Creating a Trust to Protect from Future Unknown Creditors is a Fraudulent Transfer in Washington

Creating a Trust to Protect from Future Unknown Creditors is a Fraudulent Transfer in Washington

Section 19.40.041 of the Washington Uniform Fraudulent Transfers Act provides: “(a) 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 was incurred, if the debtor made the transfer or incurred the obligation: (1) with actual intent to hinder, delay, or defraud any creditor of the debtor….”

The Townleys, appellants in United States v. Townley, 2006 WL 1345248 (9th Cir. No. 04-35767 May 17, 2006), owned their personal residence since 1977. Later, the Townleys borrowed against the equity in their residence to purchase an interest in investment property. Concerned about potential future liabilities arising from “troubled boys” with whom they had a relationship, the Townleys created the Beaver Valley Trust in 1995. The Townleys transferred their personal residence and their interest in the investment property into the trust.

The Beaver Valley Trust had an independent trustee and the beneficiaries of the trust were the Townley’s children. However, the Townleys were named as the “Trust Managers” of the trust and were given the power to handle all trust affairs. Despite the fact they no longer owned their residence, the Townleys continued to live in their personal residence rent-free.

By 2000, the Townleys had gotten themselves into trouble with the Internal Revenue Service for unpaid taxes and had been assessed nearly $175,000. In 2001, the Townleys filed for bankruptcy in an attempt to avoid their tax liability. Although the objection to the IRS’s claim by the Townleys was denied, they were given a discharge by the bankruptcy court. The bankruptcy trustee reported that there was no unsecured property available for distribution. The IRS then filed suit in U.S. District Court to reduce the federal tax assessments to judgment, to set aside the transfers to the Beaver Valley Trust as fraudulent, and to foreclose on the federal tax liens.

The Townleys claimed that they did not make the transfers to defraud the IRS, since the IRS was not even their creditor at the time they created and funded the Beaver Valley Trust. They argued that they created and transferred property into the Beaver Valley Trust to protect their assets from unknown future creditors. Mr. Townley testified that he was concerned about potential “lawsuits from the exposure we had from liability from troubled boys in the State of Washington.” The District Court judge held that since the Townleys transferred their property to the Beaver Valley Trust before the IRS became a creditor, the IRS would be considered a future creditor of the Townleys under Washington law. Although the judge agreed that the IRS was a future creditor, he held that the admission of Mr. Townley that they made the transfers to protect against unknown future creditors was a veritable confession of their actual intent to hinder, delay or defraud all creditors, including the IRS.

The Court stated:
“[The Townleys] assert that no ‘hypothetical future judgment creditor’ exists, nor did one ever exist. * * * [The Townleys fail] to realize that the IRS is such a creditor. Under [the Townleys’] reasoning, the Washington Uniform Fraudulent Transfer Act would never protect future creditors. A close reading of § 19.40.041, however, demonstrates that this section provides protections to both present and future creditors.”

“If [Section 19.40.041] is read by inserting the players in this case, it would read as follows: A transfer made or obligation incurred by the Townleys (debtor) is fraudulent as to the United States (a creditor), if the Townleys made the transfer or incurred the obligation with actual intent to hinder, delay, or defraud any potential plaintiffs who may have a cause of action (any creditor) against the Townleys (debtor). Mr. Townley’s statement that he wanted to protect his assets from any potential ‘lawsuits from the exposure we had liability from troubled boys in the State of Washington’ represents direct evidence of his intent to defraud one of his potential future creditors, which is prohibited by § 19.40.041(a).”

The Court found other factors that indicated that the transfers were fraudulent. The Townleys: (a) retained possession and control of their personal residence by continuing to live in it after they transferred ownership of the residence to the Beaver Valley Trust, (b) did not make any rent payments for their continued occupancy of the residence to the trust, (c) did not pay any of the utilities for the residence, (d) transferred substantially all of their assets to the Beaver Valley Trust (so they had no means of paying their tax (or other) bills as they came due), and (e) they received no consideration for the transfer of their properties when they gifted the assets to the Beaver Valley Trust.

What the Townley case teaches us is that you should not conduct asset protection as such. There are exceptions to this general rule, such as homestead and other statutory exemption planning, business entity planning, and spendthrift trust planning. However, as this case shows, the very fact that the clients engaged in transfers to protect assets from unforeseen future creditors had the practical effect of a sworn confession that they had the intent to fraudulently transfer assets as to all future creditors. To avoid the assertion that planning is done purely with the intent to hinder, delay, or defraud future creditors, there must be legitimate other reasons for the planning, such as estate planning, business continuation planning, or tax planning reasons.

Asset protection planning, when done in the correct manner, can be a key component of the overall estate plan of a client. Based on this case, when asset protection is done outside of a broader estate, tax, or business planning context, it is more vulnerable to attack and less likely to be able to achieve the client’s goals.

Our law firm experienced in all types of estate planning and asset protection strategies. Contact us to schedule an appointment to learn more about our firm and the planning that may be available to you and your clients.