Thomas J. Tucker, United States Bankruptcy Judge.
This case presents a dispute over the efforts of Debtor Steven G. Sharkey ("Debtor") to exempt his interest in two annuity contracts. The Court held a hearing on December 15, 2016, regarding the objection by the creditor Stevenson & Bullock, P.L.C. (the "Creditor") to Debtor's fifth amended claim of exemptions (Docket # 127, the "Objection to Exemptions"), and the Creditor's related request for sanctions against Debtor's attorneys under 28 U.S.C. § 1927. The Chapter 13 Trustee joined in the Objection to Exemptions, by filing a concurrence.
For the reasons stated in this opinion, the Court will enter an order sustaining the Creditor's Objection to Exemptions, but denying the Creditor's request for sanctions.
This Court has subject matter jurisdiction over this bankruptcy case and this contested matter under 28 U.S.C. §§ 1334(b), 157(a) and 157(b)(1), and Local Rule 83.50(a) (E.D. Mich.). This contested matter is a core proceeding under 28 U.S.C. §§ 157(b)(2)(A), 157(b)(2)(B), and 157(b)(2)(O). This matter also is "core" because it is "created or determined by statutory provision[s] of title 11," namely, 11 U.S.C. §§ 522(b)(3) and 522(b)(4). See generally Allard v. Coenen (In re Trans-Industries, Inc.), 419 B.R. 21, 27 (Bankr. E.D. Mich. 2009).
This bankruptcy case began as a Chapter 7 case, when Debtor and his spouse, Sandra Sharkey, filed their voluntary Chapter 7 petition on March 25, 2016. Michael Stevenson was appointed the Chapter 7 Trustee, and his law firm, Stevenson & Bullock, P.L.C. (the Creditor) represented the Trustee. On Debtors' motion, the case was later converted to Chapter 13, by an order entered on June 22, 2016.
There has been substantial litigation, in both the Chapter 7 and the Chapter 13 phases of this case, over Debtor's efforts to exempt his interest in two annuities. The annuities at issue will be referred to as the "Hartford Annuity" and the "Nationwide Annuity" and these are discussed
The Court held a hearing on June 15, 2016, and scheduled the Trustee's objection to exemptions for a further, non-evidentiary hearing, and granted leave for the Trustee and Debtor to conduct discovery.
Before the further hearing was held, however, the Court held a hearing on Debtors' motion to convert to Chapter 13, on June 22, 2016. At the conclusion of that hearing, the Court granted Debtors' motion to convert, with certain conditions, and then entered an order converting the case.
On July 1, 2016, Debtors filed their third amended claim of exemptions and a proposed Chapter 13 Plan.
Meanwhile, on July 25, 2016, the Creditor filed its own objection to Debtor's third amended claim of exemptions, and an objection to confirmation of Debtors' proposed Chapter 13 Plan.
On November 8, 2016 Debtors filed their fourth amended claim of exemptions, and then refiled them on November 10, 2016 with a corrected cover sheet.
In their original claims of exemption (Schedules C) and in the first three amended claims of exemption, Debtors claimed exemptions under the federal exemption provisions of § 522, namely, 11 U.S.C. §§ 522(b)(2) and 522(d). During the November 3, 2016 hearing, Debtor's counsel stated that Debtors wanted to switch to claiming exemptions under the state law exemptions, namely, under 11 U.S.C. § 522(b)(3) and the Michigan exemption statute applicable to bankruptcy debtors, Mich. Comp. Laws § 600.5451. After the Court allowed this, Debtors filed their fourth and fifth amended claims of exemption, each of which claimed exemptions under the state law exemption provisions. As discussed below, Debtors did this after their attorneys conceded, during the November 3, 2016 hearing, that Debtor had no valid claim of exemption for the Hartford Annuity or the Nationwide Annuity under the federal exemptions.
In Debtor's most recent and currently-operative amended Schedules C, Debtor Steven Sharkey claims an exemption for the entire value of the Hartford Annuity ($78,897.00) and for the entire value of the Nationwide Annuity ($17,778.00), each under the following statutory provisions:
These are discussed in part IV.C of this opinion, below.
Initially, the Court reiterates the following general principles regarding exemptions, which the Court stated in a prior case, In re Kizer, 539 B.R. 316, 319 (Bankr. E.D. Mich. 2015):
Debtors argue that the Creditor lacks standing to object to Steven Sharkey's claims of exemption in the Hartford Annuity and the Nationwide Annuity. Debtors note that the Creditor's allowed claim is entirely an administrative claim, entitled to priority under Bankruptcy Code § 507. So Debtors cannot confirm a Chapter 13 plan unless the plan at least provides for the full payment, in deferred cash payments, of the Creditor's claim (unless the Creditor agrees to a different treatment). See 11 U.S.C. §§ 1322(a)(2), 1325(a)(1), 507(a)(2), 503(b). And Debtors' Chapter 13 plan, which has not yet been confirmed, provides that the Creditor's claim will be paid in full.
