O'Brien v. AMBS Diagnostics, LLC ( 2019 )

Filed 8/8/19
CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
SECOND APPELLATE DISTRICT
DIVISION TWO
TIMOTHY O’BRIEN, B288072
Plaintiff and Respondent, (Los Angeles County
Super. Ct. No. GC048333)
v.
AMBS DIAGNOSTICS, LLC,
Defendant and Appellant.
APPEAL from an order of the Superior Court of Los
Angeles County. C. Edward Simpson, Judge. Reversed and
remanded.
Woolf & Nachimson, and Benjamin S. Nachimson for
Plaintiff and Respondent.
Butterfield Schechter, Marc S. Schechter, and Paul D.
Woodard for Defendant and Appellant.
******
A judgment creditor sought to collect a money judgment
from a debtor’s individual retirement accounts. Mere weeks after
we ruled in a published decision that the accounts were only
partially exempt from levy pursuant to Code of Civil Procedure
section 704.115, subdivisions (a)(3) and (e)1 (O’Brien v. AMBS
Diagnostics, LLC (2016) 246 Cal. App. 4th 942 (O’Brien II)),2 the
debtor formed a new limited liability company, directed the
company to adopt a 401(k) retirement plan, transferred the
money in his individual retirement accounts to the 401(k) plan,
and claimed that the funds were now fully exempt from levy
under section 704.115, subdivision (a)(1). This appeal presents
two questions: (1) Is a 401(k) plan that a debtor creates and
controls with the avowed purpose of “protect[ing] [his] assets
from creditors,” a plan principally “designed and used for
retirement purposes” (Yaesu Electronics Corp. v. Tamura (1994)
28 Cal. App. 4th 8, 14 (Yaesu); Dudley v. Anderson (In re Dudley)
(9th Cir. 2001) 249 F.3d 1170, 1177 (Dudley)), thereby rendering
the funds in that plan fully exempt from levy, and if not, (2) did
the debtor’s transfer of funds to that 401(k) plan negate the
partially exempt status those funds previously held while in the
individual retirement accounts? We conclude that the answer to
both questions is “no,” reverse the trial court’s ruling declaring
the funds to be fully exempt from levy, and remand so the trial
court can assess the extent of the partial exemption.
1 All further statutory references are to the Code of Civil
Procedure unless otherwise indicated.
2 We previously reviewed the underlying judgment in
O’Brien v. AMBS Diagnostics, LLC (Jan. 7, 2016) B260301
(nonpub. opn.) (O’Brien I).
2
FACTS AND PROCEDURAL BACKGROUND
I. Facts
A. Underlying lawsuit and judgment
Plaintiff and respondent Timothy O’Brien (O’Brien) and
three others formed defendant and appellant AMBS Diagnostics,
LLC (Diagnostics) in 2010. Diagnostics’s business venture
disintegrated into a panoply of lawsuits, including Diagnostics’s
suit against O’Brien for setting up a competing business and
trying to steal Diagnostics’s customers, thereby breaching his
fiduciary duty and intentionally interfering with Diagnostics’s
prospective economic advantage. In that suit, the trial court
ruled that O’Brien had engaged in that misconduct and awarded
$487,977 in compensatory damages and $125,000 in punitive
damages.
The court entered judgment against O’Brien and the LLC
O’Brien used for his competing business in the amount of
$622,957.21.
B. Diagnostics’s initial collection effort
Diagnostics then sought to collect on its judgment by filing
notices of levy against several of O’Brien’s assets, including four
individual retirement accounts then valued at $465,350.04. It is
undisputed that O’Brien had placed the funds in those accounts
“to contribute [to] his retirement.”
O’Brien responded that the individual retirement accounts
were exempt from levy under the exemption for such accounts in
section 704.115, subdivision (a)(3).
The trial court ruled that the funds in O’Brien’s individual
retirement accounts were fully exempt from levy.
We reversed the trial court’s ruling, determining that the
funds were partially exempt because the exemption for
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“individual retirement . . . accounts” in section 704.115,
subdivision (a)(3) exempts funds, pursuant to subdivision (e),
“only to the extent necessary to provide for the support of the
judgment debtor,” his “spouse and dependents” upon retirement.
