In The Curmudgeon's Guide To Practicing Law, author Mark Herrmann points out that “You cannot answer a legal question without knowing the context in which it is posed. You must therefore be sure to understand the context of all the work that you are doing.”1

Clients use asset protection planning techniques to organize their affairs in the event that an adverse judgment might affect their financial assets. To assure the effectiveness of this planning, advisors must understand the circumstances in which creditors may successfully challenge such advice in courts. That means having a solid understanding of creditor/debtor law, the legal concept of contempt of court, and the defense of impossibility.

CREDITOR/DEBTOR LAW

The legal battle between creditors and debtors seems muddled by conflicting legal decisions and commentary. Fortunately, the U.S. Supreme Court articulated the basic principles of creditor/debtor law in its 1999 landmark decision, Grupo Mexicano de Desarrollo v. Alliance Bond Fund.2 In this seminal case, the Supreme Court held that a federal district court had no authority to issue a preliminary injunction preventing the disposition of assets pending adjudication of a claim for money damages. In reaching this decision, the Supreme Court recognized and reiterated its approval of the traditional rule of law that a general creditor (one without a judgment) has no cognizable interest, either at law or in equity, in a debtor's property.

Many lawyers, judges and legal commentators overlook, ignore or forget this key principle of black letter law that has been unchanged in the United States since 1789. The principle is simple: A general creditor, that is, one without a judgment, has no legally recognized property interest in the assets of a debtor before getting a judgment. And until there's a judgment, it's lawful for debtors to do whatever they want with their assets.

Some commentators argue that insolvency is an exception to this rule, but Grupo Mexicano is clear: “This Court has concluded that particular exception does not exist.”3 In fact, as far back as 1861, the court recognized that before a creditor gets a judgment against a debtor, the debtor “may convert one species of property into another, and he may alienate to a purchaser.”4 Indeed, Grupo Mexicano rejected the adoption of the English Mareva injunction5 in the United States.

In 1975, Mareva revolutionized legal practice in the United Kingdom: Today, a Mareva injunction allows for a prejudgment attachment. But this is something that the Supreme Court in Grupo Mexicano considered as interfering “with the debtor's disposition of the property at the instance of a non-judgment creditor.”6

Justice Ruth Bader Ginsberg dissented in Grupo Mexicano, saying that the court should be the arbiter of “progressive social conditions,”7 and that debtors may employ “sophisticated foreign-haven judgment-proofing strategies, coupled with technology that permits the nearly instantaneous transfer of assets abroad, to avoid meritorious claims.”8 But this stance was curtly rejected by the majority with Justice Antonin Scalia stating: “[W]e suspect there is absolutely nothing new about debtors trying to avoid paying their debts… or even about their seeking to achieve these ends through ‘sophisticated… strategies.’”9Grupo Mexicano outlines the legal system or framework in which creditors and debtors fight it out. Debtors have complete dominion over their property and creditors don't exist, legally or equitably, until they get a judgment. Debtors can even transfer their money to an offshore asset protection trust.

What can creditors do? They can bring suit and, after judgment, pursue remedies. Before judgment, they can invoke an applicable statutory prejudgment attachment remedy. A creditor also can bring a bankruptcy action that would similarly allow a prejudgment freeze of assets. If the assets are transferred, creditors can pursue remedies under a relevant fraudulent conveyance law.

CONTEMPT OF COURT

Whenever a creditor legally pursues a debtor, there is the potential that during the course of litigation, a contempt of court proceeding may arise. A court imposes contempt of court on a person who embarrasses, hinders or obstructs the court in the administration of its proceedings or lessens the court's authority or dignity. Because contempt is a subjective determination, many legal practitioners are concerned about a client crossing the line and being punished by a judge who may not understand (or care about) the parameters of the law governing contempt.

