Reed, Matter of

• Citation: 700 F.2d 986,8 C.B.C.2d 370
• Decision Date: 21 March 1983
• Docket Number: No. 81-1556,T,No. 580-0019,P,No. 580-0025,No. 580-0018,580-0018,580-0019,580-0025,81-1556
• Parties: 8 Collier Bankr.Cas.2d 370, 10 Bankr.Ct.Dec. 695, Bankr. L. Rep. P 69,110 In the Matter of Hugh D. REED, et al., Debtors. FIRST TEXAS SAVINGS ASSOCIATION, INC., Adversaryexas Bank & Trust Co. and Small Business Administration, Adversary, and Jack P. Driskill, Trustee, Adversarylaintiffs-Appellees Cross-Appellants, v. Hugh D. REED, et al., Defendants, Hugh D. Reed, Defendant-Appellant Cross-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 986

700 F.2d 986

8 Collier Bankr.Cas.2d 370, 10 Bankr.Ct.Dec. 695,

Bankr. L. Rep. P 69,110

In the Matter of Hugh D. REED, et al., Debtors FIRST TEXAS SAVINGS ASSOCIATION, INC., Adversary No 580-0018, Texas Bank & Trust Co. and Small Business Administration, Adversary No. 580-0019, and Jack P Driskill, Trustee, Adversary No. 580-0025 Plaintiffs-Appellees Cross-Appellants, v. Hugh D. REED, et al., Defendants, Hugh D. Reed, Defendant-Appellant Cross-Appellee.

No. 81-1556.

United States Court of Appeals, Fifth Circuit.

March 21, 1983.

We hold that a debtor who converts nonexempt assets to an exempt homestead immediately before bankruptcy, with intent to defraud his creditors, must be denied a discharge in bankruptcy because of the provisions of Section 727 of the Bankruptcy Code, 11 U.S.C.A. 727 (West 1979), and, therefore, we affirm the decision of the district court.

I.

Hugh D. Reed, as sole proprietor, opened a shop using the trade name, Reed's Men's Wear, in Lubbock, Texas. He financed the venture in part by obtaining from the Texas Bank & Trust Company a $150,000 loan which was guaranteed by the Small Business Administration (SBA). Three months later, the bank gave Reed a $50,000 line of credit, and the SBA agreed that the original loan would be subordinated to the line of credit. The store showed a profit for the first nine months of operation in 1977, but began to lose money in 1978. By February 1979, Reed knew that his business was insolvent. After meeting with the bank, the SBA, and his major trade creditors, he signed an agreement to turn over management of the store to a consulting firm for the year 1979. In turn, Reed's trade creditors agreed to postpone collection efforts and Reed promised to resume payments in January 1980. Despite management by the consultant, the business continued to fail, and on December 15, 1979, Reed and his wife, Sharon Marcus Reed, signed a foreclosure agreement surrendering the store to the bank. Six days later, the Reeds filed voluntary petitions for bankruptcy.

From 1977 to 1979, in addition to operating Reed's Men's Wear, Reed traveled extensively as a sales representative for Scully Leather, Inc. (Scully). In 1977, he worked in Reed's Men's Wear about 75% of the time and traveled for Scully about 25% of the time. In 1978, he divided his time evenly between the store and sales for Scully. By 1979, he worked in the store only 40% of the time, and traveled for Scully 60% of the time. On the advice of his accountant, in December 1978 and January 1979 Reed set up Reyata Corporation (Reyata), wholly owned by himself, to receive the sales commissions paid by Scully for his services. Reyata in turn paid some of the commissions to Reed as salary. This arrangement allowed the corporation to retain part of Reed's earnings and reduced the tax paid by Reed on his commissions. In 1979, Scully paid Reyata $15,000 in commissions each month, including an advance commission for December, sent at Reed's request, that would not otherwise have been paid until January 1980. The bankruptcy judge found that Reyata was simply Reed's alter ego.

Reed had catholic interests and much energy. He found time to collect antiques, gold coins, and guns, and to make other investments. In a financial statement provided to the bank and to the SBA on April 1, 1979, Reed valued his gun collection at $20,000 and his antiques collection at $3,000. In the four months prior to bankruptcy, Reed augmented each of his collections. He caused Reyata to borrow $11,000, which he used to purchase more antiques. In three separate transactions during October and November, Reed accumulated, at a cost of $22,115, a collection of Krugerrands and Mexican fifty-peso pieces. One month before filing for bankruptcy, Reed purchased, for $15,000, a one-third interest in a business known as Triple BS Corporation. ¹

Two months before bankruptcy, Reed opened an account at the Bank of the West without the knowledge of his creditors. From that time until the store closed in mid-December, he deposited the daily receipts from Reed's Men's Wear in this separate account. From this account, in late November Reed repaid the loan Reyata made to purchase the antiques.

