Judge Rules That Home is Where the Heart Is

In 2000, Natalie Portman starred in "Where the Heart Is," a movie about a pregnant 17 year old girl who makes her home in a Walmart. Judge Stacey Jernigan recently had to decide a quite different case about home and the heart. The case involved whether a modern day cowpoke's heart was down on the ranch or in town in his wife's bedroom. Fortunately, like a character in a John Wayne movie, the Debtor fended off every attack and saved the ranch. In re Tinsley, No. 09-36036 (Bankr. N.D. Tex. 11/16/10). The opinion can be found here.

The Story

Our story goes back to 1979, when the Debtor's father purchased 116 acres located in Kaufman, Texas. In 2004, the Debtor moved into the Kaufman property to take care of his father. From 2004 to 2008, the Debtor stayed at the property full time and operated his own business, which consisted of running cattle and growing hay.

On September 24, 2008, the Debtor's father passed away and left the ranch to the Debtor. under his will A few days later on October 14, 2008, the Debtor married. After marriage, he d spent his days at the Kaufman property and his nights at his wife's home. The Debtor generously allowed his adult son and his family to live at the Kaufman property.

On September 10, 2009, the Debtor filed bankruptcy. Title to the Kaufman property remained in the name of his deceased father because the probate case had not been concluded. The Debtor used his wife's address as his address on the bankruptcy petition, but claimed the Kaufman property as his homestead.

The Objections

The Trustee and a creditor objected to the claimed homestead exemption on the grounds that:

a. The Kaufman property was not his homestead under Texas law; and
b. The homestead exemption was capped at $136,875 because the Debtor acquired his interest within 1,215 days before bankruptcy.

Texas Homestead Exemption

In order to establish a Texas homestead, a person must show that he has a present possessory interest in the property and must show a combination of both overt acts and intent to make the property his homestead.

The objecting parties claimed that the Debtor did not have a present possessory interest in the property because he did not hold legal title. The Court rejected this argument, finding that legal title was not necessary. The Court found that the Debtor was a tenant at will of the probate estate. While his continued possession of the property "depends upon the will and whim of the fee simple owner (i.e., the probate estate of his father)," the fact that he was the devisee under the will made it unlikely that he would lose his possessory interest.

The next issue was thornier. The homestead "is a possessory right which inures to the benefit of a family unit." The Debtor and his wife occupied two separate properties. Therefore, the Court had to determine whether the Debtor showed sufficient overt acts and intent to make the Kaufman property his homestead. The Court noted the possibility that the couple could claim both properties as a noncontiguous rural homestead, but found that this theory had not been pled.

The court found that in a dual residence scenario, the first step is to determine whether one residence was objectively the only homestead. If the usage is sufficiently ambiguous, then the court may honor the Debtor's subjective intent.

While finding that the case was extremely close, the Court found enough ambiguity to take the Debtor's subjective intent into account.

1. The Debtor spent almost every day at the Kaufman property.
2. The Debtor intended to move his bride onto the Kaufman property once it was renovated.
3. "While his new bride is eight miles down the road, the Debtor's horses, boots, tools, livelihood the past 17 years and now extended family are at the Kaufman property 365 days a year." Judge Jernigan shows real discernment here. The real test of a cowboy's residence is where he keeps his boots.

Homestead Cap

However, the ranch was not out danger yet. The creditors argued that because the Debtor acquired his interest in the Kaufman property under his father's will and his father passed away less than 1,215 days before bankruptcy, that the exemption was capped at $136,875.

The Court found that the Debtor had acquired a "vested economic interest" under the will. While noting that she "had grave doubts whether section 522(p) should apply at all in the context of a homestead 'acquired' by devise in a will within 1,215 days of the debtor filing for bankruptcy," she found that the Fifth Circuit had assumed without discussion that an inherited property was acquired. She also noted that Black's Law Dictionary defined "acquire" to mean "to gain by any means."

While it looked like a bad result, the Court was willing to hold her nose and apply the cap. However, there is an exception to the cap for the principal residence of a family farmer. After an exhaustive analysis, the Court found that: the Kaufman property was the Debtor's principal residence; that the Debtor was engaged in farming operations even though he no longer grew crops and didn't have any cattle on the property at the time of the filing (the Court found it compelling that he had operated a ranching operation on the property since 1993 and had resumed his ranching operation after recovering from a heart attack), the Debtor's debts were less than $3,544,525 and that the Debtor received more than 50% of his gross income from farming during the three years prior to bankruptcy.

The end result was that the Debtor got to keep the ranch without being subject to a cap.

