William M. Clark, Jr. v. James L. Wilmoth

United States Bankruptcy Appellate Panel
FOR THE EIGHTH CIRCUIT
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No. 08-6022
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In re: *
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James Lewis Wilmoth, etc., et al., *
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Debtor. *
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William M. Clark, Jr., * Appeal from the United States
* Bankruptcy Court for the Western
Trustee-Appellant, * District of Arkansas
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v. *
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James L. Wilmoth, et al., *
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Debtors - Appellees *
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Submitted: October 29, 2008
Filed: December 9, 2008
(Corrected December 10, 2008)
(Corrected December 31, 2008)
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Before KRESSEL, Chief Judge, SCHERMER and McDONALD, Bankruptcy Judges.
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KRESSEL, Chief Judge.
William M. Clark, Jr., the chapter 7 trustee, appeals the bankruptcy court’s1
order of May 23, 2008, overruling the trustee’s objection to the debtors’ claim of
exemptions. We have jurisdiction over this appeal from a final order. 28 U.S.C. §
158(b). Because we conclude that the debtors’ pre-bankruptcy planning was
permissible under Addison v. Seaver (In re Addison), 540 F.3d 805 (8th Cir. 2008),
we affirm.
BACKGROUND
James Wilmoth is a general contractor in Gentry, Arkansas. His business is
primarily “dirt work”: excavation and site preparation. James has worked in
construction since 1977, when he started Wilmoth Backhoe. Over the years, his
business grew as he expanded its scope and acquired more equipment until it
encountered serious troubles in 2006, when the construction market began to bottom
out.
In 2006, James went to the equipment dealers he had worked with for thirty
years to see if he could refinance or sell his equipment because his cash flow was
slowing to a trickle. At the time, the salesmen advised him to keep working with the
finance companies. James could not collect his receivables, and his business went
from being in the black into the red. He returned to the equipment dealers, most of
which agreed to refinance or waive payments. None repossessed the equipment,
perhaps due to the length of their relationships with James or because the abundance
of equipment in the area meant there was no local market for the collateral.
Construction companies all around him were folding and auctioning their equipment.
As the days and weeks went by, however, it became clear to James that repossession
was imminent.
1
The Honorable Ben T. Barry, United States Bankruptcy Judge for the Eastern and
Western Districts of Arkansas.
2
Meanwhile, Dave and Linda Bisbee sued him for breach of contract over the
construction of a subdivision. The Bisbees obtained a judgment against James for
approximately $864,000.00. Facing an enormous judgment at a time when he could
not even make payments on his equipment, James went to his lawyer, John Terry Lee,
to discuss bankruptcy. Terry advised him to sell some of his property and pay down
his mortgage to receive the protection of Arkansas’s homestead exemption, but to
leave a significant amount of assets available for creditors. James followed Terry’s
pre-bankruptcy planning advice.
In October or early November of 2007, James sold nine or ten pieces of
equipment, most or all of which were subject to liens, to an equipment broker for fair
market value and realized over $300,000.00 on the sales. Because James had been
behind on his equipment payments, he had believed at the time of sale that unless he
sold the equipment, most or all of it soon would have been repossessed. From the
proceeds, he first paid off the companies that had liens against the equipment.
James and Jodie Wilmoth maintain a homestead on 22 acres in Gentry,
Arkansas. The property contains two houses- the Wilmoths’ residence and a “mother-
in-law” structure where their daughter resides. The tract of land on which the Wilmoth
residence is located was formerly a chicken farm that had been subdivided into three
parcels. The monthly payments on the two mortgages (both held by First Horizon) are
$1832.26 and $363.00. In November 2007, the Wilmoths paid down their first
mortgage in the amount of $140,351.16 from the approximately $300,000.00 realized
on the sale of the equipment. The $140,000.00 was divided into prepayments directed
toward the next ten months and then toward principal. James testified that this was not
done to hinder his creditors, nor was it done to delay his creditors or defraud them.
The Wilmoths filed their chapter 7 petition on November 29, 2007. At the time,
one of James’s companies, Phase I Turnkey, was still completing a job. The trustee
permitted him to continue business operations long enough to finish the project. As
a result, James was able to pay Phase I Turnkey’s suppliers, vendors, and other bills.
