Inherited IRA Protected Under Section 522(d)(12)

Joining the majority position, U.S. District Judge Walter Smith has ruled that inherited IRA accounts may be exempted as "retirement funds" under 11 U.S.C. Sec. 522(d)(12). Hill v. Studensky, No. W-11-CA-00214 (W.D. Tex. 2/22/12), which can be found here. (PACER registration required).

The issue on appeal was whether an inherited IRA continued to constitute "retirement funds" once the person for whose retirement they had been saved was no longer alive. The Court found that there were two elements to be satisfied: (1) whether the account contained "retirement funds"; and (2) whether the funds were exempt from taxation.

When an IRA is inherited, the beneficiary may receive the funds immediately, in which case they are recognized as ordinary income. Alternatively, they may be transferred to a new trustee. The account will still be in the name of the decedent and the beneficiary must begin receiving distributions within one year or withdraw the entire amount within five years.

Turning to the issue of whether the inherited IRA constituted "retirement funds," the Court noted that both parties' interpretations were reasonable. However, section (d)(12)'s relation to the other subsections of section 522(d) proved important. The other subsections of section 522(d) referred to the debtor's interest in property, but section 522(d)(12) did not.

The issue of inherited IRAs is presently pending before the Fifth Circuit Court of Appeals. The Eastern District of Texas reached the same result as Judge Smith in Chilton v. Moser, No. 4:10-CV-180 (E.D. Tex. 3/16/11). The case is pending before the Fifth Circuit as Case No. 11-40377, Chilton v. Moser. The case was argued before the panel on February 8, 2012.

Stating a Cause of Action on an Avoidance Action After Iqbal

Pleading a claim to recover a preferential transfer is one of the most basic bankruptcy causes of action. Merely by establishing the date, amount and recipient of the transfer, the plaintiff can establish that a transfer was made, within 90 days before bankruptcy while the debtor was presumed to be insolvent. Most preference complaints include this basic information and then the conclusions that the payment was made on account of an antecedent debt and that the transferee received more than it would have received in a hypothetical chapter 7. Anyone who has practiced bankruptcy law for any period of time has seen (or drafted) the form complaint with an exhibit A describing the transfer. Preference complaints are sometimes paired with fraudulent conveyance claims making skeletal allegations.

After Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009) and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the Supreme Court signaled that a higher standard would be required for pleading, one of plausibility. Instead of pleading the bare elements of a cause of action, the pleading must contain sufficient facts to make the claim plausible.

How does that apply to common avoidance actions? Judge Craig Gargotta addressed that question in Crescent Resources Litigation Trust v. Nexen Pruet, LLC, Adv. No. 11-1082 (Bankr. W.D. Tex. 1/23/12), which can be found here.

In Nexen Pruet, the Litigation Trust filed a complaint which alleged two causes of action: a preference claim and a fraudulent transfer claim. The complaint included the following:

*A description of the debtors’ cash management system;

*A statement that the debtors’ schedules, statement of financial affairs, disclosure statement and a declaration of the debtors’ CFO (none of which were attached) indicated that the debtors were insolvent at all relevant times;

*An exhibit describing the transfers by date, amount, invoice number and date the check cleared; and

*A statement of each cause of action.

The defendant filed a motion to dismiss for failure to state a cause of action, alleging that the claims were based on “naked assertions devoid of further factual enhancement.” The Court found that both claims should be dismissed without prejudice.

The Court relied extensively upon In re Careamerica, Inc., 409 B.R. 737 (Bankr. E.D. N.C. 2009).

In the case of the preference claim, the Court found that the plaintiff had failed to allege sufficient facts to show that the transfer was made on account of an antecedent debt:

Notwithstanding the Court’s finding that the Trust has sufficiently pleaded the majority of the elements of a preferential transfer action, the Court finds that the Trust has not sufficiently pleaded the existence of an antecedent debt. By contrast to the cases cited above, including those which espouse even the most lenient of pleading standards, the Trust’s Complaint contains no description whatsoever of the Defendant, Nexen Pruet, much less a description of the nature of the relationship between Nexsen Pruet and the Debtors. The Complaint merely contains the conclusory allegation that “[t]he Transfers were made . . . for or on account of an antecedent debt owed by the particular Debtor to the Defendant before such Transfers were made,” with no factual allegations to support this contention (id. at 6). Without more, the Court is unable to infer the existence of an antecedent debt based on the conclusory allegations presented under Count I of the Complaint.

