LEONARD E. HUTCHINSON; SONYA C. HUTCHINSON v. UNITED STATES OF AMERICA, DEPARTMENT OF TREASURY, INTERNAL REVENUE SERVICE; JAMES SALVEN, Chapter 7 Trustee

San Francisco, CA - Criminal defense lawyer represented Plaintiffs-Appellants with affirming the Bankruptcy Appellate Panel's decision affirming the bankruptcy court's dismissal of Chapter 7 debtors' adversary complaint concerning tax liens charge.

In 2011, the IRS recorded liens for unpaid taxes, interest,

and penalties against Plaintiffs' residence in Orosi,

California. After Plaintiffs filed for Chapter 7 bankruptcy in

June 2017, the IRS in August 2017 filed a proof of claim for

both the secured and unsecured portions of its then-existing

claim for unpaid taxes, interest, and penalties. The portion

of the claim that was secured by the liens on Plaintiffs' home

and attributable only to penalties was over $162,000.

However, even before the IRS filed that claim, Plaintiffs

preemptively filed the instant adversary proceeding against

the United States and the Chapter 7 Trustee appointed in

their case, James Salven. In the first cause of action in their

complaint, Plaintiffs asserted that, because the IRS's claim

for penalties was a "claim of a kind specified in section

726(a)(4)” of Title 11 of the U.S. Code, the "lien that

secures” that penalties claim was subject to avoidance by the

trustee under § 724(a). See 11 U.S.C § 724(a) ("The trustee

may avoid a lien that secures a claim of a kind specified in

section 726(a)(4) of this title.”); see also id. § 726(a)(4)

(generally describing claims "for any fine, penalty, or

forfeiture”). Plaintiffs alleged that, because Salven had not

6 IN RE HUTCHINSON

attempted to avoid the IRS's penalties claim, Plaintiffs were

empowered to do so under 11 U.S.C. § 522(h). See id.

§ 522(h) (describing certain circumstances in which a

"debtor may avoid a transfer of property of the debtor” if

"the trustee does not attempt to avoid such transfer”); id.

§ 101(54) (broadly defining "transfer” to include, for

example, the "creation of a lien”). Plaintiffs therefore sought

to "avoid the lien” securing the penalties claim to the extent

that it encumbered their Orosi home and to the extent of the

"lesser” of the amount of the penalties claim or the amount

of Plaintiffs' homestead exemption (which was $100,000).

See Law v. Siegel, 571 U.S. 415, 417–18 (2014) (noting that

the "Bankruptcy Code provides that a debtor may exempt

certain assets from the bankruptcy estate,” and that one such

exemption, "commonly known as the 'homestead

exemption,'” protects a specified amount of "equity in the

debtor's residence”). In their second cause of action,

Plaintiffs alleged that, to the extent the liens were avoided,

they should be preserved "for the benefit of the Plaintiffs.”

Salven filed an answer to the complaint, together with a

cross-claim against the United States. In his first cause of

action, Salven asserted the right, as trustee, to avoid the liens

securing the IRS's penalties claim. In his second cause of

action, Salven alleged that, to the extent that the liens were

avoided, their value should be recovered for the benefit of

the bankruptcy estate.

The Government filed a motion to dismiss Plaintiffs'

adversary complaint, which the bankruptcy court granted in

January 2018. Hutchinson v. United States (In re

Hutchinson), 579 B.R. 860, 865 (Bankr. E.D. Cal. 2018).

Plaintiffs appealed to the BAP, but the BAP dismissed the

appeal as interlocutory in light of Salven's still-pending

cross-claim against the Government. In February 2019, the

IN RE HUTCHINSON 7

bankruptcy court entered a stipulated judgment in which

Salven and the Government agreed that the "penalty

portions” of certain of "the IRS's liens” against Plaintiffs'

Orosi residence "are avoided pursuant to 11 U.S.C.

§ 724(a).” Given the resulting final judgment in the

adversary proceeding, Plaintiffs again appealed to the BAP,

which affirmed the dismissal of their adversary complaint.

