The United States Bankruptcy Court in Roanoke, Virginia, sustained a bankruptcy trustee’s objections to two claimed exemptions for funds paid to creditors within ninety days prior to the bankruptcy filing. The case was In Re: Conley. In Conley the court found that two separate debtors, in two separate but consolidated cases, voluntarily paid certain of their creditors from either an income tax refund or a 401k distribution. The debtors disclosed these payments in their petitions and schedules and sought to exempt them in Schedule C of their respective schedules.The court found that the basis for the Trustee’s objection in the first case, involving the tax refund, was that the debtors had not exempted the entire value of the property, and that the debtors could not exempt voidable preference payments under Virginia Code Section 34-4. The court found that the Trustee’s objection in the second case, involving the 401k distribution, described the property in question as a “$3,000.00 voidable preference payment to Coalfield Services”, but failed to note any specific legal or factual basis for the objection. The court found that there was no factual dispute between the parties.
The debtors claimed in Conley that they were entitled under Bankruptcy Code Section 522(b) to claim exemptions in these payments because the Virginia homestead exemption should be interpreted literally for the benefit of hard-pressed debtors. The Court noted that the assertion raised the question whether the Virginia homestead exemption permitted one to claim an exemption in property which he owned, but which he had since used to pay a valid debt. The court further noted that there was certainly nothing improper under Virginia law for a debtor to choose among his creditors which of them would be paid and to prefer payment of certain creditors over others, assuming that he did not do so with any intent to hinder, delay or defraud his non-preferred creditors. However, the court also noted that it would be strange to uphold an exemption claim in property which the distressed debtor no longer owned to the potential prejudice of other property, either then owned or which might be acquired later, which might be of some actual current or future benefit to him. The court found that there was no Virginia case authority precisely on point, probably because, outside of bankruptcy, there is no apparent reason for a debtor to claim an exemption for property which he has used previously to pay a legally enforceable debt, assuming the lack of any intent on his part to hinder, delay or defraud other creditors.
The court in Conley cited its agreement with the ruling in the case analysis in In Re: Duty, and concluded that there was no right under Virginia law to claim an exemption in property no longer owned by the exemption’s claimant.
The court ruled that the debtors’ claims of exemptions for their voluntary pre-petition payments to creditors failed for two additional reasons flowing from the Bankruptcy Code. First, for a debtor to properly claim an exemption in the original schedules, the property claimed as exempt must be part of the bankruptcy estate on the date of the filing. Second, if the preferential payments made by the debtors were to be recovered by the trustee, as to the debtors they would still be preserved under Bankruptcy Code Section 551 for the benefit of the bankruptcy estate and their creditor’s generally. Even if the transfers were avoided as far as the recipients of the preferential payments were concerned, they were preserved to the extent that such preservation confers a benefit upon the bankruptcy estate and the creditors generally. If the payments in question had been obtained by the creditors involuntarily from the debtors, the debtors might successfully claim exemptions in them to the extent allowable under Virginia law. Because they were made voluntarily, however, the court found that Bankruptcy Code Section (g)(1)(A) precluded the claimed exemptions.
The court also found that the use of 401k plan assets to pay the second debtor’s debt to his employer did not authorize a claim of exemption in bankruptcy for the payment so made. When the debtor used these proceeds to pay his employer and certain other obligations, including his legal fees in this bankruptcy case, he received value in connection with their disposition and waived any possible right to continue to claim them as exempt.
The lesson of Conley: check all claims for exemptions and do not assume that they are valid.