As New York moves close to a major revision of exemptions available to bankruptcy and judgment debtors, a review of the history of New York exemptions shows that most have not been updated in decades. "Exemptions" refer to the property a person who has been sued, or a person who has filed bankruptcy, can keep free and clear of his or her creditors. As of today, June 29, 2010, the New York State Senate has passed S. 7034, a bill to expand New York exemptions and index them for inflation. If passed by the Assembly (considered likely) and signed by the Governor (more uncertain), the changes would go into effect thirty days later.Some assets are exempt in New York no matter what their value (example: a wedding ring; retirement accounts.) Most exemptions, however, have a dollar limit in value, and, with one exception, these dollar limits have not been adjusted in decades. For example, a bankruptcy debtor can exempt $2,400 in equity in a car and, if not claiming a homestead exemption for their residence, $2,500 in cash. These two amounts have not been raised since they were originally enacted in 1982, twenty-eight years ago. The pending legislation increases the car exemption to $4,000 and the cash exemption to $5,000.Working debtors can exempt "tools of the trade" up to a value of $600, an amount that has not changed in fifty-three years (1957.) The proposed bill increases this to $3,000. Debtors may exempt a watch valued up to $35, an amount set when the exemption was created in 1942 and unchanged ever since. Putting aside the fact that watches are increasingly rare except as fashion items, the new legislation broadens the exemption to include a watch, jewelry and art up to $1,000.The longest-running unchanged exemption is for books: the "family bible", family pictures, and school books of debtor's family of such person, and $50 worth of books kept for the family library. This $50 exemption amount dates back to at least 1842, unchanged since John Tyler was President. The proposed legislation changes the "family bible" to "religious texts" and increases the exemption to $500.Many of New York's exemptions are only updated versions of property considered necessary in nineteenth century rural America. One current exemption is for stoves and sewing machines. This exemption originally protected "spinning-wheels, weaving-looms, and stoves". The current household goods exemption was once far more itemized: "All necessary wearing apparel, beds, bedsteads and bedding, ... necessary cooking utensils, one table, six chairs, six knives and forks, six plates, six tea-cups and saucers, one sugar-dish, one milk-pot, one teapot and six spoons one crane and its appendages, one pair of andirons and a shovel and tongs." That pre-Civil War list of necessities was not simplified until 1946. And the current exemption for domestic animals was, for a long time, quite specific: "All sheep to the number of ten, with their fleeces, and the yarn or clothe manufactured from the same, one cow, two swine" and the necessary food for them.The one exemption that has been updated regularly in recent years is the homestead exemption, protecting equity in a debtor's residence. In 1850, this exemption was set at $1,000, a figure that did not rise for a hundred and nineteen years, to $2,000 in 1969, then 10,000 in 1977, and $50,000 in 2005. The proposed bill increases the amount to $150,000 for New York City, Long Island and the Lower Hudson, $100,000 for the Upper Hudson area and Albany, and $75,000 for the rest of the state, including all of Western New York. Considering how much of a house a thousand dollars could buy you in 1850, the increase seems appropriate.The proposed bill also allows New York bankruptcy debtors to claim federal exemption as an alternative to New York exemptions, and I will write more about that if and when the bill is passed.
Something else to worry about: The IRS levying on a bankruptcy debtor's pension plan even though they never filed a "Notice of Federal Tax Lien" (NFTL). Wadleigh v. IRS; 134 T.C. 14; United States Tax Court decision June 15, 2010. My thanks to Rochester bankruptcy attorney William Neild for bringing this case to my attention and explaining its significance.Here is what we already knew: when the IRS files a NFTL, it acts as a lien against all assets owned by the debtor, including assets, such as pension plans, that might be exempt as against regular creditors. So, a debtor files bankruptcy and lists an old, dischargeable, IRS tax debt: If the IRS had filed a NFTL prior to the bankruptcy filing, the lien against the debtor's assets survives bankruptcy even if the debtor's personal liability is discharged. If that debtor had, say, an exempt IRA account, the IRS could levy against that account after the bankruptcy, pursuant to the NFTA. Bankruptcy Code sect. 522(c)(2)(B) specifically states that exempt property is not exempt against properly filed tax liens.But what about unfiled tax liens? When the IRS files a NFTL, it is usually filed in the taxpayer's county and/or with the Secretary of State where the taxpayer lives. This filing puts the world, including bankruptcy trustees, on notice of the lien. But the lien itself actually