CAN TRUSTEE FORCE DEBTOR TO TURNOVER MONEY THAT NO LONGER EXISTS?

When debtor filed his Chapter 7 petition, he had $10,000 in his checking account which was used to cover checks issued before bankruptcy was filed.  On schedule C, debtor claimed that $1,000 in his checking account was exempt. The trustee demands that debtor deliver the difference between $10,000 and $1,000, or $9,000 to the trustee because only $1,000 of the $10,000 is exempt. Debtor replies that he will not transfer the $9,000 because the funds no longer exist. Debtor insists that the checks issued against the funds cleared after the bankruptcy was filed. Who is correct?

In Re Henson (9th Circuit 1/9/14), debtor had $6,995 in her checking account when she filed for Chapter 7 relief. The money was there for a short period of time because it was used to honor checks that the debtor wrote prepetition. Relying on Section 542(a), the trustee demanded that the debtor deliver this money to him. She responded that she did not have the money and would not comply. The trustee then filed a motion to turnover under Section 542(a) seeking to recover the $6,955 minus the debtor’s $800 exemption.  The bankruptcy court denied the trustee’s action against the debtor on the ground that the debtor did not have possession or control of the funds at the time the trustee moved for turnover. The district court affirmed.

Reversing, the 9th Circuit Court of Appeals, stated that with the power granted to the trustee by Section 542(a), “The trustee may seek recovery from entities having ‘possession, custody, or control’ of the property sought, whether the property was in the entity’s possession, custody, or control at the time the motion was filed or at any other point during the pendency of the bankruptcy case.”

The 9th Circuit said two key phrases showed that Section 542(a) allows a turnover motion to be brought at any time during the pendency of the bankruptcy case even if the respondent no longer possesses or has custody or control over the property at the time the motion is filed.

“First, ‘during the case’ means that the trustee may bring a motion for turnover against an entity who has possession of the property of the estate, or had possession of that property at some point during the bankruptcy case”, the court said.

“Section 542(a) does not include any words that hint at a narrower time of possession, and there is certainly no reference to the time of the motion’s filing…Nor do we infer from this silence, with respect to whether an entity’s obligation to turn over property continues after possession ceases, a requirement of present possession at the time of the motion.”

Second, the phrase “or the value of such property” indicates that the respondent need not be in possession of the property when the trustee files the turnover motion. “Because Section 542(a) permits a trustee to recover ‘the value of the property,” instead of just the property itself, possession cannot be required in order to bring the motion for turnover. This phrase shows that the trustee has a remedy in a case where an entity was ‘in possession of’ estate property at some point ‘during the case,’ but lost possession of that property by the time the trustee brought the motion for turnover. In such a case, the trustee may recover the ‘value of such property’ from the entity previously in possession.”

Prior to the new law, the trustee had two methods for recovering estate property from an entity that had possession of it at one time: 1) a summary proceeding conducted by the bankruptcy referee or, 2) a plenary proceeding, which resembled a civil trial. The result of a successful summary proceeding was a turnover order that would be enforced by a contempt motion, i.e. deliver the money or go to jail. The plenary proceeding result is enforced the same way as a judgment.

To avoid a turnover problem, debtor should exempt the entire amount with the wild card. If this is not possible, wait for all checks to be cleared first, before filing.

The Lord will fight for you; you need only to be still – Exodus 14:14.

Lawrence Bautista Yang is a graduate of Georgetown University Law Center and has been in law practice for thirty years.  He specializes in bankruptcy, business and civil litigation and has handled more than five thousand successful bankruptcy cases in California.  He speaks Mandarin and Fujien and looks forward to discussing your case with you personally.  Please call (626) 284-1142 for an appointment at 1000 S Fremont Ave, Mailstop 58, Bldg A-1 Suite 1125, Alhambra, CA 91803.