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7 8 UNITED STATES DISTRICT COURT 9 FOR THE EASTERN DISTRICT OF CALIFORNIA 10 11 In re: LEONARD E. HUTCHINSON and SONYA No. 1:18-cv-01631-NONE

C. HUTCHINSON,

12 Debtors.

MEMORANDUM OPINION RE

13 BANKRUPTCY APPEAL

UNITED STATES OF AMERICA,

14

15 Appellant,

16 v.

17

LEONARD E. HUTCHINSON (JAMES

18 EDWARD SALVEN, CHAPTER 7 TRUSTEE),

19 Appellee. 20 21 22 23 I. INTRODUCTION 24 Before the Court is an appeal filed by the Internal Revenue Service (“the government” or “IRS”), 25 challenging a bankruptcy court decision denying the government’s motion to compel a bankruptcy 26 trustee to abandon property. (See Doc. No. 7.) The bankruptcy court’s denial of the motion to abandon 27 hinged on whether certain estate property, namely a primary residence located in Orosi, California, was 28 of inconsequential value to the estate, under the law, based on the property’s encumbrances. (Doc. No. 1 2 motion to abandon. (Id.) The court finds it appropriate to rule on the government’s appeal of that order 3 without oral argument. See Fed. R. Bankr. P. 8019(b)(3); see also Local Rule 230(g). For the following 4 reasons, the government’s appeal will be denied and the judgment of the bankruptcy court will be 5 affirmed. 6 II. BACKGROUND 7 Sonya and Leonard Hutchinson (“debtors”) filed for bankruptcy under 11 U.S.C. § 701 et seq., 8 commonly known as chapter 7.2 (Doc. No. 7 at 7.) Included among the bankruptcy estate’s property is 9 the debtors’ primary residence located in Orosi, California (“the property”). Id. at 10. The estimated 10 market value of that property is $190,000. (Doc. No. 7-10 at 073.) After satisfaction of an outstanding 11 deed of trust, as well as certain “transaction[ ] costs” associated with its sale, the property’s net worth to 12 the estate is estimated at $110,000-120,000. (Id.) After the deed of trust, the next encumbrances on the 13 property are the following five secured IRS liens: 14 Recording Date Tax Interest on Tax Penalty 15 05/23/2011 $0.00 $6,450.15 $44,500.11 16 05/23/2011 $62,913.27 $17,794.31 $87,599.43 17 07/25/2011 $40,436.77 $11,403.79 $30,549.31 18 06/14/2016 $67,050.11 $4,938.42 $42.00 19 06/14/2016 $36,337.67 $2,052.10 $0.00 20 Total: $206,737.82 $42,638.77 $162,690.85 21 22 (Doc. No. 7 at 9.) 23 ///// 24 1 Specific page citations to Doc. No. 7 in this order refer to the ECF-generated pagination in the upper 25 right-hand corner of the document header. Citations to the government’s Appendix, Doc. Nos. 7-1 26 through 7-13, use the government’s pagination, as do citations to Doc. No. 8.

