Transcript:

I am attorney Jeramie Fortenberry.  In this video, we are going to talk about a question that comes up often in my consultations with clients or with potential clients. That question is: what is probate?

In simple terms, probate is a court-supervised legal process for moving assets from a deceased person to the people or the organizations that are entitled to the assets.  It is a court-supervised process, meaning that the court will be involved in the transfer and will oversee it to be sure that the right people end up with the assets and, in most situations, will make sure that there aren’t any creditors’ claims that will attach to the assets.  So in most cases, creditors’ claims are typically resolved as part of the probate process.

The goal of probate is to give the people or organizations that are entitled to the assets clear title.  This means title that a third party—such as a buyer or a lender—will accept in dealing with the property. This means that, when the probate process is finished, the people who end up with the assets will be able to deal with them as though they were their own. They will be able to, for example, sell the assets or maybe take out a loan against them and pledge the assets for security (as in the case of a mortgage of real estate). So, again, the goal is to be sure (a) that the right people end up with the assets and (b) that those assets are free and clear of any creditor claims so that the people who have the assets can deal with them without any further need for court involvement.

Now, there is some different terminology involved in probate depending on whether or not the deceased person (who is called a “decedent”) left a valid Last Will and Testament. If the deceased person had a valid Last Will and Testament, then he or she is said to have died testate. So “testate” is simply the condition of having died with a valid Last Will and Testament.

If the deceased person did not have a valid Last Will and Testament, then he or she is said to have died intestate. So, again, intestacy would be the condition of having died without a valid Last Will and Testament.

The word “probate” comes from a Latin word that means “to prove.”  The process was originally intended to prove (to establish the validity of) the decedent’s Last Will and Testament.  Well, in situations where there is no Last Will and Testament (i.e., when the person dies intestate), there is nothing to “prove” because there is no Will. In that case, the proceeding is technically called an “estate administration” or an “intestate estate administration.”

This is just a difference in terminology—nothing to really get hung up on.  But sometimes you hear these words used interchangeably.  I will often, for example, refer to an intestate estate administration as a “probate” even though, technically, we are not proving a Will.  It is just different ways of referring to the same thing.  The court processes are the same (or more/less the same, depending on your state).  The procedure for moving a Will through the court system isn’t substantially different from the procedure for moving an intestate estate through the court system.  They both have the same goal of giving clear title to the assets to whoever is entitled to the assets.  But there is some different terminology to be aware of.

There also different terminology that is used to refer to the classes of people that inherit from a deceased person.  If the decedent had a Last Will and Testament (i.e., if the decedent died testate), the people who inherit through the Last Will and Testament (the people who are named in the decedent’s Will) are referred to typically as beneficiaries. That is the term that I use that that most, I think, most attorneys and the judicial system will use to refer to people who inherit through a Last Will and Testament—the people or the organizations named in the Last Will and Testament.

If a person does not have a Last Will and Testament, then there is a system of laws that the legislatures of each state have enacted that will be a default system for distributing that person’s property.  These laws are called the laws of intestacy or the intestate succession laws, and they are basically the legislatures’ best guess as to how that property should go—the way that they think that most people would want their assets to go when they die.  It is just the legislature’s best guess.  Most of the time, it will go first to the spouse or the children and then spread out to more remote family members from there.  In that case, whoever the group of people is that inherits from an intestate estate (from a person who died without a Will)—that group of people are known as the decedent’s “heirs at law” or more commonly referred to as the “heirs.”

So if the decedent had a Last Will and Testament we are typically going to refer to the people that inherit through that Last Will and Testament as “beneficiaries.”  If the decedent did not have a Last Will and Testament, then we will typically refer to the people that inherit through the state’s intestacy laws as “heirs” or “heirs at law.”  In each case, we are just dealing with groups of people who end up with the decedent’s assets after the probate or the estate administration process is finished.

