EXEMPTION
PLANNING BY CALIFORNIA DEBTORS: MAXIMIZING PROPERTY RETAINED AFTER BANKRUPTCY AND THE RISKS OF DOING SO
By Alan M. Ahart1
I. Introduction
Once an individual debtor resolves to file bankruptcy, they and their attorney typically must decide what property to keep from creditors and the bankruptcy trustee by claiming it as exempt. The debtor’s goal is to boost the value of this exempt property, and the means of doing so is to raise funds to create equity in exemptible and other assets, such as specified pension plans, that can be shielded from creditors. Steps that are commonly taken include raising cash to utilize the socalled “wild card” exemption, increasing the debtor’s homestead exemption by purchasing a more valuable home or by paying down the mortgage on the debtor’s current home, and by funding a retirement plan. This is called prebankruptcy exemption planning and is a means of converting nonexempt assets into exempt assets.
The purpose of this article is to describe exemption planning by debtors, the boundaries thereon and the remedies available to creditors or the bankruptcy trustee when the debtor crosses a boundary. This article does not discuss whether a particular claimed exemption should be disallowed because it does not fit the statutory requirements for the exemption. Section II explains what exemptions debtors in bankruptcy may claim and the confines placed thereon by the Bankruptcy Code.2 Section III discusses the guidance the Supreme Court of the United States has issued for exemption planning. Section IV sets forth the process of claiming and objecting to exemptions and the meaning of exempt property. Section V lists the remedies of creditors and the bankruptcy trustee provided by the Bankruptcy Code when the debtor engages in “misconduct” in prebankruptcy exemption planning. Section VI describes how exempt property may be attacked as a product of a fraudulent conveyance. Section VII tells how assets might be recovered from pension plans. Section VIII discusses the effect of a bankruptcy discharge upon a
1 United States Bankruptcy Judge, Central District of California (ret.). The author wishes to thank Matthew L. Ahart and Glen Dresser for their excellent comments on this article.
2 The Bankruptcy Code is title 11 of the United States Code. All references hereafter to the Code, Bankruptcy Code or to a numbered section are to title 11, unless otherwise indicated.
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debtor who has converted nonexempt into exempt property. Section IX explains why the Bankruptcy Code has preempted state law as to the debtor’s entitlement to specific exempt property. Section X describes the limits on exemption planning under California law. The Conclusion states what a bankruptcy court may be required to determine if an exemption is contested, and the remedies that may be provided therefor.
II. Exemptions in Bankruptcy
The most important policy in bankruptcy for an individual who files a chapter 7 case is to enable the debtor to discharge as many debts as possible. The second most important policy is enabling such a debtor to exempt property in bankruptcy.3 The Bankruptcy Code generally gives debtors two alternatives when electingexemptions:either(1)stateexemptions,federalnonbankruptcy exemptions, and specified exemptions for tenancies by the entireties and retirement plans, or (2) the federal bankruptcy exemptions set forth in section 522(d) of the Bankruptcy Code.4 However, the Bankruptcy Code also authorizes any state to prohibit its debtors from electing these section 522(d) exemptions (“opt-out”).5 If a state chooses to opt-out, the state generally defines the nature and amount of the property that may be exempted by a debtor who has been domiciled in the state for the requisite period of time preceding the filing of the bankruptcy petition.
6 California has opted-out of the section 522(d) exemptions but gives debtors only in bankruptcy the right to elect: (1) a set of exemptions similar to the federal Bankruptcy Code section 522(d) exemptions, or (2) California’s regular exemptions applicable to
3 Vern Countryman, For a New Exemption Policy in Bankruptcy, 14 RUTGERS L. REV. 678, 678 (1960); see also Lawrence Ponoroff & F. Stephen Knippenberg, Debtors Who Convert Their Assets on the Eve of Bankruptcy: Villains or Victims of the Fresh Start?, 70 N.Y.U.L. REV 235, 240 (1995) (stating that exemptions are pivotal to the individual’s fresh start in bankruptcy); In re Applebaum, 422 B.R. 684, 691 (B.A.P. 9th Cir. 2008) (“The fresh start policy is implemented by allowing the individual debtor to exercise exemptions, which are intended to provide the debtor with an appropriate standard of living post-bankruptcy.”) (citation omitted).
4 11 U.S.C. § 522(d)(2)(2018). These federal bankruptcy exemptions also provide an exemption for retirement plans.
5 11 U.S.C. § 522(b)(1). However, if the debtor fails to satisfy the domiciliary requirements, the debtor may still choose the § 522(d) federal bankruptcy exemptions. See also text accompanying note 49, infra.
6 11 U.S.C. § 522(b)(3)(A).
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enforcement of money judgments.7 Consequently, just prior to filing bankruptcy a California debtor must be authorized to at least choose between these two sets of exemptions. This means that, where such a debtor converts nonexempt property into exempt property, such conversion ordinarily must be legal and not subject to nullification.8
Before the Bankruptcy Reform Act was enacted in 1978, Congress considered whether exemption planning should be barred. At least three bills that would allow certain exemption planning were introduced, each with a provision stating in identical language that conversion of nonexempt property into exempt property before filing bankruptcy would not be grounds for denying a claimed exemption, in the absence of fraud.9 Hearings were held and a couple of witnesses testified that pre-bankruptcy planning should not be permitted.10 Other witnesses testified that converting nonexempt property into exempt property was allowed in California.11 Ultimately, this provision was not included in later bankruptcy bills and no provision dealing with pre-bankruptcy planning was in the bill that became law. Moreover, the House Committee and the Senate Committee that considered the final bill declared that, as under then-current law, exemption planning was
7 CAL. CIV. PROC. CODE §§ 703.130, 703.140.
8 Any time limit on pre-bankruptcy planning could be perceived as unfair to an unsophisticated debtor who elects their exemptions on the eve of bankruptcy. Theodore Eisenberg, Bankruptcy Law in Perspective, 28 U.C.L.A. L. REV. 953, 996 (1981); see also Lawrence Ponoroff & F. Stephen Knippenberg, Debtors Who Convert Their Assets on the Eve of Bankruptcy: Villains or Victims of the Fresh Start?, 70 N.Y.U. L. REV. 235, 242 n.34 (1995) (“ a rule disallowing exemption claims for property acquired on the eve of bankruptcy would unfairly prejudice the debtor who did not have the foresight, or the professional counsel, to obtain his quota of exempt property earlier.”) (citing Frank R. Kennedy, Limitation of Exemptions in Bankruptcy, 45 IOWA L.REV. 445, 480 (1960)).
9 S. 235, § 4-503(f) (Jan. 17, 1975); H.R. 32, § 4-503(f) (Jan. 14, 1975); H.R. 31, § 4-503(f) (Jan. 14, 1975); H.R. 16643, § 4-503(f) (Sept. 12, 1974); see also Hearings on Bankruptcy Act Revision Before the Subcomm. on Civil and Constitutional Rights of the H. Comm. on the Judiciary, 94th Cong. (Feb. 20, 1976), 1976 WL 191320, [hereinafter Hearings] following page 1278 (Feb. 20, 1976), 1976 WL 191320 (statement of Joe Lee, Bankruptcy Judge).
10 See Hearings (Feb. 23, 1976), supra note 9, following page 134 (letter from Aaron K. Phelps, Bankruptcy Judge, to Congressman Don Edwards dated Feb. 17, 1976); id. following page 1355 (testimony of Conrad Cyr, Bankruptcy Judge) (Feb. 23, 1976).
11 Hearings (Feb. 20, 1976), id. following page 1284 (testimony of Bankruptcy Judge Joe Lee); see also id. following page 1381 (testimony of Mr. Paul Winkler) (stating that case law clearly allows transfer of assets from nonexempt into exempt on the eve of bankruptcy).
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permissible, the practice was not fraudulent as to creditors and permitted “the debtor to make full use of the exemptions to which he is entitled.”12
Congress has subsequently both increased and decreased the value of certain exemptions availableto debtorsin bankruptcy. Forexample,in 1984,section522(b) was amended to prevent one joint debtor in a bankruptcy case from choosing state law exemptions and the other joint debtor electing the section 522(d) exemptions.13 The Bankruptcy Reform Act of 1994 amended section 522(f)(1)(A) to prevent avoidance of judicial liens that secure debts for family support.14 In 2000 subsection (4) was added to section 522(c) to make exempt property liable for certain debts pertaining to fraudulently obtaining or providing loans or other benefits in connection with government guaranteed student loans.15 And, as listed below, in 2005, several amendments were passed that constrain specified exemptions or reduce the protection afforded exempt property:
• Section 522(b)(3)(A) restricts the use of state law exemptions by extending the look-back period for domicile before a bankruptcy case is filed;
• Section 522(c) makes exempt property liable before and after discharge for Code section 523(a)(1) nondischargeable tax debts and Code section 523(a)(5) nondischargeable domestic support obligations;
• Section 522(f)(1)(A) states that any judicial lien securing a nondischargeable domestic support obligation mentioned in Code section 523(a)(5) is not avoidable;
• Section 522(n) puts a cap on the amount of individual retirement accounts that can be claimed exempt;
12 S. REP NO 95-989, at 76 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5861-5862; H.R. REP
NO. 95-595,at361 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6316; In re Kravitz, 225 B.R. 515, 518 (Bankr. D. Mass. 1998).
13 Pub. L. No. 98-353, § 306(a)
14 Pub. L. No. 103-394, §§ 303(2), 304(d).
15 Pub. L. No. 106-420, § 4.
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• Section 522(o) decreases the value of the debtor’s state law homestead or burial plot exemption for the value attributable to debtor’s conveyance of property within 10 years before the bankruptcy case is commenced, if the conveyance was made with the intent to hinder, delay or defraud creditors; and
• Sections 522(p) and (q) limit the amount of the homestead or burial plot exemption where the debtor claims the state law exemption and the property was acquired within 1215 days before the case was commenced.16
Except for these latter amendments pertaining to homesteads, burial plots and retirement plans, there is no language in the Bankruptcy Code that authorizes a reduction in value, let alone a disallowance of, an exemption because a nonexempt asset is converted into an exempt asset even with the intent to hinder, delay or defraud creditors.17
The following section presents the Supreme Court’s teaching on the power of bankruptcy courts to restrict a debtor’s exemptions in bankruptcy.
III. The Supreme Court Guidance
During 2014 in Law v. Siegel the United States Supreme Court said the Bankruptcy Code admits no general, equitable power in bankruptcy courts to deny exemptions based on a debtor’s bad faith conduct.18 The Supreme Court also stated that “when a debtor claims a state-created exemption, the exemption’s scope is determined by state law, which may provide that certain types of debtor misconduct warrant denial of the exemption.”19 The Supreme Court cited an Eighth Circuit
16 Pub. L. No. 109-8, §§ 216(1), 224(a)(1), 224(e)(1), 307(1), (2), 308(1), (2), 322(a).
17 Crews v. First Colony Life Ins. Co. (In re Barker), 168 B.R. 773, 776-77 (Bankr. M.D. Fla. 1994); see also In re Swift, 124 B.R. 475, 482 (Bankr. W.D. Tex. 1991) (stating that, in the absence of a statutory basis for denying an exemption, the court “is reluctant to conclude that exemption claims can be disallowed solely based on a theory of impermissible pre-bankruptcy planning.”); c.f. Roosevelt v. Ray (In re Roosevelt), 176 B.R. 200, 208 (B.A.P. 9th Cir. 1994) (“ . in the Ninth Circuit a debtor may convert non-exempt property into exempt property even on the eve of bankruptcy.”).
18 Law v. Siegel, 571 U.S. 415, 425 (2014)
19 Id.; see also In re Gray, 523 B.R. 170, 175 (B.A.P. 9th Cir. 2014) (“Law v. Siegel does recognize that when a debtor claims an exemption created under state law, the scope of the exemption is
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case20 and specifiedpartsofthe Collier bankruptcytreatiseas examples ofadebtor’s misconduct that led to denial of an exemption under state law.21 This statement is not precisely correct because, as we have already seen,22 and will see,23 Congress had previously set limits on state law homestead and burial plot exemptions within the Bankruptcy Code itself. It is noteworthy that none of these cases dealt with California law.
The next section explains the process of claiming, objecting to, and the meaning of exempt property.
IV. Claiming and Objecting to Exemptions and the Meaning of Exempt Property
An individual debtor who wishes to claim property as exempt must prepare and file an exempt property list on Schedule C. This Schedule should describe each particular asset in detail and cite to a specific statutory provision authorizing the exemption. Unless the court grants an extension, Schedule C must be filed in a voluntarybankruptcycasewithin14days afterthe petition is filed,or within14days after entry of the order for relief in an involuntary bankruptcy case.24 A debtor may amend Schedule C to claim a new or revised exemption at any time before the case is closed.25
An interested party may object to a debtor’s claimed exemptions.26 Although the bankruptcy court will determine whether the objection should be sustained, it is unclear who has the burden of proof. In 1999 the Ninth Circuit Court of Appeals held that, as provided by Federal Rule of Procedure 4003(c), the objecting party has the burden of proving an exemption is not properly claimed.27 However, later lower determined under state law . . . .”).
20 In re Sholdan, 217 F.3d 1006 (8th Cir. 2000)
21 Siegel, 571 U.S. at 425.
22 See supra text accompanying note 16.
23 See infra text accompanying notes 46-52.
24 FED R. BANKR P. 1007(b)(1), (c), 4003(a)
25 FED R. BANKR P. 1007(b)(1), (c), 1009(a), 4003(a)
26 11 U.S.C. § 522(l).
27 In re Carter, 182 F.3d 1027, 1029 n.3 (9th Cir. 1999).
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court decisions have found that the Ninth Circuit Court of Appeals failed to consider California law, which puts the burden on the debtor to prove they are entitled to claim the exemption.28
An objection must be made in writing and ordinarily filed within 30 days after the Section 341(a) meeting of creditors is concluded.29 The objection can take theformofacomplaintseekingtoavoidthetransferintoexemptpropertyifitclearly indicates the plaintiff is objecting to the claimed exemption.30 Alternatively, if an amended claim of exemption is filed, objections thereto may be filed within 30-days after the amended exemption is filed.31 An objection based upon Code section 522(q) must be filed before the case is closed.32 If an exemption is first claimed after the case is reopened, an objection thereto must be filed before the reopened case is closed.33 The period to object may be extended for cause by court order upon a motion filed before expiration of the relevant period.34 Also, the bankruptcy trustee may file an objection to an exemption before one year after the case closed where the debtor fraudulently claimed the exemption.35 But to utilize this extension the bankruptcy trustee must show that the debtor committed fraud when the debtor asserted the exemption.36 This means that the trustee must demonstrate that the debtor: (1) made a representation; (2) knew the facts did not support the claim when it was made; (3) intended to deceive the trustee and the creditors when the claim was made; and (4) that the trusteejustifiably reliedupontherepresentation.37 Thus, even if the debtor fraudulently converted a nonexempt asset into an exempt asset on the eve of bankruptcy, the trustee should not be permitted to take advantage of this
28 See, e.g., In re Diaz, 547 B.R. 329, 337 (B.A.P. 9th Cir. 2016); In re Sinclair, 563 B.R. 554, 558 (Bankr. E.D. Cal. 2017)
29 FED. R. BANKR. P. 4003(b)(1).
30 In re Lee, 889 F.3d 639, 641, 645 (9th Cir. 2018).
31 FED R. BANKR P. 4003(b)(1)
32 FED R. BANKR P. 4003(b)(3)
33 FED. R. BANKR. P. 4003(b)(3).
34 FED. R. BANKR. P. 4043(b)(1).
35 FED R. BANKR P. 4003(b)(2) (emphases added).
36 See In re Stijakovich-Santilli, 542 B.R. 245, 256 (B.A.P. 9th Cir. 2015)
37 Id.
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enlarged period where the debtor accurately and fully disclosed the facts underlying the conversion.
A party generally cannot contest an exemption after the deadline has passed whether or not the debtor had a colorable statutory basis for claiming the exemption.38 After the time to object to a claimed exemption has expired,39 or the court’s order sustaining the exemption has become final, the property is exempt and is afforded the protections bestowed upon exempt property by the Bankruptcy Code. Of course, to the extent an objection is sustained, the property is not exempt and presumably is property of the estate.
Once property is exempted, it is generally withdrawn from the estate and beyond the reach of most prepetition creditors. However, there is a difference between exempting the actual property and exempting an interest in property. For example, in 2023 it appears that a California debtor may exempt equity from about $339,000 to approximately $678,000 in a homestead.40 On the other hand, a
38 Taylor v. Freeland & Krontz, 503 U.S. 638, 643-44 (1992); see also In re Lee, 889 F.3d 639, 64142 (9th Cir. 2018) (stating that, where no objection is filed, the exemption becomes final regardless of whether the debtor had colorable basis for claiming it); Preblich v. Battley, 181 F.3d 1048, 1052 (9th Cir. 1999) (“Unless a party in interest files a timely objection, the property claimed as exempt is deemed exempt and any argument that the property is not exempt is waived.”); but see In re Kuhnel, 495 F.3d 1177, 1181-82 (10th Cir. 2007) (declaring that the 30-day time period does not apply to objections raised under Bankruptcy Code section 522(g) to exemptions claimed in property voluntarily transferred and subsequently recovered by the trustee); In re Duncan, 329 F.3d 1195, 1204 (10th Cir. 2003) (stating that § 522(g)(1) applies so that the debtor is not entitled to claim a homestead exemption in property voluntarily transferred and recovered by the trustee in an adversary proceeding, notwithstanding the trustee’s failure to object within the 30-day period); In re Perez, 628 B.R. 327, 332 (B.A.P. 9th Cir. 2021) (“[T]o prevail on an objection to an exemption under [Bankruptcy Code section] 522(g)(1), the trustee must present evidence that: (1) the debtor transferred property in such a manner as to invoke the trustee’s avoidance powers; (2) either the transfer was voluntary or the debtor knowingly concealed the transfer; and (3) the property was returned to the estate as the result of the trustee’s efforts.“) (citing case).
39 In re Greenfield, 65 F. App’x 549, 552 (6th Cir. 2003) (debtor was entitled to his claimed exemption in property he transferred to himself and his spouse where the trustee did not timely object to the exemption); Hagan v. Mickens, 589 B.R. 594, 599 (W.D. Mich. 2018); Renneker v. Wyman (In re Wyman), 626 B.R. 480, 501 (Bankr. S.D. Ohio 2021); Moyer v. Rosich (In re Rosich), 570 B.R. 278, 283-84, 287 (Bankr. W.D. Wis. 2017); Salven v. Munday (In re Kemmer), 265 B.R. 224, 231-32 (Bankr. E.D. Cal. 2001); see also In re Harrell, 212 B.R. 174, 176 (Bankr. S.D. Ga. 1997) (“The trustee’s failure timely to object to a claimed exemption bars a challenge to the exemption’s validity even though there is no basis for the exemption.”) (citing cases and statute).
40 These amounts reflect an increase of 4.4% in the California Consumer Price Index for All Urban Consumers for the 2020-2021 fiscal year (July 1-June 30) and an increase of 8.3% in this index for
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California debtor can exempt their entire ownership interest in an unmatured life insurance policy or in a private pension plan not for a self-employed individual.41
Exempt property, or at least the value of the debtor’s interest that has been exempted, is generally not liable during or after the bankruptcy case for prepetition debts.42 The exceptions to this general rule are for specified liens and nondischargeable debts, or where the bankruptcy case is dismissed. 43 Similarly, exempt property is not liable for administrative expenses other than expenses incurred by the bankruptcy trustee in avoiding certain transfers or recovering property that is later exempted by the debtor, and expenses incurred by the debtor in avoiding transfers or recovering property, as specified.44
The following section describes the remedies furnished by the Bankruptcy Code for the debtor’s “misconduct” in converting nonexempt property into exempt property.
V. Remedies for the Debtor’s “Misconduct”
While a party in interest may object to a claimed exemption on the basis of a debtor’s “misconduct,” normally the Bankruptcy Code does not provide that an exemption resulting from conversion of nonexempt property may be reduced or
2021-22. See CAL. CIV. PROC. CODE § 704.730(c) (2022); www.dir.ca.gov/OPRL (Consumer Price Index Table-2020-2022 for California) These percentage changes could be higher or lower. See, e.g., letter from Martin Hoshimo, Administrative Director, Judicial Council of California, to Cara l. Jenkins, Legislative Counsel, et. al., dated Mar. 30, 2022. Also, as of January 1, 2023, California law provides that, if the value of a bankruptcy debtor’s equity in a homestead is less than or equal to the value of the debtor’s allowed exemption on the date the bankruptcy petition is filed, any postpetition appreciation in the homestead is also exempt. CCP § 703.140 (2023)
A debtor may be able to exempt the actual property by claiming “100% of FMV” as exempt, at least where no party timely objects. In re Masingale, 644 B.R. 530, 534, 539-44 (B.A.P. 9th Cir. 2022), appeals filed with 9th Cir. Nov. 17, 2022 and Nov 22, 2022.
41 CAL. CIV. PROC. CODE §§ 704.100(a), 704.115(b); In re Woodson, 839 F.2d 610, 618 n.12 (9th Cir. 1988); In re Barnes, 275 B.R. 889, 896-97 (Bankr. E.D. Cal. 2002).
42 11 U.S.C. § 522(c)
43 Id. Also, property exempted in bankruptcy may not be protected from seizure by the federal government to enforce a delinquent tax debt or a judgment for a fine, such as a restitution order. See 11 U.S.C. §§ 522 (c)(1), 523(a)(1), (13); 18 U.S.C. § 3613 and 26 U.S.C. §§ 6321, 6331, 6334.
44 11 U.S.C. § 522(k).
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invalidated.45 The notable exception is the homestead or burial plot exemption claimed under state law. In 2005, Congress extended the time a debtor must be domiciled in a state from 180 days to 730 days before the debtor may claim that state’s exemptions.46 If the debtor‘s domicile has not been situated in one state for the 730-day period, the debtor’s exemptions ordinarily are determined by the state where the debtor was domiciled in the 180-day period before the 730-day period, or the longer part of such period.47 Congress changed these domiciliary requirements to curb the “mansion loophole” where a debtor would move to a state with a more generous homestead exemption before filing bankruptcy.48 Should this provision render the debtor ineligible for any exemptions, the debtor may choose to exempt property using the section 522 (d) exemptions even though the state has opted-out.49 If the debtor converted nonexempt property into an exempt homestead or burial plot during the 10-year period preceding filing of the bankruptcy petition with the intent to hinder, delay or defraud a creditor, the value of the exemption may be reduced.50 Likewise, if the debtor acquired an interest in a burial plot or homestead during the 1215 days (about 3 years and 4 months) preceding filing of the bankruptcy petition, the value of the exemption under state law will be limited except where the debtor is a family farmer or the debtor’s previous homestead was acquired before this period in the same state.51 Finally, where the debtor has engaged in certain “bad
45 Renneker v. Wyman (In re Wyman), 626 B.R. 480, 501 (Bankr. S.D Ohio 2021); In re Swift, 124 B.R. 475, 482 (Bankr. W.D. Tex. 1991); see also In re Summerell, 194 B.R. 818, 835 (Bankr. E.D. Tenn. 1996) (noting that, even if fraud has been shown, that denial of exemptions, unrelated to the alleged fraud, is not the appropriate remedy); In re Clemmer, 184 B.R. 935, 944-45 (Bankr. E.D. Tenn. 1990) (“the prepetition bad faith actions of the debtor are insufficient to support a conclusion that the debtor’s exemptions, to which he is legally entitled under state law, should be denied.”).
46 11 U.S.C. § 522(b)(3)(A)
47 Id
48 In re Applebaum, 422 B.R. 684, 690 (B.A.P. 9th Cir. 2008) (citations omitted).
49 11 U.S.C. § 522(b)(3)(C), (d).
