Paeplow, Matter of

• Citation: 972 F.2d 730
• Decision Date: 10 August 1992
• Docket Number: No. 91-2164,91-2164
• Parties: , 23 Bankr.Ct.Dec. 488, Bankr. L. Rep. P 74,795 In the Matter of William Douglas PAEPLOW, Debtor-Appellee. Appeal of Edmond W. FOLEY, R. Kent Rowe, R. Kent Rowe, III, et al.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

Page 730

972 F.2d 730

61 USLW 2142, 23 Bankr.Ct.Dec. 488, Bankr.

L. Rep. P 74,795

In the Matter of William Douglas PAEPLOW, Debtor-Appellee Appeal of Edmond W. FOLEY, R. Kent Rowe, R. Kent Rowe, III, et al.

No. 91-2164.

United States Court of Appeals, Seventh Circuit.

Argued Feb. 13, 1992.

Decided Aug. 10, 1992.

Richard A. Cook, Asst. U.S. Atty., R. Kent Rowe, Edmond W. Foley (argued), Rowe, Foley & Huelat, South Bend, Ind., for defendants-appellants.

Henry A. Hoover (argued), South Bend, Ind., for debtor-appellee.

Before COFFEY and FLAUM, Circuit Judges, and ESCHBACH, Senior Circuit Judge.

FLAUM, Circuit Judge.

After William Paeplow received a discharge in bankruptcy under Chapter 7 of the Bankruptcy Code, a group of creditors filed a suit in state court seeking to collect on a pre-petition debt he owed them. To circumvent the prohibition discharge ordinarily places on such suits, the creditors attempted to proceed in rem against property Paeplow and his wife owned as tenants by the entirety. Paeplow sought an injunction to halt that suit; the bankruptcy court granted the injunction, the district court affirmed, 128 B.R. 429, and we affirm in turn.

I.

The facts in this case are not in dispute. In 1981, William and Janice Paeplow moved from South Bend, Indiana, to Roswell, New Mexico, where they purchased a tire business from Edmond Foley, Kent Rowe, Jerry Huelat, V.L. Beagles, Betty Beagles, Pete Cassen, and Karen Cassen (the creditors). The Paeplows subsequently took out a $60,000 loan from the First Interstate Bank of Roswell (the Bank), and jointly executed a promissory note which, among other things, secured the loan with inventory, fixtures, and accounts receivables (the security) they held in the tire business. The creditors, who still held an interest in the property securing that note, simultaneously executed an agreement subordinating their rights in that property to the Bank.

The Paeplows later defaulted on the promissory note on September 3, 1982, and on that day William Paeplow individually filed for bankruptcy. Paeplow's bankruptcy schedules listed the $60,000 promissory note as one of his liabilities, and a house he owned in South Bend, Indiana (the South Bend property) as one of his assets. Paeplow also claimed the South Bend property--which he and his wife held as tenants by the entirety--as property eligible for exemption from his creditors' claims under Indiana state law. Ind.Code § 34-2-28-1(a). Paeplow received a discharge in bankruptcy in January 1984, prior to which the Bank filed a motion with the bankruptcy court requesting relief from the automatic stay. The bankruptcy court granted that motion, giving the Bank the go-ahead to pursue a joint judgment against the Paeplows in state court and to enforce that judgment against the South Bend property. However, as will later become critical, the Bank failed to take the second necessary step to preserve its claim on the Paeplow's real estate: moving for a stay of the Paeplow's discharge--which he received without objection in January 1984--to give it time to obtain a judgment lien.

At any rate, the creditors, who still held an interest in the property securing the note, decided to take action to protect their interest. They assumed the Paeplows' liability on the note, stepping into the shoes of the Bank as its assignee, and then filed their own motion for relief from the automatic stay, so that they could seek a joint judgment and lien against the Paeplows in state court (as the Bank had intended to do). The bankruptcy court responded with an order informing the creditors that the automatic stay had been lifted as to all of Paeplow's creditors on the day of his discharge. The creditors apparently interpreted that order as a green light to pursue Paeplow's pre-petition obligation on the note. Accordingly, they filed suit in state court against Janice Paeplow for collection on the note and later amended their complaint to add her husband William as a defendant.

That suit, which the creditors characterized as an in rem action, languished for several years until trial was finally scheduled for September 26, 1990. In the interim, Paeplow never raised the defense of discharge in any pleading or pre-trial proceeding. Paeplow finally launched a collateral attack on that action by filing this suit in federal bankruptcy court on July 25, 1990, seeking to enjoin the creditors under 11 U.S.C. § 524 from taking any further steps to collect on the note.

