Archive for the ‘ Litigation ’ Category

Asset protection versus bankruptcy

A well-to-do friend called me for some planning.  He invited me to his beautiful, five-bedroom home in the hills above Westlake Village.  We sat at poolside as he described his predicament.

While he was quite wealthy, he could see losing almost all of that wealth in a snap.  He owned an insurance brokerage; one of his clients had sued him for millions of dollars, claiming that he had sold a bad policy.  Insurance malpractice, I guess.  Trial was in another two weeks, and if he lost, he would have to pay an eight-figure verdict with only seven figures of assets.  Should he file bankruptcy if that came to pass?  Should he do anything right now to protect his assets and lifestyle?

I thought it very wise to talk to me before anything happened.  I was able to explain what would happen to his house (he’d keep it, because he had such a large mortgage on it) and his other assets in bankruptcy (the trustee would take his annuity and his life insurance policies, because they were more valuable than the appropriate exemptions, but the trustee would leave most of his insurance company because it depended on his personal services to have any value).

Could he do any asset protection?  Well, yes.  But he’d need to make a decision early as to whether he was going to combine asset protection with bankruptcy.  There are some things one can do to protect assets that work only if one never files bankruptcy.

We bankruptcy attorneys shy away from fraudulent transfers.  Cathy Moran in Redwood City gives a good explanation why this is.    And certainly “fraudulent transfer” sounds only a little less loathsome than a lung disease.   But there are advantages to making a fraudulent transfer, particularly if you are trying to defeat a private creditor: the transfer creates another legal hurdle to the creditor’s ultimate recovery.  It’s essentially a bargaining chip.  Don’t try this if you owe money to the IRS, or if you want to eventually discharge your taxes in bankruptcy.

That’s something I learned from Jacob Stein, one of the few lawyers I know with his own Wikipedia page.  So when my friend asked what he should do, I told him to call Jacob, who knows a whole lot more about asset protection than I do.

There is also asset protection that works in bankruptcy.  It’s called planning.  Put as much money as you can into exempt assets: 401k, IRA, a homestead.  Insure yourself so you don’t face a multi-million verdict.  Cathy Moran talks about these strategies here.

Asset planning can go spectacularly badly in bankruptcy.  I once represented a trustee who had a debtor who thought she could buy a condo in Mulege, Baja California, then file bankruptcy in California, discharge her debts here, and retire to Mexico.   Her life’s plans changed drastically when we were able to seize and sell her condo.  She got a good lawyer, who was able to talk us out of pressing criminal charges.

If you’re facing the possibility of sudden loss, go talk to an attorney who knows something about bankruptcy and collection law.  I’ll be happy to help you out.

My client (“Wolfgang”) ran a small construction business in the summer of 2007. He hired an attorney (“Attorney David”) to help him foreclose on mechanics’ liens he had recorded, because one of his customers didn’t pay him $50,000 for a construction job. The attorney helped him, but the litigation turned very ugly: the customer countersued for $250,000 in completion damages.

The legal bills mounted. From May 2007 to November 2007, Attorney David charged more than $100,000 in attorney fees. Wolfgang settled the countersuit by paying $40,000. He never expected that result: he had hoped to collect $50,000, not pay $40,000.

The recession hit too. Construction started to tank in the San Gabriel Valley in the spring of 2007; by the summer of 2007, Wolfgang had no new jobs, and realized he needed to sell his house and take other financially-protective actions. The bills that Attorney David was piling up? Wolfgang couldn’t keep up with them, but kept promising he’d pay Attorney David.

He and his wife discussed the situation over the fall. If we’re going to sell the house and move, his wife said, I want to go back to Luxembourg (where she came from) with the children.

His wife moved back to Europe in January 2008. Wolfgang sold his house the next month. He had also invested in a Pollo Loco franchise, and he tried to keep that going. He moved in with his mother in Calabasas for five months, then moved to Luxembourg to be with his wife and children.

Attorney David felt betrayed. Stiffed. Resentful. He sued Wolfgang for the fees and interest, now more than $150,000. Not finding Wolfgang in the US, Attorney David found an attorney and process server in Luxembourg. Wolfgang didn’t answer the lawsuit, and Attorney David figured out how to garnish Wolfgang’s Luxembourgish wages.

Somehow Wolfgang found me. I filed a bankruptcy case for him, and got him discharged of his debts. Even though Wolfgang lived in Luxembourg, there was enough reason to have the case administered in Southern California. The discharge would extend to the debt to Attorney David.

