Kleven v. Household Bank F.S.B.

• Decision Date: 30 June 2003
• Docket Number: No. 02-3127.,02-3127.
• Citation: 334 F.3d 638
• Parties: Yvette Gaff KLEVEN, Trustee, Mark A. Warsco, Trustee, David R. Dubois, Trustee, Plaintiffs-Appellants, v. HOUSEHOLD BANK F.S.B., Defendant-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 638

334 F.3d 638

Yvette Gaff KLEVEN, Trustee, Mark A. Warsco, Trustee, David R. Dubois, Trustee, Plaintiffs-Appellants, v. HOUSEHOLD BANK F.S.B., Defendant-Appellee.

No. 02-3127.

United States Court of Appeals, Seventh Circuit.

Argued January 24, 2003.

Decided June 30, 2003.

Robert L. Nicholson (argued), Beckman Lawson, Fort Wayne, IN, for Yvette Kleven, Mark A. Warsco and David R. DuBois.

Charles H. Carpenter (argued), Pepper Hamilton, Washington, DC, for Household Bank F.S.B.

Before RIPPLE, EVANS, and WILLIAMS, Circuit Judges.

TERENCE T. EVANS, Circuit Judge.

Today, some people can buy a luxury automobile, say a Lexus or a Cadillac, and pay it off with an interest-free loan. The signs are everywhere: "Zero % financing." People in the market for luxury cars, however, are not in the market for Refund Anticipation Loans (RALs), the subject of the appeal in this case. RALs attract millions of people who are short on cash — those who either can't wait, or choose not to wait, for the Internal Revenue Service to process their income tax returns and send them a refund check through the mail. These people want their money now, and to get it they use a tax preparer like H & R Block and strike a bargain with a bank like Household, the defendant here. The bargain struck is a good one for only one of the two parties. Guess which one?

We start with a little background on RALs and some statistics from Milwaukee, a fairly typical American city. According to the national research, over half of all U.S. tax filers use commercial tax preparers, but the marketing of RALs is aimed mainly at low income families eligible for the earned income tax credit (EITC). Most of these people are without personal bank accounts in which to receive a direct deposit tax refund. A recent report, prepared by the University of Wisconsin-Milwaukee Employment and Training Institute in cooperation with The Brookings Institution, reviews the use of RALs by ZIP Code areas in central city Milwaukee neighborhoods. The report used the tax year 2000 and data obtained by Brookings staff from the Internal Revenue Service. Nine central city Milwaukee ZIP Codes in the heart of Milwaukee's Community Development Block Grant (CDBG) neighborhoods — the poorest neighborhoods — were analyzed, as well as other more affluent areas of the city and its suburbs. The study disclosed that in Milwaukee County, 29,458 tax filers claiming the federal earned income tax credit used tax preparers and borrowed against their refunds through RALs prior to receiving them from the IRS. The lion's share of these filers lived in Milwaukee's distressed CDBG neighborhoods.

The Brookings study found that national tax preparation chains typically charge around $100 for preparing and filing a simple tax return and an additional $75 to $100 fee for a RAL. At these rates, the study concludes, lower-income Milwaukee filers who used commercial tax preparers and RALs lost $5.5 million in tax refunds and federal EITC payments in 2000.

In a fairly routine case, a tax return filer like those identified in the study pays a fee for preparation of the return — say $100. The return discloses a refund due most likely from the EITC of, say, $600. After paying the tax preparer's fee, the filer has a choice: wait for an IRS check for $600 or enter into a RAL for a fee, usually around $75. Because walking out with $525 (or $425 if the tax preparation charge is rolled into the deal) apparently seems like a better option than waiting for $600, the bargain is struck. And unlike the Lexus buyer paying zero percent annual interest, the filer pays what amounts to an exorbitant interest rate — often over 100 percent — when computed on an annual percentage basis. For more on the study we have referred to see Alan Berube, Anne Kim, Benjamin Forman and Megan Burns, The Price of Paying Taxes: How Tax Preparation and Refund Loan Fees Erode the Benefits of the EITC (The Brookings Institution and the Progressive Policy Institute, May 2002); Anne Kim and Alan Berube, "Fast Cash for the Tax Man," Blueprint Magazine, May 21, 2002; and "Use of Refund Anticipation Loans by Earned Income Tax Credit Filers in Central City Milwaukee Neighborhoods," a study by Lois M. Quinn, Employment and Training Institute, School of Continuing Education, University of Wisconsin-Milwaukee, June 2002.

