Tag: judgment enforcement

Debtor’s (Non-Spousal) Inherited IRA Not Exempt from Civil Judgment – IL First District Rules

Case: In re Marriage of Xenakis, 2015 IL App (1st) 141297

Fact Snapshot: The judgment debtor successfully moved to discharge citations issued to the custodian of an individual retirement account (IRA) he inherited from his deceased mother.  The judgment creditor appealed, arguing that the IRA wasn’t properly exempt from the judgment’s reach.

Result: The First District agreed with the creditor and reversed the trial court’s discharge of the citations.

Memorable Quote: “We find no indication that the Illinois legislature intended to allow a judgment debtor to exempt assets that could be spent freely and frivolously at the debtor’s whim.  The [post-judgment statute] is aimed at protecting retirement assets as opposed to funds that could, conceivably, be used to supplement the lifestyle of a non-retiree debtor.”

Reasoning:

– The purpose underlying exemptions from judgments is the protection of a debtor’s essential needs.  Setting aside funds for retirement is a court-recognized example of a debtor protecting his essential needs;

– Code Section 12-1006 exempts retirement plan assets from actions to collect a judgment so long as the retirement plan is intended in good faith to qualify as one under the Internal Revenue Code of 1986;

– Code Section 12-1006 is silent on the difference between a traditional IRA and an inherited non-spousal IRA, such as the one involved in this case and is the functional equivalent of Section 522 of the Bankruptcy Code which governs debtor exemptions from the bankruptcy estate;

– The US Supreme Court has held that money in an inherited IRA does not qualify as “retirement funds” under Bankruptcy Code Section 522 1

– Funds in a non-spousal inherited IRA, on their face, are not set aside for purposes of retirement;

– Unlike in a traditional IRA, the beneficiary of an inherited IRA can freely withdraw funds at any time with no tax penalty.  In fact, the owner of an inherited IRA must withdraw its funds – either in total within 5 years of the original owner’s death or via minimum annual withdrawals 2;

– Since inherited retirement funds can be withdrawn and spent by the account holder whenever he wants, these funds don’t serve the purpose of providing a debtor with the “basic necessities of life” and so do not implicate the policies that underlie judgment exemptions;

– An inherited IRA has nothing to do with retirement since the holder can spend it at will.  It is more akin to a discretionary bank account;

(¶¶ 18-26)

After canvassing the Federal bankruptcy Code, the Internal Revenue Code, the Illinois judgment exemption statutes and the foundational rationale for the exemptions, the First District squarely held that non-spousal inherited IRAs can be attached (i.e. are not exempt) by judgment creditors.

Afterwords:

1/ Exemptions serve salutary purpose of protecting debtor from destitution and abject poverty;

2/ Retirement accounts further that prophylactic purpose;

3/ This policy of protecting debtors has limits though.  If “retirement” funds can be withdrawn and spent at will, the funds won’t be treated as retirement funds and will be within a creditor’s reach.

————————-

References:

1  Clark v. Rameker, 134 S.Ct. 2242 (2014); 11 U.S.C. §§ 522(b), (d).

2  26 U.S.C. § 408(d)(3)(C)(ii)(2012)

Seventh Circuit Files: Court Voids LLC Member’s Attempt to Pre-empt LLC’s Suit Against That Member

In Carhart v. Carhart – Halaska International, LLC, (http://law.justia.com/cases/federal/appellate-courts/ca7/14-2968/14-2968-2015-06-08.html) the plaintiff LLC member tried to shield himself from a lawsuit filed against him by the LLC by (1) taking an assignment of a third-party’s claim against the LLC; (2) getting and then registering a default judgment against the LLC; (3) seizing the LLC’s lone asset: its lawsuit against the plaintiff; and (4) buying the lawsuit for $10K.  This four-step progression allowed the plaintiff to extinguish the LLC’s claim against him.

Plaintiff was co-owner of the defendant LLC.  After a third-party sued the LLC in Minnesota Federal court (the “Minnesota Federal Case”), Plaintiff paid the third-party $150,000 for an assignment of that case.  Plaintiff then obtained a $240K default judgment against the LLC.

Meanwhile, the LLC, through its other owner, sued the plaintiff in Wisconsin State Court (the “Wisconsin State Case”) for breach of fiduciary duty in connection with plaintiff’s alleged plundering of the LLC.  While the Wisconsin State Case was pending, Plaintiff registered the Minnesota judgment against the LLC in Wisconsin Federal court.

Plaintiff, now a judgment creditor of the LLC, filed suit in Wisconsin Federal Court (the “Wisconsin Federal Case”) to execute on the $240K judgment against the LLC.  The Wisconsin District Court allowed the plaintiff to seize the LLC’s lone asset – the Wisconsin State Case (the LLC’s breach of fiduciary duty claim against plaintiff) – for $10,000.  This immunized the plaintiff from liability in the Wisconsin State Case as there was no longer a claim for the LLC to pursue against the plaintiff.  The LLC appealed.

