Materials on Trustee Recoveries

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AMERICAN BANKRUPTCY INSTITUTE
NORTHEAST BANKRUPTCY CONFERENCE
JULY 2016
TOPICS IN RECOVERIES BY CHAPTER 7 TRUSTEES
May 13, 2016
Edmond J. Ford
Ford, McDonald & Borden, P.A.
10 Pleasant St. Suite 400
Portsmouth, NH 03801
[email protected]
(603) 433-2002

A. Issues In Fraudulent Conveyance Recoveries Applicable Statutes.
In most bankruptcy cases there are three (3) statutory schemes under which the Trustee
could seek recovery of a fraudulent conveyance. (a) 11 U.S.C. §548 (a) & (b) (Fraudulent
Conveyances); (b) the applicable state version of the Uniform Fraudulent Transfer Statute; and
(c) the self-settled trust rule from BAPCPA with a ten (10) year look-back period.
1) Basic rule: 11 U.S.C. § 548.
The basic rule on 11 U.S.C. § 548 is that a fraudulent transfer may be recovered if the
transfer was made and the obligation incurred within two (2) years before the date of the filing
of the petition. “Fraudulent Transfer” for the purposes of § 548(a) means a transfer made with
the actual intent to hinder, delay, or defraud creditors or a transfer made for less than reasonably
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equivalent value when the debtor was insolvent.1
11 U.S.C. § 548(a). The look-back period for
such transfers is two (2) years. 11 U.S.C. § 548(b).
2) The ten (10) year look-back for self settled trusts.
The Trustee is also empowered to avoid “any transfer of an interest to the debtor in
property” made within ten (10) years before the date of the filing of the petition if the transfer
was “to a self settled trust or similar device” made by the debtor; the debtor is a beneficiary of
the trust; and the transfer was made “with actual intent to hinder delay or defraud any entity to
which the debtor was or became…indebted.” 11 U.S.C. § 548(e)(1). So, under Title 11, the
Trustee can look back two (2) years or, in specific instances, ten (10) years.
3) Avoidance Under State Laws Using§ 544.
The Trustee also has the power to avoid transfers which could be avoided by an (actual)
unsecured creditor under applicable non-bankruptcy law if the claim “allowable under §502 or
if disallowed is disallowed only by virtue of 11 U.S.C. § 502(e).”2
11 U.S.C. § 544(b). The
ability to stand in the shoes of an actual unsecured creditor means the Trustee can also invoke
the Fraudulent Conveyance statute of the applicable state. Each of New Hampshire, Maine,
Massachusetts, and Rhode Island has adopted the Uniform Fraudulent Transfer Act. That
means, in general, that the Trustee may seek to avoid a transfer under state law if the transfer
was made within four (4) years of the bankruptcy filing. See, e.g., Mass. Gen. Laws Ann. ch.
109A, § 10 (West); R.I. Gen. Laws Ann. § 6-16-9 (West); N.H. Rev. Stat. Ann. § 545-A:9.

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To be slightly more precise, while the debtor was insolvent, or became insolvent as a result of the transfer; or had
unreasonably small capital; or intended to incur debts beyond the debtor’s ability to pay as they matured. 11
U.S.C. § 548(a)(1)(B)(ii) (I) through (III). Interestingly, if the challenged transfer for less than reasonably
equivalent value is a transfer to an insider under an employment contract “not in the ordinary course of business”
then the Trustee does not have to prove insolvency. 11 U.S.C. § 548(a)(1)(B)(ii)(IV).
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11 U.S.C. § 502(e) disallows contingent claims for reimbursement or contribution and certain subrogation claims.
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However, Maine is the odd state out where, in Maine, the Trustee would have six (6) years.
Me. Rev. Stat. tit. 14, § 3580.
4) The effect of the resulting trust doctrine: is there ever a true time limit?
