Cross border insolvencies and financial restructurings are remarkably opaque considering we live in the Information Age. The mission of the Centre of Main Interest (the COMI) is to light some candles in the darkness and create a forum for further discussion. The Law Offices of Tally M. Wiener, Esq. are pleased to publish the COMI blog.
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Sunday, December 30, 2012
Blixseth - Ninth Circuit Bankruptcy Appellate Panel Rules Nevada Is Proper Venue For Involuntary Bankruptcy Against Former Billionaire Because Holding Companies Formed There
Our debtor, Timothy L. Blixseth, grew up poor in Oregon, built by trading in timber and real estate worked his way up to one of Forbes’ richest 400 Americans. Blixseth and his wife, Edra, lived a jetsetter lifestyle that included two Gulfstream jets, a fleet of luxury cars, and multiple expensive homes.
But like so many others who created rags-to-riches stories in real estate, Blixseth’s proved equally adept at turning riches-to-rags. By the time that he enters our picture, Blixseth has endured a lawsuit by his investors in his elite Yellowstone Club in Montana, and a bitter divorce with Edra, who by that time reportedly had trouble paying her DirecTV bill.[FN1] A sad ending for a lady who once reportedly spent $90,000 on a party with toilet paper featuring Timothy’s face (during their divorce). For those who would say that money can’t buy class, the Blixseths can be Exhibit “A”.
Apparently unable to pay his taxes, former billionaire Blixseth was forced into Chapter 7 bankruptcy by the Montana Department of Revenue ($219,258 owed), the Idaho State Tax Commission ($1,117,914 owed), and California Franchise Tax Board ($986,957).
Faced with these confused, if not contradictory, claims in the Petition, the Nevada bankruptcy court sua sponte entered order to the three revenue agencies to show cause why Nevada was the appropriate district for the Chapter 7 proceeding. The revenue agencies responded that Nevada was the correct district because Blixseth had “recently transferred most of his assets out of his personal name and into two Nevada corporate entities.”The involuntary Chapter 7 Petition was filed in the District of Nevada. The check-the-box Petition alleged that Blixseth’s residence and mailing address was outside Seattle, but his “county of residence or principal place of business” was listed as Las Vegas. The Petition left blank the box for “Location of Principal Assets of Business Debtor”. The “venue” box on the Petition listed the District of Nevada as the place of appropriate venue for the Chapter 7 proceeding against Blixseth.
The revenue agencies were referring to Desert Ranch LLLP, of which Blixseth owned a 98% interest, and Desert Ranch Management LLC, of which Blixseth owned a 40% interest.
For his part, Blixseth moved to dismiss the Petition, on the basis that he had resided outside Seattle since 2007, and that he had no business, place of business, or property in Nevada. Blixseth admitted that his primary asset was his 98% interest in Desert Ranch LLLP, but claimed that it was just a “holding company” for other, non-Nevada entities that held property in the U.S. and abroad. Further, Blixseth claimed that Desert Ranch LLLP kept its business records outside of Nevada, and conducted no business in Nevada. Blixseth also admitted that Desert Ranch Management LLC similarly conducted no business in Nevada.
By this time, only the Montana Department of Revenue (MDOR) was left in the case, and it responded that venue was appropriate in Nevada because “the heart of a creditor’s concern is the transfer of assets . . . into Nevada vehicles that are created for asset protection measures.” Because Nevada law could be apply to unwind Blixseth’s transfers, the MDOR claimed that Nevada law should apply since “Nevada had a greater interest in the case than another state.”
Under 28 U.S.C. sec. 1408, the venue of a bankruptcy case may be based on any of domicile, residence, principal place of business, or principal place of assets. None of the first three applied to Nevada. Thus, hearing the Motion to Dismiss, the bankruptcy court identified the issue as:
[When] all someone has is an equity interest in a Nevada limited-liability, limited partnership and a membership interest in an LLC, can you say for purposes of [28 U.S.C. sec.] 1408 that his principal assets are in Nevada?
