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          For those readers who are old enough to appreciate the analogy, the current asset protection (“A/P”) craze, especially among physicians, has a lot in common with the tax shelter craze of the late 70’s and early 80’s, when otherwise rational businessmen and professionals invested in convoluted, pre-packaged ventures, only to later find that the emperor really was not wearing clothes. 
     The fundamental problem was that the tax shelters were primarily designed to reduce taxes by taking (inappropriate) advantage of some tax rule, rather than making profitable investments. They violated the spirit of the law. 
     Many A/P attorneys today are making the same mistake. Protecting business assets from the creditors of the business is against public policy. It is one thing to suggest a client take reasonable, economic steps, but quite another to recommend complex, expensive transactions or structures with the primary goal of avoiding responsibility.
     With these thoughts in mind, let us quickly survey the A/P landscape.
     To begin with, Florida law is quite favorable with respect to protecting individually-owned personal and investment assets. For example, homesteads, retirement plans, life insurance, annuities, college savings plans and wages of the head of a household are exempt from creditors.1 
     There are also “quasi-exemptions”. Property owned by spouses as tenants by the entireties cannot be seized and sold to pay claims against one spouse.2 And a debtor’s management rights in a partnership or limited liability company cannot be seized and sold by a creditor of the partner or member. Instead the creditor’s remedy is limited to a so-called “charging order” directing the partnership or limited liability company to make whatever distributions it is going to make to the creditor instead of the debtor.3 
     Needless to say, it is usually not a difficult matter to achieve substantial A/P for an individual client. Of course, ethical attorneys advise their clients to take advantage of these financial benefits.
     On the business side, corporations, LLC’s, and LLP’s generally provide the owners with a shield from entity-level liabilities,4 but an entity is not eligible for the above-described exemptions, and its assets are thus exposed. So the focus of A/P planning naturally shifts to trying to protect the assets of an entity operating a business. 
     Benefit Programs. Many attorneys, CPAs, insurance salesmen and banks have been touting “Benefit Programs” (hereafter, "BP’s") as superb vehicles for achieving A/P for small businesses, especially to protect the receivables owned by physician’s P.A.’s.5 At a minimum, BP’s involve (i) a bank loan, (ii) a lien on receivables, (iii) a life insurance or annuity contract, and (iv) a deferred compensation arrangement. Usually, the BP involves a lien on the life insurance or annuity contract as additional collateral for the bank loan. 
     There are basically two types of BP’s, the loan-to-physician BP and the loan-to-P.A. BP. The loan-to-physician BP involves the direct acquisition of a life insurance or annuity contract by the physician financed by a bank loan which is secured by the allegedly exempt contract and further secured by a guaranty by the P.A., with the receivables acting as security for the guaranty.6 The security documents provide that in the event of a default (or perhaps after some brief time after the default), the bank will look to the receivables before looking to the insurance policy - and for such reason the promoters refer to the P.A. as having pledged the receivables as “primary security”.
     The A/P problem is that when the bank seizes the P.A.’s receivables to pay the loan to the physician - which presumably happens when the creditor seizes the P.A. bank accounts, shutting down the business - the P.A. has the equitable right to be paid back by the physician. In effect, the P.A. “steps-into-the-bank’s-shoes”, not only with respect to the bank’s claim against the physician, but also with respect to the bank’s lien on the exempt contract. The P.A.’s rights against the physician could in turn be seized by the creditor, destroying the A/P.7 
            In an attempt to offset the P.A.’s claim against the physician, an unfunded deferred compensation plan is added to the BP, providing the physician with a (matching) claim against the P.A. At least that’s the theory.
     The loan-to-P.A. BP involves the P.A. borrowing against the receivables and then either acquiring a life insurance or annuity contract and distributing same to the physician or transferring the cash to the physician, who then acquires the allegedly exempt contract. The problem with the loan-to-P.A. BP is that the transfer by the P.A. to the physician usually generates adverse tax consequences (discussed below). Promoters have trouble selling plans which generate additional, current taxes, so they add a deferred compensation plan to the BP in an attempt to defer the adverse tax consequences.
     The loan-to-PA deferred compensation plan can take any of several forms, but all involve the allegedly exempt asset either being subject to a substantial risk of forfeiture by the physician back to the P.A. or being carried on the P.A.’s books until some triggering event, typically the termination of the physician’s services.8 In other words, the physician’s rights don’t vest until later. The promoters assert that because this later transfer or vesting of the insurance contract resulted from a binding arrangement entered into when the BP was established - hopefully long before the malpractice event – the transfer or vesting is not to be considered contemporaneous with the arrival of the creditor.