Opinion, p. 12.

With respect to the fraudulent conveyance claim, the Court found that the pleadings with regard to both insolvency and lack of reasonably equivalent had not been adequately pled, concluding:

In this case, like in Caremerica, the Trust’s allegations with respect to the fraudulent transfer claim contained in Count Two of the Complaint do no more than mirror the elements of § 548(a)(1)(B) (see docket no. 1, at 7). The Trust argues that the Complaint, read in its entirety, contains a “detailed pleading of insolvency” and a “clear pleading of reasonably equivalent value.” (Docket no 1 at 9.) Like in Caremerica, however, “other than dates, amounts, and names of transferees included in Exhibit B,” along with general conclusory allegations of insolvency and reasonably equivalent value, the Trust fails to support its allegations with factual assertions. (citation omitted).

First, with regard to insolvency, the Trust alleges that the Debtors’ Schedules, Statements of Financial Affairs, and Disclosure Statement, along with the declaration of the Debtors’ chief financial officer, reflect that the Debtors were “deeply insolvent at all times relevant to the complaint.” (Docket no. 1 at 5.) The Trust did not attach any of these documents to its Complaint nor did it refer the Court to any specific facts provided in these documents that would allow the Court to draw a reasonable inference of insolvency. The Trust further alleges that the Debtors were insolvent “under a number of tests” and then proceeds to describe each test, without providing the applicable facts to support a finding of insolvency under any of them (id.). Second, with regard to reasonably equivalent value, the Complaint contains only one sentence, which states, “The Debtor or Debtors identified on Exhibit B received less than the reasonably equivalent value in exchange for the Transfer(s).” (Docket no. 1, at 7.) In light of Iqbal and Twombly, this Court will not accept such “threadbare recitals of a cause of action’s elements, supported by mere conclusory statements.” (citation omitted).

Opinion, pp. 14-15.

The Nexen Pruet opinion has much different implications for the two causes of actions involved. With regard to preference claims, the opinion imposes only a minor burden. In performing its due diligence before filing suit, the plaintiff should have investigated the relationship between the debtor and the creditor and, in particular, should have reviewed the invoices submitted by the creditor. Thus, pleading facts with regard to an antecedent debt should not impose a significant burden. By the same token, it does not provide that much more information to the defendant, who presumably would know this information as well.

The fraudulent conveyance claim is another matter. A preference is a preference primarily because of timing. On the other hand, a fraudulent conveyance could be based on any number of scenarios from a payment made on the debt of another to a payment made to an insider based on made-up invoices. In this regard, the heightened pleading requirements provide useful information to the defendant, as well as requiring the plaintiff to have a theory which would survive scrutiny under Rule 9011. In many cases, a preference claim and a fraudulent conveyance claim will be mutually exclusive. Generally, an antecedent debt implies value. Thus, only an antecedent debt in a transaction for less than reasonably equivalent value could be actionable under both statutes. By requiring a higher standard for pleading fraudulent conveyance claims, the Court protects defendants from having to respond to potentially spurious claims.

When An Argument Doesn't Turn Out As Well As Expected

Sometimes a legal argument which seems clever in the abstract can look downright silly when placed in context. That was the case with several arguments rejected by the court in Smith v. Citimortgage, Inc., et al, Adv. No. 11-5136 (Bankr. W.D. Tex. 2/21/12), which can be found here.

Argument #1:

39. None of the Plaintiffs’ first three (3) claims, which assert that the Defendants are in “breach” or “violation” of the Court’s orders entered in the Plaintiffs’ bankruptcy, come close to meeting the facial plausibility standard. The Plaintiffs have already settled and released these claims through the Court-approved Settlement. Specifically, through the Settlement, they have “release[d]” “Citimortgage . . . and [its] agents and employees . . . from all claims of any kind . . . that [the Plaintiffs’] may have with respect to the . . . [Plaintiffs’] Bankruptcy . . . or any other matters[.]”

