U.S. Dep't of Hous. & Urban Dev. v. Wood (In re Wood)

• Decision Date: 16 December 2019
• Docket Number: CIVIL ACTION NO. 5:19-cv-00302 , C/w Civil Action No. 5:19-cv-303
• Citation: 611 B.R. 782
• Court: U.S. District Court — Southern District of West Virginia
• Parties: IN RE: Larry Edward WOOD, et al., Debtors. U.S. Department of Housing and Urban Development (HUD), Appellant, v. Larry Edward Wood and Jessica Ann Wood, Appellees.

611 B.R. 782

IN RE: Larry Edward WOOD, et al., Debtors.

U.S. Department of Housing and Urban Development (HUD), Appellant,

v.Larry Edward Wood and Jessica Ann Wood, Appellees.

CIVIL ACTION NO. 5:19-cv-00302

C/w Civil Action No. 5:19-cv-303

United States District Court, S.D. West Virginia, Beckley Division.

Signed December 16, 2019

Fred B. Westfall, Jr., United States Attorney's Office, Charleston, WV, for Appellant.

William R. Wooton, Wooton & Wooton, Beckley, WV, for Appellees.

MEMORANDUM OPINION AND ORDER

IRENE C. BERGER, UNITED STATES DISTRICT JUDGE

The Court has reviewed the Memorandum Opinion and Order (Document 1-1), the Judgment Order (Document 5-14), Opening Brief of the Appellant U.S. Department of Housing and Urban Development (HUD) (Document 6), Brief of the Debtors/Appellees, Larry Edward Wood and Jessica Ann Wood (Document 7), and Reply Brief of the Appellant U.S. Department of Housing and Urban Development (HUD) (Document 10). After careful consideration, the Court finds that the decision of the Bankruptcy Court should be affirmed.

FACTUAL AND PROCEDURAL BACKGROUND

On September 9, 2008, the Plaintiffs borrowed $39,739.44 to purchase a modular/mobile home.¹ In the case of default, the loan was insured by the United States Department of Housing and Urban Development (HUD). The Plaintiffs ultimately defaulted on the loan on July 31, 2014. HUD paid the deficiency remaining after default on November 18, 2015—an amount totaling $23,066.66. On November 20, 2015, HUD notified the Plaintiffs of the deficiency and made a demand for payment.

In December 2015, HUD issued the Plaintiffs a Notice of Intent to Collect by Treasury Offset, informing them that the United States Department of the Treasury (the "Treasury") could offset the Plaintiffs' tax overpayment amounts against the debt owed to HUD. On February 23, 2017, the Treasury Offset Program used $9,961.00 of federal tax overpayment to offset the amount of debt owed to HUD, leaving a remaining balance owed to HUD of $15,486.47 plus interest.

On March 21, 2018, the Plaintiffs filed a bankruptcy petition, and subsequently filed their federal and state income tax returns on March 26, 2018. The returns demonstrated a federal income tax overpayment of $6,086 and a state income tax overpayment of $316. The Treasury used the income tax overpayment to offset the Plaintiffs' remaining debt to HUD on April 4, 2018. No offset was made using the state tax overpayment.

The Plaintiffs filed a complaint on May 17, 2018, seeking avoidance of HUD's lien and refund of the offset funds remitted to HUD. The Bankruptcy Court entered a Memorandum Opinion on March 31, 2019, and a Judgment Order on April 15, 2019, ordering the United States to pay the Plaintiffs $6,086. On April 15, 2019, the United States appealed the decision of the bankruptcy court.

STANDARD OF REVIEW

"When reviewing a decision of the bankruptcy court, a district court functions as an appellate court and applies the standards of review generally applied in federal courts of appeal." Paramount Home Entm't Inc. v. Circuit City Stores, Inc. , 445 B.R. 521, 526-27 (E.D. Va. 2010) (citing In re Webb , 954 F.2d 1102, 1103-04 (5th Cir. 1992) ). Legal conclusions are reviewed de novo and factual findings are reviewed for clear error. In re Harford Sands Inc. , 372 F.3d 637, 639 (4th Cir. 2004). A clearly erroneous factual finding exists when the reviewing court "is left with the definite and firm conviction that a mistake has been committed" after considering all the evidence. Anderson v. City of Bessemer City , 470 U.S. 564, 573, 105 S.Ct. 1504, 84 L.Ed.2d 518 (1985) (quoting United States v. United State Gypsum Co. , 333 U.S. 364, 365, 68 S.Ct. 525, 92 L.Ed. 746 (1948) ). For mixed questions of fact and law, the factual portions are reviewed for clear error and the legal portions are reviewed de novo. Gilbane Bldg. Co. v. Federal Reserve Bank of Richmond, Charlotte Branch , 80 F.3d 895, 905 (4th Cir. 1996).

DISCUSSION

Federal law permits setoffs, meaning "entities that owe each other money [can] apply their mutual debts against each other, thereby avoiding ‘the absurdity of making A pay B when B owes A.’ " Citizens Bank of Md. v. Strumpf , 516 U.S. 16, 18, 116 S.Ct. 286, 133 L.Ed.2d 258 (1995) (quoting Studley v. Boylston Nat. Bank , 229 U.S. 523, 528, 33 S.Ct. 806, 57 L.Ed. 1313 (1913) ). Section 553(a) of the Bankruptcy Code governs setoffs, and states in pertinent part:

(a) Except as otherwise provided in this section and sections 362 and 363 of this title, this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case ....