27 2 The government does not dispute the bankruptcy court’s findings of fact concerning the value of the property at issue or the IRS liens and agrees that only a question of law is presented by this appeal. 28 (Doc. No. 7 at 6.) Likewise, appellee raises no factual disputes. (Doc. No. 8.) 1 2 abandonment of the Orosi property, arguing that the property is of inconsequential value to the estate 3 based on the above encumbrances. (Doc. No. 7 at 8, 7-5 at 013-014.) Put differently, according to the 4 government, the property is of little or no value in the bankruptcy context because no funds would 5 remain to pay unsecured creditors after payment of the senior deed of trust and the secured tax liens if 6 the property is sold. (Id.) 7 The trustee, James Salven (“trustee”), opposed abandonment of the Orosi property, and on 8 November 14, 2018, the bankruptcy court conducted a hearing on the government’s motion. (Doc. No. 9 7-10.) The bankruptcy judge ruled from the bench and issued a minute order denying the government’s 10 motion to abandon, after finding that the Orosi property was not inconsequential to the bankruptcy 11 estate. (Id. at 11-12.) A written order also followed on November 16, 2018. (Doc. No. 7 at 11.) 12 The bankruptcy court’s ruling was grounded upon its adoption of the trustee’s position as to how 13 the above-described IRS liens should be treated under chapter 7. (Doc. No. 7-10 at 18.) Its ruling found 14 (or at least impliedly found), and no party disputes, that the penalty portions of each lien are “avoided” 15 by operation of the Bankruptcy Code and therefore are not paid as part of the process of satisfying 16 secured creditors. (Id.) The bankruptcy court also found, on a point that is disputed on appeal, that the 17 penalty portion of each lien listed above must be preserved (i.e., set aside) for the benefit of unsecured 18 creditors “lien-by-lien” and that the set-aside funds are not simply paid out to satisfy the unavoided 19 portion of the next-in-line secured IRS lien. (See id.) As a result of this finding, and for reasons set 20 forth in greater detail below, a smaller portion of the IRS’s liens (the non-avoidable portions) would be 21 treated as secured debt, with the remainder rendered an unsecured debt subject to different (and 22 potentially disadvantageous) treatment by the trustee. For the same reason, and because at least some 23 funds would be set aside for satisfaction of unsecured creditors, the bankruptcy court found that the 24 property was not of inconsequential value to the estate and therefore should not be abandoned. (Id.) 25 On November 27, 2018, the government filed its notice of appeal. (Doc. No. 7 at 11.) The 26 appellant government’s brief on appeal was filed March 9, 2019, and the appellee trustee’s brief was 27 submitted on April 8, 2019. (Doc. Nos. 7, 8.) On April 22, 2019, the government filed its reply. (Doc. 28 ///// 1 2 complete and the appeal ready for decision. (Doc. No. 10.) 3 III. JURISDICTION 4 The bankruptcy court had jurisdiction in this matter under 28 U.S.C. §§ 1334 and 157. This 5 Court has jurisdiction to decide this appeal under 28 U.S.C. § 158. 6 IV. ISSUE 7 Whether the bankruptcy court erred in denying the government’s motion to abandon property of 8 the bankruptcy estate based on the determination that avoided and preserved penalty portions of liens 9 were not of inconsequential value to the estate. 10 V. STANDARD OF REVIEW 11 A bankruptcy court’s conclusions of law are reviewed de novo, and its findings of facts are 12 reviewed for clear error. In re Johnston, 49 F.3d 538, 540 (9th Cir. 1995); see also In re Anastas, 94 13 F.3d 1280, 1283 (9th Cir. 1996). “A finding is clearly erroneous if it is ‘illogical, implausible, or 14 without support in the record.’ ” In re Gill, 574 B.R. 709, 714 (B.A.P. 9th Cir. 2017) (quoting Retz v. 15 Samson (In re Retz), 606 F.3d 1189, 1196 (9th Cir. 2010)). 16 “Once a bankruptcy court has determined that the factual predicates for abandonment under 17 11 U.S.C. § 554(a) are present, the court’s decision to authorize or deny abandonment is reviewed for 18 abuse of discretion.” In re Johnston, 49 F.3d at 540 (quoting In re K.C. Machine & Tool Co., 816 F.2d 19 238, 244 (6th Cir.1987)); see also In re Consolidated Nevada Corporation, 778 Fed. Appx. 432, 436 20 (9th Cir. 2019).3 “A bankruptcy court abuses its discretion if it applies the wrong legal standard or its 21 findings are illogical, implausible or without support in the record.” In re Gill, 574 B.R. at 714 (quoting 22 TrafficSchool.com, Inc. v. Edriver Inc., 653 F.3d 820, 832 (9th Cir. 2011)); see also In re Marshall, 721 23 F.3d 1032, 1039 (9th Cir. 2013). 24 ///// 25 ///// 26 ///// 27 3 Citation to this unpublished Ninth Circuit opinion is appropriate pursuant to Ninth Circuit Rule 36– 28 3(b). 1 2 A. Legal Context 3 A trustee appointed to administer an estate in chapter 7 bankruptcy proceedings is charged by 4 statute with “collect[ing] and reduc[ing] to money the property of the estate.” 11 U.S.C. § 704. “[T]he 5 trustee’s duty is to maximize the assets of the bankruptcy estate to allow maximum recovery for the 6 debtor’s creditors.” In Re Feiler, 218 F.3d 948, 952 (2000). But property may be abandoned, rather 7 than reduced to money, if the encumbrances on the property render it valueless to unsecured creditors 8 after the encumbrances and administrative costs are satisfied. In re Bolden, 327 B.R. 657, 667 (C.D. 9 Cal. 2005). Under 11 U.S.C. § 554, the property must be “burdensome to the estate” or “of 10 inconsequential value and benefit to the estate” in order to be abandoned and may be so abandoned upon 11 the initiative of the trustee or pursuant to a court order directed at the trustee, if requested by a party in 12 interest. 11 U.S.C. § 554. In both instances notice and a hearing are required. Id. 13 A trustee also has the power to “avoid” certain liens, i.e. certain encumbrances, when 14 administering a bankruptcy estate. See, e.g., 11 U.S.C. §§ 724, 726. This modifies the general rule that 15 “[s]ecured liens pass through bankruptcy unaffected.” In re Schlegel, 526 B.R. 333, 342 (B.A.P. 9th 16 Cir. 2015). “For example, statutory liens that are not perfected or enforceable on the date of the 17 bankruptcy petition against a bona fide purchaser are voidable.”4 In re Berg, 188 B.R. 615, 618 (B.A.P. 18 9th Cir. 1995) (citing 11 U.S.C. § 545). The particular statutory category of avoidable liens relevant 19 ///// 20 ///// 21 ///// 22