We remanded the matter back to the trial court to assess, after
looking to a number of enumerated factors, what portion of the
funds in O’Brien’s retirement accounts were “necessary” for these
purposes, keeping in mind his “ability to regenerate retirement
funds” in the years remaining until he retires.
Our opinion was handed down on April 21, 2016.
C. O’Brien’s post-remand acts
Just 18 days after we issued our opinion, O’Brien took
several actions intended, in his own words, “to protect the assets”
in his individual retirement accounts “from [his] creditors.” More
specifically, O’Brien on May 9, 2016, formed a new limited
liability corporation called The Personal Branding Group, LLC
(the LLC). Less than a month later, on June 3, 2016, the LLC
formed a 401(k) plan for the LLC’s “[e]mployees” and then
formally adopted that plan. In adopting the plan on behalf of the
LLC, O’Brien signed both as the LLC’s Managing Member and as
the Trustee of the 401(k) plan. O’Brien then transferred (or
“rolled over”) the money from his individual retirement accounts
into the 401(k) plan. On March 27, 2017, O’Brien dissolved the
LLC.
II. Procedural Background
In October 2017, Diagnostics served a notice of levy on
O’Brien’s funds in the 401(k) plan.
O’Brien responded by claiming that his “repositioning” of
the funds from his individual retirement accounts to the 401(k)
plan rendered the funds fully exempt from levy pursuant to
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section 704.115, subdivision (a)(1), thereby obviating any need for
the trial court to examine the necessity of the funds for his
retirement (as we had ordered in our prior opinion). He also
asserted that his “repositioning” was “not a fraudulent transfer.”
Diagnostics opposed O’Brien’s claim for exemption.
Specifically, Diagnostics argued that (1) the 401(k) plan was not
exempt from levy under section 704.115 because it was neither
designed nor used for retirement purposes, (2) O’Brien’s
purported rollover of funds was invalid because he did not meet
the qualifications set forth in the 401(k) plan itself for such a
rollover, and (3) transferring the money from a partially exempt
individual retirement account to a 401k plan could not, in any
event, confer fully exempt status upon the funds.
After entertaining oral argument, the trial court issued a
written ruling concluding that the money O’Brien had
transferred to the 401(k) plan was fully exempt from levy. In
reaching this conclusion, the court declined to invalidate the
rollover as a fraudulent transfer because “the circumstance[s] of
[the] rollover . . . [did] not meet the preponderance of the evidence
test of a fraudulent transfer.” The court next disregarded
O’Brien’s failure to meet the 401(k) plan’s qualification standards
because the plan, by its own terms, could be retroactively
amended; thus, the court reasoned, O’Brien could amend the
401(k) plan to change the qualifications requirement in a manner
that would retroactively convert his invalid rollover into a valid
one. The court further found that “[i]t [was] clear from the facts
that [O’Brien’s] funds in the [individual retirement accounts]
were for retirement purposes.” (Italics added.) Because the
funds were now situated in a 401(k) plan whose contents were
fully exempt from levy, the court concluded, the court upheld
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O’Brien’s claim of exemption as to all of the funds in the plan and
without any need to demonstrate what portion of those funds
were necessary for his retirement.
Diagnostics filed this timely appeal.
DISCUSSION
Although O’Brien and Diagnostics raise a number of issues
on appeal, we conclude that the exempt status of the funds
O’Brien transferred into the 401(k) plan boils down to two
questions: (1) Does the 401(k) plan adopted by the LLC in this
case qualify as a “[p]rivate retirement plan[]” within the meaning
of section 704.115, subdivision (a)(1), and if not, (2) what is the
exempt status of the funds as they now sit in a 401(k) plan that
does not qualify for a full exemption under California law?
I. Is the 401(k) Plan a “Private Retirement Plan” Fully
Exempt from Levy under Section 704.115, Subdivision
(a)(1)?
