Washington

Warning: The following opinion is provided for purposes of discussion only. We have not Shepardized™ this opinion, and do not know the subsequent disposition of this case nor whether the effect of the opinion has been overruled or superceded by other law.

U.S. v. Townley, Slip Copy,
2006 WL 1345248 (9th Cir. 05/17/2006),
case below (E.D.Wash. No. CV-02-00384-RHW, July 29, 2004).

Summary

A couple made transfers of property to a trust at a time that they had no current creditors, for the stated purpose of protecting their assets against the claims of future unknown creditors. When later they had incurred a federal tax liability, the court held that the fact that they had done asset protection planning to defeat the claims of future unknown creditors was enough to satisfy the actual intent element of the Washington fraudulent transfer laws as to the IRS.

The court also held that the trust to which the couple transferred their assets was in fact their nominee and alter ego, where the couple made no rent payments to the trust while continuing to live in the home that had been transferred, and where the affairs of the trust and the couple were so liquid and intertwined as to be indistinguishable.

FACTS

The Townleys had owned their personal residence since 1977. In 1990, the couple borrowed against the equity in their personal residence to purchase an interest in investment property.

In 1995, the Townleys created the Beaver Valley Trust and conveyed their personal residence and interest in the investment property into this new trust. Although the Beaver Valley Trust has an independent trustee and their children were the beneficiaries, the Townleys were made the "Trust Managers" for an indefinite period and given the power to handle all trust affairs. Of course, they still lived in their personal residence, but did not pay any rent to the trust or even make the utility payments.

By 2000, the Townley had gotten themselves into tax trouble and had been assessed nearly $175,000 in unpaid taxes, interest and penalties.

In 2001, the Townleys filed for bankruptcy to attempt to wash out their federal tax liability. Although the Townleys' objection to the IRS's claim was denied, the Townleys were given a discharge and the bankruptcy trustee reported that there was no unsecured property available for distribution.

The IRS then filed suit in U.S. District Court to reduce the federal tax assessments to judgment, set aside the transfers to the Beaver Valley Trust as fraudulent, and to foreclose on the federal tax liens.

The Townleys claimed that they did not make the transfers to defraud the IRS, since the IRS was not even their creditor at the time. Instead, they created and transferred property into the Beaver Valley trust to protect their assets from unknown future creditors. Mr. Townley testified that he was concerned about potential "lawsuits from the exposure we had from liability from troubled boys in the State of Washington."

The District Court held that since the Townleys transferred their property to the Beaver Valley Trust before the IRS became a creditor, they would be considered a future creditor of the Townleys under Washington law.

Far from exculpating the Townleys from a fraudulent transfer, the District Court held that their admission that they made the transfers to protect against unknown future creditors was a veritable confession of their actual intent to hinder, delay or defraud all creditors, including the IRS:

"[The Townleys] assert that no 'hypothetical future judgment creditor' exists, nor did one ever exist. * * * [The Townleys fail] to realize that the IRS is such a creditor. Under [the Townleys'] reasoning, the Washington Uniform Fraudulent Transfer Act would never protect future creditors. A close reading of § 19.40.041, however, demonstrates that this section provides protections to both present and future creditors."

"Section 19.40.041 states:

"(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation: (1) With actual intent to hinder, delay, or defraud any creditor of the debtor." [Emphasis in original].

"If this statute is read by inserting the players in this case, it would read as follows: A transfer made or obligation incurred by the Townleys (debtor) is fraudulent as to the United States (a creditor), if the Townleys made the transfer or incurred the obligation with actual intent to hinder, delay, or defraud any potential plaintiffs who may have a cause of action (any creditor) against the Townleys (debtor). Mr. Townley's statement that he wanted to protect his assets from any potential 'lawsuits from the exposure we had liability from troubled boys in the State of Washington' represents direct evidence of his intent to defraud one of his potential future creditors, which is prohibited by § 19.40.041(a)."

The District Court then noted that in addition to satisfying the actual intent test, the Badges of Fraud that constructively prove the Townleys' intent to defraud creditors were also satisfied by their admissions:

"Here, [the Townleys] have not filed any affidavits in which they denounce any intent to defraud. Nor have they filed any affidavit testimony of other witnesses that would support that they did not intend to protect their assets from any future creditors. * * * On the contrary, [the Townleys] were very open and honest about their intent to defraud potential or future creditors."

The District Court further held that a trust may be considered an "insider" for purposes of a Badges of Fraud analysis, and additionally a trust may be considered an "insider" where it for the benefit of the debtors' children, since children would be considered an insider as well.

The court found other factors that indicated that the transfers were fraudulent. The Townleys had also retained possession and control of their personal residence by continuing to live in it after the ostensible transfer, but did not make any rent payments or pay the utilities. The Townleys had transferred substantially all of their assets to the trusts (thus not giving them the ability to pay their tax bills as they came due). Finally, the Townleys had received no consideration for the transfer of their properties when they gifted them to the trusts.

