In re: Larry Edward Wood et al
MEMORANDUM OPINION AND ORDER: Directing that the decision of the Bankruptcy Court be AFFIRMED. Signed by Judge Irene C. Berger on 12/16/2019. (cc: attys; any unrepresented party) (msa)
IN THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF WEST VIRGINIA
LARRY EDWARD WOOD, et al.,
U.S. DEPARTMENT OF HOUSING AND
URBAN DEVELOPMENT (HUD),
CIVIL ACTION NO. 5:19-cv-00302
(Consolidated with Civil Action No. 5:19-cv-303)
LARRY EDWARD WOOD and
JESSICA ANN WOOD,
MEMORANDUM OPINION AND ORDER
The Court has reviewed the Memorandum Opinion and Order (Document 1-1), the
Judgment Order (Document 5-14), Opening Brief of the Appellant U.S. Department of Housing
and Urban Development (HUD) (Document 6), Brief of the Debtors/Appellees, Larry Edward
Wood and Jessica Ann Wood (Document 7), and Reply Brief of the Appellant U.S. Department of
Housing and Urban Development (HUD) (Document 10). After careful consideration, the Court
finds that the decision of the Bankruptcy Court should be affirmed.
FACTUAL AND PROCEDURAL BACKGROUND
On September 9, 2008, the Plaintiffs borrowed $39,739.44 to purchase a modular/mobile
home. 1 In the case of default, the loan was insured by the United States Department of Housing
The facts of this case are uncontested.
and Urban Development (HUD). The Plaintiffs ultimately defaulted on the loan on July 31, 2014.
HUD paid the deficiency remaining after default on November 18, 2015—an amount totaling
$23,066.66. On November 20, 2015, HUD notified the Plaintiffs of the deficiency and made a
demand for payment.
In December 2015, HUD issued the Plaintiffs a Notice of Intent to Collect by Treasury
Offset, informing them that the United States Department of the Treasury (the “Treasury”) could
offset the Plaintiffs’ tax overpayment amounts against the debt owed to HUD. On February 23,
2017, the Treasury Offset Program used $9,961.00 of federal tax overpayment to offset the amount
of debt owed to HUD, leaving a remaining balance owed to HUD of $15,486.47 plus interest.
On March 21, 2018, the Plaintiffs filed a bankruptcy petition, and subsequently filed their
federal and state income tax returns on March 26, 2018. The returns demonstrated a federal
income tax overpayment of $6,086 and a state income tax overpayment of $316. The Treasury
used the income tax overpayment to offset the Plaintiffs’ remaining debt to HUD on April 4, 2018.
No offset was made using the state tax overpayment.
The Plaintiffs filed a complaint on May 17, 2018, seeking avoidance of HUD’s lien and
refund of the offset funds remitted to HUD. The Bankruptcy Court entered a Memorandum
Opinion on March 31, 2019, and a Judgment Order on April 15, 2019, ordering the United States
to pay the Plaintiffs $6,086. On April 15, 2019, the United States appealed the decision of the
STANDARD OF REVIEW
“When reviewing a decision of the bankruptcy court, a district court functions as an
appellate court and applies the standards of review generally applied in federal courts of appeal.”
Paramount Home Entm’t Inc. v. Circuity City Stores, Inc., 445 B.R. 521, 526−27 (E.D. Va. 2010)
(citing In re Webb, 954 F.2s 1102, 1103−04 (5th Cir. 1992)). Legal conclusions are reviewed de
novo and factual findings are reviewed for clear error. In re Harford Sands Inc., 372 F.3d 637,
639 (4th Cir. 2004). A clearly erroneous factual finding exists when the reviewing court “is left
with the definite and firm conviction that a mistake has been committed” after considering all the
evidence. Anderson v. City of Bessemer City, 470 U.S. 564, 573 (1985) (quoting United States v.
United State Gypsum Co., 333 U.S. 364, 365 (1948)). For mixed questions of fact and law, the
factual portions are reviewed for clear error and the legal portions are reviewed de novo. Gilbane
Bldg. Co. v. Federal Reserve Bank of Richmond, Charlotte Branch, 80 F.3d 895, 905 (4th Cir.
