Judge rules customer funds belong to LandAmerica

Money placed with LandAmerica 1031 Exchange Services Inc. belongs to the estate and not the customers who entrusted their funds to the now-bankrupt company.

U.S. Bankruptcy Court Judge Kevin R. Huennekens ruled yesterday that customers who gave their money to the company to hold temporarily as a way to defer capital-gains taxes have no ownership over the funds.

The ruling, which could have a negative effect on the 1031 exchange industry, essentially turns about 450 exchange customers into creditors who must vie for a portion of the company's remaining assets.

"I'm appalled," said Goochland County resident Kellie Lineberry, an exchange customer of the firm, which is a subsidiary of Henrico County-based LandAmerica Financial Group Inc.

"We contend -- and we will always contend -- the money was in trust."

The exchange company held proceeds from the sale of investment property as a way for investors to defer capital-gains taxes. The investors had 180 days to buy a similar property in which to reinvest.

Customers argued they had put their money in trust.

LandAmerica disagreed, as did Huennekens.

The judge said the words "trust" and "escrow" were missing from exchange agreements and that those same contracts awarded control of the money to LandAmerica's exchange company.

"If the parties had wanted to create a trust or if they had wanted to create an escrow, they certainly were capable of doing so," Huennekens wrote in his ruling. "They did not."

The decision was supported by Dallas attorney Charles R. Gibbs, lawyer to the committee representing unsecured creditors including exchange customers.

"It's our belief that the bankruptcy code broadly defines what is property of the estate," Gibbs said. "We always believed [exchange customer money] belonged to the debtor."

The exchange company and its parent filed for Chapter 11 protection in late November.

At the time of the bankruptcy filing, LandAmerica 1031 Exchange Services owed $419.2 million to about 450 customers.

Huennekens ordered that test trials be held representing the different types of exchange agreements. The theory was that one test case would set precedent for similar claims.

His ruling yesterday related to three test cases -- those of clients whose money was lumped in one account rather than segregated. Last month, Huennekens ruled that money from separate accounts, or segregated, also belonged to the estate.

"This was expected," said Ronald A. Page Jr. with the Richmond firm Cantor Arkema, which represents more than 50 exchange customers.

Kevin J. Funk, another Cantor Arkema attorney, said the firm was reviewing options, including an appeal.

The law firm's clients hold about $40 million in claims against the exchange company.

All the customers will have to pay taxes on the money they haven't received unless they found other financing to complete their exchanges.

"They now owe capital gains on the property they sold," Funk said. "It's like a double-whammy."

Only a presidentially declared disaster can excuse them from taxes.

The ruling's effect on the exchange industry, which is required in the IRS code to defer taxes but is not regulated, could extend beyond Richmond.

"I think you're going to see a chilling effect on 1031 exchanges," Funk said. "If the reasoning catches on, [exchange customers] will be giving up any right to their money."

Mary B. Foster, past president of the trade organization Federation of Exchange Accommodators, agreed.

The judge's ruling that money belongs to the 1031 company goes against the widespread belief in the industry that exchange companies hold money as agents for taxpayers but have no rights to the funds.

"It's bad for our industry, and it's a bad decision," Foster said. "As far as the industry goes, we'd certainly like to see the decision reversed."

Contact Emily C. Dooley at (804) 649-6016 or .