Plaintiffs timely appealed to this court, and we have

jurisdiction under 28 U.S.C. § 158(d)(1). We review the

BAP's decision de novo, and we review the underlying

bankruptcy court decision using the same standard of review

the BAP did. Tracht Gut, LLC v. L.A. Cnty. Treasurer &

Tax Collector (In re Tracht Gut, LLC), 836 F.3d 1146, 1150

(9th Cir. 2016). Because the underlying decision was a

dismissal for failure to state a claim under Federal Rule of

Civil Procedure 12(b)(6), our review of that decision is de

novo. Id.; see also FED. R. BANKR. P. 7012(b) (stating that

FED. R. CIV. P. 12(b) "applies in adversary proceedings” in

bankruptcy court).

II

Section 522(h) does not authorize Plaintiffs to avoid the

liens that secure the IRS's penalties claim, and their first

cause of action was therefore properly dismissed for failure

to state a claim.

In theory, a debtor's ability to avoid certain "transfer[s]”

of property under § 522(h) could extend to tax liens. See

DeMarah v. United States (In re DeMarah), 62 F.3d 1248,

1250 (9th Cir. 1995) (citing In re Ridgley, 81 B.R. 65, 67

(Bankr. D. Or. 1987)); see also City of El Paso v. Am. W.

Airlines (In re Am. W. Airlines, Inc.), 217 F.3d 1161, 1165

(9th Cir. 2000) ("Because a tax lien is an involuntary parting

of an interest in property, it qualifies as a transfer within the

8 IN RE HUTCHINSON

meaning of the Bankruptcy Code.”); 11 U.S.C. § 101(54)

("transfer” includes the "creation of a lien,” "the retention of

title as a security interest,” and "each mode, direct or

indirect, absolute or conditional, voluntary or involuntary, of

disposing of or parting with . . . property; or . . . an interest

in property”). Under the terms of § 522(h), a transfer

(including a lien) can be avoided by the debtor if (1) the

transfer is "avoidable by the trustee under section . . .

724(a)”; (2) the "trustee does not attempt to avoid such

transfer”; and (3) "the debtor could have exempted such

property under subsection (g)(1) of this section if the trustee

had avoided such transfer.” 11 U.S.C. § 522(h); see also

DeMarah, 62 F.3d at 1250. The third of these requirements,

in turn, has several components. One of them is that "the

debtor could have exempted such property” under § 522(b)

"if such property had not been transferred.” See 11 U.S.C.

§ 522(g).1 Plaintiffs contend that they meet that requirement

because § 522(b) allows them to exempt their interest in their

principal residence up to the extent of their $100,000

homestead exemption under California law. See id.

§ 522(b)(3)(A); CAL. CODE CIV. P. § 704.730(a)(2), (b)

1 The other requirements of § 522(g)(1) would presumably be met

in the context of a lien for tax penalties that is avoidable under § 724(a).

Such a tax lien is "not a voluntary transfer of such property by the

debtor,” and the "debtor did not conceal such property.” 11 U.S.C.

§ 522(g)(1)(A)–(B). Section 522(g) also requires that the property be

one "that the trustee recovers under section 510(c)(2), 542, 543, 550,

551, or 553,” id. § 522(g), but that condition would be met "if the trustee

had avoided such [lien]” under § 724(a), see id. § 522(h). Upon such

avoidance under § 724(a), then under § 550 the trustee could "recover,

for the benefit of the estate, the property transferred,” id. § 550(a), and

the lien also would be automatically "preserved for the benefit of the

estate” under § 551. As a result, the property would then be "property

that the trustee recovers under section . . . 550, 551.” See id. § 522(g).

IN RE HUTCHINSON 9

(2017) (setting applicable "homestead exemption” at

"$100,000”); see generally Law v. Siegel, 571 U.S. at 418.

However, we held in DeMarah that, because

§ 522(c)(2)(B) states that otherwise "exempt[]” property

remains subject to "a tax lien, notice of which is properly

filed,” see 11 U.S.C. § 522(c)(2)(B), any "property

exempted from the estate remains subject to tax liens,”

DeMarah, 62 F.3d at 1251. Because, under § 522(c)(2)(B),

"Congress has denied debtors the right to remove tax liens

from their otherwise exempt property,” we held that a debtor

"may not avoid the lien for his tax penalties” under § 522(h).

Id. at 1252.

We acknowledged in DeMarah that this reading of the

code could lead to a disparity in which trustees might be able

to avoid such liens under § 724(a), while debtors cannot. Id.

(reserving the question of whether a "trustee could avoid the

penalty portion of tax liens on nonexempt property”); cf. Gill

v. Kirresh (In re Gill), 574 B.R. 709, 716 (B.A.P. 9th Cir.

