Daily Development for Friday, July 28

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

TITLE; CONSTRUCTIVE TRUST: Constructive trust may arise when a one party permits another to invest in property and pay taxes on property that the first party owns, even when the first party's ownership is a matter of public record.

Blach v. Butcher, 200 FED App. 0242p (6th Cir. 3/9/00)

How's this for an opening paragraph in a judicial opinion?

     "Even a diabolical bar examiner would be reluctant to impose   this case's complex mixture of subject matter jurisdiction, fraud,   real estate, marital property, bankruptcy, tax liens, contributory   negligence, equitable remedies, and civil procedure upon hapless   law school graduates. Because reality often marches in where   creators of hypotheticals fear to tread, however, we are the   "hapless" appellate court judges obliged to struggle with this   twisted tale of truelife conflict."

The editor's response? Wake up and smell the coffee, judge. This case is no less complex than the daily diet of actual and hypothetical problems confronting title lawyers, often with million dollar commitments needing to be resolved within hours.

Alexander and Rosemary Butcher desired to develop a condominium complex. In 1978, they personally acquired a 100 acre parcel from a limited partnership in which Alexander was a partner. A week later, they conveyed 40 acres of this parcel to LTDC, a corporation wholly owned by Alexander. Both deeds were recorded a week after the second conveyance. The same day that these deeds were recorded, Alexander, as President of LTDC, reconveyed 17 acres of the 40 acres back to himself and his wife as tenants by the entirety, and that deed was recorded four days later.

Four days after the second recording, a title company committed to insure title in LTDC for the entire 40 acres. The title company apparently did not have actual notice of the fact that LTDC had conveyed almost half the property back to the Alexanders four days earlier. The court does not indicate the purpose of the commitment, but it appears to have been a commitment to insure the titles of buyers of the condominium units as and when completed and sold. If there was a construction loan secured by the property (as one would expect), the court doesn't mention it. About four months after this commitment, LTDC indeed did execute a "master deed" [declaration?] establishing the first phase of a condominium regime.

Nine of the units in this phase of the condominium development were in fact on land that had been deeded back to the Butchers, but Alexander nevertheless executed warranty deeds to the condominium purchasers in his capacity as President of LTDC.

Six years later, having sold out most of the first phase of the condominium, the Butchers elected to carry out a second phase. They used a new corporation, HCDC, as developer. Alexander was a majority stockholder and president. (He had wholly owned LTDC the predecessor.) As President of LTDC, Alexander executed a warranty deed to HCDC of 12 acres that were part of the 17 acres that had originally been conveyed back to the Butchers in 1978 (and which LTDC therefore did not own). Three of the plaintiffs in the instant action acquired condominium units from HCDC that were located on these 12 acres.

During these years, the unit owners, presumably through their owner's association, paid the taxes and of course exercised possession and control over the property on which the condominiums were located, including the 17 acres.

The court emphasizes that several times under oath Alexander represented that LTDC and HCDC, respectively were the owners of the 17 acres. But the court later concludes that no fraudulent intent necessarily attached to these statements. Alexander himself was deceased by the time of these proceedings, as was Rosemary.

In 1988, the IRS issued an assessment against the Butchers for unpaid 1986 taxes and filed a lien against the Butcher's real estate, including the 17 acres. The lien at time of trial exceeded $150,000.

In 1991, Rosemary filed for bankruptcy, and asserted in that proceeding ownership of a tenancy by the entirety in the 17 acres. Alexander quitclaimed his own interest in the cotenancy to Rosemary that same year. The plaintiff condominium owners brought suit against Alexander, LTDC, HCDC and the IRS to establish their rights in this property. Utlimately, this suit was joined into the bankruptcy action.

The bankruptcy court granted summary judgment for the condominium unit owners, declaring a constructive trust in their favor over the 17 acres. As the court concluded that the constructive trust dated back to 1978, the court held that it predated the IRS 1988 tax lien and primed it. There followed an admittedly bizarre set of procedural complications due to the fact that Rosemary, under the protection of bankrutpcy, had not been actually served in the plaintiffs action. There was also quite a lot of skirmishing about the bankruptcy court's jurisdiction to impose a constructive trust. The ultimate outcome from the district court, however, remained unchanged.

On de novo appeal to the Sixth Circuit, the ruling of the district court was affirmed as to the existence of the constructive trust, but reversed as to the priority of the trust over the IRS lien. (The tax holding is discussed below under the heading: "Federal Income Tax; Tax Liens; Priority; Constructive Trusts."

The Sixth Circuit concluded that, under Michigan, law, a constructive trust is an appropriate remedy when it would be inequitable for a landowner to retain title to land as against the trust beneficiaries due to inequitable conduct on the part of the landowner. Here, both of the Alexanders, according to the court, over the years had personally and through their corporate agents, on numerous occasions, alleged that the corporations had lawful title to the 17 acres and the power to convey that property to the condominium unit owners, leading the unit owners to rely upon the apparent ownership as the real ownership.

