Court Opinion

ID: 765060
Source: CourtListenerOpinion
Date Created: 2012-04-18 07:38:11+00
Date Added: 2024-06-11T17:55:12.949420
License: Public Domain

182 F.3d 1027 (9th Cir. 1999)
In re: NELL CARTER, Debtor.NELL CARTER, Appellant,v.PETER C. ANDERSON, Chapter 7Trustee,Appellee.
No. 97-55117
UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT
Argued and Submitted April 15, 1999--Pasadena, CaliforniaFiled August 11, 1999

COUNSEL: Steven E. Smith, Danning, Gill, Diamond & Kollitz, Los  Angeles, California, for the appellant.
Julie A. Page and John P. Pringle, Roquemore, Pringle &  Moore, Los Angeles, California, for the appellee.
Appeal from the Bankruptcy Appellate Panel Lawrence Ollason and Alfred C. Hagan,  Bankruptcy Judges, Presiding
Before: Dorothy W. Nelson, Ferdinand F. Fernandez, and William A. Fletcher, Circuit Judges.
OPINION
W. Fletcher, Circuit Judge:

1
Appellant-debtor Nell Carter filed for personal bankruptcy  under Chapter 7. In her bankruptcy schedules she claimed that  a check for $43,260.58 received from her sub-chapter S corporation constituted employee earnings under California Civil  Procedure Code ("C.C.P.") S 706.011 and was therefore  exempt from inclusion in the bankruptcy estate under C.C.P.  S 704.070(b). The bankruptcy court sustained the trustee's  objection to Carter's claimed exemption, and a divided panel  of the Ninth Circuit Bankruptcy Appellate Panel affirmed. We  reverse and remand for further proceedings.

Background and Prior Proceedings

2
Carter, a professional entertainer, is the sole shareholder,  director, and officer of a sub-chapter S corporation named  Krynicki, Inc. ("Krynicki").1 Krynicki enters into agreements with nightclubs, casinos, and other establishments at which  Carter entertains, and Carter is then paid by Krynicki for her  services.

3
On April 3, 1995, Krynicki issued to Carter a check for  $43,260.58. The "pay stub" attached to the check indicated  "earnings" of $78,714.00, "YTD [year-to-date] earnings" of  $78,714.00, a pay period from 4-03-95 to 4-03-95, and deductions of $35,453.42 for income and other taxes. On April 11,  1995, Carter filed a petition for Chapter 7 bankruptcy. On  April 25, 1995, Carter filed Schedule C claiming $39,000 as  an exemption from the estate, corresponding to the estimated  amount of money from the check remaining in her bank  account at the time of the filing.2

4
The trustee does not dispute  that $39,000 was the amount remaining.

5
The trustee objected to the claimed exemption. Because  California has opted out of the federal scheme of exemptions  under 11 U.S.C. S 522(d), see C.C.P.S 703.130, Carter's right  to the exemption is determined under California law. The  exemption was claimed pursuant to C.C.P. S 704.070(b),  which allows a debtor to exempt 75 percent of "paid  earnings," as "earnings" are defined inS 706.011. In relevant  part, S 706.011 provides:

6
(a) "Earnings" means compensation payable by an employer to an employee for personal services per formed by such employee, whether denominated as wages, salary, commission, bonus, or otherwise.

7
. . .

8
(c) "Employee" means a public officer and any individual who performs services subject to the right of the employer to control both what shall be done and how it shall be done.

9
(d) "Employer" means a person for whom an indi vidual performs services as an employee.

10
. . .

11
(g) "Person" includes an individual, a corporation, a partnership or other unincorporated association, a limited liability company, and a public entity.

12
Whether Carter properly claimed the exemption under California law depends on whether Carter was an "employee" of  Krynicki and received the $43,260.58 check as "earnings."

13
The trustee contends that Carter drained Krynicki's corporate account on the eve of bankruptcy and mis-characterized  the April 3 payment as employee earnings under S 706.011 in  order to exempt it from the bankruptcy estate. At a hearing  before the bankruptcy court on October 3, 1995, Carter  argued that she was an employee of Krynicki, whereas the  trustee argued that she was an independent contractor. (Payments to an independent contractor are not treated as employee earnings under S 706.011 and are thus not  exempted from the estate.) During that hearing, the bankruptcy court focused exclusively on the question of Carter's  employee or independent contractor status. The hearing was  continued until November 14, 1995, at which point Carter  again argued that she was an employee. With no further discussion and without findings of fact, the bankruptcy court at  that hearing sustained the trustee's objection to the claimed  $39,000 exemption.

