Bad Debtors Find Limited Homestead Protection

When Congress amended the bankruptcy laws, one of its goals was to eliminate the practice of pouring money into an exempt homestead prior to filing bankruptcy. Due to the inviolability of the homestead under Texas law, this had been a time-honored practice. One Fifth Circuit opinion referred to paying off the mortgage prior to filing bankruptcy as “legitimate pre-bankruptcy planning.” Matter of Bowyer, 932 F.2d 1100 (5th Cir. 1991). The legislative history to the Bankruptcy Code noted that, “As under current law, the debtor will be permitted to nonexempt property into exempt property prior to filing a bankruptcy petition.” H.R. Rep. No. 95-595 (1977), at 361. However, two recent opinions demonstrate just how far things have changed.

For Mr. Green, Things Are Not So Serene

In In re Henry Alan Green, 2007 Bankr. LEXIS 1296 (Bankr. W.D. Tex. 4/9/07) and In re Teresa M. Green,(Bankr. W.D. Tex. 4/9/07) (Monroe, B.J.), the prediction that involuntary bankruptcy cases would be filed to attach homestead assets came to fruition. The Greens were not the most sympathetic debtors. While being sued by a relative (who subsequently recovered a judgment for over $500,000), the Greens liquidated their California assets and bought a Texas home for $1.44 million. As noted by the Court, the amount which they sunk into their new home was over three times what it would have taken to pay the judgment creditor. They then filed for chapter 7 in January 2005. The justifiably angry aunt objected to their discharge and prevailed. Under prior law, this would have resulted in a Mexican standoff where the Greens could not discharge their debts but would remain secure that their homestead was their castle.

However, then the law changed. Under the new law, it the Debtor acquires a homestead within 1,215 days prior to filing, the amount of the exemption is limited to $125,000. See 11 U.S.C. §522(p)(1)(B) and (D). As a result, the justifiably angry aunt wanted to see the Greens in bankruptcy so that the homestead property could be liquidated.

This is where some clever strategizing came in. If a debtor has 12 or more creditors, three creditors must join in hte petition; however, for less than 12 creditors, only a single petitioning creditor is required. Taken together, Mr. and Mrs Green had over twelve creditors, so that a single petitioning creditor could not institute an involuntary petition against them jointly. The petitioning creditor initiated separate cases against each of the spouses. The Bankruptcy Court rejected the argument that both debtors were liable upon each other's debts just because they were married. Instead, the court did an analysis of each debt as to each debtors. The court concluded that Mr. Green had eleven countable creditors and that Mrs. Green had eight. As a result, a single creditor could initiate the separate involuntary petitions against each of them. This opinion, like Judge Monroe’s prior opinion in In re Sadler, No. 06-10091 (Bankr. W.D. Tex. 10/18/06), contains a good discussion of how to count creditors for purposes of an involuntary petition.

The Green opinion is devoted to counting creditors for purposes of an involuntary bankruptcy petition. However, the issue of allowing the judgment creditor to access the homestead overshadows the more mundane issues written on by the court.

Debtor Snared By Sec. 522(o)

Another feature initiated by BAPCPA was the 10-year look back period for amounts invested into a homestead with intent to hinder, delay or defraud. 11 U.S.C. §522(o). In In re (Name Withheld by Request), 366 B.R. 677 (Bankr. S.D. Tex. 5/11/07)(Bohm, B.J.), Bankruptcy Judge Jeff Bohm waded through a lot of facts to deliver a 69 page opinion finding that $50,000 invested into a homestead on the eve of bankruptcy could not be claimed as exempt, while denying various other objections to exemptions.

Prior to filing bankruptcy, the Debtor sold stock which he owned and deposited $50,000 of the proceeds to his wife’s account. His wife then used these funds as the down payment for a residence in Bastrop County in her name. The Debtor and his wife then sold their existing residence. When the Debtor filed bankruptcy, he initially did not schedule the Bastrop County property, but subsequently amended his schedules and claimed it as exempt.

The Trustee objected to the exemption. At some point, Debtor’s counsel decided that the Debtor was not cooperating with her and withdrew. The Debtor represented himself at the exemption hearing.

Judge Bohm found that there were four elements to sustain an objection to exemption under §522(o).