50 11 U.S.C. § 522(o). One article discussing the impact of this provision stated: “If a debtor has committed an intentional fraudulent conveyance during the ten years prior to the filing of thepetition, then any allowed homestead exemption can be reduced to the extent of said fraudulent conveyance.”
Samuel K. Crocker & Robert H. Waldschmidt, Impact of the 2005 Bankruptcy Amendments on Chapter 7 Trustees, 79 AM BANKR L.J. 333,351(2005)
51 11U.S.C.§ 522(p).Oneauthorhasnotedthattwoexceptionsinthis subsectioncouldbeconstrued such that the homestead exemption would not merely be capped, but lost altogether. See Margaret Howard, Exemptions Under the 2005 Bankruptcy Amendments: A Tale of Opportunity Lost, 79 AM BANKR. L.J.397,405-06 (2005).
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acts”(e.g., violatingthesecuritieslaws, intentionally causing seriouspersonal injury or death in the preceding 5 years), the amount of the debtor’s burial plot or homestead exemption will be capped unless the debtor shows the property is “reasonably necessary for the support of the debtor and any dependent of the debtor.”52
Except for the homestead and burial plot exemptions, the only statutory civil remedies that Congress has arguably provided for a conversion of nonexempt property into exempt property on the eve of bankruptcy where the debtor transferred the property with the intent to hinder, delay or defraud a creditor are: (1) denial of thedebtor’s dischargein achapter7 case,53 (2) avoidance ofthe transfer and perhaps recovery of the asset in a chapter 7, 11, 12 or 13 case,54 or (3) dismissal of the bankruptcy case if the court finds cause to do so.55 Thus, if the debtor transferred, removed or concealed property, or permitted same, with the intent to hinder, delay or defraud a creditor or the bankruptcy trustee, within one year before filing bankruptcy, the debtor’s chapter 7 discharge may be denied.56 The next section will analyze whether the transfer of nonexempt property into exempt property on the eve of bankruptcy can be avoided as a fraudulent conveyance.
52 11 U.S.C. § 522(q)
53 11 U.S.C. § 727(a)(2)(A). “To the extent that a state allows its residents to keep (as exempt) property acquired on the eve of bankruptcy, denial of discharge may be inappropriate.” Thomas H. Jackson, The Fresh-Start Policy in Bankruptcy Law, 98 HARV. L. REV. 1393, 1445 (1985). And, although the debtor’s discharge may be denied, if the debtor’s home is exempt the debtor may retain it with mortgages substantially reduced, free of claims of creditors. First Tex. Savs. Ass’n v. Reed (In re Reed), 700 F.2d 986, 992 (5th Cir. 1983).
54 11 U.S.C. §§ 548(a)(1)(A), 550. Section 548 actually allows the trustee to avoid the transfer made on or within two years before filing of the bankruptcy petition. Id. Or, the trustee could ordinarily bring an avoidance action up to seven years after the transfer was made under Bankruptcy Code section 544(b) and the California Voidable Transactions Act. 11 U.S.C. § 544(b); CAL CIV CODE § 3439.09(a). See also In re Hurt, 542 B.R. 798, 804 (Bankr. E.D. Tenn. 2015) (“The Bankruptcy Code still provides remedies to defrauded creditors including the denial of discharge under [§] 727(a)(1) or the dischargeability of a particular debt under section 523(a)(2), dismissal of the case, or, if the fraud was in connection with the transfer of an asset, avoidance of the transfer and recovery of the asset”) (citing case).
55 11 U.S.C. §§ 707(a), 1112(b), 1208(c), 1307(c). If the debtor or the debtor’s attorney participates in a fraudulent conveyance, the individual may be liable for a crime under state or federal law. See CAL PENAL CODE § 531; 18 U.S.C. §§ 152(7), 157. Also, a California attorney who participates in a scheme to defraud a client’s creditors is subject to discipline by the State Bar. See Allen v. State Bar, 20 Cal. 3d 172, 178, 141 Cal. Rptr. 808, 811 (1977).
56 11 U.S.C. § 727(a)(1).
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VI. Attacking Exempt Property as a Fraudulent Conveyance
Courts have declared that a conversion of nonexempt property into exempt property may be avoided as a fraudulent transfer, notwithstanding the trustee’s failure to object to the exemption during the 30-day period.57 One rationale underlying these cases is that contesting an exemption is distinct from avoiding a transfer, so the deadline for objecting to exemptions does not apply to an adversary proceeding to avoid a transfer.58 In one case the Tenth Circuit found no problem by harmonizing the seemingly conflicting requirements.59 The Tenth Circuit’s rationale is flawed, however. This is because exempt property has protected status; it is not liable for most prepetition debts or administrative expenses. As such, it is inappropriate for a trustee to utilize a fraudulent transfer avoiding action as a means ofreaching exempt property,sincesuch anaction typicallyseeks to recover property in order to pay administrative expenses and most prepetition claims.60 In other words, since exempt property ordinarily is not liable for any prepetition debts or administrative expenses, it would be futile for the trustee to recover this property to pay such debts or expenses.61
Another rationale of these courts in allowing fraudulent transfer avoiding actions to pursue otherwise exempt property is that Code section 522(g)(1) prevents a debtor who has made a voluntary avoidable transfer from exempting the property
57 See In re Duncan, 329 F.3d 1195, 1202-04 (10th Cir. 2003); In re Levine, 134 F.3d 1046, 105052 (11th Cir. 1998); In re McNamara, 273 B.R. 132, 135 (E.D. Mich. 2002); see also Tavenner v. Smoot, 257 F.3d 401, 407 (4th Cir. 2001) (saying that transfers of potentially exempt property are amenable to avoidance and recovery actions by bankruptcy trustees); In re Kuhnel, 495 F.3d 1177, 1179,1182(10thCir.2007)(sayingthedeadlinetofilean actiontoavoidasecurityinterestinexempt property is two years under Code § 546(a), not the 30-day period to object to a claimed exemption); In re Greenfield,65F.App’x549,555(6thCir.2003) (“ thetrustee’sabilitytoobjecttoaclaimed exemption and to avoid a transfer are distinct and independent”); In re Page, 240 B.R. 548, 552 & n.5 (Bankr. W.D. Mich. 1999) (stating that sustaining an exemption is distinct from avoiding and recovering a transfer). It appears that in only Tavenner did the trustee timely object to the claimed exemption. See Tavenner, 257 F.3d at 405.
58 Duncan, 329 F.3d at 1202-04; Levine, 134 F.3d at 1052; McNamara, 273 B.R. at 136; Page, 240 B.R. at 552.
59 Duncan, 329 F.3d at 1203.
60 See supra text accompanying notes 42-44.
61 C.f. Moyer v. Rosich (In re Rosich), 570 B.R. 278, 288 (Bankr. W.D. Mich. 2017) (finding that, because the exempt property is not liable for most prepetiton debts, or costs of administration, recovery of the property cannot benefit the estate).
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the trustee recovers in the action.62 This section authorizes a debtor to claim as exempt the property the trustee recovers in a fraudulent conveyance proceeding; provided the property was both transferred voluntarily and not concealed by the debtor.63 As explained by the First Circuit Court of Appeals:
Although section 522(g) recognizes that the trustee ordinarily recovers property for the benefit of the bankruptcy estate, it provides a further opportunity for a debtor to claim an exemption in property thatwasnotinthedebtor’sportfoliowhenthebankruptcyproceeding began (so that the property was not subject to section 522(b)). This additional opportunity is available only for property involuntarily transferred away and not concealed by the debtor.64
The Tenth Circuit has also repeatedly relied upon section 522(g)(1) to concludethat adebtor maynot claim as exempt the propertyrecoveredby the trustee in an avoiding action.65 However, as shown by the quotation above, this section is apparently predicated upon the assumption that the debtor has not already exempted therecovered asset. Furthermore,aplainreadingofsection522(g) andthisquotation indicates the section affords the debtor a chance to exempt property; it should not be construed to strip exempt property of its exempt status.
Other courts find that, once the property is exempted, the transfer creating the exempt property cannot be avoided, at least to the extent of the value of the exemption.66 In addition to the operation of Code sections 522(c) and (k) described
62 Kuhnel, 495 F.3d at 1179; Tavenner, 257 F.3d at 407.
63 11 U.S.C. § 522(g)(1).
64 Stornawaye Fin. Corp. v. Hill (In re Hill), 562 F.3d 29, 34 (1st Cir. 2009).
65 Kuhnel, 495 F.3d at 1179; Duncan, 329 F.3d at 1199-1202
66 In re Greenfield, 65 F. App’x 549, 552 (6th Cir. 2003); Goodrich v. Fuentes (In re Fuentes), No. 2:15-cv-2080-MWF, 2015 WL 13916914, at **6-8 (C.D. Cal. Sept. 23, 2015); aff’d, In re Fuentes, 687F.App’x542(9thCir.2017); Rennekerv.Wyman (In re Wyman),626B.R.480,500-02(Bankr. S.D. Ohio 2021); Moyer v. Rosich (In re Rosich), 570 B.R. 278, 282-83, 285-86 (Bankr W.D Mich. 2017); In re Hurt, 542 B.R. 798, 804 (Bankr. E.D. Tenn. 2015); see also Hagan v. Mickens, 589 B.R. 594, 597, 600 (W.D. Mich. 2018) (concluding debtors were permitted to claim amended exemptions in former tenancy by the entirety homestead, the transfer of which had been fraudulently avoided); David Gray Carlson, The Federal Law of Property: The Case of Inheritance Disclaimers and Tenancy by the Entireties, 75 WASH & LEE L. REV 3,171(2018) (stating that, if property converted into a tenancy by the entireties is successfully exempted, the trustee’s future cause of action to avoid the transfer is blocked by Bankruptcy Code section 522(c)). Nonetheless, even if property that has
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above,67 these courts acknowledged the special status of exempt property,68 concluding there was no basis for denying a valid exemption under: (1) the Bankruptcy Code or state law,69 or (2) Code section 522, case law, Federal Rule of Bankruptcy Procedure 4003(b)(2), or state law,70 or (3) Code section 522(g) where the debtor is the transferee. 71 These decisions are better-reasoned and, therefore, provide solid authority for the proposition that, once property becomes exempt, it should be invulnerable to avoidance or recovery as a fraudulent transfer.
The next section discusses whether assets transferred into pension plans qualified under the Employee Retirement Income Security Act of 1974 (“ERISA”) can be recovered as fraudulent transfers.
VII. Attacking an ERISA-Qualified Pension Plan as a Fraudulent Conveyance
A debtor’s ERISA-qualified pension plan assets ordinarily are not protected through the exemption scheme. Instead, these assets are sheltered by the plan’s antialienation provision. ERISA requires that each eligible pension plan state that benefits provided under the plan may not be assigned or alienated.72 As such, it would seem that these benefits should be invulnerable to an avoiding action. However, the case law conflicts as to whether funds paid to a debtor’s pension plan,
been exempted in bankruptcy is not liable for most claims and cannot be recovered, some courts have concluded that, under Bankruptcy Code section 550(a), the debtor-transferee could be liable for a money judgment equal to the value of the property that was transferred. See Wyman, at 501-02; Rosich, at 286. However, other courts have determined that section 550(a) does not allow recovery of an avoided transfer from a transferring debtor. Coggin v. Reynolds (In re Coggin), 30 F.3d 1443, 1453 (11th Cir. 1994), abrogated on other issues, Kontrick v. Ryan, 540 U.S. 443 (2004); see also Reid v. Wolf (In re Wolf), 595 B.R. 735, 789 (Bankr. N.D. Ill. 2018) (“The Debtor-transferor may not be held liable as a transferor, an initial transferee, or as the entity for whose benefit the transfer was made.”) (citing cases); In re Dolata, 306 B.R. 97, 143-44 (Bankr. W.D. Pa. 2004) (“[A] debtor, as a matter of law, cannot constitute a transferee of such debtor’s own transfer within the meaning of section 550 (a) not even one for whose benefit such transfer was made.”) (citing case).
67 See supra text accompanying notes 42-44.
68 In re Greenfield, 65 F. App’x at 552.
69 Wyman, 626 B.R. at 501.
70 In re Hurt, 542 B.R. 798, 802-04 (Bankr. E.D. Tenn.).
71 FuenItes, 2015 WL 13916914, at **6-8; Wyman, 626 B.R. at 501.
72 29 U.S.C. § 1056(d)(1).
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which contains the anti-alienation provision required by ERISA, can be insulated from avoidance as a fraudulent transfer.
Some decisions have concluded that funds paid to a debtor’s ERISAqualified plan, according to the plan’s terms, are protected from avoidance.73 In one such decision the debtor claimed the retirement monies exempt under federal Bankruptcy Code section 522(b)(3)(C) and the court noted, inter alia, that this provisiondoesnotconditiontheexemptionuponthetransfersnotbeingfraudulent.74 While true, the court never mentioned whether the debtor’s plans were ERISAqualified.75 Another decision stated ERISA’s restraint on alienation would prevent recoveryofthetransfersfromanERISAplanin anonbankruptcysituationinvolving fraudulent and preferential transfers.76 The court reasoned, under Code section 541(c)(2), that ERISA’s restraint on alienation is also enforceable in a bankruptcy case to bar recovery from the plan defendants.77 But this does not provide a substantial basis for the court’s determination because it does not address whether
73 Cardiello v. Arbogast (In re Arbogast), 466 B.R. 287, 323-25 (Bankr. W.D. Pa. 2012), aff’d, 479 B.R. 661 (W.D. Pa. 2012), aff’d, 533 F. App’x 150 (3d Cir. 2013) (concluding that exempting retirement account contributions pursuant to Code section 522(b)(3)(C) was entirely appropriate regardless whether they may have been fraudulent transfers); Butler v. Beckinson, Dickinson & Co. (In re Loomer), 198 B.R. 755, 759-61 (Bankr. D. Neb. 1996) (determining that, even if transfers of funds were fraudulent, they may not be recovered from ERISA plan under Code section 550 because Code section 542(c)(2) enforces the anti-alienation provision); see also Heckert v. Heckert, No. 0219-00298-CV, 2020 WL 2608338, at **4-5 (Tex. App. May 21, 2020) (holding that creditor not entitled to avoid contributions to debtor’s 401(k) account governed by ERISA); Shah v. Baloch, 244 Ariz. 129, 132, 418 P.3d 902, 905 (Ct. App. 2017) (stating that ERISA’s anti-alienation provision prohibited judgment creditor from garnishing funds allegedly fraudulently transferred to debtor’s 401(k) account); Majteles v. AVL Corp., 182 Misc.2d 140, 145, 696 N.Y.S.2d 748, 752 (Sup. Ct. 1999), adhered to on reargument, No. 933/99, 2000 WL 35921144 (N.Y. Sup. Ct. Jan. 26, 2000) (stating funds allegedly fraudulently transferred into pension plan are protected by ERISA’s antialienation provision from judgment creditor); c.f., Edgefield Holdings, LLC v. Gilbert, No. 02-1700359-CV, 2018 WL 4495566, at **3, 8-10 (Ct. App. Tex. Sept. 20, 2018) (declaring funds in IRA and pension plan are exempt under ERISA anti-alienation provision from seizure by any creditor); Lauder v. Jacobs, 10 Misc. 3d 1052(A), at *4-5, 809 N.Y.S.2d 482 (N.Y. Surr. Ct. 2005), aff’d, 35 A.D.3d 822, 826 N.Y.S.2d 719 (Sup. Ct. App. Div. 2006) (deciding that ERISA’s anti-alienation provisions exempt funds currently controlled by TIAA-CREF from attachment (citing case)).
74 Arbogast, 466 B.R. at 324.
75 Id. at 324-25. See also infra the text accompanying notes 115-120, for a preemption justification that the assets in the plans are protected from avoidance.
76 Loomer, 198 B.R. at 760.
77 Id.
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ERISA should apply in a bankruptcy setting. As we will see, there is a strong legal basis for treating an ERISA plan differently in bankruptcy than in a nonbankruptcy setting.78 Also, although assets transferred into an ERISA pension plan prepetition may not be part of the bankruptcy estate, there is no apparent reason why they could not be brought into the estate by a successful avoidance and recovery action.
Other opinions have found that retirement funds deposited into an ERISA plan are recoverable as fraudulent transfers. These latter opinions have variously said that fraudulent conveyance claims are not preempted by ERISA,79 that the antialienation provisions of ERISA (and the Internal Revenue Code) do not preclude avoidance of fraudulent transfers to the debtor’s defined benefit plan,80 and that ERISA does not supersede the provisions of Bankruptcy Code section 550, but is intended to be harmonized with its provisions.81 They have also said that, where an ERISA account is set up under fraudulent conditions, the funds in the account may be recovered under the federal common law theory that fraud in the inducement allows rescission of the contract,82 and that fraudulent transfers to an ERISAqualified plan which are part of a Ponzi Scheme may be recovered from the corpus of the plan.83 These last two decisions analyzed the language of the anti-alienation provision and the regulation that implemented this provision. This regulation states that generally “a trust will not be qualified unless the plan of which the trust is a part provides that benefits provided under the plan may not be anticipated, assigned (either at law or in equity), alienated or subject to attachment, garnishment, levy, execution or other legal or equitable process.”84 The regulation then defines “assignment” and “alienation” to include any arrangement: (1) providing for payment to the employer of plan benefits that would otherwise be due a plan
78 See infra text accompanying notes 87-89.
79 In re Shailam, 144 B.R. 626, 630 (Bankr. N.D.N.Y. 1992) (citing case).
80 Greenfeld v. Goldschein (In re Goldschein), 241 B.R. 370, 372, 379 (Bankr. D. Md. 1999)
81 CF &I Steel Corp. v. Conners (In re CF &I Fabricators of Utah Inc.), 163 B.R. 858, 878 (Bankr. D. Utah 1994).
82 Loomer, 198 B.R. at 762 (citing case).
83 See Wagner v. Galbreth, 500 B.R. 42, 49 (D.N.M. 2013); Wagner v. Ultima Homes, Inc. (In re Vaughan Co., Realtors), 493 B.R. 597, 606-07 (Bankr. D.N.M. 2013) (same).
84 26 C.F.R. § 1.401(a)-13(b)(1).
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participant, or (2) whereby a party acquires from a participant or beneficiary an enforceable right to all or part of a plan benefit payment.85
The two decisions found that, because the transfers were neither made to an employer nor were of benefits that become payable to a plan beneficiary or participant, the plans were not subject to the anti-alienation provision.86 Furthermore, the decisions concluded that, because ERISA must be read in harmony with the Bankruptcy Code pursuant to a different section of ERISA that effectively subordinatesERISAtovirtuallyallotherfederallaws,87 theanti-alienationprovision did not prohibit recovery of fraudulent transfers to the pension plans.88 In addition, because IRA and SEP-IRA plans are not mandated to have antialienation/assignment provisions, they cannot be ERISA-qualified and, therefore, are not protected by such a provision.89
85 26 C.F.R. § 1.401(a)-13(c)(1).
86 Wagner, 500 B.R. at 49; Ultima, 493 B.R. at 607-09. See also McGraw v. Betz (In re Bell & Beckwith, 5 F.3d 150, 151, 153 (6th Cir. 1993) stating that contributions to an ERISA profit-sharing retirement plan predicated upon net income would be void ab initio and part of the bankruptcy estate if there was no net income).
87 29 U.S.C. § 1144(d). This section of title 29 generally provides that nothing in subchapter 1 of ERISA, which includes the anti-alienation provision, shall be construed to alter, amend, modify, invalidate, impair or supersede any law of the United States. See also In re Goff, 706 F.2d 574, 587 (5th Cir.1983)(“... ERISA’sspecificprovisionprecludinginterferencewiththeoperationoffederal law renders the Bankruptcy Code effective over any ERISA provisions to the contrary.”); Levine v. Cent. States Se. and Sw. Areas Pension Fund (In re Ottawa Cartage, Inc.), 55 B.R. 371, 378 (N.D. Ill. 1985) (“. . . theall-embracing languageof ERISA § 1141(d) reflects Congresshas already chosen to subordinate ERISA’s policies to those of conflicting federal statutes.”); Sterling Die Casting Co. v. Local 365 UAW Welfare & Pension Fund (In re Sterling Die Casting Co., Inc.), 118 B.R. 205, 208 (Bankr. E.D.N.Y. 1990) (“Where the Code provides, pursuant to § 547, that the funds which were subject to the transfer must revert to the debtor, that provision of the bankruptcy law must prevail over ERISA.”); Gouveia v. Pulley (In re Pulley), 111 B.R. 715, 746 (Bankr. N.D. Ind. 1989) (“Ultimately, we not only determine ERISA expressly yields to the Bankruptcy Code, but that it must.”).
88 Wagner, 500 B.R. at 49; Ultima, 493 B.R. at 607-08. Also, “the . . . authority [of the Internal Revenue Service] to proceed against a delinquent taxpayer’s interest in benefits from an ERISAgoverned plan is not constrained by ERISA’s anti-alienation provision.” In re McIntyre, 222 F.3d 655, 660 (9th Cir. 2000).
89 SIPC v. Bernard L. Madoff Inv. Sec LLC, 631 B.R. 1, 9 (Bankr. S.D N Y 2021) (IRA account); In re CRS Steam, Inc., 217 B.R. 365, 370-71 (Bankr. D. Mass. 1998) (SEP plan); In re Kellogg, 179 B.R. 379, 385-88 (Bankr. D. Mass. 1995) (SEP plan); In re Henderson, 167 B.R. 67, 69 (Bankr. N.D. Miss. 1993) (SEP-IRA); see also Velis v. Kardanis, 949 F.2d 78, 82 (3d Cir. 1991) (noting that IRA accounts are not required to have anti-alienation/assignment provisions).
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The analysis employed by these two opinions is correct. When deciding whether payments made to the debtor’s ERISA-qualified pension plan(s) are recoverable as fraudulent transfers notwithstanding the plan’s ani-alienation provision, the court ought to first ascertain whether the governing fraudulent conveyance law is federal law. If it is, for example Bankruptcy Code section 548, or the Federal Debt Collection Procedures Act where the federal government is a creditor, then the anti-alienation provision in the plan should not prohibit the court from finding that one or more transfers are fraudulent. On the other hand, if such law is not federal, such as the California Voidable Transactions Act where a creditor is the plaintiff, then the court should determine whether the transfer is an “assignment” or “alienation” of a plan benefit within the meaning of 29 U.S.C. § 1056(d)(1) or 26 C.F.R. § 1.401(a)-13(c)(1). If it is, then the transfer(s) cannot be recovered.
VIII. The Effect of a Discharge Upon a Debtor Who Converts Nonexempt into Exempt Property
If neither a creditor nor the trustee timely objects to the debtor’s discharge, and if the debtor otherwise qualifies, the debtor’s discharge will be entered in due course. The discharge voids any prepetition or postpetition judgment to the extent it determines personal liability of the debtor for a discharged debt.90 The discharge will also enjoin the commencement or continuation of any act to collect, recover or offset any discharged debt as a personal liability of the debtor.91 An example of personal liability for a debt is an in personam money judgment92 for the amount of the debt.
This means that a pre-petition unsecured creditor should be barred by the discharge from prosecuting any action, including an avoiding action, that seeks to hold the debtor
90 11 U.S.C. § 524(a)(1)
91 11 U.S.C. § 524(a)(2)
92 According to the United States Supreme Court, “[a] judgment in personam imposes a personal liability or obligation on one person in favor of another. A judgment in rem affects the interests of all persons in designated property. A judgment quasi in rem affects the interests of particular persons in designated property.” Hanson v. Denckla, 357 U.S. 235, 246 n.12 (1958).
