4 minutes reading time (899 words)

TRUST WITHSTANDS ALTER EGO ATTACK IN BANKRUPTCY

Although the case of In re Yerushalmi, 2012 WL 5839938 (Bkrtcy. E.D.N.Y., Slip Copy, Nov. 19, 2012) does not involve a foreign or domestic asset protection trust, it does have important implications in the asset protection setting.

The bankruptcy court in Yerushalmi refused to pierce a Qualified Personal Residence Trust (known in the vernacular as a “QPRT”) that was settled in 1995 and funded in 1996; the court held the QPRT was to be recognized as the owner of certain residential real property located in Great Neck, New York (referred to in the case as the “Great Neck Residence”); and that the Great Neck Residence was not part of the debtor’s bankruptcy as filed in July of 2007. The court also decided that the chapter 7 trustee was not entitled to recover “the real property expenses that were paid by the Debtor from 1996 until the bankruptcy petition date….”

The chapter 7 trustee filed an adversary proceeding claiming that the QPRT was the “alter ego of the Debtor and consequently the property held by the trust is property of the estate which must be turned over for the benefit of all creditors of the estate.”

The court noted that Debtor is an attorney, and that his law partnership dissolved in 1995, which is the same year as when the QPRT was created. While the timing was called into question by the chapter 7 trustee, the court stated that “whatever the motivation for the transfer…this transfer…fall[s] outside the reach back period for fraudulent conveyances and cannot be avoided on that basis.”

In its alter ego claim, the chapter 7 trustee “allege[d] that the Debtor ‘controlled and dominated all aspects of the QPRT’ since its creation; the real property owned by the QPRT was purchased with the Debtor’s own funds; the QPRT never established its own checking account; the QPRT did not maintain books and records; the Debtor’s wife, ‘Malka acted at all times as the nominee of the Debtor with respect to the QPRT’; [and] ‘the Debtor used his control of the [QPRT] to conceal his assets and to engage in fraudulent conveyances to shield funds from the reach of his creditors[.]’”

In what is a strong argument for offshore trust planning when compared to domestic trust planning, the court held that the chapter 7 trustee’s “alter ego claim is subject to neither the six-year statute of limitations for fraud nor the 20-year statute of limitations to enforce a judgment. “The Court agrees with the Trustee that there is no statute of limitations or reach back period on a trustee’s cause of action to recover property of the estate under Section 542 of the Bankruptcy Code.

The court then turned to the merits of the alter ego claim, that “’following the formation of the QPRT, the Debtor used the QPRT as his own personal vehicle to shield his assets from creditors.” The chapter 7 trustee alleged that the QPRT is the “’mere instrumentality’” of the Debtor and the trust should be pierced….  The chapter 7 trustee asserted among other things that the QPRT should be pierced because the Debtor exercised “complete dominion and control” over the QPRT; that the Debtor made all financials decisions for it; that only the Debtor’s funds were used to pay expenses of the Great Neck Residence; and that no trust formalities were followed.

The court first examined “whether a validly-formed estate planning trust can ever be “’pierced.’” The court cited a string of other cases, and then quoted one case in particular that “[t]here is no authority for applying, by analogy, a theory of ‘piercing the corporate veil’ to disregard the form of a trust, when the trust was not formed for an illegal purpose and there is the requisite separation between beneficiary and trustee.”

The court then found that “the weight of the caselaw in the state of New York supports a ruling that estate planning trusts generally are susceptible to attack if used for a fraudulent purpose.  However…the Court finds that the facts of this case do not rise to the level necessary to “pierce” the veil of the QPRT.”

The chapter 7 trustee conceded that the “correct analysis is not of the circumstances surrounding the transfer to the QPRT, but rather the Debtor’s conduct subsequent to the formation of the trust. The…best evidence to support [the] alter ego theory is that the Debtor allegedly claimed ownership of the Great Neck Residence [notwithstanding record ownership by the QPRT]."  The Debtor denied any claimed ownership.  The court stated it did not find this to be a material fact, for even assuming this was the case “it does not mean that the Debtor in fact owned the Great Neck Residence, nor does it prove that the Debtor completely dominated and controlled the QPRT. Without more, this statement is insufficient to declare the QPRT an alter ego of the Debtor. The cases which have pierced the trust veil have done so on much more egregious facts than these.”

The court closed its discussion by stating that “[b]ased on the undisputed facts, the Court finds that the Debtor did not engage in any conduct or enter into any transaction that would be inconsistent with the QPRT’s ownership of the property and the Trustee has failed to prove that the Debtor exercised complete domination over the trust, or even if he did, that he used that domination to commit a fraud or wrong.”

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