Federal law permits setoffs, meaning “entities that owe each other money [can] apply their
mutual debts against each other, thereby avoiding ‘the absurdity of making A pay B when B owes
A.’” Citizens Bank of Md. v. Strumpf, 516 U.S. 16, 18 (1996) (quoting Studley v. Boylston Nat.
Bank, 229 U.S. 523, 528 (1913)). Section 553(a) of the Bankruptcy Code governs setoffs, and
states in pertinent part:
(a) Except as otherwise provided in this section and sections 362 and
363 of this title, this title does not affect any right of a creditor to
offset a mutual debt owing by such creditor to the debtor that arose
before the commencement of the case under this title against a claim
of such creditor against the debtor that arose before the
commencement of the case . . . .
11 U.S.C. § 553(a). A valid setoff requires proof of four elements: (1) the creditor’s claim arose
before commencement of the case; (2) the creditor’s debt to the debtor arose before the
commencement of the case; (3) the claim and debt must be mutual; and (4) the claim must be valid
and enforceable. Id.; see also U.S. Dept. of Agriculture Rural Housing Svc. v. Riley, 485 B.R.
361, 365 (W.D. Ky. 2012). “Section 553 does not actually create any setoff rights, but merely
preserves the setoff rights that exist under applicable nonbankruptcy law.” In re Addison, 533
B.R. 520, 525 (Bankr. W.D. Va. 2015), aff’d, No. 1:15-cv-00041, 2016 WL 223771 (W.D. Va.
Jan. 19, 2016); see also Strumpf, 516 U.S. at 20.
The Tax Offset Program (TOP) allows the Federal Treasury to apply tax overpayments to
pre-existing debts owed to federal agencies—in this case, HUD. 26 U.S.C. § 6402. Section
6402(d), which outlines the rule for collection of debts owed to federal agencies, provides:
(1) In general. —Upon receiving notice from any Federal agency
that a named person owes a past-due legally enforceable debt . . . to
such agency, the Secretary shall—
(a) reduce the amount of any overpayment payable to such person
by the amount of such debt;
(b) pay the amount by which such overpayment is reduced under
subparagraph (a) to such agency; and
(c) notify the person making such overpayment that such
overpayment has been reduced by an amount necessary to satisfy
26 U.S.C. § 6402(d); see In re Sexton, 508 B.R. 646, 525 (Bankr. W.D. Va. 2014) (Connelly, J.).
However, Section 522 of the Bankruptcy Code allows debtors to “exempt certain property
from the bankruptcy estate, meaning the debtor retains that property outside the reach of creditors.”
United States v. Copley, 591 B.R. 263, 277 (E.D. Va. 2018). Section 522 exemptions apply to
“any property that is exempt under [f]ederal law . . . or [s]tate or local law that is applicable on the
date of the filing of the petition. . .” 11 U.S.C. § 522(b)(3). The local law involved in this case
is W. Va. Code § 38-10-4, which provides in pertinent part:
Pursuant to the provisions of 11 U.S.C. § 522(b)(1), this state
specifically does not authorize debtors who are domiciled in this
state to exempt the property specified under the provisions of 11
U.S.C. § 522(d).
Any person who files a petition under the federal bankruptcy law
may exempt from property of the estate in a bankruptcy proceeding
the following property:
(a) The debtor’s interest, not to exceed twenty-five thousand dollars
in value, in real property or personal property that the debtor or a
dependent of a debtor uses as a residence . . .
(e) the debtor’s interest, not to exceed in value eight hundred dollars
plus any unused amount of the exemption provided under subsection
(a) of this section in any property.
W.Va. Code § 38-10-4.