3
Ultimately, he paid Phase I Turnkey’s creditors over $440,000.00 on unsecured debts
of around $506,000.00.
The Wilmoths elected to use the Arkansas exemptions, and claimed their
homestead as exempt. The chapter 7 trustee, William M. Clark, Jr., objected to the
exemption because: 1) the identified property was two tracts with two dwellings, and
2) 11 U.S.C. § 522(o) provides for the reduction of value of an exemption where the
value is the result of the debtor’s intent to hinder, delay or defraud creditors. The
bankruptcy court held a hearing on the trustee’s objection on May 20, 2008 and
overruled the objection on both bases. The trustee has not appealed that part of the
court’s decision which held that the property consisted of one parcel.
The court found that the trustee had not met his burden of proving that the
Wilmoths acted with intent to hinder, delay, or defraud their creditors when they
increased their homestead exemption value through the liquidation of equipment. The
court noted that the addition of 11 U.S.C. § 522(o) to the Bankruptcy Code had not
changed the legal analysis of whether the transformation of non-exempt property into
exempt property was prudent pre-bankruptcy planning or fraudulent, and that the
section was likely added to the Bankruptcy Code to extend the look-back period. It
found the testimony of both Dave Bisbee and James Wilmoth to be credible, and that
the differences in testimony were reconcilable and not material. The court found it
significant that the Wilmoths had not liquidated all of their assets to increase their
homestead exemption; that had James delayed the sale, the value of the assets would
likely have diminished further, resulting in less value to the estate; that James sold the
equipment for fair market value; that James paid off secured creditors, freeing up more
assets for unsecured creditors; that James did not conceal his actions; and that the
Wilmoths acted in good faith.
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Standard of Review
“The question of whether an individual acted with intent to defraud in
converting non-exempt property into exempt property is a question of fact, on which
the bankruptcy court's finding will not be reversed unless clearly erroneous.” Jensen
v. Dietz (In re Sholdan), 217 F.3d 1006, 1010 (8th Cir. 2000) (citing Hanson v. First
Nat'l Bank in Brookings, 848 F.2d 866, 868 (8th Cir. 1988)).
DISCUSSION
The sole issue on appeal is: did the bankruptcy court err in finding no intent to
hinder, delay or defraud and therefore allowing the debtors their full homestead
exemption over the objection of the trustee, where the debtors had converted non-
exempt assets on the eve of bankruptcy to increase the value of the homestead
exemption? Debtors are allowed to “choose to exempt from property of the
bankruptcy estate that property which is exempt under the applicable state or federal
law.” 11 U.S.C. § 522(b). The Wilmoths used the Arkansas exemptions, which
provide an unlimited homestead exemption to “any resident of [Arkansas] who is
married or the head of a family.” Art. 9, § 3, Const. of Ark. (1874). The legal basis for
the trustee’s objection was 11 U.S.C. § 522(o), which was added to the Bankruptcy
Code with the 2005 amendments and states in part,
[…] the value of an interest in—
(1) real or personal property that the debtor or a
dependant of the debtor uses as a residence [… or]
(4) real or personal property that the debtor or a
dependent of the debtor claims as a homestead;
shall be reduced to the extent that such value is attributable
to any portion of any property that the debtor disposed of
in the 10-year period ending on the date of filing of the
petition with the intent to hinder, delay, or defraud a
creditor and that the debtor could not exempt, or that
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portion that the debtor could not exempt, under subsection
(b), if on such date the debtor had held the property so
disposed of.
It is not disputed that the debtors converted non-exempt property to increase their
homestead exemption within the 10-year look-back period; rather, the parties dispute
the issue of intent, and whether the addition of § 522(o) has changed the way pre-
bankruptcy homestead exemption planning is treated in the Eighth Circuit. The trustee
would have had the bankruptcy court reduce the debtors’ homestead exemption by the
extra payments they made shortly before their bankruptcy filing.
The presence of some badges of fraud is not enough for a finding of
intent; there must also be extrinsic evidence.
The Eighth Circuit Court of Appeals has spoken in a long line of cases on the
conversion of non-exempt assets to exempt assets on the eve of bankruptcy, and
“intent to hinder, delay or defraud” in the context of allowing exemptions, avoiding
fraudulent transfers, dismissing cases and denying discharges. See, e.g., Sholdan v.
