Both Sides of Asset Protection: Are You Protecting Assets or Attacking Them?

Authors: Guy C. Fustine, Jerome C. Wegley and Ashley M. Mulryan

Originally published in October 2022

Copyright © 2022 Knox McLaughlin Gornall & Sennett, P.C.

Pennsylvania LLCs

Accessing multi-member LLC assets

Charging Orders against Pennsylvania LLCs: Enacted in February 2017

• A court may enter a charging order lien against the transferable interest of the judgment debtor for the unsatisfied amount of the judgment. 15 Pa.C.S.A. § 8853
• Definition of transferrable interest: “The right, as initially owned by a person in the person's capacity as a member, to receive distributions from a limited liability company, whether or not the person remains a member or continues to own any part of the right. The term applies to any fraction of the interest, by whomever owned.” § 8812
• This is a lien only on the distributions of the LLC
• Excludes compensation for present or past service or payments under a bona fide retirement plan or other bona fide benefit plan made in the ordinary course of business, payment on a guaranty, or transfer of interests. § 8812
• Bona fide payments can be accessed by creditors via remedies such as garnishment.
• Includes both distributions and “disguised” distributions. See Frey v. Gold, 240 A.3d 933 (Pa. Super. Sept. 16, 2020) (Court found that Debtor member of LLC took inconsistent “salary” draws after charging order was entered which were the equivalent of distributions and must be paid over to the lienholder- this was the first case to consider the effect of the charging order)
• EXAMPLE: Member A of ABC, LLC has for some years received distributions from the company. However, when a judgment creditor of A obtains a charging order against A's transferable interest, the company ceases to make distributions to A and instead provides a salary to A equivalent to former distributions. A court might deem this salary a disguised distribution. 15 Pa.C.S.A. § 8853 Official Note
• The charging order constitutes a lien on a judgment debtor’s transferable interest and requires the LLC to pay over to the creditor any distribution that would otherwise be paid to the debtor. § 8853(a)
• To ensure that the LLC is making the appropriate distributions, a receiver may be appointed. § 8853(b)
• The court has the jurisdiction to issue any further order to give effect to the charging order. § 8853(b); See Frey v. Gold, 240 A.3d 933 (Pa. Super. Sept. 16, 2020) (debtor and LLC held in contempt of court for failure to distribute draws to charging order lienholder).
• EXAMPLE: A judgment creditor with a charging order believes that the limited liability company should invest less of its surplus in operations, leaving more funds for distributions. The creditor moves the court for an order directing the limited liability company to restrict re-investment. Subsection (b)(2) does not authorize the court to grant the motion. 15 Pa.C.S.A. § 8853 Official Note
• EXAMPLE: A judgment creditor with a judgment for $10,000 against a member obtains a charging order against the member's transferable interest. Having been properly served with the order, the limited liability company nonetheless fails to comply and makes a $3000 distribution to the member. The court has the power to order the limited liability company to pay $3000 to the judgment creditor to “give effect to the charging order.” 15 Pa.C.S.A. § 8853 Official Note
• The creditor can also request a foreclosure of the charging order where the purchaser at the time of sale obtains the member’s entire transferrable interest and the debtor is then a dissociated member. § 8853(c)
• Must show that the charging order will not pay the judgment debt within a reasonable time. § 8853(c)
• At any time before the sale, another member (individual or LLC) of the LLC who is not subject to the charging order may pay the full amount due to the creditor- the judgment amount- and purchase the rights back. § 8853(e)
• Only a foreclosure on the transferrable assets of the debtor. The foreclosure does not apply to the assets of the LLC. See Firstrust Bank v. Wilkinson Roofing and Siding, Inc., 277 A.3d 1130 (2022)
• At any time before the sale, the debtor may satisfy the judgment and stop the sale by filing a notice of satisfaction with the court. This eliminates the need for an additional hearing § 8853(d)
• Special provisions for single member LLCs
• The purchaser at a foreclosure sale against a sole member LLC becomes the sole member and the original member is disassociated
• If a member cannot provide evidence of an operating agreement or testimony, the court will presume that the LLC is a single member LLC for the purpose of this statute. § 8853(f); See City of Philadelphia v. Silverberg, No. 1510, 2021 WL 2410257, at *8 (Pa.Com.Pl. May 10, 2021).
• Operating Agreements cannot draft outside of these provisions. § 8853(c)(20)
• These same charging order procedures apply to Pennsylvania Partnerships and General Partnerships. 15 Pa.C.S.A. § 8454. See Pros. Real Est. P'ship v. Linn, 239 A.3d 61 (Pa. Super. Ct. 2020).
• LLCs formed in other states: The majority of states do not have a foreclosure provision upon a charging order. Indeed, most states (Alabama, Alaska, Arizona, Connecticut, Delaware, Florida, Georgia, Kansas, Maine, Maryland, Michigan, Minnesota, Mississippi, Nevada, New Hampshire, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, South Dakota, Tennessee, Texas, Virginia, and Wyoming) only allow a charging order lien to be entered against transferrable interests and expressly prohibit foreclosure upon a charging order lien interest. 2 Asset Protection: Dom. & Int’l L. & Tactics
• Arkansas, the District of Columbia, Idaho, Utah, and Vermont have similar statutes providing for foreclosure on charging order liens
• Pennsylvania’s charging order provisions cannot extend to entities not formed in Pennsylvania even if all of the members of the LLC are Pennsylvania residents and the business is located in Pennsylvania. Steamfitters Union, Loc. 420 Welfare Fund v. Direct Air, LLC, No. CV 18-1611, 2020 WL 6131163 (E.D. Pa. Oct. 19, 2020)