But Attorney David had other ideas: he sued Wolfgang in the bankruptcy court for nondischargeability of the debt, now more than $200,000. Specifically, he claimed that Wolfgang had defrauded him; he alleged that Wolfgang had misrepresented himself and case at the time he hired Attorney David, and had never intended to pay the attorney’s fees. A debt for services procured by fraud is not dischargeable under 11 USC Sec. 523(a)(2).

Attorney David’s case was weak. Wolfgang clearly breached the contract, but contract breach isn’t fraud. Fraud requires elements of knowledge (Attorney David would need to prove that Wolfgang knew he couldn’t or wouldn’t pay at the time he hired the attorney) and reliance (Attorney David would need to prove that he justifiably relied on Wolfgang’s promises). Nonpayment of fees is an occupational hazard for attorneys; we guard against this hazard by asking for fee deposits and making it clear that nonpayment is grounds to withdraw. Jay Foonberg, a coach for attorneys, memorably holds that it’s better to not work and not get paid than it is to work and not get paid, so don’t get stuck in the latter; he calls this “Foonberg’s Rule.”

Wolfgang was going to win, but the process could take months if not years. To try to settle the case, we went to mediation.

In mediation, a neutral party – here, another bankruptcy attorney – meets with both sides and tries to see if there is any ground on which to resolve the case. The case only settles if both sides agree to the terms of the settlement; otherwise, they leave the mediation and continue on to trial.

Attorney David made the first presentation in mediation: he reiterated the same settlement demand he had made six months earlier – payment of $5,000 a month for 20 months, a total of $100,000. My client rejected it out of hand because he could not commit to the payment schedule. I pointed out to the mediator that he had a tough job: Attorney David didn’t have a fraud case, and Wolfgang didn’t have assets. Wolfgang had little incentive to find a lot of money to pay for settlement, because he expected to win; and even if he lost, then Attorney David would be left with a piece of paper saying he was owed $200,000 or more, but no way to collect more than a fraction of that money.

Wolfgang did not display a compromising mindset. He found it unjust to pay one red cent to end the litigation: the truth was that he had not defrauded Attorney David.

Many people think that the justice system exists to find the truth, and then to act on it. Not so. The justice system exists to resolve disputes; it is a beautiful thing when our system of justice reaches a just and true result, but it’s entirely unnecessary that it do so.

If the justice system exists to resolve disputes, someone who is in a legal bind should recognize that he needs to think strategically and not expect the judge to find truth and vindicate him. Strategic thinking is as useful, if not more so, in a legal setting as in any other life interaction.

Wolfgang had a difficult situation: he had few assets to fight with. He had me, but my willingness to team up with him would evaporate when I had used up the $12,000 retainer I held in my trust account. His opponent was a retired attorney who showed himself willing – like Javert in Les Miserables – to follow Wolfgang back to the Old World. “Justice” doesn’t enter into the equation.

While he was dogged, Attorney David also showed himself to be a poor negotiator. After his presentation, he said that he was busy, and really wanted to settle this case because he had more important work to do than prepare for this trial. Not a good idea to back himself into a corner.

The parties ultimately settled for a payment of $20,000 by Wolfgang: half on signing the settlement agreement, and two payments of $5,000 each in 12 and 24 months.

Had the case gone to trial, it could have cost Wolfgang at least $20,000. He really faced the question of whom to pay: his attorney to defend him, or his former attorney turned tormentor. I have worked for clients who lived by the motto “millions for defense, not a cent in tribute.” However, when you are bankrupt, that motto is generally unhelpful.

Attorney David will need to question whether his effort was worth it. He spent untold hours attempting to get paid, drove Wolfgang into bankruptcy, and ended up with less than 10 cents on the dollar. That doesn’t look like a win to me.

On the other hand, Wolfgang had to pay up to get out of an almost frivolous lawsuit after filing bankruptcy. That does not look like much of a win to me, either.

Disclosing information

Attorneys often try to hide a client’s information, and disclose as little as possible about the client. This strategy sometimes has comical effects, as in this exchange I heard in a deposition:

“Q:       Do you remember where the main office for Gas del Lagarto  was located?

A:         Even though I was the officer and president of Gas del Lagarto at that time, four years ago today, I don’t recall if we had our main offices in El Paso or Ciudad Juarez.

Q:         How is it that you do you not recall whether the offices were in Texas or Mexico?

A:         You have to approach life like a movie: it has a beginning, a middle, and an end.”


Here is another highly amusing dramatization of hiding information. 


This kind of “hide the ball” mentality is incredibly frustrating for the questioning attorney, and litigants use it mostly to psych out the other side. It doesn’t make the witness look credible at all, and it benefits litigation attorneys handsomely because it drives legal fees up.