Without a court proceeding to deal with these estates, third parties (like buyers or lenders) have no way of knowing who is really entitled to the property and whether any creditor claims apply.  This means that the heirs cannot sell, mortgage, or otherwise deal with the real estate.  Heir property has the following characteristics:

• It is vulnerable to involuntary loss of the property through adverse possession, tax sales or judicial partitions;
• The heirs cannot sell the property or use it as collateral for a mortgage;
• The property is usually ineligible for federal assistance;
• Most lessees (such as tenants, timber companies, or other people who would want to deal with the real estate) will not do so due to the title issues;
• The heirs are reluctant to repair or improve the real estate since every dollar they spend on the property is divided among all of the other heirs.

Over time, as each generation passes, the ownership of the property becomes more and more fragmented and divided among a larger group of people.  At the same time, the number of unprobated estates in the title increases.  Before long, it isn’t worthwhile for any one heir to pay the property taxes and the group of heirs cannot agree to keep up with the property.  At that point, the property is usually sold for outstanding taxes.  The new owner then acquires the property for a deeply discounted value, none of which goes to the heirs.

The best way to avoid this loss is to simply deal with the estates promptly.  This keeps the title clear and allows the heirs to sell or mortgage the property at will.

As I’ve mentioned in my discussion of how to determine whether Mississippi probate is necessary, so much depends on what assets the decedent owned, where they are located, and how they are titled.

Every once in a while I get a call from someone with a deceased friend or family member that had no assets other than an automobile.  Sometimes they have been told that they need to go through probate so that they can get clear title to the automobile.  But this isn’t always the case.

The Title Bureau for the Mississippi Department of Revenue has a little-known procedure for transferring a decedent’s automobile that is titled in Mississippi without the need for probate.  To take advantage of this procedure, the decedent’s closest relatives (“next of kin”) must file an affidavit with the Mississippi Department of Revenue that contains the following information:

1. The decedent’s name, date of death, and the VIN, year, make, model, mileage, and title number of the vehicle that the decedent owned at the time of death.
2. A sworn statement that no will was probated and no administrator, executor or other personal representative has been appointed to administer the decedent’s estate.
3. Whether the decedent was married or had children.
4. The surviving relatives (“next of kin”) of the decedent.
5. The name of the person to who m the next of kin want the automobile to go to.

This information is all found in the form Affidavit When Owner Dies Without a Will, which is promulgated by the Mississippi Department of Revenue.

I sometimes get asked about whether this procedure is available if the decedent had a valid Last Will and Testament.  This question usually comes up when the decedent had a valid Last Will and Testament that is not expected to be admitted to probate.  This is usually the situation when the automobiles are the only assets involved.

The confusion is caused by the short title of the document (“Affidavit When Owner Dies Without a Will”).  At first glance, this seems to indicate that the procedure is only available if there is no will.  But this may be misleading.  The rest of the Affidavit indicates that reference to the owner dying without a will really refers to the owner dying without a will that has been or will be admitted to probate.  For example:

• The first sentence fully describes the document as an “application for assignment of title to a vehicle when the owner dies without a will being probated and no personal representative appointed or widow’s allotment made.”
• The second numbered paragraph states: “That no will was probated and no administrator, executor or other personal representative has been appointed to administer on his or her estate.”

This language indicates that that the procedure is available even if there is a valid Last Will and Testament, as long as the will is not expected to be probated, no executor is appointed, and no widow’s allowance is made.  This interpretation has been confirmed by my calls with the Title Bureau on this issue.

It is clear that the procedure is not available if the decedent’s will has been or is expected to be admitted to probate.  If the executor intends to probate the will, the automobiles will pass under the will and not through this special procedure.

I advise potential clients to contact the Title Bureau for the Department of Revenue (601-923-7200) with any specific questions about the form and the circumstances under which it can be used.  If the decedent’s only asset was an automobile and the Title Bureau confirms that the form can be used, Mississippi probate can usually be avoided.

