On Nov. 23, 2010, the 9th Circuit Court of Appeals found that bankruptcy debtor's two "trusts" were invalid and that the Chapter 7 Trustee who sued for fraudulent transfer could recover on those theories of fraudulent transfer and alter ego. (In re Schwarzkopf).
Debtor thought he was clever and set up two irrevocable trusts in 1992, where his daughter was the sole beneficiary and he appointed a 3rd party trustee to administer the trusts. The trusts ultimately had assets of several million dollars, and the trustee appeared to make payments to the debtor for years for all kinds of personal expenses.
After the debtor filed bankruptcy and sought to discharge $5.4M in debt, the trustee sued to avoid $4M in transfers and recover from the two trusts. The bankruptcy court initially found both trusts valid, but after the Trustee's motion for reconsideration, then concluded one trust was the debtor's alter ego, but that the other trust was valid since it had been created for the debtor's daughter and that it was not the alter ego of the debtor.
The trustee appealed to the district court, which concluded both trusts were invalid, even the one for the minor child, but that the trustee's claims might be time barred on the 7 year statute of limitations. Additionally, the district court concluded that to establish alter ego, the trustee had to prove legal ownership and since the debtor was neither a trustee nor beneficiary, the trusts were not his alter ego. The Trustee appealed.
The Ninth Circuit applied existing California state law and found that the trusts were established for a fraudulent purpose and therefore, the failure of an express trust merely creates a resulting trust. This has immediate implications for the statute of limitations issue as expressed by the Court in its opinion:
"Moreover, even to the extent it alleges fraudulent transfer, Goodrich's claim is not time-barred by the seven-year statute of limitations set forth in California Civil Code § 3439.09(c).2 If an express trust fails—if, for instance, it was formed for a fraudulent purpose—the trustee holds legal title to the property on a resulting trust for the trustor and his or her heirs. See Bainbridge v. Stoner, 106 P.2d 423, 429 (Cal. 1940) (In Bank). "[T]he trustee of a resulting trust is considered a voluntary trustee and . . . the statute of limitations does not begin to run in favor of a voluntary trustee until he repudiates the trust." Davenport v. Davenport Found., 222 P.2d 11, 16 (Cal. 1950). Because the Apartment Trust is invalid, Briones is a voluntary trustee on a resulting trust for Michaels and his heirs. The statute of limitations did not begin to run until Briones repudiated the trust, that is, until he answered Goodrich's complaint and denied that the Apartment Trust's assets are property of the bankruptcy estate. We therefore conclude that Goodrich's claim is not time-barred, and we affirm the district court's judgment that the Apartment Trust is invalid."
Lastly, as to the legal ownership issue, the Ninth Circuit concluded that equitable ownership is sufficient to confer ownership rights and therefore alter ego did exist. All of the debtor's shenanigans and shell trusts were for nothing.