Reed began selling his personal assets in late November. He first sold three items from his antiques collection to an acquaintance, Charles Tharpe, for $3500. He sold the remainder of his antiques on December 11 to a friend, Steve Gallagher, for $5,000. Whether this represented their fair market value was not established, but the total realized on the antiques was $8,500, while the original value plus the cost of recent purchases was $14,000. On December 10, he sold his gold coins through a broker for $19,500 cash, their approximate market value. The next day, on December 11, Reed sold to Gallagher for $5,000 each both his gun collection and his Triple BS stock. Whether or not Gallagher paid fair market value for the items was not established, but the stock had been purchased only one month earlier for $15,000.

Reed applied all of the proceeds to reduce the mortgages on his family residence, which was exempt from creditor's claims under Texas law, with the objective, the bankruptcy court found, of reducing the value of his nonexempt assets and increasing the value of his homestead exemption prior to bankruptcy. Thus he raised about $35,000, applying about $30,000 to wipe out a second mortgage home improvement loan and applying the balance of approximately $15,000 to reduce the first mortgage on his home to about $28,000.

Reed cavalierly justified his sale of assets for what appeared to be less than their fair market value. This was of no concern to his creditors, he testified, because, if he had received more for the assets, he would have simply applied the additional sum to reduce the mortgage on his homestead. No matter how much he got, there would be nothing for his creditors.

Reed also failed to account for the disposition of $19,586.83 in cash during the year preceding filing. Reed attempted to explain the "unaccounted for" cash by testifying that he habitually carried huge sums of money in cash on his person and frequently made purchases and payments in cash without obtaining receipts. He argued that the amount of "unaccounted for" cash represents only a small percentage of the amount of money which went through his hands in 1979.

The bankruptcy judge found that Reed had effected transfers designed to convert nonexempt property into exempt property less than two weeks before bankruptcy with the intent to hinder, delay, or defraud creditors. 11 U.S.C.A. Sec. 727(a)(2) (West 1979). He found that, regardless of the amount of money that might have passed through Reed's accounts, $19,586.83 is a significant sum, and that Reed had failed satisfactorily to explain its loss. This constituted an additional basis for denying discharge. 11 U.S.C.A. Sec. 727(a)(5) (West 1979).

The district court affirmed the judgment.

II.

The Bankruptcy Code provides that a debtor may be denied discharge if he has transferred property "with intent to hinder, delay, or defraud a creditor," 11 U.S.C.A. Sec. 727(a)(2) (West 1979), or has "failed to explain satisfactorily ... any loss of assets ...." 11 U.S.C.A. Sec. 727(a)(5) (West 1979). Reed was denied discharge on both bases. Though either would suffice, we review the grounds seriatim.

In considering the effect of Reed's transfers of assets, we distinguish, as did the careful opinion of the bankruptcy court, the debtor's entitlement to the exemption of property from the claims of his creditors and his right to a discharge from his debts. The Bankruptcy Code allows a debtor to retain property exempt either (1) under the provisions of the Bankruptcy Code, if not forbidden by state law, 11 U.S.C.A. Sec. 522(b) & (d) (West 1979), or (2) under the provisions of state law and federal law other than the minimum allowances in the Bankruptcy Code, 11 U.S.C.A. Sec. 522(b)(2) (West 1979).

Under the Bankruptcy Act of 1898, most courts, applying state exemption laws, had held property that would otherwise have been exempt to be deprived of its immunity if there was evidence other than the simple act of conversion showing that the debtor had acquired it with the intention of defrauding his creditors. Miguel v. Walsh, 447 F.2d 724 (9th Cir.1971); Shanks v. Hardin, 101 F.2d 177 (6th Cir.1939); Kangas v. Robie, 264 F. 92 (8th Cir.1920); In re Gerber, 186 F. 693 (9th Cir.1911); In re White, 221 F.Supp. 64 (N.D.Cal.1963); In re Martin, 217 F.Supp. 937 (D.Or.1963); In re Majors, 241 F. 538 (D.Or.1917). If intent to defraud was not proved, however, and it was shown only that granting the exemption would defeat the creditor's claim, the exemption was granted. Wudrick v. Clements, 451 F.2d 988 (9th Cir.1971) (per curiam); Huenergardt v. John S. Brittain Dry Goods Co., 116 F. 31 (8th Cir.1902); In re Dudley, 72 F.Supp. 943 (S.D.Cal.1947); In re Silansky, 21 F.Supp. 41 (E.D.Pa.1937). As stated in 3 Collier on Bankruptcy, p 522.08 (15th ed. 1982): "Under the Act, the mere conversion of nonexempt property into exempt property on the eve of bankruptcy was not of itself such fraud as will [sic] deprive the bankrupt of his right to exemptions." (Emphasis supplied.)

Before the Bankruptcy Code was adopted in 1978, it had been urged that property obtained in such last-minute conversions be ineligible for exemption. Id. See, e.g., Proposed Bankruptcy Act Revision, Hearings in H.R. 31 and H.R. 32 before the Subcommittee on Civil and Constitutional Rights of the Committee on the Judiciary, 94th Cong., 2d Sess. 1355 (1976) (Statement of Hon. Arnold K. Phelps). The Code, however, adopts the position that the conversion of nonexempt to exempt property, without more, will not deprive the debtor of the exemption to which he would otherwise be entitled. 3 Collier, supra, p 522.08. Thus, both the House and Senate Reports state:

As under current law, the debtor...