Blumsack v. Harrington

657 B.R. 505

Scott H. BLUMSACK, d/b/a Mass Athletics, LLC, Debtor.

Scott H. Blumsack, Appellant, v. William K. Harrington, United States Trustee, Appellee.

BAP NO. MW 23-003

Bankruptcy Case No. 21-40248-EDK

United States Bankruptcy Appellate Panel of the First Circuit

March 5, 2024

Appeal from the United States Bankruptcy Court for the District of Massachusetts, (Hon. Elizabeth D. Katz, U.S. Bankruptcy Judge)

Dmitry Lev, Esq., Watertown, MA, on brief for Appellant.

William K. Harrington, Hingham, MA, U.S. Trustee; Ramona D. Elliott, Esq.; P. Matthew Sutko, Esq.; Frederick Gaston Hall, Esq.; Eric K. Bradford, Esq., Boston, MA; and Stephen E. Meunier, Esq.; on brief for Appellee.

Before Godoy, Cary, and Fagone, United States Bankruptcy Appellate Panel Judges.

Fagone, U.S. Bankruptcy Appellate Panel Judge.

Before and after the filing of his chapter 13 petition, Scott H. Blumsack worked at a cannabis dispensary in the Commonwealth of Massachusetts, where state law permits the retail sale of marijuana. The debtor proposed a plan that would have been funded with earnings from his employment at the dispensary. Citing a federal statute—the Controlled Substances Act—the United States Trustee asked the bankruptcy court to deny confirmation of the debtor's plan and to dismiss his case. The court granted both requests, and the debtor now appeals.

Although the bankruptcy court erred in fashioning a rule of law that categorically prohibits an individual employed in the cannabis industry from seeking chapter 13 relief, this debtor's case was properly dismissed for cause. Dismissal was warranted because the bankruptcy court properly denied confirmation of the plan and did not abuse its discretion in denying the debtor an opportunity to file a modified plan.

BACKGROUND

The debtor filed a chapter 13 petition in April 2021. At that time, he was employed as a "budtender" at a cannabis dispensary in Massachusetts. After the petition date, the debtor became the general manager of a different dispensary, but he did not acquire an ownership interest in that dispensary. The debtor's schedules disclosed his wages from the dispensary and his spouse's income from her employment as an engineer. The debtor and his spouse commingled their wages in a joint checking account. On his schedule of assets, the debtor listed an interest in that joint checking account with a value of $85 and indicated that although the account had a balance of more than $70,000 on the petition date, those funds did not belong to him and were attributable to a withdrawal from his spouse's retirement account. On his schedule of debts, the debtor disclosed secured debt in the approximate amount of $459,000, consisting of several home mortgages. He also disclosed approximately $557,000 in unsecured debt, including a $21,000 student loan. In his chapter 13 plan (the "Plan"), the debtor proposed to make payments of $250 per month to the chapter 13 trustee over a 36-month term, meaning each creditor with a general unsecured claim would receive a small dividend. He proposed to make direct payments to his secured creditors and towards his student loan.

The United States Trustee (the "Trustee") filed a motion objecting to confirmation of the Plan and seeking dismissal of the case (the "Motion to Dismiss"). The Trustee alleged that the debtor, by virtue of his employment, was engaged in criminal activity proscribed by the Controlled Substances Act ("CSA") of 1970, 21 U.S.C. § 812. In the Trustee's view, the debtor's violations of the CSA precluded a determination that the Plan (or any plan) could satisfy the good faith requirements of § 1325(a)(3) and (a)(7).¹ Because the debtor was incapable of confirming any plan, the Trustee asserted, the debtor was ineligible for chapter 13 relief. More generally, the Trustee argued that the bankruptcy court could not condone the debtor's "ongoing illegal activity by confirming a plan that [was] funded directly or indirectly through income derived from employment at a marijuana enterprise[.]" The Trustee also sought dismissal under § 1307(c), arguing there was "cause" to dismiss where the debtor could "confirm no plan, and continuance of the case would require the trustee to administer assets representing proceeds of an illegal business." The Trustee relied primarily on three cases: Arenas v. U.S. Trustee (In re Arenas), 535 B.R. 845 (B.A.P. 10th Cir. 2015), In re Johnson, 532 B.R. 53 (Bankr. W.D. Mich. 2015), and Burton v. Maney (In re Burton), 610 B.R. 633 (B.A.P. 9th Cir. 2020).