Tax practitioners have been achieving portability with estate planning techniques (credit shelter dispositions) for decades, but portability didn’t become a part of the tax laws until the Tax Relief Act of 2010, which was signed into law on December 17, 2010.  This new feature allows the estates of predeceased spouses to pass any unused exclusion amount (currently $5 million) to the surviving spouse.

For example, a decedent who used $3 million of his $5 million exclusion amount can pass the remaining $2 million on to his surviving spouse.  This will increase the surviving spouse’s exclusion amount from the usual $5 million to $7 million, assuming the surviving spouse does not remarry.

Since portability can only be elected on a timely-filed estate tax return of the predeceased spouse, a failure to file the return could result in loss of the opportunity.  Even if the predeceased spouse’s estate is not large enough to require a Federal estate tax return (Form 706), executors should consider filing a return solely to make the portability election.

The portability election is available to estates of decedents who died after December 31, 2010.  Given that the Federal estate tax returns are due 9 months from the date of death, the first estate tax returns for estates that are eligible to make the portability election were due as early as October 3, 2011. If an estate is unable to meet this deadline, it can request an automatic six-month extension by filing Form 4768.

The IRS is working on regulations to provide further guidance on the portability election and is looking for input from the public.  Specifically, the IRS is asking for comments on the following issues:

1. The determination in various circumstances of the deceased spousal unused exclusion amount and the applicable exclusion amount;
2. The order in which exclusions are deemed to be used;
3. The effect of the last predeceasing spouse limitation described in section 2010(c)(4)(B)(i);
4. The scope of the Service’s right to examine a return of the first spouse to die without regard to any period of limitation in section 6501; and
5. Any additional issues that should be considered for inclusion in the proposed regulations.

To be considered, comments must be submitted in writing by October 31, 2011, using one of the following ways:

1. By mail to CC:PA:LPD:PR (Notice 2011-82), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC  20044.
2. Electronically to Notice.Comments@irscounsel.treas.gov.  Please include “Notice 2011-82” in the subject line of any electronic communications.
3. By hand-delivery Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Notice 2010-82), Courier’s Desk, Internal Revenue Service, 1111 Constitution Ave., NW, Washington, DC  20224.

But this raises an important question, which has not been fully settled: What sort of legal matters are simple enough for a person to handle without attorney assistance?  One of the most-often mentioned is wills.  Aren’t these routine forms that a person can be trusted to fill in themselves?  Or should attorney (or paralegal) assistance be required?

Well … let’s take a look.

In re Estate of Aldrich

In the recent case of In re Estate of Aldrich, the Florida District Court of Appeals (1^st DCA) recently had to sort out the mess left behind when Ann Dunn Aldrich took a shot at making her own will using a pre-printed legal form.

The first sentence of the statement of facts reads: “On April 5, 2004, Ms. Aldrich wrote her will on an ‘E-Z Legal form.’”  (When a case starts like this, you can expect trouble.)

It turns out that Ms. Aldrich didn’t understand the importance of a residuary clause in a Last Will and Testament.  She itemized the assets of her estate and left them to her sister (Mary Jane).  If Mary Jane predeceased Ms. Aldrich, the itemized assets were to go to Mr. Aldrich.  The will left no residuary clause, probably because Ms. Aldrich thought she had listed everything and didn’t understand the distinction between specific and residuary bequests.

Mary Jane died a few years after Ms. Aldrich signed her will, leaving Ms. Aldrich with cash and land in Putnam County, Florida.  Ms. Aldrich died a few years later, without having updated her will.

When the case went to probate, two of Ms. Aldrich’s nieces popped up, claiming that they had an interest in the cash and land that Ms. Aldrich inherited from Mary Jane.  Since the cash and land were not described in Ms. Aldrich’s will, and since the will didn’t have a residuary clause, the nieces claimed that those assets should pass through Florida’s laws of intestacy.