"(1) the debtor disposed of property within ten years preceding the bankrutpcy filing; (2) the property that the debtor disposed of was nonexempt; (3) some of the proceeds from the sale of nonexempt property were used to buy a new homestead, improve an existing homestead, or reduce the debt associated with an existing homestead, or, alternatively, to buy a new principal residence used by dependents of the debtor, improve an existing principal residence used by dependents of the debtor, or reduce the debt associated with a principal residence used by dependents of the debtor; and (4) the debtor disposed of the nonexempt property with the intent to hinder, delay or defraud a creditor."

366 B.R. at 688.

The Court did not have much difficulty with the first three elements. The Debtor sold stock which was nonexempt within the year prior to the bankruptcy. $50,000 of those proceeds could be traced into the Bastrop property. Although the Debtor himself did not reside on the Bastrop property, neither the Trustee nor any creditor had challenged the property’s status as homestead. As a result, the proceeds had been used to purchase a homestead for the debtor or alternatively for his dependents, since his two minor children were living there.

In discussing intent to hinder, delay or defraud, the Court relied on a badges of fraud analysis. The Court noted thirteen possible badges of fraud based on several cases and the Texas Uniform Fraudulent Transfer Act. The Court found that eleven of these badges of fraud were present with regard to the $50,000 transfer. While the Court engaged in an extensive discussion, the facts that the Debtor sold nonexempt property at a time that he was being threatened with suit, invested those funds in exempt property in his wife’s name, promptly filed bankruptcy and failed to accurately disclose the transactions on his schedules and statement of financial affairs should have been more than enough. Interestingly enough, in finding that the Debtor “absconded,” the Court relied on testimony from the Debtor’s former counsel about his failure to appear at the 341 meeting and her difficulties in locating and communicating with him. While this testimony may indicate a problem client, it is a little bit of a stretch to construe this as absconding.

The Court rejected the Debtor’s defense that he had effectively partitioned the funds when he deposited them in his wife’s account. The provision of the Texas Constitution allowing for a partition of martial assets has an express exception for transfers made with intent to hinder, delay or defraud creditors.

Things were not all bad for the Debtor. Judge Bohm ruled in his favor with regard to an additional payment of $11,540.99 which was paid on the Bastrop property. The Court found that $2,540.49 of these funds could be traced to the earnest money which the Debtor received for sale of his existing homestead, so that that this portion of the payment did not come from nonexempt property. As to the remaining $9,000, the Trustee was unable to show the source of the funds. The Trustee had the burden to prove that the property used was nonexempt (See Fed.R.Bankr.P. 4003). Because the Trustee could not show where the funds came from, he could not show that they came from nonexempt property. As a result, the Debtor's ability to obfuscate protected him in part.

The Court granted the Trustee an equitable lien on the Debtor’s Bastrop property in the amount of $50,000 and provided that the Trustee could enforce his lien if the Debtor did not repay the funds within 120 days.

The Court also rejected an objection to purchase of consumer goods used to furnish the new residence on the eve of bankruptcy. While §522(o) refers to “real or personal property that a debtor uses as a residence or claims as a homestead,” the reference to personal property involves the residence itself (for example, a mobile home) rather than the broader category of personal property used in connection with the residence. As a result, the Trustee’s objection failed.

As an added benefit, the Court included a section on credibility of the witnesses who testified before him. Trustee Ron Summers has now been found to be a credible witness in a written opinion. The Court also found that Debtor’s original attorney Barbara Rogers was “forthright and very knowledgeable” and “a very credible witness.” Given the encounters between Houston judges and other Houston Debtor’s attorneys in some recent cases, Ms. Rogers must be relieved to have represented a difficult client and emerged with her reputation judicially affirmed.

The Bottom Line

The box score for these cases should read Creditors 2 Homesteads 0. While Judge Monroe’s case was not about the homestead per se, the decision to allow the involuntary petitions made the loss of the homestead all but inevitable. These cases also illustrate the greater danger faced by Debtors who manipulate their homesteads on the eve of bankruptcy. In the Green case, the Debtors had already lost the discharge in their initial case. In the (Name Withheld by Request) case, there is now a judicial finding that the Debtor transferred property with intent to hinder, delay or defraud creditors during the year prior to bankruptcy. As a result, it appears probable that both debtors will lose their discharge and have the value of their homestead tapped.

The recent reform legislation enacted by Congress was named the Bankruptcy Abuse Prevention and Consumer Protection Act. While the consumer protection moniker has engendered snickers of sarcasm, Congress appears to have been successful in blocking one particular abuse of the bankruptcy process. Of course, it is yet to be known whether the net cast by the amendments to §522 will catch more innocent debtors unaware of the law's complexities than unscrupulous abusers of the system.