Chapter 7 Trustee Must Notify Creditors and Obtain Court Approval Before Paying Taxes

In In re Cloobeck, 14 C.D.O.S. 5982, No. 23-15432 (9th Cir. June 12,  2015), the United States Court of Appeals for the Ninth Circuit ruled that a chapter 7 bankruptcy trustee must notify creditors, set a hearing or opportunity for a hearing and obtain bankruptcy court approval as a condition of paying taxes incurred by the bankruptcy estate.  Specifically, a trustee must obtain court approval both as to the appropriate amount of taxes and authority to pay the taxes.

Bankruptcy Code Section 503(b)(1)(B) affords administrative priority to tax claims against the estate.  A creditor objected to the trustee's payment of estate taxes more than two years after apparently learning of the payment, arguing that Section 503(b) requires "notice and a hearing" before payment of administrative expenses.  

The trustee argued that this would be inconsistent with Internal Revenue Code (26 U.S.C.) Section 6012(b)(4), which provides that:  "Returns of an estate, a trust, or an estate of an individual under chapter 7 or 11 of [the Bankruptcy Code] shall be made by the fiduciary thereof."  Moreover, the trustee must ordinarily pay federal taxes on time.  28 U.S.C. § 960. Also, Section 503(b)(1)(D) excuses the government from filing a request for payment of an administrative expense, unlike other creditors.

The bankruptcy court rule in favor of the trustee.  On appeal, the district court affirmed and determined that the creditor's objection was untimely.  The creditor appealed to the Ninth Circuit.

The Ninth Circuit reversed and remanded for further proceedings.  Specifically, the court ruled that the trustee must notify creditors and set a hearing, or provide an opportunity for a hearing, and must also obtain court approval both as to the appropriate amount of taxes and authority to pay the taxes.  The court explained that a trustee must pay taxes in time, even if the IRS does not file a request, and must also provide notice and an opportunity for hearing.  Judge Wallace concurred in the result but write separately to voice concerns over the timeliness of the creditor's objection.

Business Bankruptcy Basics

Learn about business bankruptcy basics and earn CLE credit valid in ten states with this video, available here.  The provider, namely LexVid, should give you one video for free.  Here is the course description:

There are a number of complex issues to consider when representing a business client in a bankruptcy.  Join Reno Fernandez, San Francisco commercial bankruptcy attorney, as he covers all the basics of a business bankruptcy case.  The program will focus mostly on corporate Chapter 11 cases, which allows the business to continue to operate with the goal or reorganizing and paying creditors.  Mr. Fernandez will also cover business Chapter 7 cases, which are an effective way to dissolve and wind up if the business does not require a reorganization.  Other topics include discharge, the automatic stay, trustees, and many more.

Major Pitfalls in Chapter 7 Bankruptcy Cases

Check out Iain A. Macdonald's program presented at the State Bar of California's Annual Meeting in 2012:

FIFTEEN MAJOR PITFALLS IN CHAPTER 7 BANKRUPTCY CASES

These tips are essential for businesses, general counsel and litigators considering or involved in chapter 7 bankruptcy cases.  The video is now available online here.

In re Gasprom: Foreclosure After Abandonment, Before Closure of Chapter7 Case, Violated Automatic Stay

In In re Gasprom, 500 B.R. 598 (9^thCir. BAP 2013), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit ("BAP") held that a lienholder violated the automatic stay in bankruptcy by foreclosing on assets abandoned by the trustee before the corporate debtor's chapter 7 case was closed.

Following conversion of the case from chapter 11, the trustee moved to abandon the estate's chief asset, which was a defunct gas station with permitting and hazardous waste issues.  The asset was fully encumbered by a lien.  The bankruptcy court granted the motion over the debtor's objection (citing In re D’Annies Restaurant, 15 B.R. 828 (Bankr. D.M.N. 1981)) and noted that the effect of the abandonment would be to terminate the automatic stay.  The lienholder foreclosed later that day, and the case was closed shortly thereafter.

The debtor filed a motion to reopen the case so that it could set aside the foreclosure and recover for the alleged violation of the automatic stay.  The court reopened the case but denied the motions in advance, ruling that upon entry of the abandonment order, the automatic stay no longer enjoined the sale, and that the court would annul the automatic stay sua sponte to the extent necessary.

The BAP reversed, holding that although the collateral left the estate upon abandonment, the automatic stay remained in effect with respect to property of the debtor under Bankruptcy Code Section 362(a)(5).  The BAP declined to follow authorities holding that the automatic stay only protects the property of an individual debtor (and not a corporate debtor) following abandonment.  Instead, the court followed authorities holding that abandonment returns property to the debtor nunc pro tunc as if no bankruptcy petition had been filed.

