Deeds: Not All “Freebies” Are Fraudulent

Rodriguez v. Nelabovige (In re Kirst), 559 B.R. 757 (Bankr. D. Colo. 2016)

About a year before filing bankruptcy, a debtor conveyed his interest as a joint tenant in a residential property to his mother-in-law in consideration for $10. The chapter 7 trustee sought to avoid the conveyance as a fraudulent transfer.

The bankruptcy court described the evolution of fraudulent transfer law as follows (footnotes omitted):

Fraudulent transfer law began as criminal and therefore intentional fraud law. However, since courts struggled reaching conclusions of the subjective intent of the transferor, the fraudulent transfer law was objectified. The courts began using badges of fraud beginning with Twyne’s case in order to determine subjective fraudulent intent by reference to objective facts, and the law of fraudulent disposition was extended to constructively fraudulent transfers.

The Bankruptcy Code codifies the law of subjective and objective fraudulent transfers in 11 U.S.C. §§ 548(a)(1)(A) and (a)(1)(B). The subjective standard is whether there was actual intent to hinder, delay or defraud a creditor and the objective standard is whether the debtor-transferor received a reasonably equivalent value in exchange for such transfer and whether the debtor-transferor was insolvent or rendered insolvent by the transfer.

The basic facts were: Title to a house acquired in 2012 was held in the name of the debtor, his wife and his mother-in-law as joint tenants. In 2013 the debtor and his wife executed a quitclaim deed conveying their title to the debtor’s mother-in-law in consideration for $10.

On the face of it, it was clear that $10 was not reasonably equivalent value, so generally the conveyance could be avoided as a fraudulent transfer if the debtor was insolvent. In this case there was a dispute about whether the debtor was insolvent. However, the court did not reach this issue because it resolved the case based on the threshold question of whether there was a covered transfer in the first place.

Looking at the broader context: The mother-in-law paid the entire purchase price of $396,000 from her own funds. Prior to closing she intended to take title in her own name. However, based on concerns about what would happen to the grandchildren and where they would live if something happened to her, at the closing (and without professional advice) she decided to put title into the names of the debtor, his wife and herself as joint tenants.

Subsequently the mother-in-law consulted with an estate planner. She said that it was her intent that her grandchildren receive the property, but not while she was alive. She apparently was unsophisticated and was not aware of and did not understand the legal, tax or financial issues resulting from taking title as joint tenants.

The estate planner advised her to get the debtor and his wife off of the title as soon as possible, and then transfer title to a newly created living trust. This in fact is what the parties did. The debtor and his wife said that they agreed to the request to transfer title without consideration “without hesitation because, ‘it was not their property.'” The trust subsequently sold the property and bought a much bigger house that the entire family intended to live in. (As a result, the trustee sought to recover a portion of the cash proceeds rather than an interest in property.)

The court identified the elements required to establish the fraudulent transfer as follows: (1) debtor has an interest in property, (2) transfer of the interest occurred within 2 years before bankruptcy, (3) debtor was insolvent or rendered insolvent as a result of the transfer, and (4) debtor received less than reasonably equivalent value for the transfer. With respect to the first element, the court noted U.S. Supreme Court precedent stating:

An interest in property consisting of bare legal title holds no tangible economic value. Thus, the transfer of bare legal title does not constitute a fraudulent transfer.

Accordingly, the issue boiled down to whether the mother-in-law made a gift to the debtor of a one-third interest in the property. If not, since she paid for the house and did not receive any consideration from the debtor, under state law (1) a resulting trust arose in her favor, (2) transfers to the debtor and his wife were of bare legal title and the mother-in-law held equitable title, and (3) the fraudulent transfer claim failed.

Under state law, although there is a presumption of an intent to make a gift in circumstances involving family members, actual intent controls and the presumption can be overcome. There must be a simultaneous intent to make a gift, and delivery and acceptance of the gift. Reviewing the facts of the case, the court concluded that the mother-in-law did not intend to make a gift to the debtor. Thus the debtor received only bare legal title subject to a resulting trust in favor of the mother-in-law, who held equitable title, and the conveyance to the mother-in-law did not constitute a fraudulent transfer.

People often do not understand the full ramifications of adding family members to title or other transfers intended for asset protection or estate planning purposes. And any transfer may be subject to scrutiny for a number of years. Since this case involved a cause of action under the fraudulent transfer provisions of section 548 of the Bankruptcy Code, the look back period was only two years. However, a claim brought under state fraudulent transfer law through section 544 can have a 4 to 6 year look back period. A lot can happen in 6 years.

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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