A Constructive Approach to Ethical Asset Protection Practice

(For presentation at The Florida Bar seminar, May 12, 2005, Miami, Florida)

I. INTRODUCTION

More often than not, discussions of asset protection ethics appear designed to frighten practitioners with stories of judicial condemnation and ethical sanctions imposed on those attorneys who assist their clients’ protection against creditors. An unbalanced approach to ethical pitfalls in asset protection practice may unduly dissuade attorneys from helping their clients to preserve and defend their property. A more constructive approach to the ethics of asset protection, although recognizing realistic ethical risks, focuses more on how attorneys may effectively and ethically provide asset protection services to their clients. In this paper, I will assess the history of asset protection ethics including important recent judicial decisions in Florida and elsewhere. These recent decisions undermine prevalent criticisms of asset protection ethics and should help assure attorneys that full use of legal tool to protect their clients from adversarial creditors is consistent with, if not required by, canons of professional conduct.

Compared to other areas of law, asset protection has historically come under disproportionate ethical scrutiny in part because asset protection raises moral issues as well as ethical concerns. Recognizing moral issues in asset protection helps explain persistent ethical condemnation of asset protection legal work. Apparently, some people believe asset protection is immoral because it undermines civil justice. This argument may be summarized as follows: People who believe they have been damaged by acts of another person come to court to seek compensation from the responsible parties. In theory, a court determines fault and awards a judgment for damages. The party found responsible by the judge or jury is supposed to pay the damages awarded to the injured party. Effective asset protection frustrates the civil judgment system by making it difficult for the victorious and injured party to collect their just compensation. Taking asset protection to its theoretical critical extreme, if all defendants had no non-exempt assets, then the civil justice system would be impotent and moot. Additionally, most people agree there is a universal moral obligation to repay debts and to compensate others whom are damaged by our actions. Therefore, while its defenders view asset protection as justly protecting victims of a sometimes unfair and arbitrary civil justice system, critics see the same as an immoral practice that deprives victims of civil wrongs just remedies.

In my experience, these different moral views of asset protection lead to sometimes passionate disagreements about asset protection ethics. Those who believe it is morally wrong for a defendant to place assets out of the reach of his existing or foreseeable creditors also believe it a violation of legal ethics for an attorney to assist a client in making asset transfers that are later found to be fraudulent against creditors.

II. HISTORY: OTHER STATES

California is serious about collecting judgments. Sections 531 and 531(a) of the California Penal Code make it a misdemeanor for a person who is a “party” to a fraudulent conveyance, or who, with intent to defraud, knowingly executes or files any conveyance instrument “knowing that the person executing the same had not right, title, or interest in the property so purported to be conveyed.” (Generally, an attorney is not a party by virtue of client representation.). A few other states have criminal fraudulent conveyance statutes that apply only to transfers of secured property but not to transferred unencumbered property. In California, an attorney who assists a client in a criminal fraudulent conveyance, even if the attorney does himself not engage in a criminal act, he can nevertheless be exposed to sanctions for participating with his client in proscribed activity.

Criminal liability is theoretically possible under Title 18 of the Bankruptcy Code. The Code provides trustees two remedies against fraudulent transfers or conversions. The trustee’s first remedy is recovery of the property under Code §548, and the second remedy, applicable to transfers within the year before filing, is denial of bankruptcy discharge under Code §727. Fraudulent conveyances within one year of bankruptcy are not only grounds for discharge denial, but to the extent such transfers and hiding of assets are inconsistent with sworn bankruptcy schedules, they could warrant criminal prosecution under Title 18. An attorney who knowingly assists a debtor with hiding assets and filing an incorrect petition may expose both the debtor and the attorney to liability for a bankruptcy crime. Fortunately, criminal prosecution under the Bankruptcy Code has historically been rare, and bankruptcy courts infrequently assess even civil sanctions against attorneys for assisting debtor’s fraudulent conveyance. It is unclear whether the creditor tilt in the new bankruptcy law will bring about greater enforcement of criminal liability for fraudulent conveyances within a year of bankruptcy filing.

