In re Costas

• Citation: 555 F.3d 790
• Decision Date: 06 February 2009
• Docket Number: No. 06-16520.,06-16520.
• Parties: In re John M. COSTAS and Rachelle M. Costas, Debtors. Maureen Gaughan, Chapter 7 Trustee, Appellant, v. The Edward Dittlof Revocable Trust, and Rachelle M. Costas, Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

555 F.3d 790

In re John M. COSTAS and Rachelle M. Costas, Debtors Maureen Gaughan, Chapter 7 Trustee, Appellant, v. The Edward Dittlof Revocable Trust, and Rachelle M. Costas, Appellees.

No. 06-16520.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted May 15, 2008.

Filed February 6, 2009.

Paul Sala, Allen & Sala, P.L.C., Phoenix, AZ, for the appellant.

Mark A. Bregman, Bregman & Burt, Scottsdale, AZ, for the appellees.

Appeal from the Ninth Circuit Bankruptcy Appellate Panel Montali, Smith, and Ahart, Bankruptcy Judges, Presiding. BAP No. AZ-05-1440.

Before: ANDREW J. KLEINFELD, N. RANDY SMITH, Circuit Judges, and RICHARD MILLS, District Judge.^*

MILLS, District Judge:

The Bankruptcy Code's federal fraudulent conveyance provision allows a trustee to avoid "any transfer ... of an interest of the debtor in property" within a two year reach back period where the transfer was actually or constructively fraudulent. 11 U.S.C. § 548(a)(1). The question in this case is whether an Arizona disclaimer qualifies as a "transfer ... of an interest of the debtor in property." Because we answer this question in the negative, the Bankruptcy Appellate Panel's refusal to avoid the disclaimer under § 548 is affirmed.

I. FACTS

On October 18, 2001, Edward P. Dittlof ("Dittlof") created the Edward Dittlof Revocable Trust ("Trust") under Arizona law. The Trust provided that upon Dittlof's death, the Trust property would be distributed to several of Dittlof's children, including Rachelle Costas ("Costas"). Should a beneficiary die prior to distribution, the beneficiary's children would take the share.

Dittlof died on February 25, 2002, leaving Costas an interest worth at least $34,800. Costas, however, refused to accept it and, on November 7, 2002, executed a disclaimer under Arizona law to relinquish her claims to the Trust property.

Shortly thereafter, on December 3, 2002, Costas filed a voluntary petition for relief under Chapter 7 of the Bankruptcy Code ("the Code"). Maureen Gaughan, the Chapter 7 trustee ("Trustee"), sought to avoid Costas' disclaimer of the Trust property under 11 U.S.C. § 548. Although a previous BAP panel decision had rejected application of § 548 to similar state law disclaimers, Wood v. Bright (In re Bright), 241 B.R. 664 (9th Cir. BAP 1999), the Trustee argued that the ruling had been undermined by the Supreme Court's decision in Drye v. United States, 528 U.S. 49, 120 S.Ct. 474, 145 L.Ed.2d 466 (1999). The Bankruptcy court, however, found Drye distinguishable. The Trustee appealed and, in a thorough opinion, the BAP also distinguished Drye and adhered to its prior decision in Bright. Gaughan v. Costas (In re Costas), 346 B.R. 198 (9th Cir. BAP 2006). The Trustee now appeals from this decision.

II. STANDARD OF REVIEW

"On appeal this court reviews decisions of the BAP de novo, and thus reviews the bankruptcy court's decision under the same standards used by the BAP." Sigma Micro Corp. v. Healthcentral.com (In re Healthcentral.com), 504 F.3d 775, 783 (9th Cir.2007) (citation and internal quotations omitted). Therefore, factual findings are reviewed for clear error and legal conclusions de novo. Id.

III. ANALYSIS

The federal fraudulent conveyance provision of the Code provides that "[t]he trustee may avoid any transfer ... of an interest of the debtor in property ... that was made ... within two years before the date of the filing of the petition ..." where the transfer involved actual or constructive fraud. 11 U.S.C. § 548(a)(1).¹ The parties dispute whether a disclaimer executed under Arizona law qualifies as a "transfer ... of an interest of the debtor in property."

A. "Property" and Arizona Disclaimer Law

We begin with the two relevant and disputed terms from § 548: "transfer" and "property" (or, more broadly, "an interest ... in property"). The Code defines "transfer" expansively, reaching "each mode, direct or indirect, absolute or conditional, voluntary or involuntary of disposing of or parting with — (i) property; or (ii) an interest in property." 11 U.S.C. § 101(54). Whether a particular action constitutes a "transfer" is a matter of federal law. Walker v. First Security Bank of Idaho, N.A. (In re Walker), 77 F.3d 322, 323 (9th Cir.1996) (quoting Barnhill v. Johnson, 503 U.S. 393, 397, 112 S.Ct. 1386, 118 L.Ed.2d 39 (1992)). However, as the definition makes clear, a "transfer" cannot occur without "property" or "an interest in property." See § 101(54). Thus, the key issue in the case is elucidating the meaning of "an interest ... in property." See Frierdich v. Mottaz, 294 F.3d 864, 867 (7th Cir.2002) ("Although the definition of transfer is obviously federal, its references to `property' and `interests in property' require an analysis of whether a property interest was created under state law.")

