730-Day Rule Costs Debtor Homestead Exemption

The Fifth Circuit's recent decision in Camp v. Ingalls allowed an itinerant debtor to claim federal exemptions that would not have been available to him had he remained in Florida. That was a small victory for the debtor. However, a decision released just a few days later reveals the darker side of the 730 day rule for claiming exemptions. In the case of In re Fernandez, No. 09-32896 (Bankr. W.D. Tex. 1/26/11), which can be found here, a debtor was deprived of the generous homestead exemption allowed by both Texas and Nevada law where he had gone back and forth between these states.

What Happened

Alfred Fernandez owned a home in El Paso, Texas. When he was laid off from his job in El Paso, he relocated to Nevada for seven years. All the while, he continued to make the payments on his home in El Paso and planned to return. About a year prior to bankruptcy, he did return. When he filed for bankruptcy, he claimed his home as exempt under Texas law and the trustee objected. Then he amended his exemptions to claim the home as exempt under Nevada law and the trustee objected.

Because he had not lived in Texas for 730 days before bankruptcy, the Texas exemptions were not available to him. However, the trustee contended that Nevada law could not be used to exempt property located in Texas. The Bankruptcy Court agreed.

The Court's Ruling

Judge Leif Clark engaged in an exhaustive analysis of the legal issues involved. However, at its core, the ruling followed this logic:

1. Sec. 522(b)(3)(A) instructs the court to look to the law of the state where the debtor resided for the greater portion of the 180 days prior to 730 days if the debtor has not resided in one state for 730 days.

2. This provision requires application of Nevada law.

3. Although the Nevada exemption statutes do not expressly limit their application to property located within Nevada, it is reasonably clear that Nevada would not apply its internal exemption statutes to property located within other states. Judge Clark based this conclusion, in part, in a response given by the Nevada Supreme Court to a certified question, which noted in passing that the purpose of the exemption statute was to protect "the family, its individual members, and the community and state in which the family resides." He also noted that exemption laws exist to give guidance to Sheriffs as to what property they can levy upon. Obviously, a Nevada sheriff would not be levying upon property located in Texas, so there is no reason for Nevada to design an exemption statute to apply elsewhere.

4. Because the statute says to look to property that "is" exempt under the applicable state law, the Bankruptcy Court must apply state law in the same manner as the state would have.

5. As a result, the Debtor is not entitled to a homestead exemption under Texas or Nevada law. The Debtor could claim a homestead exemption under federal exemptions, but this exemption would only cover a portion of the debtor's equity in his residence.

The Court refused to adopt a construction in which the Bankruptcy Code effectively federalized state exemption laws. Instead, the Court applied state law in the manner in which the states would have applied it.

The Court acknowledged that its decision was not very palatable, stating:

The express language of section 522(b)(3)(A) certainly generates a result that many (including this court) would perceive to be unfair. But a perceived unfair result is not necessarily an absurd result. And absent such a finding, a court is obligated to apply the plain language of the statute as written. The language of the domiciliary requirement is, to this court, unambiguous and straightforward. Though the look-back period has changed, the structure of the provision is essentially unaltered from the original version enacted in 1978, and it is plainly and easily applied (albeit with unfortunate consequences in the case of traveling debtors). If the language of a statute is plain, then it is the duty of the court to enforce them according to their terms.

Opinion, p. 30.

While this is a harsh result, it appears to be one that Congress intended. Section 522(b)(3)(A) was intended to prevent debtors from moving to enhance their exemptions. Judge Clark's ruling is consistent with what would have happened if the debtor had remained in Nevada, namely, that he could not have claimed his Texas property as a homestead.

Federalized Exemptions

Judge Clark rejected the argument that the Bankruptcy Code transformed state laws into federal rules which could be applied independently of their state law moorings. While the context was different, I made a similar argument about the Bankruptcy Code federalizing state exemption laws in the case of In re Dyke, 943 F.2d 1435 (5th Cir. 1991). (If you read the published version, it incorrectly states that my firm represented an amicus party. In fact, there were two consolidated appeals and we represented one of the debtors). In Dyke, the issue was whether ERISA preempted the Texas Property Code exemption for retirement benefits in a bankruptcy case. The correct result, as later determined by the Supreme Court, was that the anti-alienation provisions in ERISA constituted an exemption under other federal law. However, a panel of the Fifth Circuit had previously rejected this argument. This led to the seemingly absurd result that while ERISA expressly prohibited alienation of retirement plan assets, state laws which effectively said the same thing were preempted by ERISA.