California courts have also sanctioned attorneys under RICO statutes for involvement in fraudulent conveyances. In the case of Gutierrez v. Givens, the court held that an attorney could be held liable under RICO when the attorney was the owner, director, or officer of companies which served as conduits for fraudulent conveyances and when the debtor funneled money through the attorney’s personal accounts in an effort to hide the money from a known creditor. The court said that to be liable under RICO an attorney must do more than give legal advice – he must “participate in the operation or management of the enterprise itself” and the attorney must also take part in directing the affairs of the enterprise.

A Texas attorney faced RICO liability in Cadde v. Schultz. In Cadde, an attorney (Weiner) helped his debtor/client (Schultz) transfer assets after a judgment was entered. Weiner sent written communications to the judgment creditor offering cooperation in paying the judgment to convince the creditor that settlement and payment were imminent. The court held the transferred assets and disingenuous communication to the creditor constituted a scheme to defraud and a basis for liability against Weiner for civil RICO.

Several Arizona cases are often cited as examples of attorneys’ ethical liability for involvement in their clients’ fraudulent conveyances. The most infamous Arizona result was the 1995 case of McElhanon v. Hing. Hing served as attorney for defendant Harris. After a civil court entered a $200,000 judgment against Harris, Hing prepared documents to transfer Harris’s principle asset – stock in Southwest Restaurant Systems, Inc. – to a third party. The plaintiff, finding himself unable to collect his judgment from the Southwest stock, alleged that Hing and Harris conspired to fraudulently convey assets. The Arizona appellate court upheld a lower court decision holding that there is a cause of action against a debtor’s attorney who conspires to defraud his client’s judgment creditor.

The lower court’s finding of civil conspiracy was based on the theory that a fraudulent conveyance is a “civil wrong,” and that all participants in a scheme to fraudulently convey assets share liability as co-conspirators. However, the lower court also said that such damages for conspiracy against a debtor or attorney are appropriate only where equitable remedies under fraudulent conveyance statutes are inadequate, such as a situation where a fraudulent transferee has subsequently sold property to a bona fide purchaser for value.

The Supreme Court of Oregon disciplined attorney Steven Benson because he had prepared for his defendant client two promissory notes secured by real property when in fact the loans referred to in the documents had never occurred. The loan documents were prepared to help protect his client against forfeiture of the property which had been found by another court to have been used in the commission of a criminal act. The Benson court sanctioned the attorney for assisting his client in conduct the attorney knew to be fraudulent. Attorney Benson did more than just give legal advice; he participated in the preparation of documents implementing a fraudulent conveyance which was designed to shield assets against a criminal wrong rather than just a civil judgment.

The South Carolina Supreme Court suspended attorney Carl Kenyon because he helped his client transfer assets to the attorney’s own corporation. Kenyon also placed a mortgage on the transferred property in order to keep the property outside his client’s probate proceeding where it would have otherwise been subject to seizure by the decedent’s creditors. The South Carolina Supreme Court held that assisting clients to cheat their creditors is dishonest and is a violation of the state’s ethical rules. The court stated that acts sufficient to constitute the civil definition of fraudulent conveyance do not have to be present to find fraudulent or dishonest conduct of an attorney. Again, the sanctioned attorney actively participated in a fraudulent conveyance rather than just provided legal advice.

The most expansive theory of attorney liability for asset protection work is the recent New Jersey decision of Morganroth v. Norris where the Morganroths sued the Norris law firm for intentionally participating in their client’s efforts to avoid execution on their property. The judgment creditor alleged that the attorneys went beyond the boundaries of permissible advocacy by preparing a sham lease and deed which they knew to be false, assisting in the formation of a company for the purpose of obstructing a creditors efforts to enforce a judgment, and knowingly making false representations regarding the debtor’s assets. The complaint alleged that defendant attorneys knowingly and intentionally participated in their client’s conduct to hinder, delay, and fraudulently obstruct the enforcement of a judgment. The plaintiff acknowledged the defendants had not committed common law fraud, but asserted they a claim for “creditor fraud.” The appellate court held that New Jersey law had not yet established a tort of “creditor fraud” different from common law fraud. The appellate court, however, held that it is not necessary to show common law fraud in order to sustain a cause of action when it has been otherwise demonstrated that defendants tried to defraud a creditor. The appellate court concluded that a complaint alleging an attorney knowingly and intentionally participated in his client’s conduct to hinder delay or fraudulently obstruct the enforcement of a judgment states claim under New Jersey law even if the complaint does not allege elements of common law fraud. The decision essentially endorses tort liability for fraudulent transfers based neither in statute nor in common law fraud. This case is an example of a court, morally offended by asset protection, searching for a legal theory to express condemnation and impose monetary penalties.

