Nielsen v. Field (In re Nielsen)

526 B.R. 351

In re Troy Harley Hugh Nielsen and Dianna Kathleen Nielsen, Debtors.Troy Harley Hugh Nielsen and Dianna Kathleen Nielsen, Plaintiffs,

v.Dane Field, as Trustee, et al., Defendants.

Case No. 14–00974

Adv. Pro. No. 14–90044

United States Bankruptcy Court, D. Hawai'i.

Signed March 11, 2015

Steven Guttman, Kessner Duca Umebayashi Bain & Matsunaga, Honolulu, HI, for Plaintiffs.

Re: Docket No. 37, 40, 46, 59

MEMORANDUM OF DECISION ON MOTIONS TO DISMISS AND FOR SUMMARY JUDGMENT

Robert J. Faris, United States Bankruptcy Judge

The debtors in this chapter 7 case are the settlors, lifetime beneficiaries, and trustees of a trust which they may revoke or amend at any time. They contributed real property to the trust. They live in one of the two buildings on the property. They have claimed a homestead exemption in the property and, in this adversary proceeding, seek to avoid certain judicial liens on the property. For the reasons stated below, I hold that such liens are avoidable under Bankruptcy Code § 522(f), but factual questions remain about the extent to which the liens are avoidable.

I. JURISDICTION AND VENUE.

The bankruptcy court has personal and subject matter jurisdiction. It also has statutory and constitutional authority to enter a final judgment. Venue is proper in this district.

II. BACKGROUND.

Plaintiffs Troy and Dianna Nielsen are the settlors, trustees, and “primary beneficiaries” of the Troy and Dianna Nielsen Living Trust, dated May 9, 2005 (the “Nielsen Trust”). The Nielsens have unfettered power to revoke or amend the trust.

The Nielsen Trust holds title to real property located at 442 Kupulau Drive in Kihei, Maui. There are two dwelling units on the property. The Nielsens reside in the smaller building and operate a bed and breakfast inn in the other.

The property is subject to two mortgage liens securing debts totaling about $932,953.93. In addition, Dane Field, as bankruptcy trustee of The Mortgage Store, Inc. (the “TMS Trustee”), asserts a lien on the property based on a recorded judgment against the Nielsens of $329,880.11 and a writ of attachment. OneWest Bank also asserts a judgment lien against the property of $770,091.56.

Less than ninety days after the TMS Trustee and OneWest Bank recorded their liens, the Nielsens filed a chapter 11 petition. Later, they converted their case to chapter 7.

The Nielsens' complaint in this adversary proceeding consists of four counts. The first two counts seek avoidance of the TMS Trustee's and OneWest Bank's liens as preferential transfers. The third and fourth counts seek avoidance of the same liens under section 522(f) of the Bankruptcy Code.

The TMS Trustee and OneWest argue that the court should dismiss the complaint or, alternatively, enter summary judgment in their favor.¹ They argue that the property is not property of the Nielsens' bankruptcy estate, so neither the preference avoidance power nor section 522(f) applies to it. They also argue that debtors in a chapter 7 case, such as the Nielsens, cannot invoke the power to avoid preferences.

The Nielsens seek summary judgment in their favor on the third and fourth counts of the complaint.² The TMS Trustee has moved the court to bifurcate that motion, i.e., to decide whether the property is property of the bankruptcy estate before deciding the other issues presented.³ OneWest joined in the TMS Trustee's bifurcation motion.⁴

III. STANDARD.

The court may dismiss a complaint for “failure to state a claim upon which relief can be granted.” ⁵ “To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’ ” ⁶ A formulaic recitation of the elements of a cause of action does not suffice.⁷ Only if a complaint states a plausible claim for relief will it survive a motion to dismiss.⁸

Summary judgment is appropriate if there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law. ⁹ Summary judgment should be granted against a party “who fails to make a showing sufficient to establish the existence of an element essential to that party's case, and on which that party will bear the burden of proof at trial.” ¹⁰

IV. DISCUSSION.A. The Preference Claims.

I will dismiss Counts I and II. The Bankruptcy Code provides that “the trustee may avoid” preferential transfers.¹¹ Nothing in the Code permits a chapter 7 debtor to exercise this power, even if the trustee elects to close the case without exercising the preference avoidance power.

