| HOMESTEAD ISSUES
With respect to the ability of a beneficiary of a land trust in dealing with his creditors to claim the Texas homestead exemption, the law is not settled. In In re Robinson, a Chapter 7 bankruptcy debtor's real property lost its homestead character when he transferred title to trust for the benefit of another, even though he continued to reside on the property and maintained it as his principal residence. The debtor was not allowed to claim the homestead exemption in the property he did not own. In re Robinson, 180 B.R. 174 (Bkrtcy. E.D. Texas 1995).
So when bankruptcy is imminent or if problems with judgment creditors arise, if property that is exempt as homestead under Texas law has been transferred into a land trust, even where the settlor and the beneficiary are one and the same, it would appear to be a good idea to step out of the trust by having the trustee deed the trust property to the beneficiary before filing bankruptcy or facing a final judgment which can be abstracted.
Probably in response to the large number of persons who have begun transferring property into living trusts to avoid probate costs and public filings, the Texas State Legislature in 1997 passed amendments to § 11.13 of the Texas Property Tax Code, dealing with the application of homestead exemptions to property which had been placed into trust:
"For purposes of this section:
(1) "Residence homestead" means a structure (including a mobile home) or a separately secured and occupied portion of a structure (together with the land, not to exceed 20 acres, and improvements used in the residential occupancy of the structure, if the structure and the land and improvements have identical ownership) that:
(A) is owned by one or more individuals, either directly or through a beneficial interest in a qualifying trust;
(B) is designed or adapted for human residence;
(C) is used as a residence; and
(D) is occupied as his principal residence by an owner or, for property owned through a beneficial interest in a qualifying trust, by a trustor of the trust who qualifies for the exemption.
(2) "Trustor" means a person who transfers an interest in residential property to a qualifying trust, whether by deed or by will, or the person's spouse.
(3) "Qualifying trust" means a trust:
(A) in which the agreement or will creating the trust provides that the trustor of the trust has the right to use and occupy as the trustor's principal residence residential property rent free and without charge except for taxes and other costs and expenses specified in the instrument:
(i) for life;
(ii) for the lesser of life or a term of years; or
(iii) until the date the trust is revoked or terminated by an instrument that describes the property with sufficient certainty to identify it and is recorded in the real property records of the county in which the property is located; and
(B) that acquires the property in an instrument of title that:
(i) describes the property with sufficient certainty to identify it and the interest acquired;
(ii) is recorded in the real property records of the county in which the property is located; and
(iii) is executed by the trustor or the personal representative of the trustor."
PROBATE ISSUES
Because a land trust is a form of a living trust, probate could be avoided by providing for the transfer of the interest to another beneficiary upon the death of the original beneficiary. Though estate taxes cannot be avoided, the probate process could be bypassed. Ancillary probate proceedings required in states where real estate is held by a decedent even though the decedent is a resident of another state can also be avoided since the decedent's beneficial interest in a land trust is considered personalty, and passes to the decedent’s personal representative in the state of the decedent’s domicile. Separate administration in the state where the land is situated is not necessary.34
SEPARATION OF ASSETS - LIMITATION OF LIABILITY
Each property owned by the settlor can be placed in a separate trust. Since each trust is a separate entity, the argument can be made that only the assets of that particular trust can be used to satisfy the claims of creditors of the trust. The trustee should always make it clear that he is only acting in his capacity as a trustee, and should sign all documents as follows:
1234 Main Street, Dallas, Dallas County, Texas Trust
By:_______________________________________________________________
John Trustee, as Trustee, and not personally, of the Trust named above.
All parties dealing with said Trustee shall look solely to the assets of the trust.