A. Pertinent law
California’s Enforcement of Judgments Law (§ 680.010 et
seq.) generally authorizes a creditor holding a “money judgment”
to “enforce[]” that judgment against “all property of the judgment
debtor” through a “writ of execution.” (§§ 695.010, subd. (a),
699.710.) However, to implement our Constitution’s command
that “a certain portion of the homestead and other property of all
heads of families” be “protect[ed], by law, from forced sale” (Cal.
Const., art. XX, § 1.5), our Legislature has exempted various
items of property from levy by creditors with money judgments.
(See §§ 704.010-704.210 [setting forth exemptions]; see generally,
Sourcecorp, Inc. v. Shill (2012) 206 Cal. App. 4th 1054, 1058
(Sourcecorp) [so noting].) The debtor bears the burden of
establishing that a particular exemption applies. (§ 703.580,
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subd. (b); Schwartzman v. Wilshinsky (1996) 50 Cal. App. 4th 619,
626 (Schwartzman).)
Section 704.115 exempts “[a]ll amounts held, controlled, or
in process of distribution by a private retirement plan”
(§ 704.115, subd. (b)), but draws a distinction between two types
of “private retirement plans” and grants each of them a different
type of exemption. (McMullen v. Haycock (2007) 147 Cal. App. 4th
753, 755-756 (McMullen) [so noting].) Amounts held in “[p]rivate
retirement plans” “established or maintained by private
employers or employee organizations, such as unions,” including
“closely held corporations,” are fully exempt from levy.3
(§ 704.115, subds. (a)(1) & (b); Lieberman v. Hawkins (In re
Lieberman) (9th Cir. 2001) 245 F.3d 1090, 1095; In re Cheng (9th
Cir. 1991) 943 F.2d 1114, 1116-1117.) By contrast, amounts held
in “[s]elf-employed retirement plans” or “individual retirement
. . . accounts” are exempt from levy “only to the extent necessary
to provide for the support of the judgment debtor when the
judgment debtor retires and for the support of the spouse and
dependents of the judgment debtor.” (§ 704.115, subds. (a)(3) &
(e); Schwartzman, supra, 50 Cal.App.4th at pp. 624-625.)
Critically, however, neither type of exemption is available
unless the plan or account holding the funds was, at the time of
the levy, “principally” or “primarily” “designed and used for
retirement purposes.” (Yaesu, supra, 28 Cal.App.4th at p. 14; In
re Daniel (9th Cir. 1985) 771 F.2d 1352, 1356-1357 (Daniel),
disapproved on other grounds in Patterson v. Shumate (1992) 504
U.S. 753, fn. 1; Dudley, supra, 249 F.3d at p. 1177; Jacoway v.
3 “Profit-sharing plans designed and used for retirement
purposes” are also fully exempt (§ 704.115, subd. (a)(2)), but are
not at issue in this case.
7
Wolfe (In re Jacoway) (Bankr. 9th Cir. 2000) 255 B.R. 234, 239
(Jacoway); see also § 703.100, subd. (a)(1) [where, as here, there
is no lien and the levy predates any court proceedings, “the
determination whether property is exempt shall be made [at]
. . . [t]he time of levy on the property”]; Imperial Bank v. Pim
Electric, Inc. (1995) 33 Cal. App. 4th 540, 552 [same].) This
baseline requirement of a bona fide retirement purpose seeks to
accommodate the constitutional mandate to “safeguard a source
of income for retirees at the expense of creditors” (Yaesu, at p.
13), while at the same time guarding against the over-shielding
of assets should the exemption apply to “anything a debtor
unilaterally chooses to claim” or label “as intended for retirement
purpose.” (In re Rogers (Bankr. S.D. Cal. 1998) 222 B.R. 348, 351;
In re Barnes (Bankr. E.D. Cal. 2002) 275 B.R. 889, 897; Phillips
v. Mayer (In re Phillips) (Bankr. N.D. Cal. 1998) 218 B.R. 520,
522 [“name” alone is insufficient to trigger exemption].)
