In re Mazon

• Decision Date: 11 May 2007
• Docket Number: No. 9:05-BK-04213-MGW.,9:05-BK-04213-MGW.
• Citation: 368 B.R. 906
• Parties: In re Bernard C. MAZON and Jane I. Mazon, Debtors.
• Court: U.S. Bankruptcy Court — Middle District of Florida

368 B.R. 906

In re Bernard C. MAZON and Jane I. Mazon, Debtors.

No. 9:05-BK-04213-MGW.

United States Bankruptcy Court, M.D. Florida, Ft. Myers Division.

May 11, 2007.

Christian B. Felden, Felden and Felden, Naples, FL, for Debtors.

MEMORANDUM DECISION ON TRUSTEE'S MOTION TO SURCHARGE DEBTORS' EXEMPT PROPERTY

MICHAEL G. WILLIAMSON, Bankruptcy Judge.

A trustee may equitably surcharge a debtor's statutory exemptions when the debtor has failed to schedule and turn over estate assets. A homestead exempt under Florida's constitutional exemption, however, may not be so surcharged unless the estate assets can be traced into the acquisition of an interest in the homestead.

In this case, the debtors failed to disclose assets valued at approximately $615,000, which they dissipated post petition. However, none of the dissipated estate assets can be traced into the debtors' homestead. Accordingly, the motion of the Trustee to surcharge exempt assets will be granted as to the assets claimed as exempt under the Florida general statutory exemptions and denied as to the property that has been claimed as exempt under the Florida constitutional homestead exemption.

Procedural Background

This case came on for a final evidentiary hearing on April 26, 2007, on the Trustee's Motion to Surcharge Debtors' Exemptions and/or Exempt Property (Doc. No. 147) ("Motion"). The Court considered the entire record, including the exhibit that is part of the record in this case and the record established in adversary proceedings filed by the Trustee (Adv. No. 9:06-ap-00313-MGW) ("Trustee's Adversary") and Callahan Blaine, the largest single creditor of the Debtors (Adv. No. 9:05-ap-00219-MGW) ("Creditor's Adversary"). This court has jurisdiction of this matter under 28 U.S.C. sections 157 and 1334(b). This is a core proceeding pursuant to 28 U.S.C. section 157(b)(2)(A), (B), (E), and (O).

The debtors, Bernard C. Mazon and Jane I. Mazon ("Debtors"), filed their chapter 7 petition on March 10, 2005. Robert E. Tardif, Jr. was appointed as the trustee ("Trustee"). On Schedules A and B, the Debtors scheduled a condominium unit in Naples, Florida, valued at $760,000, three 401k accounts collectively valued at $100,000, and a life insurance policy with cash value of $40,000. The Debtors claimed these assets as exempt on Schedule C.

As part of the administration of this case, the Trustee's Adversary was filed seeking the turnover of property from the Debtors. In addition, Callahan & Blaine filed the Creditor's Adversary, seeking the imposition of an equitable lien against the Debtors' homestead. The Court consolidated the two adversary proceedings for purposes of trial, and the trial was conducted on December 13, 2006, and on January 17, 2007.

During the course of discovery in the adversary proceedings, the Trustee learned that the Debtors failed to schedule and disclose various assets they owned on the date of filing. Specifically, the Debtors individually or jointly owned two annuities with a combined value of more than $2,100,000 ("Annuities"); an IRA valued at approximately $270,000 ("IRA"); and interests in two businesses, Emicole Properties, LLC and Emicole Investments, Ltd. ("Emicole Assets"). In the Trustee's Adversary, the Court entered an order and final judgment, finding that the Annuities, IRA, and Emicole Assets were property of the bankruptcy estate and not subject to exemption.

In the Creditor's Adversary, the Court entered a final judgment granting an equitable lien to the creditor in the amount of $1,102,811.86 against the Debtors' homestead unit. The Court ordered that the homestead be sold to satisfy the equitable lien. In the event that the sale amount exceeds the equitable lien, the Court ruled that the Debtors would retain the surplus as exempt property.

Although the Court awarded the Trustee the Annuities and the IRA and the Trustee was able to preserve those assets, the Trustee did not recover any Emicole Assets before they were dissipated by the Debtors. These assets consisted of (1) a financial account maintained by Emicole Investments, Ltd. at Frost Brokerage Services with a balance of $434,939.22 on the date of filing, and (2) real property in Pennsylvania owned by Emicole Properties, LLC on the date of filing and sold post petition for $181,196.23. The Debtors spent the money obtained from the Emicole Assets for their personal use.

As a result of the Debtors' failure to schedule, disclose, and turn over the Emicole Assets, the Trustee filed the Motion seeking an order surcharging the Debtors' exempt property. Specifically, the Trustee requests that the Court allow him to surcharge the three 401k accounts, the life insurance cash value, and any money that the Debtors receive from the sale of their homestead that exceeds the equitable lien in favor of Callahan & Blaine.

