About a third of U.S. jurisdictions have low-value or no exemption for life insurance cash value. Other jurisdictions have exemptions that provide substantial protection.  The exemption statutes of some jurisdictions, such as Florida, Hawaii, Arizona, and Texas, make it clear that the cash value of a life insurance policy or annuity contract owned by a debtor is protected from claims of the debtor’s creditors.  The statutes of many others, unfortunately, are hardly models of clear drafting. The confusion is precipitated by the fact that there are a number of roles a person can play with regard to a life insurance policy or annuity contract.  The debtor might be (1) the owner; (2) the insured; or (3) the beneficiary.  Furthermore, many, though not all, exemptions for life insurance and annuities are predicated on protection of a favored class, generally spouses and dependents.  Finally, just what are the interests in an insurance policy or annuity contract that are to be exempted? The clause “proceeds and avails” appears in the exemption statutes of many jurisdictions.   In some states, this clause is defined to include cash surrender values and loan values. In the statutes of many states, “proceeds and avails” and similar terms are undefined in the statutes.  Therefore, it is left to the courts to decide what is exempted by the statute.  Courts in some jurisdictions have found that such vague exemption statutes cover cash surrender value (see, e.g., In re Worthington, 28 B.R. 736 (Bankr. W.D. Ky 1983); In re Gablehart, 138 B.R. 425 (Bankr. D. Vt. 1992)),  others have found that they do not (see, e.g., In re Monahan, 171 B.R. 710 (Bankr. D. N.H. 1994)).   Others have added additional twists in construing the often tortured language of insurance exemption statutes (see, e.g., In re Sloss, 279 B.R. 6 (Bankr. D. Mass. 2002) (cash value is protected from owner’s creditors for the benefit of the original beneficiary; if the beneficiary has been changed since the policy was effected, the exemption does not apply)).

Dryden v. Estate of Joseph Gallucio, Jr. (Del. Ch. Jan 11, 2007)

The Delaware Chancery Court, in a post-trial letter opinion, awarded the proceeds of a former joint account payable to a decedent’s second wife to the decedent’s first wife, under a fraudulent transfer theory based on actual intent.

The Facts and the Court’s Decision

The decedent and his ex-wife, the plaintiff in this action, were married for 38 years until they divorced in 1995.  The divorce agreement contained provisions: (1) awarding alimony in the amount of $900 per month to the ex-wife; (2) requiring the decedent to keep an existing insurance policy in the amount of $10,000 and to name the ex-wife as beneficiary of the policy; and (3) requiring the decedent acquire a new insurance policy with the ex-wife as beneficiary that would pay the ex-wife $400 per month for her life as long as alimony is required.  Under the terms of the divorce agreement, the decedent received a $45,000 brokerage account established during the marriage that had been jointly held.

A few years after the divorce, the decedent remarried and named his new wife as beneficiary of the $10,000 policy.  Shortly thereafter, the $50,000 policy lapsed.  The decedent told his ex-wife and their children that the $45,000 brokerage account would fund his potential post-death obligations under the divorce agreement.  The decedent was then diagnosed with cancer.  A few months later, the decedent opened a new brokerage account with the assets of the old brokerage account.  The assets were titled in the name of the decedent and his second wife as joint tenants with right of survivorship.

The decedent died in 2003. His estate lacked the assets to satisfy his ex-wife’s claims.  The court found that the decedent’s second wife had been unjustly enriched by the $10,000 death benefit of the life insurance policy and imposed a constructive trust over the policy proceeds for the benefit of the decedent’s ex-wife.  The court also found that the intent of the decedent and his ex-wife in the divorce agreement was for alimony payments to survive the death of the decedent, and found that the estate was liable for the $400 monthly payment to the ex-wife.

The ex-wife sought to have the transfer of the decedent’s brokerage account to a new joint account invalidated as fraudulent under the Delaware Uniform Fraudulent Transfer Act.  The court disagreed with the second wife’s contention that, because the decedent never relinquished control of the asset, the creation of the joint account was not a transfer. Furthermore, the court found that there were a number of indicia of actual fraudulent intent on the part of the decedent:

• The transfer was a transfer to an insider;
• The decedent retained full use of the assets during his life;
• The decedent did not disclose the transfer to his ex-wife and told her that the assets transferred would be available to satisfy his posthumous obligations to her;
• A few months before the transfer, the ex-wife’s attorney had written a demand letter with respect to the lapse of the insurance, thereby threatening litigation;
• The Decedent received no consideration for the transfer.