     This article argues that BP’s, like the old tax shelters, are counterproductive. The discussion assumes the malpractice event was caused by Dr. Guilty, who along with Dr. Innocent, is a 50% stockholder in a P.A. taxed as an S corporation since its inception. The sole asset of the P.A. consists of receivables. (The discussion applies equally well to other businesses and other business assets.) It is assumed that judgments are ultimately entered against both Dr. Guilty and the P.A., no settlement is reached and the creditor aggressively asserts her rights in an effort to collect. Tax issues are discussed, but the emphasis is on the creditor’s remedies.9
     Tax issues — the loan-to-P.A. BP.  The loan-to-P.A. BP inevitably involves a transfer of cash or other assets to the physician-stockholders from the P.A. Such transfers are paid either with respect to the physicians’ stock or as compensation. If paid with respect to stock, the distribution is tax-free to the extent of the recipient’s basis in his stock, with the excess being taxed as a dividend. Dividends are generally taxed at a 15% rate for Federal income tax purposes.10 Unfortunately, it is unusual for physicians to have significant basis in their P.A. stock (because they tend to pull out all their earnings each year.)
     The principal repayments on the loan would not be deductible, but the interest payments generally would be deductible.11 If the loan is used to pay taxable compensation, the P.A. would generally have a matching deduction which would pass through to the physician-stockholders and offset their taxable income received.   At first glance, such result seems ideal. But there are at least three tax-related difficulties. The first is that the deduction does not offset employment taxes. The second is that the IRS may successfully argue that the compensation was unreasonably high, and thus not deductible.12 The third is that the deduction is suspended, except to the extent the physician has basis in his or her P.A. stock or basis in any debt owed by the P.A. to the physician.13
       The adverse tax consequences act as a significant deterrent to the idea of borrowing by the P.A. in order to fund distributions or pay compensation to the physician-stockholders. 
       Nevertheless, the simple plan of borrowing to pay compensation or to make distributions – i.e., without the insurance and deferred compensation elements – often has enough merit to justify the additional tax cost.14 To give the reader an idea of the stakes involved, consider that in the context of a loan used to pay taxable compensation where the entire matching deductions are suspended due to a lack of basis, a very rough rule of thumb would be to think of the additional taxes as effectively increasing the interest rate by, say, 50% (i.e., 3.5% on a 7% loan).15
       Tax issues — the loan-to-physician BP.  The loan-to-physician BP attempts to avoid or defer the adverse tax cost of a loan-to-P.A. BP by lending directly to the physicians. The only significant tax issue caused by loans to the physicians is whether the interest is deductible. (Again, principal payments on the loan would generally not be deductible.) The answer usually depends on what use is made of the money. For example, personal interest is not deductible, while investment interest may be deducted against investment income.16 However, a special rule denies the interest deductions where the loans are used to acquire life insurance or annuity contracts, because the cash value build-up inside the policies is not taxed unless received by the owner.17
       Most tax professionals are comfortable with the proposition that the guaranty by the P.A. and the placing of a lien against the P.A.’s receivables to secure the guaranty do not generate additional taxes unless and until the P.A. is called upon to make payment to the lender.18 At that point the payment would be considered for tax purposes as if it were payments by the P.A. to the physician-stockholders, essentially triggering the same tax issues as the loan-to-P.A. BP. The timing is more favorable, however, because the source of the payment to the bank is likely to be taxable income generated at the P.A. level, thus creating stock basis to free up the matching deductions. (The seizure by the bank will usually generate taxable income to the extent of the debt reduction.)19
       The “cover story”. Another important function of the deferred compensation plan is to provide a “cover story”. Because insurance policies and annuity contracts are designed to defer income taxation of the earnings on the cash values until withdrawn,20 the BP can be presented as a retirement vehicle, rather than an A/P device.
       Unfortunately, the economics of BP’s generally belie the cover story. The commission and other internal costs of a life insurance or annuity contract are usually much greater than the closing costs of the loan. To more than make up that difference, the net earnings on the cash value would have to significantly exceed the interest rate of the bank loan over a long time period. But if that were the case, the bank and insurance company would be better off dealing directly with each other.
       The A/P problem is that the creditor has three powerful remedies - fraudulent transfer, fraudulent conversion and fiduciary responsibility.21
       Fraudulent transfers.   The fraudulent transfer statutes entitle creditors to relief22 if any of several types of transfers are made by the debtor. 
       Actual intent. A transfer made or obligation incurred by a debtor is fraudulent … if made or incurred with the actual intent to hinder, delay or defraud a creditor of the debtor.”23 In other words, the creditor wins if either the placing of the lien on the receivables or the payment of the bonus (via payment to the bank) was done with the Aactual intent@ to hinder creditors.
       Further, in the case of actual intent the creditor is entitled to relief regardless of “whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred.”24 That is, there need not be a creditor in existence at the time of entering into the BP. Both present and future, unknown creditors are protected.
       Actual intent usually cannot be determined by direct evidence. Instead, the legislature made a nonexclusive list of factors (often referred to as “badges of fraud”) for the courts to consider.25
       In the context of a BP, such factors heavily favor the creditor. But what makes the BP promoters’ claims so ludicrous is the fact that the BP is marketed as an A/P device, creating very persuasive evidence that the lien on the receivables was created with the very purpose (i.e., actual intent) to hinder creditors.  
