SO ORDERED. SIGNED this 14 day of December, 2007. |
|
____________________________________________________________
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
In re:) RONALD EDWARD HENDERSON, JR.,) Debtor.) _______________________________________) ) In re:) MICHAEL FRANCIS SHERLOCK and) TAMMI RAE SHERLOCK,) Debtors.) _______________________________________) |
Case No. 05-42351 Case No. 06-40549 |
MEMORANDUM OPINION AND ORDER
This matter is before the Court on Debtor, Henderson's Motion for Determination that
the Portion of Debtor's Income Tax Refund Offset by the U.S. Department of Treasury is Not
Property of the Estate1 and on the Motion by Debtors Sherlock for Determination that the
Portion of Debtors' Income Tax Refund Offset by the IRS is Not Property of the Estate.2 In
both of these cases, the Chapter 7 Trustee has demanded turnover of pre-petition tax refunds
that were offset by the federal government for either prior tax debts or past due child support.
The Trustee argues that the estate is entitled to the application of the equitable doctrine of
marshaling and that the Debtors' creditors should not bear the entire burden of the set offs.
In response, the Debtors have filed these motions, seeking a determination that the Chapter
7 Trustee cannot compel turnover,3 arguing that the doctrine of marshaling is inapplicable.
These are contested matters over which this Court has jurisdiction.4 The parties have
stipulated to all relevant facts,5 and the Court grants both motions.
FINDINGS OF FACT
Ronald Henderson filed for relief under Chapter 7 of the Bankruptcy Code on July
25, 2005. In April 2006, the Chapter 7 Trustee requested turnover of $2,147.79, which
represents that portion of Henderson's 2005 income tax refund attributable to the pre-petition
portion of his tax refund, after honoring a $750 attorney fee assignment.6 In December 2006,
1Doc. 21 in Case No. 05-42351.
2Doc. 44 in Case No. 06-40549.
3The tax refunds at issue are actually the portion of the tax refunds that correspond to the pre-petition portion
of the tax refunds that Debtors were due to receive post-petition.
428 U.S.C. § 157(a) and §§ 1334(a) and (b). A motion for an order to turnover property of the estate is a core proceeding, which this Court may hear and determine as provided in 28 U.S.C. § 157(b)(2)(E).
5Doc. 33 in Case No. 05-42351 and Doc. 57 in Case No. 06-40549.
6The entire tax refund was in the amount of $4,522.00. After subtracting the $750 attorney fee assignment, the
Trustee requested just over 56% of the remainder based on the date of the bankruptcy filing.
2
the U.S. Treasury Department notified Debtor that the entire tax refund (after subtracting the
$750.00 assignment) had been applied to child support obligations owed by Debtor to the
Texas Attorney General's Office and California Child Support Services. Although Debtor
thus received none of the tax refund because the entire amount was offset, the Trustee still
requested turnover of the funds, relying on Chief Judge Nugent's In re Steele7 decision as
authority that Debtor must nevertheless repay the bankruptcy estate the pro-rata portion of
the refund, under the doctrine of marshaling of assets.
Debtors, Michael and Tammi Sherlock, filed for relief under Chapter 7 of the
Bankruptcy Code on June 23, 2006. In early March 2007, the Chapter 7 Trustee requested
turnover of $459.07, which represented the pre-petition portion of Debtors' 2006 federal
income tax refund. On March 17, 2007, the IRS informed the Sherlocks that it has applied
their entire 2006 income tax refund to the unpaid balance of other federal taxes owed by
them. Similarly, the Trustee requested turnover of the $459.07, despite the offset by the IRS,
again based upon In re Steele and the doctrine of marshaling of assets.
On May 8, 2007, Judge Somers issued an opinion in In re Blagg,8 which disagreed
with the holding in In re Steele, and declined to apply the doctrine of marshaling to facts
similar to those in the two cases currently before this Court. The Court must now decide
whether to adopt the holding of In re Steele or In re Blagg, or whether a different approach
should be taken in these cases.
7Case No. 03-13393; Adv. No. 04-5265 (Bankr. D. Kan. Nov. 17, 2005).
8372 B.R. 502 (Bankr. D. Kan. 2007).
3
CONCLUSIONS OF LAW
In In re Steele, the Court analyzed the equitable doctrine of marshaling, noting that
the trustee must demonstrate the presence of three required elements to invoke that doctrine:
(1) the existence of two creditors with a common debtor; (2) the existence of two funds
belonging to the debtor; and (3) the legal right of one creditor to satisfy his demand from
either of the funds, while the other may resort to only one fund.9 The trustee asserted that
(1) the debtors had two creditors, the IRS and the Trustee, who stood in the shoes of
unsecured creditors; (2) there were two funds belonging to the debtors, the pre-petition
refunds and post-petition property; and (3) the IRS could satisfy its claim from either of these
funds, since its claim is non-dischargeable, but the Trustee could look only to the pre-petition
refund that had been offset.
Based on those arguments, the court invoked the equitable doctrine of marshaling, and
held that the debtor was responsible for reimbursing the entire amount of the pre-petition tax
refund to the estate. He stated that “[b]ecause he has benefitted from the set off and
application of $1,222 of his tax refund to a debt that could have been collected from him
post-discharge, Steele should pay back to the estate the entirety of its share of the refund,
$1,604, as though there had been no offset.”10
9Steele, Adv. No. 04-5265 at 4 (citing Morris v. Jack B. Muir Irrevocable Trust (In re Muir), 89 B.R. 157, 160 (Bankr. D. Kan. 1988)).