Even when the four (4) years has passed or the six (6) years has passed (and even if the
transfer is not to a self settled trust), nevertheless, the Trustee may have the ability to recover
assets transferred if the transfer is made with actual intent to hinder delay or defraud. The
reason is that the transfer may not be effective to deprive the debtor of equitable title. The
transfer of property with the actual intent to hinder delay or defraud may give rise to a resulting
trust such that the Debtor still owns the property and the Trustee can recover the property
irrespective of when the recovery action is brought because the equitable interest in the
property is brought into the estate by 11 U.S.C. §541. See, e.g., Fleet National Bank v. Valente
(In re Valente), 360 F.3d 256 (1st Cir. 2004); Marcucci v. Marcucci, 65 F.3d 986 (1st Cir. 1995)
(Applying New Hampshire Law); In re Jewett, 2007 WL 1288740 (Bankr. D.N.H. 2007); See
also Restatement (Second) Trusts, §404; Restatement (Third) Trusts §9. Cf. In re Garland, 385
B.R. 280, 297 (Bankr. E.D. Okla. 2008), aff’d, 417 B.R. 805 (B.A.P. 10th Cir. 2009) (Failure to
disclose equitable interest in the home transferred results in denial of discharge).
B. The Triggering Creditor Doctrine.
The concept of a “Triggering Creditor”3
is simply the recitation of 11 U.S.C. § 544(b).
The Trustee “may avoid any transfer of an interest of a debtor in property… that is avoidable
under applicable law by a creditor holding an unsecured claim that is allowable under §502 of
this Title…” 11 U.S.C. § 544(b)(1) (emphasis added). As a result, in order to invoke the strong

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See generally, Strub & Reisner The Expansion of the Triggering Creditor Doctrine in an Action to Avoid
Fraudulent Transfers, 24 AM. BANKR. INST. L. REV., Winter 2016, at 249-77.
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arm power of §544(b), the Trustee has to identify a creditor. The identity of the creditor
impacts the relief available.
The ability to obtain relief depends on the identity of the chosen creditor. If the transfer
is more than 2 years before the bankruptcy petition, and is fraudulent based upon a claim that it
was a transfer for “less than reasonably equivalent value” while the debtor was insolvent, then
the Trustee has to establish that the “Triggering Creditor” is a creditor whose “claim arose
before the transfer was made.” E.g., N.H. Rev. Stat. Ann. § 545-A:5(I); Mass. Gen. Laws Ann.
ch. 109A, § 6 (West); Me. Rev. Stat. tit. 14, § 3576 (West); R.I. Gen. Laws Ann. § 6-16-5
(West). If the Trustee claims that the transfer was made with the actual intent to hinder delay or
defraud creditors, then the Trustee need merely establish that the “Triggering Creditor” is
simply “a creditor.” E.g., N.H. Rev. Stat. Ann. § 545-A:4; Mass. Gen. Laws Ann. ch. 109A, § 5
(West); Me. Rev. Stat. tit. 14, § 3575 (West); R.I. Gen. Laws Ann. § 6-16-4 (West).
Because it is harder to establish actual intent to hinder delay or defraud than it is to
establish that the consideration was less than reasonably equivalent value, the identity of the
“Triggering Creditor” and the fact that that creditor held a claim at the time of the transfer is an
important fact to establish.
Certain defenses peculiar to the chosen creditor might affect relief. The identity of the
“Triggering Creditor” and the knowledge or acts of that creditor may affect the Trustee’s ability
to recover. For example, suppose the “Triggering Creditor” agreed to the transfer, can the
Trustee then avoid it? Probably not based solely on those assenting creditors’ rights. U.S. Bank
Nat. Ass’n v. Verizon Commc’ns Inc., 479 B.R. 405, 411-12 (N.D. Tex. 2012) (“because Idearc’s
banks and bondholders could not have brought fraudulent transfer claims at the time of the
Idearc bankruptcy filing, they cannot be the plaintiff’s Section 544(b) triggering creditor.”) But
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it is possible that the creditor might be barred from sharing in the recovery. In re Yellowstone
Mountain Club, LLC, 436 B.R. 598, 678 (Bankr. D. Mont. 2010), amended on reconsideration
in part, No. 08-61570-11, 2010 WL 3504210 (Bankr. D. Mont. Sept. 7, 2010), amended, No.
