Bankruptcy
| Citation | Vol. 67 No. 4 |
| Publication year | 2016 |
Bankruptcy
John T. Laney III
Nicholas J. Garcia
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This Article is a review of bankruptcy opinions issued in 2015 by the United States Supreme Court, the United States Court of Appeals for the Eleventh Circuit, and the district courts and bankruptcy courts within the Eleventh Circuit.1 This Article covers issues regarding the following bankruptcy topics: lien stripping, exemptions, fraudulent transfers, the discharge injunction, executory contracts, and conversion.
Of the five bankruptcy cases2 decided by the United States Supreme Court during the 2014 Term, only one originated from the Eleventh Circuit Court of Appeals: Bank of America, N.A. v. Caulkett.3 The issue before the Supreme Court in Caulkett was whether a Chapter 7 debtor
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could avoid the claim of a junior mortgage lien holder under section 506(d) of the Bankruptcy Code4 in a situation where the claim of the senior lien holder exceeded the present value of the collateral.5 In an opinion authored by Justice Thomas, the Supreme Court reversed the Eleventh Circuit's judgment and unanimously held that a debtor may not avoid the junior lien in that situation.6
The facts of these consolidated cases are very simple. Bank of America had a mortgage lien on the home of the debtor in each case. Each mortgage lien was subordinate to a senior mortgage lien. The values of the senior mortgage liens were greater than the market value of the debtors' homes. Therefore, Bank of America's liens were "wholly underwater"7 because there was no remaining equity in the homes.8 During their respective Chapter 7 bankruptcies, the debtors moved to strip off Bank of America's liens under § 506.9 The United States Bankruptcy Court for the Middle District of Florida granted the debtors' motions, and the United States District Court for the Middle District of Florida and the Eleventh Circuit affirmed the bankruptcy court's rulings in those cases.10
The following language of § 506(d) was at issue: "To the extent that [the] lien secures a claim against the debtor that is not an allowed secured claim, such lien is void."11 The Supreme Court's determination of whether the debtor could avoid the junior lien hinged on whether the junior lienholder's claim was an "allowed secured claim."12 Under § 506(a)(1), an allowed claim is a secured claim to the extent of the value of the lienholder's interest in the collateral.13 Likewise, the allowed claim is unsecured to the extent that the value of the lienholder's interest in the collateral is less than the amount of the lienholder's allowed claim.14 Section 506(a)(1) appears to suggest that a lienholder
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whose interest has a value of zero cannot have a secured claim.15 The Supreme Court noted that such a "straightforward reading of [§ 506]" would mean that the debtors could avoid Bank of America's lien because the values of Bank of America's interests are zero.16 However, the Court did not adopt such a straightforward reading.17
Instead, the Court relied on a previously adopted definition of a "secured claim."18 In Dewsnup v. Timm,19 the Court defined "secured claim" under § 506(d) "to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim."20 In that case, a Chapter 7 debtor tried to use § 506(d) to "strip down" an undersecured lien to the value of the collateral. In other words, the debtor tried to reduce the value of the lien to the value of the collateral and avoid the remaining balance of the lienholder's claim.21 Her argument was that claims were "secured only to the extent of the judicially determined value of the [collateral]."22 The debtor relied on the definition of an "allowed secured claim" in § 506(a).23 In an opinion written by Justice Blackmun, the Court determined that if the lienholder's claim "has been 'allowed' pursuant to § 502 . . . and is secured by a lien with recourse to the underlying collateral, it does not come within the scope of § 506(d)."24 Because Bank of America's claims were allowed pursuant to § 50225 and were secured by liens, they could not be avoided.26
The debtors in Caulkett also pleaded with the Court to limit the Dewsnup decision to situations where the lienholder is partially undersecured.27 The Court reasoned that such an interpretation of Dewsnup would create "an odd statutory framework."28 A debtor would
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be allowed to strip down a junior lien if the court valued the collateral at a dollar less than the senior lien but would be forbidden from doing so if the value of the collateral was a dollar more than the senior lien.29 The Court determined that such an interpretation "could lead to arbitrary results" because of the "constantly shifting value of real property."30 Ultimately, this decision was a win for creditors who take the risk of making loans secured by junior liens.
