South Carolina Lawyer September 2016 : Page 32
Show Me the Money Collecting Judgments Against the Savvy Judgment Debtor By Bruce Wallace and Kyle Brannon So you have a money judgment that is not satisfied. With a savvy judgment debtor, the process of collecting that judgment can be challenging. My wife, children and I play Monopoly. Two of my sons like to hide the $500 bills in their pock-ets during the game. Just when we think they are bankrupt after land-ing on a hotel, they produce the cash to avoid bankruptcy and live for another roll of the dice. In real life, savvy debtors rarely produce cash to pay their debts. Instead, they have placed their wealth in investments that may be difficult to discover, attach and levy. But with careful investigation and planning, judgment creditors can reach assets that lay unseen. This article assumes the credi-tor’s lawyer has taken the basic steps to record the judgment in each county where the debtor may own property, and the lawyer has 32 SC Lawyer Playing the shell game – recovering assets in the hands of third parties South Carolina’s Statute of PHOTO BY GEORGE FULTON received a nulla bona from the coun-ty sheriff. 1 This article also assumes the creditor’s lawyer has properly filed any foreign judgment. 2 Finally, to the extent possible, this article will not address supplementary proceedings, except where they may be necessary in aid of collect-ing the assets discussed herein. Following these initial steps, this article addresses how to discover and “reach” some personal assets not readily available to satisfy a money judgment. Regardless of whether the assets are held by third parties, in trust, or constitute ownership in a limited liability company or professional corpora-tion, there are procedures for attaching such assets as part of satisfying a money judgment.
Show Me The Money: Collecting Judgments Against The Savvy Judgment Debtor
Bruce Wallace And Kyle Brannon
Collecting Judgments Against the Savvy Judgment Debtor
So you have a money judgment that is not satisfied. With a savvy judgment debtor, the process of collecting that judgment can be challenging. My wife, children and I play Monopoly. Two of my sons like to hide the $500 bills in their pockets during the game. Just when we think they are bankrupt after landing on a hotel, they produce the cash to avoid bankruptcy and live for another roll of the dice. In real life, savvy debtors rarely produce cash to pay their debts. Instead, they have placed their wealth in investments that may be difficult to discover, attach and levy. But with careful investigation and planning, judgment creditors can reach assets that lay unseen.
This article assumes the creditor’s lawyer has taken the basic steps to record the judgment in each county where the debtor may own property, and the lawyer has received a nulla bona from the county sheriff.1 This article also assumes the creditor’s lawyer has properly filed any foreign judgment.2 Finally, to the extent possible, this article will not address supplementary proceedings, except where they may be necessary in aid of collecting the assets discussed herein.
Following these initial steps, this article addresses how to discover and “reach” some personal assets not readily available to satisfy a money judgment. Regardless of whether the assets are held by third parties, in trust, or constitute ownership in a limited liability company or professional corporation, there are procedures for attaching such assets as part of satisfying a money judgment.
Playing the shell game – recovering assets in the hands of third parties
South Carolina’s Statute of Elizabeth3 can be used to unwind a fraudulent conveyance from a debtor to a third party under certain circumstances. The statute provides that every gift, grant, transfer or conveyance of property by a debtor with the “intent or purpose to delay, hinder, or defraud creditors” is void.4 If the debtor transferred assets to a third party for no consideration, the creditor must prove: (1) the grantor was indebted to the creditor at the time of the transfer; (2) the conveyance was voluntary (i.e. without consideration); and (3) the grantor failed to retain sufficient property to pay the debt owed to the creditor in full.5 The debtor must retain sufficient property to pay the debt at the time that the creditor seeks to collect its debt.6
If the transfer is supported by valuable consideration, the creditor’s proof becomes more difficult, and he must show: “(1) the transfer was made by the grantor with the actual intent of defrauding his creditors; (2) the grantor was indebted at the time of the transfer; and (3) the grantor’s intent is imputable to the grantee.”7 The creditor must show the fraudulent conveyance by clear and convincing evidence. However, if the conveyance is an intra-family transfer, burden shifts to the transferee to establish, by clear and convincing evidence, the consideration and the bona fides of the transaction.8
The Statute of Elizabeth has a three-year statute of limitations that is governed by the “discovery rule,” which provides that “the statute of limitations does not begin to run until discovery of the fraud itself or of such facts that would have led to the knowledge thereof, if pursued with reasonable diligence.”9
