Bankruptcy And Probate

This note will attempt to familiarize the reader with bankruptcy law and how it may interact with probate and intervention proceedings.¹

I. Some Questions and Answers

Q. May a solvent or insolvent probate estate be a debtor in bankruptcy and obtain the protection of the bankruptcy court?
A. NO. See 11 U.S.C. § 109.

Q. May a trust be a debtor in bankruptcy?
A. NO, unless it is a business trust. 11 U.S.C. § 101(9)(A)(v). But, the settlor of a trust may be a debtor in bankruptcy and all of the trust assets in which he/she has a beneficial interest may become property of the estate unless it is exempt.

Q. Must a debtor be insolvent to file a bankruptcy and obtain relief?
A. NO, unless an involuntary bankruptcy has been filed against the debtor.

Q. If a debtor in bankruptcy dies, may the decedent's bankruptcy estate continue or must it be dismissed?
A. YES, it may continue. Bankruptcy Rule 1016.

Q. May a Conservator, Guardian or Attorney in Fact file a bankruptcy for their subject?
A. YES.

Q. Can a pending foreclosure of property of a probate estate be stopped by the filing of a bankruptcy?
A. YES, but only if a person having "an interest in the property of the probate estate" files the bankruptcy since the estate cannot do so. Such "interested persons" may include the Personal Representative, a beneficiary, heir or claimant.

Q. Is there a probate exception to bankruptcy law when there is a conflict between a state probate court and a bankruptcy court? 
A. APPARENTLY NOT but it is not entirely clear. The recent Supreme Court ruling in the Anna Nicole Smith [Marshall] case (see cite below) held that in the narrow facts of that case, the federal bankruptcy court ruling was superior to the ruling of the state probate court. NB that the Smith case concerned a trust involved in  a probate matter. It is still an open question whether a bankruptcy court will assert any jurisdiction over a pure probate proceeding.

Q. If a property is infested with liens, litigation and title problems, can the bankruptcy court help to sell the property and maximize the value?
A. YES, the bankruptcy court can sell property free and clear of liens. The lien holders can then fight out the prioritization and distribution questions at a later date in the bankruptcy court. 11 U.S.C. § 363(f).    

Q. Can a disclaimer be considered an avoidable fraudulent transfer?
A. YES. See 11 U.S.C. § 548(a) and the new subpart (e) regarding transfers to "self settled [asset protection] trusts."  See also Gaughan v. Edward Ditloff Revocable Trust (In re Costas), 346 B.R. 198 (B.A.P. 9th Cir. 2006.)

Q. Is the power to disclaim property of an estate, property of a bankrupt estate?
A. YES, it can be. A Partial disclaimer of inherited property was considered property of a bankrupt estate in: In re Farrior; Wolfe (Trustee) v. Farrior, et al, 344 B. R. 483 (Bankr. W.D. Va. 2006).

Q. What is the effect on the property of a probate estate if a Personal Representative, heir, beneficiary or claimant, with a potential but not determined  interest in property of the estate, files for bankruptcy?
A. Because of the 11 U.S.C. § 541 broad definition of a property interest, the automatic stay may apply to the property of the probate estate. I use "may" because the courts are not consistent and the cases are very fact dependant.    

Q. What is the fraudulent transfer statute of limitations for a transfer to a "self settled [asset protection] trust."
A. While the state law of fraudulent transfers varies and has a shorter statute of limitations, the new (2005) § 548(e)(1) of the bankruptcy code provides a 10 year reach back for these avoidance actions.

Q. May a bankruptcy court probate a will or administer an estate of a deceased debtor?
A. YES and NO. In Markham v Allen, 329 U.S. 706 (1946) the Supreme Court held that the federal courts did not have jurisdiction "to probate a will or administer an estate." This is the basis for the "probate exception" in federal law but the circuits have created several different interpretations of  Markham. In Vickie Lynn Marshall [aka Anna Nicole Smith] v. E. Pierce Marshall, 547 U.S. 293 (2006) the court unanimously found that the probate exception did not apply and the federal bankruptcy court decision (awarding damages for tortious interference) was superior to the ruling of the Texas state probate court (finding the will and trust valid) as it regarded the narrow facts of the case. (The tortious interference judgment in the bankruptcy court was not premised on the validity of an existing will or trust.)