The Texas Supreme Court held in Nolana Development Association v. Corsi that a purported trustee who signed a letter without the restriction "as trustee" in which she agreed to be solely responsible to pay an additional $49,000 on a promissory note was individually liable to the joint venture for which she had allegedly held property.35
DEALING WITH THIRD PARTIES
Purchasers, lenders and title insurance companies have an interest in being able to rely upon the authority of the trustee in their dealings with him and the trust property. Since the recorded deed of the property into the trustee recites that the trustee can dispose of the property, and that all persons relying upon his authority need not inquire further, title companies, purchasers, and lenders, should be able to proceed with confidence in dealing directly with the trustee. Moreover, §§ 101.001 and 101.002 of the Texas Property Code should provide additional comfort to those parties:
"101.001 Conveyance by Person Designated as Trustee
If property is conveyed or transferred to a person designated as a trustee but the conveyance or transfer does not identify a trust or disclose the name of any beneficiary, the person designated as trustee may convey, transfer, or encumber the title to the property without subsequent question by a person who claims to be a beneficiary under a trust or who claims by, through, or under any undisclosed beneficiary or by, through, or under the person designated as trustee in that person’s individual capacity.
101.002 Liability of Trust Property
Although trust property is held by the trustee without identifying the trust or its beneficiaries, the trust property is not liable to satisfy the personal obligations of the trustee."
On the other hand, by virtue of his obligations in the trust instrument, the trustee is still accountable to the beneficiaries to the extent that the trustee acts without their express written authority.
SPENDTHRIFT TRUST PROVISIONS
Since in the typical land trust the settlor is also a beneficiary, under Texas law the contributions of the settlor to the trust can be reached by the trustor's creditors, even if there is a spendthrift provision in the trust agreement.
Section 112.035(d) of the Texas Trust Code provides as follows:
"If the settlor is also a beneficiary of the trust, a provision restraining the voluntary or involuntary transfer of his beneficial interest does not prevent his creditors from satisfying claims from his interest in the trust estate."
In the seminal bankruptcy case of In re Shurley36, the court held that spendthrift provisions in a land trust where the settlor and the beneficiary were one and the same, were not likely to be given effect, because of the self-settled nature of the trust, at least to the extent of the assets transferred to the trustee by the settlor/beneficiary. Under Texas law, the beneficiary’s contribution of her property interest in a ranch and mineral interests to the trust defeated the trust’s spendthrift and discretionary protection as to her interests, and, therefore, the beneficiary’s interest in trust was not excluded from her Chapter 7 bankruptcy estate. The spendthrift provision in favor of the beneficiary of a discretionary spendthrift trust was not effective, where the beneficiary was also a settlor of the trust. Control was not required in addition to self-settling to defeat protective trust. The beneficiary, by transferring her property to the discretionary spendthrift trust, created, at least in part, the trust. To have the status as a creator of the discretionary spendthrift trust, the beneficiary needed only to deliver property in trust to some trustee for the benefit of some beneficiaries.37
A settlor cannot create a spendthrift trust for his own benefit and have the trust insulated from the rights of his creditors. Daniels v. Pecan Valley Ranch, Inc., 831 S.W.2d 372 (Tex.App. - San Antonio 1992).
A settlor may create a trust in favor of some third party and prohibit assignment by such party of the beneficial interest in the trust, but the rule is otherwise in cases where a settlor creates a trust and makes himself the beneficiary thereof. Glass v. Carpenter, 330 S.W.2d 530 (App. San Antonio, 1959), rehearing denied.
The statute protecting the right of the trust settlor to include spendthrift provision to prohibit income and/or principal interest of beneficiary from being transferred makes spendthrift trust assets "exempt", as that term is used in the turnover statute, though the statute does not expressly describe spendthrift trust assets as being "exempt" from attachment, execution, or garnishment"; use of such magic words by the legislature is not a prerequisite for the debtor’s assets to be exempt from turnover.
MISCELLANEOUS ISSUES
A debtor/creditor relationship is inconsistent with the fiduciary duty necessary to create a trust.
No particular form of words is required for the creation of a spendthrift trust; however, the trustee must have the duty to preserve trust funds and a trustee who has no duty except to make payments as they become due is a trustee of a "passive" or "dry" trust which cannot constitute a valid spendthrift trust.
A settlor may within a trust instrument relieve the trustee of certain duties, restrictions, responsibilities and liabilities imposed on him by statute. V.T.C.A. Property Code Sections 113.056(a), 113.059(a). Neuhaus v. Richards, 846 S.W.2d 70 (Tex.App.-Corpus Christi 1992).
