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Texas Court Finds Payment of Personal Expenses By LLC Constituted Constructive Fraud in Divorce Case

Property owned by a limited liability company belongs to the company and is generally not considered either separate or community property subject to distribution in a Texas divorce case.  The limited liability company’s owners, known as “members,” do have an ownership, or “membership” interest in the company. That membership interest can be classified as separate or community property and distributed in a divorce.  Additionally, distributions made from the company are community property, even if only one spouse is a member.

A husband recently challenged a finding of constructive fraud and order for reimbursement based on expenditures by and loans to his limited liability company (LLC). He was the LLC’s sole member before and during the marriage.  The trial court granted the wife’s constructive-fraud claim and ordered reconstitution of the community estate.  The court also characterized the LLC as the husband’s separate property and reimbursed the community estate for loans made to the LLC.

The husband appealed, challenging the trial court’s findings and conclusions regarding the constructive-fraud and reimbursement claims.

The trial court found the husband spent funds on traveling, gambling, hotels, bars, and adult entertainment.  The court found more than $750,000 of these expenditures were personal. Because they were the husband’s personal expenses paid by the LLC, they were member draws and constituted distributions. Distributions are community income, and the court found the husband wasted those distributions.  The trial court also found the wife did not know about or consent to the waste.

The husband argued there was insufficient evidence to support the determination the payments were distributions.  The LLC paid the establishments directly with its credit card.  He argued the LLC and its accountants considered the expenditures legitimate business expenses.  The company’s accountant testified she had deducted the non-gambling expenses on the company’s tax returns and the IRS did not question them.

The husband provided no evidence the company benefited from paying for the expenses.  At trial, he agreed the gambling expenses should be considered member draws.  He offered no reason on appeal for treating the expenses for hotels and strip clubs differently from the gambling losses.  The appeals court noted the nature of the expenses suggested they were personal.

The appeals court found the husband had not shown the expenditures were legitimate business expenses.  Sufficient evidence supported the determination they were personal expenditures. Upon making this finding, the trial court had sufficient support to find the payments constituted distributions from the LLC.  There was no abuse of discretion in finding the husband had committed constructive fraud because distributions are community property and the wife did not know about them.

The trial court also found the community estate was entitled to reimbursement of loans to the LLC and ordered reimbursement from the husband’s separate estate.  The husband argued the LLC was a separate entity and the court abused its discretion by ordering reimbursement from his separate property.  He argued there was no evidence his separate estate benefited from the loan.  The appeals court pointed out that the community estate could not recover the loan from the LLC in a divorce proceeding, and, unless the court found constructive fraud as to the loan, it could not recover from the husband’s separate property just because he was the sole member.

The community estate could, however, recover from the husband based on his membership interest in the LLC.  To do so, the wife had to show his membership interest benefited from the loans.  The husband argued there was no evidence his membership interest became more valuable due to the loan.  He also testified that a significant amount of the funds were transferred back to the community through his salary.  The wife testified her husband said that portion of the funds would be used for cash flow and she had not considered his salary to be repayment.

The appeals court found the trial court could have reasonably determined the loan benefited the LLC and therefore indirectly benefited the husband’s membership interest.  There was legally sufficient evidence to support the trial court’s finding that the husband’s separate property benefited from the loans.

The husband also argued that the wife had not established that the value of his separate estate increased by the amount of the loan.  The appeals court noted the statutory requirement to measure reimbursement based on increased value only applies when one marital estate benefits another.  The appeals court found this was not the case here, so reimbursement could properly be measured by the cost to the community estate.  The appeals court found no abuse of discretion in calculation of reimbursement claim.

The husband also argued the reimbursement award was inequitable because it did not account for the benefit the community estate received from the company.  He noted that the community benefited from wages, draws and retirement from his interest in the company.  The appeals court agreed that the community estate benefited, but also found the trial court could have found that the loans allowed the business to continue operating after the divorce, and thereby allowed the husband to continue enjoying the same benefits.  The trial court has “great latitude” in determining the value of a reimbursement claim using equitable principles.  The appeals court found no abuse of discretion in the trial court’s finding that an offset was not justified.

Although an LLC is a separate legal entity that may own its own property, actions taken by or with regard to an LLC can affect property distribution in a divorce.  If you are facing a high-asset divorce involving business assets, you need an experienced Texas divorce attorney to fight for you.  Call McClure Law Group at 214.692.8200 to schedule a consultation.