Bank of America Fined $10,000 Per Month for Violations of Discharge Injunction

On Tuesday, United States Bankruptcy Judge Rober Drain ordered Bank of America to pay $10,000 plus attorney's fees for every month that the bank attempts to collect from Edwin and Michelle Ramos, who previously received a discharge in their chapter 7 bankruptcy case.  Although liens and mortgages were not discharged in their case, their personal liabilities were discharged, including their personal liability to to the bank.  The court stated that the ruling was intended to "send a message."

IRS Penalties for Late Filed Corporate Tax Returns are NotAdministrative Expenses

The Ninth Circuit Bankruptcy Appellate Panel has ruled that penalties imposed by the Internal Revenue Service for untimely filing corporate tax returns were not administrative expenses.  In Kipperman v. Internal Revenue Service (In re 800ideas.com), 13 C.D.O.S. 9790, BAP No. SC-12-1496-JuBaPa (9th Cir. BAP July 22, 2013), chapter 7 trustee Richard M. Kipperman appealed from the bankruptcy county's order allowing the penalties as an administrative expense necessary for preservation of the debtor's estate pursuant to Bankruptcy Code Section 503(b)(1)(A).  The BAP disagreed and remanded the case to bankruptcy court for determination of whether the penalties qualify as administrative expenses for other reasons.  

Specifically, the BAP noted that the case was a chapter 7 case.  Accordingly, the penalties were not incurred in the operation of a business and, as a result, the penalties were incurred neither to benefit the estate nor preserve it.  Moreover, the failure to timely file tax returns did not constitute a post-petition tort under Reading Co. v. Brown, 391 U.S. 471 (1968).

It is important to timely file estate tax returns or comply with procedure to excuse the filing requirement (the opinion has a good review of certain new procedures).  Nevertheless, the upshot of this case is that penalties for late filing are not entitled to administrative priority on the grounds advanced by the IRS and are apparently limited to general unsecured claims.

New Procedures for Sole Proprietorships in Chapter 7 Cases in Fresno and Bakersfield

On July 2, 2013, Chapter 7 Trustees James Salven, Trudi Manfredo and Peter Fear announced new procedures they will follow in administering sole proprietorships in chapter 7 bankruptcy cases filed in Fresno and Bakersfield, California.  Specifically, the Trustees will promptly move for an order authorizing them to shut down the business until the case is closed.  The debtor may avoid shutting down by demonstrating that all property used in the business is exempt, offering to purchase the non-exempt equity in the property (and paying a deposit), or filing a motion to compel abandonment.  It is important to fully analyze a debt it's assets and understand these procedures before filing a chapter 7 case in Fresno or Bakersfield.

Justice Kagan's First Opinion Tightens Automobile Ownership Cost Determination Under the Means Test

In her first opinion on the United States Supreme Court, Justice Elena Kagan reports the Justices' 8-1 ruling that a consumer debtor cannot deduct the IRS standard automobile ownership costs from his or her disposable monthly income under the means test if the automobile is free and clear.  In Ransom v . FIA Card Services, N.A., 11 C.D.O.S. 459 (U.S. Supr. Ct. No. 09–907 January 11, 2011), Justice Kagan explained that the means test, which is used for determining eligibility for chapter 7 and is related to the calculation of plan payments under chapter 13, includes deductions from disposable monthly income for vehicle “Ownership Costs” and vehicle “Operating Costs” pursuant to certain IRS standards.  The Ownership Costs include only loan or lease payments, and they are deemed to be $471 per month based on national automobile financing data.  Operating Costs, on the other hand, can include the expenses of driving and maintaining a vehicle.

In Ransom, the chapter 13 debtor claimed the full Ownership Cost as well as Opweating Costs of $388 per month for a car that the debtor owned free and clear.  A creditor, namely FIA Card Services, objected to the claim of Ownership Costs and argued that the payments to creditors proposed in the plan should be increased in light of the resulting higher disposable monthly income.  The bankruptcy court agreed and denied confirmation of the plan.  The Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals affirmed.

The Supreme Court focused on the language of 11 U.S.C. § 707(b)(2)(A)(ii)(I), which provides that:  “The debtor’s monthly expenses shall be the debtor’s applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor’s actual monthly expenses for the categories specified as Other Necessary Expenses issued by the Internal Revenue Service for the area in which the debtor resides.”  Specifically, the Justices ruled that the term "applicable" means that the debtor must have actually incurred the expense.  In other words, the Ownership Costs do not apply if there are in fact no loan or lease payments.  The opinion further notes that the Ownership Costs do not include the expenses of driving or maintaining an automobile, which are covered by the separate Operating Costs deduction.

