Dec 28 2013, 6:59pm CST | by Forbes
Before Michael and Megan Newcomer were married, they entered into a prenuptial agreement that excluded from a divorce division the gifts and inheritances they received, plus any growth or appreciation in any business caused by their separate personal efforts.
The best man at their wedding was Greg Kiley, Michael’s college buddy. Some years later, Kiley moved in with Michael and Megan, while Kiley and Michael worked to create a new phone company called “Velocity – The Greatest Phone Company Ever, Inc.”
By this time, Michael and Megan had four children, and had quit her career to take care of these kids.
Within a year after Velocity taking off, Michael and Megan divorced. Megan got custody of the kids, and Michael was ordered to pay a little over $1,000 per month in child support, and $3,500 in spousal support, plus sundry other expenses and payments.
But Michael did not pay as ordered, and Megan dragged him back into Court. Although Michael held himself out as the President and CEO of Velocity, he disclaimed any ownership interest in the company. Moreover:
[Michael] had banking authority for Velocity and used his personal accounts as a conduit to transfer millions of dollars to other individuals or corporations. [Michael] was also the recipient of certain “loans” from Velocity.
Megan also complained that while Michael refused to pay his lawful obligations, Michael lived in a $600,000 house and drove a Mercedes that was paid by Velocity.
For his part, Michael claimed that he had no reportable income, but instead lived on gifts from Megan’s parents (who had paid the couple’s mortgage to prevent foreclosure) and Kiley. The trial court found this claim “not credible”.
After 11 days of hearings, the trial court found that:
between 2006 and 2010, [Michael] obtained hundreds of thousands of dollars’ worth of “loans” from Velocity, drove luxury vehicles, took extravagant vacations and lived in an expensive home. The court noted that the lavishness of [Michael]‘s lifestyle did not subside even after he was supposedly “fired” from Velocity. The court found [Michael] voluntarily unemployed and, based on the lifestyle he provided his family before institution of the divorce and the lifestyle he provided himself during the pendency of the action, imputed to him an annual income of $150,000.
The trial court thus awarded the family home to Megan, with some offsets to Michael, and ordered Michael to pay his $146,983 in unpaid obligations to Megan. While neither allowing discovery nor evidence as to the ownership of Velocity, the company still factored into the trial court’s decision:
With respect to Velocity, the trial court characterized the company as a “quagmire of bank accounts, undocumented loans, unaccountable pay-outs and wire transfers of millions of dollars to and through personal accounts * * * and blatant commingling of corporate and personal funds.”
Both Michael and Megan appealed.
Michael first appealed the awarding of support to Megan, which their prenuptial agreement prohibited. Megan countered that the circumstances had changed so much between their 1992 marriage and their 2007 divorce that the prenuptial agreement no longer should be effective.
On this point, Michael lost and Megan won, the trial court having found that to sustain the prenuptial agreement would be “unfair and inequitable” because of their changed circumstances; namely, Megan giving up her career to take care of their children.
Michael’s next argument was that Megan had received gifts from her wealthy parents, and these gifts to Megan obviated her need for Michael’s income; plus, Megan stood someday to receive a huge inheritance. But this argument was rejected as well:
The trial court properly included the income from [Megan]‘s trust in computing the relative earning power of the parties. [Megan]‘s parents have no legal obligation to provide gifts or support for their daughter irrespective of their ability to do so. Any inheritance is but an expectation. The gifts and loans [Michael] received from [Megan]‘s parents during the pendency of the divorce substituted for money [Michael] was legally obligated to pay and did not. This prevented a threatened foreclosure of the family home. In fairness, such generosity should not now weigh to relieve [Michael] of some, or all, of his obligation to [Megan].
That brings us to the issue of “Imputed Income”, i.e., how much money was Michael really receiving — or should have been receiving by whatever name?
Here, the Family Law Courts have great latitude to look at a bunch of factors to determine how much money somebody should be making, such as their education, experience, employment opportunities, local salary averages, etc.
The trial court too all these factors into consideration and determined that Michael should be making at least $150,000 per year. But what really hurt Michael was that his relationship with Velocity wasn’t clear. He was taking loans against future commissions, but neither he nor Kiley could make clear to the trial court how all that worked.
Although Michael had taken loans up to $2.8 million at one time from Velocity, much of which Velocity had since written off, it was just too much for Michael to then claim that he had no reportable income between 2006 and 2009 — relying instead on Kiley’s gifts. Thus:
The trial court found [Michael]‘s true income to be “elusive.” This elusiveness was due in no small measure to the irregular business practices and lack of fiscal accountability of Velocity. Millions of dollars passed annually from Velocity through [Michael]‘s personal bank accounts. This money was then wire transferred to other individuals or related companies. Both [Michael] and Kiley regularly used Velocity accounts and credit cards for personal purposes. [Michael] and Kiley converted Velocity checks into cash at a vaguely affiliated check cashing store. Velocity paid for luxury car leases and travel for both men. During the time [Michael] claims zero reportable income, he reported monthly expenses of $7,800.