08-61570-11, 2012 WL 6043282 (Bankr. D. Mont. Dec. 5, 2012), aff’d, No. ADV 09-00014,
2014 WL 1369363 (D. Mont. Apr. 7, 2014) (“More importantly, the Court is prohibiting Credit
Suisse and the Prepetition Lenders from converting a nonrecourse loan into a recourse loan
through crafty legal negotiations with the Debtors and the Committee.”)
If the “Triggering Creditor” is the IRS, does the Trustee get to use the statute of
limitations available to the government? Yes. See In re Kaiser, 525 B.R. 697, 703 (Bankr.
N.D. Ill. 2014) (Referring to the triggering creditor as the “golden creditor” and allowing the
Trustee to rely on the IRS’ proof of claim and applicable ten year statute); In re Alpha
Protective Servs., Inc., 531 B.R. 889, 906 (Bankr. M.D. Ga. 2015) (“Trustee may step into the
shoes of a federal creditor under the [Federal Debt Collection Procedures Act, 28 U.S.C. §3304]
…”).
C. The Doctrine of Moore v. Bay
Moore v. Bay 284 US 4, 52 S.Ct. 3, 76 L.Ed. 133 (1931) addressed the issue of what
happens once the Trustee avoids a transfer. Standing in the shoes of an unsecured creditor, is the
relief limited to that which could be obtained by the “triggering” or “golden” creditor , or does it
extend beyond? The Supreme Court held that the avoidance extends beyond the amount
avoidable by the unsecured creditor. The Trustee avoids for the benefit of all creditors and not
just the creditors who had those rights. In re JTS Corp., 617 F.3d 1102, 1112 (9th Cir. 2010)
(“once avoidance is shown, the trustee’s recovery cannot be limited in certain situations”); In re
Acequia, Inc., 34 F.3d 800, 809 (9th Cir. 1994) (“the measure and distribution of recovery is not
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limited by the creditor’s right”) (quoting Collier On Bankruptcy ¶544.03[1] pp 10015-16); See,
e.g., In re Mirant Corp., 675 F.3d 530, 534 (5th Cir. 2012) (“Once a trustee’s avoidance rights
are triggered at the time of filing, they persist until avoidance will no longer benefit the estate”);
Bensimon v. Duke Energy Corp., 500 B.R. 464, 480 (W.D. Tex. 2013); .
D. Finding the Claim and Creditor.
Of course the critical issue there is that there be a claim. The Trustee may be very
interested in making sure that the “Triggering Creditor” actually files a proof of claim because
there is at least an ambiguity in the statute. The statute says that the Trustee may avoid a
transfer that is “voidable” by a “creditor holding unsecured claim that is allowable under § 502
of this title . . .”. The word used is “allowable” not “allowed.” A claim that is not filed is not
“allowed.” 11 U.S.C. § 502(a) (Declaring that “a claim . . . proof of which is filed under § 501
of this title is deemed allowed.”).
However, for a claim to be allowable now (post BAPCPA), it seems to have to be filed.
A proof of claim is disallowed if it is not timely filed “except to the extent tardily filed as
permitted under paragraph 1, 2 or 3 of § 726(a) . . .”. 11 U.S.C. § 502(b)(9). A claim which has
become late and which is not filed “as permitted by” §726 (a) would then not appear to be
allowable.