The Justices did not discuss the debtor's policy argument or alternative interpretation of the term "applicable."  These may be similar to the arguments advanced in a recent Credit Slips article.  The article argues that:  "[W]e also can think of the 'ownership expense' as the cost of saving up to replace an existing car. In addition, if we deny an ownership expense to a debtor who owns a car free and clear, we create an incentive to buy a new car on credit just before filing bankruptcy so that there is an actual out-of-pocket 'ownership expense' the debtor can deduct." 

Justice Scalia filed a dissenting opinion, arguing that the term "applicable" does not do as much work as the majority thinks.  "A House of Lords opinion holds, for example, that in the phrase ‘in addition to and not in derogation of ’ the last part adds nothing but emphasis.  Davies v. Powell Duffryn Associated Collieries , Ltd. , [1942] A. C. 601, 607."  Specifically, Justice Scalia argues that the phrase simply makes the IRS tables applicable to the means test.  The tables have entries for "one car" and "two cars," but not "no car."  In other words, the first two entries are applicable of the debtor has a car, and the last is applicable if the debtor has no car, regardless of whether there are any loan or lease payments.

In an interesting twist, the Credit Slips article criticized the Office of the US Trustee for having published guidelines on the means test that stated, without qualification, that the Ownership Costs could not be deducted if the automobile is free and clear; in other words, the US Trustee decided the Ransom case before the Supreme Court did.

By Reno F.R. Fernandez III

Homestead Cap May Not Apply To Recently-Established Residence On Previously Owned Property

In Greene v. Savage (In re Greene), 09 C.D.O.S. 12414 (9th Cir. October 2, 2009), the court ruled that a debtor who acquires real property more than 1215 days before filing bankruptcy but moved onto the property within the period is not subject to the homestead exemption cap under Bankruptcy Code Section 522(p)(1). The court analyzed the issue under Nevada law and the Bankruptcy Code and held that the 1215-day period in Section 522(p)(1) runs from the time of acquisition, not the time of residency.

In Greene, the debtor purchased a parcel of undeveloped land in Nevada in 1994. In August, 2004, Greene moved onto the property and was living in a trailer, and he recorded a homestead exemption the same month. On August 11, 2005, Greene was cited by Washoe Count for illegally using the trailer as a dwelling, and he told authorities that he slept on the property in a tent. On October 15, 2005, Greene filed a voluntary chapter 7 petition and claimed the property as fully exempt under Nevada's homestead exemption at a value of $240,000. A creditor objected to the claim of exemption and contended that it should be reduced to $125,000 because the debtor moved onto the property and declared his homestead within the 1215-day period provided in Section 522(p)(1). The bankruptcy court agreed, and the district court affirmed. The Ninth Circuit reversed in part and ruled that the debtor was entitled to claim the full amount of the homestead exemption.

Section 522(p)(1) limits the claim of homestead exemption upon a residence acquired during the 1215-day period preceding the petition date, as follows:

Except as provided in paragraph (2) of this subsection and sections 544 and 548, as a result of electing under subsection (b)(3)(A) to exempt property under State or local law, a debtor may not exempt any amount of interest that was acquired by the debtor during the 1215-day period preceding the date of the filing of the petition that exceeds in the aggregate $136,875 [the amount was raised in 2007] in value in —

(A) real or personal property that the debtor or a dependent of the debtor uses as a residence;

(B) a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence;

(C) a burial plot for the debtor or a dependent of the debtor; or

(D) real or personal property that the debtor or dependent of the debtor claims as a homestead.

Section 522(p) was enacted by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) , and the court held that its purpose is to close the so-called “mansion loophole” in which a wealthy debtor may shield assets by purchasing a lavish home in a state with an unlimited homestead exemption such as Texas or Florida shortly before filing bankruptcy.

Following the recent 5^th Circuit case of Wallace v. Rogers, 513 F.3d 212 (5th Cir. 2008), the court held that the first step in the analysis is to consider the homestead laws of the state. The Nevada homestead exemption, which derives from the state's constitution, provides that the homestead shall be exempt from any process of law, and it has been held to be absolute with few exceptions. The Nevada Supreme Court case of Savage v. Pierson, 157 P.3d 697, (Nev. 2007) held that a debtor must hold some form of equity in real property in order to claim the exemption, which “contemplates more than a general ‘interest’ in the property or the right to possession, it contemplates ownership.” Id. at 700-701. Therefore, the court held that although the Nevada the homestead exemption is a broad legal protection, it is not a property interest itself.

