FILED
NOV 7 2019
NOT FOR PUBLICATION
SUSAN M. SPRAUL, CLERK
U.S. BKCY. APP. PANEL
OF THE NINTH CIRCUIT
UNITED STATES BANKRUPTCY APPELLATE PANEL
OF THE NINTH CIRCUIT
In re: BAP No. EC-19-1047-GFB
LEONARD E. HUTCHINSON and Bk. No. 1:17-bk-12272
SONYA C. HUTCHINSON,
Adv. No. 1:17-ap-1076
Debtors.
LEONARD E. HUTCHINSON;
SONYA C. HUTCHINSON,
Appellants,
v. MEMORANDUM*
UNITED STATES OF AMERICA;
JAMES SALVEN, Chapter 7 Trustee,
Appellees.
Argued and Submitted on October 25, 2019
at San Francisco, California
Filed – November 7, 2019
*
This disposition is not appropriate for publication. Although it may be cited for
whatever persuasive value it may have, see Fed. R. App. P. 32.1, it has no precedential
value. See 9th Cir. BAP Rule 8024-1.
Appeal from the United States Bankruptcy Court
for the Eastern District of California
Honorable Frederick E. Clement, Bankruptcy Judge, Presiding
Appearances: David R. Jenkins argued for Appellants; Jonathan M.
Hauck argued for Appellee United States; Russell W.
Reynolds of Coleman & Horowitt, LLP for Appellee
James E. Salven, Chapter 7 Trustee on the brief.
Before: GAN, FARIS, and BRAND, Bankruptcy Judges.
INTRODUCTION
Debtors Leonard and Sonya Hutchinson (“Debtors”) appeal from an
order dismissing their adversary proceeding under Rule 7012(b)1 filed
against the United States Department of the Treasury, Internal Revenue
Service (“IRS”) and the Chapter 7 Trustee, James E. Salven (“Trustee”).
Debtors sought to avoid the penalty portion of five IRS tax liens pursuant
to § 724(a) and to preserve the liens under § 522(I) to the extent of their
homestead exemption.
The Trustee filed a crossclaim seeking to avoid the liens for the
benefit of the estate and ultimately entered into a stipulated judgment with
1
Unless specified otherwise, all chapter and section references are to the
Bankruptcy Code,
11 U.S.C. §§ 101-1532, all “Rule” references are to the Federal Rules
of Bankruptcy Procedure, and all “Civil Rule” references are to the Federal Rules of
Civil Procedure.
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the IRS to avoid the penalty portions of two liens and preserve them for the
estate.
Ninth Circuit precedent clearly bars Debtors from using § 522(h) to
avoid the penalty portion of tax liens, and Debtors can only preserve liens
under § 522(I) which were avoided under § 522(f) or (h). Debtors cannot
exempt property under § 522(g) where the Trustee avoids liens securing tax
penalties. Therefore, we AFFIRM.
FACTS
On June 11, 2017, Debtors filed a chapter 7 petition and scheduled
assets including their residence, which they valued at approximately
$184,994. Debtors’ residence was encumbered by a first position deed of
trust in the amount of $86,848. They claimed a homestead exemption of
$100,000 on the property.
On three separate dates prior to the petition date, the IRS properly
filed notices of tax lien against Debtors’ property, including their residence.
The IRS filed a proof of claim indicating that Debtors owed taxes and
penalties in the total amount of $591,383.62, which consisted of a secured
claim of $412,067.44 and an unsecured claim of $179,316.18. The portion of
the secured claim attributable to penalties was $162,690.85.
On August 8, 2017, nineteen days after the meeting of creditors and
eleven days after the Trustee filed his application to employ counsel,
Debtors filed their adversary complaint to avoid the penalty portion of the
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tax liens. Debtors sought to avoid the liens pursuant to § 522(h), and to
preserve the liens for Debtors’ benefit under § 522(I) to the lesser of their
homestead exemption or the amount of the penalties.
On September 7, 2017, the Trustee filed an answer and crossclaim
asserting the estate’s interest in avoiding the penalty portion of the liens
and seeking to preserve the liens for the benefit of the estate. The Trustee
noted that at the time Debtors filed their complaint, the IRS had yet to file
its proof of claim. The Trustee stated that he had discussed the potential
lien avoidance with Debtors’ counsel but had not decided that the estate
would forego the claim.
