Myers v. Army & Air Force Exch. Serv. (In re Myers), CASE NO. 19-01585-5-SWH

IN RE: ADRIAN TYLER MYERS and KELLIE LEANN MYERS, DEBTORS.

ADRIAN TYLER MYERS and KELLIE LEANN MYERS, Plaintiffs v. ARMY & AIR FORCE EXCHANGE SERVICE, Defendant.

CASE NO. 19-01585-5-SWH

ADVERSARY PROCEEDING NO. 19-00042-5-SWH

UNITED STATES BANKRUTPCY COURT EASTERN DISTRICT OF NORTH CAROLINA WILMINGTON DIVISION

September 26, 2019

CHAPTER 7

ORDER GRANTING MOTION TO DISMISS ADVERSARY PROCEEDING AND ALLOWING OBJECTION TO CLAIMED EXEMPTION

The matters before the court are the Objection to Claimed Exemption filed in the bankruptcy case on May 13, 2019, Dkt. 14, and the Motion to Dismiss Amended Adversary Complaint filed in the adversary proceeding on June 26, 2019, Dkt. 10. The debtors filed responses on May 21, 2019, Dkt. 18, in the bankruptcy case and on July 10, 2019, Dkt. 13, in the adversary proceeding. A hearing was held on July 16, 2019 in Wilmington, North Carolina, at the conclusion of which, the court took both matters under advisement.

BACKGROUND

Adrian Tyler Myers ("Mr. Myers") and Kellie LeAnn Myers ("Ms. Myers") (collectively, the "Debtors" or the "Plaintiffs") opened separate credit card accounts with Army & Air Force Exchange Service ("AAFES" or the "Defendant") on June 2, 2013 and December 16, 2014, respectively. By January 2019, both of the Debtors were delinquent on their credit card payments.¹ Mr. Myers had an outstanding balance in the amount of $3,979.00, and Ms. Myers had an outstanding balance in the amount of $1,774.74 (collectively, the Debtors owed $5,753.74 to AAFES). Around February 2019, the Debtors filed their joint federal income tax return for 2018. The Debtors allege that according to Form 1040 they were entitled to a refund from the Internal Revenue Service ("IRS") in the amount of $4,622, comprised of the following tax credits: a refundable earned income credit of $1,260, a refundable child tax credit of $587, and $2,775 withheld from the Debtors' wages. Instead of receiving a tax refund, the Debtors' overpayment was applied to their debts with AAFES on February 27, 2019 as follows: $1,774.74 in full payment of Ms. Myers's outstanding debt and $2,847.26 in partial payment of Mr. Myers's outstanding debt.

The Debtors filed a voluntary petition for relief under Chapter 7 of the Bankruptcy Code on April 9, 2019. On Schedule C, the Debtors claimed as exempt all proceeds received from a section 522 avoidance action to recover the tax refund of $4,622 setoff by AAFES. On April 12, 2019, the Debtors filed an adversary proceeding against AAFES, and on May 17, 2019, theDebtors filed an Amended Complaint, Dkt. 6. The Amended Complaint seeks to avoid and recover setoffs of property of the Debtors pursuant to section 553(b) of the Bankruptcy Code and requests that any recovered amount be deemed exempt pursuant to section 522(h).

AAFES filed an Objection to Claimed Exemption in the bankruptcy case on May 13, 2019, Dkt. 14, and filed a Motion to Dismiss Amended Adversary Complaint in the adversary proceeding pursuant to Federal Rule of Civil Procedure 12(b)(6) and Federal Rule of Bankruptcy Procedure 7012 for failure to state a claim upon which relief may be granted on June 26, 2019, Dkt. 10. The Debtors filed responses on May 21, 2019, Dkt. 18, in the bankruptcy case and on July 10, 2019, Dkt. 13, in the adversary proceeding. A hearing was held on July 16, 2019 in Wilmington, North Carolina, at the conclusion of which, the court took both matters under advisement.

ISSUE AND PARTIES' POSITIONS

The issues before the court are (1) on what date did the Debtors have a right to a tax refund; (2) did the government decrease the insufficiency in its position within 90 days prior to the petition date through its setoff; and (3) if so, whether the Debtors can claim as exempt any recovered setoffs.

First, AAFES argues that the Debtors cannot recover the tax overpayment pursuant to section 553 of the Bankruptcy Code because there was no decrease in insufficiency that would permit the Debtors to recover the offset. AAFES takes the position that the Debtors' right to a tax refund arose on December 31, 2018, and therefore, the insufficiency on the date of offset (February 27, 2019) of $1,131.74² was the same amount as it was 90 days before the Debtorsfiled their bankruptcy petition (January 9, 2019). AAFES next argues that even if the Debtors could recover the offset, the Debtors cannot claim that recovery as exempt property. AAFES contends that a taxpayer is only entitled to a refund of the amount remaining after any tax overpayment is applied to past-due legally enforceable government debts. Thus, the tax overpayment in question never ripened into a tax refund and never became property of the bankruptcy estate subject to the exemption.