existed well before the NFTL is filed with the county clerk. Internal Revenue Code (IRC) Sect. 6321 states that, as between the IRS and the taxpayer, a tax lien exists the moment the tax is 'assessed'. At that point, the IRS is empowered to seize whatever property the taxman is allowed to take away by law, even though nobody (perhaps not even the taxpayer) knows about the existence of this 'secret' lien. Now the IRS usually follows up the 6321 lien by filing a NFTL, because that protects the IRS against third parties, such as judgment creditors or bonafide purchasers. But the lien itself exists when the tax is assessed, not when the NFTL is filed.Now, as stated above, a filed NFTL survives as a lien against otherwise exempt bankruptcy property, under sect. 522(c)(2)(B). Correspondingly, if the IRS has assessed a secret 6321 lien, but has not filed a NFTL before the bankruptcy is filed, that secret does NOT survive the bankruptcy and the debtor retains exempt property free and clear of the IRS lien.So when Mr. Wadleigh filed Chapter 7 in 2005 in California, he thought he was in fine shape. He listed an old 2001 IRS debt which was dischargeable, and the IRS had never filed a valid NFTL. But then the IRS went after his pension after the bankruptcy was over, and the Tax Court said the IRS was correct as a matter of bankruptcy law. Huh? Unfortunately for the debtor, the tax court was probably right, because the debtor's pension was not an exempt asset of the bankruptcy case. More specifically, the pension was actually never an asset at all, exempt or otherwise, in the bankruptcy case. As the pension was never a bankruptcy asset, the secret lien was never avoided.This actually makes sense when you carefully examine the status of ERISA pensions in bankruptcy cases. We (bankruptcy people) regularly refer to pensions as "exempt", and we are correct: there are multiple exemptions for retirement accounts under both state and federal bankruptcy law (11 USC §522(b)(3)(C) exempts tax-exempt pensions in all bankruptcy cases, no matter what state law says, and New York CPLR §5205(c)(2) and D&C §282(iii)(2)(e) exempts all retirement accounts when New York residents file bankruptcy.) But when it comes to ERISA pensions, the issue of exemptability doesn't actually come into play because the asset itself never enters the bankruptcy estate.When Mr. Wadleigh filed bankruptcy, a separate legal entity called the "Bankruptcy estate of Wasleigh" was created as a matter of law, and all of Wadleigh's assets were transferred to this new estate. "All legal or equitable interests of the debtor in property as of the commencement of the case." are property of this estate, under 11 U.S.C. Sect. 541(a)(1). Or almost all; ERISA-qualified pensions do not transfer to the bankruptcy estate, under Sect. 541(c)(2). ERISA pensions are those pensions which cannot be transferred, voluntarily or otherwise, to third parties. The Supreme Court specifically stated that, under Sect. 541(C)(2), ERISA-qualified pensions are excluded for the bankruptcy estate. Patterson v. Shumate, 504 U.S. 753 (1992.) This anti-alienability provision in ERISA is intended to protect the pensioner from being liened by judgment creditors, but it worked to the severe disadvantage to Mr. Wadleigh. When the IRS assessed a tax liability against him for his 2001 taxes, that assessment created a secret 6321 lien against all his assets, including his ERISA pension (the anti-alienability provisions of ERISA do not extend to the IRS.) When he filed bankruptcy, all of his assets -- except his ERISA pension -- became property of the bankruptcy estate, and the unfiled IRS lien was avoided against his exempt property. But since the ERISA pension didn't ever go into the bankruptcy estate, the secret lien was never avoided by bankruptcy, and the IRS was entitled to levy against the pension post-petition.So what's a bankruptcy debtor to do? Remember, this situation only applies:
IF the wood-be bankruptcy debtor has dischargeable taxes and
IF the IRS has filed an assessment and
IF the IRS has not filed a valid Notice of Federal Tax Lien (NFTL) and
IF the debtor has an ERISA-qualified pension. That's a lot of ifs. Add one more; what if the debtor had other unexempt property? Say the debtor has $30,000 in unexempt assets and an unfiled dischargeable $25,000 tax assessment. The debtor will have to pay the trustee $30,000 for the unexempt assets (or lose them) and another $25,000 to the IRS to avoid losing an ERISA pension. In that case, the debtor might want to induce the IRS to file a tax lien (and wait three months before filing, so the lien is not avoidable as a preference). Then the unsecured unexempt assets would be only $5,000, and the $25,000 paid to the IRS would replace money that would otherwise be paid to the trustee.Another possible option: roll-over the ERISA pension to another non-ERISA pension, like an IRA. I am no tax expert, and that's who the debtor would need to consult, but a non-ERISA pension becomes exempt property of the bankruptcy estate and the unfiled secret 6321 IRS lien would be avoided as against the exempt non-ERISA pension.Inevitable disclaimer: for more information, consult a tax professional.