10Id. at 5.
4
The court in In re Blagg reached a different conclusion under nearly identical facts.
In Blagg, the court found that the equitable doctrine of marshaling should not be applied for
several reasons. The court held that the first element for marshaling was not present because
the creditors involved were not secured creditors, and the doctrine's entire purpose is to
benefit junior secured creditors.11 Second, the court held there were not two separate funds
subject to a lien by a senior lien holder, and in fact, there was in reality no perfected lien
holder.12 Third, the court held that the debtors never had the purported “two funds” in their
hands, nor did they have control over those funds.13 Fourth, the court held that 11 U.S.C. §
105 could not be used to invoke marshaling,14 because applying marshaling to the facts of
this case would directly circumvent the Bankruptcy Code's specific provisions15 that allow
a preference for governmental entities (by authorizing offset under certain circumstances).
Fifth, the court reasoned that because the debtors never actually had possession of or control
over the tax refunds at issue, there is no statutory authority to require them to turnover the
11In re Blagg, 372 B.R. at 508-09 (holding that one of the requirements for the application of the doctrine of marshaling is that the creditors involved be secured creditors) (citing Moses Lachman, Marshaling Assets in Bankruptcy: Recent Innovations in the Doctrine, 6 Cardozo L. Rev. 671, 677 (1985)).
12Although not relied upon by the court in In re Blagg, the Tenth Circuit Bankruptcy Appellate Panel has also recently held that a tax refund cannot be split into “two funds” for the purposes of marshaling by dividing the pre-petition and post-petition portions of the refund. The BAP held that because the pre-petition portion of the refund belongs to the estate, and the post–petition portion belongs to the debtor, there are not “two funds belonging to the debtor” and marshaling is not applicable. Redmond v. Miller (In re Miller), 2007 WL 2332391 (10th Cir. BAP August 16, 2007). The same analysis applies here; because the pre-petition portion of the tax refund belongs to the bankruptcy estate and the post-petition property belongs to Debtors, there are not two funds “belonging to the debtor” required for the doctrine of marshaling to apply.
13In re Blagg, 372 B.R. at 507 (citing Jacquelyn Michael Davis, Marshaling of Assets in Bankruptcy, 5 Bankr. Dev. J. 309, 309 (1987) and 53 Am. Jur.2d Marshaling Assets § 17 (2007)).
14In re Blagg, 372 B.R. at 509, n.33 (citing 2 Collier on Bankruptcy ¶ 105.01[2]).
15See, e.g., 11 U.S.C. § 553.
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funds.16 Finally, the court concluded that applying the “equitable” doctrine of marshaling
in these cases would be inequitable because it would place an improper burden upon the
debtors to collect and forward assets of the estate to the Trustee, impeding the debtor's fresh
start. In so holding, the court noted that marshaling is generally not applied against the
debtor or to the prejudice of the debtor.17
The Court finds that the approach taken in In re Blagg more persuasive, and hereby
adopts the holding of In re Blagg. Based on that decision, the Court finds that the doctrine
of marshaling is not applicable, and the Trustee may not collect the pre-petition portion of
Debtors' income tax refunds that were offset by the federal government from the respective
Debtors.18
CONCLUSION
16Id. at 510.
17Id. at 510-11.
18The Trustee also argues in In re Henderson, Case No. 05-42351, that the offset by the U.S. Department of
Treasury on behalf of child support creditors was improper because that agency used pre-petition funds belonging to the bankruptcy estate to offset post-petition child support arrearages. On this point, this Court also agrees with In re Blagg in finding that “the Trustee should seek to recover from the IRS in the first instance” if the offset was improper. It is not Debtors' duty to recover an improper offset for the estate. In re Blagg, 372 B.R. at 511 (emphasis added). The Court does not decide whether the offset was proper or not. It only decides that once a refund is offset, that tax refund is no longer property of the estate. Cf. Jones v. Internal Revenue Service (In re Jones), 359 B.R. 837 (Bankr. M.D. Ga. 2006) (adopting emerging view that federal tax overpayments are not property of the estate until the IRS has effectuated any offset to which it is entitled). In addition, the Trustee has argued that in at least one of the cases, the offset was a violation of the automatic stay imposed by 11 U.S.C. § 362. Again, if the Trustee believes either or both offset were improper because there was a violation of the automatic stay, or for any other reason, the Trustee should bring an action against the offending governmental agency. The motions currently before the Court are Debtors' motions to determine that once the funds were offset, they were no longer responsible for paying those funds into the bankruptcy estate. As far as the Court is aware, the facts relative to allegedly improper offsets have not been fully developed, and the United States is not a party to this dispute nor has it been given the opportunity to brief the offset issue, so the Court declines to decide the underlying propriety of the offsets in this opinion.
6
For the foregoing reasons, the Court hereby adopts the holding of In re Blagg and
finds that the portion of the respective Debtors' income tax refunds that were offset by the
IRS and the U.S. Department of Treasury are not property of the respective bankruptcy
estates. For that reason, Debtors will not be required to repay the offset amounts to the
estate.
IT IS, THEREFORE, BY THE COURT ORDERED that the Motion for
Determination that the Portion of Debtor's Income Tax Refund Offset by the U.S.
Department of Treasury is Not Property of the Estate19 and the Motion for Determination that
the Portion of Debtors' Income Tax Refund Offset by the IRS is Not Property of the Estate20
are both granted.
###
19Doc. 21 in Case No. 05-42351.
20Doc. 44 in Case No. 06-40549,
7