Tavenner v. Smoot (In re Smoot)

2000 WL 33988971 (4th Cir.)

For opinion see 257 F.3d 401

United States Court of Appeals, Fourth Circuit.

Lynn Lewis TAVENNER, Plaintiff - Appellee,

Kenneth R. SMOOT; Homecheck Services; Glass Apple, Incorporated, Defendants -

Appellants,

Katina Smoot a/k/a Katina Lombardo; Cory R. Smoot; Gina Smoot, Defendants.

Nos. 00-1912(L), 00-1913.

October 26, 2000.

ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF VIRGINIA AT RICHMOND

Amended Brief of Appellants

Brett Alexander Zwerdling, Zwerdling and Oppleman, 5020 Monument Avenue, Richmond, Virginia 23230, (804) 355-5719, Counsel for Kenneth Ray Smoot, Appellant.

Douglas M. Atkins, Marc S. Robinson & Associates, PLLC, 4501 Highwoods Parkway, Suite 470, Glen Allen, Virginia 23060, (804) 965-9643, Counsel for Glass Apple, Inc., Homecheck Services, Appellant.

*i TABLE OF CONTENTS

TABLE OF AUTHORITIES ... ii, iii

JURISDICTIONAL STATEMENT ... 1

STATEMENT OF ISSUES PRESENTED FOR REVIEW

Did the United States District Court commit reversible error in affirming the holding of the United States Bankruptcy Court that a trustee may avoid transfers of exempt assets pursuant to 11 U.S.C. § 548 even when the asset is automatically exempt and the debtor is not required to take any action to avail himself of the exemption?

Did the United States District Court commit reversible error in affirming the holding of the United States Bankruptcy Court that the 4th Circuit should not follow the "no harm no foul" rule whereby a trustee should not be allowed to seize assets in bankruptcy that could not be seized by the debtor's creditors prior to the debtor filing for bankruptcy? ... 1

STATEMENT OF THE CASE ... 1

STATEMENT OF FACTS ... 2

SUMMARY OF THE ARGUMENT ... 6

ARGUMENT

I. STANDARD OF REVIEW ... 7

II. DISCUSSION OF THE ISSUES ... 8

CONCLUSION ... 16

REQUEST FOR ORAL ARGUMENT

CERTIFICATE OF COMPLIANCE

FILING AND MAILING CERTIFICATE

*ii TABLE OF AUTHORITIES

CASE LAW AUTHORITY

Anderson v. City of Bessemer City, 470 U.S. 564, 574, 84 L. Ed. 2d 518, 105 S. Ct. 1504 (1985) ... 7

Butler v. David Shaw, Inc., 72 F.3d 437, 440 (4th Cir. 1996) ... 7

Green, In re, 934 F.2d 568, 570 (4th Cir. 1991) ... 7

Jarboe v. Treiber (In re Treiber), 92 B.R. 930, 932 (Bankr. N.D. Okla. 1988) ... 11, 13

Sandoval, In re, 153 F.3d 722, 1998 WL 497475 (4th Cir.(Md.)) ... 10, 11

Sibley v. Nason, 196 Mass. 125, 81 N.E. 887, 888 (1907) ... 15

Tignor, In re, 21 B.R. 219, 222 (E.D.Va. 1982) ... 15

Weiss, In re, 111 F.3d 1159, 1166 (4th Cir. 1997) ... 7

Whitcomb, In re, 140 B.R. 396 (Bankr. E.D.Va. 1992) ... 10, 11

STATUTORY AUTHORITY

11 U.S.C. § 105(a) ... 6

11 U.S.C. § 522(b) ... 9

11 U.S.C. § 522(b)(2)(B) ... 10

11 U.S.C. § 522(g) ... 8, 9

11 U.S.C. § 544(b) ... 6, 8

11 U.S.C. § 547 ... 12

*iii 11 U.S.C. § 548 ... 1, 6, 8, 9, 16

11 U.S.C. § 550 (a) ... 6, 8

Federal Rule of Appellate Procedure 6B ... 1

Federal Rule of Bankruptcy Procedure 8013 ... 7

Virginia Code § 34-28.1 ... 6, 8, 9, 13, 16

Virginia Code § 55-80 and 55-81 ... 5, 6

*1 JURISDICTIONAL STATEMENT

Kenneth Ray Smoot and Glass Apple, Inc., Homecheck (the "appellants") appeals an Order of the United States District Court for the Eastern District of Virginia, Richmond, Division pursuant to Rule 6B of the Federal Rules of Appellate Procedure.

