underwriting transactions in trusts - res ipsa...2016 texas land title institute - underwriting...

Underwriting Transactions in

Trusts

2016 Texas Land Title Institute

PRESENTED BY:

RICHARD WORSHAM Vice-President – Texas Region Underwriting Counsel

Westcor Land Title Insurance Company

Bio

Richard Worsham

Richard Worsham is a 7th generation Texan who can track his family roots in Texas back

to 1813. He is a 1985 graduate of the University of Houston Law Center, and a 1982 graduate

of the University of Texas at Arlington.

In his 30th year of practicing law, Mr. Worsham has spent 10-years as a commercial

litigator, 10-years as a title insurance fee attorney, and 10-years as a title insurance underwriter.

As a fee attorney and as an underwriter, he has worked with most of the title insurance

underwriters in Texas.

In 2015 Mr. Worsham joined Westcor Land Title Insurance Company as Vice-President

and Texas Region Underwriting Counsel, working exclusively with independent title agents.

He oversees underwriting in Texas, Oklahoma, New Mexico, Arkansas, and Lousiana for

Westcor.

Richard Worsham has extensive speaking experience teaching realtors, escrow officers

and attorneys. He has previously taught at the Texas Land Title Institute, for the Texas Land

Title Association, at South Texas College of Law’s Annual Real Estate Conference, for the

Houston Bar Association, and at the State Bar of Texas' Advanced Real Estate Seminar. He has

also taught numerous realtor seminars and continuing education courses for attorneys.

Mr. Worsham is married to Yvette Valle Worsham, and they have three children, ages

18, 14, and 2.

2016 Texas Land Title Institute - Underwriting Transactions in Trusts 1

UNDERWRITING TRANSACTIONS IN TRUSTS Scope This article is about underwriting trusts for title insurance purposes only. It addresses the minimum you need to know, what questions we ask, what documents are needed, and what problems are commonly encountered? The law of trusts, and detailed information on trusts, will be found lacking here. Trust Creation Every trust a title company closes with will have been created by a written instrument. There are all sorts of implied trusts and trust relationships created by a legal relationship, all of which reach legal recognition only when a court decides they exist. Those transactions will be done under a court order, not under a written trust agreement. Trusts are created by either a trust agreement, a will, or by a deed. Even Real Estate Investment Trusts (REITs) and foreign business trusts (both discussed below), although quite different from most trusts you will close with, are governed by trust agreements. Is it a Trust? A Trust is a separation of beneficial ownership from actual ownership. For example, Jack, the Trustee, owns Blackacre for the benefit of Jill, the beneficial owner, usually called the beneficiary of the trust. Blackacre would be the corpus of the trust, the property being held in trust. All three must exist in order for a trust to exist. Every Trust needs to be created by someone, and in Texas we generally call that person the Settlor of the Trust. As is common in Texas, this term Settlor is unique to Texas statutes, and the more common terms used elsewhere in the country are the Grantor or Trustor of the Trust. Quite often the Settlor of the trust is also a beneficiary or trustee of the trust, and in estate planning trusts, sometimes all three. The Settlor may retain rights in the trust which neither the beneficiary nor the trustee have, such as the right to revoke the trust. What if there is no separation of beneficial ownership from actual ownership? This is called a "passive trust" in the statutes, or a "dry trust" in other jurisdictions, and this defect essentially means the trust fails, and title is vested in the beneficiaries. This is addressed in Section 112.032 of the "Texas Trust Code," buried within the Texas Property Code. (References to "Trust Code" and "Property Code" are interchangeable since the Trust Code is buried within the Property Code. The researcher will look in vain for a separate publication of the Trust Code, since it's within the Property Code.) Section 112.032 provides: Sec. 112.032. ACTIVE AND PASSIVE TRUSTS; STATUTE OF USES.

a) Except as provided by Subsection (b), title to real property held in trust vests directly in the beneficiary if the trustee has neither a power nor a duty related to the administration of the trust.


b) The title of a trustee in real property is not divested if the trustee's title is not merely nominal but is subject to a power or duty in relation to the property.

Amended by Acts 1983, 68th Leg., p. 3332, ch. 567, art. 2, Sec. 2, eff. Jan. 1, 1984. The title examiner typically doesn't know if a trust is active or passive when title is being reviewed, since the trust agreement is not in hand. The examiner usually adds a Schedule C requirement to provide a copy of the trust agreement for review. However, if the closer obtains a copy of the Trust Agreement, and observes that all or substantially all of the management of the trust is vested in the beneficiary or beneficiaries, it is incumbent on the closer to revisit with underwriting or the examiner whether it is a passive trust? In the event it is, or could be interpreted to be, a passive trust, then title is effectively in the beneficiaries. The beneficiaries should then be searched for involuntary liens, particularly federal tax liens and abstracts of judgment. If any involuntary liens are found, the closer and examiner should then approach underwriting counsel on whether they should except to them on the commitment? Note that people sometimes use trusts, and particularly passive trusts, to obscure actual title to property in order to avoid creditors. Only the person reviewing the trust agreement is in a position to call this possibility to the attention of examiners and underwriting counsel. You may be concerned that the title company would miss the passive trust problem if we were using a Certification of Trust, as discussed further on in this paper. The answer is that it would be missed, and we wouldn't be terribly concerned, because of the shelter provisions in the law described in the discussion of Certifications of Trust, below. What kind of Trust is it? Estate Planning Trusts: Inter Vivos, Testamentary, Revocable and Irrevocable The vast majority of the time, probably exceeding 98% of the time, the trusts you will encounter in title insurance closings are going to be trusts designed for estate planning. These are typically divided into inter vivos trusts, meaning they were created while the Settlor was alive, and testamentary trusts, created upon death of the Settlor. Testamentary trusts are typically created by a will. Inter vivos trusts are further divided into revocable inter vivos trusts and irrevocable inter vivos trusts. As their name suggests revocable inter vivos trusts may be revoked by the Settlor while he or she is alive and irrevocable inter vivos trusts cannot be. Don't be fooled by a title on a trust agreement that calls it a revocable trust; some revocable inter vivos trusts may become irrevocable upon occurrence of specific events set forth in the trust agreement. For example, it is common for a husband and wife to create a trust that is revocable so long as both are alive, and for it to become irrevocable upon the death of one of them, so that the survivor cannot change the estate plan after one of them dies. Occasionally, in Texas, you will see a trustee set up to own real property. That is not commonly done in Texas because Texas does not have an entity theory of trusts (more on that below), but it is a common practice in other states where the law is different. While these trusts may have some label intended to differentiate them from your mom and pop estate planning trust, Texas law makes no distinction between them and an any other inter vivos trust.