Under a general exculpatory provision of a trust instrument stating that "No Trustee shall be liable for negligence or error of judgment but shall be liable only for his willful misconduct or personal dishonesty," trustees were not held to a prudent person standard, but could be liable only for willful misconduct or personal dishonesty.
If the language of a trust instrument unambiguously expresses the intent of the settlor, the instrument itself confers the trustee’s powers and neither the trustee nor the court may alter those powers. V.T.C.A. Property Code Sections. 113.056(a), 113.059(a).
Exculpatory clauses in a trust instrument are strictly construed, and the trustee is relieved of liability only to the extent that the trust instrument clearly provides that he shall be excused. V.T.C.A. Property Code Sections. 113.056(a), 113.059(a).
There appear to be ample safeguards for the trustee in the Texas Trust Code adopted as part of the Texas Property Code in 1985. To the extent that the typical land trust agreement provides for the beneficiaries to have the right to manage the property, the trustee should not be held liable for losses incurred in the process.
Property Code § 114.003 provides as follows:
"If a trust instrument reserves or vests authority in any person to the exclusion of the trustee, including the settlor, an advisory or investment committee, or one or more cotrustees, to direct the making or retention of an investment or to perform any other act in the management or administration of the trust, the excluded trustee or cotrustee is not liable for a loss resulting from the exercise of the authority in regard to the investments, management, or administration of the trust."
ABILITY OF LAND TRUST TO HIDE A TRANSFER
WHICH TRIGGERS THE RIGHTS OF A LENDER UNDER A
DUE-ON-SALE CLAUSE IN A MORTGAGE
Before the "due-on-sale" clause came into existence in mortgage instruments in the early 1970s, investors could buy real property utilizing a corporate entity or some other legal entity which provided limited liability to the investor, and take title to the property being acquired, subject to the debt, without assuming the debt.
But the advent of the "due-on-sale" clause, which later evolved into a "due-on-transfer" clause, created a dilemma for many an investor, because the holder of an existing note secured by a mortgage or deed of trust had the right to call the entire principal balance immediately due and payable upon the transfer of any interest in the property by the owner to a new owner. The due-on-sale clause is only a right to call the note due, which may be exercised at the option of the holder of the note if an interest in the property is transferred. But it is not an automatic or self-executing right. The lender will typically call the note due only if the rate of interest in the note is lower than the current market rate of interest. Occasionally there are note holders which wish to immediately recover their principal balance to be able to make other investments, regardless of the fact that the current market rate of interest is lower than the rate of interest being earned on the existing note. But as a general rule, most institutional note holders have large portfolios which are serviced by companies which specialize in the collection of mortgage notes.
Many note holders will require the borrower to escrow one-twelfth of the annual property taxes and casualty insurance premiums, and require the borrower to forward property tax statements and insurance renewals to the lender for payment from the escrowed funds. If title to the property changes hands, and a deed to the property is filed in the real property records evidencing the change in the ownership, the taxing authorities reflect the new owner’s name in the tax statements, and this alerts the note holder to the fact. If the new owner changes the insurance policy to reflect his ownership interest (which change will be necessary to provide the new owner with insurance coverage), the change will be reflected on the insurance renewal which the note holder receives, and once again the note holder will be alerted to the fact that the property has changed hands.
Prior to 1982, the courts in certain states held that due-on-sale clauses were unenforceable under certain circumstances. So in 1982, Congress passed the Garn-St. Germain Depository Institutions Act, which, among other things, pre-empted state law regarding the enforceability of due on sale clauses.
12 USC Sec. 1701j-3
Sec. 1701j-3. Preemption of due-on-sale prohibitions
"(d) Exemption of specified transfers or dispositions
With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due-on-sale clause upon -
(8) a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property . . ."
The exception in the Garn-St. Germain Act gives the homeowner the power to transfer title into a land trust without triggering the due-on-sale clause. This change in record title to the trustee can be communicated to the lender, and the property tax records and insurance policy will reflect the new record owner. If the homeowner subsequently transfers his beneficial interest to a third party, there is no change in the record title, and insurance in the name of the trustee does not change, and the fact that the property has effectively changed hands is unlikely to be discovered by the lender.