The leading Supreme Court cases involving contempt and outlining its framework are: International Union, United Mine Workers of America v. John L. Bagwell,10Shillitani v. United States,11United States v. Rylander,12Maggio v. Zeitz, Trustee in Bankruptcy,13Sheet Metal Workers v. EEOC,14Hicks v. Feiock,15 and Gompers v. Bucks Stove & Range Company.16

Here is what we take away from these cases: Contempt is either civil or criminal; either compensatory civil contempt or coercive civil contempt; direct or indirect. The types are governed by different sets of legal standards and procedures. Practitioners need to understand this legal matrix to be able to properly advise their clients. So let's look at the different types:

  • Criminal contempt — occurs when the purpose of the contempt proceeding is punishment. This may arise when there is offensive conduct directed towards the court from its judgments, orders or processes. As a criminal proceeding, all constitutional due process safeguards apply. For example, if the court orders someone not to issue press releases and a party then does so, the court can vindicate itself (after complying with due process requirements) by putting the offending party in jail for a set period of time or by imposing a fine payable to the court.

  • Civil contempt — occurs when the purpose of the proceeding is to coerce action or is remedial in nature. As a civil proceeding, it's directed towards preserving and enforcing rights of private parties involved in a lawsuit or is used to compel obedience to orders made for the benefit of a private party. This would arise, for example, when a court requires certain documents be brought to the court. If that's not done, the court can impose a daily fine to be paid to the other party or incarceration until the documents are produced.

As a result, civil contempt can be divided into compensatory civil contempt and coercive civil contempt. It also can be direct or indirect.

(a) Direct contempt — is committed by a contemptuous act done in the presence of the court. For example, a party is ordered to refrain from speaking on a certain issue but continues to do so in the presence of the judge.

(b) Indirect contempt — sometimes referred to as “constructive contempt,” it's a contemptuous act done outside the presence of the judge. The judge issues an order that a case not be discussed in public and the party so ordered does so, outside the courtroom, triggering the indirect contempt provisions.

Under civil contempt, we also have:

(a) Compensatory civil contempt — allows the court to order payment of money to a party to the lawsuit as compensation for monetary losses sustained as a result of a contemptuous act by the other party. For example, one party fails to appear at a deposition, so the court orders that the legal fees incurred by the other party be paid.

(b) Coercive civil contempt — arises when the court feels that a threat of punishment (such as a fine or imprisonment) is necessary to force a party to comply with the court's order.

With asset protection planning, indirect coercive civil contempt is the most likely to arise — and the most controversial. For example, a judge orders a debtor to repatriate money back from a foreign trust and the debtor does not comply. As a result, the judge orders imprisonment until the time the money arrives at the courthouse. When the money arrives, the contempt is purged, and the “contemptor” is free.

Generally, only a person with standing or the court itself can bring a motion and notice for an indirect coercive civil contempt action. As with any civil proceeding, the moving party has the initial burden of proof to specify in the motion and notice the acts claimed to be contemptuous. The standard of proof is a preponderance of the evidence, although some courts require a clear and convincing evidence standard.

Once the moving party, typically the creditor, has established noncompliance or the debtor admits noncompliance, the burden shifts to the debtor to show that there's a present inability to perform. This is the legally recognized excuse of “impossibility.” If the debtor cannot demonstrate “impossibility,” a court may impose a coercive penalty, such as a fine or imprisonment for an indefinite period of time. As the court in Maggio stated, even when the act causing the impossibility is reprehensive, such conduct “does not warrant issuance of an order which creates a duty impossible of performance, so that punishment can follow.”17

All coercive civil contempt actions must have a purge provision; that is to say, a provision recognizing that the debtor will not be punished if the coercion works and he complies with what the court requires. A court imposes a fine or incarceration in coercive civil contempt, in instances when the debtor has the present ability to perform but refuses to do so. If there is a fine, it is paid to the other party. If there is incarceration, the period of incarceration could be indefinite (unlike in criminal contempt procedures in which there's a definite period of incarceration).

IMPOSSIBILITY

The legal confusion surrounding coercive civil contempt occurs when a debtor asserts the defense of impossibility of compliance. As the moving party, the creditor has the initial burden of proving that the debtor has the present ability to comply as a predicate for the remedy sought. But once that burden is met and the court issues an order, the burden falls on the debtor to show proof by a preponderance of the evidence (or in some courts, clear and convincing evidence), that complying is impossible.

What if the debtor himself purposefully creates the impossibility? Almost a quarter of a century ago, the Supreme Court in Rylander unequivocally said that, “Where compliance is impossible, neither the moving party, nor the court has any reason to proceed with the civil contempt action.”18 This makes perfect sense. If an action is impossible, it cannot be purged. Without an ability to purge, coercive civil contempt also is impossible. The cause that resulted in that impossibility may well be subject to some other form of contempt or legal sanction, but it cannot be coercive civil contempt.