Mr. Aldrich believed that the assets should have gone to him, for three reasons:

1. The will only listed Mary Jane and Mr. Aldrich as potential beneficiaries and left them all of the property that Ms. Aldrich owned at the time.  It was not unreasonable to conclude, then, that Ms. Aldrich did not intend for any portion of her property to pass to anyone other than Mary Jane or Mr. Aldrich;
2. Fla. Stat. § 732.6005(2) provides that a will should be interpreted to pass all property that was owned at death, including property that was acquired after the date the will was signed; and
3. There is a legal presumption that, when someone makes a will, they intend to dispose of everything that they own.  (Again, this is a reasonable assumption).

Even though Mr. Aldrich was probably right that Ms. Aldrich intended him to get everything, he lost.  The will was very clear on who was to receive specific assets and didn’t show any intent to dispose of anything else.  The will’s silence with regard to the cash and land that Ms. Aldrich inherited from Mary Jane was not an ambiguity that left room for interpretation.  The mere fact that the will did not contain a residuary clause did not give the court the discretion to revise it.  The court reasoned:

While the will does not dispose of all the property Ann Dunn Aldrich owned at her death, this circumstance is hardly unique to her or her estate and does not contravene any rule of law or public policy.  Nor does the will reflect any mistake on her part … It does not matter whether or not Ann Dunn Aldrich owned real property in Putnam County or held [cash] at the time she executed her will, or acquired the real property and deposited the cash afterwards.  In either event, the will as written and executed failed to dispose of those unmentioned assets.

Under Florida law, when a will doesn’t dispose of all of a decedent’s property, the property that is not disposed of passes under Florida’s intestacy laws.  Since there was no residuary clause in the will, the court held that Ms. Aldrich’s nieces did have an interest in the cash and real estate that Ms. Aldrich inherited from her sister after she executed her will.

A competent attorney wouldn’t have let this happen.  The will would have had a residuary clause leaving everything to Mr. Aldrich if that was Ms. Aldrich’s intent.  If that wasn’t her intent, the will would have stated that any property not disposed of should pass to her heirs at law.  In either event, her intent would have been clear and this mess would have been avoided.

And here’s the real kicker:  A simple will like this shouldn’t cost more than several hundred dollars. One can only wonder how much of her estate went to legal fees to battle this out in court.

Lessons Learned(?)

So are wills routine legal documents that can be prepared without assistance?  In some cases, yes.  But when things go wrong, they can go really wrong.  As I mentioned in a recent post:

When it comes to reliance on forms without the advice of attorneys  …  To be honest, sometimes these things work out okay.  But sometimes they don’t. We, as attorneys, see what happens when it all hits the fan.

This case is an example of that.  Of course, the person who made the will never knew (she was dead by the time the problem was discovered).  But I’d bet that, had she known what would happen, she would have gladly spent a few hundred dollars to have a proper will drawn up.  It would have been cheap insurance against the risk involved.

1. Under the default rules, the estate would pay a 35 percent estate tax on assets that exceed the $5 million exemption and the beneficiaries would take a stepped-up basis in the property; or
2. The personal representative could elect to pay no estate tax, but would forfeit the full basis step-up.  Instead, the estate would be able to step up basis of up to $3 million for property left to a spouse and $1.3 million for property left to anyone.

The IRS recently published Revenue Procedure 2011-41, which gives personal representatives safe harbor guidance on basis allocation.  Under the Revenue Procedure, the $1.3 million and $3 million basis step-ups can be increased by the amount of the decedent’s unused net operating loss and capital loss carryovers.  If the decedent owned loss assets (assets worth less than their basis), the amount of the loss can also be added to the basis step up.

The Revenue Procedure also provides that when a beneficiary allocates basis to a depreciable asset, the added basis is treated as though it were part of a new asset that was first placed in use on the decedent’s death.

Personal representatives are required to report basis allocations by November 15, but there’s been a slight glitch: the IRS hasn’t released a final version of the form that personal representatives need to make this allocation (Form 8939).  The IRS has said that the form wouldn’t be due until at least 90 days after it is issued.

