Compiled and Edited By:
Jordan Montgomery Lewis, Esq.
Law Clerk to the Hon. Harlin D. Hale, 2014-2015
SMU Dedman School of Law, Class of 2014; Licensed in Texas, 2014
Email: [email protected]
Telephone: (903) 824-3342

Joshua Pelfrey, Spring 2015 J.D. Candidate, SMU Dedman School of Law
Extern to the Hon. Harlin D. Hale, Spring 2015
Email: [email protected]
Telephone: (254) 434-7711

Introduction

For a long time, the Texas homestead has seemed virtually unassailable. Both state and federal cases stretching from the 1800s to the late 2000s have attested to the liberality of the Texas homestead protection. However, while Texas courts continue to honor this bedrock of the state constitution, recent bankruptcy cases in the Fifth Circuit suggest that the protection may not be as inviolate as once thought.

Article 16, § 50 of the Texas Constitution states that the homestead of a “family, or of a single adult person, shall be, and is hereby protected from forced sale, for the payment of all debts,” with limited exceptions for purchase money, property taxes, owelty, a voluntary mortgage, a refinanced mortgage, construction liens, a reverse mortgage, and a manufactured home lien.[1] The Texas Constitution also provides that the homestead of a married couple may not be abandoned unless both spouses agree to it, and that only the explicitly specified exceptions may defeat the homestead, regardless of any contractual provisions that state otherwise.[2] The Texas Property Code reiterates the protection and exemptions, and adds a provision which states that proceeds from the sale of a homestead in Texas are “not subject to seizure for a creditor’s claim for six months after the date of sale” (the “Texas Proceeds Rule”).[3]

Texas law protects the homestead property itself, with an acreage limit but no limitation on value.[4] While a homestead is defined in Texas as an “estate in land,” the courts in Texas apply that definition liberally.[5] In fact, it has been determined that a vacation home[6] or even a house on land the debtor neither owns nor leases may be claimed as homestead.[7] In light of what may be claimed, it almost seems bizarre that the homestead exemption in Texas does not extend to a houseboat.[8] To create a homestead in Texas, state law merely requires designation of a piece of property as a homestead, coupled with intent to live on the property and an overt act supporting that intent. [9]

The federal exemption for a homestead is decidedly more limited and is available only in bankruptcy. 11 U.S.C. § 522(d)(1) permits a debtor to claim an exemption in property, real or personal, he or she uses as a residence. However, the debtor’s exemption is limited to $22,975,[10] and proceeds are not accounted for should the debtor sell the residence. What qualifies as a homestead under federal law is narrower than under Texas law, as real or personal property designated as homestead does not apply to vacation homes.[11] Creating a homestead under federal law is more difficult since 11 U.S.C. § 522(d)(1) is generally interpreted to require the debtor to live in the residence.[12] The federal homestead is also subject to a ten-year period[13] during which investments in the debtor’s homestead may be avoided if they were made to “hinder, delay, or defraud” creditors.[14]

The differences between state and federal homestead definitions may color how Texas and federal courts view a homestead. Furthermore, since the addition of § 522(p) to the Bankruptcy Code after the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA),[15] federal law now limits the amount that debtors can exempt through state law in the 1,215 days leading up to the filing of the bankruptcy petition.[16] Yet the Texas homestead is not an interest in the value of a debtor’s property, as it is in most states, but rather a right to the property itself. The cases that follow demonstrate how the federal courts have struggled to reconcile these concepts.

The Strong Legacy of the Texas Homestead

One of the most enduring demonstrations of the strength of the Texas homestead is the United States Court of Appeals for the Fifth Circuit’s holding in Truman v. Deason (In re Niland).[17] The facts of that case revolve around former Dallas Cowboys star John Niland (“Niland”). In 1971, Niland and his wife (together, the “Nilands”) acquired a property in Dallas on a mortgage loan. The Nilands made the home their residence. In 1977, they also acquired a condominium for use by Niland’s mother, Mrs. P. D. Niland.

In addition to playing for the Cowboys, Niland was the principal of a business called Video Information Network, Inc. When that business struggled for cash in 1982, Niland obtained several loans. In order to induce the respective financial institutions to make these loans, he designated his mother’s condominium as his homestead, and offered liens upon his actual residence instead. In the process of obtaining over $430,000 in loans, Niland bribed a loan officer, created false homestead designations, and continued to misrepresent the nature of his homestead.

After Niland defaulted, his creditors foreclosed upon his residence and sold it at auction. The purchaser, attempting to take possession of his new acquisition, found Niland living on the property. The purchaser then demanded Niland vacate the premises, but Niland refused and ultimately filed for bankruptcy protection. The Chapter 13 trustee then sought to avoid the foreclosure sale as a fraudulent transfer, and stated a claim based on Texas law that the liens on the residence were invalid due to the land’s status as Niland’s homestead.

The bankruptcy court held that—even though Niland had designated the condominium as his homestead fraudulently—the foreclosed property was Niland’s actual homestead and subject to the homestead protection. Both the district court and the Fifth Circuit affirmed this holding. The Fifth Circuit further upheld the proposition that a purchaser with constructive notice of the homestead character of a property up for foreclosure sale cannot invoke estoppel against homestead claimants.

