A couple of recent cases illustrate situations where moving assets from one state to another may have the effect of shielding those assets from creditors. In both of the cases, judgment debtors moved assets to another state and succeeded in avoiding enforcement of the judgment.
In re Cleopatra Cameron Gift Trust1, a California Judgment Against Beneficiary Unenforceable Against South Dakota Spendthrift Trust
The Cleopatra case concerned California trusts were established for the benefit of Cleopatra Cameron by her father. As part of Cleopatra’s divorce from her husband, Christopher, the court granted full custody of the couple’s minor children to Christopher and ordered Cleopatra to pay child support. Under California statutes, otherwise creditor protected trusts (spendthrift trusts) can be compelled to make distributions to third parties to fund a beneficiary’s child support and spousal support obligations.2 As such, the trusts were joined as parties in the divorce proceeding so that the court could order the trustee to make Cleopatra’s child support and spousal support payments directly to Christopher.
After a number of years of operating the trusts in California, Cleopatra exercised her right to move the trusts’ situs to South Dakota. A number of years later, Cleopatra petitioned the Circuit Court, Second Judicial District, Lincoln County, South Dakota for a declaratory judgment that the trusts are prohibited from making payments directly to Christopher. Cleopatra was relying on South Dakota statutes which specifically disavow any “exception creditors” to spendthrift trusts.3 After Cleopatra prevailed in trial court, Christopher appealed to the South Dakota Supreme Court.
The issue before the South Dakota Supreme Court on appeal was whether the California order was entitled to “full faith and credit” under the U.S. Constitution.4 Under the Full Faith and Credit Clause, one state generally cannot disregard the judgment of another state because it disagrees with the merits or reasoning of the other state. The South Dakota Supreme Court noted limits of the Full Faith and Credit Clause. One of those limits is that one state is not required to adopt the practices of another state involving “the time, manner, and mechanisms for enforcing judgments.” In the court’s view, the question was the method of enforcing the order was valid rather than the validity of the order itself. Based on this conclusion, the South Dakota Supreme Court held that, although the order for child support would be enforceable against Cleopatra in South Dakota under the Full Faith and Credit Clause, the order against the trust would not be enforceable in South Dakota. Since South Dakota law specifically prevents enforcement of judgments against spendthrift trusts, the California order was held not to be enforceable against the South Dakota trusts.
This case is significant for a number of reasons. Over the years, attorneys have argued whether the Full Faith and Credit Clause would require enforcement of a judgment against out-of-state trusts. This is especially important for domestic asset protection trusts (“DAPT”) established by residents of states without DAPT statutes. The argument is that the DAPT state (where the trust is located) may be compelled to enforce non-DAPT state court order under the Full Faith and Credit Clause.5 At least one state supreme court now has held otherwise. Based on information I have received, the parties to this case are not petitioning the U.S. Supreme Court for certiorari (the deadline for which appears to have expired).
Lapides6, Moving to Texas to Enjoy Unlimited Homestead Upheld
In Lapides, Richard and Janis Lapides owed their former law firm Hinds & Shankman, LLP (“H&S”) legal fees. In December 2018, the Bankruptcy Court in California entered a judgment in favor of H&S against Richard and Janis for $785,687.97 in damages, plus interest, and $70,491.91 for costs. In an attempt to avoid collection efforts by H&S, in 2016 and 2017 Richard and Janis sold their California real estate. They purchased homestead property in Texas in 2017 with the proceeds. California has a limited homestead exemption. Texas has an unlimited homestead exemption, meaning that judgment creditors cannot enforce any judgment against a residence no matter how much equity a debtor has in his or her homestead property. As a result of this transfer of assets from non-exempt equity in California property into fully exempt Texas homestead property, H&S filed suit in federal district court seeking an order that the transfer was fraudulent as undertaken “to hinder, delay, or defraud creditors” and, therefore, voidable.7
The court began the case with an analysis of the Texas homestead laws, which are contained within the Texas Constitution8, as well as law that homestead protections are to be liberally construed in favor of protection. Although the Texas Constitution contains certain exceptions to homestead protection, fraudulent transfers are not excepted. The court evaluated a number of cases from Texas that indicated a strong public policy in favor of homestead protection and that no exceptions should be found beyond those contained within the Constitution.