The language is not entirely consistent. Section 502(b)(9) discusses claims filed as
“permitted” by Section 726(a). Section 726(a) does not technically “permit” claims but instead
authorizes distributions to claims. Section 726(a)(1) permits a Chapter 7 Trustee to make
distributions to claims which are priority claims even though they are tardily filed under certain
circumstances. 11 U.S.C. § 726(a)(2) permits tardily filed claims to receive a distribution if the
creditor did not have notice or actual knowledge of the case in time for filing and the proof of
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claim is filed in time to permit payment. 11 U.S.C. §726(a)(3) permits tardily filed claims
generally to receive a distribution after all of the timely filed claims are paid in full, and before
the payment of penalties or interest or payment to the debtor.
In summary, it appears that the interplay between § 544(b), § 502(b), and §726(a) results
in the following observations:
(a) A Chapter 7 Trustee can probably bring a 544(b) strong arm action stepping into
the shoes of a tardily filed unsecured claim but may not be able to do so at all if the claim is not
filed.
(b) A Chapter 13 or Chapter 11 Trustee probably cannot bring a 544(b) action based
on an unsecured claim which is not filed (or the case of a Chapter 11 Trustee for a claim that is
not deemed filed).
(c) The Chapter 7 Trustee probably can use the unsecured claim of the federal
government.
(d) The Chapter 7 Trustee would probably want to file a proof of claim for the
“triggering” creditor, if a claim is not otherwise filed using the powers granted the Trustee
under Fed. R. Bankr. P. 3004.
(e) The Trustee is in a quandary with respect to the use of secured claims. The
Trustee is in a quandary with respect to the use of secured claims for the following reasons:
First, § 544(b) makes it plain that the Trustee gets to step into the shoes of “a creditor holding
an unsecured claim.” The determination as to whether the claim is secured or unsecured is
ambiguous at best. The definition of a “secured claim” is contained in 11 U.S.C. § 506. A
claim is a secured claim “to the extent of the value of such creditor’s interest in the estate’s
interest in such property . . . and is an unsecured claim to the extent that the value of such
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creditor’s interest . . . is less than the amount of such allowed claim.” 11 U.S.C. § 506(a). The
statute however, then goes on to create the rule that in many circumstances there can be multiple
standards of valuation depending upon the proposed distribution or use of the property. The
statute says “such value shall be determined in light of the purpose of the valuation and of the
proposed disposition or uses of such property, and in conjunction with any hearing on such
disposition or use or on a plan affecting such creditor’s interest.” 11 U.S.C. § 506(a). So, one
wonders how is a poor overworked Trustee to determine whether or not the claim is unsecured
and thereby giving the Trustee a “Triggering Creditor” into whose shoes he or she may step.
The matter becomes somewhat worse (or perhaps somewhat better depending on your
perspective) if the debtor we are talking about is an “individual.” In that circumstance “if the
debtor is an individual in a case under Chapter 7 or 13, such value with respect to personal
property securing an allowed claim shall be determined based on the replacement value of such
property as of the date of the filing of the petition without deduction for costs and sales or
marketing. With respect to property acquired for personal, family or household purposes,
replacement value shall mean the price a retail merchant would charge for property of the kind
considering the age and condition of the property at the time the value is determined.” 11
U.S.C. § 506(2).
So if the debtor files with a long term car loan and surrenders the vehicle resulting in a
deficiency claim against the estate, but, however, the “replacement value” of the vehicle was in
excess of the debt, then it would seem that the Trustee cannot use the car loan lender as a
“Triggering Creditor.”
E. Fraudulent Transfer Implications of Certain Intra family transfers.
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The classic fraudulent conveyance claim brought by a Trustee is the situation where the
debtor, believing that he or she is in financial difficulty, conveys away a significant asset to a
family member and retains possession. The common situation is a conveyance to a spouse or a
child. The common situation often involves a piece of real estate. It is not uncommon for the
debtor at the 341 meeting to recite that he or she wanted to make sure that the property (the
family camp, or the debtor’s car) was safe from creditors.
From a Trustee’s prospective that avoidance action is relatively straightforward. You
find that a creditor in whose shoes you can stand (if the conveyance is more than two (2) years
old). Or, you sue under 11 U.S.C. § 548 and recover the property conveyed.
