In re JAMES L. DALEY, JR., Debtor. JAMES L. DALEY, JR., Plaintiff-Appellant, v. ANN REILLY MOSTOLLER, Defendant-Appellee.
No. 12-6130
United States Court of Appeals for the Sixth Circuit
Decided and Filed: June 17, 2013
13a0166p.06
Before: MARTIN and SUTTON, Circuit Judges; ADAMS, District Judge.
RECOMMENDED FOR FULL-TEXT PUBLICATION Pursuant to Sixth Circuit I.O.P. 32.1(b). Appeal from the United States District Court for the Eastern District of Tennessee at Knoxville. No. 3:11-cv-00565—Thomas A. Varlan, District Judge. Argued: June 13, 2013.
COUNSEL
OPINION
SUTTON, Circuit Judge. Generally speaking, the assets in an individual retirement account are off limits from tax collectors and creditors in bankruptcy. Yet if the owner of a retirement account uses it in a prohibited way, the taxation and bankruptcy protection disappears. After saving $66,000 in an IRA with Merrill Lynch, James Daley filed a Chapter 7 bankruptcy petition. The bankruptcy court and the district court thought that Daley had impermissibly used the IRA to extend himself credit by granting Merrill Lynch a lien on the retirement funds to cover any potential future debts to the firm. We reverse.
I.
Daley opened an IRA with Merrill Lynch by rolling over $64,646 from another financial institution. Before doing so, Daley signed a Client Relationship Agreement with Merrill Lynch, which contained the following “liens” provision:
All of your securities and other property in any account—margin or cash—in which you have an interest, or which at any time are in your possession or under your control, shall be subject to a lien for the discharge of any and all indebtedness or any other obligations you may have to Merrill Lynch.
R.1-14 at 11. By signing the agreement, Daley thus pledged his IRA as security for any future debts to Merrill Lynch.
No debts ever arose, whether at the time Daley opened the account or later. Merrill Lynch, it is true, offers other types of accounts that do carry debt risks, and Daley might well have opened one—say a margin-trading account that allows customers to purchase securities with money borrowed from the broker. But Daley never opened this kind of account or any other, and he thus never became indebted to Merrill Lynch. Outside of his account with Merrill Lynch, Daley also did not withdraw money from his IRA, borrow from it or use it as collateral for a loan of any sort. Two years after opening the account, Daley sought protection from his creditors
II.
The Bankruptcy Code explains how to treat a Chapter 7 debtor‘s assets—what goes to creditors and what remains exempt. The bankruptcy trustee obtains control of the debtor‘s non-exempt property and distributes it to creditors.
An IRA loses its tax-exempt status if the owner “engages in any transaction prohibited by section 4975” of the tax code.
We think not for several reasons. To start, there is a statutory presumption that his account is exempt. If a retirement fund “has received a favorable determination” from the IRS, “those funds shall be presumed to be exempt from the estate.”
But this breadth of phrasing still demands the “lending of money or other extension of credit between a plan [the IRA] and a disqualified person [Daley],”
The lien provision was contingent on an event that never occurred, and above all could not occur until Daley opened a separate account. It is one thing to say that Merrill Lynch extends credit any time a customer opens a margin-trading account (and thus that a lien on an IRA acts as an extension of credit between the IRA and its owner), even in the absence of actual margin trading; it is quite another to say that Merrill Lynch extended credit to a nonexistent margin-trading account. Daley‘s naked lien, stripped of any connection to a credit transaction, was not an extension of credit.
Consistent with this analysis, the IRS in 2011 announced that lien provisions like the one in the Daley-Merrill Lynch contract would not destroy an IRA‘s tax exempt status. IRS Announcement 2011-81, 2011-52 I.R.B. 1052. The mere existence of a “cross-collateralization agreement,” as the IRS calls it, does not by itself disqualify an IRA from exempt status. At most, it is the actual use of such an agreement—and the prohibited extension of credit through it in a later transaction—that might disqualify a retirement account.
In reaching a contrary conclusion, the bankruptcy court invoked an advisory opinion by the Department of Labor, which shares administrative authority over retirement accounts with the IRS. Reorganization Plan No. 4 of 1978,
The trustee adds that the IRA lien amounted to an extension of credit even if Daley never opened any other accounts
The trustee also notes that the IRS Announcement does not apply to Daley, claiming that his account is not a cross-collateralization agreement. But it is. The IRS Announcement describes such agreements by citing a Department of Labor advisory opinion that quotes a lien provision identical in all relevant particulars to the one Merrill Lynch required Daley to sign. See 2011-52 I.R.B. at 1052; U.S. Dep‘t of Labor, Advisory Op. 2009-03A at 1. The trustee adds that the IRS ruling exempts cross-collateralization agreements only if “there has been no execution or other enforcement pursuant to the agreement against the assets of an IRA account.” 2011-52 I.R.B. at 1052. As the trustee sees it, she is executing against Daley‘s retirement account in the bankruptcy proceeding. But “enforcement pursuant to the agreement” means enforcement by a party to the contract, which is to say Merrill Lynch‘s execution of the lien against Daley‘s retirement account. The trustee has no more rights than Merrill Lynch to the assets in the IRA, and Merrill Lynch currently has none.
Janpol v. CIR, 101 T.C. 518 (1993), changes nothing. An employer guaranteed loans—loans made by a third party to an employee profit-sharing plan—prompting an inquiry into whether the guarantee amounted to an extension of credit between the employer and its benefit plan under § 4975. Janpol argued that he did not extend credit because the guarantee was conditioned on a loan default, which never occurred. The tax court disagreed, reasoning that a guarantee “is prohibited whether or not the condition for liability to the third party has arisen” because the contract itself creates a “potential for abuse.” 101 T.C. at 527. Even if Janpol were binding authority, even if “potential for abuse” were the lodestar for construing “extension of credit” and even if the IRS had not twice blessed Merrill Lynch retirement accounts, Daley‘s situation is one significant step removed from Janpol‘s. Daley never opened any accounts other than his IRA, and there was thus no possibility that he could be subjected to liability. If Janpol had merely agreed to guarantee against the possibility of future loans, loans that no one ever authorized or made, we think his case would have come out differently.
Willis v. Menotte does not help the trustee either. No. 09-82303, 2010 WL 1408343 (S.D. Fla. April 6, 2010). Willis did much more than sign a lien provision; he “transferred $700,000.00 from his Merrill Lynch account to a non-IRA account held with his wife, and then transferred the money to a third party in order to fund a real property mortgage.” Id. at *1. Even though Willis had a favorable-determination letter from the IRS, the court said, Willis‘s transfer of funds from his IRA went beyond the approved form of the account. Id. at *5. In marked contrast, other than signing the papers to open the retirement account, Daley authorized no remotely comparable transactions.
In the final analysis, Mostoller has not rebutted the statutory presumption that Daley‘s retirement account is exempt from bankruptcy. Daley signed a boilerplate lien provision as a requirement of opening an account that the IRS had approved. He made no other transactions with the account, and because he opened no other accounts there was no possibility that the
III.
For these reasons, we reverse.