“This is the way the world ends/Not with a bang but a whimper.”
The long-running bankruptcy case of flamboyant Austin developer Gary Bradley came one step closer to its end with a dissertation by the Fifth Circuit Court of Appeals on . . . burden of proof. Matter of Bradley, No. 05-51626 (5th Cir. 9/20/07). The Court’s ruling upheld the decisions by the lower courts with the result that bankruptcy trustee Ronald Ingalls was able to recover certain traceable assets from the Lazarus Exempt Trust but not others, while Mr. Bradley lost his discharge.
Once Upon A Time . . .
The roots of this case go back decades. Gary Bradley and James Gressett were involved in a number of investments, including the Circle C real estate development in Southwest Austin. While Circle C was ultimately very successful, it got caught up in the real estate bust of the 1980s and proved to be financially devastating for its owners. Circle C Development Joint Venture was able to reorganize in a chapter 11 proceeding, but Mr. Bradley and Mr. Gressett were left with tens of millions of dollars of liability to the FDIC. Gressett filed for chapter 7 protection and received a discharge in the early 1990s, while Gary Bradley resolutely tried to recover without the benefit of bankruptcy.
One strategy that Mr. Bradley allegedly employed to resurrect his finances while keeping his creditors at bay involved an entity known as the Lazarus Exempt Trust. While this trust was formed by his sister, who contributed $1,000 to it, the trust came to own many assets which had been connected with Bradley and his associates in the past. Within two years, the trust had grown from its initial seed capital of $1,000 to own over $40 million in assets. The Trust and its entities paid Bradley a salary of $15,000 per month.
Finally, facing pressure from the FDIC (which was reportedly receiving pressure from Austin’s zealous environmental community) and a family court judge who found that he could afford to pay large amounts of child support, Bradley filed for chapter 7 bankruptcy protection in 2002. Trustee Ronald Ingalls focused on the Lazarus Exempt Trust and sought to recover its assets for the benefit of creditors.
The Bankruptcy Court Ruling
After a trial in April 2004, Bankruptcy Judge Frank Monroe issued a 145 page opinion in which he found that Bradley and his associates had engaged in an elaborate plan to transfer assets controlled by Bradley into the trust. Memorandum Opinion, Ingalls vs. Bradley, Adv. No. 02-1183 (Bankr. W.D. Tex. 10/28/04). Despite the fact that none of the “self-settled” assets were directly transferred into the trust by Bradley, the court found that Bradley maintained ownership of these assets through a set of informal and largely unwritten agreements. This ownership was established through memorandums, prior deposition testimony and the way that certain transactions were structured.
Of particular importance to Judge Monroe was an understanding between Bradley and Gressett that Bradley would own an 80% interest in their joint real estate investments, while Gressett would own 80% of the non-real estate investments. While Messrs. Bradley and Gressett contended that this split was more of a guideline than an agreement, Judge Monroe determined that it made sense out of a number of transactions which would have been nonsensical otherwise. Judge Monroe found that it was this 80% interest in real estate investments which was contributed to the Lazarus Exempt Trust.
Judge Monroe was not circumspect in offering his assessment about what had occurred, making comments such as “Can anyone play the shell game better than Bradley and Gresset?” and “Backdating was a way for life for them . . . .” Memorandum Opinion, pp. 58 and 71. However, despite his obvious disdain for Bradley and company, he did not give the trustee all that he requested. The Court found that certain specific assets, which could be traced into the trust and which remained within the trust, could be determined to self-settled assets and awarded them to the bankruptcy estate. However, he declined to invalidate the trust in toto. He also declined to award a remedy for self-settled assets which could be traced into the trust, but which had been subsequently dissipated. As a result, the trust lost many but not all of its assets. Judge Monroe also denied Mr. Bradley’s discharge on the grounds that he had transferred or concealed property within one year prior to bankruptcy.
Appeal to the Fifth Circuit
Both parties appealed to the Fifth Circuit, which rendered its decision on September 20, 2007. The Court spent most of its opinion explaining why Trustee Ingalls was not entitled to more relief than he received below. The Court of Appeals acknowledged that the burden of proof for tracing assets into a self-settled trust was res nova in Texas. However, based upon general principles of trust law, the Court ruled that the party seeking to recover trust assets had the burden of proof to both trace assets into the trust and to prove that those assets or their proceeds remained within the trust. The Court of Appeals declined to assign any burden of proof to the trust. The Trustee’s two-fold burden had two consequences for his ultimate recovery. The first was that where assets could be traced into the trust, but their provenance remained uncertain, that the trust could retain these assets. Second, where self-settled assets could be traced into the trust, but had been sold or dissipated such that their current form could not be determined, that the trust would not be held liable for these assets which had passed through it. In making its ruling, the Court of Appeals was careful to note that the bankruptcy trustee had been given full access to the trust’s records. Presumably, the result could have been different in a case where the transferee was less cooperative.
The Court of Appeals also affirmed the Bankruptcy Court’s decision to reject two global challenges to the trust. The Court of Appeals agreed with Judge Monroe that Texas courts have not recognized the concept of sham or illusory trust except in cases involving marital property rights. Thus, although Judge Monroe indicated that he would have found the trust to be a sham or illusory trust, there was no legal remedy available for this finding. The Fifth Circuit also found that the Bankruptcy Court properly denied an 11th hour attempt to amend the adversary proceeding to assert a constructive trust claim over the trust assets. Thus, the trust remained intact but wounded.
