Satterfield v. Sigmon ( 1996 )

    In Re: ED L. MAHAFFEY; In Re:
                                                                        No. 95-2411
    WAYNE SIGMON, Trustee,
    Appeal from the United States District Court
    for the Western District of North Carolina, at Shelby.
    Lacy H. Thornburg, District Judge.
    (CA-93-98-4, CA-94-22-4, BK-93-40009)
    Argued: March 7, 1996
    Decided: July 10, 1996
    Before MURNAGHAN and ERVIN, Circuit Judges, and
    BUTZNER, Senior Circuit Judge.
    Vacated and remanded by unpublished opinion. Senior Judge Butzner
    wrote the opinion, in which Judge Murnaghan and Judge Ervin
    ARGUED: Judith C. Fraser, Waynesville, North Carolina, for Appel-
    lants. P. Wagne Sigmon, GRAY, LAYTON, DRUM, KERSH, SOL-
    OMON, SIGMON & FURR, P.A., Gastonia, North Carolina, for
    Unpublished opinions are not binding precedent in this circuit. See
    Local Rule 36(c).
    BUTZNER, Senior Circuit Judge:
    Ed and Violet Mahaffey, an elderly couple, conveyed their mobile
    home to their daughter, Brenda Satterfield, two months before filing
    for bankruptcy under Chapter 7. Although the deed on its face con-
    veyed a fee simple interest in the property, the Mahaffeys and their
    daughter agreed that Violet Mahaffey retained the right to live on the
    property for the rest of her life. The bankruptcy court held this to be
    a fraudulent transfer, and it denied the Mahaffeys' claim for a home-
    stead exemption in the property. The district court affirmed.
    We remand the case with directions to the bankruptcy or district
    court (collectively "the court") to decide, in the exercise of its equity
    power, whether to reform the deed to Mrs. Satterfield. Such reforma-
    tion could give effect to the intention of the parties by recognizing the
    reservation of a life estate in the property. The trustee can avoid the
    transfer of the remainder pursuant to the constructive fraud provisions
    of the bankruptcy code.
    By way of preamble, we note that it appeared to the district court
    that the Mahaffeys did not act in bad faith or with fraudulent intent.
    Moreover, if the Mahaffeys had been advised to retain their property,
    they could have claimed a homestead exemption. The trustee told the
    bankruptcy court, "it is a sad situation." But quite properly he pressed
    the rights of the bankruptcy estate. Affirming the bankruptcy court,
    the district court concluded its opinion by writing:
              Application of the law to the facts here presented forces
              this Court to the conclusion that Appellants [the Mahaffeys]
              have no relief available to them and therefore must lose their
              home. This case is compelling because of the ages and
              health considerations of the Appellants. Indeed, the Appel-
              lants' need for their home certainly far outweighs the need
              of creditors for a proportionate distribution of the sum in
              question. Nonetheless, when Appellants chose to seek the
              relief of the bankruptcy provisions, they also stepped into
              the realm of bankruptcy law. This Court is bound to uphold
              that law unless and until a higher court advises that the
              interpretation rendered is inaccurate.
    (footnote omitted).
    Ed and Violet Mahaffey live in a mobile home in Polk County,
    North Carolina. The Mahaffeys have had trouble making their
    monthly mortgage payments. Violet Mahaffey is sickly, taking sev-
    eral medications, often costing between $200 and $300 per month,
    and suffering from depression and a heart condition. She testified that
    her husband is an invalid. Violet Mahaffey earns $274 per month. Her
    husband does not earn a salary.
    Brenda Allen Satterfield, the Mahaffeys' daughter, helped her par-
    ents with the monthly mortgage payments over a period of several
    years. On November 16, 1992, the Mahaffeys transferred their mobile
    home and two lots of land located in Polk County to their daughter.
    The November 16 deed did not contain any words limiting the estate
    that was transferred. Yet both parties understood that Violet Mahaffey
    would live in the home for the remainder of her life. Violet Mahaffey
    stated: "I assigned the place to her because she said I could have it
    to live there as long as I lived." Mrs. Satterfield echoed this senti-
    ment: "[T]he deal was that I would make the payments for her and
    help her and she would live there, you know, the rest of her life."
    The Mahaffeys filed a Chapter 7 bankruptcy petition on January
    13, 1993. At that time, they had personal property totaling $2,550 and
    debts equaling $29,905.49. The real property that they transferred was
    appraised during the bankruptcy proceedings at $34,000. Tryon Fed-
    eral Savings and Loan had a mortgage on the property in the amount
    of $20,069.58. In the petition, the Mahaffeys claimed that if the
    trustee recaptured the real property, they were entitled to a homestead
    exemption under North Carolina law in the amount of the difference
    between the market value of the home and the lien on the property.
