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IN RE ESPELUND

June 30, 1959

In the Matter of Maynard Chris ESPELUND, whose wife's name is Maxine Fay Espelund, Bankrupt


The opinion of the court was delivered by: LINDBERG

This matter is before the court on petition of Pacific Finance Company, a corporation, a creditor of the bankrupt, for review of an order of the referee preserving to the trustee under § 70, sub. e(2) of the Bankruptcy Act, 11 U.S.C.A. § 110, sub. e(2) a mortgage lien on certain personal property claimed exempt by the bankrupt. The subject lien was created contractually on April 28, 1958 by the bankrupt giving to the petitioner a chattel mortgage on certain household furniture to secure the repayment of a loan then given in the amount of $ 500. The chattel mortgage was not filed as required by the laws of the State of Washington, RCW 61.04.020.

On October 9, 1958 the bankrupt filed his voluntary petition in bankruptcy, scheduling his debt to petitioner as a secured obligation. By an amendment to Schedule B-5 filed November 28, 1958 bankrupt listed as property claimed exempt from the operation of the Act all of the household goods covered by the above-mentioned mortgage, giving as its value the amount of $ 500.

 On December 2, 1958 the referee in bankruptcy entered an order decreeing that the lien of petitioner was void as to the trustee but preserved for the benefit of bankrupt's estate, and that the trustee succeeded to and could enforce the chattel mortgage.

 Also on December 2, 1958 the referee entered an order confirming in all respects the trustee's report on exempt property. Because some confusion existed as to just what was declared exempt by said report and order, an order of clarification was entered January 15, 1959, holding that all of the property claimed exempt was of a value of less than $ 500, but was still subject to said mortgage to which the trustee has been subrogated. *fn1"

 Since it is admitted by all parties that the chattel mortgage here involved was not duly filed the mortgage, then, was properly subject to being declared void as to the trustee under § 70, sub. e(1) of the Act. The referee, in ordering the lien of said mortgage preserved for the benefit of the estate and subrogating the trustee to the rights of the mortgagee held that such order was specifically authorized by Congress in 1952 when it amended § 70, sub. e(2) of the Act. Thus, the only question to be decided on this review is whether said amendment authorizes such an order with respect to exempt property.

 Section 70 of the Act deals principally with the bankruptcy trustee's title. It has been recognized that without an enactment of this sort the successful conduct of a debtor's liquidation would be impossible. As stated in Collier on Bankruptcy, 'In order to remove the bankrupt's remaining property from his hands and to facilitate the proper disposal of the same in the interests of his creditors, it is essential that the liquidation officer -- the bankruptcy trustee -- be given full title to such property with all the rights appertaining thereto, and that any property not to be dealt with in the proceeding be carefully excluded.' *fn2" Subdivision a of § 70, with great detail, provides for the vesting of title to all the bankrupt's non-exempt property in the trustee, and, significantly, emphasizes the exclusion of the bankrupt's exempt property. Section 47, sub. a(6) of the Act, 11 U.S.C.A. § 75, sub. a(6) sets forth the rights and duties of the trustee in bankruptcy with respect to exemptions of the bankrupt. He must estimate and determine the value of the exemptions claimed. He must make an itemized report and thereafter set the exemptions off to the bankrupt. As further stated in Collier on Bankruptcy, 'Since under the terms of § 70a of the Act the trustee has no title to exempt property, he may not retain such property and deprive the bankrupt of his exemption on the ground that certain creditors claim superior rights to it.' *fn3"

 Section 70, sub. e(1) of the Act declares that a transfer made or suffered by a debtor adjudged a bankrupt under the Act, which, under any federal or state law applicable thereto, is fraudulent as against or voidable for any other reason by any creditor of the debtor, having a claim provable under the Act, shall be null and void as against the trustee of such debtor. Subsection e(2), in its entirety, reads:

 
'All property of the debtor affected by any such transfer shall be and remain a part of his assets and estate, discharged and released from such transfer and shall pass to, and every such transfer or obligation shall be avoided by, the trustee for the benefit of the estate: Provided, however, That the court may on due notice order such transfer or obligation to be preserved for the benefit of the estate and in such event the trustee shall succeed to and may enforce the rights of such transferee or obligee. The trustee shall reclaim and recover such property or collect its value from and avoid such transfer or obligation against whoever may hold or have received it, except a person as to whom the transfer or obligation specified in paragraph (1) of this subdivision is valid under applicable Federal or State laws.'

