Academic journal article Washington and Lee Law Review

A Clash of Expectations: Debtors' Disclaimers of Property in Advance of Bankruptcy

Academic journal article Washington and Lee Law Review

A Clash of Expectations: Debtors' Disclaimers of Property in Advance of Bankruptcy

Article excerpt

I. Introduction

Suppose that a debtor stands to receive an amount of real or personal property by will that he does not wish to use in satisfying his creditors. Suppose also that the same debtor expects that he will soon have to file bankruptcy. Should his creditors be able to take this family property even if the debtor refuses to accept it under the will? Is it reasonable to allow creditors to reach family property even though they did not inquire into the debtor's expectations of receiving the property before extending credit?

Under common law, a debtor may disclaim devised property or, in other words, refuse to accept it. Many jurisdictions apply the common law relation-back doctrine, a legal fiction that title to the property never vested in the disclaimant.1 The relation-back doctrine causes the property to pass to other relatives, as if the disclaimant had predeceased the decedent.2 As a practical matter, the relation-back doctrine results in the debtor's children or siblings receiving the property so that creditors cannot reach it.

Some states have curtailed the power of debtors to disclaim property to avoid the claims of creditors.3 However, this Note focuses on whether state laws permitting disclaimers conflict with federal bankruptcy law. It is relatively clear that a disclaimer occurring after the debtor has filed bankruptcy is not effective because the property has already become part of the bankruptcy estate.4 The law is not so clear with regard to disclaimers occurring before the debtor files for bankruptcy (prepetition disclaimers).5 The fraudulent transfer provisions of the Bankruptcy Code empower a bankruptcy trustee to prohibit the transfer of any "interest of the debtor in property" within one year prior to filing for bankruptcy if the transferor possesses an "actual intent to hinder, delay, or defraud" creditors or "received less than a reasonably equivalent value in exchange for such transfer."6 Whether prepetition disclaimers are fraudulent transfers largely depends on whether the disclaimed property was actually a property interest of the debtor.7

In Drye v. United States,8 the Supreme Court held that a disclaimer does not defeat a federal tax lien.9 Since Drye, courts have disagreed as to whether its holding should extend to disclaimers that frustrate creditors other than the Internal Revenue Service (IRS).10 The Drye holding suggests that federal tax law preempts state disclaimer law with respect to the existence and character of a property right.11 Does this preemption mean that federal bankruptcy law also should predominate over state disclaimer law with respect to the definition of property interests?

The issue of prepetition disclaimers appears very technical, but it has important policy implications regarding federal involvement in defining property rights. The issue also has interesting implications regarding the power relationship between creditors and debtors. What is the underlying rationale of the power to disclaim? Is it merely a way to cheat one's creditors, or is it a power that prevents creditors from overreaching into property upon which they did not rely when extending credit? Is it a legitimate device by which a person can protect property with sentimental value, or is it a license for sons and daughters of the wealthy to spend extravagantly with the comfort of knowing that creditors will not attach family property? This Note attempts to answer these questions, focusing on the issue of disclaimers in advance of bankruptcy.

Part II of this Note discusses the common law and state statutory regimes that permit disclaimers. Part III considers whether the federal Bankruptcy Code permits prepetition disclaimers. In order to highlight the federal treatment of disclaimers, Part III. A explores what constitutes a transfer of a debtor's interest in property. Part III.B explores whether the Supreme Court's opinion in Drye applies to prepetition disclaimers. Finally, Parts IV and V consider policy arguments for and against permitting the use of disclaimers in advance of bankruptcy. …

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