In September, 2010, when Kiley and [Michael] testified that Kiley fired [Michael] from a job [Michael] earlier denied having, there was little change in the relationship between the two men and [Michael] appears to have continued a lavish lifestyle. He continued to travel. He bought a motorcycle and put it in a girlfriend’s name. He assisted another girlfriend in opening a teen nightclub and claimed he took no share in the club’s $9,600 or more weekly cash grosses.
At the time [Michael] claimed to be unemployed and without income, he shared a home with the second girlfriend, paying $1,400 per month rent, driving a Range Rover and a Suzuki motorcycle, traveling frequently to Las Vegas, Miami, and Chicago. The second girlfriend testified at trial that she also received many gifts of jewelry and clothing from [Michael] during this period. The girlfriend testified that during 2009 neither she nor [Michael] worked and explained their lifestyle as the result of the generosity of Kiley and Velocity. The trial court found this testimony “not credible.”
The bottom line in the Court’s was that Michael was “voluntarily unemployed” and living off Velocity through Kiley. While this seems to be an easy conclusion under the circumstances, it was still tough for the Court to determine what Michael should have been earning from Velocity so as to impute a specific amount of income to him. But, considering all the facts, $150,000 per year seemed reasonable (if not somewhat low).
The trial court gave Michael 30 days to pay up, or spend 30 days in jail. The Court of Appeals affirmed, but did give Michael a $6,000 credit for a miscalculation by the trial court as to the cash surrender value of a life insurance policy.
Megan also appealed. Her argument was that the Internal Affairs Doctrine should not have been applied in this case to apply Delaware law to a dispute in Ohio, even if it involved a Delaware corporation. The trial court’s application of Delaware law kept Megan from getting crucial discovery on Velocity. As stated by the Court of Appeals:
The doctrine of internal affairs is a conflict of laws principle which recognizes the policy that a state should have authority to regulate the internal affairs of its own corporations.
Curiously, Megan didn’t point out that the Internal Affairs Doctrine does not apply to external creditors, which even Delaware’s law has long recognized. Instead, Megan argued that the Internal Affairs Doctrine was outdated; an argument that predictably fell on deaf ears.
Next, Megan complained that the trial court should have awarded her an amount certain in Velocity, instead of just half of Michael’s interest — whatever that was or wasn’t. The problem was that establishing what interest, if at all, Michael had in Velocity would have required Megan to file a lawsuit in Delaware, where the company was formed.
Similarly, the Court of Appeals shot down Megan’s request that a Receiver be appointed for Velocity, as that is a very drastic remedy and at best Megan was simply entitled to half of whatever Michael had, if anything.
Megan also argued that because of Michael’s financial misconduct, she should get a larger award of the marital property. The problem was that the trial court did not make a specific finding of financial misconduct by Michael, and the Court of Appeals was not willing to make one itself. The Court of Appeals probably should have remanded the issue back to the trial court, but for whatever reason did not decide to do so.
Similarly, the Court of Appeals was not willing to award Megan her attorney’s fees and litigation costs. By this point in the Opinion, one certain gets the flavor that the Court of Appeals was saying “A pox on both of your houses”. The Court didn’t have any sympathy for Michael, but didn’t have much for Megan either./>/>
The most important thing we get out of this Opinion is the example of imputed income.
Many asset protection plans are defective because they provide no method — or a poor method — of getting income to the debtor while the debtor is working through creditor issues. Merely running money through a buddy or significant other will not always fly under the radar, as here. To the contrary, the more cute somebody tries to play this, the less likely a judge is to buy it.
Probably the best way to get a debtor money is to have some entity pay the money out in the open as income. Federal law, more specifically 15 U.S.C. sec. 1673(a) restricts a wage garnishment to 25% of “disposable earnings” (read: net after tax and FICA withholding). While the creditor will get a little money, the debtor will have an explainable source of income.
Otherwise, courts have great latitude in judgment enforcement proceedings to impute income to debtors. Gifts, loans and other types of value transferred to the debtor (or made available for the debtor’s use, such as credit cards) can all be determined to be imputed income by the court. But if these income streams are not wages, then the creditor may be entitled to their full value.
Notably, both the payor and the debtor/payee can be bound by the courts order, so that if the debtor receives something of value when it was supposed to go to a creditor instead, the debtor/payee can be held in contempt of court (as here) while the payee can be subject to a creditor’s suit for damages.
But this Opinion has a second lesson — an important corollary of “If you’ve got it, flaunt it.” That lesson is: “If you’re claiming not to have it, then don’t flaunt it.” Here, Michael lived well beyond that of his claim of being flat busted broke. As a consequence, both the trial court and Court of Appeals were quite willing to determine that he had other sources of income by whatever name.
Sometimes, asset protection clients get the idea in their heads that they can continue to live their ordinary lifestyle while creditors hover about. Sometimes they can, if their creditors are not aggressive. But if they have aggressive creditors, those creditors will use the debtor’s lifestyle against him or her whenever possible and utterly wreck the debtor’s credibility with the court.
To the contrary, debtors must lay low and act with austerity when they have creditor problems. If you are going to claim in open court that you are broke, you’d sure better act broke. Yet, many asset protection planners tell their clients that they can go through financial trauma without even temporarily changing their lifestyles — in the vast majority of cases that is just not true.
Source: Forbes Business
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