Opinion
Case No. 05-37920-svk.
November 3, 2010
MEMORANDUM DECISION DENYING TRUSTEE'S MOTION TO ABANDON
I. INTRODUCTION
After conversion of this case from Chapter 12 to Chapter 7, the Debtors, apparently under the impression that their discharge concluded the bankruptcy case, refinanced their farm, making substantial improvements and paying off secured creditors. The Debtors did not notify the Trustee or obtain Court approval for the refinancing. Later, when the Trustee sought to abandon the farm property, a creditor objected, contending that, even before the Debtors made the improvements, the farm had value to the bankruptcy estate. The creditor contends that the farm appreciated in value between the date of the petition and the date the Trustee sought to abandon it, and that the appreciation should inure to the benefit of the bankruptcy estate. The issue is whether the Trustee should be allowed to abandon the property under these rather tortuous circumstances.
II. STATEMENT OF FACTS
On October 1, 2005, David G. Evenson and Bonnie K. Evenson (the "Debtors") filed a Chapter 12 petition. At that time, the Debtors valued their real estate, comprised of their homestead and thirty acres of agricultural land (the "farm"), at $250,000. Liens and encumbrances against the farm totaled over $220,000, including a land contract with a balance of $174,500, a construction lien in the amount of $36,003, and a $9,574 tax lien. When the secured claims were added to the Debtors' $38,850 federal homestead exemption, the farm appeared to have no value for the bankruptcy estate. On January 27, 2006, this Court entered an order confirming the Debtors' Chapter 12 plan. The confirmation order is silent as to the vesting of the property of the estate, although there is language suggesting the Debtors' exempt property vests in the Debtors.
On June 27, 2006, the Debtors voluntarily converted their Chapter 12 case to Chapter 7. Steven McDonald was appointed Trustee (the "Trustee"). The Debtors received their Chapter 7 discharge on February 21, 2007. After administering some other assets of the estate, and apparently relying on the original $250,000 valuation from 2005, the Trustee filed a motion seeking authority to abandon the farm from the bankruptcy estate on March 31, 2010.
Meanwhile, on July 27, 2007, an unsecured creditor, Tom Braun, d/b/a Hamp Haven Farms, obtained an appraisal of the Debtors' farm that valued it at $335,000. Believing that the property was undervalued at the time of the petition and that subsequent appreciation and improvements may have doubled the value from the original valuation, Mr. Braun objected to the Trustee's proposed abandonment of the farm.
On May 10, 2010, at the preliminary hearing on the abandonment motion, the Debtors' attorney advised that, in June 2008, the Debtors refinanced the farm with Citizens State Bank of Loyal (the "Bank"). In that refinancing, which was not approved by Court, the Debtors granted the Bank a $460,000 or $470,000 mortgage on the property. The Bank duly recorded the mortgage on July 18, 2008. The Debtors represented that they used $260,000 of the refinancing proceeds to make physical improvements to the property, including additions to buildings and new construction. The remaining proceeds were used to pay off the land contract, construction, and tax liens. At the final hearing on the motion, held August 10, 2010, the Debtors' attorney explained that the Debtors needed the refinancing "to get moving and try to get something going and make some money on their farm. . . ." After learning of the unauthorized mortgage transaction, the Debtors' attorney spoke with the Bank's vice president and the attorney responsible for closing the transaction and preparing the title insurance. They told the Debtors' attorney that no record of the bankruptcy had been filed with the land records but that the Debtors had presented their discharge order to the Bank.
At the August 4, 2010 hearing, the Debtors stipulated that the amount of the Bank's mortgage was $460,000, but in their brief they gave the number as $470,000.
