Via the Florida Asset Protection Blog, I came across the case of Leo v. Powell (In re Powell), (Bankr. N.D. Ala., April 20, 2005). As a matter of black letter law, the principles upon which the case rests seem to be rather non-controversial. However, a close reading of the facts suggest that the case may have been either wrongly decided or poorly argued by the trustee in bankruptcy.
John David Powell filed for Chapter 7 bankruptcy protection. Among his assets was a 15% interest, as a limited partner, in a family limited partnership that had a net asset value of approximately $2M. The bankruptcy trustee sought to have the assets of the partnership either sold and divided or partitioned under relevant provisions of the Alabama Code.
Quite correctly, the Bankruptcy Court turned aside the specific request made by the trustee holding that the asset in the bankruptcy estate was Powell's partnership interest, not some interest in the underlying assets. In relating the facts of the case, however, something rang false.
The debtor, his brothers, and a trust for the settlors' grandchildren held 85% of the interests in the partnership. The settlors, the debtor's parents, held the remaining 15% of the interests. However, the distributions that went to the parents/settlors were grossly disproportionate to their percentage ownership of the limited partnership. While this may have been justified due to services that they rendered to the partnership, the point was never examined.
Compare the silence in Powell to the way the court addressed a similar issue in Movitz v. Fiesta Investments, LLC. (Discussed here.) It is all well and good to conclude, as the court did in Powell, that the assets of an entity belong to the entity and cannot be attached by creditors of one of the owners of the entity. But where the entity is controlled by a friendly family member and there is evidence that distributions are possibly being made to frustrate creditors (as would be the case if, without any other factual basis, disproportionate distributions were made to non-debtor family members), the court should be able to step in to protect the rights of the creditors. The opinion is silent as to the reason that this was not done.
I don't think that, based on the opinion, we can say definitively that the outcome of the case is wrong. First, the question as to disproportionate distributions seems not to have been raised by the trustee, as was the case in Fiesta Investments. Second, because the partnership did require active management, it is possible that the distributions were justified, even though they were disproportionate to the stated interests of the partners. Of course, since the court never focused on the question, we may never know what answer it might have given.