With trust you have nothing – attaching trust assets
If a debtor has assets in trust, whether a creditor can levy and execute against trust assets turns in part on whether the debtor is the settlor or a beneficiary of the trust, and the kind of trust it is. South Carolina Title 62, Part 5, provides the rules for handling creditor’s claims against a trust beneficiary. For debtors who are settlors of a trust, the property that can be attached depends on whether the trust is revocable or irrevocable; in either event, the statute disregards spendthrift provisions.10 If the assets are held in a revocable trust, during the lifetime of the settlor, the property of the revocable trust is simply “subject to the claims of the settlor’s creditors.”11 “With respect to an irrevocable trust, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.”12 “If a trust has more than one settlor, the amount the creditor or assignee of a particular settlor may reach may not exceed the settlor’s interest in the portion of the trust attributable to that settlor’s contribution.”13
Except for interests in spendthrift trusts and discretionary trust interests, creditors can reach a trust beneficiary’s interest by attachment.14 Once attachment has been made, and assuming there are no challenges to the attachment order itself, “the trustee will then pay to the creditor instead of to the beneficiary any payments the trustee would otherwise be required to make to the beneficiary, as well as discretionary distributions the trustee decides to make.”15
Spendthrift trusts have specific clauses within them to prevent creditors attaching a beneficiary’s interest in the trust principal or interest. The South Carolina Trust Code preserves the protection of spendthrift provisions: “a trustee shall have no liability to any creditor of a beneficiary for any distributions made to or for the benefit of the beneficiary to the extent the beneficiary’s interest is … protected by a spendthrift provision.”16 This is a departure from common law, where a trustee of a spendthrift trust would have to pay the creditors of a beneficiary for spousal support.17
Protection similar to a spendthrift trust protects “a discretionary trust interest as referred to in S.C. Code Section 62-7-504.”18 In Collins v. Collins,19 the S.C. Supreme Court addressed this issue with regard to a claim for child support. The husband was the beneficiary of a trust that granted full discretion to the trustees whether to pay the husband any funds until he reached the age of 28. In ruling in favor of the trustees, the Court held the husband “cannot compel the trustees to pay any part of the trust fund; and his creditors, who are in no better position, cannot reach it.”20 By contrast, under the new Trust Code, a court now can compel a trustee to satisfy a judgment for child support if the trustee breached the standard of distribution or abused its discretion regarding distributions.21 Unfortunately, the right to challenge the trustee’s abuse of discretion rests solely with the beneficiary, not with the creditor.22
Regardless of whether held in a spendthrift trust or subject to a discretionary trust interest, when a trustee makes a distribution, the statute does not protect the funds once the beneficiary receives them.23 Assuming the funds are deposited into a bank account by or for the beneficiary, then the funds are attached like any other monies on deposit.24
Where the beneficiary/debtor is entitled to a mandatory distribution, and the trustee has failed or refused to make the distribution, the creditor is entitled to reach the mandatory distribution, regardless of whether it is a distribution of principal or interest, and regardless of a spendthrift provision.25 A “mandatory distribution” is one where the “trustee has no discretion in determining whether the distribution shall be made or the amount or timing of such distribution.” 26 This provision prevents a trustee from “avoid[ing] creditor claims against a beneficiary by refusing to make a distribution.”27 In failing to make a mandatory distribution, the trustee becomes the “agent for the beneficiary,” and the withheld distribution “should be treated as part of the beneficiary’s personal assets.”28
Seeking domestic bliss – charging orders and domestic LLCs
The Uniform Limited Liability Company Act of 1996 (the “LLC Act”) provides the exclusive remedy by which a creditor of a member of an LLC may satisfy its judgment out of the debtor’s distributional interest in an LLC.29 The statute provides, in relevant part:
(a) On application by a judgment creditor of a member of a limited liability company or of a member’s transferee, a court having jurisdiction may charge the distributional interest of the judgment debtor to satisfy the judgment. The Court may appoint a receiver of the share of the distributions due or to become due to the judgment debtor …
(b) A charging order constitutes a lien on the judgment debtor’s distributional interest. The court may order a foreclosure of a lien on a distributional interest subject to the charging order at any time. A purchaser at the foreclosure sale has the rights of a transferee.30