A. Annuities and Life Insurance Policies
A number of cases decided this past year by Eleventh Circuit courts dealt with issues regarding exemptions. In McFarland v. Wallace (In re McFarland),31 the Eleventh Circuit affirmed the decision by the United States Bankruptcy Court for the Southern District of Georgia, denying the debtor's claims of exemptions for an annuity worth $170,000 and approximately $13,445 cash surrender value of a whole life insurance policy.32 The Eleventh Circuit's analysis of the annuity focused on statutory interpretation and case law.33 However, determining whether the debtor could exempt the cash surrender value of his life insurance policy involved statutory and constitutional questions.34
The debtor in this case took out a $30,000 whole life insurance policy. When the debtor was 64 years old, he transferred $150,000 from a mutual fund to an annuity. Under the terms of the annuity, the debtor's wife was the beneficiary and was to receive payments beginning in 2032. In February 2011, the debtor filed for Chapter 7 bankruptcy. After filing for bankruptcy, he claimed exemptions for the full cash surrender value of his whole life insurance policy and his annuity.35 The debtor made those exemption claims under Official Code of Georgia Annotated (O.C.G.A.) sections 33-25-11(c)36 and 44-13-100(a)(2)(E),37 respective-
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ly.38 Section 44-13-100(a)(2)(E) of the O.C.G.A. permits the debtor to exempt a payment under an annuity from becoming part of the debtor's bankruptcy estate, the property of which is used to pay back creditors.39 The debtor argued his annuity should be exempt under the statute, but the Eleventh Circuit disagreed.40
In Silliman v. Cassell,41 the Georgia Supreme Court defined "annuity" under O.C.G.A. § 44-13-100(a)(2)(E) as "an obligation to pay an amount at regular intervals for a certain or uncertain period of time."42 Furthermore, the supreme court determined that an annuity must provide for "income as a substitute for wages" to qualify for the annuity exemption.43 In denying the debtor's claim for such an exemption, the bankruptcy court found that the debtor's annuity was a future investment, as opposed to a substitute for wages, because he admitted to never drawing money from the annuity and having no intentions of doing so.44 The Eleventh Circuit agreed with the bankruptcy court and determined that its findings of facts were not clearly erroneous.45 Such admissions made it apparent that the debtor's annuity was not operating as a wage substitute.46 Therefore, the debtor could not exempt the $170,000 from his annuity.47
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Next, the Eleventh Circuit turned its focus to the life insurance exemption.48 Section 44-13-100(a)(9)49 of the O.C.G.A. provides for an exemption for the debtor's aggregate interest in the cash value of any unmatured life insurance contract owned by the debtor who is the insured.50 Such an exemption is explicitly limited to $2000.51 On the other hand, O.C.G.A. § 33-25-11(c) provides for an exemption of "the entire cash value of [the] whole life insurance policy."52 However, this statute is a non-bankruptcy provision.53 The Eleventh Circuit noted that O.C.G.A. § 44-13-100(a)(9) specifically restricts bankruptcy debtors to a cash value life insurance exemption of $2000.54 Therefore, a bankruptcy debtor may not utilize O.C.G.A. § 33-25-11(c) to circumvent O.C.G.A. § 44-13-100(a)(9) and exempt an amount in excess of $2000.55
The Eleventh Circuit recognized that one argument to support applying O.C.G.A. § 33-25-11(c) to bankruptcy debtors is that the enactment of that statute in 2006 shows the Georgia legislature's intention "to amend, clarify, or repeal [O.C.G.A.] § 44-13-100(a)(9)."56 To be clear, the debtor did not make such an argument.57 However, similarly situated debtors might pursue that argument in future contested matters over life insurance exemptions.
The debtor also challenged O.C.G.A. § 44-13-100(a)(9) on two constitutional grounds: (1) the statute violates the Equal Protection Clause of the Constitution of the State of Georgia58 because of its classifications of bankruptcy debtors and non-bankruptcy debtors; and (2) the lack of uniformity for life insurance exemptions under Georgia law violates the Bankruptcy Clause of the Constitution of the United
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States59 by "limiting bankruptcy debtors to the exemptions in O.C.G.A. § 44-13-100 while allowing non-bankruptcy debtors the protections afforded in O.C.G.A. § 33-25-11."60 Applying the rational relationship test,61 the Eleventh Circuit determined that classifying bankruptcy debtors differently than other debtors does not violate the Georgia constitution.62 It reasoned that the very purpose of bankruptcy law requires treating bankruptcy debtors differently from non-bankruptcy debtors.63 Therefore, the classifications of debtors under Georgia law "[are] rational and relate[] directly to the purpose of bankruptcy legislation."64
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