The court also emphasized the payment of taxes by the condominium association. A Michigan case had held that where a party stands by and knowingly permits another to pay property taxes, a constructive trust may arise. Although the Butcher side argued that there was no legal duty for the Butchers to inform the plaintiffs about the true state of title, since it was disclosed in the public records, the court responded that the Butchers did more than stand silent. They made affirmative allegations regarding the state of title and also stood by while others paid their property taxes.

The Butchers' side also claimed that the plaintiffs' remedy was against the title company, not against them. The court responded that, although there had not been a finding of fraud, this was a case of intentional tort. It took the view that the Butchers must have known that the title company was insuring property that its insured did not own, and failed to disclose this fact, even though Alexander was the sole owner of the insured entity. The court stated that this was, at least, "strong indication of fraud."

Comment: The caption the editor has set forth certainly overstates the holding in this case, because the Butchers' did more than stand idly by while another made a foolish decision to invest in property that the Butchers owned. The court emphasizes affirmative statements made by both Butchers regarding the fact that the condominium title was legitimate. (The court, however, does not really identify any such statements, and one could imagine that in the ordinary course of things Rosemary might in fact have had little involvement with these matters.)

But other parts of the opinion emphasize the fact that the Butchers permitted others to pay taxes on their land when the taxpayers in fact had no ownership interest. This is the aspect of the opinion that the editor finds most noteworthy. The editor could understand an equitable lien for the amount of the taxes, but it would seem bizarre for such an event, in and of itself, to result in a transfer of title.

FEDERAL INCOME TAX; TAX LIENS; PRIORITY; CONSTRUCTIVE TRUSTS: Under the federal rule "first in time, first in right," an IRS lien takes priority over a constructive trust if the lien attaches prior to the court decision declaring the existence of the trust, even where the facts giving rise to the trust predate the IRS lien.

Blach v. Butcher, 200 FED App. 0242p (6th Cir. 3/9/00)

The facts of this case are set forth under the heading: "Title; Constructive Trust." The constructive trust arose on the basis of events occurring in 1978 and again in 1984, when the taxpayers permitted property that was in title to them to be used in the development of a condominium project by corporations they controlled. A title company missed the recording of a deed back to them, and so parties acquiring interests in the condominium got title insurance that their title was good.

In 1988, the IRS attached a lien to the property.

In 1991, in proceedings arising out of the bankruptcy of one of the taxpayers, the federal district court, on summary judgment, concluded that the constructive trust arose prior to the tax lien and primed it. On appeal de novo, the Sixth Circuit panel here reversed this holding by a 2 1 vote and found for the IRS.

The court notes that the priority of a federal tax lien is a matter of federal law, not state law, and that the general rule is "first in time, first in right." (There is an exception, not at issue here, for bona fide purchasers.) But the court concludes that a constructive trust does not arise as of the time that the facts supporting the trust occur, but rather arise as of the time that the court declares the trust. (Citing In re Omegas Group, Inc. 16 F.3d 1443, 1451 (6th Cir. 1984). The latter event, of course, occurred after the IRS lien.

The language of the federal statute is as follows:

     "If any person liable to pay any tax neglects or refuses to pay the   same upon demand, the amount . . . shall be a lien in favor of the   United States upon al l property and rights to property, whether   real or personal, belonging to such person."

The court states that the interest of the constructive beneficiaries did not exist under federal law until in became "choate" until all proceedings necessary to establish it were complete. It notes that a constructive trust, in the words of a Michigan court, is not technically a trust at all, but only a remedy. Therefore, it is not choate until the remedy is granted by a court.

Other courts, however, cited by the dissent, have held that tax liens cannot attach to property not owned by the taxpayer, and have upheld constructive trusts as against IRS liens. The dissent concludes that the taxpayers in this case did not "own" the property to the extent that they were constructive trustees. Comment 1:  The court's conclusion that the constructive trust did not arise until the time it was declared by the court may ring sour with many real property types who are used to saying that a equitable lien arises as of the time of the facts giving rise to it except as against bona fide purchasers (and the IRS is not a BFP).

As all of the facts necessary to establish the constructive trust had occurred as of 1988 (or we can assume that they did for purposes of argument), it would seem to be an inappropriate leap of reasoning to conclude that simply because no court had declared that these facts gave rise to a constructive trust remedy, the taxpayers in fact were the "owners" of the property. Although the instant case does not necessarily involve fraud on the party of the constructive trustee, giving rise to the trust, many such cases do. It seems anomalous for the IRS to benefit from the taxpayer's bare legal title under these circumstances.

But we learned long ago that the general rule that "the government usually wins" is one of the most useful predictors of judicial outcomes, and thus practitioners would be wise to take a lesson from the case. The lesson is: don't dither. If there apparently are facts giving rise to an equitable claim, get into court, file the lis pendens, and argue later. Of course, such behavior mucks up title and creates a danger of slander of title claims, but on the other side is the possibility that the party who cheated your client might also have been playing a little cute with the IRS, and tax liens may be in the offing.

Comment 2: The court noted, probably accurately, that the consequences to the condominium unit owners here are not severe, since their title insurer likely will take the $150,000 hit. But the court seemed to acknowledge that its ruling will apply to cases in which title insurance is not involved, and that it is a significant new precedent.


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