National Consumer Bankruptcy Rights Center

Protecting The Rights Of Consumer Debtors In Bankruptcy

Chapter 07 – Liquidation (Sections 701 to 784)

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The 6th Circuit To Determine Whether the Debtors’ Post-Petition Application of Their Tax Refund to Future Tax Liabilities is Per Se Intent to Hinder a Trustee Justifying a Denial of Discharge

The Sixth Circuit in Wylie v Miller is reviewing the decision of the District Court for the Eastern District of Michigan. The district court reversed the bankruptcy court’s decision, holding that the bankruptcy court erred in applying a per se rule that the debtors’ post-petition application of their tax overpayment to future tax liabilities constituted an intent to hinder the trustee.

Facts

Jason and Leah Wylie filed for Chapter 7 bankruptcy and were denied discharge under 11 U.S.C. § 727(a)(2)(B) by the bankruptcy court. The denial was based on the Wylies’ post-petition election to apply a $20,736 tax overpayment from their 2019 tax return to their 2020 tax liabilities, which the bankruptcy court interpreted as an intent to hinder the trustee.

Analysis

The court’s analysis centered on the bankruptcy court’s application of a per se rule regarding the debtors’ intent. The bankruptcy court found that the Wylies’ election to apply their 2019 tax overpayment to their 2020 tax liabilities was sufficient to establish an intent to hinder the trustee. This conclusion was drawn without direct evidence of the Wylies’ intent but rather inferred from the action itself, effectively applying a per se rule that such an action always constitutes intent to hinder.

The court found this application problematic because it did not consider the specific circumstances or the debtors’ actual intent. The court highlighted that intent to hinder, delay, or defraud must be supported by concrete evidence and not merely inferred from the action of applying tax overpayments. The Wylies had consistently made similar elections pre-petition, which the bankruptcy court had previously found were made without intent to hinder, delay, or defraud. The court emphasized that exceptions to discharge must be narrowly construed, and a broad per se rule undermines this principle by potentially denying a fresh start without sufficient evidence.

The court also noted that the bankruptcy court failed to account for the Wylies’ testimony, which consistently stated that their intent was to ensure payment of future tax liabilities, not to hinder the trustee. The bankruptcy court’s failure to distinguish between intent to prefer one creditor over another and intent to hinder the trustee further weakened its position. Therefore, the application of a per se rule was inappropriate, and the court reversed the decision, remanding for entry of a discharge.

NCBRC and NACBA filed an amicus brief in support of the Debtor/Appellee.

Wylie v Miller – Amici Brief

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“Sham” Carve-Out Agreement Rejected

Calling the agreement a “sham,” the district court affirmed the bankruptcy court’s denial of a carve-out agreement between the chapter 7 trustee and the state and federal tax creditors. The court found the agreement would adhere to no one’s benefit but their own. The court also upheld the bankruptcy court’s finding that the debtor’s homestead exemption applied to section 724(b). Summerlin v. Turnage (In re Turnage), No. 22-122 (W.D. N.C. March 14, 2023).

The 72-year-old widowed debtor living on Social Security income and help from her son, filed for chapter 7 bankruptcy. She claimed an exemption of $55,000 in her home which she valued at $124,510.00. Her secured debts at the time of her petition totaled $231,788.29, and consisted of a mortgage on her home and both federal and state tax debts.

The chapter 7 trustee valued the debtor’s home at between $175,000 and $180,000. He objected to her exemption as inapplicable to her tax liens under North Carolina law. He then entered into a carve-out agreement with the debtor’s tax creditors under which he would receive $30,000 for his expenses and “[t]he IRS and NCDOR each get 60% of their secured tax liens. The remaining 40% carved out of the tax liens (approximately $38,000 after payment of the Trustee’s expenses) would be used to pay priority unsecured claims in full and the remainder would be disbursed pro rata among the general unsecured creditors.” He moved the court for authority to sell the property so he could carry out this distribution plan.

The bankruptcy court denied the motion to sell and overruled the objection to the debtor’s exemption. The trustee appealed to the district court.

The court found the appeal turned on application of section 724(b). In addition to establishing the order of distribution where tax liens are involved, that section provides that after the first mortgage is paid off, claimants holding certain types of priority claims may substitute in for the tax lien to the extent of the tax lien. The court noted that the only priority claim that would be available to substitute in for the tax lien would be the trustee’s own compensation, related primarily to the sale of the debtor’s home.

Notably, section 724(b) makes no provision for exemptions. Because North Carolina opted out of the federal exemptions, the court turned to state law to determine how the debtor’s homestead exemption would fare under a section 724(b) distribution scheme. It found state law emphasizes a liberal construction of exemption laws, favoring their application.

