Will the bankruptcy court allow an adversary proceeding by children against the parents for breach of fiduciary duty after the equitable distribution of the subject property in a Virginia divorce case?
In Spreadbury v. Spreadbury AP No: 09-1254 (Bkr. EDVA, 2010), the United States Bankruptcy Court for the Eastern District of Virginia, Alexandria Division, allowed a claim for breach of fiduciary duty to proceed by denying a motion to dismiss and a motion for summary judgment by the children’s father, holding that the children’s claim stated a genuine issue of material fact, the relevant standard under Fed.R.Civ.P 56(c) and Fed.R.Bankr.P.7056.
In Spreadbury, the initial action began on July 21, 2008, when the wife filed a voluntary Chapter 11 bankruptcy petition in the U.S. Bankruptcy Court for the Eastern District of Virginia, Alexandria Division. The children filed proofs of claim for five million dollars in her bankruptcy case. The debtor wife listed her most significant asset as a house and 100-acre real estate parcel at 1749 Atoka Road, Middleburg, Virginia, an asset referred to as “Westbury Farm”. According to her bankruptcy petition, the debtor valued the property at $4,655,900 subject to a deed of trust for $1,027,023. Concurrently, the debtor wife and her husband had a divorce action pending for approximately four years in a Virginia Circuit Court. After the bankruptcy court judge lifted the automatic stay to allow equitable distribution to proceed in the state court, a final order of divorce was entered and the husband and wife’s separate interests in the marital estate were calculated at 65% for the husband and 35% for the debtor wife, respectively. Equitable distribution by the Virginia Circuit court was made subject to review by the bankruptcy court and the order permitting relief from the automatic stay.
During the pendency of the divorce, the four children of the debtor wife and husband sought to intervene in their divorce case, but were rebuffed by the divorce court judge on the grounds that they needed to file a separate action. Three days prior to the debtor wife’s bankruptcy filing, the children filed suit against the debtor mother and their father seeking over $5 million dollars in damages for breach of fiduciary duty. Furthermore, the children filed probate court proceedings in Connecticut, where both the trust was created and where their father resided. The Fauquier Circuit Court stayed the action by the children in Virginia to allow the case in Connecticut to proceed. The children filed proofs of claim and an adversary proceeding for breach of fiduciary duty in the wife’s Virginia bankruptcy case. All of the parties agreed that the Virginia Bankruptcy Court was the most appropriate forum for resolving their dispute.
The case concerned the creation of the three trusts, a family trust, the children’s trust and the parents’ trust, and how the parents as trustees managed the assets of the children’s trust. On September 21, 1990, the parents created an irrevocable family trust, referred to as the “children’s trust,” which named the debtor wife, the husband, and the four children as donors. At that time, the husband, the debtor and two other persons were designated as trustees and only these trustees’ signatures appear on the trust instrument, not the donors’. The parties did not dispute that each of the children contributed $42,328 to the purchase of Westbury Farm. Under the terms of the family trust, the parents would receive an income interest for the shorter of their joint lifetimes or twenty-two years, with the remainder interest vesting in the living children and the issue of any deceased children in September 2012. However, before their interests expired, the parents had the responsibility to bear “all of the expenses, taxes, and costs attributable to the joint and survivor outcome interests.”
The actual title to Westbury Farm was held by a second trust created by the husband/father, naming the husband/father as the sole trustee and the children’s trust as the beneficiary. Eight years after the institution of these two trusts, the realty trust with the consent of the debtor wife and husband, entered a lease and purchase option for Westbury Farm with a third trust—the parents’ trust, a trust naming the husband and wife as sole beneficiaries during their joint lifetimes. The lease on the parents’ trust named a term of 99 years at $1.00 per year, providing an option to purchase the property for $1,750,000 at any time. In August 1999, the parents’ trust exercised the purchase option and executed to the children’s trust a $340,000 promissory note bearing interest at 7% payable in annual interest installments, with the principal due in 30 years. Although the note states it was to be secured by a deed of trust, no such instrument was recorded, and it was not determined how the amount of $340,000 was calculated. With the consent of the husband and the debtor wife as trustees, the beneficiary of the children’s trust changed to the parents’ trust, and on November 19, 2003, the husband executed a deed conveying the property into the name of the parents’ trust. According to the children in the complaint, they had no knowledge of the lease, the purchase option, or the beneficiary change, and they had not provided consent.
The children argued in their complaint that the parents breached their fiduciary duty and engaged in self-dealing by consenting to the 99-year lease and purchase option for the parents’ trust, exercising the purchase option and proving an unsecured $340,000 promissory note (on which no payment have been made); changing the beneficiary of the realty trust; accepting the $340,000 note as adequate compensation; and conveying title of the property to the parents’ trust. After discussion, the Court held that the children’s cause of action was valid and should not be dismissed; therefore, the parents could be liable for their mismanagement of the children’s trust.
You should consult with your Virginia bankruptcy and divorce lawyer concerning competing interests in property subject to equitable distribution and bankruptcy.