40. The Plaintiffs’ allegations that the Defendants are in violation of the Court’s orders are claims with respect to the Plaintiffs’ bankruptcy. Even if the Plaintiffs’ factual allegations are taken as true for the moment, through the Court-approved Settlement, the Plaintiffs’ (sic) traded their rights to enforce the related orders for a contract right to enforce the Settlement pursuant to Texas-state law. They have no right to rescission of the Settlement and cannot now assert claims against any of the Defendants that they affirmatively gave up through the Settlement.

Renewed Motion to Dismiss, pp. 14-15, Dkt #17.

At first blush, the argument that the Debtors released certain claims and are now attempting to pursue them appears to be quite plausible. However, the Bankruptcy Court’s opinion adds the relevant context.

The court declines to read this provision as precluding claims for breach of the settlement agreement itself and violation of the court order approving it. The court also declines to read this provision as precluding claims for violation of the discharge injunction that arise after execution of the settlement agreement. The provision above is best understood as applying to claims that the Smiths had at the time of execution of the settlement agreement.

Opinion, p. 9.

While the argument appeared plausible on its face, it quickly turned outrageous when it became manifestly clear that the plaintiffs were suing for violation of the settlement agreement and the order approving the settlement agreement, each of which necessarily occurred after execution of the underlying agreement. While the power to compromise claims is broad, an agreement which negates its own enforcement is no agreement at all. To put it another way, a release, no matter how broad, cannot release the right to enforce the agreement in which it is contained. Also, I am not aware of any legal principal which would allow a party to release wrongs yet to occur. What is really insidious about the argument in this case is that it appears that Citimortgage was arguing that because the discharge occurred in the bankruptcy case, that the Debtors released their right to ever enforce the discharge against Citimortgage. That is an audacious claim.

Argument #2:

28. The Fifth Circuit has long recognized that in order for a bankruptcy court to have jurisdiction over a matter, “the outcome of that proceeding [must] conceivably have an[] effect on the estate being administered in bankruptcy. (citation omitted). Once administration of a case concludes and a Court closes the case, no bankruptcy case is “being administered”—the bankruptcy court’s jurisdiction over all matters therefore ends at closure of the case. (citations omitted).

29. The Court’s closure of the Plaintiffs’ bankruptcy on September 1, 2011 ended its jurisdiction over any and all related matters. Even if the Adversary were “related to” the Plaintiffs’ bankruptcy for the purposes of 28 U.S.C. Section 157 when filed (which the Defendants deny), the Court’s jurisdiction over the Adversary would have terminated on September 1.

Renewed Motion to Dismiss, p. 11.

Close, but no cigar as noted by the Bankruptcy Court:

None of the cases relied on by Citimortgage involve a debtor’s post-discharge attempt to hold a defendant in contempt for violating court orders. For this reason, Citimortgage’s argument can be easily dispensed with. Bankruptcy courts always retain jurisdiction to interpret and enforce their own orders. (lengthy list of citations omitted). (emphasis added).

Opinion, p. 7.

Never tell a judge that he lacks authority to enforce his own order. By arguing that the court lacked authority to enforce its own orders, Citimortgage struck at the court’s authority. Orders issued by a court which cannot enforce them are not worth the paper they are written on (or in the case of electronically stored data, the PDFs into which they are converted).

What of Citimortgage’s other arguments? They were on the money. Ten out of eleven statutes relied upon by the Plaintiffs for jurisdiction were either not jurisdictional at all or were inapplicable. The court found that it lacked jurisdiction over the Plaintiffs’ Fair Debt Collection Practices Act claim and its state law claims. The court dismissed the claims brought against two employees of Citimortgage. It could be said that the Plaintiffs’ claims contained several grains of wheat among an excess of chaff.

Had the defendants excluded just two arguments from their motion, they would have done a valuable service in helping the court separate the wheat from the chaff. However, by overreaching with grimace-inducing* arguments, they attacked the very integrity of the court from which they sought relief. Better to accept a strong half-victory than to generate an opinion which is equal parts rebuke to both sides.

*--Readers, can you come up with a better term? Originally, I was going to use OMG-inducing, but when I looked it up in the Urban Dictionary, it was defined as a term overused by teenage girls in chat rooms who are incapable of spelling out entire words. I tried forehead-slap, as in Homer Simpson saying "Doh!" but that didn't quite work either. I went with grimace-inducing, even though it is a bit staid, because I could not come up with something more powerful.