III. ANALYSIS
The Debtors support the Trustee's motion for abandonment, but Mr. Braun contends that the farm should be sold for the benefit of the bankruptcy estate. To determine whether the Trustee's motion should be granted, the Court must analyze three issues: First, was the farm the property of the Debtors or property of the estate when they converted their case from Chapter 12 to Chapter 7? Second, does the post-petition appreciation in the value of the farm inure to the benefit of the Debtors, or to the estate? Third, given the time that has passed, is the Trustee still able to avoid the post-petition transfer of the mortgage to the Bank? Each of these issues will be addressed in turn.
A. The farm is property of the estate, and neither the confirmation of the plan, conversion to Chapter 7, nor full exemption of the property served to remove it from the estate.
The Bankruptcy Code definition of "property of the estate" is very broad. Section 541 of the Code includes in the estate "any legal or equitable interest of the debtor in property, as of the commencement of the case." 11 U.S.C. § 541(a)(1). Accordingly, there is no question that the farm was property of the estate when the Debtors filed their Chapter 12 petition. Three subsequent events arguably could have caused the removal of the farm from the bankruptcy estate: (1) confirmation of the Chapter 12 plan; (2) conversion to Chapter 7; and (3) the full exemption of all equity in the farm by the Debtors.
The Debtors' Chapter 12 plan was confirmed in 2006, and Bankruptcy Code § 1227(b) states that, except as provided in the plan, confirmation vests property of the estate in the debtor. The Debtors' Plan indeed addresses the post-confirmation ownership of property, but limits the Debtors' property to exempt property. Section 8 of the Plan provides: "Upon confirmation of the Plan, the Family/Farmer Debtors' exemptions shall be deemed allowed, and they shall own their exempt property free and clear of the claims of creditors, including the Chapter 12 trustee." Under this provision, the Debtors' non-exempt property remained property of the estate, even after confirmation. This conclusion is bolstered by a motion that the Debtors filed on July 11, 2006, after their case was converted to Chapter 7. In that motion, the Debtors sought abandonment of their farm personal property and livestock from the bankruptcy estate, so that the Debtors and their secured creditors could conduct an auction. The Debtors expressly delineated the personal property and livestock as property of the estate. If the confirmation order had resulted in transfer of this property to the Debtors, there would have been no need for the Debtors to move for abandonment. The Court concludes that confirmation of the Chapter 12 plan did not convert the farm from property of the estate to property of the Debtors.
The Debtors also argue that the farm was not property of the estate after the conversion to Chapter 7. Section 348(f)(1)(A) provides that when a Chapter 13 case converts to Chapter 7, "property of the estate in the converted case shall consist of property of the estate, as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion." This provision "adopts the reasoning that allowing postpetition property to be part of the estate upon conversion would deter incentive toward chapter 13 filing and would be inconsistent with the Bankruptcy Code's goal to encourage repayment plans instead of liquidation." See Adams v. Bostick ( In re Bostick), 400 B.R. 348, 357 (Bankr. D. Conn. 2009). The Debtors maintain that § 348(f)(1)(A) applies to Chapter 12 cases because Congress modeled Chapter 12 on Chapter 13, and because legislative history supports the inference that Chapter 13 provisions may be read congruously with Chapter 12 provisions. See Mitchell v. United States (In re Mitchell), 210 B.R. 978, 980-81 (Bankr. N.D. Tex. 1997). However, even if the analogy to Chapter 13 is correct, the Debtors' argument ignores that § 348(f)(1)(A) applies to remove from the estate only that property acquired after the initial filing and before the Chapter 7 discharge. See In re Bostick, 400 B.R. at 357 ("[Section 348(f)(1)] establishes that property acquired after the Chapter 13 filing and before discharge under Chapter 7 is not part of the converted estate.") (citation omitted); see also Bogdanov v. Laflamme (In re Laflamme), 397 B.R. 194, 201 (Bankr. D. N.H. 2008). As the Laflamme court recognized, § 348(f) clarifies "that Congress did not want courts to include in postconversion chapter 7 estates the property acquired by the debtor during the preconversion chapter 13 case." 397 B.R. at 201. In this case, the farm is not after-acquired property because the Debtors owned the farm on the date of their Chapter 12 petition. They were still in possession of the farm when their case converted to Chapter 7. Therefore, § 348(f)(1)(A) is inapplicable here, and the Debtors' argument must fail.