REITs and "Foreign" Business Trusts Real Estate Investment Trusts (commonly called REITs, pronounced "Reats") and "Foreign" Business Trusts are completely different animals from other trusts in Texas, so much so that it's difficult to include them in the same course. REITs are a creation of the Internal Revenue Code of the United States, which provides that so long as a trust meets a laundry list of requirements, profits and losses may flow through to the shareholders as though they were the direct owners of the real estate owned by the REIT. One of these requirements is that the REIT must have at least 100 shareholders, meaning that REITs are commonly used for large investments in multiple properties or mortgages rather than individual properties. REITs were not recognized as legal entities in Texas until 2005, when Texas amended its laws to allow REITs to do business in Texas. The change in the law garnered national notice, as every REIT in the country was stymied by Texas' law, and many articles can still be found online from when REITs became authorized in Texas. Prior to 2005, most REITs created LLC's or other subsidiaries in order to do business in Texas. "Foreign" Business Trusts mean trusts formed in other states of the United States. Prior to 2006, any foreign business trust which came into Texas was not recognized as a Trust, but would have been treated, at best, as a general partnership. See, generally, Thompson vs. Schmitt, 274 S.W. 554 (Tex. 1925), discussed below. The 2006 recodification of the Texas Business Organizations Code resulted in a provisions authorizing foreign business trusts to register with the Texas Secretary of State's office to do business within the State of Texas. So while Texas has no law allowing the creation of business trusts, if a business trust is formed in another state which recognizes a business trust as a legal entity, it can file and qualify to do business within the State of Texas. The most likely type of business trust the residential closer is going to encounter is in connection with foreclosed properties held by a Delaware business trust. In order for a lender to avoid becoming "loaned up," and run out of money to make new loans, the common practice is for the lender to take existing packages of loans and pledge them as collateral to secure bonds on Wall Street. The lender gets cash for the bonds, allowing it to make more loans, and the bond buyer receives a stream of income from the mortgage loans, paying dividends on the bonds. To securitize these bonds, they are placed in a Delaware business trust as the straw man owner, and the lender typically (though not always) becomes the servicer of that trust, managing the loans and taking a piece off the top of the revenue stream as a servicing fee. Servicing rights are a valuable income stream themselves, and can be transferred between servicing organizations. When the lender forecloses the loan, title will typically be taken in something like, "Big New York Bank as Servicer of the Mortgage Backed Securities Trust of 2012." It's not unusual for the bank to then hire a subservicer to actually handle the asset, commonly delegating authority using a power of attorney. (see discussion of authority issues below)


Is Title Vested Correctly? The most glaring error that jumps out at an underwriter looking at a title commitment for a property held in trust is a vesting error. Although we commonly refer to "trusts" as though they were a tangible thing, a noun, Texas does not have an entity theory of trusts, so title cannot be held in the name of the trust itself. Title must be held in the name of the trustee. There have been numerous Texas cases on the issue of trusts as an entity, or more to the point, as a non-entity, but none on the issue of a trust as a vested owner under as deed. In 1925, in Thompson vs. Schmitt, 274 S.W. 554 (Tex. 1925), the Texas Supreme Court was asked to recognize a "Massachusetts Business Trust" as a legal entity, providing protected liability to the beneficial owners. In an early exercise of Scalia-like judicial restraint, the Texas Supreme Court declined to recognize a business entity that had not been created by the legislature. The court determined that any group of people who get together to form a business, in the absence of forming any recognized entity, constitute a de facto general partnership, without protected liability. Seventy-one years later, in Huie vs. Deshazo, 922 S.W.2d 920 (Tex. 1996), the Texas Supreme Court noted that, “The term ‘trust' refers not to a separate legal entity but rather to the fiduciary relationship governing the trustee with respect to the trust property.” In Huie, the beneficiaries of the trust were suing the trustee, and asked for evidence of the advice provided to the trustee by counsel for the trustee. The trustee asserted attorney-client privilege, and the beneficiaries claimed it did not apply because the attorney was the "trust's" attorney, and was in effect the beneficiaries' attorney as well. In ruling against the beneficiaries, the Texas Supreme Court noted that a trust is not an entity that can retain counsel, but a fiduciary relationship between the trustee and the beneficiaries, and the trustee's counsel was therefore his own, not the beneficiaries. With Huie vs. Deshazo, the Texas Supreme Court shifted positions. In Thompson vs. Schmitt, supra, the Supreme Court stated that any group of people who get together to conduct business are a general partnership. Texas clearly has an entity theory of partnerships. See, generally, Texas Business Organizations Code Section 152.056 [previously, Tex.Rev.Civ. Stat. Ann.. art. 6132b–2.01 (Vernon Supp.2001)] and Alice Leasing Co. vs. Castillo, 53 SW3d 433, 443 (Tex. App. -- San Antonio 2001, review denied). However, in Huie and all subsequent cases in the last 20-years, Texas has refused to recognize a trust as an entity. Two years after Huie, in Bonner vs. Henderson, 147 F.3d 457 (5th Cir. 1998), the 5th Circuit echoed the Texas Supreme Court in ruling that a civil RICO action could not be prosecuted against a Trust, since a trust was not a legal entity. The Texas Supreme court repeated itself in Ray Malooly Trust vs. Juhl, 186 SW3d 568 (Tex. 2006), and in Ditta vs. Conte, 298 SW3d 187 (Tex. 2009), asserting in the latter case that, “A trust is not a legal entity; rather it is a fiduciary relationship with respect to property.” Most recently, in Hollis vs. Lynch, 827 F.3d 436 (5th Cir. 2016), the Fifth Circuit casually mentioned, “A trust cannot possess anything as it is not an entity under Texas law.” This is a complex case where Mr. Hollis, using a Bureau of Alcohol, Tobacco and Firearms ("ATF") computer site, got a permit to manufacture a machine gun. It turns out that this is fairly simple to do by taking an AR-15 semi-automatic rifle and converting it to automatic fire, essentially making an M-16 out of it. By the time the ATF realized their error, Mr. Hollis had "manufactured" his machine gun, so the ATF asked that it be turned over to them. Mr. Hollis, in the American


