The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) added a new provision regarding personal property leases, §365(p), which provides:

(1) If a lease of personal property is rejected or not timely assumed by the trustee under subsection (d), the leased property is no longer property of the estate and the stay under §362(a) is automatically terminated.
(2) (A) If the debtor in a case under chapter 7 is an individual, the debtor may notify the creditor in writing that the debtor desires to assume the lease. Upon being so notified, the creditor may, at its option, notify the debtor that it is willing to have the lease assumed by the debtor and may condition such assumption on cure of any outstanding default on terms set by the contract.
(B) If, not later than 30 days after notice is provided under subparagraph (A), the debtor notifies the lessor in writing that the lease is assumed, the liability under the lease will be assumed by the debtor and not by the estate.
(C) The stay under §362 and the injunction under §524(a)(2) shall not be violated by notification of the debtor and negotiation of cure under this subsection.
(3) In a case under chapter 11 in which the debtor is an individual and in a case under chapter 13, if the debtor is the lessee with respect to personal property and the lease is not assumed in the plan confirmed by the court, the lease is deemed rejected as of the conclusion of the hearing on confirmation. If the lease is rejected, the stay under §362 and any stay under §1301 is automatically terminated with respect to the property subject to the lease.

Automobile leases are the most common type of personal property leases in consumer bankruptcy cases. There is confusion both among the consumer bankruptcy bar as well as among automobile lessors regarding what is required for a debtor to assume a personal property lease post-BAPCPA.

Section 365(p) was added to clarify that the automatic stay terminates upon rejection of a personal property lease and in response to the pre-BAPCPA cases that held that chapter 7 debtors could not assume a lease. See In re Rogers, 359 B.R. 591, 593 (Bankr. D. S.C. 2007).

What Is the Required Form for Intent to Assume under §365(p)(2)(A)?

Other than the requirement that the communication be in writing, the statute does not require any particular form for the notice. Unlike reaffirmation agreements, the Code does not provide detail on what form a notice of assumption should take. The practice of the author is to prepare a notice of intent to assume pursuant to §365(p), using the case caption in that specific debtors case. The notice states that the debtor is, pursuant to 11 U.S.C. §365(p), to assume the debtor’s personal property lease with the lessor. In addition, the notice identifies the vehicle with specificity and includes the lessor’s account number. It is also the practice of the author to attach a certificate of service to the notice and file it with the bankruptcy court. However, neither the Code, nor the Federal Rules of Bankruptcy Procedure, requires filing such a notice.

What Response May a Lessor Make to a Notice under §365(p)?

The statute does not provide guidance as to how the lessor is required to respond. Curiously, the statute does specify that the lessor “may, at its option, notify the debtor that it is willing to have the lease assumed by the debtor and may condition such assumption on cure of any outstanding default on terms set by the contract.” See §362(p)(2)(A).

Beyond that, the statute is unclear as to exactly how assumption occurs. In response to the initial notice pursuant to §365(p)(2)(A), if the debtor and lessor don’t reach an agreement, the debtor can then provide a second notice pursuant to §365(p)(2)(B) and the lease is then assumed.

In the event that the lessor is not willing to permit assumption and the debtor is in default under the lease, the lessor can exercise its remedies under applicable non-bankruptcy state law. Finally, §365(p)(1) provides that if the trustee does not timely assume the lease, “the leased property is no longer property of the estate and the stay under §362(a) is automatically terminated.”

There Is No Requirement for Bankruptcy Court Approval or Involvement

A number of bankruptcy courts have held that bankruptcy courts should not get involved in the assumption of a personal property lease under §365(p). See, e.g., In re Rogers, 359 B.R. 591, 593 (Bankr. D. S.C. 2007); In re Gaylor, 379 B.R. 413, 414 (Bank. D. Conn. 2007); In re Finch, 2006 WL 3900111 (Bankr. D. Colo. Oct. 2, 2006) (No. 06-14016-SBD); In re Walker, 2007 WL 1297112 (Bankr. M.D.N.C. Apr. 27, 2007) (No. 06-11514C-7G); In re Kanan, No. 07-32270 (N.D. Ohio Jun. 26, 2007); In re English, No. 07-55986 (E.D. Mich. Oct. 30, 2008); In re Jeffery, No. 08-23634 (Bankr. N.D. Ind. 2009).
 