In assessing whether a plan or account was principally or
primarily designed and used for retirement purposes, courts are
to look at the totality of the circumstances. (Cunning v. Rucker
(In re Rucker) (9th Cir. 2009) 570 F.3d 1155, 1161 (Rucker);
Dudley, supra, 249 F.3d at p. 1177; In re Bloom (9th Cir. 1988)
839 F.2d 1376, 1379 (Bloom).) Relevant circumstances include
(1) the “debtor’s subjective intent” in designing and using the
plan or account (Rucker, at p. 1162; Simpson v. Burkart (In re
Simpson) (9th Cir. 2009) 557 F.3d 1010, 1018); (2) the
“chronology” or timing of the creation of the plan or account vis-à-
vis other events (Yaesu, supra, 28 Cal.App.4th at pp. 14-15); (3)
the degree of control the debtor maintains “over contributions,
management, administration, and use of funds” in the plan or
account (Schwartzman, supra, 50 Cal.App.4th at p. 629); (4)
8
whether the debtor violated or complied with Internal Revenue
Service (IRS) rules or the plan’s rules in contributing to the plan
(Rucker, at p. 1162; Bloom, at p. 1379); and, if the debtor
withdraws money from the plan or account, (5) whether those
funds were used for retirement or instead some other, non-
retirement purpose (Dudley, at p. 1177; Daniel, supra, 771 F.2d
at pp. 1354-1357).
Whether a plan or account was principally or primarily
designed and used for retirement purposes is a question of fact.
(Schwartzman, supra, 50 Cal.App.4th at pp. 626, 628; Jacoway,
supra, 255 B.R. at p. 237.) Although we ordinarily review a trial
court’s resolution of factual questions for substantial evidence
(People v. Superior Court (Jones) (1998) 18 Cal. 4th 667, 681), we
independently review whether the trial court applied the correct
legal standard (Hoover v. American Income Life Ins. Co. (2012)
206 Cal. App. 4th 1193, 1202).
B. Analysis
The trial court found that the “funds in [O’Brien’s
retirement accounts] were for retirement purposes.” (Italics
added.) However, as explained above, the pertinent legal
question is whether the 401(k) plan was principally or primarily
designed and used for retirement purposes. An inquiry into the
initial purpose of the funds is legally distinct from an inquiry into
the purpose of a plan or account where the funds were
subsequently placed; otherwise, funds that were initially placed
in a plan or account for retirement purposes would be forever
exempt; however, the law, as noted above, is to the contrary.
(E.g., Daniel, supra, 771 F.2d at pp. 1354-1357 [funds withdrawn
from retirement account and used to finance a home purchase do
not have a “retirement purpose”]; In re Marriage of LaMoure
9
(2013) 221 Cal. App. 4th 1463, 1478-1479 [funds originally
invested for retirement but later “funnel[ed] . . . through [a]” plan
“to secret and shield” the funds from a spouse were “not used for
a retirement purpose”].) Thus, by looking to the initial purpose of
the funds rather than the purpose behind the 401(k) plan, the
trial court applied the incorrect legal standard and its factual
finding based on that incorrect standard is irrelevant.
Because the facts regarding the circumstances relating to
the creation and use of 401(k) plan are undisputed, we
independently assess whether the 401(k) plan at issue in this
case was principally or primarily designed and used for
retirement purposes. (Boling v. Public Employment Relations
Bd. (2018) 5 Cal.5th 898, 912 (Boling) [“the application of law to
undisputed facts ordinarily presents a legal question that is
reviewed de novo”].) Applying each of the pertinent factors to the
undisputed facts (that is, all of the factors except the use of any
withdrawn funds because O’Brien never withdrew any money
from the 401(k) plan), those factors all point to the conclusion
that the 401(k) plan was not principally or primarily designed
and used for retirement purposes.
O’Brien freely admitted his subjective intent for creating
the 401(k) plan and in transferring the funds in his individual
retirement accounts into that plan—namely, “to protect the
assets” in those accounts “from [his] creditors.” “[T]he shielding
and hiding of assets from creditors is clearly not a ‘use for
retirement purposes.’” (Daniel, supra, 771 F.2d at p. 1358;
Dudley, supra, 249 F.3d at p. 1177 [same]; Bloom, supra, 839
F.2d at p. 1378.)
