Divorce Asset Protection

ASSET PROTECTION FOR THE COMMON MAN James W. Narron Narron, O‟Hale and Whittington, P.A. Smithfield, North Carolina I. INTRODUCTION. This paper will review some of the substantive rules relating to every day, run of the mill, planning techniques for the “common man.” The common man is our typical client. He has estate planning, family, and business needs which suggest asset protection planning. Each of us can tell his war stories: The recently divorced businessman who has real estate investments in several states, adult children and a minor child by a marriage just ended, numerous aircraft for business and pleasure, insurance payable to his estate for ease of division, will on counsel‟s desk awaiting execution, no creditors other than small credit card debt. He crashes his airplane with passengers, all killed, including him. Nominal liability insurance, all life insurance available to pay claims. No protection when needed. Or consider the dutiful wife whose mother is dying. Wife has signed on to millions of dollars of guaranties for the large floor plan at her husband‟s motor vehicle dealerships. The economy is heading south. Can daughter disclaim her mother‟s bequest or do the creditors have first claim? Should the mother‟s will create a trust for daughter‟s benefit or it is safer to leave the assets to the grandchildren in trust? Our common man will want local help and local institutions, likely not trusts in other jurisdictions or overseas. Those topics, then, are left for another paper. This topic is featured in all the trade magazines which focus on estate planning. There are numerous texts and articles, most of which are helpful. The worldwide web has thousands of sites touting various schemes and plans. Three of the most recent and helpful treatments include: H. Rosen and G. Rothschild, Asset Protection Planning, 810-2d T.M. (2005) (sometimes herein “810-2d T.M.”); J. Oshins, Asset Protection Other than SelfSettled Trusts: Beneficiary Controlled Trusts, FLPs, LLCs, Retirement Plans and Other Creditor Protection Strategies, 30 U. Miami Inst. on Est. Plan., Ch. 3 (2005) (sometimes herein “Oshins”); G. Rothschild, Protecting the Estate From In-Laws and Other Predators, 35 U. Miami Inst. on Estate Planning, Ch. 17 (2001) (sometimes herein “Rothschild”). II. SOME SIMPLE STRATEGIES. A. Liability Insurance. Common wisdom would say liability insurance offers protection adquate to cover practically all risks. Certainly adequate insurance is an essential part of every client‟s package, particularly for motor vehicle liability. Insurance has its limitations, however. Obtaining coverage is frequently an issue. For example, many private pilots carry only limited liability coverage at affordable rates. The books are full of large awards for unexpected damages. When a driver loses control he can as easily collide with a mail box as a school bus loaded with children. Coverage limitations leave large gaps in such a plan. For example, homeowners and general liability policies typically provide coverage only for accidental occurrences and may contain exclusions barring coverage for insureds‟ intentional acts.1 Some jurisdictions hold that an intentional injury exclusion clause in a liability policy is inherently ambiguous and must be construed against the insurer, e.g., State Farm Fire & Casualty v. Dunlavey, 197 1 Most liability policies provide coverage on an “occurrence” basis, which is most often described to mean in pertinent part an accident which results in bodily injury or property damage neither expected nor intended from the standpoint of the insured. F.Supp. 2d 183 (E.D. Pa. 2000), while others take the position that such an exclusion is free from ambiguity and will be enforced as written, e.g., Colonial Penn Ins. Co. v. Hurt, 162 Ga.App. 333, 291 S.E.2d 410 (1982); Commercial Unit Ins. Co. v. Mauldin, 62 N.C. App. 461, 303 S.E.2d 214 (1983) (insured shot into car occupied by estranged wife and killed the driver, later pleading guilty to second degree murder; held, an intentional act and no coverage). See, Miller v. Fidelity-Phoenix Ins. Co., 268 S.C. 72, 231 S.E.2d 701 (1977) (“not only the act causing the loss must have been intentional, but the results of the act must also have been intended;” held, fire started by 10-year old child was intentionally set, but the child‟s intent was not to harm the home but rather to enjoy the excitement of seeing the fire trucks come--insurer must pay). The cases are collected at Annot., Construction and Application of Provision of Liability and Insurance Policy Expressly Excluding Injuries Intended as Expected by Insured, 31 A.L.R. 4th 957 (1994). And see, Annot., Clause in Life, Accident, or Health Policy Excluding or Limiting Liability in Case of Insured’s Use of Intoxicants or Narcotics, 100 A.L.R. 5th 617 (2002). An insured is not likely to be covered for intentional acts and acts involving intoxication. In many jurisdictions, “bodily injury” as used in a liability policy does not include emotional injury--purely nonphysical or emotional harm. E.g., West Am. Ins. Co. v. Bank of Isle of White, 673 F.Supp. 760, 765 (E.D. Va. 1987) (wrongful job termination). Emotional distress without physical manifestation of injury is not covered in general commercial liability or homeowner‟s policies in most states. E.g., O’Dell v. St. Paul Fire & Marine Ins. Co., 223 Ga.App. 578, 579-80, 478 S.E.2d 418, 420 (1966); Jefferson-Pilot Fire & Casualty Co. v. Sunbelt Beer Distribs., Inc., 839 F.Supp. 376, 379 (D. S.C. 1993); Bituminous Fire & Marine Ins. Co. v. Izzy Rosen’s, Inc., 493 F.2d 257, 261 (6 th Cir. 1974) (Tennessee law); but see, Fieldcrest Cannon, Inc. v. Fireman’s Fund Ins. Co., 124 N.C. App. 232, 251-53, 477 S.E.2d 59, 71-72 (1996), aff’d. per curiam on reh’g., 127 N.C. App. 729, 493 S.E.2d 658 (1997), rev. den., 348 N.C. 497, 510 S.E.2d 383 (1998) (“The courts of this jurisdiction have recognized the torts of negligent infliction of emotional distress and intentional infliction of emotional distress as actions for bodily injury.”) Not every injury is insured against. For example, courts have almost uniformly held that damage to intangible property is not “property damage” covered by the standard general commercial liability policy, e.g., America Online, Inc. v. St. Paul Mercury Ins. Co., 207 F.Supp. 2d 459, 468 (E.D. Va. 2002). Nor do economic interests fall within the definition of tangible property or can be defined as an “accident” or perhaps “occurrence” in the view of most courts, e.g., Cy Thomason Co. v. Lumbermans Mut. Casualty Co., 183 F.2d 729 (4th Cir. 1950) (S.C. law) (insured‟s operations in constructing an underpass resulted in loss of business of a garage left isolated during excavations--held not an “accident” and no coverage); Southeastern Color Lithographers, Inc. v. Graphic Arts Mut. Ins. Co., 164 Ga. App. 70, 296 S.E.2d 378 (1982) (no coverage for breach of oral contract of employment where prospective employee and his wife quit their jobs and moved from a different and distant state only to find insured had no intent of hiring--no coverage because no damage to tangible property). See generally, Annot., Liability Policy Coverage for Insured’s Injury to Third Party’s Investments, Anticipated Profits, Goodwill, or the Like, Unaccompanied by Physical Property Damage, 18 A.L.R. 5th 187 (1994). One final example makes the point: An employee can be held vicariously liable for sexual harassment by supervisors on the basis of respondeat superior. Hogan v. Forsyth Country Club Co., 79 N.C. App. 483, 340 S.E.2d 116, disc. rev. den., 317 N.C. 334, 346 S.E.2d 140 (1986) (sufficient showing of ratification of sexual harassment was not made to warrant submission of issue to jury). But such liability is not generally covered by liability insurance, Russ v. Great American Ins. Companies, 121 N.C. App. 185, 188-89, 464 S.E.2d 723, 725-26 (1995), rev. den., 342 N.C. 896, 467 S.E.2d 905 (1996) (judgment against employer for damages and costs for intentional infliction of emotional distress resulting from sexual harassment not covered because inherently intentional). The cases are collected in 1 B. Ostranger and T. Newman, Handbook on Insurance Coverage Disputes, § 7.04(a)(12th ed. 2004). And see 3 R. Long, The Law of Liability Insurance, § 11C.02 (2005). B. Gift --The In-Law Dimension. “Deed the farm to my children” is a request each reader must have heard hundreds of times. Tax issues aside, what the donor does by such a gift is to substitute the donee‟s creditors for the donor‟s own creditors. The principal such creditor might be an in-law. Most non-community property states now have equitable distribution statutes which permit a court, in connection with the divorce proceeding to divide property subject to the statute between the spouses “equitably.” See generally, 1 Valuation and Distribution of Marital Property § 3.01(2) (Lexis-Nexis/Matthew Bender 2005). In North Carolina and most states, separate property (not eligible for equitable distribution) means “all real and personal property acquired by a spouse before marriage or acquired by a spouse by bequest, devise, descent, or gift during the course of marriage. . . . The increase in value to separate property and the income derived from separate property shall be considered separate property.” N.C. Gen. Stat. 50-20(b)(1). What property is separate is not as simple as the statute (and the conventional wisdom) might suggest. [I]ncreases in value to . . . separate property are “acquired” by that separate estate but “only to the extent that the increases were passive . . . .” Increases in value to separate property attributable to the financial, managerial, and other contributions to the marital estate are “acquired” by the marital estate. When the increase in value to separate property is attributable to both the marital and separate estates, each estate is entitled to an interest in the “acquired” increase consistent with its contribution. Accordingly, the marital estate shares in the increasing value of separate property “it has proportionately „acquired‟ in its own right” through financial, managerial, and other contributions, but does not share in the increase in value of separate property acquired through passive appreciation, such as inflation. [Citations omitted.] Ciobanu v. Ciobanu, 104 N.C. App. 461, 465, 409 S.E.2d 749 (1991) (plaintiff wife met her burden of proof with showing that, inter alia, she “helped paint the garage (assisted by a young man hired with marital funds to help maintain the property), helped paint the inside and assisted in odd jobs by training the young man in methods of fixing and maintaining the property”). Indeed “any increase in the value of separate property is presumptively marital property unless it is shown to be the result of passive appreciation.” Stewart v. Stewart, 141 N.C. App. 236, 248, 541 S.E.2d 209, _____ (2000), citing Conway v. Conway, 131 N.C. App. 609, 616, 508 S.E.2d 812, 817 (1998), disc. rev. den., 350 N.C. 593, 536 S.E.2d 836 (1999). Consider O’Brien v. O’Brien, 131 N.C. App. 411, 508 S.E.2d 300 (1998), wherein husband contended that his active investment participation with respect to wife‟s account which she received by gift and inheritance made the account divisible as a marital asset: We hold, therefore, that if either or both of the spouses perform substantial services during the marriage which result in an increase in the value of an investment account, that increase is to be characterized as an active increase and classified as a marital asset. In making the determination of whether the services of a spouse are substantial, the trial court should consider, among other relevant facts and circumstances of the particular case, the following factors: (1) the nature of the investment; (2) the extent to which the investment decisions are made only by the party or parties, made by the party or parties in consultation with their investment broker, or solely made by the investment broker; (3) the frequency of contact between the investment broker and the parties; (4) whether the parties routinely made investment decisions in accordance with the recommendation of the investment broker, and the frequency with which the spouses made investment decisions contrary to the advice of the investment broker; (5) whether the spouses conducted their own research and regularly monitored the investments in their accounts, or whether they primarily relied on information supplied by the investment broker; and (6) whether the decisions or other activities, if any, made solely by the parties directly contributed to the increased value of the investment account. In Lawrence v. Lawrence, 75 N.C. App. 592, 331 S.E.2d 186, cert. den., 314 N.C. 541 335 S.E.2d 18 (1985), the husband‟s repairs, alterations and additions to wife‟s property acquired before their marriage were found to be marital contributions and subject to division. In McLeod v. McLeod, 74 N.C. App. 144, 327 S.E.2d 910, cert. den., 314 N.C. 331, 333 S.E.2d 488 (1985), husband inherited a minority interest in a closely held corporation. Later, the corporation redeemed out other shareholders, leaving him owning all of the outstanding shares. The court held the redemption was a business device from which the husband, as president, derived substantial economic advantage which constituted property acquired during the marriage. It may be that the best gift of all is a family culture which encourages--maybe requires--premarital agreements which address equitable distribution issues. Twenty-six jurisdictions, including North Carolina, Virginia and Texas, have adopted the Uniform Premarital Agreement Act of 1983, under which such agreements are enforceable if disclosure is made and formalities are followed. 9 U.L.A. “Premarital Agreements” (2003). C. Tenancy By The Entireties.2 At the time of the formation of the American republic, a tenancy by the entireties was created upon a conveyance to a man and his wife. It was a tenancy which required the coincidence of the five unities: time, title, interest, possession and person. Some of the incidents of the tenancy, where it is recognized, are: (i) vesting in one person--the husband and wife, who constitute the one marital relation, seized of the entirety, per tout et non per my; (ii) upon the death of one the survivor takes by purchase under the original grant; (iii) no unilateral severance of the union of interest; (iv) no levy of execution on judgment against either husband or wife, separately; (v) no unilateral conveyance--both must join in. Davis v. Bass, 188 N.C. 200, 204-205, 124 S.E. 566, _____ (1924). 