This Article was published by YBAA Association of Yacht Sales Professionals, on their website on December 17, 2018. Article below was edited for content.

Do I own my boat? A simple answer in 99% of cases. Everyone knows that once closing occurs, title passes from the Seller to the Buyer. But what happens in those 1%?

Here is a little story to help explain this scenario. A Buyer makes an offer on the vessel, Seller accepts, and they go through the standard purchase requirements, such as survey, financing, insurance, etc. Closing occurs and the Buyer takes the vessel to another state. Three months later, the Buyer receives a complaint demanding the return of the Vessel to a complete stranger. This new party is not the Seller, never came up during the closing process and does not have a lien on the Vessel. After several years of litigation, the Buyer loses the boat to this third party.

Now you are wondering, is this legal? The short answer: yes, and it happens a lot more than people realize. Every state and the federal government has a provision which allows creditors to undo transactions that they claim were used to defraud a creditor or make the Seller insolvent. In other words, if the Seller sold the vessel in order to avoid paying a creditor, then the creditor can declare the sale null and void. The Buyer’s recourse is then to sue the Seller for the money paid. And you guessed it, if the proceeds were paid to the bank, good luck getting a dime out of them.

To make matters even more interesting, what if the Seller is named in a bankruptcy proceeding within THREE, that’s right 3 years, from the date of closing. Sections 544(b) and 550(a) of the Bankruptcy Code allow the Trustee to avoid the transfer of title and have the property returned to the Seller’s estate. Of course, the burden is on the Trustee to prove that the sale of the vessel falls into this category, but it will take time before such a resolution. Bankruptcy Courts require that decisions are made in adversarial proceedings, this means that if the Trustee does not want to settle, the Buyer must wait until the Court has a hearing on this, which could be as quick as six months to a year, all the way to the end of the Bankruptcy proceeding; which can last several years. To make things even more interesting, the Bankruptcy proceeding can be filed anywhere in the United States and the Seller does not even need to be the primary debtor. And to add spice to the litigation, the Buyer is not only fighting the Trustee and the Seller, but every other creditor as well. And if the Buyer loses, the boat’s title passes to the Trustee.

Now, do not panic and take a deep breath. This scenario is not unique to boats and largely comes up in real estate transactions, where someone sells real property without proper chain of title. Obviously, the Courts do not want to punish the Buyer, yet they must balance this with the rights of the Creditors. Thus, the Courts invented a legal term/test known as bona fide purchaser. Each State has a slightly different definition, however by means of example; Maryland defines this as an “innocent purchaser” who acquires property for valuable consideration, in good faith, and without notice of another's prior claim to the property. Fishman v. Murphy ex rel. Estate of Urban, 433 Md. 534, 546-47 (2013) (citing Julian v. Buonassissi, 414 Md. 641, 684, 997 A.2d 104, 130 (2010); People's Banking Co. of Smithsburg v. Fid. & Deposit Co. of Maryland, 165 Md. 657, 664, 170 A. 544, 547 (1934)). For the Court to declare a Buyer as a bona fide purchaser, the Buyer must obtain the property with the “absence of notice of prior claims, good faith purchase, and valuable consideration paid for the property.” Fishman, 433 Md. 534 at 547 (citing Hebron Sav. Bank v. City of Salisbury, 259 Md. 294, 299, 269 A.2d 597, 599 (1970)). Some Courts will also look at the relationship between the parties. Now boats are not real property, but the test for commercial sales under the Uniform Commercial Code, which is adopted by all states except Louisiana (which has its own definition), is similar. In other words, to be considered a bona fide purchaser, the Buyer (1) must pay fair market value; (2) without any notice of others claims on the property. Easy, right?

Fair market value is fairly easy to determine in a boat. For starters, there is a survey. Alternatively, BUCValu and NADA provide guidelines for many production vessels. So as long as the Buyer pays around the fair market value, then this element of the test is satisfied. This does not mean that Buyers cannot get great deals, e.g. boat FMV is X and he gets it a 50%. Buyers usually try to save money when buying and like to get deals. Simply put, this element can be satisfied even if the Buyer pays peanuts for the Vessel (that’s that whole thing about good faith requirement). In reality, bona fide purchaser turns on the second element of the test. It is all about notice!