Contumacious Case of Coercion or Merely Rude? Fifth Circuit Judges Debate the Meaning of Section 523(a)(6)

The case of a former corporate officer who demanded to be bought out for an alleged ownership interest and said some really nasty things resulted in a split decision with Fifth Circuit Judges Edith Jones and Catharina Haynes on opposite sides. Matter of Schcolnik, No. 10-20800 (5th Cir. 2/8/12), which can be found here.

What Happened

This statement of facts is synthesized from the two opinions in the case. Each judge referenced facts that the other did not. I am taking both opinions at face value.

Scott Schcolnik was Vice-President of Capstone Associated Services, Limited and President of Rapid Settlements, Ltd. Though the owners of the Companies occasionally referred to him as a partner, he allegedly rejected an offer to become an owner of Rapid. Nevertheless, he claimed to be a partial owner and was fired. At this point, things got colorful. Schcolnik allegedly absconded with corporate documents. He threatened to disclose alleged criminal and regulatory violations by the two Companies if they did not “buy out” his “ownership interests.” He threatened a “doomsday plan” if Stuart Feldman, the primary owner of the Companies did not “properly compensate” him for his ownership interests “which appear to be worth in excess of $1,000,000.” He threatened a “massive series of legal attacks . . . which will likely leave you disbarred, broke, professionally disgraced, and rotting in a prison cell.” He also expressed his hope that Feldman would be raped in prison.

The nasty grams* were sent on May 25 and 27, 2005. The Companies swiftly moved for a TRO, which they obtained on May 27, 2005. The TRO, which was later extended by agreement, prohibited Schcolnik from carrying out his campaign of mass destruction.

*--Nasty gram is a term of art in the Austin Division of the Western District of Texas referring to a particularly vituperative communication. While I am not completely certain, I believe I first heard the expression from Joe Martinec.

Six months later, the Companies instituted an arbitration proceeding against Schcolnik, seeking a declaration that he was not an owner. The Companies prevailed on the ownership issue, although the arbitrator noted that the Companies had held Schcolnik out as a partner, which was characterized as “excusable mistakes.”

The Companies requested attorney’s fees of $70,000 and received an award of $50,000. The fees were awarded as “equitable and just,” which is apparently a low standard.

Schcolnik filed for chapter 7 bankruptcy four days after the state court confirmed the arbitration award. The Companies filed a non-dischargeability complaint under 11 U.S.C. sections 523(a)(4)( and (a)(6). Both parties moved for summary judgment. Bankruptcy Judge Karen Brown granted summary judgment to Schcolnik on both claims. She conducted a trial on the creditors’ objection to discharge and ruled in favor of Schcolnik as well. The Companies appealed the dischargeability findings to the District Court which affirmed.

The Majority Opinion—Contumacious and Coercive

The majority opinion, written by Chief Judge Jones and joined in by District Judge Crone, affirmed the lower court holdings that the claim under section 523(a)(4) was properly denied. Although the Debtor was an officer of the Companies and owed them a fiduciary duty, the debt for attorney’s fees did not arise out of a fraud or defalcation in a fiduciary capacity. Judge Haynes concurred in this ruling.

However, the majority opinion found that summary judgment on the willful and malicious claim under section 523(a)(6) was premature. The District Court had found that the Debtor’s behavior was not “willful” as a matter of law because he did not intend to impose litigation expenses on the Companies, a contention they did not dispute.

However, Judge Jones pointed out that under Fifth Circuit precedent, an act can be considered “willful” if there was subjective bad intent or “an objective substantial certainty of harm.” The Court noted that “it would seem peculiar to deem an action causing injury not ‘willful’ when the tortfeasor’s action was in fact motivated by a desire to cause injury.” Judge Jones also noted In re Keaty, 397 F.3d 264 (5th Cir. 2005), where sanctions for baseless litigation were found to be a willful and malicious injury.

