The assets were divided in the divorce.
The divorce was over.
The house would go to Him, and he would pay Her $75,000 on stated terms.
It was the end of a miserable stretch in their lives.
Only it wasn’t.
Before anyone recorded the judgment of dissolution (that’s Californian for “divorce”) laying out the division of assets, She filed bankruptcy.
And He found out about Bankruptcy Code §544.
Powers of a bankruptcy trustee
When a bankruptcy is filed, all of the debtor’s assets become part of the bankruptcy estate.
OK, in our situation, She no longer owned an interest in the house: it was awarded to Him. When She filed bankruptcy, the house wasn’t hers.
But the bankruptcy code gives the Chapter 7 trustee powers to avoid certain transfers of property and to bring assets back into the estate that weren’t there when the case was filed.
The news coverage of the Madoff case calls this “clawing back” assets.
One of those powers is the status of a bona fide purchaser of real estate for value without notice, a BFP, in legal parlance.
Public record didn’t show division of assets in divorce
Because the deed to the family home still showed on the public record as being owned by “He and She, husband and wife”, her bankruptcy trustee could argue that an innocent purchaser, who didn’t know about the divorce, could buy from Her something she really no longer owned.
That BFP had no notice that the house was awarded to Him.
So, because no one had yet updated the public record, He had to fight for the house all over again.
Because this happened in California, the trustee had two arguments to make. One was the claim that that the house remained community property, and therefore all of the equity in the house was property of the estate. Yikes!
Second, the trustee could, and did, argue that as a BFP, he could sell Her half of the house for the benefit of her creditors. And scarier still, the bankruptcy code allows the trustee to sell jointly owned property against the will of the non-banruptc co owner.
Divorcing parties and their attorneys can draw a couple of lessons from this tale.
- Divide property promptly. As long as property is community property, it is exposed to being sucked into the bankruptcy estate should either spouse or former spouse file bankruptcy.
- Appearances count Bankruptcy trustees are entitled to rely on record title in making the BFP argument. Get property division decisions into the public record immediately.
- Co owners exposed Anytime two parties are joint owners, the bankruptcy of one party can force a sale of the property, convenient or not.
- Marital settlement agreements enhance estate Assets acquired through a marital property settlement within 6 months of a bankruptcy filing go to creditors. MSA’s are an exception to the bankruptcy estate as a snapshot of the day of filing. [Post filing acquisition of property is probably a non-issue in community property states where all of the community property as of the filing comes into the bankruptcy estate.]
In this case, the ultimate strength of the trustee’s arguments were never tested.
The amount of debt in the bankruptcy case coincided neatly with the amount He was to pay Her, and fortuitously, a refinance bought the trustee out without triggering a sale.
It’s not always so neat.
Image: Fengyuan Chang