The court was unpersuaded by the trustee’s argument that permitting the debtor to take her homestead exemption would impinge on the tax liens. The court differentiated between the homestead exemption’s applicability to proceeds from sale of the home and its applicability to the tax liens themselves. It found that “once the tax agencies agree to the carve-out they cannot direct the allocation of the value created by such carve-out.”

Finally, the court noted with distaste that the carve-out benefited only the trustee and the tax agencies. It stated: “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.”

The court affirmed the Bankruptcy Court’s decision that the Debtor’s homestead exemption applies to section 724(b) and its denial of the Motion to Sell.

Turnage WD NC March 2023

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Chapter 7 Trustee Bound by Pre-Conversion Agreement

The Chapter 7 trustee was bound by the Chapter 13 trustee’s pre-conversion concession that the creditor’s liens were valid. Therefore the Chapter 7 trustee could not prevent the creditor from receiving the proceeds from the sale of the property securing the liens. In re Hillis, No. 20-70372 (Bankr. M.D. Ga. Jan. 11, 2023).

When the debtors filed for Chapter 13 bankruptcy they listed Southern Pine Credit Union as a creditor with security interests in a lawn mower, two John Deere loaders, and a Nissan Armada. During the pendency of the bankruptcy, the debtors sought and received an order approving the sale of the lawn mower and the two loaders with the proceeds going to Southern Pine in satisfaction of the loans secured by all the vehicles including the Nissan Armada. The Trustee consented to the sale, and Southern Pine offered no opposition. The court approved the sale and ordered the creditor to release the lien on the Nissan Armada upon receipt of the proceeds.

The debtors completed the sale but converted to Chapter 7 before they had received the proceeds. Southern Pine moved for relief from stay because it had not yet received the proceeds from the sale. Soon after it filed the motion, the debtors transferred the proceeds to Southern Pine. The chapter 7 trustee, believing the underlying liens might be avoidable, objected to the motion for relief from stay and made a verbal demand at the meeting of creditors for turnover of the funds. Southern Pine responded that the trustee was barred by res judicata from reneging on the pre-conversion agreement. The debtors filed a turnover motion seeking an order requiring the creditor to release the lien on the Nissan as required by the court’s order approving the sale.

The court began by finding that the Chapter 7 trustee had standing in the case because, under section 348(f)(1)(A), the proceeds from the sale of the vehicles became part of the converted estate. Under that provision property in an estate converted from chapter 13 to chapter 7 consists of property the debtors held at the time of their chapter 13 petition which they continue to hold at the time of conversion. The court found that the sale agreement gave the debtor a contractual right to the proceeds which became property of the new estate.

The court agreed with Southern Pine, however, that the Chapter 7 trustee was barred by res judicata from challenging the pre-conversion agreement to transfer the proceeds to the creditor in satisfaction of its liens. The only issue in that regard was whether the Chapter 7 trustee was in privity with the Chapter 13 trustee such that the Chapter 7 trustee should be bound by an agreement entered into by his predecessor. The court found the elements for res judicata as outlined in Griswold v. County of Hillsborough, 598 F.3d 1289, 1292 (11th Cir. 2010), were satisfied. Specifically, where section 704(a)(5) empowers the Chapter 7 trustee to oppose the allowance of an improper claim, section 1302(b)(1) empowers the Chapter 13 trustee to exercise the powers granted in section 704(a)(5). The court observed that when the two trustees have corresponding duties, the performance of those duties by the first binds the second.

Here, the Chapter 13 trustee did not object to the debtor’s motion to sell the property, including the understanding in the motion that Southern Pine had valid liens. Nor was the motion contingent upon the debtors’ staying in chapter 13. The court also rejected the trustee’s argument that because section 348(f) permits him to reevaluate the property of the estate, he is entitled to challenge the validity of the liens. The court found the trustee’s reading of the statute to be too broad. Valuation of property does not include lien validity.

The court concluded that Southern Pine’s motion was moot by reason of its having received the proceeds from the sale. It ordered Southern Pine to release the lien as requested by the debtors and overruled the trustee’s objections.

Hillis Bankr MD Ga Jan 2023

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Debtor’s Post-Discharge Pre-Closure Motion to Convert Denied

The debtor was not permitted to convert from chapter 7 to chapter 13 post-discharge but prior to administrative closure of his case where the court found the attempted conversion to be an abuse of process and his conduct in his chapter 7 case to indicate bad faith. In re Chamoun, No. 20-5069 (C.D. Cal. Dec. 2, 2020). [Read more…] about Debtor’s Post-Discharge Pre-Closure Motion to Convert Denied