STATEMENT OF ISSUES PRESENTED FOR REVIEW

STATEMENT OF THE CASE

On December 23, 1998, Kenneth Ray Smoot filed a voluntary petition under Chapter 7 of the Bankruptcy Code in the United States Bankruptcy Court for the Eastern District of Virginia, Richmond Division. On January 19, 1999, the appointed Chapter 7 Trustee, Lynn Lewis Tavenner, filed a complaint objecting to discharge of Debtor. On February 1, 1999, Trustee filed an objection to claim of exemptions by Debtor. The debtor filed an answer to the Complaint. A hearing *2 regarding both the complaint and objection was held on March 25, 1999 at 10:00 a.m. Both the complaint and objection were taken under advisement so written briefs could be submitted. On October 8, 1999, a final disposition to the complaint and objection was entered. Debtor was denied a discharge under the final disposition. Debtor timely filed a notice of appeal, said appeal having been adjudicated on June 1, 2000 in favor of the Trustee by the United States District Court. Debtor timely filed a notice of appeal to the United States Court of Appeals on June 30, 2000.

STATEMENT OF FACTS

Kenneth Smoot was hired by CSX Transportation, Inc., (CSXT) on June 10, 1978. As a condition of his employment, he was a dues paying member of the United Transportation Union (UTU). To supplement his income during periods of unemployment or lay-offs from CSXT, in the early 1980s the debtor established an unincorporated entity known as Glass Apple under which he performed various handiwork and odd jobs around people's homes. J.A., p. 63.

In April 1995, the debtor transferred his employment with CSXT from Virginia to Ohio. In June 1996, the debtor, while in the employ of CSXT as a locomotive engineer, suffered an injury when the flooring of a locomotive engine gave way causing damage to the defendant's knees and body. The debtor had knee *3 surgery in 1996 and returned to work as a locomotive engineer with CSXT for parts of 1996, 1997, and 1998. The debtor left the employ of CSXT on June 5, 1998, selling his home in Ohio and returning to Virginia. J.A. p.63.

In January 1998, Glass Apple, Inc., was incorporated under the laws of the Commonwealth of Virginia. Kenneth Smoot, the debtor, is Glass Apple's registered agent and president. Katina Smoot, the debtor's wife, is the vice-president and is a 50% shareholder. Cory Smoot, the debtor's adult son, is the secretary, treasurer, and a 25% shareholder. Gina Smoot, the debtor's adult daughter, owns the remaining 25% of the corporation. The directors of Glass Apple are Kenneth and Katina Smoot. J.A. p.63.

Debtor incorporated Glass Apple with the hope of establishing a family business and a potential source of income for the Smoot family. Debtor was advised by medical professionals that he would need a knee replacement in approximately 15 years, and he wanted to set the company up so that his family would have a viable business when he could no longer perform manual labor. He expected his mobility to deteriorate and planned to concentrate more on managing the business after he had taught his son home repair skills. Glass Apple, through various "divisions," engaged in operations as diverse as home repair and maintenance, inspections, lawn care, music production, and off-shore investments. *4 Home Check Services is a division of Glass Apple which handles company finances. J.A. p.64.

On March 30, 1998, the United States District Court for the Northern District of Ohio entered an order finding Kenneth Smoot liable to CSXT and UTU for violations of the Federal Wiretapping Act; however, the court took the amount of damages and attorneys' fees to be awarded under advisement. The liability was based on the debtor's illegal tape-recording of an Executive Session of Public Law Board No. 3882, which had been convened to consider the debtor's claims under a labor agreement entered into between CSXT and the UTU. J.A. p.64.