2 Other forms of “joint” ownership, including tenancy in common and joint tenancy (abolished by statute in North Carolina in 1784, unless by contract, N.C. Gen. Stat. 41-2) are not covered in this paper inasmuch as their utility in an asset protection context is negligible. See generally, G. Rothschild, Protecting the Estate from In-Laws and Other Predators, 35 U. Miami Inst. on Estate Planning, § 1710.3 (2001). Interests covered in this section include only interests in real estate, not personal property. There are statutes in some states which expand the entirety bar to encompass, for example, mobile homes, e.g., N.C. Gen. Stat. 41-2.5. Although the tenancy is subject to a hodgepodge of laws from state to state, a substantial number of states which recognize tenancy by the entirety hold that the estate may not be attached by the creditors of only one spouse.3 Of course, if the parties divorce, the tenancy is severed and the interest of the debtor spouse is subject to levy, e.g., Wigginton v. Wigginton, 575 So.2d 233 (Fla. Dist. Ct. App. 1991); Fla. Stat. Ann. § 689.15; Dobbyn v. Dobbyn, 57 Md. App. 662, 471 A.2d 1068 (1984). If the debtor spouse is the surviving spouse, the entire property is subject to execution. Sanderson v. Saxon, 834 S.W.2d 676 (Ky. 1992); Brundage v. Alexander, 547 S.W.2d 232 (Tenn. 1976), unless the survivor is the slayer, Porth v. Porth, 3 N.C. App. 485, 165 S.E.2d 508 (1969) (under N.C. Gen. Stat. 31A-5, one-half to decedent‟s estate, one-half held by slayer for life, then to victim‟s estate). If the parties sell the property, Shores v. Rabon, 251 N.C. 790, 1112 S.E.2d 556 (1960), or if it is sold at foreclosure of a mortgage, In re Foreclosure of Deed of Trust, 303 N.C. 514, 279 S.E.2d 566 (1981), the proceeds are personalty and the parties are tenants in common of the proceeds. The creditors of either may then levy execution. The rule is otherwise, however, if the sale is by condemnation. Highway Comm’n. v. Myers, 270 N.C. 258, 154 S.E.2d 87 (1967). See Annot., Real Property Proceeds--Held by Entirety, 22 A.L.R. 4th 459 (1983); 7 Powell on Real Property § 52.02 [6th] (2005). 3 See S. Johnson, After Drye: The Likely Attachment of the Federal Tax Lien to Tenancy-By-The-Entireties Interest, 75 Ind. L.J. 1163 (2000) (listing as “full bar” jurisdictions: Delaware, District of Columbia, Florida, Hawaii, Indiana, Maryland, Michigan, Mississippi, Missouri, North Carolina, Ohio, Pennsylvania, Rhode Island, Vermont, Virginia, the Virgin Islands and Wyoming. See Annot., Interest of Spouse in Estate by Entireties as Subject to Satisfaction of His or Her Individual Debt, 75 A.L.R. 2d 1172 (1961). Certain debtors will learn to use these rules: Ronald and Vicky were married in 1961, after which they purchased a home as tenants by the entirety. In 1987, at a time when Ronald was indebted to a certain creditor who had filed an action to collect on his debt, they separated and Vicky was paid a lump sum under the separation agreement. Pursuant to that agreement, Vicky joined Ronald in conveying the home to his parents. The parties then divorced. Shortly thereafter, Ronald signed a consent judgment for $100,000 in favor of the creditor, which the creditor then filed. Later, Ronald married Patricia and in 1990 his parents conveyed the home to her with the intent that it be sold by her and the proceeds invested in a new marital home to be titled to her and Ronald. The creditor filed his lis pendens and the proceeds of the sale were impounded by agreement. The trial court ordered the fund paid to the creditor. The appellate court, finding no fraudulent conveyance, reversed. The separation agreement did not server the tenancy by the entirety; it continued until Ronald and Vicky conveyed to his parents, before their divorce. Dealer Supply Co. v. Greene, 108 N.C. App. 31, 422 S.E.2d 350 (1992). Presumably Ronald and Patricia live their still, thumbing their noses at the hapless creditor. The extent of the entireties bar has been limited somewhat in the federal arena. Two recent Supreme Court decisions are important. In Drye v. U.S., 528 U.S. 49 (1999), the court addressed whether an intestate interest constituted “property” or “a right to property” to which federal tax liens attach under § 6321 of the Internal Revenue Code where the debtor properly and timely disclaimed the interest under state law. The decision holds “that the Code and interpretive case law place under federal, not state, control the ultimate issue whether a taxpayer has a beneficial interest in any property subject to levy for unpaid federal taxes.” “We look initially to state law to determine what rights the taxpayer has in the property the government seeks to reach, then to determine whether taxpayer‟s statedelineated rights qualify as „property‟ or „rights to property‟ within the compass of the federal tax lien legislation.” In sum, in determining whether a federal taxpayer‟s state-law rights constitute “property” or “rights to property,” “[t]he important consideration is the breadth of control the [taxpayer] could exercise over the property.” Drye had the unqualified right to receive the entire value of his mother‟s estate (less administrative expenses) . . . or to channel that value to his daughter. The control rein he held under state law, we hold, rendered the inheritance “property” or “rights to property” belonging to him within the meaning of § 6321 . . . . Following that analysis, it was predictable that the bundle of rights held by a tenant by the entireties would be “property” or “rights to property” within the scope of § 6321 of the Internal Revenue Code, allowing the IRS to levy on a tax lien against only one spouse. S. Johnson, After Drye: The Likely Attachment of the Federal Tax Lien to Tenancy-ByThe-Entirety Interest, 75 Ind. L.J. 1163 (2000). And so it came to pass in U. S. v. Craft, 535 U.S. 274 (2002). Mr. Craft and his wife owned land as tenants by the entireties in Michigan, an entireties bar state. The IRS filed a tax lien against him for unpaid income tax assessed. Thereafter, the two of them executed a quitclaim to Mrs. Craft purporting to transfer his interest to her for $1.00. Several years later when she attempted to sell the property, a title search turned up the lien which the IRS refused to release. The proceeds of the sale were held in escrow pending this litigation. The bundle of rights Mr. Craft had as a tenant by the entireties included: “the right to use the property, the right to exclude third parties from it, the right to a share of the income produced from it, the right of survivorship, the right to become a tenant in common with equal shares upon divorce, the right to sell the property with [his wife‟s] consent and to receive half the proceeds from such sale, the right to place an encumbrance on the property with [his wife‟s] consent, and the right to block [his wife] from selling or encumbering the property unilaterally.” [at 282] Relying on Drye, “in determining whether a federal taxpayer‟s state-law rights constitute „property‟ or „rights to property,‟ [t]he important consideration is the breadth of the control the [taxpayer] would exercise over the property,” the court found “a substantial degree of control” and held that the lack of the right of unilateral alienation was not determining. The entireties interest constitutes “property” or “rights to property” for purposes of the federal tax lien statute. . . . “[E]xempt status under state law does not bind the federal tax collector.” [at 288] The issue of the valuation of Mr. Craft‟s interest was left to be determined on remand. Courts have thus far declined invitations to extend Craft beyond IRS claims under a federal tax lien.4 E.g., In re Spears, 313 B.R. 212 (W.D. Mich. 2004), rev’g. 308 B.R. 793 (Bankr. W.D. Mich. 2004) (not extended to § 541 of the Bankruptcy Code--finding bankruptcy by one of a tenant by the entireties does not sever the tenancy; In re Sinnreich, 391 F.3d 1295 (11 th Cir. 2004) (same, Florida law); In re Greathouse, 295 B.R. 562, 56768 (Bankr. D. Md. 2003) (declining to extend Craft, holding that under Maryland law property held in tenancy by the entireties estate is validly exempt from bankruptcy creditors 4 Cf., Comment, Reflections on United States v. Craft: Justifying a New Federal Common Law of Property, 34 Seton Hall L. Rev. 1353, 1374 (2004), suggesting that Craft potentially opens the door to elimination of the entireties bar to other federal liens and judgments such as the federal forfeiture law, as to which the circuits are divided. Compare, e.g., United States v. 15621 S.W. 209 th Ave., 894 F.2d 1511 (11 th Cir. 1990) (no forfeitable interest for innocent spouse under Florida law) with United States v. 1500 Lincoln Ave., 949 F.2d 73 (3d Cir. 1991) (wife‟s innocent owner defense did not preclude forfeiture of real property held by husband and wife as tenants by the entireties under Pennsylvania law). of one spouse under § 522(b)(2)(B)); In re Kelly, 289 B.R. 38, 45 (Bankr. D. Del. 2003) (including Craft is inapplicable, holding that “[u]nder Delaware law and [§ 522(b)(2)(B)], property held in an entireties estate is validly exempt and may not be reached by the creditors of one spouse”; See also Schlossberg v. Barney, 380 F.3d 174, 182 (4 th Cir. 2000) (declining to extend Craft, holding that Chapter 7 Bankruptcy Trustee proceeding pursuant to § 544 of the Bankruptcy Code cannot stand in the shoes of the IRS in a tax collection contest in order to reach property held in tenancy by the entireties exempted under § 522(b)(2)(B)); In re Ryan, 282 B.R. 742, 750 (D.R.I. 2002) (noting that “Craft gives us no indication that the reasoning therein should be extended beyond federal tax law”); In re Knapp, 285 B.R. 176, 183 (Bankr. M.D. N.C. 2002) (“giving Craft’s continued recognition of a state‟s right to recognize entireties property, the unique abilities of the federal tax collector, the long standing North Carolina law based on the doctrine of unity of the person protecting entireties property and the clear language of 11 U.S.C. § 522, this Court declines to extend Craft beyond its application to federal tax liens.”). Hatchett v. U.S., 330 F.3d 875 (6 th Cir. 2003) cert. den., 541 U.S. 1029 (2004), a tax lien case, held that Craft applied retroactively to the taxpayers in the case whose appeal was pending at the time Craft was decided. In re Basher, 291 B.R. 357 (Bankr. E.D. Pa. 2003), involved the valuation of one spouse‟s interest in a tenancy by the entireties subject to a tax lien, enforceable pursuant to Craft. The debtor contended the value was zero. The IRS argued for fifty percent of the equity value of the property. While the court discussed the actuarial life expectancies of the parties and mentioned the IRS joint life tables, the court was unable to reach a decision on valuation on the record and briefs. D. Disclaimers. 1. Introduction. Disclaimers are often mentioned as postmortem planning tools for relief from creditors. Excellent sources and materials are available. E.g., M. Wenig, Disclaimers, 848 T.M. [EGT] 1992; Coleman, Disclaimers--New Developments, Opportunities in Unsettled Areas, 33 U. Miami Inst. on Est. Plan., Ch. 16 (1999); Thompson, When It Is Better to Disclaim Than to Receive, 35 U. Miami Inst. on Est. Plan., Ch. 13 (2005). The focus here is the utility of this device to thwart claims of creditors. Disclaimers, like gifts, can be used to substitute the potential creditors of the ultimate recipients as a result of the disclaimer for those of the disclaimant himself. Where the disclaimer is qualified under § 2518 of the Internal Revenue Code (and so has no tax consequence) it can be a useful planning tool if there are anticipated potential creditor issues for the disclaimant. Of course, if those issues were anticipated at the drafting stage on the part of the testator, the process can be handled thoughtfully. A disclaimer may be made by an attorney-in-fact, e.g., N.C. Gen. Stat. 31B-1(a); Uniform Disclaimer of Property Interests Act (1999) [herein “UDPIA 1999”] (adopted in Arkansas, Hawaii, Indiana, Iowa, Maryland, New Mexico, North Dakota, Oregon, Virginia and West Virginia). UDPIA 1999 § 5(b). 2. State Law Requirements. Those who may disclaim include a comprehensive list of “person[s] who succeed[] to a property interest”, G.S. 31B-1(a), including the attorney-in-fact of any of them. The statute does not, however, apply to recoveries under the Wrongful Death Act, Evans v. Diaz, 333 N.C. 774 (1993). By its terms, the statute allows renunciation of a fractional share or any limited interest or estate. The Uniform Act and the rules in non-Uniform Act jurisdictions are similar. The renunciation must be written, must describe the property or interest renounced, declare the renunciation and its extent, and be signed and acknowledged by the person authorized to renounce. G.S. 31B-1(a), (c). The statutory method, however, is not exclusive; other means under other statutes or as otherwise provided by law may be effective. G.S. 31B-5; Sedberry v. Johnson, 62 N.C. App. 425, cert. den., 309 N.C. 322 (1983) (separation agreement). But one can renounce only an interest he has, and cannot, for example, accelerate by renunciation a remainder where there are besides his life interest other contingent interests. Stewart v. Johnson, 88 N.C. App. 277 (1987), cert. den., 373 S.E.2d 124 (1988). A fiduciary may renounce fiduciary rights, privileges, powers and immunities, but not rights of beneficiaries unless the governing instrument expressly allows a renunciation of such rights of others. G.S. 31B-1A. A qualified disclaimer of a present interest is filed within the time required by § 2518, G.S. 31B-2(a), nine months after the date of transfer of the renounced interest. A future interest must be renounced not later than six months after the event by which the taker of the property or interest is finally ascertained and his interest indefeasibly vested and he is entitled to possession even though such renunciation may not be recognized as a disclaimer for federal estate tax purposes. G.S. 31B-2(b). The renunciation must be filed with the Clerk of the Superior Court where estate proceedings have been commenced, or where such proceedings would be commenced if not commenced. A copy must be delivered to the personal representative or other fiduciary or donee or mailed by registered or certified mail. If the property renounced is life insurance proceeds, the life