The Fifth Circuit has held similarly within the past years, refusing in the case of Condit v. McKeithan (In re McKeithan)[18] to find that a debtor had abandoned her homestead, even though she had not lived there in nine years. The Fifth Circuit found that—irrespective of where the debtor commonly listed herself as residing—a homestead, once established, retained its character absent a showing of abandonment, death, or alienation, where abandonment requires “both the cessation or discontinuance of use of the property as a homestead, coupled with an intent to permanently abandon the homestead.”[19] Consequently, the debtor was allowed to exempt the property as her homestead in Chapter 7 bankruptcy.[20]

The Application of the Texas Proceeds Rule in Bankruptcy

While a property designated as a homestead in Texas is generally protected from nonexempt creditors, the sale or transfer of such property may endanger that protection in a bankruptcy context. In Lowe v. Yochem (In re Reed),[21] the bankruptcy court for the Western District of Texas considered whether proceeds from the sale of a homestead come back into the Chapter 11 bankruptcy estate after losing their exempt status under Texas law.[22] In that case, the debtor sold his homestead after both the filing of the bankruptcy case and the time for filing objections to the debtor’s exemptions had expired. In exchange for his homestead, the debtor obtained a note receivable. Pursuant to his powers under 11 U.S.C. §§ 549 and 550, the Chapter 7 trustee sought to avoid payments to the debtor on that note receivable, characterizing such disbursements as unauthorized postpetition transfers of property of the estate.[23] Judge Leif Clark held that under § 522, exempt property was forever immune from pre-petition debts, and thus was essentially removed from the bankruptcy process and not property of the estate.[24]

However, in the 2001 case of Zibman v. Tow (In re Zibman),[25] the Fifth Circuit Court of Appeals distinguished this immunity when a homestead was converted to proceeds prior to the filing of the bankruptcy petition, but during the six-month exemption period of the Texas Proceeds Rule.[26] In a Chapter 7 case, the Fifth Circuit held that the six-month exemption of proceeds from a Texas homestead was merely a contingent exemption right under state law that could be lost. This right required an action by the debtor within a certain time—the purchase of a new homestead with the money—to ensure that the proceeds retained their exempt status. Since the subsequent actions ultimately determined the status of the funds prior to the filing of the bankruptcy case, failure to meet that condition brought the proceeds into the bankruptcy estate.

The Zibman reasoning would later be relied upon by an Austin bankruptcy court in In re D’Avila[27] as a means of reinterpreting the Reed decision. In D’Avila, Judge Tony Davis focused on the fact that in Zibman, the debtor did not have exempt homestead property at the time the bankruptcy estate was created, but merely an exemption right.[28] Judge Davis then found that, since the debtor before him possessed an exempt homestead at the time of the bankruptcy petition filing, the sale of the homestead did not invoke the Texas Proceeds Rule when the proceeds were not converted into a new homestead within six-months after the sale.[29]

Judge Davis opined that this result may be unique to Chapter 7, and that the Texas Proceeds Rule could be applied differently in Chapter 13. However, the D’Avila opinion has so far been utilized to little effect, rarely argued and rarely applied by courts considering how to treat proceeds of a Texas homestead in bankruptcy. The cases that follow illustrate the recent trend in application, beginning in Chapter 13 before drifting back into Chapter 7 precedent.

Case Summaries: How to Apply the Texas Proceeds Rule in Bankruptcy

In re Carlew, 469 B.R. 666 (Bankr. S.D. Tex. 2012)

In March of 2012, Judge Jeff Bohm considered the issue of whether insurance proceeds received under a settlement with the debtor’s insurance company were subject to the Texas Proceeds Rule. In the case, debtor John Carlew (“Debtor”) received insurance proceeds when the property he claimed as his homestead was damaged by Hurricane Ike in 2008. Debtor’s insurance claim was denied under his homeowner’s insurance policy, and so he sued in state court. Ultimately, a settlement was reached in the case, and the insurer agreed to pay Debtor the sum of $73,353.98 after attorneys’ fees. Two months after receiving the insurance proceeds, Debtor filed for bankruptcy. He claimed the insurance proceeds as exempt property pursuant to the Texas homestead exemption. After six months had passed since the payment of the insurance proceeds, the Chapter 7 trustee objected to the Debtor’s exemption and claimed the insurance proceeds had become property of the estate subject to the Texas Proceeds Rule. At the hearing, Debtor testified that he intended to utilize the insurance proceeds to repair his homestead.[30]

The bankruptcy court found that Texas law regarding homestead exemption allows the debtor to exempt all of the proceeds from the settlement of the lawsuit.[31] Judge Bohm further ruled that the Debtor’s homestead exemption on insurance proceeds did not terminate due to the debtor’s non-use of the proceeds for six months, primarily because the homestead property had not been sold.[32] The bankruptcy court cited the liberal construction of the Texas homestead law in interpreting Texas Prop. Code §§ 41.001-002 as the basis for its technical ruling.

In re Garcia, 499 B.R. 506 (Bankr. N.D. Tex. 2013)

In 2011, Osman Garcia and Elia Martinez (“the Garcias”) filed a Chapter 13 bankruptcy petition, elected Texas law property exemptions, and successfully exempted their homestead without objection. During the pendency of the bankruptcy proceedings, the Garcias then sold their home and received net proceeds of approximately $64,000 that were never reinvested in another homestead. More than six months after the sale, the Garcias moved to modify their bankruptcy plan and keep the sale proceeds because the transaction had satisfied their pre-petition mortgage arrearage payments in full.