On June 5, 1998, while the amount of damages to be awarded against the debtor was under advisement in the Ohio district court, the debtor and CSXT entered into a $250,000.00 settlement and release of claims that the debtor might have against CSXT under FELA. After deducting amounts for advances and other outstanding indebtedness of the debtor, a net amount of $217,059.25 was deposited into a bank account held by Kenneth and Katina Smoot as joint tenants with rights of survivorship at the CanDo Credit Union in Ohio. On the same date, the debtor wire transferred $210,000.00 from the joint account at the CanDo Credit Union to Glass Apple's Home Check Services' account at the People's Bank of Virginia (currently, F&M Bank). J.A. pp.64 and 65.

*5 The Ohio district court entered judgment on August 7, 1998, against Kenneth Smoot and in favor of CSXT for $170,000.00 and a judgment against Kenneth Smoot and in favor of UTU for $180,000.00. On September 24, 1998, the Ohio district court entered a second judgment against Kenneth Smoot in favor of CSXT in the amount of $25,847.31 representing the attorney fees and costs incurred by CSXT in litigating its Federal Wiretapping claim against the debtor. J.A.p.65. These judgments are pending appeal in the United States Court of Appeals for the Sixth Circuit.

On December 11, 1998, the UTU filed a suit in the Circuit Court for the County of Chesterfield, Virginia, against the debtor, Katina Smoot, Cory Smoot, Gina Smoot, Glass Apple, and Home Check Services, seeking to set aside transfers as fraudulent or voluntary transfers pursuant to sections 55-80 and 55-81 of the Virginia Code and to have these assets made available for satisfaction of the August 7, 1998, judgment. The UTU also filed an ex parte petition for attachment. On December 14, 1998, after the UTU posted the necessary bond, the circuit court issued a writ of attachment ordering the Sheriff of Chesterfield County to attach by levy specified property. On or about December 21, 1998, CSXT filed a petition to intervene as co-plaintiff. J.A. p. 65.

Before a hearing on the circuit court's writ of attachment could be held, the *6 debtor filed this Chapter 7 bankruptcy petition on December 23, 1998. The schedules, as amended, assert an exemption in the amount of $217,000 for "funds received pursuant to workmen's compensation suit (FELA injury settlement)" under Va. Code § 34-28.1 and an exemption in the amount of $233,333.00 for anticipated proceeds from a legal malpractice suit. J.A. pp. 65 and 66.

Appellee Lynn Tavenner was appointed interim chapter 7 trustee of debtor's chapter 7 case and now serves as trustee. On January 19, 1999, the trustee filed this adversary proceeding to avoid and recover fraudulent transfers' and objecting to the debtor's discharge. On February 3, 1999, this court entered an order pursuant to Bankruptcy Code § 105(a) granting the trustee's motion for preliminary injunction against specified property of the defendants. J.A.p.66.

SUMMARY OF THE ARGUMENT

Exempt property under Virginia code § 34-28.1 is not recoverable under Bankruptcy Code § 544(b) and 550(a), and Virginia code § 55-80 and 55-81. Exempt property under Virginia code § 34-28.1 is not recoverable under Bankruptcy Code § 548. The Bankruptcy and District courts erred in its insolvency calculation for purposes determining the nature of voluntary conveyance.

*7 ARGUMENT

I. STANDARD OF REVIEW

The standard of review for this Court is de novo. In bankruptcy cases, the court must "review de novo the decision of the district court, effectively standing in its place to review directly the findings of fact and conclusions of law made by the bankruptcy court." Butler v. David Shaw, Inc., 72 F.3d 437, 440 (4th Cir. 1996). Rule 8013 of the Federal Rules of Bankruptcy Procedure sets out the standard of review of a bankruptcy court's judgments. Rule 8013 provides that "findings of fact shall not be set aside unless clearly erroneous, and due regard shall be given to the opportunity of the bankruptcy court to judge the credibility of the witnesses." Fed. R. Bankr. P. 8013. A trial court's findings of fact are clearly erroneous "when, although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed." In re Green, 934 F.2d 568, 570 (4th Cir. 1991). The Supreme Court has stated "where there are two permissible views of the evidence, the fact finder's choice between them cannot be clearly erroneous." Anderson v. City of Bessemer City, 470 U.S. 564, 574, 84 L. Ed. 2d 518, 105 S. Ct. 1504 (1985). Thus, the standard of review for the bankruptcy court's legal conclusions is de novo. See In re Weiss, 111 F.3d 1159, 1166 (4th Cir. 1997).

