Marketability Issues of Titles Held by Trusts and Trustees

This article was originally published in The Colorado Lawyer, Vol.29, No. 8, August 2000. The Colorado statutes discussed in this article have been changed since the article was published. This article should be consulted as historical background only. Please also see related article:  “Trusts and Titles New Colorado Law”

The revocable living trust has become popular nationwide as an alternative means of clearing title to an individual’s property at death. Although significantly less need exists for this estate planning vehicle in states like Colorado that enjoy the benefits of a progressive probate system, such states are in the minority. Even for Colorado practitioners who confine their use of the revocable living trust to a limited set of circumstances, familiarity with the issues surrounding real estate conveyances by and to trusts is crucial.

Many clients new to Colorado will arrive with an established revocable living trust, and in many cases, it will be appropriate to maintain that plan. Colorado residents who own real property in states with antiquated probate laws may prefer holding it in a trust to avoid ancillary probate of the property at their death. Colorado practitioners also will confront trust issues when assisting residents of other states in the acquisition or sale of Colorado real estate.

Real estate title marketability issues likely will appear with increasing frequency in trust and estate practices, partly because of the need for a “second generation” of real estate conveyances out of trusts. During the trustor’s life, he or she may need to refinance or sell real property previously conveyed to the trust. After the trustor’s death, the successor trustee will need to sell or distribute real property to trust beneficiaries.

Lack of compliance with statutory recording requirements in the “first generation” instrument, conveying the real estate into the trust, creates title issues that the Colorado Supreme Court’s recent decision inLagae v. Lackner did not resolve. Unfortunately, such lack of compliance is pervasive. Causes of noncompliance include uncertainty regarding the purpose and meaning of the statutory recording requirements; continuation of longstanding traditional practices that predate the statutes; and conveyances done without attorney assistance.

This article reviews existing statutory requirements governing conveyances of real estate to trustees and trusts and the judicial interpretation of those statutes; discusses implications of these authorities in situations common to trust and estate practices; and summarizes proposed statutory reforms and their impact on the issues. The examples in this article assume that the trustor and trustee of a revocable living trust are the same person, as is typically the case.

Conveyance of Real Property to a Trustee

CRS § 38-30-108 provides that, for all instruments conveying real estate, a trustee must name the beneficiary of the trust and define the trust agreement. Alternatively, the instrument may properly identify some other document recorded in the county public record where such information appears. If these requirements are not met, the description of the grantee as a trustee will be considered a description of the person only and will not provide notice of a trust or other representative capacity of the grantee.

It is traditional practice for conveyances of all types of property to trusts to be made to the trustee because the trust itself was not recognized in common law as an entity capable of owning property. The purpose of statutes like CRS § 38-30-108 is to address historic problems plaguing the marketability of titles vested in grantees, where the grantee is identified with the nondescriptive label “trustee.” These titles were considered inalienable because the trustee label created a duty of inquiry on third parties to investigate the bona fides of the trust. To eliminate this burden and prevent fraudulent abuse of the trustee label by debtors trying to throw creditors off their trail, legislatures enacted curative statutes.

These curative statutes generally require the initial instrument of conveyance to the trustee to provide evidence of the bona fides of the trust. The “cure” for failure to comply with these recording requirements is harsh: third parties dealing with the purported trustee can disregard the trustee label and need not concern themselves with issues of potential trust beneficiaries or fiduciary duties that the purported trustee owes to them. Under the express terms of CRS § 38-30-108 and many similar statutes, marketable title is established in the purported trustee as an individual. This bright line promotes the alienability of titles held by a trustee, but courts and legislatures continue to struggle with its consequences in individual cases.

In 1970, in Board of County Comm’rs of Co. of Pitkin v. Blanning, the Colorado Court of Appeals, interpreting the predecessor statute to CRS § 38-30-108, lent support for the potential severity of the current statute’s cure by explicitly holding that when the statute’s recording requirements are not met, the instrument of conveyance “vests” “both legal and equitable title” in the grantees in their individual capacity. This holding not only allows a grantee from the purported trustee to prevail over trust beneficiaries, but also implies that when the purported trustee dies, the trust can obtain marketable title to the property only by receiving a personal representative’s deed from the purported trustee’s estate.

