In re Turnage

• Docket Number: Case No. 21-50224
• Decision Date: 26 August 2022
• Citation: 644 B.R. 656
• Parties: IN RE: Nancy Money TURNAGE, Debtor.
• Court: U.S. Bankruptcy Court — Western District of North Carolina

644 B.R. 656

IN RE: Nancy Money TURNAGE, Debtor.

Case No. 21-50224

United States Bankruptcy Court, W.D. North Carolina, Statesville Division.

Signed August 26, 2022

Thomas C. Flippin, Law Offices of Thomas C. Flippin, Elkin, NC, for Debtor.

Jimmy R. Summerlin, Jr., Young, Morphis, Bach & Taylor, LLP, Hickory, NC, Trustee, Pro Se.

ORDER DENYING TRUSTEE'S MOTION FOR AUTHORITY TO CONDUCT SALE AND OVERRULING TRUSTEE'S OBJECTION TO EXEMPTIONS

Laura T. Beyer, United States Bankruptcy Judge

THIS MATTER is before the court on the Chapter 7 Trustee's October 18, 2021 Objection to Exemptions ("Objection") and November 12, 2021 Motion for Authority to Conduct Sale of Real Property Free and Clear of Liens and Interests and to Approve Carve Out ("Motion"). After the filing of responses by the Debtor, replies by the Trustee, the Debtor's surreply to the Motion, and the Trustee's supplement to the Motion and several continued hearings, the court held a hearing on the Motion and Objection on March 4, 2022. The Trustee and the Debtor's attorney appeared at the March 4 hearing.¹

The Motion and Objection are closely related, and the court heard argument on both matters simultaneously. There is no dispute about the material facts. To summarize, the Motion seeks to sell the Debtor's residence and use the proceeds to pay administrative expenses and a portion of the claims against the Debtor's estate. The Objection asserts that the Debtor's exemptions do not apply to certain claims of the federal and state governments. At its most basic level, the Trustee's proposal embodied in the Motion and the Objection is in no way controversial. The job of a Chapter 7 trustee, after all, is to liquidate the property of a debtor's estate and then distribute the proceeds among the debtor's creditors pursuant to the Bankruptcy Code's priority scheme. 6 COLLIER ON BANKRUPTCY ¶ 700.04 (16th ed. 2021). Similarly, the Objection is consistent with the language of the North Carolina exemption statute. See N.C. GEN. STAT. § 1C-1601(e) ("The exemptions provided in this Article are inapplicable to claims: (1) Of the United States or its agencies as provided by federal law; (2) Of the State or its subdivisions for taxes, appearance bonds or fiduciary bonds; ...."). The Trustee's proposal, however, quickly becomes more complicated than these basic concepts, the complications cause the proposal to violate core principles of bankruptcy law, and, ultimately, the court cannot approve the proposed transaction.

Normally, a Chapter 7 trustee only seeks to sell a debtor's real property when there is available equity over the claims secured by the property and any exemptions available to the debtor. Bankruptcy trustees (like executing judgment creditors outside bankruptcy) ordinarily must satisfy liens secured by the property and pay a debtor's exemption prior to reaching funds available for paying their administrative claims and distribution to the rest of the creditor body. See DeGiacomo v. Traverse (In re Traverse), 753 F.3d 19, 29 (1st Cir. 2014) ("Bankruptcy courts have defined the equity that justifies a sale of property, consistently and explicitly, in one way: the value remaining for unsecured creditors above any secured claims and the debtor's exemption." (citations omitted)). In this case, using either party's estimate for the value of the Debtor's real estate, there does not appear to be any equity in the property over a mortgage and tax liens.

The Debtor scheduled the value of her residence at 4206 West Old US 421 Highway in Hamptonville, North Carolina at $124,510 based on the tax value, and the Trustee reports in his Motion that a realtor valued the property at $175,000 to $180,000 after an exterior-only review. The Debtor scheduled a mortgage on the property to First National Bank of PA with a balance of $52,703, and the Motion says the Trustee verified a mortgage payoff of $52,166.81 as of September 14, 2021. In addition to the mortgage, the property secures significant tax liens.² The Debtor scheduled secured claims of $113,143.00 for the Internal Revenue Service ("IRS") and $47,942.29 for the North Carolina Department of Revenue ("NCDoR"). The Motion says the Trustee verified that the IRS holds two tax liens totaling $113,143.59 and the NCDoR's lien is secured by $37,856.99 of the Debtor's property.³ In her Schedule C, the Debtor claimed a $55,000 exemption in her residence pursuant to North Carolina General Statute section 1C-1601(a)(1).⁴