tradition, sued. Among a plethora of arguments, Mr. Hollis asserted that he didn't own a machine gun, the Hollis Trust did, and a Trust was not a person within the meaning of the law outlawing individuals possession of machine guns. Fortunately for Mr. Hollis, but unfortunately for this legal argument, he resides in Texas, and the 5th Circuit pointed out that as a Trust is not a legal entity in Texas, it can possess nothing, Mr. Hollis as trustee did, and Mr. Hollis was therefore in violation of the law. As noted above, in 2006 Texas allowed foreign business trusts to file with the Texas Secretary of States' office to do business here. At the same time, Texas added this provision in Texas Business Organizations Code Section 9.202, “A foreign non-filing entity or a foreign filing entity registered under this chapter enjoys the same but no greater rights and privileges as the domestic entity to which it most closely corresponds.” Read against the context of Thompson vs. Schmitt, does that mean a trust would continue to have unlimited liability like a general partnership, or would it now be construed to have all of the rights of a REIT, authorized to do business in Texas in 2005? It appears to be undecided. The problem with the "non-entity" line of cases is the separate line of cases under Lighthouse Church of Cloverleaf vs. Texas Bank, 889 SW2d 595 (Tex. App. - Houston [14th Dist.] 1994, writ refused). Dealing with a defunct corporation, the Court stated, "A deed is void if the grantee is not in existence at the time the deed is executed." There are about 10-cases citing the Lighthouse Church of Cloverleaf case for this point, none of which deals with whether a deed into the name of the trust is a valid conveyance or not? It is a reasonable inference that a deed into a purported entity that is not a legally recognized entity, such as a trust, is void. The way to avoid this issue is to deed into the name of the trustee only, and never in the name of the trust. The exceptions to that rule is when a trust is a recognized business entity. In Texas, that is strictly going to be when the trust is a REIT or a business trust formed in a State which recognizes a business trust as an entity. Correcting Current Vesting Errors By current vesting errors, we are referring to a situation where title is currently vested in the name of the trust rather than the trustee. In most inter vivos trusts, this is easily fixed. Grantors of the trust are usually also grantors on the deed, and often still beneficiaries of the trust. A correction deed into the trustee will solve the problem. Unfortunately, Section 5.029 of the Texas Property Code, creates a bit of confusion here, because it considers a vesting error a material correction, and requires joinder of both grantors and grantees of the original instrument to correct title. Section 5.029 does not anticipate a problem where the original grantee may not actually legally exist, or how you create a signature block for a potentially legally non-existing entity? The answer is that the trustee must sign in any event, both as original grantee and substitute grantee for it to be a valid correction. Of course, most trusts are created for estate planning purposes, so it is common for the original grantors of the deed and the trust to be deceased. This is where correction becomes more difficult, because the underwriter must consider title both as it was granted, to the trust, and as it might have passed if that conveyance was void, by intestate or testate succession. For example, decedents may have passed the property one way according to the trust, a different way under the


residuary clause on their will, and possibly neither is the same as title would have passed under Texas intestate succession laws. Does the residuary clause in the will control if part of the estate plan, the trust, was not followed by proper conveyance of title, or does decedent die intestate? Given the lack of legal precedent to guide underwriting counsel here, the underwriter must identify each party with a potentially adverse claim to title and neutralize them. That usually involves curative deeds from, or joinder in the transaction of, all trustees and beneficiaries under the trust, and all testate and intestate heirs of decedent. It's not unusual to encounter disagreement among the parties, but it is better this disagreement be identified and resolved pre-closing than it become an adverse claim to title. Correcting Past Vesting Errors By past vesting errors, we are referring to conveyances up the chain where title was once held in the name of a trust which conveyed out to someone else, either the current owner or a successor to the current owner. Ideally, we would do a material correction deed under Section 5.029 of the Texas Property Code, as discussed above. That is most likely only practical if the current record title owner received title directly from the trust. Beyond that, each underwriter will decide the matter based on the length of time since the error occurred, amount of the risk, warranties in the deeds, and whether an indemnity can be had, or applies? The examiner or closer should be asking their underwriter. If the length of time is long enough, adverse possession makes the gap moot. There are 3, 5, 10 and 25 year limitations periods for adverse possession, the shortest requiring the claimant have "color of title," generally meaning a valid conveyance into them filed of record. The quality of the warranties in that conveyance, the stature and financial resources of the grantor, and the amount of the risk or potential risk come into the decision. The consideration is not just the conveyance out of the trust, but other conveyances in the chain subsequent to the conveyance out of the trust. For example, a subsequent quitclaim deed in the chain from a party not known to the underwriter for a $300-thousand dollar property is going to be considered a very different risk from a general warranty deed from a nationally known lender for a $1,000 strip of land that is tangential to the transaction. In terms of specific indemnities, some underwriters may not accept an indemnity if they consider the matter to go to the root of title and to be likely to be litigated, but might willingly accept one if they consider the matter unlikely to create a problem. Conveyances through the name of the trust, where no one has yet complained, are more likely to be matters the underwriter is going to accept an indemnity for. The master indemnity covers the authority of trustees on transactions under $500,000. A deed containing the signature of the trustee, upon which title is based, would likely trigger that indemnity, even if title was previously erroneously vested. Intelligent claims counsel may wish to argue that issue, though, and the closer should not rely on the master indemnity when there is an earlier error in vesting without approval of underwriting counsel. In the absence of evidence of an actual dispute as to title, it is likely that most underwriters will take this risk so long as the dollar values are reasonable, but they will go through this process of asking questions in order to determine if their company is in the risk alone or not? At some dollar value, though, the prudent decision is to send the customer to court to quiet title.