Following briefing and a hearing, the bankruptcy court granted Paeplow's request for an injunction, In re Paeplow, 119 B.R. 610 (Bankr.N.D.Ind.1990), concluding that the creditors' state court action was untimely. The promissory note and South Bend property were listed on Paeplow's bankruptcy schedules and were discharged before the creditors took action to reduce their claim to a judgment lien. Hence, Paeplow's liability on the note had been discharged, and his interest in the South Bend entirety property exempted, preventing the Bank or its assignees from taking action to collect on the note or to proceed in rem against the property. 11 U.S.C. § 524(a)(2). The district court affirmed. In re Matter of Paeplow, 128 B.R. 429 (N.D.Ind.1991). We review findings of fact in bankruptcy cases under the clearly erroneous standard, Bankruptcy Rule 8013, In re Weber, 892 F.2d 534, 538 (7th Cir.1989), and conclusions of law de novo. In re Newman, 903 F.2d 1150, 1152 (7th Cir.1990). The district court found this case limited to issues of law. We agree, and with the de novo standard in mind, turn to each of the creditors' contentions on appeal.

II.

Several sections of the Bankruptcy Code are relevant to this case. 11 U.S.C. § 541(a)(1) provides that "all legal or equitable interests of the debtor in property as of the commencement of the case" are pulled into the bankruptcy estate for the benefit of all creditors. 11 U.S.C. § 522(b) provides that, notwithstanding § 541, an individual debtor may exempt from the bankruptcy estate certain enumerated items. Alternately, a state may opt out of the federal exemption scheme in § 522 and provide its own list of exempted items. The bankruptcy trustee then has the power to sell or use all non-exempt § 541 property for the benefit of all creditors. § 366(b)(1). Significantly, the trustee may reach property the debtor holds as a tenant by the entirety, subject to either the federal or state exemption scheme, whichever is in effect. § 363(h). After distribution of the estate's assets, a debtor emerges from bankruptcy under the fresh start policy with a discharge of his or her debts; § 524 provides that discharge enjoins any former creditors from commencing any action to collect a "personal liability" of the debtor.

State property law is also relevant to this case. Indiana continues to recognize tenancy by the entirety, a common law form of marital ownership that creates between spouses joint ownership of an undivided interest in property which may not be transferred or encumbered by either spouse acting alone. See, e.g., State of Indiana v. Union Bank & Trust Co., 177 Ind.App. 632, 380 N.E.2d 1279, 1280 (1978). Creditors operating under this regime cannot execute on entirety property without first obtaining a judgment against both spouses. See, e.g., Enloe v. Franklin Bank & Trust Co., 445 N.E.2d 1005 (Ind.Ct.App.1983).

One further observation about Indiana state law is warranted. As noted, § 522 permits states to opt out of the federal exemption scheme, and the Indiana legislature chose to do so in 1980. Ind.Code § 34-2-28-0.5. The legislature simultaneously amended the state's existing exemption scheme to exempt

[a]ny interest the judgment debtor has in real estate held as a tenant by the entireties on the date of the filing of the petition for relief under the bankruptcy code, unless a joint petition for relief is filed by the judgment debtor and spouse, or individual petitions of the judgment debtor and spouse are subsequently consolidated.

Ind.Code § 34-2-28-1(a)(5) (emphasis added). As will become important later, the plain language of the statute, which applies only to bankruptcies, appears to grant an individual debtor who holds an interest in entirety property a complete exemption from the claims of all creditors, including those made by joint creditors of both spouses.

III.

The creditors argue that the district court erred in three respects: (1) in not allowing the creditors to follow the old Indiana practice of permitting post-discharge in rem proceedings against a debtor's entirety property; (2) in concluding that the South Bend property entered Paeplow's bankruptcy estate under 11 U.S.C. § 541; and (3) in concluding that Paeplow received an exemption on his South Bend property under Ind.Code § 34-2-28-1. Another panel of this Court recently confronted these same issues, In re Matter of Hunter, 970 F.2d 299 (7th Cir.1992), and our analysis here closely tracks the sound reasoning of that decision.

A.

The creditors first argue that the district court improperly refused to follow the old Indiana practice of permitting post-discharge in rem actions against the entirety property of a discharged debtor. Such actions were permitted by Indiana courts as long as the creditor held a joint claim against both spouses, rather than a claim against the filing debtor alone. See Smith v. Beneficial Fin. Co., 139 Ind.App. 653, 218 N.E.2d 921, 923 (1966); First Nat'l Bank v. Pothuisje, 217 Ind. 1, 25 N.E.2d 436, 438-40 (1940); Echelbarger v. First Nat'l Bank, 211 Ind. 199, 5 N.E.2d 966, 968 (1937).

Those decisions emerged largely in response to a feature of the Bankruptcy Act of 1898 (the Act)--since superseded by the Bankruptcy Code of 1978--which presented an opportunity for debtors to perpetrate legal fraud on unsuspecting joint creditors. The Act provided that property which the debtor was capable of "transfer[ing] or which might have been levied upon" would...