Turning to the language of Section 522(p)(1), the court carefully considered the meaning of the terms “interest,” and “acquire” and “amount.” Black's Law Dictionary defines “interest” as “a legal share in something; all or part of a legal or equitable claim to or right in property.” Black’s Law Dictionary 885 (9th ed. 2009). The court cited “possessory interests, leasehold interests, and ownership interests” as examples of interests in real property, and it noted that such interests “run with the land” in that they pass from one purchaser to another. To the contrary, the court held that a homestead is a “personal right or privilege” that does not “run with the land.”

Furthermore, the term “acquire” is at odds with the language used to refer to homesteads, the court held. For example, the verb used to refer to a homestead exemption in Section 522(p) is “claim,” as follows: “real or personal property that the debtor or dependent of the debtor claims as a homestead.” 11 U.S.C. § 522(p)(1)(D) (emphasis added). Furthermore, Black’s Law Dictionary provides that “acquire” means “[t]o gain possession or control of; to get or obtain.” Black’s Law Dictionary 26 (9th ed. 2009). Therefore, the court held that Congress intended a substantive difference by its use of distinct terms and that the term “acquire” refers to gain possession or control “by purchasing or gaining an ownership interest” in property.

Finally, the court explained that the term “amount of interest” refers to an interest capable of quantification. In particular, the exception provided in Section 522(p)(2)(B) provides that the homestead cap does not apply to an “interest transferred from a debtor’s previous principal residence (which was acquired prior to the beginning of such 1215-day period) into the debtor’s current principal residence, if the debtor’s previous and current residences are located in the same State.” Since the residence itself is not transferred, the court held that the exception refers to a monetary value or equity transferred from the previous residence. In accord with the Massachusetts case of In re Lyons, 355 B.R. 387 (Bankr. D. Mass. 2006), the homestead is not a quantifiable interest; it is a classification of property under state law.” Id. at 390.

In light of Nevada law and the language of Section 522(p)(1), the court ruled that the 1215-day period runs from the time the debtor acquired ownership of real property, even if the debtor moved onto the property within the period. Greene has the potential to aid debtors with investment properties in states with generous homestead exemptions similar to Nevada's in that debtors may file bankruptcy relatively soon after establishing residency, notwithstanding the homestead cap in Section 522(p)(1).

By Reno F.R. Fernandez III

"Ride Through" Option Did Not Survive BAPCA

In Dumont v. Ford Motor Credit Company (In re Dumont), C.D.O.S. 11793, 08-60002 (9th Cir. September 15, 2009), the Ninth Circuit held that the "Ride Through" option, which allowed debtors to retain collateral and continue to make payments, did not survive the Bankruptcy Abuse and Prevention Act of 2005 ("BAPCPA").

In 2003, Antoinette Dumont purchased a car from Ford Motor Credit Company. The loan documents contained an "ipso facto" clause, which provided that the loan would be in default if Dumont filed bankruptcy. In 2006, Dumont filed a voluntary chapter 7 petition, and she listed the car as an asset with a value of $5,800. At the time, Dumont owed $8,288 for the car, and she was making payments of $335.78 per month. Dumont filed a Statement of Intention with the bankruptcy court, stating that she would retain the car and continue making payments (Bankruptcy Section 521(a)(2)(A) requires a debtor to file a Statement of Intention with respect to collateral). A discharge was entered in Dumont's case, and three months later Ford repossessed the car even though the payments were current.

Under Ninth Circuit law, a debtor was entitled to retain collateral and continue making payments. See McClellan Fed. Credit Union v. Parker (In re Parker), 139 F.3d 668, 673 (9th Cir. 1998). A creditor holding a lien against the collateral was barred from taking possession of the collateral. Dumont successfully moved to reopen her bankruptcy case and alleged that Ford violated the discharge injunction. The bankruptcy court disagreed, and the Bankruptcy Appellate Panel ("BAP") affirmed.

The Ninth Circuit ruled that BAPCPA added a requirement to Bankruptcy Code Section 362(a)(1)(A), requiring debtors to elect one of three options with respect to collateral: redeem (essentially, to "buy back" the property); reaffirmation (to reaffirm the debt with approval from the bankruptcy court); or assumption (to assume the debt). Because Dumont did not elect one of these options in her Statement of Intention, Ford's rights under the loan agreement were revived, including the "ipso facto" clause, and Dumont was in default of the loan.