After reviewing the Texas authorities on point, the court looked to the Havoco9 case from Florida which had very similar facts. Like Texas, Florida has unlimited homestead protection as part of its own Constitution. In Havoco, the Florida Supreme Court ruled that statutory fraudulent transfer laws could not trump constitutional homestead protections. The Lapides court reached the same result as applied to Texas homestead protections. Based on the rulings in Lapides and Havoco, the debtors were able to engage in what otherwise would have constituted fraudulent transfers without any recourse to the judgment creditor.10
The law of asset protection is ever changing. More states are adopting DAPT statutes which increases protection from creditors. However, more states also are adopting the Uniform Voidable Transactions Act, which gives creditors expanded rights to void transfers (and likely in a more favorable venue). As people engage in more structures to protect their assets, we will inevitably see a continued development of laws dealing with Full Faith and Credit, conflicts of laws, fraudulent conveyances, voidable transactions, and other issues. Some states will adopt a more creditor-friendly public policy; others a more debtor-friendly public policy. Cases like Cleopatra and Lapides illustrate how differences in state laws affect creditors’ rights. Likewise, they show that asset protection planning can be successful in the right circumstances.
- Matter of the Cleopatra Cameron Gift Trust, Dated May 26, 1988, 2019 SD 35, 931 N.W.2d 244.
- Cal. Prob. Code § 15305(c).
- SDCL 55-1-25. This statute specifically repudiates exception creditors under the Restatement (Third) of Trusts and the Uniform Trust Code. Restatement (Third) of Trusts § 59 specifically provides an exception to spendthrift protections for “support of a child, spouse, or former spouse.” Uniform Trust Code § 503 excepts, among other creditors, “a beneficiary’s child, spouse, or former spouse who has a judgment or court order against the beneficiary for support or maintenance.”
- Article IV, Section1 of the United States Constitution.
- Note here that the trusts were moved to South Dakota before California’s adoption of the Uniform Voidable Transactions Act (“UVTA”). Section 10 of UVTA gives jurisdiction to state of the debtor’s principal residence. If California law could be applied to determine that a transfer of the trust to South Dakota was a voidable transfer, could that change the outcome? I have heard some argue it would change the analysis, but others argue it may not.
- Hinds & Shankman, LLP v. Richard Lapides, et al., 2019 WL 4956148.
- As opposed to the Cleopatra case, the actions here all occurred after California adopted the UVTA. Nonetheless, Texas homestead laws prevailed. I do not know certain important facts, such as whether Richard and Janis relocated to Texas before or after purchasing the homestead (or, really, whether that would even matter to the court given the known creditor status of H&S). Perhaps there is some reason why the Sec. 10 of the UVTA was not addressed by the court of which I am unaware. Although not addressed in the court’s opinion, it could be important that TX homestead protections are constitutional (same with FL) whereas other states’ have statutory homestead exemptions.
- Tex. Const. Art. 16, § 50(a).
- Havoco of America, Ltd. v. Hill, 790 So.2d 1018 (Fla. 2001).
- Although Florida has fraudulent conversion statutes whereby a conversion of non-exempt assets to exempt assets by a debtor, that likely also cannot trump the state constitution. Likewise, a bankruptcy court in Florida has just held that statute did not apply when the trustee of an offshore asset protection trust engaged in the conversion rather than the debtor who first transferred assets to the trust. See In re Rensin, 2019 WL 2004000 (Bank. S.D.Fla., May 3, 2019). Edmondson, Gray, “Asset Protection Trusts: Update on Recent Litigation,” June 25, 2019, https://esdlawfirm.com/apt-update-june2019/#easy-footnote-bottom-14-780.