Individual Protections

Exemptions From Judgment Creditors, Generally

All personal property is subject to seizure, levy and sale upon execution, unless specifically exempted, ordinarily by statutory enactment.  Gulf Mortg. and Realty Investments v. Alten, 422 A.2d 1090 (1980).

State and federal exemptions from judgment creditors serve the important purpose of “protect[ing] the debtor's essential needs.” United States v. Security Industrial Bank, 459 U.S. 70, 83 [103 S.Ct. 407, 74 L.Ed.2d 235] (1982) (Blackmun, J., concurring in judgment).

As the House Judiciary Committee explained in the process of enacting § 522, “[t]he historical purpose” of bankruptcy exemptions has been to provide a debtor “with the basic necessities of life” so that they “will not be left destitute and a public charge.” H.R.Rep.No. 95-595, p. 126 (1977).

There is no indication that the General Assembly intended to exclude persons self-employed on a part-time basis or as partners from exemption from execution of individual retirement funds.  Marine Midland Bank v. Surfbelt, Inc., W.D.Pa.1982, 532 F.Supp. 728.

Pennsylvania Statutory Exemptions

Generally, $300 (with certain limitations) is exempted from access of a judgment creditor in Pennsylvania.

Exemption of particular property: A judgment creditor cannot access the following personal property of a debtor according to Title 42 PAS § 8124.

• Wearing apparel
• Bibles and school books
• Sewing machines belonging to seamstresses or used and owned by private families, but not including sewing machines kept for sale or hire
• Uniforms

Retirement Accounts

Pennsylvania law protects retirement funds and accounts from attachment or execution by judgment creditors. See 42 Pa.C.S. § 8124(b) (enumerating the types of retirement funds and accounts that shall be exempt from attachment or execution on a judgment).

Special protections exist for state and municipal employees’ retirement and pension accounts.