insurance company must be notified by registered or certified mail. G. S. 31B-2(c). If the renunciation is of realty, it must be recorded in the county registry where the land lies and is not effective until that is accomplished. G.S. 31B-2(d). Renunciation of real estate cuts off spousal rights including “dower, inchoate and marital rights, or any interest in the real property or real property interest renounced.” G.S. 31B-2(d). If the renunciation is timely filed under G.S. 31B-2(a), “the renounced interest devolves as if the renouncer had predeceased the date of transfer . . . .” It “relates back.” G.S. 31B-3(a)(1). If the filing is untimely, the interest devolves as if the renouncer had died on the date of the renunciation. Renunciation or waiver of renunciation binds all persons claiming under or through the renouncer or the one waiving renunciation. G.S. 31B-4(b). The anti-lapse statute applies notwithstanding that the renouncer did not actually predecease the decedent through whose estate passes the renounced interest. G.S. 31B-5(b). Renunciation is not a transfer. It merely triggers a set of statutorily defined legal rights which determine ownership. The renouncer never holds title. Hinson v. Hinson, 80 N.C. App. 561 (1985). For state law purposes, renunciation is barred by (1) an assignment, conveyance, encumbrance, pledge, or transfer of the property or interest or a contract therefore by the person authorized to renounce, (2) a written waiver of the right to renounce, [or] [(3)] a sale of the property or interest under judicial sale before the renunciation is effective. A fiduciary‟s application for appointment or the assumption of duties does not waive the right to renounce any right, power, privilege or immunity by the fiduciary. G.S. 31B4(c). The right to renounce is not barred by acceptance of the property, interest or benefit-under North Carolina law--notwithstanding that the renunciation will not be qualified for federal purposes. G.S. 31B-4(e) (added by 1998 amendment, effective September 18, 1998). Reliance on the validity of a renunciation for purposes of further transfer is protected unless there is “actual knowledge” of a bar or a waiver. G.S. 31B-4(d). 3. Federal Law Requirements. The regulations under § 2518 set out the requirements for a qualified disclaimer. (a) In general. For the purposes of section 2518(a), a disclaimer shall be a qualified disclaimer only if it satisfies the requirements of this section. In general, to be a qualified disclaimer-(1) (2) The disclaimer must be irrevocable and unqualified; The disclaimer must be in writing; (3) The writing must be delivered to the person specified in paragraph (b)(2) of this section within the time limitations specified in paragraph (c)(1) of this section; (4) The disclaimant must not have accepted the interest disclaimed or any of its benefits; and (5) The interest disclaimed must pass either to the spouse of the decedent or to a person other than the disclaimant without any direction on the part of the person making the disclaimer. (b) Writing--(1) Requirements. A disclaimer is a qualified disclaimer only if it is in writing. The writing must identify the interest in property disclaimed and be signed either by the disclaimant or by the disclaimant‟s legal representative. (2) Delivery. The writing described in paragraph (b)(1) of this section must be delivered to the transferor of the interest, the transferor‟s legal representative, the holder of the legal title to the property to which the interest relates, or the person in possession of such property. (c) Time limit--(1) In general. A disclaimer is a qualified disclaimer only if the writing described in paragraph (b)(1) of this section is delivered to the persons described in paragraph (b)(2) of this section no later than the date which is 9 months after the later of-(i) The date on which the transfer creating the interest in the disclaimant is made, or The day on which the disclaimant attains the age of 21. (ii) (2) A timely mailing of a disclaimer treated as a timely deliver. Although section 7502 and the regulations under that section apply only to documents to be filed with the Service, a timely mailing of a disclaimer to the person described in paragraph (b)(2) of this section is treated as a timely delivery if the mailing requirements under paragraphs (c)(1), (c)(2) and (d) of § 301.7502-1 are met. Further, if the last day of the period specified in paragraph (c)(1) of this section falls on a Saturday, Sunday or a legal holiday (as defined in paragraph (b) of § 301.7503-1), then the delivery of the writing described in paragraph (b)(1) of this section shall be considered timely if delivery is made on the first succeeding day which is not Saturday, Sunday or a legal holiday. See paragraph (d)(3) of this section for rules applicable to the exception for individuals under 21 years of age. Treas. Reg. 25.2518-2. The regulations allow for a disclaimer of a jointly-held interest, including tenancies by the entireties, “regardless of whether such interest can be unilaterally severed under local law.” Treas. Reg. § 25.2518-2(c)(4)(i), effective for disclaimers after December 31, 1997. With respect to joint bank, brokerage and other investment accounts (e.g., an account held at a mutual fund) established between spouses or between persons other than husband and wife, if the transferor may unilaterally regain his own contributions during life, the transfer is not a completed gift, so a timely disclaimer by the surviving co-tenant after the contributing tenant‟s death, will be effective to avoid a transfer of such part of the joint account not attributable to consideration furnished by the surviving joint tenant. Treas. Reg. §25.25182(c)(4)(iii). The upshot of the regulation is that the entire account may be disclaimed by the surviving spouse who did not make contributions to the account. 4. Problem Area: Acceptance of Benefits. Although not a state law problem in North Carolina, G.S. 31B-4(a)(3) (repealed effective September 18, 1998), replaced by G.S. 31B-4(e) (no bar by acceptance), acceptance of benefits is a disqualifying factor under federal law. § 2518(b)(3) (“such person has not accepted the interest or any of its benefits”), and under the Uniform Act, § 5(3). See Treas. Reg. 25.2518-2(d)(1). 5. Creditor Avoidance--State Law. This writer prepared a disclaimer for a daughter of her mother‟s estate, thereby passing, pursuant to the mother‟s will, all of the mother‟s property to a trust for her grandchildren. Daughter had co-signed a guaranty for her husband‟s business, which guaranty was called by the bank soon after the mother‟s death. The following introductory letter went to the trustee of the grandchildren‟s trust: ISSUE NUMBER ONE: CREDITOR‟S RIGHTS G.S. 31B-l(a)(3), (4) allows a renunciation of property interests to which one succeeds as a devisee or legatee. G.S. 31B3(a) provides that the property or interest renounced devolves as if the renouncer had predeceased the decedent. “A renunciation relates back for all purposes to the date of the death of the decedent . . . .” G.S. 31B-3(b) provides that the devolution of an interest created by testamentary disposition shall be governed by the “anti-lapse” statute. The “anti-lapse” statute, 31-42, applies only if the testator‟s will does not make provisions for how any disclaimed interest would pass. Mrs. __________‟s codicil has a provision indicating how disclaimed property should pass. The majority rule with respect to rights of the creditors of a disclaimant appears to be that a renunciation defeats the ability of creditors of the renouncer to reach the interest renounced. 80 Am. Jur. 2d Wills, § 1598 (1975); Annot., Creditor’s Rights to Prevent Debtor’s Renunciation of Benefit Under Will or Debtor’s Election to Take Under Will, 39 A.L.R. 4th 633 (1986). Some courts, however, have viewed a renunciation in certain circumstances as constituting a fraudulent conveyance. See e.g., In re Estate of Kalt, 16 Cal. 2d 807, 108 P.2d 401 (1940). Stein v. Brown, 580 N.E.2d 1121 (Ohio 1985); Estate of Abesy, 470 N.W.2d 713 (Minn. Ct. App. 1991). Compare, Bradford v. Calhoun, 120 Tenn. 53, 109 S.W. 502 (1907) (so long as there is no collusion with remaindermen, renouncer‟s motives are immaterial). There are no North Carolina cases on point, and so no definitive conclusion can be made as to what rule would be followed by our Supreme Court. The result in such a case might turn upon whether the renunciation qualifies as a statutory renunciation. Chapter 31B of the North Carolina General Statutes does not specifically address the issue. At least five (5) arguments can be made, however, in support of protection of the renounced interest from the renouncer‟s creditors: (1) G.S. 31B-3 indicates that the property renounced “devolves as if the renouncer had predeceased the decedent.” A literal application of this language would indicate that creditors should have no greater right than in the circumstance that the renouncer actually predeceased the decedent. The language is not supportive of characterization of a renunciation as a conveyance. (2) G.S. 31B-4 precludes renunciation of property with respect to which a judicial sale has been made before the renunciation is effected. Presumably, renunciation is not barred prior to such time. (3) G.S. 31B-4 provides that the renunciation is binding upon “all persons claiming through or under” the renouncer. Creditors should be considered to fall in this category. (4) It seems unlikely that the public policy of North Carolina would be considered to preclude this result, in light of G.S. 36A-115(b)(3) (relating to spendthrift trusts), which preserves from the claims of creditors the corpus of a trust in which the beneficiary‟s interest shall cease upon a creditor‟s attempt to reach the interest. That is, if creditors cannot reach property from which the beneficiary has been receiving benefit, why should they be able to reach property from which the beneficiary has not derived any benefit? (5) Treas. Reg. 25.2518-l(c)(2), relating to the federal gift tax consequences of qualified disclaimers, indicates that a disclaimer will be effective “only if under local law the disclaimed property is free from claims of the disclaimant‟s creditors. To the extent local law permits the disclaimant‟s creditors to satisfy their claims out of the disclaimed property, the disclaimer is not a qualified disclaimer.” It is clear from the language of Chapter 31B of the North Carolina General Statutes that statutory renunciations are intended to constitute qualified disclaimers. See e.g., G.S. 31B-2(a), limiting the time for filing a renunciation to the qualified disclaimer period for federal estate tax purposes. Dictum in at least two (2) cases decided before the effective date of Chapter 31B of the North Carolina General Statutes, 1975, tends to make one uncomfortable in rendering any definitive opinion. Property that is the subject of a common law renunciation in North Carolina might, indeed, be vulnerable to creditors as indicated in Perkins v. Isley, 224 N.C. 793, 325 S.E. 2d 588 (1944): “Whether or not the right to renounce a testamentary gift is superior to the right of a judgment creditor is not presented or decided.” Likewise, dictum in Reese v. Carson, 3 N.C. App. 99, 164 S.E.2d 99 (1968), also points to this issue in stating that the “motives of the donee in declining the gifts are immaterial, at least so long as he receives no fraudulent benefit for the renunciation.” Accord, Hinson v. Hinson, 80 N.C. App. 561, 343 S.E.2d 266 (1986) (dictum); Bass v. Bass, 105 N.C. 436, 413 S.E.2d 310 (1992). 6. Creditor Avoidance--Bankruptcy. Present creditor issues may make invalid an otherwise qualifying disclaimer. Some states provide by statute that a disclaimer by a competent adult is ineffective if the disclaimant is insolvent at the time of the disclaimer. See e.g., Fla. Stat. Ann. § 732.801(6)(a) (West 2005); Mass. Gen. Laws Ann., Ch. 191A § 8 (West 1994). Minn. Stat. Ann. § 525.532 Subd. 6 (West 2004); N.J. Stat. Ann. § 3B:9-9 (West Cumm. Supp. 2005) (“a fraud on the person‟s creditors as set forth in the „Uniform Fraudulent Transfers Act‟”). Others provide creditors of the disclaimant have no interest in the disclaimed property. E.g., Mo. Rev. Stat. § 469.010 (2005); Vernon‟s Tex. Civ. Stat. § 37A (2003). The UDPIA 1999 is silent on the rights of creditors of those who disclaim. My letter continued: Section 541 of the Bankruptcy Code sets out what assets are part of a bankrupt‟s estate. In general, the federal law looks to state law to determine title to an asset. Accordingly, it would appear that the renunciation could be accomplished even in the face of claims by creditors in a bankruptcy case in post-petition cases. There are no cases in North Carolina on this point. Compare, e.g., Mickelson v. Detlefsen, 466 F.Supp. 161 (D. Minn. 1979), with In re Brajkovic, 151 B.R. 402 (Bankr. W.D. Tex. 1993). Most bankruptcy cases hold that a beneficiary‟s disclaimer of a bequest within 180 days following filing of a petition constitutes a “transfer” which the bankruptcy trustee can avoid. See, e.g., In re Chenoweth, 132 B.R. 161 (Bankr. S.D. Ill. 1991), aff’d., 143 B.R. 527 (S.D. Ill. 1992), aff’d., 3 F.3d 1111 (7th Cir. 1993); In re Lewis, 45 B.R. 27 (Bankr. W.D. Mo. 1984). If the disclaimer is pre-petition, there are differing views. Compare In re Atchison, 925 F.2d 209 (7th Cir. 1991) (Ill. law), cert. den., sub nom, Jones v. Atchison, 502 U.S. 860 (1991) (beneficiary‟s pre-petition disclaimer testamentary bequest under Illinois law did not constitute a “transfer” which could be avoided under § 548(a) of the Bankruptcy Code), and In re Simpson, 36 F.3d 450 (5th Cir. 1994) (Tex. law) (rejecting reasoning of Brajkovic, supra; here disclaimer filed one day before petition), with In re Brajkovic, supra (disclaimer of real estate inheritance six weeks before filing constituted a transfer). See Coleman, Disclaimers--New Developments, Opportunities and Unsettled Areas, 33 Univ. of Miami Inst. on Est. Plan., ¶ 1611.4 (1999). In Drye, supra, the court “look[ed] initially to state law to determine what rights in the property the Government [sought] to reach, then to the federal law to determine whether the taxpayer‟s state-delineated rights qualify as „property‟ or „rights to property‟ within the compass of [§ 6321].” So, one might conclude that pre-petition disclaimers would be set aside under the bankruptcy law. Such has not been the case. The courts have not extended Drye beyond § 6321 of the Internal Revenue Code. Blackwell v. Lurie (In re Popkin & Stern), 223 F.3d 764 (8 th Cir. 2000) (Missouri Uniform Fraudulent Transfer Act, not a federal law); Grassmuck, Inc. v. Nistler (In re Nistler), 259 B.R. 723 (Bankr. D. Ore. 2001) (disclaimer related back, not a transfer of interest); Cassel v. Kolb, 267 B.R. 861 (N.D. Cal. 2001), rev’d., 321 F.3d 868 (withdrawn, Amended Opinion, 326 F.3d 1030) (9th Cir. 2003) (no property interest, so no transfer; bankruptcy law distinguished from § 6321-reversed on finding that interest accepted, so disclaimer not valid); accord., Garrett v. Bank of Okla. (In re Faulk), 281 B.R. 15 (Bankr. W.D. Okla.). Compare In re Kloubec, 247 B.R. 246 (Bankr. N.D. Iowa 2000) (extending Drye to bankruptcy law). 