Bankruptcy Chapter 7 Texas; charging order; wildcard exemption

Author: LegalEase Solutions 

RESEARCH FINDINGS

Wild card exemption:

            Chapter 7 bankruptcy case allows the debtor to protect “exempt” assets from liquidation and sale by the trustee.  There are federal and state law exemptions to protect a debtor’s assets.  Some states permit to use only state exemptions while others allow the debtors to use federal exemptions as well. The “wildcard exemption” is a federal exemption.  Wildcard exemption allows the debtor to protect “non-exempt” assets from the bankruptcy trustee which otherwise may not be have been protected.  The law sets the exemption at a certain dollar amount and the debtor may apply it to any type of property or to financial assets, like cash or investments.  In 2012, the federal wild card amount stood at $1,150 in assets.  However, the state wild card amounts vary.  Texas provides the most generous state exemption scheme that allows up to $60,000 in wild card exemptions to Texas filers.[1]  But filers must claim either federal bankruptcy exemptions or state ones.  There shall be no mixing between the two systems.[2]

Charging order:

            A charging order is a court order that directs an LLC’s manager to pay to the debtor-owner’s personal creditor any distributions of income or profits of the LLC that would otherwise be distributed to the debtor-member.

Like most states, in Texas the general rule is that the money or property of a Texas limited liability company (“LLC”) cannot be taken by creditors to pay off the personal debts or liabilities of the LLC’s owners.  Even if the creditors may not be able to collect an owner’s personal debts directly from an LLC, there are certain other ways the creditors may try to go behind the LLC for the owner’s personal debt.  One way to do this is to obtain a charging order which requires that the LLC pay the creditors all the money distributed to the debtor-owner.  Texas is a state that permits personal creditors of an LLC owner to obtain a charging order against the debtor-owner’s membership interest.[3]

RELEVANT STATUTES:

Exemption statutes:

General exemptions under Texas law are codified in Chapters 41 (real property) and Chapter 42 (personal property) of the Texas Property Code.

Real Property Exemptions: Chapter 41 of the Property Code

Personal Property Exemptions under Chapter 42 of the Property Code

11 USC § 522 – Deals with Exemptions.

11 U.S.C. § 522(d)(5) – wildcard. No citation for Texas.

 Texas Business Organizations Code Sections 101.112: member’s membership interest subject to charging order.

 On application by a judgment creditor of a member of a limited liability company or of any other owner of a membership interest in a limited liability company, a court having jurisdiction may charge the membership interest of the judgment debtor to satisfy the judgment.

  • If a court charges a membership interest with payment of a judgment as provided by Subsection (a), the judgment creditor has only the right to receive any distribution to which the judgment debtor would otherwise be entitled in respect of the membership interest.
  • A charging order constitutes a lien on the judgment debtor’s membership interest.
  • The entry of a charging order is the exclusive remedy by which a judgment creditor of a member or of any other owner of a membership interest may satisfy a judgment out of the judgment debtor’s membership interest.
  • This section may not be construed to deprive a member of a limited liability company or any other owner of a membership interest in a limited liability company of the benefit of any exemption laws applicable to the membership interest of the member or owner.
  • A creditor of a member or of any other owner of a membership interest does not have the right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the limited liability company.

Texas Business Organizations Code Section 153.256: Charge In Payment Of Judgment Creditor

  • On application to a court by a judgment creditor of a partner or other owner of a partnership interest, the court may:
    • charge the partnership interest of the partner or other owner with payment of the unsatisfied amount of the judgment, with interest;
    • appoint a receiver for the debtor partner’s share of the partnership’s profits and other money payable or that becomes payable to the debtor partner with respect to the limited partnership; and
    • make other orders, directions, and inquiries that the circumstances of the case require.
  • To the extent that the partnership interest is charged in the manner provided by Subsection (a), the judgment creditor has only the rights of an assignee of the partnership interest.
  • The partnership interest charged may be:
    • redeemed at any time before foreclosure; or
    • in case of a sale directed by the court, and without constituting an event requiring winding up, purchased:
      • by one or more of the general partners with separate property of any general partner; or
      • with respect to partnership property, by one or more of the general partners whose interests are not charged, on the consent of all general partners whose interests are not charged and a majority in interest of the limited partners, excluding limited partnership interests held by a general partner whose interest is charged.
    • The remedies provided by Subsection (a) are exclusive of other remedies that may exist, including remedies under laws of this state applicable to partnerships without limited partners.