Under the plain language of CRS § 38-30-108 and under the court’s decision in Blanning, where the instrument of conveyance to the trustee failed to comply with the recording requirements, the trust can properly acquire marketable title only with a new, compliant deed. The purported trustee can execute a new deed to himself or herself that complies with CRS § 38-30-108, or convey to the trust itself in a manner compliant with CRS § 38-30-166 (see section below entitled “Conveyance of Real Property to a Trust”). However, a new deed cannot relate back to the date of the original conveyance and legitimize it because CRS § 38-30-108 requires that the original deed cross-reference any document satisfying the recording requirements. Even if a new compliant deed can be recorded before the trustee dies, a “gap” will remain in compliance, creating a risk that the purported trustee passed a legitimate chain of title to a stranger during the gap. If the purported trustee dies before a new deed can be recorded, the successor trustee must acquire marketable title to the property from the purported trustee’s estate.

The Supreme Court decision in Lagae took some, but not all, of the sting out of CRS § 38-30-108. The Colorado Court of Appeals, continuing the logic of its earlier decision in Blanning, held that CRS § 38-30-108 must be given its plain meaning. In addition, when the statute’s recording requirements are not met, personal judgment creditors of the grantee trustee can levy against the purported trust property over the objections of trust beneficiaries. The Supreme Court reversed the Court of Appeals decision inLagae, avoiding the statute’s harsh result under the facts of that case by holding that the statute protects only creditors who can demonstrate reliance on the noncompliant deed.

The Supreme Court’s decision clearly backs off of the bright line provided in the language of the statute itself and in the Court of Appeals opinions in Blanning and Lackner. The Supreme Court opinion carefully avoids the words “required” and “requirements” when describing CRS § 38-30-108 and, instead, uses terms such as “provided by” and “guidelines.” The Court refers to deeds that fail to satisfy statutory requirements as “nonconforming” rather than “noncompliant.” References to the purported trustee as having “facially valid title” or “apparent ownership” are cited with favor in cases from other jurisdictions construing similar statutes, and the trustee’s title is never described as vested. The Court explicitly held that CRS § 38-30-108 is a notice statute, meaning that a party who relies on facially valid title in the trustee as an individual will be “protected” by the statute. The Court declined to elaborate on adequate or persuasive forms of creditor reliance because it was clear that the judgment creditor had not relied on the noncompliant instrument in extending credit to the trustee.

Lagae does not eliminate the potential risks flowing from a noncompliant deed where a third party who dealt with the trustee during the notice gap can demonstrate reliance. If the purported trustee, acting in breach of his or her fiduciary duties, conveyed or encumbered the property during the notice gap, a subsequent purchaser from the trust may not be protected, even if that purchaser wins the race to the clerk and recorder. The noncompliant deed may be deemed an irregularity that serves as constructive notice of the trustee’s ability to create a renegade chain of title, preventing any subsequent grantee who has not adequately examined the record from claiming the status of a bona fide purchaser. Lagae also leaves the door open for a judgment creditor of the trustee to levy against the trust property over the protest of trust beneficiaries, as long as that creditor can demonstrate that it relied on the noncompliant deed in issuing a loan to the purported trustee.

A subsequent purchaser from the trust may find that the seller-trust’s title company is willing to insure against the risk of a superior yet undisclosed claim and may find comfort in the existence of title insurance should such a disaster arise. The trust’s warranties of title provide further protection.

On the seller side of that transaction, however, trust beneficiaries retain the risk that, should a title contest arise, the purchaser still may pursue a claim against the trust for breach of the trust’s warranties of title. The title company may pursue the trust as subrogee to the rights of the purchaser. Although title companies may insure conveyances from a purported trustee or his or her successors, attorneys representing trustee-sellers should educate their clients about the risk that the purported trustee previously may have conveyed good title to the property or allowed his or her personal creditors to rely on the noncompliant deed. Clients, who usually have better knowledge of the purported trustee, are better able to assess this risk. If there is reason to suspect that trustee mischief has occurred and the purported trustee is deceased, attorneys should explore the possibility of further reducing risk by probating the property through the purported trustee’s estate.

It is unclear whether Lagae has an impact on the issues presented by distributions of trust property to beneficiaries after the trustee’s death. Arguably, the statute no longer vests title in a trustee as an individual, but merely gives him or her license to cause potential problems during the notice gap. This reading may lead title examiners to relax their requirement that a personal representative’s deed must be recorded to clear title after the trustee’s death. A beneficiary may receive marketable title with a recorded death certificate for the purported trustee and a recorded affidavit describing the successor trustee’s authority to convey the property out of the trust to the beneficiary.

The statutory reforms summarized below will provide specific authority for such a procedure. However, these reforms will not eliminate the risk flowing from potential trustee mischief during the notice gap. Attorneys must continue to evaluate these risks with their clients on a case-by-case basis, weighing the costs and benefits of a title search or a probate before making distributions of property to trust beneficiaries.