The Seventh Circuit voided the sale of the Wisconsin State Case finding the sale price disproportionately low.

Under Wisconsin law, a chose in action is normally considered intangible property that can be assigned and seized to satisfy a judgment.  However, the amount paid for a chose in action must not be so low as to shock the conscience of the court.

In this case, the court branded the plaintiff a “troll of sorts”: it noted the plaintiff buying the LLC’s claim (the Wisconsin State Case) at a steep discount: the defendant paid $150,000 for an assignment of a third-party claim against the LLC and then paid only $10,000 for the LLC’s breach of fiduciary duty claim against plaintiff.

The court found that under Wisconsin law, the $10,000 the plaintiff paid for the LLC’s claim against him was conscience-shockingly low compared to the dollar value of the LLC’s claim.  The plaintiff did not purchase the LLC’s lawsuit in good faith.  The Seventh Circuit reversed the District Court’s validation of plaintiff’s $10K purchase so the LLC could pursue its breach of fiduciary duty claim against the plaintiff in the Wisconsin State Case.

Take-aways:

This seems like the right result.  The court guarded against a litigant essentially buying his way out of a lawsuit (at least it had the appearance of this) by paying a mere fraction of what the suit was possibly worth.  

The case serves as an example of a court looking beneath the surface of a what looks like a routine judgment enforcement tool (seizing assets of a judgment debtor) and adjusting the equities between the parties.  By voiding the sale, the LLC will now have an opportunity to pursue its breach of fiduciary duty claim against the plaintiff in state court. 

Prior Charging Order Trumps Later Divorce Court Order Involving Restaurant LLC Payouts

The Third District Appellate Court answers some important questions concerning the priority of competing creditors’ rights in the assets of a common debtor and the nature of appellate jurisdiction in FirstMerit Bank v. McEnery, 2014 IL App (3d) 130231-U.

There, a creditor obtained a $1.8M judgment against a defendant who had interests in several restaurant LLC ventures (the “LLCs”).  The creditor then moved for and received a charging order against all current and future distributions flowing from the LLCs until the judgment was satisfied.  The effect of the charging order was to place a lien or “hold” on the defendant’s distributions.  (See http://paulporvaznik.com/charging-orders-judgment-debtor-llc-member/5961).

A couple years later, defendant’s wife obtained an order in a divorce case that gave her a 50% interest in the LLCs.  About a year after that (divorce case) order, the trial court (presiding over the underlying suit) granted the plaintiff’s “turn over” motion (motion to require defendant to turn over future LLC distributions to the plaintiff/judgment-creditor.

The disputed issue: what took precedence?  The charging order against the LLCs or the later divorce court ruling giving defendant’s wife a 50% interest in the LLCs?  The trial court found that the prior charging order took priority over the defendant’s wife’s interest in the LLCs.  Defendant’s wife appealed.

Held: Affirmed.  Plaintiff’s charging order take priority over defendant’s wife’s interests in the LLCs

Reasons:

The Court first held that the trial court’s turn over order didn’t conflict with the divorce court order giving the wife a 50% share of the LLCs since that later order wasn’t “final” and appealable.

– Illinois Supreme Court Rule 301 provides that every final judgment is appealable as of right;

An order is final where it either terminates the litigation between the parties on the merits or disposes of the rights of the parties – either the entire controversy, or a separate branch of the litigation;

– A notice of appeal must be filed within 30 days after the entry of a final order or within 30 days after entry of the order disposing of the last pending post-judgment motion;

– Where multiple parties and claims are involved, a party seeking an appeal must request a Rule 304(a) finding (that there is no reason to delay enforcement of or appeal from an order) from the trial judge;

– An order entered in a citation proceeding under Code Section 2-1402 is final when the citation petitioner is in a position to collect against the judgment debtor or third party or the petitioner has been foreclosed from doing so

(¶¶ 30-33)

Here, the divorce court order granting the defendant’s wife a 50% share in the LLCs – while entered before the turn over order – wasn’t final because it didn’t terminate the divorce case.  There was no order of marital dissolution and the divorce case continued for further status.  As a result, the divorce court’s 50% share order was subordinate to the trial court’s charging order and later turn over order.

Take-away:

This case rewards aggressive creditor enforcement steps.  By charging (liening) the debtor’s LLC interests, the creditor was in a position to take “first dibs” on the LLC distributions to the debtor, even though a court order later gave the debtor’s spouse a 50% share in the LLCs. 

The case also cements the proposition that a charging order impresses a lien on a debtor’s LLC distributions and that this charging lien will take primacy over any later judgment or lien filing related to the same LLC distributions.