The Importance of Proper Planning: Partnership & Trust Assets of Deceased Spouse Become Property of Bankruptcy Estate
A recent opinion involves the convergence of a family partnership, will and probate estate, trust and Bankruptcy estate and highlights the need for appropriate planning and quality legal advice for each step in order to avoid a negative result years down the road.
In Trauner, Ch. 7 Trustee v. Thadikamalla, et al, Adv. Proceeding No. 11-05233, 2012 Bankr. LEXIS 4956 (Bankr. N.D. Ga. September 28, 2012)(J. Diehl) (click here for .pdf of Order), the facts showed the following. In December 2000 Debtor, her spouse and their two children created a Limited Partnership. However, no documents were ever executed by the partners. Debtor's spouse served as the de facto general partner for the Partnership until his death in November 2002. At the time of his death, Mr. Thadikamalla held a 60% interest in the Partner, Debtor held 10% and the two children 10% and 20%.
After Mr. Thadikamalla's death, no action was taken with respect to the continuation or termination of the Partnership. Debtor was the legal representative of his estate. His Will established a credit shelter Trust for the benefit of Debtor which was to provide for the health, maintenance, and support of Debtor. Upon her death, remaining property of the Trust would be divided into equal shares for each child or the surviving members of the child's family. The Trust corpus was not protected, and could be used to support the beneficiaries during their lifetime.
The 2008 Partnership tax return listed Debtor's interest in the Partnership as 70% based on her Partnership interest and as a domestic partner. Debtor filed a Chapter 7 Petition on May 1, 2009. As of that date, the Partnership owned several properties, including several that were unencumbered and others that had equity. Debtor scheduled a 10% interest in the Partnership on Schedule B, with a value of zero. The 2009 Partnership tax return was changed to state that Debtor had only a 10% interest, with the childrens' interest 40% and 50%, respectively.
The Trustee field suit against Debtor, her spouse's Estate, and the two children, to obtain a declaratory judgment that Debtor owned 70% of the Partnership, for partition and sale of Partnership property and for turnover of Partnership property (among other claims not discussed herein). Click here for the Complaint (w/out exhibits due to size). The Trustee moved for summary judgment.
The Court determined that the Partnership was a limited liability partnership and it was governed by the Georgia Revised Limited Partnership Act, effective in 1988. Because no documents were executed, the default provisions of the Act applied. Under these provisions, the death of Mr. Thadikamalla resulted in the dissolution of the Partnership, but not the termination. No action was taken by Debtor, as the representation of her late husband's estate, to terminate the Partnership. Therefore, Mr. Thadikamalla's 60% Partnership interest became part of his probate estate, and pursuant to his Will passed to the Trust. Debtor was the sole beneficiary of the Trust until her death. Thus, the Court held,as of the date of the filing of her Chapter 7 Petition, Debtor owned a 70% interest in the Partnership (her original 10%, plus the Trust's 50%).
The Court also held that the Debtor's 70% interest in the Partnership was property of the Bankruptcy estate.
"Here, because Debtor was the beneficiary under the Trust, which allowed her to use the entirety of the Trust to her benefit, including invading the corpus, Debtor's interest in the Trust also becomes property of the estate in full" "Trustee is the essentially the assignee of Debtor's rights in the Partnership and could seek to wind up the partnership."
The Trustee has the legal right to wind up the Partnership based on Debtor's original 10% interest. O.C.G.A. §14-9-803(a). The Trustee also has authority as successor to Debtor's rights as the legal representative of her late husband's probate estate. O.C.G.A. §14-9-705.
Finally, the Court denied the Trustee's request for declaratory judgment that he is entitled to 70% of the Partnership property, and his request that certain properties owned by the Partnership be turned over as bankruptcy estate property:
[B]ecause the Partnership has not been wound up or cancelled, the estate's interest is limited to the Debtor's interest in the Partnership. A determination regarding the distribution or liquidation of the Beach Condos, as Partnership property, would only be available to the Trustee in accordance with the procedures provided under applicable Georgia law.
Trustee's ability to liquidate the Partnership assets does not originate with remedies under § 363(h). Instead, Trustee succeeds to Debtor's state law rights to wind up the Partnership. Without winding up the Partnership, partition is premature... Here, Debtor's interest is limited to her interest in the Partnership. Property held by the Partnership does not qualify as "an undivided interest as a tenant in common, joint tenant, or tenant by the entirety." ...Debtor did not hold the subject property as a tenant in common, joint tenant, or tenant by the entirety. Again, the Partnership owns the Beach Condos, and the Defendant Partners share an interest in the Partnership. O.C.G.A. § 14-9-701. Further, the Beach Condos do not have co-owners; the Partnership holds title to the Beach Condos. The estate holds a 70% Partnership interest, and this form of ownership is distinct from the forms of ownership listed in § 363(h).
Based on the determination that the Partnership is dissolved, but not terminated, the [bankruptcy] estate's interest is limited to Debtor's interest in the Partnership, not the property held by the Partnership. The Partnership property -- the Beach Condos, is not subject to turnover under § 542(a).
Hindsight is always 20/20, and most people do not plan on passing away prematurely or becoming insolvent. In this case, we can speculate how the outcome may have been different with appropriate planning. Certainly, the family members/partners could have, and should have, executed the appropriate Partnership documents when the Partnership was created to avoid the default statutory provisions. A business lawyer may have also suggested other business forms, such as a limited liability company. It appears the Debtor's spouse did do some estate planning and perhaps the Trust was appropriate, the record suggests that Debtor and her children did little or no additional planning after his death with respect to the Partnership. A business lawyer may have been able to advise them of the proper steps that could have been taken to protect the Partnership property, including perhaps winding up the Partnership and creating a new entity to hold the Property. Finally, this case is a lesson to Bankruptcy lawyers to go above and beyond the usual inquiries when a client identifies an interest in a family business, whether it is a partnership, limited liability company or a trust. Ask for all relevant documents, including tax returns, and ask about any transfers of property of the entity (or ownership interests in the entity). Unfortunately, by the time clients make it to the point of seeing a Bankruptcy lawyer it is too late to fix many of the problems.
Scott Riddle’s practice focuses on bankruptcy and litigation. Scott has represented Chapter 7 and 11 debtors, creditors, creditor committees, trustees, court-appointed receivers and other interested parties in bankruptcy cases and bankruptcy litigation. For more information, click here.