The bankruptcy courts have a long history of being willing to use their judicial power under the Bankruptcy Code to prevent perceived efforts by debtors to inappropriately shield their assets from creditors. This is true even when the debtors employ structures and devices that are complex and crafted in seeming compliance with applicable law. A recent example of this judicial scrutiny is reflected in Bankruptcy Judge Barbara Houser’s June 29, 2016 decision regarding the claimed exemption of offshore annuities by Samuel Evans Wyly.

Wyly commenced his bankruptcy case after a $123 million judgment was rendered against him in a securities fraud action brought by the SEC. The alleged securities fraud involved transactions undertaken by a variety of offshore trusts and offshore corporations controlled by Mr. Wyly and his brother (since deceased).

Wyly’s offshore entities were also the subject of litigation in the bankruptcy court regarding IRS claims for alleged tax evasion. Wyly’s objections to the IRS tax claims became the subject of a lengthy trial and a 400+ page decision by the bankruptcy court in May 2016.

Judge Houser’s most recent decision involves litigation over several exemptions claimed by Mr. Wyly under Texas law. In particular, Wyly asserted that future payments due him under a series of private annuities from the offshore corporations were exempt under Texas law. These claims of exemption were disputed by the SEC and the Official Unsecured Creditors Committee.

The structure of the various annuity transactions was quite complex. Beginning in 1992, Wyly and his brother established 16 offshore trusts and 38 offshore corporations owned by those trusts. Both the trusts and the corporations were created predominately in the tax haven jurisdiction of the Isle of Man. Wyly transferred assets of substantial value, directly or indirectly, into those offshore corporations in return for private annuities promising a series of future payments to Wyly.

As of the date of his bankruptcy petition, Wyly had received more than $282 million in annuity payments. However, he had also forgiven an additional $61 million in annuity payments and did not expect to receive a further $76 million in payments due to him because the obligated offshore corporations had become insolvent as a result of financing Wyly family lifestyle expenses.

In his motion for summary judgment, Wyly argued that the policy for liberal application of exemption statutes and the doctrine of plain meaning construction required a decision that the offshore annuities were fully exempt under Texas law. The SEC, on the other hand, argued in its cross-motion for summary judgment that, as “self-settled” instruments, the annuities were non-exempt. And the Creditors Committee argued that Wyly’s continuing control over the offshore annuity obligor’s prevented the exemption.

The court began by taking judicial notice of the various findings of fact and conclusions of law contained in its earlier decision on the IRS tax claims. The Court then framed the question at issue as “whether the Offshore Annuity payments are ‘benefits … to be provided to [a] … beneficiary under … an annuity … used by an … individual’ that is exempt in an unlimited amount under Texas law.” And paraphrasing, the Court then asked “are the Offshore Annuity Payments the type of benefit that the Texas legislature intended to exempt from the claims of [Wyly’s] creditors?”

At the outset, the court noted that no party had identified a controlling precedent and the court had likewise not found one. The court rejected Wyly’s position that “the very unique circumstances surrounding his establishment of, control over, and manipulation of the relevant IOM trusts, Annuity Obligor’s, and Nevada corporations are irrelevant.” The court also rejected the SEC’s notion that all self-settled instruments are non-exempt.

The issue that ultimately seemed to drive the court’s decision to reject the claimed exemption was Wyly’s continued control over the annuity obligors. While the agreements provided that Wyly, as the annuitant, would retain no ongoing control, that is not in fact the way the transactions operated. Management of the offshore corporations that were annuity obligors conducted the operations of those corporations in accordance with the expressed “wishes” of Mr. Wyly. The court found that Wyly continued to control the assets purchased by the various annuity obligors and decided which members of Wyly’s family got to use or enjoy possession of those assets.

The court found that the annuities actually served as a means to accumulate substantial wealth offshore and to support the lavish lifestyle of Wyly’s family, with little regard for the long-term impact on the annuity obligor’s duty to honor their contractual promises of annuity payments.

Finally the court held that the annuities did not meet the statutory requirements of Texas law in that they were never expected to honor their alleged obligation to pay fixed sums to Wyly. The court found that fact was demonstrated by, among other things, Wyly’s willingness to forgive substantial annuity obligations and to render annuity obligors insolvent through actions he directed.

As the court concluded, debtors should not be permitted to manipulate their assets in such a way that they continue to enjoy the benefits of the assets while simultaneously shielding those assets from creditors. Thus, even with carefully crafted instruments, a debtor’s designs can be frustrated when those instruments operate to wrongfully place assets beyond the reach of creditors.