The chronology of events confirms O’Brien’s subjective
intent. O’Brien created the LLC mere weeks after we declared
10
that the funds in his individual retirement accounts were not
fully exempt. Soon thereafter, he created the 401(k) plan,
adopted the plan and transferred his money from those accounts
into the plan. Once his aim was accomplished, he dissolved the
LLC.
What is more, O’Brien in undertaking these various acts
maintained almost total control over his “contributions,
management, administration and use of [his] funds”: He created
the LLC and named himself as managing member; he created the
401(k) plan and named himself trustee; he adopted the 401(k)
plan for the LLC; and he signed the adoption resolution in both of
the above stated capacities.
The 401(k) plan also did not comply with the plan’s rules by
purporting to transfer money into the 401(k) plan despite not
meeting the plan’s qualifications for doing so. This also violates
the IRS rules. (See In re Bell & Beckwith (6th Cir. 1993) 5 F.3d
150, 152-153 [contributions to a profit-sharing plan in violation of
the plan’s terms are void ab initio, and hence do not qualify for
ERISA protection under the IRS’s rules].) Because we must focus
on the purpose at the time of levy, it does not matter that the
401(k) plan might be retroactively amended at some point in the
future to modify its qualification requirements.
O’Brien resists this conclusion with two further arguments.
First, he argues that the trial court’s finding that his
rollover was not a “fraudulent transfer” forecloses us from finding
that the 401(k) plan was not principally or primarily designed
and used for retirement purposes. This finding, O’Brien
continues, is supported by Gil v. Stern (In re Stern) (9th Cir.
2003) 345 F.3d 1036 (Gil), in which the Ninth Circuit held “‘that
the purposeful conversion of nonexempt assets to exempt assets
11
on the eve of bankruptcy is not fraudulent per se.’” (Id. at p.
1043.) Thus, O’Brien concludes, his transfer of partially exempt
assets from his individual retirement accounts to the fully
exempt 401(k) plan is also not fraudulent. O’Brien’s argument
mixes apples and oranges. Both the trial court’s finding, and Gil,
addressed whether the debtor’s movement of funds was a
fraudulent transfer within the meaning of the Uniform Voidable
Transactions Act (Civ. Code, § 3439 et seq.). However, whether a
transfer is “fraudulent . . . does not dispose of the question of
whether [a] plan was used for retirement purposes.” (Daniel,
supra, 771 F.2d at p. 1358.)
Second, O’Brien contends that he never withdrew any
funds from the 401(k) plan and thus the funds retained the same
character they had while in his individual retirement accounts—
namely, that they were for retirement purposes. However,
O’Brien’s decision not to withdraw the funds from the 401(k) plan
does not “conclusively establish[] a primary retirement purpose”
for the plan. (Rucker, supra, 570 F.3d at p. 1161 [“we are
. . . aware of no precedent stating that the lack of withdrawals or
loans in itself conclusively establish a primary retirement
purpose”].) At most, and like the debtor in Rucker, O’Brien has
established a secondary retirement purpose that has been
eclipsed by his principal and primary purpose of creating the
401(k) plan to, in his own words, “protect [his] assets” “from [his]
creditors.”
II. What Is the Exempt Status of the Funds?
Because, as we have concluded, the 401(k) plan was not
principally or primarily designed and used for retirement
purposes, such that the plan is not an exempt plan within the
meaning of section 704.115, we must next ask: Did O’Brien’s
12
transfer of the partially exempt funds out of his individual
retirement accounts into this non-exempt 401(k) destroy the
partially exempt status of those funds or leave it intact? Because
this question turns on the application of the law to undisputed
facts, our review is de novo. (Boling, supra, 5 Cal.5th at p. 912.)
The Enforcement of Judgments Law adopts a default rule
that the exempt status of funds will follow those funds as they
are moved as long as the funds themselves can be traced back to
an exempt source. (§ 703.080, subd. (a) [“a fund that is exempt
remains exempt to the extent that it can be traced into deposit
accounts or in the form of cash or its equivalent”]; see also id.,
subds. (b) & (c).) However, “particular exemption[s]” may
override this default rule and preclude tracing. (Id., subd. (a)
[noting that tracing rule is “[s]ubject to any limitation provided in
[a] particular exemption”].)