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personally liable.93 This may be the case even where the unsecured creditor obtains a nondischargeable money judgment against the debtor.94
However, an unsecured creditor could request the bankruptcy trustee to file an action to avoid the transfer pursuant to Bankruptcy Code section 544(a), (b) and/or 548. If successful, the property could be brought back into the estate regardless of the debtor’s discharge because return of the property would be an in rem or quasi-in rem action,95 not an act to collect a discharged debt as the personal liability of the debtor. The trustee could then sell the property for the benefit of creditors. Alternatively, if the property has previously been exempted, or is in an ERISA-qualified pension plan, the court could order a money judgment for the value of the property against a transferee-debtor.96 In a chapter 7 case this
93 United States v. Westley, 7 F. App’x 393, 404-07 (6th Cir. 2001); Rountree v. Nunnery (In re Rountree), 448 B.R. 389, 400-10, 420 (Bankr. E.D. Va. 2011); see also In re Handy, 624 F.3d 19, 21-22(1stCir.2010) (statingthatunsecuredcreditorwhichsoughtaconstructivetrustremedyagainst the debtor was nevertheless barred by the debtor’s discharge because the creditor did not hold an in rem claim); In re Vandevort, No. LA-05-23588-EC, 2009 WL 7809927, at *6 (B.A.P. 9th Cir. Sept. 8, 2004) (stating that prepetition rights of creditor to bring fraudulent transfer claims are superseded until these claims are abandoned, particularly when the debtor’s discharge has been denied); JMS Labs Ltd.(U.S.A.) v. Silver Eagle Labs., Inc. (In re Lockwood), 414 B.R. 593, 602 (Bankr. N.D. Cal. 2008) (noting that, where the trustee has abandoned fraudulent transfer claims and the debtor’s discharge has been denied, a creditor can pursue these claims in collecting its debt).
94 SuVicMon Dev., Inc. v. Morrison, 991 F.3d 1213, 1219-22 (11th Cir. 2021); but see Lockwood, 414 B.R. at 602 (stating that, where a trustee has abandoned fraudulent transfer claims and a debt to a creditor has been declared nondischargeable, the creditor can pursue these claims in collecting its debt).
95 In re Khurana, Adv. No. 3:19-ap-07001-TLM2019 WL 7372664, at **2, 5 & n.8 (B.A.P. 9th Cir. Dec. 16, 2019); In re Antonious, 373 B.R. 400, 407-08 (Bankr. E.D. Pa. 2007); Millbury Nat’l Bank v. Palumbo (In re Palumbo), 353 B.R. 37, 41-42 (Bankr. D. Mass. 2006); see also United States v. Floersch, 276 F.2d 714, 717 (10th Cir. 1960) (stating that an action against the transferee under the Internal Revenue Code is in the nature of a proceeding in rem); Malis v. Zinman, 436 Pa. 592, 597, 599, 261 A.2d 875, 877-79 (Sup. Ct. 1970) (stating that a suit to set aside transfer of an interest in real property as a fraudulent conveyance is an in rem proceeding); Gulda v. Second Nat’l Bank of Boston, 323 Mass. 100, 104, 80 N.E.2d 12, 15 (Sup. Jud. Ct. 1948) (referring to suits to set aside fraudulent conveyances of land as quasi in rem actions).
96 11 U.S.C. § 550(a). Under this section, the trustee may recover for the benefit of the estate, the property transferred, or its value, from the initial, any subsequent transferee, or the entity for whose benefit the transfer was made. Id However, some courts have held that a transferor-debtor cannot be any such transferee or entity. See supra note 66. Also, this section does not provide for recovery of the transferred property or its value from the transferor See 11 U.S.C. § 550(a) (emphasis added); c.f. First Midwest Bank v. RMG Sports Group LLC, No. CV 05872, 2021 WL 4206784, at *6 (N.D. Ill. Sept. 16, 2021) (“Because the [Illinois Uniform Fraudulent Transfer Act] does not list the transferor as a party against whom an avoidance can be issued the statute necessarily implies that a judgment of avoidance may not be issued against the transferor.”). Therefore, even assuming a
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judgment would not be discharged because the cause of action under Code section 544 or 548 first arose postpetition.97 But in a chapter 11 case, entry of discharge would likely bar the trustee’s action because prosecution of all pre-confirmation claims would be enjoined.98 In a chapter 12 or 13 case entry of discharge would bar the trustee’s action only where the confirmed plan provided for such a money judgment.99
If the trustee refuses to prosecute such an action, the court could authorize an unsecured creditor to do so.100 Similarly, if the state law fraudulent transfer claims were abandoned in the bankruptcy court,101 if the statute of limitations for the filing of an avoidance action on these claims under Code section 544 or 548 has expired (e.g., two years after the bankruptcy case was commenced)102 or if the trustee did not pursue such claims
transfer is avoided as fraudulent, it is uncertain whether a bankruptcy court can, in any event, order recovery of the property or its value from a transferor-debtor.
97 Cardiello v. Arbogast (In re Arbogast), 466 B.R. 287, 307 (Bankr. W.D. Pa. 2012) (citing case), aff’d, 479 B.R. 661 (W.D. Pa. 2012), aff’d, 533 F. App’x 150 (3d Cir. 2013); see also Sikirica v. Wettach, 511 B.R. 760, 768-69 (W.D. Pa. 2014), aff’d, 811 F 3d 99 (3d Cir. 2016) (stating that liability of a transferee of an avoided transfer is not affected by a chapter 7 bankruptcy discharge) (citing cases); Titus v. Shearer, 498 B.R. 508, 524-25 (W.D. Pa. 2013) (same); Cohen v. Sikirica, 487 B.R. 615, 627-28 (W.D. Pa. 2013) (stating that the bankruptcy court correctly rejected the argument that discharge of the underlying debt barred an avoidance action pursuant to Code section 544 where the same creditor had a claim when the fraudulent transfer occurred and when the bankruptcy petition was filed); Shearer v. Oberdick (In re Oberdick), 490 B.R. 687, 699 (Bankr. W.D. Pa. 2013) (effectively the same); see also Renneker v. Wyman (In re Wyman), 626 B.R. 480, 498 (Bankr. S.D. Ohio 2021) (concluding § 548 causes of action arise postpetition and the trustee’s authoritytopursuesuchcausesdidnotariseuntilthetrusteewasappointedpostpetition,andtherefore said causes were not discharged in chapter 7 case).
98 11 U.S.C. § 1141(b).
99 11 U.S.C.§§ 1228(a), (c), 1328(a), (c).
100 In re Jin Qing Li, No. NC-17-1062-STaB, 2018 WL 1354548, at*8 (B.A.P. 9th Cir. Mar. 12, 2018); JMS Labs Ltd. (U.S.A.) v. Silver Eagle Labs., Inc. (In re Lockwood), 414 B.R. 593, 602 (Bankr. N.D. Cal. 2008); California v. PG & E Corp. (In re Pac. Gas & Elec. Co.), 281 B.R. 1, 13 (Bankr. N.D. Cal. 2002).
101 Nat’l Am. Ins. Co. v. Ruppert Landscaping Co., 187 F.3d 439, 441 (4th Cir. 1999); Unisys Corp. v. Dataware Prods., Inc., 848F.3d311,314 (1st Cir. 1988); In re Tribune Co. Fraudulent Conveyance Litig., 499 B.R. 310, 325 (S.D.N.Y. 2013); In re Vandevort, 2009 WL 7809927, at *5, No. LA-0523588-EC (B.A.P. 9th Cir. Sept. 8, 2004); JMS Labs, 414 B.R. 593, 602 (Bankr. N.D. Cal. 2008); In re Tessmer, 329 B.R. 776, 779 (Bankr. M.D. Ga. 2005).
102 Tribune, 499 B.R. at 322 (citing case); Tessmer, 329 B.R. at 779; Barber v. Westbay (In re Integrated Agri, Inc.), 313 B.R. 419, 427-28 (Bankr. C.D. Ill. 2004); see also Hauge v. Murphy, 2010 WL 11596870, at *3, No. 09-CV-143-J (D. Wyo. Apr. 6, 2010) (stating that creditors may pursue or resume a fraudulent conveyance action when the trustee no longer has a viable cause of action);
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and the bankruptcy case has been closed,103 a creditor could theoretically prosecute these claims solely to recover the transferred property. Assuming that such an action would be successful, would it benefit the unsecured creditor? The debtor would again have title to the property. But the unsecured creditor would be barred by the debtor’s discharge from taking any steps to collect its debt, such as seeking to attach or levy execution on the property. Consequently, if the property has been exempted and the debtor has been discharged, unsecured creditors must hope that the trustee files an action to avoid the fraudulent transfer, obtains a money judgment in the action, and is able to collect enough money from the debtor to make this endeavor worthwhile.104
The following section will show that, with respect to a debtor’s entitlement to the homestead, burial plot and retirement plan exemptions, California law is preempted by the Bankruptcy Code. This means that California law cannot be utilized to reduce or eliminate one of these exemptions, due to the debtor’s “misconduct” in converting nonexempt property into exempt property on the eve of bankruptcy.
IX. Any Constraints on the Burial Plot, the Homestead and the Bankruptcy Retirement Plan Exemptions by State Law are Preempted in Bankruptcy
Creditors or the bankruptcy trustee could potentially utilize California law to pursue assets held in pension plans or that would otherwise be protected by exemptions. However, the United States Supreme Court has also said that state law is preempted to the extent it actually conflicts with federal law, such as where the “state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.”105 According to the Ninth Circuit, “Congress has broad authority to preempt state laws, but whether Congress has done so in a particular instance is a matter of congressional intent.”106 Thus, the question
Klingman v. Levinson (In re Klingman), 158 B.R. 109, 113 (N.D. Ill. 1993) (same).
103 Vandevort, 2009 WL 7809927, at *6; City Nat’l Bank v. Chabot (In re Chabot), 100 B.R. 18, 23 (Bankr. C.D. Cal. 1989), aff’d, 131 B.R. 720 (C.D. Cal. 1991), aff’d, 992 F.2d 891 (9th Cir. 1993).
104 If the trustee simply obtains a money judgment, and attempts to enforce such a judgment against the debtor’s interest in an ERISA-qualified pension plan under California law, ordinarily the debtor will be able to protect the assets of the plan because non-assignable property is not liable for the judgment. See infra text accompanying notes 71-88, and Coastline JX Holdings LLC v. Bennett, 80 Cal. App. 5th 985, 993, 1003, 296 Cal. Rptr. 3d 437, 441, 449 (Cal. Ct. App. 2022).
105 English v. Gen. Elec. Co., 496 U.S. 72, 79 (1990) (citing cases); Hillsborough Cnty., Fla. v. Automated Med. Labs., Inc., 471 U.S. 707, 713 (1985) (citing cases).
106 Sherwood Partners, Inc. v. Lycos, Inc., 394 F.3d 1198, 1200 (9th Cir. 2005).
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becomes: has Congress intended to displace California law with respect to a bankruptcy debtor’s entitlement to any exemptions?
When the Bankruptcy Reform Act of 1978 passed, Congress apparently believed there was no need to restrict a debtor’s exemptions on account of prebankruptcyexemptionplanning.107 Congress also must havethought thatexemption planning was not fraudulent as to creditors, including in California, and that the practice enabled debtors in bankruptcy to make full use of the exemptions to which theywereentitled.108 Theseconclusions arenot onlydemonstratedbythelegislative history,109 but also by the fact that Congress provided a slate of federal bankruptcy exemptions for debtors in states that would permit their debtors to elect these federal exemptions. During the subsequent 44 years, Congress has not enacted any statute that expressly disallows a debtor’s claimed exemption due to “misconduct” of the debtor.
What Congress has done is make it more difficult for a debtor to move to another state before bankruptcy to take advantage of the state’s superior homestead exemption.110 Congress has also placed a cap on the value of the homestead and burial plot exemptions claimed by a bankruptcy debtor pursuant to state law.111 But these caps do not apply to all debtors and are narrowly tailored to very specific circumstances.112 Unless the debtor has invoked these caps by violating one or more oftheseprovisions ofthe BankruptcyCode,the valueofthe debtor’s otherwisevalid homestead or burial plot exemption should not be reduced. If Congress desired to actually abolish a debtor’s homestead exemption because of the debtor’s fraud or other misbehavior, it certainly could have said so.113
107 See supra text accompanying notes 9-12.
108 Id.
109 See supra text accompanying notes 9-12.
110 See supra text accompanying notes 46-49.
111 See supra text accompanying notes 50-52.
112 See supra text accompanying notes 50-52.
113 One commentator has observed: “Congress’s failure to put an end to unlimited homestead exemptions, once and for all, however, is the least positive aspect of its treatment of exemptions. Congress chose to isolate particular types of conduct such as moving to a state with generous exemptions shortly before bankruptcy filing or participating in securities fraud and to place homestead caps on only those debtors.” Margaret Howard, Exemptions Under the 2005 Bankruptcy Amendments: A Tale of Opportunity Lost, 79 AM. BANKR. L.J. 397, 418 (2005).
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Nevertheless, could California shorten or lengthen the 10-year look-back period for limiting the amount of the homestead exemption where the debtor has converted nonexempt property into an exempt homestead with the intent to hinder, delay or defraud a creditor? The answer is no for the reason that doing so would clearly conflict with Code section 522(o). Could California bar a debtor’s homestead exemption altogether if the debtor is guilty of fraud when converting nonexempt property into an exempt homestead or burial plot? Given that the Bankruptcy Code simply reduces the value of the homestead exemption for fraudulent conversion during the 10-year period, a California law that would purportedlynullifythehomesteadorburialplot exemptionforfraudulentconversion ought to be preempted. This is because Bankruptcy Code section 522(b)(3)(A) grants exemption of a homestead or burial plot under state law upon a condition that caps the amount of such an exemption.114 If California law were to completely disallow such an exemption, this section of the Bankruptcy Code would become surplusage. By the same token, California could not alter the 1215-day period, reduce or eliminate the ceiling in Code section 522(p), nor impose this ceiling on the principal residence of a family farmer who is a debtor. Also, California could not lawfully augment the types of debts or crimes owed or committed by the debtor that would cause the debtor’s homestead exemption to be capped pursuant to Code section 522(g)(1), nor prevent a bankruptcy judge from invoking Code section 522(q)(2) in order to raise the amount of the homestead exemption where it is reasonably necessary for the support of the debtor and any dependent of the debtor.
Congress has also preempted state law for exemptions in certain retirement plans. The Bankruptcy Code furnishes an exemption for specific retirement plans for all individual debtors, regardless of the other exemptions they claim.115 This exemption is for retirement funds in specified tax-exempt funds or accounts, such as IRAs, whether the debtor elects state law or federal bankruptcy exemptions, and section 522(n) generally places an upper limit on the value of a debtor’s IRA or Roth IRA exemption.116 If the retirement funds are in a plan that has received a favorable determination from the IRS in effect when the petition is filed, the retirement funds
114 11 U.S.C § 522(b)(3), (o)
115 11 U.S.C. §§ 522(b)(3)(C) and 522(d)(12). These are retirement funds in a fund or account exemptfromtaxationundersections401,403,408,408A,414,457,or501(a) oftheInternalRevenue Code. See id.
116 11 U.S.C. § 522(n).
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are presumed to be exempt.117 If no such determination is in effect, the retirement funds are nevertheless exempt if the debtor shows that no prior determination to the contrary has been made and the retirement fund is in substantial compliance with the applicable requirements of the Internal Revenue Code, or the retirement fund fails to be in such substantial compliance andthedebtoris not materiallyresponsible for the failure.118 Unlike for the homestead exemption, Congress has not included any restriction for the debtor’s “misconduct” in establishing or operating an otherwise exempt retirement plan. If the debtor satisfies the statutory prerequisites for retirement funds, the funds are exempt, in part because the Supreme Court has already told us that a bankruptcy debtor’s exemptions cannot be modified because the bankruptcy court has no equitable authority to do so.119 And, because this retirement exemption is a federal one and Congress has precisely specified the conditions for this exemption including a detailed flexible cap only for regular and Roth IRAs any California law relating to the eligibility of such a retirement plan for exemption in bankruptcy should be preempted.120 The virtually inescapable conclusion is that California law should have no effect on a debtor’s bankruptcy retirement plan or account defined in Code section 522(b)(3)(C) or (d)(12), homestead or burial plot exemption. The ensuing section discusses the limits of exemption planning under California law.
X. The Boundaries of Converting Nonexempt Property into Exempt Property Under California Law
There are older cases where a debtor took monies from certain nonexempt sources and invested or put them into accounts at financial institutions to claim exemptions under previous laws. In Wudrick v. Clements the debtors refinanced their vehicles and used part of the proceeds to fund a savings and loan association account in order to claim a $1,000 exemption therein pursuant to then-existing law.121 The Ninth Circuit allowed the
117 11 U.S.C. § 522(b)(4)(A)
118 11 U.S.C. § 522(b)(3)(C), (b)(4), (B).
119 See supra text accompanying note 18.
120 C.f. Cardiello v. Arbogast (In re Arbogast), 466 B.R. 287, 324 (Bankr. W.D Pa. 2012), aff’d, 479 B.R. 661 (W.D. Pa. 2012), aff’d, 533 F. App’x 150 (3d Cir. 2013) (concluding that, because the debtor claimed retirement funds exempt under Code section 522(b)(3)(C), a state law provision barring exemption for contributions made to retirement accounts that constitute fraudulent transfers did not apply).
121 Wudrick v. Clements, 451 F.2d 988, 989 (9th Cir. 1971).
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exemption.122 In a different case the debtor claimed a similar $1,000 exemption, using the proceeds of sale of his automobile, which sale violated a federal district court order prohibiting the disposition.123 The Ninth Circuit upheld the referee’s decision: (1) denying the claim of exemption and (2) ordering that the debtor held the $1,000 in a constructive trustforthebankruptcytrustee.124 Inanotherinstancethedebtorsurrenderedalifeinsurance policy about a week before filing bankruptcy and, acting upon advice of counsel, deposited $1,000ofthese proceedsinto afederalsavingsandloanassociation andclaimedthisexempt under then-current law.125 The deposit was withdrawn twenty days later, put into a bank account in the name of the debtor’s wife and subsequently used for living expenses of the unemployed debtor.126 The bankruptcy trustee refused to declare the original deposit exempt, which ruling was sustained by the referee and the district court.127 However, the Ninth Circuit reversed and allowed the exemption.128 It explained that exemption rights are to be determined based upon the conditions existing when the bankruptcy petition is filed, that the exemption statutes of California are liberally applied and that the evidence did not support a finding of fraud.129
In a further case, about a week before being adjudicated bankrupts under the former Bankruptcy Act, the debtors purchased shares in a building and loan association valued at $1,000 when they were heavily in debt and clearly insolvent.130 The debtors claimed these sharesasexempt under then-currentlaw.131 TheDistrict Court orderedthestockbeset apart
122 Id. at 989-90.
123 Mott v. Groves, 428 F.2d 1208, 1209 (9th Cir. 1970).
124 Id at 1209-10.
125 Love v. Menick, 341 F.2d 680, 681 (9th Cir. 1965)
126 Id. at 681.
127 Id. at 681-82. The district court actually allowed a partial exemption in the deposit on an entirely different basis. See id.
128 Id at 683.
129 Id. at 682. See also In re Jackson, 472 F.2d 589, 590 (9th Cir. 1973) (stating that, where debtor took $1,000 from his business as a logging contractor shortly before filing bankruptcy and deposited this sum at a federal savings and loan association in his and his spouse’s names as joint tenants, the funds were exempt because they remained community property) (citing case).
130 In re Dudley, 72 F. Supp. 943, 944-45 (S.D. Cal. 1947), aff’d, Goggin v. Dudley, 166 F.2d 1023 (9th Cir. 1948).
131 In re Dudley, 72 F. Supp. at 944.
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as exempt, saying, among other things, that exemption statutes generally are subject to the most liberal construction the courts can give them.132 The District Court also declared:
It is well settled that it is not a fraudulent act by an individual who knows he is insolvent to convert a part of his property which is not exempt into property which is exempt for the purpose of claiming his exemptions therein, and of thereby placing it out of the reach of his creditors.133
The Ninth Circuit affirmed on the grounds and for the reasons stated in the district court’s opinion.134 And, in a more recent decision,135 the Ninth Circuit, inter alia, found that a profit-sharing plan into which the debtor transferred the proceeds of his IRA of $1.4 million less than 3 years before the bankruptcy petition was filed was exempt.136 The Ninth Circuit said it was constrained by its previous opinion in Wudrick, that had similar facts.137
In another case, the debtors continued to operate a business while insolvent and, after receiving the advice of counsel regarding available exemptions and deciding to file bankruptcy, acquired merchandise on credit that they sold in the ordinary course of business for over $17,000.138 Theythen usedthese proceedstofund exemptionsinshares of afederal savings and loan association and credit union, but not to pay the creditors who supplied some of this merchandise.139 The referee disallowed the exemptions, concluding that these circumstances constituted fraud.140 The District Court affirmed, analogizing the facts to a
132 Id. (quoting case).
133 Id. at 947 (citing case).
134 Goggin v. Dudley, 166 F.2d 1023 (9th Cir. 1948)
135 Gill v. Stern (In re Stern), 345 F.3d 1036 (9th Cir. 2003)
136 Id. at 1039, 1045-46. In this case the bankruptcy trustee challenged the exemption on the basis that the debtor’s transfer of monies from the IRA into the profit-sharing plan was fraudulent. The fact that the deadline to object to the debtor’s exemptions had probably expired was not mentioned.
137 Stern, 345 F.3d at 1043-44. The Ninth Circuit also stated the following facts did not support a finding of fraud: (1) debtor had been sued and lost an arbitration before he transferred the funds, (2) debtor testified inconsistently as to his motive for transferring the funds, (3) he may have been insolvent when he conveyed the funds, (4) debtor transferred the funds to benefit himself and his wife, (5) he conveyed all or substantially all of his property into the plan, and (6) he retained control of the funds after the transfer. See id at 1044-45.
138 In re White, 221 F. Supp. 64, 65 (N.D. Cal. 1963).
139 Id. at 65.
140 Id Also, the debtors could be guilty of a crime. See supra note 55. Moreover, if this case occurred today, counsel advised the debtors to incur this debt, and if the debtors had primarily
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situation where a debtor takes out a secured loan, immediately invests the proceeds in exempt property, and files bankruptcy.141 The District Court remarked that parties to a bankruptcy proceeding are to be judged according to standards that are “stricter than the morals of the marketplace.”142 The District Court also relied upon two California statutes which provide that making a promise to pay without an intention to do so constitutes fraud.143
Similarly, in another case, the debtor pledged shares of stock to secure a loan and promised to repay the loan when the stock was sold, but had no intention of performing this promise.144 The debtor sold the stock and used the proceeds to pay for real property that became his homestead.145 The referee concluded that the debtor was guilty of actionable fraud, and was not entitled to claim the homestead as exempt.146 Both the district court and the Ninth Circuit affirmed.147 However, as noted, this case applying California law to the acquisition of a homestead today ought to be preempted by Bankruptcy Code sections 522(o), (p).148
There are also longstanding cases from the California courts, not involving bankruptcy,149 where an insolvent debtor obtained monies through fraud and used the
consumerdebts andnonexempt propertyvaluedbelow $226,850,counsel couldbe liablefor damages and subject to other remedies under the Bankruptcy Code. See 11 U.S.C. §§ 101(3), (4A), (8), (12A), 526(a)(4), (c); Milavetz, Gallop & Milavetz, P.A. v. United States, 559 U.S. 229, 235-47 (2010).
141 White, 221 F. Supp. at 67.
142 Id at 68; but see In re Wilson, 123 F. 20, 21-23 (9th Cir. 1903) (observing that decisions of the Supreme Court of California demonstrate that there can be no fraud solely due to the diversion of funds obtained from the sale of goods by an insolvent debtor either to procure a homestead or to discharge a lien thereon; distinguishing cases where the funds themselves were fraudulently acquired).