In response, the Creditor argues that as the holder of an allowed administrative expense in this case, it is a "party in interest," at least until its claim is actually paid in full. And Fed. R. Bankr. P. 4003(b)(1) says that, with exceptions not applicable, "a party in interest" may file an objection to a debtor's claimed exemptions. The Creditor also argues that Debtor's standing argument should be rejected on the basis of laches, because Debtors waited too long to first challenge the Creditor's standing.
In addition, the Creditor argues that the Chapter 13 Trustee's "concurrence" to the Creditor's objections to exemption (Docket # 133), which was filed on December 1, 2016, should be viewed as a timely objection by the Chapter 13 Trustee to Steven Sharkey's claims of exemptions in the annuities. Debtors do not dispute that the Chapter 13 Trustee has standing, on behalf of the general unsecured creditors in this case, to object to Debtor's exemptions. But as the Creditor's counsel concedes, the Trustee's concurrence and the Trustee's standing to object to exemptions do not give the Creditor its own standing to object.
"Generally, to have standing in a bankruptcy case, `a person must have a pecuniary interest in the outcome of the bankruptcy proceedings.'" In re Moss, 320 B.R. 143, 149 (Bankr. E.D. Mich. 2005) (citations omitted). The Court finds that the Creditor does have a sufficient pecuniary interest in the outcome of the exemption issue to give the Creditor standing to object to the exemptions.
Regardless of what Debtors' Chapter 13 plan proposes, and regardless of what that plan must propose in order to be confirmed, at this point there is no guarantee that Debtors' proposed plan, or any later-amended plan Debtors may file, actually will be confirmed. Indeed, the Chapter 13 Trustee and the Creditor each have objected to confirmation, including on grounds unrelated to the outcome of the exemption dispute.
Furthermore, even if Debtors do manage at some point in the future to confirm a plan, there is no guarantee that Debtors will successfully complete that plan, by making all of the required payments and meeting all of the other requirements of the plan.
For these reasons, it is certainly possible that Debtors' Chapter 13 case will fail, as many Chapter 13 cases do, and that this case will be converted back to Chapter 7.
During the December 15 hearing, Debtor's counsel suggested, without citing any authority, that in such a re-conversion scenario, the Creditor would be able to object anew to Steven Sharkey's claimed exemption in the annuities, after conversion back to Chapter 7.
The Court must reject this argument, because there is clearly at least one scenario in which the Creditor would
Fed. R. Bankr. P. 1019(2)(B). It is not entirely clear whether or how the second of these exceptions would apply under the circumstances of this case, but under the first of these exceptions it is clear, at a minimum, that the Creditor would not be able to file a new objection to exemptions if this case converted back to Chapter 7 more than a year after confirmation of a Chapter 13 plan. (And Debtors are proposing a 60-month plan).
For these reasons, the Court concludes that the Creditor does have a sufficient pecuniary interest to have standing to object to Debtor's exemptions now.
As noted above, Debtor Steve Sharkey's latest amended claim of exemptions lists three statutory provisions as the basis for claiming as exempt the entire value of the Hartford Annuity and the Nationwide Annuity. During the December 15, 2016 hearing, however, Debtor through his attorney abandoned all but one of these statutory provisions, conceding that the annuities are not validly exempt under the abandoned statutory grounds. The Court will discuss each statutory provision separately.
Debtor's latest amended Schedule C first lists Mich. Comp. Laws § 600.5451(1)(k) as a basis for exempting the annuities. With certain specified limitations, that section in the Michigan bankruptcy exemption statute permits a debtor to exempt "[a]ll individual retirement accounts, including Roth IRAs, or individual retirement annuities as defined in section 408 or 408a of the internal revenue code, 26 USC 408 and 408a, and the payments or distributions from those accounts or annuities." During the December 15 hearing, Debtor's counsel conceded that neither of the annuities is exempt under this statutory provision, because neither of the annuities is an individual retirement account or individual retirement annuity, as defined in § 408 or § 408A of the Internal Revenue Code, 26 U.S.C. §§ 408 and 408A. While the Hartford Annuity and the Nationwide Annuity are both annuity contracts, neither annuity is an "individual retirement annuity" as defined in 26 U.S.C. § 408(b). One of the requirements in order to be such an "individual retirement annuity" is that the annuity contract "is not transferrable by the owner." 26 U.S.C. § 408(b)(1). It is clear and undisputed that each of the annuities in this case is transferrable by the owner, Steven Sharkey.
