In re Seely

492 B.R. 284

In re James Grove SEELY, III, Gabriela Paul, Debtor(s).

No. 2:12–bk–11522–BB.

United States Bankruptcy Court,

C.D. California,

Los Angeles Division.

June 5, 2013.

Michael Jay Berger, Beverly Hills, CA, for Debtor.

Aaron De Leest, Los Angeles, CA, Eric P. Israel, Danning, Gill, Diamond & Kollitz LLP, Los Angeles, CA, for Trustee.

Alvin Mar, Los Angeles, CA, Ron Maroko, Los Angeles, CA, for U.S. Trustee.

John J. Menchaca (TR), Los Angeles, CA, Trustee.

MEMORANDUM DECISION DENYING TRUSTEE'S MOTION FOR TURNOVER OF PROPERTY OF ESTATE AND SURCHARGE OF DEBTORS' EXEMPT ASSETS

SHERI BLUEBOND, Bankruptcy Judge.

Chapter 7 trustee John J. Menchaca (the “Trustee”) moved for turnover of $113,802.13 from debtors James Grove Seely, III and Gabriela Paul (jointly, the “Debtors”), representing $58,259.16 in nonexempt cash that was on hand as of the petition date (the “Prepetition Cash”) plus an additional $55,542.98 in nonexempt cash that the Debtors received during the pendency of this bankruptcy case (the “Postpetition Cash”). The trustee based his request for turnover on the contention that these funds were improperly expended without an order of this Court.¹ As the funds expended no longer remain in the Debtors' possession, the Trustee sought an order surcharging proceeds of a personal injury settlement that were paid to Debtors' former counsel, Thomas E. Kent, to be held in trust pending further order of this Court (the “Exempt Funds”).

For the reasons set forth below, the Court finds that the Trustee failed to establish that any portion of the Prepetition Cash or the Postpetition Cash was improperly expended,² and, therefore, that his motion for turnover and to surcharge the Exempt Funds must be denied. Separate orders to this effect will be entered concurrently herewith.

IPROCEDURAL HISTORY

The Debtors filed a voluntary chapter 11 petition commencing the above-entitled bankruptcy case (the “Case”) on January 16, 2012. The Debtors' original schedules reflected that, as of the petition date, the Debtors owned, among other things: (1) their primary residence; (2) three pieces of real property held for rental/investment purposes; (3) cash in various bank and brokerage accounts totaling $58,259.16; and (4) a personal injury lawsuit in which the Debtors were the plaintiffs (the “Personal Injury Action”). In their original Schedule C, the Debtors claimed exemptions in a portion of the foregoing cash and a portion of the rental income generated by their investment properties.

On May 10, 2012, the Debtors filed a motion for approval of a compromise of the Personal Injury Action. Pursuant to that compromise, the defendants in that action were to pay $275,000 in full and final settlement of the Personal Injury Action. On May 17, 2012, the Century Park East Homeowners' Association (the “HOA”) filed a response to the Debtors' compromise motion, noting that the HOA had filed a notice of lien on any settlement proceeds generated by the Personal Injury Action and offering to consent to a release of its lien if the settlement proceeds were held in trust pending further order of the Court rather than paid outright to the Debtors. The HOA noted further in its response to the compromise motion that, contrary to a representation made in that motion, the Debtors had not claimed an exemption in any proceeds generated by the Personal Injury Action. The HOA also filed on May 17, 2012 a motion to convert the case to chapter 7.

On June 4, 2012, the Debtors filed an amended Schedule C. This amended schedule deleted the Debtors' claim of exemption with regard to the Prepetition Cash and asserted an entirely different set of exemptions. Included in the new set of exemptions was a claim of exemption with regard to any proceeds generated by the Personal Injury Action (the “Settlement Proceeds”). The Debtors filed yet another amended version of Schedule C on October 16, 2012. This third version of the Debtors' Schedule C claimed that the entirety of the Settlement Proceeds was exempt.

The Bankruptcy Court granted the Debtors' motion for approval of compromise by order entered June 18, 2012 and directed that the net Settlement Proceeds (which amounted to $270,357.51) be deposited into the client trust account of the Debtors' then counsel, Thomas E. Kent, and held in trust pending further order of the Court.