The IRS filed a motion to dismiss asserting that the Ninth Circuit’s
holding in DeMarah v. United States (In re DeMarah),
62 F.3d 1248 (9th Cir.
1995) precluded Debtors from avoiding the tax liens under § 522(h) as a
matter of law, and pursuant to § 522(c)(2)(B), the tax liens would take
priority over Debtors’ homestead exemption.
Debtors acknowledged that the Trustee’s crossclaim took precedence
over their complaint but argued that they maintained a right to preserve
the lien for their benefit under § 522(i)(2) if the Trustee was successful in
avoiding the penalty portion of the liens. Debtors argued that because the
Ninth Circuit did not explicitly take into account the effect of § 522(i)(2) in
ruling that debtors cannot avoid tax liens under § 522(h), the holding of In
re DeMarah is dicta.
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The bankruptcy court disagreed and dismissed Debtors’ complaint
with prejudice. The bankruptcy court followed the holding of In re
DeMarah in ruling that § 522(c)(2)(B) precludes chapter 7 debtors from
avoiding tax liens on otherwise exempt property even if the liens could be
avoided by the Trustee under § 724(a). The bankruptcy court further held
that because Ҥ 522(c)(2)(B) precludes the debtors from ever invoking
§ 522(h) to avoid a tax lien securing penalties . . . [i]t follows that the
debtors cannot rely on § 522(i)(2) to preserve an avoided tax lien for their
benefit.”
The IRS and the Trustee entered into a stipulated judgment to avoid
the penalty portions of three liens listed on the May 23, 2011 notice of tax
lien which totaled $132,099.54. Debtors filed a timely notice of appeal.
JURISDICTION
The bankruptcy court had jurisdiction pursuant to
28 U.S.C. §§ 1334
and 157(b). We have jurisdiction under
28 U.S.C. § 158.
ISSUES
Whether the appeal is moot;
Whether the bankruptcy court erred in dismissing the complaint.
STANDARDS OF REVIEW
We review our own jurisdiction, including whether an appeal is
moot, de novo. Silver Sage Partners, Ltd. v. City of Desert Hot Springs (In re
City of Desert Hot Springs),
339 F.3d 782, 787 (9th Cir. 2003). De novo review
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requires that we consider the matter as if no decision had been previously
rendered. Kashikar v. Turnstile Capital Mgmt., LLC (In re Kashikar),
567 B.R.
160, 164 (9th Cir. BAP 2017).
We review a dismissal of an adversary proceeding under Civil Rule
12(b)(6) de novo. EPD Inv. Co., LLC v. Bank of Am. (In re EPD Inv. Co., LLC)
523 B.R. 680, 684 (9th Cir. BAP 2015). A dismissal without leave to amend is
reviewed for abuse of discretion.
Id. A bankruptcy court abuses its
discretion if it applies the wrong legal standard, misapplies the correct
legal standard, or if its factual findings are illogical, implausible, or without
support in the record. Traffic School.com, Inc. v. Edriver Inc.,
653 F.3d 820, 832
(9th Cir. 2011).
DISCUSSION
A. The Appeal Is Not Moot
We cannot exercise jurisdiction over a moot appeal. United States v.
Pattullo (In re Pattullo),
271 F.3d 898, 900 (9th Cir. 2001). A case is
constitutionally moot “if the issues presented are no longer live and there
fails to be a ‘case or controversy’ under Article III of the Constitution.”
Pilate v. Burrell (In re Burrell),
415 F.3d 994, 998 (9th Cir. 2005). The test for
mootness is whether an appellate court can give the appellants effective
relief if it decides the merits in their favor.
Id. As long as the parties have a
concrete interest in the outcome of the litigation, the case is not moot.
Chafin v. Chafin,
568 U.S. 165, 172 (2013).
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The IRS argues that Debtors’ appeal is moot because the Trustee
succeeded in avoiding the penalty portion of two tax liens in the amount of
$132,099.54 which the Trustee believed would exhaust all equity from
Debtor’s property. The IRS suggests that the only way the appeal is not
moot is if Debtors have a meaningful interest in attempting to avoid the
penalty portion of the three remaining liens, which have a combined value
of approximately $30,000.
