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Debtor Who Spent Annuity After Filing Bankruptcy Granted Discharge - In re Leone Albany Case

"Something went awry in this case", and indeed it did. This understated line opens the conclusory paragraph of the decision by Judge Robert E. Littlefield Jr. in In re Leone, Bankruptcy Court Northern District of New York (Albany Division) Chapter 7 #05-16603; AP #07-90199; Decision Dec. 9, 2011.)

The debtors refinanced their home, filed bankruptcy, and transferred the refinance funds to an annuity while the petition was being filed. The original chapter 13 trustee did not go after the refinance cash or object to the annuity exemption. When converted to chapter 7, the new trustee objected to exempting the annuity, but by them the money was mostly spent. The chapter 7 trustee sought to deny the debtors a discharge.

But denial of discharge "is the death penalty of bankruptcy", so said Judge Littlefield later in the conclusory paragraph, "a harsh remedy to be reserved for a truly pernicious debtor." The judge declined to impose such a penalty here.

That something went awry in this case might have had to do with the date of its initial filing - September 17, 2005, a month before the momentous changes to the bankruptcy code, known as BAPCPA, went into effect. The decision never mentions this factor, but massive numbers of bankruptcy cases were filed in the period leading up to BAPCPA's effective date, October 17, 2005. The Rochester court alone had two thousand filings in October that year, almost as many as all of 2011.

In the wake of this wave of filings, some attorneys may have rushed the preparation a little, and some trustees, overwhelmed with new cases, might have overlooked details that would have been picked up in a calmer period.

In any case, in July 2005 the debtors refinanced their house, and received a little over $35,000 in cash. They then consulted a bankruptcy attorney in early September, who advised them to shift the money into an annuity to protect it from creditors and bankruptcy.

The attorney apparently failed to advise them that an annuity purchased within six months of filing bankruptcy would only be exempted up to $5,000; the debtors would have been better advised to have waited six months before filing, but people were scared at that time that BAPCPA would make it all but impossible to file bankruptcy (incorrect, as it turned out), so I am not surprised that the debtors and their attorney rushed out a bankruptcy filing.

The bankruptcy petition was signed Sept. 12, when the refinance funds were still in a regular bank account, and they listed as an unexempt asset in the amount of $27,500. But the debtors on the same day wrote a $21,000 check to an annuity company, where it was received on Sept. 16. The chapter 13 petition was filed Sept. 17, and the annuity check cleared the debtors' bank account September 21.

Awry indeed. As the decision pointed out, the assets of the bankruptcy case are those assets existing on the petition date - Sept. 16 - and as the check had not yet cleared the bank, the cash in the bank was still an asset - an unexempt asset - of the bankruptcy case.

The debtors amended their schedule of assets and exemptions (Schedules B & C) on February 16, 2006. The amendment claimed - incorrectly - that the debtor's money was in an exempt annuity when the case was filed, but the trustee never objected to that amended exemption claim (the deadline to do so is 30 days after the close of the trustee hearing.) And for some reason the chapter 13 trustee also never demanded turnover of the pre-petition cash which had been deposited into the annuity.

The debtors chapter 13 plan was confirmed March 14, 2006. The confirmation order included a provision stating that "no article of property, real or personal, with a value of more than $2,500 may be sold or otherwise disposed of without prior consent of the Trustee" (chapter 13 plans in Rochester have a similar provision, for assets worth more than $1,000.)

Never the less, the debtors ran out of money and invaded the annuity to pay bills. Things didn't work out in Chapter 13, so the debtors voluntarily converted the case to Chapter 7 Sept. 12, 2006. A new chapter 7 trustee was appointed.

Perhaps I should point out that as frantic as the period of September 2005 was for the bankruptcy system, September 2006 was extraordinarily calm. So many cases were filed before BAPCPA went into effect that few new cases were filed afterwards. In Rochester, over 7,600 cases were filed in 2005 before October 17 and none more were filed the rest of that year. So a chapter 7 trustee appointed in September 2006 would have had plenty of time to review the nuances of this case, the exact opposite of the situation when it was first filed.

