Kudos to a foresightful and beneficent mother who hired an astute trusts and estates lawyer to save the home of her profligate son.
The May 3 opinion by the Sixth Circuit Bankruptcy Appellate Panel shows that estate planning, if done professionally, can insulate property from voracious creditors.
A man owed $4 million to a bank secured by a mortgage on his home. The bank intended to foreclose.
To prevent her son from losing his home, his mother paid the bank $490,000 in 1993, in return for which the bank released its lien on the home. At the same time, the son transferred the home to a trust created simultaneously by his mother.
The son and his wife were co-trustees of the trust. They, their children, and others were beneficiaries and contingent beneficiaries of the trust, which was designed to persist for as long as the rule against perpetuities allows.
The trust instrument provided that the home “shall be” the residence of the son and his wife during their lifetimes. The trust went on to allow four other persons to live in the home upon the death of the son and his wife.
The son and his wife were still living in the home when they filed chapter 7 petitions more than two decades later. A creditor sued the couple in the name of the trustee, claiming that the debtors’ interest in the property was a transferable legal life estate. The creditor wanted the court to compel them to turn the home over to the trustee. The parties agreed, though, that the trust had title to the home.
The bankruptcy court ruled that the debtors instead had an equitable life estate only allowing them to reside in the property. The creditor appealed.
Bankruptcy Judge Daniel S. Opperman, the chief judge of the BAP, upheld the bankruptcy court in a nonprecedential opinion. He found the result within the four corners of the trust instrument.
Judge Opperman cited several provisions in the trust ensuring that the debtors and their children would have the right to live in the home and could not lose it. He also pointed to a spendthrift provision which, he said, expressed the mother’s “intent that the debtors not have a legal title which they could dispose of to their, or their children’s, detriment.”
Judge Opperman went on to say that the “spendthrift provision states the intent of the settlor that the debtors not be allowed to alienate or encumber their interest in the property.” He said that the trust did “not grant the debtors the right to do anything other than reside in the principal personal residence. It does not give them the right to rent the property to someone else or collect income from the property.”
Under Tennessee law, Judge Opperman concluded that the trust indeed created an inalienable equitable life estate.
The creditor had previously conceded there was no obligation to turn over the property to the trustee if the BAP found an equitable estate, which turned out to be true. Judge Opperman explained why, citing Section 542(a) in a footnote.
That section requires the turnover of property that a trustee may “use, sell, or lease under section 363.” Since the debtors had a “nontransferable equitable interest, as opposed to a transferrable legal interest,” Judge Opperman said there was no obligation to turn over the property because “the trustee could not use, sell, or lease that interest.”
Would the result have been the same if the profligate son had instead been the settlor of the trust?
If it were a revocable trust, the son probably would have lost the property no matter how long the trust had been in existence. An irrevocable trust created by the son might hold up had it been created long enough in advance of bankruptcy so the transfer to the trust would not have been a fraudulent transfer.
The trust was unassailable in the case at bar because the mother in substance had purchased the home from the son for fair value. Chances are, the trust would have held up even had the mother created the trust not long before bankruptcy because the son received fair value, assuming that $490,000 was the worth of the home.