Negotiations between the Debtors and the HOA followed. The parties attended a mediation before the Honorable Scott Clarkson that culminated in a settlement (the “HOA Settlement”) that was read into the record at the end of the mediation. The HOA Settlement provided for, among other things: (1) $125,000 to be paid to HOA out of the Settlement Proceeds in exchange for a release of claims against the Debtors under sections 523 and 727; (2) allowance of an exemption in the balance of the Settlement Proceeds (the “Net Exempt Funds”); (3) dismissal of a preference action then pending against the HOA; and (4) conversion of the Case to chapter 7. Although the Debtors later attempted to repudiate the HOA Settlement, on February 13, 2013, the bankruptcy judge before whom the case was then pending issued an order granting a motion by the HOA to enforce the HOA Settlement and an order converting the case to chapter 7. Thereafter, the case was transferred to Judge Sheri Bluebond, and John J. Menchaca was appointed chapter 7 trustee.

On February 14, 2013, the Debtors filed a motion seeking release of the Settlement Proceeds on the ground that they are exempt (the “Release Motion”). The Trustee opposed that motion on the ground that he was preparing, but had not yet had an adequate opportunity to file, a motion to surcharge the Settlement Proceeds. At the initial hearing on the Release Motion, the Court continued the hearing to May 1, 2013, so that the Trustee could file a surcharge motion and have it heard concurrently with the Release Motion on May 1.

The Trustee filed a motion to surcharge the Settlement Proceeds on April 5, 2013 [docket no. 340] (the “Surcharge Motion”). The Surcharge Motion was based upon the Trustee's review of the Debtors' monthly operating reports and bank statements. Copies of the Debtors' monthly operating reports were attached as Exhibits 1 through 11 to the Surcharge Motion. Copies of the Debtors' bank statements were attached as Exhibit 12 to the Surcharge Motion.

Based on his review and analysis of Exhibits 11 and 12 to the Surcharge Motion, the Trustee calculated that, during the pendency of the Debtors' chapter 11 case, the Debtors had total receipts, net of deposits attributable to Mr. Seely's social security benefits, inter-account transfers, reimbursements, refunds and returned purchases, of $107,935.23. The Debtors do not dispute that they spent all of these net receipts together with all of the Prepetition Cash during the pendency of their chapter 11 case for total disbursements of $166,194.38 during this period. Of this amount, the Trustee calculated that $52,392.25 should be characterized as authorized disbursements, ³ leaving a total of $113,802.13 that in allegedly improper expenditures. The Trustee sought by way of the Surcharge Motion to recoup these allegedly unauthorized disbursements by surcharging the Debtors' otherwise exempt funds, namely, the Settlement Proceeds.

The Surcharge Motion came on for hearing concurrently with the Release Motion on May 1, 2013. This memorandum sets forth the basis for the Court's decision to deny the Surcharge Motion and grant the Release Motion. Separate orders resolving these motions are being entered concurrently herewith.

IIDISCUSSION

As the Ninth Circuit explained in Latman v. Burdette, 366 F.3d 774 (9th Cir.2004), “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.” Id. at 786. However, surcharge of a debtor's exemption is an extraordinary remedy—one that should be applied only where circumstances warrant. A court's decision to impose a surcharge must be supported by specific findings of fact and conclusions of law which must include a finding of misconduct by the debtor, quantifiable damage to the estate and circumstances that make it equitable to require that such damage be reimbursed from the debtor's exemption. See Lin v. Siegel (In re Law), 2006 WL 6810960, 2006 Bankr.LEXIS 4847 (9th Cir. BAP Dec. 29, 2006). Absent wrongdoing by the debtor, surcharge should not be imposed.

Here, the Trustee contends that surcharge is warranted because the Debtors expended assets of the estate to pay their personal living expenses while they were in chapter 11 without first obtaining permission from the Court to do so. This argument presupposes that the Debtors were required to obtain permission from this Court before making such expenditures. The Trustee acknowledges that, unless the Court orders otherwise, Bankruptcy Code section 363(c)(1) authorizes a chapter 11 debtor in possession to use, sell or lease property of the estate in the ordinary course of business, if the debtor's business is authorized to be operated, but the Trustee contends that, “The Debtors are individuals who are not operating a business....” Surcharge Motion, p. 8, lines 21–22.⁴ Therefore, the Trustee reasons, the Debtors' personal expenditures were not authorized under section 363(c)(1). In effect, the Trustee seeks to establish a per se rule that, if an individual chapter 11 debtor fails to obtain a court order authorizing him to spend estate assets for post-petition living expenses, his expenditures will be considered wrongful disbursements that can be charged against his exempt assets. The Court rejects this proposition as a matter of law.

Prior to the adoption of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), the...