Assumption Pursuant to §365(p)(2) Does Not Excuse Compliance with Reaffirmation Requirements under the Code

Bankruptcy courts also reasoned that §365(p) is independent of §524(c) and that §365(p) does not result in a waiver of discharge, and that to reaffirm the debtor’s obligations under the lease, a reaffirmation agreement is still necessary. In re Walker, 2007 WL 1297112 (Bankr. M.D.N.C. Apr. 27, 2007) (No. 06-11514C-7G); In re Finch, 2006 WL 3900111 (Bankr. D. Colo. Oct. 2, 2006) (No. 06-14016); In re Gaylor, 379 B.R. 413, 414 (Bank. D. Conn. 2007); In re Creighton, 2007 WL 541622 (Bankr. D. Mass. Feb. 16, 2007) (No. 06-13333); In re Finch, 2006 WL 3900111, (Bankr. D. Colo. Oct. 2, 2006) (No. 06-14016); In re Kanan, No. 07-32270 (N.D. Ohio Jun. 26, 2007).

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Since the enactment of BAPCPA, both bankruptcy and appellate courts have been split on the issue of whether debtors may deduct vehicle ownership expenses for vehicles that are not encumbered and for which debtors do not make an actual monthly loan or lease payment. To date, the Seventh Circuit Court of Appeals and four Bankruptcy Appellate Panels have ruled on this issue: Two hold that debtors may not take such deduction (Eighth and Ninth Circuits), and two panels, along with the Seventh Circuit Court of Appeals, hold that debtors may take such deduction (Sixth and Tenth Circuits). Six district courts have also published opinions on this issue, five of which deny debtors such deduction and one that allows such deduction.

Court of Appeals Opinion

• In re Ross-Tousey, No. 07-2503, Opinion (7th Cir. Dec.17, 2008): holds that a debtor who owns his car free and clear may take an ownership deduction for such vehicle.

Bankruptcy Appellate Panel Opinions

• In re Wilson, 383 B.R. 729, 734 (B.A.P. 8th Cir. 2008), holds that debtors are not “allowed a deduction for vehicle ownership expense if such expense [is] not in fact being incurred.”
• Ransom v. MBNA America Bank N.A. (In re Ransom), 380 B.R. 799 (B.A.P. 9th Cir. 2007), holds that such expenses are not applicable if debtors do not incur actual vehicle ownership expenses.
• In re Kimbro, 389 B.R. 518 (B.A.P. 6th Cir. 2008), holds that “debtor[s] may deduct an ownership expense for a vehicle regardless of whether the debtor has a debt or lease payment on that vehicle.”
• Pearson v. Stewart (In re Pearson), 390 B.R. 706 (B.A.P. 10th Cir. 2008), holds that debtor may “take the ownership expense deduction for their fully owned vehicle.”

District Court Opinions

• In re Armstrong, 395 B.R. 127 (E.D. Wash. 2008), allows the deduction of vehicle ownership expense for a vehicle that debtor owns outright.
• Grossman v. Sawdy, 384 B.R. 199 (E.D. Wis. 2008), holds that debtors must actually make ownership or lease payments for ownership expenses to be applicable.
• Wieland v. Thomas, 382 B.R. 793 (D. Kan. 2008), disallows transportation ownership deduction when debtors do not make any vehicle payments.
• U.S. Tr. v. Deadmond (In re Deadmond), No. CV 07-15-H-CCL, 2008 U.S. Dist. LEXIS 4426 (D. Mont. Jan. 21, 2008), holds that a statute allows deduction for vehicle ownership expenses for debtors who have loan or lease payments.
• Meade v. McVay (In re McVay), 384 B.R. 132 (W.D. Tex. 2008), holds that debtors must “qualify for a [vehicle ownership] deduction by having an existing ownership or lease payment.”
• Fokkena v. Hartwick (In re Hartwick), 373 B.R. 645 (D. Minn. 2007), holds that debtors must have a loan or lease obligation to deduct vehicle ownership expense.

Section 522(c) of the Bankruptcy Code states that “unless the case is dismissed, property exempted under this section is not liable during or after the case for any debt of the debtor that arose, or that is determined under §502 of this title as if such debt had arisen, before the commencement of the case” with certain limited exceptions. Section 522(l) states that “unless a party in interest objects, the property claimed on (Schedule C) is exempt.” Rule 4003(b) gives creditors 30 days after the initial meeting of creditors in which to object. The Supreme Court has held that the statute and rule mean what they say, that is, that failure to make a timely objection precludes a challenge, even if there was no colorable basis for the exemption. Taylor v. Freeland & Kronz, 503 U.S. 638 (1992).   

The court noted that “deadlines may lead to unwelcome results, but they prompt parties to act and they produce finality.” 503 U.S. at 287. However, several recent cases have demonstrated that the finality produced by the exemption statute may not be all encompassing.    These cases have allowed claimants to recover property claimed as exempt despite the failure to raise a timely objection. The cases have arisen in three areas: claims of ownership, constructive trust and fraudulent conveyance.