We argued that ERISA could not preempt state exemption laws in a bankruptcy case because the state law had become federalized when it was incorporated by the Bankruptcy Code. The Fifth Circuit adopted our reasoning but got there by a slightly different route. The Court stated:

Like Title VII, the Bankruptcy Code relies on state law to assist in the implementation and enforcement of its goals. The principal goal of the Bankruptcy Code is to ensure that a debtor comes out of bankruptcy with adequate possessions to have a "fresh start." (citation omitted). The Code adopts a federal exemption scheme which satisfies this goal; but recognizing that circumstances are different in the various states, the Code also "permits the states to set exemption levels appropriate to the locale." (citation omitted). If this Court were to interpret ERISA to preempt provisions of the state exemption schemes, the states would be unable to set enforceable exemption levels on retirement benefits. This would relegate many debtors to a federal exemption scheme which might be inappropriate to the locale. As a consequence, the enforcement scheme contemplated in the Bankruptcy Code would be modified and impaired.

Under the specific language of ERISA section 514(d), this Court cannot construe ERISA to modify or impair the policies of other federal laws. The Bankruptcy Code, in particular, is a federal law that ERISA cannot disturb. (citation omitted). The Texas legislature has created a state exemption scheme that advances the principal goal of the Bankruptcy Code. One such exemption in this state scheme, section 42.0021(a) of the Texas Property Code, permits bankrupt debtors to exempt the funds in their retirement plans. Tex. Prop.Code Ann. § 42.0021(a)(Vernon Supp.1991). If the ERISA preemption clause is enforced against section 42.0021(a), the preemption clause would impair the ability of the Bankruptcy Code to ensure -- through the Texas state exemption scheme -- that Texas debtors can get a "fresh start" after bankruptcy. Accordingly, this Court concludes that ERISA section 514(d) saves the Texas state exemption scheme from preemption. ERISA does not preempt section 42.0021(a) of the Texas Property Code.

In re Dyke, at 1449-50.

The Fifth Circuit held that the Texas Property Code advanced the policies of the Bankruptcy Code, but did not state that the Bankruptcy Code federalized state exemption laws. The nuance is important. If the state law had become federal law, it could have been interpreted as federal law. However, where it merely advanced the policies of the Bankruptcy Code, the case was weaker.

Unintended Consequences

When Congress added the 730-day residency requirement into BAPCPA, it was no doubt trying to discourage debtors from making an exemption-enhancing move, such as the one made by Bowie Kuhn. However, under Judge Clark's logic, the actual consequence of the statute is to provide that the prior state's law will never apply, since states do not design their exemption statutes to have extra-territorial application. This will mean that migrant debtors will be limited to or receive the benefit of the federal exemptions. Since most states have opted out of the federal exemption scheme, this means that a choice that would have been unavailable to most debtors becomes the only choice.

Judge Clark, in a Scalia moment, was quick to point out that just because Congress didn't think through the consequences of its wording did not give the Court license to adopt a different construction.

It seems clear that the plain language of the statute yields an unfortunate result. Here, it deprives this debtor of his home, even though outside of bankruptcy, Texas law would preserve his home against the claims of his creditors. Yet an unfortunate result is not sufficient grounds to ignore the plain language of a statute. It is certainly never grounds to simply ignore Congressional intent, nor does it ever justify simply rewriting a statute a particular judge or judicial panel does not like. And that principle of judicial restraint must cut across all ideological lines, as it is central to the nature of the judiciaryʼs role in a constitutional form of government. (citation omitted). This statute plainly directs a court to deprive the unlucky debtor who has moved to the state of filing within the two year period prior to filing of the state exemptions not only of the state in which she resides but also of the state in which she used to reside, and gives her, in return, the right to claim federal exemptions (whether on the basis this court espoused in Battle or on the basis of the failsafe provision at the end of section 522(b)(3)). The result, in this case, is that the debtor will lose his house. The court takes no pleasure in being the enforcing officer of a wrongheaded and plainly unfair statute. But it is up to Congress, not the courts, to fix this problem.

Opinion, pp. 41-42 (emphasis added).

(Note: When I wrote about Justice Scalia's dissent in Hamilton v. Lanning, I stated, "Justice Scalia is willing to be a minority of one for the proposition that when Congress passes laws that are foolish or just plain wrong, that the courts have an obligation to throw their words back at them and yield a foolish judgment." Thus, a Scalia moment is one where the Court consciously renders an absurd judgment because the statutory text demands it. It is worth noting that the Supreme Court's jurisprudence interpreting BAPCPA has taken the opposite approach and has tried to make sense of the law regardless of what a strict reading of the text would dictate.).

The Fernandez decision is a big deal. While it is heartbreaking for Mr. Fernandez personally, the larger significance is that Judge Clark has indicted Congress for legislative malpractice for constructing a statute in which one portion (applying the law of the former state) will never apply. It will be interesting to see what the higher courts do with this difficult issue.