Opinion
No. 04-82851.
December 13, 2004
OPINION
Before the Court are three related pleadings filed by the Chapter 7 Trustee, Gary T. Rafool ("TRUSTEE"). The TRUSTEE has filed an objection to the claim of exemption by the Debtors, Robert L. Hoerr ("ROBERT") and Janelle R. Hoerr ("JANELLE") (jointly, the "DEBTORS") under Section 12-1001(b) of the Illinois personal property exemption statute. 735 ILCS 5/12-1001(b). The TRUSTEE also filed a motion against the DEBTORS for turnover of the loan proceeds received from JANELLE'S parents on the eve of bankruptcy. The third motion filed by the TRUSTEE seeks an extension of the time for filing complaints objecting to the DEBTORS' discharge, in order to insure that if the Court rules in his favor, the monies are in fact received.
The following facts are not in dispute. In March of 2004, the DEBTORS repaid a loan of $3,000 to JANELLE'S parents from their income tax refund. After the DEBTORS consulted with an attorney regarding the filing of a bankruptcy petition, the attorney advised them that a Chapter 7 Trustee could recover the loan repayment for the benefit of their creditors, suggesting that the DEBTORS reborrow the money. JANELLE'S parents agreed and reloaned the DEBTORS $2,500 in May, 2004.
On June 21, 2004, the DEBTORS filed a Chapter 7 petition, disclosing both the payment of the loan and the reborrowing. The DEBTORS scheduled $1,500 in cash on hand, which they acknowledge is the remaining portion of the $2,500 loan. The DEBTORS claimed those monies as exempt under the wild card exemption provided by 735 ILCS 5/12-1001(b). JANELLE'S parents were listed as unsecured creditors for the personal loan. Unsecured claims totaled $51,315.80.
The TRUSTEE filed a motion for turnover of $2,500, representing the proceeds of the second loan made by JANELLE'S parents. The TRUSTEE also objected to the DEBTORS' claim of exemption in the cash on hand of $1,500, charging them with interference with his avoiding powers. In order to assure his ability to recover the funds, the TRUSTEE moved for an extension of the time in which to object to the DEBTORS' discharge. The DEBTORS opposed the motions and the objection, claiming that the monies had been properly claimed as exempt. A hearing was held on September 13, 2004, and the Court took the matters under advisement. The parties submitted briefs and the matter is ready for decision from the Court.
The second loan transaction between the DEBTORS and JANELLE'S parents certainly falls within the rubric of "prebankruptcy planning." The unusual twist is that the intended beneficiaries of that transaction were JANELLE'S parents, not the DEBTORS. But for that second loan, the TRUSTEE would have had a solid preference claim against JANELLE'S parents for avoidance of the $3,000 repayment of the first loan. The new value advanced in the form of that second loan appears to have manufactured a defense under 11 U.S.C. § 547(c)(4) for all but $500 of the loan repayment. To come within this exception, a defendant must establish (1) a preference was received; (2) after the preference was received, the creditor extends new value on an unsecured basis; and (3) which remains unpaid in whole or in part on the petition date. 11 U.S.C. § 547(c)(4); Matter of Prescott, 805 F.2d 719 (7th Cir. 1986).
The DEBTORS do not dispute that the payment of the loan to JANELLE'S parents meets the elements for a preferential transfer under Section 547(b). As the DEBTORS candidly admit, their reborrowing, made on the advice of counsel, was an attempt to defeat an action by the TRUSTEE to recover the original payment by qualifying for the "new value" exception. While the TRUSTEE has made a demand upon JANELLE'S parents for the return of the funds received from the DEBTORS in March, 2004, he has not filed an adversary proceeding against them, predicting their assertion of the new value defense and recognizing the uncertainty of the outcome of that suit.
At the hearing, the DEBTORS' attorney disclosed that he advised the DEBTORS prior to the bankruptcy filing that the tactic might not be successful. If the "new value" defense carries with it an implicit requirement that the extension of credit be made in good faith, the DEBTORS expressed concern that the transfer might still be avoided. While Section 60c of the Bankruptcy Act contained an explicit requirement that the subsequent credit be given in good faith, the elimination of that condition in the Bankruptcy Code has been regarded as deliberate. See, In re George Transfer, Inc., 259 B.R. 89 (Bankr.D.Md 2001).
