California Court Finds Fraudulent Transfer Under Uniform Fraudulent Transfer Act–Calls Into Question Usefulness of Domestic Asset Protection Trusts
June 24, 2013
Authored by: Kathy Sherby and Stephanie Moll
The California Court of Appeals in Kilker v. Stillman, 2012 WL 5902348 (Cal. App. 4 Dist., Unpublished), Nov. 26, 2012, found that a fraudulent transfer had occurred when a California resident created an asset protection trust in Nevada, even though the trust was created several years prior to the litigation giving rise to the judgment creditor.
Here, the defendant, Frank Stillman (“Stillman”), a soil engineer, created the Walla Walla Group Trust in 2004 and funded the Trust with virtually all of his assets, for “asset protection” at a time when he had no known current creditors, “because soil engineers are frequently sued.” The initial trustee of the trust was the Nevada accountant who helped Stillman set up the trust, but Stillman had removed the initial trustee and replaced him with a trusted employee. Even though Stillman was not the Trustee, he managed all of the trust assets, which he used to pay his own personal expenses even though Stillman’s brother was the named beneficiary of the Trust. Thus, notwithstanding the actual provisions of the Trust, Stillman handled the Trust as if it were his alter ego.
In 2008, Stillman was sued by the Kilkers who were seeking compensation for damages they incurred in connection with the soil testing performed by Stillman prior to the installation of their pool in 2000. Stillman entered into a consent judgment with the Kilkers, agreeing to pay them $92,000 in damages. However, when the Kilkers attempted to execute the judgment on certain California realty, the Trustee of the Trust objected to the Sheriff’s sale of the property as a third-party owner on the basis that the realty was owned by the Trust and not Stillman. Due to this third-party objection, the Sheriff’s sale was called off. The Kilkers then filed this action to invalidate the Trust and by doing so, the third-party objection to the Sheriff’s sale, on the basis that the transfer of the property to the Trust in 2004 was a fraudulent transfer under the Uniform Fraudulent Transfer Act (UFTA).
In order to establish the existence of a fraudulent transfer, the creditor must show that (1) there was an intent to “hinder, delay, or defraud any creditor”, (2) the transfer was without sufficient consideration, (3) leaving the debtor without sufficient assets to meet current or future obligations. The Trustees first argued that the Kilkers were not current creditors at the time of the transfer. Even though the Kilkers were not known current creditors at the time of the transfer, the event giving rise to the liability had occurred in 2000 prior to the 2004 transfer by Stillman of property to the Trust. Going beyond the limited holding that the Kilkers were current creditors, albeit then unknown, essential for a finding that the transfer was a fraudulent transfer, the Court stated that so long as the creditors can show that the transfer was made to “hinder, delay or defraud any creditor”, including a future creditor, the transfer would be a fraudulent transfer. The Court noted that Stillman testified that the purpose of the Trust was to protect his assets from his creditors, that he had transferred virtually all of his property to the Trust, leaving him with little or no assets to satisfy his debts. The Court had no problem finding that there was sufficient evidence of a fraudulent transfer by reason of the nature and purpose of the Trust, formed to preclude creditors from reaching the assets of the Trust.
The Trustees pointed out that, under Nevada law, a self settled spendthrift trust was valid and that the Trust had been formed under Nevada law, that Nevada law applied to the Trust and that under Nevada law this self-settled spendthrift Trust was valid against his creditors. In response to this argument, the Court pointed out that Nevada had adopted a Uniform Fraudulent Transfer Act substantially the same as the California UFTA. Consequently, the Court found that, while the Trust may be valid under Nevada law, the transfers to the Trust were fraudulent transfers and invalid as to all creditors, whether current or future creditors.
If you are considering this type of planning for your own estate planning needs, you should contact your attorney to consider whether a self settled spendthrift trusts can be validly created and funded in your personal circumstances if the state whose law applies to the formation and administration of the trust has enacted the Uniform Fraudulent Transfer Act, without dealing with the inconsistency between the spendthrift protection and the Uniform Fraudulent Transfer Act.