143 White, 221 F. Supp. at 67.
144 Miguel v. Walsh, 447 F.2d 724, 725 (9th Cir. 1971)
145 Id.
146 Id. at 725, 727.
147 Id
148 See supra text accompanying notes 109-114
149 There is also a fairly current case from the California courts that dealt with pre-bankruptcy exemption planning, Nagel v. Westen, 59 Cal App. 5th 740 (Cal. Ct. App. 2021). This decision is thoroughly examined in Eric P. Israel & Alphamorlai L. Kebeh, Debtors Beware: Exemption Planning in California Now Subject to Challenge, 35 CAL BANKR J. 317 (2021)
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monies to pay down the mortgage on,150 purchase151 or improve152 his homestead. While some of those decisions granted an equitable remedy to the defrauded party such as a superior lien on the homestead the courts generally did not deprive the debtor (or his spouse) of the homestead exemption amount upon sale of the property.153
Together, these decisions demonstrate that, if upon the eve of bankruptcy, an insolvent debtor funds an otherwise valid “wild card,” retirement or other exemption with monies that are not fraudulently obtained, nor are the cash proceeds of a credit line (such as an advance on a credit card), nor violate a court order, the exemption must be allowed. In addition, these decisions show that the debtor’s “misconduct” in purchasing154 or improving a homestead, or in paying down a mortgage thereon
150 Shinnv.MacPherson,58Cal.596(1881); see also Randallv.Buffington,10Cal.491,494(1858) (stating there is no rule of law that prevents an insolvent debtor from using money he made in his business to pay off the mortgage on his homestead); In re Henkel, 11 F. Cas. 1124, 1126 (D. Cal. 1872) (construing California law, federal district court stated that an insolvent debtor “may apply funds in his possession to the discharge of incumbrances on his homestead without impairing its inviolability as such.”).
151 See Kemp v. Enemark, 194 Cal. 748, 750-56, 230 P. 441 (1924); Duhart v. O’Rourke, 90 Cal App. 2d 277, 279-81, 221 P.2d 767, 769 (1950); see also Salven v. Munday (In re Kemmer), 265 B.R. 224, 236 (Bankr. E.D. Cal. 2001) (holding that, where insolvent debtors sold real property to sellers for less than reasonably equivalent value and used the proceeds towards the purchase of a real property homestead within one year of filing bankruptcy, sellers were liable for the value of the debtors’ equity in the property at the time of transfer).
152 See, e.g., Shinn v. MacPherson, 58 Cal. 596 (1881).
153 See Kemp, 194 Cal. at 750-56, Shinn v. MacPherson, 58 Cal. at 596, 598-99 (1881); Duhart, 90 Cal. App. 2d at 280; see also Strauss v. Cole (In re Mamtek), 588 B.R. 72, 79 (Bankr. W.D. Mo. 2018); see also Parker v. Riddell, 41 Cal. App. 2d 908, 914, 108 P.2d 88, 91 (1940) (“When the proceeds from property fraudulently obtained find their way into a homestead for the purposes of seclusion, the right of a creditor thus defrauded may become paramount to that of the owner of the homestead, dependent upon the facts of the case.”); Holden v. Williams, 167 Cal. App.2d 313, 31617, 334 P.2d 291 (1959) (imposing an equitable lien ahead of the debtors’ homestead exemption); but see Miguel, 447 F.2d at 727. Miguel was wrong to say the debtor was not entitled to the homestead exemption. Acting under former Bankruptcy Act section 70c, the Ninth Circuit stated that the bankruptcy trustee had the same powers as a creditor under California law. However, as stated in the text, the California courts did not deprive a debtor of the debtor’s homestead exemption where the monies obtained from a defrauded creditor were invested in the homestead. Instead, the remedy given to such creditor ordinarily was a lien on the homestead superior to the debtor’s exemption therein.
154 Actually, Bankruptcy Code § 522(o) and (p) should preempt this California law with respect to the purchase of a homestead. See supra text accompanying notes 109-114.
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should not be the basis for overturning the debtor’s homestead exemption under California law.
Conclusion
A California debtor, on the eve of bankruptcy, ordinarily is allowed to convert nonexempt property into exempt property. If there is no timely objection to a claimed exemption, or if the bankruptcy court finally overrules any such objection, the property is withdrawn from the estate and is liable only for the claims described in Code sections 522(c) and (k). If there is a timely objection to debtor’s otherwise valid homestead or burial plot exemption, including the filing of an adversary proceeding to avoid the transfer creating the exempt property, Bankruptcy Code sections 522(o), (p) furnish the sole means for the court to reduce, but not cancel, the exemption. Also, thebankruptcy court must not decrease the value of, or nullify, the debtor’s otherwise valid exempt homestead because the debtor fraudulently improved orpaid downthemortgagethereon. Similarly,ifthereis atimelyobjection to a Code section 522(b)(3)(C) or (d)(12) retirement plan or account exemption, it must be allowed where the requirements of the relevant subsection are met. If the retirement plan or account is not among those listed in these subsections, the court may have to figure out whether the plan is an ERISA-qualified plan that contains the requisite anti-alienation provision and whether said provision immunizes the plan assets from a fraudulent conveyance avoidance action. And, if the plan’s assets are not so protected, then the court may also have to decide whether the retirement plan satisfies any applicable California exemption.155 In the event the debtor claims an otherwise valid exemption in any other property, such as a “wildcard” exemption,156 the exemption must be allowed unless a party timely objects and shows the debtor funded the exemption by violating a court order, or by fraudulently obtaining funds (such as recently drawing down a credit line).
If the bankruptcy trustee files a timely avoidance action in a chapter 7 case after the property has been exempted, and the court determines the transfer converting thepropertyshould beavoided,generally thedebtorshouldbeheld liable
155 For a discussion of what retirement plans and other property are exempt under California law, see ALAN M. AHART, ENFORCING JUDGMENTS AND DEBTS, Chapter 6E (2022).
156 The maximum current amount of the “wild card” exemption totals $33,650. This amount, and the amounts of several other exemptions under California law, are set forth in California Judicial Council Form EJ-156, “CURRENT DOLLAR AMOUNTS OF EXEMPTIONS FROM ENFORCEMENT OF JUDGMENTS.”
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for a money judgment equal to the value of the transferred property.157 Such a judgment would be effectively nondischargeable in a chapter 7 case even where the debtor has been discharged because it would be predicated upon postpetition acts: the trustee’s avoidance action has no existence independent of bankruptcy and only arose postpetition.158 However, if the avoidance action is brought by a creditor that has not lawfully acquired the cause of action under Code section 544 or 548 for the benefit of all creditors,159 the debtor should be liable for a money judgment only if the creditor holds a nondischargeable judgment or the debtor has not received a bankruptcy discharge.
157 If the trustee brings an action to avoid the transfer of nonexempt property into exempt property and obtains a judgment declaring the transfer void ab initio pursuant to Bankruptcy Code section 544 and California Civil Code section 3439.07(3)(C), and if Bankruptcy Code section 551 does not apply, then the exempt property should become property of the estate. Also, the debtor should not be able to assert any equitable defense to defeat the trustee’s avoidance action under said section 544 See Podell v. Podell (In re Davis), 785 F.2d 926, 927 (11th Cir. 1986); Wansdown Props. Corp. N.V. v. Azari (In re Wansdown Props. Corp. N.V.), No. 19-13223 (DSJ), 2022 WL 16749078, at**13-14 (Bankr. S.D.N.Y. Nov. 7, 2022); Arnold v. First Citizens Nat’l Bank (In re Cornerstone Holmes, Inc.), 567 B.R. 37, 52-53 (Bankr. W.D.N.Y. 2016).
158 In re Brown, No. 15-90085-MM, 2018 WL 2308267, at *8, Adv. (B.A.P. 9th Cir. May 21, 2018) (Spraker, J., concurring).
159 Duckor, Spradling & Metzer v. Baum Trust (In re P.R.T.C., Inc.), 177 F.3d 774, 782 (9th Cir. 1999); Briggs v. Kent (In re Prof’l Inv. Props. of Am.), 955 F.2d 623, 626 (9th Cir. 1992); In re Lahijani, 325 B.R. 282, 288 & n.10 (B.A.P. 9th Cir. 2005); see 11 U.S.C. § 503(b)(3)(B), (b)(4).
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SECTIONS 725 AND 363: WHEN A TRUSTEE DOESN’T NEED A COURT ORDER TO DISTRIBUTE OR DISPOSE
By Elmer Dean Martin III
Section 725 is probably one of the most ignored sections of the Bankruptcy Code. Only one decision surfaces in a LEXIS bankruptcy data base search for any case having any analysis of it.1 Most readers will reach for their code book to read section 725 for the first time. Section 363 is probably one of the most cited sections of the Bankruptcy Code. Most readers would not in any way connect these two sections. Nevertheless, they both contain an often-overlooked fundamental statement of Congress’ intent to separate certain judicial and administrative functions in bankruptcy cases.
Section 725 states:
[B]efore final distribution of property of the estate under section 726 of this title, the trustee, after notice and a hearing, shall dispose of any property in which an entity other than the estate has an interest, such as a lien,and that has not beendisposedofunderanothersection of this title. (emphasis added)
Section 363 states:
The trustee, after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate . . . .
(emphasis added)
Section 102(1) states:
(1) “after notice and a hearing”, or a similar phrase
(A) means after such notice as is appropriate in the particular circumstances, and such opportunity for a hearing as is appropriate in the particular circumstances; but
(B) authorizes an act without an actual hearing if such notice is given properly and if
(i) such a hearing is not requested timely by a party
1 In re Engman, 395 B.R. 610 (Bankr. W.D. Mich. 2008).
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in interest; . . .. (emphasis added)
Normally a trustee requests a court order when the trustee sells property of a bankruptcy estate not in the ordinary course of business. The trustee of course prefers to act pursuant to a court order for protection against later being challenged for conducting a sale.2 But does a court even have jurisdiction to issue an order authorizing a trustee to conduct a sale to which nobody, after notice, objects? Such an order is properly characterized as a “comfort order.” Most courts generally issue such comfort orders although an argument can be made than an order which is not necessary is not much comfort.
Comfort order requests arise in many different contexts. One frequent context occurs when a trustee seeks an order authorizing reporting of a transaction by the trustee for income tax purposes in a certain manner. Whether that is appropriate depends on the context and how and for what the order is requested.3 But should acourtissue anorder purporting to authorize anactionbya trusteewhich Congress has mandated is subject to the discretion solely of the trustee?
Thelegislativehistoryofsection 725clearlystates thatatrusteeisauthorized by statute to dispose of property described in that statute and no court authorization is appropriate.4 The same statutory language appears in section 363 with regard to the disposition of the property described in that statute.
The issue of how section 725 should be applied, and its relationship to section 363, recently came up in a chapter 7 case. A trustee moved to sell to a creditor a judgment which the trustee had obtained in a bankruptcy adversary proceeding. The creditor claimed a lien on the judgment and any proceeds from collection of the judgment. There was notice, an opportunity to object by a day certain. no objection, but the court refused to grant the sale motion holding that there was no authority for what in essence was a distribution of property to a secured
2 Curry v. Castillo, 297 F.3d 940 (9th Cir. 2002) (trustee’s quasi-judicial immunity from suit). Also what may be legally possible, as discussed here, may not be practically possible. A trustee may not need court authorization to legally sell or transfer property but it would be an unusual title insurance company which would insure title in the transferee without a court order authorizing the transfer.
3 Compare In re Euroamerican Propagators, LLC, Case No. 17-00326-LT-7, Docket No. 321, Response to Trustee’s Motion For A “Comfort” Order (Bankr. S.D. Cal. September 17, 2019) with In re Management VI Properties, LLC et al., Case No. 8:12-BK-11540-MW, Docket No. 528, Trustee’s Motion For Authorization To Prepare and Submit Estate Income Tax Returns (Bankr. C.D. Cal. Aug 10, 2016).
4 See infra note 5.
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creditor. The court noted that section 726 provided for distribution to unsecured creditors of property of the estate. But in theory property which is fully encumbered is not supposed to be property of the estate or at least is not the proper subject of a sale motion. In response the trustee filed a supplemental brief citing and relying on section 725. In the course of that exchange, however, the trustee asked, in the alternative to an order authorizing the distribution, for an order that no order authorizing the distribution was required. The court chose to issue an order authorizing the sale even though the trustee contended that on the facts and authority no order was necessary. This isolated encounter with the history of a relatively unknown section of the Bankruptcy Code, however, is relevant to the operation of sales under section 363 which is omnipresent in asset bankruptcy cases.
As originally proposed in legislative proceedings leading up to enactment of section 725 Congress decidedthat the court,not thetrustee,shall disposeof property of the type referenced in section 725. The legislative history is very clear that Congress intended to remove the court from operation of section 725 and as enacted the statute authorizes the trustee to dispose of property referenced in section 725 as the trustee shall in her discretion determine pursuant to her business judgment.5 It is further apparent that this Congressional intent is also manifested in title 11 U.S.C. § 363(b)(1) in language identical to the language in section 725. Indeed, the Bankruptcy Commission Report emphasizes that Bankruptcy Code requirements for the court to get involved in sales of assets by a bankruptcy estate was to be limited to such actions by the trustee which the Code specifically required. Accordingly, a trustee was authorized to sell property of the estate without a court order after proper
5 See 4 COLLIER ON BANKRUPTCY ¶ 725-02 (15th ed. 1993):
Section 725 provides for disposition of the property by the trustee after notice and hearing. Both the House bill and the Senate amendment thereto had provided that the court, after notice and hearing, would determine the appropriate disposition of the property and that the trustee would dispose of the property in accordance with such determination. The explanationgiven forthe deletion ofthe determinationby thecourt was that thefinalversion “transfers an administrative function to the trustee in accordance with the general thrust of this legislation to separate the administrative and the judicial functions where appropriate.” Nevertheless, because of the retention of the language “after notice and a hearing” in section 725, there will have to be a hearing before the court if under section 102(1)(B)(i) a party in interest makes a timely request for an actual hearing on or objects to the trustee's proposed disposition of property. A dispute would thereby be raised requiring resolution by the court.
See also H.R. 8200, 95th Cong. (1st Sess.1977); S.REP.NO. 95-989, at 96 (1978); 124 CONG.REC. 17415 (Oct. 6, 1978); 124 CONG REC 11064, 11098 (Sept. 28, 1978)
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notice if no party in interest objected.6
Accordingly, while it is often customary for a trustee to seek a sale authorization, if there is no dispute between parties in interest after proper notice of thesale,thehistoryofsection 725indicatesthatatrusteeisauthorizedtosell without any court order.7 Accordingly, interestingly, what a trustee should ask for in a sale transaction is not courtauthorizationforthesalebut foradeterminationthatnocourt authorization is necessary if no party interest after notice objects to the proposed sale.
The Engman decision referenced above8 appears to be the only analysis of the authorization issue discussed here. In Engman the trustee first moved under F.R.B.P. 9019 for approval of a settlement which involved distribution of property. The court acknowledged that it at first encouraged proceeding under Rule 9019 in proceedings leading up to the cited decision, but then notes citing section 725:
However, it now appears that more was at issue than merely whether the accommodations that have been reached should be approved or not. What prompts this observation is a too frequently overlooked provision of the Bankruptcy Code9 . . . .
This court was remiss in not recognizing the potential applicability of Section 725 when the former trustee had previously asked to make such distributions. However, the former trustee was equally remiss in failing to bring that section to the court's attention
6 See REPORT OF THE COMMISSION ON THE BANKRUPTCY LAWS OF THE UNITED STATES, H.R. DOC.
NO. 98-137 Part I, at 191 (1973):
Subdivision (a) is a sharp departure from the requirements of appraisal and court approval in § 70f of the present Act and Proposed Rule 606(a) and (b). The trustee is given discretion as to how to sell property of the estate in order to maximize the return to creditors. The court is not to be involved in the absence of any dispute, but notice of a proposed sale must be given to a creditors’ committee and to creditors requesting notice as provided in § 4307(c).
7 Keeping in mind the comment in note 2 supra that what the law may allow title insurance companies may not allow.
8 Note 1 supra.
9 Engman, 395 B.R. at 616.
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in any of his motions or oral arguments.10
Trustee is asking for court authority to distribute to lienholders and purported co-owners their share of sales made long ago. There is, then, no question that Section 725 governs this aspect of trustee's motion. Consequently, the court must now address how its provisions apply.11
After discussing the purpose of section 725 as authorizing the distribution of property to holders of liens on such property, the court then addressed whether the trustee had authorization to make that distribution under section 725 or whether a court order was required to confer that authorization.
The court first discussed the parallel authority given to the trustee under section 363(b)(1) to sell property after giving notice and receiving no objection stating:
Some debate has arisen as to whether a court should ever enter an order authorizing a Section 363(b) sale given Section 102(1)(B)(i)'s acknowledgmentthatnoticewithout ensuingobjection will suffice.12
Under the former Act, the court would validate virtually every decision the Chapter 7 trustee made because of its own involvementin theestate's affairs.However,thebroadadministrative discretion a trustee now enjoys has eliminated such judicial paternalism.13
Although the court may be called upon from time to time to later consider the propriety of a trustee's decision that was clearly within his discretionary authority to make, the court's assessment of that decisionis limitedtoconsideringonly whether it comported with the trustee's responsibilities to the estate. It is not for the court to
10 Id. at n.9.
11 Id. at 619.
12 Id. at n.20.
13 Id. at 627.
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substitute its own judgment for that of the trustee's. All that matters is whether the trustee met the standard expected of any other fiduciary under the circumstances.14
Then the court applied its analysis of a trustee’s authority under section 725 independent of authority under a court order and summed up its conclusions:
Section 725, like Section 363(b), conditions the Chapter 7 trustee's authority to proceed as contemplated only upon there first being “notice and a hearing.” Consequently, trustee could have, had he chosen, attempted to secure the necessary authority to make the distributions he proposes by simply serving a notice of his intentions upon the creditor body pursuant to Rule 6007(a) with the hope that no objection would then be filed.15
The benefit of this written discourse is readily apparent. However, for better or worse, it also has placed a varnish upon what Congress originally enacted. Consequently, the obscurity Section 725 has enjoyed for all these years presents a rare opportunity to virtually step back in time to consider the Bankruptcy Code once again in its pristine state. In a sense, the Galapagos Islands offered the same opportunity to Charles Darwin, albeit the observations he derived from that laboratory are hopefully far more controversial than the observations this court has derived from Section 725.
What Section 725 does reveal are certain fundamentals concerning case administration. They include:
(1) that trustees, as opposed to bankruptcy judges, are to administer bankruptcy estates;
(2) that trustees are presumed to have the authority to act on the estate's behalf at their sole discretion, subject only to the accountability they owe as the estates' fiduciaries; (3) the exceptions to this broad authority are only those where the Bankruptcy Code itselfspecifically subjects aparticulartrusteeactivityto priorcreditor or court review; . . . .16
14 Id. at 628.
15 Id. at 629.
16 Id. at 631.
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It should also be noted that Engman recognizes that notice of a section 725 motion is prescribed by F.R.B.P. 6007(a).17 Rule 6007(a) requires limited notice.
Engman’s “step back in time to consider the Bankruptcy Code once again in its pristine state . . . .” should be done more often. The same applies to the Internal Revenue Code. The effect of the “sands of time” and the consequences of the failure to trace the origin of authorities through later history has been discussed in this journal many times.18 Spending the time to thoroughly research the history of any authority which has origin in the distant past can be very informative.
17 Id. at 628.
18 E. Martin, Section 553 and Setoff in Tax Controversies in Bankruptcy Cases; The Ninth Circuit’s Holding in Sokolow v. United States that the Supreme Court’s 1932 Decision in Lewis v. Reynolds Has Been Superseded, Should be Adopted in Every Circuit or Adopted By The Supreme Court, 33 CAL BANKR J. 471 (2016) (traces the history of a 1932 Supreme Court decision presently relied on by the IRS and demonstrates that it is based on superseded authority); E. Martin, Constitutional Limitations on Judicial Regulation of Market Mechanisms in Determining What is “Fair and Equitable” in Chapter 11 Cases: Radford Redux in North LaSalle and Bonner, 34 CAL. BANKR. J. 29 (2017) (tracing the history of the Absolute Priority Rule from 1913 “Digging in the Sands of Time for the Treasure of Truth”).
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Vol. 36 Cal. Bankr. J. No. 2 (2023) 114
HOMESTEAD EXEMPTIONS OF A CHAPTER 7 DEBTOR AFTER TRUSTEE CARVE-OUTS IN OVER-ENCUMBERED PROPERTY: A COMPARISONOFTWO2022CASES
By Leslie A. Cohen, Brian A. Link1
Introduction
In the same month in the summer of 2022, two different courts on two different sides ofthecountryreachedopposedpositions onthequestionofadebtor’s ability to effectively enforce a homestead exemption following a trustee’s carve-out agreement with a secured lender on over-encumbered residences.2
Most meaningfully, this represents another episode in a “split” among lower courts, and an important question is ripe for review: can or cannot a debtor utilize an important safeguard exempting part of the value of their home when a trustee’s separate agreement with a secured lender suddenly brings an overencumbered residence “back into play” with funds available for a chapter 7 trustee’s sale during the bankruptcy case? And, is a Debtor with no equity in their house at greater risk of the losing it to a trustee’s sale than a Debtor with equity up to the exempt amount? And if so, does that result make sense relative to the spirit and policy underlying the bankruptcy laws?
At a minimum, despite the varied procedures and sale postures on appeal in the different cases,3 the diverging results offer an essential practice pointer and case study for debtors and bankruptcy practitioners. While the two decisions did implicate principles as varied as that of standing in constitutional law,4 to what it
1 Leslie A. Cohen is an attorney and owner of Leslie Cohen Law, PC in Santa Monica, CA. Brian A. Link is Assistant Professor for Teaching of Business Law at Pepperdine University in Malibu, CA.
2 See infra Parts II-III, comparing Stark v. Pryor (In re Stark), 2022 U.S. Dist. LEXIS 114275, 2022 WL 2316176, 71 Bankr. Ct. Dec. 181 (E.D.N.Y. June 28, 2022) [hereinafter “Stark”] with Babaee v. Marshack (In re Babaee), 2022 Bankr. LEXIS 1713, 2022 WL 2191369 (B.A.P. 9th Cir. June 17, 2022) [hereinafter “Babaee”]. Babaee currently under appeal to the Ninth Circuit Court of Appeals. Babaee v. Marshack, Jul 01, 2022 (No. 22-60023 and 22-660022).
3 See infra Parts II-III.
4 See infra Part III.A.
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means to calculate equity under state law,5 at the end of the day that it is a vital inquiry for debtors and their attorneys attempting to navigate bankruptcy proceedings (and does speak more broadly to the meaning of homestead exemptions under federal law).