These points were discussed at length during an earlier hearing, held November 3, 2016. That hearing concerned the Creditor's objection to Debtor's earlier claims of exemption, under the federal exemptions, including Bankruptcy Code § 522(d)(12). That section exempts "[r]etirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986." During the November 3, hearing, the parties and the Court walked through several provisions of the Hartford Annuity contract and the Nationwide Annuity contract,
Thus, Debtor's counsel conceded, during the November 3 hearing, that neither § 408 nor § 408A of the Internal Revenue Code, 26 U.S.C. § 408, 408(A), covers or applies to either the Hartford Annuity or the Nationwide Annuity. This necessarily means that Debtor also concedes that these annuities are not exempt under Mich. Comp. Laws § 600.5451(1)(k).
In the Creditor's Objection to Exemptions, the Creditor argued that Mich. Comp. Laws § 600.5451(1)(k) does not apply; and Debtor's written response to the objection did not contest this point. Rather, Debtor's written response argued only about 11 U.S.C. §§ 522(b)(3)(C) and 522(b)(4), discussed below.
For these reasons, Debtor's written claims of exemption for the Hartford Annuity and Nationwide Annuity based on Mich. Comp. Laws § 600.5451(1)(k) are disallowed.
Debtor's latest amended Schedule C also lists 11 U.S.C. § 522(b)(3)(C) as a statutory basis for exempting the Hartford Annuity and the Nationwide Annuity. The wording of that section is identical to the wording of the federal exemption contained in 11 U.S.C. § 522(d)(12), quoted above, and is available to a debtor who elects the state exemptions. The concession by Debtor's counsel during the November 3 hearing that § 522(d)(12) does not apply to the annuities at issue, therefore, also amounts to a concession that § 522(b)(3)(C) does not apply to those annuities. And at the December 15 hearing, Debtor's counsel expressly withdrew Debtor's claim of exemption under
For these reasons, Debtor's written claims of exemption for the Hartford Annuity and the Nationwide Annuity based on 11 U.S.C. § 522(b)(3)(C) are disallowed.
The final statutory provision claimed to support an exemption in the annuities at issue, in Debtor's latest amended Schedule C, is stated as "11 U.S.C. § 522(b)(4)(A)(B)." There is no such section in the Bankruptcy Code. The Court construes this as a claim of exemption based on 11 U.S.C. § 522(b)(4), and its subsections (A) and (B).
Section 522(b)(4) states, in its entirety:
Debtor argues that § 522(b)(4) provides him with an independent basis for exemption of the annuities at issue, separate and in addition to what § 522(b)(3)(C) provides standing alone. Or, put another way, Debtor argues that § 522(b)(4) acts to expand the exemption of § 522(b)(3)(C) from what it would be under the wording of § 522(b)(3)(C) standing alone. More specifically, Debtor makes the following argument. It is true, Debtor says, that the Hartford Annuity and the Nationwide Annuity do not qualify for exemption under the language of § 522(b)(3)(C), because they are not funds or accounts that "are exempt from taxation under section 408" of the Internal Revenue Code (or under any of the other Internal Revenue Code sections listed in § 522(b)(3)(C)). These annuities are not, for example, "individual retirement annuities" as defined by Internal Revenue Code § 408(b), 26 U.S.C. § 408(b) — if they were, they would be "exempt from taxation under section 408" of the Internal Revenue Code, and therefore exempt under the language of Bankruptcy Code § 522(b)(3)(C). But, Debtor argues, these annuities
Debtor's counsel acknowledged at the December 15 hearing that § 522(b)(4)(A) does not apply to the annuities at issue. That is, the annuities are not "in a retirement fund that has received a favorable determination under section 7805 of the Internal Revenue Code of 1986," within
Before further considering Debtor's argument under § 522(b)(4)(B), the Court notes that the Creditor disputes Debtor's view about how §§ 522(b)(3) and 522(b)(4) interact. The Creditor makes a difficult argument — it argues that § 522(b)(4)(B) can never have any effect unless § 522(b)(3)(C) already applies to the annuity at issue. In substance, the Creditor argues that unless the annuity first meets the requirement under § 522(b)(3)(C), that it is exempt from taxation under one of the specified Internal Revenue Code sections (here, § 408), then § 522(b)(4)(B) has no effect or operation. Under the Creditor's view, the only time § 522(b)(4)(B) would have any effect or operation is when a fund or annuity, that otherwise is exempt from taxation under one of the specified Internal Revenue Code sections, is subject to disqualification of its tax-exempt status. The example of this that the Creditor gives is where some disqualifying transaction has occurred.