The Pennsylvania legislature has made a policy decision that, for purposes of state law, rollover funds into IRAs are exempt from execution and are not limited to the $15,000 per year limit. In re Barshak, 106 F.3d 501, 504 (3d. Cir. 1997) codified at Section 8124(b)(1)(ix) of Title 42

Insurance

Where debtor deposited life insurance policies under trust agreement as security for note, but creditor did not realize on conveyance, administrator pendente lite was entitled on debtor's death to amount which creditor might have claimed with interest from date it was paid to date of debtor's death only, where estate was insolvent.  Fidelity Trust Co. v. Union Nat. Bank of Pittsburgh, 169 A. 209, 313 Pa. 467, Sup.1933, certiorari denied 54 S.Ct. 530, 291 U.S. 680, 78 L.Ed. 1068.

Insurance proceeds in Pennsylvania are protected from Judgment Creditors as follows:

• Certain amounts paid, provided or rendered by a fraternal benefit society as provided by 40 Pa.C.S. § 6531 (relating to benefits not attachable).
• Claims and compensation payments under the act of June 2, 1915 (P.L.736, No.338), known as "The Pennsylvania Workmen's Compensation Law," except as otherwise provided in the act.
• Any policy or contract of insurance or annuity issued to a solvent insured who is the beneficiary thereof, except any part thereof exceeding an income or return of $100 per month.
• Any amount of proceeds retained by the insurer at maturity or otherwise under the terms of an annuity or policy of life insurance if the policy or a supplemental agreement provides that such proceeds and the income therefrom shall not be assignable.
• Any policy of group insurance or the proceeds thereof.
• The net amount payable under any annuity contract or policy of life insurance made for the benefit of or assigned to the spouse, children or dependent relative of the insured, whether or not the right to change the named beneficiary is reserved by or permitted to the insured. The preceding sentence shall not be applicable to the extent the judgment debtor is such spouse, child or other relative.
• The net amount payable under any accident or disability insurance.
• Certain amounts paid, provided or rendered by a fraternal benefit society as provided by section 305 of the act of July 29, 1977 (P.L.105, No.38), known as the "Fraternal Benefit Society Code."
• Certain amounts paid, provided or rendered under the provisions of section 106(f) of the act of July 19, 1974 (P.L.489, No.176), known as the "Pennsylvania No-fault Motor Vehicle Insurance Act."
• Certain amounts paid, provided or rendered under the provisions of section 703 of the act of December 5, 1936 (2nd Sp.Sess., 1937 P.L.2897, No.1), known as the "Unemployment Compensation Law."

Federal Bankruptcy Exemptions

Specific Dollar Amounts of Exemptions 11 USC § 522(d):

• $27,900 of equity in your principal residence under federal exemptions. You must live in the home when Petition is filed to use the homestead exemption. Does not include investment properties
• $4,450 for your motor vehicle
• $1,875 for jewelry
• $700 per individual item with a $14,875 aggregate value on household goods, furnishings, appliances, clothes, books, animals, crops, musical instruments
• $2,800 for tools of the trade, including implements and books
• Health aids
• $14,875 in loan value, accrued dividends, or a life insurance policy interest
• “Wildcard” exemption of $1,475 plus $13,950 of unused homestead exemption

Retirement Funds in bankruptcy

Under section 522 of the Bankruptcy Code, an individual debtor is authorized to exempt from their bankruptcy estate “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.” 11 U.S.C. §§ 522(b)(3)(C), 522(d)(12).

Contributions that were made from Chapter 7 debtor's paycheck to mandatory retirement account that they were required to contribute to as condition of their employment did not represent even indirect transfers by debtor, such that debtor could not be denied a Pennsylvania state law exemption therein on fraudulent transfer grounds, where debtor lacked any control over such contributions.  In re Arbogast, Bkrtcy.W.D.Pa.2012, 466 B.R. 287, affirmed 479 B.R. 661, affirmed 533 Fed.Appx. 150, 2013 WL 4007772.

The federal bankruptcy exemption limit for IRAs and Roth IRAS is $1,512,350.

Inherited IRAs are not protected. The Supreme Court of the United States heard the In re Clark debtor-beneficiary's appeal and affirmed the Seventh Circuit's decision, ruling that inherited IRAs are not included in the definition of “retirement funds” under section 522(b)(3)(C) of the Bankruptcy Code. Clark v. Rameker, 573 U.S. 122 (2014).

