Protecting the Under-Insured Defendant
Michael McGrath, Frederick J. Petersen
A client causes serious injury to another. That client's insurance is insufficient to cover the damages that may be awarded against him. What may counsel for the under-insured client do without exposing himself to civil liability, violating criminal statutes or betraying the rules of professional responsibility?
ARIZONA EXEMPTION LAW
The initial issue is whether the under-insured client has property which could be attached to satisfy a judgment in excess of insurance coverage.
The Arizona Legislature has provided its citizens the right to retain certain "necessities," which exempts property from attachment by creditors and is beyond the reach of a bankruptcy trustee in a federal bankruptcy proceeding.
The United States Congress has made clear in the legislative history for the Bankruptcy Code, passed in 1978, that it is entirely appropriate for a lawyer to assist a client in "bankruptcy planning." Permissible bankruptcy planning authorizes the transmutation of non-exempt property (i.e., stocks and bonds) into an exempt asset.
By far the most commonly used planning tool is the conversion of a non-exempt asset into additional equity in a homestead. The Arizona homestead statute exempts up to $150,000 of equity in a home. Please note that a homestead or personal property exemption is not available against federal tax liens.
Based on Arizona's exemption for an automobile (only $5,000 of equity for each spouse), an individual facing financial liability may need to sell or refinance an existing vehicle, or convert automobile equity into another exempt asset while leasing or buying a new vehicle that does not have excessive equity.
An individual's interest in an ERISA-qualified retirement plan is not considered the judgment debtor's property, because ERISA-qualified plans are necessarily subject to spendthrift trust provisions. However, a transfer to a retirement plan is not exempt from attachment by creditors where the transfer has been made within four months of the defendant's bankruptcy filing.
Finally, Arizona's exemption for an individual's tools of trade may permit the transfer of a small amount of money into property in which the debtor can use in his or her business. While one can only exempt $2,500 per person for a "tools of the trade" exemption, exemptions are applied in a liquidation value setting; this means that a debtor can keep property free from attachment by creditors or a bankruptcy trustee, unless the executing party can establish that the property can be sold and there would be net proceeds in excess of the exempt amount.
Often the first reaction of an individual facing civil liability is to simply give his or her non-exempt property to a family member or friend. Arizona has adopted the Uniform Fraudulent Transfer Act, which renders such conveyances subject to reversal if the "intent" of the transferor is to hinder, delay or defraud creditors, or because the transfer was done without fair consideration, while the debtor was insolvent or was left with insufficient assets in relation to his or her business (a constructive fraudulent transfer). Arizona's fraudulent transfer statutes apply both to present creditors and future creditors. In other words, a transfer can be made before an obligation to a creditor is incurred, but that creditor may have the right to set it aside. Further, the statute of limitations to attack a fraudulent transfer is four years from the date of the transfer.
Under the Bankruptcy Code there is a separate fraudulent transfer statute. The bankruptcy statute addresses both actual and constructive fraudulent transfers, though a transfer made with intent to hinder, delay or defraud creditors-actual fraudulent intent-cannot be enforced by parties who became creditors after the transfer. In other words, the actual fraudulent intent standard under the Bankruptcy Code applies only to present creditors.
Under the Arizona statute, in determining actual fraudulent intent, one may consider whether "before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit."
The Arizona legislature has criminalized the conduct of fraudulent transfers. A.R.S. §44-1211 makes it a Class 2 misdemeanor to be a party to a fraudulent conveyance of any lands, goods, or chattels with intent to deceive and defraud others. A.R.S. §44-1217 establishes as a Class 2 misdemeanor the fraudulent selling, conveying, assigning or concealment of property with intent to defraud creditors. Also, A.R.S. §13-2205 makes it a Class 6 felony for a person to secrete, assign, convey or otherwise dispose of property ... to prevent that property from being subject to payment of a judgment. This criminal statute significantly increases the consequences of a debtor's conduct once a judgment has been entered.
AN ATTORNEY'S LIABILITY FOR A CLIENT'S FRAUDULENT CONVEYANCE
An attorney may be held responsible for a conspiracy to defraud creditors when assisting or advising a client to transfer assets to avoid payment of a debt. McElhanon v. Ong Hing, 151 Ariz. 386, 728 P2d 256 (App. 1985), reversed on other grounds 151 Ariz. 403, 728 P2d 273 (1986). Attorney Hing defended clients, Greer and Harris, in a civil action. After a jury returned a verdict against Harris, but not Greer, attorney Hing stepped over the line. He assisted the transfer of Greer's stock in a restaurant corporation to Harris, and personally held the restaurant stock as collateral for a promissory note made by Greer and Harris for his attorneys fees. In post-judgment execution proceedings, the judgment creditor became aware of the stock transfer and Hing's participation. The Court of Appeals determined that in Arizona there is a cause of action for damages rising out of a conspiracy to commit a fraudulent conveyance. The Court rejected Hing's claim that his status as an attorney insulated his actions. Further, the Court determined that the communication between Hing and his clients was not privileged because it was done in furtherance of a conspiracy to commit a fraudulent conveyance. Finally, the Court determined that the creditor need not actually hold a lien at the time of the fraudulent transfer, but any creditor, has standing to bring an action for a conspiracy to commit a fraudulent conveyance.
A key to the McElhanon decision was the presence of an actual intent to defraud. The Court tends to distinguish situations where an attorney advises a client on how to manage and protect assets from a situation where actual intent to defraud is found.
The McElhanon decision followed the decision of the Wisconsin Supreme Court in Dalton v. Meister, 71 Wis.2d 504, 239 N.W.2d 9 (WI 1976), where, in anticipation of a trial, a defendant, with the help of his attorney and bank, transferred all of his assets so that they could not be recovered by the plaintiff. The Wisconsin court found that third parties may be liable for conspiracy to defraud a creditor.
While McElhanon was a civil case, an attorney must consider A.R.S. §13-1003. This criminal statute makes it a felony to agree with one or more persons that one of them will engage in conduct in furtherance of an offense.
THE CODE OF PROFESSIONAL RESPONSIBILITY
It has long been held in certain jurisdictions that an attorney who encourages a client to make a fraudulent conveyance may be guilty of a fraudulent conveyance. See Townsend v. State Bar of California, 32 Cal. 2d 592, 197 P.2d 326 (1948). In Townsend, the California Supreme Court sitting en banc, determined that an attorney who advises a client to convey certain real property for the purpose of delaying and defrauding creditors, commits an act involving moral turpitude and dishonesty. While Townsend had previous offenses with the California Bar, this conduct, and his attempt to cover it up, lead to a three-year suspension.
Arizona's Rules of Professional Conduct include several rules which impact a lawyer providing "asset planning" services to an under-insured client.
E.R. 1.2 proscribes counseling or assisting a client in criminal or fraudulent conduct. E.R. 3.3 "Candor Toward The Tribunal" proscribes making false statements of fact or law, or failing to disclose a material fact to the court. Finally, E.R. 8.4 "Misconduct" defines professional misconduct as including engaging in dishonesty, fraud, deceit or misrepresentation.
The Arizona Supreme Court has recently decided in an asset-planning case, that a lawyer does not commit misconduct unless it is proven that the attorney engaged in "knowing misconduct." The Supreme Court determined for there to be a violation of either §1.2 or §3.3, the state bar must prove that a lawyer's conduct is intentional if it is to constitute an ethical violation. See In re Tocco, Ariz. Supreme Ct. No. 98-0056-D, filed Sept. 14, 1999.
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