The same thing happens on a regular basis in other intra-family circumstances where our
sense is that the transfer was not “bad.” So for example, the debtor that testifies that he
transferred his weekly paychecks every week for the last twenty (20) years into an account
controlled by his or her spouse who then managed the family finances. Is that a fraud on
creditors? Or, where prospective debtor enters into a divorce stipulation conveying substantial
assets to his or her spouse, is that a fraud on creditors? Or, the situation where the debtor,
despite being unable to pay creditors, nevertheless finds a way to pay his or her child’s private
education. Is that a fraud on creditors? Does it depend on whether the child is under eighteen
(18)? Does it depend on whether the education might be otherwise obtainable through the
public schools?
1 Divorce.
In general bankruptcy courts do not like to be involved in domestic disputes. However,
a transfer in connection with a divorce could be a transfer for less than reasonably equivalent
value. At least in New Hampshire, the rule is that the fact that the transfer is made pursuant to a
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divorce does not insulate it from a fraudulent conveyance claim, but the transfer would only be
avoidable under § 548 if the allocation of property between the divorcing parties was “[not]
within the range of likely distribution that would be ordered by the state divorce court if the
property division had actually been litigated in that state court. In re Sorlucco, 68 B.R. 748, 753
(Bankr. D.N.H. 1986); see also In re Pilavis, 233 B.R. 1, 11 (Bankr. D. Mass. 1999) (“I join
with other courts which have considered the problem in endorsing the analysis used by Judge
Yacos.”)
2. Can a spouse be a creditor before divorce?
In general within a family unit, there is an ongoing obligation to provide for others. In
New Hampshire that doctrine finds two embodiments. First, the statute, and second, the
common law doctrine of necessaries. The statute is New Hampshire R.S.A. 546-A:2. That
statute provides that:
Every person whose income or other resources are more than sufficient
to provide for his or her reasonable subsistence compatible with
decency or health owes a duty to support or contribute to the support of
the following persons when in need: his or her wife, husband or child
under the age of eighteen . . .
N.H. R.S.A. 546-A:2
The second source of such an obligation is the Doctrine of Necessaries. See St. Joseph
Hospital of Nashua v. Rizzo, 141 N.H. 9, 12, 676 A.2d 98 (1996) (The Common Law Doctrine
of Necessaries “applies to make the wives in the instant case liable to the hospital to the extent
that husbands or their husband’s estates are unable to pay for necessary medical services
provided.”). See also Cheshire Medical Center v. Holbrook 140 N.H. 187, 663 A.2d 1344
(1995). The Doctrine of Necessaries as described in Holbrook is as follows: at common law the
husband was obligated to provide for his wife “with food, clothing and medical needs” and the
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failure to do so “made him legally liable for essential goods or services provided to his wife by
third parties.” Cheshire Med. Ctr. v. Holbrook, 140 N.H. 187, 189, 663 A.2d 1344, 1346
(1995).
If there is an obligation, then the payment that satisfies that obligation is not (in most
cases) a fraudulent conveyance. 11 U.S.C. §548(d)(2)(A) (value means or includes “satisfaction
or securing of a present or antecedent debt but does not include an unfulfilled promise to
provide support to … a relative of the debtor”); R.I. Gen. Laws Ann. § 6-16-3 (West) (similar);
Mass. Gen. Laws Ann. ch. 109A, § 4 (West); Me. Rev. Stat. tit. 14, § 3574. From the
obligation to provide flows the question of what payments within a family are protected by that
obligation, and what payments within a family are not so protected.
3. Tuition payments.
At least some courts have held that college tuition payments paid on behalf of a child are
not value to the debtor and therefore transfers for less than reasonably equivalent value. See,
e.g., In Re Leonard, 454 B.R. 444 (Bankr. E.D. Michigan 2011); but see, In Re Karolak, 2013
WL 4786861 (Bankr. E.D. Michigan 2013) (Finding the receipt of reasonably equivalent value
in exchange for tuition payments for grammar school education, noting that in Michigan, “a
parent has a legal obligation under Mich. Comp Laws Ann. § 380.1561 (1) to provide schooling
for their children”); see also In re Akanmu, Geltzer v. Xavarian High School, 502 B.R. 124,
132 (Bankr. E.D. N.Y. 2013). (Noting that “it is axiomatic that parents are obligated to provide
their children’s necessities such as food, clothing, shelter, medical care and education.”