 Issues:

  1. Identify the statutes cited by trustee and creditor in their objections in a bankruptcy case?

The trustee’s motion in the case requests an authorization for the sale of debtor’s business interests pursuant to 11 USC § 363 (b) and (f) – Use, sale, or lease of property. The statue is extracted herewith.

(b)

(1) The trustee, after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate, except that if the debtor in connection with offering a product or a service discloses to an individual a policy prohibiting the transfer of personally identifiable information about individuals to persons that are not affiliated with the debtor and if such policy is in effect on the date of the commencement of the case, then the trustee may not sell or lease personally identifiable information to any person unless—

(A) such sale or such lease is consistent with such policy; or

(B) after appointment of a consumer privacy ombudsman in accordance with section332, and after notice and a hearing, the court approves such sale or such lease—

(i) giving due consideration to the facts, circumstances, and conditions of such sale or such lease; and

(ii) finding that no showing was made that such sale or such lease would violate applicable nonbankruptcy law.

(2) If notification is required under subsection (a) ofsection 7A of the Clayton Act in the case of a transaction under this subsection, then—

(A) notwithstanding subsection (a) of such section, the notification required by such subsection to be given by the debtor shall be given by the trustee; and

(B) notwithstanding subsection (b) of such section, the required waiting period shall end on the 15th day after the date of the receipt, by the Federal Trade Commission and the Assistant Attorney General in charge of the Antitrust Division of the Department of Justice, of the notification required under such subsection (a), unless such waiting period is extended—

(i) pursuant to subsection (e)(2) of such section, in the same manner as such subsection (e)(2) applies to a cash tender offer;

(ii) pursuant to subsection (g)(2) of such section; or

(iii) by the court after notice and a hearing.

(f) The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate, only if—

(1) applicable nonbankruptcy law permits sale of such property free and clear of such interest;

(2) such entity consents;

(3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property;

(4) such interest is in bona fide dispute; or

(5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

 Case laws:

In the opinion delivered by Justice Thomas in Schwab v. Reilly, 560 U.S. 770, (2010), the U.S. Supreme Court held that “[w]hen a debtor files a Chapter 7 bankruptcy petition, all of the debtor’s assets become property of the bankruptcy estate, see 11 U.S.C. § 541, subject to the debtor’s right to reclaim certain property as ‘exempt,’ § 522(l ).”  The Court notes that “[t]he Bankruptcy Code specifies the types of property debtors may exempt, § 522(b), as well as the maximum value of the exemptions a debtor may claim in certain assets, § 522(d).” Id.  Moreover, the “[p]roperty a debtor claims as exempt will be excluded from the bankruptcy estate ‘[u]nless a party in interest’ objects. § 522(l).” Id.

In re GNI Grp., Inc., 402 B.R. 195, 199-200 (S.D. Tex. 2008) the District Court held that, “[a] bankruptcy court abuses its discretion when it “(1)  applies an improper legal standard or follows improper procedures …, or (2) rests its decision on findings of fact that are clearly erroneous.” (quoting In re Cahill, 428 F.3d 536, 539 (5th Cir.2005).

Section 363 of the Bankruptcy Code permits the Trustee to settle claims against the debtor and to “use, sell, or lease, other than in the ordinary course of business, property of the estate.” See 11 U.S.C. § 363(b); In re GNI Grp., Inc., 402 B.R. 195, 202 (S.D. Tex. 2008).

In re ASARCO, L.L.C., 650 F.3d 593, 601 (5th Cir. 2011), the fifth circuit considered the legal standard related to §§ 363(b) or 503(b) and held that “[s]ection 363 of the Bankruptcy Code addresses the debtor’s use of property of the estate and incorporates a business judgment standard.”  “Subsection 363(b) provides that “a debtor-in-possession, ‘after notice and hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate.’ ” Id. (quoting In re Cont’l Air Lines, Inc., 780 F.2d 1223, 1226 (5th Cir.1986); 11 U.S.C. § 363(b)(1)).  The Court stated that “[i]n such circumstances, “for the debtor-in-possession or trustee to satisfy its fiduciary duty to the debtor, creditors and equity holders, there must be some articulated business justification for using, selling, or leasing the property outside the ordinary course of business.” Id.; see also In re Moore, 608 F.3d 253, 263 (5th Cir.2010) (“A sale of assets under § 363 … is subject to court approval and must be supported by an articulated business justification, good business judgment, or sound business reasons.”). Id. at 601.

