Judge Somers

12-05155 Morris v. Pioneer Credit Recovery, Inc. et al (Doc. # 24)

Morris v. Pioneer Credit Recovery, Inc. et al, 12-05155 (Bankr. D. Kan. Oct. 23, 2013) Doc. # 24

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SIGNED this 22nd day of October, 2013.


Opinion Designated for Electronic Use, But Not for Print Publication

In Re:



CASE NO. 12-11367

ADV. NO. 12-5155


The Chapter 7 Trustee, J. Michael Morris, filed this action to avoid allegedly

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preferential or fraudulent transfers made by Debtor John Wesley Knowles to the United
States Department of Agriculture - Rural Housing Service (“RHS”) as indemnification for
payments made by the RHS to Bankwest of Kansas, the Debtor’s mortgage lender under a
Department of Agriculture guaranteed loan program. The parties have filed a stipulation
of facts and submitted the case on written briefs. The Court has jurisdiction.1

For the reasons discussed below, the Court denies the Complaint, except as to the
transfer for the benefit of the Department of Agriculture of $1,572.78 by a prepetition
wage garnishment. The defendants agree this transfer was preferential and will pay the
amount to the Trustee upon the entry of an order.

As its findings of fact, the Court adopts the parties’ stipulations,2 which are
supported by attached exhibits and state substantially as follows:

1. On or about February 25, 2005, John W. Knowles (“Debtor”) executed and
delivered a promissory Note to Bankwest of Kansas (“Bankwest”), whereby he promised
to pay Bankwest the sum of $42,000, with interest thereon at 6% per annum. As
consideration for the Note, Bankwest made a loan to Debtor.
1 This Court has jurisdiction over the parties and the subject matter pursuant to 28 U.S.C.
§§ 157(a) and 1334(a) and (b), and the Standing Order of the United States District Court for the District
of Kansas that exercised authority conferred by § 157(a) to refer to the District’s bankruptcy judges all
matters under the Bankruptcy Code and all proceedings arising under the Code or arising in or related to a
case under the Code, effective July 10, 1984. Furthermore, this Court may hear and finally adjudicate this
matter because it is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(F) and (H). There is no
objection to venue or jurisdiction over the parties.

2 Dkt. 17 and 19.


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2. The Note was secured by a mortgage on the following described real property:
All of Lots Nineteen (19) and Twenty (20), Block One
Hundred One (101), North Addition to the City of Colby,
Kansas, as shown by the recorded Plat thereof, commonly
known as 815 E. 8th Street, Colby, KS 67701.

3. The loan made by Bankwest was guaranteed by the United States of America
acting through the Rural Housing Service (“RHS”), an agency of the United States
Department of Agriculture (“USDA”). The Loan Note Guarantee (“Guarantee”) includes
the following: “5. The Loan Note Guarantee will terminate automatically (a) upon full
payment of the guaranteed loan; or (b) upon full payment of any loss obligation
hereunder; or (c) upon written notice from the Lender to RHS that the guarantee will
terminate provided this Loan Note Guarantee is returned to be canceled by RHS.”
4. On February 16, 2005, Debtor executed a Request for Single Family Housing
Loan Guarantee. The Request includes:

I certify and acknowledge that if the Agency pays a loss claim
on the requested loan to the lender, I will reimburse the
Agency for that amount. If I do not, the agency will use all
remedies available to it, including those under the Debt
Collection Improvement Act, to recover on the Federal debt
directly from me. The Agency’s right to collect is
independent of the lender’s right to collect under the
guaranteed note and will not be affected by any release by the
lender of my obligation to repay the loan. Any Agency
collection under this paragraph will not be shared with the

5. Debtor defaulted on the Bankwest loan, and Bankwest filed a petition of
foreclosure on July 23, 2009. On October 26, 2009, a Journal Entry of Judgment was

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entered in Bankwest of Kansas v. John W. Knowles, Case No. 09CV27, Thomas County,
Kansas, granting the plaintiff an in personam judgment and a judgment of foreclosure, in
the amount of $39,662.08, together with interest, costs, and fees as detailed in the
Judgment. This was the full amount owed under the loan.