The Debtors also contend that the farm is not property of the estate, because all of the equity in the farm was claimed exempt, and the Trustee did not object to the exemption within 30 days after the close of the meeting of creditors, as required by Bankruptcy Rule 4003(b)(1). Although there may have been some support for this argument in the past, the Supreme Court recently issued a decision rejecting this contention. Schwab v. Reilly, 130 S. Ct. 2652 (2010). Generally, property of the estate is subject to the debtor's right to claim exemptions under Bankruptcy Code § 522. Sometimes the exemptions meet or exceed the fair market value of the property as of the petition date, allowing a debtor to claim the property as fully exempt unless an interested party objects. 11 U.S.C. § 522( l); Fed.R.Bankr.P. 4003(b)(1). Yet, even when a debtor claims property as fully exempt and there is no objection, the estate's interest in the property is not extinguished. Reilly, 130 S. Ct. 2652; accord In re Gebhart, 2010 WL 3547641 (9th Cir. Sept. 14, 2010). Until the exempt property is sold by the trustee or abandoned from the estate, rather than the property itself, the Bankruptcy Code allows the debtor to maintain only an interest in the property up to the value of the claimed exemption. Reilly, 130 S. Ct. at 2662.
In this case, the Debtors valued the farm at $250,000 and listed exemptions and liens totaling nearly $260,000. Therefore, on paper, the farm was fully encumbered and exempt, and neither the Chapter 12 nor the Chapter 7 trustee objected to the Debtors' claimed exemption. However, even if the Debtors' interest in the farm is fully exempt, the estate maintains its interest in the farm until the Trustee sells or abandons it. Id. at 2662. Reilly and its progeny also clarify that a trustee need not object to the debtor's stated exemptions to preserve the right to later challenge the valuation of exempt property if the property is undervalued or appreciates while the bankruptcy case is pending. Id. at 2660-61; In re Gebhart, 2010 WL 3547641, *3 ("[e]ven when a debtor claims an exemption in an amount that is equal to the full value of the property as stated in the petition and the trustee fails to object, the asset itself remains in the estate . . ."). In Gebhart, the Ninth Circuit Court of Appeals considered two consolidated appeals involving homes that were fully exempt on the petition date, but which later appreciated in value. 2010 WL 3547641, *1. The debtors argued that because their homes were fully exempt on the petition date and the trustees did not object to the exemptions within the statutory time limit, the homes were withdrawn from the bankruptcy estates, and were owned by the debtors free and clear of the estate's interest. Id. Upon this belief, one debtor even refinanced his home with a lender who was apparently unaware the bankruptcy case was still open. Id. at *4. The court held that that the debtors' assertion of ownership was erroneous, and that the homes were not withdrawn from the bankruptcy estate merely because they were fully exempt and the trustees did not object to the exemptions. Rather, the court reiterated the principle that the homestead exemption operates to cap a debtor's interest in property at a certain dollar amount; it does not relinquish the full fair market value of the property to a debtor. Id.
In summary, since the Debtors owned the farm on the date of their Chapter 12 petition, the farm remained property of the estate through the administration of the Chapter 12 case, and confirmation of the plan did not operate to transfer the farm to the Debtors under § 1227(b). Nor did § 348(f)(1)(A) serve to remove the farm from the estate when the case was converted to Chapter 7. Under the rationale of Reilly and Gebhart, the fact that the Debtors claimed the farm as fully exempt also does not remove the farm from the bankruptcy estate, although the Trustee is bound to recognize the Debtors' $38,850 exemption in the farm. The next question is whether the post-petition appreciation of the value of the farm inures to the benefit of the Debtors, or to the estate. B. The post-petition appreciation in the value of the farm inures to the benefit of the estate.
