Legal Versus Equitable Interests in Bankruptcy

Equitable Interests in Property During BankruptcyWhen one files bankruptcy, a bankruptcy estate is created. The bankruptcy estate consists of all legal or equitable interests the debtor possesses in any property, at the time of the filing of the bankruptcy petition [See USC 541(a)(1)]. In bankruptcy, one may have a legal interest in property, or an equitable interest in property.

A legal interest is represented by ownership in property that is generally more recognizable by law. If one buys an automobile and titles the automobile in his or her name, then clearly that party has a legal interest, as evidenced by the title.

An equitable interest may arise when the party does not have a legal interest in the property, but fairness or equity dictates that the party should have an interest in the property.

The first type of equitable interest is found in the creation of an express trust. In an express trust, a trustee possesses legal interest in property, which is held for the benefit of another party, generally referred to as the beneficiary. The beneficiary of the trust holds an equitable interest. An beneficiary interest in a trust must be revealed in the bankruptcy schedules, as one must reveal any equitable interest, as such interest is part of the bankruptcy estate.

A common type of equitable interest is found in situations where a parent titles an automobile in his or her name, but the automobile was purchased with funds provided by the child of the parent. Such an arrangement usually is made because the parent is helping the child escape heavily burdensome automobile insurance premiums. In such instance, the parent has legal interest in the automobile and the child has an equitable interest. In fairness, the automobile is really property of the child.

Such circumstance may be referred to as a resulting trust. The parent is the trustee, holding legal title to the automobile, and the child is the beneficiary.

If the person filing bankruptcy has only legal title, or what is referred to as bare legal title, but no equitable interest in the property, that property may excluded from liquidation by the bankruptcy trustee in a Chapter 7 bankruptcy, and not subject to the liquidation test in a Chapter 13 bankruptcy. The liquidation test holds that a person filing Chapter 13 bankruptcy must pay his or her unsecured creditors an amount equal to what such creditors would receive if the same person filed a Chapter 7 bankruptcy.

Another situation that often arises is where a parent co-signs a loan for his or her child to purchase an automobile or home. Although the child may have furnished the down payment, tendered all loan payments, maintained the property, and had exclusive use of the property, an argument may be made that the parent does not have solely bare legal title because the parent used his or her credit in assisting the child in the purchase. The parent has contributed to the value of the asset by employing his or her credit in the purchase.

A number of factors can determine whether a party has an equitable interest in the property. How long before the bankruptcy filing was the property possessed by the equitable owner? Does the legal owner need permission from the equitable owner to use the property? Which party maintains the property or incurs expenses relating to repairs of the property? Who tenders monthly payments on the loan for the property? Where are billing statements sent? Where is the property located, and in whose possession?

A number of prominent bankruptcy cases in the Southern District of Florida have addressed the issue of legal versus equitable title. These cases generally arise where the bankruptcy trustee is attacking the claim by the filer of the bankruptcy that he or she only possesses bare legal title. These cases generally occur in situations involving either automobiles, bank accounts, or real property.

In re Fletcher involved a scenario wherein an automobile was purchased by the bankruptcy filer’s mother but was titled in both the mother and the filer’s names. The bankruptcy filer paid all insurance and maintenance on the automobile.

The bankruptcy court looked to Florida law which holds that when an individuals name is on the title to property, it is presumed that such individual holds also beneficial interest (or equitable interest) in such property. The bankruptcy filer may rebut such presumption may demonstrating with clear and convincing evidence that he or she does not possess a beneficial (or equitable) interest in such property.

The bankruptcy court in Fletcher held that although the mother possessed legal title to the automobile, the bankruptcy filer possessed a beneficial interest in the automobile, and such automobile therefore was subject to turnover to the Chapter 7 bankruptcy trustee.

Conversely, in the case of In re Mullennix, also in the Southern District of Florida found that turnover should be denied where the mother paid all insurance, maintenance, and expenses relating to the automobile, but the bankruptcy filer possessed legal title to the automobile.

As Fletcher revealed, the equitable interest or beneficial interest may be a fractional interest. For example, a situation may arise wherein the parent, along with other family members, and the child him or herself, contribute towards the purchase of an automobile which is titled in the name of the parent. In such an instance, the parent possesses legal title, but arguably an equitable interest in the monetary contribution he or she made towards the purchase of the automobile utilized by the child. The other family members similarly possess an equitable interest, along with the child, pursuant at a minimum, to the amount of the child’s contribution towards the purchase of the automobile.

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