    The trustee objected to the Mahaffeys' election of an exemption in
    the property. On April 1, 1993, the trustee filed an adversary proceed-
    ing against Mrs. Satterfield, seeking a return of the property. By a
    deed recorded on April 19, 1993, before any hearing in the adversary
    proceeding, Brenda Satterfield, together with her husband, conveyed
    the property back to the Mahaffeys to avoid the perception that they
    were engaging in a fraudulent transfer. Mrs. Satterfield explained:
              [W]hen we assigned the property back to my mother, I was
              so upset because we didn't want it to appear that I had
              accepted this property just to protect it from bankruptcy at
              all. And so I wanted that transferred back to prove--because
              I have never had dealings like this before and I didn't want
              anybody to think that we were trying to be dishonest at all.
    The bankruptcy court held that the trustee could avoid the transfer
    from the Mahaffeys to Mrs. Satterfield for lack of adequate consider-
    ation pursuant to 11 U.S.C. § 548(a)(2). With respect to the convey-
    ance from the Satterfields back to the Mahaffeys, the bankruptcy
    court allowed the trustee recovery under § 550(a), which permits the
    trustee to recover property from the "initial transferee" or "any imme-
    diate or mediate transferee of such initial transferee." 11 U.S.C.
    § 550(a)(1),(2). The bankruptcy court also held that the Mahaffeys
    could not exempt the property under 11 U.S.C. § 522(g), which
    allows exemptions for property the trustee recovers if the transfer
    "was not a voluntary transfer" of the property. The district court
    The Mahaffeys rely on the "no harm, no foul" principle enunciated
    in In re Treiber, 
    92 B.R. 930
    , 932 (Bankr. N.D. Okla. 1988). Under
    this approach, a transfer of property that could have been exempted
    cannot constitute a fraudulent conveyance since the property would
    be immune from the claims of creditors if it were not conveyed. As
    a majority of courts that have considered the issue have noted, how-
    ever, the "no harm, no foul" approach seemed more appropriate under
    the old Bankruptcy Act, in which exempt property was not part of the
    bankruptcy estate. See, e.g., In re Wickstrom, 
    113 B.R. 339
    , 350
    (Bankr. W.D. Mich. 1990) (citing cases). Under the new Bankruptcy
    Code, in contrast, all property, including potentially exempt property,
    is part of the estate until the debtor claims an exemption. See 11
    U.S.C. § 541(a). Consequently, a transfer of potentially exempt prop-
    erty could harm creditors. In the case before us, both the bankruptcy
    and district courts declined to follow In re Treiber. We agree, and we
    find no error in their interpretation of the code. Because of the differ-
    ence between the old and the new bankruptcy codes, we do not rely
    on the "no harm, no foul" approach as a basis for our decision.
    Generally, federal appellate courts do not consider issues that the
    parties have not raised either below or on appeal. See Singleton v.
    428 U.S. 106
    , 120 (1976). Yet in "exceptional circumstances,"
    to prevent injustice, we may raise issues sua sponte. Id. at 121;
    Washington Gas Light Co. v. Virginia Electric and Power Co., 
    438 F.2d 248
    , 250-51 (4th Cir. 1971). In this case, we have enough facts
    before us about the parties' intentions that we can, to prevent injus-
    tice, remand the case for the court to consider reformation of the deed
    of transfer.