“Once a debtor files a bankruptcy petition, the automatic stay of 11 U.S.C. § 362(a) arises
to protect debtors by providing them with ‘a breathing spell’ and also to protect creditors by
‘promoting orderly and fair distribution among creditors.’” Addison, 533 B.R. at 524 (quoting
Shaw v. Ehrlich, 294 B.R. 260, 267 (W.D. Va. 2003). The automatic stay “protects debtors not
only from the commencement or continuation of legal actions against them, but also from any acts
to obtain possession of, create or enforce liens against, or collect assets included in the debtor’s
estate.” Sexton, 508 B.R. at 657 (noting that the “stay is the most powerful protection the
Bankruptcy Code affords debtors”).
These statutes give rise to two issues in the present case: (1) whether a debtor’s tax
overpayment becomes property of the estate and hence protected by the stay, and (2) whether, if
part of the debtor’s estate, the debtor may exempt the overpayments under § 522 of the Bankruptcy
Code and thereby defeat a governmental creditor’s right to setoff under § 553 of the Bankruptcy
Code and the TOP codified at 26 U.S.C. § 6402.
The Bankruptcy Court held that the Debtors’ tax overpayment became property of the
estate protected by the stay because it vested in the estate at midnight on December 31, 2017, and
because the treasury did not act to offset the debt owed to HUD until after the Debtors’ bankruptcy
petition was filed. Furthermore, the Bankruptcy Court, following the case law within the Fourth
Circuit, held that the Debtors’ right to exempt their tax overpayment under § 522 trumps the
governmental right of offset under § 553 and § 6402. The Bankruptcy Court noted that “since the
Woods listed their anticipated 2017 federal tax refund on their Schedule A/B and exempted
portions of it on Schedule C, those exempted portions are not available for setoff by HUD. The
nonexempted portions, however, would, inter alia, be available for setoff should HUD wish to
pursue a stay lift.” (Bankr. Op. at 6.) The Bankruptcy Court also held that “§ 522(c) [of the
Bankruptcy Code] prevents a creditor from exercising its setoff rights against properly exempted
tax overpayments.” Id. at 7.
After careful consideration of the relevant issues, the Court finds that the decision of the
Bankruptcy Court should be affirmed.
A. The Tax Overpayment Became Part of the Bankruptcy Estate
The Court must first determine whether the Debtors’ tax overpayment became part of the
bankruptcy estate, subject to the protections of the automatic stay. Copley, 591 B.R. at 277;
Addison, 533 B.R. at 526−27. Courts have held that a tax overpayment becomes property of the
taxpayer “at midnight on December 31 of the taxable year in which the payment occurred.”
Copley, 591 B.R. at 278; Sexton, 508 B.R. at 662. “Absent specific action by the United States
regarding the Debtors’ overpayment—i.e., absent the United States completing the statutorily
authorized offset under § 6402—before midnight on December 31 [of the taxable year] the
Debtors’ property interest in the overpayment vested at that time.” Copley, 591 B.R. at 278.
Moreover, because the government had not acted to set off the overpayment by the time
the Debtors filed their bankruptcy petition, the tax overpayment became subject to the provisions
of the Bankruptcy Code upon the filing of the bankruptcy petition. Copley, 591 B.R. at 277
(“Upon filing for bankruptcy, all of the Debtors’ property, including the . . . overpayment, became
part of the bankruptcy estate, and by extension, subject to the provisions of the Bankruptcy
Code.”). If the taxpayer files for bankruptcy prior to the government employing the offset
provisions, “the debtor’s interest in the property at that time vests in the bankruptcy estate. If,
thereafter, the government wants to use the overpayment for a setoff under section 6402, it must
first get relief from the stay or act under an applicable exception enumerated in section 362(b).”
Sexton, 508 B.R. at 658 n.14.