The Florida Supreme Court has infrequently sanctioned attorneys in connection with their client’s fraudulent transfers. In 1993, attorney Edward Rood was suspended for one year in part because he assisted his son’s fraudulent conveyance to protect real property from his son’s creditors. In 1987, the younger Rood conveyed real property to his father without receiving any consideration at a time when a Michigan judgment had already been entered against him. Edward Rood was actively involved in the fraudulent conveyance by holding title to his son’s property to shield the property from creditor levy. In addition, Rood allegedly had committed other ethical violations including filing knowingly false documents with a probate court. Edward Rood was suspended for one year.

Florida attorney Edward Klein was sanctioned, in part, for assisting the assignment of homeowners association assets to a successor homeowners association shortly before the original association filed bankruptcy. The Klein case is often cited as an example of attorney liability for assisting a fraudulent conveyance in Florida, yet as the Supreme Court’s opinion points out, Klein did much more than assist a fraudulent conveyance. The Florida Bar had filed a 17-count complaint against Klein, and the referee found that the attorney had engaged in 61 Rule violations, many of which were unrelated to the fraudulent conveyance. Again, this attorney did more than give advice; he formed a successor homeowners association and assisted with the assignment of the debtor association’s assets to the successor corporation.

The common thread running through ethical liability for attorney’s asset protection services is the attorney’s active participation in asset transfers. In most cases of ethical sanctions, the attorney either prepared documents of conveyance or encumbrance or he was the transferee of his client’s property. Giving advice concerning asset transfers or conversions, without more, has rarely caused assessment of ethical liability.

III. CURRENT ASSET PROTECTION ETHICS IN FLORIDA

The history of attorney liability for civil damages and ethical violations is background for a current analysis of asset protection ethics in Florida. The Florida Rules of Professional Conduct contain both affirmative and negative obligations relevant to asset protection. Affirmatively, Rule 4-1.1 requires an attorney to provide competent representation and possess the legal knowledge, skill, and preparation necessary for legal representation. Rule 4-1.3 states that a lawyer should act with commitment and dedication to his client’s interest and pursue representation with zeal and advocacy. The Rules’ negative proscription is found in Rule 4-1.2(d) which states that a lawyer shall not counsel a client or assist a client in conduct which the lawyer knows to be fraudulent. However, a lawyer may discuss legal consequences of any proposed course of conduct and may counsel or assist a client to determine the validity, meaning, or application of the law.

The negative proscription against counsel in the commission of a “fraud” (in Rule 4-1.2(d)) has been the focus of asset protection ethics. The underlying legal issue is whether a “fraudulent” transfer or conversion is tantamount to “fraud.” If a fraudulent conveyance is equivalent to common law fraud, then an attorney who advises a client to make a fraudulent conveyance, and/or who assists in a transfer which the attorney should reasonably know is a fraudulent conveyance, may be violating Rule 4-1.2(d). On the other hand, if a fraudulent conveyance, though containing the term fraud, is distinct from fraud as contemplated by the ethical rule, then asset protection planning, even if including fraudulent transfers, is outside the negative proscriptions of Rule 4-1.2(d).