7. IRS Liens. Drye v. U.S., 528 U.S. 49 (1999), has settled what had been a split of authority among the circuits. A disclaimer cannot defeat a federal tax lien. In sum, in determining whether a federal taxpayer‟s state-law rights constitute “property” or “rights to property,” “the important consideration is the breadth of the control the [taxpayer] could exercise over the property.” Morgan, 309 U.S. at 83, 84 L. Ed. 2d 585, 60 S. Ct. 424. Drye had the unqualified right to receive the entire value of his mother‟s estate (less administrative expenses), see National Bank of Commerce, 472 U.S. at 725 (confirming that unqualified “right to receive property is itself a property right” subject to the tax collector‟s levy), or to channel that value to his daughter. The control rein he held under state law, we hold, rendered the inheritance “property” or “rights to property” belonging to him within the meaning of § 6321, and hence subject to the federal tax liens that sparked this controversy. Drye, supra, at 61. 8. Medicaid Eligibility. The law with regard to whether a disclaimer is effective to avoid disqualification for Medicaid eligibility is still developing. Apparently, there are no North Carolina cases and the Department of Social Services has not promulgated any regulation on this issue. The predominant view is that disclaimed property will be taken into account in determining eligibility for Medicaid. Troy v. Hart, 697 A.2d 113 (Md. Ct. Spec. App. 1997) cert. den., 347 Md. 255, 700 A.2d 1215 (1997); Hoesley v. State Department of Social Services, 498 N.W.2d 571 (Neb. 1993); Contra., Nielsen v. Cass County Social Services Bd., 395 N.W.2d 157 (N.D. 1986) (a split decision subsequently overruled by statute) as stated in Hinschbergen, by Olson v. Griggs County Social Services, 499 N.W.2d 876 (N.D. 1993). Although it once seemed that the majority rule might hold a disclaimer will not be set aside and so will be effective to prevent recovery by the provider of past Medicaid benefits, e.g., In re Estate of Dominguez, 541 N.Y.S.2d 934 (Surr. Ct. 1989), the prevailing wisdom now goes the other way. Compare, Molloy v. Bane, 631 N.Y.S.2d 910 (N.Y.A.D.2d Dept. 1995) (renunciation by Medicaid recipient must be considered for purposes of determining eligibility, decision based on public policy). III. BAD BOY SET ASIDES. A. Fraudulent Transfers. Forty-two of the United States jurisdictions have now enacted the Uniform Fraudulent Transfer Act (1984 Act) [herein “UFTA”], including North Carolina, Tennessee, Georgia, Oklahoma, Wisconsin, Texas and Ohio.5 Under the UTFA, “[A] transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor‟s claim arose before or after the transfer was made or the obligation incurred, if the debtor made the transfer or incurred the obligation: (i) with actual intent to hinder, delay, or defraud any creditor of the debtor . . . .” § 4(a). Such a transfer can be avoided by a creditor. § 7(a). In addition, a transfer made without fair consideration by an insolvent person, or one who will be rendered insolvent by reason of the transfer is a “fraudulent” conveyance. § 4, §2. “[A] debtor is insolvent if the sum of the debtor‟s debts is greater than all of the debtor‟s assets at a fair valuation.” § 2(a). A debtor not paying his debts as they become due is presumed to be insolvent § 2(b). “Badges of fraud” are listed at § 4(b).6 Finally, a transfer made without 5 6 7A pt. II Uniform Laws Annotated (Supp. 2005, at 28). Section 4(b) provides: (b) In determining actual intent under subsection (a)(1), consideration may be given, among other factors, to whether: (1) the transfer or obligation was to an insider; (2) the debtor retained possession or control of the property transferred after the transfer; (3) the transfer or obligation was disclosed or concealed; (4) before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit; (5) the transfer was of substantially all the debtor‟s assets; (6) the debtor absconded; fair consideration by a person who is engaged in business or who is about to be engaged in a business, for which the transferor‟s remaining property is unreasonably small, will also be deemed to be a fraudulent conveyance, without regard to actual intent. § 5. (7) the debtor removed or concealed assets; (8) the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred; (9) the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred; (10) the transfer occurred shortly before or shortly after a substantial debt was incurred; and (11) the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor. A creditor who can seek relief under the UFTA is one who has a “claim” which is defined as “a right to payment, whether or not the right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, disputed, undisputed, legal, equitable, secured or unsecured.” § 1(3). A transfer may be fraudulent “whether the creditor‟s claim arose before or after the transfer was made or the obligation incurred.” § 4(a). Not every creditor, without respect to when his claim arose, can invoke the Act‟s protections. A “future creditor” whose existence must be proved for purposes of a fraudulent transfer claim, is “one with a legal claim against a person at the time that person makes a conveyance, even one that has not yet been reduced to judgment or even filed, [and] is entitled to set aside the conveyance if he can show it was made with actual intent to hinder, delay or defraud present or future creditors. A future creditor is further defined as a “creditor whose claim may foreseeably arise in the near future and exists when a conveying party can reasonably foresee incurring the costs of a judgment at the time of the conveyance.” Koffman v. Smith, 682 A.2d 1282, 1287 (Pa. Super. 1996) (citations omitted). So, in this case because the possibility of a future claim existed (plaintiff complaint filed December 31, 1992; defendants dissolved partnership and one sold assets to another and the other‟s wife for $1.00 by conveyance dated March 3, 1993, and the testimony by defendants was that they were aware that they could foreseeably incur the cost of the claim in the near future and deliberately avoided reserving assets to satisfy such claim), the judgment creditor was a “future creditor.” Consider Watson v. Harris, 453 S.W.2d 667, 38 A.L.R. 3d 582 (Mo. 1968): Alva and Hazel had been going together for several months, but their relationship had turned sour. Alva, age 76, apparently formulated a plan to harm his sweetie, 24 years his junior. He executed deeds to all of his land except cemetery lots and delivered them to his stepdaughter. He made out his Will, disposing of his personalty. Five days later he shot and killed Hazel and then killed himself. Hazel‟s estate recovered a judgment for the wrongful death against Alva‟s estate and then sought to set aside the gratuitous conveyance to the stepdaughter. The Missouri statute referred to “every conveyance . . . made or contrived with the intent to hinder, delay or defraud creditors . . . shall be . . . deemed and taken, as against said creditor . . . prior to and subsequent, to be clearly and utterly void.” [Emphasis added.] The Court compared the case to the situation of a person who plans to enter a hazardous business undertaking and who first conveys away his property. It considered the badges of fraud, especially the transfer of property just prior to the intentional tort, rendering Alva virtually insolvent. The case sets aside the conveyance as fraudulent. Where a transfer is proved fraudulent, it can be set aside “to the extent necessary to satisfy the creditor‟s claim.” § 7(a)(1), 8(b). In addition to various equitable remedies, if the creditor has obtained a judgment, he can levy execution. § 7(b). The statute imposes a ceiling such that where a fraudulent conveyance has been found, the defrauded creditor cannot obtain greater relief than he might have obtained if the fraudulent transfer had not been made. § 8(c). Transfers in good faith and for value are not voidable under the Act. § 8. Section 548 of the Bankruptcy Code is the federal analog of the UTFA. That section allows the bankruptcy trustee to avoid certain prior “fraudulent” transfers of the debtor (as well as certain prior “fraudulent” obligations), made or incurred within one year before the date the petition was filed (increased to two years by the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act, P.L. 109-8, § 1402, effective for cases commenced after April 20, 2006, id., § 1406(b)(2). If a fraudulent conveyance is found, the bankrupt could be denied discharge. 11 U.S.C. § 727(a)(2)(A). More than that, such a transfer is an automatic violation of 18 U.S.C. 152(7), a criminal statute providing for fines and imprisonment for any person who, in connection with a bankruptcy case, knowingly and fraudulently conceals any property belonging to the estate of a debtor, § 152(1); knowingly and fraudulently receives any material amount of property from a debtor after the filing of a bankruptcy case, with intent to defeat the provisions of the Bankruptcy Code, § 152(5); or in a personal capacity or as an agent or officer of any person or corporation, in contemplation of a bankruptcy case by or against the person or any other person or corporation, or with intent to defeat the provisions of the Bankruptcy Code, knowingly and fraudulently transfers or conceals any of his property or the property of another person or corporation, § 152(7). This statute is not limited to the bankrupt, nor is it limited to transfers within the one-year period. B. Dirty Hands--Creditors All Paid. Pat and Joe were planning to be married. Joe owned property on which he was having difficulty making the mortgage payments because of business reversals. He had one unencumbered parcel, a convenience store and apartment building recently inherited. So, he had counsel to form a corporation, had the shares issued to Pat, and conveyed to it the store and the apartment building. Joe stated in his affidavit that he decided to form a corporation and convey the unencumbered lot to the corporation so that the store which was on the lot “would be able to continue to operate and would not be seized or tied up by any creditor.” Joe‟s trial lawyer in his answer to Pat‟s ejectment action, brought on behalf of the corporation, alleged that the corporation “was formed by [Joe] and the stock issued in the name of [Pat] for the benefit of [Joe] for the sole purpose of preventing creditors to take possession of the property due to the cash flow position of [Joe].” He stated that Pat had agreed to convey the stock to him when he requested it. He became current in his mortgage payments and then made that request. She changed her mind and filed an action to throw him off the property. The Trial Court accepted Joe‟s request to impose a constructive trust on the corporate stock and ordered Pat to transfer the shares to him. On appeal the judgment was reversed: “[I]t is not necessary that an action be filed by a creditor or that the person conveying the property not pay his lawful debts. If the conveyance is made to a person with the intent that the grantee will hold the property so that creditors cannot reach it, the parties to that conveyance are in pari delicto and the law will not require the grantee to reconvey the property.” Moffett v. Daniels, 80 N.C. App. 516, 342 S.E.2d 925, cert. den., 317 N.C. 705, 347 S.E.2d 344 (1986), following Penland v. Wells, 201 N.C. 173, 159 S.E. 423 (1931). The cases are collected in Annot., Rule Denying Recovery of Property to One Who Conveyed to Defraud Creditors as Applicable Where the Claim Which Motivated the Conveyance Was Never Established, 6 A.L.R. 4th 862 (1981); Annot. Rule Denying Relief to One Who Conveyed His Property to Defraud His Creditors as Applicable Where the Threatened Claim Which Occasioned the Conveyance Was Never Established, 157 A.L.R. 945 (1945). IV. EXEMPTIONS. Any discussion of exemptions in pre-bankruptcy planning is beyond the scope of this paper. There are, however, “exemptions” from claims of creditors that merit consideration during the review of any client‟s situation. A. Insurance. Subject to some limitations, many states have statutes which provide that insurance proceeds payable to a named beneficiary are exempt from the claims of the creditors of the insured. For example, N.C. Gen. Stat. 58-58-115 provides: [E]xcept in cases of transfer with intent to defraud creditors . . . the lawful beneficiary or assignee thereof, other than the insured . . . or the executor or administrator of such insured . . . shall be entitled to its proceeds and avails against creditors and representatives of the insured . . .: Provided, that subject to the statute of limitations, the amount of any such premiums for said insurance paid with intent to defraud creditors, with interest thereon, shall inure to their benefit from the proceeds of the policy . . . . Indeed, North Carolina has a constitutional exemption providing that “upon [insured‟s] death, the proceeds from the insurance shall be “paid to or for the benefit of a spouse or children or both, or to a guardian, free from the claims of the representatives or creditors of the insured or his or her estate.” N.C. Const. Art. X, § 5. Other states have similar statutes, e.g., Code of Va. § 38.2-3122 (2002) (the “lawful beneficiary of an insurance policy”); Tenn. Code Ann. §§ 6-7-201, 202, 203 (2000) (“the benefit of the surviving spouse and children,” § 201; “payable to the testate estate shall pass under the dispositive provisions of the will, but shall not be subject to the debts of the deceased spouse unless specifically charged therewith in the will,” § 202); S.C. Code Ann. § 38-63-40 (2002) (“payable to a beneficiary other than the insured‟s estate in which such proceeds . . . are expressed to be for the primary benefit of the insured‟s spouse, children, or dependents are exempt from the creditors of the insured . . .”); see 22A J. Appleman, Insurance Law and Practice, § 14583 (1979); L. Russ and T. Segalla, 5A Couch on Insurance 3d § 66.13 et. seq. (2004). The general rule should be that no careful practitioner will suffer his clients to die without a beneficiary designated on each life insurance policy in a manner to preserve this exemption. Of course, where the spouse has co-signed notes for guaranties, careful planning would indicate that the beneficiary named might be a trust for her benefit, or for the benefit of her and the children. In this writer‟s practice, nearly every letter of transmittal with estate planning document drafts includes a request for copies of the declaration page of each life insurance policy, a change of beneficiary form (often available only upon request of the insured himself to the agency servicing the contract) and sample language proposed to designate new beneficiaries7, as follows: PRIMARY BENEFICIARY: [WIFE‟S NAME], spouse of Insured. 