In re ASARCO, L.L.C., the Court opined that “[t]he business judgment standard in section 363 is flexible and encourages discretion.”  Further, the Court quoted Cont’l Air Lines, 780 F.2d at 1226, and held that “[w]hether the proffered business justification is sufficient depends on the case…. [T]he bankruptcy judge ‘should consider all salient factors pertaining to the proceeding and, accordingly, act to further the diverse interests of the debtor, creditors and equity holders, alike.’ ” Id. at 601.

In re Cont’l Air Lines, Inc., 780 F.2d 1223, 1226 (5th Cir. 1986), the Fifth Circuit held that “[w]hen a proposed use, sale, or lease of assets is outside the ordinary course of business, § 363(b) requires that the assets be property of the estate.”  However, the property included in the estate is determined by 11 U.S.C. § 541. Id.  In the case, the Court opined that “for the debtor-in-possession or trustee to satisfy its fiduciary duty to the debtor, creditors and equity holders, there must be some articulated business justification for using, selling, or leasing the property outside the ordinary course of business.” Id.

In re Cont’l Air Lines, Inc., the Court referred Matter of Baldwin United Corp., 43 B.R. 888, 906 (Bankr.S.D.Ohio 1984) in which it was held that “[t]he debtor-in-possession “is required to justify the proposed [transaction] with sound business reasons”; and Matter of St. Petersburg Hotel Assoc., Ltd., 37 B.R. 341, 343 (Bankr.M.D.Fla.1983) which held that “[s]ection 363 “also impliedly requires the Court to find that it is good business judgment for the Debtor to enter into” the transaction.  The Court, In re Cont’l Air Lines, Inc., further held that, “[w]hether the proffered business justification is sufficient depends on the case.”

In re Cont’l Air Lines, Inc., the Fifth Circuit further held that “[i]f the requirements in § 363(b) are satisfied, a proposed transaction is still subject to the requirements in 11 U.S.C. § 363(d) and (e).”  The Court also observed that, “[a]ccording to § 363(d), the use, sale or lease of estate property is authorized under § 363(b) “only to the extent not inconsistent with any relief granted under section 362(c), 362(d), 362(e) or 362(f)….’”  Moreover, the Court noted that, “[s]ection 363(e) further provides that, on the request of an entity having an interest in property used or proposed to be used, “the court, with or without a hearing, shall prohibit or condition such use … as is necessary to provide adequate protection of such interest.” Id.  The Court also affirmed that, “[a]dequate protection, as defined by 11 U.S.C. § 361, may be cash payments, additional or replacement liens, or such other relief as to provide “‘the indubitable equivalent of such entity’s interest in such property.’” Id.

In re ASARCO, L.L.C., 650 F.3d 593 (5th Cir. 2011), the Fifth Circuit affirmed that “[s]ection 363 is meant to “govern[ ] the use of funds by the debtor in possession while it operates its business after the bankruptcy petition is filed….”   However, the Court held that “[U]nder § 363(b), if the debtor in possession wants to use funds from the estate for a transaction outside the ordinary course of business, the debtor must obtain advance approval from the bankruptcy court.” Id.

In Schwab v. Reilly, 560 U.S. 770, (2010), the U.S. Supreme Court opined that subject to certain exemptions, “the Federal Rules of Bankruptcy Procedure require interested parties to object to a debtor’s claimed exemptions within 30 days after the conclusion of the creditors’ meeting held pursuant to Rule 2003(a).” See Fed. Rule Bkrtcy. Proc. 4003(b).  The Court noted that, “[i]f an interested party fails to object within the time allowed, a claimed exemption will exclude the subject property from the estate even if the exemption’s value exceeds what the Code permits. See, e.g., § 522(l ).” Id. (citing Taylor v. Freeland & Kronz, 503 U.S. 638, 642–643, (1992)).

