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
randolphp@umkc.edu
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.
Readers are urged to respond, comment, and argue with the daily
development or the editor's comments about it.
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