Conclusions of Law

A. Trustee's Right to Surcharge Exempt Property in Exceptional Circumstances

The filing of bankruptcy creates an estate composed of all legal and equitable interests of the debtor in property. 11 U.S.C. § 541. In Florida, a debtor may exempt from property of the estate either property specified in Section 522(d) of the United States Bankruptcy Code or, alternatively, the exemptions permitted under Florida statutory and constitutional state law and non-bankruptcy federal law. By willfully and fraudulently Concealing and dissipating estate assets, a debtor, effectively, keeps more assets than the Bankruptcy Code allows. Essentially, the debtor secretly exempts assets because the concealment and dissipation prevents administration of the assets by a trustee for the benefit of creditors.

The threshold legal issue presented by the Trustee's motion is whether a bankruptcy court may authorize a surcharge against a debtor's exempt assets in circumstances such as these where there has been a material failure to disclose assets of a bankruptcy estate that are subsequently dissipated. There is no Eleventh Circuit Court of Appeals case or any Florida case — either bankruptcy court or district court — on this point. Courts around the country, however, have had occasion to consider whether a trustee should be permitted to surcharge exempt property.

The Bankruptcy Code does not explicitly provide for the remedy of surcharge against a debtor's exemptions. Latman v. Burdette, 366 F.3d 774, 785 (9th Cir.2004). However, the "broad authority granted to bankruptcy judges to take any action that is necessary or appropriate `to prevent an abuse of process'" described in section 105 has been recently reaffirmed by the United States Supreme Court in the case of Marrama v. Citizens Bank of Massachusetts, ___ U.S. ___, ___, 127 S.Ct. 1105, 1112, 166 L.Ed.2d 956 (2007). Indeed, as noted by the Supreme Court in Marrama, "even if § 105(a) had not been enacted, the inherent power of every federal court to sanction `abusive litigation practices,' [citation omitted] might well provide an adequate justification for a prompt" remedy when faced with a debtor's active misconduct to take advantage of the bankruptcy system for improper purposes as occurred in Marrama and as has occurred in this case. Id.

The need to prevent abuse of the judicial system is all the more imperative in the bankruptcy context. As the Supreme Court has explained, bankruptcy courts "are courts of equity and `appl[y] the principles and rules of equity jurisprudence.'" Young v. United States, 535 U.S. 43, 50, 122 S.Ct. 1036, 152 L.Ed.2d 79 (2002) (quoting Pepper v. Litton, 308 U.S. 295, 304, 60 S.Ct. 238, 84 L.Ed. 281 (1939)); see also Bank of Marin v. England, 385 U.S. 99, 103, 87 S.Ct. 274, 17 L.Ed.2d 197 (1966) ("There is an overriding consideration that equitable principles govern the exercise of bankruptcy jurisdiction."); SEC v. United States Realty & Improvement Co., 310 U.S. 434, 457, 60 S.Ct. 1044, 84 L.Ed. 1293 (1940) ("Good sense and legal tradition alike enjoin that an enactment of Congress dealing with bankruptcy should be read in harmony with the existing system of equity jurisprudence of which it is a part."). Chief among these equitable principles and rules is the concept that a debtor who seeks relief under the Bankruptcy Code must act in good faith and not for any improper purpose. As the Supreme Court has explained, "[o]nly exemplary motives and scrupulous good faith" can stir a court of equity to grant relief in bankruptcy. Shapiro v. Wilgus, 287 U.S. 348, 356-57, 53 S.Ct. 142, 77 L.Ed. 355 (1932); see also Little Creek Dev. Co. v. Commonwealth Mortgage Corp. (In re Little Creek Dev. Co.), 779 F.2d 1068, 1072 (5th Cir.1986) (noting that the good faith standard "protects the jurisdictional integrity of the bankruptcy courts by rendering their powerful equitable weapons (i.e., avoidance of liens, discharge of debts, marshalling and turnover of assets) available only to those debtors and creditors with `clean hands.'"); In re Wiggles, 7 B.R. 373, 375 (Bankr.N.D.Ga.1980) (tracing the origins of the concept of good faith in the bankruptcy context to Shapiro)

The Supreme Court has also recognized that bankruptcy courts have long relied upon their inherent equitable powers in passing on and preventing "a wide range of problems arising out of the administration of bankrupt estates." Pepper, 308 U.S. at 304, 60 S.Ct. 238. Clearly, failure to disclose assets and the misappropriation of those assets falls squarely within the types of problems with which a bankruptcy court must be able to effectively deal.

The only explicit reference to a right to surcharge is found in section 506(c).¹ See 2. W. Norton, Bankruptcy Law and Practice 2d § 43:4, p. 43-27 (2004) (referring to trustees' section 506(c) claims as "Surcharge Claims"). This section, however, is limited to a trustee's right to recover the reasonable and necessary costs and expenses of preserving or disposing of property securing a claim to the extent the secured claimant has benefited. Yet, even absent specific...