Jobst W.F. Blachy v. Robert E. Butcher and Rosemary Butcher, Co-Personal Representatives of the Estate of Alexander Michael Butcher, Deceased Rosemary Butcher, Individually Little Traverse Development Company, a Michigan Corporation H.C. Development Company, a Michigan Corporation, (99-1185/1492)
Docket: 99-1185
Court: Court of Appeals for the Sixth Circuit; July 21, 2000; Federal Appellate Court
In the case 221 F.3d 896 (6th Cir. 2000), the plaintiffs, comprising twelve condominium owners and Lawyers Title Insurance Corporation, filed a lawsuit against Rosemary C. Butcher, representatives of her deceased husband Alexander M. Butcher's estate, Little Traverse Development Company (LTDC), H.C. Development Company (HCDC), and the Internal Revenue Service (IRS). The plaintiffs sought a declaration that they were the rightful legal titleholders of property previously owned by the Butchers as tenants by the entirety. After extensive litigation lasting eight years, the District Court for the Western District of Michigan granted summary judgment in favor of the plaintiffs, imposing a constructive trust on the disputed property.
The defendants, including the Butchers, LTDC, and HCDC, appealed the imposition of the constructive trust, while the IRS challenged the ruling that a federal tax lien on the Butchers' property was subordinate to the plaintiffs' constructive trust. The appellate court reversed the district court's decision concerning the IRS's tax lien but affirmed the judgment regarding the constructive trust.
The factual background reveals that the Butchers intended to develop resort condominiums through LTDC. In 1978, they acquired approximately 100 acres of land and subsequently conveyed part of that property to LTDC. A series of recorded deeds established their ownership structure and transactions related to the property in question.
On July 18, 1978, Lawyers Title issued a title commitment to LTDC for 40.81 acres, failing to identify a prior 17.83-acre conveyance from LTDC to the Butchers due to the recent recording of the warranty deed and lack of disclosure from Alexander. Consequently, the title commitment inaccurately identified LTDC as the owner of the entire acreage. On November 1, 1978, Alexander executed a master deed creating Harbor Cove Phase II on the full 40.81 acres, and from 1981 to 1984, LTDC constructed and sold condominiums on the disputed 17.83 acres, with nine units sold to the plaintiffs or their predecessors.
On May 8, 1984, Alexander established HCDC, where he held majority ownership and executive roles. In late October 1984, he signed a warranty deed to convey 12.60 acres of the disputed land from LTDC to HCDC, which then developed and sold condominiums on that land, including three sold to the plaintiffs. Throughout these transactions, Alexander represented both entities as holding title to the respective condominiums.
In August 1988, the IRS assessed approximately $61,000 in unpaid taxes against the Butchers, later filing a tax lien against their interests in the 17.83 acres, with the total liability exceeding $150,000. Following Rosemary Butcher's bankruptcy filing on March 1, 1991, the condominium owners learned of the 1978 conveyance and subsequently, in September 1991, Rosemary amended her bankruptcy schedules to claim ownership of the disputed acreage. Prior to this, the plaintiffs had been paying property taxes on the land. Alexander quitclaimed his interest in the 17.83 acres to Rosemary on October 31, 1991, shortly before his death in December.
Procedurally, Rosemary's bankruptcy case was filed in the Eastern District of Michigan. Subsequently, Lawyers Title and the condominium owners sued Alexander, LTDC, HCDC, and the IRS in state court, not including Rosemary due to her bankruptcy status. The IRS removed the action to federal court, where the proceedings were stayed while the plaintiffs sought a constructive trust in Rosemary's bankruptcy case.
Following Alexander's death in late 1991, the Butcher defendants sought to dismiss a district court action due to the lack of substitution of Alexander's estate. The plaintiffs countered by requesting a transfer to bankruptcy court. On August 16, 1993, the district court denied the dismissal, ruling that a stay related to an adversary proceeding tolled the substitution requirement under Rule 25(a)(1) of the Federal Rules of Civil Procedure, a ruling not contested on appeal. The district court also granted the plaintiffs' motion to transfer the case to the Bankruptcy Court for the Eastern District of Michigan.