This is the position of a recent Wall Street Journal editorial on the deregulation of the practice of law.  The authors, Clifford Winston and Robert W. Crandall, are Fellows at the Brookings Institution, a Washington D.C. think tank.

The authors argue that the time to deregulate the practice of law has come.  The regulation that they oppose comes in three primary forms:

1. The ABA has accreditation requirements for law schools, which artificially restricts the number of would-be lawyers who can obtain a legal education;
2. Many state bar associations require individuals to graduate from an ABA-accredited law school before they can sit for the state bar exam; and
3. Most legal ethics rules prohibit non-lawyers from providing legal services (or owning an interest in a law firm).

Winston and Crandall contend that these restrictions limit competition and raise the cost of legal services.  If they were removed, attorneys would face more competition (from other attorneys and even non-lawyers) and be forced to innovate and lower prices.

Allowing accounting firms, management consulting firms, insurance agencies, investment banks and other entities to offer legal services would undoubtedly generate innovations in such services and would force existing law firms to change their way of doing business and to lower prices.

The authors’ position is developed more fully in a soon-to-be released book titled, “First Thing We Do, Let’s Deregulate All the Lawyers” (2011, Brookings Press).

Of course, the regulations that the authors oppose are in place for a reason (and it’s not just attorney job security).  The educational and licensing requirements help ensure a minimum level of competence in the legal profession.  The prohibition against ownership of law firms by non-lawyers helps ensure that the attorney is answerable only to the client and not to a shareholder.  (When any lawyer raises these points, they are already tainted with self-interest.  After all, the lawyer’s own job security is threatened by the type of deregulation that is being proposed.)

As I’ve written before, I’m not a big fan of the myth that law is a profession and not a business.  And I am generally opposed to unwarranted governmental regulation.  But I am hesitant to throw open the floodgates by lowering barriers to entry into the legal profession.

In fact, given the competence of some of the lawyers that I have encountered, I would argue that more stringent standards are needed.  In many legal cases, there’s too much at stake to sacrifice competence in the name of innovation.  But these high-stake legal cases aren’t usually mentioned in this context.  Instead, those who argue for deregulation point to commodity work: wills (ouch!), no-contest divorces, trademark applications, incorporation services, etc.

Non-lawyers (LegalZoom, RocketLawyer, etc.) are already making inroads in these commodity service areas.  I would agree with the authors that some routine administrative services do not require three years of legal education and a bar exam.  If a person can obtain the form he or she needs from a non-lawyer and (this is important) the matter is simple enough for the person to handle himself, why should he have to pay for a lawyer’s time?

But Winston and Crandall have misdiagnosed the disease.  The real problem (assuming we agree that there is one) isn’t who is engaged in providing legal services, but what activities should be included under the umbrella we call the practice of law.  Instead of making it easier for anyone to become an attorney, we should be talking about what types of services should require the assistance of an attorney at all.

What the lawyer brings to the table is substantive knowledge and the ability to apply legal principles to a client’s individual situation.  That is the sine qua non of the practice of law.  The documents are just paper and ink.  If attorneys still think of themselves as document providers, what will they sell when the documents are free?

In my trust and estate practice, I get calls sometimes from clients with one basic question: “What do you charge for a [insert document]?”  My answer: Nothing.  I don’t charge for documents.  If they know what document they need, they are better off going to LegalZoom or the local office supply store and buying it.  I don’t sell documents; I sell skill.  I believe that I really do know more than my clients about what the law is and how to apply it to accomplish their goals.  They believe it too.  That—and not the documents—is what the client gets in exchange for their hard-earned dollar.

So I disagree with Winston and Crandall.  The time has not come to deregulate the practice of law, but the time may have come to redefine it.  Instead of lowering the overall competency of the legal profession, let’s get back to the ongoing discussion of what activities can be safely carved out of the definition of “the practice of law.”