23 4 No dispute has been raised in this matter regarding perfection of the IRS tax liens at issue. Such liens operate as follows: 24 A federal tax lien is a statutory lien. A tax lien in favor of the United States 25 arises by operation of law if a person is unable to pay a tax liability after 26 demand for payment is made. The lien attaches to all real and personal property of the taxpayer. Moreover, this statutory lien is perfected against 27 a taxpayer without the necessity of filing a Notice of Federal Tax Lien.

28 In re Berg, 188 B.R. 615, 618 (B.A.P. 9th Cir. 1995) (internal citations and footnote omitted). 1 2 §§ 724(a) and 726(a)(4) allow a chapter 7 trustee (but not the debtor or a third party) to avoid a lien to 3 the extent the lien secures the claim for a penalty, including a tax penalty.”). 4 As explained below, avoided liens are preserved for the benefit of the estate automatically under 5 § 551, whether they arise from penalties or another category.6 The legislative history of § 551 clarifies 6 that Congress intended, in part, to “prevent[] junior lienors from improving their position at the expense 7 of the estate when a senior lien is avoided.” In re Van de Kamp’s Dutch Bakeries, 908 F.2d 517, 519 8 (9th Cir. 1990). This latter point is critical to the Court’s analysis and parties’ contentions in this appeal. 9 The court is mindful that § 551 is meant “to increase the assets of the bankruptcy estate.” Id. (internal 10 quotations and citation omitted). 11 Upon avoidance of a lien, the trustee “steps into the shoes of the former lienholder . . . and 12 enjoys the same rights in the property that the original lienholder . . . enjoyed.” In re Lebbos, No. ADV 13 11-2386-RSB, 2012 WL 6737841, at *14 (B.A.P. 9th Cir. Dec. 31, 2012). This means “a trustee who 14 avoids an interest succeeds to the priority that interest enjoyed over competing interests.” In re Van de 15 Kamp’s Dutch Bakeries, 908 F.2d at 519. 16

17 5 Title 11, § 724(a) states that “[t]he trustee may avoid a lien that secures a claim of a kind specified in 18 section 726(a)(4) of this title.” Section 726(a)(4) specifies, in turn:

19 … [P]roperty of the estate shall be distributed— […] 20 (4) fourth, in payment of any allowed claim, whether secured or unsecured, for any fine, penalty, or forfeiture, or for multiple, exemplary, 21 or punitive damages, arising before the earlier of the order for relief or the 22 appointment of a trustee, to the extent that such fine, penalty, forfeiture, or damages are not compensation for actual pecuniary loss suffered by the 23 holder of such claim; […] 24 Thus, a trustee may avoid liens for fines, penalties, forfeitures, or multiple, exemplary, or punitive 25 damages, within the constraints specified in § 726. 26 6 Title 11, § 551, entitled “Automatic preservation of avoided transfer,” states in its entirety: “Any 27 transfer avoided under section 522, 544, 545, 547, 548, 549, or 724(a) of this title, or any lien void under section 506(d) of this title, is preserved for the benefit of the estate but only with respect to property of 28 the estate.” 1 2 general terms how lien avoidance, encumbrances, and § 551 interact:

3 In a hypothetical situation in which the estate owns property worth $1 million, there is a first lien in the amount of $500,000 held by FirstBank; a 4 second lien in the amount of $400,000 held by SecondBank; and a third lien in the amount of $600,000 held by ThirdBank. It follows that the first 5 and second liens are fully secured, whereas ThirdBank has a secured claim 6 for $100,000 and an unsecured claim for $500,000.