Debtors contend that the appeal is not moot because they assert a
right to intervene in the Trustee’s action and preserve the liens for their
benefit despite the fact that the Trustee has avoided the liens. Debtors
argue that the bankruptcy court erred in holding that their ability to
preserve the liens under § 522(I) is dependent on Debtors having avoided
the liens under § 522(h). The property has not been sold and the proceeds
have not been distributed.
The two liens avoided by the Trustee have a greater value than
Debtors’ homestead exemption. Because preservation of a lien under
§ 522(i)(2) is limited “to the extent that the debtor may exempt such
property,” Debtors’ rights would be unaffected by avoiding the remaining
penalty portions of the tax liens.
However, to the extent that the dismissal order foreclosed Debtors’
ability to claim a homestead exemption after the liens were avoided,
Debtors’ rights could be affected by a favorable outcome in this appeal.
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Therefore, the appeal is not moot.
B. The Bankruptcy Court Did Not Err In Dismissing The Complaint
Under Civil Rule 12(b)(6), made applicable in adversary proceedings
by Rule 7012(b), a party may move to dismiss a complaint for failure to
state a claim upon which relief can be granted. Dismissal of an adversary
proceeding under Civil Rule 12(b)(6) may be based on “either a lack of a
cognizable legal theory or the absence of sufficient facts alleged under a
cognizable legal theory.” Johnson v. Riverside Healthcare Sys., LP,
534 F.3d
1116, 1121 (9th Cir. 2008). Debtors’ complaint lacks a cognizable legal
theory.
1. The Debtors Cannot Avoid The Tax Liens Under § 522(h)
In the adversary proceeding, Debtors sought to avoid the penalty
portion of the tax liens under §§ 522(h) and 724(a). Section 522(h)
authorizes debtors to use the trustee’s avoidance powers, including the
power to avoid liens under § 724(a), if the trustee does not attempt to avoid
such liens. Section 724(a) allows a trustee to avoid a lien that secures a
claim specified in § 726(a)(4), which includes any fine, penalty, or
forfeiture, or exemplary, or punitive damages.
Debtors can avoid a transfer of property under § 522(h) only if five
conditions are met:
(1) the transfer cannot have been a voluntary
transfer of property by the debtor;
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(2) the debtor cannot have concealed the property;
(3) the trustee cannot have attempted to avoid the
transfer;
(4) the debtor must exercise an avoidance power
usually used by the trustee that is listed within
§ 522(h); and
(5) the transferred property must be of a kind that
the debtor would have been able to exempt from
the estate if the trustee (as opposed to the debtor)
had avoided the transfer pursuant to one of the
statutory provisions in § 522(g).
In re DeMarah,
62 F.3d at 1250. However, even if Debtors can otherwise
satisfy these conditions, they cannot use § 522(h) to avoid liens that secure
tax penalties. Id. at 1251-52.
In In re DeMarah, the Ninth Circuit held that chapter 7 debtors cannot
avoid the penalty portion of tax liens because exempt property remains
liable for tax liens under § 522(c)(2)(B). Id. at 1251. The Ninth Circuit
reasoned that although § 522(c)(2)(A) provides that avoided liens which
secure noncompensatory penalties do not remain attached to exempt
property, Congress “carefully added § 522(c)(2)(B) which brings back the
whole of any tax lien. That explicit language belies any argument that the
debtor can escape a part of the tax lien.” Id. at 1252.
Debtors argue that the holding of In re DeMarah is not binding
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precedent because the Ninth Circuit did not specifically cite or address
§ 522(I) in its analysis. Where the Ninth Circuit “confronts an issue
germane to the eventual resolution of the case, and resolves it after
reasoned consideration in a published opinion, that ruling becomes law of
the circuit.” United States v. McAdory,
935 F.3d 838, 843 (9th Cir. 2019)
(quoting Cetacean Community v. Bush,
386 F.3d 1169, 1173 (9th Cir. 2004)).
The Ninth Circuit specifically addressed the question of whether a
debtor can use § 522(h) to avoid the penalty portion of a tax lien and clearly
held that “Congress has denied debtors the right to remove tax liens from
their otherwise exempt property . . . even the penalty portion of the tax lien
remains fixed on that property.” In re DeMarah,
62 F.3d at 1252. The
holding of In re DeMarah is law of the circuit which the bankruptcy court
and this panel must follow.
