TITLE “WOLF PITS” IN THE BANKRUPTCY LANDSCAPE

A “wolf pit” is a conical hole, concealed under a layer of soil, with a sharpened stake hammered at the bottom. It is best avoided. Bankruptcy poses certain pitfalls to the title insurer, also best avoided.  Learn to Identify and steer clear.

The most common pitfalls are 1. an open bankruptcy, 2. a violation of the automatic stay, 3. a prior fraudulent and/or preferential transfer, 4. failure to record a mortgage within 30 days, and 5. the assumption that a discharge in bankruptcy removes liens and judgments from the debtor’s real property.

A bankruptcy is generally commenced with the debtor filing a petition listing all assets and creditors.  Filing puts all debtor’s property, whether or not listed, under the control of the Trustee in Bankruptcy. After filing, neither the debtor, nor her creditors, can reach her property.

Open Bankruptcy

Title may not be insured until the case is closed (a discharge is not sufficient), or there is a court order to sell. However, even with an order, you must wait until the appeal period has expired, without an appeal having been filed. (Consult with underwriting counsel when the bankruptcy is a Chapter 13). This applies even where only one spouse has filed and title is held as tenants by the entirety. It also applies to property that the debtor did not schedule as an asset, or property inherited during the pendency of the bankruptcy.

Violation of Automatic Stay

Filing a petition triggers an automatic stay, which bars creditors from enforcing their liens against debtor’s property until the case is closed or the automatic stay lifted. In a foreclosure, actions taken in violation of the automatic stay are generally void ab initio. Therefore title coming through a foreclosure, where proceedings were had in violation of the automatic stay, may not be insurable.

Gift transfers, Fraudulent Conveyances, Preferential Transfers

A fraudulent transfer is one made for inadequate or no consideration, either with the intent to defraud (actual fraud), or which rendered the grantor insolvent (constructive fraud). A preferential transfer is made by a debtor, prior to filing for bankruptcy, which gave a preference to one creditor over another.  A deed by a settlor to his living trust, a deed given to one’s children, reserving a life estate, a deed between spouses, all are vulnerable to being avoided by the trustee as fraudulent transfers.  Deeds in lieu are an example of transfers which can be both preferential and fraudulent and which also can be avoided by the trustee. In New York, a trustee can challenge a fraudulent conveyance for six years from the transfer, and a preferential transfer made 90 days prior to filing, unless the transferee was an insider, in which case there is a one year statute of limitations.

Failure to record a mortgage within 30 days

A trustee can avoid a mortgage which was not timely recorded.

Judgments

Judgments are not automatically removed as liens against real property as a result of debtor’s discharge. The debtor will no longer have personal liability for the judgment, but the creditor will retain a lien against her real property, except in those rare instances where there is an order returning the bankruptcy estate to the debtor “free and clear”.  In such a case, only those debts which were scheduled will be removed as liens. Always discuss “free and clear’ orders with underwriting counsel, and notwithstanding the court order, never omit open real property taxes

Can or Can’t an Irrevocable Trust be Decanted?

 

While decanting irrevocable trusts is not new in New York (the first decanting statute was enacted in 1992), it has suddenly become a hot topic of inquiry, perhaps because of the frequency with which trusts are now employed and because lifetime trusts created after 6/25/97 are irrevocable unless the trust provides otherwise.  The term decanting refers to pouring wine from an old bottle into a new bottle. So, by analogy, trust assets, like wine, are decanted (invaded) and poured from the old trust into a new trust.

We all know that even an irrevocable trust can be revoked pursuant to the Estate Powers and Trust Law. EPTL, at section 7-1.9, permits the revocation of an irrevocable trust provided that the creator and all the beneficiaries join in a duly acknowledged signed writing.  However, under certain circumstances, EPTL 10-6.6 permits a trustee, where the original trust granted the trustee the power to invade the principal, to use his power of appointment to transfer trust assets from an existing irrevocable trust into a new trust, without the consent of the trust creator or beneficiaries, even if the new trust favors only one, and not all, of the beneficiaries.

There are limitations on the trustee’s power to decant. For example, the new trust cannot benefit beneficiaries not named in the original trust, the exercise of this power of appointment must not decrease fixed income interest or violate general principals of fiduciary loyalty, AND, as with the exercise of any power by a trustee, must always be in furtherance of the trust purpose and in the best interests of the trust beneficiaries.

There are many tax consequences involved in the decision to decant, which are the province of accountants and tax lawyers and beyond the scope of title insurance, but should you get a call from a client concerning decanting, or should you see an example of a trustee transferring a trust asset into a new trust, you will have some familiarity with the concept.  As always, call underwriting counsel with any questions.

 

Deed in Lieu of Foreclosure and Mortgage Recording Tax: The Tax Man Gets His Due

You should be aware that the New York State Department of Taxation and Finance issued  Tax Bulletin TB-MR-575 on January 6 , 2014,  concerning  mortgage recording tax in the context of a a deed in lieu of foreclosure transaction. The bulletin makes it clear that where a deed in lieu is given, the underlying mortgage may not treated as a supplemental mortgage under Section 255 of the Tax Law and therefore cannot be assigned, modified or consolidated without the payment of  mortgage tax on the full amount of the debt secured. http://www.tax.ny.gov/pubs_and_bulls/tg_bulletins/mrt/deed_in_lieu.htm

When  mortgagee and  borrower decide  it is mutually advantageous  to avoid the foreclosure process and where borrower’s indebtedness exceeds the equity in the property, borrower may make an offer to convey the property to the lender in return for certain consideration such as forgiveness of personal liability on the note. When the same entity is both the owner of the real property as well as the holder of the mortgage, the fee interest and the mortgage interest are said to merge, thereby extinguishing the lien of the mortgage.  Under certain circumstances, the mortgagee may wish to avoid a merger and to keep the mortgage alive.  One reason was the belief that when the mortgagee transfers the property to a new purchaser, the mortgage can be assigned to a new lender thereby saving the purchaser some mortgage tax and making the property that much more attractive. The Tax Bulletin makes clear that this is not possible and mortgage tax must be paid on the full amount of the debt secured.

 

Proposed Licensing Bill: Best Defense is a Good Offense

Some of you may have noticed that March was chillier than usual.  It wasn’t only a stalled Canadian storm system funneling cold air our way, but an  ill wind blowing down from state regulators in Albany which sent a chill down some spines.

The word is that anywhere from 25 to 100 agents, chosen at random, received subpoenas from the Department of Financial Services (DFS) ordering the production of very detailed information concerning corporate structure, fee schedules, expenses, compensation, and financing information. The level of scrutiny made the data call pale by comparison. Many of the affected agents jointly hired legal counsel and successfully challenged the subpoenas, but all signs point in the direction of industry-wide regulation and licensing.

While the DFS’s recent investigation of the forced- insurance practices of some lenders, which parallels federal investigations, doesn’t impact the title industry,  it is strong evidence of the consumer protection direction in which the Department is leaning .

The New York State Land Title Association  knows which way the wind is blowing.  Many of us have long championed regulation, while at the same time chafing at its mention.  Rather than waiting for regulation to be imposed by regulators,  the NYSLTA  has taken a proactive stance and finalized its draft  of a balanced licensing bill.  It will begin its lobbying efforts in Albany on 4/22 and 4/23.  While regulation can be a bitter bill, the NYSLTA’s input should make the medicine go down easier.