Dietz (In re Sholdan), 217 F.3d 1006 (8th Cir. 2008) (Sholdan I) (trustee objected to
chapter 7 debtor’s claim of exemption where debtor had increased value of homestead
exemption on eve of bankruptcy); Sholdan v. Dietz (In re Sholdan), 217 F.3d 1006
(8th Cir. 2000) (Sholdan II) (same); Kelly v. Armstrong, 206 F.3d 794 (8th Cir. 2000)
(Armstrong IV) (trustee challenged four property transfers by chapter 7 debtors on the
eve of bankruptcy that debtors had used to purchase exempt annuities); Panuska v.
Johnson (In re Johnson), 880 F.2d 78 (8th Cir. 1989) (creditor objected to chapter 7
debtor’s discharge where, on the eve of bankruptcy, debtor had converted $400,000
into exempt property); Norwest Bank Neb. v. Tveten (In re Tveten), 848 F.2d 871, 874
(8th Cir.1988) (creditor objected to chapter 11 discharge where, on the eve of
bankruptcy, debtor had converted $700,000 of non-exempt property into exempt
property); Forsberg v. Sec. State Bank of Canova, 15 F.2d 499 (8th Cir. 1926)
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(creditor objected to debtor’s discharge where, on the eve of bankruptcy, debtor had
traded non-exempt property for exempt property).
Between the time that the parties submitted their briefs and oral argument, the
Eighth Circuit Court of Appeals again addressed the issue of exemptions and pre-
bankruptcy planning. In Addison v. Seaver (In re Addison), 540 F.3d 805 (8th Cir.
2008), the Eighth Circuit declined to define a bright-line rule on when the transfer of
value from non-exempt to exempt assets is egregious enough to be proscribed,
choosing instead to leave the discretion largely to the bankruptcy court. However, it
cautioned that the sort of pre-bankruptcy planning Addison engaged in is usually
permissible. The Eighth Circuit compared the language of § 522(o) to § 548, which
allows a bankruptcy trustee to avoid pre-petition transfers made “with actual intent to
hinder, delay or defraud” the debtor’s creditors, and § 727(a)(2), which directs the
court to grant a debtor’s discharge unless a debtor has transferred assets “with intent
to hinder, delay, or defraud a creditor or an officer of the estate.” Id. at 811. Based on
the nearly identical phrasing, the Eighth Circuit concluded that a debtor’s intent under
§ 522(o) should be determined under the badges of fraud approach. Id. at 813 (citing
Sholdan II at 1009; Jackson v. Star Sprinkler Corp. of Fla., 575 F.2d 1223, 1237 (8th
Cir. 1978); Graven v. Fink (In re Graven), 936 F.2d 378, 383 (8th Cir. 1991)).
However, there must be extrinsic evidence of fraud, other than the badges themselves,
to support a finding of intent to defraud.2 Addison at 814. “[A] debtor's conversion of
non-exempt property to exempt property on the eve of bankruptcy for the express
purpose of placing that property beyond the reach of creditors, without more, will not
2
“In finding that Addison had the requisite intent to defraud, the bankruptcy court
properly looked to the badges of fraud […] and found four badges of fraud resulting
from Addison's day-of-filing mortgage payment […]. The bankruptcy court's
underlying factual findings are themselves not clearly erroneous; however, they do not
identify any ‘extrinsic evidence of fraud.’ In the absence of extrinsic evidence of
fraud, we find clear error in the bankruptcy court's ultimate determination of intent to
defraud.” Addison at 813-14 (footnote omitted).
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deprive the debtor of the exemption to which he otherwise would be entitled.” Id. at
814 (quoting Hanson, 848 F.2d at 868).
The addition of § 522(o) to the Bankruptcy Code does not
establish any new law in the Eighth Circuit.