The Court recognizes that there is a circuit split on this issue. 2 Some courts have held that
tax overpayments are contingent property interests that do not become part of the bankruptcy estate
if the tax overpayment is less than preexisting debt owed. In re Gould, 401 B.R. 415, 425 (9th
Cir. B.A.P. 2009), aff’d 603 F.3d 1100 (9th Cir. 2010), cert. denied, 562 U.S. 1030 (2010); In re
Luongo, 259 F.3d 323, 335 (5th Cir. 2001). Section 6402 allows the United States to offset tax
overpayments against pre-existing liabilities owed to it. 26 U.S.C. § 6402. Additionally, under
the Bankruptcy Code, § 553 allows creditors to offset debts that existed prior to filing a petition
2 “Compare Sexton, 508 B.R. at 662-64 (ruling that the government’s post-petition setoff of the debtor’s tax
overpayment to non-tax federal debt was a violation of the automatic stay because the debtor’s interest in her tax
overpayment was property of the bankruptcy estate and was properly exempted by the debtor), with Riley, 485 B.R.
at 365-67 (ruling that the debtors were never entitled to a tax refund because their governmental debts exceeded their
tax overpayment and therefore, the debtors had no refund that became property of the bankruptcy estate that could be
claimed as exempt).” Addison, 533 B.R. 520, 528.
for bankruptcy. 11 U.S.C. § 553(a). These provisions have been read together to hold that such
tax overpayments constitute contingent claims and do not become part of the bankruptcy estate.
See Gould, 401 B.R. 415; Luongo, 259 F.3d at 335 (noting that if “the prior unpaid tax liability
exceeded the amount of the overpayment, the debtor was not entitled to a refund and the tax refund
did not become property of the estate”); Riley, 485 B.R. at 365−67.
However, a “majority of courts” have determined that tax overpayments become part of
the bankruptcy estate. Copley, 591 B.R. at 279; Sexton, 508 B.R. at 668; Addison, 533 B.R. at
531. That tax overpayments become part of the bankruptcy estate is further bolstered by other
provisions of the Bankruptcy Code.
Under the Bankruptcy Code, “Section 541(a) defines
property of the estate liberally to include all of the debtor’s property interests, no matter who
controls or possesses the property or where it is located.” Addison, 533 B.R. at 529 (quoting
Sexton, 508 B.R. at 658); see also Owen v. Owen, 500 U.S. 305, 308 (1991); Copley, 591 B.R. at
279. “Section 541(b) sets forth certain property interests that are excluded from the bankruptcy
estate. This court finds it instructive that nowhere in Section 541(b) . . . does Congress exclude a
debtor’s interest in his tax overpayment or right to a refund.” Addison, 533 B.R. at 529 (quoting
Sexton, 508 B.R. at 662); United States v. Whiting Pools, Inc., 462 U.S. 198, 205 (1983); In re
Yonikus, 996 F.2d 866, 869 (7th Cir. 1993) (“[T]he term property has been construed most
generously and an interest is not outside its reach because it is novel or contingent or because
enjoyment must be postponed. . . . In fact, every conceivable interest of the debtor, future,
nonpossessory, contingent, speculative, and derivative, is within the reach of § 541.”) (internal
quotation marks omitted).
As such, the Court finds that the Debtors’ tax overpayment was property that became part
of the bankruptcy estate on December 31, 2017, and protected by the automatic stay at the time
the Debtors filed the bankruptcy petition on March 21, 2018.
B. Section 522 Exemption Trumps Section 553 Setoff in This Case
The tax overpayment at issue in this case is subject to the competing provisions of § 522
and § 553 of the Bankruptcy Code.
“An apparent conflict exists between § 553, which
unqualifiedly preserves the right of offset, and § 522(c), which provides that property claimed
exempt is not liable for prepetition debts.” Copley, 591 B.R. at 281. Courts have reached
conflicting conclusions concerning both the interaction between § 522 and § 553 and the “effect
of a taxpayer’s filing bankruptcy while the government is in the process of executing an offset
pursuant to § 6402.” Id. at 274−75. 3
The Fourth Circuit has not yet resolved the conflict between the exemption provisions
under § 522 and tax offset provisions under § 553 and § 6402. 4 Copley, 591 B.R. at 274.
However, “it is settled law within the Fourth Circuit that a properly-claimed exemption trumps a
creditor’s right to offset mutual prepetition debts and liabilities.” Sexton, 508 B.R. at 662 (citing
In re Moore, 350 B.R. 650 (Bankr. W.D. Va. 2006), 656; In re Ward, 210 B.R. 521, 536 (Bankr.