The District Court also adopted an alternate theory: The trust amounted to the nominees of the Townleys, and thus its assets were available to satisfy their creditors under a nominee or alter ego theory:

"Here, [the Townleys] have retained control over the property of Beaver Valley Trust. [The Townleys] have the beneficial use of the property owned by the Trust, and they do not compensate the Trust for this use. There is a fluid financial arrangement between [the Townleys] and the Trust. Sometimes Defendants are paid for working for the Trust, sometimes they are not. Sometimes [the Townleys] pay the utility bill, sometimes the Trust pays the bill. The office of the Trust is located in [the Townleys'] residence. The ownership of the property changed hands without any consideration. The Townleys created and controlled Beaver Valley Trust, with the intent to protect their assets from potential creditors. For all intents and purposes, Beaver Valley Trust is the Townleys and the Townleys are Beaver Valley Trust and the interests of Beaver Valley Trust are inseparable from the interests of the Townleys. As such, Beaver Valley Trust is a nominee or 'alter ego' of the Townleys. As nominee or 'alter ego,' it holds the Residential and Investment properties for their benefit. Thus, even if the transfers of the Residential and Investment Properties to Beaver Valley Trust by the Townleys were not fraudulent and could not be avoided, the Residential and Investment Properties owned by Beaver Valley Trust are available to satisfy the Townleys' tax liabilities.

Based on all the foregoing, the District Court entered an order granting the IRS summary judgment and allowing them to directly foreclose upon those assets.

In a short memorandum opinion, the Ninth Circuit affirmed:

"The district court did not err in holding that the Townleys transferred their real property into the Beaver Valley Trust in violation of the Washington Uniform Fraudulent Transfers Act. The Townleys' repeated admissions that they transferred property to the Trust in order to avoid potential future creditors provide direct evidence of fraud. Further, by demonstrating that the property transfer was characterized by multiple badges of fraud, the government also showed compelling circumstantial evidence of fraud. Therefore, the government provided the requisite 'clear and satisfactory proof' that the Townleys possessed an 'actual intent to hinder, delay or defraud a creditor' under the UFTA."

ANALYSIS

This case illustrates at least five very important points for planners:

(1) The fact that that your clients have no creditors now when you are doing the planning does NOT mean that their planning cannot be challenged as a fraudulent transfer by a later-appearing creditor.

(2) If the stated purpose of your clients' planning is asset protection, i.e., to protect assets against future unknown creditors, that by itself may be enough to establish actual intent to engage in a fraudulent transfer.

(3) If your clients are living in a house that is owned by a trust but they are not paying rent to the trust, the arrangement is in danger of being set aside as a fraudulent transfer.

(4) If your clients' relationship with their trust is so liquid that they and their trust have little separation in their identities, the trust may be considered your clients' alter ego and its assets will be available to satisfy their creditors.

(5) If you are making transfers to trusts where asset protection is an issue, use for-value transfers instead of gifting.

No Existing Creditors Does Not Ensure Safety

A myth has persisted in the asset protection world that as long as you do planning when there are no creditors around, it will ipso facto be safe. That ignores that the UFTA has an entire section 4 that relates to "Transfers Fraudulent as to Present and Future Creditors," and which applies "whether the creditor's claim arose before or after the transfer was made or the obligation was incurred . . .."

There is what amounts to a "transferred actual intent" in fraudulent transfer law. If you make a transfer that is meant to defeat the rights of one creditor, that may be sufficient for a completely different creditor who comes along later to say that the planning was done with actual intent to defraud it too.

This transferred actual intent also applies on what amounts to an undefined group of unknown future creditors. If you do planning with the intent to defeat the rights of any future creditors who may later appear, regardless of who they are, then that intent will be applied to set aside the transfer as to any particular creditor who does in fact appear later.

[Query: But what is "asset protection" if not planning that has as its very intention the desire to defeat the rights of creditors, whether appearing now or in the future?]

This also means that the UFTA does NOT, repeat NOT, provide anything like a safe harbor simply because the planning was done when no creditors were present IF the planning was done with the intent to defeat any creditors, including future unknown creditors.

Do not also delude yourself into thinking that because you had your clients execute an Affidavit of Solvency that such gives you a free pass to thereafter to do asset protection planning willy-nilly for your clients, because it doesn't.

In fact, the value of such affidavits is somewhere between speculative and dubious, though some planners swear by them. My gut feeling is that these affidavits accomplish little more than creating a list of assets for creditors to start investigating where stuff disappeared to.

