Rigby v. Mastro (In re Mastro), 465 B.R. 576 (Bankr. W.D. Wash. 2011), Adversary No. 09-01439-MLB, Bankruptcy No. 09-16841 (Ch. 7), Hon. Marc Barreca. Appeal history: Mastro v. Rigby, 764 F.3d 1090 (9th Cir. 2014).

Issue

Can a layered structure — an irrevocable trust, an offshore trust, and a set of Delaware series limited liability companies — keep assets away from creditors when the layers are built after the owner is already insolvent?

And can a spouse who says she knew nothing about any of it be held personally liable for what went through it?

The Western District of Washington answered both questions after a bench trial that ran from April to July of 2011.

Case Summary

Michael Mastro developed Seattle real estate for forty years and ran a substantial hard money lending operation alongside it. Hard money loans are loans too risky for a conventional lender, and his were typically secured by second or third position deeds of trust on other developers’ projects.

By 2008 the model had stopped working. His borrowers could not pay. His second and third collateral positions had collapsed in value. He was running roughly $2.5 million a month in negative cash flow and owed about $100 million to a group of private lenders he called “Friends and Family,” all payable on demand.

The court made a finding that decides most of this case. Mastro became insolvent sometime before August 21, 2008, and stayed insolvent until the involuntary petition was granted a year later. He failed all three tests — unreasonably small capital, inability to pay debts as they came due, and liabilities exceeding assets. His own financial statements showed a net worth of $125.6 million at the end of 2008. His amended bankruptcy schedules, filed nine months later, showed negative $196.4 million.

Now hold that August 21, 2008 date against what he built.

Layer one — the irrevocable trust

On August 21, 2008 — the same day — Mastro and his wife Linda formed the Mastro Irrevocable Trust, with Mastro and their son Michael K as co-trustees. They moved three unencumbered houses into it, valued in the trust documents at $23.7 million. No consideration was paid. They were both named beneficiaries.

On September 30 Mastro wrote to his Friends and Family lenders that “our organization is strong and healthy.” Ten days later he rescinded his policy of repaying those loans on demand.

Layer two — the offshore trust and the series LLCs

On October 10, 2008, two months after the irrevocable trust, Mastro formed the LCY Trust. Compass Trust Corporation, a Belizean entity, was trustee. Compass S.A., also Belizean, was protector. The trust owned four Delaware limited liability companies: LCY, LLC, and three series — Series Home, Series Jewelry, and Series Automobiles.

Into those went the Medina residence, a Rolls Royce, seven pieces of jewelry including a 15.93 carat ring and a 27.80 carat ring, and roughly $1 million in cash in an account that never appeared on a bankruptcy schedule. No consideration was paid for any of it.

Here is the wiring that mattered. From the opinion:

“Mastro was the one-man advisory committee for Compass S.A., and under the terms of the LCY Trust agreement, the advisory committee controlled Compass S.A. who, in turn, controlled the trustee, Compass Trust Corporation. Thus, Mastro had effective control over the LCY Trust and all its assets.”

And, separately: “The LCY Trust was arranged such that Mastro had the unilateral ability to cause all of the trust assets to be distributed to himself or in any other manner that he directed at any time.”

After the transfers, nothing in their lives changed. The court found they “continued to live in the Medina Residence, possess their jewelry, drive the Rolls Royce and spend the LCY Account funds on themselves” — on luxury cars, designer clothing, ski trips, travel to Europe, gold, and lawyers.

Layer three — the paper encumbrance

In February 2009 a $12 million promissory note was executed in favor of a Monaco proprietorship, secured by a deed of trust recorded against the Medina residence. No new money was advanced. The court called the transaction a sham and found that recording the deed of trust “was intended by Mastro to hinder, delay or defraud his creditors by giving the appearance that the Medina Residence was encumbered for a $12,000,000 obligation while it really was not.”

A supporting memorandum of understanding was back-dated to December and faxed to Monaco in the middle of the night for a signature. A reconveyance in the file turned out to be a forgery.