7 Where the insured‟s revocable trust is named, the trust must contain the usual boilerplate language concerning use of insurance proceeds, “The Trustee shall pay from the trust fund (as herein provided) those amounts to my estate or to the persons or authorities eligible to receive the same which are certified by the personal representative of my estate as being required to pay (i) any bequest in my will, (ii) any of my debts, health care expenses, funeral expenses and administration expenses of my estate, except that the Trustee, in his discretion may decline to pay any of my debts or expenses from life insurance proceeds which are exempt from creditor's claims, and . . . .” CONTINGENT BENEFICIARY: Trustee of the [HUSBAND‟S NAME] REVOCABLE TRUST U/A/O ____________________, 2005, wherein [HUSBAND‟S NAME] is named as original Trustee and [WIFE‟S NAME] is named as alternate Trustee; provided, if the trust is not in existence, or if, for any other reason, the company or a court concludes that payment cannot be made to the Trustee, payment of such insurance proceeds shall be made to the SECOND CONTINGENT BENEFICIARIES. SECOND CONTINGENT BENEFICIARIES: [NAMES OF CHILDREN], children of Insured. B. Qualified Plans. Since Patterson v. Shumate, 504 U.S. 753 (1992), a retirement plan which is “qualified” under ERISA is absolutely protected from the plan participant‟s creditors. Unless such a plan is defective in some respect, e.g., In re Hall, 151 B.R. 412 (Bankr. W.D. Mich. 1993) (debtor and his spouse, the only participants in the plan, were not employees, so the plan was non-ERISA-qualified), the exemption is absolute and not dependent on “the vagaries of state spendthrift trust law,” Patterson v. Shumate, supra, at 765. There is authority that if the IRS determines a plan to be qualified, the Bankruptcy Court does not have authority to determine otherwise. In re Youngblood, 29 F.3d 225 (5th Cir. 1994); accord., In re Rueter, 11 F.3d 850 (9th Cir. 1993). Qualified plan assets are, however, vulnerable to federal tax liens of the plan participant. In U.S. v. Sawaf, 74 F.3d 119 (6th Cir. 1996), the court relied on Treas. Reg. § 1.401(a)-13(b)(2) which provides that an antialienation provision under § 401(a)(13) shall not preclude the enforcement of a federal tax levy under § 6331 or the collection by the United States on a judgment resulting from an unpaid tax assessment. The court rejected the debtor‟s reliance on ERISA and on Patterson v. Shumate. And see, Shanbaum v. United States, 32 F.3d 180 (5th Cir. 1994) (ERISA, 29 U.S.C. 1144(d), provides that it shall not be “construed to alter, amend, modify, invalidate, impair, or supersede any law of the United States . . . or any rule or regulation imposed under such law.” “Section 6634 [of the IRC] which specifically exempts certain property from levy, does not exempt pension plan benefits from collection.”); Ameritrust Co. v. Derakshan, 830 F.Supp. 406 (N.D. Ohio 1993); In re Raihl, 152 B.R. 615, 618 (Bankr. 9 th Cir. 1993); In re Jacobs, 147 B.R. 106, 107-08 (Bankr. W.D. Pa. 1992). State taxes are not collectible from qualified plans; ERISA as federal law preempts state law. C. IRAs. Patterson v. Shumate does not extend to IRAs, which are not qualified under ERISA. The federal exemptions of Section 522 of the Bankruptcy Code apply only in those states which have not “opted out” of the federal exemption system. There are sixteen states which have not opted out, and in those states the bankruptcy debtor can choose either the federal or state exemptions. Most of the states have opted out of the federal exemptions, including Alabama, Arizona, California, Colorado, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Mississippi, Missouri, Montana, Nebraska, Nevada, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, South Carolina, South Dakota, Tennessee, Utah, Virginia, West Virginia and Wyoming. In those states, the exemptions of Sec. 522 do not apply, and one must look to each of those state's exemption laws to see whether IRAs are exempt from the claims of judgment creditors. Many states provide such an exemption, e.g., N.C. Gen. Stat. 1C-1601(a)(9) (“individual retirement plans as defined in the Internal Revenue Code”-presumably including Roth IRAs); S.C. Code § 15-41-30(12)(2005) (“to the extent reasonably necessary for the support of the debtor and any dependent of the debtor” and may be limited by fraudulent conveyance); Code of Va. § 34-34B (Supp. 2005) (limited by § 3434C “to the extent that the [plan] would provide an annual benefit in excess of $25,000”); Tex. Code Ann., Property § 42.0021(a) (but Roth IRAs not exempt under § 42.0021(b)); Official Code of Ga. Ann. § 18-4-22(a) (limited if “based upon a judgment for alimony or for child support”). See generally, Annot., Individual Retirement Accounts as Exempt From Money Judgments in State Courts, 113 A.L.R. 5th 487 (2003). Careful reference to the state exemption statute is required--many refer to § 408, and so do not include Roth IRAs under § 408A. Rousey v. Jacoway, ____ U.S. ____, 125 S. Ct. 1561 (2005), holds that debtors can exempt assets in their IRAs from the bankruptcy estate pursuant to Bankruptcy Code § 522(d)(10)(E), making IRAs exempt under federal law in those sixteen states which have not opted out of the federal exemptions.. See generally, Annot., Individual Retirement Accounts as Exempt Property in Bankruptcy, 133 A.L.R. Fed. 1 (1996). The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act, P.L. 109-8 § 224(a), amended § 522 of the Bankruptcy Code, expanding the sweep of protection for retirement arrangements not protected by Patterson v. Shumate. The new law exempts retirement funds to the extent those funds are in a fund or account that is exempt from taxation under §§ 401, 403, 408, 408A, 414, 457 or 501(a). If the retirement fund has received a favorable ruling, in effect at the filing date, funds are presumed to be exempt. If there is no ruling, funds are exempt if the debtor shows that no contrary determination has been made by a court or the IRS and the fund is in substantial compliance with the Internal Revenue Code. If the fund is not in substantial compliance, it can nevertheless be exempt if the debtor is not materially responsible for such failure. Under new Bankruptcy Code § 522(h), the exemption for assets in an IRA or Roth IRA is limited to $1,000,000, “except that such amount may be increased if the interests of justice so require” (adjusted periodically by 11 U.S.C. 104 by the Consumer Price Index). The addition of Bankruptcy Code §§ 522(d)(12), (b)(2)(C), for retirement funds makes clear that they are exempt under federal law. These new provisions take effect 180 days after April 20, 2005. P.L. 109-8, § 1501. Whether such assets are exempt in the numerous states which have opted out of the federal exemptions is determined under the exemption laws of those respective states. The IRS can, of course, levy on an IRA--even if rolled over from a retirement plan, even though the spouse had not waived her survivorship rights. Kopec v. Kopec, 70 F.Supp. 2d 217 (E.D. N.Y. 1999). The Internal Revenue Manual indicates that because IRAs provide for taxpayers‟ future welfare, levy on the IRA corpus will be accomplished only in flagrant cases. I.R.M. § 5.11.6.2 (3-13-2000). But see, First Federal Savings and Loan Assoc. of Pittsburgh v. Goldman, 664 F.Supp. 101, 86-2 U.S.T.C. ¶ 9624 (W.D. Penn. 1986). (IRS argues it is not bound by Internal Revenue Manual--and wins.). V. ENTITY PLANNING. A. Corporations.8 No citation is needed to support the proposition that a corporation limits the liability of its shareholders--if they are not involved in the tort or did not endorse the corporate obligation personally. Mom and Pop are protected--unless Pop is driving the corporate dump truck when the wreck occurs. The tortfeasor can always be sued. Mom is not liable, however, unless perhaps she had supervisory duties which were breached, giving rise to an action against her, individually. Palsgraf would hold that she should foresee that failure to conduct background checks and random drug and alcohol testing, to require periodic safety training and to monitor driver safety could lead to personal liability for her, individually, as an original tortfeasor, not through respondeat superior. 8 Professional corporations are beyond the scope of this topic. A corporate officer who takes part in the commission of a tort by the corporation is personally liable for that tort. For example, where the president and CEO is responsible for submission of union dues and PAC contributions and does not do so, he is liable for conversion. Laborers Combined Funds of Western Penn. v. Cioppa, 346 F.Supp.2d 765 (W.D. Pa. 2004). Where the “participation” is supervision, the rule also applies. Where the president of the corporation daily visited the work site of an excavation project and gave orders to the foreman, he was personally liable for damages caused by loss of lateral support due to removal of soil from adjoining land. Levi v. Schwartz, 95 A.2d 322 (Ct. App. Md. 1953). See, Esteel Co. v. Goodman, 82 N.C. App. 692, 348 S.E.2d 153 (1986), disc. rev. den., 318 N.C. 693, 351 S.E.2d 745 (1987) (president held personally liable in conversion for selling, on behalf of the corporation, leased property on which option to purchase had not been exercised); Annot., Personal Civil Liability of Officer or Director of Corporation for Negligence of Subordinate Corporate Employee Causing Personal Injury or Death of Third Person, 90 A.L.R. 3d 916 (1979). Directors cannot delegate some duties. Where the directors appoint a committee to supervise the manager in the conduct of corporate affairs and the directors met only three times during the two-year existence of the corporation, and a dividend was declared when the corporate liabilities exceeded assets, the directors were individually liable to creditors, notwithstanding that they had no knowledge of the corporation‟s financial condition. “Good faith alone will not excuse them when there is lack of proper care, attention, and circumspection in the affairs of the corporation which is exacted of them as trustees.” Anthony v. Jeffress, 172 N.C. 378, 379 90 S.E. 414, 415 (1916). See Annot., Liability of Corporate Directors for Negligence in Permitting Mismanagement or Defalcations by Officers or Employees, 25 A.L.R. 3d 941 (1969). The books9 are full of examples of personal liability that do not respect the corporate veil: 9 ed. 2004). R. Robinson, Robinson on North Carolina Corporation Law, § 16.09 (7th • Federal Anti-trust Law: “Wherever a corporation shall violate any of the penal provisions of the anti-trust laws, such violation shall be deemed to be also that of the individual directors, officers, or agents of such corporation who shall have authorized, ordered, or done any of the acts constituting in whole or in part such violation . . . .” 15 U.S.C. 24 (Clayton Act). • Environmental Liability: 42 U.S.C. 9607(a)(2) (“any person who at the time of disposal of any hazardous substance owned or operated any facility at which such hazardous substances were disposed of”). See Wilson v. McLeod Oil Co., Inc., 327 N.C. 491, 519, 398 S.E.2d 586, 600 (1990), reh’g. den., 328 N.C. 336, 402 S.E.2d 844 (1991) (citing N.C. Gen. Stat. § 143-215.93 which provides strict liability for any “person having control over oil or other hazardous substances”); United States v. Carolina Transformer Co., 739 F.Supp. 1030 (E.D. N.C. 1989) (officers may be held liable as owners and operators if certain criteria are met: active participation, capacity to control waste disposal, ability to abate damage, equity ownership). • State Sales and Use Tax, Withholding Tax: “Any officer . . . of any corporation or limited liability company required to file a report with the Secretary [of Revenue] who has custody of funds . . . and who allows the funds to be distributed to the shareholders . . . or to the members [without remitting] taxes that are due is personally liable for the payment of the tax.” N.C. Gen. Stat. 105-253(a). • Federal Withholding Taxes: §§ 6671, 6672 of the Internal Revenue Code are the so-called “100% penalty” rule under which a “responsible person” is personally charged with the liability of withholding taxes not paid. Officers, employees, directors, and shareholders or other persons with sufficient control to direct disbursement of funds, whether or not they exercise that control directly, are responsible persons. A judgment creditor can, of course, levy execution on a debtor‟s closely-held corporate shares. E.g., N.C. Gen. Stat. § 1-324.3. What he has if he bids in at the Sheriff‟s sale is another matter if the interest is not controlling. A minority share interest is a minority share interest, regardless of the owner. B. Limited Partnerships and LLCs. It is familiar learning that the liability of a limited partner and a member of an LLC is limited to his investment in the entity.10 The entity‟s creditor, no more than a corporate creditor, cannot pursue his claim through the entity veil to these owners. 1. The Charging Order Regime. 