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.