The debtor opposed the Motion to Dismiss, arguing that the Trustee was unable "to cite a single case where a debtor was held to be ineligible for bankruptcy relief" solely due to his employment in a "marijuana-related business." The debtor sought to distinguish the cases cited by the Trustee. In particular, he maintained that, unlike the debtor in Arenas, he had another source of funding for the Plan beyond his own employment—his spouse's income derived from a "non-marijuana-related position" as a federal government employee.

The chapter 13 trustee also objected to confirmation of the Plan. Among other things, she argued that the entire balance of the joint checking account on the petition date was estate property that must be contributed to the Plan to satisfy § 1325(a)(4). The debtor resolved this objection through a stipulation providing that if the case survived the Motion to Dismiss, the debtor would propose a modified plan affording a 100% dividend to unsecured claims (other than the student loan claim which he would pay directly).² The bankruptcy court approved the stipulation during a hearing in March 2022.

Immediately after approving the stipulation, the bankruptcy court conducted an evidentiary hearing on the Motion to Dismiss. The debtor averred that the stipulation contemplated a lump sum plan payment that was "directly traceable to a rollover" from his wife's retirement account and argued that the balance of a modified plan could also be derived from that rollover. The debtor asked the bankruptcy court to take judicial notice of his schedules and the stipulation "and the alternative sources of funding a plan that are embedded within the stipulation and the facts that underlie that aspect of the case." The court denied this request because the stipulation did not identify the funding source for the contemplated modified plan.

The debtor then testified about his spouse's income and the funds from her retirement account, although it appears that neither he nor the Trustee anticipated the need for such testimony. On direct examination, the debtor testified that he was unsure of the exact amount of his wife's income, but he believed that she earned more than $100,000 per year. He also testified that, in late 2020, his wife transferred about $70,000 in retirement funds to their joint checking account and then to a savings account. When asked how much of the initial deposit remained in the savings account, the debtor responded that he was "not sure." Despite that uncertainty, he testified that the retirement funds in the savings account were sufficient to fund his plan. On cross-examination, the debtor stated that the joint checking account was "use[d] for daily living" and admitted that the retirement funds were not the only monies deposited into the joint checking account: he and his wife also deposited their paychecks into that account. As for the savings account, the debtor was unsure whether it was held jointly, and he admitted that he did not know how much money was transferred from the joint checking account to the savings account after the withdrawal from his wife's retirement account. He was also unsure whether other funds may have been transferred into that account from the joint checking account subsequently. The debtor was the only witness at the hearing; his spouse did not testify.

In his closing argument, the Trustee opined: "It is not asking too much of a debtor to obey federal criminal law as a condition of obtaining relief under the Bankruptcy Code." The debtor countered: "There has never been a reported case where a W-2 employee who is legally . . . employed within their state has been denied relief in bankruptcy for that reason." On the contrary, the debtor asserted, the trend among courts is to find "creative ways to allow the debtor to take advantage of . . . relief in bankruptcy while carving out some way that marijuana business revenues do not specifically fund reorganization plans." To the extent the court deemed his wages to be a "pariah" unfit to fund a plan, the debtor asked the court to credit his testimony about alternative sources of funding a modified plan.

In his post-hearing brief, the Trustee pointed to the debtor's admission that the retirement funds were commingled with paychecks that the debtor and his wife received. The Trustee further posited that money is fungible and incapable of being segregated within a household. He elaborated that the Plan "relies on the wages from . . . ongoing illegal activity . . . whether or not the funds are segregated" and suggested that the Plan was "designed" to shield those wages from creditors. In the Trustee's view, the debtor's employment at the dispensary should: (1) preclude a good faith finding regardless of whether the debtor's wages fund the plan; and (2) more generally bar the debtor from obtaining bankruptcy relief.

Responding to the latter contention, the debtor asserted that "cannabis does not preclude availability of relief in federal courts." As for the Trustee's approach to good faith, the debtor argued that the inquiry should turn on the totality of the circumstances, rather than a single factor. In addition, he asserted that the good faith analysis under § 1325(a)(3) centers not on the terms of the plan, but the manner of its proposal.

After taking the matter under advisement, the bankruptcy court denied confirmation of the Plan and dismissed the case. In re Blumsack, 647...