O'Brien v. AMBS Diagnostics, LLC

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).

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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.

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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

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(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

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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

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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

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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

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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

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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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