The MDOR argued in response that since the Nevada charging order statutes require a creditor to enforce a judgment against debtor’s interest in these types of business entities only in a Nevada court, the location of the debtor’s interest is the state of registration, i.e., Nevada.
Blixseth responded that under the U.C.C. and common law, the “location” of such intangible assets as partnership and LLC interests are the same as their owner’s domicile, i.e., Washington state.
The bankruptcy court agreed with Blixseth, and held that the location of the interests in the LLLP and LLC were not in Nevada, and therefore venue was not appropriate in Nevada, and dismissed the Petition. On appeal, the Ninth Circuit’s Bankruptcy Appellate Panel reversed in a 2-1 decision.
The Majority (of 2) agreed that partnership and LLC interests are intangible property. Since such property has no physical location, the Majority noted that is a “legal fiction” to say that intangible property has anything like a location or situs. Thus, the Majority would not find that Blixseth’s principal assets were in Nevada.
Yet, legal fictions are inherently pliable, and so it was that the Majority began a “context specific” analysis that focused on a “common sense appraisal of the requirements of justice and convenience in particular conditions”. In other words, the Majority was prepared to discard the bright-line venue rules for a facts-and-circumstances approach.
And here is where it gets interesting.
The Majority first noted that an involuntary bankruptcy proceeding “is, at bottom, a creditor collection device”. This meant that it was important to consider what rights the bankruptcy trustee would have to seize and liquidate Blixseth’s LLLP and LLC interests.
In Nevada, the sole remedy of a creditor against a debtor’s interests in a partnership or LLC is a charging order against that interest. Nevada law further provides that only a Nevada court may enter the charging order against a Nevada entity [Note: Other state's courts are quite likely to disagree, but that is not at issue here.]
Because a creditor’s rights are limited to Nevada law and Nevada courts, this in the view of the Majority created sufficient reason that Nevada was the correct venue for bankruptcy courts to administer this particular case.
To cure any misapprehension that this would somehow let Blixseth off the hook, the Court took pains to describe that:
In addition to pursuing a charging order, a bankruptcy trustee in Blixseth’s case may have other methods of liquidating his interests in Desert Ranch and Desert Management. As a practical matter, since these interests would constitute property of the bankruptcy estate under sec. 541(a), by standing in Blixseth’s shoes as a member or partner in the entities, the trustee could seek to judicially dissolve the companies and distribute their assets to the members.
And further in Footnote 8:
FN8. The trustee may seek to dissolve either Desert Ranch, an LLLP, Desert Management, an LLC, or both. The legal mechanisms for judicial dissolution of the two business structures are nearly identical.
In other words, a bankruptcy trustee stands in the shoes of the debtor, and thus as the debtor can force a judicial dissolution of a partnership or LLC.
That Nevada law should apply should be of no surprise to Blixseth:
Presumably, in organizing the Nevada entities, and conveying his valuable properties to them, Blixseth desired to take advantage of the separate legal identities bestowed on Desert Ranch and Desert Management under Nevada law in his future dealings with business associates and personal creditors. Given Blixseth’s strategy in dealing with his assets, we find it disingenuous that he now argues that, although he chose to take advantage of the Nevada statutory scheme in creating the LLLP and LLC, into which he then transferred all of his valuable assets, now Nevada is not a proper venue for his creditors to pursue their efforts to seize and liquidate those assets. Surely, if notions of justice carry any weight, Blixseth’s conduct warrants a conclusion that venue in Nevada is proper.
Moreover, as noted above, if Blixseth is eventually adjudicated an involuntary debtor, it is obviously more convenient for a Nevada trustee to administer his bankruptcy case. Put another way, how can it be anything other than inconvenient, assuming as Blixseth apparently argues that Washington is a proper venue for the bankruptcy case, for a trustee appointed there to have to come to a Nevada court to obtain a charging order or to dissolve Desert Ranch and Desert Management. Under these facts, as compared to Washington, Nevada would seem to be the much more convenient venue for the bankruptcy case.