Judge Graber entered a strong dissent. Noting that BAPCPA has been criticized for its lack of clarity, Judge Graber explained that the text of Bakruptcy Code Section 521(2), which BAPCPA redesignated as 521(a)(2), was left unchanged. Furthermore, Congress made no comment to suggest that it intended to impose a new requirement under Bankruptcy Code Section 362(h)(1)(A) despite the vigorous public debate surrounding the "ride through" issue. In other words, Judge Graber argued that BAPCPA perpetuated the status quo, and he concluded that he would not have overrulled Parker.

By Reno F.R. Fernandez III

Actions Against Non-Debtor Spouse May Violate Discharge Injunction

In Lumb v. Cimenian, 2009 WL 427836 (1st Cir. BAP Feb. 23, 2009), the First Circuit Bankruptcy Appellate Panel (“BAP”) held that post-discharge actions against a non-debtor spouse of a chapter 7 debtor can violate the discharge injunction of Bankruptcy Code Section 524.

In this case, the debtor had entered into a business transaction with a creditor which did not substantially involve the debtor’s wife. The debtor later filed a voluntary chapter 7 petition. Thereafter, the creditor sent a letter to the debtor’s lawyer threatening to take legal action against the debtor’s wife. The creditor subsequently sued the debtor’s wife, who successfully defended the lawsuit. The creditor appealed, and the Supreme Court of Main affirmed, observing that the lawsuit was devoid of “even the slightest merit” and awarding $50,000 in attorney fees to the wife.

The debtor brought an adversary proceeding against the creditor in bankruptcy court, alleging that the creditor’s lawsuit against his wife amounted to a violation of the discharge injunction of Bankruptcy Code Section 524 in that the creditor’s actions were an effort to coerce him into paying the discharged debt. The bankruptcy court ruled in favor of the creditor, holding that the discharge offered no protection to the wife because she had not filed the bankruptcy.

The debtor/husband appealed, and the BAP reversed the bankruptcy court, ruling that: “Although we are not aware of any case in which a creditor was found to have violated the discharge injunction by virtue of actions taken against a third party, we note that the prohibition in section 524(a)(2) is not limited to actions by creditors against the debtor to collect on a discharged debt."

Actions Taken In Violation Of The Automatic Stay May Not Be As Void As You Think…

In Burkhart v. Coleman (In re Tippett), --- F.3d ---, 2008 WL 4070690 (9th Cir. Sept. 4, 2008), the Ninth Circuit held that Bankruptcy Code Section 549(c) protects a bona fide purchaser of real property where the Trustee failed to record notice of bankruptcy, even though the sale violates the automatic stay. The opinion serves as a warning to trustees to record the notice of bankruptcy where the debtor holds real property, and it confirms that the automatic stay may not apply to transfers of property initiated by the debtor under certain circumstances.

Mr. and Mrs. Tippett filed a voluntary Chapter 7 petition in May of 2001. They listed their homestead as having a value of $140,000, with two liens against it in the total amount of approximately $135,000. The Trustee did not record the petition or notice of bankruptcy with the County Recorder’s office. In November of 2002, the Tippetts sold their home to Seitu Coleman for $225,000 without obtaining approval from the bankruptcy court, and the Tippets received net proceeds of over $75,000. Coleman financed the purchase with two purchase money loans secured by deeds of trust. It was undisputed that Coleman was a bona fide purchaser of the property in that he had no notice of the bankruptcy.

The Trustee filed an adversary proceeding against the Tippetts, Coleman, and the lenders who held the deeds of trust, seeking to recover the sale proceeds, avoid the lenders' liens, and quiet title on the grounds that the sale violated the automatic stay under Bankruptcy Code Section 362 and 542. The Trustee also sought to revoke the Tippetts' discharge for knowingly and fraudulently selling an asset of the estate under Bankruptcy Code Section 727(d). The bankruptcy court ruled in favor of the Trustee. On appeal, the Bankruptcy Appellate Panel reversed and entered judgment in favor of Coleman, concluding that the Tippetts' unauthorized transfer of the residence to Coleman did not violate the automatic stay.

The Ninth Circuit affirmed the BAP decision and upheld the sale. The Court ruled that California's bona fide purchaser statute was not preempted by the Bankruptcy Code because it is consistent with the Bankruptcy Code’s policies of giving debtors a fresh start and equality of distribution of a debtor's assets among creditors. The court also ruled that the Bankruptcy Code provides a defense to bona fide purchasers against actions brought under Bankruptcy Code Section 549. In support of this conclusion, the court reaffirmed its controversial holding in Schwartz v. United States (In re Schwartz), 954 F.2d 569, 574 (9th Cir. 1992), that the automatic stay does not apply to transfers initiated by the debtor.