Memorandum of Decision Re: Property of Estate

FOR THE NORTHERN DISTRICT OF CALIFORNIA In re JOHN M. WAHLUND,                                       No. 92-10299      Debtor. ___________________________/ In re PEGGY L. HOBBS,                                                        No. 93-10105      Debtor. ___________________________/ PEGGY L. HOBBS,      Plaintiff,                                                                                     A.P. No. 93-1028     v.                                                                              A.P. No. 93-1069 JOHN M. WAHLUND,      Defendant. ______________________________/ JOHN M. WAHLUND,      Plaintiff,                                                                                     A.P. No. 93-1054    v.                                                                               A.P. No. 92-1389 PEGGY L. HOBBS,      Defendant. _______________________________/
Memorandum of Decision
I. Introduction      From 1974 to 1991, Lee Hobbs and John Wahlund were partners in a real estate brokerage and investment business known as Cutten Realty. The partnership was successful and the partners evidently trusted each other; the partnership lasted until Lee's death in 1991.      During the course of the partnership, Lee and Wahlund together purchased several real properties and made investments in other real property partnerships. Title to the real properties was not taken or held in the partnership name, but was held in the partners' names individually, as well as Lee's wife, Peggy Hobbs. Partnership funds were used to make the purchases. At all times, Lee and Wahlund intended these properties to be partnership assets notwithstanding record title. All properties were carried on the books as partnership property, there is a written memorandum signed by both partners establishing at least one as partnership property, and, at a meeting just a month before Lee's death, both partners acknowledged that all of the properties belonged to the partnership notwithstanding record title.      During his life, and with the apparent cooperation of dishonest notaries, Lee regularly forged his wife's name to deeds and other documents. There is no evidence that Wahlund was aware of this practice.      Lee and Wahlund had only a 2-page partnership agreement. However, it did expressly state that the partnership would maintain life insurance on each partner and that on the death of a partner "the sum due the deceased partner for his partnership interest shall be the proceeds of all life insurance received by the surviving partner." Peggy consented in writing to this agreement.      Wahlund did in fact turn over $360,000.00 in life insurance proceeds to Peggy, but kept the proceeds of an additional $50,000.00 policy which he maintains was not intended by the partners to be included in the benefits to the survivors of the deceased partner.       A dispute has now arisen (evidenced by the four adversary proceedings noted above) as to Peggy's rights in the partnership and its assets. Both Wahlund and Peggy have filed Chapter 11 bankruptcy petitions, and are debtors in possession, so this court is the appropriate forum for resolving these issues.      Wahlund claims that he is entitled to quiet title to the former partnership property in his name, notwithstanding that Peggy is now a record title holder. He also alleges that she owes him a nondischargeable debt for collecting $5,400.00 in rents from partnership tenants after Lee's death. He also alleges that he is entitled to the $50,000.00 additional life insurance but that if he is not then he is still entitled to an offset for $172,000.00 Lee was overdrawn in his partnership account and the $5,400.00 in rents Peggy collected.      Peggy claims that she is entitled to the proceeds from the $50,000.00 life insurance policy, and that Wahlund's obligation for converting these funds is nondischargeable. She also claims ownership of the partnership properties in her name, either on the merits or because, as a debtor in possession, she has the rights of a bona fide purchaser for value pursuant to section 544(a)(3) of the Bankruptcy Code. She also claims about $10,000.00 in commissions due to Lee at the time of his death.
II. The $50,000 Life Insurance Policy
     Wahlund claims that the $50,000.00 life insurance policy was taken out separately from the other $360,000.00 insurance, and was intended to assist the surviving partner in keeping the business going after the death of the other partner. There is considerable evidence to support this position, including the sound reason for such insurance and the fact that at a meeting shortly before Lee's death he and Wahlund told a mutual lawyer that there was about $350,000.00 in life insurance for Peggy, who was also present. However, the written agreement specifically says all life insurance received by the surviving partner is due the deceased partner on account of his partnership interest. If the partners had intended some insurance not to be included, they should have modified the agreement. Accordingly, the court finds that the additional $50,000.00 in insurance proceeds belongs to Peggy.
