Dec 20 2013, 1:22am CST | by Forbes
Attorney Morris took over the litigation defense of a California corporation called Micromark in litigation against it tenant, after a fire damaged Micromark’s building. In reviewing the file, Morris discovered that Micromark had inadvertently allowed a default judgment to be taken against it by the tenant. Morris then decided, after researching the issue, that Micromark would probably be unsuccessful in setting aside the default — so he did nothing.
A month later, the Court did indeed finally enter default against Micromark, in the neighborhood of $2.4 million.
To counter the default, Morris and Micromark’s owner, Cheung, placed two encumbrances on Micromark’s property to secure two newly-issued promissory notes from Micromark for $703,000. Later, the equity value of the property was determined to be $400,000.
The first note from Micromark was for $500,000 and made to Morris. This note purportedly secured Morris’ attorneys fees and costs, although at the time of this note was issued, Morris was only owed barely a tenth of that amount, being $53,000.
The second note from Micromark was to Cheung in the amount of $203,000 and was purportedly to secure her (undocumented) loans to Micromark.
Morris recorded both encumbrances shortly thereafter, and just a couple of weeks before the tenant/creditor filed its $2.4 million abstract of judgment with the country recorder.
Morris also filed a motion on behalf of Micromark to set aside the judgment. Confirming Morris’ suspicions about the default judgment, this motion was denied.
But even before Morris’ motion was denied, the tenant launched a fraudulent transfer lawsuit against Micromark, Cheung and Morris, alleging that the encumbrances were not legitimate transactions but instead were intended to defeat the tenant’s collection rights.
Morris testified that because the property was Micromark’s only asset, taking an interest against it was the only way of securing his payment. Cheung, on the other hand, admitted that she was just trying to tie the property up so that the tenant couldn’t enforce the judgment against it.
The Court in the fraudulent transfer action was less than impressed by the testimony of Morris and Cheung, and held that Cheung (on behalf of Micromark) had the intention to hinder and delay the tenant’s collection against Micromark’s property.
For his part, Morris attempted to prove that he acted in good faith in taking his $500,000 note secured by the property — arguing that he just wanted to make sure that he was paid his attorney’s fees.
Apparently, Morris didn’t understand that in a fraudulent transfer case, the transferee’s own motivation in making the transfers is irrelevant to negate a fraudulent transfer (it might still be relevant to conspiracy and punitive damages against the transferee). Instead, it was Morris’ knowledge of Cheung’s intent (i.e., the transferor’s intent) that is relevant.
On this point, Morris flopped, sayeth the Court:
• He knew Micromark was unable to pay its bills as they came due and was thus presumed insolvent;
• He knew Micromark was in default, and the default was unlikely to be set aside;
• He knew about [tenant]‘s judgment before recording the liens;
• He knew that Cheung wanted a lien on the property to keep her only asset should [tenant] prevail;
• He had ample evidence that Cheung commingled Micromark’s corporate assets with her personal assets, and did not treat the corporation as a separate entity, which made it impossible for Cheung to put a lien on her own property to keep it from creditors;
• Although Cheung provided bills and receipts to support her $203,000 promissory note, Morris failed to investigate or audit whether Micromark had repaid Cheung for expenditures in prior years; and
• The facts put Morris on notice that Cheung’s intent was to make sure that Micromark did not have to pay the $2.3 million judgment, but would be able to first pay her (Micromark’s sole shareholder) and him (Micromark’s attorney).
But even above and beyond all that, Morris simply wasn’t owed $500,000 by Micromark at the time that the company gave him the note for that amount. Thus:
Even if Morris had proven he acquired his $500,000 promissory note and secured it in good faith, he still failed to show that the obligation was for a reasonably equivalent value. The $500,000 note was nearly ten times the value of the services he had provided at the time the note was taken. The superior court rejected Morris’s argument that his note was intended as a line of credit for future fees, finding instead that it clouded title of the property for the full $500,000 from the outset, and prevented satisfaction of other claims. Finally, Morris crafted the deed of trust so that it would remain in place until the conclusion of his future legal services and until he released it, thereby encumbering the property for an uncertain period of time and further hindering other creditors. Thus, having failed to show good faith and reasonable equivalent value, the court declared that the conveyances to Cheung and Morris were null and void.
On his own behalf, Morris appealed the fraudulent transfer judgment. Micromark and Cheung didn’t appeal (what defense did they have?), but Morris appealed.
