Opinion ID: 3064379
Heading Depth: 3
Heading Rank: 2

Heading: State Law Deference

Text: To summarize, section 548 only applies to interests in “property,” as defined by state law, and Arizona law says that Costas had no property interest in the disclaimed property. The remaining question, and the problematic one, is how to translate this state law rule back into the bankruptcy context. Ordinarily, bankruptcy courts look to Butner to answer this question. There, the Supreme Court addressed a circuit split over the ownership of rents. Butner, 440 U.S. at 51-54. Some circuits followed state law in determining who received postpetition rents, whereas other circuits fashioned a federal rule of equity to allow mortgagees to receive the rents. Id. Ultimately, the Court rejected the federal equity rule, explaining that “Congress has generally left the determination of property rights in the assets of a bankrupt’s estate to state law.” Id. at 54. Thus, “[u]nless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding.” Id. at 55. Applying the principle of Butner to similar disclaimers, several appellate courts have found § 548 inapplicable. Simpson v. Penner (In re Simpson), 36 F.3d 450 (5th Cir. 1994) (Texas law); Jones v. Atchison (In re Atchison), 925 F.2d 209 (7th Cir. 1991) (Illinois law); Hoecker v. United Bank of Boulder, 476 F.2d 838 (10th Cir. 1973) (concluding that Colorado disclaimer rules preclude use of the fraudulent conveyance provision contained in § 67(d)(2) of the Bankruptcy Act); see also In re Bright, 241 B.R. 664 (9th Cir. BAP 1999) (Washington law). For example, the Seventh Circuit took a broad view of Butner, explaining that “[a]ll applicable state law must be construed to determine whether a debtor possesses a property interest,” including the relation back rule. IN RE COSTAS 1387 Atchison, 925 F.2d at 212. The contrary view, the court found, “fail[ed] to give full application to the relation back doctrine under applicable state laws.” Id. at 211. Based on this deferential approach to state law, the Atchison court concluded that a disclaimer was not a “transfer of an interest in property” subject to avoidance under § 548(a). Id. at 212. [6] Though most courts have found that Butner principles preclude avoidance of disclaimers under § 548, this line of authority has been thrown into doubt by Drye v. United States, 528 U.S. 49 (1999).4 In Drye, a tax debtor inherited his mother’s estate after the IRS had obtained a tax lien on all his “property and rights to property.” Id. at 52-53. Relying on Arkansas’ relation-back disclaimer rule, Drye disclaimed his inheritance and argued that he had no property to which the IRS lien could attach. Id. at 53. The Supreme Court, however, 4 We are the first circuit court to address Drye’s impact on § 548 avoidance. Lower courts have split on the issue, compare In re Faulk, 281 B.R. 15 (Bankr. W.D. Okla. 2002); In re Nistler, 259 B.R. 723 (Bankr. D. Or. 2001); In re Kolb, 267 B.R. 861, 866-67 (N.D. Cal. 2001), rev’d on other grounds, 326 F.3d 1030 (9th Cir. 2003) with In re Schmidt, 362 B.R. 318, 322-23 (W.D. Tex. 2007) (suggesting that Simpson may be invalid after Drye); In re Kloubec, 247 B.R. 246 (Bankr. N.D. Iowa 2000), aff’d on other grounds, 268 B.R. 173 (N.D. Iowa 2001), as have commentators, compare David B. Young, The Intersection of Bankruptcy and Probate, S. Tex. L. Rev. 351, 384-88 (2007) (concluding that “[t]ax decisions do not alter the rule that a prepetition disclaimer that is unassailable under state law should not become avoidable once a bankruptcy petition has been filed”); Kevin A. White, A Clash of Expectations: Debtors’ Disclaimers of Property in Advance of Bankruptcy , 60 Wash. & Lee L. Rev. 1049, 1085 (2003) (concluding that Drye does not extend to the bankruptcy context), with Jon Finelli, Comment, In re Costas: The Misapplication of Section 548(a) to Disclaimer Law, 14 Am. Bankr. Inst. L. Rev. 567, (2006) (criticizing the BAP’s decision in this case); David A. Lander, Does the Supreme Court Decision in Drye Mean that a Disclaimer of Inheritance Is a Fraudulent Conveyance, Norton Bankr. L. Adviser, No. 12 (Dec. 2002) (suggesting that, after Drye, courts should reassess the majority rule because “state law disclaimers are not the types of state law property rights to which the bankruptcy courts must defer in applying or not applying § 548). 