In re Franklin

506 B.R. 765

In re David J. FRANKLIN, Debtor.

No. 13–81207.

United States Bankruptcy Court, C.D. Illinois.

Signed March 12, 2014.

John Vandevelde, Rock Island, IL, for Debtor.

Jeana K. Reinbold, Chapter 7 Trustee, Woburn, MA, Trustee.

OPINION

THOMAS L. PERKINS, Bankruptcy Judge.

This matter is before the Court on the objection of the Chapter 7 Trustee, Jeana K. Reinbold (TRUSTEE), to the claimed exemptions of the Debtor, David J. Franklin (DEBTOR), in two bank accounts and the TRUSTEE'S motion for turnover of the funds. The primary issue concerns the application of 42 U.S.C. § 407, which protects social security benefits paid or payable, to a bank account containing funds traceable to social security benefits. The TRUSTEE contends that the exemption provided by § 407 may be denied for equitable reasons and may be capped based upon a needs-based test. For two alternative reasons, the TRUSTEE'S objection must be denied.

The DEBTOR filed a petition under chapter 7 of the Bankruptcy Code on June 13, 2013. At the time the petition was filed, the balance on hand in his checking account was $2,303.43 and his savings account had a balance of $11,119.47. The only funds deposited into the savings account were from social security. The DEBTOR owns his residence valued at $90,804, which has no nonexempt equity. The DEBTOR'S vehicle, a 1990 Volvo, valued at $1,000, was described as not currently driveable. Schedule I discloses that the DEBTOR is retired and that he has a monthly income of $4,091.09, comprised solely of pension income of $2,699.69 and social security benefits of $1,391.40. According to Schedule J, the DEBTOR'S monthly expenses total $2,650.42, including a tax payment to the Internal Revenue Service of $400, leaving monthly net income of $1,440.67. The Internal Revenue Service has filed a priority claim for 2011 and 2012 income taxes totaling $4,778.92.

In his original Schedule C, the DEBTOR did not assert an exemption in the savings account under 42 U.S.C. § 407. The TRUSTEE objected to the DEBTOR'S claim of exemption under 735 ILCS 5/12–1001(g)(1), correctly noting that the state law exemption is limited to a debtor's “right to receive” a social security benefit and does not protect benefits which the debtor received and placed in a bank account prior to the filing of bankruptcy. In re Schoonover, 331 F.3d 575 (7th Cir.2003); Fayette County Hosp. v. Reavis, 169 Ill.App.3d 246, 119 Ill.Dec. 937, 523 N.E.2d 693 (Ill.App. 5 Dist.1988). Both the federal bankruptcy and the Illinois exemption schemes draw a distinction between a “debtor's right to receive” a payment or benefit and “property that is traceable” thereto.

In response to the TRUSTEE'S objection, the DEBTOR filed Amended Schedule C on September 30, 2013, again claiming the savings account balance as fully exempt under § 12–1001(g)(1), and adding a claim of full exemption under 42 U.S.C. § 407. The DEBTOR also claimed the funds in the checking account as fully exempt under 735 ILCS 5/12–704, which exempts from garnishment benefits payable by pension or retirement funds or systems, and as fully exempt under the wildcard exemption as well. The TRUSTEE objected to the amended exemption claims, contending that 42 U.S.C. § 407 is not a blanket exemption for all segregated funds traceable to social security payments without regard to the amount of funds accumulated. She argues that a court has the authority to limit the exemption to amounts reasonably necessary to pay for basic living expenses.

There is no dispute that the DEBTOR opened the savings account at least eight months before bankruptcy, upon the advice of counsel, for the sole purpose of segregating and holding his social security payments in order to preserve their exempt status. There is also no dispute that the funds in the checking account consist solely of accumulated pension benefits. The parties have submitted briefs and the issues are ripe for decision.

ANALYSIS

In her brief, the TRUSTEE, acknowledging that the DEBTOR'S exemption overage under the wildcard provision is minimal, represents that her objection to the claim of exemption in the checking account will not be pursued if her objection to the savings account is not sustained by the Court. ¹ As a result, the Court will first address the DEBTOR'S claim of exemption in his savings account, based upon the exemption provided for social security benefits under federal law.

