Are funds seized prepetition by a creditor, and now in the possession of the Sheriff, Property of the Estate?

tentative from Judge Maureen Tighe re the issue of whether funds seized by a creditor but still in possession of the Sheriff are property of the estate.

1:18-13040 Eric Rodriguez Chapter 7

Motion By Debtor For Order Authorizing And Instructing the Riverside County Sheriff’s Office to Return Levied Funds to Debtor

On December 13, 2018, Eric Rodriguez (“Debtor”) received a notice from his bank (“Chase”) that it had received a bank levy in the amount of $14,301.57 from the Riverside County Sheriff’s Office (the “Sheriff”) on behalf of judgment creditor Freddy Harrison. Debtor filed this case as a chapter 13 on December 20, 2018.  The Sheriff then sent Debtor a notice acknowledging the bankruptcy filing, but indicating that if Debtor wanted the funds to be returned, he must seek an order from the Bankruptcy Court; otherwise, the funds would be turned over to the Trustee. The total being held by the Sheriff is $11,367.68 (the “Funds”).

Debtor files this motion seeking the return of the Funds held by the Sheriff under the Court’s equitable powers.  The funds are not claimed as exempt.  The case has been converted to chapter 7, and the trustee has now filed a no asset report. Creditors Veronica Gamm, Marina Noorall, and Fredy Harrison (“Creditors”) filed an opposition to the Motion. They argue that the funds are not exempt and the claim is not dischargeable.  Creditors further argue that “title in the funds transferred immediately to Plaintiffs” upon the levy.

An execution lien arises upon service of a writ of execution and notice of levy. Cal. Civ. Proc. Code § 700.140(b). While the execution lien is in effect, there are limits placed upon withdrawals and payments of checks. Cal. Civ. Proc. Code § 700.140(d). That execution lien terminates when the funds levied upon are paid to the levying officer. Cal. Civ. Proc. Code § 700.140(f).

There is a complex body of authority regarding whether the funds are owned by the debtor or by the levying creditor once the levied funds are paid to the levying officer.  As the lead case on the issue states, “[a]lthough [CCP § 700.140] suggests that debtor’s interest in the funds was transferred when the funds were paid to the levying officer and the lien terminated, the statute does not plainly say so.”  In re Hernandez, 483 B.R. 713, 721 (B.A.P. 9th Cir. 2012).  The analysis in bankruptcy cases has turned on whether Debtor has an exempt property interest or other rights under applicable law, which must be determined on a case-by-case basis.  In re Hernandez, 483 B.R. at 724.  Construing the same provisions of California statutory law at issue here, the Hernandez court determined that levied funds were property of the estate because debtor had an automatic exemption in the funds because they were largely traceable to social security income. Id. at 723.  The BAP therefore ruled that because debtor had an exempt property interest in the funds, the creditor’s “levy did not operate to extinguish those interests.” Id. at 724.  “In short, debtor had grounds to recover the exempt funds and could have challenged the levy in the state court prepetition on that basis.” Id. at 725.

The Court in In re Massey faced almost identical facts. 2013 WL 1282032 (Bankr. S.D. Cal. Mar. 26, 2013). In Massey, a chapter 7 debtor brought a motion for turnover of funds in her bank account that was subject to a levy by the Los Angeles County Sheriff’s Department. Id. at *1. The Court found that a chapter 7 debtor did not have standing to file a turnover motion under § 542, relying on the decision in Hernandez, 483 B.R. 713. The Court then considered whether to treat Debtor’s motion as a motion to avoid a lien under § 522(f) due to impairment of an exemption, but found it to be procedurally defective.  The court further found that, even if the property were estate property, that no lien existed to avoid because the funds had already been levied on and the lien had terminated under Cal. Civ. Proc. Code § 700.140(e) (now subsection (f)). Id. at *1.

The Court in In re Paul, 85 B.R. 850, 853 (Bankr. E.D. Cal. 1988), held that a notice of levy filed by the California State Board of Equalization under Cal. Rev. & Tax Code § 6703 transferred ownership interest in the funds to the Board, and the money was therefore not property of the estate. Id. at 853. Section 6703 states that “the notice of levy shall have the same effect as a levy pursuant to a writ of execution.” Id. The Paul stated in dicta that “it is doubtful that a judgment debtor would have any interest in the amounts in the deposit account which are the subject of the levy [under C.C.P. § 700.140.]” Id. at FN 3.