7 Absent § 551, if the trustee avoided the second lien (and it “disappeared”), the still-remaining liens of FirstBank and ThirdBank (totaling $ 1.1 8 million) would exceed the value of the property ($1 million). FirstBank 9 would be unaffected by the avoidance, but ThirdBank would receive a windfall by improving the amount of their secured claim by $400,000, all 10 while the estate incurred the administrative expense to litigate the avoidance of SecondBank’s lien. If the trustee were to sell the property 11 under 11 U.S.C. § 363(b), the unsecured creditors would still not receive any portion of the proceeds from the sale. 12

13 Section 551, however, changes the scenario. Again, assuming SecondBank’s lien is avoided, if the second lien is preserved for the 14 estate’s benefit, the sale of the property for $1 million would yield $500,000 for FirstBank, $100,000 for ThirdBank, and $400,000 for the 15 estate. In short, the estate would enjoy the benefits of having avoided SecondBank’s lien and SecondBank and ThirdBank would receive 16 distributions in pari passu with other unsecured creditors on account of 17 their unsecured claims. Lawrence E. Pecan, Section 551 of the Bankruptcy Code: Avoiding the Perils of the Useless Avoidance 18 19 of Liens, 2 BUS. & BANKR. L. J. 91, 93 (2014). Here, the question is whether the tax and interest portions of the IRS’s five liens enjoy a higher 20 priority over the penalty portions of the liens, despite each lien being comprised of tax, interest, and 21 penalties at recordation. It appears that the law does not clearly delineate the extent to which certain 22 categories of avoided and preserved liens might confer greater rights to the estate by operation of § 551, 23 than rights the actual creditor would have held following avoidance of its lien. What priority do avoided 24 penalty liens take? That is the question here. 25 B. Contentions 26 Here, the government contends that its five liens are, in essence, divisible, and should be sorted 27 between taxes owed, with interest, and penalty balances. (See generally Doc. No. 7.) Once divided, 28 1 2 order under § 724(b).7 (Id. at 13-14.) Under the government’s theory, this means the potential value to 3 the estate from sale of the Orosi property is evaluated in light of each of the five secured tax balances 4 ($206,737.82), with interest ($42,638.77), before looking to the penalty portions ($162,690.85). (Id. at 5 12-13.) The avoided penalty portions of the liens would receive distributions only if funds remained 6 following satisfaction of the senior deed of trust and the tax and interest portions of the secured IRS 7 liens. (Id. at 13-14.) Under this theory of the appropriate distribution, the Orosi property is of 8 inconsequential value to the estate because reduction of the property to money will not satisfy the tax 9 and interest portion of each of the five IRS liens. (Id. at 12-13.) Thus, with no funds remaining to pay 10 unsecured creditors, the sale of the property would not benefit the estate. (Id.) The preserved liens 11

12 7 Title 11, Section 724(b) states:

13 (b) Property in which the estate has an interest and that is subject to a lien that is not avoidable under this title (other than to the extent that there is a 14 properly perfected unavoidable tax lien arising in connection with an ad 15 valorum tax on real or personal property of the estate) and that secures an allowed claim for a tax, or proceeds of such property, shall be 16 distributed— (1) first, to any holder of an allowed claim secured by a lien on such 17 property that is not avoidable under this title and that is senior to such tax 18 lien; (2) second, to any holder of a claim of a kind specified in section 19 507(a)(1)(C) or 507(a)(2) (except that such expenses under each such section, other than claims for wages, salaries, or commissions that arise 20 after the date of the filing of the petition, shall be limited to expenses incurred under this chapter and shall not include expenses incurred under 21 chapter 11 of this title), 507(a)(1)(A), 507(a)(1)(B), 507(a)(3), 507(a)(4), 22 507(a)(5), 507(a)(6), or 507(a)(7) of this title, to the extent of the amount of such allowed tax claim that is secured by such tax lien; 23 (3) third, to the holder of such tax lien, to any extent that such holder’s allowed tax claim that is secured by such tax lien exceeds any amount 24 distributed under paragraph (2) of this subsection; (4) fourth, to any holder of an allowed claim secured by a lien on such 25 property that is not avoidable under this title and that is junior to such tax 26 lien; (5) fifth, to the holder of such tax lien, to the extent that such holder’s 27 allowed claim secured by such tax lien is not paid under paragraph (3) of this subsection; and 28 (6) sixth, to the estate. 1 2 The trustee, on the other hand, asserts that the distribution order of the IRS liens is determined 3 solely by the liens’ recordation dates relative to one another, i.e. which lien is senior and which lien is 4 junior. (Doc. No. 8 at 1, 3-4.) Since each of the five IRS liens contains both an avoidable portion and a 5 portion that cannot be avoided, under the trustee’s theory the first lien’s avoidable portion (penalties) is 6 preserved for the benefit of the estate and deducted from any sale proceeds at the time the tax and 7 interest portions of the liens receive distributions. (Id. at 3-4, 7-8.) This process is repeated with respect 8 to the second, third, fourth, and fifth liens, or until such time as all of the property sale funds are 9 exhausted. (Id.) Thus, according to the trustee, the Orosi property is clearly not of inconsequential 10 value to the bankruptcy estate because its sale will result in funds for distribution to unsecured creditors. 11 (Id. at 2-3.) 12 C. Case Law 13 As noted, there is little case law on the precise question presented here. However, two decisions 14 cases from this circuit are informative, In re Bolden and In re Gill. In Bolden, a case cited by both 15 parties, a debtor filed a motion to force a chapter 7 trustee to abandon the debtor’s residence, valued by 16 the court at $975,000, as property of the estate, arguing the residence was of no value based on its 17 encumbrances. In re Bolden, 327 B.R. at 660-61, 666. After satisfaction of an outstanding deed of trust 18 and administrative costs, the court estimated that the net proceeds from the sale of the property would be 19 $567,000. Id. at 666-67. That net amount represented the funds available to satisfy encumbrances and 20 unsecured priority claims. Id. at 667. 