1388 IN RE COSTAS rejected Drye’s theory and held that the tax lien attached to disclaimed property despite state law relation-back rules. Id. at 52. After discussing the breadth of federal tax lien law, the Court described its analysis: “We look initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer’s state-delineated rights qualify as ‘property’ or ‘rights to property’ within the compass of the federal tax lien legislation.” Id. at 58. Although Drye asserted that he had nothing but the right to reject a gift, the Supreme Court disagreed, reasoning that a rejected gift returns to the donor, whereas a disclaimer channels the property to another person. Id. Finding this power to channel a sufficient state law interest to constitute “property” under the federal tax lien provisions, the Court held that the lien attached despite Drye’s refusal to take the property. Id. at 61. The Trustee urges us to extend Drye to the bankruptcy context and recognize the “right to channel” as an “interest . . . in property” for purposes of the Code. The Trustee’s argument is that Drye recognizes a “right to channel” interest that constitutes “property” not just for tax lien cases, but as a matter of federal law. Further, the Trustee suggests that Drye accords with bankruptcy policy by increasing the size of the debtor’s estate. In contrast, Costas requests that we adhere to the more deferential approach of Butner and treat the disclaimer as Arizona would. The Trustee’s argument has some force: if the “right to channel” has been recognized as a “property” interest for one federal statute, why not for the other? Nevertheless, we believe that Drye is distinguishable, both factually and legally, and that its adoption in the bankruptcy context would, in any event, be inappropriate. First, Drye is distinguishable based on timing issues. Although Drye, like this case, involved a collision between federal law and state relation back doctrines, the impact IN RE COSTAS 1389 between the two occurred at a different time. In Drye, the tax lien was already in place prior to the execution of the disclaimer. Id. at 52-53. Thus, before the taxpayer attempted to execute his disclaimer, the federal government already had an interest in the subject property. Application of the state law fiction would have stripped the government of this interest. Id. [7] In contrast, the disclaimer here occurred pre-petition, meaning that the retroactive divestment of property interests occurred prior to the bankruptcy estate gaining any interests in the right to disclaim. Therefore, the state law did not operate to defeat any pre-existing interests. Rather, the situation in Drye is more analogous to a post-petition disclaimer, where a debtor invokes the disclaimer protections of state law only after the creation of the bankruptcy estate. In cases of postpetition disclaimers, courts have generally included disclaimed property in the estate, reasoning that the right to disclaim itself belongs to the estate as of the time of filing. See 11 U.S.C. § 541(a)(5)(A); In re Scott, 385 B.R. 709 (Bankr. D. Neb. 2008). This context mirrors Drye because in both situations full deference to the state’s disclaimer rules would strip parties of pre-existing interests. Thus, Drye accords well with the post-petition situation, but not with pre-petition disclaimers where no prior interests exist. [8] Second, Drye is distinguishable based on its legal context. Indisputably, Drye is, first and foremost, a tax lien case. The Court’s language repeatedly stressed this limitation, see Drye, 528 at 52 (“This case concerns the respective provinces of state and federal law in determining what is property for purposes of federal tax lien legislation.”); id. (“the disclaimer did not defeat the federal tax liens) (internal quotations omitted); (explaining the issue as “whether [Drye’s] interest in his mother’s estate constituted ‘property’ or ‘rights to property’ under § 6321”), and the cases cited were tax cases, id. at 59 (collecting tax cases to demonstrate that neither state exemption nor disclaimer rules interfere with tax collection). Indeed, 1390 IN RE COSTAS the Court itself even distinguished the case from the closely analogous gift tax regime. Id. at 57 (“The absence of any recognition of disclaimers in §§ 6321, 6322, 6331(a), and 6334(a) and (c), the relevant tax collection provisions, contrasts with § 2518(a) of the Code, which renders qualifying state-law disclaimers ‘with respect to any interest in property’ effective for federal wealth-transfer tax purposes and those purposes only.”); see also id. at 57 n.3. Admittedly, similarities exist between the tax lien statute and the Code, as