11 U.S.C. § 553(a). A valid setoff requires proof of four elements: (1) the creditor's claim arose before commencement of the case; (2) the creditor's debt to the debtor arose before the commencement of the case; (3) the claim and debt must be mutual; and (4) the claim must be valid and enforceable. Id. ; see also U.S. Dept. of Agriculture Rural Housing Svc. v. Riley , 485 B.R. 361, 365 (W.D. Ky. 2012). " Section 553 does not actually create any setoff rights, but merely preserves the setoff rights that exist under applicable nonbankruptcy law." In re Addison , 533 B.R. 520, 525 (Bankr. W.D. Va. 2015), aff'd , No. 1:15-cv-00041, 2016 WL 223771 (W.D. Va. Jan. 19, 2016) ; see also Strumpf , 516 U.S. at 20, 116 S.Ct. 286.

The Tax Offset Program (TOP) allows the Federal Treasury to apply tax overpayments to pre-existing debts owed to federal agencies—in this case, HUD. 26 U.S.C. § 6402. Section 6402(d), which outlines the rule for collection of debts owed to federal agencies, provides:

(1) In general. —Upon receiving notice from any Federal agency that a named person owes a past-due legally enforceable debt ... to such agency, the Secretary shall—

(a) reduce the amount of any overpayment payable to such person by the amount of such debt;

(b) pay the amount by which such overpayment is reduced under subparagraph (a) to such agency; and

(c) notify the person making such overpayment that such overpayment has been reduced by an amount necessary to satisfy such debt.

26 U.S.C. § 6402(d) ; see In re Sexton , 508 B.R. 646, 658 (Bankr. W.D. Va. 2014) (Connelly, J.).

However, Section 522 of the Bankruptcy Code allows debtors to "exempt certain property from the bankruptcy estate, meaning the debtor retains that property outside the reach of creditors." United States v. Copley , 591 B.R. 263, 277 (E.D. Va. 2018). Section 522 exemptions apply to "any property that is exempt under [f]ederal law ... or [s]tate or local law that is applicable on the date of the filing of the petition..." 11 U.S.C. § 522(b)(3). The local law involved in this case is W. Va. Code § 38-10-4, which provides in pertinent part:

Pursuant to the provisions of 11 U.S.C. § 522(b)(1), this state specifically does not authorize debtors who are domiciled in this state to exempt the property specified under the provisions of 11 U.S.C. § 522(d).

Any person who files a petition under the federal bankruptcy law may exempt from property of the estate in a bankruptcy proceeding the following property:

(a) The debtor's interest, not to exceed twenty-five thousand dollars in value, in real property or personal property that the debtor or a dependent of a debtor uses as a residence ... (e) the debtor's interest, not to exceed in value eight hundred dollars plus any unused amount of the exemption provided under subsection (a) of this section in any property.

W.Va. Code § 38-10-4.

"Once a debtor files a bankruptcy petition, the automatic stay of 11 U.S.C. § 362(a) arises to protect debtors by providing them with ‘a breathing spell’ and also to protect creditors by ‘promoting orderly and fair distribution among creditors.’ " Addison , 533 B.R. at 524 (quoting Shaw v. Ehrlich , 294 B.R. 260, 267 (W.D. Va. 2003)). The automatic stay "protects debtors not only from the commencement or continuation of legal actions against them, but also from any acts to obtain possession of, create or enforce liens against, or collect assets included in the debtor's estate." Sexton , 508 B.R. at 657 (noting that the "stay is the most powerful protection the Bankruptcy Code affords debtors").

These statutes give rise to two issues in the present case: (1) whether a debtor's tax overpayment becomes property of the estate and hence protected by the stay, and (2) whether, if part of the debtor's estate, the debtor may exempt the overpayments under § 522 of the Bankruptcy Code and thereby defeat a governmental creditor's right to setoff under § 553 of the Bankruptcy Code and the TOP codified at 26 U.S.C. § 6402.

The Bankruptcy Court held that the Debtors' tax overpayment became property of the estate protected by the stay because it vested in the estate at midnight on December 31, 2017, and because the treasury did not act to offset the debt owed to HUD until after the Debtors' bankruptcy petition was filed. Furthermore, the Bankruptcy Court, following the case law within the Fourth Circuit, held that the Debtors' right to exempt their tax overpayment under § 522 trumps the governmental right of offset under § 553 and § 6402. The Bankruptcy Court noted that "since the Woods listed their anticipated 2017 federal tax refund on their Schedule A/B and exempted portions of it on Schedule C, those exempted portions are not available for setoff by HUD. The nonexempted portions, however, would, inter alia , be available for setoff should HUD wish to pursue a stay lift." (Bankr. Op. at 6.) The Bankruptcy Court also held that " § 522(c) [of the Bankruptcy Code] prevents a creditor from exercising its setoff rights against properly exempted tax overpayments." Id. at 7.

After careful consideration of the relevant issues, the Court finds that the decision of the Bankruptcy Court should be affirmed.

A....