       The structure of loan-to-physician BP’s also supports the creditor’s actual intent argument. Loan-to-physician BP’s have two serious structural flaws. The first is that they involve the leveraged purchase of an insurance or annuity contract with a lien on the P.A.’s receivables as additional security. Other than providing an argument to support A/P, there is little, if any, reason to add the deferred compensation plan to a loan-to-physician BP. Second, because the cash value inherent in a life insurance or annuity contract is much easier to liquidate than receivables in the event of a default, the requirement that the bank look to the guarantor’s assets (the receivables) before looking to the insurance policy is not only contrary to normal business practice, but serves no valid economic or business purpose other than hindering the P.A.’s creditors.
       Reasonably equivalent value. Even in the absence of actual intent, there is a fraudulent transfer with respect to both current and future, unknown creditors if the P.A. did not receive a reasonably equivalent value in exchange for the transfer or obligation and the P.A. either had unreasonably small remaining assets for the business (i.e., was too “thin”) or "reasonably should have believed that [it] would incur debts beyond [its] ability to pay as they came due.”26        Two rules greatly enhance the creditor’s prospects in asserting this type of fraudulent transfer. First, obligations incurred by a debtor (the guaranty by the P.A.) for the sole benefit of third parties (the physicians) are generally not considered to have been incurred for a “reasonably equivalent value” for fraudulent transfer purposes.27 Second, for purposes of the fraudulent transfer statutes the malpractice claim is considered a debt, even though contingent.28
       Timing. It is important to note that the malpractice lawsuit can include (or be amended to include) fraudulent transfer counts regardless of how long ago the BP was established.29 If a fraudulent transfer count is grounded on actual intent, the statute of limitations merely requires that the action be brought within the later of four years of the date of the fraudulent transfer or “1 year after the transfer or obligation was or could reasonably have been discovered by the claimant.”30 Presumably, in the case of a BP, the one year period will commence when financial disclosures are made in the discovery process or in settlement negotiations.
       The fraudulent transfer counts could lead to various forms of relief even before the bank is paid. In addition, the physician’s malpractice defense lawyer may be concerned that the fraudulent transfer defense may make a bad impression on the judge regarding the physicians’ characters.
       Fraudulent conversion. The deferred compensation bonus can also be rendered void as a fraudulent conversion. A fraudulent conversion is the changing of an asset, directly or indirectly, from one which is reachable by creditors (e.g., the cash) into one which is exempt from creditors (e.g., life insurance) with the intent to hinder, delay or defraud a creditor.31
       There is generally a four year statute of limitations on asserting this argument. However, in the context of a BP, the creditor has a strong argument that the four year period does not begin running until the deferred compensation payment (i.e., the seizure by the bank) was made. That is, the deferred compensation plan probably has the practical effect of eliminating the statute of limitations under the fraudulent conversion statute.
       The physicians can counter that each bonus was exempt from creditors as the payment of wages or salary to the head of a household,32 and thus there was no conversion of an asset reachable by creditors. 
       Unfortunately for the physicians, Florida case law denies the wage exemption for severance pay and for wages paid to debtors who are closely involved in owning and operating a business - the idea being that the earnings were really business income, rather than compensation for services.33
       Fiduciary duties. As a general proposition, corporate officers and directors owe fiduciary duties to the corporation and its stockholders, but not to the creditors of the corporation.34 However, when a corporation becomes insolvent, such duties to the stockholders shift so as to become duties to the creditors of the corporation. The basic idea is that the stock is worthless, so the creditors become the residual owners.35
       The deferred compensation plan creates an obligation of the P.A. to each physician, and thus makes the physician a creditor of the P.A. In the case of contests between creditors competing for the debtor’s insufficient assets, the law does not look favorably on creditors who control the debtor. Control need not be absolute.36 The other creditors have a strong argument that the deferred compensation claim should be equitably subrogated to the claims of the other creditors.37 In the instant situation, this means the other creditors must be paid in full before anything is paid on either physician’s claim (for deferred compensation).
       Obviously, a corporation should not pay a liquidation or other dividend when insolvent. Directors who approve of paying dividends before making provisions for the P.A.’s creditors can be held personally liable.38
       Directors of the P.A. can also be held personally liable for causing the P.A. to enter into the BP if the creditor can show that it was unreasonable to believe that adopting the BP was in the P.A.’s best interest and the director either directly or indirectly received an improper personal benefit.39
       Problems with groups. The larger the group, the larger the A/P nightmare. To begin with, the P.A.’s receivables are larger, creating a bigger target for the plaintiff. If one thinks of the group P.A.’s receivables as being owned pro rata by the physician-stockholders, one can also say that each physician-stockholder’s receivables are subject to the malpractice of each of the other physician-stockholders, multiplying the risk by the number of physicians in the group. And even if the P.A. has employment or stockholder agreements which require the guilty physician to directly or indirectly reimburse the other physician-stockholders, one can easily imagine significant difficulties in enforcing those claims.