Citing the “best interests of creditors” test under § 1325(a)(4),[33] the Chapter 13 trustee objected to the modification, arguing that the sale proceeds were no longer exempt under the Texas Proceeds Rule. The trustee further argued that if the Garcias were allowed to keep the proceeds, the creditors would be deprived of money that would be available to them if the estate were to be liquidated. The Garcias disagreed and stated that the test was satisfied because the sale proceeds were indeed exempt and, as such, would be unavailable to creditors in the test’s hypothetical liquidation scenario. The bankruptcy court denied the modification, finding that proceeds were not exempt and thus, the modification did not satisfy the best interests of creditors test. Accordingly, the homestead proceeds became nonexempt property of the estate as of the date of the debtors’ plan modification.[34]

Viegelahn v. Frost (In re Frost), 744 F.3d 384 (5th Cir. 2014)

In 2009, Mark Frost (“Frost”) filed a Chapter 13 bankruptcy petition and exempted the real property he claimed as his homestead from the bankruptcy estate under Texas law. During the course of the bankruptcy case, Frost sold his homestead property. Prior to the end of the six-month exemption window, the Chapter 13 trustee discovered that Frost had used approximately $23,000 of the net proceeds for purposes other than purchasing another homestead. The trustee challenged the exempt status of these proceeds, arguing that by failing to reinvest the proceeds from the sale into a new homestead within six months, the proceeds had become nonexempt property of the estate. Frost disagreed, arguing that § 522(c) bankruptcy exemptions are fixed at the time of filing the petition and do not later lose their exempt status (also known as the “Snapshot Rule”).[35] While Frost did not mention D’Avila in his arguments, he argued that the facts of Zibman were distinguishable from his case, since the debtor in Zibman had converted his homestead to proceeds prior to bankruptcy, whereas Frost had sold his homestead after the homestead had already been declared exempt. The bankruptcy court, the district court, and the Fifth Circuit Court of Appeals all ruled for the trustee, f holding that Zibman applied regardless of whether a homestead was sold prior to or after the filing of a bankruptcy petition. The Fifth Circuit ruled that the $23,000 had been re-characterized as nonexempt property when it was spent on something other than a homestead, and thus was now property of the estate.

In making this ruling, the Fifth Circuit expressed that when a debtor chooses exemptions under state law, the entirety of state law applies at the time of filing, and that because the six-month limit to the homestead exemption was “an integral feature of the Texas law applicable on the date of filing . . . it must continue in effect during the pendency of a bankruptcy case.”[36] The Fifth Circuit went on to say that if it adopted Frost’s reading of § 522(c), then the statute would exempt property that would not be protected under Texas law, which would limit the state’s power to “restrict the scope of its exemptions.”[37] The Fifth Circuit further rejected an argument by Frost that, in Schwab v. Reilly,[38] the United States Supreme Court had preempted the Texas limitation requiring that the proceeds of his homestead be reinvested into another homestead property within six months.[39] The Fifth Circuit found Schwab inapplicable to the facts before it.[40]

Cage v. Smith, et al (In re Smith), 514 B.R. 838 (Bankr. S.D. Tex. 2014)

In re Smith represents a reversal of the reasoning set forth by Judge Davis in D’Avila. Cody W. Smith and Tracy G. Smith (“the Smiths”) exempted their homestead without objection when they filed Chapter 7 bankruptcy in the spring of 2012.[41] After receiving their discharge in 2013, the Smiths sold their homestead and received net proceeds of $815,935.77. The Smiths did not reinvest the proceeds from the sale in another homestead.

More than six months after the sale, but prior to the case being closed, the trustee initiated an adversary proceeding against the Smiths requesting that the proceeds from the sale be turned over to the estate. The Chapter 7 trustee relied on the Fifth Circuit’s holding in In re Frost that— pursuant to the Texas Proceeds Rule—the proceeds from a post-petition sale of an exempted homestead that had not been reinvested in another home within six months lost their exempt status and reverted back to the estate. The Smiths disagreed and argued, inter alia, that the proceeds from the sale of their homestead were not subject to the Texas Proceeds Rule because the sale did not occur until after receiving a discharge. While the Smiths cited numerous authorities, including Schwab, they did not bring the D’Avila opinion to the attention of the court.

The court ruled in favor of the Chapter 7 trustee and found that the proceeds from the debtors’ post-discharge sale were now property of the estate. The court suggested that—because the Chapter 7 trustee has a fiduciary duty to attempt to recover all nonexempt assets for the benefit of the creditors while a bankruptcy case remains open—the date under which proceeds of a homestead no longer are subject to the Texas Proceeds Rule might be the date the bankruptcy is closed, rather than the discharge date. The court did not consider whether a trustee could reopen a closed case to pursue a debtor’s proceeds of a former homestead.[42]

Garcia et al v. Bassel, 507 B.R. 907 (N.D. Tex. 2014)

On appeal from the Garcia bankruptcy court’s decision, the district court affirmed that when a Chapter 13 debtor sells his homestead and does not reinvest the proceeds in a new homestead within six months, the proceeds lose their exempt status, and thus must be returned to the bankruptcy estate.[43] The district court relied upon the reasoning of the Fifth Circuit in In re England, which held that the “object of the proceeds exemption statute was solely to allow the claimant to invest the proceeds in another homestead, not to protect the proceeds, in and of themselves.”[44] Consequently, the proceeds of the Garcias’ homestead became property of the estate.