That didn’t end well for Morris, either. Rejecting Morris’ argument that the note and encumbrance simply secured his fees, the Court of Appeals commented that:
This case presents the paradigm illustration of a fraudulent conveyance.
Moreover, and quite stingingly, the Court referred to Morris as:
a lawyer who claims he is going to do a lot work in the future that will generate fees in the six figures and who was part and parcel, if not the mastermind, behind two fraudulent conveyances.
The State Bar of California brought a disciplinary action against Morris, alleging two counts, both based on the fraudulent transfer case. We’ll discuss them in reverse order, since the second count can be dispensed with quickly.
The second count accused Morris of not self-reporting the fraudulent transfer judgment against him, with Bar Counsel contending that such was a “fraud judgment” requiring self-reporting under California Business & Professions Code sec. 6068(o)(2). But the hearing judge disagreed that the fraudulent transfer case was anything like “a civil action for fraud”, and thus dismissed this count, and the Review Department affirmed that dismissal.
The much more serious count was the first count, which alleged that Morris’ involvement in the fraudulent transfer was an act of “moral turpitude, dishonesty, corruption” under B&P Code sec. 6106.
On this point, the hearing judge found in Morris’ favor, and accepted his arguments that Morris was only securing the payment of his fees. The Review Department disagreed:
The issue before us is whether the evidence establishes that Morris violated his ethical duties by creating the promissory notes and recording the deeds of trust to assist Cheung in hindering and delaying B Five’s collection of its judgment. We conclude that it does. Morris’s conduct exhibits his bad faith and dishonesty in violation of section 6106.
* * *
Morris recorded a deed for $500,000, an amount that far exceeded the services he had provided and that clouded title for the full value of the property. We also find no merit to Morris’s argument that the encumbrance was not actually for $500,000 but only for the value of his legal services as they were rendered. His claim is contrary to the deed of trust filed in the recorder’s office. The public record indicates the property was encumbered for $500,000. Moreover, he continued to encumber the property for almost two years while he appealed the superior court’s decision—at a time he clearly knew Cheung’s intent was to thwart her creditors and he was no longer representing Micromark’s interest in [tenant's] lawsuit.
In sum, Morris created obligations for Micromark and secured them with deeds of trust totaling $703,000 when he knew Micromark was insolvent and its only asset was the Foothill Property, which he knew might be worth no more than $500,000. He recorded the deeds shortly after he learned that [tenant] had obtained a default judgment for potentially $1 million, and he made no effort to ascertain the actual judgment amount. Moreover, he knew the obligations and encumbrances were suspect because the notes and deeds of trust were out of all proportion to fees owed to him and there was insufficient documentation of the Cheung loans. The evidence surrounding the transfers establishes clear and convincing evidence that Morris’s acts were designed to prevent [tenant] from collecting on its judgment. We find that such acts were shrouded in bad faith and dishonesty in violation of section 6106.
The Review Department found only one aggravating factor: The tenant was seriously harmed in its ability to timely collect against Micromark by the fraudulent transfers. Indeed, the tenant incurred the significant amount of $114,011 in fees to unwind the fraudulent transfers.
In mitigation, the Review Department found that Morris had no prior record of discipline, demonstrated good character, and cooperated with the State in the investigation. Character witnesses established that Morris was trustworthy, honest, and high moral standards. Substantial evidence highlighted Morris’ community service, substantial pro bono work for seniors, and other community activities which were exemplary — if not far beyond anything that most attorneys do for their communities.
Doubtless, these strong mitigating factors softened the blow of the discipline that was about to rain down upon Morris, and rain down it did.
In handing down the discipline on Morris, the Review Department noted that Morris conduct was very serious:
Morris drafted and recorded encumbrances on Micromark’s sole asset to prevent [tenant] from collecting on its judgment. [Tenant]‘s costs increased when it had to file an action to void the transfers and defend against Morris’s appeal. Morris had no legitimate basis for maintaining the encumbrances on the property, yet he maintained them while he pursued an appeal. Morris’s misconduct was serious, significantly harmed [tenant], and was directly related to his practice.
In reviewing similar cases of misconduct, the Review Department focused on Townsend v. State Bar, 32 Cal.2d 592 (1948), where an attorney was suspended for three years for advising his client to transfers assets to her mother to avoid the collection of a debt. But Attorney Townsend had more aggravating factors, and fewer mitigating factors, so the Review Department declined to give Morris a three-year suspension.