Having laid out this background, Judge Jones reached the penultimate point of her opinion:

Shcolnik allegedly engaged in a course of contumacious conduct that required the Appellants to file meritorious litigation against him, resulting in the instant fee award; whereas in Keaty, the debtors pursued the burdensome suit that provoked a sanctions award against them. This is a distinction without a difference, however. It would make no sense for the infliction of expense in litigating a meritless legal claim to constitute willful and malicious injury to the creditor, as in Keaty, while denying the same treatment here to the infliction of expense by a debtor’s attempt to leverage an equally baseless claim through a campaign of coercion. That Texas law may allow the arbitrator to assess attorneys’ fees in favor of a party without specifically finding a willful and malicious injury is not conclusive. If the facts are as Appellants allege, Shcolnik either had the motive to inflict harm or acted so as to create “an objective substantial certainty of harm” to the Appellants. Id.

Viewed in light of our precedents, there is a genuine, material fact issue for trial. Shcolnik’s behavior resulted in willful and malicious injury if his claims of ownership were made in bad faith as a pretense to extract money from the Appellants. See Keaty, 397 F.3d at 273 (willful and malicious injury to intentionally “pursu[e] meritless litigation for the purpose of harassment[.]”). The litigation costs he forced upon them are different from the million dollar claim he made against them, but they were neither attenuated nor unforeseeable from his alleged intentionally injurious conduct. (emphasis added).

Opinion, pp. 6-7.

The Dissent—Insulting and Demeaning Is Not Enough

Judge Haynes concurred in the ruling on section 523(a)(4), but dissented with regard to willful and malicious injury. She cited three grounds for dissent:

The effect of the majority opinion is to transform all litigation precipitated by aggressive demand letters into potential “malicious” acts for purposes of nondischargeability. Additionally, the effect of the majority opinion is to allow an end-run around an arbitration proceeding in which both parties willingly participated. Finally, the majority opinion glosses over the lack of connection between the allegedly malicious acts and the arbitration award of attorneys’ fees now sought to be rendered non-dischargeable. Because the bankruptcy and district courts reached the correct result under our existing precedents, I would affirm.

Haynes Dissenting, p. 9.

Judge Haynes elaborated on her first point as follows:

Debtors often come to bankruptcy with judgments against them. It is certainly not an unusual occurrence for parties to make claims in litigation or arbitration that do not carry the day. Nonetheless, the majority opinion transforms the ordinary litigation loser into one who has caused “willful and malicious injury” to another. It does so, apparently, because of the colorful language used by Shcolnik, without the assistance of legal counsel, in his emailed demand letters that preceded litigation which in turn was followed by the arbitration proceeding in question. So, I start there.

No doubt the e-mail letters Shcolnik wrote are insulting and demeaning. I would not write such a document nor countenance another to do so. However, we are not here to teach a course in professionalism or civility. The majority opinion transforms incivility into “a campaign of coercion” or “contumacious conduct” by ipse dixit. The question arises – were these “nasty demand letters,” in fact, “coercive” or “contumacious?” We do not have a case setting out a test for where the quintessential demand letter ends and the parade of horrible suggested by the majority opinion begins. Wherever that line is, it is not crossed here, and I disagree with transforming the regrettable unpleasantness and aggressiveness that often attend the prelude to litigation into “coercive” or “contumacious” conduct so easily. Shcolnick’s e-mail letters, however reprehensible they undeniably are, do not. (emphasis added).

Haynes Dissenting, p. 10.

Between judges, “ipse dixit” is a strong term. Known as the “Bare Assertion Fallacy,” it literally translates as “he himself said it.” It is used to refer to an argument that is made without any support. The terms that were said to be ipse dixit were “coercive” and “contumacious.” “Contumacious” is defined as stubbornly defiant or rebellious, while “coercive” means serving or intending to coerce. While contumacious is closely associated with contempt of court, Shcolnik’s words were no doubt stubbornly defiant, but the question is “So what?” There does not seem to be a logical connection between stubbornly defiant and willful and malicious. Coercive is a more difficult question and I will return to that later.

Next, Judge Haynes turned to the results of the arbitration proceeding. Noting the strong federal policy of deferring to arbitration, she pointed out that the arbitrator had only awarded fees as “equitable and just” rather than for wrongdoing, malice or bad faith. She also noted that the arbitrator implicitly found that Shcolnik’s position had some merit when he found that the references to Shcolnik as a partner were “excusable mistakes.”