Even if In re DeMarah was not binding as Debtors argue, Debtors
failed to satisfy a necessary condition to proceed under § 522(h) because
the Trustee attempted to avoid the liens. Debtors filed their complaint less
than twenty days after the meeting of creditors and before the IRS had even
filed its proof of claim evidencing the tax liens. At the time Debtors filed
their complaint, the Trustee had not taken action to avoid the liens, but
there is no temporal requirement in § 522(h). The Code simply states that a
debtor may avoid a transfer if “the trustee does not attempt to avoid such
transfer.” § 522(h)(2). The Trustee timely answered the complaint and filed
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a crossclaim against the IRS. Once the Trustee asserted the estate’s interest
in avoiding the lien, Debtors could no longer maintain the action under
§ 522(h).
2. Debtors Cannot Preserve The Lien For Their Benefit
Debtors argue that despite the fact that the Trustee has avoided the
liens, § 522(I) allows Debtors to preserve those avoided liens for their
benefit. Section 522(i)(2) states:
Notwithstanding section 551 of this title, a transfer
avoided under section 544, 545, 547, 548, 549, or
724(a) of this title, under subsection (f) or (h) of this
section, or property recovered under section 553 of
this title, may be preserved for the benefit of the
debtor to the extent that the debtor may exempt
such property under subsection (g) of this section or
paragraph (1) of this subsection.
Section 522(i)(2) “adopts the rule of section 551 that avoided
transfers are preserved.” 5 COLLIER ON BANKRUPTCY ¶ 522.12 [4] (Alan N.
Resnick & Henry J. Sommer, eds. 16th ed. rev. 2012). A trustee or debtor
who avoids a lien “succeeds to the priority that interest enjoyed over
competing interests.” Retail Clerks Welfare Tr. v. McCarty (In re Van De
Kamp’s Dutch Bakeries),
908 F.2d 517, 519 (9th Cir. 1990). If the trustee
avoids the liens, § 551 automatically preserves the liens for the benefit of
the estate. Heintz v. Carey (In re Heintz),
198 B.R. 581, 584 (9th Cir. BAP
1996).
Section 522(i)(2) allows Debtors to preserve an avoided lien for their
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benefit only if the liens were avoided by Debtors under § 522(f) or (h).
Additionally, Debtors can only preserve an avoided lien for their benefit
“to the extent that the debtor may exempt such property under subsection
(g).” Section 522(I) does not give Debtors greater exemption rights than
they would have if the Trustee avoids the liens instead.
Generally, debtors can assert exemption rights on property avoided
by the trustee pursuant to § 522(g). However, where the avoided transfers
are liens securing tax penalties, Debtors cannot claim an exemption on the
property secured by the liens. The holding of In re DeMarah applies equally
to situations where the Trustee avoids liens securing tax penalties and
preserves the liens for the estate. Congress allowed noncompensatory
penalties to be avoided “to protect [ ] unsecured creditors from the debtor’s
wrongdoing.” In re DeMarah,
62 F.3d at 1252 (quoting S. Rep. No. 95-989,
95th Cong. 2d Sess. 96). It would be absurd to hold that Debtors cannot
avoid liens securing tax penalties under § 522(h) but permit Debtors to
benefit from their wrongdoing if instead the Trustee avoids the liens.
CONCLUSION
Binding Ninth Circuit precedent precludes Debtors from avoiding
liens securing tax penalties under § 522(h). Debtors cannot preserve liens
for their benefit under § 522(i)(2) unless the liens were avoided by the
Debtors under § 522(h) or (f), and Debtors cannot exempt the property
under § 522(g) if the liens avoided by the Trustee secured tax penalties. For
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the reasons set forth above, we AFFIRM.
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