Asset Protection Update: Curci Investments, LLC
By: Martin M. Shenkman, Esq. and Alan Gassman, Esq.
The authors thank Steven J. Oshins, Esq. for his thoughtful comments and guidance in this area.
This article was originally published in Leimberg Information Services, Inc. (LISI)
Curci Investments, LLC is a case where bad facts may result in possible changes in the law that may harm well intentioned planning for Californian debtors by allowing courts to invade LLCs owned by debtors, as opposed to having a charging order as the sole remedy.
The debtor in Curci behaved in a manner that any professional would find objectionable, and he clearly controlled the LLC in question. There were major mistakes in ignoring the entity formalities, and seemingly little purpose in the entity other than to shield assets from a creditor who was owed only a small percentage of the value of the assets. The entities were controlled and used personally by a husband and wife who were both responsible for the debt, and the only owners of the LLC. It is also noteworthy that the court applied California law, without even considering whether Delaware law should have applied since the LLC was formed and maintained in Delaware.
What will commentators and courts read into such a case? Will this result in a broadening of the attack on legitimate investment entities? There is also always a concern that other state courts may look at this case when evaluating how to handle similar situations. The real risk, however, is that when the courts dealing with asset protection cases reach to do justice, and prevent a bad actor from prevailing, the results could well be misinterpreted or misapplied to harm clients who have conducted themselves in a proper and ethical manner. While Klabacka was a favorable case wherein a Nevada DAPT was upheld as protecting assets from both spousal support (alimony) and child support claims, a number of other recent cases successfully challenged LLCs and trusts used to protect assets. In Leathers, the court held that a taxpayer fraudulently transferred assets to a trust to avoid tax debt. Another reminder that creating entity structures (LLC, corporation, partnership, trust) to protect assets will not succeed if the debtor himself does not respect the integrity of those entities was provided in Transfirst. A trust was held to be a mere nominee for the taxpayer and could be disregarded to satisfy a tax lien. Whether the “weight” of Curci as another bad fact-bad law asset protection case will unduly tip the scales against clients who plan properly remains to be seen. The take-home lesson for all practitioners may be to craft more careful and layered plans and emphasize to clients the vital importance of both proper motives and the proper administration of the plan.
In Curci Investments, LLC, the California appellate court remanded the case to the trial court to determine whether reverse veil piercing would apply. Reverse veil piercing arises when the request for piercing comes from a third-party outside the targeted business entity. The trial court had concluded that reverse piercing was not available, and that the sole remedy of the judgment creditor was a charging order. The creditor sought to add the debtor’s investment LLC (JPBI) as a judgment debtor on a multi-million-dollar judgment it had against the debtor (Baldwin) personally. It warrants noting that the appellate court observed that the debtor’s wife also was liable on the loan to the creditor to the extent that the husband and wife had California community property, and that the LLC was community property. This may turn out to be the distinguishing factor in permitting reverse veil piercing, which generally requires that a third-party has been harmed in an inequitable manner under circumstances where there is “such a unity of interest and ownership between the corporation and its equitable owner that the separate personalities of the corporation and the shareholder do not in reality exist.”
The debtors did not have the LLC integrated with sound estate tax and multiple entity planning, and may have expected that they would be forced eventually to pay the creditor, given the relatively small percentage of their overall apparent net worth at the time of implementation. The planning these debtors undertook was unlikely to have been recommended or assisted by many California lawyers, given that California law and California Bar rules which make fraudulent transfers, and aiding and abetting fraudulent transfers, criminal acts.
In January 2004, the debtor created a Delaware limited liability company to hold and invest cash balances of the debtor and his wife. It had two members. The debtor husband held a 99% member interest and his wife held a 1% member interest. Debtor was the manager and the chief executive officer of the investment LLC. In these roles, and given his membership interest, he determined when, if at all, the investment LLC would make distributions. Practitioners are well aware that controlling distributions in an estate tax context may be inadvisable as it might result in estate inclusion. The Curci case points out that retaining control over distributions will similarly be a negative factor in the context of asset protection planning.