E.D. Va. 1997)); see also Copley, 591 B.R. at 279; Addison, 533 B.R. at 531.
3 Compare, e.g., Addison, 533 B.R. at 520 (concluding § 6402 setoff rights are subject to the automatic stay); Sexton,
508 B.R. at 646 (concluding that a properly claimed exemption under § 522 supersedes § 553), with Gould, 401 B.R.
at 424 (holding that under § 6402 a debtor is only entitled to a tax refund to the extent her overpayment exceeds her
unpaid tax liability); Luongo, 259 F.3d at 335 (holding that a tax refund does not vest in the bankruptcy estate until
after application of § 6402(a), such that only the remainder after applying the offset is part of the bankruptcy estate
protected by the stay); Riley, 485 B.R. at 365.
4 However, a case involving the issue is currently pending appeal to the Fourth Circuit, so this may be soon resolved.
See Copley v. United States, 591 B.R. 263, No. 18-2347 (4th Cir., Nov. 9, 2018).
This Court will review the Bankruptcy Court’s decision to “disallow a setoff for abuse of
discretion.” Copley, 591 B.R. at 275; see also In re Larbar Corp., 177 F.3d 439, 447 (6th Cir.
1999)); Gould, 401 B.R. at 421. On review, “a bankruptcy court necessarily abuses its discretion
if it bases its decision on an erroneous view of the law or clearly erroneous factual findings.”
Gould, 401 B.R. at 429. In a factually analogous case, the reviewing court determined “[i]t would
be difficult to find that a court weighed these competing interests, as the Bankruptcy Court did
here, abuses its discretion when ultimately deciding between allowing or disallowing a § 553
offset.” Copley, 591 B.R. at 282. For the following reasons, the Court affirms the Bankruptcy
Court’s finding that the exemption provision under § 522 applies to disallow a setoff under § 553
in this case.
First, courts have construed the general rule established by § 553(a)—that the Bankruptcy
Code does not affect setoff rights existing prior to the filing of a bankruptcy petition—to be
permissive rather than mandatory. Strumpf, 516 U.S. at 20; Copley, 591 B.R. at 276.
“Historically, allowing setoff under the Bankruptcy Code remained within the equitable discretion
of the court presiding over the bankruptcy action, rather than mandatory.” Copley, 591 B.R. at
284 (citing Cumberland Glass Mfg. Co. v. De Witt, 237 U.S. 447, 455 (1915); In re Alexander,
255 B.R. 145, 147 (W.D. Ky. 1998)). This permissive quality allows courts to recognize when
compelling circumstances exist for disallowing the setoff under § 553 if the debtor properly
exempts the property prior to the setoff being invoked. Id. In this case, the competing exemption
provisions of § 522 constitute one such compelling circumstance.
Second, when faced with conflicting statutes, the more specific statute governs over the
more general statute. Morton v. Mancari, 417 U.S. 535, 550-51 (noting that “a specific statute
will not be controlled or nullified by a general one”). In this case, the “general rule” contained in
§ 553 is less specific than the exemption provision under § 522, which looks to specific state and
local laws to determine the applicable exemption rules. See 11 U.S.C. § 522(b)(3); W.Va. Code
§ 38-10-4. Under this reasoning, the exemption provision under § 522 applies to the Debtors’ tax
overpayment in this case.
When two statutes conflict, the court should interpret the statutes in a way that gives effect
to both provisions. Husted v. A. Philip Randolph Institute, 138 S.Ct. 1833, 1842 (2018) (quoting
Ricci v. DeStefano, 557 U.S. 557 (2009)). While this argument cuts both ways, “the majority
position [is] that interpreting § 522 to supersede § 553 would give meaning to both provisions in
more circumstances than the reverse.” Copley, 591 B.R. at 286. “Were the Court to allow § 553
to supersede § 522, the likely effect would be to broadly nullify exemptions claimed under § 522.”
