For lawyers who defend corporate directors and officers against breach of fiduciary duty or fraud claims, the specter of a client's personal liability may loom large. Insurance may not cover liability for a breach of fiduciary duty claim (often an intentional tort), and bankruptcy protection similarly may not apply. Nonetheless, some solace may be found in California's forgiving debtor exemption laws: judgment creditors are barred from reaching qualified retirement accounts.
These retirement account protections are grounded in California Code of Civil Procedure section 704.115. The statute can fully exempt ERISA retirement assets from judgement creditors, regardless of the nature of the liability. McMullen v. Haycock, 147 Cal. App. 4th 753, 755, (2007). So long as the judgment debtor proves an actual intention to use the ERISA account for retirement purposes, the law will exempt the account from creditor reach. O'Brien v. AMBS Diagnostics, LLC, 38 Cal. App. 5th 553, 561, (2019). If, however, the debtor has shown an intention inconsistent with using the ERISA account for retirement purposes—for example, using some of the funds to finance a home long before retirement—then the exemption may be lost.
Funds held in individual retirement accounts ("IRA") also enjoy some, albeit lesser, protection. McMullen, 147 Cal. App. at 755. For IRA accounts, the protection extends "only to the extent necessary to provide for the support of the judgment debtor." To determine the extent of the exemption, the Court will examine how much is needed to satisfy the debtor's "common necessaries of life" based on his or her personal financial situation. J. J. MacIntyre Co. v. Duren, 118 Cal. App. 3d Supp. 16, 18, 173 Cal. Rptr. 715, 716 (App. Dep't Super Ct. 1981). Recreation, music lessons, and insurance expenses may justify exemption in the appropriate context. Importantly, the debtor may use tracing to claim the exemption over eligible ERISA funds transferred to another account type. McMullen, 147 Cal. App. at 758.
What happens when an account holder rolls ERISA assets into an IRA account that otherwise would receive only limited protection? Does the original source of the ERISA funds control to give full protection, or does the IRA roll-over destroy the fully-exempt status?
The caselaw is split on this issue. The more debtor-friendly cases hold that the rolled-over funds should retain their former, fully-exempt status. McMullen, 147 Cal. App. at 755. In McMullen itself, the debtor claimed a full exemption over funds in his IRA account, which he had rolled over from his fully-exempt ERISA retirement plan. No other assets were added to the rollover IRA. Opposing the full exemption, the creditor argued that the IRA rollover extinguished the full exemption as IRAs are only partially exempt under the statute's express language.
Agreeing with the debtor, McMullen held that full exemption should apply. In doing so, McMullen relied on Section 703.080, which expressly allows tracing of exempt funds that are distributed to deposit accounts or in the form of cash or its equivalent. McMullen also noted California's policy that exemption statutes should be construed (as far as practicable) to the judgment creditor's benefit. The liberal tracing application honored the policy goal of allowing a debtor to best protect his or her assets.
McMullen expressly disagreed with a California bankruptcy court that came to the opposite conclusion. In re Mooney held that an IRA rollover should extinguish the fully-exempt status. 248 B.R. 391, 397 (Bankr. C.D. Cal. 2000). While the Mooney court did not dispute that tracing is sometimes appropriate, it used the express statutory language giving IRA accounts only partial protection to override the tracing allowance. Noting that the legislature never expressly stated an intention to treat rolled-over IRAs different from other IRAs, the Mooney court refused to infer such an intention either. The Mooney court also noted that pre-retirement access to an IRA is generally easier than for an ERISA employer-sponsored plan. The Court thus declined to give the rolled-over IRA complete exemption from the judgment creditor.
In the years since McMullen and Mooney were decided, a third opinion has agreed with McMullen. O'Brien v. AMBS Diagnostics LLC, 38 Cal. App. 5th 553, 564, 251 Cal. Rptr. 3d 41, 49 (2019) (holding that Mooney was wrongfully decided and agreeing with McMullen that no policy reason existed to extinguish the full exemption simply because the assets are deposited in an IRA rather than "a safe deposit box" or "under a mattress.").
Defendants confronted with an adverse judgment that may push them into bankruptcy can take solace in the fact that these protections apply even if the claims include fraud and other torts otherwise not dischargeable in bankruptcy. See In re Phillips, 206 B.R. 196, 203 (Bankr. N.D. Cal. 1997), as corrected (Mar. 17, 1997), aff'd, 218 B.R. 520 (N.D. Cal. 1998). Clients and practitioners alike who face (or assert) fiduciary duty claims can benefit from being familiar with the foregoing rules and exceptions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.