Joint Marital Assets: Tenancy By the Entireties

A tenancy by the entireties is a form of co-ownership of real or personal property by spouses, with its essential characteristic being that “each spouse is seised per tout et non per my, i.e., of the whole or the entirety and not of a share, moiety or divisible part.” In re Gallagher's Estate, 43 A.2d 132 (1945).

A tenancy by the entireties requires a legally binding marriage plus the satisfaction of all four unities, i.e., unity of time, unity of title, unity of possession, and unity of interest; if one of the unities is lacking, then, by common law, there can be no joint tenancy or entirety. Constitution Bank v. Olson, 423 Pa.Super. 134, 620 A.2d 1146, 1149 (1993)

• Unity of time requires that the interests of the tenants vest at the same time. In re Estate of Rivera, 194 A.3d 579 (Pa. Super. 2018)
• Unity of title requires the tenants to have obtained their title by the same instrument. Id.
• Unity of possession requires the tenants to have an undivided interest in the whole estate. Id.
• Unity of interest requires the tenants to have estates in the property of the same type, duration and amount. Id.

Entireties property ≠ marital property. Presumption that all property coming into marriage is matrimonial property for the purpose of establishing divorce support is not equivalent to creation of entireties property, which requires that property be acquired in joint names of the spouses; matrimonial property applies only when equitable distribution is claimed. 23 P.S. § 401(f); Fratangelo v. Fratangelo, 520 A.2d 1195, 1201 (1987).

“[I]n this Commonwealth, a presumption exists that property held by a husband and wife is held by the entireties and that said presumption can be overcome only when the opposing party demonstrates, through clear and convincing evidence, that the property was not intended to be held by the husband and wife as entireties property.” Johnson v. Johnson, 908 A.2d 290, 296 (Pa. Super. 2006).

Compare with In re Estate of Rivera, 194 A.3d at 586 (indicating Pennsylvania jurisprudence has not adopted a de facto tenancy by entireties).

For the duration of the entireties estate, either spouse has the presumptive power to act for both, so long as both spouses share the proceeds, and neither spouse may appropriate property for their own use, to the exclusion of the other spouse, without the consent of the other spouse. Fazekas v. Fazekas, 737 A.2d 1262, 1264 (Pa. Super. 1999)

Entireties property is unavailable to satisfy the claims of the creditor of one of the tenants. Patwardhan v. Brabant, 439 A.2d 784, 785 (1982). See also Garden State Standardbred Sales Co., Inc. v. Seese, 417 Pa.Super. 15, 611 A.2d 1239, 1243 (1992) (“It is well settled that Pennsylvania subscribes to the majority view which holds that entireties property is unavailable to satisfy the claims of the creditor of only one of the tenants.”)

“Intention is the cardinal and controlling element in determining if a husband and wife shall take ownership of property by the entireties, and if such ... sufficiently appears, it will be given effect.” Constitution Bank v. Olson, 620 A.2d 1146, 1149 (1993).

Courts consider various factors when discerning whether or not property is part of the entireties estate.

Financial Accounts

• Who opened the account and did the other spouse have the authority to access the account?
• Recently, the Pennsylvania Superior Court found that because the husband opened a brokerage account in his name, he was the only contributor of funds, he was the only authorized user on the account, and because there was no other signatory, the brokerage account did not create an entireties estate. Jones v. McGreevy, 2022 PA Super 8, 270 A.3d 1, 15, appeal denied sub nom. Jones v. McGreevey, 280 A.3d 867 (Pa. 2022).
• “Where property or an account is placed in the names of a husband and wife, a gift and the creation of an estate by the entireties is presumed even though the funds used to acquire the property or to establish the account were exclusively those of the husband. The placing of the property in both names, without more, creates an estate by the entireties.”) (internal citations omitted); In re Barsotti, 7 B.R. 205, 207 (Bankr. W.D. Pa. 1980)
• Funds transferred from joint bank account owned by judgment debtor and his wife to life insurance policy owned by judgment debtor for wife's benefit were held in tenancy by the entireties, and thus were protected from execution by Pennsylvania exemption statute, where funds were never in judgment debtor's individual control. Plastipak Packaging, Inc. v. DePasquale, 363 Fed.Appx. 188 (2010).

