Cohen v. Chernushin (In re Chernushin), 911 F.3d 1265 (10th Cir. 2018) –

After a debtor’s postpetition death, a chapter 7 trustee brought an adversary proceeding seeking to sell a second home that had been owned by the debtor and his nondebtor wife as joint tenants with right of survivorship. The wife objected arguing that the bankruptcy estate no longer had any interest in the property. The bankruptcy court ruled in favor of the wife; the district court agreed; and the chapter 7 trustee appealed to the 10^th Circuit.

When the debtor filed bankruptcy, he listed a primary residence and a second home in his petition. Both properties were owned with his wife as joint tenants with right of survivorship. He claimed a bankruptcy exemption for the primary residence, but not the second home.

Although the case was initially filed as a chapter 13 reorganization proceeding, it was later converted to a chapter 7 liquidation. A week after the debtor committed suicide the chapter 7 trustee brought an adversary proceeding seeking to sell the second home. The key question was whether the home was part of the bankruptcy estate.

Under section 541 the estate includes “all legal or equitable interests of the debtor in property as of the commencement of the bankruptcy case.” The court noted that property interests are determined under state law, explaining that uniform treatment by federal and state courts “serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving ‘a windfall merely by reason of the happenstance of bankruptcy.'” However, after a determination of property interests is made, federal bankruptcy law determines whether the interests are part of the bankruptcy estate.

The court emphasized that when section 541 limits estate property to interests as of the commencement of the case, this “places both temporal and qualitative limitations on the reach of the bankruptcy estate” – meaning that (1) normally property acquired postpetition will not become property of the bankruptcy estate, and (2) the trustee stands in the shoes of the debtor and does not have any greater rights than the debtor had.

In this case the court looked to state law to determine the debtor’s interest in property owned as joint tenants with right of survivorship. Under applicable state law a joint tenant’s interest terminates upon death, with the surviving joint tenant continuing to own the property free of the deceased’s interest.

In a joint tenancy with right of survivorship each party has an undivided interest in the whole property. Although the tenancy can be severed, severance must occur prior to the death of a tenant because title to the whole property vests in the surviving tenant at the moment of death. Since a trustee has no greater rights than the debtor, the court concluded that upon the death of the debtor the wife owned the entire property and the second home was no longer part of the bankruptcy estate.

The trustee made several arguments in an attempt to overcome this conclusion. One argument was based on FRBP 1016. That rule provides that the death or incompetency of the debtor “shall not abate” a chapter 7 liquidation case and “the estate shall be administered and the case concluded in the same manner, so far as possible, as though the death or incompetency had not occurred.”

The trustee argued that this meant the bankruptcy estate did not change with the death of the debtor. The court was not persuaded. It noted that the case cited by the trustee to support this proposition involved circumstances where death did not change the debtor’s entitlement to the property, while in this case death did change entitlement since upon death the debtor’s interest was extinguished.

Next the trustee argued that a trustee has plenary power over the bankruptcy estate’s assets, including the power under section 363(h) to sell the interests of both the estate and a co-owner in property where the debtor had an undivided interest as a joint tenant as of commencement of the case. Further, he argued that property that is not abandoned or administered remains property of the estate, and allowing property to be removed upon the death of the debtor would create considerable disorder and usurp the rights of the debtor’s creditors.

The court rejected this argument, finding that it was based upon a misunderstanding about the property that became part of the bankruptcy estate. The interest that became part of the bankruptcy estate was subject to extinguishment upon death. The trustee had a right to sell the property only as long as the estate still had an interest.

The trustee made a further argument that he could use his strong arm powers under section 544 to avoid the transfer of the property to the wife. However, the court again found the there was an automatic extinguishment of the estate’s interest in the property upon the debtor’s death and there was no transfer that could be avoided.

As a variation on this theme, the trustee argued that his status as a hypothetical lien creditor allowed him to liquidate or “redeem” the debtor’s undivided interests in the jointly held property. This argument was no more successful than the others. The lien attaches only to the interests of the debtor, and the lien terminates if the debtor dies before attachment or levy has been made upon the interest.

The trustee also argued that he could assert the rights of a bona fide purchaser, including the right to avoid a prior convenience. Yet again the court held that there was no prior conveyance to avoid. Rather, the debtor’s interest simply terminated.

Accordingly, the 10^th Circuit affirmed the lower court decisions finding that the bankruptcy estate had no interest in the second home since the interest terminated upon the debtor’s death.

Note that it was critical that the joint tenancy was not severed prior to the debtor’s death. On that point, the court commented in a footnote that there were prior cases holding that under state law the filing of a bankruptcy petition by a joint tenant severed the joint tenancy. However, after those cases the state legislature amended the joint tenancy statute to specifically provide that filing a bankruptcy petition would not sever the joint tenancy.

In a jurisdiction that does not address the effect of a bankruptcy filing, there is a good chance that creation of the bankruptcy estate will be viewed as a transfer that severs a joint tenancy – at least for tenancies that can be severed unilaterally by a joint tenant (as opposed to, for example, tenancies by the entireties).

Vicki R Harding, Esq.