The case of In re: Patrick Hannon and Elizabeth Hannon; No. 12-13862 (Bankr. D. Mass. 2019) presents a situation in which the IRS argues that the bankruptcy trustee and law firm representing the trustee should not receive compensation from the estate assets, because the trustee should have abandoned the assets since the trustee could not bring value to the unsecured creditors of the estate. The bankruptcy court rejected the argument of the IRS and allowed the trustee and the law firm to take their fees from assets that would otherwise go to satisfy outstanding debts due to the IRS. The case brings to light the sometimes tricky determination regarding assets and lienholders in a bankruptcy case.
The Hannons owed money to the IRS but at the outset of their bankruptcy case the amount owed to the IRS had yet to be conclusively determined. The Hannons originally filed their bankruptcy case as a chapter 11 seeking to reorganize their debts, they converted the case to chapter 7 in 2013 recognizing that reorganization would not work and they needed to liquidate their assets. In a chapter 11 case debtors generally control their assets without a trustee. In a chapter 7 the bankruptcy court appoints a trustee to liquidate the assets. When a case converts from chapter 11 to chapter 7 the fluidity of the financial situation can make it quite difficult for the incoming trustee to know exactly what the debtor owes and exactly what the estate owns (or the value of what it owns.)
In this case it appears that both the amount of debt and the value of the assets were, at least somewhat, in question. If the trustee could determine that the amount owed to lienholders would prevent any property from reaching general unsecured creditors, the trustee should have abandoned the assets of the estate so that the secured creditors could use their lien interests to dispose of the properties, while the estate became a no asset estate with nothing available to unsecured creditors. Trustees serve unsecured creditors and secured creditors generally take care of their own interests. If a trustee administers property encumbered by a lien, the trustee brings no value to the estate for the benefit of unsecured creditors, while potentially reducing the amount that the lienholder could otherwise obtain upon the sale of the liened property. Essentially, the IRS argues here that the trustee should have known that the estate did not have any property available for unsecured creditors and should have turned over the property of the estate to the lienholders and quietly backed out of the case. The bankruptcy court must decide if the trustee acted properly under the circumstances or acted in a manner that negatively and improperly harmed the interests of the secured creditor.
Although the bankruptcy court in Massachusetts handled the bankruptcy aspect of the case, the litigation between the Hannons and the IRS took place in Maine for reasons not explained in the opinion. When the conversion from chapter 11 to chapter 7 occurred in January of 2013, the litigation between the Hannons and the IRS had not concluded. So, the amount owed to the IRS in the case remained unknown. The Hannons and the IRS reached an agreement in July of 2013 resulting in a final judgment entered in November of 2013. At the time of the agreement, paragraph 8 of the document contained the following provision:
The Trustee shall continue to sell or otherwise liquidate the Estate’s personal and real property in the ordinary course.
Additionally, the bankruptcy court noted:
In December of 2013, the IRS assented to a motion filed by the trustee in the IRS Lien Avoidance Action to suspend all deadlines in the proceeding until the trustee completed his liquidation of the estate’s assets. The assented-to motion states: “[T]he parties have recently conferred regarding the within Adversary Proceeding and have agreed that it will be most cost-effective to allow the trustee to complete his liquidation of all Estate assets before expending additional resources in this matter.”
From the perspective of the IRS, having the trustee liquidate the estate assets can provide good value. The trustee does the work of cleaning up title and selling the assets. These acts can take considerable time and effort. The IRS does not always do a good job of this and does not always bring the maximum value. The trustee can sometimes handle estate assets much more efficiently and cost effectively. So, agreements between the IRS and the trustee allowing the trustee to administer property that might be fully encumbered can make sense. The assets also could be wasting assets where having the trustee administer them during a period of dispute concerning the scope of a lien makes additional sense. On the other hand, if the assets of the estate are entirely encumbered with the federal tax lien, perhaps the IRS feels that it can obtain the best value without having someone in the middle.
Despite the language of the agreement, the IRS objected to the trustee’s fees and the attorney for the trustee’s fees. The bankruptcy court denies the motion of the IRS to reduce or eliminate the fees allowing them to be paid by the estate, which means that less assets in the estate remain with which to satisfy the IRS debt. The failure to pay the IRS debt in full or as fully as possible also has implications for the debtors if the tax debts were non-dischargeable. The debtors would prefer to see the IRS paid and eliminate a debt the IRS will pursue after the bankruptcy estate.
Although the court allowed most of the trustee’s fees, it did trim them with respect to action taken after the extent of the debt due to the IRS and the value of the property became clear. This caused a small reduction in the amount of the trustee’s fees and the legal award. Without much more information about who knew what when, I have no basis to conclude that the decision incorrectly allowed the fees. Twice the IRS agreed to allow the trustee to continue working with assets of the estate. The IRS should have known when it made those agreements that the trustee deserved compensation for those efforts. The question I would have concerns the reasonableness of those efforts under the circumstances but not whether the trustee should receive some compensation. The case points out the difficulties all parties face when uncertainty exists concerning the amount owed and the value of assets and the need to immediately control the assets. Both the IRS and the trustee in this situation need to carefully document their interactions if they want to show that action was properly taken or not taken.