In footnote 9, the Majority also rejected the Dissent’s view (to be discussed below) that the UCC or common law compelled a different result. To the contrary, the Majority quoted Justice Cardozo that the better approach to intangible property involved “a common sense appraisal of the requirements of justice and convenience in particular conditions.” The Majority further noted that the UCC’s approach to intangibles was in the context of perfection, not collection.
But then again, the Majority was careful to note, this is a facts-and-circumstances approach, and it might be in another case that venue based on the debtor’s residency might be more defensible. But here, it didn’t make any sense, and thus the Majority held that Nevada was the proper venue for Blixseth’s bankruptcy.
Judge Hollowell dissented on the basis that “intangible property follows the person . . . and is located where a person is domiciled,” citing to the UCC and the common law doctrine. Even if the UCC dealt only with perfection, that perfection gives notice to creditors and other parties if there are any encumbrances on the debtor’s interest — and therefore that place of perfection (the debtor’s residence as to intangibles) should govern venue for collection cases as well.
The Majority tells us, however, that this method is not an absolute. Instead, a facts and circumstances approach will be used, and residency will determine venue only if it makes sense in a particular case.The theory of the dissent — that partnership and LLC interests are intangibles such that the UCC rule that the appropriate venue is where the debtor resides — has been suggested by academics and others who follow the topic to be the correct method for selecting venue.
So, assuming that the Majority’s opinion stands up if Blixseth challenges it before the full Ninth Circuit, what we are left with is a facts and circumstances test for where a bankruptcy challenge to a partnership or LLC can be brought. In other words, a crapshoot.
The Majority position makes more sense. While having one single state as the domicile of intangible property makes sense from the perspective of U.C.C. perfection, i.e., to give notice to competing creditors of security interests in the property, such an artificial restriction makes little sense when it comes to actual enforcement proceedings against the property.
To the contrary, considering the inherently transient nature of intangible property and the practical difficulties in running down creditor-dodging debtors who are unwilling to voluntarily pay their debts, creditors should be given the widest possible latitude to select their forums and shop law so as to satisfy the debts owed to them.
Historically, questions like this, whether in the venue context or choice-of-law context, were almost non-existent. Once-upon-a-time, most states had adopted some uniform act such as the Uniform Limited Liability Company Act such that it didn’t matter where the lawsuit was brought or whose law would apply — the result would be the same.
Not so now, since some states are trying to “beat the competition” by adopting unique legislation in an attempt to attract entity formation business (much like some states have adopted trust statutes that are more attractive than those in other states).FN2 With some states attempting to “game the system” in favor of debtors so as to attract new company formation business, now is not the time to blindly pledge allegiance to antiquated notions of outdated and ineffective common law rules relating to the fictional situs of intangible property.
What the proliferation of harshly pro-debtor state laws likely means is that we will see more of these cases, and because a facts-and-circumstances analysis will be used, the outcome of these cases will probably uncertain right up until the moment of decision.
The practical lesson of this Opinion is to restate an asset protection “best practice”: Good asset protection planning presumes that the asset protection structure will work no matter where the structure is challenged or which state’s laws will apply to the controversy. Planning based on a presumption that any particular jurisdiction will be the venue, or that any particular jurisdiction’s laws will apply, is inherently unsound.
Speaking of which, another troubling part of this case is the Majority’s conclusion that the Bankruptcy Trustee can “step into the shoes” of the debtor under Nevada law, and force the liquidation of these entities. If this pans out, it will provide a powerful tool for creditors to unwind business entities that are used, as here, primarily to shield assets from creditors. Particularly since debtors have little ability to restrict when they can be placed into an involuntary bankruptcy proceeding, this decision must give the heebie-jeebies to planners whose first line of defense is a business entity to attempt to shield personal assets.
In re Blixseth, ___ B.R. ____, 2012 WL 6562839 (9th Cir.BAP, Dec. 17, 2012). Full Opinion at http://goo.gl/pc7Jp
FN1. K.Dolan, Follow-Through to Big Sky, Big Trouble, Forbes, July 21, 2008.
FN2. This phenomena of states adopting legislation just for the purpose of competing with other states, and not for any sound policy reasons, is often referred to as a “race for the bottom”.