 The proviso sentence was added by the 1952 amendment. As indicated, the referee construed this amendment as authorizing the order entered. The trustee seeks to sustain this interpretation. It is the petitioner's contention, on the other hand, that as the property involved was reported exempt by the trustee and confirmed by the referee the only power the bankruptcy court has over said property is the power to set it aside to the bankrupt; that it does not have authority to determine the validity of liens or claims which third persons may have to or upon exempt property.

 Clearly, the Act before the amendment did not authorize the type of order here entered nor is such claimed. Although the subdivision states that 'All property of the debtor' affected by such a transfer shall be discharged from the obligation the sentence wherein those words are contained must be read in whole. When so read it states that all property so affected shall pass to the trustee for the benefit of the estate. But exempt property does not pass to the trustee for the benefit of the estate. In the absence of the amendment the trustee or indeed any creditor of the bankrupt could assert that the chattel mortgage, being unfiled, would be void as to him, but it would be an idle act for the debtor could assert his right of exemption as against all creditors except the mortgagee, and has done so here. The debtor could not prevail against the mortgagee for it is well settled in Washington that an unfiled chattel mortgage is good between the parties. Watson v. First National Bank, 82 Wash. 65, 143 P. 451.

 Although § 70, sub. e is silent about exempt property before the 1952 amendment it was wholly ineffective with respect to exempt property for the reasons just indicated. The question, then, is whether Congress intended by virtue of the 1952 amendment to make said subdivision effective with respect to exempt property.

 No case has been cited, nor has the court been able to find one, construing the meaning of the 1952 amendment to said subdivision as here applied. Legislative history of the amendment seems limited to the remarks contained in House Report No. 2320, 82nd Congress, 2nd Session (1952) at page 16. *fn4" Nothing in said report indicates an intent on the part of Congress to give meaning to § 70, sub. e by virtue of the amendment which would expand the rights of creditors through the trustee to the exempt property of the bankrupt. The clear meaning of the intent of Congress gleaned from said report is that provision is made whereby the trustee may be subrogated to the rights of the transferee or obligee, whenever the need arises, so that the benefits intended for the estate by striking down a lien or transfer do not thereby pass on to a junior incumbrancer or junior interest not entitled thereto. In other words, when a voidable mortgage is declared void as to the trustee it hardly benefits the estate if there exists a junior mortgagee or other interest junior to the mortgage or transfer declared void, who, by the very act of the trustee in declaring the first transfer or obligation void, is elevated to the rank of first mortgagee or incumbrancer. The junior interest is not entitled to this windfall because he took his security subject to the then existing voidable security (if he did not, he would not be junior). But elevated in rank he is in the absence of the proviso added by the 1952 amendment. This, as evidenced by the House Report, is what Congress sought to prevent.

 Prior to the enactment of this amendment Jacob I. Weinstein, the then Chairman of the National Bankruptcy Conference, commenting on the proposed amendments, in the Journal of the National Association of Referees in Bankruptcy, indicated that this type of situation was the need for said amendment and would be corrected thereby. *fn5" After the enactment of the amendment Samuel C. Duberstein, Referee in Bankruptcy for the Eastern District of New York, in the same journal commented on this amendment and cited two cases -- White v. Steinman, 2 Cir., 120 F.2d 799, and In re Andrews, 7 Cir., 172 F.2d 996, both decided before the amendment -- where the amendment would have been particularly applicable. *fn6" Both of those cases involved the situation where the striking down of one lien or obligation had the effect of elevating a junior interest in the property to a higher rank.

 This, it seems, is the sort of situation discussed in the House Report, supra. But that is not the situation presented here. In the case at bar there is no 'junior interest' which would obtain an tee striking down the petitioner's mort-unearned windfall by virtue of the trusgage lien. Here, in the absence of the 1952 amendment, we would merely have an order declaring the chattel mortgage void as to the trustee. This would merely be a declaration of a status existing by virtue of Washington law. But this status could not benefit the bankrupt's estate because the property is exempt from the operation of the Act and the title thereof does not vest in the trustee. If it could not benefit the estate there can exist no need for preservation so as to prevent the 'benefit' from passing on to some ...


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