Based in part on his 2007 appraisal, Mr. Braun has alleged significant post-petition appreciation of the farm, which he argues should be considered in determining whether the farm should be abandoned from the bankruptcy estate. Generally, any post-petition appreciation of estate property accrues to the benefit of the estate until the property is liquidated or abandoned by the trustee. 11 U.S.C. § 541(a)(6) (the bankruptcy estate is comprised of, inter alia, "[p]roceeds . . . of or from property of the estate. . . ."); see Potter v. Drewes ( In re Potter), 228 B.R. 422, 424 (B.A.P. 8th Cir. 1999) ("Nothing in Section 541 suggests that the estate's interest is anything less than the entire asset, including any changes in its value which might occur after the date of filing. . . . Except to the extent of the debtor's potential exemption rights, postpetition appreciation in the value of property accrues for the benefit of the trustee.").
Reilly and Gebhart also illuminate the analysis of whether the appreciation of the farm belongs to the Debtors or the bankruptcy estate. In Reilly, the Court held that when property is undervalued at the time of the petition, or later appreciates in value, the benefit inures to the estate. 130 S. Ct. at 2667 (stating that any value in property beyond the value of debtor's claimed interest in that property is preserved for the estate). This reasoning, the Court observed, ensures that a debtor receives a fresh start, and not a "free pass." Id.
In Reilly, the Court considered the case of a debtor who undervalued personal property and claimed all of the property as exempt in her petition. Because the debtor's exemptions were within the statutory guidelines, the trustee did not object within the 30-day period under Bankruptcy Rule 4003(b)(1). Later, the trustee learned that the property was appraised at a much higher value. Id. at 2658. The trustee then sought to liquidate the property, pay the debtor her exemption and distribute the excess to the creditors. Id. The debtor objected, contending that because the property was fully exempt as of the petition date, the estate had no interest in the equipment, and that the trustee had slept on his rights by not objecting within the 30-day deadline. Id. The Court dismissed both arguments. First, the Court held that the debtor's valuation of property is not binding on the trustee, but merely aids "the trustee in administering the estate by helping him identify assets that may have value beyond the dollar amount the debtor claims as exempt." Id. at 2663. Second, the trustee was not required to object to the debtor's claimed exemptions to preserve the estate's interest in the property because the debtor's exemptions were within the statutory limits and raised "no warning flags that warranted an objection." Id. at 2666.
In Gebhart, the Ninth Circuit addressed the related issue of whether a post-petition increase in the value of real estate inures the benefit of the debtor or to the trustee. 2010 WL 3547641, *1. The Gebhart debtors accurately stated their equity interests in their homes, but the fair market value of the homes appreciated post-petition. Id. at *3. The Ninth Circuit held that "any additional value in the property remains property of the estate, regardless of whether the extra value was present at the time of the filing or whether the property increased in value after filing." Id. The debtors in Gebhart claimed that allowing the appreciation to inure to the benefit of the estate encouraged a trustee to dally in the administration of the estate. Id. at *4. The Ninth Circuit refuted that argument, stating that if the debtor believes the trustee is sitting on his rights, the debtor's recourse is to move for abandonment. Id.; see also In re Heflin, 215 B.R. 530, 535 (Bankr. W.D. Mich. 1997) ("To the extent the trustee delays selling the home to wait for it to appreciate, the debtor gets to live in it for free. If the debtor believes he is being prejudiced by the trustee's delay, he can move for abandonment.") (citing 11 U.S.C. § 554(b); Fed.R.Bankr.P. 6007(b)).