6. A Sheriff’s sale was held on December 10, 2009. Bankwest purchased the
property for $44,390.02 by issuing a credit bid against the judgment. This bid included
all amounts due under the loan and judgment.
7. Bankwest subsequently sold the property, resulting in net proceeds in the
amount of $20,280.37. Bankwest then submitted a loss claim to the USDA - RHS in the
amount of $21,200.45. On November 26, 2010, the USDA paid Bankwest $20,662.73 on
this claim.
8. On April 9, 2011, pursuant to 31 U.S.C. § 3720A, the USDA sent notice to
Debtor of the delinquent indebtedness in the amount of $20,662.73, giving Debtor 60
days to respond and assert any defenses; otherwise, the indebtedness would be certified to
the Department of the Treasury Offset Program (“TOP”). Debtor did not respond to the
notice. On June 11, 2011, the USDA certified the debt to the Department of the Treasury
for offset.
9. On or about February 15, 2012, pursuant to 26 U.S.C. § 6402(d), the
Department of the Treasury paid Debtor’s 2011 federal income tax overpayment to the
USDA. The overpayment amount was $6,085. The USDA applied $6,068 to the debt,
and the Treasury Department retained a $17 service charge.

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10. The Department of the Treasury, pursuant to 31 U.S.C. § 3720, through its
agent Pioneer Credit Recovery, Inc., garnished Debtor’s wages prepetition in the amount
of $2,541.83, which was applied to the debt. The amount of $1,572.78 was garnished
within ninety (90) days of the filing of the bankruptcy. The USDA has indicated a
willingness to turn the $1,572.78 over to the Trustee, but as of the date of the stipulation,
had not done so. The USDA has requested an order approved by Debtor’s counsel before
making payment to the Trustee.
11. The Chapter 7 bankruptcy case was filed May 25, 2012.
12. Debtors included the following entities on the mailing matrix for notice in
their bankruptcy case:3 Bankwest of Kansas, Pioneer Credit Recovery, US Department of
Treasury (Debt Management Services), Department of the Treasury (Financial
Management Services), and US Department of Agriculture. The address listed for the
USDA does not comply with District of Kansas Local Bankruptcy Rule 2002.2.
13. On July 16, 2012, the Trustee made demand on Pioneer Credit Recovery for
avoidance and recovery of the preferential transfer effected through wage garnishment.
See ¶ 10. No response was received and this adversary action was filed September 24,
14. Debtor was insolvent on the dates when (a) the Department of the Treasury
paid the USDA the Debtor’s 2011 federal income tax overpayment, see ¶ 9 above (the
3 The addresses are listed in the stipulation, but omitted above for simplicity.

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“set-off”), and (b) Debtor’s wages were garnished prepetition, see ¶ 10 above. The setoff
and all such garnishments occurred within two (2) years of the filing of the
bankruptcy case.


A. The parties’ positions.
As found above, Debtor obtained a loan from Bankwest, secured by his residence,
and guaranteed by the RHS. After Debtor’s default, Bankwest obtained a judgment
against Debtor for the full debt owed, foreclosed the mortgage to satisfy the judgment,
and, at the sheriff’s sale, bid in the full amount of the judgment and other amounts owed.
Bankwest subsequently sold the property for less than the bid amount, and sought
recovery of the difference from the RHS under the Guarantee. The RHS paid the claim
and sought reimbursement from Debtor, causing his 2011 federal income tax refund of
$6,068 to be offset, and garnishing his wages in the amount of $2,541.83. The RHS
agrees that $1,572.78 of the garnishments was preferential because obtained within 90
days of the filing of the petition. The Trustee seeks to recover the IRS offset and the
remaining garnished wages of $969.05 as fraudulent transfers.

The Trustee’s theory of recovery is simple. He contends that the RHS’s Guarantee
automatically terminated when Bankwest bid in the amount owed by Debtor at the
foreclosure sale. He relies upon the fact that the Guarantee provides that it shall terminate
upon “full payment of the guaranteed loan” and that Bankwest’s bid at the foreclosure
sale constituted full payment of the guaranteed debt under Kansas law. Therefore,


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according to the Trustee, because the Guarantee terminated, the payments made by the
RHS to Bankwest were gratuitous and may be recovered by the Trustee for the benefit of
the estate. The RHS argues that the Guarantee did not terminate, that its obligation to pay
Bankwest under the Guarantee is not dependent upon Kansas law, that USDA regulations
authorized the payment made to Bankwest, and that Debtor agreed in the certification to
the Request for Single Family Housing Loan Guarantee to indemnify the RHS for the
amount paid to Bankwest.