In an unpublished opinion on June 17, 2022, the Ninth Circuit’s Bankruptcy Appellate Panel (BAP) in Babaee v. Marshack (In re Babaee) dismissed the appeals of two chapter 7 debtors who challenged a chapter 7 trustee’s (i) motion to sell their residence, and (ii)compromisemotion to approve,underRule 9019,twoagreements with junior creditors to subordinate and transfer part of their liens to the estate.6 The bankruptcy court found the trustee could negotiate with the secured creditors and sell the property without any regard to the debtors’ homestead exemption.7 Following approval and an auction at the bankruptcy court, the sale closed, the debtors moved out and the property was sold.8 Approving this decision, the BAP reasoned that the debtors lacked standing to challenge the motions given the sale hadalreadytakenplaceandredresswasimpossiblebecauserejectingtheagreements would purportedly restoretheliens andoffernodistributionto thedebtors, obviating any pecuniary remedy.9 Interestingly, the BAP considered, and rejected, the debtors’ argument that their ability to enforce their homestead exemption was a “competing standing argument.”10
Eleven days later, on June 28, 2022, the U.S. District Court of the Eastern District of New York in Stark v. Pryor (In re Stark) reached essentially a contrary position, overturning a bankruptcy court’s order approving a trustee’s sale motion which included a compromise with a secured lender that was explicitly not subject to the debtor’s homestead exemption.11 A final sale had not taken place while the courts properly first wrestled with the exemption application.12 The District Court found that thedebtor’s homestead exemption would be entitledto distribution from thesale
5 See infra Part III.B.
6 Babaee, 2022 Bankr. LEXIS 1713, at *1.
7 Id. at *5.
8 Id. at *5-6.
9 Id. at *7-11.
10 Id. at *9-10.
11 Stark, 2022 U.S. Dist. LEXIS 114275, at *1.
12 Id. at *6-7.
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proceeds of over-encumbered property following the trustee’s “give up” (i.e., ‘carve out’) agreement with the mortgage lender.13 The court found that, at the end of the day, equity is not frozen on the petition date, and if an agreement (like appreciation) creates or results in equity, then that equity is subject to the debtor’s homestead exemption, which must bepaid to the debtor from the saleproceeds.14 Asthis article goes to press, the U.S. District Court in North Carolina has recently affirmed a bankruptcy court decision, Summerlin v. Turnage (In re Summerlin), denying a carve-out sale similar to Stark, reasoning that the court had correctly barred secured tax creditors from making a deal with the trustee to provide payments on the priority tax claims and for the trustee’s administrative expenses (all to generate a small meaningless distribution to general creditors) while denying the debtor’s homestead exemption.15 This further illustrates the timeliness of this important topic.
Despite the limited precedential value of Babaee and the differing sale dispositions in the two lines of cases (Babaee on the one hand, Stark and Summerlin on the other), the Ninth Circuit BAP’s own equating of standing with the question of ascribing the value of a carve-out to a debtor or to a trustee, makes these cases worth comparing. To whom does the value of a carve-out belong: the debtor or the trustee? This question arises or will arise in an ample number of bankruptcy decisions and is worth exploring.
This article proceeds in the following manner. In Part I, it briefly provides the relevant statutes and nature of the bankruptcy estate, liens, and homestead exemptions, and defines “carve out” (or “give up”) agreements in the context of a trustee’s attempt to sell over-encumbered property in a chapter 7 case. In Part II, this article summarizes the facts of the Babaee and Stark cases. In Part III, this article summarizes the holdings of those respective decisions, while evaluating them and providing a brief comparison. In Part IV, this article makes an argument that the Stark decision offers a better rationale when viewed in light of all the purposes of the Bankruptcy Code and applicable exemption statutes. It also looks at some additional case law; notes the urgency of this exemption question following a recent Ninth Circuit decision; and briefly mentions that the standing argument in Babaee may just be used a work-around of the controversial idea that section 363(m)
13 Id. at *12-16.
14 Id. at *15-16.
15 Summerlin v. Turnage, No. 5:22-cv-00122-KDB-DSC, 2023 WL 2496181 (W.D.N.C. Mar. 14, 2023) [hereinafter “Summerlin”].
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operates as a bar to appellate review the scope of which is currently being considered by the U.S. Supreme Court (and which may be published as this article is coming to press). Part V briefly concludes this article.
Part I – The Bankruptcy Estate and Homestead Exemptions: Some Relevant Law
Though bankruptcy cases are governed by federal law, state law still generally defines “property rights.”16
A “lien” under the Code is “a charge against or interest in property to secure payment of a debt or performance of an obligation” (and a “security interest” is a “lien created by agreement”).17 Secured liens generally “ride through” (or survive) a bankruptcy proceeding; even if completely “underwater,”18 a chapter 7 debtor generally cannot “strip” a junior creditor’s lien on their home.19 A “claim” is of course more broadly defined, but includes a secured right to payment.20 Distributions in a bankruptcy case are subject to a specific priority scheme depending on the type of the claim.21 Claims may be subordinated by agreement (or equitably by a court).22
Though “equity” is not a defined term in 11 U.S.C. § 101, it is well understood and can be defined as the “amount by which the value of an interest in property exceeds secured claims or liens; [or] the difference between the value of the property and all encumbrances on it.”23
Filing a bankruptcy petition creates a “bankruptcy estate” which, generally speaking, includes “all legal or equitable interests of the debtor in property as of the
16 E.g., Butner v. United States, 440 U.S. 48, 48-49 (1979)
17 11 U.S.C. § 101(37), (51)
18 E.g., Dewsnup v. Timm, 502 U.S. 410, 418, 112 S. Ct. 773, 778 (1992).
19 Bank of Am., N.A. v. Caulkett, 575 U.S. 790, 135 S. Ct. 1995 (2015).
20 11 U.S.C. § 101(5)
21 E.g., 11 U.S.C. §§ 506, 726
22 11 U.S.C. § 510.
23 EQUITY (7), Black's Law Dictionary (11th ed. 2019).
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commencement of the case.”24 Code25 section 522, however, exempts certain property from the estate, including property that is exempt under “State or local law.”26 California debtors cannot make use of the federal exemptions of 11 U.S.C. § 522(d) due to California’s “opt out,”27 but rather make use of one of two state exemption schemes.28 The first (bankruptcy-only) exemption scheme permits protecting equity in real property, but may be used as a sort of “wildcard” to protect other property as well.29 The second, more general exemption law (C.C.C.P. § 704) would apply to a debtor (such as in Babaee) with more substantial home equity.30 California law provides also that in a bankruptcy case “where the debtor’s equity in a residence is less than or equal to the amount of the debtor’s allowed homestead exemption as of [the petition date], any appreciation in the value of the debtor’s interest in the property during the pendency of the case” would qualify for exemption.”31
New York exemption law (relevant to the Stark decision discussed herein32) is analogous to California law. It creates a homestead exemption for property “in
24 11 U.S.C. § 541
25 Unless otherwise noted, all references to the “Code” or “Bankruptcy Code” mean 11 U.S.C. § 101 et seq. References to the “Rules” or “Bankruptcy Rules” means the Federal Rules of Bankruptcy Procedure (FRBP).
26 11 U.S.C. § 522(b)(1)-(3)(A).
27 See, e.g., 11 U.S.C. § 522(b)(2) and Cal. Code Civ. Proc. [hereinafter “CCCP”] § 703.130. For a discussion of state exemption laws being permissible despite the U.S. Constitution’s “Supremacy Clause” (Art. VI), see e.g., In re Applebaum, 422 B.R. 684 (B.A.P. 9th Cir. 2009).
28 CCCP § 703.140. While the filing of homestead declaration is not required, debtors must still schedule exemptions per 11 U.S.C. § 521(a)(2).
29 CCCP § 703.140(b)
30 CCCP § 704.730. In the Babaee case, the debtor claimed the § 704 series exemptions. As discussed in Part IV.C infra, in 2021 California significantly increased the amount of the potential homestead exemption.
31 CCCP § 703.140(c).
32 As for the Summerlin case, the District Court noted that North Carolina has also “opted out of the Federal exemptions,” and that North Carolina “construes exemptions liberally with an eye in favor of exemption.” Summerlin, 2023 WL. 2496181 at *3 [internal citations omitted].
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value above liens and encumbrances, owned and occupied as a principal residence.”33
As cited in both Stark and Babaee, the Ninth Circuit BAP has held that “[i]t is universally recognized . . . that the sale of a fully encumbered asset is generally prohibited.”34 However, the Babaee decision states that there is no “per se rule” that prohibits carve-out agreements, which are proposed workarounds where a trustee agrees to sell a house within the bankruptcy case in return for the lien-holder’s agreement to “give up” (or “carve out”) some of the proceeds of the sale to the estate.35 The case law notes that there is a rebuttable “presumption of impropriety” in such carve-out agreements that requires disclosure and a showing of benefit to the estate(but could be upheld, as was the case in Babaee. 36
Bankruptcy Code section 363 authorizes trustee sales of estate property,37 including “free and clear of any interest in such property of an entity other than the estate.”38 If requested, such a sale can also include a protection for good faith buyers, preventing “reversal or modification on appeal” unless stayed pending appeal.39
The requirement of standing, essential to a federal court’s jurisdiction, is “essential and unchanging.”40 As mentioned in Babaee, “[c]onstitutional standing requires an injury in fact, which is caused by or fairly traceable to some conduct or some statutory prohibition, and which the requested relief will likely redress.”41
33 N Y C P L R § 5206(a) See also Stark, 2022 U.S. Dist. LEXIS 114275, at *11-12.
34 In re KVN Corp., Inc., 514 B.R. 1, 5 (B.A.P. 9th Cir. 2014) (discussing the duties of a chapter 7 trustee, noting even the “official Handbook for Chapter 7 Trustees” (at 6-7)); see Stark at *10 and Babaee at *10.
35 Id. at 4-5.
36 Id. at 8.
37 11 U.S.C. § 363(b).
38 11 U.S.C. § 363(f)
39 11U.S.C.§ 363(m).Asdiscussed inPartIV infra,asofthis writingtheSupremeCourtiscurrently considering the extent of language, whether it is a bar to appellate relief or just a limitation on the formation of remedies.
40 Lujan v. Defenders of Wildlife, 504 U.S. 555, 560 (1992)
41 In re Veal, 450 B.R. 897, 906 (B.A.P. 9th Cir. 2011) See also Stark, 2022 U.S. Dist. LEXIS
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Prudential standing is simply “the doctrine that a plaintiff must assert its own legal rights and may not assert the legal rights of others.”42
Part II – Facts of the Cases
This second part provides a brief summary of the facts of each of the two recent 2022 cases noted above, that illustrate the important interplay of homestead exemptions and the bankruptcy estate in the common context of chapter 7 trustee sales. It should also be noted that the Babaee case is currently on appeal to the 9th Circuit.
A. The Babaee Case
Fariborz and Malihe Babaee (together the “Babaees”) filed a joint chapter 7 bankruptcy petition in the Central District of California in January 2020.43 They scheduledtheirNewport Beach,CAresidence(withavalueof$2.9million)together (on Schedule D) with two tax liens and four consensual security interests for about $2.6 million (and the Babaees also scheduled about $430,000 in nonpriority unsecured debts).44 The trustee’s compromise motion (discussed below) later calculated encumbrances on the Newport Beach property to actually be in excess of $2.9 million.45 TheBabaees utilizedtheCaliforniastateexemption schemepursuant to C.C.C P § 704.730 to claim the then-applicable $175,000 homestead exemption.46
A few months after the petition date, the chapter 7 trustee filed a Notice of Assets and began the process of marketing the debtors’ Newport Beach residence for sale, eventually receiving an offer for $2.86 million.47 The trustee also negotiated agreements with two junior secured creditors in the third and fourth positiondeedsoftrust,to subordinateandtransferaportionoftheirlienstotheestate
114275, at *7.
42 Veal, 450 B.R. at 907 (B.A.P. 9th Cir. 2011).
43 Babaee, 2022 Bankr. LEXIS 1713, at *1-2.
44 Id. at *2.
45 Id. at *2-3.
46 Id. at *2.Thecase was filedbefore the 2021exemptionchanges in California(see infra Part IV.C).
47 Babaee at *2.
121 Vol. 36 Cal. Bankr. J. No. 2 (2023)
and consent to sale of the property.48 The trustee later sought by motion per FRBP 9019 to approve the agreements (a “Compromise Motion”), to which the debtors objected.49
The Babaees noted in objection to the trustee’s Compromise Motion, inter alia,thattheresultoftheproposedcompromiseandsalewouldbeanend-runaround the Debtor’s homestead exemption, and that there is a general disfavoring in the law of sales of “fully encumbered properties.”50
The trustee also filed a motion to sell the Newport Beach residence property “subject to overbids, [and] free and clear” pursuant to 11 U.S.C. § 363. In the same motion, the trustee requested the sale be free and clear of the debtor’s homestead exemption under 11 U.S.C. § 522(g). The Babaees submitted an omnibus objection to the Compromise Motion and the sale motion.51
The bankruptcy court overruled the debtors’ objections and approved and granted both of the trustee’s motions. Additionally, an overbidder at the hearing successfully bid at a brief auction and increased the sale price $20,000 to a total of $2.88 million.52
The bankruptcy court’s sale order contained a finding, per 11 U.S.C.§ 363(m),protectingthebuyersbasedontheir“goodfaith.” Thedebtorswere unsuccessful in seeking a stay pending appeal, and so moved out of the property with the home sale closing in November 2021.53
48 Id.
49 Id. at *2-4. It appears from the BAP’s opinion that the third-position junior lien holder, Comerica Bank, subordinated about $40,000 ($449,325 – “all but $410,000”) and the fourth-position junior lien holder, Valley Economic Development Center, Inc. (VEDC) agreed to subordinate about $234,000 ($425,000
“all but $191,000”) which would total about $274,000. Assuming the trustee’s calculation of total encumbrances of $2,982,082, this reduction would result in secured obligations of about $2.7 million, less than the trustee’s original sale price of $2.86 million. The trustee would laterestimatenetrecoverytotheestateatover$290,000,withalaterrevised distributionthatincluded a partial ($45,000) distribution to the debtors, and apparently a compromise also as to the IRS’s tax claim. Id. at *4.
50 Id. at *3.
51 Id. at *4.
52 Id. at *5.
53 Id. at *5-6.
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–
On appeal, the debtors conceded the sale of the Newport Beach residence could not be reversed because of the section 363(m) protections. Accordingly, the BAP stated the “appeal [was] limited to the propriety of the bankruptcy court’s approval of the compromises . . . [and] the Sale Order only to the extent the Sale Order approves the proposed distribution scheme.”54
The trustee was unsuccessful in attempting to have the appeal dismissed as moot, and so theNinth Circuit BankruptcyAppellatePanel heardthedebtors’timely appeal of both orders as described above. As discussed below however, the BAP would ultimately dismiss the appeal for the debtors’ apparent lack of standing.55
B. The Stark and Summerlin Cases
In February 2020, New York resident Sharyl Stark (“Stark”) filed a chapter 7 bankruptcy petition with the Eastern District of New York.56 She caused the bankruptcy petition to be filed less than a week before a scheduled foreclosure sale following a December 2019 New York state court foreclosure judgment. (The mortgage holder commenced foreclosure proceedings in 2012.)57 Stark was ostensibly seeking to prevent the foreclosure of her house, which she and her husband had indebted with a mortgage note for $1.32 million in 2004.58
Stark scheduled the value of the house at over $2.22 million. Stark also scheduled a mortgage encumbering the house at over $2.56 million. On the petition date that means it was undisputed that Stark had no equity in the property. Stark claimedahomesteadexemption,perN.Y.CivilProcedureLaw§ 5206,of$170,825. There was also an indication Stark was willing to surrender the property.59
Just two months after the chapter 7 trustee’s appointment, the trustee filed a “No Distribution” report and abandoned the property. However, after two weeks the trustee was able to rescind his report, and in June 2020 the trustee filed a motion
54 Id. at *6-7.
55 Id.
56 Stark, 2022 U.S. Dist. LEXIS 114275, at *1-2.
57 Id.
58 Id. at *1.
59 Id. at *4.
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to compel Stark to permit access, inspection, and valuation of the property, apparently with an eye toward sale of the home.60
While the access motion was still pending however, in July 2020 the trustee also filed a motion to sell the house.61 That sale motion indicated the trustee and mortgage lender had agreed to a “carve-out” agreement in exchange for the trustee selling the property through the bankruptcy process. However, due (as the trustee claimed) to the still-pending inspection and valuation, the trustee was unable to provide “the precise nature” (read: amount of) the carve-out to which the mortgage lender was willing to agree, instead only representing he would ensure a “meaningful” such carve-out that would result in a distribution to unsecured creditors.62
Stark opposed the sale motion on two grounds, that (i) such carve-out [the E.D.N.Y. court also uses the term “give-up” devices in its opinion] agreements are not just highly disfavored but proscribed by the Code, and that (ii) even if permissible, a debtor remains entitled to her homestead exemption, meaning the sale with carve-out could not beapproved absent both a paymentto satisfythehomestead exemption and a “sizable payment to the unsecured creditors.”63
The New York bankruptcy court disagreed that the Code proscribed such carve-outs on over-encumbered property to affect a sale, stating they are permissible “in at least some circumstances.”64 And as to Stark’s second argument, the bankruptcy court said such carve-out would not be subject to the debtor’s homestead exemption, reasoning in part because the “carved-out funds flow from the trustee’s negotiation rights and not the debtor’s equity in the property.”65 Thus, the carve-out funds would belong to the estate for the trustee to manage as non-exempt property (and subject to the typical chapter 7 distribution, with debtor only receiving a distribution after all creditors have been paid in full).66
60 Id. at *5.
61 Id.
62 Id. at *5-6.
63 Id. at *6-7.
64 Id. at *6.
65 Id.
66 Id. at *6-7.
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Stark filed a timely appeal of the order approving the sale, on the same grounds as her objection to the sale motion, disputing the trustee’s power to negotiate such a sale and asserting any such sale would be subject to the debtor’s homestead exemption.67 Although the bankruptcy court vacated the automatic stay during the appeal, permitting the foreclosure of the property, such foreclosure had not taken place.68 Additionally, the court would be careful to note that despite the motion being styled as a “sale motion,” “the Bankruptcy Court did not [yet] approve or disapprove a sale in this case [but] [r]ather, pending those details, the court explicitly reserved judgment on whether the sale ultimately would be allowed.”69 In the Stark case, the amount of the exemption was unknown because the amount of the carve-out was unknown; these uncertainties could, the court noted, compel the trustee one way or the other, all hinging on whether or not creditors would benefit. And such a decision to “green-light the trustee’s moving forward with the sale” would have “attendant consequences.”70
Perhaps then the order on appeal in Stark is better styled as a compromise approval motion rather than a pure “sale motion” (both of which were present in the Babaee case). Either way, however, the New York District Court determined it had jurisdiction over the appeal. A sale order is certainly a “final order” subject to appeal, and so also is an order of “decision granting or denying an exemption” final for purposes of appellate jurisdiction.71
The Stark court did reach the merits of that decision on appeal, as described below, ultimately holding that such a carve-out sale would be subject to the debtor’s claimed homestead exemption, because the value of a carve-out flows from the debtor’s property rights.72
In Summerlin, the bankruptcy court addressed a situation of a widowed debtor, Ms. Nancy Turnage, who had little income and a home over-encumbered by a mortgage as well as tax liens in favor of the Internal Revenue Service (IRS) and
67 Id. at *7, 10.
68 Id. at *9 n.2.
69 Id.
70 Id.
71 Id. at *7-9.
72 See infra Part III.B.
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the North Carolina Department of Revenue (NCDOR).73 The Trustee reached a carve-out deal with the taxing agencies to allow the property to be sold and a portion of proceeds paid to the them, leaving $30,000 for the Trustee’s commission a small dividend to unsecured creditors, and around $2,000 to the debtor.74 The Bankruptcy Court rejected the Trustee’s deal, noting that in North Carolina, exemptions should be strictly enforced, and that there must be a separate legal basis for denying the important homestead exemption (i.e. neither the taxing authorities nor the Trustee could circumvent the statutory exemption scheme, in that case of 11 U.S.C. § 724(b)).75 The Court stated:
“And for her ’fresh start,’ the Debtor, a 72-year-old widow with no meaningful source of income, loses her home and gets no more than a check for about $2,000. The minimal benefit to the other general unsecured creditors does not obscure the reality of this agreement. As the Christensen court described a similar agreement, this agreement is a “sham.” It is not intended to benefit the general unsecured creditors but it was concocted to allow the tax agencies to “tip” the Trustee for selling the Debtor’s home. The Court will not sanction this bastardization of the bankruptcy process. As a result, the Court will affirm the Bankruptcy Court’s decision that the Debtor’s homestead exemption applies to § 724(b) and denial of the Motion to Sell.”76
Part III – Conclusions of the Cases
Despite the different sale dispositions and the seemingly different bases for the courts’ conclusions, they holdings of these appellate decisions are worth comparing on the fundamental question of homestead exemptions in the case of over-secured properties in chapter 7 bankruptcy cases.
A. That’s risk, Babaee
Styling theNinth Circuit BAP’s decisionas merely anunpublisheddismissal of appeal for lack of standing unduly downplays its relevancy. The Babaee court
73 Summerlin, 2023 W.L. 2496181 at *1-2.
74 Id. at *4.
75 Id. at *3 (citing Law v. Siegel, 571 U.S. 415, 134 S. Ct. 1188 (2014)).
76 Id. at *4.
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makes a startling statement in contrast to what many practitioners may counsel their clients about the unlikelihood of a chapter 7 trustee selling their over-encumbered home:
When they filed their petition and sought a discharge of their considerable unsecured debt, Debtors took the risk that Trustee might sell the Property, and they would be paid their homestead exemption only to the extent there were proceeds left over after payment of costs of sale and consensual liens.77
But is such a risk proper? The Babaee court felt it is, essentially concluding that if equity is created, that equity must run to the benefit of the trustee and the estate, and never the debtor who otherwise would have had superior claim to at least some equity in their own home. The court reasoned that once the debtors filed for chapter 7, they surrendered all their assets to the estate.
As discussed above, the Babaees appealed the California bankruptcy court’s granting of both: (1) the Compromise Motion seeking approval of negotiations with two junior secured lenders to subordinate (and transfer) parts of their liens to the estate, which would result in some payment to unsecured creditors of the estate; and (2) the Sale Motion, approving sale of the Newport Beach residence subject to overbid, with attendant buyer protections per section 363(m) and a finding per section 522(g) that debtors’ exemptions would not attach to recovered liens.78
TheBabaees wereunsuccessful in obtaining stayspending appeal, and so the property was sold, with the trustee simply holding the proceeds (about $225,000) following some distributions to creditors and taxing authorities.79
Because the irreversible sale took place, the BAP stated that the “appeal is limited to the propriety of the bankruptcy court’s approval of the compromises” and the sale order “only to the extent” it approved the distribution scheme.80
The BAP noted that on appeal, the debtors would have to evidence their standing. The BAP divided the standing argument into two types, asserting the
77 Babaee, 2022 Bankr. LEXIS 1713, at *11.
78 See discussion supra in Part II.A.
79 Babaee, at *5-6.
80 Id. at *6-7.
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debtors would have to demonstrate constitutional or prudential standing.81 Constitutional standing, the court defined, requires “showing that the orders on appeal resulted in an injury in fact fairly traceable [in this case] to the compromise, or that reversal of those orders would redress any injury.”82 Prudential standing would similarly require a showing the debtors were “directly and adversely affected pecuniarily by the orders on appeal.”83
The BAP reasoned that reversing the compromise orders would “undo the settlement” and permit the junior lenders to pursue the full amounts of the original liens (more than $100,000 in excess of the sale proceeds held by the trustee), resulting in no distribution to the debtors.84 Thus, the BAP asserted it could not see its way to locating any redress if the case were decided on the merits.
However, the BAP briefly made two other brief observations that merit further analysis. Firstly, the BAP cursorily dismissed debtors’ argument that having to relocate due to the home sale was an adverse pecuniary event. The BAP wrote that because “the sale cannot be undone” the “compromise itself had no impact on Debtors other than to enable the sale of their over-encumbered property.”85 But recognizing the compromise order as there to “enable the sale,” and treating it separately from the sale but still falling under the ambit of section 363(m) irreversibility, is to unwarrantedly expand such buyer protections. And, there is no reason why the court could not have reversed the order as to distribution while maintaining the compromise as to the secured creditors’ voluntary reduction of their debts, as the distribution of the carved-out funds did not affect the secured creditors oneway ortheother. Also,giventheconcernof“prudential standing”with ensuring a litigant is the “real party in interest” and attempting to vindicate their own rights,86 it is unclear how the debtors’ claim could not be on their own behalf.