The Creditor has not briefed or fully developed its argument on this point, and has cited no authority to support its argument. The argument seems dubious. For one thing, as for the examples of disqualification given above, the very Internal Revenue Code section that would create the tax exemption for the individual retirement account or the individual retirement annuity in the first place — § 408 — also takes the tax exemption away. So, if one of the disqualification examples given above applied to an otherwise tax exempt account, it would mean that the purported individual retirement account/individual retirement annuity is not exempt from taxation under Internal Revenue Code § 408. And if that is so, then Bankruptcy Code § 522(b)(3)(C) would not apply in the first place.
What this suggests is that the Creditor's view of the interaction between
But as it turns out, it is not necessary to resolve this statutory interpretation dispute, because even under Debtor's view of how these subsections interact, Debtor fails to satisfy the requirements of § 522(b)(4)(B).
To meet the requirements of § 522(b)(4)(B), quoted above, Debtor must show that the Hartford Annuity and the Nationwide Annuity are "in substantial compliance with the applicable requirements of the Internal Revenue Code of 1986." Or failing that, Debtor must show that "the debtor is not materially responsible for" the failure of the fund to be in such substantial compliance with the Internal Revenue Code.
Debtor has failed to demonstrate either of these things. First, it is clear that neither the Hartford Annuity nor the Nationwide Annuity is "in substantial compliance with the applicable requirements of the Internal Revenue Code." The reference in this statutory provision to "the applicable requirements of the Internal Revenue Code" clearly is a reference to the requirements that the Internal Revenue Code imposes in order for the annuity to be "exempt from taxation" under one of the specific Internal Revenue Code sections listed in § 522(b)(3)(C). This is clear because § 522(b)(4) begins with, and is modified in its entirety by, the following language: "
The Hartford Annuity and the Nationwide Annuity are not in such "substantial compliance." This is because, as Debtor's counsel has admitted, neither of these annuity contracts meets the requirement of 26 U.S.C. § 408(b)(1) that "[t]he contract is not transferrable by the owner." Rather, the Hartford Annuity contract and the Nationwide Annuity contract each clearly provide that they are transferrable by the owner, Steven Sharkey.
Given that neither annuity is "in substantial compliance with the applicable requirements of the Internal Revenue Code," Debtor must demonstrate that he "is not materially responsible for that failure." 11 U.S.C. § 522(b)(4)(B)(ii)(II). Debtor has failed to demonstrate this; rather, the undisputed facts clearly show that Debtor is materially responsible for that failure. This is so, as the Creditor argues, because it was Debtor who purchased the Hartford Annuity and the Nationwide Annuity contracts, each of which contain terms that make them fail to qualify as individual retirement annuities under Internal Revenue Code § 408(b). Mr. Sharkey could have established and purchased an individual retirement account or an individual retirement annuity, which would now qualify for exemption under Bankruptcy Code § 522(b)(3)(C), but he did not do so. Instead, he purchased non-qualified annuity contracts.
In arguing that the annuities are "in substantial compliance," Debtor cites language in each of the annuity contracts, and in letters from the Hartford and Nationwide about the annuities, tending to show
In short, the contract language and letters cited by Debtor, concerning how the annuity contracts here are intended to or do comply with Section 72 of the Internal Revenue Code, do nothing to establish that the annuity contracts are in substantial compliance with Internal Revenue Code § 408.
Debtor's counsel acknowledged as much during the November 3, 2016 hearing. During that hearing, Debtor's counsel acknowledged the distinction between an annuity under Internal Revenue Code Section 72 on the one hand, and an individual retirement annuity as defined by Internal Revenue Code § 408(b) on the other hand, and acknowledged that an annuity contract's mere compliance with Internal Revenue Code Section 72 is not enough to make it exempt from taxation under Internal Revenue Code § 408, or under any of the other Internal Revenue Code sections cited in Bankruptcy Code § 522(d)(12). Such admissions apply with equal force now, because § 522(b)(3)(C) has the identical wording as § 522(d)(12).
Debtor's counsel stated the following during the November 3, 2016 hearing:
Thus, Debtor's counsel has admitted, correctly, that the mere fact that an annuity contract is covered by Internal Revenue Code § 72 does not mean that it is also covered by Internal Revenue Code § 408(b).