Conveyance of Real Property to a Trust

Many practitioners avoid the problems of CRS § 38-30-108 by availing themselves of the authority granted in CRS § 38-30-166 to acquire property in the name of the trust. CRS § 38-30-166 provides that a trust may acquire real property in the name of the trust upon compliance with the statute’s recording requirements. The statute requires recording an affidavit setting forth the name of the trust, the names and addresses of the trustees, and the identity of the trustee or trustees who have authority to deal in real property on behalf of the trust.

CRS § 38-30-166 was enacted as part of a modern trend to recognize trusts as legal entities that can own property. The statute is in derogation of common law, and its recording requirements have been strictly construed as preventing acquisition of real property by a trust when the affidavit is not recorded properly. The affidavit recording requirements serve the essential purpose of identifying for the public record who has the authority to control the real estate owned by the trust, who has authority to convey it, and where those persons can be found.

Although the recording requirements imposed under CRS § 38-30-166 are minimal compared to CRS § 38-30-108, failure to comply with CRS § 38-30-166 is common for the same reasons failure to comply with CRS § 38-30-108 is common. Similar but not identical problems arise when the trustee dies. Under CRS § 38-30-108, a noncompliant deed is still effective to convey the property from the grantor to the grantee, only the conveyance is to the grantee as an individual, not as a trustee. The plain meaning of CRS § 38-30-166 is that lack of compliance with recording requirements results in lack of authority to “acquire” property, and title remains in the grantor.

Once again, even if a title company is willing to insure with a late-filed affidavit, such a procedure has no authority in the law and will not eliminate the risk that even a bona fide purchaser from the trust will be charged with constructive notice of transactions, not by the trust or trustee, but by the grantor to the trust. Under current law, the only way to eliminate this risk, or to deliver marketable title to the trust beneficiaries, is to probate the property through the deceased grantor’s estate.

Statutory Reform

The Colorado Bar Association’s (“CBA’s”) Real Estate Law, Trust and Estate, and Business Law Sections have approved statutory amendments and legislative reform to address these issues. Unfortunately, these reforms were dropped from legislative sponsorship in the year 2000 based on a misunderstanding that the Supreme Court’s decision in Lagae had rendered them obsolete. The legislative amendments will be reintroduced in the next legislative session, and no objections to passage are expected at that time.

Changes to CRS § 38-30-108

If proposed statutory reforms are passed, the recording requirements of CRS § 38-30-108 will provide a choice of one or more methods of documenting the bona fides of a trust when an instrument conveys an interest in real property to a trustee. These methods are (1) naming the beneficiary of the trust; (2) identifying the trust agreement, court order, or other document establishing the trust; or (3) properly cross-referencing another document of record that contains the required information. When an instrument of conveyance to a trustee fails to comply with any of these methods, the description of the grantee will be presumed, not held, to be a description of the person only. Regardless of whether the noncompliant instrument was recorded before or after passage of the proposed statutory revisions, the revisions explicitly allow the required information to be recorded subsequently in an affidavit cross-referencing the noncompliant deed. All persons thereafter will have notice of the trustee’s representative capacity.

The need for a late-filed affidavit will be moot in a large number of cases under the revised recording requirements because many attempts to convey to trustees that fail under the existing statute will satisfy the simpler requirement of identifying the trust agreement (for example, “John Doe, Trustee of the John Doe Revocable Living Trust dated September 1, 1987”). The provision for a late-filed affidavit will provide a means of establishing a legitimate chain of title for the beneficiaries of the trust or their grantees after the death of the purported trustee, without the need for a personal representative’s deed. However, these revisions do not eliminate risks flowing from the notice gap during the period of noncompliance. Statutory reform cannot eliminate this risk entirely because doing so would emasculate CRS § 38-30-108 and risk revival of the marketability problems this statute originally was enacted to cure. Attorneys must manage this risk by making their clients aware of it and helping clients weigh the risk presented by the facts of the individual case against the costs of a title search, new title policy, or probate.

Changes to CRS § 38-30-109 and 38-30-166

Under the proposed reforms, CRS § 38-30-166 no longer will apply to trusts. Instead, the proposed repeal and re-enactment of CRS § 38-30-109 will provide authority for trusts to hold property. CRS § 38-30-109 currently provides a five-year cure period for instruments of conveyance executed prior to March 16, 1921, that failed to satisfy the requirements of CRS § 38-30-108. CRS § 38-30-109 can be repealed after CRS § 38-30-108 is revised to provide authority for a late-filed affidavit. Repealing CRS § 38-30-109 allows a new home for the provisions concerning a trust taking title in its own name and allows these provisions immediately to follow the provisions for taking title in the name of a trustee.