The term “Notice” has many meanings and definitions and every lawyer can argue one way or another. The conservative test is the same as for the “discovery rule”, constructive notice that something is not right. For example, Buyer knows that the Vessel is in litigation or, the Buyer knows that the Seller is in Bankruptcy. Another, is that the Buyer is a child of the Seller, and knows that parents are about to lose the boat to a judgment from the Court. This is where the relationship of the Buyer and Seller matter. The closer the Buyer and Seller are to one another, the more scrutiny one can be subject to. Another factor to look at is the availability of information, such as abstracts of title and general litigation searches. Timing also becomes an issue, as the closer the transaction to the date of the claim by the Creditor/Trustee, the stronger the argument by that third party. Finally, price can be a great indicator that something is wrong, e.g. “buy this 100-foot yacht for only $100” should raise huge alarms. Remember, the Court is looking at whether the Buyer knew that there was an issue with title. Generally, the Buyer retains the broker and/or the documentation company to find out about issues of title. And just because a bank is involved, does not mean they will do the proper search. Remember, the burden is on the Buyer (thus on his agents who are hired to assist in the purchase, a.k.a. the broker) to do their due diligence and find out if there are issues with the title.

Anyone who has ever worked with our office or who has conducted a sale with a corporate Buyer/Seller or on an off-shore transaction, should be familiar with the term “due diligence.” In a nutshell, it is a standard list of what is necessary to close the transaction. For example, pulling an abstract, requesting corporate documents and resolutions to buy or sell, and demanding the Seller issue a warranty of title. These steps help protect the Buyer in the event that there is a fraudulent transaction being pulled by the Seller. As the price of the vessel rises, so should the amount of time devoted to the due diligence. Finally, anytime there is a corporate client, the check must include the owners, because at the end of the day, fraud is not the act of the corporation, but its managers and members.

Although the names were omitted the little story which opened this article is based on a real fact pattern. Fortunately, our office, as part of its normal due diligence, requested a “due diligence letter” from the Seller’s counsel. In that letter, in addition to the standard language, there is a paragraph directly dealing with the situation of claims by third parties. This letter, written by the Seller’s attorney (remember that distance between parties), is now the basis for a claim to be declared a bona fide purchaser. Further, such letters are a great tool when dealing with foreign registries while you wait for a deletion from a registry. Finally, if the sale is declared null and void, and the Buyer comes after the broker, the broker can point to this letter as a defense to negligence.

So, when does one demand a due diligence letter? Remember, due diligence letters take time to be drafted and require counsel or an accountant, thus like with a survey the sooner the Seller retains one, the better. There are costs to the Buyer and Seller which should be considered. Generally, a demand for a due diligence letter should be made anytime the Seller is a company, the transaction hits a certain price threshold, and/or a foreign flag is considered by the Buyer. Ideally, the best time to ask for such a letter is with the first offer, in the “extra provisions” section. The next opportunity is shortly after the offer is accepted. The last possible time, where the Buyer actually has bargaining power, is at Buyer’s acceptance. Thereafter, the negotiating power shifts to the Seller and most refuse to provide a due diligence letter because of the extra costs.

In most scenarios brokers do not ask for a due diligence of any kind. Further, the chances of a boat being subject to a fraudulent Court action, is fairly rare. But it does happen, and if the Buyer did not do his or her due diligence, that boat and all that money basically disappears or there is substantial cost to prove ownership. In summary, it is better to spend an extra couple of dollars to get the right paperwork in place at closing rather than tens of thousands for the Buyer to prove that they are a bona fide purchaser.

There are many little factors that the Court looks at to create the picture. It is the job of those assisting the Buyer, from brokers to lawyers, to make sure that those factors tell your story, not those of the Creditor.

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