Mark Bradshaw’s e-Bulletin re Shapiro v. Henson

Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:

SUMMARY

In Shapiro v. Henson (9th Cir. January 9, 2014), in a published decision, the United States Court of Appeals for the Ninth Circuit reversed the district court’s ruling affirming the bankruptcy court’s denial of a trustee’s motion for turnover pursuant to 11 U.S.C. § 542(a).  The Ninth Circuit held that a 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.  Click here http://cdn.ca9.uscourts.gov/datastore/opinions/2014/01/09/11‑16019.pdf to read this published decision.

FACTS

In a case of first impression in the Ninth Circuit, the Ninth Circuit addressed whether a trustee’s turnover power is solely restricted to recovering bankruptcy estate property, or its value, from entities having possession, custody, or control of such property at the time the motion for turnover is filed or whether a trustee may seek turnover from an entity that had possession, custody, or control of the subject property at any time during the bankruptcy case. 

The facts of the case are as follows.  Barbara Henson filed a Chapter 7 bankruptcy petition.  On the petition date, Henson had a checking account with $6,955.19.  Henson had written several checks drawn on this account before bankruptcy which the bank honored after the petition date.  Brian Shapiro (the bankruptcy trustee) sent Henson a letter demanding turnover of the funds that had been in her bank account.  Henson denied being in possession of the funds.  Shapiro then filed a motion for turnover under 11 U.S.C. § 542(a) against Henson to recover $6,155.19 of her petition‑date account balance (i.e., the full amount on the petition date less an $800 exemption).

The bankruptcy court denied the motion because Henson did not have possession or control of the funds at the time Shapiro filed the motion for turnover.  Shapiro appealed and the district court affirmed.  Shapiro then appealed to the Ninth Circuit.

HOLDING

The Ninth Circuit held that a trustee may seek recovery from entities having “possession, custody, or control” of the property sought if the property was in the entity’s possession, custody, or control at any point during the pendency of the bankruptcy case.

REASONING

Section 542(a) states in part that “[A]n entity . . . in possession, custody, or control, during the case, of [property of the estate, or exempt property], shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value or benefit to the estate.”  Relying heavily on the text of the statute, the Ninth Circuit found that the phrase “during the case” means that a trustee may bring a motion for turnover against an entity so long as that entity had possession of that property at any point during the bankruptcy case.  In further support of this reading the Ninth Circuit noted that the phrase “or the value of such property” indicates that the entity need not be in possession of the property itself when the trustee files the motion for turnover.

The Ninth Circuit also found the pre Code dua method system for turnover significant, noting that possession at the time of a plenary (i.e., not enforced via motion for contempt) turnover motion’s filing was not required, even though present possession in a summary proceeding is required.  The Ninth Circuit also noted the practical challenge to trustee where any Section 542 motion could be defeated by a transfer of possession of the subject property.

AUTHOR’S COMMENT

While the Ninth Circuit’s decision provides a clear rule and is based on a logical reading of Section 542(a), the practical implications could be significant.  In Newman v. Schwartzer (In re Newman), 487 B.R. 193 (9th Cir. BAP 2013), cited by the Ninth Circuit, a chapter 7 debtor failed to list an income tax refund on his bankruptcy schedules and then spent the tax refund when it was received.  The BAP (properly) granted the trustee’s turnover motion even though the tax refund monies were no longer in the debtor’s possession.  In fact, the debtor’s conduct could have been subject to more severe penalties including denial of discharge. 

Based on the Ninth Circuit’s decision, Henson is now subject to the same rule though her situation is more sympathetic.  She did not fail to disclose assets – she simply filed a chapter 7 petition at a time when she had pending checks that had not yet cleared her bank account.  Henson’s situation is probably common, and the Ninth Circuit’s decision will now subject otherwise innocent debtors to turnover of funds they do not have and likely cannot obtain.  In a practical sense, before filing a bankruptcy petition debtors will have to ensure that all pending checks clear or they will have to stop payment on all checks prior to the filing.

The Ninth Circuit’s decision also expands the potential targets for turnover motions.  Before the Ninth Circuit’s decision, entities in possession of estate property could expect a demand letter or turnover motion from a trustee (or debtor in possession).  Now the universe has clearly expanded to entities which had such possession, custody or control of estate property at any time during a bankruptcy case.

These materials were written by Mark Bradshaw of Shulman Hodges & Bastian, LLP, in Irvine, California (mbradshaw@shbllp.com).  Editorial contributions were provided by ILC member Ori Katz of Sheppard Mullin in San Francisco, California (OKatz@sheppardmullin.com). 

Thank you for your continued support of the Committee.

Best regards,Insolvency Law Committee