On January 11, 2006, Tony Hiett personally guaranteed a $2.527 million loan to his Goergia-based real estate company, Hiett Homes and Developments, Inc. Suffice it to say that his timing was inopportune -- Bears Stearns & Co. was to crash shortly thereafter, with Lehmann Brothers soon to follow, and the 2007 financial meltdown then swept like a tsunami through the homebuilding industry.
Among the carnage was Hiett Homes, which defaulted on the loan, and Tony Hiett, who was called on his personal guarantee. Tony's bank swept $100,000 from his personal account, and Tony and his wife Kellymoved to Florida to pursue a business opportunity there. When the deal in Florida didn't work out either, Tony and Kelly moved to Alabama and tried to start over.
In 2009, Tony formed five Alabama companies, of which Hiett Automotive, Inc. and Hiett Holdings, Inc., will be of most interest. Tony filled out all the paperwork to form the companies, and made Kelly the sole shareholder and himself the manager. Kelly did not contribute any money into the companies to gain her shares, and Tony didn't put any money into the companies either.
Hiett Automotive was in the business of buying and selling cars. Hiett Holdings was a broker in the buying and selling of other products which were not cars. On May 10, 2010, Kelly transferred all of her shares in Hiett Holdings to Rex Hiett, who was providing financial assistance to that company.
Rex did not pay for the shares in Hiett Holdings that he acquired from Kelly, but instead Rex invested in both Hiett Automotive and Hiett Holdings to get them going, taking out personal loans to do so. Rex arranged a deal to acquire an inventory of cars, and obtained an Alabama auto dealer's license so that Hiett Automotive could sell cars. Rex also took out insurance for that company.
Still, Rex did not run the day-to-day operations of either Hiett Automotive or Hiett Holdings -- that was done almost exclusively by Tony, who was also the sole signatory on the checking accounts of the two businesses. And here is where it starts to get interesting.
Tony would later testify that he tried, but couldn't get a personal bank account in Alabama. Kelly didn't try to get one either. So neither Tony nor Kelly had a personal bank account, and although Tony was running the two companies, he didn't take a salary or regular wages from either.
Instead, both Tony and Kelly used debit cards from (you guessed it) the bank accounts of Hiett Automotive and Hiett Holdings to make personal purchases and to pay personal expenses. Hiett Automotive was also paying for a $3 million life insurance policy on Tony's life.
Tony would keep records on what benefits he and Kelly took from the companies, and they were reported on the companies' tax returns as "commissions". Tony would later testify that he knew that keeping money in the corporate accounts, as opposed to corporate accounts, prevented his creditors from levying on that money. On at least one occasion, a judgment creditor served Hiett Automotive with a garnishment for any of Tony's money it was holding for him, but Tony responded in the negative.
On April 17, 2012, Tony filed for Chapter 7 bankruptcy in Alabama. On December 15, 2012, one of Tony's creditors filed an adversary proceeding challenging the transfers, and also objecting to Tony's discharge.
Bankruptcy Code section 727(a)(2)(A) provides that a debtor can be denied a discharge where the debtor was involving in "transferring, removing, destroying, or concealing any of the debtor' property" in the one-year period prior to the debtor's bankruptcy petition, where the debtor did so with the intent to hinder, delay or defraud a creditor.
Here, Tony's creditor argued that Tony used Hiett Automotive and Hiett Holdings to conceal his earnings, by using those companies to pay personal expenses instead of depositing those earnings into a personal bank account that could be levied upon.
The Bankruptcy Court noted that what Tony did was hardly novel:
The facts here are strikingly similar to those in In re Coady, 588 F.3d 1312 (11th Cir.2009). In Coady, the debtor, a real estate developer, found himself $27 million in debt after an economic downturn. Id. at 1314. He later formed a corporation with his wife as the sole shareholder. He worked in that company for years and never drew a salary. All the while he paid his personal expenses out of the business accounts. Id. The Eleventh Circuit affirmed the decisions of the Bankruptcy Court and the District Court which denied the debtor a discharge. Id. at 1315.
In Coady, the Eleventh Circuit rejected the debtor's assertion that "diverting the fruits of his labor to avoid acquiring assets was not a transfer or concealment under sec. 727(a)(2) ."Id. Instead, it found that the debtor had an equitable interest in the companies because the debtor was the "sole person actually and actively involved" in the corporations and "whatever increase in equity [came] about in the future through [his] labor [would] be protected from his creditors, while being available for his benefit or to fulfill his legal obligations of support for his family. "Id. at 1315–16 (alterations in the original) (internal quotation marks and citations omitted).