The LLC Act defines a “distributional interest” to mean “all of a member’s interest in distributions in the limited liability company,” and it defines “distributions” as “a transfer of money, property, or other benefit from a limited liability company to a member in the member’s capacity as a member or to a transferee of the member’s distributional interest.”31
While the reported case law interpretations of Section 33-44- 504 are few, two recent S.C. Supreme Court opinions provide practical guidance. First, in Kriti Ripley, LLC v. Emerald Investments, LLC,32 the S.C. Supreme Court reversed the trial court’s denial of the creditor’s (Kriti) motion to foreclose its charging order against the debtor’s (Emerald) distributional interest in the company (ARP II).33 Kriti and Emerald were both members in ARP II.34 In 2005, Kriti obtained a New York judgment against Emerald in excess of $1 million. Kriti then domesticated its New York judgment under South Carolina’s Uniform Enforcement of Foreign Judgments Act.35
Shortly thereafter, Kriti obtained a charging order against Emerald’s distributional interest in ARP II in South Carolina.36When Emerald failed to pay pursuant to the charging order for nearly three years, Kriti filed a motion to foreclose Emerald’s distributional interest in ARP II.37 The trial court denied Kriti’s motion to foreclose, reasoning that Kriti had alternative remedies and that foreclosure was a drastic remedy that could lead to an inequitable forfeiture.38 On appeal, the Supreme Court reversed this decision, holding that (i) Section 33-44-504 provides the “exclusive remedy” for a creditor to satisfy its judgment through a debtor’s interest in an LLC, (ii) foreclosure of a distributional interest is not a drastic remedy, and (iii) foreclosure does not operate as a forfeiture of a distributional interest, because Emerald could have avoided the foreclosure by paying the judgment.39 The Supreme Court remanded the case to the trial court to conduct the sale through the “normal foreclosure process.”40
On remand, the trial court contemplated the “normal foreclosure process” where the property is a debtor’s distributional interest in an LLC. 41 The trial court considered two options: a sheriff’s sale of the distributional interest,42 and a judicial sale conducted by the master-inequity, just like a foreclosure sale of real property.43 Because Kriti controlled ARP II and ARP II’s operating agreement would not allow for the purchaser at the foreclosure sale to obtain a membership interest in ARP II, the Court found that “[i]t is unreasonable to expect that anyone (besides Kriti) will bid to purchase Emerald’s distributional interest at a Sheriff’s sale conducted on the Courthouse steps,”44 which would effectively deprive Emerald of its $2.5 million capital contribution and equity in ARP II. Conversely, the Court found that “the procedures followed for the foreclosure of a real estate mortgage provide Emerald with additional safeguards designed to protect against a wholly insufficient sales price.”45 For these reasons, the Court ordered that the matter be referred to the master-inequity for a judicial sale following the rules for a foreclosure of a real estate mortgage, with appropriate adjustments to account for the fact that property being sold was a distributional interest rather than real estate.46
The S.C. Supreme Court next considered the ramifications of a foreclosure sale of the debtor’s distributional interest in Levy v. Carolinian, LLC.47 In this case, the plaintiffs (Levys) obtained a judgment against a member (Patel) of Carolinian, LLC (Carolinian).48 The Levys obtained a charging lien on Patel’s distributional interest in Carolinian, followed by a foreclosure of its charging lien.49 At the sale, the Levys outbid Carolinian for Patel’s distributional interest in Carolinian.50 After the Levys took ownership of the distributional interest, Carolinian, pointing to several provisions of its operating agreement, asserted that it could compel the Levys to sell the distributional interest to Carolinian.51 The Levys disagreed and filed a declaratory judgment action.52
After review of the operating agreement, the trial court held that Carolinian could compel the Levys to sell their distributional interest. 53 On appeal, the S.C. Supreme Court reversed the trial court, holding that the provision of the operating agreement Carolinian relied upon did not apply to the Levys because the Levys were not members of Carolinian, but merely a transferee of a distributional interest in Carolinian.54
The operating agreement stated that no member could voluntarily or involuntarily sell any part or all of his membership interest to another individual without prior written consent of the members that own more than 67 percent of Carolinian. It also stated that if a member attempted to transfer all or a portion of his membership share without such consent, the transfer would be deemed null and void.55 Carolinian argued that the Levys did not obtain the necessary consent and, therefore, Carolinian was entitled to purchase the interest the Levys purchased.