*8 II. DISCUSSION OF THE ISSUES

1. Exempt Property under Virginia Code § 34-28.1 is not Recoverable Under Bankruptcy Code § 44(b) and 550(a), and Virginia Code §§ 55-80 and 55-81.

Your appellant references the Memorandum Order of the United States Bankruptcy Court in Adversary Proceeding Number 99-3006-T at J.A.p.66, and more specifically part I (A) which ends J.A.p.70, by reference.

2. Exempt Property under Virginia Code § 34-28.1 is not Recoverable Under Bankruptcy Code § 548

a. Supremacy Clause Inapplicable

In addition to the bases existing under state law for the trustee to attempt to avoid the transfer of the funds, the trustee also relies upon Bankruptcy Code § 548, which sets forth the powers of a trustee in bankruptcy to avoid fraudulent transfers. The section provides for the setting aside not only of transfers infected by actual fraud but some other transfers as well -- so-called constructively fraudulent transfers.

The Bankruptcy Court held that it is possible for a fraudulent transfer of potentially exempt property, whether infected by actual fraud or a constructive fraudulent transfer, to be subject to avoidance pursuant to § 548. J.A.p.76. It reasoned that § 522(g) seemed to contemplate this result and referenced the *9 Supremacy Clause of the U.S. Constitution as a basis for § 522(g) voiding Virginia Code § 34-28.1 exemptions. J.A.p.79. This is the source of the Bankruptcy and District Court's error.

Bankruptcy Code § 522(g) addresses property the trustee recovers and how the debtor can exempt that property if it was

property he could have exempted. There is no issue as the whether or not the personal injury proceed was exempt under state law. The property, thus, was not potentially exempt, it was exempt as a matter of fact, thus there is no conflict between state and federal law and, further, § 522(g) is not controlling in any event.

Bankruptcy Code § 522(b) specifically authorizes state exemptions within the bankruptcy scheme. As such, your Appellant asserts that Virginia Code § 34-28.1 is, as a matter of the Bankruptcy Code, part of that Code and, thus, has the same standing as any other federal exemption or law. For this reason, the Supremacy Clause cannot function to have one federal statute void another federal statute that is on equal footing. As such, this issue becomes one of substantive law. Substantive law in a federal district is to be interpreted according to the laws of the state in which it is located. As such, the Bankruptcy Court's ruling with regard to the state law issue should be enforced in the same manner within the Bankruptcy Court and this Court. Therefore, exempt property under Virginia Code § 34-28.1 is not recoverable under Bankruptcy Code § 548 under any *10 circumstance.

b. Transfers of Exempt Property Cannot be Characterized as Fraudulent

In re Whitcomb, 140 B.R. 396 (Bankr. E.D.Va. 1992), J.A. p. 150, involved a debtor that transferred her interest in entireties property on the eve of her bankruptcy. The complainant in the case attempted to have the bankruptcy court deny the debtor's discharge based upon the transfer being characterized as fraudulent. The court held that the transfer was not fraudulent because the entireties property would have been exempt from the Plaintiff's claim had it come into the debtor's estate under § 522(b)(2)(B). Thus the actual exemption was relevant, not the issue of value.