Secondly, the BAP summarily stated that the debtors ignored that “the value of the Property that was encumbered by the . . . liens never belonged to Debtors and
81 Id. at *7-8.
82 Id. at *11.
83 Id. at *7 (citing Palmdale Hills Prop. v. Lehman Com. Paper, Inc. (In re Palmdale Hills Prop., LLC), 654 F.3d 868, 874 (9th Cir. 2011)).
84 Babaee, at *8.
85 Id. at *9.
86 E.g., supra at Part II.
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thus could not be subject to their homestead exemption.”87 That is a separate point from the availability of funds or reclaiming of liens. Also, the BAP did not have to necessarily conclude that the value of the encumbered property “never belonged to the Debtors,” as the Stark court makes clear.
B. A Stark Contrast
The Stark court was more forgiving in its holding, but not merely because there was no actual sale yet consummated following the trustee’s motion. In Stark, thecourtheldthat equity createdissubjecttoadebtor’shomesteadexemptionclaim, as “value” stems from the debtor’s property rights.88
Recall that in Stark, the trustee brought a sale motion and represented there would be some carve-out sufficient to make a meaningful distribution, exempt from the debtor’s homestead exemption, just as was stated in Babaee. With the lower bankruptcy court denying application of the debtor’s homestead exemption to the anticipated (if vague) carve-out, the District Court in New York found it still had an appealable final order, even if it was not a final sale order (despite its title) (and thus outside of section 363(m) irreversibility considerations).89 And it would turn out that while Stark was unsuccessful in challenging carve-outs generally, she would be successful in asserting her homestead claim.90
The Stark court did reach the merits after finding it had jurisdiction, and concluded that although courts could approve of such generally-disfavored sales of over-encumbered property in certain circumstances, such sales are still subject to a debtor’s homestead exemption.91
Toarrive at this result,theEastern District of New Yorkreasoned as follows:
87 Babaee, at *9.
88 Stark, 2022 U.S. Dist. LEXIS 114272, at *15-16.
89 See discussion supra at Part II.B.
90 Stark, at *10.
91 Id. at *10-15.
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(i) New York state law exempts (to a statutorily-defined amount) the “value” of a property “above liens and encumbrances” (citing N.Y. C.P.L.R. § 5206(a)), and thus “speaks to equity in the residence.”92
(ii) A carve-out agreement will ultimately result in a secured creditor agreeing to take less than the sale proceeds, which results in equity (in an amount depending on the stipulated reduction) even where there was none before.93
(iii) In exchange as consideration for this give-up, a secured creditor is not “valuing” the section 363 sale process as an end in and of itself (and thus not monetizing the trustee’s role as trustee), but rather the value it is receiving in a speedier (and likely less expensive) delivery of the property in the bankruptcy case than to which the creditor is already entitled (i.e., foreclosure).94
(iv) Thus, in exchange for the carve-out, the trustee is facilitating an exchange of the debtor’s rights to e.g. remain in the property, or refinance it, that is to say, the debtor’s property rights.95
(v) Finally, if the exchange is really for debtor’s property rights in the house, those rights are protected by the homestead exemption, as such exemption is meant to protect the “value” of the residence.96
Additionally, the Summerlin decision directly addressed and rejected the concept of allowing the trustee to sell over-encumbered property to get fees while wiping out the Debtor’s homestead exemption, writing it was “clear that the only substantial beneficiaries of his ‘backroom’ deal with the tax agencies [were] the Trustee himself ad those [taxing] agencies.”97. The Summerlin court did not hesitate to attack the process as contrary to the fresh start goals of chapter 7.
92 Id. at *11-12.
93 Id. at *12.
94 Id. at *13.
95 Id. at *14.
96 Id. at *15.
97 Summerlin, at *4.
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While the Stark decision may have the impact of effectively barring many trustees from entering into short sales without paying the homestead exemption, we argue below that this decision is still in keeping with not just general state law concerns of keeping debtors housed, but also in line with all the purposes of federal bankruptcy law as well.
C. Summary Reading of the Holdings Together
Reading them more generously, it is possible to read Babaee and Stark in such a way that harmonizes the two decisions. As mentioned above, though styled as a motion for approval of sale that included a carve-out, the trustee in Stark left the amounts undisclosed or vague pending an attempt to inspect and value Stark’s residence, thus there was no actual sale really approved by the bankruptcy court’s granting of the motion.98 In contrast, in Babaee, the trustee had brought separate motionsforcompromiseandsale,withthesalemotioncontainingthetypicalcaveats and protections (e.g., of section 363(m)), and there ultimately being scheduled the auction for the same day as the consolidated hearings.99 The debtor in Stark did not even apparently have to contend with a post-appeal foreclosure despite vacatur of the protections of the automatic stay,100 whereas the Babaees could not obtain a stay of the sale motion order pending appeal, which was fatal to the case in the eyes of theNinthCircuitBankruptcyAppellatePanel.101 The Summerlin decisionalsoarose in a different procedural context, before the sale was consummated (in response to a trustee’s sale motion and objection to debtor’s homestead exemption), so the court had the opportunity to speak directly to whether or not sales of over-encumbered properties with carve-outs for the trustee should be allowed.
These cases have different dispositions, but they do speak to the same ultimate issue: the efficacy of a debtor’s homestead exemption after a trustee’s carve-out with secured lenders in the context of a generally disfavored sale of overencumbered property.
Additionally, the Babaee court itself is inviting greater scrutiny beyond comparison of the sale dispositions in the different cases. The BAP dismissed the
131 Vol. 36 Cal. Bankr. J. No. 2 (2023)
98 Stark, at *9 n.2. 99 Babaee at *5.
Stark, at *9 n 2.
Babaee, at *5-6.
100
101
debtors’ appeal for lack of standing. But the Babaee court explicitly equates, as “what is in essence a competing standing argument,”102 with the question, “where a chapter 7 debtors’ homestead is apparently over-encumbered, [does] the opportunity to realize[] value through” such a carve-out “belong” to the debtor or the trustee?103 That is exactly the question in Stark: and Summerlin is the “give-up” negotiated by thetrusteeextractedfrom thevalueoftheproperty(andthedebtor’spropertyrights), or the trustee’s bankruptcy powers?104 Thus, the cases are worth comparing despite their different procedural tee-ups. Babaee answers the question in the negative from the debtor’s perspective, though it does so behind the screen of a constitutional/prudential standing argument.105 Stark answers the question in a prodebtor way: equity, however arrived at, is equity, and that is what the homestead exemption is meant to protect, along with debtor’s property rights.106 Summerlin likewise states straightforwardly that a trustee cannot deprive a debtor from their homestead by making a deal with undersecured creditors. These authors assert that Stark and Summerlin have the better argument in terms of both rationale and policy, as discussed below in Part IV.
Part IV – Approval of the Stark Rationale That Equity Belongs to the Debtor
The goal of this Part IV is to elucidate why the rationale presented by the Eastern District of New York in its Stark decision is better reasoned in light of all of the purposes of homestead exemptions and the Bankruptcy Code. While the argument could be made that the cases are so distinguishable given the varied sale dispositions presented in each situation, by Babaee’s own admission the question is still ultimately one of the status of a debtor’s homestead exemption. Stark makes a convincing argument that equity capture belongs to the debtor. Babaee, in contrast, takes the position that once a debtor files bankruptcy, they give up all property to the estate. At a minimum, it is worthwhile for practitioners knowing the consequences of the sale statuses on appeal even if the Code does not envision such extremely different results. This Part IV also briefly points to a relevant decision out of the Central District of California; expresses the urgency of this question given California’s heightened exemptions after 2021; and hints that the Babaee decision
102 Id. at *9-10.
103 Id. at *10.
104 E.g., Stark, at *13.
105 Supra Part III.A.
106 Supra Part III.B.
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could be read an alternative to a jurisdictional bar of appellate mootness being read into section 363(m)and that is currentlybeing evaluatedby the U.S. SupremeCourt.
A. Stark and Summerlin Support Exemption Rights
While it is true that “property of the estate” is broad and, as Babaee tells us, that a paramount concern of the Bankruptcy Code is to maximize returns for creditors,107 theCodedoesnotdosoinavacuum.Rather,theCodesetsupanorderly distributionin aclearhierarchical schemathat at thesame timerecognizes important exemptions. Congress did not seek to undo centuries of common law but rather preserved the fundamental role the states themselves play in defining “property,” and by allowing the states to determine what exemptions apply in bankruptcy. Creditors as well as debtors benefit from this set-up; the Code provides that liens and secured obligations “ride through” the bankruptcy process in addition to their enhanced priority. Further, a fundamental goal of the Bankruptcy Code is to afford a “fresh start” to honest debtors.108
State law recognizes the importance of homes to individuals, and the importance of keeping people housed. State-based homestead exemptions operate alongside judicial protections or statutorily-regulated foreclosure proceedings to offer a critical protection: creditors cannot easily swoop in and sell out residences from underneath debtors. The bankruptcy process is just as concerned with preserving order and avoiding the oft-feared proverbial “rush to the courthouse” as it is in uniformly maximizing creditor returns. The nuanced recognition by the Stark court of the realities of short sales, carve outs, and foreclosures helps preserve this important balance.
Aside from concerns about debtors losing their homes though, the Stark case presents a solid basis in law. It begins with a straightforward account of equity: the difference in the value of a property and any liens or other obligations thereon. It recognizes the homestead exemption protects this equity, and in so doing helps preserve the debtor’s bundle of property rights, including (if even for a time) to reside and exclude others.109
107 Babaee, 2022 Bankr. LEXIS 1713, at *10.
108 Grogan v. Garner, 498 U.S. 279, 286 (1991) (citing Local Loan Co. v. Hunt, 292 U.S. 234, 244, 54 S. Ct. 695, 699, 78 L. Ed. 1230 (1934)).
109 Stark, 2022 U.S. Dist. LEXIS 114275, at *13-14.
133 Vol. 36 Cal. Bankr. J. No. 2 (2023)
The Stark decision then employs a straightforward contracts analysis. It is blacklettercontractlawthatlegally-sufficientbilateralconsiderationmustbepresent in support of every contract. If a lender is giving up some right for example, the right to the full amount of its secured indebtedness that lender must be receiving something of legal value in return (otherwise the agreement would fail as a matter of contract formation). That something of legal value is exactly what the Stark decision is after, and it is grounded in reality: the lender is seeking to have the property sold outside of the state foreclosure processes, often much more quickly and cheaply, and instead done through the bankruptcy process. But that value, Stark correctly reasons, is only realized by a sale without the debtor’s consent and against those debtor’s property rights which makes “the [state] foreclosure process such a headache” in the first place.110 And so the homestead exemption if such a sale is approved is that price of doing business.
Additionally, it should be noted that these sales and discussions over homestead exemptions are occurring in the context of generally disfavored sales of over-encumbered properties. Whythegeneral distasteforsuchcarve-out situations? Liens survive bankruptcy proceedings. The sale of over-encumbered assets by a trustee is disfavored precisely because of the negative, and frankly outweighed, consequences of permitting such sales. Debtors may be able to better arrange for short sales or negotiations with abandoned assets than a trustee. And in no event is a trustee an agent of a single creditor, but rather owes the duties of the office to the estate as a whole. Significantly advantaging one or two secured creditors (often to pay unsecured creditors pennies on the dollar) when so many have reasonably relied on the general rule that over-encumbered properties will not be sold threatens the viability of chapter 7 for debtors with low or no equity in their residences.
The New York bankruptcy court that was overturned in Stark stated that:
The Court finds that the Trustee in this case utilized a right conferred upon him upon the filing of the chapter 7 petition to obtain a benefit for the estate. When a debtor files for chapter 7 relief, he or she surrenders title and the right to control of their property to a chapter 7 trustee in exchange for a discharge of all debts without any repayment obligation.111
110 Stark, 2022 U.S. Dist. LEXIS 114275, at *14.
111 In re Stark, Case No. 8-20-70948-reg, 3 (Bankr. E.D.N.Y. Sep. 25, 2020).
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But the District Court saw past that argument to realize “value” comes from the home, and debtor’s rights in it, not from the trustee. The BAP in Babaee had nearly identical reasoning when it equated debtor’s “standing” against the trustee’s, writing: “Debtors fail to realize that, once they filed their chapter 7 case, they gave up their ability, i.e., their standing, to control their property.”112 This language did not convince the court in Stark. These authors assert that it should similarly be overturned in Babaee. Likewise, the Summerlin case states:
“the Trustee’s Motion must be denied because it substantially benefits no one other than himself and the tax agencies. Bankruptcy aims to relieve an honest debtor from the weight of oppressive indebtedness and permit her to start afresh free of obligations and responsibilities resulting from financial misfortune . . . property may not be sold solely to benefit secured creditors or the Trustee.”113
B. Babaee differs from other California cases
The Stark court cited a California case, In re Wilson, that also offers a nuanced discussion of a debtor’s homestead exemption.114 In a 2013 case, a Central District of California Bankruptcy Court held that, where a debtor had failed to schedule her “wild card” exemption when filing, she was nevertheless still entitled to such exemption when the trustee had negotiated “bankruptcy-fee ‘carve-outs’” that functioned as “tips” to the estate to sell two underwater properties.
Relevant for this article’s purposes, the bankruptcy court framed the setup as follows:
Put another way, apparently the lenders are willing to “tip” the estate so that they will not have to foreclose on these Properties. The Debtor agrees that the Trustee is able to conduct these sales; however, the Debtor argues that she must be paid her exemption amounts after the sale. Of course, payment to the Debtor of her exemption amounts impedes the Trustee from engaging in a Section
112 Babaee, 2022 Bankr. LEXIS 1713, at *10.
113 Summerlin, at *4.
114 The Stark court also disagreed with a contrary California opinion in the Eastern District of California. Stark, 2022 U.S. Dist. LEXIS 114275, at *13 (citing In re Bunn-Rodemann, 491 B.R. 132 (Bankr. E.D. Cal. 2013)).
135 Vol. 36 Cal. Bankr. J. No. 2 (2023)
363 sale because there would be no benefit to the estate if the Debtor received all of the funds carved out by the banks.115
Though a smaller “wild card” exemption, the lesson is still instructive. Implicitly, the court recognized where “value” comes from as the Stark court would later do. “The ‘carve-outs’ from the Properties are the means by which the estate is acquiring funds that are subject to the exemptions.”116 As soon as it became evident thatthelenderswerewillingtomakeacarve-out,thedebtorupdatedherexemptions, believing “that there may be exemption value because the lenders may pay a tip to the estate for the privilege of avoiding foreclosure proceedings and the consumer protection requirements imposed by the State of California.”117 This is exactly the reality recognized in Stark. Wilson has a nice summary worthy of the Stark case:
It does not matter how funds are generated by the estate through a Section 363 sale, including if derived from a “tip” from Bank of America or Wachovia so that they will not have to undertake a foreclosure proceeding under California law. Funds derived from these sales are property of the estate and are subject to valid exemptions. The wild card exemption is designed precisely for this purpose to attach to any estate property that the Debtor designates in her Schedule C form. In this instance, the Debtor has designated funds derived from the sale of the Properties for exemption, and she is entitled to the exemption.118
The BAP in Babaee should have found similarly as the Stark case did.
C. California’sHigherExemptionsSince2021MakeThisanUrgent Question After the Ninth Circuit’s
Recent
Barclay v. Boskoski Decision
In late 2022, the Ninth Circuit Court of Appeals in Barclay v. Boskoski also issued an important decision, finding in a chapter 7 debtor’s case that a court must
Vol. 36 Cal. Bankr. J. No. 2 (2023) 136
115 In re Wilson, 494 B.R. 502, 505
C.D. Cal.
116 Id 117 Id. at 506.
Id.
(Bankr.
2013)
118
119
“apply the state exemption law in effect on the filing date of the bankruptcy petition, rather than on the creation date of the lien.”
While the Barclay case was about avoiding a judicial lien per Code § 522(f), the broadly-applicable reasoning of that decision120 means debtors and courts will likely look to Barclay in other exemption contexts. And with California significantly increasing the value of the homestead exemption (of C.C.C.P. § 704.730) significantly in 2021,121 which will concomitantly require the amount of carve-outs to increase as well, the question of whether or not such carve-outs are subject to homestead exemptions is a particularly urgent one in California postBabaee.
D. Section 363(m) as a Bar to Appellate Review Is Under Scrutiny
Finally, it is interesting to note that beyond the citations for standing generally, the Babaee decision is light on case law for its discussion of a debtor lacking standing when faced with the fallout of an involuntary sale of their home. It seems that, with the section 363(m) sale representing a “done deal,” the BAP saw no way out.122 But this solution ignores an important question about section 363(m) sales on appeal, and one currently (as of this writing) pending before the Supreme Court in its 2022-23 term.
In granting review in MOAC Mall Holdings LLC v. Transform Holdco LLC, 123 the Supreme Court is deciding whether the Second Circuit was correct in deciding that section 363(m) “creates a rule of statutory mootness . . . which bars appellate review of any sale authorized by 11 U.S.C. § 363(b).”124 The alternative is that section 363(m) limits available remedies (but not appellate jurisdiction).
119 Barclay v. Boskoski, 52 F.4th 1172, 1175 (9th Cir. 2022).
120 Citing Owen v. Owen, 500 U.S. 305, 308, 111 S. Ct. 1833, 114 L. Ed. 2d 350 (1991)
121 See, e.g., Jay Adkisson, California Increases Homestead Exemption in New Legislation, Forbes, https://www.forbes.com/sites/jayadkisson/2020/09/19/california-increases-homestead-exemptionin-new-legislation/?sh=37bdb18e197d (accessed Feb. 26, 2023).
122 See supra Part III.A.
123 MOAC Mall Holdings LLC v. Transform Holdco LLC, ___ U.S. , 142 S. Ct. 2867 (2022).
124 In re Sears Holdings Corp., No. 20-1846-BK, 2021 WL 5986997, at *2 (2d Cir. Dec. 17, 2021), cert. granted sub nom. MOAC Mall Holdings LLC v. Transform Holdco LLC, ___ U.S. ___, 142 S. Ct. 2867 (2022)
137 Vol. 36 Cal. Bankr. J. No. 2 (2023)
If the Babaee court’s dismissal of a case stands because of a predicate sale that utilized the buyer protections of section 363(m), practitioners should be aware of this attempted end-run around appellate mootness on these other jurisdictional grounds of standing. Moreover, overturning a section 363 sale may be unnecessary when distribution to the debtor (as opposed to the estate keeping the carve out proceeds) is an option.
Part V – Conclusion
Carve-outs to enable a trustee to sell over-encumbered property in the streamlined process of a chapter 7 case are generally disfavored, for good reason. Mirroring concerns of state law, federal law honors exemptions with the broader end goal ofmaking sure involuntaryhomesales are not taken lightly. The Stark decision makes a convincing case that the purpose of the homestead exemption is to fairly entitle a debtor to realize some equity, if any, in his or her home, regardless of how that equity came about (by appreciation, or by carve-out). Part of that persuasive argument is that a debtor does also realize value even in over-encumbered properties, even if just by limited “discouragement” of such sale e.g., by staying in the home for a longer period and so requires such sales be subject to the homestead exemption. The California debtors in Babaee did realize a loss, and the “risk” envisioned by the Ninth Circuit BAP should not encompass a trustee’s negotiation that ignores a debtor’s own interests to affect a sale of over-encumbered property where those secured parties’ liens are preserved. Maximizing creditors’ returns is a paramount objective of the Code; but so is the “fresh start” of the unfortunate debtor, buttressed in part by the homestead exemption. The punitive outcome of Babaee illustrates, at a minimum, the importance to debtor’s counsel of bringing timely challenges and properly asserting the exemption – and warning debtors that theirover-encumbered properties may besold outfrom underthem, thus potentially chilling the availability of chapter 7 to debtors who need a fresh start. The question of homestead exemptions is particularly timely at this moment in California given the recent increase in the homestead exemption. If for now California debtors (or other debtors in the region of the Ninth Circuit) are at greater risk of losing their homes compared to their East Coast counterparts, higher courts should weigh in and err on the side of preserving debtor’s homestead exemptions as contemplated by the Bankruptcy Code.
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TAXNEWS&VIEWS
By Elmer Dean Martin III
I. Subchapter V: Does it belong in Chapter 11, 12 or 13?
A. Why Does Subchapter V1 Create Income Tax Confusion?
A Subchapter V case of an individual looks a little bit like a Chapter 12 or 13 case. There are trustees and debtors in possession in all three case types. A Subchapter V debtor can confirm a plan without creditor approval and so can a Chapter12 or13 debtor. Theremayormaynot bedifferences in whethertheincome of the debtor is property of the bankruptcy estate.
A review of the history of Subchapter V and the materials intended to guide the parties in operating in a Subchapter V case indicates that no thought was given to whether special income tax considerations apply in Subchapter V cases.2 Indeed, the legislative history misstates a very important distinction in section 1186 with income tax significance.3
The House Report states that section 1186 mandates inclusion of a debtor’s post-petition income in the debtor’s estate. Section 1186(a) states: “If a plan is confirmed under section 1191(b) of this title, property of the estate includes . . . earnings from services performed by the debtor.” However, if a plan is confirmed under section 1191(a), which allows confirmation by creditor consensus, the income of the debtor from the debtor’s services is not included in the estate.
The consequence of this distinction, as discussed hereinafter, is that at the beginning of every Subchapter V case the income tax reporting and payment obligations of the trustee or debtor in possession are not known because at the time
1 “Subchapter V” refers to the provisions of the Bankruptcy Code added by the Small Business Reorganization Act of 2019, Pub. L. No. 116-54, 133 Stat. 1079.
2 H.R. REP NO. 116-171 (July 23, 2019)
3 Id. at page 6: “New section 1186 concerns property of the estate. Subsection (a) provides that a plan is confirmed, property of the state includes all property acquired by the debtor after the date of commencement of the case . . . It also includes all earnings from services performed by the debtor during such period.”
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of the case commencement nobody knows whether the estate will own the debtor’s income as a result of a plan cramdown rather than consensual acceptance by the creditors.4
In Chapter 11 plans which are not Subchapter V plans a debtor’s income is property of the estate under section 1115. Section 1181 provides that section 1115 does not apply in Subchapter V cases. As noted, the conjunction of Subchapter V confirmation rules and income tax rules creates complications in confirming a Subchapter V plan simply because it may not be known what the income of a Subchapter V estate is until it is known if a plan confirmation will be consensual or cramdown. Because the income must be known, reported, and any taxes paid in order to confirm a plan, a debtor has a dilemma. This just one example of the issues which can arise because of the intersection of I.R.C. sections 1398 and 1399 with the Bankruptcy Code.5
Another interesting possible conflict arises from the conjunction of section 1141(b), which revests property of the estate upon confirmation unless provided otherwise in the plan, and section 1186(a) which includes future earnings in the estate if confirmation is a cramdown until the “case is closed, dismissed or converted to a case under Chapter 7, 12 or 13 . . .” This seems to mean that the estate reports the income of the debtor until the debtor’s plan is fully consummated and the case is closed which implies that section 1141(b) does not apply.6 Also,
4 What it means to “own a debtor’s income” is a complex subject in itself. The same issue arises in Chapter 12 and 13 cases, but in those cases the income of the debtor will always be income of the estate. Suppose the debtor is a wage earner. Is the debtor’s estate subject to employment taxes and income tax withholding? In 2006, the IRS promulgated a comprehensive Notice regarding reporting of personal income as required by § 1115. I.R.S. Notice 2006-83, I.R.B. 2006-40 (Oct. 2, 2006). The Office of the United States Trustee concurrently issued a form entitled “Certification of Receipt and Understanding of Notice – Individual Chapter 11 DebtorIRS Filing and Reporting Requirements Under Section 1115 Of The Bankruptcy Code” which was supposed to be signed by every individual filing a Chapter 11 case and which acknowledges that the debtor has read and understood the notice. However, I’m not aware that any Chapter 11 individual debtor has ever been required to sign this form.
