Thursday, May 29, 2008

Debt Buyers Win Respect in New Opinion

Debt buyers are not the most popular people these days. However, their role as economic scavengers was acknowledged in a recent opinion from Judge Leif Clark of San Antonio. In re Salvador Santana, No. 07-30027 (Bankr. W.D. Tex. 5/21/08).

In Santana, Portfolio Recovery Associates, LLC filed a Notice of Transfer of Claim with respect to a claim that they had acquired from Capital One in the amount of $604.19. The Debtor objected on the basis that "a third party purchasing the instrument at a very reduced cost and having [the] Bankruptcy Court enforce payment is not in the best interest of the debtor."

While the Debtor's objection was no doubt accurate (that is, that is not in the best interest of the debtor to recognize the transferred claim), this was not a valid objection.

Judge Clark recognized that a purchaser of claims was entitled to enforce the full amount of the claim regardless of what it paid. While the creditor might receive a windfall, it was also assuming the risk of default by the debtor. As a result, the benefit should accrue to the debt buyer and not the debtor.

Judge Clark wrote:

"The holder of a claim is permitted to sell the claim for less than the face amount of the claim, and the transferee is entitled to enforce the claim for its face value, even though the transferee bought the claim at a discount. In other words, the debtor is not entitled to the benefit of the discount. This is so because the discount represents the transferee's assumption of risk of payment at less than the face amount of the debt. The transferor 'cashed out' its risk of nonpayment by agreeing to accept less than face value from the transferee, but again the debtors are not entitled to the benefit of that de facto writedown. Insofar as the debtor is concerned the original debt is till owed to whomever is the current rightful owner of the obligation. the transferee 'bought' the obligation, and is now the rightful owner entitled to enforce the debt at its face value. Because this is a chapter 13 case, it is almost certain that the debt will not be paid at its face value. . . . Thus, the transferee has factored in these risks when it set the price to be paid for the claim that it purchased. To realize the benefit of its bargain, however, it needs to be able to enforce the full amount of the claim purchased. And so the law allows."

Only in bankruptcy court would a claim for $604.19 merit such a thoughtful opinion!

Monday, May 26, 2008

Bankruptcy Court Limits Texas Homestead Under 1,215 Day Rule

The Bankruptcy Court for the Western District of Texas was recently faced with several issues relating to the homestead limitations under 11 U.S.C. Sec. 522(o) and (p). In re Fehmel, No. 07-60831 (Bankr. W.D. Tex. 5/22/08)(Frank R. Monroe, B.J.). Judge Monroe's opinion decides what it means to acquire an "interest" in property within 1,215 days, as well as interpreting the rollover and fraud provisions of the exemption statute.

The Issues

The Debtors owned a homestead which was purchased more than 1,215 days before bankruptcy. Within the 1,215 day period, they purchased a new homestead prior to selling the old one. They made the downpayment on the new homestead by drawing down on a corporate line of credit. Subsequently, they sold their old home and paid the proceeds into the corporate bank account. They made substantial improvements to the new homestead property, renovating the main house and adding a barn, a workshop and a guest house. At the time that they purchased the new homestead, the Debtor's company was doing well. However, subsequent reverses put the company out of business and caused the Debtors to file bankruptcy. At the time that they filed bankruptcy, the new homestead was worth almost double what they had paid for it.

Union State Bank, which had obtained a judgment on a guarantee of corporate debt, objected to the homestead exemption on the basis that the Debtors had acquired the homestead within 1,215 days before bankruptcy and should be limited to $125,000, that the downpayment from the corporate line of credit should be deducted from the allowed exemption based on fraud and that the debtors were not entitled to credit for reinvestment from the prior homestead.

The Debtors responded that they were allowed $125,000 in equity per debtor, that they had used the funds from sale of the prior homestead to improve the new property and that any additional equity was the result of passive appreciation which should not be counted toward the homestead cap. The Debtors also argued that their use of the corporate line of credit was not fraudulent and that the bank had tacitly consented to this personal use of the funds.

The Court's Ruling

The Court released its opinion on May 22, 2008, finding that the Debtors' exemption was limited to a total of $273,750 in equity. Judge Monroe noted that while the parties had relied on the amount of $125,000 contained in the original version of BAPCPA, that the cap had been adjusted to $136,875 in April 2007. The Court found that the cap should be applied on a per debtor basis. Section 522(m) states that the limitations contained in Sec. 522 are to be applied per debtor in a joint case. As a result, the homestead cap was doubled in a joint case.

The Court rejected arguments to enhance or diminish the homestead exemption based on passive appreciation, rollover from a prior residence or fraud.

The Debtor relied on a line of cases which held that passive appreciation should be added to the amount of the homestead cap. These cases hold that "any amount of interest" as used in the statute refers to the equity acquired by the debtor such that passive appreciation should not cause the debtor to exceed the limitation.

Courts are split on what the phrase "any amount of interest" means. One line of cases holds that "any amount of interest" refers to acquiring legal title to the property, while a competing line holds that it refers to obtaining equity in the property. The cases following the equity approach exclude passive appreciation in value from the amount of interest subject to the homestead cap while the cases applying the title approach look solely at when the debtor acquired title.

The Bankruptcy Court chose to follow the title theory. Judge Monroe stated:

"The title theory allows a court to focus on when the debtor acquired its interest in the property as opposed to the potential myriad of points in time which equity increased in value. It also avoids the incongruous result where property is acquired outside of the 1,215 day period but the exemption is limited based on equity accumulated during this period."

Memorandum Opinion at 18.

