Gill v. Kirresh (In re Gill), 574 B.R. 709 (9th Cir. BAP 2017) –

A debtor moved to compel a chapter 7 trustee to abandon residential property on the basis that it was of inconsequential value to the bankruptcy estate. The bankruptcy court denied the motion, and the debtor appealed to the Bankruptcy Appellate Panel (BAP).

The debtor filed a chapter 13 bankruptcy which he later converted to a chapter 7. The debtor’s schedules showed a residence that he valued at $500,000, and unsecured debt of ~$128,000 consisting of $80,000 in student loans and $48,000 of other unsecured debt that was subject to discharge. A creditor with a lien on the residence filed a proof of claim for secured debt, and the IRS filed a proof of claim for ~$212,000, of which it claimed ~$162,000 was secured, including ~$48,000 in tax penalties.

By the time the secured creditor moved for relief from the automatic stay to proceed with foreclosure, she was owed ~$371,000. The creditor argued that between the secured claim and the IRS tax lien the debtor had no equity in the property. Although the debtor contended there was equity, the creditor and the trustee agreed to a stipulated order giving the trustee six months to sell the residence.

In response the debtor moved to compel the trustee to abandon the bankruptcy estate’s interest in the residence pursuant to section 554 of the Bankruptcy Code. The debtor contended that the $500,000 residence was subject to debt of $650,000 – considering the liens, the debtor’s $40,000 homestead exemption and proposed administrative fees. Thus, he claimed the court should find that the property was burdensome or of inconsequential value and benefit to the estate within the meaning of section 554.

The trustee opposed the motion claiming that unsecured creditors could receive ~$48,000: The trustee expected to sell the property for $500,000 free and clear of the liens, with liens transferred to proceeds. The first lien would be paid off, with the IRS lien attaching to any remaining sale proceeds. However, at that point the trustee would seek to avoid, subordinate and preserve the penalty portion of the IRS tax lien for the benefit of unsecured creditors. Specifically:

• Under section 724(a) of the Bankruptcy Code, a trustee may avoid a claim of the kind specified in section 726(a)(4).
• Section 726(a)(4) describes claims for “any fine, penalty, or forfeiture, or for multiple, exemplary, or punitive damages” arising prebankruptcy to the extent that they are not “compensation for actual pecuniary loss suffered by the holder of such claim.”
• Finally, under section 551 the trustee has a right to preserve any liens avoided under section 724(a) for the benefit of the estate.

While commenting on the surprising dearth of cases on this issue, the BAP concluded that the trustee could proceed as proposed. The court explained that the purpose of section 724 is to protect unsecured creditors from the debtor’s wrongdoing. Avoiding the penalty portion of tax liens and preserving them for creditors enriches the bankruptcy estate, while still allowing the IRS to obtain principal and interest of the tax liens in the normal order of priority.

Thus, in effect the trustee was entitled to collect the amount that would have been due to the IRS for the $48,000 tax penalty portion of its tax lien claim for distribution to unsecured creditors. This in turn meant that the property had more than inconsequential value. Accordingly, the BAP held that the bankruptcy court did not abuse its discretion in denying the debtor’s motion to abandon the property.

Apparently, the bankruptcy court merely found that with a price of $500,000 there was substantial value for unsecured creditors in a sale of the residence that was free and clear of the IRS lien. Notwithstanding the bankruptcy court’s failure to make any explicit findings about the nature of the substantial value, the BAP decided that its analysis of avoiding, subordinating and preserving the tax penalty lien was implicit in the bankruptcy court’s ruling. That seems a bit odd, although perhaps understandable since there was a sound basis for the bankruptcy court’s conclusion as articulated by the BAP.

Vicki R Harding, Esq.