       A major reason for using a corporate entity to operate a group practice is that the innocent physicians are generally protected by the corporate shield (i.e., are not liable to the malpractice creditor). However, such protection does not extend to liability grounded on personal misbehavior. As discussed above, the presence of the malpractice creditor can create fiduciary duties, which, if broken, can generate joint and several liabilities of the otherwise innocent physician-stockholders. Thus, another powerful argument against participating in a group practice is that the physicians who participate in the A/P decisions can be exposed personally.   The temptations may be too real. The following simplified example illustrates how a group BP might work in the case of an informed and aggressive plaintiff.
       Example. Guilty and Innocent, M.D., P.A. is owned equally by Dr. Guilty and Dr. Innocent. The P.A. and the stockholder-physicians enter into a BP pursuant to which each physician borrows $250,000 from a bank which is invested in a single premium deferred annuity owned by such physician and pledged as collateral for his bank loan. The loans call for interest only payments (at least during the relevant time period of his example.) Pursuant to the BP, the P.A. guarantees both bank loans and secures such guarantees with a “primary” lien on its $500,000 of receivables. Each physician purchases a minimal $250,000 malpractice insurance policy each year.40
       Dr. Guilty commits an obvious act of malpractice with significant damages and a lawsuit is promptly filed. The insurance company investigates, offers the limits, and withdraws, leaving the P.A. and Dr. Guilty to fend for themselves.
       The P.A. and Dr. Guilty enter into settlement discussions with the plaintiff, offering $50,000 in addition to the policy limits on the grounds that the plaintiff cannot collect any excess judgment that might be obtained. To bolster their arguments, the P.A. and Dr. Guilty provide comprehensive financial disclosures, including a copy of the BP documents and tax returns. The plaintiff declines the offer after consulting with a debtor-creditor lawyer. 
       The plaintiff amends her complaint to include fraudulent transfer counts against the P.A., Dr. Guilty and Dr. Innocent and asks the court to place the receivables and the annuities in receivership. The three defendants move for a stay of the fraudulent transfer counts until the plaintiff obtains a judgment. The court denies the stay and sets a hearing date for the fraudulent transfer counts. 
       The physicians are reluctant to testify under oath as to their A/P motives in entering into the BP. They seek the advice of their own debtor-creditor specialist and realize they are spending money in a lost cause. Dr. Guilty is anxious to avoid bankruptcy. Both physicians are leery of the “starting over” problem (discussed below), the risk that even their wages might be considered fraudulent transfers, and fiduciary liability. So they settle with the plaintiff for $600,000 plus the malpractice insurance proceeds.
       Dr. Innocent is upset with Dr. Guilty. Difficult negotiations ensue, leading to the split up of the P.A.
       The above example reveals a structural problem inherent in all group practices, to-wit: the larger the group, the better the creditor’s position and the more likely that the P.A. will become liable for a malpractice judgment, not only exposing each physician’s “share” of the P.A.’s receivables and other assets to the malpractice of other physicians, but also exposing physicians who are directors or officers to liability for breach of fiduciary duties.41
       The above example also shows why BP’s are harmful. The BP accelerated the timing of the creditor’s remedies and made the physicians look like irresponsible schemers.
       Starting over. A major problem which is rarely addressed properly in A/P planning is how the business will be conducted after the judgment is rendered. Suppose in the above example that the physicians form a new entity to carry on the business. The issue presented is whether the new entity can be held liable for the old P.A.’s debts to the judgment creditor and others. The answer tends to be highly fact dependent, but consider one extreme: if the new entity is operating out of the same location with the same personnel, same patients and same owners, it is highly likely that the new entity would be held liable as a mere continuation of the old P.A.41
       Note also that the P.A.’s patient records and goodwill can be considered valuable assets which can be the subject of a fraudulent transfer.42 And as mentioned above, wages and other payments to the physician-stockholders after the malpractice event can be challenged as fraudulent transfers and disguised dividends.43 Noncompete covenants could also present difficulties. A corporate chapter 11 bankruptcy might be considered as a means of safely resolving the various creditor-rights issues.
       A bankruptcy may be a viable part of a starting over plan for the debtor-physician.44 The basic idea would be to attempt to discharge the malpractice judgment in bankruptcy, retaining the physician’s exempt assets. Note however, that the 2005 Bankruptcy Act generally (i) denies the discharge if there was a fraudulent transfer within two years of filing the bankruptcy petition45; (ii) limits the IRA exemption to $1,000,00046;  (iii) limits the homestead exemption to $125,000 of equity – although the homestead limit is neutralized by holding title in a tenancy by the entireties47 or by building up the equity over more than 40 months (1,125 days) in the same state48; and (iv) perhaps most importantly denies access to chapter 7 if the debtor makes above average income for his or her community.49
       In the absence of a bankruptcy, so long as a debtor-physician does not take an ownership position, he may be able to practice as an employee - perhaps of his former partners’ new P.A. - by relying on the exemption from creditors for wages paid to the head of a household.  