In re Sandoval, 153 F.3d 722, 1998 WL 497475 (4th Cir.(Md.)) J.A.p. 173, supports this decision indirectly. In Sandoval, the debtor, prepetition, transferred his residence and automobile from himself individually to himself and his wife as tenants by the entireties. A creditor of the debtor filed a complaint to deny the debtor a discharge on the grounds that the debtor, with intent to hinder, delay or defraud a creditor, transferred the residence and automobile within a year prior to the date of the filing of the bankruptcy petition. The debtor argued that, becauase his interest in the residence and automobile had only nominal value, the creditors were not harmed by his prepetition transfer of the residence and automobile. *11 Therefore, the debtor argued, the transfers could not have been made with the requisite fraudulent intent.

The court in Sandoval rejected the debtor's proposition that Whitcomb stood for lack of value being relevant in determining fraudulent intent. It was this "broader proposition" advanced by Sandoval that the court rejected. The court further stated that it declined to follow the Whitcomb case on the issue of whether or not value was relevant in finding fraudulent intent. As such, it did not alter or reverse the Whitcomb decision linking exemptions with fraudulent intent as relevant to each other.

Further, the facts in Sandoval involved the debtor creating exempt property from non-exempt property. This is inconsistent with the facts in Whitcomb and the instant appeal where both debtors had exempt property prepetition.

As such, it is clear that fraudulent intent cannot be inferred from the transfer of exempt property, as supported by Whitcomb and Sandoval.

c. Analysis of Authority with Similar Factual Issues

Finally, the facts in the case at bar are similar to the facts reviewed by the United States Bankruptcy Court for the Northern District of Oklahoma in Jarboe v. Treiber (In re Treiber), 92 B.R. 930 (N.D.OkI. 1988). Although not binding on this Court, Treiber is persuasive authority as this is a case of first impression in the Fourth Circuit. In Treiber, the debtor conveyed his one-half interest in his *12 residence to his wife. Within one year of that transfer, the debtor filed for relief under chapter 7 of the Bankruptcy Code. The trustee filed an adversary proceeding seeking to avoid the preferential transfer pursuant to Section 547 of the Bankruptcy Code.

The issue before the Oklahoma Bankruptcy Court was whether it is possible to have a voidable preference under Section 547 of the Bankruptcy Code where the preference is totally exempt property. The court held the transfer non-voidable because the property was exempt under state law. The court stated:

"For to hold otherwise, would afford creditors a right in exempt property prior to bankruptcy which the law does not give them at the time of the filing or after adjudication. And, it would deny to the bankrupt the right to accomplish before bankruptcy that which he could clearly do after bankruptcy. Surely, ifa bankrupt is entitled to have exempt property of which he is seized at the time of the filing of the bankruptcy set apart from the bankruptcy estate, he is entitled to make a valid transfer of it prior to the date of filing. This view accords the bankrupt his full right under the exemption laws, while at the same time preserving to the trustee the right to challenge the exempt character of the transferred property in proceedings like these."

*13 Emphasis added. Treiber at 932. In the case at bar, the Trustee does not challenge the exempt character of the property, but instead challenges the ability of the Debtor to transfer this exempt property. The Bankruptcy Court's ruling allows creditors, through the trustee, to attach assets which they could not otherwise attach outside of bankruptcy thus denying the Debtor his exemption afforded by Section 34-28.1.

In the case at bar, the Bankruptcy Court argues that a transfer of exempt property would not be voidable under the Bankruptcy Act, but is allowed under the new Bankruptcy Code. The trustee in Treiber made the same argument and lost. The trustee was correct in asserting exempt property is included in the bankruptcy estate under the new Bankruptcy Code. However, the trustee wrongfully concluded a preference of exempt property could be avoided. The Oklahoma Bankruptcy Court rejected the trustee's argument stating, "No creditor is injured when the entire subject matter of a preference consists of exempt property. If the property had not been conveyed, the creditors would not have shared in it. In short,-no harm, no foul." Emphasis added. Treiber at 932. Glass Apple asserts the "no harm, no foul" rule should be followed in the Fourth Circuit as well. The Bankruptcy Court cites no authority rejecting the "no harm, no foul" rule and makes a sweeping conclusion that creditors could somehow be harmed by a transfer of exempt property. The creditors in the case at bar could not attach the *14 exempt assets. A trustee stands in the shoes of a debtor's creditors. Neither a trustee nor debtor's creditors can be injured or harmed by a transfer of exempt assets. It simply is not possible.