Around the same time the couple sold three cars to a Bellevue dealership for roughly $415,000 and immediately bought them back as used vehicles. In March and April, Mastro bought 100 gold bars for $99,300 and had them delivered to the house. They were never scheduled.

Result

The court avoided the transfers on parallel grounds and entered judgment against multiple parties.

The transfers into both trusts were void as transfers into a self-settled trust under RCW 19.36.020, and independently avoidable as fraudulent transfers under 11 U.S.C. §§ 544, 548(a)(1)(A)-(B), 548(e), and RCW 19.40.041(a)(1)-(2). The court held both grounds applied to the irrevocable trust and to the LCY Trust.

It also closed a clever argument. Debtors sometimes reason that if a transfer is void under RCW 19.36.020, nothing was ever conveyed, so there is no transfer for a trustee to avoid. Washington rejected that in Wiswall v. Wallaert, 149 B.R. 665 (Bankr. W.D. Wash. 1992), and the Mastro court applied it again.

Linda was held individually liable on two independent theories. As a subsequent transferee under 11 U.S.C. § 550(a)(2), because under the Ninth Circuit’s dominion test she had “the right to put the money to one’s own purposes” — she was a signer on the unscheduled account and wrote checks on it. And as a person “for whose benefit such transfer was made” under § 550(a)(1), because she was a named beneficiary of both trusts. The Ninth Circuit describes the resulting judgment as turnover of specified personal property, including the two large diamond rings and the gold bars, “along with gold bars and money worth $1,394,406.00.”

Her separate property defense failed twice over. The 1989 premarital agreement required the couple to open two specific accounts — one funded at $200,000 a year, one at $5,000 a month — so community property would accumulate somewhere traceable. They never opened either one. Under In re Marriage of Fox, 58 Wash. App. 935, 795 P.2d 1170 (1990), a court is not bound to enforce a premarital agreement the parties did not mutually observe, and the burden sits on the spouse seeking to enforce it. The court held the agreement abandoned and rescinded. Independently, Linda could not trace. Property acquired during marriage is presumed community property, rebuttable only by clear and convincing evidence, and separate property stays separate only “so long as it can be clearly traced and identified.” Her agreement listed “jewelry” at a million dollars without describing a single piece.

The court also found her “a witness lacking veracity,” noting she disavowed at trial documents she had admitted signing in deposition and that portions of her sworn declarations “proved to be utterly false.” A partial summary judgment she had won on the rings in June 2010 was vacated a year later on that basis.

Michael K, the son, was held liable as an initial transferee for the $23.7 million transferred into the irrevocable trust, less $750,000 and $8,358,990 the trustee recovered from selling two houses. But following Paloian v. LaSalle Bank, N.A., 619 F.3d 688 (7th Cir. 2010), the court held he was liable solely in his capacity as co-trustee and not personally — noting he received no benefit and participated only because of his relationship with his father.

The Belizean entities defaulted. They were sanctioned $1,000 a day for refusing to cooperate in discovery, $402,000 accrued as of July 1, 2011, and Compass Trust Corporation was liable as an initial transferee in its capacity as trustee.

What happened on appeal

Linda appealed, then disappeared. She was eventually found living in France, was indicted on criminal bankruptcy charges arising from this proceeding, and a French Court of Appeal denied United States extradition requests.

The district court dismissed her appeal under the fugitive disentitlement doctrine. In Mastro v. Rigby, 764 F.3d 1090 (9th Cir. 2014), the Ninth Circuit reversed, holding the doctrine was too blunt an instrument on these facts, and remanded for the district court to consider the merits. It expressly declined to reach the merits itself.

So the findings described above are the bankruptcy court’s findings, and as far as I can determine they have not been reviewed on the merits by any appellate court. I have not located a published decision on remand. I cite this case for how a Washington court reasons through a layered structure, not as settled appellate law.

Asset Protection Summary

Four things failed here, and each one is something a client can control.

Timing failed. Every protective layer was built after insolvency — the irrevocable trust on the exact day the court identified as the boundary. Nothing fixes this. A structure funded by an insolvent debtor who is dodging demand notes is not protection; it is a second cause of action.