In re Gregory Davis 05-90690 (Judge Kaplan, June 11, 2010.) Note: the Case number on this case is 05-90690, NOT 05-09690, as is listed on the decision and order of June 11, 2010. Background information for this case note came from the court docket and the claims register, not just the decision.This case was filed October 11, 2005, in the massive rush of cases filed immediately preceding the implementation of BAPCPA, the new bankruptcy provisions. Schedule F listed a total of thirteen claims for a total of $71,590.00. The case was closed as a no-asset case Feb. 28, 2006. A year later, February 25, 2007, the trustee moved to reopen the case due to an unscheduled asset. Apparently the debtor had a pre-bankruptcy claim, arising out of a personal injury accident July 13, 2005, that had not been listed on his bankruptcy schedules.A motion to settle the personal injury action for $25,000 was filed Dec. 22, 2008 and approved a month later. A separate motion to compromise an underinsured motorists claim for $65,000 was made Sept. 22, 2009 and approved a month after that.On March 19, 2007, the Court Clerk sent out a notice to creditors to file claims. The deadline, or "bar date", to file timely claims was June 20. It appears that only two claims were filed prior to the bar date, for $5,267.58. On September 16, 2009, the Court Clerk sent out a "Notice of Surplus Funds" to all creditors, stating that the time to file claims against the surplus had been extended to Oct. 9. As noted by the Court in its decision and order, the provision in Bankruptcy Rule 3002 authorizing this so-called "Surplus Money Notice" was deleted in 1996, following amendments to the Bankruptcy Code's treatment to tardy claims in 1994. The court stated that "[f]or some reason, a Surplus Money Notice went out in this particular case...", meaning for some reason other than a legally-justified reason. In any case, no new claims were filed by October 9. Then, on November 15, 2009, the trustee filed thirteen claims, one for each of the originally-scheduled claims (including the two claims for which a timely proof of claim had previously been filed by the actual creditor.) These thirteen claims were for $71,590, the originally scheduled amounts, and included a student loan claim for $43,575.The trustee's Final Report was filed Feb. 3, 2010. It states that the trustee had $51,675.56 to distribute; that all fifteen claims would be treated as timely filed general unsecured claims, and that they would be paid about 56% of their claims. It also stated that the trustee would receive $7,375.21 as a commission on the funds he was distributing to creditors. The trustee only receives a commission on funds paid to creditors, not funds paid to the debtor as surplus.On Feb. 21, 2010, the debtor's attorney objected to the final report and filed an objection to the thirteen claims filed by the trustee. The objection simply stated that the claims were tardily filed. In a letter dated May 18, 2010, the trustee took the position that his thirteen claims should be allowed as valid tardy claims in the case (there is nothing to indicate why the original final report listed the trustee's claims as timely, not tardy.) The Court disagreed with the trustee's position, in a careful statutory analysis:Bankruptcy Code §501(a) authorizes a creditor to file a claim. §501(c) states that if a creditor does not file a timely claim, the trustee may file a claim for the creditor.Bankruptcy Code §726 describes the order in which payment is to be made to creditors in a Chapter 7 case:§726(a)(1) provides first payment to priority and administrative claims, including trustee commissions and expenses.§726(a)(2) directs the next right-of-payment to the following:
(A) timely-filed 501(a) claims;
(B) timely-filed 501(c) claims and
(C) tardily-filed 501(a) claims IF the creditor did not have actual notice of the bankruptcy claims bar date. §726(a)(3) directs the next payment tier to tardily-filed §501(a) claims that don't fall into the lack-of-notice exception of §726(a)(2).§726(a)(4) and (5) directs payment to fines and penalties and to post-petition interest.§726(a)(6) directs any remaining surplus to the debtor.The Court's conclusion is simple: a tardy claim filed by the trustee under §501(c) doesn't fall anywhere in the §726 distribution scheme. It would appear that for a trustee-filed claim under §501(c) is ever to be paid, it would have to have been filed before the claims bar date passed.Observation: The predicament the trustee found himself in this case was unfortunate. The claims notice was mailed out two years after the case was filed because the debtor failed to list the personal claim asset on the original schedules. The claims were years old at that point and the bankruptcy schedules only listed a single address for each creditor. There is no way of knowing how accurate those addresses were, or whether credit departments, collection agencies or claims purchasers had contacted the debtor prior to the filing (I always include every address I can find for every creditor listed on my client's schedules.) I don't know what the trustee intends to do with this case, but it is not too late to induce creditors to file claims. Even now such claims would be treated as tardily-filed 501(A) claims, which at a minimum would be paid in the §726(a)(3). From my own experience, I know how difficult it is to track down someone at a national credit card bank who can locate some account closed out years earlier, and which has often been sold off to some murky third party. In this particular case, the trustee might get lucky; if the huge student loan claim is still outstanding, that claim would be easier to track and to induce to file a claim (and the debtor would get his student loan bill paid off, not the worst outcome.) But the method used by the trustee here was improper. The trustee undertook no investigation into why claims were not filed, and didn't even bother to knock off the two timely-filed claims from the list of claims he filed. If he had prevailed, he would have received his full commission, but I doubt any of the creditors that didn't file claims would have received any benefit. The dividend checks would have been mailed to the same dated addresses where the request to file claims had been filed. The checks probably would have been returned undeposited, and eventually these unclaimed dividends would have been deposited with the court clerk, to remain in limbo for years.
