Thursday, October 28, 2010

Schwab v. Reilly Places Homesteads at Risk Years After Filing

A new opinion from the Ninth Circuit illustrates the practical implications of Schwab v. Reilly, 130 S.Ct. 2652 (2010). In Matter of Gebhart, No. 07-16769 (9th Cir. 9/14/10), the Court held that the Trustee was entitled to reap the benefits of post-petition appreciation in the Debtor’s homestead. The opinion can be found here.

Two Homesteads Going Up Over the Years

Gebhart involved two consolidated appeals. In the first case, the Debtors filed chapter 7 in August 2003 and claimed the Arizona homestead exemption. On the petition date, the Debtor’s equity was less than the $100,000 exemption. The Trustee did not object. In November 2006, the Trustee sought to employ a broker to sell the home, contending that its value had appreciated beyond the exemption amount. In the second case, the Debtor filed bankruptcy in June 2004 and claimed the Washington homestead exemption. Two years later, the Trustee sought to sell the home, which had appreciated in value. Both Debtors cried foul. The Arizona court ruled that the property remained in the estate, while the Washington court ruled that the unopposed exemption removed the property from the estate.

It's Exempt But What Is "It"?

The Ninth Circuit acknowledged that “{q]uite simply, property that has been exempted belongs to the debtor.” However, the question is, just what was exempted and passed out of the estate? Following the Supreme Court, the Ninth Circuit stated that where an exemption was limited to a dollar amount (as was the case with both the Arizona and Washington exemption statutes):

Instead, what is removed from the estate is an “interest” in the property equal to the value of the exemption claimed at filing. (citation omitted). The implication for the cases at issue here are clear: the fact that the value of the claimed exemption plus the amount of the plus the amount of the encumbrances on the debtor’s residence was, in each case, equal to the market value of the residence at the time of filing the petition did not remove the entire asset from the estate.

Opinion, at 14071-72.

A Bad Result They Admit

The Ninth Circuit did not shy away from the implications of its decision.

The debtors argue that the result we reach today will lead to uncertainty about the status of exempt property and abuses by trustees. The facts of the Gebhart bankruptcy suggest that some of these concerns are legitimate. Gebhart remained in his home for five years after filing for bankruptcy, paying his mortgage and believing that his bankruptcy was finished when he received his discharge. Gebhart may have been mistaken in his belief, but his misapprehension was shared by his mortgage lender, which refinanced the home, apparently unaware of any claims on the property by the Trustee. A Chapter 7 debtor will not be certain about the status of a homestead property until the case is closed (something that may not happen for several years after bankruptcy filing) or the trustee abandons the property.

Opinion, at 14074.

Notwithstanding these concerns, the Court held that the Trustee was not stopped to claim the homestead property and could not be compelled to abandon the property.

Opening Pandora's Box

This case illustrates the Pandora’s box opened by Schwab v. Reilly. While that case involved a dispute over the value of property as of the petition date, these cases involved post-petition appreciation. Debtor’s attorneys cannot assume that an unobjected to exemption means that the debtor gets to keep the property. If the exemption is defined by a dollar amount, the Trustee can sit back and wait for appreciation.

How serious is the risk for Texas debtors? Texas is one of the minority of states which allow use of federal exemptions. Most of these exemptions are dollar limited. On the other hand, Texas law allows unlimited exemptions for the homestead, tax qualified retirement accounts, annuities and cash value of life insurance. Texas law allows an aggregate exemption of $60,000.00 for certain categories of personal property.

How could this issue arise in Texas? Here are a few possibilities:

1. The Debtor uses federal exemptions to claim a homestead with no equity and a business under the wildcard exemption. Subsequently, either real estate prices rebound or the debtor makes a success of the formerly languishing business. At that point, the Trustee could sell the now valuable asset.

2. The Debtor takes federal exemptions and undervalues an asset, such as tools of the trade. If the Trustee subsequently finds out that the asset had more value, he could sell it. That was the fact scenario in Schwab v. Reilly.

3. The Debtor claims Texas exemptions and claims $5,000 worth of jewelry. Subsequently, it turns out that the jewelry was worth $45,000. While that would still be under the $60,000 cap, Texas law limits the jewelry exemption to $15,000. Again, under-valuation can be remedied without a timely objection.

4. If the Debtor claims Texas exemptions, but acquired their homestead within 1,215 days, then the homestead is subject to a cap under Sec. 522(p). If the homestead subsequently appreciates, the Trustee could move to sell even though the property was under the cap on the petition date.

5. The most unlikely scenario is one where the debtor owns an asset such as artwork which has negligible value on the petition date. Post-petition, the artist dies and acquires a cult following. As a result, the total value of the Debtor’s personal property exceeds $60,000. However, in this instance, the debtor should be able to take advantage of depreciation in other personal property assets, such as vehicles, to offset the appreciation of the artwork. The challenging aspect of the Texas personal property exemption is that the cap applies to the overall group of assets. As a result, the change in value of one asset may be offset by the decline in value of another.


Anonymous said...

The Debtor can resolve the Schwab issue by filing a motion to abandon the property back to the Debtor. In an asset case, this should be done as a matter of course by the Debtor's attorney.

Anonymous said...

Ha! Photograph praying to St. Anthony since childhood, most likely he comes through inside of a pinch.
HOWEVER, my sister lost my mom's twelfth grade class ring TWICE in 2 different tornados that swept her house away (8 years apart) found that damn ring both times, and she accounts for to my opinion and yep, lost forever. And some years back on a holiday to Padua (home of St. Anthony's
basilica) I lost my travel journal, everything I ate, bought saw and studied about this trip was gone.
It was devastating for the writer...all my notes, and only sixty
minutes after praying on bended knee there. It never
did appear....

My blog - ,cheap earrings for girls **