Finding that the payment of a parochial education “does not change the fact that, by doing so,
they satisfied their legal obligation to educate their children, thereby receiving reasonably
equivalent value and fair consideration.”).
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F. Homestead Issues.
The Debtor has the right to assert claims of Homestead and thereby exempt certain real
property. The Debtor can do that under either applicable state law, or under the federal
exemption scheme. The federal exemption scheme applies to the Debtor’s “aggregate interest”
in real property or in personal property that the Debtor or dependents of the Debtor use as a
residence. The federal scheme also give the Debtor the right to exempt as a homestead a burial
plot. The exemption may not exceed the sum of $23,675.00. 11 U.S.C. § 522(d)(1). The
federal exemption scheme is parsimonious by comparison to the states of Massachusetts, Maine,
Rhode Island and New Hampshire. The Federal Scheme does not define “residence”.
Residence and domicile are probably different. The 6th Circuit has described the
difference as follows.
A brief discussion of the related concepts of domicile and residents may
be useful before examining the constitutionality of the University’s
regulations. Generally, an individual’s “domicile” is his “true, fixed, and
permanent home and principal establishment.” It is the place to which he
returns whenever he is absent. … “Residence,” in contrast, requires both
physical presence and an intention to remain some indefinite period of
time but not necessarily permanently…. Thus domicile is an individual’s
permanent place of abode where he need not be physically present, and
residence is where the individual is physically present much of the time.
An individual consequently may have several residences but only one
domicile.
Eastman v. Univ. of Michigan, 30 F.3d 670, 673 (6th Cir. 1994); See In re: Marsico 278
B.R. 1 (Bankr. D.N.H. 2002) (residence and domicile are different; New Hampshire state law
Homestead Exemption requires domicile while the Federal Exemption under 522(d)(1) requires
residents.)
Each of the states have homestead exemptions. New Hampshire’s Homestead Exemption
is found in N.H. R.S.A.480:1. It exempts an interest of up to $120,000 in a domicile. See In re
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Marsico 278 B.R. 1 (Bankr. D.N.H. 2002). Massachusetts has an automatic Homestead
Exemption of $125,000 and a “declared Homestead Exemption” in the amount of $500,000.
Mass. Gen. Laws Ann. Ch. 188 §1. The Maine Homestead Exemption is capped at $95,000.
Me. Rev. Stat. Ann. Tit. 14, § 4422. The Rhode Island homestead exemption is up to the sum of
$500,000. R.I. Gen Laws Ann. § 9-26-4.1 (West).
In general, the holder of the Homestead has to own the real estate or have some interest
in the real estate, has to occupy the real estate, and generally has to have the intent to remain on
the premises for an indefinite period of time.
1. The Effect of Temporary Absence from the Homestead.
Certain absences from the premises may not destroy the entitlement to a homestead. For
example, a temporary absence from the premises will not eliminate the right to a homestead. In
re Dubravsky, 374 B.R. 467 (Bankr. D.N.H. 2007); In re Cole, 185 B.R. 95, 98 (Bankr. D. Me.
1995) (“nothing more than a vague intention to live on the Hartland property”; “no present
plans or tangible, contemporary preparations to move there” is not enough); In re Marrama,
307 B.R. 332, 336-37 (Bankr. D. Mass. 2004) (To obtain and declare a Homestead estate,
Debtor must “occupy or intend to occupy the property.”).
2. The Effect of Absence pursuant to a divorce.
Absence by virtue of a divorce may not, at least in New Hampshire, deprive the Debtor
of the claim of Homestead. In re Eckols, 63 B.R. 523 (Bankr. D.N.H. 1986).