The trustee argues that the addition of § 522(o) changed the required analysis
of intent to hinder, delay or defraud in the context of pre-bankruptcy homestead
exemption planning. We disagree. More importantly, the Eighth Circuit disagrees. The
Eighth Circuit has determined that the traditional badges of fraud approach applies to
the analysis of the requisite intent under § 522(o). Addison at 813. Rather than
establishing a new evidentiary standard for pre-bankruptcy homestead exemption
planning, the addition of § 522(o) marks out a look-back period of ten years. Addison
at n. 7. It also extends what was the law in the Eighth Circuit and made it uniform
national law. After rejecting the argument that § 522(o) creates a new evidentiary
standard, the court stated that § 522(o) “merely establishes a 10-year look-back period
[…] from which such evidence may be considered”. Id. To the extent there was any
doubt about whether § 522(o) created new law, the Eighth Circuit resolved that
question in the negative.
The trustee argues that to read § 522(o) as merely defining the look-back period
would render it superfluous. As interpreted by the Eighth Circuit in Addison, the
addition does not establish any new law in this circuit. The Eighth Circuit had already
held that under some circumstances, shifting non-exempt assets into exemptions pre-
bankruptcy would result in the denial of the exemption or discharge, but other courts
had not uniformly applied the same analysis and some had allowed the exemptions
almost regardless of intent. See, e.g., In re Farmer, 295 B.R. 322 (Bankr. W.D. Wis.
2003) (holding that debtors are entitled to “full use” of exemptions, regardless of their
source); In re Sumerell, 194 B.R. 818, 835 (Bankr. E.D. Tenn. 1996) (“this court is
not persuaded that even if the requisite showing of bad faith or fraud had been
established, that denial of exemptions, unrelated to the alleged fraud, is the appropriate
remedy”); Barker v. First Colony Life Ins. Co. (In re Barker), 168 B.R. 773 (Bankr.
8
M.D. Fla. 1994) (holding that Chapter 7 debtor was entitled to “full use” of
exemptions, regardless of whether debtor acted with intent to hinder, delay or defraud
creditors); In re Swift, 124 B.R. 475 (Bankr. W.D. Tex. 1991) (overruling objection
to exemption, because although “[t]here of course is great appeal to preventing a
perceived malfeasor from enjoying the fruits of his or her malfeasance”, the
Bankruptcy Code did not contain a statutory basis for that remedy).
Prior to the 2005 amendments, few other circuits had addressed whether a
debtor’s exemption could be denied or reduced on the basis that it was created or
increased by the conversion of non-exempt property with fraudulent intent. The Fifth,
Sixth, Ninth and Tenth Circuits had directly allowed the remedy. See, e.g., Latman v.
Burdette, 366 F.3d 774, 786 (9th Cir. 2004) (holding that “the bankruptcy court may
equitably surcharge a debtor's statutory exemptions when reasonably necessary both
to protect the integrity of the bankruptcy process and to ensure that a debtor exempts
an amount no greater than what is permitted by the exemption scheme of the
Bankruptcy Code”); Marine Midland Bus. Loans, Inc. v. Carey (In re Carey), 938
F.2d 107, 1073 (10th Cir. 1991) (affirming allowance of homestead exemption where,
although debtor paid down mortgage with non-exempt assets, her “other activities do
not bespeak of fraudulent intent”); Hardage v. Herring Nat’l Bank, 837 F.2d 1319
(5th Cir. 1988) (ordering lower court to reconsider debtor’s exemption claim and
evaluate it for bad faith, stating “concealment of an asset bars the exemption of that
asset”); Shanks v. Hardin, 101 F.2d 177 (6th Cir. 1939) (affirming denial of
homestead exemption where debtor had acquired additional property interests from
his siblings for the “purpose of converting non-exempt property into property in
which he would be entitled to a homestead and thus prevent his creditors from
reaching it”).
