The U.S. Bankruptcy Code provides that if a debtor makes an intentional fraudulent transfer within one year of the filing of bankruptcy petition, the debtor will be denied a discharge. Since the primary reason that a debtor files for bankruptcy is to obtain a discharge, and thus wash away creditors from that point forward, the denial of a discharge is a very serious penalty. But what if the transfer is of a relatively small amount relative to everything else going on with that debtor? Will the bankruptcy court still deny the discharge?
We find the answer to this question in the Opinion and Order issued by the U.S. District Court for the Western District of Oklahoma in Cadlerock III, LLC v. Wheeler, 2024 WL 4307204 (W.D.Okla., Sep. 26, 2024).
Debtor (Wheeler) was the guarantor of his ex-wife’s business debts and when she defaulted then the debtor was sued on his guarantee. Eventually, judgment was entered against debtor for a little more than $5 million. Seeking to wash out the judgment in bankruptcy, debtor filed a voluntary Chapter 7 petition in the U.S. Bankruptcy Court for the Western District of Oklahoma. Before we go further, we first have to take a trip back in time fifteen years.
In 2009, the debtor created a wealth preservation trust (“WPT”) under Oklahoma’s domestic asset protection trust (“DAPT) statute. At the time the debtor created his WPT, the Oklahoma WPT statute had a $1 million contribution limit. Importantly, because of this $1 million contribution limit, the Oklahoma WPT statute further allowed a debtor who had taken money out of a WPT to later “replenish” the trust with additional contributions ― so long as the $1 million contribution limit was not violated. When, in 2014, the Oklahoma legislature amended the Oklahoma WPT statute to do away with the $1 million contribution limit, for whatever reason it did not also do away with the replenishment clause.
Anyway, when debtor created his WPT in 2009, he and his then-wife contributed to the WPT their interest in a land and cattle company. When the former best friends and lovers went through a divorce two years later in 2011, the debtor partially revoked the WPT to be able to pay his divorce obligations to his now ex-wife. This created the debtor’s opportunity to replenish his WPT, which we will discuss further below.
Debtor filed his Chapter 11 petition on October 21, 2021. Less than a year before, on December 29, 2020, and January 21, 2021, respectively, the debtor transferred two properties to the land and cattle company which, it will be recalled, was itself owned by the debtor’s WPT. No value was exchanged for these transfers; they were purely gifts to the WPT.
Shortly after each transfer, the debtor signed memoranda prepared by his estate planner which stated that the debtor was taking advantage of his right to replenish his WPT for the property that he had taken out of it earlier. Importantly, debtor did not tell his estate planning attorney that he was being pursued by his creditor on the $5 million judgment.
Now we finally return to the Opinion and Order that is the subject of this article. The court first discussed that under Bankruptcy Code § 727(a)(2)(A), if the debtor makes an intentional fraudulent transfer in the one year prior to the filing of the bankruptcy petition, the debtor will be denied a discharge.
To defeat the charge that he had acted with intent, debtor argued that he relied upon the advice of his estate planning counsel in making these transfers. There was a big problem with this argument, however, which is that the debtor didn’t tell his estate planner that he had a large judgment against him which a creditor was chasing. Since the advice of counsel defense requires that that the debtor disclose all relevant facts to his counsel, and the debtor did not do so, the debtor could not take advantage of this defense.
The bigger issue the debtor’s claim that the values of the properties that were fraudulently transferred ― which in total were less than $100,000 ― were so small in relation to the amount that the debtor would face in undischarged indebtedness (which had grown to over $20 million) was such that it would be unfair to use these small transfers (0.005% of the overall debt) to deny the debtor a discharge. In essence, the debtor was arguing that the fraudulent transfers were de minimis in relation to the claims against the debtor.