Planning Must Be Done For Non-Asset Protection Reasons

Except for recognized homestead and statutory exemption planning, and some business entity planning and spendthrift trust planning, you should not conduct asset protection in its own name.

As this case shows, that the clients engaged in transfers to protect assets from unforeseen future creditors had the practical effect of a sworn confession that they had the intent to fraudulently transfer assets as to all creditors who came later. You cannot allow your clients to make this confession, which means that you cannot allow them to admit that they engaged in planning for the purpose of defeating ANY creditors of any kind.

This has significant practice ramifications: You should not have an engagement letter that says that a purpose for your planning is asset protection. You should not give your clients a memorandum that discusses the asset protective effects of what they are about to do. And you can't let your clients give affidavits or testify at depositions that the reason that they engaged in their planning was because of concerns of unknown future creditors. That doesn't work.

Because, if your clients so testify or the creditors gets possession of any documents that talks about asset protection, that will be evidence of actual intent to hinder, delay or defraud creditors under UFTA, even if the creditor who does appear later was totally unforeseen.

There is nothing in the law that authorizes asset protection planning generally, except as allowed by some statutes. But there is plenty that prevents it, including primarily the fraudulent transfer laws. By and large, the legislatures and the courts want to see creditors get paid on their judgments and they have not given unconditional approval to planning that has as its stated purpose the shielding of assets from creditors.

If a client can't stand up and give a straight-faced reason why the planning was done for legitimate other purposes than to lessen the rights of creditors, that planning will be in grave danger until the UFTA Statute of Limitations has run.

Trusts With Personal Residences Must Charge Rent To Be Respected

The District Court repeatedly focused on the fact that the Townleys had transferred their home to the trust, but had continued to live in it while paying no rent or even the utility payments. This fact was important in determining that the trust was really just a nominee of the Townleys or their alter ego.

The upshot of this is obvious: If you expect to put a personal residence into a trust have it respect for creditor-debtor purposes, it is critically important that the clients make regular rent payments to the trust and make all the utility payments.

Although the tax code may or may not require this, don't forget: The tax code does not matter at all in determining state creditor-debtor issues. There is a Grand Canyon-sized disconnect between tax law and creditor-debtor law, and this disconnect often manifests itself in what constitutes an independent entity or an arms-length relationship.

Not paying rent or utilities may work from a tax perspective doesn't mean that the civil courts will respect the arrangement – to the contrary, to the civil law courts the arrangement will look like a sham.

Trust And Individual Affairs Must Be Identifiably Separate

We also see in this case where alter ego law is once again being expanded to set aside an obvious asset protection scheme, where the debtors claimed that they transferred assets but continued to enjoy and control them. You simply can't have it all ways: If you expect the trust to be treated as a legally independent entity, then you must treat it as a legally independent entity. That means an arm's length relationship between your clients and the trust must exist at all times.

We recently saw in the Ehmann case in relation to a family LLC that you cannot treat a business entity like the family piggy bank and think that it will still be respected for creditor-debtor purposes. Ditto for trusts.

It bears repeating that the fact that you may be able to do some things from a tax standpoint and have them survive scrutiny does not mean that they will survive the civil court's scrutiny under nominee and alter ego theories. It may very well be that a much higher standard of separation and independence is required to survive a judgment collection challenge than would be required to meet a tax treatment standard, particularly for trusts treated as grantor trusts.

Asset Protection's Four-Letter Word: Gift

The fraudulent transfer laws are primarily aimed at transactions that are without "reasonably equivalent value". The quite logical reason for this is simple: If the debtor doesn't get back something of value from the transferee, there is nothing available for the creditor to satisfy the judgment. Gifts are inherently without "reasonably equivalent value" – there is no consideration for a gift.

Because of this (and although I know that gifts are a bread-and-butter technique for estate and charitable planning), if asset protection is an issue then gifts should be avoided because they are easy for creditors to set aside.

The Bottom Line

Asset protection is a very difficult planning area. There is no "safe harbor" simply because the planning was done at a peaceful time when there were no creditors on the horizon. That is a myth and one that is now exploded. You cannot do asset protection planning in its own name and expect it to survive scrutiny. Either the asset protection will be explainable for legitimate, non-creditor reasons, or it will probably fail. And, as with business entities, you must respect trusts as separate stand-alone legal entities. This includes paying rent when a home is in the trust. Finally, you must avoid making gifts where asset protection is a concern, because gifts are inherently weak forms of transfers for creditor-debtor purposes.

Arguably, the real art of asset protection is creating a fundamentally sound plan that has a solid asset-protective effect, but doesn't appear to be an asset protection plan at all.

Click here for Summary Judgment Order

U.S. v. Townley, Slip Copy,
2006 WL 1345248 (9th Cir. 05/17/2006)

United States Court of Appeals, Ninth Circuit.