Authority Issues - Can the Trustee Do the Deal? Trusts are sometimes set up in order to protect assets from sale or seizure by creditors. So-called "spendthrift trusts" often place property in the trust because the beneficiary is not considered to be able to handle their financial affairs in a responsible manner. In estate planning trusts, husbands and wives sometimes have concern about the survivor changing the estate plan after they are gone, and certain rights may disappear to the survivor once one of the grantors of the trust dies. This means that not all trustees have authority to sell property. In the absence of specific authority to sell and convey property, the trustee cannot do so. The Texas Trust Code, buried within the Texas Property Code, provides the trustee with such authority, but in the absence of a specific provisions incorporating the Trust Code into the Trust Agreement by reference, it does not control. However, a statement that the trustee has, "...all of the authority provided a Trustee under the Texas Trust Code,..." will give the trustee authority to sell and convey real property. (In fact, we commonly see this phrase used in powers of attorney or regarding executor authority in wills, in order to expand their authority with the minimum of explanation.) You must read the trust documents in order to determine whether the trustee has authority, unless you use a Certification of Trust instead. Certification of Trust Section 114.086 of the Texas Property Code (Trust Code) describes the form of a certification of trust. Unlike many Texas statutes, it does not provide a form, but merely describes the contents. Texas Property Code Section 114.086(f) provides shelter provisions for the person relying upon a certification of trust, "A person who acts in reliance on a certification of trust without knowledge that the representations contained in the certification are incorrect is not liable to any person for the action and may assume without inquiry the existence of the facts contained in the certification." The statute provides for excerpts from the trust agreement regarding trustee authority to be attached to the Certification of Trust, though it's not legally required. Liability remains between the trustee and beneficiaries, but a buyer or title insurer relying on the Certification of Trust is sheltered from such liability. Title underwriters increasingly prefer the Certification of Trust because it is less time consuming to review and provides the title company with some degree of liability protection. The Certification of Trust should have all of the elements set forth in the statute, without omission. Otherwise, the shelter provisions provided by the law may not apply. Merely because a document is labeled a Certification of Trust does not mean it matches the provisions Section 114.086 of the Texas Property Code; many other states have forms for Certifications of Trust that do not match the Texas statute, and their forms tends to drift across state lines and get used in Texas and other states. The closer should be aware of the problem and avoid it.


Because trust agreements almost always provide for eventual replacement of the trustee, a current certification of trust is required for closing. Neither the current vesting deed or a dated certification of trust are reliable in showing who the current trustee is, and without review of the trust agreement no succession can be determined. The closer should not rely on an existing certification of trust, but require a new one for the current transaction. There is no legal requirement that the Certification of Trust be filed of record, or that it even be notarized in order to be filed of record, but it is best practice to do so. Most underwriters require it. Authority in REITs & Business Trusts With REITs and foreign business trusts, you should always read the authority documents. These entities vary widely in how they are organized. They often put ultimate authority in someone other than a trustee, and there may even been corporate officers with titles similar to corporations. It's preferable that the authority documents be reviewed by an attorney who is experienced with these business entities. In the real world, that may not be possible. Much more is done on faith than any underwriting counsel is reasonably comfortable with. REITs often do business with special purpose entities, sometimes referred to as single purpose entities (in either case, "SPE's") or "bankruptcy remote" entities, typically formed as a limited liability company, limited partnership or corporation, and designed to hold a single large asset. Large REITs may frown on the title officer wishing to drill down behind the owning entity to make determinations of authority. Due to money coming out of one investment into another, there may be several corporate layers in a particular transaction. Similarly, banks tend to syndicate loans on Wall Street to securitize bonds, and the assets may be transferred into a Delaware business trust as a holding unit, with the lender maintaining servicing rights. It's also common for the lender to then transfer those servicing rights to a company dedicated to that business, often called a subservicer. When the loans become foreclosed, the trust then becomes the de facto owner, acting through a servicer or subservicer. Quite often the REO manager offering title is merely brandishing a questionable looking power of attorney from the servicer lender as evidence of authority. In both of these authority situations, with the REIT and the business trust as a straw man holder for mortgages, the underwriter has to recognize that the person offering title is typically a property management or REO specialist, and may not even understand the business structure behind them. Only rarely will they have counsel behind them who can explain the business structure, and as business people, the property managers seem loathe to consult with them. Typically the property or REO manager is looking to move the property with the least amount of fuss possible, and is certainly not looking for a title agent who wants to drill down and get every last agreement resulting in their ultimate authority. That search can ultimately result in hundreds of pages of documents, or even a thousand, reflecting the terms of the bonds and the terms the trustee holds the collateral for the bonds - the mortgages and the REO - under, in addition to