Two years after forming the investment LLC, the husband/debtor personally borrowed $5.5 million from the creditor’s predecessor in interest. One month after executing the note, the debtor settled eight family trusts to provide for his grandchildren. The investment LLC loaned $42.6 million to three family general partnerships formed by debtor for estate planning purposes. Although all of these loans were payable to the investment LLC, the debtor and his wife listed them as “Notes Receivable” on their personal financial statements. This carelessness was interpreted by the court as yet another factor confirming the debtor’s disregard of entity formalities. Practitioners should be alert to clients having financial statements prepared, or even more so preparing statements themselves to submit to lenders, and incorrectly listing trust or entity assets as their own. Similarly, schedules attached to a prenuptial agreement listing entity or trust assets as the clients might also serve to document that the client is disregarding the formalities of those trusts and entities. The challenge in many cases is to successfully educate clients to consult with counsel before undertaking such matters.
The creditor sued and obtained a judgment. The debtor did not respond to the discovery, and the creditor filed a motion to compel resulting in sanctions against the debtor. Antagonizing the court will rarely prove a positive step to enhancing the end result.
The debtor, as manager of the investment LLC, executed amendments to the family notes for $42.6 million to extend their terms by five years to July 2020, with no consideration. While the case did not explain why, presumably this was to further delay their repayment to defer the point in time when the investment LLC might have cash if the creditor pursued it. If a client is going to modify notes or other contractual arrangements, it would certainly be preferable that such steps be taken before the pendency of litigation. Further, any such steps should be taken under the guidance of the client’s advisers who can take precautions to properly structure any changed terms, and to document the arm’s length nature of the modifications or changes.
The creditor made a motion in August of 2014, and after that date any monetary distributions made by the investment LLC to the debtor, in his capacity as a member of the LLC, were ordered to be paid to the creditor instead. This is known as a charging order and has generally been viewed as the only remedy planners wish to permit potential claimants to have.
The creditor at the time of the trial had received no money as a result of the charging order. However, the debtor had caused the investment LLC to distribute $178 million to him and his wife, as members, between 2006 and 2012. There were no distributions made subsequent to the October 2012 entry of judgment on the note due to the creditor. These facts no doubt incurred the ire of the court both as to dollar amount and timing. The cessation of payments on the notes is perhaps somewhat similar to the cessation of distributions during the divorce in the Pfannenstiehl case. The lower court held for the ex-spouse in part perhaps because of the cessation of payments as soon as the divorce was known. Fortunately for clients seeking asset protection, that holding was reversed. But the lesson to be more careful prior to and during litigation seemed to be lost on the defendants in Curci.
The creditor argued that the investment LLC was the debtor’s alter ego, that the debtor was using the investment LLC to avoid paying the judgment and that an unjust result would occur unless that LLC’s assets could be used to satisfy the creditor’s personal debt.
The creditor claimed that the debtor held virtually all the interest in the investment LLC personally, controlled the investment LLC’s actions, and appeared to be using the investment LLC as a personal bank account. The creditor argued that under these circumstances it would be in the interest of justice to disregard the separate nature of the investment LLC and allow the creditor to access the investment LLC’s assets in order to satisfy the judgment against the debtor, Baldwin. Practitioners are well aware that no trust or entity should be used to pay personal expenses, and certainly not as the equivalent of an “incorporated pocket book” (or the trust or LLC equivalent). Practitioners should insist that clients desiring any asset protection benefit from planning have at least an annual review meeting with appropriate advisers so that each adviser is aware of the plan and collectively all advisers can help police the proper administration of that plan.
The lower court cited an earlier case and held that reverse veil piercing was not available in California. On appeal, the creditor asserted that this earlier case, Postal Instant Press, is distinguishable (in good part because the decision noted that the creditor had the remedy of attaching the shareholder’s stock, as opposed to being limited to only having a charging order), and urges the court to conclude that reverse veil piercing is available in California and appropriate in this case. The appeals court determined that the prior case was distinguishable, and that reverse veil piercing is possible under certain circumstances, and thus remanded for the lower court to make a factual determination as to whether the investment LLC’s veil should be pierced.
