Cotenancy Disputes: Splitting the Baby

Cotenancy has significant implications for the value of the holdings of the participants. When cotenant interests are transferred, there is a significant value discount of 10-30% or more.

A Long History of Cotenancies

Cotenancies, especially for real estate, have existed for a long time. They are common where real property has been owned within families over several generations – where, for example, siblings jointly purchased land and transferred their interests to children by gift or bequest. Often down the road the various cotenants have differing financial objectives – some want to retain the property as is, some want liquidity, and some simply want out of the joint and several obligations. These situations raise interesting questions of value in estates and gifting, and often eventually result in operating and liquidity disputes.
The concept of cotenant ownership of real estate was far more prevalent 40, 50, 60 or more years ago, an era well before more sophisticated entity structures were prevalent. Could it be that people believed that gold and real estate were more dependable, tangible, and simple commodities than cash? Real estate was simple, and many if not most businesses relied on real estate for their livelihood. And uniform corporate and partnership laws were only developed within the last hundred years. Limited liability company laws are an even more recent development.

Partition Rights

Statutes exist to address cotenancy operating rights and ownership obligations, and access to liquidity—in the form of partition rights. Partition rights vary by jurisdiction, but generally in the US, a cotenant is free to transfer its interest to anyone at any time. Transferring a cotenant interest by gift or bequest is relatively easy. But selling one is not and, in most cases will take an extended period of time to sell if successful at all. If a cotenant seeks to exit or achieve liquidity, the laws on partition allow a cotenant to seek a physical partition of the property equal in value to its interest. If that is not practical, the cotenant can force a buyout by the other cotenant generally at fair market value or force a sale of the property and distribution of the cash proceeds in satisfaction of each owner’s interest.

Not surprisingly, litigation becomes a partition tool when cotenants cannot agree on an action plan, but this too delays the outcome and is expensive for everyone. The statutory partition process, although perhaps “fair” and “equitable” from a legal perspective, normally leaves one or more cotenants with an unsatisfactory conclusion with little redress.

The inability to freely transfer a cotenant interest materially impairs its value, an issue that arises in values of estates and gifts but may impact liquidity values as well. The cost of impairment is similar to discounts for lack of control and liquidity often found in business appraisals.

Cotenancy Disputes on the Rise

As one might imagine, with the aging and passing of the Baby Boomer generation, the number of estates involving cotenancies is also on the increase. Correspondingly, the number of cotenancy disputes is on the increase. A current and very interesting case was just decided by the Vermont Supreme Court in Beverly Newton Wells et v. Paul Spera (22-AP-178, 2023 VT 18). The Court was eventually required to decide how the partitioning action was to be resolved (the parcel could not be physically divided), which of two cotenants would be allowed to buy out the other cotenant in the absence of an outright sale, and which would be forced to sell his interest for half the value of the parcel in spite of his significant unreimbursed capital investments into the property.

Another recent decision is the Estate of Mary Mae Fisher from the Wyoming Supreme Court (2023 WY 25). The Fisher case addressed the right of a cotenant to transfer its property interest without notice to the other cotenants in spite of the fact that a partition action was already underway at the time of the death of one of the cotenants. Ultimately the transfer was allowed to proceed while the partition action was still in play. Again, there were winners and losers.

These cases emphasize that liquidity and thereby the value of property held in cotenancy is frequently impaired by the lack of control over the operation and liquidity of the interest. If you seek solutions while all is calm, it may be possible to recast cotenant ownership as an entity (an LLC, formal partnership, or even a corporation) that establishes ground rules for people to enter and leave the entity, and practical steps to achieve liquidity.

Although uncommon, we have seen newly created cotenancies developed to meet unique investment and tax objectives of the cotenants. In these cases, a tenant-in-common agreement is often used by the cotenants to express the nature of the arrangement – a cotenancy and not a partnership or other entity – and document basic provisions concerning operations, decision making, capital improvements, debts and incumbrances, right of sale of cotenant interests, and partition rights and remedies.