2017) (holding that a trustee is "expressly authorized . . . to

avoid, subordinate and preserve the penalty portion of the

IRS's tax lien for the benefit of the estate's unsecured

creditors”). But we explained that "Congress could logically

have wanted to allow tax penalties to be avoided if that

would benefit unsecured creditors,” while "eschew[ing]

benefiting debtors who had incurred those penalties by

failing to pay their taxes.” DeMarah, 62 F.3d at 1252

(emphasis added).

Under our binding decision in DeMarah, Plaintiffs

cannot invoke § 522(h) to avoid a properly filed tax lien,

even if that lien would be avoidable by the trustee under

§ 724(a). Plaintiffs contend in their brief that "the DeMarah

Court failed to properly construe the relevant provisions of

the Bankruptcy Code in reaching its decision,” but as a three-

10 IN RE HUTCHINSON

judge panel we lack the authority to reconsider DeMarah's

clear and directly applicable holding. See Miller v. Gammie,

335 F.3d 889, 899–900 (9th Cir. 2003) (en banc).

In all events, Plaintiffs' effort to invoke § 522(h) fails for

a second, and independent reason. As noted earlier, here the

trustee did "attempt to avoid” the tax lien to the extent that it

secured the penalties claim, see 11 U.S.C. § 522(h)(2), and

he largely succeeded in that effort. See supra at 6. Because

this clear requirement of § 522(h) was not met here,

Plaintiffs could not invoke that section even if (contrary to

DeMarah) it were otherwise applicable.

We affirm the dismissal of Plaintiffs' first cause of

action.

III

Plaintiffs contend that even if Salven, as trustee, acted to

avoid the liens, the property should have been preserved for

Plaintiffs' benefit, rather than for the benefit of the estate.

At the hearing on the Government's motion to dismiss,

Plaintiffs argued that their second cause of action therefore

should not be dismissed or that, alternatively, they should be

allowed to intervene in Salven's cross-claim against the

Government. We conclude that Plaintiffs cannot preserve

for their own benefit the portions of the tax liens that were

avoided by the trustee, and that their complaint was therefore

properly dismissed in its entirety with prejudice.

A transfer that is avoided by the trustee "under section

. . . 724(a) . . . is preserved for the benefit of the estate but

only with respect to property of the estate.” 11 U.S.C. § 551.

Because Salven, as trustee, avoided the penalty portions of

the tax liens pursuant to § 724(a), it follows that, under the

plain language of § 551, those liens are preserved for the

IN RE HUTCHINSON 11

benefit of the estate. See Heintz v. Carey (In re Heintz),

198 B.R. 581, 585–86 (B.A.P. 9th Cir. 1996) (holding that,

regardless of whether the debtor claims an exemption, any

interest of the debtor in property at the commencement of

the bankruptcy case is "property of the estate” as that phrase

is used in § 551).

Plaintiffs contend, however, that this aspect of § 551 is

overridden by § 522(i)(2), which provides:

Notwithstanding section 551 of this title, a

transfer avoided under section 544, 545, 547,

548, 549, or 724(a) of this title, under

subsection (f) or (h) of this section, or

property recovered under section 553 of this

title, may be preserved for the benefit of the

debtor to the extent that the debtor may

exempt such property under subsection (g) of

this section or paragraph (1) of this

subsection.

11 U.S.C. § 522(i)(2). According to Plaintiffs, they can

"exempt such property under subsection (g)” because, to the

extent that they are relying on their homestead exemption

under California law, they assertedly have met all of the

requirements of subsection (1) of § 522(g). See supra at 8 &

n.1. And because the trustee acted under § 724(a) in

avoiding the IRS liens securing the penalties claim, Plaintiffs

argue that the plain language of § 522(i)(2) establishes that,

to the extent of Plaintiffs' homestead exemption, the avoided

liens "may be preserved for the benefit of the debtor[s]”

12 IN RE HUTCHINSON

rather than the estate. 11 U.S.C. § 522(i)(2). We reject this

contention.2

Plaintiffs' reliance on § 522(i)(2) fails because, under

our decision in DeMarah, that provision is equally

subordinate to § 522(c)(2)(B)'s bright-line rule that debtors

lack "the right to remove tax liens from their otherwise

exempt property.” 62 F.3d at 1252. We acknowledged in

DeMarah that the property was arguably subject to

exemption under the literal terms of § 522(g)(1), as

incorporated into § 522(h), and that, if these provisions

"existed in a vacuum,” that would suggest that the debtor

could avoid the tax lien under § 522(h) to the extent of the

exemption. Id. at 1251. But those provisions do not exist in

a vacuum, and we held that any such lien-avoidance

authority of the debtor under § 522(h) could not be invoked

to make an end-run around § 522(c)(2)(B)'s settled rule that

tax liens apply to exempt property. Id. at 1251–52. We

perceive no principled basis on which to reach a different

conclusion when § 522(g)'s exemption authority is instead

incorporated into § 522(i)(2).

