Bankruptcy Trustee Can't Sell Home, But IRA Fair Game

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By Diane Davis

Oct. 2 — A bankruptcy trustee can't sell a debtor's home even though he discovered undisclosed assets and had to “disentangle the [d]ebtors' web of deceit,” but the husband's retirement account valued at $240,000 was fair game to sell due to the debtors' bad faith, a district court in North Carolina held Sept. 29.

Judge Martin Reidinger of the U.S. District Court for the Western District of North Carolina concluded that the findings of the bankruptcy court were insufficient to support the order allowing the sale of the debtors' residence.

According to the court, the record was insufficient to determine whether there was any equity available for creditors other than Wells Fargo, or whether there were any other joint creditors to share in the equity. There was also nothing in the record showing whether debtors Gilbert and Susan Joseph were in default under the terms of the note or deed of trust, the court said.

Events Leading to Bankruptcy

The debtors began experiencing financial difficulties before 2011. They borrowed from Gilbert's individual retirement account (IRA) three times from 2009 to 2011, and they mortgaged their home twice. The first mortgage from Ameritrust Mortgage Company for $503,965 was signed by both debtors as tenants by the entireties. AmeriTrust subsequently endorsed the promissory note to Wells Fargo; however, the Deed of Trust was never recorded.

The debtors later obtained an additional loan of $40,000 from First Bank, successor to Bank of Asheville, which was secured by a Deed of Trust and recorded.

Subsequently, First Bank began a state foreclosure proceeding against the debtors' home. The debtors' filed for Chapter 7 bankruptcy in which the debtors' nonexempt assets are liquidated and the proceeds are distributed to creditors.

The debtors' bankruptcy schedules stated that the residence was worth $500,000, and secured a debt owed only by the husband to Wells Fargo for $428,287. First Bank was owed $31.977, which was classified as an unsecured business-related debt, and only the wife had an IRA.

Trustee Langdon M. Cooper issued a report of no distribution, discharged the debtor's debt, and closed the case.

Unrecorded Mortgage Discovery

After the case was closed, First Bank resumed its foreclosure action. Following a title search, the debtors learned that Wells Fargo's mortgage was unrecorded and that First Bank had a first lien against the residence giving it the right to foreclose.

Wells Fargo then filed a civil action in state court against the debtors requesting relief to record a photocopy of the Deed of Trust, or to hold the residence in a constructive trust or impose an equitable lien.

Bankruptcy Case Reopened

The trustee attempted to reopen the bankruptcy case, arguing that the debtors had misrepresented their equity position to the court in that they had claimed they had little equity in the residence due to the secured claim of Wells Fargo, but then post-discharge that Wells Fargo's claim did not encumber the residence at all. The trustee asked the court for permission to sell the residence.

The debtors, however, contended that the errors in their petition were merely incorrectly scheduled and were not discovered until after the case was closed.

Inaccuracies, False Statements

The bankruptcy court found that the debtors' schedules incorrectly stated First Bank was an unsecured creditor when it had a first lien mortgage against the residence. Wells Fargo's Deed of Trust was never recorded and the note was only signed by the husband, the court said.

The petition also incorrectly stated that only the wife had an IRA, when in fact, the husband also had one worth $234,000. In addition, the debtors failed to disclose three pre-petition withdrawals from the husband's IRA totaling $81,305. The court also found that the debtors lied on three separate occasions about the husband's IRA being the source of funds used to pay off the First Bank debt.

The debtors' inaccuracies, and false statements prejudiced the Trustee directly and their creditors indirectly, because the Trustee had to incur extraordinary time and expense to disentangle the Debtors' web of deceit,' the bankruptcy court said. As a result, the bankruptcy court granted the trustee's motion to sell the house

The bankruptcy court also concluded that Wells Fargo was a joint creditor on the residence because both debtors signed the Deed of Trust. The fact that the Deed of Trust wasn't recorded was of no consequence because an unrecorded conveyance is valid as between the parties to the conveyance, the court said.

Would Sale Benefit the Estate?

Disagreeing with the bankruptcy court, the district court concluded that the effectiveness of the Wells Fargo Deed of Trust as between the debtors and Wells Fargo was unimpaired by the failure to record. The Deed of Trust remains enforceable, the court said.

The court then looked to whether a sale of the debtors' residence would benefit the estate. A sale benefits the estate when the proceeds generate equity that can be distributed among unsecured creditors, the court said. Since the residence is held as tenants by the entireties, the sale must benefit unsecured joint creditors, the court said.

According to the court, allowing the sale solely for Wells Fargo's benefit is improper because it can pursue its own legal means to recover the property in state court. Further, there was nothing in the record showing that the debtors were in default. Thus, the findings of the bankruptcy court aren't enough to support an order allowing the sale, the court said.

The court agreed with the bankruptcy court that the debtors acted in bad faith and prejudiced the trustee with regard to the debtors' IRAs. According to the court, the debtors intentionally, and in bad faith, filed their petition and schedules with many errors and omissions. The debtors also swore under penalty of perjury that the petition was true and correct, the court noted.

The court also found it significant that the debtors lied to conceal their largest asset — the IRAs. The trustee was prejudiced by the debtors' actions because he had to spend time and incur costs to overcome the Debtors' evasive responses and misrepresentations, the court said.

David R. Hillier, Gum, Hillier, McCroskey, P.A., Asheville, N.C., represented appellants Gilbert and Susan Joseph; Langdon M. Cooper, and Jennifer Ann Youngs, Mullen, Holland Cooper, P.A., Gastonia, N.C., represented appellee/Trustee Langdon M. Cooper.

To contact the reporter on this story: Diane Davis in Washington at  ddavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at  jhorowitz@bna.com