3. Court Erred in its Insolvency Calculation for Purposes Determining Nature of Voluntary Conveyance

The court failed to treat certain debts as either those that were joint, but primarily weighted towards his wife, in its insolvency calculation. As such, the court's determination that the debtor was insolvent at the time of the transfer of his personal injury proceed was erroneous. The debtor was, in fact, solvent.

The Bankruptcy Court held that the trustee was entitled to recover exempt assets because Debtor failed to receive reasonably equivalent value in exchange for the $210,000. The Debtor received a substantial benefit from Glass Apple as President and as a director despite him failing to receive stock in exchange for his capital contribution. Debtor made an investment in Glass Apple expecting to recover his investment through future employment and income. It is undisputed Debtor was advised by medical professionals that his knee would have to be replaced within fifteen years of 1997 as a result of his personal injury accident. It is also undisputed that Debtor was unable to perform manual labor at the level he had previously performed at CSXT. Debtor was well aware of the fact that his physical condition would continue to deteriorate over the years and he would be *15 unable to perform any manual labor in his later years. He chose to invest in Glass Apple to provide a means of future employment for himself as well as his family.

The legislature has determined that a victim should be allowed to retain proceeds from a personal injury action because these proceeds are used to compensate the victim for lost future earning power. Perhaps it was best stated by the Tignor court when it quoted:

"Debtors ought to be allowed to retain sole title to causes of action for personal injuries because those injuries may diminish a debtor's future earning power. Because of the fresh start policy of bankruptcy, it would be unfair and inconsistent to give creditors a bonanza on account of a debtor's injuries. 'It is not, and never has been, the policy of the law to coin into money for the profit of his creditors, the bodily pain, mental anguish or outraged feelings of a bankrupt. None of the Federal or English bankruptcy acts, nor our own insolvency statutes, have gone to that length."'

In re Tignor, 21 B.R. 219, 222 (E.D.Va. 1982); quoting Sibley v. Nason, 196 Mass. 125, 81 N.E. 887, 888 (1907). The debtor in the case at bar simply attempted to establish a family business so that he would have a source of income and employment in the future. Debtor was well aware of his limited future earning capacity. Glass Apple asserts future employment is reasonably equivalent value *16 for a $210,000 investment.

The only creditor with standing to challenge the exchange would be a creditor who had been harmed by the exchange. As Debtor exchange $210,000 of exempt property, no creditors were harmed by the exchange. As a result, no creditor has standing to assert Debtor failed to receive reasonably equivalent value in exchange for the $210,000 in personal injury settlement proceeds. The trustee stands in the shoes of the Debtor's creditors and lacks standing for the same reason. Again the "no harm, no foul" rule should be applied. In light of the facts and circumstances of this particular case, it was error for the Bankruptcy Court to hold the Trustee was entitled to recover exempt assets under Section 548 on the grounds Debtor did not receive reasonably equivalent value for his exempt assets. Those exempt assets had no value to Debtor's creditors. Even if the Debtor received nothing in exchange, Debtor's creditors cannot object.

CONCLUSION

The District Court erred in affirming the Bankruptcy Court's Final Judgment as follows. The District Court erred in holding a trustee is empowered to avoid transfers of active exempt assets pursuant to Section 548. The District Court erred in holding Section 548 preempted Virginia Code Section 34- 28.1. The District Court erred in holding the Debtor fraudulently transferred assets which could not *17 be reached by his creditors. The District Court further erred by denying the Debtor his discharge. Finally, the District Court erred by holding Debtor failed to receive reasonably equivalent value in exchange for his exempt assets. Therefore, this Court should reverse the District Court and remand this matter accordingly.

*18 REQUEST FOR ORAL ARGUMENT

Appellant, Kenneth Ray Smoot, respectfully requests leave to argue this appeal orally before this honorable Court.