B. Under Kansas mortgage foreclosure law, a judgment creditor has no
deficiency claim against the debtor following a full credit bid.
There is no question that under Kansas mortgage law, when a creditor is granted a
judgment on a note secured by a mortgage, the mortgage is foreclosed, the property is
sold to the judgment creditor by credit against the judgment, and the sale is confirmed, the
amount of any deficiency judgment is determined by the simple mathematical calculation
of the difference between the judgment amount and the bid amount.4 When the amount
the creditor bids is the full amount owed by the judgment debtor, a full credit bid, the
mathematical calculation results in no deficiency. The creditor cannot thereafter recover
anything from the judgment debtor, even if the property is later sold by the creditor for
substantially less than the amount of its credit bid. Because the creditor purchased the
property for the full amount of the debt, the debt is deemed to have been paid in full, even
thought the creditor has not received any cash payment. In this case, Bankwest bid the

4 Federal Land Bank v. Cummings, 12 Kan. App. 2d 134, 137-38, 735 P.2d 1110, 1113 (1987).

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full amount owed, and it has no claim against Debtor for the difference between the credit
bid and the amount Bankwest later received when it sold the property to a third party.

C. Bankwest’s full credit bid did not terminate the Guarantee.
The question here is the impact of the Kansas full-credit-bid rule on the right of
Bankwest to receive payment under the Guarantee. That agreement provides that “[t]he
Loan Note Guarantee will terminate automatically (a) upon full payment of the
guaranteed loan; or (b) upon full payment of any loss obligation hereunder; or (c) upon
written notice from the Lender to RHS that the guarantee will terminate provided this
Loan Note Guarantee is returned to be canceled by RHS.” The Trustee contends that the
phrase stating the Guarantee “will terminate automatically . . . upon full payment of the
guaranteed loan” is unambiguous and was triggered by Bankwest’s full credit bid.
Evaluation of the Trustee’s position requires the Court to apply rules of contract
construction to the Guarantee.

As stated by the Trustee in his reply brief, “‘When the United States enters into
contract relations, its rights and duties therein are governed generally by the law
applicable to contracts between private parties.’”5 Determining the intent of the parties is
the ultimate goal of contract interpretation. “The whole agreement should, if possible, be
construed so as to conform to an evident consistent purpose, and a court should interpret

5 Dkt. 22 at 3 (quoting Franconia Assocs. v. United States, 536 U.S. 129, 141 (2002)).

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the contract in a manner that makes the contract internally consistent.”6 “Contracting
parties are presumed to contract in reference to the existing law.”7 All existing applicable
regulations must be read into the contract just as if an express provision to that effect
were inserted in the contract.8

The Guarantee was issued by the USDA, acting through the RHS, under Title V of
the Housing Act of 1949 (42 U.S.C. § 1472), and a program established by the Cranston-
Gonzalez National Affordable Housing Act of 1990,9 and amended in 2004 to be called
the “Doug Bereuter Section 502 Single Family Housing Loan Guarantee Program,”
codified at 42 U.S.C. § 1472(h).10 Under that program, guaranteed loans are made only to
low- or moderate-income families or those whose income does not exceed 115 per cent of
the median income of the area.11 Preference is given to first-time home buyers or
veterans, their spouses, or children of deceased veterans.12 A guaranteed loan may only
be used to purchase or build a single-family residence for the borrower; the borrower

6 17A Am. Jur. 2d Contracts § 376 (obtained from Westlaw at AMJUR CONTRACTS § 376,
database updated Aug. 2013).
7 Id. at § 371 (obtained from Westlaw at AMJUR CONTRACTS § 371).
8 Id.
9 Pub. L. No. 101-625, § 706(b) (1990), 104 Stat 4079.
10 Act of Aug. 4, 2004, P.L. 108-285, § 3, 118 Stat. 917.
11 42 U.S.C. § 1472(h)(3).
12 42 U.S.C. § 1472(h)(5); 7 C.F.R. § 1980.353(b).