       At the latest, the starting over problem should be considered when planning for settlement negotiations. Obviously, the physicians can be more effective negotiators if they have a specific plan as to how they would start over and how much they would be willing to pay to avoid doing so. One can imagine circumstances where it would be in the physicians’ interests to accelerate the starting over process.
       Closing comments. A key to good planning is to appreciate that judges not only want their judgments to have meaning, but have broad authority to enforce them.50 There is no silver bullet, especially via an off-the-shelf program which is marketed as providing A/P. As shown in this article, if the creditor understands the flexibility inherent in the equitable nature of his rights, a BP just makes the situation worse.
     It is fair to say that attempting to protect business assets from creditors creates and accelerates powerful creditor remedies. Creditor remedies can be particularly dangerous in the context of a group practice. That is not to say that restructuring a business in response to changing conditions is a bad idea, but rather that in the case of business assets, A/P, if it comes at all, comes as a side consequence of attempting to achieve other goals.
© 2007 Steven M. Chamberlain, Esq. All rights reserved. Republication with attribution permitted. 

     01Fla. Const. Article X, §4; Fla. Stat. Chapter 222.
     02Hulbert v. Schackelton, 560 So.2d 1276 (Fla. App 1 Dist. 1990); but Cf., Whetstone v. Coslick, 117 Fla. 203 (Fla. 1934), where the court ruled that reachable assets of a debtor spouse which were converted to a tenancy by the entireties could not be protected from the debtor’s creditor. The IRS, however, can seize and sell tenancy by the entireties property to collect the debt of one spouse. U.S. v. Craft, 535 U.S. 274 (2002).
     03F.S. §§608.433 (LLC) and 620.8504 (partnership). The judgment creditor also gets a lien which, in the case of a partnership interest, can be foreclosed, but the buyer at the foreclosure sale only gets the rights of an assignee or transferee, which - as is also true for transferees of LLC membership interests - do not include a say in management.
     04The shield provided by an LLP is arguably stronger. F.S. §620.8306(3) simply states that LLP partners are not liable for partnership level debts, while F.S. §608.701 states that the laws for piercing a corporate shield apply to attempts to pierce an LLC shield. 
     05See, e.g., Hardin, “Living Well and Retiring Poor”, in House Calls, Alachua County Medical Society, September-October 2003.
     06Fla. Stat. §607.0833 provides that a corporate guaranty of a loan to an employee, director or officer is permissible if it is reasonably expected to benefit the corporation.
     07See, e.g., School Board of Broward County v. J.V. Construction Corp., 93 A.F.T.R. 2d 2004-2340 (S.D. Fla. 2004). Because the creditor was not party to any of such contracts, this equitable principle cannot be overcome by any of the BP’s contractual provisions between or among the physician, bank and P.A. Cf., In re Toy King Distributors, Inc., 256 B.R. 1, at 223 (Bankr. M.D. Fla. 2000.) In further support of the creditor’s position, it should be noted that the loan is used to acquire the exempt asset and both the physician and the P.A are indebted to the same creditors. Cf., In re Hale, 141 B.R. 225 (Bankr. N.D. Fla. 1992.) In Dade County School Board v. Radio Station WQBA, 699 So.2d 701 (Fla, 3rd DCA 1997), the court opined that “The doctrine of equitable subrogation was created to afford the courts an avenue to ensure complete justice between parties irrespective of technical legal rules… The policy behind the doctrine is to prevent unjust enrichment by assuring that the party responsible for a debt is ultimately answerable for its discharge…[I]t is a flexible and elastic doctrine.” In the case of a loan-to-P.A. BP, the creditor can argue that the receivables were the working capital of the P.A. and that the physician’s property which was acquired with the distribution (or bonus) from the P.A. and pledged to the bank should, as a matter of equity, be considered as contributed back to the capital of the P.A.   Cf., Farmer’s and Merchants Bank v. Gibson, 7. B.R. 437 (Bankr. N.D. Fla. 1980), reversed because homestead is not subject to marshaling, Gibson v. Farmers and Merchants Bank, 81. B.R. 84 (N.D. Fla. 1986) and Mission Bay Campland, Inc. v. Sumner Financial Corporation, 731 F.2d 768 (11th Cir., 1984) where an insider loan was equitably characterized as a contribution to the capital of the debtor.
     08IRC §83 governs the income taxation of the receipt of property in exchange for services. Deferral grounded in a substantial risk of forfeiture is suspect if the physician controls the corporation so that the risk is not realistic. New IRC §409A is generally effective for compensation deferred after 2004 (and in the case of a funded trust, post 2004 earnings on amounts previously deferred.) It accelerates income tax recognition of the deferred compensation under loan-to-PA BP’s unless specific distribution, funding and election requirements are met. 
