In re Adams, 506 B.R. 688 (Bankr. E.D.N.C. 2014) –

An individual debtor owned commercial real estate with his wife as tenants by the entireties and co-owned some rental properties with his son as tenants in common. The chapter 7 trustee sought to compel turnover of rents from these properties. The debtor objected, arguing that the rents were exempt as entireties property and as “earnings for personal services” respectively.

The debtor was in the business of residential land development. Although most of his projects were owned by separate limited liability companies, he also owned an office building as tenants by the entirety with his wife and owned mobile homes as a tenant in common with his son. In both cases the trustee argued that the debtor’s 50% share of the rents was property of the bankruptcy estate.

As background:

• Section 541(a)(6) of the Bankruptcy Code provides that the bankruptcy estate includes “Proceeds, products, offspring, rents, or profits of or from property of the estate, except such as are earnings from services performed by an individual debtor after commencement of the case.”
• Section 522(b)(3)(B) provides an exemption for “any interest in property in which the debtor had, immediately before the commencement of the case, an interest as a tenant by the entirety or joint tenant to the extent that such interest as a tenant by the entirety or joint tenant is exempt from process under applicable non-bankruptcy law.”
• As is typically the case, applicable state law provided that entireties property is exempt from process by a creditor of only one spouse.

With respect to the commercial property, the debtor argued that the rent derived from property held as entireties property should also be treated as entireties property. However, the court concluded that under applicable state law personal property (as opposed to real property) could not be held as tenants by the entirety.

The debtor also relied on state legislation enacted in 1982 that gave husband and wife equal rights to rent. The court noted that this change was intended to override prior common law that gave a husband 100% control over the rents to the exclusion of the wife.

The debtor interpreted the statute as changing the status of the rents from 100% controlled by a husband (and thus subject to the husband’s creditors) to 100% controlled jointly by a husband and wife so that rents took on the characteristics of entireties property. The court was not persuaded. Instead it viewed the change as providing that rents are under the 50/50 control of a husband and wife so that the rents were subject to creditors of each to the extent of their 50% interests.

With respect to the rent from the mobile homes owned by the debtor and his son as tenants in common, the debtor argued that the rents were “earnings from services” excluded from the bankruptcy estate. In support of this position, the debtor cited a state court of appeals case (Jacobi-Lewis) holding that “future rental payments are analogous to future earnings.” This case included a dissenting opinion that questioned treatment of rent payments as equivalent to earnings from personal labor or skills, and the Adams court noted another bankruptcy decision (Dillon) that declined to follow Jacobi-Lewis.

The court agreed with both the dissenting opinion and the Dillon decision. It concluded that the Jacobi-Lewis decision was inconsistent with existing precedent and would not be followed by the state supreme court. Thus, it determined that the rents from the mobile homes were not “earnings from services,” with the result that the debtor’s 50% interest in rents was part of the bankruptcy estate.

It is certainly not an inevitable conclusion that rents from property owned by an individual debtor will be part of the bankruptcy estate. As the court noted, there are some states that allow personal property to be held as tenants by the entireties. In those states, it is reasonable to speculate that rents from entireties property could be considered exempt entireties property. And the alternate argument that rents from property held by an individual debtor should be considered earnings from services might also get some traction before a different court – particularly if the debtor was actively involved in managing the property.

Vicki R. Harding, Esq.