The U.S. Court of Appeals for the Seventh Circuit recently addressed two issues of first impression under a Wisconsin statute that permits resident debtors to shield certain assets from execution by creditors.
First, the Seventh Circuit concluded that the owner of a state-qualified college savings account had a sufficient interest in the account to qualify it as exempt. Second, the Seventh Circuit concluded that an annuity that provides a death benefit qualifies as exempt.
A copy of the Court’s opinion is available at: Link to Opinion
The debtor was a retiree who incurred significant medical expenses caring for his wife before she passed away, and as a result of a stroke he suffered after she passed away. The debtor sought the advice of an attorney about pre-bankruptcy exemption planning and converting his non-exempt assets into exempt assets. As a result, the debtor borrowed $95,000 from the bank and mortgaged his unencumbered home. With that loan, he established college savings accounts for his 5 grandchildren. He also converted a $42,000 certificate of deposit into an annuity. The annuity would begin paying in 35 years and it also contained a death benefit provision.
When the debtor filed bankruptcy, he listed the college savings accounts and annuity as exempt property. The Trustee objected and argued that the debtor had transferred property in an attempt to defraud his creditors. The Trustee also argued that the college savings accounts and annuity were not exempt under the statutory definitions of those assets.
The bankruptcy court concluded that there was no evidence that the debtor transferred his property with the intent to hinder or defraud creditors. The bankruptcy court also held that under the college savings account statute, only the beneficiary had an interest in the account, not the owner. And, finally, the bankruptcy court held that the annuity was exempt under the statute because it contained a death benefit clause.
Although the district court vacated the bankruptcy court’s findings, it agreed with most of the bankruptcy court’s reasoning. The district court held that there was insufficient evidence to establish the debtor had improperly transferred his assets. The district court also agreed with the bankruptcy court’s interpretation of the college savings account statute that the accounts were not exempt because only the beneficiary of the account had an interest in it. As to the annuity, the district court narrowed the bankruptcy court’s interpretation of the applicable statute and remanded the case for additional fact-finding to determine whether the annuity qualified under the more narrow interpretation.
On remand, the bankruptcy court again concluded that the annuity was exempt even under the narrower interpretation. Both sides preserved their respective appeals of all orders issued to the district court. After the district issued a final order affirming the bankruptcy court’s rulings, the debtor appealed the disallowance of the college savings accounts and the Trustee appealed the ruling on the annuity.
On appeal, the Seventh Circuit analyzed both Wisconsin state statutes at issue. As to the college savings accounts, the Court concluded that the statute was not ambiguous and the term “interest in a college savings account” was not limited to the beneficiary’s interest and interpreting it as such would produce an illogical result. “If account owners may not invoke the general exemption in [the statute], as the trustee suggests and the lower courts held, then a college savings plan can be reached by an account owner’s creditors, impairing the beneficiary’s right to qualified withdrawals.”
As to the annuity, the Appellate Court quickly identified that the exemption specifically includes “providing benefits by death.” And because the debtor’s annuity contained a death benefit clause, the Court concluded that the debtor’s annuity qualified.
The Appellate Court pointed out, however, that the inquiry did not stop there. Not only must the annuity qualify under the statutory definition, but it had to either be (a) employer sponsored or (b) compliant with the Internal Revenue Code. It was undisputed that the debtor’s annuity was not employer sponsored and the issue of whether it complied with the Internal Revenue Code had not been previously addressed. The Trustee, however, had not previously raised the argument in the bankruptcy court that the annuity did not comply with the Internal Revenue Code. As a result, district court deemed the argument waived and the Seventh Circuit affirmed.
Holding that the debtor’s college savings accounts were exempt, and that the issue of whether his annuity complied with the Internal Revenue Code had been waived, the Seventh Circuit reversed the district court’s ruling disallowing the exemption for the college savings accounts and affirmed the district court’s ruling regarding the annuity being exempt.
Ralph T. Wutscher
McGinnis Wutscher LLP
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