     09For a deeper discussion of certain tax and ERISA issues, see Clark and Forman, “Tax and ERISA Considerations Associated With Nonqualified Severance Benefit Plans Sponsored by Professional C Corporations”, (Fla. B. J., January, 2004.) For a discussion of four popular types of A/P plans involving loans to P.A.’s, see Wells and Jovanovich, “Analysis of Asset Protection Plans for Physician Practice Groups”, (Fla. B. J., March, 2004.)
     010IRC §§1(h), 301 and 1368; §301(a)(1) of the Jobs and Growth Tax Relief Reconciliation Act of 2003.
     011See Notice 89-35, 1989-1 C.B. 875, re deductibility of interest payments made by an S corporation.
     012See, Pediatrical Surgical Associates, P.C. v. Commissioner, TC-Memo 2001-81.
     013IRC §1366(d).
     014This is especially true if the creditor’s remedies are limited because the compensation or distribution proceeds are not directly traceable to the purchase of an exempt asset and there is a substantial non-A/P reason for the transaction, such as one of the physicians needs the money for personal reasons or has been advised to diversify his investments because too much of his net worth is tied up in his P.A. stock or prefers to avoid malpractice insurance by funding an escrow account (see note 40 infra).
     015Assume a $100,000, 7% loan to the P.A. is used to pay compensation and that such payment generates additional income and employment taxes of $35,000, but the matching deduction is suspended. The net effect is that the physicians are paying interest on $100,000, but only have $65,000 of assets to invest. Until the suspended deduction may be deducted (e.g., by generating P.A. income which was used to pay the (nondeductible) principal on the loan, thus generating basis in their P.A. stock) the investments made by the physicians would have to earn a 10.77% return to cover the interest due on the loan. (Taxation of the return blurs the analysis.) Note that the tax would be avoided if the physicians practiced via a partnership or as sole proprietors.
     016IRC §163.
     017IRC §264.
     018The IRS might argue that the contractual arrangements between the bank and the P.A. should be considered property which is taxable income for the physician for purposes of IRC §83.
     019IRC §§61 and 108.
     020If the insurance policy is funded too rapidly the first dollars withdrawn or borrowed will be considered earnings, rather than return of capital, and thus will be subject to income tax and a possible 10% penalty. (IRC §72(e)(10), 72(v) and 7702A.) With deferred annuities, a 10% penalty can be imposed if the withdrawals commence before the annuity starting date. (IRC §72(q).) Note also that in order to avoid diminishing the alleged A/P benefits of the lien on the receivables, the bank note is designed to be as close to interest-only as the “anti-evergreen” bank rules permit. (No debt, no lien, no A/P.) Where life insurance treatment is desired, BP’s can be structured to avoid multiple loans by having the physician borrow to purchase a single premium immediate annuity. The annuity distributions are used to pay the life insurance premiums.
     021Although it could be important as a practical matter in some situations, the following discussion does not include the creditor remedy of placing the P.A. or debtor-physician into a Florida receivership or an involuntary bankruptcy (11 U.S.C. §303). Note that if the P.A. files a chapter 11 bankruptcy petition (“Reorganization”), it is likely that the malpractice creditor would be in position to thwart any plan of reorganization which did not provide for full payment over time (“cram down”, 11 U.S.C. §1129(b).)
     022Fla. Stat. §726.108(1)(c) lists certain types of relief the court may grant, including avoidance, attachment, injunction, receivership, and “any other relief the circumstances may require.” The “other relief” provision merely supplements the other relief provisions, and does not create a cause of action against non-transferees. Freeman v. First Union National Bank, 865 So.2d 1272 (Fla. 2004.) A judgment may be entered under Fla. Stat. §726.109(2). Fla. Stat. §222.29 denies any statutory exemption resulting from a fraudulent transfer.
     023Fla. Stat. 726.105(1)(a).
     024Id. Some BP promoters argue that - contrary to the statutory language - the statute is not designed to provide relief for future creditors who are not identified within one year of entering into the BP. There is no support for that proposition in Florida case law. In Friedman v. Heart Institute of Port St. Lucie, Inc., 863 So.2d 189, 192 (Fla. 2003), the Florida Supreme Court analyzed the Florida Uniform Fraudulent Transfer Act, stating “The applicable statutory provisions in this area of the law are exceedingly clear.”
     025Fla. Stat. §726.105(2). The list includes, in relevant part, whether (i) the transfer or obligation was to an insider, (ii) the P.A. had been threatened with suit before the transfer was made or obligation was incurred, (iii) the transfer was of substantially all of the P.A.’s assets, (iv) the P.A. was insolvent or became insolvent shortly after the transfer was made or obligation was incurred, (v) the value received by the P.A. was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred, (vi) the transfer was made shortly before a substantial debt was incurred and (vii) the P.A. transferred essential assets (the receivables) to a lienor (the bank) who transferred the assets to an insider (the physician, by releasing the lien on the insurance policy.) See, In re PSI Industries, Inc., 306 B.R. 377 (Bankr. S.D. Fla 2003) for a discussion of the evidentiary problem. Note also that in proceedings supplementary there is a presumption that a transfer to an insider was fraudulent, thus shifting the burden of persuasion to the transferee. (Treated Timber Products, Inc. v. S & A Associates, 488 So.2d 159 (Fla. 1st DCA 1986.))
