Matthew C Abel
MEMORANDUM OF DECISION HOLDING IRS ACTIONS IN VIOLATION OF AUTOMATIC STAY AND IN CONTEMPT OF CHAPTER 13 PLAN CONFIRMATION ORDER
Debtors claim that IRS violated the automatic stay and plan confirmation order when it placed an administrative freeze on their tax refund. We hold 1 that IRS violated §§ 362(a)(3) and (6) of the Bankruptcy Code, and that IRS acted in contempt of the Chapter 13 plan confirmation order when it froze Debtors’ tax refund.
FACTUAL 2 AND PROCEDURAL HISTORY
Debtors filed a Chapter 13 petition on May 23, 1996. Their petition listed a 1992 underpayment of taxes owed to IRS as an unsecured priority debt in the amount of $193. Debtors served IRS with a copy of the schedules and the proposed Chapter 13 plan on August 12, 1996. The plan proposed that Debtors pay $199 per month to the Chapter 13 Trustee, and provided for full payment of the IRS debt. IRS did not object to confirmation, and the plan was confirmed on September 19, 1996.
By February of 1997, Debtors were approximately three (3) months behind in their plan payments. That February, Debtors filed their Form 1040 personal income tax return for the year 1996, claiming an overpayment refund due of $2,007. The refund was not timely received, and upon inquiry, Debtors were told by IRS bankruptcy specialist 3 Kenneth Farley that IRS had frozen Debtors’ refund.
On March 31, 1997, Debtors filed a complaint for monetary damages, attorneys’ fees, injunctive relief and declaratory relief against IRS for its alleged violation of the automatic stay (citing
On the day of trial, the parties stipulated to a partial settlement of the following issues:
a. The United States would pay $2,000 to Debtors who, in turn, agreed that for the rest of the case it would be deemed that IRS and the IRS Special Procedures Office had followed its standard procedure for dealing with inquiries from Chapter 13 Debtors about refunds, and that there was no bad faith or attempt to coerce a setoff or immediate payment of the pre-petition debt.
b. Debtors waived the right to claim a violation of§ 362(a)(7) in light of the parties stipulation that the 1996 overpayment is not an obligation to the debtors “that arose before the commencement of the case” within the ambit of§ 362(a)(7) . The debtors also waived the right to claim a violation of§ 525 .
c. Debtors reserved contentions that the practice followed by the IRS violated§ 362(a)(3) or (6) (the latter only on the contention that the freeze is for eventual collection, because Debtors waived allegations of bad faith or coercion specific to this case). Debtors reserved the contention that the IRS’s actions under its standard practice were in contempt of the confirmation order.
d. If Debtors were entitled to damages under any of their reserved theories, that damages were $1,000 in general damages and $7,000 in emotional damages. The United States reserved the night to appeal the Court’s prior rejection of its argument that§ 362(h) does not cover emotional damages.
e. If Debtors did not win on damages (not counting the $2,000 being paid to settle the bad faith/coercion contentions referred to under item ‘a’ above), no attorneys fees would be awarded. If Debtors won damages, then the United States would pay $12,500 in attorney fees for all work through the conclusion of the case in the Bankruptcy Court. If Debtors won and the government appealed and lost, then the government would pay additional attorney fees incurred in any appeals not to exceed $5,000 (for a maximum attorney fees award of $17,500).
f. Debtors reserved contentions that the IRS’s failure to notify Debtors of its practice of freezing refunds violated the Due Process clause of the Fifth Amendment, for purposes of declaratory and/or injunctive relief, [the constitutional issues were later rendered moot] 6
g. The government waived the right, in this case only, to seek a modification of Second Circuit precedent treating *160 any willful act that violates the stay with the, knowledge thereof as a “willful violation” (although the government did not concede, for other cases, that this interpretation of willful violation was correct). Accordingly, if a stay violation was found, it would be deemed willful.
