A chapter 7 trustee sought to set aside as a a debtor’s transfer of her interest in property held jointly with her husband to her husband’s corporation as a constructive fraudulent conveyance. The bankruptcy court agreed that it was a fraudulent transfer; the district court reversed; and the 4th Circuit reversed in part, vacated in part and remanded for further proceedings.
In 2001 the debtor and her husband (the Pfisters) acquired undeveloped real property financed through a mortgage loan. Originally the husband intended to have his wholly owned corporation (AGC) buy the property, as specified in the purchase agreement. However, on advice of his accountant, he changed his mind. Instead he and his wife took title to the property and then leased it to AGC. The decision to take title in their names, not AGC’s, was “considered and intentional.”
AGC never paid rent, but instead made mortgage payments directly to the bank. Although AGC paid for the land, the debtor and her husband continued to hold title. When they refinanced the mortgage in 2002, AGC was listed as the borrower, and the Pfisters granted a mortgage on the property to secure the loan. AGC continued to make the loan payments.
The property was mortgaged several more times over the next few years. In each case the Pfisters granted the bank a mortgage on the property. Sometimes the Pfisters were identified as borrowers and other times AGC was identified. But in each case AGC made all of the loan repayments.
In December 2008 the parties intended to follow the pattern of the Pfisters granting the mortgage but in preparing the documents the lender identified AGC as the mortgagor. An attorney realized this was an issue at the closing. To fix the problem the Pfisters deeded the property to AGC in exchange for $10.00.
Seven months later Mrs. Pfister filed a chapter 7 bankruptcy, and eventually the chapter 7 trustee moved to set aside the transfer of her interest in the property to AGC as a constructive fraudulent conveyance. The trustee alleged that she had a one-half interest in property with a value of $270,000 at a time that she was insolvent so that the transfer was avoidable under Sections 548 and 544 of the Bankruptcy Code.
As background, both actual and constructive fraudulent transfers can be avoided under Section 548 of the Bankruptcy Code, or by exercising similar rights under state law under Section 544 of the Bankruptcy Code. Constructive fraud is established by showing that (1) the debtor did not receive reasonably equivalent value and (2) it was insolvent, intended to incur debts beyond the ability to pay when due, or was left with unreasonably small capital. Once a trustee avoids a fraudulent transfer, it can recover the property or alternatively seek the value of the propoerty under Section 550 of the Bankruptcy Code.
AGC argued that it always owned the property by way of a resulting trust. That would mean that it held equitable title and the Pfisters held only bare legal title. The trustee can recover only the property interest that the debtor actually owned. A trust severs the legal and equitable interests. So, if a resulting trust was created in favor of AGC, Mrs. Pfister held only bare legal title, which did not have significant value. In that case Mrs. Pfister’s title lacked value so that she conveyed it for reasonably equivalent value, and thus the transfer was not a fraudulent conveyance.
Under applicable state law:
The general rule is that when real estate is conveyed to one person and the consideration paid by another, it is presumed that the party who pays the purchase money intended a benefit to himself, and accordingly a resulting trust is raised in his behalf… But when the conveyance is taken to a wife or child, or to any other person for whom the purchaser is under legal obligation to provide, no such presumption attaches. On the contrary, the presumption in such case is that the purchase was designed as a gift or advancement to the person to whom the conveyance is made.
According to the 4th Circuit, since Mrs. Pfister is the wife of Mr. Pfister and Mr. Pfister is the sole owner of AGC, there was a presumption under state law that the purchase was intended as a gift by Mr. Pfister to Mrs. Pfister.
AGC could rebut the presumption by proving “(1) it paid for the property (or committed to pay for the property), (2) with the intent to own it, (3) on the date of purchase.” The 4th Circuit emphasized that the trust must arise at the time the deed is delivered, not at some future point in time.
Here, it was clear that AGC did not commit to pay until after the initial acquisition. Further, at the time of the purchase the parties clearly contemplated a rental arrangement with AGC as a tenant. Thus, the majority of the court concurred with the bankruptcy court that there was no justification for finding that there was a resulting trust.
A dissenting opinion took issue with the majority’s analysis. The conclusion it reached was that a resulting trust is an equitable remedy designed to implement the intent of the parties where one pays for the property and for some reason title is in the name of another. Here it was clear that the intent of the parties was that Mrs. Pfister had mere legal title and AGC “is and always has been the equitable owner of the property.”
The dissenting opinion took particular issue with the bankruptcy court analysis that determined intent based on the parties named in the deed. By definition, circumstances giving rise to a resulting trust contemplate the title was held by somebody other than the intended equitable owner. Thus, the dissenter would have found that there was a resulting trust and AGC was the equitable owner.
It can be very difficult to predict how equitable trusts will be treated in a bankruptcy. If the parties start out with an equitable trust arrangement and then decide to transfer title to reflect the actual intent, they should be aware that the transfer is potentially subject to avoidance, as occurred in this case.
Vicki R. Harding, Esq.