     026Fla. Stat. §726.105(1)(b). The statute of limitations for these types of fraudulent transfers is four years. Fla. Stat. §726.110(2).  Paragon Health Services, Inc., v. Cental Palm Beach Community Mental Health Center, Inc., 859 So.2d 1233 (Fla. 4th DCA 2003.) To reduce exposure, the P.A. could get an appraisal of its intangible assets and argue that compensation is adjusted to meet cash-flow. However, the appraisal exacerbates the starting over problem (discussed infra), while adjusting compensation to cash-flow lends support to the creditor’s argument that compensation was a disguised dividend.
     027Cf., In re Galbreath, 286 B.R. 185 (Bankr. S.D. Ga. 2002.)
     028Friedman, note 24, supra. Fla. Stat. §726.106(1) provides another type of fraudulent transfer. In particular, the placing of the lien on the receivables and the payment to the bank are each a fraudulent transfer if (A) the P.A. did not receive “a reasonably equivalent value in exchange” for the lien or payment, as the case may be, and (B) the P.A. was insolvent immediately thereafter. This type of fraudulent transfer does not cover future creditors. Assuming the malpractice event occurred after the BP was installed, the malpractice petitioner would not be an existing creditor who could complain under Fla. Stat. §726.106(1) about the placing of the lien. But the creditor would have a solid argument that any compensation paid to the physician after the cessation of business would meet the statutory requirements.
     029Cf., Friedman, note 24, supra, where the Institute sued the physician for breach of a covenant not to compete. The physician transferred $400,000 to his fiancé and the Institute amended its complaint to include a fraudulent transfer count against the physician and his fiancé. The court denied the physician’s motion for a stay until the underlying case was resolved.
     030Fla. Stat. §726.110(1).
     031Fla. Stat. ‘222.30, which provides a four year statute of limitations.
     032F.S. §222.11.
     033E.g., in the case of in re Stroup, 221 B.R. 537 (Bankr. M.D. Fla. 1997), the court denied a minority-stockholder-physician’s claim that deferred compensation on termination of employment measured as a percentage of the P.A.’s accounts receivables was exempt. The court relied on several theories, one of which was that the payment was akin to a dividend on the physician’s stock in the P.A. Another was that the payment was akin to severance pay, which is not considered exempt. See also, See, e.g., In re Manning, 163 B.R. 380 (Bankr. S.D. Fla. 1994) (compensation paid by wife’s corporation not exempt) and In re Zamora, 187 B.R. 783 (Bankr. S.D. Fla 1995) (attorney’s compensation from his corporation not exempt.)
     034Guaranty Trust & Savings Bank v. United States Trust Co., (103 So. 620, 622 (Fla. 1925.) Fla. Stat. §607.0830 sets general standards for directors, but not officers. Case law, however, is clear that both officers and directors have fiduciary duties to the corporation. See, e.g., Tinwood v. Sun Banks, Inc., 570 So.2d 955, 959 (Fla. 5th DCA 1990.)
     035Guaranty, Id.
     036See, e.g., in re Harrison,216 B.R. 451 (Bankr. S.D. Fla. 1997), in which the court disregarded the lack of control in a 50% stockholder and found that there was no “arms length agreement.”
     037E.g., in Yeager v. Summit Group Central Florida, 654 So.2d 189 (Fla. 5th DCA, 1995) the court held that a creditor of an insolvent corporation who owed a fiduciary duty to such corporation was not entitled to share with the other creditors. At a minimum, an officer or director of an insolvent corporation is precluded from preferring himself to the detriment of other creditors in his dealings with the corporation. Whitley v. Carolina Clinic, Inc. , 455 S.E. 2d 896, 899 (1995). See, also, in re Toy King Distributors, Inc., supra, note 7, at 168, where the court noted that a transfer benefiting a director or officer can be considered a breach of the duty of loyalty even when made for adequate consideration and in good faith; the focus being not on the harm to the corporation, but the benefit that inures to the director or officer.
     038Fla. Stat. §607.06401(3) bans any distribution that would result in the P.A. having a negative net worth or being unable to pay its debts in the ordinary course of business as they came due. Fla. Stat. §607.0834 (the so-called “claw-back” provision) makes the directors who voted or assented to the distribution liable to the corporation. There is a two year statute of limitations. Fla. Stat. §607.06401(4) insulates directors if the net worth determination is made after a procedure involving a valuation of corporate assets. Accordingly, many A/P planners structuring a loan-to-P.A. BP will recommend that the P.A.’s intangible assets be appraised. See, e.g., Wells and Jovanovich, note 9, supra. The claw-back provision could be particularly useful to a creditor if the director assents to a distribution to a stockholder (e.g., of patient records or compensation characterized by the court as an unlawful distribution) after the malpractice judgment has been issued.