5 11 COLLIER ON BANKRUPTCY ¶¶ 1.03, 2.03, 2.07, 3.01, 3.02, 3.03 and 3.06 (16th ed.). has a discussion of issues arising out of §§ 1398 and 1399, some of which are discussed herein, which would impress the reader as a collection of arguments similar to arguments as to how many angels can dance on the head of a pin. However, failure to do the dance can be detrimental to a debtor’s advisers who ignore the dance, while advisers who represent creditors, debtors and guardians of the federal and state fiscs are good dancers.
6 When an estate terminates for income tax purposes, and income is no longer included in the estate, is not necessarily easy to determine. See supra note 5. Generally, in a Chapter 11 plan, in addition
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conversion to Chapter 12 or 13 will continue inclusion of post-petition income in the estate notwithstanding section 1186(a). Section 1190(2) seems to make the trustee responsible for administration of what may be income of the estate after confirmation.
B. Tax Substantive Law Fundamentals
All bankruptcy lawyers filing bankruptcy cases for individuals are expected to know some fundamental tax laws applicable in bankruptcy cases of individuals. Oftenthesefundamentals areoverlookedandthepersonsresponsibleforcompliance with the tax laws escape consequences simply because these fundamentals are not known by the debtors and creditors affected by noncompliance with these laws or by judges charged with confirming only plans which conform to these laws. These are:
1. The bankruptcy estate of an individual in Chapter 7 and 11 cases is a taxable entity separate from the individual debtor.7
2. The gross income of the estate under title 26 U.S.C. includes the gross income of the individual debtor to which the estate is entitled under title 11 U.S.C.8
3. The individual debtor may elect to terminate the debtor’s tax year as of the case commencement date in order to allow prepetition income tax liabilities of the debtor for the year of filing to be paid by the debtor’s estate if the estate has assets.9
to an “effective date” there should also be an explicit “not effective” date.
7 I.R.C. § 1398 (2023) How much of what is discussed here applies to bankruptcy estates of individuals for state income tax purposes warrants an exegesis solely on this subject. I don’t even concede that there is a California income tax law which imposes an income tax on bankruptcy estates of individuals. See E. Martin, In Bankruptcy Planning Consider Federal and State Law, TAXATION FOR ACCOUNTANTS, May 1991 at 285; E. Martin, In Bankruptcy Planning Consider Federal and State Law, TAXATION FOR LAWYERS, August 1991 at 23. I litigated this issue in In re Hollingsworth, CaseNo.2:96-bk-52815 (Bankr.C.D.Cal.1996). Californiasettledinasealedsettlementagreement, Docket No. 579, when threatened with having to refund every tax ever collected by California from the bankruptcy estate of an individual, Chapter 7 or 11
8 Id.
9 Id. See In re Turboff, 93 B.R. 523 (Bankr. S.D. Tex. 1988) (debtor failed to elect to close his tax year when he filed his bankruptcy case on July 27, 1987, and accordingly the debtor was required to
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4. A trustee or debtor in possession is required to file annual income tax returns for the debtor’s estate and pay any income taxes due.10
5. The bankruptcy estate of an individual in a Chapter 12 or 13 case is not a taxable entity separate from the debtor.11
6. If the debtor owns interests in pass through entities (partnerships, LLCs or Subchapter S corporations) the income or losses for the entire year of filing pass through to the estate.12
7. If an individual owns interests in pass through entities which file a bankruptcy case any income earned by the pass through entities will be taxed to the individual even though all cash owned by the entities will go to the entity’s creditors.13
8. If an individual owns property which has no equity and if sold will generate a taxable gain the filing of a bankruptcy case by the individual will convert the gain from potentially not taxable to taxable.14
pay income taxes on 1987 income incurred before his case commencement even though all of his property went to his bankruptcy estate). Special issues arise if only one spouse files a bankruptcy case, especially in community property states.
10 Turboff, 93 B.R. 523 See also I.R.C. § 6012(a)(8) and (b)(3) and (b)(4) (2023)
11 Turboff, 93 B.R. 523 See also I.R.C. § 1399 (2023)
12 I R S Chief Counsel Advice Memorandum 200217003 (Dec 14, 2001), citing Gulley v. Comm’r, T.C.M. 2000-190, 79 T.C.M. (CCH) 2171 (2000) and Katz v. Comm’r, 116 T.C. 5 (2001).
13 E. Martin, To File an Income Tax Return or Not to File – What Should a LLC Chapter 7 Trustee Do?, 35CAL. BANKR.J. 171 (2020).
14 For example, a foreclosure of a lien on real estate before filing of a case could generate income which is not subject to taxation because I.R.C. § 108 (2023) considers debt of an insolvent debtor discharged to be not taxable. However, if the debtor owned the property when he filed his case and the trustee abandoned the property back to the debtor after which it was foreclosed, then the gain on the sale is capital gain on which the debtor must pay income taxes. See E. Martin, Is Debt Cancellation Income Resulting From a Discharge of Nonrecourse Debt in Foreclosures in 2009 and 2010 excludible from income or eligible for deferral?, 30 CAL. BANKR.J. 313, 319 n.13:
ItshouldbenotedinpassingthatasappliedbytheIRS thereisa trap fortheunwary bankruptcy attorney here because recourse debt is converted into nonrecourse debt by a bankruptcy discharge. See Priv. Ltr. Rul. 8918016 (Jan. 31, 1989). Accordingly, foreclosure of property owned by a debtor post-discharge and after abandonment or case closing would result in taxable gain under the present
Vol. 36 Cal. Bankr. J. No. 2 (2023) 142
9. An abandonment of an asset from an individual’s estate will for tax purposes result in the asset being considered always an asset of the individual.15
10. If a trustee does not abandon an asset which has no equity and the asset is disposed of by the estate through foreclosure or otherwise and the disposition generates a taxable gain for the estate the trustee may be personally liable for the tax on the gain either to creditors of the estate if there are other assets or to the IRS.16
C. Tax Procedural Law Fundamentals.
Although it may be difficult to determine what the income of a Subchapter V case estate may be, the reporting of that income and payment of taxes on that income, whatever it is, is similar in both Chapter 11 cases in general and in Subchapter V cases in particular.
In all Chapter 11 cases, including those under Subchapter V, a plan may not be confirmed unless all prepetition and post-petition returns are filed and taxes reported are paid. If a plan is consensual then there may be no income taxes on personal service income of the debtor for the estate to report and pay because the income will not be the estate’s property. If the plan is not consensual then the plan cannot be confirmed until the returns are filed for the income and the taxes on the income are paid. Strangely this seems to require the debtor to solicit acceptances of a plan before a plan can be the subject of a disclosure statement or a plan proposal.
interpretation of § 1.1001-2, whereas in a pre-bankruptcy foreclosure the gain would generally be excluded from taxable income by § 108. Consequently every bankruptcy case which includes encumbered real property with recourse debt requires a tax analysis under § 1001 as well as § 1398. The latter relates to the electiontoterminatethedebtor'staxyearuponcommencementofacasecontaining assets, which, although it is a tax law, should be considered to be within the responsibility of bankruptcy lawyers to advise their clients, at least to the extent that they must seek timely tax counsel as to the advisability of that election. Many consumer bankruptcy lawyers have a standard § 1398 provision in their retainer agreement and those that do not, should.
15 Mason v. Comm’r, 646 F.2d 1309 (9th Cir. 1980).
16 See note 14 supra.
143 Vol. 36 Cal. Bankr. J. No. 2 (2023)
1. 11 U.S.C. § 1184 (small business debtors under Subchapter V must comply with the requirements of section 1106(a)(6).
2. 11 U.S.C. § 1191(a) (providing that requirements of section 1112 apply in Subchapter V).
3. 11 U.S.C. § 1191(a) (applying section 1129(a)(2)’s “Code compliance” confirmation requirement to cases under Subchapter V).
4. 11 U.S.C. § 1112(b)(4)(I) (debtors must “timely pay taxes owed after the date of the order for relief” or face conversion or dismissal of case).
II. Subchapter V belongs in Chapter 11 But Subchapter V Cases May Have Income Tax Issues Different From Other Chapter 11 Cases.
Ironically it may be observed that the similarities between Subchapter V and Chapters 12 and 13 have createdinquirybybankruptcylawyersintowhether income tax issues in Subchapter V cases are the same or similar to those in Chapters 12 and 13. The general answer is that the same tax laws apply in all subchapters of Chapter 11 and in Chapters 12 and 13, but they apply in some respects differently because of the different property rights regulated by the different chapters. Also, there is no doubt about whether Subchapter V is in Chapter 11 despite resembling Chapters 12 and 13.
The attempt to transport income tax concepts between the chapters of the Bankruptcy Code often creates complicated controversies. Section 1232 of the Bankruptcy Code resulted from one of such complicated controversies. In Hall v. United States17 the Chapter 12 debtor sold property of his estate and the sale resulted in a tax due as a result of the sale. The debtor claimed that the tax was due from the estate and not from him. The Supreme Court held that the income tax from the sale of the property of the estate could not be “incurred by the estate” because for tax purposes a Chapter 12 case does not create an estate separate from the debtor and therefore “the tax liability resulting from Petitioners’ post-petition farm sale . . . is neither collectible [from the estate] nor dischargeable in the Chapter 12 plan.”
Section 1232 was enacted to allow the income taxes resulting from the sale of farm property to be paid from the Chapter 12 estate and to be discharged. A
17 566 U.S. 506 (2012).
Vol. 36 Cal. Bankr. J. No. 2 (2023) 144
review of the court decisions applying section 1232 reveals how an income tax controversy which arose from the application of the Internal Revenue Code in a bankruptcy case continues to live on even after enactment of section 1232 which was intended to end that controversy.
The bottom line of all this discussion about I.R.C. §§ 1398 and 1399 is that lawyers and accountants should be careful about considering these sections in any bankruptcy case involving an individual because while the lawyers and accountants in the case may, and often do, ignore these tax laws, the lawyers and accountants representing creditors, debtors and government entities may be aware of and enforce them. One CPA who lives and breathes bankruptcy told me that during his entire long career dealing with bankruptcy tax issues he had never even once filed an election to terminate an individual’s tax year as of the date of the commencement of the debtor’s bankruptcy case and had never even heard of such an election. As noted above, this can have unfortunate consequences for the accountant as it did for the bankruptcy lawyers in the case cited above.18
145 Vol. 36 Cal. Bankr. J. No. 2 (2023)
18
See supra note 9.
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AUTHORITIES Page 147 Vol. 36 Cal. Bankr. J. No. 2 (2023)
Allen v. State Bar 20 Cal. 3d 172, 141 Cal. Rptr. 808 (1977) 87 In re Antonious 373 B.R. 400 (Bankr. E.D. Pa. 2007).........................................................................................95 In re Applebaum 422 B.R. 684 (B.A.P. 9th Cir. 2008)............................................................................78, 86, 119 Arnold v. First Citizens Nat’l Bank (In re Cornerstone Holmes, Inc.) 567 B.R. 37 (Bankr . W.D.N.Y. 2016).....................................................................................106 Babaee v. Marshack (In re Babaee) 2022 Bankr. LEXIS 1713, 2022 WL 2191369 (B.A.P. 9th Cir. June 17, 2022)...........................................................................................passim Bank of Am., N.A. v. Caulkett 575 U.S. 790, 135 S. Ct. 1995 (2015) 118 Barber v. Westbay (In re Integrated Agri, Inc.) 313 B.R. 419 (Bankr. C.D. Ill. 2004) 96 Barclay v. Boskoski 52 F.4th 1172 (9th Cir. 2022)...........................................................................................136, 137 In re Barnes 275 B.R. 889 (Bankr. E.D. Cal. 2002).......................................................................................85 Briggs v. Kent (In re Prof’l Inv. Props. of Am.) 955 F.2d 623 (9th Cir. 1992)....................................................................................................106 In re Brown Adv. No. 15-90085-MM, 2018 WL 2308267, at *8, (B.A.P. 9th Cir. May 21, 2018)................................................................................................106 In re Bunn-Rodemann 491 B.R. 132 (Bankr. E.D. Cal. 2013) 135 Burtch v. Revchem Composites, Inc. (In re Sierra Concrete Design, Inc.) 463 B.R. 302 (Bankr. D. Del. 2012) 74 Butler v. Beckinson, Dickinson & Co. (In re Loomer) 198 B.R. 755 (Bankr. D. Neb. 1996)....................................................................................91, 92 Butner v. United States 440 U.S. 48 (1979)...................................................................................................................118 California v. PG & E Corp. (In re Pac. Gas & Elec. Co.) 281 B.R. 1 (Bankr. N.D. Cal. 2002) 96 Cardiello v. Arbogast (In re Arbogast) 466 B.R. 287 (Bankr. W.D. Pa. 2012), aff’d, 479 B.R. 661 (W.D. Pa. 2012), aff’d, 533 F. App’x 150 (3d Cir. 2013) 91, 96, 100 In re Carter 182 F.3d 1027 (9th Cir. 1999)....................................................................................................82
CASES
AUTHORITIES Page Vol. 36 Cal. Bankr. J. No. 2 (2023) 148 In re Celsius Network LLC 22-10964, 2023 Bankr. LEXIS 2 (Bankr. S.D.N.Y. Jan. 4, 2023).................................68, 69, 70 CF &I Steel Corp. v. Conners (In re CF &I Fabricators of Utah Inc.) 163 B.R. 858 (Bankr. D. Utah 1994) .........................................................................................92 City Nat’l Bank v. Chabot (In re Chabot) 100 B.R. 18 (Bankr. C.D. Cal. 1989), aff’d, 131 B.R. 720 (C.D. Cal. 1991), aff’d, 992 F.2d 891 (9th Cir. 1993) 97 In re Clemmer 184 B.R. 935 (Bankr. E.D. Tenn. 1990) 86 Coastline JX Holdings LLC v. Bennett 80 Cal. App. 5th 985 296 Cal. Rptr. 3d 437 (Cal. Ct. App. 2022) 97 Coggin v. Reynolds (In re Coggin) 30 F.3d 1443 (11th Cir. 1994), abrogated on other issues, Kontrick v. Ryan 540 U.S. 443 (2004)...................................................................................................................90 Cohen v. Sikirica 487 B.R. 615 (W.D. Pa. 2013)...................................................................................................96 Crews v. First Colony Life Ins. Co. (In re Barker) 168 B.R. 773 (Bankr. M.D. Fla. 1994) 81 In re CRS Steam, Inc. 217 B.R. 365 (Bankr. D. Mass. 1998) 93 Curry v. Castillo 297 F.3d 940 (9th Cir. 2002)....................................................................................................108 Dewsnup v. Timm 502 U.S. 410, 112 S. Ct. 773 (1992)........................................................................................118 In re Diaz 547 B.R. 329 (B.A.P. 9th Cir. 2016) 83 In re Dolata 306 B.R. 97 (Bankr. W.D. Pa. 2004) 90 Duckor, Spradling & Metzer v. Baum Trust (In re P.R.T.C., Inc.) 177 F.3d 774 (9th Cir. 1999)....................................................................................................106 In re Dudley 72 F. Supp. 943 (S.D. Cal. 1947), aff’d, Goggin v. Dudley, 166 F.2d 1023 (9th Cir. 1948) 101, 102 Duhart v. O’Rourke 90 Cal App. 2d 277, 221 P.2d 767 (1950)................................................................................104 In re Duncan 329 F.3d 1195 (10th Cir. 2003)......................................................................................84, 88, 89
AUTHORITIES Page 149 Vol. 36 Cal. Bankr. J. No. 2 (2023) Edgefield Holdings, LLC v. Gilbert No. 02-17-00359-CV, 2018 WL 4495566, at **3, 8-10, (Ct. App. Tex. Sept. 20, 2018) 91 English v. Gen. Elec. Co. 496 U.S. 72 (1990) 97 In re Engman 395 B.R. 610 (Bankr. W.D. Mich. 2008) passim Faith v. Inline Distrib. Co. (In re Newton Enters.) Nos. 9:13-bk-12388-PC, 9:14-ap-01127-PC, 2015 Bankr. LEXIS 1831, at *6 (Bankr. C.D. Cal. June 3, 2015) 73 First Midwest Bank v. RMG Sports Group LLC No. CV 05872, 2021 WL 4206784, at *6, (N.D. Ill. Sept. 16, 2021) 95 First Tex. Savs. Ass’n v. Reed (In re Reed) 700 F.2d 986 (5th Cir. 1983) 87 Gill v. Stern (In re Stern) 345 F.3d 1036 (9th Cir. 2003)..................................................................................................102 In re Goff 706 F.2d 574 (5th Cir. 1983)......................................................................................................93 Goggin v. Dudley 166 F.2d 1023 (9th Cir. 1948) 102 Goodrich v. Fuentes (In re Fuentes) No. 2:15-cv-2080-MWF, 2015 WL 13916914, at **6-8, (C.D. Cal. Sept. 23, 2015); aff’d, In re Fuentes, 687 F. App’x 542 (9th Cir. 2017)..................................................................89, 90 Gouveia v. Pulley (In re Pulley) 111 B.R. 715 (Bankr. N.D. Ind. 1989).......................................................................................93 In re Gray 523 B.R. 170 (B.A.P. 9th Cir. 2014) 81 Greenfeld v. Goldschein (In re Goldschein) 241 B.R. 370 (Bankr. D. Md. 1999) 92 In re Greenfield 65 F. App’x 549 (6th Cir. 2003) ..............................................................................84, 88, 89, 90 Grogan v. Garner 498 U.S. 279 (1991).................................................................................................................133 Gulda v. Second Nat’l Bank of Boston 323 Mass. 100, 80 N.E.2d 12 (Sup. Jud. Ct. 1948) 95 Gulley v. Comm’r T.C.M. 2000-190, 79 T.C.M. (CCH) 2171 (2000) 142 Hagan v. Mickens 589 B.R. 594 (W.D. Mich. 2018) 84, 89
AUTHORITIES Page Vol. 36 Cal. Bankr. J. No. 2 (2023) 150 Hall v. United States 566 U.S. 506 (2012).................................................................................................................144 Halperin v. Moreno (In re Green Field Energy Servs.) 585 B.R. 89 (Bankr. D. Del. 2018) ............................................................................................74 In re Handy 624 F.3d 19 (1st Cir. 2010)........................................................................................................95 Hanson v. Denckla 357 U.S. 235 (1958) 94 In re Harrell 212 B.R. 174 (Bankr. S.D. Ga. 1997) 84 Hauge v. Murphy No. 09-CV-143-J, 2010 WL 11596870, at *3, (D. Wyo. Apr. 6, 2010) 96 Heckert v. Heckert No. 02-19-00298-CV, 2020 WL 2608338, at **4-5 (Tex. App. May 21, 2020), 91 In re Henderson 167 B.R. 67 (Bankr. N.D. Miss. 1993) 93 In re Henkel 11 F. Cas. 1124 (D. Cal. 1872) ................................................................................................104 Hillsborough Cnty., Fla. v. Automated Med. Labs., Inc. 471 U.S. 707 (1985)...................................................................................................................97 Holden v. Williams 167 Cal. App.2d 313, 334 P.2d 291 (1959)..............................................................................104 In re Hurt 542 B.R. 798 (Bankr. E.D. Tenn. 2015) 87, 89, 90 In re Jackson 472 F.2d 589 (9th Cir. 1973) 101 In re Jin Qing Li No. NC-17-1062-STaB, 2018 WL 1354548, at*8, (B.A.P. 9th Cir. Mar. 12, 2018) 96 JMS Labs Ltd. (U.S.A.) v. Silver Eagle Labs., Inc. (In re Lockwood) 414 B.R. 593 (Bankr. N.D. Cal. 2008).................................................................................95, 96 Katz v. Comm’r 116 T.C. 5 (2001).....................................................................................................................142 In re Kaypro 218 F.3d 1070 (9th Cir. 2000) 73 In re Kellogg 179 B.R. 379 (Bankr. D. Mass. 1995) 93 Kemp v. Enemark 194 Cal. 748, 230 P. 441 (1924) 104
AUTHORITIES Page 151 Vol. 36 Cal. Bankr. J. No. 2 (2023) In re Khurana Adv. No. 3:19-ap-07001-TLM, 2019 WL 7372664, at **2, 5 & n.8, (B.A.P. 9th Cir. Dec. 16, 2019) 95 Klingman v. Levinson (In re Klingman) 158 B.R. 109 (N.D. Ill. 1993) 97 In re Koubourlis 869 F.2d 1319 (9th Cir. 1989) 72 In re Kravitz 225 B.R. 515 (Bankr. D. Mass. 1998)........................................................................................80 In re Kuhnel 495 F.3d 1177 (10th Cir. 2007)......................................................................................84, 88, 89 In re KVN Corp., Inc. 514 B.R. 1 (B.A.P. 9th Cir. 2014) 120 In re Lahijani 325 B.R. 282 (B.A.P. 9th Cir. 2005) 106 Lauder v. Jacobs, 10 Misc. 3d 1052(A), at *4-5, 809 N.Y.S.2d 482 (N.Y. Surr. Ct. 2005), aff’d, 35 A.D.3d 822, 826 N.Y.S.2d 719 (Sup. Ct. App. Div. 2006) 91 Law v. Siegel 571 U.S. 415 (2014).....................................................................................................81, 82, 126 In re Lee 889 F.3d 639 (9th Cir. 2018)................................................................................................83, 84 Levine v. Cent. States Se. and Sw. Areas Pension Fund (In re Ottawa Cartage, Inc.) 55 B.R. 371 (N.D. Ill. 1985) ......................................................................................................93 In re Levine 134 F.3d 1046 (11th Cir. 1998) 88 Local Loan Co. v. Hunt 292 U.S. 234 (1934) 133 Love v. Menick 341 F.2d 680 (9th Cir. 1965)....................................................................................................101 Lujan v. Defenders of Wildlife 504 U.S. 555 (1992).................................................................................................................120 Majteles v. AVL Corp. 182 Misc.2d 140, 696 N.Y.S.2d 748 (Sup. Ct. 1999), adhered to on reargument, No. 933/99, 2000 WL 35921144 (N.Y. Sup. Ct. Jan. 26, 2000) 91 Malis v. Zinman 436 Pa. 592, 261 A.2d 875 (Sup. Ct. 1970) ...............................................................................95 In re Masingale 644 B.R. 530 (B.A.P. 9th Cir. 2022)..........................................................................................85 McGraw v. Betz (In re Bell & Beckwith 5 F.3d 150 (6th Cir. 1993) 93
AUTHORITIES Page Vol. 36 Cal. Bankr. J. No. 2 (2023) 152 In re McIntyre 222 F.3d 655 (9th Cir. 2000).....................................................................................................93 In re McNamara 273 B.R. 132 (E.D. Mich. 2002)................................................................................................88 Miguel v. Walsh 447 F.2d 724 (9th Cir. 1971)............................................................................................103, 104 Milavetz, Gallop & Milavetz, P.A. v. United States 559 U.S. 229 (2010) 103 Millbury Nat’l Bank v. Palumbo (In re Palumbo) 353 B.R. 37 (Bankr. D. Mass. 2006) 95 MOAC Mall Holdings LLC v. Transform Holdco LLC ___ U.S. ___, 142 S. Ct. 2867 (2022)......................................................................................137 Mott v. Groves 428 F.2d 1208 (9th Cir. 1970)..................................................................................................101 Moyer v. Rosich (In re Rosich) 570 B.R. 278 (Bankr. W.D. Wis. 2017) 84, 88, 90 Nagel v. Westen 59 Cal App. 5th 740 (Cal. Ct. App. 2021) 103 Nat’l Am. Ins. Co. v. Ruppert Landscaping Co., 187 F.3d 439 (4th Cir. 1999)......................................................................................................96 Owen v. Owen 500 U.S. 305, 111 S. Ct. 1833, 114 L. Ed. 2d 350 (1991) .......................................................137 In re Page 240 B.R. 548 (Bankr. W.D. Mich. 1999)...................................................................................88 Palmdale Hills Prop. v. Lehman Com. Paper, Inc. (In re Palmdale Hills Prop., LLC) 654 F.3d 868 (9th Cir. 2011)....................................................................................................128 Parker v. Riddell 41 Cal. App. 2d 908, 108 P.2d 88 (1940) 104 Pereira v. United Parcel Serv. of Am., Inc. (In re Waterford Wedgwood USA, Inc.) 508 B.R. 821 (Bankr. S.D.N.Y. 2014) 73 In re Perez 628 B.R. 327 (B.A.P. 9th Cir. 2021)..........................................................................................84 Podell v. Podell (In re Davis) 785 F.2d 926 (11th Cir. 1986)..................................................................................................106 Preblich v. Battley 181 F.3d 1048 (9th Cir. 1999) 84 Randall v. Buffington 10 Cal. 491 (1858) 104 Reid v. Wolf (In re Wolf) 595 B.R. 735 (Bankr. N.D. Ill. 2018) 90