As we see it, an attack on RALs based on fairness and equity would certainly have some appeal. But the appeal we consider today attacks RALs from a different angle. In our case, over 100 adversary proceedings were consolidated in the bankruptcy court, and all of them present the same question: What happens when a tax filer enters bankruptcy proceedings within 90 days of signing off on a RAL? The plaintiffs are trustees in chapter 7 cases seeking to recover the tax refund payments received by Household Bank. The trustees want to get their hands on the funds under two theories, arguing that the funds are impermissible setoffs or avoidable preferences under §§ 553 and 547 of the Bankruptcy Code.

The transactions in question proceeded in the following manner. During the 90-day period before filing for bankruptcy, the debtor applied for a RAL from Household by filling out a form entitled "Loan Application, Authorization and Certification for a Refund Anticipation Loan." The debtor also established a bank account at Household for the sole purpose of electronically receiving a federal income tax refund. In addition, the debtor completed a Form 8453 consenting to have the IRS deposit his tax refund directly into the account with Household and, with the bank's helping hand, he designated a routing number and bank account number corresponding to that account on his return. At or about the same time, the debtor was provided with two additional items — a disclosure document and a summary sheet.

The bankruptcy court rejected the trustees' pleas, concluding that the transactions resulted in money in the bank's pocket that was more appropriately considered a recoupment and that the bank came upon the funds in the ordinary course of business. Warsco v. Household Bank F.S.B., 272 B.R. 246 (Bankr.N.D.Ind.2002). The district court agreed with this determination when it rejected the trustees' appeal. We begin with a closer look at the mechanics of a RAL.

It is undisputed that the bank retained exclusive control over the RAL accounts and that no funds other than the tax refund were deposited into them. And the bank's exclusive control, of course, meant that the debtors could not get their hands on the funds once they reached the designated account. The undisputed facts also provide the following information about each individual RAL transaction: (1) the name and social security number of the debtor, (2) the loan application date, (3) the loan amount, (4) the date the loan check was issued, (5) the date the electronic fund transfer from the IRS was received into the debtor's account at the bank, and (6) the date the bank took control of the deposit. The parties have also stipulated, in each case, as to the date the bankruptcy petition was filed and the prior years, if any, when the debtor participated in the bank's RAL program. As to this point, it is noteworthy that only 15 of the more than 100 debtors in our case were first-time parties to RALs with Household. Lastly, the parties agree that all of the transfers were made in accordance with the ordinary business practices of parties engaged in the tax refund loan industry.

In responding to the trustees' claims, both below and here, the bank contends that each debtor made an absolute assignment of his tax refund or, alternatively, that it held a perfected security interest in the refund or its proceeds. As an affirmative defense to the preference claims, the bank asserts that the money it received is protected by the ordinary course of business defense under § 547(c)(2). It also characterizes each payment as a recoupment, rather than a setoff, which prevents the trustees from recovering the funds under § 553(b) or § 549(a).

Upon submitting an application, or perhaps a day later, the debtor received a check from Household in the amount of his anticipated federal tax refund, less Household's fee. Sometime thereafter, the IRS deposited the debtor's tax refund into the debtor's designated account at Household. Household then immediately transferred the funds to itself. It is this transfer, by which the bank actually received the money, that the trustees seek to avoid.

Section 547(b) of the Bankruptcy Code allows a trustee to avoid some payments to creditors made during the 90 days prior to bankruptcy. These payments are regarded as "prefer...