In a significant footnote, the district court acknowledged that “the Texas intermediate courts disagree [with the Fifth Circuit’s interpretation that Tex. Prop. Code. §41.001(c)] requires the debtor to reinvest the proceeds in a new homestead to retain exempt status.”[45] The footnote compares holdings from the Fifth Circuit to London v. London,[46] which held that “[t]he text of §41.001(c) . . . does not contain language limiting the exemption to those instances in which the homestead claimant plans to buy another home.” The Texas appellate court in London acknowledged that its interpretation of the exemption provision differed from the Fifth Circuit, and declared: “Texas state courts are not bound by the decisions of federal courts other than the United States Supreme Court.”[47] The Texas Supreme Court for its part has yet to rule on this issue, but a future ruling has the potential to vastly impact Fifth Circuit cases when applying the Texas Proceeds Rule. As the Fifth Circuit in Frost has already stated: “the entirety of applicable state law applies” if a debtor elects to use the Texas exemptions in a bankruptcy case.[48] As such, a Texas Supreme Court ruling in favor of the holding in London could create Texas state law precedent that would essentially preempt the Fifth Circuit’s current rulings regarding Tex. Prop. Code § 41.001(c).

Case Summaries: Whether the Texas Homestead Is an Interest or a Right

In re Odes Ho Kim v. Chong Ann Kim (In re Kim), 405 B.R. 179 (Bankr. N.D. Tex. 2009)

In the case of In re Kim, the bankruptcy court considered another novel issue intersecting bankruptcy and the Texas homestead. On December 21, 2007, the case was initiated when a creditor filed an involuntary Chapter 7 petition against debtor Odes Kim (the “Debtor”). Soon after, the court entered an order for relief.[49] Debtor then converted to Chapter 11, claimed a homestead exemption under Texas law in the property on which he and his non-filing spouse, Chong Ann Kim (“Mrs. Kim”), resided, and listed the value of the exempt property as $1,127,880. The creditor objected, arguing that § 522(p) of the Bankruptcy Code capped Debtor’s homestead property exemption at $136,875 since Debtor’s property had been acquired within the 1,215-day period preceding the date when the petition was filed.[50] Debtor challenged the applicability of § 522(p) to a case initiated by involuntary petition, as well as the constitutionality of using such a device to circumvent the homestead protections provided in the Texas Constitution and to strip his spouse of her homestead protections without initiating an adversary proceeding. The bankruptcy court sustained the creditor’s objection, holding that the exemption in the property was limited to the § 522(p) limitation because the homestead had been acquired within the 1,215-day period preceding the date of the filing of the petition.

After that ruling, Debtor initiated an adversary proceeding to determine what rights his non-filing spouse might have to the homestead. The bankruptcy court concluded that the non-filing spouse’s separate exemption has been preempted by Congress by the enactment of § 522(p).[51] Mrs. Kim contended that she possessed a separate, vested homestead exemption not subject to the § 522(p) limitation. However, the court held that only the Debtor could exempt property that had become property of the estate because the Bankruptcy Code does not include a provision that allows the non-debtor to claim an exemption. The bankruptcy court further held that the Bankruptcy Code does not compensate the non-filing spouse for her homestead interest.[52] The bankruptcy court held that Mrs. Kim’s homestead interest did not include vested economic rights. Thus, Mrs. Kim could neither take an additional exemption in the property—as she would be entitled to if she had filed bankruptcy herself—nor could she prevent the sale of the homestead. The bankruptcy court reasoned that if Congress wanted to protect a non-debtor spouse’s homestead exemption in property subject to § 522(p), it could have included a provision in the Bankruptcy Code regarding such protection.[53]

On appeal, Judge Godbey of the United States District Court affirmed that the § 522(p) limitation preempts Texas law allowing for an unlimited exemption in the debtor’s homestead property and a separate spousal homestead.[54] The district court therefore affirmed the bankruptcy court’s holding that, because Debtor acquired the homestead property within the 1,215-day period preceding the date of the filing of the involuntary bankruptcy petition, the exemption the Debtor could take in the homestead property was subject to the $136,875 cap.[55] The district court also found that § 541(a)(2) eliminates the rights of a non-debtor spouse to community property since community property is included in the bankruptcy estate. Therefore, the non-filing spouse has no right to assert a separate and additional exemption in property claimed as homestead.

Kim v. Dome Entertainment Center, Inc. (In re Odes Ho Kim), 748 F.3d 647 (5th Cir. 2014)

The Debtor and Mrs. Kim next appealed to the United States Court of Appeals for the Fifth Circuit. The Fifth Circuit affirmed both that the non-debtor spouse’s homestead rights were limited by § 522(p) and that there was no unconstitutional taking of the value of the non-debtor spouse’s homestead interest.[56] Therefore, a non-filing spouse may not assert a separate exemption in property claimed as the family’s homestead. When the § 522(p) limitation applies, the amount that both the debtor and the debtor’s non-filing spouse may claim as a homestead is capped if the homestead was purchased within the 1,215-day period preceding the filing of an involuntary petition. In this case, though the Debtor had listed his residence on the bankruptcy schedules as exempt under Texas homestead law, the property was acquired within the 1,215-day period and thus subject to the § 522(p) limitation. Further, because Mrs. Kim has no economic vested interest in the property pursuant to her separate homestead interest, she is not entitled to compensation nor to prevent the sale of the property by a trustee. After the sale, any proceeds from the sale of the Debtor’s property in excess of the capped amount will thus become property of the estate under 11 U.S.C. § 541(a)(2)(A).

