IRA Funds Garnished Pre-Petition Not Part of Bankruptcy Estate

Posted by NCBRC - October 9, 2020

Where the judicial lien against the debtor was fully satisfied before the debtor filed his bankruptcy petition, the transfer of funds from his IRA used to satisfy the lien was not an avoidable transfer under section 547 or section 522(f) or (h). Elliott v. Pacific Western Bank, No. 18-17421 (9th Cir. Aug. 12, 2020).

When the debtor defaulted on a loan held by Pacific Western Bank, PWB obtained a state court judgment against him and instituted a levy against the debtor’s employee retirement plan (IRA). Under California law, the funds in the debtor’s IRA were exempt only to the extent they were necessary for the debtor’s post-retirement support. The state court issued an executory lien against the debtor’s IRA, and PWB garnished the funds to cover the amount owed. Three months later, the debtor filed chapter 7 bankruptcy. After he received his discharge, he filed an adversary complaint seeking to recover the funds garnished from his IRA under the theory that they were exempt under state law and section 522(f) of the Bankruptcy Code. PWB argued that the funds were not exempt in the bankruptcy proceeding because the lien had been fully executed prior to the filing of the bankruptcy and, therefore, they did not become part of the bankruptcy estate. The bankruptcy court agreed. The district court affirmed.

On appeal, the Ninth Circuit began with section 522(h) which permits a debtor to step into the shoes of the trustee to avoid a transfer of exempt property. The Ninth Circuit applies a five-part test to determine whether the debtor can avoid a transfer under section 522(h): “(1) the transfer cannot have been a voluntary transfer of property by the debtor; (2) the debtor cannot have concealed the property; (3) the trustee cannot have attempted to avoid the transfer; (4) the debtor must exercise an avoidance power usually used by the trustee that is listed within § 522(h); and (5) the transferred property must be of a kind that the debtor would have been able to exempt from the estate if the trustee (as opposed to the debtor) had avoided the transfer pursuant to one of the statutory provisions in § 522(g). See 11 U.S.C. §§ 522(g) and (h).”

The court here found that the only issue was whether the property fell under the fifth part of the test as being of the kind that the debtor would have been able to exempt it had the trustee avoided the transfer under 547. Section 547(b)(5) permits a trustee to set aside a preferential transfer if that transfer allowed a creditor to receive more than it would have if the property had been distributed in a chapter 7 liquidation case—the “greater amount test.” The debtor argued that because the lien was attached to property that was entirely exempt in bankruptcy under section 522(f), the creditor would have received nothing in the bankruptcy case.

Determination of whether the debtor had an exemption at the time he filed his petition depended on whether he retained a property interest in the transferred IRA funds. Because property interests are established by state law, the court looked to California’s treatment of the debtor’s ownership of the funds in his IRA. The court concluded that: “Under California law, [the debtor’s] ownership interest in the funds either terminated when the funds were paid to the sheriff, see CCP § 700.140(f), or after [the debtor’s] state-court exemption claim was denied and the funds were released to the Bank, see CCP §§ 703.580(d)–(f), 703.610.” The debtor did not file his bankruptcy petition until one month after the later of these two events. Therefore, the Ninth Circuit found that he had no property interest in the funds on the date of his petition and could not have avoided the transfer based on section 522(f) and (h).

Having found that the debtor had no property interest in the funds when he filed for bankruptcy, the court held that the transfer was not subject to avoidance under section 547 or section 522(h). The court affirmed.

Elliott 9th Cir. Aug 2020

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