     039Fla. Stat. §607.0830 insulates a director from liability for any action he took as such if he performed his duties (i) in good faith, (ii) with ordinary prudence under the circumstances, and (iii) in a manner he reasonably believed to be in the best interests of the corporation. Fla. Stat. §607.0831 further insulates a director unless the director breached his duties (i.e., violated the above standards) and such breach is described in one or more of five categories, three of which might be useful to a creditor. The first relevant category is that the director received an improper personal benefit. In the case of a loan-to-physician BP, the creditor has a strong argument that the P.A.’s guaranty is an improper personal benefit because it violates Fla. Stat. §607.0833, which allows such guaranty only if the board of directors reasonably expects the guaranty to benefit the P.A. Another of the potentially relevant categories is the liability described in Fla. Stat. §607.0834 (discussed in note 38, supra) The third relevant category is that the adoption of the plan was reckless (as defined in the statute) or in bad faith.
     040Fla. Stat. §458.320, entitled “Financial Responsibility,”provides (with certain exceptions) that physicians must either have (i) malpractice insurance coverage of at least $100,000 per claim, with a minimum of $300,000 annual aggregate, (ii) an irrevocable letter of credit in the same amounts, or (iii) an escrow account in the lesser amount. The amounts are raised to $250,000/$750,000 for physicians with hospital privileges. The physician can instead “go bare” by agreeing to pay malpractice judgments up to the relevant amounts, with the penalty of a loss or suspension of his medical license upon failure to pay. (Going bare also requires a notice to patients and the Florida Department of Health.) Because hospitals can be held liable for failure to assure its staff-privileged physicians meet their financial responsibility requirements (Mercy Hosp., Inc. v. Baumgartner, 870 So.2d 130 (Fla. 3rd DCA 2003)), hospitals rarely permit their staff-privileged physicians to go bare. But see, Plantation General Hospital, Ltd. Partnership v. Horowitz, 895 So. 2d 484 (Fla. App. 3rd Dist. 2005), in which the court held to the contrary (i.e., that the physician responsibility statute does not create a private cause of action against the hospital.)
     041Fiduciary liability is joint and several, rather than prorata, exposing Dr. Innocent to liabilities beyond what he received. In re Toy King Distributors, Inc., note 7, supra.
     042See, e.g., Amjad Munim, M.D., P.A. v. Ajar, 648 So. 2d 145 (Fla. 4th DCA 1994) and Laboratory Corp. of America v. Professional Recovery, 813 So.2d 266 (Fla. 5th DCA 2002.)
     044In Myers v. Brook, 708 So. 2d 607 (Fla. App., 2d Dist. 1998) compensation paid to physician-stockholders for services previously rendered to the P.A. were found to be fraudulent transfers. The court also suggested that whether the wages were fraudulent transfers and the amount thereof are probably jury questions.
     045The Bankruptcy statutes were reformed, generally effective for bankruptcies filed after October 17, 2005.    The new rules make bankruptcy a much less viable protection technique for a debtor whose income exceeds the community average. With certain exceptions, such a debtor may not utilize chapter 7, but instead will be pushed into chapter 13. The new chapter 13 rules require the debtor to file and operate under a plan which dedicates all of the debtor’s net income, less reasonable living expenses, over a five year period to the creditors. As a general rule, reasonable living expenses will be determined by IRS tables.
     04611 U.S.C. §727(a)(2). See, e.g., In re Matus, 303 B.R. 660 (Bankr. N.D. Ga., 2004), applying the previous one year rule.
     04711 USC §522(n).
     04811 USC §522(b)(2)(B).  Even if the homestead were acquired more than 1,125 days before the bankruptcy petition, the exemption may not be available beyond the $125,000 limit to the extent of equity associated with a fraudulent conveyance into the homestead within ten years of filing the petition, nor with respect to a debt arising from certain crimes or acts (e.g., an intentional tort or willful or reckless conduct resulting in serious physical injury or death within five years prior to the bankruptcy petition). 11 USC §522(q)(1).
     04911 USC §707(b).  
     050In those cases where the physician prefers to avoid or delay - perhaps to age some fraudulent transfer - filing a chapter 7 petition, the involuntary bankruptcy rules can generate interesting games. The involuntary petition can be filed by one creditor (holding more than $12,300 of undisputed, noncontingent claims) unless there are more than 11 outstanding creditors, in which case three creditors (whose noncontingent, undisputed claims exceed $12,300) must jointly file the petition. 11 USC §303.
     051The court is considered a court of equity when it sits in proceedings supplementary to enforce its own judgment. George E. Sebring Co. v. O’Rourke, 134 So. 556 (Fla. 1931.) Simply put, this means fairness matters. How could it be considered fair in the context of a BP for the bank to get paid out of the receivables, the physician to keep the exempt contract and the creditor/malpractice victim to get nothing?