On November 18, 1993, the plaintiffs' action and Rosemary's bankruptcy proceeding were consolidated. The bankruptcy court subsequently substituted Rosemary and Robert E. Butcher as representatives of Alexander's estate on February 11, 1994. In late November 1994, the bankruptcy court granted summary judgment to the plaintiffs, imposing a constructive trust over 17.83 acres for the benefit of condominium owners and determining that the trust related back to 1978, predating the IRS's tax lien against the Butchers from 1988.
The Butcher defendants appealed, and on July 31, 1995, the district court reversed the bankruptcy court's ruling based on the precedent set in XL/Datacomp, Inc. v. Wilson, which held that a bankruptcy court cannot impose a constructive trust over estate property. The district court decided that the appropriate remedy was to declare the debt nondischargeable and remanded the case.
Upon remand, the bankruptcy court, believing a constructive trust was still warranted, transferred the plaintiffs' claim back to the United States District Court for the Western District of Michigan and lifted the automatic stay to allow the plaintiffs to add Rosemary as a defendant and include a fraudulent conveyance count against the Butchers. The plaintiffs successfully moved to amend their complaint, and all parties filed cross-motions for summary judgment. The district court ruled in favor of the plaintiffs, imposing a constructive trust and finding the Butcher defendants' arguments regarding standing, jurisdiction, and the statute of limitations to be meritless. The court established that the constructive trust took effect retroactively from July 12, 1978, the date of the property conveyance, thus rendering the 1988 federal tax lien subordinate to the plaintiffs' interest in the property.
The Butcher defendants filed a motion for reconsideration, contesting the imposition of a constructive trust over Rosemary's nonbankruptcy interest due to her lack of service with a summons and amended complaint. The district court recognized this error, ordering plaintiffs to serve Rosemary within fourteen days and requiring her to respond with reasons against the constructive trust over her interest in 17.83 acres. The United States also moved for clarification, suggesting the court was incorrectly extending the trust to both of Rosemary’s interests. The Butcher defendants later filed a supplemental motion, acknowledging that Rosemary's attorney had received the necessary documents through an agreement, but still sought to deny summary judgment. Rosemary subsequently filed a detailed response opposing the constructive trust.
The district court rejected all motions from the Butcher defendants and the United States except for the claim that the constructive trust was overly broad. Consequently, the court clarified that the trust would only apply to Rosemary's nonbankruptcy interest. Following a further motion for reconsideration by the Butcher defendants, which was denied, an appeal was initiated.
The appeal addresses various legal issues regarding the district court's summary judgment on the constructive trust claim. The standard of review for this summary judgment is de novo. The court upheld the constructive trust, stating it was necessary to prevent unjust enrichment from Rosemary and Alexander's actions, in line with Michigan law, which allows for such trusts to rectify situations involving fraud or inequitable conduct.
The district court imposed a constructive trust to prevent the Butchers from unjustly enriching themselves at the plaintiffs' expense. On July 12, 1978, the Butchers conveyed 17.83 acres to LTDC and then back to themselves as tenants by the entirety. They subsequently obtained building permits and financing while representing that LTDC or HCDC owned the property. Since the Butchers did not assert their individual ownership until after Rosemary's bankruptcy filing, the condominium owners believed they held valid title and paid property taxes accordingly.
The Butchers claimed the court did not find fraud; however, a constructive trust can be established without such a finding, as it aims to prevent injustice. The court noted that the Butchers knew they retained legal title while allowing others to believe otherwise, which justified the imposition of the trust. They also contended they had no duty to inform the plaintiffs about the conveyance, but they were still obligated not to mislead them regarding ownership.