Deciding whether a fraudulent transfer is a form of “fraud” as used in the Florida Bar’s ethical rules calls for a review of basic legal concepts. First, civil actions are based either in contract or tort. There are two varieties of torts: torts of negligence and intentional torts. Classic fraud is an intentional tort (an intentional act of deception or misrepresentation which causes damages to an injured party). More specifically, the elements of tortious fraud are (1) a false misrepresentation of fact, (2) knowledge or belief that the misrepresentation is false, (3) intention to induce someone to act or refrain from action in reliance on the misrepresentation,(4) justifiable reliance, and (5) damages incurred on account of reliance. The Florida Bar Rules of Professional Conduct clearly prohibit an attorney from advising or assisting their clients in the commission of a crime or intentional tort of common law fraud. The issue for asset protection ethics is whether fraudulent conveyance and fraudulent conversions are within the scope of the intentional tort of fraud.

Only recently have Florida courts directly addressed the legal nature of fraudulent transfers. The initial case (in 2003) was BankFirst v. UBS Paine Webber, et al. in which BankFirst sued a debtor’s lawyers and financial advisors for damages on the theory of common law conspiracy to make a fraudulent conveyance. The Fifth District Court of Appeals, in one of its most concise decisions, upheld the trial court’s dismissal of BankFirst’s civil conspiracy action based on the conclusion that Florida’s Uniform Fraudulent Conveyance Act (FUFTA) does not create a cause of action against a third party who allegedly assisted a debtor in the fraudulent transfer of property where the third party is not a transferee. Though the brief holding does not directly address whether fraudulent conveyance is an intentional tort, or the ethics of asset protection planning, the cases cited by the Fifth District Court of Appeal provide a window into these issues.

One case cited in the BankFirst decision was Elliott v. Glushon in which a bankruptcy trustee sued attorney Eugene Glushon for his role in structuring the fraudulent transfer of bankruptcy estate property. The federal appeals court held that fraudulent transfers include many actions which are not common law fraud. This distinction implies that fraudulent conveyance is not part of the intentional tort of fraud and deception.

The BankFirst court also cited Mack v. Newton where a corporate debtor sold 188 cows subject to a mortgage and applied the proceeds, not to reduce the cow mortgage, but to reduce another debt. Defendant Newton was one of the principals of the bankrupt corporation, and he was also a principal of another entity who received the benefit of the proceeds from the cow sale. The appellate court held that a third party is not liable for the value of the property fraudulently conveyed, even though he may have participated or conspired in the fraudulent conveyance, provided he did not receive any of the property transferred. The Mack court stated that, “the purpose of those sections of the Bankruptcy Act which are here relevant is to clearly preserve the assets of the bankrupt; they are not intended to render…liable all persons who may have contributed, in some way, to the dissipation of the assets…The actions legislated against are not ‘prohibited,’ those persons whose actions are rendered ‘null and void’ are not made ‘liable’ and the term such as damages is not used.”

Lastly, the Fifth District Court of Appeals relied on the Florida case of Yusem v. South Florida Water Management District. In Yusem, a debtor transferred over $200,000 to a foreign asset protection trust to shelter the money from creditor collection. The Fourth District Court of Appeals found that “the trial court misapprehended the purpose and scope of a fraudulent conveyance action. A fraudulent conveyance action is simply another creditor’s remedy. It is either an action by a creditor against a transferee directed at a particular transaction which, if declared fraudulent, is set aside thus leaving a creditor free to pursue the asset, or it is an action against a transferee who has received an asset by means of fraudulent conveyance and should be required to either return the asset or pay for the asset by way of judgment or execution.” Simply, the Yusem court said a fraudulent conveyance action is a creditor recovery tool and not a basis for additional damage awards.

By citing the Elliott, Mack, and Yusem decisions, the Fifth District Court of Appeal signaled that a violation of the fraudulent conveyance statutes is not a civil wrong which substantiates claims of liability or damages. Inasmuch as damages are an essential element of classic fraud, if fraudulent conveyance is not a basis for new damages, then it is logically distinct from the intentional tort of fraud.