Trust accounts

• Where the wife did not prove that she had a vested interest in an irrevocable trust that listed her husband as the sole beneficiary, the Pennsylvania Superior court found that the trust did not create an entireties state. Jones v. McGreevy, 2022 PA Super 8

Sale of Entireties Property

• Monies received from the sale of entireties property are impressed with the status of entireties property even where the funds are placed into a bank account owned by only one spouse. Sterling v. Smith, 200 Pa.Super. 544, 189 A.2d 889 (1963), see also Johnson v. Johnson, 908 A.2d 290, 295–296 (Pa.Super.2006).
• Stock purchase agreement entered into between spouses through their agents, under which corporate shares were sold for the purpose of paying for both spouse's in-home care, did not sever the tenancy by the entireties held by the spouses in the original shares of stock, even though stock purchase agreement stated that the tenancy by the entireties in the stock shares themselves shall cease as of the closing date, and the proceeds of the stock sale were divided into two separate income streams; the tenancy by the entireties continued in the proceeds of the sale of entireties property, and the division of the proceeds into two income streams merely reflected that both spouses were each represented by separate agents responsible for their care, and the monies were to be made payable directly to each agent. In re Est. of Navarra, 2015 PA Super 65, 113 A.3d 829 (2015)

Trust With Spendthrift Clauses

Generally, a spendthrift trust is one in which the beneficiary is entitled to the income from the trust property for life and “his interest shall not be transferable by him and shall not be subject to the claims of his creditors.” Schreiber v. Kellogg, 50 F.3d 264, 275 (3d Cir.1995). A judgment creditor may not attach to a beneficiary's interest subject to a spendthrift provision. 20 Pa.C.S. § 7741.

The effect of a valid spendthrift provision is that the income can be attached, if at all, only in the hands of the beneficiary. Estate of Widener, 697 A.2d 281 (Pa.Super.1996), appeal denied, 548 Pa. 670, 698 A.2d 594 (1997), cert. denied, sub nom. 10 Summary of Pennsylvania Jurisprudence 2d. Probate, Estates and Trusts § 31:7.

“Trust property that is subject to a power of withdrawal, during the period the power may be exercised and after its lapse, release or waiver, may be reached by a creditor or an assignee of the holder of the power whether or not the interest of the holder in the trust is subject to a spendthrift provision.” 20 Pa.C.S. § 7748.

Absent a valid spendthrift provision, a creditor may ordinarily reach the interest of a beneficiary the same as any other of the beneficiary's assets. This does not necessarily mean that the creditor can collect all distributions made to the beneficiary. The interest may be too indefinite or contingent for the creditor to reach or the interest may qualify for an exemption under the state's general creditor exemption statutes. See [Restatement] (Third) of Trusts § 56 (2003); Restatement (Second) of Trusts §§ 147-149, 162 (1959).

Spendthrift trusts are excluded entirely from bankruptcy estates under 11 U.S.C § 541(c)(2). See Patterson v. Shumate, 504 U.S. 753, 757–60 (1992).

When the beneficiary of the trust is also the Settlor

• Spendthrift clause does not preclude any creditor from reaching the interest of a settlor-beneficiary. Mogridge's Estate, 342 Pa. 308, 20 A.2d 307 (1941).
• Under the Code, whether the trust contains a spendthrift provision or not, a creditor of the settlor may reach the maximum amount that the trustee could have paid to the settlor-beneficiary. If the trustee has discretion to distribute the entire income and principal to the settlor, the effect of this subsection is to place the settlor's creditors in the same position as if the trust had not been created. 20 Pa. Stat. and Cons. Stat. Ann. § 7748 (West)
• No person can put their own property out of reach of their creditors and at the same time enjoy the benefits of that property. Posner v. Sheridan, 299 A.2d 309, 314 (1973)

Domestic Asset Protection Trusts (DAPT)

This is a self-settled spendthrift trust. A creates an irrevocable discretionary spendthrift naming A as beneficiary.