By the way, Richard Granat has written a more substantive analysis and rebuttal of some of these points, which is worth a read if you have an interest in the topic.  He mentions some of the disasters he has seen when non-lawyers are allowed to handle services that probably should have been done by an attorney (or at least a better-trained paralegal).

I plan to follow this up in the next several days with a blog post about a recent Florida case involving an “E-Z Legal Form” that didn’t work out as it should.  I could share other stories as well.  When it comes to reliance on forms without the advice of attorneys  …  To be honest, sometimes these things work out okay.  But sometimes they don’t. We, as attorneys, see what happens when it all hits the fan.  This gives us an insight that Winston and Crandall do not have.

The initiative is focusing on transfer records in 15 states for evidence of property transfers to family members.  The current roster of states includes Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia, Washington, and Wisconsin.  It is expected that the program will expand to other states soon.  The IRS is being aggressive with this initiative (it went to court to force the California Board of Equalization to disclose transfer data).  Those involved in preparing estate and gift tax returns should counsel their clients of the need to file a Form 709 for intrafamily transfers of real estate for less than full consideration.

President Obama’s 2012 Budget

When President Obama reached a compromise with top-ranking Republicans in 2010 to raise the Federal estate tax exemption to $5 million with rates of 35 percent, he warned that this “generous treatment” would only be temporary.  The President’s 2012 budget seeks to follow through on that warning.

Estate and Gift Tax Exemptions and Rates

President Obama’s 2012 budget, which was released in mid-February, would return the Federal estate exemption to its 2009 level of $3.5 million.  The gift and generation-skipping transfer (GST) tax exemption would be set at $1 million.  A 45 percent tax rate would apply for all transfer taxes.

Portability of Deceased Spouse’s Unused Exemption

Portability allows a surviving spouse to take advantage of the unused exemption of a predeceased spouse.  Under TRA 2010, spouses of individuals who die after December 31, 2010, but before January 1, 2013, can increase their exclusion amount by the amount of the exemption that was unused by their predeceased spouse.   President Obama’s budget would make portability permanent (it is currently set to expire at the end of 2012).

Restrictions on the Use of Grantor Retained Annuity Trusts (GRATs)

The President’s 2012 budget would curb the use of GRATs to arbitrage the applicable Federal interest rate.  In a low-interest rate environment, GRATs are used to transfer wealth between family members at a reduced gift tax cost if the grantor survives the term of the GRAT (for a more detailed explanation of GRATs, see my article on Making Good Use of GRATs in 2010). This has resulted in the widespread use of short-term, “zeroed out” GRATs as a tax planning technique.  The President’s budget would curb this technique by requiring a 10-year minimum term and a remainder value that is greater than zero.

Restrictions on Valuation Discounts

Valuation discounts are often used in estates that are worth more than the Federal estate tax exemption.  These discounts are especially appropriate in family-owned businesses, where the value of the business is likely to be impaired by lack of marketability to the general public.  It is not uncommon for valuation discounts to reach 30 to 40 percent, resulting in a substantial tax savings.

The IRS is aware of these techniques and has litigated a string of family limited partnership cases, with mixed success in the courts.  President Obama’s budget creates a new class of tax restrictions that would prevent the use of valuation discounts in some family-controlled companies.

Curbing the Use of Dynasty Trusts

Dynasty trusts are funded with assets that pass free of the GST tax exemption. These trusts are typically created in a jurisdiction that does not follow the common law rule against perpetuities, allowing the trusts to continue indefinitely.  This allows the trust assets to be sheltered from transfer taxes throughout the term of the trust over many generations.  The Obama administration would curb this benefit by placing a 90-year maximum term on new dynasty trusts or money added to existing dynasty trusts.

Discussions Beginning in Congress

In early June, the New York Post reported that Senate Republicans are retreating from their push for an all-out repeal of the estate tax.

According to the Post, both sides of the aisle are comfortable with a $5 million exemption amount.  But there is disagreement about the tax rates that should apply.  Democrats are pushing for a 45 percent tax rate; Republicans prefer the current 35 percent rate.

