actual intent, as distinguished from intent presumed in law, to hinder, delay, or defraud either present or future creditors, is fraudulent as to both present and future creditors.”

To prevail on an action under § 273 for constructive fraud, the plaintiff must show that the transfer that a was made without fair consideration and either: (i) the transferor is insolvent or will become insolvent by the transfer at issue; (ii) the transferor is engaged in or is about to engage in a business transaction for which its remaining property constitutes unreasonably small capital; or (iii) the transferor believes that it will incur debt beyond its ability to pay.  The court held that the government’s evidence failed to show that Mr. Evseroff was insolvent or became insolvent as a result of the transfer.  Therefore, the government’s claim under § 273 should have failed, and it did.

However, in addition to its cause of action for constructive fraud under § 273, the government sought recovery of the transfers to the trust under the actual intent provisions of § 276 of the Act.  In order to succeed on a fraudulent transfer claim based on actual intent, a creditor must show intent by the transferor to hinder, delay, or defraud.

Since there is rarely direct evidence of actual intent, intent is often inferred from circumstances surrounding the transfer.  Courts look to “badges of fraud” to demonstrate actual fraudulent intent including, among others: (i) transfers to the transferors relatives; (ii) lack of fair consideration for the transfers; (iii) the transferor’s continued possession, use or benefit of the property transferred; (iv) the transferor’s knowledge of the creditor’s claim; and (v) the debtor’s insolvency after the transfer. 

In a claim under § 276 involving actual intent, insolvency is only one of many potential factors, and is not a “threshold” factor. 

Under New York law, actual intent for purposes of § 276 must be proved by clear and convincing evidence. Marine Midland Bank v. Murkoff, 120 A.D.2d 122, 508 N.Y.S.2d 17, 20 (2nd Dep’t 1986); United States v. Mazzeo, 306 F.Supp.2d 294 (E.D.N.Y.2004).  The “clear and convincing” standard means that plaintiffs often an uphill battle, though by no means impossible. 

Consider In re D’Amico (Case No. 96-23724, Bkrpt. W.D.N.Y. 1996). The debtor transferred three parcels of real property to his wife shortly after learning of potential claims against him.  The trustee sought to have the transfers set aside as fraudulent under §§ 273 and 276.  The court specifically found that the bankruptcy trustee had failed to show that the debtor was insolvent, and thus the trustee’s claim under § 273 failed.  However, in considering the trustee’s claim of actual fraud under § 276, the court found that:

• The property transfers were made by the debtor without consideration;
• The debtor continued to use and enjoy the properties in the same manner as he did prior to the transfers;
• The debtor continued to pay all of the expenses of the properties;
• The debtor’s spouse continued to treat the properties as if her husband still had the same legal and beneficial interest in them as prior to the transfers;
• The property transfers were made shortly after charges were filed against the debtor; and
• The debtor’s explanation that the transfers were done for estate planning purposes “completely lacked credibility.”

The court found that these findings indicated by clear and convincing evidence that the debtor had made the property transfers with actual intent to hinder, delay or defraud creditors.  The D’Amico case is only one of many cases in New York and in other jurisdictions in which courts have found actual intent to hinder, delay or defraud creditors without regard to the debtor’s solvency.

I expect that the 2nd Circuit will remand the Evseroff case to the district court to reconsider the issue of actual intent. Whether Mr. Evseroff’s transfers to the trust were fraudulent is a matter of fact that should be given full consideration.  If the case is remanded and the district court decides that the evidence of fraudulent intent is not clear and convincing, the result in the end will be the same. 

However, the court’s assertion in its September decision that a transfer cannot be fraudulent under New York law if the transferor remains solvent appears incorrect.  Bad facts - facts that infer actual intent to hinder, delay or defraud - will continue to have the potential to cause big problems for clients who make substantial transfers, whether or not they are solvent.

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This entry was posted on Monday, April 9th, 2007 at 2:58 pm and is filed under Cases. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.