2 Plaintiffs' reading of § 522(i)(2) implicitly rests on the assumption

that a "transfer” qualifies under that subsection if it is avoided either

"under section 544, 545, 547, 548, 549, or 724(a) of this title” or "under

subsection (f) or (h) of this section.” The bankruptcy court and the BAP

instead took the view that the transfer had to satisfy both clauses, and

they held that Plaintiffs could not meet the resulting requirement that the

liens had to be avoided "under subsection (f) or (h) of this section.” That

was true, the courts concluded, because § 522(f) and § 522(h) only

address avoidance by the debtor, and here, the trustee avoided the liens.

We need not decide which reading of § 522(i)(2) is correct on this point.

Even assuming that Plaintiffs are right in asserting that avoidance "under

subsection (f) or (h)” is not required here, their invocation of § 522(i)(2)

still fails for the reasons we explain.

IN RE HUTCHINSON 13

Indeed, the text of § 522(c)(2)(B) makes quite clear that

its rule that debtors cannot use exemption authority to escape

tax liens applies even if (as here) the tax liens are otherwise

avoided by a trustee under § 724(a). Section 522(c)(2) has

two separate subsections describing liens that apply to

exempt property. The first of these says that exempt

property remains liable for "a debt secured by a lien that is

. . . not avoided under . . . section . . . 724(a).” 11 U.S.C.

§ 522(c)(2)(A) (emphasis added). That provision is

inapplicable here, because the trustee did avoid the relevant

tax liens under § 724(a). The second subsection of

§ 522(c)(2), however, provides that exempt property

remains liable for "a debt secured by a lien that is . . . a tax

lien, notice of which is properly filed,” and it says nothing at

all about whether that tax lien has otherwise been avoided.

11 U.S.C. § 522(c)(2)(B). Given the obvious contrast in

language, § 522(c)(2)(B) would operate, vis-à-vis a debtor,

to preserve "tax lien[s]” against otherwise exempt property

regardless of whether the trustee has avoided them. This

difference in language "belies any argument that the debtor

can escape a part of the tax lien.” DeMarah, 62 F.3d at 1252

(emphasis added).

Because § 522(c)(2) thus makes clear that a debtor's

exemption power cannot escape a tax lien, regardless of

whether that lien was avoided by the trustee, it would be

completely contradictory to then construe § 522(i)(2) (or

§ 522(g), for that matter) as allowing a debtor, after a trustee

has avoided the tax lien, to then preserve the avoided lien

"for the benefit of the debtor” by claiming an exemption

under § 522(g). 11 U.S.C. § 522(i)(2) (emphasis added).

Such a result—having the trustee avoid the lien only to turn

over the benefits to the debtor, whose exempt property

would then be free of the lien—would create precisely the

kind of end-run around § 522(c)(2)(B) that we rejected in

14 IN RE HUTCHINSON

DeMarah. Alternatively, if the result were that the trustee

avoided the lien only to turn over the benefits to the debtor,

whose exempt property would then be subject to the lien

under § 522(c)(2)(B), that would effectively nullify the

trustee's express lien-avoidance power under § 724(a). The

only way to read these provisions sensibly together is to

conclude that a debtor may not invoke § 522(i)(2) in order to

override § 551's otherwise applicable rule that, after the

trustee avoids a lien under § 724(a), the lien "is preserved for

the benefit of the estate.” Id. § 551.

We therefore hold that the BAP properly concluded that

the penalty portions of the tax liens that Salven successfully

avoided were preserved for the benefit of the estate and not

Plaintiffs.3

Because Plaintiffs’ claims all failed as a matter of law,

the BAP correctly affirmed the bankruptcy court’s dismissal

of Plaintiffs’ adversary complaint with prejudice.



AFFIRMED.