This would usually be the end of the analysis for a Chapter 7 trustee, and no motion to sell the property would end up in front of the court. Even using the Trustee's more favorable numbers and without considering the Debtor's homestead exemption, there does not appear to be any equity available for the Debtor's estate, as the total amount subject to liens ($203,167.39) exceeds the value of the property as estimated by the Trustee's realtor ($175,000–$180,000) by over $20,000. Since there is no equity available for the estate, the Trustee would normally not pursue a sale. If the Trustee wanted to sell the property despite the lack of equity, the court would not let him, as this court does not allow trustees to administer bankruptcy estates solely for the benefit of secured creditors. See Joseph v. Cooper, 539 B.R. 489, 497 (W.D.N.C. 2015) ("In order to authorize the sale, the Bankruptcy Court must determine whether such a sale would benefit the estate. A sale benefits the estate when the proceeds generate equity that can be distributed among unsecured creditors." (citing Reeves v. Callaway, 546 F. App'x 235, 241 (4th Cir. 2013) )); In re Fontana, Ch. 7 Case No. 14-30773, 2015 Bankr. LEXIS 3771, at *4 (Bankr. W.D.N.C. Nov. 4, 2015) ("This result is consistent with the longstanding principle that Chapter 7 trustees are not to pursue claims for individual creditors." (citing In re Miller, 197 B.R. 810, 814–15 (W.D.N.C. 1996) )); In re Marko, Ch. 7 Case No. 11-31287, 2014 WL 948492, at *5 (Bankr. W.D.N.C. Mar. 11, 2014) ("The Bankruptcy Code generally contemplates that over encumbered property not be sold." (citing 11 U.S.C. § 363(f)(2) )).

Since there does not appear to be any equity in the Debtor's residence, the Trustee invokes a Chapter 7 exception to the normal order of distribution of sale proceeds as part of the justification for the proposed sale. Section 724(b) of the Bankruptcy Code allows Chapter 7 trustees to subordinate some types of tax liens in order to pay particular priority claims. 11 U.S.C. § 724(b) ; COLLIER ¶ 724.03. This section is an unusual provision in the Bankruptcy Code that allows a Chapter 7 trustee to administer encumbered property for the benefit of certain priority claimants and includes an alternate distribution scheme. See COLLIER ¶ 724.03[5], [7].

Distributions pursuant to the alternate distribution scheme begin as they would without § 724(b), by paying any liens senior to the tax lien that will be subordinated. § 724(b)(1). The alternate distributions begin at the next step, as claimants holding certain types of priority claims substitute in for the tax lien to the extent of the tax lien. § 724(b)(2). Third, the tax lien is paid to the extent that it exceeds the payments to priority creditors under § 724(b)(2). § 724(b)(3). Next, any liens that are junior to the tax lien are paid. § 724(b)(4). To the extent that the subordinated tax lien has not already been paid, it is satisfied after the junior liens. § 724(b)(5). Finally, any remaining proceeds go to the debtor's estate. § 724(b)(6).

The tax liens against the Debtor's residence in this case are appropriate for subordination pursuant to § 724(b). The Debtor, however, with one significant potential exception, does not owe any of the types of priority claims that can be paid pursuant to § 724(b). See § 724(b)(2) (listing, by reference to 11 U.S.C. § 507, certain priority claims, including domestic support obligations and wages, salaries, or commissions owed, that can be paid ahead of the subordinated tax claims). The one type of priority claim that the Trustee would be able to pay is his own compensation, which would be entirely (or at least primarily) related to the sale. See id. (including the administrative expenses of a Chapter 7 trustee pursuant to § 507(a)(1)(C) and 507(a)(2) ). A corollary of the rule against allowing trustees to administer estates with no available equity, and a problem for the Trustee here, is not allowing trustees to administer estates for their own benefit. See In re Sunbum5 Enters., LLC, Ch. 7 Case No. 09-14839, Adv. Nos. 10-1268, 10-1269, 2011 WL 4529648, at *9 (M.D. Fla. Sept. 30, 2011) ("[T]he recognized purpose of § 554(b)—which allows parties in interest to move for abandonment—is to prevent trustees from unnecessarily administering assets that bring no value to the estate and to thwart the practice of trustees increasing their own commissions by not abandoning valueless property on their own." (citing In re Paolella, 79 B.R. 607, 609 (Bankr. E.D. Pa. 1987) )); COLLIER ¶ 704.02[1] ("[T]he legislative history of the Code made clear Congress's displeasure with prior practices under which trustees’ administration of ‘nominal asset cases’ benefited only the trustees themselves." (citing H.R. REP. No. 595, 95th Cong., 1st Sess. 93 (1977))). But see In re Reeves, Ch. 7 Case No. 10-2562-8, 2011 WL 841238, at *3 (Bankr. E.D.N.C. Mar. 8, 2011), aff'd sub nom. Reeves v. Callaway, No. 11-CV-280, 2012 WL 10180780 (E.D.N.C. Aug. 14, 2012), aff'd 546 F. App'x 235 (4th Cir. 2013) (unpublished per curiam) ("[T]rustees in this district frequently liquidate fully secured property for the benefit of the secured creditor where the trustee is authorized to recover his costs of disposal of the property pursuant to § 506(c)."). The Trustee, however, negotiated "carve outs" with the IRS and the NCDoR⁵ to allow 40% of the sale proceeds that would normally be paid on their liens to instead go to unsecured claims,...