both broadly rely on state law to define “property.” Nevertheless, tax lien rules do not translate directly into bankruptcy rules. See, e.g., Musolino v. Sinnreich (In re Sinnreich), 391 F.3d 1295, 1297-99 (11th Cir. 2004) (refusing to apply United States v. Craft, 535 U.S. 274 (2002), an extension of Drye, in the bankruptcy context). In the tax lien context, collection is the primary focus. United States v. Kimbell Foods, Inc., 440 U.S. 715, 734 (1979). This vital function often “justifies the extraordinary priority accorded federal tax liens . . . .” Id. Indeed, the Supreme Court has repeatedly construed tax lien provisions to permit the government to reach property beyond the grasp of other creditors. See, e.g., Craft, 535 U.S. at 276 (finding that federal tax lien attached to interest in entireties property under Michigan law); United States v. Security Trust & Sav. Bank of San Diego, 340 U.S. 47, 51 (1950) (“[W]e hold that tax liens of the United States are superior to the inchoate attachment lien of [a state law creditor] . . . .” ). [9] This purpose contrasts sharply with the policy of bankruptcy law, which largely respects substantive state law rights,5 neither granting a creditor new rights in the debtor’s property nor taking any away. Raleigh v. Ill. Dep’t of Rev., 530 U.S. 15, 20 (2000) (“Creditors’ entitlements in bankruptcy arise in 5 For a thorough exploration of the implications of this policy on bankruptcy law, see Thomas H. Jackson, The Logic and Limits of Bankruptcy Law (1986). IN RE COSTAS 1391 the first instance from the underlying substantive law creating the debtor’s obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code. The ‘basic federal rule’ in bankruptcy is that state law governs the substance of claims . . . .”) (internal citations omitted). Indeed, the Court in Butner expressly invoked this goal of achieving “[u]niform treatment of property interests by both state and federal courts within a State . . . .” Butner, 440 U.S. at 55. By replicating state law rights, the Court hoped to (1) reduce uncertainty, (2) discourage forum shopping, and (3) “prevent a party from receiving ‘a windfall merely by reason of the happenstance of bankruptcy.’ ” Id. (quoting Lewis v. Mfrs. Nat. Bank, 364 U.S. 603 (1961)). Extending the rule in Drye to the bankruptcy context, however, would undermine all of these goals. Uncertainty would increase because disclaimers, though generally valid, would lose effect in bankruptcy. Second, forum shopping would increase because creditors of disclaimants would have an incentive to push for bankruptcy in order to gain an interest in otherwise protected property. Finally, many creditors, including those in this case, would receive a windfall: although the disclaimed property was absolutely protected under state law, they would receive a share of the property solely because Costas filed for bankruptcy within two years of her disclaimer. Thus, based on the concerns set out in Butner, little justification exists for permitting creditors to reach property that, but for the fortuity of a bankruptcy filing, would remain beyond their grasp. Further, the inappropriateness of extending Drye is reinforced by comparing the Code’s treatment of exemptions to the treatment under the federal tax lien statute. In Drye, the Court stressed the breadth of “property” under § 6331 of the Internal Revenue Code by noting that the tax lien statute recognized only a narrow range of exemptions, none of which mentioned disclaimers. Drye, 528 U.S. at 56-57. On this ground, the Court distinguished the gift tax statute, which explicitly incorporates an exception for disclaimers. Id.6 6 The estate tax employs the same exception for qualified disclaimers. See 26 U.S.C. § 2046. 1392 IN RE COSTAS While the Code lacks an express exemption for disclaimers like § 2518(a), its exemptions are nonetheless quite broad, allowing a debtor to take advantage of all available state law exemptions. 11 U.S.C. § 522; see also Owen v. Owen, 500 U.S. 305, 308 (1991). Again, this highlights the key difference between “property” for purposes of tax collection and for bankruptcy: the former largely trumps state law, the other tries to incorporate it. [10] For these reasons, we find that Drye is distinguishable and we refuse to extend its logic to the bankruptcy context. Instead, we apply the principles of Butner and hold that a disclaimer, properly executed under Arizona law, is not a “transfer . . . of an interest of the debtor in property” for purposes of § 548.