In its reasoning, the Court cited several provisions of the LLC Act to show a clear distinction between a distributional interest and a membership interest:
The LLC Act defines a member’s distributional interest as ‘all of a member’s interest in distributions by the [LLC].’ A distributional interest in an LLC is personal property and may be transferred in whole or in part. A distributional interest does not include the member’s broader rights to participate in management of the LLC. A transfer entitles the transferee to receive, the extent transferred, only the distribution to which the transferor would be entitled. A transfer of a distributional interest does not entitle the transferee to become or to exercise any rights of a member. A transferee may become a member of the LLC if and only to the extent all other members consent or as otherwise set forth in the LLC operating agreement.56
Because provisions of the Carolinian operating agreement applied only to members, and the Levys did not purchase, or seek to purchase, a membership interest in Carolinian, the operating agreement did not apply to the Levys or their purchase of the distributional interest.57 Therefore, the Supreme Court reversed the trial court and held that Carolinian could not compel the Levys to sell their distributional interest.58
Similarly, the Uniform Partnership Act also contains a charging order statute.59 While no reported cases interpret this statute, its language is nearly identical to that of the LLC Act. Thus, the procedure for a creditor to obtain a charging order against a debtor’s distributional interest in a partnership would be the same as the LLC Act.
Two’s company, three’s a crowd – chasing shares in professional corporations
Sometimes the creditor obtains a judgment against an individual professional, but not against the professional corporation the professional debtor owns. Because professional corporations are separate legal entities, creditors cannot directly attach the assets of the corporation to satisfy the debts of the individual professional/shareholder. The general attachment statute specifically applies to a debtor’s ownership in the stock of any association or corporation. “The rights or shares which any defendant may have … in the stock of any association or corporation, together with the interest and profits thereon … shall be liable to be attached and levied upon and sold to satisfy the judgment and execution.” 60 Part of the omitted language, of course, describes an exception for property “exempt from attachment.”61
With regard to the majority of rights and obligations, professional corporations operate in the same way regular corporations do. However, professional corporations are unique because they can only be owned by individuals, partnerships or corporations authorized to “render a professional service” described in the corporation’s articles of incorporation.62 The Professional Corporation Supplement contains a restriction against transferring shares to individuals, general partnerships and professional corporations not qualified under §33-19-200. Specifically, a shareholder in a professional corporation cannot “pledge shares” to a non-qualified individual or entity.63 Such transfers are void.64
One must consider whether the prohibition against transfer constitutes an “exemption” under the Code,65 or otherwise prevents attachment and levy. Florida and Pennsylvania have held that a similar statutory prohibition on transfer does not prevent attachment and levy. In Street v. Sugarman,66 the Florida Supreme Court, interpreting language similar to South Carolina’s Professional Corporation Supplement, held that “the fact the corporation may not voluntarily ‘issue’ or the shareholders may not ‘sell or transfer’ their stock voluntarily to a non-professional is not reason to prevent an execution and sale, by law for a judgment creditor.” 67 To hold otherwise, reasoned the Court, would “afford professionals a shelter for their assets, which appears to be inconsistent with the spirit of the Act ...”68
Pennsylvania’s Superior Court reached the same conclusion when considering similar language in its statutes. In Gulf Mtg. & Realty Investments v. Alten,69 the Pennsylvania court held a professional corporation’s shares should be seized and sold, as “all personal property is subject to seizure, unless specifically exempted, ordinarily by statutory enactment.”70 Resolving the prohibition against voluntary transfer to non-professionals, the Court stated that Pennsylvania’s corporate act restricted “the issuance and transfer of shares of a professional corporation, subject to the rightful claims of creditors,” but did not “prevent the shares from being seized and sold to licensed persons or back to the corporation, or otherwise disposed of upon dissolution of the corporation.”71
The next time you obtain a money judgment against a savvy debtor, you need to consider these investment vehicles. Remember to seek in post-judgment discovery for the debtor’s interests in trusts, limited liability companies, partnerships and professional corporations. Once discovered, in addition to supplementary proceedings, the procedures described here will allow creditors to reach almost any personal asset owned by any judgment debtor. If you can find them, they can be reached, attached, levied and sold to satisfy your judgment.
Bruce Wallace is a member in the Charleston office and Kyle Brannon is an associate in the Columbia office of Nexsen Pruet.