Thaw v. Moser (In re Thaw), 769 F.3d 366 (5th Cir. 2014)

In Thaw v. Moser, the Fifth Circuit again considered the circumstance of a Texas homestead exemption claimed by a non-filing spouse,[57] though this time for a house acquired after the enactment of BAPCPA.[58] The key facts are as follows: the debtor, Dr. Stanley Thaw (“Dr. Thaw”), and his wife Kernell Thaw (“Mrs. Thaw”) (together, the “Thaws”) executed a contract to build a home for $1.75 Million in late 2009, and then quickly executed a Contract for Deed increasing the price to $2.15 Million.[59] At about the same time, Dr. Thaw’s former business partner acquired a judgment against him.[60] In the following months, the Thaws made large monthly payments and ultimately closed on the purchase of the home in late June of 2011.[61] In December of the same year, Dr. Thaw filed Chapter 7 bankruptcy, but Mrs. Thaw did not.[62] In the schedules filed by Dr. Thaw along with his petition, he listed the home as exempt property under § 522(b) of the Bankruptcy Code and the homestead provisions of the Texas Constitution and Texas Property Code.[63]

The Chapter 7 trustee objected to the exemption of the Debtor’s homestead, and Dr. Thaw subsequently conceded that his homestead exemption was capped by 11 U.S.C § 522(p).[64] However, the bankruptcy court held that Dr. Thaw’s exemption should be further reduced to $0 pursuant to 11 U.S.C. § 522(o) because Dr. Thaw intended to defraud his former business partner.[65] Mrs. Thaw then argued that she had a separate, vested homestead property right not subject to the limits of §§ 522(o) and (p). She compared her interest to a life estate that could be taken away without just compensation equal to 82.77% of the proceeds of any sale of the home.[66]

The Thaws then appealed not only whether and to what extent the homestead was exempt pursuant to 11 U.S.C. § 522(p), but also whether Mrs. Thaw had a separate, vested homestead property right that was not subject to the limits of §§ 522(o) and (p). Mrs. Thaw argued that subjecting her homestead property rights to the bankruptcy statutes would be an unconstitutional taking. The district court affirmed the bankruptcy court and held that the non-filing spouse of a debtor had no separate property interest in the homestead exemption, and therefore there was no taking.[67] The Fifth Circuit again affirmed, holding that—since BAPCPA was in effect before the Thaws purchased the property—the Thaws acquired their homestead with notice of how the Bankruptcy Code would operate in the event of Dr. Thaw’s bankruptcy. In sum, the Fifth Circuit ruled that the sale of the property would be neither a “gratuitous confiscation” nor “so unreasonable or onerous as to compel compensation.”[68]

In re Parsons, No. 12-12649, 2014 Bankr. LEXIS 5038 (Bankr. W.D. Tex. Dec. 12, 2014)

The Parsons decision handed down by Judge Davis on December 12th, 2014 is consistent with the notion that the Texas homestead exemption is independent from a property interest.[69] In that case, the debtors listed their homestead as exempt, despite the fact that the property was subject to liens exceeding their equity in the property. The Chapter 7 trustee objected to the exemption, relying upon a line of cases from other circuits that have held that a homestead in which a debtor holds no equity cannot be exempted.[70] Thus, the Chapter 7 trustee sought to sell the debtors’ homestead—per his powers under 11 U.S.C. § 724(b)—and pay administrative expenses.[71]

The court overruled the Chapter 7 trustee’s objection, finding that an exemption claimed under Texas homestead law required a different result, since the state constitution and statutes extend homestead protection to the property itself rather than an interest in the property up to a specified dollar amount.[72] Applying the United States Supreme Court’s holding in Schwab v. Reilly,[73] the bankruptcy court noted that an exemption defined by the language “interest up to a specified dollar amount” does not give the debtor an exemption in the property itself. The language in the Texas Constitution and the Texas Property Code, on the other hand, lies “in the property itself, with no limitation on value.”[74] Thus, the court reasoned, even if the debtors’ have no equity to exempt, they still have a residence that is exempt under Texas homestead law.

Case Summaries: Other Recent Homestead Issues in Bankruptcy

Law vs. Siegel, 134 S. Ct. 1188 (2014)

This case resolved the question of whether a bankruptcy court has the authority to surcharge a debtor’s homestead exemption if the debtor engages in fraudulent misconduct. In 2004, the debtor filed Chapter 7 bankruptcy, valuing his California home at $363,348 and claiming $75,000 of that as exempt under California homestead law. He also claimed that the property was subject to a first mortgage of $150,000 owed to a bank and a second lien for $168,000 owed to “Lin’s Mortgage & Associates.” Because the value of the homestead exemption and the mortgage liens exceeded the value of the house, there was nothing available for distribution to the debtor’s general unsecured creditors.

However, subsequent litigation revealed that the second mortgage lien did not exist. The Chapter 7 trustee expended more than $500,000 in fees and costs to investigate and litigate the second lien. Ultimately, not one but two individuals claimed to be the named beneficiaries of the lien. The first, a Lili Lin of Artesia, California, denied ever loaning the debtor any money. However, a Lili Lin of China claimed to be the true beneficiary and proceeded to engage the trustee in costly litigation for over five years. Ultimately, the court concluded that “Lili Lin” most likely did not exist. The house sold for about $680,000 and only one creditor timely filed a proof of claim (the claim was settled for $120,000). The trustee sought to surcharge the homestead exemption in order to be reimbursed for his legal expenses. The bankruptcy court ordered that the debtor’s homestead be surcharged in its entirety. The Bankruptcy Appellate Panel and the United States Court of Appeals for the Ninth Circuit affirmed.