The Court also found support from the reasoning of a recent Fifth Circuit opinion. In Matter of Rogers, 513 F.3d 212 (5th Cir. 2008). In Rogers, the Fifth Circuit declined to choose between the title and equity theories. However, it held that interest referred to "vested economic interests." As a result, in that particular case, the fact that a property owned by the debtor more than 1,215 days before bankruptcy became the debtor's homestead within the 1,215 day period did not trigger the homestead cap because the debtor did not acquire any additional vested economic interest when the property's status changed. The Bankruptcy Court relied on this analysis to state, "Title, unlike a designation of homestead, is clearly a vested economic interest. When a debtor acquires title, he acquires a vested economic interest in the property." Memorandum Opinion at 19.

The Court rejected arguments for either supplementing the homestead exemption based on rollover from a prior homestead or reducing the amount of the exemption based on fraud.

The Court found that it was the Debtor's burden of proof to show that monies from a prior residence had been invested into the new property. Here, the Debtors had deposited the funds from sale of the initial residence into a company account where they were co-mingled with corporate funds. While the Debtors claimed that these funds had been used to make improvements on the property, they failed to trace any specific funds from the corporate account into the homestead. As a result, they failed to meet their burden of proof.

However, the Court also found that the creditor failed to meet its burden of proof with respect to fraud under Sec. 522(o). The Court found that three out of four elements were present, in that the debtors had disposed of property within ten years prior to the bankruptcy, that the funds were non-exempt and that the funds were used to enhance the value of the homestead. However, the Court found that the bank failed to show that the debtor had disposed of the non-exempt property with intent to hinder, delay or defraud.

The Court noted that the term "intent to hinder, delay or defraud" is not defined in the Bankruptcy Code. The Court chose to use the badges of fraud analysis from the Uniform Fraudulent Transfer Act. While the Court analyzed 13 separate factors, the most telling ones were that the Debtors had acted openly in using the corporate line of credit and that they had not been insolvent at the time that the downpayment had been made. As a result, the Court found that fraudulent intent was absent.

The Court's opinion also contains a discussion of the Texas tools of the trade exemption. The Court sustained the objection on the basis that the Debtor did not have a trade or profession at the time that he filed bankruptcy and that the tools were not actually used in a trade or profession.

Disclaimer: I represented Union State Bank in this case.

Wednesday, May 21, 2008

Obscure Provision Protects Local Taxing Authorities

Three years after the adoption of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, there are still opportunities to find something new in the statute. Under both the Bankruptcy Act and under the Code prior to BAPCPA, it was possible for a debtor to ask a court to redetermine the appraised values used to compute ad valorem taxes so long as the values had not been previously contested.

As the Fifth Circuit explained:

"Debtors financially involved are not always vigilant in the exercise of their rights to challenge tax claims or secure abatements; their mangaments may be inept, incompetent, uninterested, or dishonest; indeed, they may be under pressure to accept overassessements which may aid in maintaining their credit standard or commercial rating.

"The [Act], by authorizing redetermination in those instances where the tax claim was never appealed, serves to protect creditors of the bankrupt from the bankrupt's lack of diligence or interest."

City of Amarillo v. Eakens, 399 F.2d 541, 544 (5th Cir. 1968). Allowing redetermination of property tax values turned the appraisal system on its head. Under the laws of many states, including Texas, property tax values must be protested in a timely manner or they become final. Tax rates are then set based on the final valuations. Section 505 allowed a debtor to come in after the appraisal rolls had been finalized and taxes set and complain that the valuations were not correct. Needless to say, taxing authorities did not like this. Among other difficulties, the opportunity for redetermination was open-ended, allowing debtors to go back indefinitely in time so long as the values had not previously been protested.

Redetermination of tax values was a controversial issue under the Bankruptcy Code. Some courts abstained from redetermining property tax values, In re New Haven Projects Ltd. Liability Co., 225 F.3d 383 (2nd Cir. 2000), while others allowed it, In re Hospitality Ventures/La Vista, 314 B.R. 843 (Bankr. N.D. Ga. 2004); In re Fairchild Aircraft Corp., 124 B.R. 488 (Bankr. W.D. Tex. 1991). The cases declining to exercise jurisdiction relied on language in the legislative history to the code stating that abstention was appropriate "where uniformity of assessment is of significant importance." S. Rep. No. 989, 95th Cong., 2d Sess. 11 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5853.

As a debtor's lawyer, I have not hesitated to use this provision to object to ad valorem tax claims which seemed excessive based on the valuation determined in the Bankruptcy Court. However, on a recent claims objection, I came across Section 505(a)(2)(C) (in fairness, I came across it when the Court asked me how it affected my objection). Section 505(a)(2)(C) states that the court may not redetermine:

"the amount or legality of any amount arising in connection with an ad valorem tax on real or personal property of the estate, if the applicable period for contesting or redetermining that amount under any law (other than bankruptcy law) has expired."

This subsection eliminates the ability to retroactively challenge valuations going back many years. Instead, only valuations which could have been challenged on the petition date may be redetermined in the Bankruptcy Court. However, if the time to challenge has not expired on the petition date, Section 108(a) would appear to give the debtor two years in which to file the motion (providing that where nonbankruptcy law establishes a deadline which has not expired on the petition date, that the trustee may commence the action within the longer of the original period or two years).

This amendment also seems to quiet the controversy over redetermination is proper. By limiting redetermination to situations where the protest period has not expired on the petition date, Congress appears to have implicitly endorsed it in that one case.

To date, there are not any published decisions under this subsection. One pre-BAPCPA case noted that the result would have been different under the new law. In re Delafield 246 Corp., 368 B.R. 285 (Bankr. S.D. N.Y. 2007). However, I was not able to find any cases applying the new statute. Thus, it appear that this subsection remains shrouded in obscurity.