The TRUSTEE'S indignant contention that the DEBTORS should not be allowed to get away with such a brazen usurpation of his avoidance rights is founded, alternatively, on two provisions of the Bankruptcy Code and a provision of the Illinois personal property exemption law, each of which he argues is dispositive as a matter of law based on the undisputed facts. The TRUSTEE first turns to Section 541(a)(3) of the Bankruptcy Code, which defines property of the estate to include interests in property that the trustee recovers from transferees using the trustee's avoiding powers, such as preferences and fraudulent transfers. 11 U.S.C. § 541(a)(3). Based on this provision, the TRUSTEE accuses the DEBTORS of intentionally depriving the estate of property that would have been available for distribution to creditors. By its own terms, however, Section 541(a)(3) is merely definitional, and comes into play only if an avoidance action is successfully prosecuted. It gives no additional powers to the TRUSTEE and does not enable the TRUSTEE to "end run" the necessity of first avoiding the transfer. Section 541(a)(3) is of no help to the TRUSTEE'S position.
The TRUSTEE also seeks a "turnover" order against the DEBTORS pursuant to Section 542(a) of the Bankruptcy Code. 11 U.S.C. § 542(a). The purpose of this provision is to enable the trustee to obtain possession of property of the debtor that is being held by another. Matter of USA Diversified Products, Inc., 100 F.3d 53 (7th Cir. 1996). In order to prevail on a turnover claim, the trustee must establish that (1) an entity other than a custodian; (2) was, during the case, in possession, custody or control; (3) of property that the trustee could use, sell or lease; and (4) that such property is not of inconsequential value or benefit to the estate. In re Moore, 312 B.R. 902 (Bankr.N.D.Ala. 2004). It is crucial to the trustee's claim that the asset to be turned over is property of the estate. In re Greer, 242 B.R. 389 (Bankr.N.D.Ohio 1999). Only property in which the debtor has an interest that properly becomes part of the bankruptcy estate can be made the subject of an order for turnover under Section 542(a). In re Rosenzweig, 245 B.R. 836 (Bankr.N.D.Ill. 2000). If the debtor does not have the right to possess or use the property at the commencement of a case, a turnover action cannot be used to acquire such rights. Id.; In re Asousa Partnership, 264 B.R. 376 (Bankr.E.D.Pa. 2001).
In his motion, the TRUSTEE seeks turnover of the sum of $2,500 from the DEBTORS, representing the loan proceeds received in May, 2004. To the extent that the TRUSTEE is seeking to indirectly unravel the new value defense, by considering the $2,500 to be funds not of the DEBTORS but of JANELLE'S parents that he could have recovered from them, he attempts to create a fictional state of affairs that, based upon the stipulated facts, simply did not exist on the petition date. The second loan is characterized as an absolute transfer of the $2,500 from JANELLE'S parents to the DEBTORS. Section 542(a) does not provide a basis to ignore or collapse the transfer so as to treat the funds as if they were still the property of JANELLE'S parents, subject to recovery by the TRUSTEE on account of his preference claim. Even if the funds could be considered to be property of JANELLE'S parents, Section 542(a) does not provide a basis to compel turnover to the trustee of funds that a debtor holds for another, in lieu of a direct action against the owner.
The TRUSTEE makes no allegation that the second loan was not a true, unconditional loan. He does not assert, for example, that the DEBTORS and JANELLE'S parents had a secret deal that the $1,500 would be held by the DEBTORS until the exemption was allowed at which time those funds would be returned to her parents. If such a deal existed, it might be grounds for denial of the claim of exemption, as having been made for an improper purpose.
To the extent that the TRUSTEE is seeking turnover of the $1,000 that the DEBTORS spent prior to filing the bankruptcy petition, his motion for turnover is improper. To the extent that the TRUSTEE is making a demand for the $1,500 which the DEBTORS had on hand on the date the bankruptcy petition was filed, that determination will turn on the propriety of the DEBTORS' claim of exemption. This Court will consider his motion, limited to those funds, in conjunction with his objection to their claimed exemption.
The TRUSTEE'S objection to the DEBTORS' claim of exemption in cash on hand of $1,500 as of the date of the bankruptcy filing, is premised upon the second to last paragraph of the Illinois personal property exemption law, which provides:
If a debtor owns property exempt under this Section and he or she purchased that property with the intent of converting nonexempt property into exempt property or in fraud of his or her creditors, that property shall not be exempt from judgment, attachment, or distress for rent. Property acquired within 6 months of the filing of the petition for bankruptcy shall be presumed to have been acquired in contemplation of bankruptcy.