The debtor’s argument was flatly rejected by the court: “There is no de minimis exception for fraudulent conduct by a debtor in bankruptcy.” But, recognizing that such a firm rule could lead to injustice in some circumstances, further noted that: “Nevertheless, the Court may consider the de minimis value of an allegedly fraudulent transfer when probing the debtor’s intent.” Thus:
“The Court acknowledges that the value of the House Transfers was small relative to the size of Wheeler’s debts but agrees with the Bankruptcy Court that such value was significant relative to Wheeler’s $102,392.94 in reported assets. * * * The Bankruptcy Court did not ignore the relative value of the House Transfers, however. Rather, in the course of its well-reasoned Findings of Fact and Conclusions of Law, the Bankruptcy Court noted the facts pertinent to Wheeler’s argument but nevertheless found that Wheeler acted with fraudulent intent because, in sum: (1) Wheeler, with knowledge of the Judgment and within one year of the Petition, made the House Transfers to Wheeler Land, which was owned by the Wheeler WPT, a trust expressly created to protect Wheeler’s assets from creditors; and (2) when seeking advice from counsel, Wheeler failed to disclose the Judgment.”
Based on all this, the U.S. District Court affirmed the decision of the U.S. Bankruptcy Court which denied the debtor his discharge. Note that this decision is subject to possible further appeal to the Tenth Circuit Court of Appeals.
ANALYSIS
What is unstated in the opinion is any indication why the debtor did not simply wait a couple of more months before filing his bankruptcy petition, which would have put his transfers past the one-year period of Bankruptcy Code § 727(a)(2)(A). Most likely, the creditor was conducting post-judgment enforcement activities that pressured the debtor into filing. But if not, this was a very serious error by the debtor or his counsel since these minor transfers within the one-year period resulted in the wholly predictable result that his discharge would be denied. It is entirely possible, though we don’t really know, that just as the debtor did not tell his estate planner about the judgment against him, the debtor also did not tell his bankruptcy counsel about the transfers. If that is the case, then we can chalk this one up to another “garbage in, garbage out” result when it comes to clients being something less than fully candid when it comes to seeking advice from their counsel.
Otherwise, this case is a reminder that if a debtor is going to make a transfer with the intent of placing assets beyond the reach of creditors, then basically they have committed themselves to not filing for bankruptcy until a year has passed from the date of the transfer. It usually makes no sense for a debtor to file for bankruptcy unless they will get a discharge, since ― as I have written repeatedly ― there usually is no place where creditors are more powerful and debtors are more exposed than in bankruptcy. To be sure, bankruptcy can give a debtor some temporary relief, but once the bankruptcy case really starts to roll then it can quickly become very unpleasant for debtors.
Another thing that doesn’t make any sense in this case is that the debtor’s transfers to his Oklahoma WPT were probably going to be avoided anyway by the bankruptcy court, since Bankruptcy Code § 548(e) creates a 10-year limitations period for fraudulent transfers to self-settled trusts and similar vehicles. Or, if the debtor had never filed for bankruptcy, then the Oklahoma fraudulent transfer laws would have similarly avoided these transfers. So why make them in the first place?
From the debtor-planning point of view, what the debtor might have instead done with the two properties would have been to negotiate with his creditor such that it would get some amount of money from the debtor’s presumably-protected WPT in exchange for consenting to the debtor transferring the properties into the WPT. Alternatively, the debtor could have let the two properties be levied upon an auctioned off, but then had his WPT come in and bid for the properties at the judicial sale. Either one of the options would have resulted in a much better result than what finally did transpire. Oh sure, the WPT might have ended up paying up to $100,000 which was the supposed value for the two properties, but that would have been an infinitely better outcome than the debtor losing his discharge to the purported $20 million in debts.
But that’s the thing with many debtors (including some that I have represented), which is that they really don’t want the creditor to get anything when they would be much better off giving the creditor something. To this extent, these debtor can be said to be “too smart by half”. As here, apparently.
Stay tuned to see if this case goes up to the Tenth Circuit, which might make for some interesting reading.
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