Bankruptcy: Voluntary Payments & Claimed Exemptions in Chapter 7 Cases

     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.

Bankruptcy: Bankruptcy Exemptions - Intentional Tort

    The United States Bankruptcy Court at Alexandria, Virginia, in the case of In Re: Scott, entered a judgment in favor of the creditor in the amount of $12,735 on a theory of conversion. In doing so, the Bankruptcy Court determined that the judgment was nondischargeable under Bankruptcy Code §523(a)(6). In Scott the Bankruptcy Court found that the creditor hired the debtor to look after the creditor's elderly mother, paying the debtor $28,000 in advance wages. The debtor quit the job six weeks later and refused to return the unused funds. The debtor subsequently filed for bankruptcy and the creditor filed a nondischargeability complaint. In the debtor's bankruptcy schedules she listed exemptions of a car, clothing, household goods, jewelry and a savings account. The creditor challenged both the specific items claimed as well as the debtor's right to claim any exemptions at all against a claim for an intentional tort. 

    In regard to the creditor's challenge for specific items, the Bankruptcy Court found that Virginia state law exemptions include the homestead exemption under Virginia Code §34-4 and the poor debtor's exemption under Virginia Code §34-26. The Court ruled that the debtor was entitled to claim a "poor debtor's" exemption on the car, and that the debtor's interest in the vehicle was less than $2,000. The Court also found that the debtor's claim for $5,400 in exemptions for the household goods did not exceed the amount allowed under Virginia Code §34-4. The Bankruptcy Court denied the debtor's "poor debtor's" claim for exemption for a herringbone gold necklace, as there was no evidence that the necklace was a family heirloom. The Bankruptcy Court also denied the debtor's claim for an exemption in a $300 savings account as tenants by the entirety property.

    In regard to the creditor's claim that the debtor was not entitled to any exemptions because Virginia law does not allow for the assertion of Virginia exemptions against a claim based on an intentional tort, the Bankruptcy Court examined the bankruptcy statutes and the results that other courts had reached on similar questions. The Bankruptcy Court noted that other courts had reached different opinions. However, the Bankruptcy Court decided that since Congress had specifically legislated as to the type of claims that could be enforced against exempt property, and since the creditor's claim in this case did not fall within any of the enumerated exceptions, in this case, the debtor was entitled to her exemptions notwithstanding the fact that the creditor held a nondischargeable claim based upon an intentional tort.

Bankruptcy: IRA Accounts and Exemptions

     The United States Bankruptcy Court, in Smith v. Bryant, ruled that the debtor’s IRA funds were not excluded from the bankruptcy estate. In doing so, the Court examined and explained that there are significant differences between IRA's and ERISA-qualified retirement plans, the provision in Bankruptcy Code §541(c)(2) exempting qualified funds from the bankruptcy estate does not apply to the IRA funds in this case.

     In Smith the debtor, after her termination of employment from a bank, rolled over her interest in a stock and thrift plan at the bank into her own individual retirement account. The debtor argued that the IRA should have been excluded from her bankruptcy estate because the assets used to fund the IRA had been accumulated in an ERISA-qualified retirement plan.
     In reviewing the differences between ERISA-qualified retirement plans and IRAs, the Court noted that IRAs are subject to almost complete control by its owner and do not contain the same anti-assignation and non-alienation provisions required under ERISA-qualified plans. The Court stated that if the debtor had an interest in a trust that contained an anti-alienation provision that was created under Virginia law, such an interest would also be excluded from her bankruptcy estate under Bankruptcy Code §541(c)(2). Nevertheless, because the debtor created her IRA and had complete control over the funds in it, the funds were not exempt from the bankruptcy estate, and the debtor was ordered to turn the funds over to the trustee.
     The Court's ruling in Smith clarifies the issue regarding IRA accounts and exemptions, and with debtors frequently changing jobs, the issue is likely to resurface in many instances.

Bankruptcy: Lien Avoidance Case Review: Judicial Liens Larger than Available Exemptions

     In the case of Andrews Distributing Co. v. Stanley the United States District Court at Big Stone Gap, Virginia, held that a creditor's lien must be avoided in the amount of the debtors' homestead exemption, but the amount not avoided would remain a lien against the debtors' real property. The District Court's decision overruled a bankruptcy court's decision avoiding the entire lien. The Bankruptcy Court had concluded that the debtors' homestead exemption was impaired by the presence of the creditor's lien, and thus avoided the lien in full. The creditor, on appeal to the District Court, contended that the Bankruptcy Court erred, in that the clear language of Bankruptcy Code §522(f) mandated that the lien be avoided only to "the extent that" it impaired the exemption. The District Court agreed with the creditor and ruled that under the plain meaning of Bankruptcy Code §522(f), only the amount of the judicial lien which impaired the exemption should be avoided. The District Court stated that the Court of Appeals for the 4th Circuit, in strongly worded dicta, had addressed this issue in the case of In re Opperman. The Court of Appeals in Opperman concluded that a lien larger in amount than the exemption available to the debtor did not impair that exemption. Thus, in Andrews the District Court found for the creditor and decided that only that part of a lien which actually interfered with the debtor's homestead exemption may be avoided.

Bankruptcy: Homestead Exemptions

     Virginia Code §34-26 and §34-4 provide for commonly used exemptions in bankruptcy.
     Virginia Code §34-26 is the "poor debtor's" exemption. This law was updated in 1992. Instead of listing exempt items such as horses, oxen, cattle, bushels of wheat, corn, etc. (as it was pre-1992), the statute now sets out categories with dollar limitations: tools of trade up to $10,000.00; household furnishings up to $5,000.00; family heirlooms up to $5,000.00; motor vehicles up to $2,000.00; and wearing apparel up to $1,000.00.
     Virginia Code §34-4 provides for a flat $5,000.00 exemption per head of household.
     The 1992 statutory charges resulted in an increase in the debtor's effective exemptions of personal property, as well as severe a decrease in effectiveness of the previous frequently used "Sheriff's levy" on personal property.