In Re: Walter Johnson Bk 08-14477 Judge Bucki April 21, 2010. This Chapter 13 case was filed October 9, 2008. According to the decision, Roger Dulski transferred the real estate at 1985 Genesee Street, Buffalo, to the debtor ten days earlier. Dulski himself had filed Chapter 13 in 2000 and again in 2005, both of which cases had been dismissed. During the eight years he owned the property, Dulski failed to pay property taxes, water bills or sewer charges, and the property accumulated $70,000 in secured taxes and fees. Dulski then transferred the property to Johnson, who is described as a "tenant" in the building, operating a car repair facility there. Johnson then immediately filed his Chapter 13 case, proposing to value the property at $32,000 and avoid all the tax liens and fees in excess of that amount. Unsecured creditors would receive a distribution of 5%.The City of Buffalo filed an objection to the plan, based on the good faith requirement of Sect. 1325(a). Specifically, Sect. 1325(a)(3) requires that "the plan has been proposed in good faith and not by any means forbidden by law" and Sect. 1325(a)(7) "the action of the debtor in filing the petition was in good faith."The Court noted that these are two separate requirements, that the plan be proposed in good faith and that the petition be filed in good faith. As for the first requirement, the court found that the plan was filed in good faith: "The present facts do not necessarily indicate a lack of good faith with respect to the proposal of a plan, as needed to comply with section 1325(a)(3). No matter how ambitious or even aggressive in its assertion of rights, a plan is generally proposed in good faith when it seeks nothing more that what the law would allow. See In re Cavaliere, 238 B.R. 247 [Judge Bucki] (Bankr. W.D.N.Y. 1999)."However, the court found the petition was not filed in good faith. The court noted that Johnson was not personally liable on the secured debt related to the Genesee Street property, acquired the property immediately prior to filing bankruptcy, and had made no effort to deal with the financial problems of the property outside of bankruptcy. In other words, the property was acquired exclusively to cram down the secured creditors in bankruptcy, and the bankruptcy was filed exclusively for the same purpose. "Essentially, therefore, the present bankruptcy attempts to resolve problems that are not of Johnson's making, but which were transferred to Johnson for the purpose of compromising the rights of another person's creditors."For that reason, the objection was upheld and the plan as filed not approved. As a post-decision note, the debtor filed an amended plan a week after this decision was filed, calling for full payment with interest to all the property tax and fees secured creditors and 100% repayment to unsecured creditors. This plan was confirmed.
In re: Tanya Calloway 09-12133 (Judge Bucki; Feb. 16, 2010); In re Nguyen Bk 05-92833 (Judge Bucki Sept. 22, 2009). In August 2005, New York increased its "homestead exemption" from $10,000 to $50,000. In a previous bankruptcy case out of Rochester (I was the trustee), a creditor had asserted that the change only applied to debts that would be incurred after the change, not retroactively. Several bankruptcy and district courts disagreed, and held that the statute was retroactive, a position adopted by the Second Circuit: CFCU Community Credit Union v. Hayward, 552 F.3d 253 (2nd Cir. 2009).In th Calloway case (attached), the debtor seeks to avoid a judicial lien against her house, and the creditor opposes the motion. The creditor attempts to differentiate Hayward because in this new case it is an actual judgment lien, not just a debt, which existed prior to the August 2005 change. The creditor's position is that it would be unconstitutional for them to be deprived of their property rights (their lien against the unexempt homestead) by a legislative action. They also claim that it would be a misinterpretation of the statute.The bankruptcy court disagreed. Following a similar decision by fellow Buffalo Judge Kaplan, In re Trudell, 381 B.R. 441 (Bankr. W.D.N.Y. 2008), Judge Bucki applied the statute retroactively even to judgment liens. Quoting an old New York Court of Appeals case, Watson v. New York Central Railroad Company, 47 N.Y. 157, 162 (1872), "a judgment creditor of an owner has no estate or proprietary interest in the land." Judge Bucki had previously ruled on this very issue in an unreported slip opinion in the Nguyen case in September 2009 (attached here). Post-decision appeals: The Nguyen decision is currently on appeal before the District Court for the Western District of New York (09-cv-00913; Judge Richard J. Arcara). The Calloway decision is also on appeal to District Court (10-cv-00250; Judge William M. Skretny.) The creditors in both the Nguyen and the Calloway appeals are represented on appeal by Attorney Edward Crossmore, the same attorney who appealed Hayward, unsuccessfully, all the way to the Second Circuit.