United States v. Hutchinson (In re Hutchinson)

615 B.R. 596

IN RE: Leonard E. HUTCHINSON and Sonya C. Hutchinson, Debtors.

United States of America, Appellant,

v.Leonard E. Hutchinson (James Edward Salven, Chapter 7 Trustee), Appellee.

No. 1:18-cv-01631-NONE

United States District Court, E.D. California.

Signed May 1, 2020

Filed May 4, 2020

Jonathan Hauck, U.S. Department of Justice, Tax Division, Washington, DC, for Appellant.

David R. Jenkins, David R. Jenkins, PC, Fresno, CA, for Appellee.

Russell W. Reynolds, Coleman and Horowitt, Fresno, CA, for Trustee James Edward Salven.

MEMORANDUM OPINION RE BANKRUPTCY APPEAL

Dale A. Drozd, UNITED STATES DISTRICT JUDGE

I. INTRODUCTION

Before the Court is an appeal filed by the Internal Revenue Service ("the government" or "IRS"), challenging a bankruptcy court decision denying the government's motion to compel a bankruptcy trustee to abandon property. (See Doc. No. 7.) The bankruptcy court's denial of the motion to abandon hinged on whether certain estate property, namely a primary residence located in Orosi, California, was of inconsequential value to the estate, under the law, based on the property's encumbrances. (Doc. No. 7 at 12.)¹ After finding that the property was of value to the estate, the bankruptcy court denied the motion to abandon. (Id. ) The court finds it appropriate to rule on the government's appeal of that order without oral argument. See Fed. R. Bankr. P. 8019(b)(3) ; see also Local Rule 230(g). For the following reasons, the government's appeal will be denied and the judgment of the bankruptcy court will be affirmed.

II. BACKGROUND

Sonya and Leonard Hutchinson ("debtors") filed for bankruptcy under 11 U.S.C. § 701 et seq. , commonly known as chapter 7.² (Doc. No. 7 at 7.) Included among the bankruptcy estate's property is the debtors' primary residence located in Orosi, California ("the property"). Id. at 10. The estimated market value of that property is $190,000. (Doc. No. 7-10 at 073.) After satisfaction of an outstanding deed of trust, as well as certain "transaction[ ] costs" associated with its sale, the property's net worth to the estate is estimated at $110,000-120,000. (Id. ) After the deed of trust, the next encumbrances on the property are the following five secured IRS liens:

Recording Date	Tax	Interest on Tax	Penalty
05/23/2011	$0.00	$6,450.15	$44,500.11
05/23/2011	$62,913.27	$17,794.31	$87,599.43
07/25/2011	$40,436.77	$11,403.79	$30,549.31
06/14/2016	$67,050.11	$4,938.42	$42.00
06/14/2016	$36,337.67	$2,052.10	$0.00
Total:	$206,737.82	$42,638.77	$162,690.85

(Doc. No. 7 at 9.)

During administration of the chapter 7 estate, the government filed a motion to compel abandonment of the Orosi property, arguing that the property is of inconsequential value to the estate based on the above encumbrances. (Doc. No. 7 at 8, 7-5 at 013-014.) Put differently, according to the government, the property is of little or no value in the bankruptcy context because no funds would remain to pay unsecured creditors after payment of the senior deed of trust and the secured tax liens if the property is sold. (Id. )

The trustee, James Salven ("trustee"), opposed abandonment of the Orosi property, and on November 14, 2018, the bankruptcy court conducted a hearing on the government's motion. (Doc. No. 7-10.) The bankruptcy judge ruled from the bench and issued a minute order denying the government's motion to abandon, after finding that the Orosi property was not inconsequential to the bankruptcy estate. (Id. at 11-12.) A written order also followed on November 16, 2018. (Doc. No. 7 at 11.)

The bankruptcy court's ruling was grounded upon its adoption of the trustee's position as to how the above-described IRS liens should be treated under chapter 7. (Doc. No. 7-10 at 18.) Its ruling found (or at least impliedly found), and no party disputes, that the penalty portions of each lien are "avoided" by operation of the Bankruptcy Code and therefore are not paid as part of the process of satisfying secured creditors. (Id. ) The bankruptcy court also found, on a point that is disputed on appeal, that the penalty portion of each lien listed above must be preserved (i.e., set aside) for the benefit of unsecured creditors "lien-by-lien" and that the set-aside funds are not simply paid out to satisfy the unavoided portion of the next-in-line secured IRS lien. (See id. ) As a result of this finding, and for reasons set forth in greater detail below, a smaller portion of the IRS's liens (the non-avoidable portions) would be treated as secured debt, with the remainder rendered an unsecured debt subject to different (and potentially disadvantageous) treatment by the trustee. For the same reason, and because at least some funds would be set aside for satisfaction of unsecured creditors, the bankruptcy court found that the property was not of inconsequential value to the estate and therefore should not be abandoned. (Id. )

On November 27, 2018, the government filed its notice of appeal. (Doc. No. 7 at 11.) The appellant government's brief on appeal was filed March 9, 2019, and the appellee trustee's brief was submitted on April 8, 2019. (Doc. Nos. 7, 8.) On April 22, 2019, the government filed its reply. (Doc. No. 9.) On April 30, 2019, the government filed a notice with the court that the record in the case was complete and the appeal ready for decision. (Doc. No. 10.)