The United States Supreme Court reversed, noting that 11 U.S.C. § 105(a) grants a bankruptcy court authority to “issue any order, process, or judgment that is necessary or appropriate to carry out” the provisions of the Bankruptcy Code, and that the court has inherent power to sanction abusive litigation practice, but that a bankruptcy court may not contravene a specific statutory provision. 11 U.S.C. § 522(k) expressly states that a homestead exemption is “not liable for payment of any administrative expense.” As such, the Supreme Court ruled that the bankruptcy court exceeded the limits of its authority under § 105(a) and its inherent powers. The Court’s ruling in Marrama[75] would not have led to a different result, as its dictum only “suggests that in some circumstances a bankruptcy court may be authorized to dispense with futile procedural niceties in order to reach more expeditiously an end result required by the Code.”

The Supreme Court noted in its decision that the bankruptcy court still has various sanctions available to enforce its judgments. It can (i) deny a discharge under 11 U.S.C. § 727(a); (ii) impose sanctions for bad-faith litigation conduct under Federal Rule of Bankruptcy Procedure 9011; (iii) further sanction under § 105(a); (iv) enforce a monetary sanction that survives the bankruptcy case through the normal procedures for collecting money judgments; or (v) refer fraudulent conduct in a bankruptcy case for criminal prosecution under 18 U.S.C. § 152. The Supreme Court pointed out that though its ruling may produce inequitable results for other trustees and creditors when the debtor engages in such egregious misconduct, it is not for the courts to alter the balance that Congress struck in crafting § 522.[76]

In re Cowin, 492 B.R. 858 (Bankr. S.D. Tex. March 21, 2014)

This case involved a trustee’s objection to the debtor’s homestead exemption pursuant to 522(o). In a lengthy opinion, the court discussed the elements necessary to satisfy this statutory provision, as well as the form of relief that should be awarded if the elements are satisfied. The elements as determined by the court are: (1) the debtor disposed of property within 10 years of the filing of his case (in this case it occurred within 2 years); (2) the debtor disposed of property which was nonexempt (a 2010 note which debtor applied to the purchase of his condo); (3) the nonexempt property was used to pay for a portion of his homestead; and (4) the debtor disposed of nonexempt property with the intent to hinder, delay or defraud his creditors (the court went through 13 badges of fraud and determined that the trustee had shown 9 of the 13).

The bankruptcy court ultimately determined that the elements of Section 522(o) had been satisfied and sustained the objection. The court ruled that the homestead exemption would be reduced by the value of the nonexempt asset used for the acquisition of the home. The court then imposed an equitable lien on the homestead upon which the trustee could immediately foreclose. The court also required the debtor to provide “adequate protection” to the trustee until the property was sold or the debtor vacated the premises. The adequate protection consisted of the debtor’s payment of all mortgage payments, HOA fees, property taxes, insurance and other ongoing expenses (plumbing and electrical) necessary to preserve the estate’s interest in the property.

Cipolla v. Roberts (In re Cipolla), 2013 WL5596848, 541 Fed. Appx. 473 (5th Cir. Oct. 14 2013) (unpublished).

The case of Cipolla v. Roberts (In re Cipolla) deals with the issue of whether § 522(o) applies when a debtor creates a lien on one property to obtain a loan which he uses to purchase another property he then claims as his homestead. The debtor in this case was a lawyer licensed in Texas and Missouri. He acquired a partial interest in residential property in Missouri in 1985 and acquired the rest in 1995 as a gift from his parents. In 1999 he used a home equity loan on the previously unencumbered Missouri property to purchase real property on South Padre Island as a recreational and retirement property. Debtor made the South Padre property his principal residence in 2001. Debtor borrowed additional sums against the Missouri property ($16,000 in 2002 and $56,000 in 2005) while the Texas property remained unencumbered. Debtor also amassed substantial unsecured debts from 2000 through 2009. The debtor filed for bankruptcy and claimed the Texas property as his homestead. The trustee objected to the exemption to the extent that it was purchased with funds borrowed against the Missouri property pursuant to Bankruptcy Code Section 522(o).[77]

The bankruptcy court sustained the trustee’s objection, and the district court affirmed most of the bankruptcy court’s ruling. On appeal, the Fifth Circuit held that the four badges of fraud found by the bankruptcy court were sufficient evidence that the debtor’s property was transferred with the intent to hinder, delay or defraud creditors. Even though the debtor had not actually “transferred” the property, the debtor’s disposal of the property constituted a fraudulent transfer under the Texas Uniform Fraudulent Transfer Act (TUFTA),[78] as TUFTA encompasses every mode of disposing of property. The Fifth Circuit found that the bankruptcy court did not err in considering the entire course of the debtor’s finances after the transfers at issue were made, but transfers closer in time to the transfer were clearly more relevant than later ones. The bankruptcy court was allowed to use the debtor’s demeanor in judging credibility. Also relevant was the significant amount of debt incurred close in time to the Texas property purchase.