III. Setoffs
     It is undisputed that during the partnership Lee withdrew about $120,000.00 more than Wahlund did. Both partners knew about this, discussed it with their accountant and bookkeeper, and intended, as late as a month before Lee's death, to come to some sort of agreement relating to it. However, they never did. Wahlund now claims that he is entitled to set off this sum against the $50,000.00 life insurance proceeds he kept.      The record does not reflect that Lee and Wahlund intended the life insurance to be subject to the setoff. It seems clear that whatever they had in mind, they contemplated that the full amount of the life insurance (exempt from execution pursuant to state law) would go to Peggy. Accordingly, the court rules that to the extent that the partnership accounts did not become moot pursuant to the partnership agreement upon the death of a partner they may not be set off against the life insurance proceeds.      After Lee's death, Peggy proceeded to collect $5,400.00 in rent from property which, for the reasons set forth below, then belonged to Wahlund notwithstanding record title. Wahlund is entitled to a setoff for these funds against the life insurance. Accordingly, Peggy shall have a claim against Wahlund in the allowed amount of $44,600.00, plus interest at the legal rate from November 13, 1991.
IV. Properties and Investments
     The evidence is overwhelming that, notwithstanding record title, the partnership owned the Eureka real property at 1802 California Street, 3988 Walnut Avenue, and 910 Third Street. Additionally, the partnership had investments in properties at 904 B Street, 2120 Campton Road, and Victoria Ranch Estates. All of these properties were carried on the partnership books and considered by both partners to be partnership assets. In addition, at the meeting just prior to Lee's death he acknowledged specifically to a mutual lawyer that each of these properties belonged to the partnership. Also, a written memorandum signed by both partners acknowledges that the Campton Road property is partnership property.      Since all of the property in question was partnership property, and since Peggy expressly agreed that upon Lee's death she would accept the life insurance in return for all of Lee's partnership interest, any partnership property held in her name belongs to Wahlund and she holds it in trust for him. Peggy shall be allowed an equitable lien against the properties to secure the $44,600.00 still owed to her. Aside from this lien, except to the extent section 544(a)(3) of the Code mandates a different result (as described below), the court will decree that Peggy has no right, title, or interest in the real property listed above and any interest in her name now belongs to Wahlund.      Peggy seeks to avoid the legal effect of certain transfers made by Lee without her knowledge by forging her name. However. in light of the court's finding that all of the properties were always partnership property notwithstanding legal title, the court does not see how she can turn these forgeries to her advantage. She is still getting exactly what she agreed to, and there is no indication that Wahlund was in any way culpable.
V. Avoidance Pursuant to section 544(a)(3)
     Because Peggy is a debtor in possession, resolution of this case is not as simple as declaring the equitable rights of the parties. Pursuant to section 544(a)(3) of the Bankruptcy Code, Peggy's bankruptcy estate has the rights of a bona fide purchaser of the real estate. Thus, even though she has no equitable ownership rights in the real property, she may reduce Wahlund's rights to an unsecured claim as to any property she could have conveyed good title to on the date she filed her bankruptcy petition. Each property will have to be examined individually to determine if anything of record or in the condition of the property would put a purchaser on notice of Wahlund's interest.
A. 2120 Campton Road
     The partnership owned a one-half interest in the office building at 2120 Campton Road. At the time Peggy filed her Chapter 11 petition, title was in her name; it had been held in joint tenancy with her husband prior to his death. However, as noted above, the true owner of the property was Cutten Realty. The property was also occupied in part by Cutten Realty as its place of business, pursuant to a written lease.      Peggy's claim to this property fails for two reasons. First, the lease was not recorded; Cutten Realty's possession is inconsistent with record title. Where a lease is recorded, a purchaser does not need to inquire about unrecorded rights of the tenant. However, when the lease is unrecorded, a purchaser must inquire as to all rights of the tenant; examination of the lease alone is not enough. Gates Rubber Co. v. Ulman, 214 Cal.App.3d 356, 369 (1989); Basch v. Tidewater etc. Co., 49 Cal.App.2d Supp.743, 750 (1942).      Second, even if possession is consistent with record title a purchaser will only be protected where there are no circumstances which would indicate the need of inquiry. Three Sixty Five Club v. Shostak, 104 Cal.App.2d 735, 738 (1951). In this case, the tenants were paying rent to Wahlund, not Peggy. Her lack of rental income records was a circumstance which would have put a purchaser on notice even if the leases had been recorded.      Any potential purchaser would have a duty to inquire into the rights of all the tenants, by virtue of their open possession. In re Probasco, 839 F.2d 1352, 1354 (9th Cir.1988). The duty of inquiry was more than the mere examination of unrecorded leases, and would have disclosed that Peggy collected no rent, that Cutten Realty had ownership rights, and that the tenants considered Cutten Realty to be the owner. These facts destroy Peggy's claim to bona fide purchaser status as to this property.