3. The Effect of a Sale.
If the Debtor has sold the property and moved out, the proceeds (at least in New
Hampshire) are not excluded by the homestead exemption. In re Schalebaum, 273 B.R. 1
(Bankr. D.N.H. 2001); In re Visconti, 426 B.R. 422 (Bankr. D.N.H. 2001).
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4. The Effect of Multiple Lots or units.
The homestead has to be occupied. The question that arises then, when the homestead is
alleged to be two different lots, what does it mean to be occupied?
Generally, if the Debtor actually uses and occupies the adjacent parcel in connection with
its principal residence as a part of his principal residence then the Debtor is entitled to claim the
lot as part of the homestead. See, e.g., In re MacLeod, 295 B.R. 1, 5 (Bankr. D. Me. 2003)
(“Residential use may extend also to contiguous property which is used for a complimentary
activity, like family recreation. It may even extend to incidental business use…”); In re
Edwards, 281 B.R. 439, 450 (Bankr. D. Mass. 2002) (“Debtor actually used and occupied the
adjoining parcel as part of and in connection with his principal residence as of the date of the
filing of his bankruptcy petition.); In re Mirulla, 163 B.R. 910 (Bankr. D.N.H. 1994) (Debtor
resided in a hotel owned by him only the units actually used were exempt.); See also In re
Iodice, No. BK 13-11283-BAH, 2014 WL 4925982 (Bankr. D.N.H. Sept. 30, 2014); In re
Myers, 323 B.R. 11 (Bankr. D.N.H. 2005).
G. The interplay between Homestead and Trustee Avoidance Actions: In re: Traverse,
753 F.3d 19 (1st Cir. 2014) cert. denied sub nom. DeGiacomo v. Traverse, 135 S. Ct.
459 (2014).
In most jurisdictions, the homestead can be and frequently is waived. The waiver is
arises either as a matter of statute or explicitly in a mortgage. See, e.g., N.H. R.S.A. 480:5-a
(purchase money Mortgage encumbers the homestead without waiver). Even if the instrument
is not a purchase money mortgage, in New Hampshire and in most other jurisdictions the deed
encumbering the homestead right may waive the homestead if certain required formalities are
met. N.H. R.S.A. 480:5-a.
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However, the mortgage holder sometimes fails to properly record the Mortgage or the
Mortgage holder fails to have the Mortgage properly executed. See In re Traverse, 753 F.3d 19
(1st Cir. 2014) cert. denied sub nom. DeGiacomo v. Traverse, 135 S. Ct. 459, (2014) (Mortgage
not recorded at all.); See In re Pellerin, 529 B.R. 801 (Bankr. D.N.H. 2015) (Defective
acknowledgement). Those circumstances may give the Trustee the right to avoid the Mortgage
pursuant to the strong arm powers. 11 U.S.C. §544(a). After avoiding the mortgage, the
Trustee will then preserve it for the benefit of the estate. 11 U.S.C. § 551. Having preserved
the Mortgage “for the benefit of the estate” what has the Trustee now obtained?
In Traverse, the First Circuit said essentially that the Trustee obtained nothing. The
Trustee did not obtain the right to recover payments in as much as the Trustee did not hold the
Note. In re Traverse, supra at fn. 9 (“Absent a separate agreement the contrary, avoidance and
preservation of a security interest do not entitle the Trustee to payments on the underlying
debt.”). Unless the Trustee can sell for more than the homestead, the First Circuit does not
permit the Trustee to sell. Thus, in at least Massachusetts, the Trustee could not sell the
property without paying Ms. Traverse the $500,000 homestead. Since the property was not
worth $500,000, the avoidance of the Mortgage did not immediately benefit the Trustee.
What is a Trustee to do?
