Order Denying Defendant's Motion to Dismiss

JANICE MILLER KARLIN. Bankruptcy Judge.

Plaintiff Patricia E. Hamilton ("Trustee"), Trustee for the Chapter 7 bankruptcy estate of Debtor Patricia K. Stamatson, seeks to avoid the postpetition transfer Debtor made of her home to Defendant Jerry Livingston ("Livingston"). The Trustee also seeks to avoid a lien she contends Debtor granted Livingston on that property (the "Emporia property"). Livingston moves to dismiss the complaint, asserting that the Trustee has failed to state a claim upon which relief can be granted, relying on Fed. R. Civ. P. 12(b)(6).1 He argues that because Debtor amended her Schedule C to add the Emporia property as an exempt asset after she transferred it to him, and the Trustee did not object to the amendment, the Emporia property was no longer property of the estate on the day the Trustee filed her complaint. As a result, he argues the Trustee cannot prevail on her claim under 11 U.S.C. § 549.2 As to the Trustee's lien avoidance claim, Livingston asserts that because the Trustee has not yet, at the complaint stage, produced the purported missing mortgage, she cannot prevail as a matter of law on her § 544 claim. Because the Court finds that the Trustee's complaint states a claim under Rule 12(b)(6) for both claims, it denies Livingston's motion.

I. Factual and Procedural History

The following facts are taken from the complaint, exhibits attached thereto, and the record in this adversary proceeding and the underlying bankruptcy case.3 Debtor and her husband purchased the Emporia property for $190,000 in August, 2012. Livingston paid the $188,306.61 required to close the sale via a cashier's check dated August 9, 2012.

Contemporaneously with the closing, someone apparently notified the Armed Forces Insurance Exchange to add the newly acquired Emporia property to Debtor's insurance policy. Effective August 10, 2012, the insurance policy on the Emporia property listed Debtor and her spouse as owners and Livingston as "mortgagee."4 When Debtor filed her bankruptcy petition sixteen months later, on December 12, 2013, she indicated the Emporia property was her residence and also listed it on Schedule A ("Real Property"), noting it had a fair market value of $169,900 with a "$0.00" secured claim. At this time, she elected not to exempt the Emporia property (or any other real estate), but did exempt many items of personal property on Schedule C ("Property Claimed as Exempt").

Debtor originally listed Livingston as an unsecured creditor on Schedule F ("Creditors Holding Unsecured Nonpriority Claims") with a claim of $200,000. She included the following explanation in the column that asked for the date she incurred the Livingston debt and the consideration for the claim: "11/2013 Personal Loan/Creditor loaned the Debtor and her husband the money to purchase their home. There is no promissory note."5

On December 30, 2013, eighteen days after filing her Chapter 7 petition, Debtor and her husband executed a promissory note to Livingston in the amount of $200,000 at 4.25% interest "for the property purchased" in Emporia, Kansas—the property purchased more than a year earlier.6 Attached to the note was a copy of the August 2012 cashier's check from Livingston. The note required Debtor and her husband to pay $750 monthly until the note was paid in full. A few days prior to the execution of the promissory note, Debtor executed a will stating that in the event of her death, Livingston should be given the deed to the Emporia property.7

Several months later, in March 2014, Livingston executed an affidavit claiming an interest in the Emporia property, and he filed it with the Lyon County Register of Deeds on May 1, 2014. The affidavit stated that "by instrument dated August 10, 2012"—the day after the date on the cashier's check he provided for purchase of the Emporia property—Livingston had "an interest" in the Emporia property.8 The

Affidavit further states "[t]hat by virtue of said above-mentioned instrument, an unrecorded documents (sic) being held by the undersigned, the undersigned hereby claim (sic) an equitable estate in and to said real property from and after the date of said above-mentioned instrument."9 Also in May 2014, the county issued a real estate tax statement listing Livingston as a "contract buyer."10