CONCLUSION
Like a magician's illusion, the land trust does not always appear to be what it really is. The land trust uses its own form of smoke, mirrors, and misdirection to hide the true beneficial owner. But like a magic trick, if everyone understood the secret gimmick, it would lose its effectiveness.
END NOTES
1 Bryan Dunklin is in private law practice in Dallas, Texas with the firm of Bryan Dunklin & Associates, Attorneys and Counselors at Law, P.C. He has taught real estate law and tax at Southern Methodist University since 1985. Mr. Dunklin graduated from Southern Methodist University with honors in 1975 with a Bachelor of Arts Degree. After serving on the staff of the Democratic National Committee in Washington, D.C., including involvement in a campaign school put on for incumbent governors and United States senators, Mr. Dunklin served as the administrative assistant to Phil Gramm when Senator Gramm ran for the U.S. Senate for the first time in 1975. After serving as the Executive Director of the Democratic Party in Dallas County, Mr. Dunklin returned to graduate school and received his Master of Business Administration and Juris Doctor degrees from SMU in 1981. He served on the staff of the Journal of Air Law and Commerce. In addition to private law practice, Mr. Dunklin has also been the president and general counsel of a real estate investment, management, and brokerage firm, and the general counsel of a national bank. He is one of the coaches of the SMU Law School Client Counseling Team. Mr. Dunklin has coached two of the SMU law school teams to the American Bar Association national competitions, one of which was a National Finalist. He was recently chosen as an Honorary Member of the SMU Law School Board of Advocates. Mr. Dunklin has been a speaker for various organizations such as the Dallas Bar Association Real Property Section, Apartment Association of Greater Dallas, Greater Dallas Board of Realtors, and Association of Independent Real Estate Owners.
2 Your Step-by-Step Guide to Land Trusts, William Bronchick, 1999
3 27 Henry VIII, chap. 10,
4 Bronchick, supra at 8.
5 Sayles, Richard A., A Device for Texas Land Development: The Illinois Land Trust, 10 Houston L.Rev. 692, 1973
6 Report of the American College of Trust and Estate Counsel, Validity of Illinois Land Trusts, August 2, 1993.
7 Sayles, Richard A., A Device for Texas Land Development: The Illinois Land Trust, 10 Houston L.Rev. 692, 1973
8 Texas Real Estate Law, Charles J. Jacobus, 7th Ed., 1996, at 89.
9 Ibid, at 90
10 Neeley v. Intercity Management Corporation, 623 S.W.2d 942 (Tex.Civ.App.-Houston, 1981), rehearing denied.
11 Bronchick, supra at 14 and 15.
12 Neeley v. Intercity Management Corporation, 623 S.W.2d 942, 950 (Tex.Civ.App.-Houston, 1981), rehearing denied.
13 Bronchick, supra at 17.
14 Id. at 19 - 27.
15 Id. at 43.
16 DeBole, Paul L., The Attorney’s Guide to Trust Conveyances, The Practical Real Estate Lawyer, January 1998, at 84
17 Texas Property Code § 92.201 et.seq.
18 Texas Real Estate License Act, Article 6573a.
19 Bronchick, supra at 49, 50.
20 Id. at 50.
21 Id. at 32.
23 Sayles, supra, at 694.
24 Sayles, supra, at 695.
25 Treas. Reg. Sec. 301.7701-2(a)(1) (1972)
26 I.R.C. §§ 671-678
27 Bronchick, supra at 70.
28 IRS Revenue Ruling No. 92-105.
29 Bronchick, supra at 71.
30 Bronchick, supra at 71, 72.
31 IRS Revenue Ruling No. 92-105.
32 Bronchick, supra at 72.
33 Bronchick, supra at 73.
34 Garrett, Land Trusts, 1955 U. Ill. L.F. 655, 661.
35 Nolana Development Association v. Corsi, 682 S.W.2d 246 (Tex. 1984)
36 In re Shurley, Bkrtcy. W.D. Tex. 1994, 171 B.R. 769, appeal decided 115 F.3d 333, rehearing and suggestion for rehearing en banc, denied 124 F.3d 195, certiorari denied 118 S.Ct. 444, 139 L.Ed.2d 380.
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