Can a chapter 7 bankruptcy trustee avoid and recover a transfer of real property in an unrecorded Final Decree of Divorce in Virginia?

Can a chapter 7 bankruptcy trustee avoid and recover a transfer of real property in an unrecorded Final Decree of Divorce in Virginia?

Yes, in the case of Phillips v. Chandler,  215 B.R. 684 (E.D. Va. 1997), the United States District Court for the Eastern District of Virginia reversed a bankruptcy judge’s decision and allowed the chapter 7 trustee to avoid and recover a transfer from a husband to a wife, based on the trustee’s strong-arm avoidance powers based on his status as a hypothetical judicial lien creditor in 11 U.S.C. §544(a)(1).  The Phillips v. Chandler case illustrates the benefits of recording divorce decrees and separation agreements or property settlement agreements in the appropriate county land records in Virginia, to best protect the interests of a spouse when either former spouse might later file bankruptcy.

In Chandler, the husband and wife were divorced in the Circuit Court of Hanover County Virginia.  Under the terms of the Final Decree of Divorce, the real property, which had been owned by the husband and wife as tenants by the entirety with the common-law right of survivorship, was transferred to the wife by virtue of Virginia Code Section 20-107.3(C) , which gives the Virginia divorce court judge authority to divide or transfer jointly owned marital property and jointly owned marital debt under Virginia’s equitable distribution statute.   In Virginia, by operation of law, Section 20-111 of the Code of Virginia, the survivorship in a tenancy by the entirety is terminated, thus converting the tenancy into a tenancy in common, with each spouse owning a half interest, unless otherwise indicated.  Thus, each former spouse’s interest in the real property, which was previously protected from the creditors of each spouse alone by the tenancy by the entirety, becomes subject to the liens of judgment creditor under Virginia Code §8.01-434.  Because of this consequence, Virginia divorce lawyers are advised to record a deed from both spouses to the recipient spouse prior to the entry of the divorce decree where there are recorded judgment liens or other interests of the transferring spouse which may attach if the tenancy should convert to a tenancy in common.

The husband in Chandler filed chapter 7 bankruptcy after the parties’ divorce was finalized, but before the divorce decree was recorded.  The chapter 7 trustee in the husband’s bankruptcy case filed a motion to avoid and recover the transfer of husband’s interest in the real property to wife, based on his strong arm powers as a hypothetical judicial creditor who extends credit to the bankruptcy debtor at the time of the filing of his case and obtains a judicial lien on all property on which a creditor could have obtained, regardless of whether such a creditor actually exists.  The bankruptcy court judge, relying on Barnes v. American Fertilizer Co., 144 Va. 692, 130 S.E. 902 (1925), granted the husband Debtor’s motion to dismiss and motion for summary judgment on the grounds that the requirements of Virginia’s recording statute, found in Virginia Code §55-96(1)(A) , (which did not expressly include divorce decrees) cannot operate to void a transfer of real property in a divorce decree, even though the final decree of divorce was not yet recorded, as required under Virginia Code §20-107.3.

The United States District Court for the Eastern District of Virginia reversed and remanded the case to the bankruptcy court judge for damages.  The federal district court first recognized that a federal court interpreting state legislation must use that state’s rules of statutory construction, such that a court must assume that the legislature is familiar with existing Virginia case law and that a statute may not be construed in such a way to cast doubt on the otherwise clear language of a related statute.   The federal court found that the purpose of Virginia’s enactment of both the recording statute and the equitable distribution statute decree recording provision was to promote public notice and to eliminate hidden or unrecorded interests in real estate.  The court further held that the recording requirement of the Virginia equitable distribution statute was an absolute determinant of the validity of property transfers in divorce decrees.  The common law holding of Barnes was necessarily overruled by the enactment of the Virginia statutes.  The district court judge ruled that the Virginia recording statute must be broadly read and interpreted to include the recording requirements of the Virginia equitable distribution statute, such that it implicitly includes the recording of divorce decrees to give public notice.  Consequently Virginia Code Section 55-96(A)(1) voided the transfer of real property in the unrecorded final decree of divorce and the trustee would be able to avoid the husband’s transfer of his half interest to the wife using his strong arm powers in Bankruptcy Code Section 544(a)(1).

You should consult with your Virginia bankruptcy and divorce attorney or Richmond Divorce lawyer James H. Wilson, Jr., to discuss the effects of your former spouse’s bankruptcy on the results of your divorce case.

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