B. Section 522(f) and “Property of the Estate.”

A chapter 7 debtor may avoid the “fixing” of certain “judicial liens” (including judgment and attachment liens ¹²) “on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled under” section 522(b).¹³

Because debtors may only claim exemptions in “property of the estate,” ¹⁴ the lien avoidance power is also limited to property of the estate.

The bankruptcy estate includes “all legal or equitable interests of the debtor in property as of the commencement of the case ...” ¹⁵ Such property, “ by whomever held,” ¹⁶ is added to the estate and made available to all creditors in the order of their entitlements.

C. The Nielsen Trust Property is Property of the Estate.

OneWest and the TMS Trustee argue that the property belongs to the Nielsen Trust, not the Nielsens, and that therefore the Nielsens have no interest in that property which they could exempt. The Nielsens take the opposite position.

I agree with the Nielsens and hold that the property is the Nielsens' property and therefore property of their bankruptcy estate.

Hawaii courts and statutes have never squarely addressed whether self-settled, revocable trusts, also known as “living trusts,” are separate entities. When a state court has not addressed an issue, federal courts have a duty to predict how a state court would rule on an issue “ ‘using intermediate appellate court decisions, decisions from other jurisdictions, statutes, treatises, and restatements as guidance.’ ” ¹⁷ Federal courts are not precluded from affording relief simply because a state court has not directly addressed a particular issue.¹⁸

1. Under Hawaii law, self-settled revocable trusts are not separate entities.

No party in this adversary proceeding has cited a statute or state appellatecourt decision discussing the legal status of revocable trusts under Hawaii law. I conclude that a Hawaii court would find that self-settled revocable living trusts are not separate entities and that the trust property belongs to the settlor.

Hawaii has adopted the common law of England “as ascertained by English and American decisions....” ¹⁹ The Restatement (Second) of Trusts defines a trust as a “fiduciary relationship with respect to property....” ²⁰ As another authority put it, “[a] trust may be defined as a fiduciary relationship in which one person holds a property interest, subject to an equitable obligation to keep or use that interest for the benefit of another.” ²¹ The settlor creates the trust, and the trustee holds the legal title to the trust property for the benefit of the trust's beneficiary. ²² The common law also treats the settlor of a revocable living trust as the owner of the trust res for purposes of creditors' rights.²³ In this respect, trusts are different from corporations and limited liability companies, which are separate legal entities and do hold title to property. ²⁴

Other persuasive authorities lead to the same result. California law, which Hawaii courts often follow, treats living trusts as estate planning devices and not separate legal entities.²⁵ “Unlike a corporation, a trust is not a legal entity.... ‘A probate or trust estate is not a legal entity; it is simply a collection of assets and liabilities.’ ” ²⁶ Further, a trust does not hold title to the trust res. “Title to trust property is in the trustee, not in the trust.²⁷ “Legal title to property owned by a trust is held by the trustee, and common law viewed the trustee as the owner of the trust's property.” ²⁸ Hawaii's Encyclopedia of Estate Planning has a similar view of living trusts. According to that treatise, “it is ‘business as usual’ concerning the management and control of the trust assets, and only upon the Settlor's death is the separate legal entity of the trust fully recognized.” ²⁹

The federal district court for this district has also held that, under Hawaii law, the settlor, trustee, and beneficiary of a revocable living trust “effectively owned the property.” ³⁰ In the Amonette case, an individual filed suit under the Truth in Lending Act. The defendant lender argued that TILA did not apply because the loan was to an “organization,” i.e., the plaintiff's revocable living trust which owned the mortgaged property. The district court rejected this contention. Although Amonette was decided under the TELA statute, not the Bankruptcy Code, the court's analysis of the revocable living trust under Hawaii law is equally applicable here.

Viewing living trusts not as separate entities, but as will substitutes, is consistent with Hawaii case law holding that debtors may not shield their assets from creditors by putting them in a self-settled trust. For instance, in Cooke Trust Co. v. Lord,³¹ Hawaii's Supreme Court held that a debtor cannot protect his property by putting it in a self-settled trust, even if it has a spendthrift provision.³² If self-settled trusts were separate entities like LLCs or corporations, the result would be different. The property of a corporation is generally not available to a shareholder or officer's creditors.³³

2. The Nielsens' trust property is property of the estate.

Since the Nielsen Trust is not a separate entity from the Nielsens, the property they contributed to the Nielsen Trust became property of the bankruptcy estate. But even if the living trust is a separate...