In re Cheatham

• Decision Date: 07 May 2004
• Docket Number: No. 03-31928-WRS.,03-31928-WRS.
• Citation: 309 B.R. 631
• Parties: In re William Parker CHEATHAM, Karen Harris Cheatham, Debtors.
• Court: U.S. District Court — Middle District of Alabama

309 B.R. 631

In re William Parker CHEATHAM, Karen Harris Cheatham, Debtors.

No. 03-31928-WRS.

United States District Court, M.D. Alabama.

May 7, 2004.

Earl Gillian, Jr., Montgomery, AL, for Debtors.

Janie Salmon Gilliland, Montgomery, AL, for Trustee.

Tom McGregor, Montgomery, AL, Trustee.

Memorandum Decision

WILLIAM R. SAWYER, Bankruptcy Judge.

This Chapter 7 bankruptcy case is before the Court upon the Trustee's Objection to Debtors' Claim of Exemptions. (Doc. 7). The parties have submitted briefs (Docs. 15, 18, 19, 22, and 23) and there are no material facts in dispute. Upon consideration of the pleadings, the arguments and stipulations of counsel, and having considered the briefs on file, the Court overrules the Trustee's objection. The Court finds that the Prepaid Affordable College Tuition Program contract benefits are property of the Debtors' children and for this reason are not property of the estate.

I. FACTS

The Debtors filed a petition under Chapter 7 of the Bankruptcy Code on June 24, 2003. (Doc. 1). On the schedules filed with their petition, the Debtors claimed as exempt two contracts issued pursuant to the Prepaid Affordable College Tuition Program ("PACT Contracts"). (Doc. 1, Sch. C). Under the Alabama MasterPACT program, a purchaser enters into a contract to prepay instate college tuition and mandatory fees on behalf of a qualified beneficiary. (Doc. 15, Ex. 1). In this case, the Debtors purchased contracts on behalf of their two minor children. The Debtors claimed the entire amount of the PACT Accounts ($5,173.00 in the daughter's account and $9,463.00 in the son's account) exempt pursuant to Ala.Code § 19-3-1. ("Express trust for support, maintenance and education of relative; qualified trust under Internal Revenue Code; definitions"). The Debtors later amended their Schedule C to claim also the exemption pursuant to Ala.Code § 27-14-32. (Doc. 13). See § 27-14-32 ("Exemption from debt of proceeds — Annuity contracts."). The Trustee objects to those claims of exemption. (Docs. 7, 15, 19 and 22).

Before the Court reaches the question of whether the PACT contracts are exempt property, it must first determine whether they are property of the bankruptcy estate pursuant to 11 U.S.C. § 541. The Court held a status conference on February 3, 2004, and specifically inquired of the parties about this question. (See Doc. 20, Order Setting Status Conference). At that conference, the parties stipulated that the Debtors' testimony would be that they intended to make a transfer to their children at the time the contracts were funded. Given this stipulation, it was not necessary for the Court to conduct an evidentiary hearing.

II. LEGAL CONCLUSIONS

This Court has jurisdiction pursuant to 28 U.S.C. § 1334. This is a "core proceeding" pursuant to 28 U.S.C. § 157(b)(2)(B).

A. Procedural Setting

When a debtor files a petition in bankruptcy under Chapter 7 of the Bankruptcy Code, an estate is created. This estate consists of "all legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. § 541(a). It is the Trustee's duty to gather up the property of the estate, convert it to cash, and cause the cash proceeds to be distributed to creditors in accordance with the scheme prescribed by Congress. 11 U.S.C. §§ 704, 726. To mitigate the severity of the forced liquidation of the debtor's property, Congress has provided that debtors may set apart certain of their property as exempt. 11 U.S.C. § 522. Congress further provided that the States may opt out of the Federal exemption scheme and provide their own. 11 U.S.C. § 522(b). Alabama has done that. See Ala.Code § 6-10-11. Therefore, Alabama state law governs the propriety of a claim for exemption in bankruptcy cases filed in Alabama. See e.g., In re Simmons, 308 B.R. 559, 561-62 (Bankr.M.D.Ala.2004); In re Perine, 46 B.R. 695, 696 (S.D.Ala.1983).

It is also the duty of the Trustee to examine the debtor's claim of exemption and, when appropriate, make an objection. 11 U.S.C. § 522; Fed. R. Bankr.P. 4003(b). In the case at bar, the Debtors' claimed the PACT contracts as exempt pursuant to Alabama Code Sections 19-3-1 and 27-14-32. This contested matter arose in the context of the Trustee's objection to the Debtors' claim of exemption. (Doc. 7).