Accordingly, the court found that the decedent acted with actual intent to hinder his ex-wife’s claim, noting that:

With this conclusion, it is unnecessary to explore whether [the ex-wife] established a prima facia [sic] case that the Decedent was insolvent at the time of the transfer and, thus, the burden of proving his solvency and the fairness of the transfer shifted to [the defendant].

The court noted that, although the wife clearly was entitled to the sum of the $400 monthly payments she had not received to date, plus interest, she had offered no evidence as to the present value of the future income stream of monthly payments.  The court left the record open to allow this issue to be resolved, noting that the purchase of an annuity likely was the easiest solution.

Analyzing a Fraudulent Transfer Claim

Since there is rarely direct evidence of actual intent, intent in a fraudulent transfer action is often inferred from circumstances surrounding the transfer.  Courts look to “badges” or indicia of fraud to demonstrate actual fraudulent intent including, among others: (i) transfers to insiders; (ii) the transferor’s continued possession, use or benefit of the property transferred; (iii) concealment of the transfer; (iv) a lawsuit or the threat of a lawsuit before the transfer; (v) the transfer of substantially all of the debtor’s assets; (vi) the lack of reasonably equivalent consideration; (vii) the debtor’s insolvency after the transfer; and the timing of the transfer with respect to the incurrence of a substantial debt.

Note that where the claim is based on actual intent, insolvency is only one of many potential factors considered by the court.  Even if the decedent in this case had been solvent at the time of the transfer of the account to himself and his second wife as joint tenants, the fact that the court found that the transfer was made with the actual intent to hinder his ex-wife’s claim to his posthumous obligation to provide her with $400 monthly payments allowed the court to invalidate the transfer to the extent needed to meet the decedent-debtor’s obligation.

Though the case at hand involved relatively small amounts, the amounts likely were substantial in the view of the parties involved.  Estate planners always should be aware of the potential for fraudulent transfer claims when advising clients and assisting with regard to intra-family transfers, particularly where a client may have obligations to an ex-spouse.

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1. File timely annual reports with the Secretary of State.

2.  Operate using the proper name of the company.  If the company uses a fictitious name (a “d/b/a” name), be sure that it is registered with the proper authorities, such as the Secretary of State and county registries.

3.  Be sure that the company’s clients, customers, vendors and other third parties know that they’re dealing with the company, and not you personally, in contracts, on invoices, etc. 

4.  When signing a contract on behalf of the company, be sure that the small print doesn’t hold you personally liable, and be sure to indicate that you’re signing not personally, but as an officer, manager, partner, etc.

5.  Don’t mix business and personal finances.  Don’t pay personal expenses from the company’s account.  Document all payments from you to the company as capital contributions or loans, and from the company to you as compensation, dividends, etc.

6.  Be sure that your company’s auto insurance covers to cover potential liability when your employees use their personal vehicles for your business purposes.

7. Be sure that company retirement plans and other benefits plans are properly maintained and that all required IRS and Department of Labor filings for these plans are made on time.

8.  Have the company’s CPA send an letter to the company’s attorney each year letting the attorney know what tax-related items should be documented in the company records for tax purposes, including, for example, owners’ salary and bonuses, loans to owners, capital contributions, major sales and purchases of capital assets, etc.

9.  Hold annual meetings and document the company’s major activities for the year in the minutes of the meeting.

10.  If equipment and real estate are owned separately from the operating business (as they should be, when practical), be sure that arm’s-length leases are in place.

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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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Mr. Riser earned his A.B., with Distinction, in Russian from the University of North Carolina at Chapel Hill, where he also earned his M.A. in Slavic Linguistics.  He earned his J.D. from the University of North Carolina School of Law, and his LL.M. in Estate Planning from the University of Miami School of Law.

Mr. Riser is admitted to practice in North Carolina and Georgia, and is admitted as a Solicitor in England & Wales.  He is a member the American Bar Association, Section of Real Property, Probate and Trust Law (Chair: Asset Protection Planning Committee), Section of Taxation, and Section of Business Law.

Mr. Riser is the co-author, with his law partner, Jay D. Adkisson, of Asset Protection: Concepts and Strategies (McGraw-Hill, 2004).

Mr. Riser is recognized as a national speaker and published authority on asset protection planning and limited liability company issues.  Mr. Riser’s numerous articles have appeared in leading professional journals, and he has been quoted widely in national financial and professional media. He regularly teaches professional education courses on asset protection planning and advanced estate planning techniques.

Mr. Riser served as a Sergeant in the U.S. Army from 1987 to 1991 and is a combat veteran of Operation Desert Storm.