In this case, because the farm is property of the estate, the post-petition appreciation inures to the benefit of the estate. While the Debtors are entitled to their claimed exemption, to allow them to recover the additional appreciation in the farm would represent a windfall at the expense of their creditors. While neither party has provided the current fair market value of the Debtors' farm, Mr. Braun has represented that in 2007 the farm was appraised for $335,000. Additionally, this Court cannot ignore the financing that the Debtors were able to obtain in 2008, suggesting a higher value than when the petition was filed. That additional value must accrue to the creditors, under the holdings of Reilly and Gebhart. Moreover, like the Gebhart debtors, the Debtors in this case may not excuse their unsanctioned 2008 refinancing by the Trustee's inaction. See id. at *4. The Debtors note that by 2008 their Chapter 7 case had been pending for nearly two years without administration of the farm by the trustee, and that they needed financing to pay off liens that were coming due. While the case was indeed lingering, and the Trustee has not explained why he delayed from 2006 to 2010 to seek to abandon the farm, the Debtors' proper recourse was to seek to compel the Trustee to abandon the farm, just as the Debtors compelled the Trustee to abandon the personal property and livestock for auction in 2006. 11 U.S.C. § 554(b); Fed.R.Bankr.P. 6007(b). The Court concludes that, notwithstanding the Trustee's delay, the farm including any appreciation in value remains property of the estate and inures to the benefit of the creditors, subject to the Debtors' claimed exemption.
C. Equitable tolling applies to enable the Trustee to seek to avoid the Bank's mortgage.
The Debtors' final argument is that the Trustee cannot avoid the Bank's mortgage because the statute of limitations has expired. Under the Debtors' theory, since it is too late to avoid the Bank's mortgage, there is now no equity in the farm, and the Trustee should abandon it. This rather brazen position ignores that the Debtors' transfer of the mortgage was apparently made without any notice to the Trustee until well after the transfer was made. The Debtors should not receive a windfall (the appreciation in the value of the farm) as a result of an unauthorized transfer of property that was not disclosed to the Trustee, and may never have been disclosed absent Mr. Braun's objection to the abandonment.
Subject to some exceptions, under Bankruptcy Code § 549(a), a trustee has the power to avoid a transfer of property of the estate that occurs after the commencement of the case, unless the transfer is authorized under the Bankruptcy Code or by the Court. This provision applies here, because the term "transfer" includes the creation of a lien. 11 U.S.C. § 101(54)(A). The purpose of § 549(a) is "to protect creditors from unauthorized transfers of estate property in which the debtor is a willing participant." Paloian v. Grupo Serla S.A. de C.V., 433 B.R. 19, 42 43 (N.D. Ill. 2010) (citations omitted). Once the trustee establishes that there was an unauthorized transfer of estate property, the burden of proof shifts to the transferee to establish that the transfer is valid. Fed.R.Bankr.P. 6001; see James B. Downing Co. v. Agri Dairy Prods., Inc. ( In re James B. Downing Co.), 74 B.R. 906, 909 (Bankr. N.D. Ill. 1987).
A special defense applies to real estate transferees. The trustee cannot avoid a post-petition transfer of real property to a good faith purchaser without notice of the bankruptcy who gave fair equivalent value for the transfer. 11 U.S.C. § 549(c). In this case, the Debtors effected a post-petition transfer of property of the bankruptcy estate by granting the Bank a mortgage on the farm. The mortgage was given without Court approval, and no provision of the Bankruptcy Code authorized the transfer of the mortgage. Unless the Bank can establish that it was a good faith transferee without notice of the bankruptcy who gave fair equivalent value for the mortgage, it appears that the Bank's mortgage is avoidable by the Trustee. According to the Debtors' attorney, representatives of the Bank saw a copy of the discharge before the mortgage was recorded, which may make the Bank's defense difficult to prove. See Balsley v. Farmers Merchs. Bank (In re Elliott), 81 B.R. 460, 463 (Bankr. N.D. Ill. 1987) (bank's admission of receipt of notice of commencement of the bankruptcy case defeated good faith purchaser defense under § 549(c)).
The defense does not apply if a copy or notice of the bankruptcy petition was recorded in the applicable land records. In this case, no such recordation was made.