In Schwab, the Court opined that, “most assets become property of the estate upon commencement of a bankruptcy case, see 11 U.S.C. § 541, and exemptions represent the debtor’s attempt to reclaim those assets or, more often, certain interests in those assets, to the creditors’ detriment.

In re Solly, 392 B.R. 692, 694 (Bankr. S.D. Tex. 2008), the Bankruptcy Court held that, “[s]ection 522(d)(5) allows a debtor to exempt ‘the debtor’s aggregate interest in any property, not to exceed in value $1,075 plus up to $10,125 of any unused amount’ of the debtor’s homestead exemption.”  The Court further referred Taylor v. Freeland & Kronz, 503 U.S. 638, (1992), in which it was held that “if a debtor schedules an exempt asset as having an ‘unknown’ value, and no objection is filed, then the debtor may exempt the entire value of that asset, regardless of the ultimate amount actually generated from the liquidation of the asset.” Id.   The Court opined that it “believes it would encourage abuse to permit a debtor, after a trustee’s objection, to exempt a potentially valuable interest in its entirety simply because the debtor claimed the value as ‘unknown.’” Id.  The Court further noted that, “[e]xempting the value of the entire interest would frustrate the trustee’s main objective—to liquidate non-exempt property to pay allowed claims.” Id.  The Court stated that it is for the above reasons, “the court in In re Forti, 224 B.R. 323, 329 (Bankr.D.Md.1998), ruled that the debtors could not list the value of their assets as “unknown.”

The Court In re Solly, made it clear “that the asset should be valued at either (1) the entire value of the debtors’ interest on the petition date; (2) zero value; or (3) the entire value of the interest on the petition date not exceeding the maximum exemption.” at P. 695.  In re Solly, the Court disagreed with the trustee’s contention and held that “[a]gain, § 522(d)(5) states that a debtor may exempt ‘the debtor’s aggregate interest in any property, not to exceed in value $1,075 plus up to $10,125 of any unused amount’ of the debtor’s homestead exemption.” Id.  While noting the above, the Court stated that “[t]he key term in § 522(d)(5) is ‘value,’ which implies an amount capable of fluctuation, rather than a fixed dollar amount.” Id.  The Court further explained with an example that the language in § 522(d)(5) is different from the language in other subsections of § 522. Id.   The Court noted that “§ 522(d)(11)(D) provides that a debtor may exempt any right to receive a payment not to exceed $20,200 from a personal injury claim, (emphasis added).”  Affirming its view the Court held that, “Payment, as opposed to value, suggests a fixed amount, which requires no valuation.”

In re Solly, the Court provided an elaborate discussion on the debtor’s aggregate interest under § 522(d)(5) and observed that, “[w]hen there is uncertainty about the money damages in a potential lawsuit, the value of the lawsuit is less than the amount of damages ultimately received.” (citing Polis v. Getaways, Inc. (In re Polis), 217 F.3d 899, 903 (7th Cir.2000)).  “Therefore, a lawsuit with a fifty percent chance of resulting in a $1,000 judgment would not be worth $1,000; at the most, the lawsuit would be worth $500, although risk aversion principles would likely reduce its value.” Id.  The Court concluded that, “[i]t is the value of the lawsuit that contributes to a debtor’s aggregate interest under § 522(d)(5)—not the ultimate recovery amount.” Id.

Thus, the Court In re Solly, held that “‘[t]he fact that the value of the property that the debtor seeks to exempt has changed since the filing date of the petition will not affect the amount of property that the debtor may exempt.’” (quoting Tidwell v. Leskosky (In re Leskosky), 287 B.R. 295, 296 (Bankr.M.D.Ga.2002).

The Court In re Solly, held that, “[t]he party prosecuting an objection to exemption has the burden of proving that the exemption is not properly claimed.” Fed. R. Bankr.P. 4003(c). at P. 697.  In the case, the Court further noted that, “[a]ccordingly, the Trustee has the burden to prove at the valuation hearing that Debtor has improperly claimed the Malpractice Claim as exempt.” Id.  The Court stated that, “[a]s a practical matter, the Trustee must adduce testimony and/or introduce exhibits to meet his burden of proof.”  However, the Court in In re Hobbs, 333 B.R. 751, 755 (Bankr. N.D. Tex. 2005), has held that, “[t]he burden of proof falls on the creditor to prove that the case falls within one of the 727(a) exceptions by a preponderance of the evidence.”