The Code does not define "property" or "an interest ... in property." Rather, "Congress has generally left the determination of property rights in the assets of a bankrupt's estate to state law," Butner v. United States, 440 U.S. 48, 54, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979), meaning that "[i]n the absence of any controlling federal law, `property' and `interests in property' are creatures of state law." Barnhill, 503 U.S. at 398, 112 S.Ct. 1386 (citations omitted). Therefore, to understand the definition and scope of "property," we turn to Arizona law.

Like other states, Arizona allows beneficiaries to renounce their interests in trusts through use of a disclaimer. See Az.Rev. Stat. § 14-2801 (2004) (repealed).² A "disclaimer"³ has been defined as "the refusal to accept an interest in or power over property." Uniform Disclaimer of Property Interests Act § 2(3) (1999). At all relevant times, Arizona law required disclaimers to be filed with the court and a representative or fiduciary of the decedent "not later than nine months" after the effective date of the instrument. Az. Rev.Stat. § 14-2801(B), (C) (testamentary and non-testamentary, respectively). The disclaimer itself also had to "describe the property or interest disclaimed, declare the disclaimer and its extent and be signed by the disclaimant." § 14-2801(F). Where the beneficiary had previously made "[a]n assignment, conveyance, encumbrance, pledge or transfer of the property or interest or a contract" or accepted certain benefits or interests in the property, the right to disclaim was barred. § 14-2801(J), (M). The Trustee concedes the validity of Costas' disclaimer under Arizona law. Costas, 346 B.R. at 200.

A properly executed disclaimer carries a significant advantage for an insolvent debtor: it shields the disclaimed interest from the disclaimant's creditors. Arizona achieved this protection through § 14-2801(G), which provides that "[a] disclaimer relates back for all purposes to the date of death of the decedent." This relation-back rule, a common feature in many states, is a legal fiction that retroactively eliminates any property interest that a disclaimant previously held in the disclaimed property. As the Supreme Court has explained, "an effective disclaimer ... relate[s] back to the moment of the original transfer of the interest being disclaimed, having the effect of canceling the transfer to the disclaimant ab initio and substituting a single transfer from the original donor to the beneficiary of the disclaimer." United States v. Irvine, 511 U.S. 224, 239, 114 S.Ct. 1473, 128 L.Ed.2d 168 (1994). "An important consequence of treating a disclaimer as an ab initio defeasance is that the disclaimant's creditors are barred from reaching the disclaimed property." Id. at 239-240, 114 S.Ct. 1473.

In short, Arizona's relation-back rule says that a disclaimant neither transfers nor possesses an interest in disclaimed property and thus creditors cannot reach the disclaimed interest.

B. State Law Deference

To summarize, section 548 only applies to interests in "property," as defined by state law, and Arizona law says that Costas had no property interest in the disclaimed property. The remaining question, and the problematic one, is how to translate this state law rule back into the bankruptcy context.

Ordinarily, bankruptcy courts look to Butner to answer this question. There, the Supreme Court addressed a circuit split over the ownership of rents. Butner, 440 U.S. at 51-54, 99 S.Ct. 914. Some circuits followed state law in determining who received post-petition rents, whereas other circuits fashioned a federal rule of equity to allow mortgagees to receive the rents. Id. Ultimately, the Court rejected the federal equity rule, explaining that "Congress has generally left the determination of property rights in the assets of a bankrupt's estate to state law." Id. at 54, 99 S.Ct. 914. Thus, "[u]nless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding." Id. at 55, 99 S.Ct. 914.

Applying the principle of Butner to similar disclaimers, several appellate courts have found § 548 inapplicable. Simpson v. Penner (In re Simpson), 36 F.3d 450 (5th Cir.1994) (Texas law); Jones v. Atchison (In re Atchison), 925 F.2d 209 (7th Cir.1991) (Illinois law); Hoecker v. United Bank of Boulder, 476 F.2d 838 (10th Cir. 1973) (concluding that Colorado disclaimer rules preclude use of the fraudulent conveyance provision contained in § 67(d)(2) of the Bankruptcy Act); see also In re Bright, 241 B.R. 664 (9th Cir.BAP1999) (Washington law). For example, the Seventh Circuit took a broad view of Butner, explaining that "[a]ll applicable state law must be construed to determine whether a debtor possesses a property interest," including the relation back rule. Atchison, 925 F.2d at 212. The contrary view, the court found, "fail[ed] to give full application to the relation back doctrine under applicable state laws." Id. at 211. Based on this deferential approach to state law, the Atchison court...