As a matter of public policy, Congress decided to subordinate unavoidable tax liens to the payment of domestic support obligations. Bankruptcy Judge Louis A. Scarcella of Central Islip, N.Y., rebuffed a debtor’s creative arguments aimed at overturning subordination.
Simplified, these are the facts: The debtor divorced his wife several years before he filed a chapter 7 petition. He owed his former wife more than $250,000 in unsecured domestic support obligations entitled to first priority under Section 507(a)(1)(A).
The debtor owned a home with two mortgages and tax liens. The home was worth more than the two mortgages but less that the mortgages combined with the tax liens.
Ordinarily, Judge Scarcella said in his October 25 opinion, the chapter 7 trustee would abandon the home. And if the trustee had moved to sell the home, Judge Scarcella said he wouldn’t have allowed a sale solely for the benefit of secured creditors and the payment of fees for the trustee and professionals.
However, this case was different given the former wife’s domestic support obligations, or DSOs.
With the consent of the wife, the trustee filed a motion to sell the home and distribute the proceeds in accordance with Section 724(b). The section provides as follows:
Property in which the estate has an interest and that is subject to a lien that is not avoidable under this title . . . and that secures an allowed claim for a tax, . . . shall be distributed —
(1) first, to any holder of an allowed claim secured by a lien on such property that is not avoidable under this title and that is senior to such tax lien;
(2) second, to any holder of [an administrative] claim [under] section 507(a)(1)(C) or 507(a)(2) . . . , [or a DSO under] 507(a)(1)(A) . . . ;
(3) third, to the holder of such tax lien . . . .
The trustee proposed to distribute the net proceeds (after payment of the two mortgages) first to the payment of administrative claims, and second to the former wife on account of her DSOs.
The debtor consented to the sale but opposed the trustee’s proposed distributions. In substance, the debtor wanted proceeds in excess of the two mortgages to be applied to his tax liens. Evidently, the debtor preferred paying taxing authorities rather than his former wife.
The debtor advanced two theories: (1) The subordination of the tax liens was the equivalent of a prohibited carveout by a mortgagee to create value for unsecured creditors by selling the property while paying nothing for the debtor’s homestead exemption; and (2) the net proceeds after payment of the two proceeds should not be applied to administrative expenses.
Although Judge Scarcella wrote a comprehensive 32-page opinion explaining why the debtor was wrong, the debtor’s arguments held no water for one simple reason: the arguments flew in the face of the statute.
Regarding the first argument, Judge Scarcella said that the tax lienholders were not taking a haircut. The tax liens were subordinated, not waived.
Judge Scarcella explained that Section 724(b)(2) “automatically subordinates a tax lien secured by property, allowing a trustee to sell property in which there is no equity to provide a recovery for administrative and priority claims from funds that would have been distributed to the tax lien holder.”
Judge Scarcella said that In re Stark, 20-4766, 2022 WL 2316176 (E.D.N.Y. June 28, 2022), was “inapposite.” In Stark, a district judge in the Eastern District of New York held that a debtor is entitled to a homestead exemption in sale proceeds when the mortgage lender offers to buy the home and voluntarily takes a haircut designed to create an estate for unsecured creditors and the trustee’s commission. To read ABI’s report, click here.
Judge Scarcella explained that Stark was not controlling because, in the case before him, “the statutory subordination is not the product of a voluntary ‘give-up’ or negotiated carve out agreement.” In short, the “distributive scheme employed by the trustee here conforms with the clear command of the statute.”
The debtor’s second argument was based on the idea that paying administrative expenses violated his homestead exemption. To that, Judge Scarcella said that the “debtor’s argument ignores the express language of § 724(b)(2).”
Judge Scarcella overruled the debtor’s objection to the trustee’s proposed distribution and approved the same of the home.
As a matter of public policy, Congress decided to subordinate unavoidable tax liens to the payment of domestic support obligations. Bankruptcy Judge Louis A. Scarcella of Central Islip, N.Y., rebuffed a debtor’s creative arguments aimed at overturning subordination.
Simplified, these are the facts: The debtor divorced his wife several years before he filed a chapter 7 petition. He owed his former wife more than $250,000 in unsecured domestic support obligations entitled to first priority under Section 507(a)(1)(A).
The debtor owned a home with two mortgages and tax liens. The home was worth more than the two mortgages but less that the mortgages combined with the tax liens.
Ordinarily, Judge Scarcella said in his October 25 opinion, the chapter 7 trustee would abandon the home. And if the trustee had moved to sell the home, Judge Scarcella said he wouldn’t have allowed a sale solely for the benefit of secured creditors and the payment of fees for the trustee and professionals.