What Morris got instead was a two-year probated suspension, with the first year being an actual suspension, a requirement that he re-take and pass the Multistate Professional Responsibility Examination, and the numerous other onerous reporting and other requirements that go with a suspension.
Among the numerous takeaways from this opinion, one really stand out — Townsend lives.
It has been easy enough for California attorneys to somewhat flippantly discount the 1948 opinion in Townsend as being a 75-year old opinion that is no longer in step with the times. The theory has gone, looking at more recent cases where California attorneys have dodged civil liability for fraudulent transfers, that so long as the attorney is not a participant in the fraudulent transfer (as Morris here was as a transferee), the attorney could not be ethically dinged either.
But here we see that Townsend is as vibrant as it ever was: A California attorney who counsels a client to commit a fraudulent transfer, as Morris did in advising Cheung to take out her note against Micromark, is putting their law practice in very serious peril.
Another thing to note is that the “duty of advocacy”, i.e., the duty of a client to advise a client of all their options, plays utterly no role in the defense of an ethics action based on a fraudulent transfer. An attorney can give their clients all sorts of advice — but advising them to commit a fraudulent transfer is advice they cannot ethically give.
Further, the old saw that “Who cares if a transfer is a fraudulent transfer because the client was going to lose the property anyway?” is one with a warped blade. While that may be the client’s view, there is still significant harm to the creditor in having to incur the cost to unwind the fraudulent transfer. It is exactly that harm, the very intended consequence of the attorney’s advice, that leads to Bar discipline.
On a technical note, an attorney who represents debtors that takes an attorney’s lien against the debtors’ assets to secure payment is an old and tried-and-true strategy. However, it is subject to the “ pigs get fat, and hogs get slaughtered” rule. An attorney’s lien against the debtor/client’s assets is only so good as (1) the amount of money actually then owed to the attorney, (2) the perfection of the attorney’s lien, and (3) the priority of the attorney’s lien.
Here, Morris satisfied (2) and (3) by perfecting his lien before the tenant filed its abstract of judgment. But Morris was a hog, not content to secure his $53,000 in fees then actually owed to him, but going for the utterly arbitrary $500,000 in the hopes of taking up the balance of Micromark’s equity in its property. Doing this gave rise to the completely plausible inference that Morris was not legitimately protecting his fees, but trying to defeat creditors.
We also see, again, that the existence of a fraudulent transfer is not indicated by whether the creditor gets the assets in the end, but whether there was an intent at the beginning to “hinder, delay or defraud” creditors. For some reason, attorneys who advise debtors suffer from a blind spot that makes them unable or unwilling to see the “hinder, delay” part. If a debtor intends merely to slow down a creditor, or make them incur additional costs as leverage for settlement, that by itself can be a fraudulent transfer even if in the end the creditor is successful at getting at the assets.
This does not mean that every client situation that results in a fraudulent transfer could, or should, result in ethical sanctions to the attorney involved. There are many factors that go into planning when a client has creditors, and an attorney with proper motives may simply miss on calculating available assets to satisfy creditors, potential liabilities, etc. Sometimes clients and attorneys miscommunicate and can’t ever get on the same page. But the intent of the client and the attorney cannot be to “hinder, delay or defraud creditors”, even if just to get better settlements, for that indicates the impermissible intent to fraudulently transfer assets.
While asset protection planning has become more popular among estate planners, there is utterly no evidence that attorneys engaging in fraudulent transfers have become in any way more palatable to Bar Counsel. To the contrary, there is growing evidence in the increasing volume of these cases that Bar Counsel are now looking to make an example out of attorneys who advise or assist their clients with fraudulent transfers.
But asset protection planning has never been about making fraudulent transfers in the first place, but rather in doing legitimate planning that avoids fraudulent transfers. Unfortunately, too many attorneys are equating the rise in popularity in asset protection planning with a mythical loosening of the fraudulent transfers laws (and, thus, Bar Counsel’s grounds for dealing with those transfers) that is simply not occurring. Attorneys must learn to recognize when a transfer will be a fraudulent transfer, and not counsel to their clients to make such a transfer, if they expect their bar card to remain safely in their wallets.
And you don’t need a bogus loan to take that to the bank.
Matter of Morris, 2013 WL 6598701 (Cal.Bar.Ct., Unpublished, Dec. 4, 2013). Full Opinion at http://goo.gl/HSPpoV
Source: Forbes Business
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