The Debtors contend that even if the mortgage is an avoidable post-petition transfer, it is now too late for the Trustee to bring an avoidance action, since two years have passed since the transfer. 11 U.S.C. § 549(d). Under § 549(d) "[an] action or proceeding under this section may not be commenced after the earlier of — (1) two years after the date of the transfer sought to be avoided; or (2) the time the case is closed or dismissed." The operative date here is the date the Bank recorded the mortgage, July 18, 2008. See Wis. Stat. § 706.08(1)(a) (in Wisconsin, perfection of a mortgage transaction occurs on the date the document is recorded). Two years from July 18, 2008, is July 18, 2010, and that date has indeed passed. However, under similar circumstances, courts have permitted equitable tolling of the two-year statute of limitations. See Young v. United States, 535 U.S. 43 , 49-50 (2002); see also Olsen v. Zerbetz ( In re Olsen), 36 F.3d 71 (9th Cir. 1994). In Olsen, the Ninth Circuit Court of Appeals held that equitable tolling is an appropriate remedy where a debtor keeps a trustee "in the dark" about a post-petition conveyance. Olsen, 36 F. 3d. at 72. In that case, the debtors conveyed pre-petition property to their son, even though the debtors knew the trustee had listed the property for sale. Id. at 73. The debtors made the conveyance without court authorization and without notice to the trustee. Id. The Olsen court held that the unsanctioned transfer of estate property violated the debtors' duty to cooperate with the trustee and surrender any recorded information. Id. Like the Debtors in this case, the Olsen debtors argued that the transfer could not be avoided because more than two years had passed since the transfer and the trustee was time-barred from pursuing an avoidance action under § 549(d). Id. The court rejected that argument, holding that "[b]ecause the trustee remained in the dark `without any fault or want of diligence or care on his part,' the statute did not begin running until he discovered the conveyance." Id. at 73 (citations omitted). The Debtors in this case also failed to obtain Court approval or notify the Trustee before granting the mortgage to the Bank. And while the Bank duly and publicly recorded the mortgage, that recordation was not enough to put the Trustee on notice of the transfer. As the Olsen court recognized, the trustee "had no duty to duty to routinely check if the [debtors] had clouded legal title. [The trustee] was entitled to rely on the [debtors'] prior statements and presumed willingness to cooperate." Id. at 73, n. 3. As in Olsen, the Court finds equitable tolling is an appropriate remedy in this case. Accordingly, the statute of limitations for an avoidance action under § 549 may be equitably tolled to the date the Trustee discovered the post-petition transfer to the Bank. It is not clear from the record when the Trustee learned of the post-petition mortgage; the two-year period should begin on the date that he became aware of the transaction.
IV. CONCLUSION
For these reasons, the Court holds that the Debtors' farm is property of the estate, any appreciation on that farm inures to the benefit of the estate, and the Trustee may seek to avoid the Debtors' post-petition transfer to the Bank through equitable tolling of the statute of limitations in § 549(d). Since there appears to be equity in the farm for the estate above the Debtors' exemptions, abandonment without further analysis is not appropriate. The Trustee should determine the present value of the farm, consider the potential ramifications of the avoidance of the Bank's mortgage (including analyzing the costs of the litigation, the Bank's potential defenses, and any claims that may be made for the post-petition expenses of insuring and maintaining the farm), and determine whether avoidance of the mortgage and marketing the farm or compromising with the Bank, the Debtors, and Mr. Braun is likely to produce the highest benefit to the creditors. If after due analysis, the Trustee determines that there is no value in the farm for the bankruptcy estate, the Trustee should file another motion to abandon the farm, with a full explanation of his rationale. Given the delay that has already ensued, the Trustee should act with all deliberate speed to either administer or abandon the farm.
A separate order will be issued denying the Trustee's motion for abandonment.
Dated: November 3, 2010