CONCLUSION

Recent cases have defined exceptions to the generally accepted rule that the Texas homestead is an impregnable defense against most creditors. As identified by the Zibman, Frost, Smith, and Garcia cases, selling one’s homestead during or after bankruptcy constitutes a much riskier proposition for the debtor than once thought. Though it is well established in Texas law that failure to reconvert proceeds from a homestead back into a homestead within six months eliminates the homestead protection, it appears equally well established by the London opinion that Texas courts believe such proceeds can be used during that time for anything the debtor wants or needs without risk of loss. The Fifth Circuit in Frost has made it clear that it interprets this Texas Proceeds Rule differently. The effect of the Texas Proceeds rule in both Chapter 7 and 13 bankruptcy cases is that a debtor who sells his or her homestead at any time during the bankruptcy case will certainly lose the proceeds, should the debtor fail to reinvest the proceeds entirely in a new homestead. This strict interpretation of the rule raises the question whether the sale of a homestead, years after the closing of a bankruptcy case, without the subsequent reinvestment in a new homestead by the debtor must result in an action reopening the bankruptcy case and demanding turnover of the proceeds. However, this issue may one day be resolved by the Texas Supreme Court, which may “overrule” the Fifth Circuit’s interpretation of the Texas Property Code as it now exists.

On the other hand, the Kim and Thaw cases demonstrate that Texas law entitling a spouse to a separate homestead right has clearly been preempted, barring a United States Supreme Court decision otherwise. As these cases indicate, a debtor’s non-debtor spouse who shares homestead property with the debtor is subject to the value § 522(p) limitation if the homestead was acquired within the 1,215-day period preceding the bankruptcy petition. Furthermore, the debtor’s use of the exemption wholly consumes the spouse’s right to a separate homestead exemption he or she would possess if unmarried. This limitation has been held not only to preempt Texas homestead law exempting a homestead of unlimited value, but also to modify the Texas Supreme Court’s decision in Benchmark Bank v. Crowder, which held that when a homestead is subject to foreclosure of a federal tax lien on an indebtedness owed by a taxpayer, the taxpayer’s spouse, who does not owe any of that indebtedness, has a separate homestead interest and must be compensated for the loss of the homestead estate.[79]

[1] Tex. Const. art. XVI, § 50(a).

[2] Id. at § 50(b)-(h).

[3] Tex. Prop. Code § 41.001(c) (West 2000).

[4] In re McCombs, 659 F.3d 503, 507 (5th Cir. 2011); in Texas, the homestead consists of “not more than two hundred acres of land, which may be in one or more parcels [not in a town or city], with the improvements thereon; the homestead in a city, town or village, shall consist of lot or contiguous lots amounting to not more than 10 acres of land, together with any improvements on the land; provided, that the homestead in a city, town or village shall be used for the purposes of a home, or as both an urban home and a place to exercise a calling or business, of the homestead claimant, whether a single adult person, or the head of a family; provided also, that any temporary renting of the homestead shall not change the character of the same, when no other homestead has been acquired.” Tex. Const. art. XVI, § 51.

[5] “Homestead laws are liberally construed by the courts.” London v. London, 342 S.W.3d 768, 776 (Tex. App.–Houston [14th Dist.] 2011, no pet.).

[6] First Interstate Bank of Bedford v. Bland, 810 S.W.2d 277 (Tex. App.—Ft. Worth 1991, no pet.).

[7] Norris v. Thomas (In re Norris), 413 F.3d 526, 529 (5th Cir. 2005) (citing Culver v. James, 1 S.W. 314 (Tex. 1886)).

[8] Norris v. Thomas, 215 S.W.3d 851 (Tex. 2007) (holding that a yacht did not qualify for a homestead exemption).

[9] In re Schott, 449 B.R. 697, 701 (Bankr. W.D. Tex. 2011).

[10] 11 U.S.C. § 522(d)(1)(2012). Amount effective through April 1, 2016.

[11] In re Brown, 299 B.R. 425, 427-28 (Bankr. N.D. Tex. 2003).

[12] Generally, a residence will refer to a home that a debtor owns and occupies at the time of the filing. In re Anderson, 240 B.R. 254, 258 (Bankr. W.D. Tex. 1999).

[13] This provision also applies to the Texas homestead when a Texas debtor chooses the state exemptions in bankruptcy; however, outside of bankruptcy, such actions by a debtor have no effect on the claim of a Texas homestead exemption. See First Tex. Sav. Ass’n v. Reed (In re Reed), 700 F.2d 986 (5th Cir. 1983).

[14] 11 U.S.C. § 522(o); see also In re Presto, 376 B.R. 554, 569 (Bankr. S.D. Tex. 2007).

[15] Bankruptcy Abuse Prevention and Consumer Protection Act Of 2005 (BAPCPA), Pub. L 109-8, § 322, 119 Stat. 23 (2005).

[16] 11 U.S.C. § 522(p).

[17] 825 F.2d 801 (5th Cir. 1987).

[18] Condit v. McKeithan (In re McKeithan), 486 Fed. App’x. 482 (5th Cir. 2012).

[19] Id. at 483-84.

[20] Id. at 485.

[21] 184 B.R. 733 (Bankr. W.D. Tex. 1995).

[22] As discussed by the Fifth Circuit Court of Appeals in In re England, 975 F.2d 1168, 1173 (5th Cir. 1992).

[23] Reed, 184 B.R. at 736.

[24] Id. at 740-741.

[25] Zibman v. Tow (In re Zibman), 268 F.3d 298 (5th Cir. 2001).

[26] Tex. Prop. Code § 41-001(c) (West 2000).

[27] In re D’Avila, 498 B.R. 150 (Bankr. W.D. Tex. 2013).

[28] Id. at 154-55.