14
A divided panel of the Ninth Circuit Bankruptcy Appellate  Panel ("BAP") affirmed. The majority concluded, "The trustee's evidence rebutted Carter's prima facie exemption claim.  Carter was unsuccessful in producing sufficient evidence to  show that she was an employee. The bankruptcy court's  implicit finding that Carter was not compensated as an  employee was not clearly erroneous[.]" The dissent argued for  a remand on the ground that the bankruptcy court may have  misunderstood the relationship between a subchapter S corporation and its shareholder/employee.

Discussion

15
For Carter to be entitled to an exemption underS 706.011,  she must show both that she was an "employee" of Krynicki  and that the check for $43,260.58 was payment of "earnings"  within the meaning of that provision.3  We discuss "employee"  status and "earnings" in turn.

16
1. Was Carter an "employee" under S 706.011?

17
The distinction between an employee or an independent  contractor is made in many areas of the law, including income  taxation (see Spicer Accounting, Inc. v. United States, 918  F.2d 90 (9th Cir. 1990)), Employment Retirement Income  Security Act of 1974 (ERISA) (see Nationwide Mut. Ins. Co.  v. Darden, 503 U.S. 318 (1992)), workers' compensation (see  S.G. Borello & Sons, Inc. v. Dep't. of Indus., 48 Cal. 3d 341  (1989)), and employment discrimination (see Adcock v.  Chrysler Corp., 166 F.3d 1290 (9th Cir. 1990), petition for  cert. filed, 67 U.S.L.W. 3749 (U.S. May 10, 1999) (No. 981902)), among many others. Indeed, whenever a federal statute uses the term "employee" and "contains no other provision that either gives specific guidance to the meaning of the  term `employee' or suggests that the common law definition  is inappropriate, we must presume that Congress intended to  incorporate traditional principles of agency law. " Loomis  Cabinet Co. v. OSHRC, 20 F.3d 938, 941 (9th Cir. 1994) (citing Nationwide Mut., 503 U.S. 318 (1992)). California has  also recognized that "[m]uch 20th-century legislation for the  protection of `employees' has adopted the `independent contractor' distinction as an express or implied limitation on  coverage." S.G. Borello & Sons, 48 Cal. 3d at 350. When a  distinction between "employees" and "independent  contractors" becomes relevant, both federal and state law provide multiple-factor tests that distinguish one from the other.

18
California follows the traditional common law distinction between "employees" and "independent contractors," generally referring to the factors set forth in the Restatement  (Second) of Agency S 220. See id. at 350-351 (1989). The  "principal test" is "whether the person to whom service is rendered has the right to control the manner and means of  accomplishing the result desired." Id. at 350 (quoting Tieberg  v. Unemployment Ins. Appeals Bd., 2 Cal. 3d 943, 946  (1970)). California courts have developed multiple factors  indicative of "control," including: (1) whether the person performing services is engaged in a distinct occupation or business; (2) the kind of occupation, with reference to whether, in  the locality, the work is usually done under the direction of  the principal or by a specialist without supervision; (3) the  skill required in the particular occupation; (4) whether the  principal or the worker supplies the instrumentalities, tools,  and the place of work for the person doing the work; (5) the  length of time for which the services are to be performed; (6)  the method of payment, whether by the time or by the job, (7)  whether or not the work is a part of the regular business of the  principal; and (8) whether or not the parties believe they are  creating the relationship of employer-employee. See S.G.  Borello & Sons, 48 Cal. 3d at 351; see also Community for  Creative Non-Violence v. Reid, 490 U.S. 730, 751-52 (1989)  (listing similar factors). Reflecting on a trend in applying  these factors, the California Supreme Court has noted that  "[t]he modern tendency is to find employment when the work  being done is an integral part of the regular business of the  employer, and when the worker, relative to the employer,  does not furnish an independent business or professional  service." S.G. Borello & Sons, 48 Cal. 3d at 357 (quoting 1C Larson, The Law of Workmen's CompensationS 45.00, p. 8174 (1986)).