During the time period in question, it was IRS policy to input a freeze code (the “V-freeze”) into its computerized accounting system when a taxpayer declared bankruptcy. Tax refunds owed to debtors were only frozen if the debtor owed money to the IRS. IRS made no effort to notify such debtor that his or her tax refund had been administratively frozen. Rather, it was IRS policy to wait until a debtor realized that his/her refund was late, and it is was that debtor’s duty to inquire regarding the status of that refund. When debtors made such an inquiry, an IRS bankruptcy specialist determined whether or not the debtor was current with his/her plan payments. If the debtor was current, IRS released the V-freeze. If the debtor was not current, IRS policy allowed the bankruptcy specialist to tell the debtor that he or she may obtain his or her refund by curing the plan arrearage (IRS offered to do so by sending the necessary part of the refund to Chapter 13 Trustee). Sometimes, IRS also offered debtors the option of paying the IRS debt in full, and the IRS would then release the remaining refund to the debtor.
DISCUSSION
I. The V-freeze as imposed by IRS violates
Debtors first claim is that the V-freeze as imposed by the IRS violates
(a) Property of the estate includes, in addition to the property specified in section 541 of this title—
viii. all property of the kind specified in such section that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7,11, or 12 of this title whichever occurs first; and
ix. earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first.
Under the
The issue, unfortunately, is not that simple.
“
The first line of eases stresses the effect of the ‘vesting’ of estate property in a debtor under
The second line of cases, giving much weight to
The third line of cases holds that upon confirmation, all property except that property needed to fund the Chapter 13 Plan revests in a debtor under
The fourth, and most recent line of cases to emerge, holds that upon confirmation, all property vests in a debtor under
The fourth line of cases is similar to the third line in that they both hold that the estate continues to collect property even after pre-confirmation estate property vests in a debtor under
The first view which says that the estate terminates after confirmation cannot be valid. This view renders the broad language of
In addition to the problems with statutory construction, such a theory means that if a Chapter 13 debtor were to obtain a windfall one day after confirmation, such a windfall would not be available to creditors. It also means that a post-petition creditor could attach those wages which a debtor needs to fulfill the terms of the plan without running afoul of the automatic stay.
In re Rangel,
For similar reasons, the second view, which holds that confirmation does not effect the estate, cannot be valid, because such a reading ignores the express wording of
The third line of cases suffers from flaws as well. First of all, it reads into
IRS argues that the fourth view, which gives a broad definition to property of the estate, will hinder Debtors from obtaining post-confirmation credit because it will render the automatic stay applicable to an expansive category of property. This is a valid concern, but we are constrained by the statutory text, and we refuse to read nonexistent requirements into the statute merely because it might help post-confirmation debtors obtain credit. Such policy considerations should be considered at the legislative level, not here:
If the theory behind Chapter 13 is that a debtor is to devote disposable income to the repayment of creditors, it is unclear why the Code should be interpreted to enable a debtor to incur more debt. Second, the Code and local rules contemplate oversight of the obtaining of credit post-petition. Third, the Code provides a mechanism for the repayment of a creditor who has extended credit for property or services which were necessary for a debtor to effectuate the plan. That Congress chose not to include all post-petition creditors seems to indicate that those creditors who extend credit for property or services which are not necessary to the plan do so at the peril of not being able to collect on that debt *163 until the debtor is free form the bankruptcy. ... Such a conclusion makes sense in light of the Code policy that all of a debtor’s income, not just a portion, should be dedicated to the plan.
In
re
Rangel,
For the above-mentioned reasons, we adopt the fourth view of the interplay between
IRS argues that even if all post-confirmation property remains property of the estate until the case is closed, the Supreme Court’s interpretation of
In
Strumpf,
the United States Supreme Court held that a bank’s temporary administrative freeze of a debtor’s account while the bank sought to enforce its rights to a § 553(a)
10
setoff did not violate
Respondent’s reliance on these provisions rests on the false premise that petitioner’s administrative hold took something from respondent, or exercised dominion over property that belonged to respondent. That view of things might be arguable if a bank account consisted of money belonging to the depositor and held by the bank. In fact, however, it consists of nothing more or less than a promise to pay, from the bank to the depositor, and petitioners temporary refusal to pay was neither a taking of possession of respondent’s property nor an exercising of control over it, but merely a refusal to perform its promise. In any event, we will not give§§ 362(a)(3) or (6) an interpretation that would proscribe § 542(b)’s ‘exception’ and § 553(a)’s general rule were intended to permit.