AUTHORITIES Page 153 Vol. 36 Cal. Bankr. J. No. 2 (2023) Renneker v. Wyman (In re Wyman) 626 B.R. 480 (Bankr. S.D. Ohio 2021)................................................................................84, 86 Roosevelt v. Ray (In re Roosevelt) 176 B.R. 200 (B.A.P. 9th Cir. 1994)..........................................................................................81 Rountree v. Nunnery (In re Rountree) 448 B.R. 389 (Bankr. E.D. Va. 2011)........................................................................................95 Salven v. Munday (In re Kemmer) 265 B.R. 224 (Bankr. E.D. Cal. 2001) 84, 104 In re Sears Holdings Corp. No. 20-1846-BK, 2021 WL 5986997, at *2 (2d Cir. Dec. 17, 2021) 137 Shah v. Baloch 244 Ariz. 129, 418 P.3d 902 (Ct. App. 2017) ...........................................................................91 In re Shailam 144 B.R. 626 (Bankr. N.D.N.Y. 1992).......................................................................................92 Shearer v. Oberdick (In re Oberdick) 490 B.R. 687 (Bankr. W.D. Pa. 2013) 96 Sherwood Partners, Inc. v. Lycos, Inc. 394 F.3d 1198 (9th Cir. 2005) 97 Shinn v. MacPherson 58 Cal. 596 (1881) ...................................................................................................................104 In re Sholdan 217 F.3d 1006 (8th Cir. 2000)....................................................................................................82 Sigma Micro Corp. v. Healthcentral.com (In re Healthcentral.com) 504 F.3d 775 (9th Cir. 2007)......................................................................................................73 Sikirica v. Wettach 511 B.R. 760 (W.D. Pa. 2014), aff’d, 811 F.3d 99 (3d Cir. 2016).........................................................................................................96 In re Sinclair 563 B.R. 554 (Bankr. E.D. Cal. 2017) 83 SIPC v. Bernard L. Madoff Inv. Sec. LLC 631 B.R. 1 (Bankr. S.D.N.Y. 2021) 93 Stark v. Pryor (In re Stark) 2022 U.S. Dist. LEXIS 114275, 2022
Bankr. Ct. Dec. 181 (E.D.N.Y. June 28, 2022) passim Sterling Die Casting Co. v. Local 365 UAW Welfare & Pension Fund (In re Sterling Die Casting Co., Inc.) 118 B.R. 205 (Bankr. E.D.N.Y. 1990) 93 In re Stijakovich-Santilli 542 B.R. 245 (B.A.P. 9th Cir. 2015) 83 Stornawaye Fin. Corp. v. Hill (In re Hill) 562 F.3d 29 (1st Cir. 2009) 89
WL 2316176, 71
AUTHORITIES Page Vol. 36 Cal. Bankr. J. No. 2 (2023) 154 Strauss v. Cole (In re Mamtek) 588 B.R. 72 (Bankr. W.D. Mo. 2018)......................................................................................104 Sulmeyer v. Pacific Suzuki (In re Grand Chevrolet, Inc.) 25 F.3d 728, 732 (9th Cir. 1994)................................................................................................73 In re Summerell 194 B.R. 818 (Bankr. E.D. Tenn. 1996).....................................................................................86 Summerlin v. Turnage No. 5:22-cv-00122-KDB-DSC, 2023 WL 2496181 (W.D.N.C. Mar. 14, 2023) passim SuVicMon Dev., Inc. v. Morrison 991 F.3d 1213 (11th Cir. 2021) 95 In re Swift 124 B.R. 475 (Bankr. W.D. Tex. 1991)...............................................................................81, 86 Tavenner v. Smoot 257 F.3d 401 (4th Cir. 2001)................................................................................................88, 89 Taylor v. Freeland & Krontz 503 U.S. 638 (1992) 84 In re Tessmer 329 B.R. 776 (Bankr. M.D. Ga. 2005) 96 Titus v. Shearer 498 B.R. 508 (W.D. Pa. 2013)...................................................................................................96 In re Tribune Co. Fraudulent Conveyance Litig. 499 B.R. 310 (S.D.N.Y. 2013)...................................................................................................96 In re Turboff 93 B.R. 523 (Bankr. S.D. Tex. 1988)...............................................................................141, 142 Unisys Corp. v. Dataware Prods., Inc. 848 F.3d 311 (1st Cir. 1988) 96 United States v. Floersch 276 F.2d 714 (10th Cir. 1960) 95 United States v. Westley 7 F. App’x 393 (6th Cir. 2001) ..................................................................................................95 In re Vandevort No. LA-05-23588-EC, 2009 WL 7809927, at *6, (B.A.P. 9th Cir. Sept. 8, 2004).......................................................................................95, 96, 97 In re Veal 450 B.R. 897 (B.A.P. 9th Cir. 2011)................................................................................120, 121 Velis v. Kardanis 949 F.2d 78 (3d Cir. 1991) 93 Wagner v. Galbreth 500 B.R. 42 (D.N.M. 2013) 92, 93 Wagner v. Ultima Homes, Inc. (In re Vaughan Co., Realtors) 493 B.R. 597 (Bankr. D.N.M. 2013) 92, 93
AUTHORITIES Page 155 Vol. 36 Cal. Bankr. J. No. 2 (2023) Wansdown Props. Corp. N.V. v. Azari (In re Wansdown Props. Corp. N.V.) No. 19-13223 (DSJ), 2022 WL 16749078, at**13-14 (Bankr. S.D.N.Y. Nov. 7, 2022) .........106 In re White 221 F. Supp. 64 (N.D. Cal. 1963) ....................................................................................102, 103 In re Wilson 123 F. 20 (9th Cir. 1903)..................................................................................................103, 136 In re Wilson 494 B.R. 502 (Bankr. C.D. Cal. 2013) 136 In re Woodson 839 F.2d 610 (9th Cir. 1988) 85 Wudrick v. Clements 451 F.2d 988 (9th Cir. 1971)....................................................................................100, 101, 102 STATUTES 11 U.S.C. § 101 75, 118, 119 11 U.S.C. § 101(3)........................................................................................................................103 11 U.S.C. § 101(4A) 103 11 U.S.C. § 101(5)........................................................................................................................118 11 U.S.C. § 101(8)........................................................................................................................103 11 U.S.C. § 101(12A) 103 11 U.S.C. § 101(37)......................................................................................................................118 11 U.S.C. § 101(51) 118 11 U.S.C. § 102(1)........................................................................................................................107 11 U.S.C. § 363........................................................................................................................passim 11 U.S.C. § 363(b) 66, 120, 137 11 U.S.C. § 363(b)(1) .....................................................................................................68, 109, 111 11 U.S.C. § 363(c) 66 11 U.S.C. § 363(c)(1) 68 11 U.S.C. § 363(f).........................................................................................................................120 11 U.S.C. § 363(m) passim 11 U.S.C. § 502(h)..........................................................................................................................71 11 U.S.C. § 503(b)(3)(B)..............................................................................................................106 11 U.S.C. § 503(b)(4) 106 11 U.S.C. § 506.............................................................................................................................118 11 U.S.C. § 510 118 11 U.S.C. § 521(a)(2) 119 11 U.S.C. § 522.......................................................................................................................90, 119 11 U.S.C. § 522 (c)(1) 85 11 U.S.C. § 522 (d).........................................................................................................................86 11 U.S.C. § 522(b) 80 11 U.S.C. § 522(b)(1) 78, 119 11 U.S.C. § 522(b)(2) ...................................................................................................................119
AUTHORITIES Page Vol. 36 Cal. Bankr. J. No. 2 (2023) 156 11 U.S.C. § 522(b)(3) .....................................................................................................................99 11 U.S.C. § 522(b)(3)(A).........................................................................................................passim 11 U.S.C. § 522(b)(3)(C) passim 11 U.S.C. § 522(b)(4) ...................................................................................................................100 11 U.S.C. § 522(b)(4)(A) 100 11 U.S.C. § 522(b)(4)(B)..............................................................................................................100 11 U.S.C. § 522(c) 80, 85, 89, 105 11 U.S.C. § 522(d) 78, 80, 86, 119 11 U.S.C. § 522(d)(12) ...................................................................................................99, 100, 105 11 U.S.C. § 522(d)(2) 78 11 U.S.C. § 522(f).........................................................................................................................137 11 U.S.C. § 522(f)(1)(A).................................................................................................................80 11 U.S.C. § 522(g) passim 11 U.S.C. § 522(g)(1) ...................................................................................................84, 88, 89, 99 11 U.S.C. § 522(k) 85, 89, 105 11 U.S.C. § 522(l) 82 11 U.S.C. § 522(n)....................................................................................................................80, 99 11 U.S.C. § 522(o) passim 11 U.S.C. § 522(p)...................................................................................................................passim 11 U.S.C. § 522(q)..............................................................................................................81, 83, 87 11 U.S.C. § 522(q)(2) 99 11 U.S.C. § 523(13)........................................................................................................................85 11 U.S.C. § 523(a)(1) 80, 85 11 U.S.C. § 523(a)(2)......................................................................................................................87 11 U.S.C. § 523(a)(5)......................................................................................................................80 11 U.S.C. § 524 (a)(1) 94 11 U.S.C. § 524(a)(2)......................................................................................................................94 11 U.S.C. § 526(a)(4) 103 11 U.S.C. § 526(c) 103 11 U.S.C. § 541.............................................................................................................................119 11 U.S.C. § 541(a) 66 11 U.S.C. § 541(a)(1)......................................................................................................................66 11 U.S.C. § 541(b)(1) .....................................................................................................................66 11 U.S.C. § 541(c)(2) 91 11 U.S.C. § 542(c)(2)......................................................................................................................91 11 U.S.C. § 544(a) 95 11 U.S.C. § 544(b) 87, 95 11 U.S.C. § 546(a)..........................................................................................................................88 11 U.S.C. § 546(e) 74, 75 11 U.S.C. § 547...................................................................................................................66, 71, 93 11 U.S.C. § 547(b) 66, 72 11 U.S.C. § 547(c)(2) 73
AUTHORITIES Page 157 Vol. 36 Cal. Bankr. J. No. 2 (2023) 11 U.S.C. § 547(c)(2)(A)................................................................................................................73 11 U.S.C. § 547(c)(2)(B) ................................................................................................................73 11 U.S.C. § 547(c)(3) 74 11 U.S.C. § 547(f)...........................................................................................................................72 11 U.S.C. § 548 passim 11 U.S.C. § 548(a)..........................................................................................................................74 11 U.S.C. § 548(a)(1)(A) 87 11 U.S.C. § 550 71, 87, 91, 92 11 U.S.C. § 550(a)....................................................................................................................90, 95 11 U.S.C. § 551 106 11 U.S.C. § 707(a)..........................................................................................................................87 11 U.S.C. § 724(b)........................................................................................................................126 11 U.S.C. § 725 passim 11 U.S.C. § 726.....................................................................................................................109, 118 11 U.S.C. § 727(a)(1) 87 11 U.S.C. § 727(a)(2)(A) 87 11 U.S.C. § 741...............................................................................................................................75 11 U.S.C. § 761 75 11 U.S.C. § 1106(a)(6)..................................................................................................................144 11 U.S.C. § 1112...........................................................................................................................144 11 U.S.C. § 1112(b) 87 11 U.S.C. § 1112(b)(4)(I) .............................................................................................................144 11 U.S.C. § 1115 140 11 U.S.C. § 1129(a)(2)..................................................................................................................144 11 U.S.C. § 1141(b)................................................................................................................96, 140 11 U.S.C. § 1181 140 11 U.S.C. § 1184...........................................................................................................................144 11 U.S.C. § 1186 139 11 U.S.C. § 1186(a) 139, 140, 141 11 U.S.C. § 1190(2)......................................................................................................................141 11 U.S.C. § 1191(a) 139, 144 11 U.S.C. § 1191(b)......................................................................................................................139 11 U.S.C. § 1208(c)........................................................................................................................87 11 U.S.C. § 1228(a) 96 11 U.S.C. § 1228(c)........................................................................................................................96 11 U.S.C. § 1232 144, 145 11 U.S.C. § 1307(c) 87 11 U.S.C. § 1328(a)........................................................................................................................96 11 U.S.C. § 1328(c) 96 18 U.S.C. § 152(7)..........................................................................................................................87 18 U.S.C. § 157 87 18 U.S.C. § 3613 85
AUTHORITIES Page Vol. 36 Cal. Bankr. J. No. 2 (2023) 158 26 U.S.C. § 6321.............................................................................................................................85 26 U.S.C. § 6331.............................................................................................................................85 26 U.S.C. § 6334 85 29 U.S.C. § 1056(d)(1) .............................................................................................................90, 94 29 U.S.C. § 1144(d) 93 Bankruptcy Reform Act of 1978.....................................................................................................98 Bankruptcy Reform Act of 1994 80 CAL CIV CODE § 3439.07(3)(C) 106 CAL. CIV. CODE § 3439.09(a) .........................................................................................................87 CAL CIV PROC CODE § 703.130 79 CAL. CIV. PROC. CODE § 703.130.................................................................................................119 CAL. CIV. PROC. CODE § 703.140 .....................................................................................79, 85, 119 CAL CIV PROC CODE § 703.140(b) 119 CAL. CIV. PROC. CODE § 703.140(c).............................................................................................119 CAL CIV PROC CODE § 704 119 CAL CIV PROC CODE § 704.100(a) 85 CAL. CIV. PROC. CODE § 704.115(b)...............................................................................................85 CAL CIV PROC CODE § 704.730 119 CAL. CIV. PROC. CODE § 704.730(c).......................................................................85, 119, 121, 137 CAL. PENAL CODE § 531.................................................................................................................87 California Voidable Transactions Act 87 Employee Retirement Income Security Act of 1974 (“ERISA”).............................................passim ERISA § 1141(d) 93 I.R.C. § 108...................................................................................................................................142 I.R.C. § 401.....................................................................................................................................99 I.R.C. § 403 99 I.R.C. § 408.....................................................................................................................................99 I.R.C. § 408A 99 I.R.C. § 414 99 I.R.C. § 457.....................................................................................................................................99 I.R.C. § 501(a) 99 I.R.C. § 1398.................................................................................................................140, 141, 145 I.R.C. § 1399.................................................................................................................140, 142, 145 I.R.C. § 6012(a)(8) 142 I.R.C. § 6012(b)(3) .......................................................................................................................142 I.R.C. § 6012(b)(4) 142 N.Y. C.P.L.R. § 5206 123 N.Y. C.P.L.R. § 5206(a) .......................................................................................................120, 130 Small Business Reorganization Act of 2019, Pub. L. No. 116-54, 133 Stat. 1079..................................................................139, 140, 143, 144
AUTHORITIES Page 159 Vol. 36 Cal. Bankr. J. No. 2 (2023) OTHER AUTHORITIES 4 COLLIER ON BANKRUPTCY ¶ 725-02 (15th ed. 1993) 109 11 COLLIER ON BANKRUPTCY ¶¶ 1.03, 2.03, 2.07, 3.01, 3.02, 3.03 and 3.06 (16th ed.)...............140 124 CONG REC 11064, 11098 (Sept. 28, 1978) 109 124 CONG REC 17415 (Oct. 6, 1978) 109 Adkisson, Jay, California Increases Homestead Exemption in New Legislation, Forbes, https://www.forbes.com/sites/jayadkisson/2020/09/19/california-increases-homesteadexemption-in-new-legislation/?sh=37bdb18e197d (accessed Feb. 26, 2023)..........................137 AHART, ALAN M., ENFORCING JUDGMENTS AND DEBTS, Chapter 6E (2022)...............................105 Black's Law Dictionary (11th ed. 2019) 118 Carlson, David Gray, The Federal Law of Property: The Case of Inheritance Disclaimers and Tenancy by the Entireties, 75 WASH & LEE L.REV 3,171 (2018) 89 Countryman, Vern, For a New Exemption Policy in Bankruptcy, 14 RUTGERS L. REV. 678 (1960).................................................................................................78 Crocker, Samuel K., & Robert H. Waldschmidt, Impact of the 2005 Bankruptcy Amendments on Chapter 7 Trustees, 79 AM.BANKR.L.J. 333, 351 (2005)...............................86 Eisenberg, Theodore, Bankruptcy Law in Perspective, 28 U.C.L.A. L. REV. 953 (1981)..............79 Howard, Margaret, Exemptions Under the 2005 Bankruptcy Amendments: A Tale of Opportunity Lost, 79 AM. BANKR. L.J.397,405-06 (2005) .................................................86, 98 https://celsius.network/earn 67 https://coinmarketcap.com/charts/ ..................................................................................................65 https://www.coindesk.com/business/2023/01/05/crypto-layoffs-heres-the-grimcount-since-april/ 65 https://www.investopedia.com/terms/s /stablecoin.asp...................................................................68 https://www.moneycontrol.com/msite/wazirx-cryptocontrol-articles/a-beginners-guide-tocryptocurrency-article/#:~:text=What%20Is% 20Cryptocurrency%3F ,controlled%20by%20a%20central%20authority ......................................................................65 https://www.wlrk.com/webdocs/wlrknew/AttorneyPubs/WLRK.28224.22.pdf 67 I.R.B. 2006-40 (Oct. 2, 2006).......................................................................................................140 I.R.S. Chief Counsel Advice Memorandum 200217003 (Dec. 14, 2001) 142 I.R.S. Notice 2006-83...................................................................................................................140 Israel, Eric P. & Alphamorlai L. Kebeh, Debtors Beware: Exemption Planning in California Now Subject to Challenge, 35 CAL BANKR J. 317 (2021) 103 Jackson, Thomas H., The Fresh-Start Policy in Bankruptcy Law, 98 HARV L. REV 1393, 1445 (1985) 87 Kennedy, Frank R., Limitation of Exemptions in Bankruptcy, 45 IOWA L.REV. 445 (1960).........79 Martin III, Elmer Dean, Constitutional Limitations on Judicial Regulation of Market Mechanisms in Determining What is “Fair and Equitable” in Chapter 11 Cases: Radford Redux in North LaSalle and Bonner, 34 CAL. BANKR. J. 29 (2017)..........................113
AUTHORITIES Page Vol. 36 Cal. Bankr. J. No. 2 (2023) 160
State Law
TAXATION FOR ACCOUNTANTS
May 1991 ..............................................................................141 Martin III, Elmer Dean,
Bankruptcy Planning
Federal and State Law, TAXATION FOR LAWYERS, August 1991...................................................................................141 Martin III, Elmer Dean,
Debt Cancellation Income Resulting From a Discharge of
Debt in Foreclosures in 2009 and 2010 excludible from income or
for deferral?, 30 CAL BANKR J. 313, 319 n.13 142 Martin
(2016) ........................................113
35 CAL
ANKR
J.
(2020)..................................................................................................142 Ponoroff,
the Eve of Bankruptcy: Villains
of the Fresh Start?, 70 N.Y.U.L. REV.235 (1995) ..............................................................................................78, 79 www.dir.ca.gov/OPRL (Consumer Price Index Table-2020-2021 for California).........................................................85 RULES FED R. BANKR P.1007(b)(1) 82 FED. R. BANKR. P. 1007(c)..............................................................................................................82 FED. R. BANKR. P. 1009(a)..............................................................................................................82 FED R. BANKR P. 4003(a) 82 FED. R. BANKR. P. 4003(b)(1).........................................................................................................83 FED R. BANKR P.4003(b)(2) 83, 90 FED R. BANKR P.4003(b)(3) 83 FED. R. BANKR. P. 4003(c)..............................................................................................................82 FED R. BANKR P.4043(b)(1) 83 FED. R. BANKR. P. 6007(a)............................................................................................................113 FED. R. BANKR. P. 7001 to 7087...............................................................................................67, 75 FED R. BANKR P. 7002 67 FED. R. BANKR. P. 7003..................................................................................................................67 FED R. BANKR P. 9019 110, 116, 122 REGULATIONS 26 C.F.R. § 1.401(a)-13(b)(1).........................................................................................................92 26 C.F.R. § 1.401(a)-13(c)(1)...................................................................................................93, 94
Martin III, Elmer Dean, In Bankruptcy Planning Consider Federal and
,
,
In
Consider
Is
Nonrecourse
eligible
III, Elmer Dean, Section 553 and Setoff in Tax Controversies in Bankruptcy Cases; The Ninth Circuit’s Holding in Sokolow v. United States that the Supreme Court’s 1932 Decision in Lewis v. Reynolds Has Been Superseded, Should be Adopted in Every Circuit or Adopted By The Supreme Court, 33 CAL. BANKR. J. 471
Martin III, Elmer Dean, To File an Income Tax Return or Not to File –What Should a LLC Chapter 7 Trustee Do?,
. B
.
171
Lawrence & F. Stephen Knippenberg, Debtors Who Convert Their Assets on
or Victims
AUTHORITIES Page 161 Vol. 36 Cal. Bankr. J. No. 2 (2023) LEGISLATIVE MATERIALS H.R. 16643, § 4-503(f) (Sept. 12, 1974) 79 H.R. 31, § 4-503(f) (Jan. 14, 1975).................................................................................................79 H.R. 32, § 4-503(f) (Jan. 14, 1975) 79 H.R. 8200, 95th Cong. (1st Sess.1977) 109 H.R. REP. NO. 116-171 (July 23, 2019)........................................................................................139 H.R. REP NO 95-595,at 361 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6316 80 Hearings on Bankruptcy Act Revision Before the Subcomm. on Civil and Constitutional Rights of the H. Comm. on the Judiciary, 94th Cong. (Feb. 20, 1976), 1976 WL 191320.............79 Pub. L. No. 103-394, § 303(2) 80 Pub. L. No. 103-394, § 304(d)........................................................................................................80 Pub. L. No. 106-420, § 4 80 Pub. L. No. 109-8, § 216(1) 81 Pub. L. No. 109-8, § 224(a)(1)........................................................................................................81 Pub. L. No. 109-8, § 224(e)(1) 81 Pub. L. No. 109-8, § 307(1)............................................................................................................81 Pub. L. No. 109-8, § 307(2)............................................................................................................81 Pub. L. No. 109-8, § 308(1) 81 Pub. L. No. 109-8, § 308(2)............................................................................................................81 Pub. L. No. 109-8, § 322(a) 81 Pub. L. No. 98-353, § 306(a)..........................................................................................................80 REPORT OF THE COMMISSION ON THE BANKRUPTCY LAWS OF THE UNITED STATES, H.R. DOC NO 98-137 Part I, at 191 (1973) 110 S. 235, § 4-503(f) (Jan. 17, 1975)...................................................................................................79 S. REP NO 95-989,at 76 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5861-5862 80 S. REP. NO. 95-989, at 96 (1978) ..................................................................................................109
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