The contested matter at issue raises two separate issues. The first issue is whether the property in question is property of the estate. If the answer to that question is affirmative, the next question is whether the subject property properly may be claimed as exempt. In the case at bar, the Court has answered the first question in the negative, therefore it is unnecessary to reach the second question.

B. The PACT Contracts are not property of the estate

The estate consists of "all legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. § 541(a)(1); see In re Thomas, 883 F.2d 991, 995 (11th Cir.1989). The question in this case is what interest, if any, did the Debtors own in the PACT contracts as of the date of the bankruptcy petition?

The Debtors filed their petition in bankruptcy on June 24, 2003. (Doc. 1). At least one of the PACT contracts in question appears to have been funded at some point during the month of May, 1993, 10 years earlier. This is inferred from the heading on Trustee's Exhibit No. 1 which states as follows: "Master PACT, For Spring 1993 Enrollment Period, May 1, 1993 — May 31, 1993." (Doc. 15, Ex. 1). Schedule I indicates that the Debtors have two children, ages 12 and 7. It would appear that the older child's PACT contract was funded in May of 1993 and the younger child's account would necessarily have been funded at some later point in time.

While the precise dates upon which the contacts were funded cannot be determined with certainty from the Court's record, it is undisputed that the transfers to the PACT program were not fraudulent conveyances because the Trustee makes no such argument in this case. If the funding of the PACT contract is a transfer from the Debtors to their children which is made as of the date on which the contract is funded, it would appear that the Debtors no longer had an interest in the funds, or the contract after that time.

The PACT program was created by an act of the Alabama legislature in 1990. 1990 Ala. Acts 90-570; see Ala.Code § 16-33C-1 et seq. The intention of the Alabama Legislature was expressed as follows:

It is therefore the legislative intent of this act to establish an educational trust fund as an agency and instrumentality of the State of Alabama to assist qualified students to pay in advance the tuition costs of attending state colleges and universities and thereby to encourage such qualified students to attend state colleges and universities in the State of Alabama.

1990 Ala. Acts. 90-570. Therefore, it was the intention of the Alabama legislature that this program provide a means to pay, in advance, the costs of tuition at state colleges and universities.

The PACT contract provides, in part, as follows:

The P.A.C.T. Program guarantees payment of undergraduate Instate Tuition and Mandatory Fees on behalf of the Qualified Beneficiary to the Alabama Public Postsecondary Institution in which the Qualified Beneficiary matriculates.

P.A.C.T. Contract, Section III. (Doc. 15, Ex. 1).

By prepaying college tuition, one may minimize the risk of tuition costs rising at a rate greater than the interest rate on monies held in a savings account or another investment device. As contract benefits are described as "prepaid tuition," it appears that the Debtors paid their children's college tuition at the time the PACT contracts were funded. It follows then, that the contract benefits became the property of the children and were no longer the property of the parents, as of the date the contracts were funded. Further support for this conclusion may be found in the definitional section of the contracts where the children are named as beneficiaries, or "qualified beneficiaries." (Doc. 15, Ex. 1, Para. 2.01).

The Alabama Court of Civil Appeals handed down a decision which involved a PACT contract similar to the one at issue here. Johnson v. Taylor, 770 So.2d 1103 (Ala.Civ.App.1999) (injunction preventing father from disposing of child's property survived dismissal of petition to modify divorce decree). In its discussion of the PACT contract, the Court made the following statements:

On May 12, 1994, the trial court entered an order enjoining the father from disposing of any of the child's personal items, allowing the child to retrieve all her personal items and her pet, and enjoining the father from impairing in any manner the child's right and entitlement to her PACT account. Id. at 1104. (emphasis added).

* * *

At a hearing on the grandmother's verified complaint, the father argued that the trial court's December 14, 1995, dismissal order, wherein the trial court dismissed the pending motion for custody pendente lite filed on October 19, 1994, acted as a dismissal of the court's earlier order dated May 12, 1994, which had enjoined the father from spending the child's PACT money. Id. at 1105 (emphasis added).

* * *

The grandparents, in addition to seeking custody, had attempted to stop the father from throwing away his child's things and from invading the child's college money. ... The injunction preventing the father from taking his child's college money was not addressed in the order ... In its original order enjoining the father from taking the child's college money. ... Id. at 1105. (emphasis added).

The Alabama Court of Civil Appeals repeatedly refers to the child's rights under the PACT contract as the child's property or the child's college money. The decision in Johnson v. Taylor turns on a fine point of Alabama law concerning the issue of whether a temporary restraining order in a divorce proceeding survives entry of judgment. While that point of law has no...