One thing that a Trustee could do is make a deal with the Debtor. The Trustee avoided
the Mortgage. Having avoided the Mortgage, the Trustee finds some difficulty in obtaining a
monetary judgment against the bank. See In re Spodris, 516 B.R. 196 (Bankr. D Mass 2014).
Some Trustees have, with some success, renegotiated the loan transaction. The Debtor is
discharged of the personal obligation to pay the Note. The Mortgage securing the Note has
been avoided. A resolution between the Debtor and the Trustee might involve the re-execution
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of the Mortgage and modification of the Note obligation or execution of a new Note obligation
to the benefit of the Bankruptcy Estate, which new Note obligation might have more favorable
terms to the Debtor. Having negotiated a more favorable Mortgage with the Debtor, the Trustee
might then be in a position to sell it. Having sold the Mortgage, the Trustee has thereby realized
payment for the benefit of unsecured creditors (including the former Mortgagee).
In other instances, the Trustee may be in a position to sell the Mortgage itself. The idea
there being that the Mortgage secures the non-recourse obligation. It is a least conceivable that
at some time in the future, that the Debtor will choose to leave the property (or will die) and
upon that event, somebody will sell the property. Selling the property will yield proceeds that
will be available to satisfy an outstanding Mortgage.
H. The Effect of Tax Liens in 11U.S.C. §724(b). Debtor’s lawyers do not
ordinarily think of it or even notice it, but, the Bankruptcy Code permits the Trustee to
subordinate the claim of the IRS if the claim is secured by a lien. 11 U.S.C. § 724(b) essentially
says that the IRS lien is held for the benefit of priority claims. In essence, an IRS claim secured
by a lien is given the same priority as any other IRS tax claim: an 8th priority. That means that
the first seven (7) priorities ahead of it will get paid out of the proceeds of its lien. The seven
(7) priorities ahead of it include such interesting things as: The Trustee’s fees and expenses;
domestic support obligations; employee wages and benefits. Thus, it occurs from time to time
that Trustee may encounter fully encumbered property which the Trustee may nevertheless be in
a position to sell and for which sale the Trustee may generate benefits to estate constituents.
The other thing that happens with 11 U.S.C. § 724(b) is that the Trustee steps into the
shoes of the IRS with respect to the priority that the IRS has. The priority differs depending on
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the collateral and the competing liens. The important one however is the lien of secured
creditors in revolving collateral or securing revolving debt.
If the Debtor is not an individual but instead a business and if the bank has provided a
line of credit secured by inventory and receivables, then under appropriate circumstances the
IRS lien will come ahead of the bank. The appropriate circumstances are that the IRS lien goes
on record and that forty (45) days thereafter pass. 26 U.S.C. 6323 (c); Rice Inv. Co. v. United
States, 625 F.2d 565, 571 (5th Cir. 1980) (term loan secured by revolving inventory loses to tax
lien for inventory acquired more than forty five days after the recording of the tax lien); Texas
Oil & Gas Corp. v. United States, 466 F.2d 1040, 1053 (5th Cir. 1972) (Dealing with a
revolving loan secured by accounts receivable: “Because this potential interest in future
accounts receivable cannot pass muster under the traditional choateness doctrine and because
the 1966 amendments to the tax lien statute do not appear to expand that choateness doctrine in
any manner other than to extend the required time of receipt for 45 days past the filing of the tax
lien, the bank lien is inferior to the federal tax lien”); See also United States v. Pioneer Am. Ins.
Co., 374 U.S. 84, 89, 83 S. Ct. 1651, 1655, 10 L. Ed. 2d 770 (1963) (“The federal rule is that
liens are ‘perfected in the sense that there is nothing more to be done to have a choate lien—
when the identity of the lienor, the property subject to the lien, and the amount of the lien are
established.”). At that point, after the forty (45) days, the IRS lien will come out ahead of any
revolving line of credit facility, and will come out ahead of a security interest which encumbers
revolving collateral. That means that a Chapter 7 Trustee can subordinate the tax lien, liquidate
the collateral and pay some priority claims.

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