The court noted that ordinarily a corporation is considered a separate legal entity, distinct from its stockholders, officers and directors, with separate and distinct liabilities and obligations. The same is true of a limited liability company (LLC) and its members and managers. That distinction can be disregarded by the courts if being used to perpetrate a fraud, circumvent a statute, or accomplish some other wrongful or inequitable purpose. The distinction can also be disregarded under an alter ego doctrine when the actions of the entity are deemed to be those of the equitable owner. One of the most significant advantages of the LLC format is also one of its disadvantages in the context of asset protection planning. Corporations should have bylaws, a shareholders’ agreement and annual minutes. LLCs were designed for simplicity, but that simplicity may prove seductively dangerous as clients operating under LLCs may lack many of the independent legal documents that might serve to corroborate the independence of a corporate entity in the corporate context. Florida estate planning and corporate lawyer Robert C. Burke, Jr. often says that “For every complex problem there is a simple answer . . . and it is the wrong answer . . . complex problems call for complex solutions.” Practitioners should encourage clients with LLCs not to rely on state default rules and instead have them craft appropriate operating agreements. Meetings ideally should be held and those meetings should, if feasible, be corroborated with written and signed minutes or consents.
The distinction between owners and entities may be disregarded if there is such a unity of interest and ownership between the corporation and its equitable owner that the separate personalities of the corporation and the shareholder do not in reality exist. There must also be an inequitable result if that distinction is recognized. Piercing the entity veil will be permitted when justice requires. This is a fact-sensitive analysis. Reverse veil piercing arises when the request for piercing comes from a third-party outside the targeted business entity. The court noted that the debtor had spent five years trying to collect on the debt. As with all fact-sensitive analysis practitioners should endeavor to document and corroborate the independent nature of the client’s LLC. As noted above, annual meetings are a useful means of doing so. The mere fact that the managers and members of the LLC meet with all their advisers may itself help demonstrate that the entity is not a mere alter-ego for the members.
Steven J. Oshins, Esquire of Oshins & Associates, LLC shared the following with the authors, “This case is illustrative that there is no such thing as bullet-proof asset protection planning. There will always be exceptions to exceptions, and it will often depend on which judge you get and in which court. This case definitely won’t stop planners from utilizing charging order protected entities as a part of their repertoire, but it will make them realize that although this planning will almost always result in a favorable settlement or judgment, a few plans won’t work as planned. Asset protection is often a game of probabilities. You lose some and you win most.”
LLC and limited partnership planning for multiple member entities needs to be carefully structured and managed to help protect legitimate non-debtor members from having their interests in the entities damaged by reverse veil piercing and alter ego challenges. LLCs that are basically the personal checking account of their 99% member and 1% owner spouse cannot expect to be respected in situations where creditors are unduly taken advantage of or mislead in inequitable circumstances. While clients often ask for (if not demand) a simple fix, using a one-dimensional plan, advisers should be cautious to advise that based on Curci and other negative developments noted in earlier footnotes, that an overly simplistic single-layered plan may not succeed. Further, for clients insisting on lower cost, practitioners might advise that the failure to follow up annually with all their advisers, even if costs are incurred, could torpedo any possible planning benefits. The law often changes, and cases like Curci remind practitioners that no one strategy should be relied upon by any person or family. More often, a combination of strategies and categories of creditor protection arrangements will be in the family’s best interest. This case also points out the advantages of using offshore structuring well in advance of creditor situations occurring for those clients who are willing to bear the costs of compliance while acting honorably and honestly in their dealings with possible creditors and general conduct.
 Curci Investments, LLC v. Baldwin, Court of Appeal, Fourth Dist., Div. 3, CA G052764 Aug. 10, 2017.
 Klabacka v. Nelson, 133 Nev. Advance Opinion 24 (5/25/2017).
 M.R. Leathers, CA-10, 2017-1 USTC ¶50,212, May 4, 2017.
 Transfirst Group, Inc. v. Magliarditi, 2017 WL 2294288 (D. Nev., May 25, 2017).
 Balice, (DC NJ 8/9/2017) 119 AFTR 2d ¶ 2017-5134.
 Pfannenstiehl v. Pfannenstiehl, 88 Mass. App. Ct. 121 (2015), 37 N.E.3d 15.
 Postal Instant Press, Inc. v. Kaswa Corp. (2008) 162 Cal.App.4th 1510.