Almost a year after Debtor filed her bankruptcy petition, on November 4, 2014, she and her husband executed a warranty deed for the Emporia property to Livingston, for no apparent consideration. Neither Debtor nor Livingston notified the Trustee of the conveyance, notwithstanding that the Trustee had contacted Livingston before the conveyance, on October 16, 2014, to advise him that the Emporia property was now estate property and that he could take no action to enforce his secured claim or any equitable interest without obtaining Bankruptcy Court approval on written notice.11 Even at a special meeting of creditors held November 17, 2014, a meeting attended by both Livingston and Debtor, neither advised the Trustee of this recent deed although the Emporia property was apparently a subject of that meeting. At the meeting, Debtor admitted signing a promissory note to Livingston soon after her bankruptcy filing and that the Emporia property secured the loan Livingston had made to her.

A week after the special meeting, on November 25, 2014, and almost a year after filing bankruptcy, Debtor finally amended Schedule C in an attempt to exempt her interest in the Emporia property. On the same day, she amended her Schedule D ("Creditors Holding Secured Claims"), describing the "nature of [Livingston's] lien" as a "Mortgage," and tying his mortgage to the Emporia property by listing that address with the same value she had included in her original Schedules.12 The instructions for Schedule D clearly state the information is to be true "as of the date of filing of the petition."13

The Trustee filed her adversary complaint against Livingston on December 29, 2015, alleging that the warranty deed executed by Debtor to Livingston on November 4, 2014 was a postpetition transfer prohibited by § 549, and also that Livingston's purported security interest in the Emporia property was unperfected and therefore subject to avoidance under § 544. The Trustee has requested the Court avoid Livington's security interest in the Emporia property and for other related relief.

Livingston, in his motion to dismiss, argues that the Trustee has not alleged, and cannot demonstrate, an essential element of a § 549 claim based on this reasoning: 1) because Debtor amended Schedule C to exempt her interest in the Emporia property a year after filing bankruptcy; 2) because the Trustee did not object to that exemption within the 30 days allowed by Rule 4003(b)(1) of the Federal Rules of Bankruptcy Procedure; and 3) because the exemption then relates back to the date of petition, the property was no longer property of the estate when Debtor conveyed it to Livingston in November 2014. Livingston also suggests that the Trustee's § 544 claim must be dismissed—before discovery has even begun—because the Trustee has not yet discovered or attached (as an exhibit to her complaint) a document that constitutes the purported security interest in the real property.

II. Burden of Proof and Standards for Dismissal Under Rule 12(b)(6)

To survive a Rule 12(b)(6) motion to dismiss, a plaintiff's complaint must allege sufficient facts to support a plausible claim for relief.14 A claim must be supported by factual assertions "`that allow the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.'"15 When a court considers a motion to dismiss, factual allegations contained in the complaint are accepted as true and the plaintiff has the burden of showing that those facts support a finding in its favor.16

III. Analysis

A. Avoidance of a Postpetition Transfer, § 549

To successfully avoid a postpetition transfer, the Trustee must prove that: (1) a transfer of property occurred; (2) the property transferred was property of the estate; (3) the transfer occurred after the commencement of the case; and (4) the transfer was not otherwise authorized by the Bankruptcy Code or the bankruptcy court.17 If the Trustee fails to allege in her complaint facts supporting any one of these elements, the Court must dismiss the case.18

Livingston's motion to dismiss challenges the Trustee's showing on only the second factor, contending that the Emporia property was not property of the estate when Debtor executed the deed to him in November 2014 because of the retroactive effect of Debtor's amended Schedule C. The Trustee counters with several arguments.

First, the Trustee argues that because Debtor had not claimed the Emporia property as exempt at the time she voluntarily conveyed it to Livingston, the property was property of the estate for the purposes of the Trustee's rights under § 549. Second, the Trustee argues that even if the property was exempt at the time of the conveyance, Livingston has no standing to raise Debtor's claim of exemption as a defense against a trustee's avoidance power. Finally, the Trustee argues that § 522(g),19 which dictates when a debtor may exempt property recovered by a trustee, would bar Debtor from claiming the property as exempt because she voluntarily conveyed it to Livingston.