19
Using a short-hand version of the standard test, C.C.P.  S 706.011 defines an "employee" as "any individual who performs services subject to the right of the employer to control  both what shall be done and how it shall be done."4 We  believe that under this definition it is enough that Carter was  subject to the "right" of the corporation to control her performance. A test requiring actual control would not be welldesigned for a person, like Carter, who claims to be an  employee but who is also the sole shareholder of a subchapter  S corporation. Because the would-be employee is also the sole  shareholder, she is not controlled by the corporation in the  same way as a person who is an employee (but not the sole  shareholder) of a subchapter S corporation, or who is an  employee of a non-subchapter S corporation. But even outside  the context of subchapter S corporations and bankruptcy  exclusion statutes, California law does not insist on actual  control. Under California law, "it is the right to control, not  the exercise of the right, which bears on the status of the work  arrangement." S.G. Borello & Sons, 48 Cal. 3d at 357 n.9.5

20
On the record before us, it is clear that Carter is an  employee of Krynicki within the meaning of S 706.011. That  section requires that the individual performing services be  "subject to the right of the employer to control both what shall  be done and how it shall be done," and includes a  "corporation" within the definition of employer without distinguishing among types of corporations. Among other things, Carter's performance engagements were made through Krynicki, which had the legal right to specify the services she performed and to control the manner in which she performed  them; Carter was paid by Krynicki rather than by the establishments at which she performed; and expenses connected  with Carter's performances, including payments to her agent,  personal manager, and musicians, and payments for all professional equipment, were all paid by Krynicki rather than  Carter.

21
Our holding that Carter is an employee is consistent with  our earlier decision in In re Cheng, 943 F.2d 1114 (9th Cir.  1991), in which we interpreted a related provision of California law exempting assets from the bankruptcy estate, C.C.P.  S 704.115. Thedebtor in Cheng was the sole shareholder of  a close corporation who claimed an exemption for a retirement plan. Under S 704.115(b), "[a]ll amounts held, controlled, or in process of distribution by a private retirement  plan . . . are exempt." However, under S 704.115(e), "selfemployed retirement plans" are only exempt "to the extent  necessary" to provide for the debtor's retirement. The trustee  in Cheng claimed the retirement plan at issue was a "selfemployed retirement plan," and the bankruptcy court agreed  because "Dr. Cheng managed and used the plan in a manner  that makes it factually more like a self-employed retirement  plan or an individual retirement account." Cheng, 943 F.2d at  1116 (quoting the bankruptcy court). This court reversed,  holding that under California law a close corporation is not  treated differently from other corporations:

22
Although the legislative history indicates that the policy behind section 704.115(e) is to limit the exemption for plans that are controlled by one per son, the statute says what it says, and it was improper for the bankruptcy court to read beyond it. If the California legislature intended to treat closely held corporations differently than large corporations, it could have done so explicitly.

23
Id. at 1117. Just like S 704.115 in Cheng, S 706.011 in this  case does not distinguish among types of corporations. Dr.  Cheng had a "private" rather than a "self-employed" retirement plan because the money was held by his corporation,  even though Dr. Cheng was the de facto manager of the  money. Similarly, Carter is an employee because she is subject to the right of control by her corporation, even though in  real terms she is no more controlled by Krynicki than Dr.  Cheng's retirement plan money was controlled by his corporation.

24
In holding that Carter was not an employee of Krynicki,  the bankruptcy court may erroneously have focused on the  relationship between Krynicki and the nightclubs and other  establishments where Carter performed. For purposes of  S 706.011, the proper focus is on the relationship between  Krynicki and Carter. If Carter had contracted directly with  nightclubs, she would have been acting as an independent  contractor. But Carter structured the arrangement so that Krynicki, rather than she, contracted with nightclubs. Under  this arrangement, Krynicki acted as an independent contractor  and Carter as an employee of Krynicki.6

25
We therefore hold that the bankruptcy court and the  BAP erred in finding that Carter was an independent contractor of her own corporation. But that does not end the analysis,  for Carter is only entitled to an exemption if the payment constituted "earnings" within the meaning ofS 706.011.