Additionally, the Butchers argued that any recourse should be against Lawyers Title for failing to discover the conveyance. Nevertheless, their deceptive actions were not excused by the negligence of Lawyers Title, and a comparative negligence defense does not apply to intentional torts. Their failure to disclose the conveyance, particularly when seeking title commitment, suggested fraudulent intent. Hence, the court affirmed the imposition of the constructive trust over Rosemary’s interest.
Constructive trusts do not invalidate IRS tax liens. The district court ruled that a constructive trust should retroactively date to July 12, 1978, the date of the deed from LTDC to the Butchers, concluding that the Butchers lacked any property interest to which the 1988 tax lien could attach. Consequently, the tax liens were deemed subordinate to the plaintiffs' beneficial interest established by the constructive trust. According to 26 U.S.C. § 6321, a tax lien attaches to all property of a taxpayer who neglects tax payment, necessitating an examination of the taxpayer's property rights. Federal law dictates the taxability of interests created by state law. Under Michigan law, a constructive trust is a remedy for fraudulent breaches and only arises upon judicial imposition. Since the constructive trust was not established until a decade after the federal tax lien's inception, the government contends that the tax lien should take precedence. Furthermore, while Michigan law may allow for "relation back" to prioritize a constructive trust against private claims, federal law governs the priority of tax liens, asserting that the first lien in time has priority. Federal law does not permit subordination of tax liens based on the "relation back" doctrine, as established in relevant case law, which affirms that property rights created by court actions do not retroactively affect the priority of a federal tax lien.
Competing claims must meet the federal standard of "choateness" prior to the establishment of a federal tax lien to have priority over it. A state-created lien is considered choate when the lienor, the property, and the lien's amount are clearly identified. The court in Dishman ruled that a state attachment lien is subordinate to a federal tax lien if the state judgment establishing the lien is issued after the federal tax lien is filed. Similarly, in In re Omegas Group, a constructive trust is not effective until a judicial ruling is made. The plaintiffs' constructive trust claim only became choate with the district court's 1998 judgment. However, the court found unpersuasive cases cited by the district court that suggested a retroactive application of a constructive trust could defeat a federal tax lien, as they did not satisfy the federal choateness standard and conflicted with established case law. The IRS properly perfected its lien by filing against the Butchers' property, and the plaintiffs' lack of diligence contributed to their legal challenges. Thus, it would be inequitable to retroactively apply a constructive trust to override the tax lien in favor of the plaintiffs. The court concluded that a judicially-created remedy cannot retroactively defeat a choate federal tax lien, and the equities favor the IRS, reversing the district court's ruling on this matter. Additionally, the district court had jurisdiction over the nonbankruptcy portion of Rosemary's interest in the property, and the quitclaim deed and Alexander's death did not extinguish the plaintiffs' constructive trust claim. Rosemary’s interest was not part of her bankruptcy estate.
The Butchers contend that Rosemary and Alexander's 17.83 acres, owned as tenants by the entirety, became part of Rosemary's bankruptcy estate upon her filing. They further assert that Rosemary became the sole owner after Alexander quitclaimed his interest shortly before his death. They argue that the Western District of Michigan lacked jurisdiction, claiming that only the Eastern District of Michigan's bankruptcy court had jurisdiction over the property.
The court disagrees with the Butchers' jurisdiction claim, affirming that Rosemary's interest in the property did indeed become part of her bankruptcy estate upon her bankruptcy filing on March 1, 1991, as outlined in 11 U.S.C. § 541(a)(1). The court notes that Michigan, which retains the common law concept of tenancy by the entirety, allows for such property to be included in a bankruptcy estate, where joint creditors can reach it, but individual creditors cannot.
The ruling references In re Arango, which clarifies that while individual possessory interests in entireties property may not exist under state law, such interests are recognized under bankruptcy law, thus making them part of the debtor's estate. A leading bankruptcy treatise indicates that a trustee can sell a debtor's interest in entireties property, with proceeds distributed accordingly to the non-filing spouse. This aligns with 11 U.S.C. § 363(j), which mandates that the trustee distribute the non-filing spouse's share of proceeds from such a sale.