21 Among the encumbrances on the property were eight secured IRS tax liens totaling 22 $1,324,632.52. In re Bolden, 327 B.R. at 659. This amount was comprised of $450,672.75 in unpaid 23 taxes, $249,022.93 in penalties, and $624,936.84 in interest on both the taxes and the penalties. Id. The 24 interest later was allocated proportionately between the taxes and penalties owed, based on the avoidable 25 nature of interest on penalties as opposed to interest on taxes. Id. at 664-65. 26 Ultimately, the bankruptcy court concluded that the trustee had a statutory right to preserve the 27 avoided liens for the benefit of the estate, rejecting the debtor’s argument that the property should be 28 abandoned based on its encumbrances. In re Bolden, 327 B.R. at 664. The trustee estimated that 1 2 from the sale were exhausted; therefore, the sale of the property would confer a benefit on the estate. Id. 3 at 664-65. In adopting the trustee’s view, the bankruptcy court reasoned that “[b]y avoiding the penalty 4 portions of the tax liens and preserving them for the benefit of the creditors, the estate is enriched while 5 the IRS still obtains the principal portion of its liens, with interest, in the order and priority of each 6 respective lien.” Id. at 665. The bankruptcy court further opined: 7 [T]he trustee steps into the shoes of the lienholder, preserving for the estate the respective priority of each lien. The trustee who avoids an 8 interest succeeds to the priority that interest enjoyed over competing interests. Congress’ motivation for instituting this provision was to 9 prevent junior lienholders from improving their position at the expense of 10 the estate when a senior lien is avoided. 11 Id. (internal quotations and citations omitted).8 12 Similarly, in Gill, a case cited by the bankruptcy court in this case, a bankruptcy appellate panel 13 reviewed a bankruptcy court’s decision denying a debtor’s motion to compel a trustee to abandon 14 debtor’s residence based on its encumbrances. In re Gill, 574 B.R. at 711-12. In that case, the trustee 15 had estimated the residence in question would sell for $500,000. Id. at 712. After satisfying the 16 $371,000 first lien, which secured a promissory note, the trustee represented that the balance would be 17 put towards a single secured IRS tax lien of $161,530. Id. at 711-12. Of that amount, $48,276.33 was 18 19 8 The Ninth Circuit has partially quoted Title 11, § 551’s legislative history as follows: 20 This section is a change from present law. It specifies that any avoided transfer is automatically preserved for the benefit of the estate. Under 21 current law, the court must determine whether or not the transfer should be 22 preserved. The operation of the section is automatic, unlike current law, even though preservation may not benefit the estate in every instance. . . . 23 The section as a whole prevents junior lienors from improving their position at the expense of the estate when a senior lien is avoided. 24 S. Rep. No. 989, 95th Cong., 2d Sess. 91 (1978), U.S. Code Cong. & 25 Admin. News 1978, pp. 5787, 5877. 26 In re Van de Kamp’s Dutch Bakeries, 908 F.2d 517, 519 (9th Cir. 1990). The legislative history’s 27 reference to “any avoided transfer” and not “lien” is perhaps somewhat misleading due to excerpting; the legislative change encompassed both transfers of property and liens, and did so for the same reason. 28 S. Rep. No. 989, 95th Cong., 2d Sess. 91 (1978), U.S. Code Cong. & Admin. 1978, pp. 5787, 5877. 1 2 distribution towards the debtor’s $48,000 of dischargeable unsecured nonpriority debt. Id. 3 The bankruptcy appellate panel in that case concluded that the same statutes at issue here 4 “expressly authorized” the trustee “to avoid, subordinate and preserve the penalty portion of the IRS’s 5 tax lien for the benefit of the estate’s unsecured creditors.” In re Gill, 574 B.R. at 716. The bankruptcy 6 appellate panel reasoned, in part:

7 The purpose of § 724(a) is to protect unsecured creditors from the debtor’s wrongdoing. Enforcement of penalties against a debtor’s estate serves not 8 to punish the delinquent taxpayers, but rather their entirely innocent 9 creditors. Innocent creditors should not be punished for the actions of delinquent debtor taxpayers. By avoiding the penalty portions of the tax 10 liens and preserving them for the benefit of the creditors, the estate is enriched while the IRS still obtains the principal portion of its liens, with 11 interest, in the order and priority of each respective lien.

12 13 Id. (internal quotations and citations omitted). 14 The debtor in Gill attempted to distinguish the holding of Bolden from his case based on the fact 15 that there were eight secured IRS tax liens in Bolden versus only the single IRS tax lien in his case. In 16 re Gill, 574 B.R. at 717. The bankruptcy appellate panel rejected this argument, stating simply that 17 “[t]his is a distinction without a difference” and noting that the estate would receive $48,000 from the 18 avoided and preserved penalties whether the IRS had one lien or eight liens totaling the same amount. 19 Id. 20 This case parallels Bolden and Gill in significant ways: at issue is a property with more 21 encumbrances than the proceeds from its sale can satisfy; a deed of trust that must be satisfied first, with 22 IRS tax liens trailing; and each IRS tax lien including an amount attributable in part to an avoidable 23 penalty. When the decision in Bolden and Gill are read together in light of the statutory purpose behind 24 avoidance of penalty liens (protecting unsecured creditors from the debtor’s wrongdoing), as well as 25 Congress’ intent in making preservation of avoided liens automatic (preventing junior lienholders from 26 improving their position at the estate’s expense when a senior lien is avoided), it compels the conclusion 27 that the bankruptcy court in this case did not abuse its discretion in denying the government’s motion to 28 1 2 meaningful way.9 Nonetheless, below the undersigned will examine the government’s arguments in 3 detail. 4 The government correctly argues that the notion that an avoided lien, preserved for the benefit of 5 the estate, may nonetheless result in a distribution order that in essence elevates junior creditors is not 6 without precedent. In the case of In re Skumpija, No. 11-00338-8-SWH, 2013 WL 6092156 (Bankr. 7 E.D.N.C. Nov. 19, 2013), a bankruptcy court was faced with the question of the priority order of a lien 8 avoided as invalid. Upon consideration of a motion to reconsider, the bankruptcy court in that case 9 reversed its prior decision allowing a trustee to proceed with sale of a property over the debtor’s 10 objection. Id. at *1-3. 11 Just as in Bolden and Gill, the property at issue in Skumpija was encumbered beyond its fair 12 market value. In re Skumpija, 2013 WL 6092156, at *2. Among the encumbrances was a first deed of 13 trust for $330,000 and a second deed of trust for $200,000. Id. The latter was avoided by the trustee in 14 an earlier proceeding, with the bankruptcy court finding that the deed of trust, executed between the 15 debtor and her mother, had failed to describe properly or even identify the note which it allegedly 16 secured. Id. at *1-2. Three additional judgment liens trailed the two deeds of trust. Id. at *2. 17 While the debtor contended that sale of the property in question would not benefit the estate due 18 to the encumbrances on the property, the trustee countered that proceeds remaining after satisfaction of 19 the first deed of trust would benefit the estate because the trustee would assume the position of the 20 avoided second deed of trust. In re Skumpija, 2013 WL 6092156, at *2. The bankruptcy court found 21 that the property was of benefit to the estate and issued an order allowing the sale of the property free 22 and clear of liens. Id. 23 ///// 24 9 Litigants did not argue one difference that the Court notes: it was the debtors in both Bolden and Gill 25 who moved for an order directing the trustees to abandon property; whereas, here it is the government. 26 Indeed, in Bolden the government supported the trustee’s opposing motion to turn over property. In re Bolden, 327 B.R. 657, 661 (C.D. Cal. 2005). (Gill makes no mention of the government taking a 27 position in that case.) That fact that the government moves to abandon in this case appears to be “a distinction without difference,” which in no way compels a different outcome from that of Bolden and 28 Gill. In re Gill, 574 B.R. 709, 717 (B.A.P. 9th Cir. 2017). 1 2 that in stepping into the shoes of the second deed of trust’s creditor, the trustee held only an “invalid 3 deed of trust” that amounted to a lien preserved for the estate but “subject to defects under state law.” 4 Id. at *3 (emphasis added). The debtor contended that the trustee’s position after avoidance was 5 subordinate to all properly perfected liens on the property, namely the first deed of trust and the three 6 judgment liens. Id. Upon reconsideration, the bankruptcy court agreed with this reasoning. Id. at 6. In 7 doing so, the bankruptcy court indirectly addressed the question posed by this appeal. The bankruptcy 8 court in In re Skumpija recognized that “the manner in which [a lien] is preserved matters a great deal . . 9 . .” Id. at *3. In discussing § 551 preservation, that court noted that the statute “consists of one sentence 10 which plainly states” that any transfer avoided under title or lien void under it is preserved for the 11 benefit of the estate but only with respect to property of the estate. Id. at *4. However, the bankruptcy 12 court further observed that “[w]here the disagreement lies, and where the statute is silent, is in regard to 13 priority in light of the trustee’s successful avoidance of the [second deed of trust] as invalid.” Id. 14 In confronting the question of what, exactly, it means to step into the shoes of the creditor whose 15 lien is avoided, the bankruptcy court concluded that doing so “does nothing to enhance (or detract from) 16 the rights of that creditor viz-a-viz other creditors.” Id. at *4 (internal quotations and citations omitted). 17 In reaching this conclusion, the court explained that the determination of the property rights inherited 18 varies depending on the reason for the avoidance of the lien, quoting a learned treatise as follows:

19 [I]t matters whether a lien is avoided based on some defect such as the invalidity of a deed of trust, or a failure of perfection, as opposed to lien 20 avoidance based on preferential or fraudulent transfers. As summarized 21 by Collier’s:

22 when a trustee avoids a prepetition security interest because the secured party has failed properly to perfect or record its 23 lien, the avoided lien held by the estate is subject to the same state law defect and is likely subordinate to liens 24 properly perfected or recorded prepetition. On the other 25 hand, if the lien is avoided not on the basis of a state law defect where the trustee avoids the lien under section 26 544(a)(1), but instead, is avoided as a preference under section 547 or as a fraudulent transfer under section 548, 27 the estate steps into the shoes of the holder of the avoided lien and the lien’s priority remains the same as it was with 28 1 r espect to other liens prior to the avoidance. 2 5 Collier on Bankruptcy, ¶ 551.02 at 551–4 (Alan N. Resnick & Henry J. Sommer eds., 16th ed. rev. 2013); see also, Carvell [v. Bank One, 3 Lafayette, N.A.,] 222 B.R. [178,] 180 [B.A.P. 1st Cir. 1998] (noting that in 4 preference actions, for example, if an avoided lien’s priority was not retained, avoidance would create a windfall for junior lienors, in the form 5 of a benefit unattainable outside of bankruptcy). 6 Id. at *5. Most important to resolution of this appeal is the acknowledgement that when a trustee avoids 7 an encumbrance under the federal bankruptcy code, the lien’s priority remains intact. 8 Applying these principles, the bankruptcy court in Skumpija concluded that the defects of the 9 second deed of trust arising inherently under state law also demoted that deed of trust to fifth position, 10 after the properly perfected first deed of trust and three judgment liens. Id. at *6. Because avoidance 11 would therefore not benefit the estate until the other four encumbrances were satisfied, and because the 12 other four encumbrances exceeded the value of the property, the court concluded the property was of no 13 value to the estate. Id. Accordingly, the court reconsidered its initial order allowing the sale of the 14 property and instead on reconsideration granted the motion to abandon property. Id. 15 The same principles applied by the bankruptcy court in Skumpija apply here, though it is in part 16 application of those principles that lead this Court to a result opposite than that reached in Skumpija. 17 The subordination of the second deed of trust in Skumpija resulted from operation of state law, not the 18 bankruptcy code. Here, in contrast, the ability of a trustee to avoid liens for penalties arises by operation 19 of the bankruptcy code, not state law. Accordingly, the trustee here steps into the shoes of the holder of 20 the avoided lien and the lien’s priority remains the same as it was with respect to other liens prior to 21 avoidance.10 22 Here, the government asserts that lien avoidance and preservation as outlined in this case allows 23 the “result of diverting property subject to prepetition federal tax liens to pay general unsecured 24 creditors before satisfying actual tax losses by the United States.” (Doc. No. 7 at 14-15.) While at first 25 blush the government’s argument appears somewhat persuasive, upon a close reading of §§ 724, 726, 26

27 10 Here, while only portions of the five IRS liens are avoided, there is no authority suggesting the avoided parts should be considered as separate, distinct, and junior liens vis-à-vis the unavoided portions 28 of the same liens. WwAOw 4.140°UV VLYV9IL MAES Ae POU VI Te PT OY te VI al || and 551 together and with, it is apparent that it misses the mark. Compensation for “any fine, penalty, 2 | or forfeiture, or for multiple, exemplary, or punitive damages” is disfavored by law “to the extent that 3 | such fine, penalty, forfeiture, or damages are not compensation for actual pecuniary loss suffered by the 4 | holder of such claim.” 11 U.S.C. § 726. That is precisely why the penalty portion of an IRS lien may be 5 | avoided and preserved for the benefit of the estate—not the benefit of the junior lienholder, which in this 6 || case is the IRS. Under the circumstances presented in this case, preserving the avoided portion of each 7 || lien appears to leave a pot of funds available for distribution to unsecured creditors. While the IRS is g || one such unsecured creditor, it may not be the only one. Thus, the dispute in this case is not purely 9g || academic. 10 Finally, it is true that “[a]n order to compel abandonment is the exception, not the rule. 11 | Compelled abandonment under § 554(b) is generally reserved for instances where a trustee is merely 12 || churning property worthless to the estate just to increase fees.” In re Gill, 574 B.R. at 714 (internal 13 || quotations and citations omitted). Here, however, the government has not argued that such misfeasance, 14 | the churning of property worthless to the estate, is taking place nor is there any indication of such 15 || misfeasance. 16 In sum, there is no assertion on appeal of errors of fact embodied within the bankruptcy court’s 17 || decision. Having conducted a de novo review of the bankruptcy court’s conclusions of law, the 18 || undersigned also finds no error or abuse of discretion. Accordingly, the bankruptcy court’s decision will 19 || be affirmed. 20 VII. CONCLUSION 21 For the foregoing reasons, the bankruptcy court’s decision is AFFIRMED. 22 3 IT IS SO ORDERED. ~ ~ 54|| Dated: _May 1, 2020 □□□ A Tonge |

UNITED STATES DISTRICT JUDGE

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