In an early case, the Second Circuit had contemplated denial of an exemption
as a remedy for abusive pre-bankruptcy exemption planning. Schwartz v. Seldon, 153
F.2d 334, 337 (2d Cir. 1945) (where debtor had borrowed against exempt insurance
policies and then repaid the debts shortly before bankruptcy, exemption was properly
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allowed: “even the conversion of nonexempt property into exempt property by an
insolvent contemplating bankruptcy has been held a transaction not intended to
defraud creditors in the absence of evidence of extrinsic fraud”) (emphasis added)
(citing Forsberg v. Sec. State Bank, 15 F.2d 499 (8th Cir. 1926)). The Fourth and
Seventh Circuits had set limitations on pre-bankruptcy exemption planning but not
come to the conclusion that denial of the exemption was an appropriate remedy. See,
e.g., Smiley v. First Nat’l Bank of Belleville (Matter of Smiley), 864 F.2d 562, 569 (7th
Cir. 1989) (court affirmed denial of discharge for fraudulent use of exemptions, noting
that although the courts “should not prohibit a debtor's full use of exemptions within
the limits of the law” they should “look, however, for extrinsic signs of fraud”); Ford
v. Poston, 773 F.2d 52 (4th Cir. 1985) (affirming avoidance of transfer under 11
U.S.C. § 727 where debtor, with actual intent to defraud, had converted non-exempt
property into exempt property). The First, Third, and Eleventh Circuit Courts of
Appeals had not published any opinions on the propriety of pre-bankruptcy exemption
planning. In addition, although § 522(o)’s exemption abuse remedy did not change the
treatment of abusive or fraudulent exemptions in the Eighth Circuit, our courts have
not previously set a definite look-back period.
The court was not clearly erroneous in finding that although some
badges of fraud were present, there was no extrinsic evidence of
intent to hinder, delay or defraud.
At trial, the court found that some badges of fraud were present but others were
not. The common badges of fraud include, among others, “(1) actual or threatened
litigation against the debtor; (2) a transfer of all or substantially all of the debtor's
property; (3) insolvency on the part of the debtor; (4) a special relationship between
the debtor and the transferee; and (5) retention of the property by the debtor after the
transfer.” Armstrong IV at 798 (quoting Kelly v. Armstrong, 141 F.3d 799 (8th Cir.
1998) (Armstrong III). For instance, the court found that the transfer benefitted the
debtors and that they were in possession of the assets and that the transfer occurred
at the time of the Bisbee judgment, but that the Wilmoths did not liquidate
substantially all of their assets, fully disclosed their transfer, did not convey the
10
equipment for inadequate consideration, and relied on the advice of counsel. The court
gave significant weight to the fact that the Wilmoths’ Statement of Financial Affairs
fully disclosed the Wilmoths’ payments to their mortgagor, First Horizon. The record,
including the testimony and documentary evidence, supports the court’s finding that
some, but not all, of the badges of fraud were present. In addition, the debtors were
able to use some of the payments on their mortgage as advance payments of their
monthly contractual payments, enabling them to weather the period immediately
following the cessation of their business and save their home.
Although the court found the presence of some badges of fraud, it found no
extrinsic evidence that the Wilmoths acted with intent to defraud. The court noted in
particular that James was forthcoming with the trustee, received fair value for the
equipment, and acted upon the advice of counsel. The court found that the assets
would have continued to diminish in value or even be repossessed, and as a result, the
sale actually benefitted the estate.
The trustee may not raise a new argument on appeal.
The trustee argues for the first time at oral argument on appeal that even if the
debtors’ conversion of exempt to non-exempt property was not fraudulent, it was an
attempt to hinder or delay creditors and that the disjunctive phrasing of the statute
allows the court to find intent to hinder even where there is no intent to defraud.
“Ordinarily, we do not consider an argument raised for the first time on appeal. We
consider a newly raised argument only if it is purely legal and requires no additional
factual development, or if a manifest injustice would otherwise result.” Henning v.
Mainstreet Bank, 538 F.3d 975, 979 (8th Cir. 2008) (quoting Orr v. Wal-Mart Stores,
Inc., 297 F.3d 720, 725 (8th Cir. 2002)); Stalnaker v. DLC, Ltd., 376 F.3d 819 (8th
Cir. 2004) (“We do not ordinarily review an issue on appeal if the parties did not first
raise it at trial unless it is a strictly legal question and manifest injustice would result
from our failure to review it”).
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We decline to address the trustee’s new argument, except to note that the Eighth
Circuit “has been reluctant to deny a homestead exemption without a finding of intent
to defraud.” Addison at 812 (citing Sholdan I, 108 F.3d at 888; Panuska v. Johnson
(In re Johnson), 880 F.2d 78, 80 n. 1 (8th Cir. 1989); Coder v. Arts, 213 U.S. 223,
242, 29 S. Ct. 436, 53 L. Ed. 772 (1909)).
CONCLUSION
For the foregoing reasons, the judgment of the bankruptcy court is affirmed.
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