Volume V, Number 3 – September 1996
© Donlevy-Rosen & Rosen, P.A.
TENANCY BY THE ENTIRETIES:
Protection No More!
INTRODUCTION. This issue was scheduled to be a review of Barbados. However, a decision in a recent case which may put at risk certain “do-it-yourself” protection techniques was handed down, and is discussed in this issue.
Until the decision in IN RE: JUAN E. PLANAS was handed down in mid-July, it was widely believed that holding title to assets as “tenants by the entireties” (TBE), in those states which accord that form of ownership its traditional common law treatment, offered a significant degree of protection from the claims of the creditors of one spouse. The PLANAS decision has changed all of that.
BACKGROUND. Tenancy by the entireties is a unique form of joint ownership which can only exist between a husband and wife. There are three important aspects to a traditional tenancy by the entireties, the last two of which are derived from the legal fiction of the first one. The referred to legal fiction is that each spouse is considered to own the entire property, rather than an undivided interest in it (as is the case with a traditional joint ownership with right of survivorship; See, APN, Vol. III, No. 3). Following from this legal fiction, neither spouse, acting alone, may transfer any portion of the property during the joint lives of the spouses. Finally, the third important aspect of a traditional TBE is that neither spouse, acting alone, may encumber the property. Thus, the husband and wife must act together to transfer or encumber the TBE property. As a corollary to this proposition, a creditor of only one spouse cannot look to that property to satisfy its claim. Only joint creditors, i.e., those creditors with claims against both spouses, may reach the entireties property to satisfy a claim. Complications arise when only one spouse files bankruptcy but seeks to “exempt” the TBE property.
The questions which were initially raised by that situation were: Are the TBE assets included in the debtor’s bankruptcy estate under the Bankruptcy Code, and, if such assets are included, are they subject to administration by the Bankruptcy trustee?
UP TILL NOW. The majority view in the United States under the 1978 Bankruptcy Code has been that all TBE property is included in the debtor’s bankruptcy estate and is subject to administration in bankruptcy where the debtor and spouse were jointly liable on debts at the time of filing of the bankruptcy petition. A majority of cases have also held that the amount of the TBE property in excess of joint claims would continue to be exempt from the claims of the separate creditors of the debtor spouse. Thus, until now, a couple could feel somewhat secure in knowing that TBE property was only exposed to the extent of their joint obligations. The bankruptcy trustee in PLANAS sought to change this rule and utilize any joint debt of the couple as a “lever” to overturn an entireties status for the benefit of all creditors (of the same class), not merely for the benefit of joint creditors.
THE DILEMMA. In reaching its decision, the PLANAS Court had to wrestle with the idea of whether to treat all creditors of the same class equally – which would require the liquidation of the debtor’s interest in TBE property for the benefit of all same-class creditors, or whether a “sub-class” of creditors, i.e. “joint creditors”, should be recognized, as is essentially the majority view. The Court’s dilemma arose from the following enigma: if an individual creditor is allowed to benefit from the entireties property forming part of the bankruptcy estate (as sought by the PLANAStrustee), that creditor is in a better position with respect to the debtor then he would otherwise be under state substantive law. On the other hand, if an individual creditor is not allowed this extra benefit (as held in the majority of cases), this would ostensibly be violative of a goal of the Bankruptcy Code — to equalize distribution among creditors of the same class.
THE DECISION. The court looked to the U.S. Supreme Court for guidance, and found that Moore v. Bay, a case decided in 1931, stood for the proposition that the bankruptcy trustee was to make only one distribution to all creditors without distinction. Although that case was decided under a prior Bankruptcy act, and has been subject to substantial criticism, the court found that other courts have determined, by analogy to the principle annunciated in Moore v. Bay, that it is entirely proper to allow the trustee to utilize a small joint debt owed by a couple as a lever to overturn an entireties immunity for the benefit of all same-class creditors. Thus, the PLANAS Court ordered the bankruptcy trustee to administer (and to distribute to all creditors of the bankruptcy estate) of all accounts and properties held by the couple.
CONCLUSION. Although the Planas decision does not represent the majority view in the United States, it does open the door a little wider to creditors, illustrating all the more that reliance upon state or common-law created exemptions is risky, at best, and disastrous at worst. Even where the full common law protection of TBE property is strongly upheld, relying upon that form of ownership for protection is precarious: the non-debtor spouse can die (regardless of good health, one can be involved in an accident), and the protection vanishes in an instant. Divorce would likewise end the protection. Just as bad, however, can be the increased estate tax costs which might be incurred through excessive use of the TBE form of ownership: depending upon the size of the couples’ combined estates, the over-utilization of the TBE form of ownership can result in increased estate taxes of as much as $330,000!
Individuals desiring to effectively protect their hard-earned or inherited wealth should seek professional advice from an attorney whose practice is concentrated in asset protection planning.