Two cases recently decided by Florida’s Third District Court of Appeals directly hold that fraudulent conveyances are not intentional torts. In Beta Real Corp. v. Graham the court reviewed a situation where a British law firm allegedly stole $9 million of which $1.4 million ended up in a Florida bank account in the name of B.V.I. Corporation, and $675,000 of which was used to acquire a Florida condominium. In order to obtain in personam jurisdiction over the defendant, the plaintiff argued that the defendant had committed a fraudulent transfer which constituted a tortious act. Commission of a tort within Florida substantiates Florida court jurisdiction. The appellate court held that a fraudulent conveyance does not amount to a tortious act, and therefore, it denied jurisdiction. In Danzas Taiwan, Ltd. v. Friedman the same court again considered whether a fraudulent transfer was a tort which gave rise to in personam jurisdiction. In this case, a plaintiff alleged that Danzas Taiwan participated in a fraudulent conveyance because it physically transferred tangible property for a fee. The court held that the assistance given in the alleged fraudulent conveyance did not amount to a tort and did not therefore warrant in personam jurisdiction against Danzas Taiwan for conspiracy to assist a fraudulent transfer.

The Florida Supreme Court decision in Havoco v. Hill is best known for its holding that the conversion of non-exempt assets into homestead, although falling within the definition of a fraudulent transfer or conversion, is nevertheless irreversible because of the constitutional protection afforded homestead. The Havoco decision stated that the only exception to homestead’s immunity from fraudulent conveyance remedies is when the debtor had engaged in “actual fraud, or other egregious conduct.” In making the explicit distinction between exempt fraudulent transfers to homestead and “actual fraud,” the Supreme Court indicated that fraudulent conveyances are different than actual fraud otherwise treated under Florida law.

In 2004, the Florida Supreme Court directly addressed the issue of damage liability for assisting a fraudulent conveyance. In the case of Freeman v. First Union National Bank. Lewis Freeman was appointed receiver over a company called Unique Gems which allegedly ran a Ponzi scheme. The receiver alleged that defendant First Union was liable for money damages because it aided and abetted a fraudulent transfer by allowing Unique Gems to wire transfer money to Liechtenstein after the State of Florida had filed a lawsuit. The Supreme Court held that “there is simply no language in the FUFTA that suggests the creation of a distinct cause of action for aiding and abetting claims against non-transferees.” The Court stated that “we simply can see no language in FUFTA that suggest intent to create an independent tort for damages.” The fraudulent transfer statutes, the Court explained, were not intended to provide a cause of action for monetary damages against a non-transferee party arising from their participation in a fraudulent transfer.

The Florida Supreme Court decision in the Freeman case is a clear statement that a fraudulent conveyance is not a tort or a basis for monetary damages against any third party other than the property transferee. Given the Florida Supreme Court’s pronouncements, coupled with preceding decisions of Florida’s appellate courts to the effect that a fraudulent conveyance is not a tort and does not support damage claims, there is no longer grounds to assert that a fraudulent conveyance is common law fraud. There should be no doubt but that the fraudulent transfer statues are creditor remedial tools not related to common law tortious fraud, and therefore, not within the category of “criminal or fraudulent conduct” contemplated by Florida’s Code of Professional Responsibility.

If giving legal advice with respect to fraudulent conveyance is not akin to counseling tortious fraud proscribed by Rule 4.1-2(d), an attorney then must consider the extent of legal services affirmatively required to zealously help his client exercise basic property rights and protect his client against adversarial creditors. According to both the Florida Constitution and the United States Supreme Court, people have a basic right to both protect and freely transfer their property absent any creditor lien or other equitable interest. Florida’s Constitution gives its citizens a basic right to protect their property. Article I, Section 2, Basic Rights, provides that “all natural persons, female and male alike, are equal before the law and have inalienable rights among which are…to acquire, possess, and protect property” (emphasis added).