10 E.g., N.C. Gen. Stat. 59-303 (limited partnership); N.C. Gen. Stat. § 57C-330(h) (member of LLC not liable for company obligations); Limited Partnership Act 2001 (2001 § 303); RULPA 1996, § 303; Uniform Limited Liability Act, § 303. The uniform acts are found in 6A Uniform Laws Annotated (2003). Limited Partnerships and LLCs have an additional protective feature, an advantage over the corporation, in that a creditor of the partner or LLC member generally cannot have levy of execution on the partner‟s or member‟s interest, but is entitled only to a charging order. The charging order remedy has been around at least since the Uniform Partnership Act of 1916, but there are few reported cases discussing such relief. An understanding of statutory basis for a charging order is a first necessity. Not all charging orders are created equal. Compare RULPA11 § 703 and ULLCA12 § 504: § 703. Rights of Creditor. On application to a court of competent jurisdiction by any judgment creditor of a partner, the court may charge the partnership interest of the partner with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the partnership interest. This [Act] does not deprive any partner of the benefit of any exemption laws applicable to his [or her] partnership interest. RULPA § 703. § 504. Rights of Creditor. (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 distribution due or to become due to the judgment debtor and make all other orders, directions, accounts, and inquiries the judgment debtor might have made or which the circumstances may require to give effect to the charging order. 11 RULPA jurisdictions include, among others, Georgia, Kentucky, North Carolina, Ohio, Oklahoma, South Carolina, Tennessee, Texas, Virginia, and Wisconsin. 12 ULLCA jurisdictions include, among others, South Carolina. The ULLCA allows the transferor of a distributional interest to seek a judicial determination that it is equitable to dissolve and wind up the company‟s business. § 503(e)(2). (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 transferee. (c) At any time before foreclosure, a distributional interest in a limited liability company which is charged may be redeemed: (1) by the judgment debtor; (2) with property other than the company‟s property, by one or more of the other members; or (3) with the company‟s property, but only if permitted by the operating agreement. (d) This [Act] does not affect a member‟s right under exemption laws with respect to the member‟s distributional interest in a limited liability company. (e) This section provides the exclusive remedy by which a judgment creditor of a member or a transferee may satisfy a judgment out of the judgment debtor‟s distributional interest in a limited liability company. ULLCA § 504. North Carolina‟s LLC Act creditor provision tracks the RULPA language, N.C. Gen. Stat. § 57C-5-03; as do those found at Ga. Code Ann. § 14-11-504(a) (although (b) provides that (a) is not an exclusive remedy); Ky. Rev. Stat. Ann. § 275.260; Minn. Stat. § 322B.32 (charging order “sole and exclusive remedy”); Tex. Code Ann., Business Organizations § 101.112 (Supp. 2004-2005). So, for example, in South Carolina, S.C. Code § 33-44-503 (Supp. 2004) and Virginia, Va. Code Ann. § 13.1-1041.1 (Supp. 2004) (follows ULLCA, replacing § 13.1-1041, repealed, 2004), a creditor might have an easier time than in North Carolina. From an asset protection perspective, the North Carolina LLC Act provisions are preferable when selecting the jurisdiction for organization. Most LLC statutes provide that the law of formation jurisdiction governs the organization, internal affairs, and member liability of a foreign LLC. L. Ribstein and R. Keatinge, Limited Liability Companies, § 13.3, Appendix 13-5 (2005); N.C. Gen. Stat. § 57C-7-01. Likewise, the law of the state of organization will generally control the rights, powers, and liabilities of general and limited partners and be respected by courts in other jurisdictions under conflict of law principles. III A. Bromberg and L. Ribstein, Bromberg and Ribstein on Partnerships, § 12.25(b); N.C. Gen. Stat. § 59-901; Annot., Conflict of Laws as to Partnership Matters, 29 A.L.R. 2d 295 (1953). In Georgia, The trial court has discretion to determine whether or not a judicial sale of the partnership interest in an appropriate means in aid of the charging order. . . . The status of a purchaser of the charged interest is similar to that of an assignee in that the purchaser, like an assignee, has the right to receive the distributions the debtor partner would have been entitled to receive, but the foreclosure sale does not place the purchaser in the position of a limited partner. Accordingly, if the creditor under the charging order is the purchaser, the creditor does not by virtue of the purchase become a substituted limited partner, and is only entitled to receive the distributions to which the debtor limited partner would have been entitled. “The principal change in the creditor‟s current status [under the charging order] as a result [of purchasing the charged interest at] the foreclosure and sale is that the creditor now owns the partner‟s entire financial interest in the partnership, including all amounts ultimately due the partner on dissolution after settlement of liabilities.” [Citations omitted.] Nigri v. Lotz, 216 Ga. App. 209, ____, 453 S.E.2d 780, 783 (1995). 13 The Court notes that courts in other states and text writers “have generally agreed that the charging order 13 The Georgia statute provides: (a) On due application to a court of competent jurisdiction by any judgment creditor of a limited partners, the court may charge the interest of the indebted limited partner with payment of the unsatisfied amount of the judgment debt and may appoint a receiver and make all other orders, directions, and inquiries which the circumstances of the case may require. (b) The interest may be redeemed with the separate property of any general partner, but may not be redeemed provisions authorize the sale of a charged partnership interest.” 453 S.E.2d at 783 (citing cases). In addition, the Georgia UPA contains a charging order remedy similar to the ULPA, but the former statute provides that the charged interest “is not liable to be seized and sold by the judgment creditor under execution.” 453 S.E.2d at 783, n. 3. See Gee v. Reingold, 259 Ga. App. 898, 578 S.E.2d 572 (2003) (following Nigri v. Lotz). In Herring v. Keasler, 150 N.C. App. 598, 563 S.E.2d 614, rev. den., 356 N.C. 435, 572 S.E.2d 431 (2002), the court reached a different result, holding that: with partnership property. (c) The remedies conferred by subsection (a) of this Code section shall not be deemed exclusive of others which may exist. (d) Nothing in this article shall be held to deprive a limited partner of his statutory exemption. with respect to a judgment debtor‟s membership interest in a limited liability company, a trial court “may charge the membership interest of the member with payment of the unsatisfied amount of the judgment with interest.” N.C.G.S. § 57C-5-03 (2001). This “charge” entitles the judgment creditor “to receive . . . the distributions and allocations to which the [judgment debtor] would be entitled.” N.C.G.S. § 57C-5-02 (2001). The “charge” does not dissolve the limited liability company or entitle the [judgment creditor] to become or exercise any rights of a member.” Id. Furthermore, because the forced sale of a membership interest in a limited liability company to satisfy a debt would necessarily entail the transfer of a member‟s ownership interest to another, thus permitting the purchaser to become a member, forced sales of the type permitted in section 1-362 are prohibited. The statute considered in Herring, like its analogue in North Carolina‟s RULPA, N.C. Gen. Stat. § 59-7-03, has no “exclusivity” prohibition of foreclosure, e.g., Alaska Stat. § 32.11.340(b). Other courts have reached a similar conclusion, that the charging order “was the only means by which a judgment creditor can legally command payment from the [limited partner] debtor‟s partnership interest. In re Stocks, 110 B.R. 65 (Bankr. N.D. Fla. 1989) (distinguishing rights of creditors of partners in a general partnership); accord., Givens v. Nat’l. Loan Investors, L.P., 724 So.2d 610 (Fla. App. 5 th Dist. 1998); In re Jaffee, 235 B.R. 490 (Bankr. S.D. Fla. 1999) (citing Krauth v. First Continental Dev-Con, Inc., 351 So.2d 1106, 1108 (Fla. 4 th D.C.A. 1977) (holding that the Uniform Partnership Act has made the statutory charging order the only means by which a judgment creditor can legally demand payment from a debtor‟s partnership interest). Many cases go the other way, however, mostly based on a special statute, e.g., In re Allen, 228 B.R. 115 (Bankr. W.D. Pa. 1998) (Pennsylvania law). Some states provide by statute that the charging order is a creditor‟s exclusive remedy, but most do not, using a partnership-type charging order provision. 1 Ribstein and Keatinge, supra, Appendix 7-9. The authors suggest that the partnership “exclusivity” cases are not necessarily apposite in the LLC arena because the concern to limit disruption of the entity‟s ongoing business is addressed differently in LLC statutes than in RULPA. Under most LLC statutes, e.g., N.C. Gen. Stat. § 57C-5-02 (“an assignment entitles the assignee to receive, to the extent assigned, only the distributions and allocations to which the assignor would be entitled but for the assignment.”), charging creditors and their assignees cannot obtain dissolution and liquidation. See Ribstein and Keatinge, supra, at 7.13. Even if foreclosure were allowed, the purchaser at the sale would have only the status of an assignee--he cannot become a member without consent, e.g., N.C. Gen. Stat. § 57C-5-04. The trend may be in this direction. See H. Rosen and G. Rothschild, Asset Protection Planning, 810-2d T.M. at A-40 (2005).14 2. Single Member LLC. At least one case has held that the charging order regime does not apply to a single member LLC and that the interest of the single-member debtor was wholly assigned to the Chapter 7 Trustee who obtained all of her rights, including the right to control management. Pursuant to the Colorado limited liability company statute, the Debtor‟s membership interest constitutes the personal property of the member. Upon the Debtor‟s bankruptcy filing, she effectively transferred her membership interest to the estate. See 11 U.S.C. § 541(a). Because there are no other members in the LLC, the entire membership interest passed to the bankruptcy estate, and the Trustee has become a “substituted member.” 14 “[E]xclusivity may be a poor rule, since it forces member‟s creditors to resort to an unfamiliar remedy.” Section 7-80-702 of the Limited Liability Company Act requires the unanimous consent of “other members” in order to allow a transferee to participate in the management of the LLC. Because there are no other members in the LLC, no written unanimous approval of the transfer was necessary. Consequently, the Debtor‟s bankruptcy filing effectively assigned her entire membership interest in the LLC to the bankruptcy estate, and the Trustee obtained all her rights, including the right to control the management of the LLC. The Debtor argues that the Trustee acts merely for her creditors and is only entitled to a charging order against distributions made on account of her LLC membership interest. However, the charging order, as set forth in Section 703 of th Colorado Limited Liability Company Act, exists to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose, or from having to accept a creditor of another member as a co-manager. A charging order protects the autonomy of the original members, and their ability to manage their own enterprise. In a single-member entity, there are no non-debtor members to protect. The charging order limitation serves no purpose in a single member limited liability company, because there are no other parties‟ interests affected. The Colorado limited liability company statute provides that the members, including the sole member of a single member limited liability company, have the power to elect and change managers. Because the Trustee became the sole member of Western Blue Sky LLC upon the Debtor‟s bankruptcy filing, the Trustee now controls, directly or indirectly, all governance of that entity, including decision regarding liquidation of the entity‟s assets. [Footnotes omitted.] In re Albright, 291 B.R. 538 (Bankr. D. Colo. 2003) (creditor rights statute modeled on Uniform Partnership Act--similar to ULLCA quoted, supra, 1997 version). The court gives us all comfort--and worthwhile instruction--in footnote 9: 9. The harder question would involve an LLC where one member effectively controls and dominates the membership and management of an LLC that also involves a passive member with a minimal interest. If the dominant member files bankruptcy, would a trustee obtain the right to govern the LLC? Pursuant to Colo.Rev.Stat. § 7-80-702, if the non-debtor member did not consent, even if she held only an infinitesimal interest, the answer would be no. The Trustee would only be entitled to a share of distributions, and would have no role in the voting or governance of the company. Single member LLCs may not provide asset protection. 3. Fraudulent Transfer. It hardly needs repeating that following all the formalities is not sufficient to cover a fraudulent conveyance to a limited partnership or an LLC. In Interpool, Ltd. v. Patterson, 890 F.Supp. 259 (S.D. N.Y. 1995), the debtor, shortly before trial, conveyed nearly $1.4 million to a family limited partnership in which he and his wife were partners. One week following that transfer, he created a trust naming himself and his wife trustees and transferred his 95.613% limited partnership interest to the trust. The trust had special “protective” provisions under which a creditor would be entitled to receive only what the debtor and his wife could obtain from the trust. The debtor argued that the transfer was for equal value--the interests he received in exchange were worth their face value to him. Says the court: The existence of a fair exchange must be determined from the perspective of creditors rather than from the vantage point of the debtor. [Courts have] held that a conveyance is not an exchange for equivalent value when it makes the debtor “execution proof” and the debtor‟s assets unreachable by creditors. In determining whether a conveyance is fraudulent, “[t]he touchstone is the unjust diminution in the estate of the debtor that otherwise would be available to creditors.” “Viewing the fairness of the transfer from the perspective of a creditor is consistent with the policy underlying statues against fraudulent conveyances, which were enacted to protect the rights of creditors by preventing debtors from making transfers that would „hinder, defraud or delay‟ creditors.” . . . The conclusion that [debtor] did not receive equivalent value alone suffices to establish that the transaction was not made for fair consideration and, in consequence, that it must be set aside . . . . Interpool Ltd. v. Patterson, 890 F.Supp. at 267. Firmani v. Firmani, 332 N.J. Super. 