26
2. Did the $43,260.58 received by Carter constitute  "earnings" under S 706.011?

27
Section 706.011 defines "earnings " as "compensation  payable by an employer to an employee for personal services  performed by such employee." Although there is no California case law that tells us specifically what counts as earnings  under S 706.011,7 it is at least clear that a primary criterion is  that the payments mustbe for "personal services performed."  If that were the sole criterion, one might conclude that all  income to Krynicki is potentially available to Carter as  "earnings" since her personal services are Krynicki's sole  source of income. But such an expansive definition of earnings does not correspond with economic reality. Before earnings are available to Carter, Krynicki must pay expenses,  including salaries to other employees, equipment costs, and  administrative expenses. Earnings to Carter are not Krynicki's  gross income, but rather Krynicki's gross income less  expenses, sometimes referred to as "net profits."

28
The trustee contends that net profits are not earnings,  and seizes upon Carter's characterization of the $43,260.58  payment on April 3 as "net profits" as a basis for objecting to  the claimed exemption. But the trustee's argument that net  profits cannot be earnings is incorrect. For purposes of federal  income tax, compensation to sole shareholder/employees of  close and subchapter S corporations may be paid out of net  profits in the form of earnings. See Elliotts, Inc. v. C.I.R., 716  F.2d 1241, 1242, 1248-49 (9th Cir. 1983) (holding that payment by a close corporation of 50 percent of net profits to sole  shareholder/employee as compensation does not warrant a  presumption of "disguised dividends"). Net profits under federal tax law can be either earnings or dividends when paid to  a sole shareholder/employee, although "distinguishing  between dividends and compensation for services received by  a shareholder-employee of a closely held corporation " can  sometimes be "troublesome." Id. at 1243.8 But despite the  occasional troublesome nature of the inquiry in the tax field,  it is clear that the term "net profits" is often used to refer to  money paid out as earnings, and we find that Carter's use of  the term in the context of a bankruptcy proceeding is in no  way inconsistent with her having received the April 3 payment as earnings.

29
The problem for Carter, however, is that on the record  before us there is little indication that the payment was actually earnings within the meaning of S 706.011. Indeed, there  is some reason to suspect that it was not. Carter had estimated  the gross income of Krynicki for all of 1995 as $115,000, yet on April 3 of that year she paid herself (before withholding)  a lump sum of $78,714.00, which she has attempted to characterize as net profits or earnings. But when Carter made this  payment to herself, the preparations for the bankruptcy filing  were well underway. It is possible, perhaps even likely, that  in the ordinary course of business, absent bankruptcy, some  or all of that money either would have been paid as current  expenses or kept in reserve against future expenses. Or the  payment could have come from funds that had been retained  in some earlier year. On the current record, we simply do not  know.

30
Except to the degree that there is a correlation between  the April 3 payment to Carter and the earnings Carter could  legitimately have expected to receive from Krynicki during  that period, the April 3 payment cannot qualify for the earnings exemption under S 706.011. Because the bankruptcy  court erroneously found that Carter was not an "employee,"  it neither developed a record nor ruled on the furtherquestion  whether some or all of the April 3 check to Carter constituted  "earnings." Remand is appropriate when "the bankruptcy  court's factual findings are silent or ambiguous as to a material factual question." In re Hall, Bayoutree Assoc., Ltd., 939  F.2d 802, 804-05 (9th Cir. 1991). We therefore reverse and  remand for a determination of whether Carter's April 3 check  represented "earnings" under C.C.P. S 706.011.

31
REVERSED and REMANDED.

Notes:

1
 A "sub-chapter S" corporation is a corporation formed to take advantage of the tax treatment provided by Sub-chapter S of the Internal Revenue  Code, 26 U.S.C. S 1361 et seq.

2
 Carter actually prepared and signed her bankruptcy petition and schedules, reflecting the April 3 check, prior to April 3. The plans for the bankruptcy filing clearly anticipated the April 3 payment.