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must be eligible for assistance; and the residence must be located in a rural area.13 The
loans are targeted to areas that have a demonstrated need for additional sources of
mortgage financing for low- and moderate-income households.14

The Guarantee provides for payment to Bankwest of the lesser of (1) any loss of an
amount equal to 90 percent of the principal amount actually advanced to Debtor, or

(2) any loss “of an amount up to 35 percent of the principal amount actually advanced to
[Debtor], plus 85 per cent of any additional loss sustained by [Bankwest] of an amount up
to the remaining 65 percent [of] the principal amount actually advanced to [Debtor].” It
provides the guaranteed loss shall cover interest to the date of the final loss settlement if
Bankwest liquidates the collateral in an expeditious manner, in which circumstance, the
“[n]et proceeds received from liquidation of the collateral will be used in calculating the
amount of loss sustained by [Bankwest].” It further provides that “[a]ny amount due
under this instrument will be determined and paid, as provided in 7 CFR Part 1980,
Subpart D in effect on the date of this instrument.”
The referenced regulations provide further detail about the liquidation of collateral
and the calculation of the guaranteed loan loss. If a borrower of a guaranteed loan cannot
make a loan payment, the lender is required to assist the borrower or liquidate the loan.15
If a lender concludes that a loan must be liquidated, the lender is to notify the RHS of the

13 42 U.S.C. § 1472(h)(4).
14 42 U.S.C. § 1472(h)(11).
15 7 C.F.R. §§ 1980.309(f); 1980.371; 1980.374.


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decision and initiate a foreclosure within 90 days.16 The lender must proceed in an
expeditious manner and is expected to make the maximum collection possible on the
indebtedness.17 The lender is directed to “consider the possibility of recovery of any
deficiency apart from the acquisition or sale of collateral” and to “submit a
recommendation on such recovery considering the borrower’s assets and ability to pay,
prospects of future recovery, the costs of pursuing such recovery, recommendation for
obtaining a judgment, and the collectability of a judgment in view of the borrower’s

Loss payments in settlement of a guarantee under the housing program are made
within 60 days of the lender’s properly filed claim.19 The loss payment is determined by
applying the net proceeds from the property to the unpaid debt.20 The net proceeds are
defined differently, depending upon which of three circumstances is involved. First, if at
liquidation, title to the property is conveyed to a bona fide third-party purchaser, the loss
payment is based upon the net sale proceeds received for the property.21 Second, “[i]f, at
liquidation, title to the property is conveyed to the Lender, then the Lender must prepare

16 7 C.F.R. § 1980.374.
17 7 C.F.R. § 1980.374(a) and (b).
18 7 C.F.R. § 1980.374(b).
19 7 C.F.R. § 1980.376(a).
20 7 C.F.R. § 1980.376(a)(1).
21 7 C.F.R. § 1980.376(a)(1)(i).


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and submit a property disposition plan to RHS for RHS concurrence.”22 The plan must
address the proposed method of sale, the estimated value and minimum sale price, the
estimated costs of sale, and any other information that could impact the loss on the loan.
The lender is allowed 6 months to sell the property. For purposes of determining the loss
payment under this second alternative, the loss payment “will be based on the net
proceeds received for the property when the sale is conducted in accordance with the plan
as approved by RHS.”23 Third, “[i]f a deficiency judgment is obtained, the Lender must
enforce the judgment against the borrower before loss settlement if the current situation
provides a reasonable prospect of recovery. A loss payment will be made when the
Lender holds a deficiency judgment but there are not current prospects of collection, even
if there may be in the future.”24

As the RHS contends, the Court finds that automatic termination of the Guarantee
was not triggered by Bankwest’s full credit bid at the foreclosure sale. Since, under the
terms of the Guarantee and the applicable regulations, the amount of the bid is irrelevant
to the calculation of the loss to be paid to Bankwest, a full credit bid does not equate to
payment in full. Implicit in the Trustee’s position that the Guarantee was automatically
terminated by Bankwest’s full credit bid is the use of Kansas law for construing the

22 7 C.F.R. § 1980.376(a)(1)(ii).
23 Id. A different net proceeds calculation would apply if the lender could not make a sale during
the 6 months, but Bankwest apparently made a timely sale of the property in this case.
24 7 C.F.R. § 1980.376(a)(1)(iii).