Conclusion

In conclusion, Judge Jernigan remarked:

The court would conclude with the old saying that “home is where the heart is,” and, although the Debtor may have spent his nights with his new bride at the Kemp Property, rather than the Kaufman Property, the facts and circumstances in this case certainly show that the Kaufman Property is the Debtor’s true home and where his “heart” is. This case is certainly unique in that it implicates section 522(p)(1) for reasons not originally contemplated by Congress (i.e., this is hardly a case of letting a debtor get through a “mansion loophole,” in that no non-exempt property was put in a large, luxurious mansion on the eve of bankruptcy). Fortunately, for this Debtor, even though he “acquired” property which he used as his homestead within 1,215 days of filing bankruptcy, Congress anticipated certain situations to which they did not want section 522(p)(1) to apply and drafted section 522(p)(2)(A).

Opinion, p. 35. In the final analysis, a bad unintended consequence was avoided due to the fortuitous intervention of an exception that happened to fit the Debtor to a t.

Bad News for the Non-Filing Spouse

Frequently it makes sense for only one spouse to file bankruptcy. Where the husband has wracked up large business debts in his name only and the wife has significant separate property or sole management property, the husband can file bankruptcy without bringing the wife's non-joint assets into the estate. This allows a certain amount of double-dipping. The husband can claim his assets and the joint assets as exempt and the wife can keep her non-estate assets as well. While this will benefit the couple 99% of the time, two recent cases show a downside for the non-filing spouse.

In Kim v. Kim, No. 3:09-CV-1082-N (N.D. Tex. 8/11/10), which can be found here(PACER registration required), creditors filed an involuntary bankruptcy petition against Mr. Kim and then sought to limit his homestead exemption under 11 U.S.C. Sec. 522(p) for the reason that the property had been acquired within 1,215 days before bankruptcy. As a result, the debtor's homestead exemption was limited to $136,875. Had the spouse joined in the bankruptcy, the couple would have been entitled to double this amount. Instead, Mr. Kim filed a declaratory judgment action against Mrs. Kim to determine whether her homestead interest in the property (1) precluded sale of the property by the estate and (2) whether she was entitled to compensation for her interest. The Petitioning Creditor intervened and opposed the relief.

The Bankruptcy Court granted summary judgment in favor of the Petitioning Creditor and the District Court affirmed. The District Court found that bankruptcy law preempted Texas state homestead law. Because the homestead was joint community property, it became property of the estate. Because it became property of the estate, bankruptcy law determined the extent to which it could be exempted. The result for Mrs. Kim was that the involuntary bankruptcy petition, to which she was not a party, diminished her homestead rights. Not only that, but because she remained outside of the bankruptcy proceeding, the couple received only half of the homestead protection they would have otherwise had under Sec. 522(p).

One of the cases relied upon by the Kim court was In re Douglass, 2008 WL 2944568 (Bankr. W.D. Tex. 2008)(a case that I am intimately familiar with because I was on the losing side). In that case, the husband filed chapter 13. He made a tactical decision not to claim the homestead as exempt. Instead, he argued that the house was contaminated and was worth no more than the value of the land. Because the house was not being occupied as a residence, he was successfully able to cram down the value on the house. Had the case proceeded to discharge, the couple would have been able to retain the house. However, mid-way through the case, the wife moved back into the house and the husband sought to sell the home and pay off his chapter 13 plan early. The parties agreed to allow the sale of the home and to fight over the proceeds. The Bankruptcy Court ruled that (1) the wife was not entitled to any compensation for her homestead rights under Texas law and (2) the wife had failed to establish a separate property interest in the home. (She had provided the down payment for the home from her separate property).

Had the husband not filed bankruptcy, he could not have sold the property without the wife's consent. Therefore, the husband's filing divested the wife of a valuable right without her consent. Of course, if the husband had not filed bankruptcy, the property would have been foreclosed upon and the wife would have lost her interest.

These two cases are a powerful cautionary that sometimes the decision to remain outside of the bankruptcy can have negative consequences for the non-filing spouse. While it may seem unfair, it is a simple matter of reading Sec. 541(a)(2) which includes all joint management community property in the estate.

Hat Tip to Howard Mac Spector for sending me the Kim case.

Court Protects Homestead Proceeds But Leaves Open Question on Tardy Objections

Texas has one of the most generous homestead exemptions in the country. However, a quirk in the law allows an exemption in homestead proceeds to be lost due to the passage of time. San Antonio Bankruptcy Judge Leif Clark recently found a creative solution to the problem created by an obstreperous creditor seeking to outlast the debtor and preclude reinvestment of the proceeds from sale of a homestead. In re Bading, No. 06-52750 (Bankr. W.D. Tex. 9/22/07). However, the opinion raises the question of why Judge Clark had to work so hard when Supreme Court precedent provided a simpler alternative.