B. 3988 Walnut Avenue
     At the time Peggy filed her bankruptcy petition, record title to the property at 3988 Walnut Street was held in the names of Lee and Wahlund, as individuals. Peggy had been on title as a joint tenant with Lee as to his half, but in 1988 Lee had forged her signature on a deed conveying her interest to him as his separate property.      Section 544(a)(3) is not relevant to this property because Peggy was not a record title holder when she filed her bankruptcy petition. Even though deed was forged, it clouded the title. Section 544(a)(3) only comes into play where the debtor had clear record title on the date of the filing of the petition. In re Elin, 20 B.R. 1012 (D.N.J.1982).
C. Victoria Ranch Estates
     Victoria Ranch Estates was a separate partnership. Cutten Realty owned eight percent, although the partnership agreement stated that Wahlund and Lee each owned four percent as individuals. Since record title was in the name of Victoria Ranch Estates, section 544(a)(3) is not applicable.
D. 910 Third Street
     At the time Peggy filed her bankruptcy petition, record title to the apartment building was owned half by Peggy (as survivor under joint tenancy with Lee) and half by Wahlund. However, the building was managed by Cutten Realty and the tenants, under unrecorded leases, would have identified Cutten Realty as the owner. The fact that Peggy had no rental income records alone would have required a purchaser to make inquiry of the tenants, in addition to the duty described above where leases are not recorded. Such an inquiry would have revealed Cutten's ownership. Accordingly, section 544(a)(3) does not cut off Wahlund's equitable rights in the property.      Peggy takes the legal position that occupation by the tenants only would put a purchaser on notice as to their rights, not Wahlund's. However, the court finds no merit to this position. If there are facts which warrant investigation, the purchaser is charged with whatever knowledge an investigation would have revealed. Cal. Civil Code section 19; American Medical International, Inc., v. Feller, 59 Cal.App.3d 1008, 1020 (1976).
E. 1802 California Street
     Title to the apartment building at 1802 California Street was held the same as 910 Third Street. As to that property also, Peggy did not have rental income records and the tenants, under unrecorded leases, would have identified Cutten Realty as the owner. For the same reasons as those discussed above, section 544(a)(3) may not be used to deprive Wahlund of his ownership rights.
F. 904 B Street
     Record title to the apartment building at 904 B Street was held 1/3 by Wahlund, 1/3 by Peggy, and 1/3 by third parties. Since the evidence did not establish that a reasonable inquiry would have revealed Wahlund's rights, his interest will be avoided pursuant to section 544(a)(3); he may file an unsecured claim for the value of his equitable interest thus avoided.
VI. Nondischargeability
     Both parties exercised dominion over property which they did not have rights to: Peggy as to the Walnut Avenue rents and Wahlund as to the $50,000.00 life insurance policy. However, each was acting on the basis of a tenable legal position and a good faith belief that he or she had a right to the funds. Under such circumstances, the element of malice is absent and the obligations are not nondischargeable pursuant to section 523(a)(6). Not every technical conversion results in a nondischargeable debt. Davis v. Aetna Acceptance Co., 293 U.S. 328, 332 (1934).
VII. Commissions
     Peggy claims that Wahlund did not pay her commissions due to Lee when he died. This allegation seems to have arisen from the extreme adversarial relationship between the parties, and was not supported by the evidence.
VIII. Conclusion
     The evidence is overwhelming and completely convincing that all of the real property in question belonged to the partnership and passed to Wahlund on Lee's death in return for the $360,000.00 in life insurance Peggy received and the $50,000.00 disputed life insurance proceeds. Wahlund is entitled to a setoff of $5,400.00 against the $50,000.00, but owes Peggy the balance. Peggy is entitled to the equitable lien discussed above. Half of Wahlund's 2/3 equitable ownership interest in the property at 904 B Street is avoidable pursuant to section 544(a)(3). There are no nondischargeable debts.      Plaintiff in each adversary proceeding shall submit a form of judgment in accordance with this memorandum, which counsel for the defendant has approved as to form. The clerk shall file a copy of this memorandum in each of the adversary proceedings.      This memorandum constitutes the court's findings and conclusions pursuant to FRCP 52(a) and Bankruptcy Rule 7052.
Dated: August 8, 1993                                                                              _______________________                                                                                                                      Alan Jaroslovsky                                                                                                                      U.S. Bankruptcy