    Bankruptcy courts are courts of equity. Katchen v. Landy, 
    382 U.S. 323
    , 336 (1966). As courts of equity, they have the power to reform
    written instruments, including deeds, to effectuate the intent of the
    parties. See generally American Employers Ins. Co. v. St. Paul Fire
    & Marine Ins. Co., Ltd., 
    594 F.2d 973
    , 977 (4th Cir. 1979) (insurance
    policy); In re Cleveland, 
    53 B.R. 814
    , 817 (Bankr. E.D. Va. 1985)
    (deed). North Carolina courts are empowered to reform deeds. Light
    v. Equitable Life Assurance Society of the United States, 
    286 S.E.2d 868
    , 872 (N.C. App. 1988). Federal courts look to state law in defin-
    ing property interests. Butner v. United States , 
    440 U.S. 48
    , 55
    Durham v. Creech, 
    231 S.E.2d 163
     (N.C. Ct. App. 1977), dealt
    with a situation similar to the one we consider. Grantors, by reason
    of mistake, conveyed real property in fee simple though they intended
    to reserve a life estate in the property. The court ordered reformation
    of the conveyance to reserve a life estate to the grantors. For addi-
    tional examples of reformation of a fee simple to a life estate, see
    Restatement of Restitution § 49 & illus. 4 (1936) (gratuitous transac-
    North Carolina courts do not allow reformation, however, if the
    rights of a bona fide purchaser would be prejudiced. Hice v. Hi-Mil,
    301 N.C. 647
    , 653, 
    273 S.E.2d 268
    , 272 (1981). The Bankruptcy
    Code grants to trustees the "rights and powers" of bona fide purchas-
    ers of real property. 11 U.S.C. § 544(a)(3). The Code does not auto-
    matically make the trustee a bona fide purchaser; rather, it extends to
    the trustee the powers possessed by such figures. In re Wilkinson, 
    186 B.R. 186
    , 191 (Bankr. D. Md. 1995).
    To determine bona fide status, bankruptcy courts apply state law.
    See In re Morse, 
    30 B.R. 52
    , 54 (Bankr. 1st Cir. 1983); David G.
    Epstein, Steve H. Nickles, James J. White, 2 Bankruptcy § 6-61, at
    129 (1992). Although a trustee's actual knowledge will not preclude
    bona fide status, constructive notice, as determined by state law, will
    "defeat the trustee's rights under § 544(a)(3) just as such notice would
    defeat the rights of any bona fide purchaser of real property." Collier
    Bankruptcy Manual ¶ 544.02, at 544-11, 12 (Lawrence P. King ed.,
    3d ed. 1996).
    Under North Carolina law, a bona fide purchaser is one who "pays
    valuable consideration and buys without actual or constructive notice
    of any claims on title." Creech, 231 S.E.2d at 167. Constructive
    notice includes information found in the chain of title of the property
    and facts obtainable through "such inquiry as a cautious and prudent
    [person] would make." New Hanover County v. Holmes, 15 N.C.
    App. 548, 550, 
    190 S.E.2d 396
    , 397 (1972). For the sale of real prop-
    erty, such an inquiry would encompass an examination of the prop-
    erty to ensure that no party was in possession. See Metropolitan Life
    Ins. Co. v. Dial, 
    209 N.C. 339
    , 350-51, 
    183 S.E. 609
    , 615-16 (1936).
    Dial relied on the longstanding rule in North Carolina that possession
    constitutes constructive notice. It quoted Heyer v. Beatty, 
    83 N.C. 244
    , 248 (1879), in which the North Carolina Supreme Court
              Possession is suggestive of title or right in the possessor,
              and a prudent man should and would inquire into such
              apparent right before trading with another; and, if he do not,
              it is but just to the rights of the party in possession to hold
              the purchaser as affected with notice of the equities in his
              favor . . . .
    See also Morehead v. Harris, 
    262 N.C. 330
    , 339, 
    137 S.E.2d 174
    , 183
    (1964) (dictum).
    To reiterate, under 11 U.S.C. § 544(a), a court need not be con-
    cerned with the trustee's actual knowledge regarding the possession
    of real estate. The proper inquiry is whether, under North Carolina
    law, a hypothetical purchaser of real estate would have attained the
    status of a bona fide purchaser.
    If the deed is reformed, the reserved life estate would not be
    included in the property that the trustee seeks to avoid, because, hav-
    ing been reserved, it was never fraudulently conveyed. In that event,
    the court should consider the status of Ed Mahaffey. Did the parties
    intend that he have a life estate in the mobile home? If so, would the
    estate be measured by his life or Violet's life? It seems unlikely that
    the parties intended him to have no interest in the home, but this is
    a possibility.
    The remainder interest is a different story. Section 548(a) outlines
    two types of transactions that constitute fraud. The first addresses
    actual fraud--where the debtor makes a conveyance with a subjective
    intent that evidences fraud. Section 548(a)(1) allows the trustee to
    avoid transfers that the debtor makes "with actual intent to hinder,
    delay, or defraud any entity to which the debtor was. . . indebted
    . . . ." As the district court noted, and as the testimony of the parties
    reveals, the Mahaffeys did not perpetrate actual fraud.