735 ILCS 5/12-1001. The exact meaning of the statute is difficult to discern. The first sentence, phrased in the disjunctive, provides that the exemption will not be allowed if either the property was purchased with the intent of converting nonexempt property into exempt property or was purchased in fraud of creditors. That sentence refers to property "purchased" by the debtor. The second sentence establishes a rebuttable presumption that all property "acquired" within six months of filing was acquired in contemplation of bankruptcy. The presumption appears to be a burden shifting device so that a debtor, with respect to any property in which an exemption is claimed that was acquired within the six-month period prior to bankruptcy, has the burden to prove that such property was not purchased either with the intent to convert nonexempt property to exempt property or in fraud of creditors.
The Court's research disclosed only one case interpreting this provision of the exemption statute. In In re Wallace, 30 B.R. 5 (Bankr.C.D.Ill. 1983), the debtors cashed in a certificate of deposit and paid off existing loans on three life insurance policies just days before filing their bankruptcy petition. Judge Coutrakon denied the debtors' claim of exemption, finding evidence of actual intent to defraud their creditors. In that case, however, there was a blatant conversion of the debtors' nonexempt property, the C.D.'s, to exempt property, the cash value of life insurance policies.
The statute plainly applies to a situation where a debtor transfers property that he owns, that is nonexempt, in exchange for exempt property. Because the $2,500 was received as a new loan, it cannot be said that the DEBTORS "converted" any property they owned into the loan proceeds. Rather, in two separate and independent transactions, the DEBTORS repaid a loan to JANELLE'S parents and later borrowed additional funds from them. Even if this Court would not consider those transactions to be separate ones, the DEBTORS maintain that the original loan repayment was made with exempt funds. That representation was not challenged by the TRUSTEE and there is nothing in the record which would contradict it. Additionally, the TRUSTEE'S right to avoid the preferential transfer made to JANELLE'S parents never belonged to the DEBTORS. No nonexempt property belonging to the DEBTORS was used to acquire exempt property.
Prior to the filing of a petition in bankruptcy, any property that the DEBTORS had an interest in cannot be technically termed to be " exempt," but is only exemptible or potentially exempt. Matter of Wickstrom, 113 B.R. 339 (Bankr.W.D.Mich. 1990). A debtor's exemptions are determined as of the time of the filing of the bankruptcy petition. In re Ellis, 274 B.R. 782 (Bankr.S.D.Ill. 2002). Here, the TRUSTEE made no attempt to reconstruct the DEBTORS' financial circumstances on the date the loan repayment was made.
Whether the DEBTORS "purchased" the loan in "fraud" of their creditors is a more difficult question, given their admitted role in orchestrating the new loan for the purpose of providing a defense to JANELLE'S parents against an obvious preference claim. A "purchase" of the property sought to be exempted is an express condition that must be satisfied in order for the statute to apply. Only if the Court first determines that the DEBTORS "purchased" the funds in question, is it then necessary to address whether they have carried their burden to disprove that the purchase was made in fraud of creditors.
Because the legislature used different terms in consecutive sentences, a distinction must have been intended between "purchased" and "acquired." Different words in a statute should be given different meanings unless the context indicates otherwise. Central States, Southeast and Southwest Areas Pension Fund v. Reimer Express World Corp., 230 F.3d 934, 941 (7th Cir. 2000). Statutory words are to be given their ordinary, contemporary, common meaning, absent an indication of a contrary legislative intent. Williams v. Taylor, 529 U.S. 420, 431, 120 S.Ct. 1479, 1488, 146 L.Ed.2d 435 (2000).
The verb "purchase" means "to obtain in exchange for money or its equivalent; buy." THE AMERICAN HERITAGE DICTIONARY OF THE ENGLISH LANGUAGE (4th ed. 2000). The verb "acquire" means "to gain possession of." Id. Broader in meaning, property may be "acquired" by purchase, by gift, by devise, or even by loan. "Purchase", a subset of "acquire," contemplates a transfer of property owned by the purchaser in exchange for the property purchased. By accepting a loan of $2,500 from JANELLE'S parents, the DEBTORS transferred no property or tangible value to them. Thus, the funds were not "purchased" by the DEBTORS and the statute is inapplicable. This conclusion gives effect to the common meaning of the words used by the legislature and is consistent with the statute's purpose to protect against a prepetition diminution of a debtor's nonexempt assets.
Presumably, the DEBTORS promised JANELLE'S parents that they would repay the $2,500 loan. This Court does not consider a bare promise of repayment to be the kind of tangible consideration contemplated by the term "purchase" as used in the statute.