The Vanishing Exemption and Absolute Protection of Exempted Property

Most exemption statutes are limited by the type and value of the property to be claimed as exempt, but are not limited as to time. Thus, exempt property will keep its status so long as it retains its exempt character. However, a sale or other transformation of the exempt property will usually cause it to lose its exempt character. The Texas homestead exemption extends not only to a homestead owned and occupied by the debtor, but to the proceeds from sale of a homestead as well. Tex. Prop. Code §41.001(c). The proceeds exemption is one which is limited by time. It lasts for the lesser of six months or until the debtor acquires another homestead. The purpose of the proceeds exemption is to give the debtor a limited period of time in which to acquire a new homestead. As a result, the statute creates a vanishing exemption. Homestead proceeds which were fully protected five months and 29 days after sale of the home become cash subject to claims of creditors after six months and one day.

This vanishing exemption creates a potential conflict between state and federal law in the bankruptcy context. According to 11 U.S.C. §522(c), “property exempted under this section is not liable during or after the case for any debt of the debtor that arose, or that is determined under section 502 of this title as if such debt had arisen, before the commencement of the case” (with certain exceptions). Thus, the Bankruptcy Code gives exempted property absolute protection from pre-petition claims.

This absolute protection is implemented in two ways. First, the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure provide a limited time in which to object to exempt property. 11 U.S.C. §522(l); Fed.R.Bankr.P. 4003(b). If the property is claimed as exempt and the exemption is not timely challenged, the property remains exempt regardless of whether it would have been subject to a valid objection. Taylor v. Freeland & Kronz, 503 U.S. 638 (1992). Second, the property’s exempt status is determined as of the petition date using the “snapshot” approach. Matter of Zibman, 268 F.3d 298 (5th Cir. 2001).

A Fading Snapshot

While the Zibman decision recognized the “snapshot” approach, it also noted that like a bad Polaroid, the picture could fade. According to the Fifth Circuit:

“(T)he law and facts existing on the date of filing the bankruptcy petition determine the existence of available exemptions but . . . it is the entire state law applicable on the filing date that is determinative. Courts cannot apply a juridical airbrush to excise offending images necessarily picture in the petition-date snapshot.”

Zibman at 304.

Thus, Zibman teaches that where conditions exist on the petition date which would limit the exemption, the snapshot approach does not eliminate those limitations. However, it seems important to the Fifth Circuit’s analysis that the condition must exist as of the petition date. In the Zibman case, the debtors had sold their homestead approximately two months prior to bankruptcy. Thus, the snapshot on the petition date revealed an exemption which had just four months remaining in the absence of reinvestment. Since the debtors had moved to another state, reinvestment was not a possibility.

In the Zibman case, the Trustee obtained an order extending the time to object to exemptions until after the six month reinvestment period expired. When the debtor failed to purchase a new homestead, the trustee objected and was sustained by the Fifth Circuit. Thus, although the exemption was still valid on the petition date, it was a limited exemption and was defeated by the timely filed objection.

Although the Trustee benefitted from an extension of time in Zibman, the court noted that the debtor could benefit from one as well. In a footnote, the Court noted that although the debtors could have requested tolling of the six month period, they failed to do so.

Bading Determines Calculation of Six Month Period

In Judge Clark’s Bading decision, the court examined how to calculate the six month period in the face of creditor obstruction. The debtor owned two contiguous lots which made up her homestead. Prior to bankruptcy, Gulfside Supply, Inc. recorded an abstract of judgment against the debtor. Under Texas law, an abstract of judgment creates a lien against all real estate owned by the debtor in the county, but does not attach to a homestead. Since the debtor only owned a homestead, the abstract of judgment should have been a nullity. However, as noted by the Bankruptcy Court, “title companies are notorious cowards.” When the creditor refused to release the lien, the debtor was put to a Hobson’s choice to either pay off the invalid lien or risk losing the ability to sell the property.

In this case, the debtor found a middle ground. It reached an agreement with the creditor to release its lien from one of the two tracts. The sale of the first lot closed on December 4, 2006 and the debtor received proceeds of approximately $142,000. The debtor did not reinvest these proceeds out of fear that acquiring a new homestead would void the exemption on the second tract.

Instead, the debtor then filed bankruptcy on December 29, 2006 and filed a motion to avoid lien on the second tract. The motion to avoid lien was granted. However, at this point, the debtor was faced with a timing dilemma. The creditor, which had not objected to the debtor’s exemptions, contended that it was not required to file an objection until after the property lost its exempt character and that the six month clock had begun to run on the sale of the first tract. Under the creditor’s position, there was only one month in which to complete the sale of the second tract and invest the proceeds from both tracts in a new homestead. To avoid this problem, the debtor, relying on the Zibman dicta, filed a motion to toll the reinvestment period.