Ownership
The ownership cases are the easiest to explain. The Code allows a debtor to claim property of the estate as exempt. If the property is not property of the estate, it is not property that can be exempted. Additionally, the exemption is to remove the property from the estate and insulate it from claims of creditors. However, it does not determine disputed claims of title. Rule 7001(2) states that “a proceeding to determine the validity…of a(n)…interest in property” must be determined by adversary proceeding.     
A recent case made this point with this humorous example: Just in case there is any confusion, let’s suppose I claim an exemption on the Brooklyn Bridge, and you fail to timely object to my exemption claim. Is the sainted bridge thus exempt? Technically, §522(l) says it is.    But of course, what difference does my exemption claim make if Hizzoner, Mayor [Michael] Bloomberg, comes to court and successfully establishes that, in fact, the Brooklyn Bridge is not my bridge to claim, but is safely still property of the City of New York, safely untarnished by my exercise in hubris? None at all, you correctly reply, none at all. In re Rendon, No. 06-52501 (Bankr. W.D. Tex. 2007) (unpublished).   

Constructive Trust
Related to the title concept is the constructive trust. Under a constructive trust, property acquired through fraud or other wrongdoing is treated as though it is held in trust by the title holder for the benefit of the party wronged. Section 541(d) provides that if the estate holds legal but not equitable title to property, the beneficial interest does not become property of the estate.    Thus, if the beneficial interest is not property of the estate, it is not subject to being claimed as exempt.    

Numerous cases hold that a valid constructive trust claim will take priority over a claimed exemption. Davis v. Cox, 356 F.3d 76 (1st Cir. 2004) (equitable interest prevented funds from entering estate); In re Financial Federated Title and Trust Inc., 347 F.3d 880 (11th Cir. 2003); In re Gouge, 2008 Bankr. LEXIS 261 (Bankr. S.D. Tex. 2008); In re Huie, 2007 Bankr. LEXIS 2614 (Bankr. E.D. Tex. 2007); In re Agnew, 2005 Bankr. LEXIS 3118 (Bankr. D. Mt. 2005); In re Hecker, 316 B.R. 375 (Bankr. S.D. Fla. 2004).   
Most of the cases previously cited involved timely filed objections to exemptions.    However, Abramowitz v. Palmer, 999 F.2d 1274 (8th Cir. 1993) squarely addressed the failure to object to an exemption. The court concluded:

Ms. Palmer asserts, however, that because the bankruptcy trustee failed to object to the exemption of the home from the bankruptcy proceedings the home effectively “fell out” of the bankruptcy estate.   We agree.   In Taylor v. Freeland & Kronz, the Supreme Court held that failure to object to a debtor’s claim of exemption within the 30-day time limited prescribed by Bankruptcy Rule 4003(b) precludes trustees and creditors from challenging the exemption of that property after the 30 days have expired. In this case, Dr. Palmer claimed the Missouri home as exempt and thus it did not remain part of the bankruptcy estate for distribution as neither the trustee nor any creditor filed an objection. We agree that the trustee is now precluded from including the Missouri home in Dr. Palmer’s bankruptcy estate.   999 F.2d at 1276-77.    

However, the exemption did not protect the property from the party asserting the constructive trust. These cases offer a limited exception for the benefit of the defrauded party, but do not help the trustee or general creditors of the estate. This is consistent with the statutory principle that the equitable interest in property subject to a constructive trust does not enter the estate.    

However, when the bankruptcy trustee was the defrauded party, the trustee could assert the constructive trust claim against property, which would have otherwise been exempt under state law. In Matter of McClain, 516 F.3d 301 (5th Cir. 2008), the debtor failed to disclose funds on hand on the petition date. He then purchased an insurance policy on his father’s life. After the death of the father, the trustee learned about the insurance policy and sought to recover the proceeds. The bankruptcy court granted summary judgment, ruling that use of undisclosed funds would not give rights to the trustee. The Fifth Circuit reversed, finding that the trustee had an interest under the constructive trust doctrine.

Texas law, which is applicable in this case, follows the majority of jurisdictions in holding that “a person who wrongfully uses stolen or fraudulently obtained funds to purchase an insurance policy shall hold that policy and its proceeds in trust for the benefit of the one from whom the funds were stolen or taken.” (citations omitted) “This may be true even where a statute protects the proceeds of insurance policies from actions by creditors.” (citation omitted) Thus, under Texas law, the use of funds wrongfully obtained to make premium payments on an insurance policy creates a property interest in the proceeds of that policy on behalf of the owner of the funds wrongfully obtained. 516 F.3d at 313.

Fraudulent Transfer
The intersection of exemption law and fraudulent transfer law raises some difficult issues. If property has been fraudulently transferred to the debtor, it starts off as property of the estate and thus may be claimed as exempt. However, the cases illustrate that being able to claim an exemption is not the same as being able to retain the property claimed as exempt. The fraudulent transfer cases involve several different scenarios:

(a)        The debtor has fraudulently transferred the property away but attempts to claim an exemption in the transferred property.
(b)        The debtor has fraudulently converted nonexempt property into exempt property.
(c)        Property has been fraudulently conveyed to the debtor, who claims it as exempt.