118, 752 A.2d 854 (2000) (conveyance to family partnership to limit recovery by charging order); Nat’l. Loan Investors, L.P. v. Robinson, 98 S.W.3d 781 (Tex. App. Amarillo 2003) (following Interpool Ltd., supra, on “creditor‟s” perspective analysis, even though not part of the fraudulent conveyance statute); In re Meyer, 206 B.R. 410, 418 (Bankr. E.D. Va. 1997), vacated on other grounds, 244 F.3d 352 (4 th Cir. 2001). 4. The Assignee Creditor and the IRS. Whether a creditor under a charging order properly receives his assignor‟s Schedule K-1 is open to some question. Rev. Rul. 77-137, 1977-1 C.B. 178, the only published ruling to consider the tax effect of an assignment, involved the voluntary assignment of a limited partnership interest. The partnership agreement allowed assignment of “the right to share in the profits and losses of the partnership and to receive all distributions, including liquidating distributions, to which the limited partner would have been entitled had the assignment not been made.” The assignor in the ruling agreed to exercise any residual powers remaining to him in favor of the assignee. The ruling holds that “even though the general partners did not give their consent to the assignment, since . . . the assignee acquired substantially all of the dominion and control over the limited partnership interest, for federal income tax purposes [the assignee] is treated as a substituted limited partner [and] must report the distributive share of partnership items of income, gain, loss, deduction, and credit attributable to the assigned interest on [his] Federal income tax return . . . .” GCM 36960 (December 20, 1976), provides a more thorough analysis to the IRS position, holding, Assignees of limited partnership interests will be required to report distributive shares of partnership income or loss attributable to the assigned interests, even though they do not become substituted limited partners, when they acquire dominion and control over those interests. However, to the extent that assignors retain substantial rights with respect to those interests that are not to be exercised solely on behalf of the assignees, assignees do not have the requisite dominion and control. ... [T]o the extent that an assignor retains residual rights that may not be exercised on behalf of the assignee, the assignee may be said to lack control over the assigned interest. [Citing cases from several states.] Clearly, an analysis of state law is required--the issue is whether the debtor-assignor “retains substantial rights with respect to the [charged] interests that are not exercised solely on behalf of the assignees.” Consider the North Carolina LLC Act: Under N.C. Gen. Stat. § 57C-5-03, “the judgment creditor has only the rights of an assignee of the membership interest.” Under N.C. Gen. Stat. § 57C-5-02, “an assignment entitles the assignee to receive, to the extent assigned, only the distributions and allocations to which the assignor would be entitled but for the assignment.” [Emphasis added.] “The charge [or in the parlance of the statute, „[a]n assignment of a membership interest‟]does not dissolve the limited liability company or entitle the assignee to become or exercise any rights of a member.” Further, “[e]xcept as provided in the articles of organization or a written operating agreement, [an] encumbrance against all or any part of the membership interest of a member shall not cause the member to cease to be a member or the secured party to have the power to exercise any rights or powers of a member.” So, even if the charging order effectively charges the entire interest (italicized words, above) to the fullest extent allowed--all distributions including liquidating distributions, for example--the debtor-assignor remains the member. In that capacity, he still votes • • • to adopt or amend an operating agreement; to admit members to sell or transfer all or substantially all of the assets of the company; and • to dissolve, G.S. 57C-3-03. In addition, the debtor-assignor is entitled to access to information and records, G.S. 57C-304. Under G.S. 57C-502, “a member ceases to be a member upon assignment of all of his membership interest.” If the charging order leaves the debtor-member with residual interests, the creditor-assignee should not be treated as the member for tax purposes under the authority of the GCM, cited above. That is the IRS position. The retained dominion and control, at least “to the extent [not] assigned” causes the debtor-assignor to retain the status of a member. The charging order is really a garnishment mechanism. The member remains taxable on company income under the principles of Lucas v. Earl, 281 U.S. 111 (1929). See 1 A. Willis, J. Pennell, P. Postlewaite, Partnership Taxation, ¶ 9.01[2] (6th ed. 2004). It has been suggested that the operating agreement include a provision requiring the entity to issue the K-1 to the judgment creditor in those states where the statutory status of an assignee is broader than in North Carolina. The authors cite the Florida statute as an example: An assignment entitles the assignee to share in such profits and losses, to receive such distribution or distributions, and to receive such allocation of income, gain, loss, deduction, or credit or similar item to which the assignor was entitled. H. Rosen and G. Rothschild, Asset Protection Planning, 810-2d T.M. at A-41 (2005), quoting Fla. Stat. § 620.152(1)(c) (2001) (Florida Uniform Limited Partnership Act). Notwithstanding the language of the quoted statute, the only reported decision under it makes clear that the creditor, as assignee, is entitled to share only in profits and surplus-“this assignment does not . . . entitle the assignee to become or exercise any of the rights or powers of a partner. Section 620.152(1)(b), Florida Statutes.” In re Stocks, 110 B.R. 65, 67 (Bankr. N.D. Fla. 1989). Whether such a provision would be effective is doubtful. 5. Planning. The authors of BNA Portfolio, 810-2d T.M., include thoughtful forms, planning and drafting comments, at A-41 to -43, one of which bears repetition: In addition, the LLE‟s (Limited Liability Entity, including limited partnership and LLC) governing agreement should provide that the consent of all partners or members is required to liquidate the limited partnership. In a similar vein, the certificate and agreement respectively establishing and governing the LLE should be drafted (as they now can be under the IRS‟s “Check the Box” Regulations) to provide the LLE with perpetual existence. Perpetual existence will avoid any possibility that the creditor of a debtor limited partner will be able to satisfy the creditor‟s claim out of the assets of the LLE by the simple expediency of the LLE‟s automatic dissolution at the end of a set period. The LLE‟s governing agreement also should not provide that the death, incapacity, retirement or other event of withdrawal of a partner or member shall cause a dissolution (even where the agreement to provide that a majority in interest could then vote to continue the entity). For a limited partnership, consideration should also be given to having more than one general partner, or in the alternative using a corporation, limited liability company or trust as the general partner, in order to diminish or preclude the possibility of the termination of the limited partnership by reason of the death or incapacity of the last acting general partner. [Footnote omitted.] It is as critical to review the form agreements as it is to document actions of the entity and of the partners/members with the entity. If the players do not respect the status of the entity, why should the court, when asked to ignore it? Indeed, why not treat partner/member loans as capital contributions (to the entity) or insider preferences (to the partner/member), to hinder the creditor of the partner/member? The written record should be complete and reflect arms-length deals. C. Trusts. 1. Scope. Our common man has no interest in offshore trusts and is put off by the reputed cost of their creation. Their lawyer has much else to do besides, and is somewhat intimidated by the law of Nevis. The topic is beyond the scope of this paper. Six states have statutes providing for Domestic Asset Protection Trusts, but with nominal exception there will be no readers of this paper from those states: Alaska, Delaware, Nevada, Rhode Island, Utah, and Oklahoma. Use of such trusts is apparently limited.15 The topic is beyond the scope of this paper. 15 As of January, 2004, a total of approximately 1,250 Domestic Asset Protection Trusts have been established in four states: Alaska, 681; Delaware, 400; Nevada 150; Rhode Island, 17; Utah, 0 [law took effect January 1, 2004]. Shaftel, Domestic Asset Protection Trusts--Key Issues and Answers, Vol. 30, No. 1, ACTEC Journal 10 (Summer 2004); R. Nenno, The Domestic Asset Protection Trust Comes of Age, 38 U. Miami Inst. on Est. Plan., Ch. 2 (2004). Finally, nine states and the District of Columbia as of May, 2005, had adopted the Uniform Trust Code [UTC] 7C Uniform Laws Annotated (Supp. 2005). Virginia adopted its version of the UTC in 2005, Virginia Code Ann. Ch. 55-541, as did North Carolina, N.C. Gen. Stat. Ch. 36C. The UTC has been criticized, and passage defeated in several states, because it is said to depart radically from the traditional trust concept under which the trust is to follow the grantor‟s intent. Under the UTC Notwithstanding the breadth of discretion granted to a trustee in the terms of the trust, including the use of such terms as “absolute”, “sole”, or “uncontrolled”, the trustee shall exercise a discretionary power in good faith and in accordance with the terms and purposes of the trust and the interests of the beneficiaries. UTC § 814(a). The comment makes clear the intent that a court can--must--review the trustee‟s discretion (say, on behalf of the beneficiary‟s creditor): “Despite the breadth of discretion purportedly granted by the wording of a trust, no grant of discretion to a trustee, whether with respect to management or distribution, is ever absolute.” Compare, e.g., Lineback v. Stout, 79 N.C. App. 292, 339 S.E.2d 103 (1986) (“the net income and so much of the principal as shall be necessary for the general welfare, support, maintenance and benefit of my said daughter, in the absolute and uncontrolable [sic] discretion of my said trustee,” held to be a discretionary trust and, absent breach of trustee‟s duty to exercise her judgment reasonably to carry out the intent of the testator, court would not require distributions to pay for nursing home care). Compare, e.g., Virginia Code Ann. 55548.14A (effective July 1, 2006) (tracking UTC language quoted above). North Carolina adopted a version of the UTC in 2005 (effective January 1, 2006, but as will be set out below, preserved much of existing North Carolina law regarding spendthrift, support, and discretionary trusts). North Carolina‟s new statute departs from the UTC wording of § 814(a), tracking instead North Carolina case law (quoted in text, infra). N.C. Gen. Stat. § 36C-8-814(a). This paper will not make an effort to cover the impact of the UTC on asset protection by the use of trusts. That subject is examined thoroughly in Merric and Oshins, The Effect of the UTC on the Asset Protection of Spendthrift Trusts, Estate Planning (Aug., Sept., Oct. 2004); S. Oshins, Asset Protection Other Than Self-Settled Trusts: Beneficiary Controlled Trusts, FLPs, LLCs, Retirement Plans and Other Creditor Protection Strategies, 39 U. Miami Inst. on Est. Plan. § 311 et. seq. (2005). 2. Trusts from A to B for A. A settlor cannot create a spendthrift trust for his own benefit and hope to avoid his creditors‟ claims. This is the law in virtually every jurisdiction. E.g., Pilkington v. West, 246 N.C. 575, 99 S.E.2d 798 (1957) (leading case); German Est. v. U.S., 7 Ct. Cl. 641, 851 U.S.T.C. ¶ 13,610 (1985). The cases are collected in Annot., Validity of Spendthrift Trusts, 34 A.L.R.2d 1335 (1954). It is immaterial that the settlor is solvent at the time of the creation of the trust. It is against public policy to permit a man to tie up his own property in such a way that he can still enjoy it. A. Scott, Scott on Trusts § 156, n. 5 (Fratcher ed. 1987). There are statutes in a number of states which so provide. If the settlor reserves a general power of appointment, even if exercisable by will alone, his creditors can reach the interest, e.g., Petty v. Moores Branch Sanitarium, 110 Va. 815, 67 S.E. 355 (1910), and that is true even if there is a gift over upon default in the exercise of the power. Restatement (2d) of Property (Donative Transfers) § 13.3 (1986). 