servicing and subservicing agreements. No one with the customer wants you going through those documents, making interpretations, and asking questions they're not qualified to answer. The answer for the underwriter is to look very carefully at what entity is ultimately behind the transaction. If it's a large and well known local REIT, such as Hines REIT or Weingarten REIT, or the mortgage servicer is a large bank such as Chase or Wells Fargo, and the principal actors in the transaction are clearly employees or subservicers for those organizations, it's likely that the underwriter is not going to require you to drill too deep into the authority documents, and accept much at face value. However, if it's a lesser known REIT, or a business trust with unknown principals, and an internet or records search can provide no further insight into the entities, it's much more likely that the underwriter is going to want to review the managing and authority documents, however voluminous. Homestead Property Merely because homestead property is moved to a inter vivos trust does not mean that it loses its homestead status. Section 41.0041 of the Texas Property Code provides that property within a "Qualifying Trust" as follows: Sec. 41.0021. HOMESTEAD IN QUALIFYING TRUST. a) In this section, "qualifying trust" means an express trust:

1) in which the instrument or court order creating the express trust provides that a settlor or beneficiary of the trust has the right to: A. revoke the trust without the consent of another person; B. exercise an inter vivos general power of appointment over the property that

qualifies for the homestead exemption; or C. use and occupy the residential property as the settlor's or beneficiary's principal

residence at no cost to the settlor or beneficiary, other than payment of taxes and other costs and expenses specified in the instrument or court order:

i. for the life of the settlor or beneficiary; ii. for the shorter of the life of the settlor or beneficiary or a term of years

specified in the instrument or court order; or iii. until the date the trust is revoked or terminated by an instrument or

court order recorded in the real property records of the county in which the property is located and that describes the property with sufficient certainty to identify the property; and

2) the trustee of which acquires the property in an instrument of title or under a court order that: A. describes the property with sufficient certainty to identify the property and the

interest acquired; and B. is recorded in the real property records of the county in which the property is

located. b) Property that a settlor or beneficiary occupies and uses in a manner described by this

subchapter and in which the settlor or beneficiary owns a beneficial interest through a


qualifying trust is considered the homestead of the settlor or beneficiary under Section 50, Article XVI, Texas Constitution, and Section 41.001.

c) A married person who transfers property to the trustee of a qualifying trust must comply with the requirements relating to the joinder of the person's spouse as provided by Chapter 5, Family Code.

d) A trustee may sell, convey, or encumber property transferred as described by Subsection (c) without the joinder of either spouse unless expressly prohibited by the instrument or court order creating the trust.

e) This section does not affect the rights of a surviving spouse or surviving children under Section 52, Article XVI, Texas Constitution, or Part 3, Chapter VIII, Texas Probate Code.

When you read Section 41.0021, above, it makes fairly clear that a property in a properly created trust can still be homestead for property tax and exemption purposes under Texas law. It does not make clear how you comply with Constitutional issues which arise when encumbering or selling property. For example, Texas case law is clear that the Texas Constitution requires that joinder of the spouse is required in any transaction involving homestead property, whether or not it is the separate property of one of the spouses. Gonzales vs. Gonzales, 273 SW 798 (Tex. 1925); See, also, Texas Family Code Section 5.001, Stallings vs. Hullum, 35 SW 2 (Tex. 1896), Rogers vs. Henshaw, 37 Tex. 625 (1872), Sampson & Keene v. Williamson and Wife, 6 Tex. 102 (1851). As the Constitution governs over the statute, notwithstanding the provisions of Texas Property Code Section 41.0021(d), it would therefore be necessary to ask whose homestead is it when it is in a Trust, the Trustee's or the Beneficiaries'? Note that the statute does not require the Trustee to be one of the beneficiaries. In order to be sure of meeting Constitutional requirements, get everyone's signatures on a document selling or encumbering homestead within the trust, the beneficiaries, the trustee, and the spouses of all of them. According to In Re Vasquez, 37 Collier Bankr. Cases 2nd 611 (W.D. Tex. 2012) a property within a trust is not homestead if it was transferred to the trustee prior to September 1, 2009, the effective date of Section 41.0021(b), above. Any time you do a homestead loan on property held in Trust, you must also either except to the terms and conditions of the Trust Agreement or other instrument creating the Trust, or get any individual with a contingent or future right to subordinate their rights to the insured lien. Without such an exception or subordination, you have a lien that only covers the property during the period of ownership and control of the current borrower. Home Equity Loans If property held by a trustee can be homestead, then it would appear that a home equity loan can be done within the Trust. However, in addition to the property meeting ALL of the requirements of Section 41.0021 of the Texas Property Code, and in addition to the requirement that the property be deeded into the trustee on or after September 1, 2009, the closer must also meet the requirements of Article 16, Section 50(a)(6) of the Texas Constitution. Article 16, Section 50(a)(6)(A) requires a home equity be a written agreement with the consent of each owner and owner's spouse. Consequently, for a homestead held by a trustee, all trustees and beneficiaries and their spouses must join in the loan.