    The second type of fraud is "constructive fraud." This species of
    fraud allows the trustee to
              avoid any transfer of an interest of the debtor in property,
              or any obligation incurred by the debtor, that was made or
              incurred on or within one year before the date of the filing
              of the petition, if the debtor voluntarily or involuntarily . . .
              received less than a reasonably equivalent value in exchange
              for such transfer or obligation; and . . . was insolvent on the
              date that such transfer was made or such obligation was
              incurred, or became insolvent as a result of such transfer or
              obligation . . . .". 11 U.S.C. § 548(a)(2)(A),(2)(B)(i)).
    The transfer of the remainder took place on November 16, 1992,
    less than one year before the Mahaffeys filed for bankruptcy on Janu-
    ary 13, 1993. The Mahaffeys received less than reasonably equivalent
    value for the remainder. Satterfield promised to make mortgage pay-
    ments in the future, but an "unperformed promise to furnish support
    to the debtor" does not constitute value. 11 U.S.C. § 548(d)(2)(A).
    Finally, the Mahaffeys were insolvent on the date of the transfer; their
    debts exceeded their assets.
    The transfer of the remainder constitutes a fraudulent transaction
    which the trustee can avoid. Despite the Satterfields' beneficial inten-
    tions, the transfer back to the Mahaffeys does not remedy the finding
    of constructive fraud. The trustee may recover from either the "initial
    transferee," Mrs. Satterfield, or from the "immediate . . . transferee of
    [the] initial transferee," the Mahaffeys. 11 U.S.C. § 550(a)(1),(2). The
    Mahaffeys cannot protect the remainder from the trustee pursuant to
    11 U.S.C. § 522(g) since they voluntarily transferred the property.
    The next question concerns homestead exemptions. North Carolina
    has opted out of the exemptions listed in the federal code. N.C. Gen.
    Stat. § 1C-1601(f) (1995). Consideration of the applicable homestead
    exemption in this case therefore depends solely on North Carolina
    law. See Cheeseman v. Nachman, 
    656 F.2d 60
    , 62 (4th Cir. 1981).
    Section 1C-1601 of the North Carolina Code delineates the prop-
    erty exempt from the bankrupt's estate. Of relevance to this case,
    § 1C-1601(a)(1) exempts "[t]he debtor's aggregate interest, not to
    exceed ten thousand dollars ($10,000) in value, in real property or
    personal property that the debtor or a dependent of the debtor uses as
    a residence . . . ." North Carolina law requires continued ownership
    and use of the property to claim an exemption. In re Love, 
    42 B.R. 317
    , 319 (E.D.N.C. 1984). If the exempt residence ceases to be used
    as a residence or is no longer owned by the debtor, then the home-
    stead exemption does not apply. Id. The effect of the exemption is to
    render such property "free of the enforcement of the claims of credi-
    tors for indebtedness incurred before or after the exempt property is
    set aside . . . for so long as the debtor owns it." N.C. Gen. Stat. § 1C-
    1604(a). The exemption scheme is designed to give debtors a "fresh
    start"--a chance to retain enough possessions to"begin anew."
    Nachman, 656 F.2d at 63-64. For this reason, exemptions are to be
    liberally construed. See, e.g., In re Hollar, 
    184 B.R. 25
    , 28 (Bankr.
    M.D.N.C. 1995).
    By its terms, § 1C-1601(a)(1) does not confine exemptions to hold-
    ers of a fee simple interest in real estate. "The debtor's aggregate
    interest" is broad enough to include a life estate. A life estate entitles
    its holder to "exclusive possession and control" during its existence.
    1 American Law of Property: A Treatise on the Law of Property in
    the United States § 216, at 129 (1952). The owner of a life estate has
    --with minor exceptions, such as the need to avoid"waste"--as com-
    plete a present ownership in the property as the holder of a fee simple
    interest in property. If Violet alone has a life estate, she can claim a
    $10,000 exemption in the value of her life estate. If Ed has an estate
    in the property, he, too, is entitled to claim a $10,000 exemption.
    Tryon Federal Savings and Loan Association's $20,070 mortgage
    is not affected by the exemption. The mortgage is a secured claim,
    which is not discharged by bankruptcy. See David G. Epstein, Steve
    H. Nickles, James J. White, 2 Bankruptcy § 7-10, at 300 (1992).
    Although certain liens can be limited to the extent they conflict with
    exemptions, mortgages do not fall into this category. See 11 U.S.C.
    § 522(c); Fitzgerald v. Davis, 
    729 F.2d 306
     (4th Cir. 1984). Nor
    would the remainder be affected by the homestead exemption.
    If the deed is not reformed, the district court may re-enter its previ-
    ous order. The judgment is vacated, and the case is remanded for fur-
    ther proceedings consistent with this opinion. Each side should bear
    his or her costs.