Id.
IRS argues that, akin to the bank’s temporary freeze in Strumpf, the V-freeze imposed by the IRS did not “take control” of estate property. IRS claims that it merely refused to perform its promise to Debtors to refund their taxes.
Before examining the inherent problems with IRS’ analogy, we first note that we should construe
Strumpf s
holding narrowly. “It is a fundamental axiom of bankruptcy law that the automatic stay is pervasive and exemptions from the stay are strictly construed. The logic of the foregoing compels a narrow reading of
Strumpf.
In addition, the language of the decision itself dictates that its holding is limited to the so called ‘bankers dilemma’ of preserving a creditor’s setoff rights.”
In re Megan-Racine Assocs., Inc.,
Even a broad reading of
Strumpf
however, would not render it’s holding applicable here. In
Strumpf,
the Court held that the bank’s temporary freeze did not violate
There is no question that a tax refund or a right thereto is property of the estate.
11
Holden v. United States of America (In re Holden),
Further, there is no question that the V-freeze, which indefinitely delayed Debtors’ receipt of their refund, was an exercise of control over estate property. “Withholding possession of property from a bankruptcy estate is the essence of ‘exercising control’ over possession.”
Transouth Financial Corp. v. Sharon (In re Sharon),
For the reasons mentioned above, we find that the refund due Debtors was property of the estate under
II. The V-freeze as imposed by IRS violates
Debtors next claim that IRS’ imposition of the V-freeze violates
Again, IRS argues that
Strumpf
controls here, and again, we disagree. First, as noted above,
Strumpf
was concerned with a bank who was seeking to assert its pre-petition right of setoff under § 553(a). “[W]e will not give ...
*166
Because there is no right to setoff the funds in question, we must ask why IRS froze the refund due to Debtors. IRS argues that it placed its freeze to prevent unauthorized automatic setoffs by the. IRS. We note that even if this was one of the freeze’s purposes, another obvious purpose and effect was to expedite the eventual collection of pre-petition debts due IRS. Other than debt collection, IRS advances no other credible reason
14
for the imposition of the glacial V-freeze. Such a finding is bolstered by the fact that IRS admits that in some instances, its agents would offer inquiring debtors the option of repaying their prepetition IRS debt in full in order to quickly unfreeze the withheld refund. “Because the IRS had no setoff rights, its placement and retention of a signal on its computer which prevented the issuance of debtors’ refund cheek was an act to collect or recover the IRS’ pre-petition tax claim prohibited by
III. The V-freeze as imposed by IRS violates the plan’s Confirmation Order
Debtors next claim that the V-freeze was in contempt of the Chapter 13 Plan Confirmation Order. IRS argues that the plan only provides for the manner of payment by Debtors, and does not pre-elude IRS from retaining Debtors’ tax refund.
Under
IRS claims its V-freeze is needed in order to protect itself if Debtors default on their plan and it is dismissed without a discharge. We disagree. No such adequate protection or quasi-security interest is provided for in the plan. “Because creditors are limited to those rights that they are afforded by the plan, they may not take actions to collect debts that are inconsistent with the method of payment provided for in the plan.” 8
Collier on Bankruptcy,
¶ 1327.02[l][b] (Matthew Bender 15th Ed. Revised 1996). As an unsecured creditor, IRS has no more authority to demand, retain, control, or threaten to repossess estate property as security for its unsecured debt than any other unsecured creditor. IRS retained no right to be treated as a secured creditor, because post-confirmation creditors “may not later assert any interest other than that provided for it by the confirmed
*167
plan.”
In re Eason,
CONCLUSION
We find that IRS’ V-freeze violated
Notes
. Our subject matter jurisdiction over this controversy arises under
. The parties stipulated that IRS followed its standard procedures in dealing with Debtors. Accordingly, in-depth factual findings regarding IRS' conduct in this particular case are not necessary. Rather, the real issue is whether IRS' former general procedure of placing V-freezes on post-petition refunds violated the automatic stay.
