Case Notes: Entity Transfer Restrictions and Trust Funding

Analyzing Inwood Nat’l Bank v. Fagin

Background

Often, when funding an irrevocable trust during life (and sometimes even a revocable trust) with closely-held business interests, the grantor runs headlong into transfer restrictions. These restrictions may be found in a stand-alone shareholder agreement or buy-sell agreement, or may sometimes be found within an LLC operating agreement or limited partnership agreement. But, these restrictions often create procedures whereby the management of the business itself must approve share or equity transfers.

What if, however, it is not the entity management but instead the grantor that changes their mind and seeks to veto a pending transfer before approval by management is satisfied? At what point is such a transfer complete for state law purposes? While cases like Smaldino v. Commissioner have tackled the transfer tax aspects of such restrictions, a recent case from the Texas Supreme Court – Inwood National Bank v. Fagin, No. 24-0055 (January 31, 2025) – explored whether the business can be thrown under the bus if, for example, a grantor changes their mind.

Facts

The Fagins were a married couple (at least at the time of the transfer at issue in this case), and the wife (Christy) held shares of Inwood Bancshares, Inc. which was taxed as an S corporation. Christy proposed to transfer some of her Inwood shares to a trust for her husband, Kyle, which was to make a QSST election. The shares were subject to a shareholder agreement, that required Inwood to approve share transfers. Accordingly, when the QSST was funded, it noted on its schedule of assets that the grantor (Christy) “intends” to transfer certain shares “upon approval by Inwood Bancshares, Inc.”

The trust was executed, and Christy sought approval for the transfer. She had lost her share certificate, which had to be replaced as part of this approval process. But the process of getting the replacement gave her just enough time to get cold feet and realize “that transferring her Inwood shares to [the QSST] would make those shares Kyle’s separate property by gift, which she could never get back.” Accordingly, she informed Inwood that she would not be proceeding with the transfer and never surrendered her (replacement) share certificate for the issuance of new shares to her and the QSST. In turn Inwood did not countersign the various documents needed to proceed, like a subscription agreement between Inwood and the QSST.

Kyle, instead of settling matters in house (perhaps because of some discord, as the facts imply that their marriage has since terminated), sought a declaration that the QSST owned the shares and sued Inwood for tortious interference (with some other unspecified claims against Christy being thrown in that were later settled). At issue was whether the QSST itself, with the statement of Christy’s intent with regard to the Inwood shares on Schedule A to such trust, was an “enforceable and irrevocable” contract to transfer the shares notwithstanding the requirement of approval from Inwood. The tortious interference claim alleged that Inwood was the source of information to Christy about the transfer being irrevocable.

Inwood was granted summary judgment, and Kyle appealed. The court of appeals reversed summary judgment, and Inwood petitioned the Texas Supreme Court for review.

Analysis and Holding

In short, the Court concluded that the transfer of shares under the trust itself was subject to an express condition of approval by Inwood that was never fully satisfied, and thus was never complete – despite the irrevocability of the trust. Likewise, the Court concluded that there could be no bilateral contract for the transfer of the shares because the shareholder agreement itself imposed a condition precedent to the share transfer – approval by Inwood - that again was never satisfied. An e-mail from Inwood’s attorney indicating that the transfer would be completed the following week was not enough to establish satisfaction of this condition precedent, as it did not create an issue of fact due to (1) Christy never actually taking the final step of surrendering her share certificate, and (2) Inwood never countersigning the subscription agreement.

(Ironically, this e-mail itself was held against Kyle as it was sent months after execution of the QSST – the Court implied that Kyle was arguing against the proposition that the transfer was supposedly “completed” when the trust agreement was signed by relying on this subsequent e-mail.)

Accordingly, the judgment of the court of appeals was reversed.

Key Takeaways

This is not a new or novel issue, but unlike many cases it involved some excellent drafting in the context of what occurred after the QSST was executed. Many trusts include a schedule of assets that are transferred or are intended to be transferred, often as “Schedule A” or a similar label. Merely including property on that schedule is not sufficient in many cases to evidence a transfer of the property when the law, or contract, mandates a different method and procedure of transfer (and approval thereof).

For example, real estate must be transferred by a deed. While there can be workarounds, such as the Heggstad petition in California to treat real property listed on such a schedule as if it is owned by a revocable trust even if the settlor never formally transfers such property during life, these workarounds typically refer to legal impediments to title. Contractual impediments, however, are a different story.

The Court in this case relied upon the conditional wording on Schedule A of the QSST, whereby the share transfer could not occur until Inwood approved the transfer. This was contrasted with the affirmative, unconditional transfer of $100 also indicated on such Schedule. But even if there was no shareholder agreement imposing a mandatory requirement of consent by Inwood, the Court implied that this condition on the trust itself would have been enough to determine that this was a future gift (instead of an immediate gift) and thus was unenforceable.

So, let’s take it a step further. Let’s assume that, like many trusts, the drafter had not had the foresight to include this express condition for a future gift. Would the condition of approval by Inwood itself in the shareholder agreement been enough, by itself, to avoid completion of the gift? Most likely, the answer would be yes.

In either case, there was an external condition that had to be satisfied. Presumably, proving the satisfaction of this condition would require written evidence which did not exist in this case. At no point did the husband, Kyle, argue for any oral approval of the condition. And as noted by the Court, Inwood specifically set forth the conditions to its approval including a bilateral subscription agreement between the QSST and Kyle, along with the issuance of a new share certificate to the QSST (which first required Christy to surrender her own share certificate). Neither of these procedural conditions of acceptance happened.

So what is our lesson? To me, it is that contractual conditions matter and must be strictly observed in wealth transfers – even if the donee themselves is not a party to those contractual conditions. This was at issue in Smaldino, but with the failure to meet such contractual conditions being self-imposed by the donor themselves in the face of a transfer that was supposedly completed. Without belaboring the finer points of contract law, however, what if the parties had performed as if the share transfer had actually occurred? While performance can sometimes save unsatisfied contractual conditions or lack of consideration, Smaldino involved a similar lack of performance in accordance with the supposed intended outcome. In the present case, only one party acted as if the transfer had occurred – it takes two to tango, and as confirmed by the Texas Supreme Court, one is always free to change their mind and withdraw their promises before performance of said tango.