The Butchers argue that creditors cannot reach the property interests of only one tenant in a tenancy by the entirety, citing Craft v. United States. However, Craft is distinguishable since it did not involve bankruptcy property, leaving the impact of bankruptcy on entireties interests unaddressed. In contrast, cases like Grosslight and Arango directly involve such issues. The Butchers also assert that Alexander's quitclaim of his interest in 17.83 acres to Rosemary, occurring seven months after her bankruptcy filing, terminated the tenancy by the entirety. According to M.C.L. 557.101, this conveyance indeed ended the entireties interest, but since Alexander quitclaimed after the 180-day window post-bankruptcy petition, Rosemary retained an interest in the property outside of bankruptcy, as per 11 U.S.C. 541(a)(5)(A).
There was no merger of Rosemary's bankruptcy and nonbankruptcy interests, and the Butchers had previously claimed that Rosemary held a separate interest in the property, which they cannot now contradict due to a lack of judicial estoppel, as they were not successful with that argument in earlier proceedings. After the bankruptcy court transferred the constructive trust issue to the district court and lifted the automatic stay, the district court had the jurisdiction to adjudicate this matter regarding Rosemary’s nonbankruptcy interest in the property.
The Butchers’ claim that a constructive trust cannot be imposed on Rosemary’s postpetition interest fails because the trust was established by the district court, not the bankruptcy court, and it pertains solely to her nonbankruptcy interest. Additionally, the Butchers contend that Rosemary should not be held accountable for the actions of Alexander and associated entities. However, Rosemary inherits Alexander's obligations regarding her nonbankruptcy interest, meaning if Alexander was not entitled to his interest, it is subject to a constructive trust regardless of Rosemary's current ownership status.
Rosemary's interest in the property could be subjected to a constructive trust due to her lack of "clean hands," stemming from her acquiescence in the conveyance from LTDC to herself and her husband, her failure to inform the plaintiffs about this conveyance, and her acceptance of tax payments from the plaintiffs while keeping her and Alexander's legal title undisclosed. Although Rosemary’s role was less significant than Alexander’s in misleading the plaintiffs, this was not a decisive factor. Additionally, Alexander’s separate interest in the property did not become part of Rosemary's bankruptcy estate when she filed or when she acquired his interest via quitclaim deed, leading to the affirmation of the district court's ruling.
Regarding jurisdiction, the Butchers contended that the bankruptcy court's exclusive jurisdiction over debtor property under 28 U.S.C. § 1334(e) meant the district court lacked authority to rule on the constructive trust claim. However, the plaintiffs argued that the bankruptcy court appropriately transferred the claim, as it could share jurisdiction. The transfer involved Rosemary's interest acquired post-bankruptcy filing, thus not violating § 1334(e). The district court's interpretation, supported by prior decisions, confirmed that bankruptcy courts can transfer jurisdiction over specific issues to other courts.
On the issue of standing, the Butcher defendants challenged the plaintiffs' ability to maintain their constructive trust claim based on various arguments, including issues with title and alleged non-appearance of plaintiffs. These arguments were deemed irrelevant to the standing requirements, which necessitate showing an injury in fact, a causal connection to the defendant's actions, and the likelihood of redress from a favorable court decision.
Plaintiffs allege a legal injury stemming from a defective title due to the Butcher defendants' actions, which can be remedied through a constructive trust. Lawyers Title has standing based on the subrogation clauses of the title insurance policies issued to condominium owners, leading to the affirmation of the district court's decision on this matter. The Butcher defendants challenge the removal of the case to federal court, arguing that naming the IRS instead of the United States violates 28 U.S.C. 1444. However, precedent indicates that such misnomers do not obstruct removal; thus, the plaintiffs' naming error does not prevent federal jurisdiction.