In response, the Debtors argue that their right to the tax refund did not arise until February 15, 2019; and accordingly, when setoff occurred on February 27, 2019, the amount of the insufficiency decreased from $5,753.74 to $1,131.74. Regarding the claim of exemption, the Debtors assert that they can claim any recovered setoffs as exempt pursuant to section 522(h) because under section 541(a)(3) of the Bankruptcy Code, interests in property recovered under sections 550 and 553 become property of the bankruptcy estate.

DISCUSSION

A defendant may move to dismiss a case for failure to state a claim upon which relief may be granted under Federal Rule of Civil Procedure 12(b)(6), as made applicable to adversary proceedings through Federal Rule of Bankruptcy Procedure 7012. Fed. R. Civ. P. 12(b)(6); Fed. R. Bankr. P. 7012. "The purpose of a Rule 12(b)(6) motion is to test the sufficiency of the complaint." Edwards v. City of Goldsboro, 178 F.3d 231, 243 (4th Cir. 1999). A complaint must contain sufficient facts that when accepted as true "state a claim to relief that is plausible on its face." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570 (2007); Ashcroft v. Iqbal, 556 U.S. 662, 678-79 (2009). When ruling on a 12(b)(6) motion, a court must accept the plaintiff's factual allegations as true and draw all reasonable factual inferences in the plaintiff's favor. Edwards, 178 F.3d at 244.

Section 553 of the of the Bankruptcy Code does not create a right of setoff; "[i]t merely preserves any right of setoff accorded by state law, subject to certain limitations." Durham v. SMI Indus. Corp., 882 F.2d 881, 883 (4th Cir. 1989) (citations omitted). North Carolina recognizes the right to setoff where mutual debts exist between the parties. Id. (citing Old Southern Life Ins. Co. v. Bank of North Carolina, 36 N.C. App. 18, 30-31, 244 S.E.2d 264, 271 (1978)) (citations omitted). Four requirements must be satisfied to preserve a valid right of setoff under section 553: (1) the creditor must hold a "claim" that arose prior to commencement of the bankruptcy case; (2) the creditor must owe a "debt" to the debtor that arose prior to commencement of the bankruptcy case; (3) the claim and the debt must be mutual; and (4) both the claim and the debt must be valid and enforceable. 11 U.S.C. § 553 (2018); In re Abbott, No. 12-01166-8-SWH, 2012 WL 2576469, at *5 (Bankr. E.D.N.C. July 3, 2012); In re Goodman, No. 11-02760-8-JRL, 2012 WL 529574, at *4 (Bankr. E.D.N.C. Feb. 17, 2012); see also 5 Collier on Bankruptcy § 553.01[1] (Alan N. Resnick & Henry J. Sommer eds., 16th ed. rev. 2019).

Section 553(b) limits the ability of creditors to exercise the right of setoff and allows a trustee to recover "offsets [of] a mutual debt owing to the debtor on or within 90 days before the date of the filing of the petition . . . ." 11 U.S.C. § 553(b)(1). However, a trustee may recover only

to the extent that any insufficiency on the date of such setoff is less than the insufficiency on the later of—

(A) 90 days before the date of the filing of the petition; and

(B) the first date during the 90 days immediately preceding the date of the filing of the petition on which there is an insufficiency.

11 U.S.C. § 553(b)(1). This limitation prohibits a creditor from improving its position within 90 days prior to the debtor filing a bankruptcy petition. In re Goodman, Case No. 11-02760-8-JRL,2012 WL 529574, at *5-6 (Bankr. E.D.N.C. Feb. 17, 2012) (citations omitted). For purposes of that subsection, the Code defines an "insufficiency" as the "amount, if any, by which a claim against the debtor exceeds a mutual debt owing to the debtor by the holder of such claim." 11 U.S.C. § 553(b)(2).

Two major flaws exist in the Debtors' arguments. First, the Debtors misapply 11 U.S.C. § 6402(m) to conclude that the Debtors' "right to payment" of the tax refund did not arise until February 15, 2019. Section 6402(m) of the Internal Revenue Code became effective in 2018 (tax year 2017) and states the following:

(m) Earliest date for certain refunds

No credit or refund of an overpayment for a taxable year shall be made to a taxpayer before the 15th day of the second month following the close of such taxable year if a credit is allowed to such taxpayer under section 24 (by reason of subsection (d) thereof) or 32 for such taxable year.

11 U.S.C. § 6402(m) (emphasis added). The Debtors argue that under section 6402(m), February 15th is the earliest date that the Debtors had a right to a tax refund.

According to the Debtors' analysis, a $5,753.74 insufficiency existed on January 9, 2019 ($5,753.74 was owed to AAFES and the Debtors had no right to a tax refund). On February 27, 2019, a $1,131.74 insufficiency existed after setoff of the $4,622 tax overpayment. Thus, the Debtors conclude that AAFES improved its position within the 90-day pre-petition period. Whereas, AAFES calculates that a $1,131.74 insufficiency existed on January 9, 2019 because the Debtor's claim to a potential tax refund arose on December 31, 2018. AAFES takes the position that when setoff occurred on February 27, 2019, AAFES's position was not improved because a $1,131.74 insufficiency still existed.

The Debtors rely solely on 11 U.S.C. § 6402(m) to support the proposition that ...