In response, Livingston generically relies on the right of debtors to freely amend their schedules at any time, and the fact that amendments relate back to the filing of the petition. Second, Livingston denies he lacks standing to raise Debtor's late-filed exemption of the Emporia property as a shield against the Trustee's avoidance powers. Instead, he claims that his argument merely demonstrates that as a matter of law, because of the relation back of the amended Schedule C, the Emporia property is deemed to have been exempt—and thus no longer property of the estate—almost a full year before Debtor conveyed the property to him in November 2014. Finally, Livingston disputes the applicability of § 522(g) because he contends the Trustee has failed to meet the necessary prerequisite for its application—that the trustee "recover" the property before the debtor seeks to exempt it, noting the Trustee did not file the avoidance action until after the exemption was allowed.

Livingston primarily relies on In re OBrien,20 a Western District of Michigan bankruptcy case, to support his argument. In OBrien, the debtors amended their schedules to exempt a tax refund after they had already spent it.21 The trustee objected to the exemption and filed a motion for turnover of the refund.22 The trustee's main argument against allowing the exemption of the refund was that because the refund had already been spent, it could not, as a matter of law, be exempted as the property was "already gone."23 The court allowed the exemption and overruled the trustee's motion for turnover, finding that the amended exemption related back to the date of filing, at which point the money eventually spent by the debtors was "removed or reclaimed" from the estate.24

But OBrien provides no real support for Livingston's position under our facts. First, the OBrien case was not a trustee avoidance action. Instead, it was a turnover motion directly against the debtor. By contrast, the Trustee here is seeking to avoid what the complaint avers is an unauthorized transfer that occurred at a time when apparently no one disputes Debtor's interest in the Emporia property was property of the bankruptcy estate.

Ironically, the instant case is much more similar to another case decided by the same judge who decided O'Brien. In Lasich v. Wickstrom (In the Matter of Wickstrom),25 the trustee sought to avoid three prepetition preferential or fraudulent transfers by the debtors to one of their creditors. The transferees sought summary judgment, arguing that the property transferred was ultimately exempted by the debtors, and thus the trustee could not avoid the transactions. The Wickstrom court labeled this defense—which boils down to an argument that the debtors' other creditors would not have benefitted from the property anyway since the property was exempt and not available for execution by unsecured creditors—the "no harm, no foul" argument. Other courts refer to it as the "diminution of the estate" doctrine.26

As the Wickstrom court notes, this doctrine was used primarily under the Bankruptcy Act of 1898 to determine whether a preference could be avoided. The doctrine focused on the "issue of whether a given transfer diminished or depleted the debtor's estate" and dictated that "if the transfer (of exempt property) did not diminish or deplete the debtor's estate, the trustee would not be able to avoid the transfer."27 Thus, under this doctrine, any exempt or exemptible property, whether transferred pre- or postpetition, was not subject to the trustee's avoidance powers. This result was based primarily on the fact that, under the Bankruptcy Act, exempt property was never part of the bankruptcy estate.28

This doctrine has been rejected by a majority of courts, including by the Tenth Circuit BAP29 and even more recently by Judge Somers in a § 548 fraudulent transfer case,30 primarily due to the 1978 change in the Bankruptcy Code defining what constitutes the estate at the time of filing.31 In In re Taylor, the debtors filed bankruptcy several months after granting a security interest in their car to a bank creditor.32 The bank failed to perfect its security interest prior to the petition date, and the trustee was allowed to avoid the bank's interest under § 544(a)(1) for the benefit of all unsecured creditors notwithstanding that debtors had properly exempted the car in their original schedules. The court held that exemptions are a personal right of the debtor, and that a creditor may not assert that right as a defense in an avoidance action—regardless whether the exemption was allowed by the court.33

The Tenth Circuit BAP in Taylor also cited favorably to a Ninth Circuit case, In re Noblit,34 which, in turn, adopted the rationale of a case from the Northern District of Indiana, In re Richards.35 The Richards court illustrated the importance of the debtor's personal right to exemptions:

