For over nine years, the co-authors of this column, both Chapter 11 business bankruptcy specialists, have reported myriad topics involving distressed businesses that utilize (or at least attempt to) the Bankruptcy Code to restructure or orderly wind up their affairs. In 2018, we examined bankruptcy topics such as the use of opt-out provisions in Chapter 11 plans related to substantive consolidation of debtor entities, whether a bankruptcy case should be dismissed because the debtor filed its bankruptcy petition in bad faith, and the scope of discovery allowed in bankruptcy cases under Federal Rule of Bankruptcy Procedure 2004. We also reported on cases where unusual situations had to be reconciled with bankruptcy law principles, including whether a television network should be allowed to keep millions in advertising revenue from a company utilized as a Ponzi scheme, whether a retired couple who grew marijuana, in compliance with legalization rules under Colorado law but still illegal under federal law, should be allowed to utilize federal bankruptcy law to obtain a discharge of debts, and whether the Philadelphia Parking Authority should be liable for emotional distress damages when it twice impounded a debtor's car in violation of the automatic stay, once when the debtor was visiting his terminally ill mother-in-law in Puerto Rico.

Today we report on a case where a Chapter 7 trustee took the position that a 74-year-old man suffering from various illnesses, who was thrown in jail on a bench warrant and was told by deputy sheriffs “your body or your money,” voluntarily paid the bench warrant amount if the only other choice he was given was to remain in jail. In In re Schmitt, Case No. 18-21755, Bankruptcy Judge Beth E. Hanan of the U.S. Bankruptcy Court for the Eastern District of Wisconsin, in an 11-page decision, decided the answer was “no.”

'I'm Stuck in Folsom Prison … And Time Keeps Draggin' On'

The court began its opinion by noting “What Wayne Schmitt faced was no Johnny Cash song.” He paid a bench warrant rather than remain in jail. One day later, he filed a Chapter 7 bankruptcy petition, only to have the chapter 7 trustee object to the debtor's attempt to exempt the payment when avoided as a preference. The background is the stuff of country songs.

Schmitt was sued in small claims court and a bench warrant was issued for his arrest on Oct. 2, 2017. The warrant provided that Schmitt could either pay the judgment in full ($3,713.38) or provide his 2015 and 2016 tax returns, bank account statements, property tax bills and all corporate documents for entities in which he was a shareholder, partner or member to the plaintiff's attorney. Schmitt alleged he attempted to send the documents, but apparently they were not received. On Feb. 28, 2018, two county sheriff deputies arrived unannounced and took the 74-year-old man to jail. According to the opinion, at the jail, the deputies informed Schmitt “… they wanted 'his body or his money,' and gave him no other alternatives to satisfy the warrant.”

Schmitt later testified that he borrowed the funds to pay the warrant from Alyce Head, a relative, and paid $4,016 (including jail ATM fees). The docket in the small claims court action reflects payment of the judgment on Feb. 28, 2018, and cancellation of the warrant.

Schmitt filed his Chapter 7 bankruptcy petition the next day. The filing of a bankruptcy petition commencing a bankruptcy case creates a bankruptcy estate that includes the debtor's property. A Chapter 7 trustee is appointed to administer the estate for the benefit of the debtor's creditors. However, a debtor may claim certain property as exempt under Section 522 of the Bankruptcy Code.

Schmitt listed the payment as a preference on his schedules of assets, and claimed an exemption in the amount of the preferential payment, meaning if the payment was avoided, then Schmitt, not the bankruptcy estate, would receive the funds. The trustee objected to the exemption, arguing that the debtor could not avoid the payment because, among other things, the payment was made voluntarily.

'Look What You Made Me Do … Look What You Just Made Me Do'

A debtor can avoid a prepetition payment pursuant to Section 522(h) of the Bankruptcy Code if two conditions are met: the transfer would be avoidable by the trustee and the trustee does not attempt to avoid the transfer; and the debtor could have exempted the property under Section 522(g). Section 522(g), in turn, allows a debtor to exempt property recovered by the trustee only if the debtor did not transfer the property voluntarily.

It appears the trustee did not dispute the payment was avoidable as a preference under Section 547 of the Bankruptcy Code. In fact, he sent a letter to the transferee demanding turnover of the payment it had received from the debtor. As to whether the trustee would not attempt to avoid the transfer, the court noted in a footnote that either the trustee or the debtor would pursue avoidance of the payment depending on the court's decision.

The issue was whether the payment was voluntary. The trustee argued that the court adopt a bright line definition of a “voluntary transfer” as one made of the debtor's own volition and in the absence of fraud or other unlawful conduct by the creditor. The debtor argued that the payment was involuntary because it “involved a heavy dose of coercion,” since the only alternative was to remain in jail and was not made of Schmitt's own free will.

The court noted the Bankruptcy Code does not define the term “voluntary,” and there is little legislative history. The court observed the general rule that “… an involuntary transfer occurs when property is transferred by operation of law, such as by means of an execution of judgment, repossession, or garnishment.” The court then reviewed cases it viewed as somewhat analogous to Schmitt's situation. First, in Via v. Colonial American National Bank (In re Via), 107 B.R. 91 (Bankr. W.D. Va. 1989), the court found a payment to avoid wage garnishment was made involuntarily. In In re Hill, 566 B.R. 891 (Bankr. W.D. Mich. 2017), a “court agent more like a bounty hunter” sought to enforce a seizure order. The agent arrived unannounced to seize the debtor's property. The encounter began with the agent threatening to shoot the debtor's dog. As a result, Hill's family members gathered cash and paid several thousand dollars to the agent. Not surprisingly, the court found the payment was not voluntary. Finally, in a more conventional setting, in In re Yarber, 522 B.R. 328 (Bankr. D. Or. 2014), the court found that bail bond payments were not voluntary if they prevented incarceration.

Here, the court concluded that Schmitt's payment was involuntary. Two deputies took Schmitt to jail and offered him no alternative but to pay. The court wrote, “Mr. Schmitt faced immediate severe consequences: loss of liberty or loss of funds.” The court concluded that the payment was made by operation of law and an involuntary act under Section 522(g).

Conclusion

Bankruptcy courts are faced every day with applying provisions of the Bankruptcy Court to real world situations that were not contemplated by the drafters of the statute. That being said, it would be difficult to imagine that the drafters of these provisions of the Bankruptcy Code intended a payment by a 74-year-old man to get out of jail made when told by sheriff's deputies “your money or your body” was voluntary. The co-authors have reviewed hundreds of case decisions over the past nine years, but this one clearly fell into the category of “you can't make this stuff up.” We wish all of you a healthy and happy New Year.

Andrew C. Kassner is the chairman and chief executive officer of Drinker Biddle & Reath, a national law firm with more than 635 lawyers in 12 offices. He chaired the corporate restructuring group for almost 20 years. He can be reached at [email protected] or 215-988-2554.

Joseph N. Argentina Jr. is an associate in the firm's corporate restructuring practice group in the Philadelphia and Wilmington, Delaware, offices. He can be reached at [email protected] or 215-988-2541.