This principle of law has been either overlooked, misunderstood, misapplied or ignored in a number of highly publicized cases such as FTC v. Affordable Media, LLC,19 a/k/a, the Anderson case, and In re Lawrence.20 In these cases, courts not only included statements as gratuitous dicta, that the defense of impossibility would not be allowed if the defendant caused the impossibility, but also got the law wrong. In a nutshell, the only crucial point in time to determine impossibility is the present: Does the debtor have the present ability to comply with coercion? The impossibility, even if self-created or self-induced, is a complete defense to a charge of coercive civil contempt — at least according to the Supreme Court.21

KNOW THE LAW

The key to wealth planning is the protection of assets, whether physically, economically, from governmental impositions such as excessive taxation, as well as from legal liability. The litigation industry is in full force and clients will be seeking to use their legal right to employ the tools and techniques that defend their wealth.

The issue of contempt of court always looms large whenever litigation or even a threat of litigation arises. Knowledgeable professional planners need to fully understand the law of contempt. They must not only be able to inform their client but someday also may have to educate a judge.

For their help in preparing this article, the author thanks two lawyers in his firm, Salvador Orofino and Carl Linder, as well as Howard S. Fisher, a sole practitioner in Beverly Hills Calif., Ronald Neiwirth, a partner with Miami's Flowler White Burnett P.A., and Barton Udell, in-house counsel at Gator Investments in Miami.

Endnotes

  1. Mark Herrmann, The Curmudgeon's Guide To Practicing Law, ABA Publishing, Chicago, IL 2006, at p. 26.
  2. Grupo Mexicano de Desarrollo v. Alliance Bond Fund, 527 U.S. 308 (1999).
  3. Ibid., at note 4, p. 320.
  4. See Adler v. Fenton, 16 L. Ed. 696 (1861), in which the Supreme Court stated: “Our laws determine with accuracy the time and manner in which the property of a debtor ceases to be subject to his disposition, and becomes subject to the rights of his creditor. A creditor acquires a lien upon lands of his debtor by a judgment; and upon the personal goods of the debtor, by delivery of an execution to the sheriff. It is only by these liens that a creditor has a vested or specific right in the property of his debtor… These regulations cannot be contravened or varied by any interposition of equity” (quoting Moran v. Dawes, 1 Hopk. Ch. 365, 367 (N.Y. 1825)).
  5. Mareva Compania Naviera S.A. v. International Bulk Carriers S.A. [1980], 1 All ER 213 (preventing foreign defendants from removing their assets from a jurisdiction).
  6. Grupo Mexicano, supra note 2, at p. 329.
  7. Ibid., at p. 336.
  8. Ibid., at p. 338.
  9. Ibid., at p. 322.
  10. International Union, United Mine Workers of America, et al., Petitioner v. John L. Bagwell et al., 512 U.S. 821 (1994).
  11. Shillitani v. United States, 384 U.S. 364 (1966).
  12. United States. v. Rylander 460 U.S. 752 (1983).
  13. Maggio v. Zeitz, Trustee in Bankruptcy, 333 U.S. 56 (1947).
  14. Sheet Metal Workers v. EEOC, 478 U.S. 421 (1986).
  15. Hicks v. Feiock, 485 U.S. 624 (1988).
  16. Gompers v. Bucks Stove & Range Company, 221 U.S. 418 (1911).
  17. Maggio, supra note 13, at p. 64.
  18. United States v. Rylander, 460 U.S. 752 (1983), at 757. The court, however, put the burden of proving the defense of impossibility on the party raising it. As stated in Falstaff Brewing v. Miller Brewing (702 F.2d 770 (1983), note 7): “It is clear, however, that inability… whether or not self-induced — is a complete defense to a charge of coercive civil contempt” (citing United States v. Rylander).
  19. FTC v. Affordable Media, LLC, 179 F. 3d 1228 (9th Cir. 1999). The Andersons were named defendants in this case
  20. In re Lawrence, 261 B.R. 630 (S.D. Fla. 2000.)
  21. Editor's note: But beware that the bar is rather high to satisfy the court that it is truly impossible for the debtor to comply.

SPOTLIGHT

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