Accordingly, Livingston does not have standing to raise Debtor's exemption as a defense to this action, and as a matter of policy, to give credence to Livingston's defense (that Debtor's exemption of the property allows her to prefer him—an allegedly unsecured creditor—over her other unsecured creditors) would result in an inequitable distribution of property, including a preferential payment to one creditor at the expense of other creditors. This would subvert the spirit as well as the mandate of the Bankruptcy Code and undermine federal policy by allowing some creditors to avoid the priority scheme.37

This analysis applies equally to the Trustee's avoidance power under § 549. While debtors may, at any time, freely (in good faith) exempt property in which they retain an interest under § 522,38 a creditor is not entitled to appropriate this right to defend against an otherwise avoidable transfer. This case proves the point. If the Court prohibited the Trustee from seeking to avoid the transfer here because the Debtor has now elected to exempt it, Livingston could enjoy a windfall to the detriment of other unsecured creditors and administrative claimants.

Thus, the Court finds that the Trustee has, at the pleading stage, satisfied the second element she must show to avoid the transfer under § 549. As Livingston does not challenge that the complaint supports each of the other requirements for a claim under § 549, the Court finds that the Trustee has stated a claim, and Livingston's motion to dismiss this claim pursuant to Rule 12(b)(6) must be denied.39

B. Avoidance of an Unperfected Security Interest, § 544

To prevail on an avoidance action under § 544, the Trustee must show that the creditor has a valid lien on the subject property and that the lien was not properly perfected under applicable state law when the bankruptcy was filed.40 Here, the Trustee's complaint alleges that, in August 2012, when Debtor purchased the Emporia property with her non-filing spouse, Debtor obtained a loan from Livingston to enable her to purchase the property.

The Trustee's complaint then supports her § 544 claim with an abundance of factual allegations and supporting exhibits, including:

Additionally, the Trustee alleges that Livingston's interest was unperfected as of the petition date, as evidenced by the failure of Livingston or the Debtor to follow procedures required by Kansas law to perfect an interest in real property. The Court also notes Debtor's Amended Schedules A and D, filed within a week after the special meeting of creditors, acknowledged under penalty of perjury that Livingston was a secured creditor as of the date of petition and that the collateral securing his claim was the Emporia property.42

As a preliminary matter, the Court notes that Livingston's reply brief is completely silent regarding the Trustee's § 544 count, apparently conceding the arguments contained in the Trustee's response to his motion to dismiss on this count. The Court will nevertheless review why the argument contained in his original motion to dismiss on this count does not justify dismissal.

Livingston argued that because Kansas law requires mortgages to be in writing to be enforceable, and because the Trustee failed to attach to her complaint a copy of the written instrument purporting to be the mortgage, that her complaint fails to state a claim. In so arguing, Livingston misunderstands both Kansas law regarding lien interests as well as the standard for granting a motion to dismiss an avoidance action under § 544 at this stage of the proceedings.

First as to Kansas law. One of the very cases upon which Livingston relies, EllaMae Investments, LLC v. Terra Firma Development, LLC,43 notes that there may not even need to be a document entitled "mortgage" for Livingston to have an enforceable lien (that a trustee could avoid) on the Emporia property:

The Court thus finds that at this stage of the pleadings, the failure of the Trustee to produce a mortgage is simply immaterial in light of all the factual allegations of her complaint—which must be taken as true upon evaluating a motion to dismiss—that the parties intended to create a lien.45

Accordingly, the Court finds that the allegations of the complaint meet the standard of Rule 12(b)(6) for stating a claim under § 544(a), and the Trustee is entitled to conduct discovery in an attempt to now prove these allegations.

III. Conclusion

The Court finds that because the Trustee has met her burden to state a claim under Rule 12(b)(6) for both her § 549 and § 544 claims, Livingston's motion to dismiss46 is denied. The Trustee's complaint demonstrates that there is plenty of smoke; the Trustee will be given the opportunity to prove it is truly a fire.

It is so ordered.47