Control failed. Mastro sat on a one-man advisory committee that controlled the protector, which controlled the trustee. The court found effective control and a unilateral power to distribute everything back to himself. A structure only separates you from your assets to the extent someone genuinely independent stands between you and them. This is the first thing I look for when I review an existing offshore structure, because clients are nervous about giving up control and some structures are sold with a control path back built in. The Andersons made the same mistake in FTC v. Affordable Media, LLC, 179 F.3d 1228 (9th Cir. 1999): they served as protectors of their own trust, and they were jailed for civil contempt.

Consideration and documentation failed. Every transfer was for free. The February note was a sham. The back-dated memorandum and the forged reconveyance did more damage than the transfers themselves.

Conduct after the transfer failed. They kept the house, the jewelry, the car, and the money. A court reads that as evidence the transfer was never real.

The series structure is worth a separate word, because series LLCs are being marketed hard right now. Search this opinion for a holding that turns on the series. There is not one. The court treated the entities as a conduit and avoided the transfers. A series LLC segregates liability between assets. It does not answer whether you were permitted to put the asset in there in the first place.

The same is true of Belize. No question of Belizean law was ever reached. A foreign jurisdiction only protects you if a creditor has to litigate there, and a creditor only has to go there if the transfer into the structure was clean when it was made.

Takeaway

No structure signed in August 2008 would have saved Michael Mastro. Not a Cook Islands trust, not the Bridge Trust®, not anything. I would rather say that plainly than let anyone read this review as a sales argument.

What this case is really about is the man he was in 2004, when the market was fine, the loans were performing, and no one had sued him. That version of him had every option. He could have separated operating risk from personal wealth at a time when there was no creditor to hinder, no insolvency to prove, and no badges of fraud to find — and ended up with an unremarkable structure nobody ever looked at twice.

He waited. The record of what he did after the window closed runs to a twenty-two thousand word opinion.

Two structural differences are worth naming, because they are the two findings the court convicted him on. A properly built structure does not let the person who funded the trust control the protector; the Trust Protector is independent, and the settlor cannot declare the shift to foreign administration. And because a trust registered offshore from inception is already foreign, nothing is transferred at the moment of crisis — the fraudulent transfer question was answered years earlier, when there was no creditor in the picture.

I cannot promise anyone an outcome, and I will not. What timing changes is the position you negotiate from — whether a creditor’s attorney is looking at a clean transfer made years before any claim, or at a timeline like this one.

Having built the second kind of case for a living, I know which one I would rather be looking at from the other side.

Structure before stress.

Authorities

Rigby v. Mastro (In re Mastro), 465 B.R. 576 (Bankr. W.D. Wash. 2011)
Mastro v. Rigby, 764 F.3d 1090 (9th Cir. 2014)
Wiswall v. Wallaert, 149 B.R. 665 (Bankr. W.D. Wash. 1992)
Paloian v. LaSalle Bank, N.A., 619 F.3d 688 (7th Cir. 2010)
In re Marriage of Fox, 58 Wash. App. 935, 795 P.2d 1170 (1990)
RCW 19.36.020; RCW 19.40.021; RCW 19.40.041(a)(1)-(2)
11 U.S.C. §§ 544, 548(a)(1), 548(e), 550(a)(1), 550(a)(2)

Note on the opinion: 465 B.R. 576 is reported, though footnote 1 states the disposition was not designated for publication, and bankruptcy court decisions are persuasive rather than binding. The Ninth Circuit reinstated Linda Mastro’s appeal in 2014 and remanded for merits review; I have not located a published decision on remand.

Resources

Brian T. Bradley, Esq. is licensed in Washington, Oregon, and California and represents clients nationwide. Request a legal consultation.

General educational information, not legal advice. No attorney-client relationship is formed by reading this article.

In re Mastro (Bankr. W.D. Wash. 2011) — Case Review

In re Mastro (Bankr. W.D. Wash. 2011) — Case Review

Issue