. Debtor has since added the contention that the IRS's actions violated
. On May 19, 1997, IRS filed a Motion to Dismiss the adversary proceeding for failure to state a claim upon which relief could be granted under
. Under their constitutional claims, Debtors sought injunctive and declaratory relief, because Debtors were concerned that IRS would continue to institute the V-freeze on their post-petition refunds throughout the plan. After trial, but before we issued our decision, IRS notified the Court that it had changed its policy and no longer instituted V-freezes on post-petition refunds due Debtors. IRS submitted an affidavit of James Spinale, manager of the two Insolvency Units of the Office of Special Procedures of IRS' New England District, which described IRS' new procedure for automatically refunding post-petition refunds due to debtors. On June 17, 1999, we ruled that the Debtors’ constitutional claims for declaratory and injunctive relief
*160
had therefore become moot, and said that we would decline to rule on the constitutional claims. “A fundamental and longstanding principle of judicial restraint requires that courts avoid reaching constitutional questions in advance of the necessity of deciding them.”
Lyng v. Northwest Indian Cemetery Protective Assoc.,
. The Debtor and IRS have stipulated that the tax refund became due post-petition. “Debtors waived the right to claim a violation of
.
See
§§ 349(b)(3) and § 704(9);
also see In re Rangel,
. IRS claims to have a solution to this conundrum — it says that only property and income that is explicitly listed in the plan becomes property of the post-confirmation estate.
See In re Heath,
. The applicable portion of § 553(a) states "... this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under his. title against a claim of such creditor against the debtor that arose before the commencement of the case ...”
. Because the mere right to a tax refund is property of the estate, we realize that a
pro rata
portion of this right may have 'vested' in Debtors under
Technically, therefore, IRS did not violate
We note that this conclusion does not effect our
IRS might argue, although it does not, that since a
pro rata
portion of the refund became property of the estate pre-confirmation, that the
pro rata
portion which vested in Debtors prepetition should be available for setoff under
IRS cannot make this argument, however, because IRS stipulated that the refund due Debtors was deemed post-petition in nature. The mutuality requirement of
. There are many reasons why
Strumpf
does not apply here. Unlike the bank's temporary freeze in
Strumpf,
the V-freeze here was instituted on Debtors’ refund without notifying debtor and lasted for an indefinite period. While
Strumpf
held that ''[a] temporary refusal to pay was neither a taking of possession nor an exercising of control over ... [debtor's bank account]”, the Court was not concerned with, and therefore did not rule on, the validity of a pervasive and indefinite freeze.
See Town of Hempstead Employees Federal Credit Union v. Wicks (In re Wicks),
Further, IRS claimed the right to freeze not only past refunds, but future refunds as well. "This act was similar to placing a continuing garnishment on debtors’ future income. The failure of a creditor to remove a continuing garnishment after the automatic stay has become effective has been held to violate the automatic stay.”
In re Burrow,
. The parties have stipulated that the refund owed to Debtors arose post-petition. Therefore
. We are not convinced by IRS' claim that the V-freeze is the only reasonably efficient manner to deal with Debtors in Chapter 13 cases. As another court noted rather simply, "[i]f a computer can be told to hold and offset a tax refund, it can be told to release a tax refund. Surely, once a plan had been confirmed, the IRS could have canceled the computer's hold on debtors' tax refund and could have ordered the computer not to make a setoff.”
In re Burrow,
IRS does not deserve special treatment or exemptions from the automatic stay because it could not figure out a way to program its computers to act in a legally permissible manner. No other creditor enjoys such immunity, and we flatly refuse to confer such immunity here.
. "The provisions of a confirmed plan bind the debtor and each creditor, whether or not the claim of such creditor is provided for by the plan, and whether or not such creditor has objected to, has accepted, or has rejected the plan.”
. Because IRS had no setoff right, we need not address the issue of whether or not the confirmation of a chapter 13 plan negates pre-petition rights to setoffs not mentioned in the plan.
. IRS previously agreed to pay $2000 in consideration for Debtors' stipulation that IRS followed its general procedures with dealing with Debtors and did not act in bad faith.