UNITED STATES OF AMERICA, Plaintiff--Appellee,
v.
Bryce W TOWNLEY, individually and as Trustee for Bryce and Charlene Townley
Living Trust; Charlene R Townley, individually and as Trustee for Bryce and
Charlene Townley Living Trust, Defendants--Appellants,

and

Bruce Alden Banister, Trustee for Beaver Valley Trust; Daniel Sidebottom; John
Doe; George Barth; Beaver Valley Trust, Defendants.

No. 04-35767.

D.C. No. CV-02-00384-RHW.

Argued and Submitted May 4, 2006.

Decided May 17, 2006.

James A. McDevitt, Esq., USSP--Office of the U.S. Attorney, Spokane, WA, W. Carl Hankla, Esq., Charles Bricken, Esq., Richard Farber, Esq., U.S. Department of Justice Tax Division, Washingon, DC, for Plaintiff-Appellee.

Alan Richey, Esq., Port Hadlock, WA, for Defendants-Appellants.

Appeal from the United States District Court for the Eastern District of Washington, Robert H. Whaley, Chief District Judge, Presiding.

Before REINHARDT, MCKEOWN, and CLIFTON, Circuit Judges.
MEMORANDUM [FN*]

FN* This disposition is not appropriate for publication and may not be cited to or by the courts of this circuit except as provided by 9th Cir. R. 36-3.

_________________________

*1 Defendants Bryce and Charlene Townley appeal the district court's grant of summary judgment in favor of the government. We affirm.

The district court did not err in holding that the Townleys transferred their real property into the Beaver Valley Trust in violation of the Washington Uniform Fraudulent Transfers Act. The Townleys' repeated admissions that they transferred property to the Trust in order to avoid potential future creditors provide direct evidence of fraud. Further, by demonstrating that the property transfer was characterized by multiple badges of fraud, the government also showed compelling circumstantial evidence of fraud. Therefore, the government provided the requisite "clear and satisfactory proof" that the Townleys possessed an "actual intent to hinder, delay or defraud a[ ] creditor" under the UFTA. R.C.W.A § 19.40.041(a)(1); see also Sedwick v. Gwinn, 73 Wash.App. 879, 873 P.2d 528, 531 (Wash.App.1994); Clearwater v. Skyline Construction Co., Inc., 67 Wash.App. 305, 835 P.2d 257, 264-67 (Wash.App.1992).
The Townleys also argue that collateral estoppel or, alternatively, res judicata precludes the government from bringing the foreclosure action altogether. This argument is without merit. Neither the claims nor the issues litigated and decided in the bankruptcy proceedings were identical to those raised before the district court. While the court determined that the residential property was not part of the estate, it did not discuss whether the real property parcels had been fraudulently transferred from the estate or whether the Trust should be considered a distinct legal entity. See Kourtis v. Cameron, 419 F.3d 989, 994 (9th Cir.2005); Mpoyo v. Litton Electro-Optical Systems, 430 F.3d 985, 987 (9th Cir.2005). Further, the record suggests that the IRS was precluded from meaningfully participating in the bankruptcy proceeding such that it was unable to assert its unique interests before the court, even had it desired to do so.

Finally, the Townleys argue that the action is barred because the government failed to obey administrative procedures and exhaust applicable administrative remedies. As noted by the district court, this claim is frivolous. The IRS is permitted to prepare substitute Form 1040 tax returns. See 26 U.S.C. § 6020(b)(1) ("If any person fails to make any return required by any internal revenue law or regulation ... the [IRS] shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise."); see also Rapp v. Commissioner, 774 F.2d 932, 935 (9th Cir.1985). Similarly, the IRS did not err in failing to produce a 23C Assessment Certificate. We have repeatedly held that a Form 4340 Certificate of Assessment and Payment, complete with an assessment date, is alone sufficient to establish that a tax assessment was properly made. See Koff v. United States, 3 F.3d 1297, 1298 (9th Cir.1993)("[When provided with Forms 4340,] which set forth all the information th[e] regulation requires, [taxpayers] have already been given all the document to which they are entitled by section 6203.").

*2 AFFIRMED.
C.A.9 (Wash.),2006.
U.S. v. Townley
Slip Copy, 2006 WL 1345248 (9th Cir.(Wash.))

The legal opinions are a matter of public record (that's how we got them), and as such there can be no defamation for republishing them. Sometimes, however, legal opinions are reversed, vacated, or significantly modified, etc., and we do not discover this fact until somebody points it out to us. As we do not desire to publish inaccurate or outdated information, if a legal opinion has been reversed, vacated, or significantly modified, please advise us of this fact immediately, by fax to (877) 698-0678 or you may also send regular postal correspondence to Riser Adkisson LLP at 1827 Powers Ferry Road, Building One, Suite 200, Atlanta GA 30339.