In helping clients explore whether a Chapter 7 bankruptcy filing makes the most sense for their situation, our D.C. bankruptcy lawyers will review more than the current financial situation. The court will also want to see whether there have been any sizable transfers in recent months or even years. In cases where this has occurred, we may advise waiting a period of time before proceeding, or be ready with a clear explanation for the court.
Bankruptcy trustees may challenge such transfers, which could even result in a potential finding of fraud. Or it could prompt the court to dismiss the case altogether. It could also mean your case takes longer to complete, and penalties and additional costs may be imposed.
The bankruptcy estate – that which is subject to liquidation in a Chapter 7 – is all the property a debtor owns at the time of filing. The recent case of Anderson v. Architectural Glass Construction illustrates how under certain conditions, the bankruptcy estate can include property that the debtor discards prior to the bankruptcy declaration. In these cases, the trustee can reclaim that property.
The U.S. Court of Appeals for the Fourth Circuit recently weighed such the case, which had resulted in conflicting rulings from the bankruptcy and district courts.
In 2001, the debtor acquired a parcel of undeveloped property in South Carolina. She and her husband took out a mortgage on the property, and both agreed to repay the loan. Originally, the intention had been that the husband’s company would eventually buy the property and that the company – not the couple as individuals – would use the land.
The initial purchase contract listed the company as the buyer, but on the advice of an accountant, they decided to purchase it themselves and then lease the property to the company. The goal was to lower the company’s tax obligations, which would ultimately benefit them, as the husband was the sole owner.
However, the company never paid any rent to the couple. Instead, the business made mortgage payments directly to the bank. The title was never transferred, so even though the company was paying for the land, the couple still remained owners of record.
The following year, the couple refinanced the mortgage, and in doing so, granted the bank a security interest in the property in exchange for $170,000. The difference between the refinance and the original mortgage was that the refinance listed the company as the borrower, making it responsible for loan repayments. This didn’t change anything regarding the way the mortgage had always been paid – directly from company coffers.
Over the course of the next several years, the property was refinanced a number of times, with the couple each time granting security interest in the property. The mortgages each differed in who was identified as the borrower. Some listed the couple and others the company. The company paid the mortgage regardless.
In 2008, the company took out an $87,000 loan, with the owner listing the property as collateral. In those documents, the bank listed the company – not the individual – as the mortgagor. When an attorney at closing realized that the company wasn’t listed on the property’s deed, the couple deeded the property to the company for $10,000.
Seven months after that, the wife filed for Chapter 7 bankruptcy protection. The trustee in the case sought to set aside the transfer of the property interest to the company as a constructively fraudulent conveyance. The trustee indicated that the wife’s one-half interest in the property was valued at some $270,000, but she had disposed of it for the nominal consideration of $10,000. Because she was insolvent at the time of the transfer, the trustee alleged, the transaction should be voided under 11 U.S.C. 548(a)(1)(B).
The allegation resulted in a two-day trial, and the bankruptcy court decided in favor of the trustee. The court found that in transferring the property to the company for less than the reasonable equivalent value, she had committed fraud. The court rejected the couple’s argument that the company had always owned an interest in the property.
Upon appeal, the district court reversed, accepting the facts found by the bankruptcy court, but finding that the company’s use of the property and payment of the mortgage compelled a reversal. The district court determined that wife held only a bare legal title to the property. That bare legal title is an asset without significant value, and therefore, the transfer of the property wasn’t conducted for less than actual value.
The trustee appealed, and the federal appellate court vacated the district court’s judgment and remanded the case for further proceedings.
Contact Harris S. Ammerman, bankruptcy attorney serving Washington D.C., Maryland and Virginia, by calling (202) 638-0606.