[29] “When a homestead itself is held as of the petition date and as of the date exemption is claimed, the Texas Proceeds Rule is simply not implicated.” Id. at 159.

[30] In re Carlew, 469 B.R. 666, 671 (Bankr. S.D. Tex. 2012).

[31] Id. at 674-676. The Court noted that its opinion was based in part on the fact that the trustee had failed to meet his burden to show that the entire amount awarded in the settlement should not be allocated to payment for damage to Debtor’s homestead.

[32] Id. at 676.

[33] 11 U.S.C. § 1325(a)(4) (2012).

[34] In re Garcia, 499 B.R. 506, 514 (Bankr. N.D. Tex. 2013) aff'd sub nom. Garcia v. Bassel, 507 B.R. 907 (N.D. Tex. 2014).

[35] Viegelahn v. Frost (In re Frost), 744 F.3d 384, 386 (5th Cir. 2014).

[36] Id. at 387 (quoting Zibman, 268 F.3d at 300).

[37] Id. at 388.

[38] Schwab v. Reilly, 560 U.S. 770 (2010).

[39] Frost, 744 F.3d at 390.

[40] Id. at 391.

[41] In re Smith, 514 B.R. 838, 841 (Bankr. S.D. Tex. 2014).

[42] Pursuant to 11 U.S.C. § 350, a Chapter 7 trustee may reopen a case to pursue assets of the estate after the case has been otherwise fully administered.

[43] Garcia et al v. Bassel, 507 B.R. 907, 912 (N.D. Tex. 2014).

[44] In re England, 975 F.2d 1168, 1174-75 (5th Cir. 1992).

[45] Garcia, 507 B.R at 911 n.4.

[46] 342 S.W.3d 768, 775 (Tex. App.—Houston [14th Dist.] 2011, no pet.).

[47] Id. at 774.

[48] Frost, 744 F.3d at 386.

[49] Kim v. Kim (In re Kim), 405 B.R. 179, 182 (Bankr. N.D. Tex. 2009).

[50] 11 U.S.C. § 522(p) (2012).

[51] Kim, 405 B.R. at 187 (Bankr. N.D. Tex. 2009) (citing HR Rep. 109–31(I), 109th Cong., 1st Sess. 2005 n. 72, 2005 U.S.C.C.A.N. 88 (2005) (“In effect, this provision overrides state exemption law authorizing a homestead exemption in excess of this amount and allows such law to control if it authorizes a homestead exemption in a lesser amount.”)).

[52] Id. at 188.

[53] Id.

[54] Kim v. Kim (In re Kim), No. 3:09-CV-1082-N, 2010 U.S. Dist. LEXIS 145648 (N.D. Tex. Aug. 11, 2010).

[55] Id. at * 11.

[56] Kim v. Dome Entm’t Ctr, Inc. (In re Odes Ho Kim), 748 F.3d 647, 650 (5th Cir. 2014). Though this appears to be the ultimate result, the second part of the Fifth Circuit’s Kim opinion does not provide much guidance on such compensation.

[57] Thaw v. Moser (In re Thaw), 769 F.3d 366, 367-368 (5th Cir. 2014).

[58] BAPCPA added Bankruptcy Code provisions 11 U.S.C. §§ 522(o) and (p). Pub.L. No. 109–8, §§ 308, 322, 119 Stat. 23, 81–82, 96–97 (2005).

[59] In re Thaw, 496 B.R. 842, 845-46 (Bankr. E.D. Tex. 2013).

[60] Id. at 845.

[61] Moser, 769 F.3d at 368.

[62] See id.

[63] Thaw, 496 B.R. at 847.

[64] Dr. Thaw stipulated that his homestead exemption was capped at $146,450 under 11 U.S.C. § 522(p). Id. at 848.

[65] Moser, 769 F.3d at 368.

[66] Thaw, 496 B.R. at 847.

[67] Both the district court’s and the bankruptcy court’s holdings were entered prior to the Fifth Circuit’s Kim decision.

[68] Thaw, 769 F.3d at 371.

[69] In re Parsons, No. 12-12649, 2014 Bankr. LEXIS 5038 (Bankr. W.D. Tex. Dec. 12, 2014)

[70] See In re Messina, 687 F.3d 74 (3d Cir. 2012); see also In re Reeves, No. 10-02562, 2011 Bankr. LEXIS 875, 2011 WL 841238, at *1 (Bankr. E.D.N.C. Mar. 8, 2011).

[71] Parsons, 2014 Bankr. LEXIS at *5.

[72] Id. at *8.

[73] 560 U.S. 770, 782 (2010).

[74] Tex. Const. art. XVI, § 51; Tex. Prop. Code § 41.002 (West 2000).

[75] Marrama v. Citizens Bank of Mass., 549 U.S. 365, 375–376 (2007).

[76] Siegel, 134 S. Ct. at 1191; cf. Guidry v. Sheet Metal Workers Nat’l Pension Fund, 493 U.S. 365, 376–377 (1990).

[77] “Under § 522(o ), a debtor cannot claim a homestead as exempt to the extent that the debtor's interest in that property is attributable to nonexempt property disposed of during the ten years preceding the bankruptcy filing with the intent to hinder, delay, or defraud a creditor.” Cipolla v. Roberts (In re Cipolla), 541 F. App’x 473, 475-76 (5th Cir. 2013).

[78] Tex. Bus. & Comm. Code. §§ 24.001-013.

[79] Benchmark Bank v. Crowder, 919 S.W.2d 657, 662 (Tex. 1996).