As to the first ground, Judge Haynes is probably wrong. Where a court makes a finding on a lesser standard but does not expressly negate the higher standard, the parties are free to establish whether the higher standard could have been met. Archer v. Warner, 538 U.S. 314 (2003) is not completely on point, but it allowed a plaintiff who had received a promissory note in settlement of a fraud claim to go behind the note and prove fraud in the original transaction. However, Judge Haynes is closer on the second point. If the arbitrator found that the Debtor did not assert a baseless claim, then the Companies would be precluded from relitigating that point in bankruptcy court. Here, the finding is implicit so that it is a close call.

Finally, Judge Haynes found that the connection between the nasty emails and the arbitration proceeding was to remote to connect them. She wrote:

Indeed, even if the e-mail letters were “coercive” or “contumacious” and even if we ignore the lack of arbitration findings to support the majority opinion, the undisputed facts show that any burden imposed on Appellants by the e-mail letters was quickly removed – the purportedly wrongful documents were sent on May 25 and 27, 2005. On May 27, 2005, the state district court granted a temporary restraining order that was later extended and continued by agreement throughout the litigation and arbitration, barring Shcolnik from taking the actions Appellants claimed put them in immediate fear. It was not until six months later that the matter was referred to the arbitration at issue here, breaking any purported causal connection between the claimed wrongful behavior and the fee award here at issue.

Moreover, the lack of causal connection is precisely why the arbitrator made no specific finding of wrongfulness. Indeed, the allegedly wrongful acts caused the arbitration of the ownership/partnership dispute, in which case, the arbitrator’s lack of a specific finding to that effect (and findings inconsistent with that) is meaningful, or they did not, in which case, the alleged “campaign of coercion” or “contumacious conduct” did not cause the attorneys’ fees award.

The majority opinion concludes that “Shcolnik’s behavior resulted in willful and malicious injury if his claims of ownership were made in bad faith as a pretense to extract money from the Appellants.” Maj. Op. at 7. The opinion rests on a misconstruction of Keaty. Moreover, it is undeniable that the majority opinion’s conclusion is not supported by the record, the arbitrator’s decision, or, indeed, the events that actually transpired below. As we gave effect to the sanctions in Keaty, we should give effect to the arbitrator’s ruling here. The attorneys’ fees awarded as equitable and just in the arbitration were for resolution of the ownership/partnership dispute, not for anything else.

Haynes Dissenting, pp. 13-14.

What It Means

This case is significant for several reasons. The fact that two bright, articulate and conservative judges reached diametrically opposite results shows both the independence of the judges involved and the difficulty of the question.

The opinions by Judge Jones and Judge Haynes recall the story of the blind men and the elephant. They are both describing the same thing, but they are describing different parts of it. Judge Jones focused on the apparent intent of the original emails. It is not unreasonable to construe the emails as a blatant attempt at extortion. It would be illegal to demand money in exchange for not releasing damaging information, so the debtor demanded a buyout instead. However, the fact that he demanded a buyout under the threat of destroying his former employer says volumes about his intent.

On the other hand, Judge Haynes focused more on the disconnect between the “nasty” emails and the arbitration proceeding. Yes, the emails were reprehensible. However, the campaign was brought to a half within two days and the arbitration was not even commenced for another six months. The Companies would have had a good claim for a willful and malicious injury if the Debtor had actually used the purloined documents to wreak havoc. The Companies probably would have had a good claim for their costs in obtaining the TRO. However, the Companies sought to recover their attorney’s fees for what Judge Haynes characterized as “resolution of the ownership/partnership dispute, not for anything else.” While the ownership dispute may have been commenced for sinister reasons, unlike the sanctionable conduct in Keaty, it was not baseless.

I think Judge Haynes has the better argument. While the opening salvos of the campaign clearly could have resulted in willful and malicious injury, they did not. It is like someone who threatens to shoot but after considering the consequences puts the gun down. The conduct could be characterized as a terroristic threat, but it is not murder. Both judges are right to focus on Keaty. However, the important question is whether the legal position taken was baseless. If the position taken, although asserted for ulterior motives, was not baseless, then it should not give rise to a nondischargeable debt.

It will be interesting to see whether the en banc court steps in to resolve the dispute.