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Guarantee. The RHS’s reliance on federal law, particularly the USDA regulations for the
housing program, rather than state law, to construe the Guarantee is fully supported by
general principles of contract construction which direct that applicable regulations be read
into the Guarantee.

The RHS’s position is also supported by Shimer, 25 a United States Supreme Court
opinion construing the Veterans’ Administration’s guarantee of a mortgage loan under
Title III of the Servicemen’s Readjustment Act of 1944, as amended. In Shimer, where
the effect of a Pennsylvania anti-deficiency statute was in issue, the Supreme Court held
that the applicable regulations made “clear that they were intended to create a uniform
system for determining the [Veterans’] Administration’s obligation as guarantor, which in
its operation would displace state law.”26 The Supreme Court reasoned that the
regulations spelled out the method for determining the loss after a sale “in such great
detail that there can be little doubt of an administrative intent that such method should
provide the exclusive procedure.”27 Although as noted by the Trustee, there are factual
distinctions between Shimer and this case, those distinctions do not detract from the
importance of the Shimer rationale to loan guarantee programs other than the one
involved there. In this case, the USDA regulations define the loss payment on the
guaranteed loan made by Bankwest in such detail that the Court is confident the

25 United States v. Shimer, 367 U.S. 374 (1961).

26 Id. at 377.

27 Id. at 379.


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regulations provide the exclusive procedure and displace Kansas law. Likewise, the
Court is unpersuaded by the Trustee’s arguments distinguishing other cases cited by the
RHS in support of the proposition that the Kansas law full-credit-bid rule does not bar
Bankwest’s loss claim under the Guarantee.28

The Court therefore concludes that the Guarantee did not terminate when
Bankwest at the mortgage foreclosure sale bid the full amount owed by Debtor to
Bankwest, leaving no deficiency judgment. Although Kansas law determined Debtor’s
liability to Bankwest after the sale, it did not determine the obligation of the RHS to
Bankwest under the Guarantee.

D. The RHS properly paid the loss to Bankwest.
In this case, Bankwest liquidated the collateral and, after purchasing the mortgaged
premises at the foreclosure sale, sold the property to a third party. It calculated its loss in
accord with the applicable regulations. The Trustee does not challenge that calculation.
The RHS paid the loss to Bankwest. The payment was not gratuitous.

E. Debtor was obligated to the RHS for the amount it paid to Bankwest.
Debtor agreed in the acknowledgment and certification portion of the Request for
Single Family Housing Loan Guarantee that if the RHS “pays a loss claim on the
requested loan to the lender, I (We) will reimburse the Agency for that amount.” The
payments which the Trustee seeks to recover as fraudulent transfers were made in

28 See cases cited by the RHS in its brief, dkt. 21 at 8-10, and the Trustee’s response, dkt. 22 at
pages 6-8.


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fulfillment of Debtor’s obligation to indemnify the RHS for valid, non-gratuitous
payments to Bankwest. The amount garnished from Debtor’s wages and the amount of
Debtor’s IRS refund offset in payment to the RHS may not be recovered as fraudulent


For the foregoing reasons, the Trustee’s claim to recover Debtor’s 2011 federal tax
refund and $969.05 of the prepetition wage garnishments as fraudulent transfers is denied,
and as agreed by the parties, the claim to recover $1,572.78 of the prepetition wage
garnishments as preferential transfers is sustained.

The foregoing constitutes Findings of Fact and Conclusions of Law under Rule
7052 of the Federal Rules of Bankruptcy Procedure, which makes Rule 52(a) of the
Federal Rules of Civil Procedure applicable to this proceeding. A judgment based upon
this ruling will be entered on a separate document as required by Federal Rule of
Bankruptcy Procedure 7058, which makes Federal Rule of Civil Procedure 58 applicable
to this proceeding.

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