1 See S.C. Code Ann. §§ 15-35-510 to -540.
2 See S.C. Code Ann. §§ 15-35-900 to -960.
3 S.C. Code Ann. §§ 27-23-10 to -90.
4 S.C. Code Ann. § 27-23-10(A).
5 See In re Ducate, 369 B.R. 251, 258 (Bankr.
D. S.C. 2007).
8 See In re J.R. Deans Co., 249 B.R. 121, 134 (Bankr. D.S.C. 2000).
9 Id. At 132.
10 S.C. Code Ann. § 62-7-505.
11 S.C. Code Ann. § 62-7-505(a)(1).
12 S.C. Code Ann. § 62-7-505(a)(2).
14 S.C. Code Ann. § 62-7-501(a).
15 S.C. Code Ann. § 62-7-501 cmt.
16 S.C. Code Ann. § 625-501(b)(1).
17 McLean v. McLean, 273 S.C. 571, 257 S.E.2d 751 (1979). McLean’s holding rested in large measure on the fact that the husband had created the trust from his own assets, distinguishing the case from Collins v. Collins, infra note 19.
18 S.C. Code Ann. § 62-7-501(b)(2).
19 239 S.C. 170, 122 S.E.2d 1 (1961).
20 Id. At 185, 122 S.E.2d at 8.
21 S.C. Code Ann. § 62-7-504(c).
22 S.C. Code Ann. § 627-504(d).
23 S.C. Code Ann. § 62-7-502(c).
24 See e.g., McManus v. Bank of Greenwood, 171 S. C. 84, 171 S.E. 473 (1933) (holding that funds on deposit are choses in action that can only be reached through supplemental proceedings); Johnson v. Serv. Mgmt., Inc., 319 S.C. 165, 459 S.E.2d 900 (Ct. App. 1995) , aff’d, 324 S.C. 198, 478 S.E.2d 63 (1996) (same).
25 S.C. Code Ann. § 62-7-506.
27 Id. At cmt.
29 See S.C. Code Ann. § 33-44-504(e); Levy v. Carolinian, LLC, 410 S.C. 140, 145, 763 S.E.2d 594, 596 (2014).
30 S.C. Code Ann. § 33-44-504.
31 S.C. Code Ann. § 33-44-101(5)-(6).
32 404 S.C. 367, 746 S.E.2d 26 (2013).
33 404 S.C. 367, 382, 746 S.E.2d 26, 34 (2013).
34 Id. At 370, 746 S.E.2d at 27.
35 S.C. Code Ann. § 15-35-900 et seq.
36 404 S.C. 367, 373, 746 S.E.2d 26, 29 (2013).
37 Id. At 374, 746 S.E.2d at 30.
38 Id. At 379, 746 S.E.2d at 31.
39 Id. At 381-383, 746 S.E.2d at 33-34.
40 Id. At 384, 746 S.E.2d at 35.
41 Order Granting Mot. Alter or Amend at 8 (Case No. 2008-CP-10-2344).
42 S.C. Code Ann. § 15-39-640 et seq.
43 Order at 8-9.
44 Id. At 11.
45 Id. At 14.
46 Id. At 14-15.
47 410 S.C. 140, 763 S.E.2d 594 (2014).
48 Id. At 142, 763 S.E.2d at 594-95.
51 Id. At 144, 763 S.E.2d at 595-96.
52 Id. At 144, 763 S.E.2d at 596.
54 Id. At 146, 763 S.E.2d at 597.
55 Id. At 144, 763 S.E.2d at 595-96.
56 Id. At 146, 763 S.E.2d at 596-97 (citing S.C. Code Ann. §§ 33-44-101(6); 33-44-501; 33- 44-502; 33-44-503) (internal citations omitted).
57 Id. At 146, 763 S.E.2d at 597.
58 Id. At 148, 763 S.E.2d at 598.
59 S.C. Code Ann. § 33-41-750.
60 S.C. Code Ann. § 15-19-220.
62 S.C. Code Ann. § 33-19-200(a).
63 S.C. Code Ann. § 33-19-220.
65 S.C. Code Ann. § 15-19-220.
66 202 So.2d 749 (Fla. 1967).
67 202 So. 2d at 750.
68 Id. At 751.
69 422 A.2d 1090 (Pa.Super. 1981).
70 Id. At 1094.
71 Id. At 1095 (emphasis added).