In this case, [Tony] is the sole person actively managing and working in both Hiett Automotive Alabama and Hiett Holdings. All of his personal expenses are paid out of the corporate accounts. But when the plaintiff attempted to reach the corporate accounts, it was told that no personal assets were being held by the companies. He has never taken a salary from either corporation. He has diverted the "fruits of his labor" into the two corporations and then used the business assets to support himself and his family all the while effectively shielding those assets from creditors.
And with that, the Bankruptcy Court denied Tony's discharge.
ANALYSIS
Although a factually simple case, there are some important lessons to be distilled from this Opinion.
First, there is an old saying in asset protection planning that "all bets are off in bankruptcy". This truism is in recognition of the cold hard fact that the bankruptcy courts have extraordinary powers to accomplish one of their main purposes, which is to marshal assets for the benefit of creditors. But the saying also pays deference to the fact that, as here, if the debtor has engaged in hijinks immediately prior to filing for bankruptcy, the debtor's primary benefit -- the discharge -- can become a very iffy thing.
Which is another way of saying that financially distressed clients can't go out and do a bunch of very aggressive things to thwart their creditors, and then soon thereafter file for bankruptcy, since then 727(a)(2) will rear its ugly head and the discharge may be denied.
Which is to say that bankruptcy is like a hydrogen bomb dropped on all the parties involved in a collection proceeding -- it wipes everybody out. Creditor's claims are wiped out, and the debtor's non-exempt assets are lost to the bankruptcy estate.
But if the debtor can't get a discharge, then bankruptcy becomes a very one-side hydrogen bomb -- the debtor cannot wipe out the creditor's claims (in fact, those claims will probably be forever immune to discharge), but the debtor still loses all non-exempt assets.
In settling creditor-debtor cases, the debtor's opportunity to obtain a discharge carries very substantial weight in settlement negotiations. If the debtor can't get a discharge, then creditors have much less reason to settle on anything like favorable terms to the debtor.
Instead, creditors can just proceed with making the debtor's life utterly miserable -- hauling the debtor into court every 90 days or so for debtor's examinations, issuing subpoenas to family, friends and business associates in the hunt for assets, and forever preventing the debtor from getting on with his or her financial life. Since most states allow for judgments to be renewed every 10 years or so, perpetually, creditors can literally hound the debtor right to the point where they either die or flee the country.
The second lesson is just as important, which is that are consequences for debtors who attempt to use business entities and the like to hide personal assets and income. Most importantly is the concept of "imputed income", which is that if the debtor is taking non-monetary benefits from a company (such as paying personal credit cards and expenses), the creditor can have these benefits recharacterized as income for purposes of garnishment and levy.
While this Opinion of course stops at Tony's discharge being denied, presumably now Tony's creditors are going to state court to have all of the payments made for Tony's benefit re-characterized as Tony's imputed income, thus rendering the companies potentially liable under the garnishment for whatever Tony has received in the past, and of course what he might receive in the future.
It is of course oh-so-easy for planners to say in the friendly surroundings of a conference room, "In the the worst case, we'll just have a company or trust pay all your credit card bills and make payments directly for your expenses." But in the not-so-friendly confines of a courtroom, those payments become imputed income or de facto distributions that are available to creditors.
The crazy thing here is that if Tony had simply taken a salary from Hiett Automotive and Hiett Holdings, his creditors might not have gotten much, if anything, because of the federal restriction on wage garnishments to 25% of a debtor's disposable net income (i.e., after tax and FICA withholdings, and basic living expenses). Here, Tony may very well have outsmarted himself.
Which is to say that instead of trying to figure out sneaky ways to get a debtor money, sometimes the debtor should just be paid a salary, and if the creditor gets 25% then at least the debtor is making some progress in paying down the judgment, however small. But that is for the debtor who is willing to adopt a more modest lifestyle, and not toodle around like a High Roller while creditors are chasing.
But that is for debtors who don't have any desire to pay their debts, and for those folks there will always be little sympathy in the courts.
CITE AS
In re Hiett, 2014 WL 4929053 (M.D.Ala., Sept. 30, 2014). Full Opinion at http://goo.gl/DAxmsq
This article at http://onforb.es/12n2Kgv and http://goo.gl/epXDHR
