The Bankruptcy Code is written in a way that’s intended to treat all similar creditors class fairly when the debtor’s property is distributed. If a debtor gives a creditor a “preference”; that is, if he transfers property or money to an existing creditor before filing his petition, the bankruptcy trustee may be able to sue that creditor in order to recapture the amount paid or transferred. The amount recovered is then added to the value of the bankruptcy estate and distributed to creditors. This so-called “preference” principle was the focus of a recent decision by the District of Colorado Bankruptcy Court involving a divorced couple, W. Dutton and M. Clark.
Clark, who had purchased the marital home in his own name (and who undertook sole responsibility for the accompanying mortgage loan), transferred title to himself and Ms. Dutton. Mr. Clark remained solely liable on the mortgage. The couple separated and Mr. Clark moved out in 2013. They filed for divorce in 2014
As part of their divorce, Mr. Clark agreed to give Ms. Dutton a quitclaim deed transferring all of his title to the property. He provided this deed in 2015, and Ms. Dutton subsequently assumed responsibility for the mortgage. The following year, Mr. Clark filed a Chapter 7 bankruptcy petition. Ms. Dutton did not file. In 2018 Ms. Dutton resold the home to an unrelated third party. The trustee sued Ms. Dutton to recover a portion of the net amount she received from that sale.
What Is “Equivalent Value”?
To establish a preference, the trustee must, among other things, show that the bankrupt did not receive value “substantially equivalent” to the obligation being satisfied. If he did, the amount received simply becomes part of the bankruptcy estate. At that point, the property transferred is placed beyond the trustee’s reach, though the amount received naturally becomes part of the estate.
According to CNN Money, in 2008, nearly one in five Colorado homeowners were “underwater”; that is, the value of their properties was less than the amount owned in mortgage loans. Dutton and Clark were no exception. By 2018 when the property was sold, however, the value had improved significantly, and Ms. Dutton was able to net about $83,000 from the sale. The trustee sought to recover from Ms. Dutton the one-half of that amount less one-half of the $75,000 Colorado homestead exemption.
In denying the trustee’s motion, the Court concluded that when Mr. Clark took on the obligation to provide a quitclaim deed in 2014, the property was still “underwater”. As such, when he later executed and delivered that deed – that is, when he satisfied his preexisting obligation to do so – no equity was transferred to Ms. Dutton. Mr. Clark, said the Court, effectively received zero equity in exchange for the preexisting obligation, which was equivalent to what he was transferring to Ms. Dutton. That the property was no longer “underwater” when the deed was delivered and that Ms. Dutton was subsequently able to sell it for a net gain, were irrelevant.
An unfavorable decision in this case would have cost Ms. Dutton nearly $4,000.00. It shows that transfers of title between divorcing spouses can present complex issues, particularly if one later files for bankruptcy. As we’ve previously written , it’s usually preferable to obtain a bankruptcy discharge first and then proceed with the divorce. When, as in the Clark case, this isn’t possible, questions of property value and the dates of various actions can be critical. You owe it to yourselves to get expert advice from an experienced Colorado bankruptcy attorney.
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