Contributed by Katherine Doorley
“Possession is nine tenths of the law.” The United States Bankruptcy Appellate Panel of the Ninth Circuit amended that old adage in its recent decision in In re Newman, No. NV-12-1439-JuKiD (B.A.P. 9th Cir. Feb. 4, 2013), in which the Panel held that a federal income tax refund was subject to turnover, despite the fact that the debtor had spent the refund before turnover was sought.
The debtor appealed an order of the United States Bankruptcy Court for the District of Nevada compelling him to turn over a portion of his federal income tax refund to the chapter 7 trustee. A few months after the debtor had received his discharge, the trustee requested a copy of his federal tax return, which showed that the debtor and his wife received a refund, which refund had not been listed on the debtor’s schedules. Receiving no response, the trustee sent a second letter stating that a portion of the tax refund was property of the estate and sought an order compelling turnover of that sum. In response, the debtor argued that because he had filed a joint tax return with his wife, part of the refund was her property and not property of the estate and was, therefore, not subject to turnover. The debtor also argued that the trustee’s turnover motion was untimely because the debtor and his wife had already spent their tax refund by the time the motion was filed. The bankruptcy court granted the turnover motion.
The Bankruptcy Appellate Panel heard the case on appeal to consider whether the tax refund was properly considered property of the estate and whether the bankruptcy court’s turnover order was proper.
The panel considered nonbankruptcy law to determine the nature and extent of the debtor’s interest in the tax refund. Under Nevada law, all property acquired by either spouse during a marriage is community property. The panel concluded that because the tax refund was community property subject to the joint control of either spouse, section 541(a)(2) of the Bankruptcy Code “dictates that the entire prorated tax refund is property of the debtor’s bankruptcy estate.”
Turnover Under Section 542(a) of the Bankruptcy Code:
Having determined that the tax refund was property of the estate, the panel next considered whether the bankruptcy court had erred in ordering turnover of the tax refund. Turnover actions are governed by section 542 of the Bankruptcy Code, which provides in relevant part “an entity, other than a custodian, in possession, custody, or control, during the case, of property that the trustee may use, sell, or lease under section 363 of this title, or that the debtor may exempt under section 522 of this title, shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value or benefit to the estate.”
The debtor relied on Brown v. Pyatt (In re Pyatt), 486 F.3d 423 (8th Cir. 2007) in arguing that because he had spent the tax refund, it was no longer in his “possession, custody or control” within the meaning of section 542(a).  In Pyatt, the Eighth Circuit held that a debtor could not be compelled to turn over money in his bank account at the time he filed for bankruptcy protection because the money in the account was used to honor prepetition checks that cleared soon after the filing, because the funds were no longer in the debtor’s possession or control.  The court reasoned that a trustee could compel turnover only from parties having actual possession or control of property of the estate at the time of the turnover demand, in part out of a concern that if present possession was not required, a trustee could proceed against both the debtor and the recipient and obtain a potential double satisfaction.
The panel disagreed with the Eighth Circuit’s holding in Pyatt and noted that among the circuit courts and bankruptcy appellate panels that have addressed the issue of turnover, Pyatt represents a minority view.  In particular, the panel focused on its previous decision in Rynda v. Thompson (In re Rynda), No. NC-11-1312-HDoD, 2012 WL 603657 (B.A.P. 9th Cir. Jan. 30, 2012), in which another panel held that section 542(a) does not require current possession to compel turnover.  In Rynda, as in Newman, the chapter 7 debtor had failed to schedule her state or federal tax refunds.  Upon learning of the refunds, the chapter 7 trustee demanded that the debtor turn them over.  The debtor argued in response that the refund was no longer in her possession.  On appeal, the panel held that despite the fact the debtor no longer had possession of the tax refund, she was not relieved of her obligation to “deliver to the trustee and account for such property or its value.” The panel further held that the debtor’s obligation to deliver her tax refund to the trustee was not waived merely because the debtor no longer had possession.  The panel finally concluded that “since the Debtor had been in possession of property of the estate, the Turnover Order was appropriate even though the Debtor did not possess the funds at the time the Trustee filed the Turnover Motion.”
The Newman panel adopted the holding of Rynda, stating that, under the Bankruptcy Code, “the obligation to turnover extends not just to property presently in someone’s possession, custody, or control but to property in its ‘possession, custody or control during the case.’” The panel noted that the debtor was clearly entitled to a tax refund on the petition date, and that the debtor received the refund post-petition, therefore, the debtor was in “possession, custody or control” of the property “during the case.”  The panel concluded that despite the fact that the debtor no longer possessed the funds, he was not relieved of his statutory obligation to deliver “to the trustee and account for such property or its value” and that “if a debtor demonstrates that [he] is not in possession of the property of the estate or its value at the time of the turnover action, the trustee is entitled to recovery of a money judgment for the value of the property of the estate.” 
The panel held that the Bankruptcy Court properly granted the turnover motion because the trustee was entitled to recovery of a money judgment for the value of the property of the estate. While this was a chapter 7 individual case, debtors should be aware that they could be compelled to repay the estate for property no longer in their possession.