The Butcher defendants also claim the constructive trust is barred by a six-year statute of limitations. However, the applicable statute is fifteen years for land recovery, and since the first deed was delivered to the plaintiffs on October 22, 1981, and the lawsuit was filed on October 16, 1991, their claim is not time-barred. The defendants incorrectly assert that the claim accrued on July 12, 1978, when title was conveyed, but it actually accrued when the plaintiffs received their warranty deeds, which is consistent with Michigan law. Even assuming the earlier date, the claim remains within the fifteen-year limitation.
Lastly, the Butcher defendants argue that the constructive trust is void regarding Rosemary because it was imposed before she was served with legal documents. This argument, raised during reconsideration, was partially accepted by the district court, which required the plaintiffs to serve Rosemary and allowed her the chance to respond. Subsequently, the Butcher defendants filed a supplemental motion for reconsideration. The district court's order for summary judgment is upheld as valid concerning Rosemary.
The Butcher defendants contended that the district court's imposition of a constructive trust was void due to a lack of personal jurisdiction over Rosemary after a final judgment. They argued the court could not amend its judgment, citing a belief that Rosemary was served individually. However, the court retained authority to amend its judgment under Federal Rule of Civil Procedure 60(b) for mistakes, even post-judgment, as supported by Kingvision Pay-Per-View Ltd. v. Lake Alice Bar. The court correctly rejected the defendants' jurisdictional argument, determining that jurisdiction over Rosemary was established when her attorney, Robert Butcher, accepted service of the amended complaint on her behalf. Rosemary's claim that this acceptance was contingent on receiving additional time to respond was procedurally defaulted due to her failure to timely raise it. Additionally, Rosemary had previously been served as a personal representative of Alexander's estate, thus was aware and had the opportunity to respond. She had filed a response contesting the plaintiffs' summary judgment. Rosemary was appropriately added as a defendant due to her acquisition of Alexander's interest in the property during the litigation, consistent with Rule 25(c) of the Federal Rules of Civil Procedure, which allows for continuation of actions despite interest transfers. Substitution of parties can occur post-litigation if the transfer happened during the case.
Plaintiffs' claim against Rosemary is a continuation of their claim against Alexander, thus not barred by the statute of limitations, validating Rosemary's substitution into the case. The Butcher defendants raised several arguments: 1) the statute of frauds prevents a constructive trust; 2) the bankruptcy court lacked authority to transfer the constructive trust claim due to mootness; 3) the action became moot after Alexander's substitution; 4) no unjust enrichment occurs when a title insurer pays claims; 5) equity lacks jurisdiction if legal relief is adequate; 6) a constructive trust cannot exist without the plaintiffs having good title; and 7) if Alexander acquired 17.83 acres improperly, he had no interest to quitclaim to Rosemary. Most of these arguments are poorly articulated, variations of previously addressed points, and deemed meritless. The court affirms the district court's judgment on these issues. However, it reverses the judgment regarding the IRS's tax lien, ruling it is not subordinate to the plaintiffs' constructive trust. Judge Siler concurs in part but dissents on the superior status of the constructive trust over the IRS tax lien, noting that relevant case law supports tax lien superiority under different circumstances. He emphasizes that there is no established Sixth Circuit authority determining the priority of a federal tax lien over a constructive trust beneficiary retroactive to before the tax lien's filing.
Reliance Ins. Co. v. Brown is cited as conflicting with In re Omegas Group, rendering it unhelpful. The district court's reliance on Hobson v. United States establishes that the IRS cannot possess greater rights than a taxpayer. FTC v. Crittenden and TMG II v. United States support this conclusion, with the IRS having conceded that tax liens do not attach to property under a constructive trust. The majority view holds the IRS as faultless, but the dissent argues that condominium owners, misled by their title company regarding ownership, are equally faultless. The dissent suggests that the IRS could have been aware of the construction activity indicating the Butchers' lack of ownership. It posits that both parties share equal fault, with the IRS holding no superior rights over the Butchers. The hypothetical scenario of the Butchers acquiring property through fraudulent means raises concerns about the implications of the majority ruling, suggesting it could lead to unjust outcomes for the condominium owners. The dissent ultimately advocates for affirming the district court's decision in full.