We conclude that the default tracing rule applies here, and
that the funds O’Brien transferred from his individual retirement
accounts to the 401(k) plan retained the partially exempt status
they acquired when initially held in those accounts. This
conclusion is all but dictated by McMullen, supra, 147
Cal. App. 4th 753. There, the debtor transferred funds from “[a]
fully exempt private retirement plan” into a partially exempt
individual retirement account. (Id. at p. 757) Reasoning that
“[t]he goal of protecting retirement assets is best met by applying
the [default] tracing [rule] liberally to allow a debtor to trace
funds in a manner that best protects his or her assets,” McMullen
held that “the exempt private retirement plan funds retained
their full exemption under section 704.115 . . . after being rolled
over into the” individual retirement account. (Id. at p. 760.)
Because O’Brien, like the debtor in McMullen, also moved his
13
funds from a more exempt placement (here, the partially exempt
individual retirement account) to a less exempt placement (here,
the non-exempt 401(k) plan), McMullen’s logic and holding apply
with equal force here.
Diagnostics resists this conclusion. The closest support we
can find for its position is In re Mooney (Bankr. C.D. Cal. 2000)
248 B.R. 391 (Mooney). Mooney, which predated McMullen, held
that a debtor’s transfer of funds from a fully exempt retirement
plan to a partially exempt individual retirement account caused
the funds to lose their fully exempt status because, in that court’s
view, the statutory language limiting the exemption for funds in
an individual retirement account to those funds “necessary” for
support (that is, section 704.115, subdivision (e)) constituted an
exemption-specific override. (Id. at pp. 395-400.)
Mooney does not alter our conclusion regarding the
applicability of the default tracing rule in this case for three
reasons. First, Mooney’s conclusion rested on the exemption-
specific override applicable to money that is placed in individual
retirement accounts. In this case, however, O’Brien moved his
money from such accounts into a 401(k) plan that we have
determined is, on the facts of this case, not exempt. Because
there is no exemption-specific override for such non-exempt
funds, Mooney’s reason for refusing to apply the default tracing
rule does not apply in this case. Second, we agree with McMullen
that Mooney was wrongfully decided. McMullen considered but
ultimately rejected Mooney’s reasoning because it could “see no
policy reason to extinguish the full exemption [attaching to funds
in a 401(k) plan] simply because the assets are deposited in an
[individual retirement account] rather than in a safe deposit box
or under a mattress.” (147 Cal.App.4th at p. 760.) We are
14
persuaded by this reasoning. Lastly, a ruling that the partial
exemption attaching to the funds in O’Brien’s individual
retirement accounts are automatically obliterated because he
transferred them to a non-exempt 401(k) plan is inconsistent
with the rule that we must construe exemptions “in the favor of
the debtor” (Sourcecorp, supra, 206 Cal.App.4th at p. 1058), and
would effectively grant Diagnostics an unanticipated (and, under
the law detailed above, unwarranted) windfall.
Consequently, the funds now sitting in the 401(k) plan
must still be evaluated to determine what portion of them is
“necessary to provide for the support of” O’Brien when he “retires
and for the support of the spouse and dependents” of O’Brien
(§ 704.115, subd. (e))—in other words, to undertake the inquiry
for which we remanded this case previously.
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DISPOSITION
The order is reversed and remanded. The trial court’s
ruling that the funds transferred from O’Brien’s individual
retirement accounts to the 401(k) plan are fully exempt is
reversed. Because those funds retain their partially exempt
status, we remand for the trial court to undertake the inquiry
specified in section 704.115, subdivision (e) as well as in our prior
decision in O’Brien II, supra, 246 Cal.App.4th at pp. 950-951.
The parties are to bear their own costs on appeal.
CERTIFIED FOR PUBLICATION.
______________________, J.
HOFFSTADT
We concur:
_________________________, Acting P.J.
ASHMANN-GERST
_________________________, J.
CHAVEZ
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