Q. Can the trustee of a bankrupt estate be a survivor of a joint tenancy with a deceased co tenant?
A. NO, the bankruptcy petition breaks the required unities and the trustee has only a percentage interest as a tenant in common. See: In re Danna J. Monroe. Friedman v. Juratovac, 2003 WL 22038534 (Bankr. D. Md. 2003)

II. Bankruptcy 101

Bankruptcy courts have many unusual and extraordinary powers. The bankruptcy law can be found in 11 U.S.C. § 101, et seq.

a. Automatic Stay

Upon the bare filing of a bankruptcy petition, an automatic stay is imposed to protect the debtor from almost all creditors. 11 U.S.C. § 362.

b. Types of Bankruptcy

There are six types of bankruptcy:

Chapter 7 Liquidations.
Chapter 9 Adjustment of Debts of a Municipality.
Chapter 11 Reorganization.
Chapter 12 Adjustment of Debts of a Family Farmer or Fisherman with Regular Annual Income.
Chapter 13 Adjustment of Debts of an Individual With Regular Income.
Chapter 15 Ancillary and Cross Border Insolvency Cases (International Cases).

c. Who May Be A Debtor In Bankruptcy

Section 109 describes who may be a debtor. For our purposes it is more important to note that a decedent's estate may not be a debtor in bankruptcy. However, a Conservator or Guardian may be a bankruptcy debtor as may a trust and an Attorney in Fact.

d. Property of the Estate

Much like the IRS definition of income, § 541 indicates that almost any kind of interest in property is property of the bankruptcy estate unless the Code says that it is excluded. Such property of the estate will be protected by the automatic stay and will be administered by the trustee. For our purposes this means that if a personal representative, trustee, heir, beneficiary or claimant declares bankruptcy, the bankruptcy laws (automatic stay, avoidance powers, etc.) will affect the probate testate property that they may have an interest in. While an estate cannot declare bankruptcy to stop a foreclosure, anyone with an interest in the property can file and stop the foreclosure until such time as the court grants relief from the stay.

e. Avoidance Powers
        
A bankruptcy trustee or debtor in possession (the administrative fiduciary in a Chapter 11 reorganization) has the power to avoid (undo) liens and transactions. 

§ 544 makes a trustee (and a DIP) a lien creditor and a successor to certain creditors and purchasers.
§ 545 allows trustees to avoid statutory liens such as mechanics, hospital and Medicaid liens.
§ 547 allows the avoidance of preferential transfers or payments by a debtor pre petition.
§ 548 allows the avoidance of fraudulent transfers and conveyances.
§ 549 allows the avoidance of certain post petition transactions made by the debtor.

f. Discharge of Debt

Each of these bankruptcy chapters have the ability to discharge or otherwise alter the debt of a debtor.

In Chapter 7 see § 727.
In Chapter 9 see §§ 943 and 944(b).
In Chapter 11 see §§ 1129 and 1141 (d)(1).
In Chapter 12 see §§ 1225, 1227 and 1228.
In Chapter 13 see §§ 1325, 1327 and 1328.
In Chapter 15 see §§ 1519, 1521 and 1522.

The rules regarding a discharge in each chapter differ and they must all be read within the context of § 523 Exceptions to discharge. Section 523 is not in the chapter series (i.e., the 700s, 900s, 1100s, 1200s, and 1300s) but is generic to all of the chapters subject to the exceptions variances of each of the chapter discharge sections.

g. Restructuring Debt

In addition to the discharge of debt, some of the bankruptcy chapters allow the alteration of the terms and conditions of debt, both unsecured and secured. Chapters 9, 11, 12 and 13 provide for such powers while Chapter 7 only discharges some or all of the debt depending upon the sum recovered by the trustees liquidation of the estate property, if any.

III.  Conclusion

Bankruptcy is one more tool that the probate and intervention practitioner may use: to administer their estate; to maximize the value of assets; and, to fulfill the fiduciary duties required. It is always a good day when a foreclosure can be avoided; fraudulently transferred money returned to an estate or problematic properties sold at a fair price. These are things the bankruptcy courts can do .

Bankruptcy law is constantly in flux and the new Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) makes life even more interesting. More so than most trial courts, decisions of bankruptcy courts are frequently published. These trial court decisions are often in conflict with each other. The decisions reflect many different approaches and solutions to the same problems presented. Relatively few bankruptcy case have gone to the U.S. Circuit courts and fewer still to the U.S. Supreme Court.  The law is developing as we speak and with the advent of the radical 2005 amendments to the Code, there is much left to interpret. How this will affect probate law is unclear but even with the unanimous but very narrow decision in the Anna Nicole case, we see that the "probate exception" is still in play and its future is unclear.