Because the legislature did not want lenders to overreach and use homestead property to collateralize other consumer and business transactions, Article 16, Section 50(a)(6)(H) prohibits a home equity loan from being secured by any non-homestead property. This means that every individual in title, both trustees and beneficiaries, must also claim the property as homestead and reside on the property. If any one of them does not reside on the property, then any portion of the property owned by them or their spouse is arguably non-homestead, creating what we sometimes call a "mixed collateral problem," potentially causing the entire home equity lien to be struck down by a court because it includes non-homestead property. In summary, in order to do a home equity loan with title in the trustee of the trust, you must:

Property must have been conveyed to the Trustee on or after September 1, 2009 The trust must be revocable by the beneficiary or Settlor/Grantor of the Trust, without

requiring approval of any other person [TPC Section 41.0021(a)(1)A] The Trustee or beneficiary must have authority to exercise the right to designate the

property as homestead [TPC Section 41.0021(a)(1)B] Settlor or beneficiary must have the right to occupy the property without rent other than

property taxes and other costs of ownership, either for life, a term of years, or until the trust is terminated by an instrument filed of record. [TPC Section 41.0021(a)(1)B]

Trustee must be vested in title by a court order or deed which accurately describes the real property, and is filed of record. [TPC Section 41.0021(a)(2)]

Require that the Trustee, his or her spouse, the beneficiaries, and all spouses of beneficiaries, reside in the house and claim it as homestead. See, Article 16, Section 50(a)(6)(H)

Require joinder of the Trustee, his or her spouse, the beneficiaries, and all spouses of beneficiaries, in execution of all home equity loan documents. See, Article 16, Section 50(a)(6)(H)

Either except to the terms and conditions of the instrument creating the trust, OR, require all contingent beneficiaries and persons with future interests to subordinate their interests to the insured lien.

As difficult as that sounds, in many mom and pop revocable inter vivos trusts, the beneficiaries and the trustees are the same persons, and these standards can often be met easily.

Powers of Attorney Unless a Trust Agreement or other instrument creating a trust specifically allows a Trustee to act through a power of attorney, he may not delegate authority to close a real estate transaction using one. West v. Hapgood, 174 S.W.2d 963 (Tex. 1943), Transamerican Leasing Co. vs.

Three Bears, Inc., 586 SW2d 472 (Tex. 1979). This is a commonly overlooked issue missing from most trust agreements. As most inter vivos trusts are created for estate planning purposes, it is not unusual to find the trustee physically or mentally unable to act, and have relatives show up brandishing a power of attorney to act as trustee. It's not possible unless the Trust anticipates the Trustee delegating discretionary power, preferably specifying the use of a power of attorney specifically. Fortunately, most Trust


agreements provide for substitution of the Trustee in the event of disability, which can sometimes solve the problem (Though families often seem loathe to have someone determined to be mentally disabled.) In other situations, the Trustee may merely be incapacitated to attend the closing, and may be perfectly capable of signing paperwork to amend the Trust agreement to allow for use of a power of attorney, or to provide for substitution of a child or spouse as trustee. As in all capacity situations, there may be those cases where the determination of capacity is questionable, at best. In that situation, underwriting counsel is always going to look at who else has standing, now or in the future, to challenge the transaction? Their joinder or written consent may be required. Fiduciary Relationship A trust is characterized by the Trustee having a fiduciary relationship with the beneficiary. A fiduciary is held to the highest standards of fair dealing with the person owed a fiduciary duty, meaning the trustee must put the interests of the beneficiary ahead of his own. Any trustee who is dealing with trust property for his own benefit and placing his or her interests ahead of the beneficiary is guilty of breaching that fiduciary duty. There are two exceptions to the fiduciary duty requirements. One is where the trustee is also the settler and beneficiary of the trust, and set up the trust for his own benefit. This is common in trusts created for estate planning purposes, at least as long as the settlor is still alive. The second is where the trustee is taking action in his own interest that is specifically authorized by the trust instrument. For example, when setting up a trust primarily for estate planning purposes, a settlor may anticipate giving his future trustees authority to act in their own interest. Generally, if a trustee is self dealing with property held in trust, the examiner or closer should review the trust agreement to determine whether there are provisions which allow the trustee to act in their own interest. If there are no such provisions, it is not a transaction they should be closing or insuring, as the beneficiaries or a subsequent trustee may bring suit to recover the property at a later date. Missing Trust Agreements Occasionally someone will assert they have lost their trust agreement, yet title will be in the trustee. Obviously, a Certification of Trust would solve this problem. If the customer does not feel comfortable providing you with a Certification of Trust because they cannot find the trust agreement, then we are not comfortable insuring title from the Trustee. Courts were created to resolve such matters, and it's better the customer resolves that than we do. Undisclosed Trusts


Theoretically, it's legal to have an undisclosed Trust behind a Trustee, where you deal with a person who labels himself simply as "trustee," without disclosing who he's working for. See, Section 101.001 of the Texas Property Code. However, as a general rule, most underwriters will not close for an undisclosed trust. The underwriter has no way of underwriting for risk associated with trust terms or involuntary liens if they do not know what trust the trustee is acting for. Further Information Feel free to contact me if you have any further questions: Richard D. Worsham Vice-President / Texas Region Underwriting Counsel Telephone: 281-362-5860 1900 Saint James Place, Suite 201 Houston, TX 77056 Toll Free: 800.327.7969 [email protected]

Presented by

Richard D. WorshamVice-President/Texas Region Counsel

UNDERWRITING TRANSACTIONSIN TRUSTS

Are there Creation Documents?

ALL trusts that you close will have been created by a written instrument, typically a:

Trust Agreement

Will

Deed

2016 TEXAS LAND TITLE INSTITUTE2

Is it a Trust????

A trust is a separation of actual ownership from beneficial ownership.Example:

Janet, the trustee, holds property for the benefit of Jack, the beneficiary.

The property is called the corpus of the trust.

Trusts are created by a grantor or trustor, called a “settlor” in the Texas statutes, who provides assets to be held in trust.


Is it a Trust????

What if there’s no clear separation of actual and beneficial ownership?

Property Code Section 112.032Sec. 112.032. ACTIVE AND PASSIVE TRUSTS; STATUTE OF USES.