The proposed re-enacted provisions of CRS § 38-30-109 will allow trusts to take title in the name of the trust and allow trustees to record a statement of authority meeting the requirements of CRS § 38-30-172.25 Under re-enacted CRS § 38-30-109, recording such a statement will provide prima facie evidence of the existence of the trust and the authority of the person executing a deed of conveyance on behalf of the trust. The trust’s authority to acquire property would no longer be contingent on satisfying this recording requirement. The statement of authority could be recorded at any time, even by the successor death trustee after the death of the original trustor. No statement is required until the trustee acts on behalf of the trust to convey, encumber, or otherwise affect title to the real property.

Practitioners should not rely on the statutory reforms discussed in this article until they actually are passed by the legislature. Publications of the CBA sections working on the legislation likely will follow the progress of statutory reform. The CBA sections also will inform their members when passage is complete.

Title Insurance Coverage for the Trust

An often overlooked issue is the impact of a conveyance of real property to a trust on existing title insurance covering the property. Since 1998, the American Land Title Association (“ATLA”) standard policy for owners of from one to four family residences expressly extends policy coverage to the trustee and beneficiaries of a living trust to which the insured transfers the home after the policy date.26 Most existing title insurance policies do not include an insured’s living trust within the definition of “insured.” In addition, the trust would not be included in the standard language covering those who succeed to the insured interest “by operation of law,” such as heirs, distributees, devisees, survivors, personal representatives, next of kin, or corporate or fiduciary successors.

To avoid disputes with a title insurer about policy coverage after a conveyance to an insured’s trust, the client can purchase a policy endorsement, purchase a new policy, or convey to the trust by general warranty deed. The least expensive option is to purchase an additional insured endorsement, extending policy coverage to the insured’s trust. The client should expect to provide a copy of pertinent provisions of the trust, as well as documentation on the transaction conveying the property to the trust. An endorsement will not extend coverage to title defects resulting from the conveyance to the trust, appreciation in the value of the property, or any other circumstances the original policy does not cover.

To obtain coverage of these circumstances, the client will need to purchase a new owner’s policy, which is considerably more expensive, although a discount usually will be provided if the client obtains the new policy from the same company that issued the original policy. A new policy is particularly recommended for Colorado clients who use out-of-state counsel to transfer to their trusts property located in other states. Continuing title policy coverage to the insured’s trust by using a general warranty deed has disadvantages: (1) as with the additional insured endorsement, coverage will be limited to terms of the original policy; (2) state law may limit recovery to the consideration paid by the grantee;27 (3) the trustee may have to sue himself or herself or a family member to get coverage; and (4) the warranty may have no value after the original insured warrantor is deceased.

Conclusion

Colorado attorneys can protect their clients’ privacy and reduce their risks by exercising the statutory authority to convey property to the trust rather than the trustee. Nevertheless, until legislative reform, even the limited affidavit recording requirements of CRS § 38-30-166 must be strictly complied with, and the affidavit must be recorded simultaneously with any deed by which a trust acquires a real property interest. Although not specifically required by CRS § 38-30-166, identifying the successor trustees in the affidavit can expedite future transactions following the trustee’s death.

When establishing a revocable living trust estate plan for clients, attorneys should insist on handling conveyances of real property to the trust and should advise clients to seek legal counsel before conveying any future acquired real property to the trust. Attorneys should never assist clients in conveying to the trust real property located in other states unless they are licensed to practice in those states.

Practitioners assisting with transactions involving previous noncompliant deeds to trusts and trustees need to know how to spot and solve the issues discussed in this article. Attorneys representing buyers from trusts should be careful. Although warranties and title insurance may protect buyers, buyers may wish to avoid the defect altogether. Attorneys representing trusts making conveyances should recognize that title insurance protects buyers, not grantors.

Post-death distributions of real estate defectively conveyed to the trust or trustee require a case-by-case approach. After legislative reform, successor trustees will be able to step in without a probate more easily. However, the legislation will not eliminate the risk of a renegade chain of title or other legitimate claim to the property created during the notice gap. Attorneys should be aware of the nature of these risks and the means to manage them.

 

Disclaimer — Content is general information only. Information is not provided as advice for a specific matter, nor does its publication create an attorney-client relationship. Laws vary from one state to another. For legal advice on a specific matter, consult an attorney.