Some local bankruptcy cases involving probate are listed in the addendum.

CASE ADDENDUM

District of Columbia

In re Sandra Dockery. Mann v. McCarthy, 116 B. R. 1 (Bankr. D.C. 1990).
Automatic stay does not stay a probate proceeding. 11 U.S.C. §§ 362 (FN 6) and 541(b)(1) and (d). Trustee of a bankruptcy debtor that purchased property of a probate estate pre petition, is a hypothetical bona fide purchaser free from claims against the estate.

In re B & W Management, Inc. Brown v. Brown, 63 B.R. 395 (Bankr. D.C. 1986). Only a "person" may be a debtor in bankruptcy and not a decedent's estate.

Virginia

Murry v. Mares, 147 B.R. 688 (E.D. Va. 1992). A bankrupt debtor surviving spouse may not prevent the probate of her late husband's estate on the theory that her interest in the decedent's estate is property of her estate and therefore affected and protected by the automatic stay stemming from her case.

In re Edna J. Valentine, 2007 WL 39120 (Bankr. E.D. Va.). Bankruptcy court had no jurisdiction to review rulings made by a [DC] probate court relating to tort and fraud claims. These claims were brought as an adversary proceeding in the bankruptcy case by the assignee of the claims (assigned to him by the bankruptcy trustee.) Probate court's rulings on the issues were res judicata. 

In re Charles R. Farrior. Wolfe (Trustee) v. Farrior, et al, 344 B.R. 483 (Bankr. W.D. Va. 2006). When a debtor in bankruptcy has disclaimer rights in a will as personal representative of a decedent, the disclaimer rights are property of the debtor's estate and may be administered by the bankruptcy trustee.

In re Angela H. Brown, Shaia v. Estate of Winfree Brown, 1996 WL 757100 (Bankr. E.D. Va. 1996) A bankrupt debtor's interest in property of the estate may be successfully waived by a properly drafted and executed Property Settlement Agreement.

In re Dwight E. Avis, 1996 WL 910911 (Bankr. E.D. Va. 1996) When the debtor's interest in a trust was not effectively scheduled and disclosed, the case may be reopened and the trustee may administer the assets of the trust.

Maryland

In re Donna J. Monroe. Friedman v. Juratovac, 2003 WL 22038534 (Bankr. D. Md. 2003). When a debtor held a joint tenancy with rights of survivorship pre petition, the trustee then has only the debtor's interest in a tenancy in common since the 4 unities have been broken by the transfer of the debtor's portion of his joint interest in the joint tenancy to the estate.

In re Marilyn E. Roberts, 2005 WL 3108224 (Bankr. D. Md. 2005) A personal representative of an insolvent estate may not file a bankruptcy for the decedent's estate. A decedent's estate is not a person and therefore may not be a debtor in bankruptcy. 11 U.S.C, § 109(a)

In re Howard L. Klienman, 274 B.R. 171 (Bankr. D. Md. 2002). Debtor's interest in life insurance proceeds for his deceased wife is exempt and not available to creditors per Maryland law. Maryland Courts and Judicial Proceedings Article, Sec 11-504(b)(2).

In re Fife Symington, III, 209 B.R. 678 (Bankr. D. Md. 1997). Debtor (then serving as Governor of Arizona) filed her Chapter 7 bankruptcy case in Arizona. The Arizona bankruptcy court issued an order allowing creditors to examine the financial records of debtor's mother (Martha F. Symington) a resident of Maryland. The Maryland bankruptcy court issued a subpoena against the resident mother to produce the documents requested. Subsequently the original debtor (Governor of Arizona) was indicted and her mother (Martha F. Symington, the Maryland resident) died. The records requested were never produced by the deceased mother's personal representative despite the Arizona court order and the Maryland subpoena.       

The creditors then moved to substitute a new personal representative for Martha F. Symington's probate estate in light of the conduct of the original personal representative. This court granted an order substituting the personal representative of Martha Symington's probate estate, reasoning that  the mother's probate estate was eligible to be subject to a bankruptcy examination as an "entity" per Bankruptcy Rules 2004 and 9014.