An annuity contract that qualifies for treatment as an individual retirement annuity under Internal Revenue Code § 408 is often referred to as a "qualified" annuity. An annuity contract that does not so qualify, and that is not part of a qualified employee benefit plan under the Internal Revenue Code, such as a 401(k) plan, is often referred to as a "non-qualified" annuity. Non-qualified Section 72 annuities are afforded favorable tax treatment in some ways, but they are different from, and do not have the same tax treatment as, qualified annuities. For a discussion of some of the differences in tax treatment between qualified annuities and non-qualified annuities, see Taxation of Annuities, in Insured
Finally, the letters from The Hartford and Nationwide, which Debtor filed on December 12, 2016, make clear that the annuities at issue here are non-qualified annuities that are not covered by any of the Internal Revenue Code sections listed in Bankruptcy Code § 522(b)(3)(C). First, the letter from Nationwide, dated December 9, 2017 and addressed to Debtor's counsel, states, in pertinent part, the following:
Contract details Owner: Steven G. Sharkey Annuitant: Steven G. Sharkey Contract number: [number redacted]
Similarly, the letter from The Hartford, also dated December 9, 2016 and addressed to Debtor's counsel, refers to the Hartford Annuity contract as "[t]he non-qualified annuity contract" and merely states that it is "in compliance with IRC Section 72."
For all of these reasons, neither the Hartford Annuity nor the Nationwide Annuity is exempt based on § 522(b)(4)(B).
The Creditor seeks sanctions against Debtor's attorneys, based on 28 U.S.C. § 1927. The Creditor argues that the attorneys' conduct in filing five amended claims of exemption, and in moving for and obtaining conversion of this bankruptcy case from Chapter 7 to Chapter 13, multiplied the proceedings unreasonably and vexatiously, causing the Creditor to incur excess attorney fees. The Creditor argues that Debtor's attorneys knew or reasonably should have known that all of the claims of exemption made for the annuities at issue were frivolous.
Under 28 U.S.C. § 1927,
The United States Court of Appeals for the Sixth Circuit recently confirmed that bankruptcy courts have authority to order relief under § 1927. See Grossman v. Wehrle (In re Royal Mgt., Inc.), 652 Fed. Appx. 330, 341-42 (6th Cir. 2016), cert. denied sub nom. Grossman v. Wehrle, No. 16-642, ___ U.S. ___, 137 S.Ct. 831, ___ L.Ed.2d ___, 2017 WL 276189 (January 23, 2017). And the Sixth Circuit recently discussed § 1927 as follows:
Knopf v. Elite Moving Systems, No. 16-1307, ___ Fed.Appx. ___, ___ 2017 WL 360555, at *4 (6th Cir. January 25, 2017) (footnote omitted).
Finally, in a recent case, the Bankruptcy Appellate Panel for the Sixth Circuit reviewed the case law and extensively described the standards applicable in the Sixth Circuit under § 1927:
Montedonico v. Blasingame (In re Blasingame), 559 B.R. 676, 686-89 (6th Cir. B.A.P. 2016) (footnote omitted).
Applying the above standards, the Court concludes that sanctions under § 1927 are not warranted in this case. While the actions of Debtor's counsel that the Creditor complains of did "multiply the proceedings," no such actions were done "in objective bad faith." And the Court cannot find that Debtor's counsel knew or should have known that any of their actions were frivolous. Nor can the Court find that the litigation tactics of Debtor's counsel "needlessly obstruct[ed] the litigation of nonfrivolous claims."
Although ultimately unsuccessful, Debtor's claims of exemption under Bankruptcy Code §§ 522(d)(12), 522(b)(3)(C), and 522(b)(4) were not frivolous. It is true that the factual record, arguments, and exemption claims evolved over the course of several hearings in this case, held over a several-month period spanning both the Chapter 7 and Chapter 13 phases of this case. But the Court cannot say that the actions of Debtor's counsel were either unreasonable or vexatious. And even if there had been any "inadvertence or negligence," or "incompetence" by Debtor's counsel over the course of these proceedings — something the Court does not need to decide — that alone would not be sufficient to permit or justify sanctions under § 1927, under the case law quoted above.
Finally, even if this Court had discretion to award sanctions under § 1927, the Court would exercise its discretion in favor of not awarding sanctions, under the circumstances of this case.
For these reasons, the Creditor's request for sanctions under § 1927 will be denied.
For the reasons stated in this opinion, the Court will enter an order sustaining the Creditor's objections to exemption, disallowing Debtor's claims of exemption in the Hartford Annuity and the Nationwide Annuity, and denying the Creditor's request for sanctions.
The terms of these two annuity contracts were discussed at length during the November 3, 2016 hearing. (See Transcript of November 3, 2016 hearing (Docket # 137) at 6-31. This hearing transcript is cited in this opinion as "11/3/16 Hr'g Tr. at ___.")