A Few Concluding Thoughts

This isn’t the first time we’ve seen what President Obama is proposing.  A similar bill (H.R. 4154, Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Act of 2009) was passed by the House of Representatives in 2009.  No Republicans voted for the bill, and it died in the Senate.

Based on previous legislative attempts, it is not clear that a return to 2009 levels is a viable option.  It seems more likely that President Obama’s budget is intended to appease those in his party who were critical of the concessions at the end of 2010 while leaving himself room to compromise in return for concessions from top-ranking Republicans.

I see these recent developments as more of a starting point for discussions, preliminary volleys before the real fight begins.  With any luck, we won’t need to wait until December 2012 to see how it ends.

The Takeaway

This could have far-reaching implications for Mississippi real estate attorneys, lenders, and title companies.  Since limited liability company operating agreements (or other business entity documents for that matter) are not public record, any business in the chain of title could potentially invalidate a lender’s security interest in a mortgage.  We can expect banks and other lenders to take a closer look at transfers in the chain of title from business entities.

The Facts

Michael was a minority owner of Kinwood LLC.  He formed another LLC (Northlake LLC) of which he was the sole owner.  He then deeded Kinwood LLC real estate to Northlake LLC and used the real estate to secure a loan.  Northlake LLC defaulted on the loan and declared bankruptcy.

It turns out that the operating agreement of Kinwood LLC did not permit Michael to transfer the real estate from Kinwood LLC in the first place.  As a minority owner, Michael didn’t have the votes required to execute a deed without the consent of the other members.

When the other members of Kinwood LLC learned what had happened, they had the bankruptcy judge declare both the deed to Northlake LLC and the deed of trust void.

The bank appealed the bankruptcy judge’s order to the district court, which affirmed, and then to the Fifth Circuit.  The bank argued that the deed of trust was not void, but voidable.  Because the bank had accepted the deed of trust from Northlake LLC in good faith (without knowledge that the transfer from Kinwood LLC was not authorized), the deed of trust should be enforceable.

The Fifth Circuit found that the case involved a matter of Mississippi law for which there is no controlling precedent.  It certified the following question to the Mississippi Supreme Court:

When a  minority member of  a  Mississippi  limited  liability  company prepares and executes, on behalf of the LLC, a deed to substantially all of the LLC’s real estate, in favor of another LLC of which the same individual is the sole owner, without authority to do so under the first LLC’s operating agreement, is the transfer of real property pursuant to the deed: (i) voidable, such that it is subject to  the   intervening  rights of  a   subsequent bona fide  purchaser for value and without legal notice, or  (ii) void ab initio, i.e.,  a   legal nullity?

The Law

• A limited liability company operating agreement can limit the actual authority of a member to bind the company in certain transactions.
• Even if a member does not have actual authority, he may have apparent authority. Apparent authority can bind the LLC unless:
  • The member does not have actual authority to act for the company; and
  • The person with whom he is dealing has knowledge of the fact that the member has no such authority.

The Analysis

• Actual Authority – Do to the limitation in the operating agreement, Michael clearly did not have actual authority to transfer the real estate from Kinwood LLC to Northlake LLC.
• Apparent Authority – Focusing on the transfer from Kinwood LLC to Northlake LLC: Michael knew he didn’t have actual authority.  That knowledge was imputed to Northlake LLC.   Applying the above analysis for apparent authority:
  • The member (Michael) did not have actual authority to act for the company (Kinwood LLC);
  • The other party to the transaction (Northlake LLC) had knowledge that Michael didn’t have authority to transfer the property.
  • Thus, Michael had no apparent authority to transfer the property from Kinwood LLC to Northlake LLC.

The Holding

Since Michael had neither actual nor apparent authority to transfer the property, his actions did not affect the title to the property.

Northlake Development, L.L.C. v. Bankplus, 2011 WL 1743943, No. 2010-FC-01308-SCT (Miss. May 5, 2011)