In re Drumheller

574 B.R. 422

IN RE Daniel M. DRUMHELLER and Lois F. Drumheller, Debtors

Case No. 15–14896–FJB

United States Bankruptcy Court, D. Massachusetts, Eastern Division.

Signed October 4, 2017

Hilmy Ismail, Law Office of Hilmy Ismail, North Attleboro, MA, Robert S. Simonian, Bucacci and Simonian, P.C., Fall River, MA, for Debtors.

Warren E. Agin, Daniel Kostrzewa, Swiggart & Agin LLC, Boston, MA, for Trustee.

MEMORANDUM OF DECISION ON TRUSTEE'S OBJECTION TO CLAIM OF EXEMPTION IN IRA ANNUITY [Doc. # 28]

Frank J. Bailey, United States Bankruptcy Judge

In the above-entitled chapter 7 case, debtor Daniel Drumheller (individually, "the Debtor"; with his spouse and joint debtor, "the Debtors") has claimed as exempt, under 11 U.S.C. § 522(b)(3)(C) and MASS. GEN. LAWSch. 235, § 34A, his interests in three annuity contracts with Allianz Life Insurance Company of North America ("Allianz"). In the matter now before the Court, the chapter 7 trustee, Warren Agin (the "Trustee"), has objected to the claim of exemption as to one such annuity contract (the "Annuity Policy") on essentially two grounds: first, that it was sold prepetition and is therefore not an asset of the Debtor in which the Debtor can claim an exemption; and second, that the Annuity Policy is not exempt because the Debtor engaged in a so-called prohibited transaction—sale, transfer, or assignment of the Annuity Policy, or use of the Annuity Policy as collateral for a loan—that caused the Annuity Policy to lose its exempt status under the Internal Revenue Code ("IRC"). After an evidentiary hearing and for the reasons stated below, I now overrule the objection.

Factual Background

Except where indicated, the following facts were stipulated in the Joint Pretrial Memorandum or at the trial. The Debtor purchased the Annuity Policy in 2005 from Allianz with a lump sum rollover of funds from a tax qualified retirement account in the amount of $143,866.92. The Annuity Policy was intended to qualify as an Individual Retirement Annuity ("IRA") under 26 U.S.C. § 408(b). In their bankruptcy filing the Debtors identified an interest in three retirement annuities and stated the value of each annuity at the time of filing as "unknown." The only annuity policy that is at issue in this objection is the Annuity Policy as defined above, which policy has an account number that ends with 4003. With their bankruptcy petition, the Debtors also filed a Schedule C, their schedule of property claimed as exempt, and on it elected the "state and non-bankruptcy federal exemptions" and claimed the Annuity Policy as exempt. At the trial the parties stipulated that the Annuity Policy was a tax qualified retirement account; accordingly, unless the actions of the Debtor described below caused the Annuity Policy to lose its qualified status, the Annuity Policy is exempt. The Annuity Policy gave the Debtor a right to a series of annual payments, each in the amount of $7,204.07. The Annuity Policy states that it is not transferable and the entire interest of the "[o]wner is non-forfeitable." Nonetheless, on February 25, 2014, the Debtor entered into an annuity purchase contract (the "Purchase Agreement") with J.G. Wentworth Originations, LLC ("Wentworth") whereby the Debtor received $27,000 and purported to "sell, transfer and assign" the Annuity Policy to Wentworth. Specifically, the Purchase Agreement states that the Debtor was selling the "Annuity Policy" and the "right to receive the Purchased Payments," which are defined as, in aggregate, $43,224.42 (a stream of six annual payments at $7,204.07 beginning on 11/19/2014). In an attachment to the Purchase Agreement it states that "[y]ou understand that this transaction is a sale of Your [the Debtor's] Annuity Policy and the Purchased Payments to Us [Wentworth], not a loan. You are selling all right and title in those to Us." (Underscore in the original.)