(a) Except as provided by Subsection (b), title to real property held in trust vests directly in the beneficiary if the trustee has neither a power nor a duty related to the administration of the trust.

(b) The title of a trustee in real property is not divested if the trustee's title is not merely nominal but is subject to a power or duty in relation to the property.


Is it a Trust????

If there’s no separation of actual and beneficial interest, legally title is vested in the beneficiaries.

We don’t want to litigate whether a trust is passive or not, particularly with creditors of the beneficiaries.

If a trust appears to vest all authority in the beneficiaries, then search the beneficiaries for involuntary liens, and except to them.


What kind of Trust?

Typically, probably over 98% of the time, the trusts you will encounter are estate planning trusts, normally characterized as:Inter Vivos – created while alive

Testamentary – created upon death.

Inter Vivos Trusts are either –Revocable – meaning the grantor can revoke it while

alive.

Irrevocable – meaning the grantor cannot revoke it.


What kind of Trust?

Occasionally, you will see a trust used for owning investment property. This is not commonly done in Texas because Texas does not

have an entity theory of trusts. (more later)

Common in other states because they have laws allowing “business trusts,” which allows a trust to be a business entity with the same limited liability protections as corporations, LLC’s and LP’s.

In Texas, trusts used for business purposes are not substantially different in rights or organization from any other revocable inter vivos trust.

2016 TEXAS LAND TITLE INSTITUTE

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What kind of Trust?

Completely different are:

REITS – Real Estate Investment Trusts

Since the IRS requires they have 100 shareholders or more for tax advantages, typically used strictly for investment property

“Foreign” business trusts

formed in another state which recognizes business trusts as an entity; and

can qualify to do business in Texas by filing with the Texas Secretary of State’s office (as of 2006).


What kind of Trust?

Some business trusts are used to hold mortgages syndicated to secure bond offerings on Wall Street.

Example: “Big New York Bank as Servicer of the Mortgage Backed Securities Trust of 2012”These type of trusts often foreclose and sell REO in

Texas.


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Is Title Vested Correctly?

Thompson vs. Schmitt, 274 S.W. 554 (Tex. 1925).

TX Supreme Court declines to recognize a trust as a legal entity.

When any group of people get together to form a business in a form not recognized by the State, it is a de facto general partnership.

Huie vs. Deshazo, 922 S.W.2d 920 (Tex. 1996).

“The term ‘trust” refers not to a separate legal entity but rather to the fiduciary relationship governing the trustee with respect to the trust property.”

An attorney hired by the trustee represents the trustee, and his information is privileged from inquiry by the beneficiaries.

Bonner vs. Henderson, 147 F.3d 457 (5th Cir. 1998).

Dismissed suit for RICO violations against the trust because a trust is not a legal entity nor an “association in fact.”

In Texas, a trust is a contractual right, not an entity.



Ray Malooly Trust vs. Juhl, 186 S.W.3d 568 (Tex. 2006).

You cannot sue a Trust, because it is not a legal entity

You must sue the Trustee.

Ditta vs. Conte, 298 S.W.3d 187, 191 (Tex. 2009).

“A trust is not a legal entity; rather it is a fiduciary relationship with respect to property.”

Hollis vs. Lynch, 827 F.3d 436 (5th Cir. 2016).

“A trust cannot possess anything as it is not an entity under Texas law.”



2005 – Texas authorized REITS to do business in the State of Texas Prior to this most REITS acted in Texas acted through “REO

subsidiaries,” special purpose entities created to hold property in Texas.

2006 –Texas Business Organizations Code re-codified: Allowing Foreign Business Trusts, recognized in their own jurisdiction, to

file to do business in Texas; and

Adding: “A foreign non-filing entity or a foreign filing entity registered under this chapter enjoys the same but no greater rights and privileges as the domestic entity to which it most closely corresponds.” (TX Bus. Org. Code Section 9.202)



Non Existent Entity Problem Lighthouse Church of Cloverleaf v. Texas

Bank, 889 S.W.2d 595 (Tex. App. – Houston [14th Dist.] 1994, writ refused.).

“A deed is void if the grantee is not in existence at the time the deed is executed.”

There are about 10-cases which cite this case as authority for this principle, and 3-4 older cases.

It raises a question as to whether a deed into a non-existent Trust entity is completely invalid?



We have no specific case law on the effect of vesting property in the

name of an inter vivos Trust


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Generally, do not title property in the name of the trust.

Title it in the name of the TrusteeExample – title the property

in “Jane Doe, Trustee of the Jane Doe Trust” Do not title it in merely “The Jane Doe Trust.”



EXCEPT, you may title property in the name of a –REIT – Real Estate Investment Trust; or

A “Foreign” business trust. It has to be formally created in another state, filed with the corporate authority in that state.

If not filed in Texas, it must be filed in some state and be recognized as a legal entity there.


Correcting Vesting in the Name of the Trust

What if, up the chain of title, a prior deed vested in the name of the trust, which is not a REIT or foreign business trust.

If you can locate the trustee up the chain, you can get a correction deed.

Since you’re changing ownership, it is a material correction under 5.029 of the Texas Property Code, requiring a correction deed signed by grantors and grantees, one of which may not legally exist.

You can ask your underwriter to take the risk.

On risks under $500,000, the Master Indemnity covers lack of authority of a trustee.

Some underwriters may accept a specific indemnity, and some may give one.


Correcting Vesting in the Name of the Trust

What if the current vesting is in the name of the trust? Typically, it’s the principals in the trust who did it, and a

correction deed is fairly easy to get. Since you’re changing ownership, it is a material correction

under 5.029 of the Texas Property Code, requiring a correction deed signed by grantors and grantees, one of which may not legally exist.