In re Hill, 08-36267, 2011 WL 6936357 (Bankr. S.D. Tex. Dec. 30, 2011), the Bankruptcy Court held that, “[a] ‘basic’ rule of bankruptcy law is that ‘state law governs the substance of claims.’” (quoting In re McCombs, 2011 WL 4553052, at *2 (5th Cir. Oct. 4, 2011)).

In re Hill, 08-36267, 2011 WL 6936357 (Bankr. S.D. Tex. Dec. 30, 2011), the Court discussed the scheme of exemptions in Texas legislature as follows:

“In order to prevent a “debtor from becoming destitute, the Texas legislature enacted a scheme of exemptions that limits the ability of creditors to reach certain essential assets of the debtor. The decision to exempt property is an important one, recognizing that the exempt property is vital to the debtor’s continued existence.” In re Swift, 129 F.3d at 801. Generally, Texas courts liberally construe the scope of exemptions, “with most doubts about the existence of an exemption resolved in favor of the debtor claiming the exemption.” Id.; see also In re Norris, 413 F.3d 526, 528 (5th Cir.2005). In doing so, courts look beyond the plain language of the statutes to examine the exemption’s purpose and intent. Stephenson v. Wixom, 727 S.W.2d 747 (Tex.App.-Fort Worth, 1987). In numerous cases, they have extended specific exemptions to include the proceeds from the disposition of exempt property, including proceeds from an insurance policy or lawsuit. In re Swift, 129 F.3d 792, 801 (finding that “proceeds, insurance, cause of action, etc., are a substitute for the exempt property that is lost. To be effective, the substitute must be treated as if it were the lost item. Otherwise, the protection provided by the exemption would be meaningless, and creditors could attack the unfortunate debtor”).”

In re Harrington, 306 B.R. 172, 176-77 (Bankr. E.D. Tex. 2003), the Court cited Taylor v. Freeland & Kronz, 503 U.S. 638, (1992), and held that, “§ 522(l) of the Bankruptcy Code requires a debtor to file a list of the property that the debtor claims as statutorily exempt from distribution to creditors, and ‘[u]nless a party in interest objects, the property claimed as exempt on such list is exempt.’” See 11 U.S.C. § 522(l).

In re Harrington, the Court discussed Taylor as follows:

“In Taylor, a chapter 7 debtor had listed as exempt the money that she expected to win in a discrimination lawsuit against her employer. The debtor described this property as “Proceeds from lawsuit—[Davis] v. TWA” and “Claim for lost wages” and listed its value as “unknown” on her Schedule C (Property Claimed As Exempt). Despite representations from the debtor’s attorneys that the debtor might recover between $90,000 and $110,000, the chapter 7 trustee elected to forego any objection to the debtor’s claimed exemption within thirty days of the § 341 meeting of creditors because he thought the cause of action likely had a negligible value. However, that assessment proved to be erroneous. The debtor subsequently settled her lawsuit for $110,000, $71,000 of which went directly to her attorneys as payment of attorneys’ fees. After learning of the settlement, the trustee filed a complaint against the debtor’s attorneys in the bankruptcy court, seeking turnover of the $71,000 based upon his assertion that such sums constituted property of the debtor’s bankruptcy estate. The attorneys argued for retention of the fee payment because the debtor had exempted the entire proceeds of the lawsuit from the bankruptcy estate without objection. The United States Supreme Court eventually held that even though the debtor did not have a good-faith or reasonably disputable basis for claiming the entire amount of the proceeds as exempt under either federal or state law, the exemption claim was nonetheless valid because no party in interest had objected to the claimed exemption within the 30–day objection period established by Rule 4003(b). Taylor, 503 U.S. at 643–44, 112 S.Ct at 1648–49.”

 

In Mangus v. Miller, 317 U.S. 178, 187, (1942), the Court held that, “[t]he sale of the interest of a co-tenant may be separately effected in a bankruptcy proceedings.”

[1] http://smallbusiness.chron.com/wild-card-exemption-filing-chapter-7-bankruptcy-57333.html

[2] http://bankruptcy.justia.com/laws/texas-bankruptcy-exemption-statutes-39

[3] http://www.nolo.com/legal-encyclopedia/llc-protection-members-personal-debt-texas.html