The Debtor was not represented by counsel in connection with this transaction, but when he received the Purchase Agreement, he was concerned that it stated that he was selling the Annuity Policy, which he testified was not his intention. He intended to sell only six payments and otherwise to retain ownership of the Annuity. Therefore, he called Wentworth, and, no doubt having heard this lament from other customers, Wentworth sent him an "addendum" to correct this problem.¹ The addendum is called Waiver of Annuity Policy Transfer and Ownership Addendum (the "Addendum"). The Addendum provides that, "[n]otwithstanding anything to the contrary in the Contract Documents and the Closing Documents, in this transaction, you [the Debtor] are only selling, transferring and assigning your right to receive the Purchased Payments." It also says that "[w]e [Wentworth] hereby waive your obligation to sell, transfer and assign the Annuity Policy itself." Satisfied that he was selling only six payments, the Debtor signed the Purchase Agreement and the Addendum and sent them to Wentworth. In addition, at Wentworth's instruction, he signed and sent a letter to Allianz changing the payee from himself to another entity called R.C. Henderson Trust ("Henderson"), to whom Wentworth had "sold and/or contributed its interest" in the Annuity Policy. He stated in the instructional letter that Henderson was now the payee of the "the following payments: A) 6 annual payments of $7,204.07 each, beginning on 11/19/2014 and ending on 11/19/2019." The Debtor also signed and sent a "Service Request" to Allianz that transferred ownership of the Annuity Policy from himself to Henderson. The form informed the Debtor that "IRS guidelines prohibit any individual other than the annuitant to be the owner of an IRA/SEP," but he signed it anyway. He also changed the beneficiary on the entire Annuity Policy from his wife to Henderson, even though he has repeatedly testified that he never intended to transfer ownership of the Annuity Policy to Wentworth or Henderson.

Also among the closing documents, the Debtor executed a cover letter that accompanied what is styled a Uniform Commercial Code Financing Statement ("UCC"), but also states that it is for "Notice Filing Only." The parties have stipulated that the UCC was filed in the Office of the Secretary of the Commonwealth of Massachusetts to give notice of a lien in favor of Henderson on the Annuity Policy.

The parties have stipulated that the Debtor's intent was to sell the six annual payments to Wentworth (payable to Henderson) and that Wentworth had the same intention, with an obligation to pay the Debtor $27,000. It is also undisputed that Allianz still reflects in its records that the Debtor is the "Owner" of the Annuity Policy. Finally, at least three of the annuity payments of $7,204.07 have gone to Henderson, and the Debtor has paid income taxes on those amounts as he would if he had received the payments himself.

Positions of the Parties

The Trustee argues that the series of transactions described above resulted in the loss of the exemption of the retirement account. He says that on February 25, 2014, in return for a payment of $27,000, the Debtor transferred or assigned the entire Annuity Policy to Wentworth and, in turn, to Henderson, in order to secure his assignment to Henderson of the right to receive the six annuity payments. As a result, he argues, the Debtor lost his right to the exemption for one of two reasons: the Annuity Policy is no longer an asset of the estate because it was sold prepetition; or, because the Annuity Policy does not comply with the requirements of the Internal Revenue Code insofar as the transfer constituted a "prohibited transaction" under 26 U.S.C. § 4975 whereby the Annuity Policy was no longer a tax qualified account, or because it was used as collateral for a loan, also a prohibited transaction.

Therefore, the Trustee argues, he has a right to recover the account under 11 U.S.C. §§ 550 and 551 (but he has not yet brought a complaint against a third-party transferee for any such relief). He points out that the Annuity Policy itself makes clear that it cannot be alienated or transferred, but that the Debtor changed the ownership of the fund to Henderson in violation of the Annuity Policy terms. Such violation caused the Annuity Policy to lose the protection of state and federal law, including the protection against "involuntary alienation." The Debtor's instruction to Allianz to make Henderson the owner and beneficiary of the Annuity Policy, as well as the recipient of the six payments, made it clear that the Debtor engaged in a prohibited transaction. In the alternative, according to the Trustee, the Debtor's UCC Financing Statement with regard to the Annuity Policy was a prohibited transaction because the owner of a qualified retirement account may not use the account as collateral. 26 U.S.C. § 408(e) (detailing disqualifying events, including the sale of a retirement account and its use as collateral). Thus, the Debtor lost the benefit of state law, MASS. GEN. LAWS ch. 235, § 34A, by not maintaining the retirement account in compliance with the Internal Revenue Code.

The Debtor sees it quite differently. The Debtor says that the facts are clear: he neither sold the Annuity Policy nor used it as collateral. He says that he did nothing more than assign the six payments. He relies on the Addendum to establish these facts. He also relies on the subsequent performance of the Purchase Agreement and the Annuity Policy by both Henderson and Allianz, respectively. It is agreed that Allianz has not changed the name of the owner of the Annuity Policy from the Debtor to Henderson or Wentworth and has merely made the last few payments to Henderson, and that the Debtor has paid income taxes on the payments made to Henderson. The Debtor maintains that, at most, his sale of the payments has resulted in a loss of his right to claim an exemption in those six payments .

Jurisdiction

The matter before the Court, an objection to claim of exemption, arises under the Bankruptcy Code...