Criminal Restitution Orders, Limited Liability Companies, Fraudulent Transfers, Nominees and Other Related Topics Coming Together in USA v. Michael David Wilhite (June 2019)

Mr. Wilhite was convicted of mail fraud and aiding and abetting in violation of federal law. He was also a delinquent taxpayer with an outstanding federal income tax liability and, at the time of certain alleged fraudulent transfers, he was being investigated for the federal crimes he ultimately pled to. During the time period Mr. Wilhite would be considered a “debtor” under Colorado’s UFTA, his wife, Mrs. Wilhite, formed several companies establishing herself as sole owner while Mr. Wilhite was the person essentially controlling and operating the companies.

This case is instructive on so many levels. Every asset protection lawyer should read both the District Court decision and the 10th Circuit’s appellate decision for elucidation of multiple concepts of particular relevance to asset protection community. For example, when a debtor and debtor’s spouse come into your office for the initial meeting, it is not unusual for the debtor to suggest that because of debtor’s outstanding liabilities the debtor’s spouse should form a new company owned 100% by the non-debtor spouse but which will be run by debtor spouse in debtor’s capacity as an employee. Indeed, this brilliant strategy is then shortly followed by the suggestion that the debtor spouse be paid a very modest salary to minimize the amount that could be garnished by the debtor’s creditors.

The Wilhite case addresses the non-debtor spouse’s ownership of a limited liability company run predominantly by the debtor. After analyzing the facts, the District Court determined that Mrs. Wilhite was acting as Mr. Wilhite’s nominee and Mr. Wilhite owned an equitable interest in the company. Interestingly, the conclusion was not as easy to reach as it might first seem because Mrs. Wilhite was not only the owner of record but also performed meaningful services for the company. Nonetheless, when weighing all of the facts including extensive testimony by the company’s employees, it was clear that Mr. Wilhite was viewed as the owner and decision-maker.

Clearly, any transfers from Mr. Wilhite to Mrs. Wilhite with the intent to hinder, delay or defraud Mr. Wilhite’s creditors would constitute a fraudulent transfer. In the instant case the District Court had to rule on debtor’s defense that at the time of its formation, the company at issue had no value and, therefore, positioning Mrs. Wilhite as the owner could not have been fraudulent as to debtor’s creditors. To understand the argument, we first need to understand that the government was attempting to collect a debt under the federal law governing criminal restitution. Under this law (13 U.S.C. 3613), the debt is a lien in favor of the United States on all property and rights to property of the person fined. Therefore, if Mr. Wilhite was considered the equitable owner of the membership interest ostensibly owned by Mrs. Wilhite, the government was entitled to a lien on his membership interest. The court had little difficulty confirming that a membership interest in a limited liability company is a property interest subject to the government’s lien.

Going back to the debtor’s defense that the limited liability company had no value, the court concluded that the formation of the limited liability company by Mrs. Wilhite, as nominee for her husband, was tantamount to a transfer by her to her debtor-husband covered by fraudulent transfer law. The court stated that a fraudulent transfer may occur at the moment an asset is created—which is the situation with the company formed by Mrs. Wilhite. In explanation, the court further stated: “…were we to accept [debtor’s] contention that [the company] could not be fraudulently transferred at its creation because it did not then have value, we would establish a loophole for industrious debtors: Have your spouse file the paperwork for a new business venture but otherwise run the company as your own, and the government will not be able to do anything about it because no one could have said when the company was started whether it would have been successful or not.”

Next we focus on why so little was said about charging orders being the exclusive remedy for creditors seeking to reach a debtor’s interest in a limited liability company or partnership. Under existing law, the United States is generally subject to the same charging order limitations as other creditors if it is a creditor of an LLC member. However, there are exceptions to this rule and one of them is a criminal restitution award. Under the criminal restitution law, the government has lien rights in and is entitled to reach all of debtor’s property and interests in property. State laws in regards to charging orders and collecting against members of LLC’s is preempted by the federal law…”[E]xempt status under state law does not bind the federal collector.” Apparently, Mr. Wilhite didn’t push this issue in his appeal as there was no mention of LLC law or collection restrictions related to charging orders.

Yet another fascinating aspect of the case dealt with what percentage of the limited liability company was deemed to have been fraudulently transferred to Mr. Wilhite. As indicated earlier, Mrs. Wilhite was the owner of record and performed services for the company. Because these factors were legitimate indicators of ownership, it was determined that Mrs. Wilhite transferred less than 100% of her ownership interest to her husband. Each side’s experts argued over what the ownership percentages should be. The court found that based on the testimony presented, the government’s witness was more credible and accepted his recommendation of 73.9% being owned by Mr. Wilhite.

The finding that the company was owned by both spouses led to another important concept which the court was forced to address; namely, does the government need to foreclose just the 73.9% interest owned by the debtor or can it sell 100% of the membership interests and then account over to the non-debtor member for her share of the proceeds. The court found that the relevant test for whether a court may order the sale of property in which the debtor owns only a partial interest is found in United States v. Rodgers. Based upon the four nonexclusive factors identified in Rodgers, a sale of 100% of the membership interests was found to be the most appropriate course of action balancing the interests of the non-debtor owner and the government.

The final issue for discussion involved a contribution of $200,000 by the limited liability company to a charitable foundation created by Mrs. Wilhite. Mr. Wilhite would unquestionably be considered a debtor at such time under the UFTA. The court determined that the contribution of $200,000 from the company to the foundation was a fraudulent transfer by Mr. Wilhite, as the equitable owner of the company. But then we get into some pretty interesting facts and analysis. The debtor argued that since he was deemed to only have a 72.4% interest in the foundation, only 72.4% of the $200,000 should be reachable by the government. However, at the time of the collection effort, the foundation’s bank account was $14,150. Under these circumstances how much is the government entitled to collect…72.4% of the $14,150 or 100% of the remaining balance. The court first clarified that at no time did Mr. Wilhite have an interest in the foundation; instead, he had an interest in the funds transferred to the foundation by the company. At the time the company transferred the funds to the foundation, Mr. Wilhite was deemed to have a 72.4% interest in the company. Accordingly, the government could reach that percentage of the original funds transferred.

The court then dismissed the debtor’s argument that since the funds came from the company and went directly to the foundation, the government had no right to access the funds since the government’s lien was solely with respect to the deemed membership interest of Mr. Wilhite and not the assets of the company. The court found that while that may be the normal analysis with regard to collection cases, this case was anything but normal. Here, the court decided that the $200,000 transferred to the foundation should be viewed as, first, a distribution to the members (72.4% to Mr. Wilhite and 27.6% to Mrs. Wilhite) and then a contribution by the Wilhites to the foundation of their respective shares. The court then discussed the selection of an appropriate equitable method for tracing money that has lost its separate identity. The court adopted the “lowest intermediate balance rule.” Applying this rule to the facts, the government was entitled to the entire remaining balance of $14,150.