There is no place for this in bankruptcy. The debtor comes to the court seeking a release from his debts; in exchange, he needs to provide documentation that he has nothing to pay them with.  If anyone on the “other side” of the debtor, that is, the creditors, the trustee, or the judge, believes that the debtor is playing fast and loose with information, or hiding something, the debtor can only be hurt.  Penalties for failing to divulge required information range from the trivial to the criminal.

As a debtor, you should expect that a good bankruptcy attorney will give you advice on when and how to file bankruptcy. You should not expect that the attorney will dig you out of a hole you made by failing to provide documentation or information when you were asked for it.

We have been able to help debtors who thought it was to their advantage to hide information.  Usually, we counsel them to determine a coherent narrative that explains all the documentary facts, disclose the information, and advance the narrative. It works much better than trying to frustrate the other side.

You are a person who can’t pay your bills.  One day, a disheveled guy comes to your door, asks whether you answer to your name, and when you say “yes,” he hands you a summons in a state-court lawsuit seeking a money judgment for an unpaid debt.

Once you get the summons, you have 30 days to answer it.  You’re not going to answer, because it will cost you $400 to do so and you don’t really have a defense; you owe this money, you just can’t pay it.

If you don’t answer in 30 days, then the attorneys may file a request for a default judgment.  That usually takes about a month to get.

After they have the default judgment, they may take collection action.  That includes placing a lien on your house, garnishing wages, levying accounts, and dragging you down to their office for deposition to find out your social security number and your intimate financial details.

A bankruptcy filing will stop this process at whatever stage it has gotten to.  You won’t be able to recover money already levied or garnished, but you will be able to set aside a lien.

The tenant who wanted her rent back

My client was a landlady who rented her three-unit house not far from the beach in Ventura. The county came by one day and put yellow tags on two of the units, calling them “substandard” and evicting the tenants that day. Why “substandard?” Mostly because the area was zoned for one unit only: there was no way to have three units on the lot legally. But there were other, fixable, health and safety issues; the building was not the Ritz-Carlton.
Three months later, the landlady had demolished the units, short-sold the remaining house, and filed for bankruptcy protection.
The tenant in the middle unit didn’t want her to get off so easy. She filed an adversary proceeding, a lawsuit, in the bankruptcy asserting a nondischargeable debt: she claimed she was entitled to a refund of all the rent she had paid, since the unit was illegal the entire time and California law says you can’t collect rent on an illegal or uninhabitable unit. She claimed that the debt was nondischargeable, that is, the landlord should still owe it despite getting bankruptcy protection, because the landlord had collected each rent check by fraud, or because the act of renting the unit was a “willful and malicious” tort.
My client refused to settle: she didn’t see any reason she should refund rent for a period of time (three and a half years) when the tenant actually occupied the apartment without an express complaint. The tenant demanded a five-figure lump-sum payment to drop the case.
So we went to trial. Trials in bankruptcy court are blessedly short: no juries, just the judge, the parties, and the testifying witness. Not much chance to argue: the judge knew the law, and we had submitted briefs beforehand.
The tenant testified that she developed some questions about the legality of the units, and visited the city’s planning department. She discovered that the units were indeed illegal. “You didn’t bring this to the landlady’s attention then, did you?” “No,” the tenant admitted. “I was scared of her, and besides, I didn’t want to jeopardize the place where I was living, the benefit of my tenancy.”
The tenant also testified that she knew, from her first phone conversation with the landlady, that the unit she would rent had some issues. She took it anyway because she was desperate.
At the end of the trial, right after we finished our [short] closing arguments, the judge made findings of fact from the bench. No fraud, no willful and malicious tort, judgment for defendant. My landlady client was able to walk away from her debts, including this frivolous one.
Facts win cases; bad lawyering can lose them. Here, the facts spoke for themselves. Without a lawyer, however, the landlady would have been lost in the morass of procedures and evidence objections (who but a lawyer really knows what “hearsay” is?).
Even more so than other clients, bankruptcy clients need to make a cost-benefit analysis. Had the landlady not fought the case, she would have left her bankruptcy with a nondischargeable judgment of around $50,000. Her defense cost around $15,000. She might have settled for $15,000 before trial, but negotiations broke off. It’s up to the client to determine when to settle or go forward; the landlady went forward because of principle, but later regretted not just writing a check to settle. But who knows? Had she settled early on, she might have regretted that course of action too.
If you face a similar situation, a bankruptcy in Ventura or Los Angeles counties where someone wants to make sure you don’t get your discharge, we can help you at Faucher & Associates.