Even assuming, arguendo, that the DEBTORS "purchased" the $2,500, it was not fraudulent as to creditors. Generally, "fraud" requires a concealment or a deception. Thornwood, Inc. v. Jenner Block, 344 Ill.App.3d 15, 799 N.E.2d 756 (Ill.App. 1 Dist. 2003) (intentional omission or concealment of a material fact); In re Marriage of Gurin, 212 Ill.App.3d 806, 571 N.E.2d 857 (Ill.App. 1 Dist. 1991) (intentional misrepresentation of a material fact); State Sec. Ins. Co. v. Frank B. Hall Co., 258 Ill.App.3d 588, 630 N.E.2d 940 (Ill.App. 1 Dist. 1994) (includes any act, omission, or concealment calculated to deceive, including silence, if accompanied by deceptive conduct or suppression of material facts constituting an act of concealment). Here, unlike most fraud situations, there was no transaction between the DEBTORS and the allegedly defrauded parties. The transaction was solely with JANELLE'S parents. Moreover, the DEBTORS voluntarily and fully disclosed the second loan, the circumstances surrounding it and the reason for it. There was no deception or concealment involved.
Even constructive fraud, which does not require proof of actual dishonesty or intent to deceive, requires a breach of a duty that the law declares to be fraudulent because of its tendency to deceive others. Prodromos v. Everen Securities, Inc., 341 Ill.App.3d 718, 793 N.E.2d 151 (Ill.App. 1 Dist. 2003). A special kind of constructive fraud as to creditors is defined in the Uniform Fraudulent Transfer Act, 740 ILCS 160/1 et seq., as a transfer by a debtor without receiving a reasonably equivalent value in exchange for the transfer. A necessary element is that the debtor must have disposed of or parted with an asset. Regan v. Ivanelli, 246 Ill.App.3d 798, 804, 617 N.E.2d 808, 814 (Ill.App. 2 Dist. 1993). But the DEBTORS received the $2,500, which was transferred by JANELLE'S parents.
Moreover, the TRUSTEE has not produced any authority to support the conclusion that one who anticipates filing a bankruptcy case owes a legal duty to a hypothetical Trustee-in-waiting, or to existing creditors, to preserve possible avoidance actions or, more generally, to arrange his financial affairs so as to maximize the nonexempt value of the anticipated bankruptcy estate. Absent such a duty, although the DEBTORS' conduct may be labeled, pejoratively, as a sharp practice, or complimentarily, as a creative strategy, it cannot be characterized as a fraud on their creditors. Therefore, even if it could be determined that the DEBTORS "purchased" the second loan from JANELLE'S parents, the Court concludes that 735 ILCS 5/12-1001 does not provide a basis for denying the DEBTORS the ability to exempt the $1,500 remaining on hand as of the petition date from those loan proceeds.
Finally, by what is most often asserted as a last resort, the TRUSTEE turns to the equitable powers of the Court. Section 105(a) of the Bankruptcy Code empowers bankruptcy courts to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title." Section 105, however, does not authorize relief inconsistent with more specific commands of the Bankruptcy Code. Those equitable powers "can only be exercised within the confines of the Bankruptcy Code." Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206, 108 S.Ct. 963, 99 L.Ed.2d 169 (1988). As the TRUSTEE noted at the hearing, the Bankruptcy Code offers at least one other remedy which he could have pursued. A transfer of property made with the actual intent to hinder or delay creditors may result in denial of the debtor's discharge. 11 U.S.C. § 727(a)(2). The TRUSTEE views the denial of the DEBTORS' discharge as too drastic a sanction and this Court agrees.
Here, again, the hurdle to prove a transfer seems insurmountable given that the DEBTORS merely accepted a new loan.
Section 105(a) may not be used to create new law, to expand the avoidance rights provided in Section 547(b), or to deem a defense provided by Section 547(c) inapplicable for what the Court perceives are equitable considerations. See, Matter of Fesco Plastics Corp., Inc., 996 F.2d 152 (7th Cir. 1993) (under the guise of Section 105(a), a court may not disregard a specific Code section addressing an issue and instead employ its equitable powers to achieve a result not contemplated by the Code). See, also, In re Swift, 124 B.R. 475 (Bankr.W.D.Tex. 1991) (refusing to use Section 105(a) to deny exemption claim where debtors engaged in substantial prebankruptcy planning). The Bankruptcy Code neither prohibits the DEBTORS' conduct nor provides the TRUSTEE a remedy vis-a-vis the DEBTORS, and this Court will not manufacture one out of whole cloth. The use of Section 105(a) is inappropriate in this case.
Having determined that the DEBTORS' claim of exemption in the $1,500 is allowable, the relief requested by the TRUSTEE will be denied. This Opinion constitutes this Court's findings of fact and conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052. A separate Order will be entered.