I should also point out that the debtors, rather than converting to chapter 7, could have withdrawn their chapter 13 case and then filed a new chapter 7. Given all the trouble they have gone through the last four years, that might have been the better strategy. Chapter 13 is completely voluntary, and a debtor can always withdraw. Chapter 7 cases, on the other hand, can only be dismissed if it is in the best interest of creditors, and if a debtor is asking for their chapter 7 case to be withdrawn, it is usually because something bad has happened - like an unexempt asset has been discovered - and it is rarely in the creditor's interest to dismiss such a case.

In any case, the new chapter 7 trustee obtained several extensions of the deadline to object to exemptions, finally filing a bankruptcy lawsuit (adversary proceeding) a year later, October 17, 2007. The trustee also sought a money judgment against the debtors for the depleted annuity funds, and a denial of discharge for false statements on the schedules and for spending the annuity without permission.

First, the exemption issue: as stated above, a trustee has only 30 days after the conclusion of the "341" hearing to object to an exemption. When a case originally filed in chapter 13 is converted to chapter 7, a new 341 hearing is scheduled. The debtor claimed that the deadline to object to exemption expired after the conclusion of the 341 hearing in Chapter 13, and the new chapter 7 hearing did not restart the clock. Judge Littlefield noted that courts are split on that issue (he cites multiple cases on both sides of the question), but said that in this case the debtors never objected to the repeated requests by the trustee to extend the exemption objection deadline in chapter 7, which were granted by court order, so it was now too late for the debtors to object to the chapter 7 trustee's authority to make an exemption objection motion.

PRACTICE NOTE FOR ATTORNEYS: If a case is originally filed in chapter 13, and then converted to chapter 7, and the chapter 7 trustee wants an extension of time to object to exemptions, and that exemption objection period had run out during the chapter 13 phase of the case, DON'T CONSENT TO THE EXTENSION!

So the court concluded that the cash in the bank was an asset of the case when the petition was filed, and that the chapter 7 trustee was correct that the funds were not exempt. So far so good for the trustee. So far, but no farther. Because the chapter 13 trustee had not objected to the exemption, the debtors were free to treat the annuity funds as exempt, even though it turned out later they weren't. So objection to discharge because of allegedly violating the plan order (spending an asset of over $2,500 without permission) was denied. So was the request for a money judgment for the depleted amount, for the same reason.

The court found that the debtors never attempted to hide the funds, disclosing what they were doing all along, so denial of discharge for making false oaths, or failure to maintain records, was also denied.

Most interesting, perhaps, was the issue of whether the debtors transferred assets post-petition with intent to hinder, deceive or delay a trustee; that is, by converting the refinance cash, an unexempt asset, into an annuity, an exempt asset. Such a transfer after the petition is filed (or within a year before a petition is filed) is grounds to deny discharge under 11 USC Sect. 727 (a)(2)(A) and (B). The key is the debtor's intent.

That the original source of the funds was an exempt asset, namely, equity in the debtor's residence which was turned into cash by the refinance two months before filing, may have had some influence on the court. The debtors argued that they converted an exempt asset into an unexempt asset, temporarily, and then back to an exempt asset (well, so they thought, anyway.)

The court concluded that the debtors were acting in good faith based on advise of counsel. To quote from the decision:

The court recognizes that "reliance upon advice of counsel" is not an "impenetrable shield" behind which a debtor may continually hide. In re Dubrowsky, 244 B.R. 560, 575 (E.D.N.Y. 2000). "The advice of counsel is not a defense when it is transparently clear that the advice is improper." Id. (citing In re Kelly, 135 B.R. 459, 462 (Bankr. S.D.N.Y. 1992)). After reading the four documents prepared by the Debtors, the court finds the Debtors to be forthcoming and credible. The Debtors believed that the purchase of the annuity was permissible and in conformance with the advice they received from their attorney. There is nothing in the record to counter this. Thus, the court cannot conclude that the Debtors‟ reliance on advice of counsel was not reasonable and in good faith.

The bottom line of this awry case is very careful pre-petition preparation of a bankruptcy case is absolutely essential. Once a case is filed, it cannot be unfiled, at least in chapter 7. I tell my clients that almost all of my work is done by the time I file the case. A carefully prepared bankruptcy case should sail through the bankruptcy system with no problem, or at least with no unexpected problems. It is only when a case is not quite properly prepared that things go awry.

For more information about filing bankruptcy in the Rochester area, contact me for a phone analysis, at no charge, of your situation.

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