Secondly, the United States Supreme Court, in Grupo Mexicano v. Alliance Bond Fund reinforced a property owner’s rights to freely transfer his property prior to judgment, subject to equitable remedies available under fraudulent conveyance statutes. The Court held that until a creditor establishes a judgment and converts the judgment to a lien upon a debtor’s property, the creditor cannot use equitable remedies which interfere with the debtor’s free use or transfer of property. The Court stated the general rule that “a judgment establishing a debt was necessary before a court of equity would interfere with a debtor’s use of his property.” Under the Supreme Court’s holding, a person is free to convey any interest in his property until such time as a creditor establishes an equitable interest through execution of a money judgment, a statutory fraudulent conveyance remedy, or by other means.

Absent exceptions noted above, an attorney’s client with future creditor concerns has the right to convey or encumber all or any part of his property regardless of whether such transfer may ultimately be alleged to be reversible under Florida’s fraudulent conveyance statutes. The attorney’s ethical obligation to advocate his client’s position arguably includes a duty to advise the client of asset protection options. The attorney’s affirmative duties become more pronounced as Florida law provides relatively safe harbors for asset protection such as the purchase and funding of homestead property. An attorney’s previous concerns regarding third-party liability claims for damages on theories of civil conspiracy or aiding and abetting, as well as ethical considerations involving counseling clients in “fraudulent activity,” no longer excuse asset protection planning.

Just because a potential debtor warrants asset protection does not mean an attorney is ethically obligated to provide these services if the attorney reasonably does not feel competent to practice in this area. As stated above, the Bar’s ethical rules prohibit attorneys from advising clients in areas of law where the attorney is not competent and experienced. Asset protection is a relatively specialized and complex area of law involving issues of debtor-creditor collection law, tax planning, civil litigation, bankruptcy, and related areas. Each asset protection attorney has their relative strengths and weaknesses, but all should be at least familiar with issues relevant to the design and defense of asset protection plans. A significant change in any area of law related to asset protection planning can significantly change appropriate legal tools and strategies to protect clients from future creditors.

A current example of complexity in competent asset protection is the Bankruptcy Reform Act. In most cases, asset protection planning does not include anticipated bankruptcy because even under current law the bankruptcy system is unkind to wealthy debtors. The new bankruptcy law, however, substantially increases the divide between creditor remedies in state court and consequences for debtors in the bankruptcy system. For example, while the new bankruptcy law does not diminish debtor’s immediate constitutional homestead protection in state court collection proceedings, a Florida debtor in bankruptcy cannot protect his homestead unless he has resided in the property for over three years. A debtor who feels that he has comfortably protected his wealth in a homestead property, for example, may find himself stripped of his homestead equity under the new bankruptcy law if forced into the bankruptcy court by aggressive creditors. Secondly, Florida debtors who are head of household have unlimited exemption of salary and wages in state court collections. Whereas a Florida debtor eliminate unsecured debt in Chapter 7 bankruptcy regardless of salary level as long as salary in relationship to expenses does not constitute substantial abuse, the new bankruptcy law forces debtors to pay part of their earnings to repay unsecured creditors if their annual salary exceeds median income (approximately $38,000 in Florida). Given the enhanced creditor remedies available in bankruptcy court under the new bankruptcy law, creditors may soon be more likely to initiate involuntary bankruptcy proceedings. Understanding the new the bankruptcy act has already become a prerequisite for competent asset protection planning because asset protection must now pay more attention to involuntary bankruptcy and bankruptcy alternatives.

In conclusion, Florida attorneys may ethically provide clients effective asset protection planning. The ethics of asset protection practice now are comparable to ethical practice of other complex and specialized legal areas. Attorneys representing potential debtors are obligated to zealously defend their clients from creditor claims including directing their clients to consider competent asset protection representation. Yet, even as asset protection becomes integrated in legal practice and supported more by Florida court decisions, it may take additional time for asset protection to eliminate its lingering moral stigma. Asset protection attorneys may expect occasional resistance or condemnation by judges or attorneys who believe attorneys should not help people protect assets from judgments handed out by the civil justice system. Perhaps the effectiveness of competent asset protection is the cause for much of the ethical criticism and moral objection. While attorneys may confidently provide asset protection advice and design asset protection plans without fear of civil liability or ethical violations, attorneys should remain cautious about preparing transfer documents or otherwise actively participating in conveyances subject to challenge.