The Court of Appeals was fairly dismissive of the arguments raised by the Trust and the Debtor, devoting just 3 ½ pages to these issues. The Fifth Circuit rejected the argument that it would be necessary to pierce the corporate veil in order to consider transfers to entities controlled by the trust to be self-settled assets. The Court found that a trust is not a legal entity separate from its trustee. Apparently this led to the conclusion that an asset transferred to a corporation owned by the trust was the same as a transfer to the trust itself. Next, it found that the trust had waived its argument that Mr. Bradley was not a “settlor” of the trust (as opposed to his sister who made the original contribution) for the reason that this argument was not made to the District Court. Finally, the Circuit Court noted that “when the bankruptcy court’s weighing of the evidence is plausible in light of the record taken as a whole, a find of clear error is precluded, even if we would have weighed the evidence differently.” Fifth Circuit opinion, p. 17. This generic finding of plausibility avoided the need to examine the evidence in depth as Judge Monroe did.
What Does It All Mean?
While the opinion from the Court of Appeals turned out to be somewhat dry and technical and largely anticlimactic, there are several lessons which can be learned from the larger saga.
1. It is better to file sooner rather than later.
In some respects, this is a tale of two partners. James Gressett took his medicine and filed bankruptcy in the early 1990s. He received a discharge and was able to start over again. Gary Bradley, on the other hand, tried to tough it out. When he filed bankruptcy some ten years later, he succeeded in attracting much more attention than if he had filed more promptly. It has long been rumored that environmental activists who did not like Bradley’s development activities exerted political pressure on the FDIC to attempt to collect from Bradley rather than settle with him. This led to Bradley’s ill-advised decision to attend a post-judgment deposition without the benefit of counsel. By the time that Bradley filed for bankruptcy, newspaper articles and the FDIC deposition provided the Trustee with a road map for his investigation.
2. The concept of a self-settled trust just got larger.
In some respects, the Fifth Circuit’s opinion on the Bradley matter is like Arthur Conan Doyle’s dog which didn’t bark (that is, the remarkable thing is what was never discussed). The Fifth Circuit never really explained how assets which had never been held in the name of the debtor could be treated as self-settled assets in the hands of the trust. Normally, a self-settled trust is easy to determine. The Debtor owns an asset and then contributes that asset to a trust under which he is the beneficiary. At this point, the trust is determined to be self-settled and any spendthrift trust restriction is unenforceable.
In the Bradley case, Judge Monroe took a very expansive view of what constituted a self-settled asset. Although his opinion is quite detailed, he still had to buy into the trustee’s theory of the debtor as puppet-master pulling the strings of his associates and their entities. Based upon the opinions, it appears that there was never a legally enforceable agreement for third parties to hold property for Mr. Bradley, but that they acted as if there was such an agreement. Whether the other parties to the alleged scheme acted out of fear, loyalty or foolishness, it doesn’t seem as though they had an obligation to act at Bradley’s direction. This raises the question of whether the fact that the parties acted as though they were dealing with Gary Bradley’s property is sufficient to establish that they were in fact dealing with Gary Bradley’s property. The Fifth Circuit responded to this tantalizing question with a shrug, dismissing the issues as mere fact finding to be upheld so long as they were plausible. The Fifth Circuit also punted on the issue of whether someone who was not the named settler of a trust could make a self-settled contribution to the trust, finding that although this issue was presented to the bankruptcy court, it had not been presented to the district court. While the court of appeals did not expressly rule on this issue, the clear implication is that they would have agreed with the bankruptcy court that anyone who contributes an asset to a trust is a settler; otherwise, the entire case would turn on a technicality of appellate procedure (namely, whether an issue raised in the bankruptcy court but not the district court is waived).
The potentially expansive reach of this case is shown by the following hypothetical. Assume that parents own a business and their children work in the business. When the children reach adulthood, the parents sell the business to the children at a favorable price with an “understanding” that the children will take care of the parents in their old age. More than four years later, the children decide to form a trust for their parents’ support. They sell the business to the trust at the same favorable price that they paid and name the parents as primary beneficiaries. Prior to the Bradley case, this transaction would have been untouchable. The original transfer occurred outside of the four year period for recovering a fraudulent transfer and the property was transferred to the trust by the children, not the parents. However, following the logic of the Bradley opinion, it could be argued that the parents retained ownership of the business through their “understanding” with the children such that the asset was self-settled when it was contributed to the trust. The main difference between this hypothetical and the Bradley case is that the parents and children would be considered sympathetic parties, while Gary Bradley failed to attract much sympathy for himself. Of course, this should not be determinative when resolving legal issues.
3. Documents are important.
In discussing one of the many transactions in his Memorandum Opinion, Judge Monroe states, “None of the trial testimony makes sense. The documents do.” Memorandum Opinion, p. 55. Although the Trustee did not win on every issue, it is clear that his success was due to his ability to process large quantities of documents and sort out the ones which helped his case. The proof of the conspiracy emerged from prior deposition testimony (which can be considered low-hanging fruit), notes from meetings and analysis of the details of a myriad of transactions. Without these documents, the Trustee would not have had a case, since the witnesses on the Bradley side all testified to a different version of the facts. Conversely, the fact that the Lazarus Trust cooperated and provided the Bankruptcy Trustee with massive amounts of documents allowed the Court to apportion the burden of proof to the Trustee with the result that the Trustee did not prevail on all of his arguments.