III. JURISDICTION

The bankruptcy court had jurisdiction in this matter under 28 U.S.C. §§ 1334 and 157. This Court has jurisdiction to decide this appeal under 28 U.S.C. § 158.

IV. ISSUE

Whether the bankruptcy court erred in denying the government's motion to abandon property of the bankruptcy estate based on the determination that avoided and preserved penalty portions of liens were not of inconsequential value to the estate.

V. STANDARD OF REVIEW

A bankruptcy court's conclusions of law are reviewed de novo , and its findings of facts are reviewed for clear error. In re Johnston , 49 F.3d 538, 540 (9th Cir. 1995) ; see also In re Anastas , 94 F.3d 1280, 1283 (9th Cir. 1996). "A finding is clearly erroneous if it is ‘illogical, implausible, or without support in the record.’ " In re Gill , 574 B.R. 709, 714 (9th Cir. BAP 2017) (quoting Retz v. Samson (In re Retz) , 606 F.3d 1189, 1196 (9th Cir. 2010) ).

"Once a bankruptcy court has determined that the factual predicates for abandonment under 11 U.S.C. § 554(a) are present, the court's decision to authorize or deny abandonment is reviewed for abuse of discretion." In re Johnston , 49 F.3d at 540 (quoting In re K.C. Machine & Tool Co., 816 F.2d 238, 244 (6th Cir.1987) ); see also In re Consolidated Nevada Corporation , 778 Fed. Appx. 432, 436 (9th Cir. 2019).³ "A bankruptcy court abuses its discretion if it applies the wrong legal standard or its findings are illogical, implausible or without support in the record." In re Gill , 574 B.R. at 714 (quoting TrafficSchool.com, Inc. v. Edriver Inc. , 653 F.3d 820, 832 (9th Cir. 2011) ); see also In re Marshall , 721 F.3d 1032, 1039 (9th Cir. 2013).

VI. DISCUSSION

A. Legal Context

A trustee appointed to administer an estate in chapter 7 bankruptcy proceedings is charged by statute with "collect[ing] and reduc[ing] to money the property of the estate." 11 U.S.C. § 704. "[T]he trustee's duty is to maximize the assets of the bankruptcy estate to allow maximum recovery for the debtor's creditors." In Re Feiler , 218 F.3d 948, 952 (2000). But property may be abandoned, rather than reduced to money, if the encumbrances on the property render it valueless to unsecured creditors after the encumbrances and administrative costs are satisfied. In re Bolden , 327 B.R. 657, 667 (Bankr. C.D. Cal. 2005). Under 11 U.S.C. § 554, the property must be "burdensome to the estate" or "of inconsequential value and benefit to the estate" in order to be abandoned and may be so abandoned upon the initiative of the trustee or pursuant to a court order directed at the trustee, if requested by a party in interest. 11 U.S.C. § 554. In both instances notice and a hearing are required. Id.

A trustee also has the power to "avoid" certain liens, i.e. certain encumbrances, when administering a bankruptcy estate. See, e.g., 11 U.S.C. §§ 724, 726. This modifies the general rule that "[s]ecured liens pass through bankruptcy unaffected." In re Schlegel , 526 B.R. 333, 342 (9th Cir. BAP 2015). "For example, statutory liens that are not perfected or enforceable on the date of the bankruptcy petition against a bona fide purchaser are voidable."⁴ In re Berg , 188 B.R. 615, 618 (9th Cir. BAP 1995) (citing 11 U.S.C. § 545 ). The particular statutory category of avoidable liens relevant here is penalties, which includes IRS-assessed penalties.⁵ In re Gill , 574 B.R. at 716 ("Taken together, §§ 724(a) and 726(a)(4) allow a chapter 7 trustee (but not the debtor or a third party) to avoid a lien to the extent the lien secures the claim for a penalty, including a tax penalty.").

As explained below, avoided liens are preserved for the benefit of the estate automatically under § 551, whether they arise from penalties or another category.⁶ The legislative history of § 551 clarifies that Congress intended, in part, to "prevent[ ] junior lienors from improving their position at the expense of the estate when a senior lien is avoided."

In re Van de Kamp's Dutch Bakeries , 908 F.2d 517, 519 (9th Cir. 1990). This latter point is critical to the Court's analysis and parties' contentions in this appeal. The court is mindful that § 551 is meant "to increase the assets of the bankruptcy estate." Id. (internal quotations and citation omitted).

Upon avoidance of a lien, the trustee "steps into the shoes of the former lienholder ... and enjoys the same rights in the property that the original lienholder ... enjoyed." In re Lebbos , No. ADV 11-2386-RSB, 2012 WL 6737841, at *14 (9th Cir. BAP Dec. 31, 2012). This means "a trustee who avoids an interest succeeds to the priority that interest enjoyed over competing interests." In re Van de Kamp's Dutch Bakeries , 908 F.2d...