Fractional Remainder Interest: Sale Will Thwart Grantor’s Estate Planning Objectives – Who Cares?

In re Corse, 486 B.R. 241 (Bankr. D.R.I. 2013) –

The chapter 7 trustee in an individual debtor case asked for court approval to sell the debtor’s one-quarter remainder interest in a residential property.  The debtor’s mother, who had transferred the interest to the debtor, along with two of the debtor’s sisters, objected.

The debtor’s mother retained a life estate in the house where she lived and transferred four equal remainder interests in the house to her four daughters (including the debtor) as joint tenants with right of survivorship.  The parties agreed that (1) the daughters did not provide any consideration for the interests, and (2) the mother intended the transfer to be an estate planning tool and not a gift.  Subsequently the mother obtained quit claim deeds from each of her daughters reconveying their interests to her, although the reconveyance deeds were never recorded and were held in escrow.

When the debtor filed bankruptcy, her schedules did not disclose any interest in real property, and did not include the remainder interest in her mother’s house.  Apparently she was “wholly unaware” that the remainder was an interest in real estate, or even that it was an asset of hers.

The trustee received a $30,000 bid to purchase the remainder interest.  The mother and two of the non-debtor daughters filed objections to the trustee’s motion for approval of the sale.  (The debtor and the fourth daughter did not participate in the objection.)

First, they argued that the debtor held only bare legal title, so that the bankruptcy estate had nothing to sell.  However, the court noted that the debtor held both legal and equitable interests in the residence.  They also argued that the daughters intended to reconvey the residence to their mother through the unrecorded quit claim deeds.  However, regardless of any intent, a trustee can exercise the powers of a bona fide purchaser to cut off an unrecorded transfer of a debtor’s interests.  (See Bankruptcy “Strong Arm” Powers: Bye Bye Mortgage.)  So, the debtor’s unrecorded quit claim deed could be avoided.

Next they argued that the debtor could disclaim her rights.  However, once the bankruptcy was filed, any disclaimer rights became property of the bankruptcy estate that could be exercised only by the chapter 7 trustee.

They also made an argument based somehow on the debtor’s right to claim a homestead exemption.  However, after the trustee obtained the bid, the debtor filed amended schedules to claim an exemption not for her remainder interest, but rather for the sale proceeds under the “wild card” exemption.  So, the debtor did not assert a homestead exemption, and the objecting mother and sisters did not have standing to assert the exemption on behalf of the debtor.  (Besides, the homestead exemption was not available given that the debtor never attempted to move into the house, and in fact was unaware that she had an interest in real estate.)

The final argument was that the proposed sale by the trustee would defeat the mother’s estate planning objectives in making the transfers.  The proposed sale would cause the joint tenancies with rights of survivorship to be converted into tenancies in common.  The court was not impressed: “[T]hey failed to provide the Court with any applicable legal authority as to why any potentially adverse effect on their respective property rights justified denial of the proposed sale pursuant to Bankruptcy Code §363.”

If the trustee had been attempting to sell not only the debtor’s interests but also the interests of the other co-owners under Section 363(h) of the Bankruptcy Code, the court acknowledged that a weighing of interests of the bankruptcy estate versus those of the co-owners would have been required.  However, in this case the trustee was proposing to sell only the one-quarter undivided interest of the debtor.  Consequently, any disadvantage to the co-owners created by the sale was not relevant.

This case illustrates that it can be easy to lose control of property – particularly in bankruptcy where a trustee is aggressively looking for assets to liquidate and has strong arm powers to help clear the way, but even outside of bankruptcy.

Although the case is somewhat confusing on this point, it appears that the mother’s original intent in conveying to her daughters as joint tenants with rights of survivorship was to keep the property in the family after she died.  (As background, in most states, joint tenancy with rights of survivorship means that if one of the joint tenants dies, that person’s interests transfer to the other joint tenants.  In contrast, if interests are held as tenants in common, a joint tenant’s interest can be inherited by that tenant’s heirs, as opposed to transferring to the other original joint tenants upon death.)  However, even outside of bankruptcy this sort of joint tenancy can be easily defeated through a subsequent conveyance.

And if the mother intended that the reconveyance deeds provide some sort of safety net to insure that the daughters did not transfer their interests to outside parties, that strategy suffered from the weakness that an unrecorded deed is not going to be binding on a bona fide purchaser.  This weakness is exacerbated in a bankruptcy since a hypothetical bona fide purchaser is always available.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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