Borrower’s transfer of properties to Illinois land trust shortly before defaulting on mortgage loan was not a fraudulent transfer to third parties exempting it from the discharge injunction

After borrowing over a million dollars to develop property, the debtor in Firstmerit Bank, N.A. v. Soltys, 2015 IL App (1st) 140100 (Mar. 11, 2015) transferred his interest in six other properties to separate Illinois land trusts. The development project failed a year later and the bank commenced foreclosure proceedings. The foreclosure left a deficiency of close to $4000. Thereafter, the debtor filed a chapter 7 bankruptcy where he disclosed his ownership interest in the properties held in the trusts. The trustee determined there were no assets and the debtor was discharged. The bank did not file a proof of claim or object to the discharge. Instead, it brought an action in state court to recover the deficiency. It argued that the discharge did not prohibit the suit because the land trusts were third party recipients of the debtor’s fraudulent transfers. The trial court dismissed the action and the appellate court affirmed. Under Illinois law, an Illinois land trust places both the legal and equitable title in the trustee and the beneficiary is considered the true owner. The land trust beneficiary’s interest is considered intangible personal property controlled by the debtor. It is therefore not a transfer to a third party, but to the debtor himself. The appellate court also noted that the Section 548(e)(1) of Bankruptcy Code specifically addresses self-settled trusts and does not treat such trusts as third parties. Under this provision, creditors can avoid a transfer by a debtor to a self-settled trust, but it must timely file an adversary claim. The bank did not do so. Thus, the trust properties do not fall under the fraudulent transfer to third parties exception to the bankruptcy discharge and the bank’s state court action constitutes a violation of the discharge injunction.

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