The following states have DAPT friendly laws: Alabama, Alaska, Connecticut, Deleware, Hawaii, Indiana, Michigan, Missouri, Mississippi, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming. Thirteenth ARTEC Comparison of the Domestic Protection Trust Statutes, Updated through August 2022. Not accepted by Pennsylvania.

Example: Ohio

• Ohio requires that the trust instrument must: (1) be irrevocable; (2) expressly state that OH law wholly or partially governs validity, construction, and administration of trust; (3) contain spendthrift clause that includes the interest of the settlor; (4) appoint at least one qualified trustee. Ohio Revised Code § 5816.02(K)
• A Qualified Trustee must manage the Trust. A Qualified Trustee is a resident individual or corporation with trust powers under OH law and whose activities are subject to Ohio Superintendent of Banks, FDIC, Comptroller of Currency, or Office of Thrift Supervision. § 5816.02(S).
• Creditor may avoid a transfer made with the specific intent to avoid the specific creditor. Only the portion of the qualified disposition necessary to satisfy the creditor’s claim is avoided, and the avoided portion is subject to the fees and costs incurred by a trustee in defending the claim (so long as the trustee has not acted in bad faith). §§ 5816.07(A) & 5816.08 Future creditors: 18 months after qualified disposition. Existing creditors: Later of 18 months after qualified disposition or 6 months after qualified disposition was or could have been discovered, with the limitation that the creditor must make demand on its claim within 3 years after the qualified disposition. The maximum combination of the 3-year demand limitation and the 6-month filing limitation provide an absolute 3.5 year bar. § 5816.07(B)&(C). Furthermore, Ohio Rev. Code § 1301.401 contains a personal property recording mechanism that serves as notice to the world.

Successful creditors’ claims against trust: support payments and attorneys fees

• ‘Income of a trust subject to spendthrift or similar provisions shall nevertheless be liable for the support of anyone whom the income beneficiary shall be under a legal duty to support.’ Act of April 24, 1947, P.L. 100, s 12, 20 P.S. s 301.12.
• Arrears of child support. “Payment of daily living expenses, includes all reasonable living expenses that one would occur in the course of daily living, such as those involved in rearing children.” Drevenik v. Nardone, 862 A.2d 635
• An instrument that places a testamentary gift out of bounds from creditors for the collection of “debts” had no effect to preserve that property from the incursion of family members seeking payment of a support obligation. Moorehead’s Estate, 289 Pa. 542, 137 A. 802 (1927).
• A married woman who has been abandoned by her husband may sue her husband, although he is now a resident of a foreign state, and use foreign attachment to reach his interest under a spendthrift trust created and being administered in Pennsylvania, in order to collect amounts spent by her from her separate property for the support of herself and her minor children. Gessler v. Gessler, 181 Pa. Super. 357, 124 A.2d 502 (1956).
• The third circuit held in interpreting Pennsylvania law that invasion of a spendthrift trust “for services rendered and materials furnished which preserve or benefit the interest of the beneficiary,” so as to permit collection of attorney's fees from the trust. The intent of the grantor as to whether these fees should be paid from trust assets was held irrelevant. However, the court also held that such payment was permitted only if the services rendered by the attorney were shown to have benefitted or preserved the interest of the beneficiaries from whose interests the fees were to be paid. Schreiber v. Kellogg, 50 F.3d 264 (3d Cir.1995)

Authors: Guy C. Fustine, Jerome C. Wegley and Ashley M. Mulryan

Originally published in October 2022

Copyright © 2022 Knox McLaughlin Gornall & Sennett, P.C.