Debtor argues that Creditors have an affirmative duty to return levied property to the bankruptcy estate. That duty arises under § 542(a). In re Del Mission Ltd., 98 F.3d 1147, 1151 (9th Cir. 1996); In re Knaus, 889 F.2d 773, 775 (8th Cir. 1989); United States v. Whiting Pools, Inc., 462 U.S. 198 (1983). Section 542(a) states as follows:
(a) Except as provided in subsection (c) or (d) of this section, an entity, other than a custodian, in possession, custody, or control, during the case, of property that the trustee may use, sell, or lease under section 363 of this title, or that the debtor may exempt under section 522 of this title, 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.
11 U.S.C.A. § 542(a)(emphasis added). Section 542 does not require the turnover of nonestate property, as reflected by a number of the cases cited by Creditors. Debtor cites the Ninth Circuit’s unpublished decision in Bayley for the proposition that failure to carry out the affirmative duty to return levied property to the debtor is a violation of the automatic stay.  In re Bayley, 678 F. App’x 593 (9th Cir.), cert. denied sub nom. The Best Serv. Co. Inc. v. Bayley, 138 S. Ct. 174 (2017). The 9th Circuit’s decision in Bayley leaves out important facts that were addressed at greater length in the lower courts’ rulings on that case, including that the property was claimed to be fully exempt.  See In re Bayley, 2015 WL 224720, at *1 (C.D. Cal. Jan. 14, 2015), aff’d, 678 F. App’x 593 (9th Cir. 2017); In re Bayley, 2014 WL 12701505, at *4 (Bankr. C.D. Cal. Oct. 6, 2014).

Here, it appears that Debtor had ten days from the date he was served with the notice of levy to file a claim of exemption. C.C.P. § 703.520(a). The notice of levy was received by Debtor on December 13, 2018. Debtor’s bankruptcy was filed on December 20, 2018– before the expiration of the ten days allowed by statute. Therefore, Debtor still had the ability to file a claim of exemption with respect to the Funds on the petition date. The “wildcard” exemption under C.C.P. § 703.140(b)(5) is only available to debtors in bankruptcy. See C.C.P. § 703.140(a). Is there any other exemption that Debtor might have claimed under applicable state law? If so, that right to a claim of exemption constitutes a “legal or equitable interest[] of the debtor in property as of the commencement of the case” within the meaning of § 541(a), and is therefore property of the estate.

Where are the Funds now? Have they been paid to the levying officer, or are they still frozen in Debtor’s bank account with the execution lien still in effect? If the lien is still in effect, the Funds are clearly still property of the estate, but are likely subject to a security interest. The Court needs more information from the parties.

If the Debtor still had an opportunity to claim an exemption under state levy procedures, for example, the funds would be property of the estate under Whiting Pools, but they may be subject to a security interest by the Creditors. United States v. Whiting Pools, Inc., 462 U.S. 198, 211 (1983)(“When property seized prior to the filing of a petition is drawn into the Chapter 11 reorganization estate, the Service’s tax lien is not dissolved; nor is its status as a secured creditor destroyed.”).

The Court acknowledges that, while the debtor has not claimed any exemption in the funds, he has the right to amend his schedules. However, the Funds would have to enter the bankruptcy estate before the Debtor could exempt them.
Lastly, if the Funds are estate property, the Court would not order them to be turned over to the Debtor without abandonment of the property by the chapter 7 trustee. Debtor states that Trustee has “relinquished interest in the funds,” but it is unclear what that means. Section 554(c) of the Bankruptcy Code provides that “any property scheduled under section 521(a)(1) of this title not otherwise administered at the time of the closing of a case is abandoned to the debtor and administered for purposes of section 350 of this title.” Debtor scheduled the funds in his schedule A/B, but the case has not been closed. It follows that the property has not been abandoned.

Conclusion
It is unclear on this record whether the Funds are property of the estate. If they are, it is further unclear whether the Funds are subject to a security interest. The parties should come prepared to discuss these issues, particularly those raised by the BAP’s decision in Hernandez and the issue of available exemptions. Further briefing may be required.

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