Id. at 286.
Last, as noted by the Bankruptcy Court, interpreting the exemption provisions in § 522 to
trump the offset provisions in § 553 furthers the overarching goals of federal bankruptcy law. The
Supreme Court has recognized two fundamental goals of federal bankruptcy law: giving the debtor
a fresh start and ensuring efficiency and fairness among creditors. Stellwagen v. Clum, 245 U.S.
605, 617 (1918); Katchen v. Landy, 382 U.S. 323, 328 (1966); (Bankr. Op. at 6) (“Rather than
allow a chaotic race to judgment or other remedies, the Code established procedures for, priorities
of, and practices relating to, creditors and their respective recoveries from the estate. Indeed, . . .
a contrary result poses a considerable threat to settled bankruptcy principles and policies.”). As
such, finding that § 522 applies in this case furthers the overall goals of the Bankruptcy Code.
In sum, the Court finds that § 522 of the Bankruptcy Code trumps the offset provisions of
§ 553 of the Bankruptcy Code and § 6402 of the TOP. As such, the Bankruptcy Court correctly
concluded that the Debtors are entitled to recover the $6,086 tax overpayment at issue in this case.
C. Stay Provisions under Section 326 Specifically Exempt “Income Tax Liability”
The stay provisions of the Bankruptcy Code further reinforce the Court’s conclusion that
the Debtors’ tax overpayments were not subject to the offset. Under the Bankruptcy Code, §
326(b)(26) “constrains the reach of the automatic stay by excepting from violating the automatic
stay, the setoff under applicable nonbankruptcy law of an income tax refund . . . against an income
tax liability.” Addison, 533 B.R. at 529 (quoting Sexton, 508 B.R. at 662). Because the statutory
provision is worded to except an income tax refund against income tax liability, presumably debts
owed to other federal agencies are not included in the exception. Id. (quoting Sexton, 508 B.R. at
663) (noting that “[u]nder the statutory canon of construction expressio unius est exclusio alterius,
Congress’s specific inclusion of the phrase ‘income tax liability’ excludes the application of the
provision to non-tax liabilities”). Because Congress did not choose to omit “the modifier ‘income
tax’ before the word ‘liability’” the Court agrees with other decisions within this circuit finding
that debts owed to other federal agencies are not exempted from the automatic stay. Sexton, 508
B.R. at 663. As such, the Court finds that the Debtors’ tax overpayment was protected by the
D. Retroactive Annulment of the Stay
The United States argues in the alternative that even if the automatic stay applied and was
violated by offsetting the tax overpayment, the United States nevertheless has a right to seek a
retroactive modification of the automatic stay to allow the offset. However, the Court finds that
retroactive annulment of the automatic stay is improper in this case.
The bankruptcy judge has the discretion to decide whether to lift the automatic stay.
Sexton, 508 B.R. at 666. Equity “weighs heavily against the party seeking an annulment” of an
automatic stay. Id. Courts have found it proper to retroactively annul an automatic stay for
innocent violations—such as where the creditor is unaware of the automatic stay or the violation
of the automatic stay is a technicality. Id. In this case, however, the United States was aware
that the Debtors had filed for bankruptcy yet moved to intercept and withhold the Debtors’ tax
overpayment anyway. Id. (finding that an analogous fact pattern did not warrant retroactive
annulment of the automatic stay).
Thus, the Court finds that retroactive annulment of the automatic stay is not equitable in
this case. Accordingly, the Bankruptcy Court’s decision to return the tax overpayment to the
Debtors is affirmed.
Wherefore, after careful consideration the Court ORDERS that the decision of the
Bankruptcy Court be AFFIRMED.
The Court DIRECTS the Clerk to send a certified copy of this Order to counsel of record
and to any unrepresented party.
ENTER: December 16, 2019
Disclaimer: Justia Dockets & Filings provides public litigation records from the federal appellate and district courts. These filings and docket sheets should not be considered findings of fact or liability, nor do they necessarily reflect the view of Justia.
Why Is My Information Online?