3. Gifts and Bequests. The pool of wisdom is large which says that virtually all gifts and bequests should be in trust, e.g., Oshins, supra, at §302, but not all clients are convinced. Especially in those cases where there is a perceived need for asset protection, careful consideration of trust design can achieve many of the goals of most clients. In this writer‟s office, it is a rare case, indeed, to find a bequest to a physician or other obviously high risk child not in trust. For high net worth clients who have a financially successful child or children, generationskipping within the exemption is an added incentive for trust use. 4. Beneficiary Control. The beneficiary should have a broad limited power of appointment. There is no finer incentive for a child‟s kindness to a parent than the specter of disinheritance. There are other concerns. North Carolina law precludes allocations or distributions by a trustee in favor of himself as beneficiary. N.C. Gen. Stat. §§ 32-34; 36C-8-814(b) (effective January 1, 2006)16. Other states have similar statutes, e.g., S.C. Code Ann. § 62- 16 N.C. Gen. Stat. § 36C-8-814(b), (c): (b) Subject to subsection (d) of this section, and unless the terms of the trust expressly indicate that a rule in this subsection does not apply: (1) A person other than a settlor who is a beneficiary and trustee of a trust that confers on the trustee a power that would, except for this subsection, constitute in whole or in part a general power of appointment may not exercise that power in favor of the trustee/beneficiary, the trustee/beneficiary‟s estate, the trustee/beneficiary‟s creditors, or the creditors of the trustee/beneficiary‟s estate. (2) Notwithstanding subdivision (1) of this subsection, if the trust confers on the trustee the power to make discretionary distributions to or for the trustee‟s personal benefit, the trustee may exercise 7-404(C)(7) (no adjustment as between principal and income if trustee is a beneficiary); Va. Code Ann. §§ 55-548.14B.1., 2 (“A person other than a settlor who is a beneficiary and trustee of a trust that confers on the trustee a power to make discretionary distributions to or for the trustee‟s personal benefit may exercise the power only in accordance with an ascertainable standard.”) (effective July 1, 2006). Where there are two or more fiduciaries, the power may be exercised by those or the one not disqualified. The statute can be overridden, but at what cost? The beneficiary would then have a general power under § 2041 of the Internal Revenue Code, and if the beneficiary can reach the corpus, so can his creditors. Compare In re Bottom, 176 B.R. 950 (Bankr. N.D. Fla. 1994) (under Florida law the trustee and the sole beneficiary cannot be one in [sic] the same in a spendthrift trust-“a spendthrift trust cannot exist if the beneficiary is able to control the assets of the trust before its maturation.”), with In re Hersloff, 147 B.R. 262 (Bankr. N.D. Fla. 1992) (debtor the power in accordance with an ascertainable standard. (3) The trustee may not exercise a power to make discretionary distributions to satisfy a legal obligation of support that the trustee personally owes another person. For purposes of this subsection, a “general power of appointment” means any power that would cause the income to be taxed to the trustee in his individual capacity under section 678 of the Internal Revenue Code and any power that would be a general power of appointment, in whole or in part, under section 2041(b)(1) or section 2514(c) of the Internal Revenue Code. (c) A power whose exercise is limited or prohibited by subsection (b) of this section may be exercised by a majority of the remaining trustees who exercise of the power is not so limited or prohibited. If the power of all trustees is so limited or prohibited, the court may appoint a special fiduciary with authority to exercise the power. one of three trustees, spendthrift clause valid, trust excluded from property of bankruptcy estate pursuant to § 541(c)(2)). One approach is to have a co-trustee in addition to the beneficiary, e.g., N.C. Gen. Stat. § 36C-8-814 (quoted above), and to confer on the beneficiary the power to remove and replace the co-trustee with one not related or subordinate. Rev. Rul. 95-58, 1995-2 C.B. 191; P.L.R. 9746007 (August 11, 1997). A beneficiary serving as trustee could have tax implications, see Pennell, Estate Planning: Drafting and Tax Considerations In Employing Individual Trustees, 60 N.C. L. Rev. 799 (1982), and cause creditor problems. Friendly, but independent trustees, are recommended. Make distribution of income and principal discretionary. If distributions are required, creditors can require them to be made. If strangers cannot be trusted, give the beneficiary power, as trustee, but limit it by an ascertainable standard--a support trust. See N.C. Gen. Stat. § 36C-8-814(b)(2) (effective January 1, 2006) (ascertainable standard required). Include a limited power of appointment to extend to the beneficiary‟s family members during the beneficiary‟s life in order to avoid the necessity for gifts by the beneficiary. The trust should be designed for use as a “family bank” and so should not limit investment to those allowed by the state‟s trust investment statute, e.g., N.C. Gen. Stat. § 36A-2 (North Carolina Prudent Person Rule). Allow the trust to own homes, make business investments. The successive beneficiaries should understand they are to fund their lifestyles by their own efforts. Trust funds are to grow wealth, not buy automobiles or pay apartment rent. 5. Discretionary Trusts. Because creditors can reach all mandatory distributions (at the common law and under the UTC, e.g., N.C. Gen. Stat. § 36C-5-506(b) (effective January 1, 2006) (even if a spend thrift trust if trustee has not made distribution to beneficiary within a reasonable time after the designated distribution date), there is an asset protection incentive to use a discretionary trust or support trust instead. The new North Carolina statute has some of the old and some of the new. In general, creditors can reach a trust interest by attachment of present or future distributions unless the beneficiary‟s interest (i) is subject to a spendthrift provision; (ii) is a discretionary trust; or (iii) is a protective trust interest. A spendthrift provision is valid only if it restrains both voluntary and involuntary transfer. No magic words are required, save that the trust recites that the beneficiary‟s interest is subject to a “spendthrift” trust or uses similar words. A beneficiary may not transfer such a trust interest and, with a narrow exception, a creditor cannot reach it before its receipt by the beneficiary. Old documents which include standard spendthrift provisions should be adequate to continue such protection, formerly provided by N.C. Gen. Stat. § 36A-115 (now repealed), e.g., North Carolina Will Manual Service at XVI-25, -26 (N. Wiggins, ed., Wachovia Bank and Trust Company 1979). The statutory exception to the spendthrift provision is child support under a court order. The exception applies alike to discretionary trusts and protective trusts. N.C. Gen. Stat. § 36C-5-503 (effective January 1, 2006). A beneficiary‟s interest in a discretionary trust is not transferrable and not reachable by creditors (except to satisfy a child support order). If the beneficiary is also trustee, his interest is safe from his creditors if his discretion is limited by an ascertainable standard. N.C. Gen. Stat. § 36C-5-504 (effective January 1, 2006). The definition of a discretionary trust includes what formerly was defined as a “discretionary trust” and a “support trust” in N.C. Gen. Stat. § 36A-115(b)(1) and (2) (now repealed). In particular: A discretionary trust interest shall include an interest in any one or any combination of the following: (a) A trust in which the amount to be received by the beneficiary, including whether or not the beneficiary, or a class of beneficiaries, is to receive anything at all, is within the discretion of the trustee. A trust in which the trustee has no duty to pay or distribute any particular amount to the beneficiary, but has only a duty to pay or distribute to the beneficiary, or apply on behalf of the beneficiary, those sums that the trustee, in the trustee‟s discretion, determines are appropriate for the support, education, or maintenance of the beneficiary. (b) N.C. Gen. Stat. § 36C-5-504(a)(2) (effective January 1, 2006). A “protective trust” (which does not include a settlor‟s retained interest) is one which requires that the interest terminates or becomes discretionary if (i) the beneficiary alienates or attempts to alienate; (ii) any creditor attempts to reach the beneficial interest by attachment, levy, or otherwise; or (iii) the beneficiary becomes insolvent or bankrupt. N.C. Gen. Stat. § 36A-5-508 (effective January 1, 2006). This language tracks former N.C. Gen. Stat. § 36A-115 (now repealed). The general rule, and the rule of the Restatement (2d) of Trusts, is broader. Restatement (2d) of Trusts § 157 (1959): Although a trust is a spendthrift trust or a trust for support, the interest of the beneficiary can be reached in satisfaction of an enforceable claim against the beneficiary, (a) by the wife or child of the beneficiary for support, or by the wife for alimony; (b) for necessary services rendered to the beneficiary or necessary supplies furnished to him; for services rendered and materials furnished which preserved or benefit the interest of the beneficiary; by the United States or State to satisfy a claim against the beneficiary; (c) (d) See Va. Code Ann. § 55-545.03 (effective July 1, 2006) (child support, services to protect beneficiary‟s interest, federal and state and local government claims trump spendthrift provisions); N.C. Gen. Stat. § 36C-5-503 (effective January 1, 2006) (only child support trumps spendthrift, discretionary or protective trust interest under the statute). The general rule is that a support trust is not available to satisfy claims of creditors other than the special creditors listed above, Restatement (2d) of Trusts § 154 (1959); A. Scott, Scott on Trusts § 154 (Fratcher ed. 1987), but where the beneficiary‟s interest is not limited to his needs for support, his creditors can reach it. A discretionary trust offers more. It should not include language articulating any standard and that is especially so where the UTC is or may be the law. Where there is a standard, it will be enforced. E.g., N.C. Gen. Stat. § 36C-5-506(b) (effective January 1, 2006) (“whether or not a trust contains a spendthrift provision, a creditor or assignee of a beneficiary may reach a mandatory distribution of income or principal . . . .”); Kuykendall v. Proctor, 270 N.C. 510, 519, 155 S.E.2d 293, ____ (1967) (“to [A] for life . . . for her use and benefit and the said trustee is to manage [the property] for the said [A] and use the rents and profits thereof or so much thereof as may be necessary to keep her in comfort,” held, mandatory, and a breach of trust not to exercise discretion to make some distributions). Even where the trustee‟s discretion is stated to be absolute, in the trustee‟s “sole judgment”, the trustee‟s exercise of that discretion is always subject to the court‟s review. The court will always compel the trustee to exercise a mandatory power. It is otherwise, however, with respect to a discretionary power. The court will not undertake to control the trustee with respect to the exercise of a discretionary power, except to prevent an abuse by him of his discretion. The trustee abuses his discretion in exercising or failing to exercise a discretionary power if he acts dishonestly, or if he acts with an improper, even though not a dishonest motive, or if he fails to use his judgment, or if he acts beyond the bounds of a reasonable judgment. Woodard v. Mordecai, 234 N.C. 463, 471, 67 S.E.2d 639, ____ (1951). Compare the new statutory standard (which is somewhat different from the Uniform Trust Code language, quoted above at 54): Notwithstanding the breadth of discretion granted to a trustee in the terms of the trust, including the use of such terms as “absolute”, “sole”, or “uncontrolled”, a trustee abuses the trustee‟s discretion in exercising or failing to exercise a discretionary power if the trustee acts with bad faith, acts dishonestly, acts with an improper motive, even though not a dishonest motive, or if the trustee fails to use the trustee‟s judgment in accordance with the terms and purposes of the trust and the interests of the beneficiaries. N.C. Gen. Stat. § 36C-8-814(a) (effective January 1, 2006). The court generally will not substitute its judgment for the trustee‟s judgment. Clearly the power to sprinkle income or principal or both among several beneficiaries goes far toward requiring multiple interests to be considered in the inquiry of whether an abuse of discretion has occurred with respect to a single beneficiary. A true discretionary trust gives the beneficiary no claim against the trustee to require distributions. Neither does the beneficiary‟s creditor have such a claim, and this rule carries over to the new North Carolina statute and in the UTC. In a non-UTC state, the common law is that even the beneficiary‟s interest in a discretionary trust is assignable, IIA Scott on Trusts § 152.4 at 119, notwithstanding that the assignee--the creditor--could not force a distribution. So, a spendthrift provision should always be included in a discretionary trust. Oshins, supra, ¶ 306. This is especially so where the UTC is or may become the law in the jurisdiction. See 810-2d T.M. at A-49. Generally, no special language is required, and the books are full of forms. The provision protects against voluntary and involuntary alienation and works in the bankruptcy arena. 11 U.S.C. 541(c)(2) (“A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable non-bankruptcy law is enforceable in a case under this title.” ). As mentioned above, there are some claims that trump even a spendthrift provision. One such claimant is the tax collector. Even if a forfeiture [“whereby if either the beneficiary or his creditor try to alienate the beneficiary‟s right to trust income, then that right ceases and the trustee is given discretion to distribute the income among some group that may or may not include the prior beneficiary.”] did occur under Maryland law, it would not be effective against an IRS assessment. Whether state law can prevent a federal tax lien from attaching to a state-created interest by creating a forfeiture whenever the government tries to levy is a question of federal law. Many courts have held that a simple spendthrift trust cannot defeat a federal tax lien. One federal court has held that a spendthrift trust combined with a forfeiture clause is not effective to defeat a federal tax lien. ... The reason behind all the cases . . . supports the idea that [a federal tax lien] cannot be defeated by a forfeiture provision. The point is that while such trust clauses create a legitimate property right under state law which can shield the beneficiary from ordinary creditors, such trusts cannot be effective against a federal tax lien, as a matter of federal law. It would be offensive and disruptive to federal tax law for a beneficiary to receive an income stream for years without paying taxes on it, only to have the income stream disappear once the IRS discovers the misfeasance and moves against it [citations omitted]. U.S. v. Riggs Nat’l. Bank, 636 F.Supp. 172, 176-77 (D.D.C. 1986); accord., In re Orr, 180 F.3d 656 (5th Cir. 1999) (rights under Texas spendthrift trust constitute “property” or “rights to property” subject to attachment pursuant to § 6321). VI. CONCLUSION. Attention to even a few of the details mentioned in this paper can go a long way to preserving the life‟s work of the common man who encounters an unfortunate liability. Such liabilities come unannounced and in an unlimited array of surprising strikes, which continue to evolve with the expanding creativity of the litigation Bar. Some protection is better than none.