After a hearing, the Bankruptcy Court came to three important conclusions:

1) The fact that Gulfside failed to file a timely objection to exemption was irrelevant. The court stated:

“Gulfside responds that a creditor should not be required to file a ‘conditional objection’ based on what might happen after the close of the time allowed for objection to exemptions, on pain of those exemptions being allowed as a matter of law under section 522(l). The court agrees with Gulfside on this issue. Were the rule otherwise, then trustees and creditors alike would have a duty to object in every proceeds case, just to make sure they preserved their rights. That strikes the court as an unnecessary formality, and one that is difficult to square with the rationale employed by the Fifth Circuit in Zibman to reach its result.”

Bading, slip op., p. 6, n. 5.

2) The six month clock did not begin to run until the second tract was sold.

The six month clock is triggered by sale of “a” homestead, not part of the homestead. Here, the debtor had a single purchaser for both parts of the homestead. The closing of the sale of the complete homestead was delayed by the creditor’s unjustified refusal to release its lien. As a result, there was not a sale of “a” homestead until the second closing, so that the six month clock did not begin to run until that date.

3) If the single sale theory did not work, the court found that equitable tolling would apply.

The court noted that both Texas law and the Zibman opinion held open the possibility that the six month period to reinvest could be tolled. Tolling is an equitable principle. Where, as here, the creditor delayed the debtor’s ability to sell through its refusal to release an invalid lien, there were sufficient grounds to toll the six month reinvestment period.

Thus, the net result was that the debtor was able to sell her homestead free of the offending judgment lien and the creditor’s stall tactics failed to achieve their desired result.

Invoking Avril Lavigne

Judge Clark’s reasoning is elegant and avoided an obvious injustice. However, it raises an obvious question: “Why do you have to make things so complicated?”* Judge Clark would never have had to reach the issues of unitary homestead sales or equitable tolling if he had simply followed Taylor v. Freeland & Kronz and ruled that failure to timely object to the claimed exemption ended the inquiry.

Judge Clark justified his failure to deem the objection waived on two grounds:

1) Practicality; and
2) Fealty to the Fifth Circuit’s reasoning in Zibman.

The practical argument questions the reasonableness of requiring conditional objections in cases involving homestead proceeds. The most reasonable response to this argument is: So what? Cases involving exemptions of homestead proceeds are relatively rare. In order to have a case involving proceeds, the sale must have taken place pre-petition. The deadline to object to exemptions occurs 30 days after the conclusion of the first meeting of creditors. Fed.R.Bankr.P. 4003(b). While the creditors’ meeting must be commenced 20-40 days after the filing of the petition, Fed.R.Bankr.P. 2003(a), there is no rule as to when the meeting must be concluded. As a result, the trustee may simply continue the meeting to a date after the conclusion of the six month reinvestment period. If that isn’t satisfactory, a creditor could move to extend the time to object or could file a conditional objection. All of these solutions are easy to accomplish. Since proceeds cases are unusual, it is reasonable to require trustees and creditors to take these nominal steps to preserve their rights rather than to argue that Supreme Court precedent should be disregarded.

The rationale of the Zibman opinion offers offers little support to the tardy creditor. In that case, the trustee obtained an order extending the time to object to exemptions. The trustee filed his objection within that time period. As a result, Zibman should not be construed as authorizing out of time objections. Indeed, the Zibman rationale simply recognizes that the debtor’s right to exempt proceeds may depend on events happening after the petition date. This is not an invitation to ignore the rules requiring timely objections to exemptions.

Finally, allowing untimely objections to exemptions based on events occurring after the petition date would lead to absurd results. Under Taylor v. Freeland & Kronz, which is an intellectual cousin to Republic Supply Co. v. Shoaf, 815 F.2d 1046 (5th Cir. 1987), failure to file a timely objection to exemption allows the debtor to retain the claimed property regardless of whether the debtor had a colorable claim of exemptions in the first place. If Zibman is read as allowing untimely objections, it means that a conditional claim to exemption of homestead proceeds would receive less protection than a debtor’s attempt to exempt a stack of gold bullion or a herd of Ethiopian hog-nosed goats** as his homestead. The legal system would be seriously out of joint if it accorded greater rights to the frivolous than the conditionally correct. The entire concept of statutes of limitation assumes that creditors must be diligent to protect their rights. If a creditor is unable to focus its attention on a claim which will be resolved in less than six months, the court should not create a judicial do-over for it.

*--This is the refrain from a recent song by semi-punk songstress Avril Lavigne.
**--A rare form of livestock found only in Bastrop County. Apologies to Joe Martinec and Eric Borsheim. For the full story of the Ethiopian hog-nosed goats, write to me at ssather@bnpclaw.com.