3
 We note that there was sustained discussion and some disagreement in  the bankruptcy court and the BAP concerning burdens of proof, production and persuasion. The burdens of production and persuasion were properly set forth by the BAP. A claimed exemption is "presumptively valid."  9 Collier on Bankruptcy, P 4003.04 (15th ed. rev. 1998); In re Patterson,  128 B.R. 737, 740 (Bankr.W.D.Tex. 1991). Carter claimed $39,000 as an  exemption under C.C.P. S 704.070, and this claim is presumptively valid.  Once an exemption has been claimed, it is the objecting party's burden  (the trustee in this case) to prove that the exemption is not properly  claimed. See Fed. R. Bankr. P. 4003(c). Initially, this means that the  objecting party has the burden of production and the burden of persuasion.  The objecting party must produce evidence to rebut the presumptively  valid exemption. In re Lester, 141 B.R. 157, 161 (S.D. Ohio 1991). If the  objecting party can produce evidence to rebut the exemption, the burden  of production then shifts to the debtor to come forward with unequivocal  evidence to demonstrate that the exemption is proper. See In re Moneer,  188 B.R. 25, 28 (Bankr.N.D. Ill. 1995); Fed.R.Evid. 301. The burden of persuasion, however, always remains with the objecting party. There was  no real dispute in the bankruptcy court or the BAP concerning these burdens in the abstract. Rather, the parties disputed the relationship between  a subchapter S corporation and a shareholder/employee under C.C.P.  S 706.011, which was reflected in the disagreement about burdens of  proof, production, and persuasion.

4
 The Legislative Committee Comment to S 706.011 provides: "This  chapter deals only with the garnishment or withholding of earnings for  services rendered in an employer-employee relationship. See Section  706.020. Subdivisions (b) and (c) [which define`employee'] are based on  the common law requirements for such relationship. " C.C.P. S 706.011  (Legislative Committee Comment).

5
 Many professionals are in a similar situation -- doctors, lawyers,  accountants -- and they are ordinarily considered employees of their  respective corporations, even if they are the sole shareholder. This court,  applying the federal common law test of "employee " status, does not consider them independent contractors of their own corporations. See, e.g.,  Idaho Ambucare Ctr., Inc. v. United States, 57 F.3d 752, 754 (9th Cir.  1995) (applying common law and holding that for federal "employee"  taxes doctor was an employee of his own professional association but not  an employee of out-patient facility contracting with doctor's professional  association); Spicer, 918 F.2d at 94 (applying common law and holding  that for federal "employee" taxes a shareholder accountant is employee  and not an independent contractor of his own S corporation).

6
 For a comparable arrangement under California law, see Cal. Unemp.  Ins. Code S 656. For purposes of unemployment compensation, there is a rebuttable presumption that an accountant is an independent contractor  with her clients. But if that same accountant operates through her own  subchapter S corporation, she is an employee of that corporation. See  Spicer, 918 F.2d at 94.

7
 In fact, there is only one California case that discusses C.C.P.  S 706.011. See Moses v. DeVersecy, 157 Cal. App. 3d 1071 (1984). The  court in Moses held that a self-employed CPA was not an "employee" of  his clients for purposes of S 706.011. This holding has no bearing on Carter's situation because the disputed relationship is between Carter and  Krynicki, not Carter and the various establishments where she performs.

8
 The subchapter S form bypasses the usual disputes over "earnings" and  "dividends." The subchapter S "pass through " taxation avoids "problems  encountered by many closely held concerns in justifying salary payments  to shareholder employees under a `reasonableness' test so as to permit  deductibility." William H. Painter, Painter on Close Corporations  S 1.10.1 (3d ed. 1997); see Elliotts, Inc. , 716 F.2d at 1244-45 (analyzing  deductibility of employee compensation for a non-subchapter S corporation). The earnings/dividends issue ordinarily arises for a subchapter S  corporation in analyzing taxes on "wages," such as Social Security and  unemployment taxes. See Spicer, 918 F.2d at 92; Johnson v. Chater, 127  F.3d 756, 758-59 (8th Cir. 1997). However, when the issue is whether  such "wage" taxes are owed, the taxpayer's motivation is to characterize  the compensation as dividends rather than earnings. The motivation is precisely the opposite in Carter's situation.