LandAmerica Ruling Puts 1031 Exchanges in Jeopardy

At the Real Estate Practice Seminar I attended last week, there was a lot of buzz among real estate attorneys across Virginia about the astounding LandAmerica decision rendered May 7th in the bankruptcy court for the Eastern District of Virginia. For those who have not heard about the decision, Judge Huennekens found that none of the 450 claimants who had escrowed a whopping $227 million with LandAmerica as a Qualified Intermediary (QI) for their 1031 exchanges can recover these funds. Instead, the funds are now considered part of the bankrupt company's assets in bankruptcy! The reasoning for the opinion is that no express trusts were created in favor of these claimants, the 1031 exchangors.

This opinion has sent widespread shock throughout the bar because of its far reaching implications. Not only have these claimants/exchangors lost their escrowed profits from their "first leg" transaction, but they now have to pay capital gains on those profits, and may be contractually liable to complete the "second leg" transaction without their monies.

In speaking with one attorney representing 20 claimants (and counting) who will probably be filing appeals of the decision, I learned that LandAmerica began to invest the escrowed funds in securities, not conservative, liquid accounts. When the market went south, the escrowed funds were at risk and then began to lose value. It is my understanding that, as the losses mounted, LandAmerica began to utilize new escrows to fund escrows that were being called upon for the "second leg" transactions, a la a Ponzi scheme. It has been established that LandAmerica took on new 1031 escrows mere days before filing bankruptcy, so it is likely that principals there knew that the house of cards would fall as there would be no more new escrows accepted to provide funding for these "last in" transactions.

Because of this federal judge's far-reaching ruling, real estate practitioners are wondering how funds escrowed for 1031 exchanges can ever be deemed safe and separate from the assets of the QI. I know many of our local title agents and branch offices for title underwriters are preparing various responses and guidance for us, as they all act as QI's for 1031 exchanges.

[In full disclosure, I should mention that I sold my former company, The Closing Company, to LandAmerica in 2004, and was employed there as an Area Manager overseeing the operations I formerly owned. I left one year later in 2005. I was not employed in the Exchange Services division, although I did recommend their services to clients of mine while I was at LandAmerica and on occasion afterwards. Fortunately, I have not done so since ~2006. - Cheri Lewis]

"Change Order"

This month I am presenting a seminar to real estate colleagues in the bar across Virginia. To introduce one of my case studies, I am using this image. It is one of my favorites and highlights the risks of construction law practice. N.B: The small dinghy in front of the larger boat is named "Original Contract."