If grantors of the trust and the deed are deceased, then typically you can obtain joinder of all parties with an interest in title, and most underwriters will take the risk. This will include the deceased grantor’s testate and intestate

heirs, who often have the greatest financial interest in challenging the conveyance into trust.


Excepting to Vesting in the Name of the Trust

Vest on Schedule A “subject to requirements”

Exception:

The Land is vested in the name of a trust. Company requires either – A correction deed into the trustee of the Trust, consistent

with Section 5.029 of the Texas Property Code; or

Company requires joinder of all testate and intestate heirs of ____________, and all trustees and beneficiaries of the Trust shown as vested in title.


Can the Trustee Do the Deal?

A trustee cannot sell or convey the real property held in trust without specific authority to do so set forth in the formation document.

A provision in a Trust Agreement or will saying the trustee has “all of the authority provided for a Trustee under the Texas Trust Code,” provides the Trustee with specific authority to sell and convey real property.



Some trustees do not have authority to sell real property.

Some trusts are specifically created in order to protect the property from creditors or resale.

Example – spendthrift trusts

Some trusts the authority of the trustee to sell disappears upon death of the other spouse, in order to assure the survivor bequeaths property as both agreed.



You may NEED TO READ the Trust formation documents to determine trustee authority.


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Instead of reading the Trust Agreement, we can rely on a current Certification of Trust.Because trusts provide for replacement of trustees,

we cannot rely on an old certification.

Must be in the form described in Section 114.086 of the Texas Property Code.

ONLY if the Certification of Trust meets the provisions required under Texas law does the insured and insurer get the benefit of the shelter provisions in 114.086(f).


Sample Trustee Authority Exception

Record title to the Land is vested in a Trustee or Trustees. Company requires either –a) A current Certification of Trust in the form

contemplated by section 114.086 the Texas Property Code, evidencing authority of the Trustee(s); or

b) A review of the formation documents for the trust.

c) Company reserves the right to make further requirements.


Authority in REITs & Business Trusts

With REITS and foreign business trusts, you SHOULD always read the authority documents. Recommend this be done by an attorney

familiar with this type of entity.

Such Trusts often put authority in some entity other than the trustee.

For Trusts holding debt or REO, typically there will be a servicer, possibly also a sub-servicer, with POA authority.


Authority in REITs & Business Trusts

With REITS and foreign business trusts, REALITY is that much is done on faith. REO management does not understand

their own structure.

They’re going to throw a resolution or POA at you and say they have authority.

You have to decide whether you want to drill for more authority documentation or lose a major customer.

Much decision making is done based on the size of the institution.


Homestead Issues

Homestead Property - Property held in a Trust can still be homestead, provided: It is a Revocable Trust.

Trustee has authority to designate it as homestead.

Settlor or beneficiary resides on property as primary residence at no cost other than payment of taxes and other costs designated in the trust formation documents.

Property is properly deeded into the trustee.

Property was transferred into the Trust AFTER September 1, 2009 (see In re Vasquez, 37 Colliers Bankr. Cases 2nd 611 (W.D. Texas 2012)

(See, also, TX Property Code Sec 41.0021)


Homestead Issues

Homestead Issues add Constitutional Issues Texas Constitution requires joinder of BOTH husband

and wife in any homestead transaction.

See, also, Section 5.001 of the Texas Family Code, which says, “Whether the homestead is the separate property of either spouse or community property, neither spouse may sell, convey, or encumber the homestead without the joinder of the other spouse… ”

If it’s in the name of a trustee, exactly whose homestead is it?


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Home Equity Loans A Home Equity Loan or Reverse Mortgage can be

done in a trust, if: Property meets the requirements to be homestead under TX

Property Code Sec 41.0021;

ALL of the Trustees and Beneficiaries and their spouses reside in the property and claim it as their homestead. Const. Article 16, Sec. 50(a)(6)(H) prohibits home equity loans being

secured by any non-homestead property.

Executed by ALL of the Trustees and Beneficiaries and their spouses. Const. Article 16, Sec. 50(a)(6)(A) requires a home equity be a written

agreement with the consent of each owner and owner’s spouse.


Home Equity Loans

Each signatory should sign both individually and as a trustee or beneficiary of the named trust.

Preferably there is a homestead tax exemption on the property.

Either - Except to the terms of the trust in the policy,

Subordinate any current or future rights set forth in the trust agreement to the insured mortgage. (include contingent beneficiaries)


Powers of Attorney

A Trustee may NOT delegate trustee authority using a power of attorney.

UNLESS, the trust agreement specifically provides the trustee with authority to delegate trustee authority using a power of attorney.

Common error – most don’t


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Fiduciary Duty

Always remember that a trustee, like an agent under a power of attorney or an executor, is a fiduciary of the beneficiaries.

Always be suspicious of self dealing by the Trustee, unless the Trustee is also the Grantor/Settlor and beneficiary of the Trust, and it appears to have been set up for the Trustee to self deal.


Missing Trust Agreements

Occasionally someone will assert they have lost the trust agreement.You may accept a Certification of

Trust.

If they don’t feel comfortable providing a Certification of Trust, then we shouldn’t be comfortable insuring the trustee’s ownership of the property. This is what courts are for.


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Undisclosed Trusts

Occasionally someone will ask you to insure title in the name of an individual, designated simply as “Trustee,” without disclosing the name of the Trust or he is acting for.

While technically legal, most underwriters will say, “No.” We have no idea who we’re insuring or why in this circumstance?


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Feel free to call with questions:

Richard D. WorshamVice-President / Texas Region Underwriting Counsel

Telephone: 281-362-58601900 Saint James Place, Suite 201

Houston, TX 77056

Toll Free: 800.327.7969

[email protected]