Upon the filing of a petition in bankruptcy, section 522 of the Bankruptcy Code provides that a debtor is entitled to retain certain assets as exempt from the bankruptcy estate. 11 U.S.C. § 522. Section 522(b) allows a debtor to claim either the federal bankruptcy exemptions listed in subsection (d) or exemptions available under nonbankruptcy law, unless the applicable state law precludes the debtor from claiming the federal bankruptcy exemptions. Section 522(b), in essence, authorizes each state to “opt-out” of the scheme of exemptions provided under federal bankruptcy law, restricting its residents to the exemptions provided under the law of that state and under federal statutes other than section 522(d). Illinois has exercised that opt-out option, thus mandating the use of other federal exemptions plus the exemption statutes enacted in Illinois. One such nonbankruptcy federal exemption is that provided for social security benefits. Sections 407(a) and (b) of the Social Security Act provide:

(a) In general

The right of any person to any future payment under this subchapter shall not be transferable or assignable, at law or in equity, and none of the moneys paid or payable or rights existing under this subchapter shall be subject to execution, levy, attachment, garnishment, or other legal process, or to the operation of any bankruptcy or insolvency law.

(b) Amendment of section

No other provision of law, enacted before, on, or after April 20, 1983, may be construed to limit, supersede, or otherwise modify the provisions of this section except to the extent that it does so by express reference to this section.

42 U.S.C. § 407.

Section 407(a) contains three distinct directives. First is the anti-assignment provision, which prevents a recipient from assigning or otherwise transferring the right to future payments. Second is the general exemption provision, which protects social security benefits paid or payable from creditor collection rights. Third is the exclusion from bankruptcy and insolvency laws, which decrees that benefits paid or payable are not subject to the operation of the federal bankruptcy laws or any other insolvency law. These proscriptions have been part of the Social Security Act since 1935.

Under the Bankruptcy Act of 1898, exempt property was expressly excluded from the interests of the bankrupt that vested in the trustee. Bankruptcy Act, sec. 70a. Since October 1, 1979, the effective date of the Bankruptcy Code of 1978, the estate created by section 541(a) includes exempt property, at least initially, which is subject to passing out of the estate through the claim of exemption process. See Schwab v. Reilly, 560 U.S. 770, 130 S.Ct. 2652, 177 L.Ed.2d 234 (2010). Bankruptcy Code section 541 makes no mention of social security benefits or of § 407. Section 522, also failing to mention § 407, provides an exemption for a debtor's right to receive a social security benefit but not for property that is traceable to such a benefit.²11 U.S.C. § 522(d)(10) and (11).

Section 407(b) was added in 1983 as a clarifying amendment. The House Conference Report indicates that the amendment was in response to bankruptcy court orders entered in several hundred cases ordering the Social Security Administration to send all or part of a debtor's benefit check to the chapter 13 trustee. SeeP.L. 98–21, Social Security Amendments of 1983, House Conference Report No. 98–47, 1983 U.S.C.C.A.N. 404.

The Bankruptcy Code has been amended often since its enactment. None of those amendatory enactments contain any reference to § 407. Several amendments have made sweeping changes, none more so than the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). BAPCPA adopted the newly defined term “current monthly income” which, among other things, is used to determine whether a chapter 7 filing is presumed abusive, seesection 707(b)(2)(A)(1), and whether a chapter 13 debtor is proposing to use all of her projected disposable income to make payments to unsecured creditors, see section 1325(b)(2). Benefits received under the Social Security Act are expressly excluded from a debtor's “current monthly income.” 11 U.S.C. § 101(10A)(B).

EQUITABLE EXCEPTIONS TO THE SOCIAL SECURITY ACT EXEMPTION FOR SOCIAL SECURITY BENEFITS ARE NOT PERMITTED

The TRUSTEE does not dispute that § 407, providing a broad exemption for social security benefits, on its face covers accumulated benefits paid out to a debtor and held on deposit in a bank account. Rather, the TRUSTEE contends that the exemption may nevertheless be denied where allowing it would run afoul of the exemption's purpose or otherwise be inequitable. The TRUSTEE relies on the admitted fact that the DEBTOR opened the savings account on the advice of his attorney for the sole purpose of holding and segregating the deposited funds in order to preserve their exempt status. The TRUSTEE also argues that the purpose of the exemption is not being served where the DEBTOR is simply hoarding the benefits without any present need to use the funds for living expenses.

The TRUSTEE'S arguments have now been foreclosed by the United States Supreme Court. On March 4, 2014, the SupremeCourt issued its opinion in Law v. Siegel, ––– U.S. ––––, 134 S.Ct. 1188, 188 L.Ed.2d 146 (2014). The debtor, a California resident, filed a chapter 7 petition, asserting that his house was encumbered by two liens arising from separate deeds of trust, claiming the allowable California homestead exemption of $75,000, and representing that because the...