The first scenario is the easiest to resolve. If the debtor transferred property away, but claims it as exempt in the event that it is later recovered by the trustee or as a prophylactic measure to keep the trustee from recovering the property, the exemption is precluded by the Code. In In re Woodin, 294 B.R. 436 (Bankr. D. Ct. 2003), the debtor transferred property to her husband, but also claimed it as exempt. The trustee did not object to the exemption, but did file an adversary proceeding to recover the property. The husband sought summary judgment on the basis that his wife had claimed the property as exempt and the trustee had not objected. The court rejected the argument, stating: “The court concludes that Taylor does not control this proceeding because the transferred property sought to be exempted was not an asset of the debtor’s estate on the petition date or any time subsequent.” Id. at 439.  

The second scenario involves a transfer that converts nonexempt property into exempt property. In In re Bossart, 2007 Bankr. LEXIS 4349 (Bankr. S.D. Tex. 2007), aff’d, 389 B.R. 511 (S.D. Tex. 2008), aff’d, 2008 U.S. App. LEXIS 21807 (5th Cir. 2008), the debtors purchased an exempt annuity on the eve of bankruptcy. The trustee did not object to the exemption, but later sued the company that issued the annuity to recover the payment. The insurance company paid the funds into the registry of the court. The bankruptcy court found that the funds could be recovered because they were transferred with the intent to hinder, delay or defraud creditors.    The bankruptcy court did not expressly consider whether the funds were exempt. The district court found that the funds used to purchase the annuity were not the same as the annuity itself and that the trustee was not stopped from recovering the funds based on the failure to object. The Fifth Circuit affirmed these rulings.    

The Bossart rulings represent lazy reasoning. The fraudulent conveyance suit against the insurance company was nothing less than a collateral attack upon the exemption. While the insurance company was technically a transferee of the debtor’s funds, the debtors exchanged those funds for an annuity. If the funds used to purchase the annuity are recovered, then the annuity will go away as well. This conclusion is reinforced by the fact that Texas law allows creditors to challenge an exemption based on that it was obtained with the intent to hinder, delay or defraud creditors. In re Soza, 542 F.3d 1060 (5th Cir. 2008). Where Texas substantive law imposed a limitation on the ability to claim an exemption based on fraudulent intent, the trustee should not have been able to make an end run around §522 by suing the issuer of the annuity rather than the debtors.

The Tenth Circuit had a more thoughtful analysis of the issue in In re Duncan, 329 F.3d 1195 (10th Cir. 2003). In that case, the debtor had owned property in his own name and then transferred it to himself and his wife as tenants by the entireties. He claimed the property as exempt both as entireties property and under the Wyoming homestead exemption. No one objected. The trustee then recovered the property. At this point, the debtor sought to assert his exemption. The bankruptcy court granted the debtor his $10,000 homestead exemption. The Tenth Circuit ruled that the debtor could not claim an exemption on property that was voluntarily transferred and then recovered by the trustee pursuant to 11 U.S.C. §522(g). It then turned to the question of whether recovery of the property was precluded by the failure to object. The court concluded that where the limitations period to object to an exemption was 30 days and the limitations period to recover fraudulently transferred property was two years, the two limitations periods could be reconciled by giving the trustee the longer period in which to seek recovery. The court stated:

We are mindful that the basic premise of Taylor has been affirmed in this circuit (citation omitted). Yet that case did not involve an adversary proceeding to recover property voluntarily and fraudulently transferred. An objection to exemptions is not tantamount to an action to recover exempt property (citation omitted). Accordingly, we hold that debtor is not entitled to claim a homestead exemption in property voluntarily transferred and recovered by the trustee in an adversary proceeding notwithstanding the trustee’s failure to object within the 30-day period of Fed. R. Bankr. P. 4003(b). Id. at 1203-04.

In the final scenario, property is transferred to the debtor, who files bankruptcy and claims the property as exempt. Under §522(l), failure to object would render the property as exempt, which would mean that under §522(c), the property would not be subject to the claims of prepetition creditors. Unlike the conversion of nonexempt property cases, the bankruptcy trustee would not have a claim to the property. The fraudulent transfer claim would belong to the creditors of the transferee. Under §101(5) and (10), a creditor is an entity that has a claim, including a right to payment of money. Since most fraudulent conveyance statutes give the plaintiff the right to recover the value of the transfer, the party seeking recovery would clearly be a creditor. Since exempt property is not liable for claims of a creditor, would the property then be protected from a fraudulent conveyance claim? To the extent that a fraudulent conveyance claim is analyzed as being something different from an objection to exemptions, the answer would be no. However, unlike the constructive trust cases, the debtor would hold both legal and equitable title.  The better practice would certainly be to file a timely objection to exemption.

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