Sunday, September 07, 2014

Kim Case KOs Homestead Interest of Non-Filing Spouse

This has not been a good year for Texas homesteads involved in bankruptcy proceedings.    In April, the Fifth Circuit ruled (after nearly two years under advisement) that the non-filing spouse does not have a separate homestead estate entitled to protection when the other spouse files bankruptcy, or, as happened in this case, has an involuntary petition brought against him.    Kim v. Dome Entertainment, Inc. (In re Kim), No. 10-10882 (5th Cir. 4/9/14), which can be found here.   While the legal reasoning of the decision is solid, it is a blow to those of us who consider the Texas homestead to be sacrosanct.
What Happened

Odes Ho Kim purchased a home in Irving, Texas for $1,048,028.36 which he occupied with his spouse Chong Ann Kim.    About two years later, Dome Entertainment Center obtained a judgment against him in California for more than $5 million.   Dome then filed an involuntary petition against Mr. Kim in Texas.   Because the home was acquired less than 1,215 days before bankruptcy, Dome objected that Mr. Kim's homestead exemption  was limited to $136,875.    The Bankruptcy Court sustained the objection.   Mr. Kim then filed a declaratory judgment seeking to determine Mrs. Kim's interest in the property.   Dome intervened.   Judge Harlin "Cooter" Hale ruled that 11 U.S.C. Sec. 522(p) preempted the unlimited Texas homestead exemption and that Mrs. Kim did not have a “separate and distinct exempt homestead interest in the property that would entitle her to compensation or to prevent the sale of the Property.”   The District Court affirmed and held that Mrs. Kim did not have a vested property right in the property.

The Fifth Circuit's Ruling

Mrs. Kim argued on appeal that under Texas law, she had a homestead interest which was independent of her husband's interest in the property and that this interest was her separate property which did not enter the bankruptcy estate.    The characterization of this interest was important because under 11 U.S.C. Sec. 541(a)(2), any interest which the debtor has in property as separate, sole management or joint management property enters the estate.   The parties stipulated that the real property fit into one of these categories which made sense since the property was purchased by Mr. Kim and was titled in his name.   

Texas law offers several unique protections to spouses:
  • Under Texas Property Code Sec. 41.004, a homestead cannot be abandoned without the consent of the other spouse.
  • Under Texas Family Code Sec. 5.001, regardless of whether the property is characterized as separate or community property, it cannot be conveyed without the consent of the other spouse.
  • Finally, under Texas Estates Code Sec. 102.003 and 102.005, the homestead right shall descend and vest in the heirs unless the property is still occupied by a surviving spouse.  
So, were the unique rights granted to spouses under Texas law a property interest excluded from the bankruptcy estate?    The Fifth Circuit said that it didn't matter.

Even were we to accept this argument, it would not affect our analysis of the bankruptcy court’s authority to order a forced sale of the Kims’ residence. Both the United States Supreme Court and the Supreme Court of Texas have rejected arguments similar to those urged by the Kims.
Opinion, p. 9.    The Court relied on United States v. Rogers, 461 U.S. 677 (1983), which held that a Texas homestead could be sold to pay taxes owing by one spouse over the objection of the other spouse based on the federal government's superior right to collect taxes.    The court found that this ruling was analogous to 11 U.S.C. Sec. 363 which allows property to be sold free and clear of the interest of a co-owner.    The Court also relied on Texas case law that held that Texas homestead laws could not preclude enforcement of a federal statute allowing sale of the homestead.   Because the spousal rights under Texas law exist to prevent non-consensual sale or abandonment of the homestead, a superior federal law allowing sale of the property could trump these Texas rights.

Having concluded that the Bankruptcy Court had the authority to order sale of the residence, the Court turned to the issue of whether Mrs. Kim was entitled to a separate share of the proceeds from Mr. Kim.    Unfortunately, the Court had previously ruled in Matter of Rogers, 513 F.3d 212 (5th Cir. 2008) that section 522(p) only applied to "vested economic interests."    If Mrs. Kim had held a vested economic interest, she might have qualified for a share of the proceeds.

After a lengthy analysis of Texas law, the court concluded that, although the spouse's rights had been analogized to a life estate, they did not qualify as "vested economic rights."    As a result, Mrs. Kim went away empty-handed.

Dealing With Kim

The Kim case exposes a danger when dealing with Texas homesteads.    If the exemption is capped by Sec. 522, the non-filing spouse can be kicked out of the property and limited to her husband's capped exemption.    What can be done to avoid this?   I can think of three ways to mitigate the problem of varying utility.

Because the property was purchased by Mr. Kim in his sole name, it was likely his sole management community property or at least joint management community property.   If a couple purchases a high-dollar home knowing that the husband has a high risk of getting sued within the next 1,215 days, it might make sense to take title in the wife's name.   Outside of bankruptcy, Texas law would protect the husband from the wife selling the property and making off with the proceeds.   Another option would be for the couple to enter into a marital partition agreement prior to purchasing the home stating that any property acquired jointly by them would be owned as their separate property in equal shares.    If the non-filing spouse had a 50% interest in the property as separate property, that interest would not enter the estate.    Of course, a partition done on the eve of bankruptcy could be set aside as a fraud on creditors.    As a result, this would need to be done well before bankruptcy is contemplated.   

Of course, most people don't purchase property expecting to file bankruptcy within 1,215 days.   This leads to the second fix.   The Texas legislature could state that each spouse individually owns a life estate in the property.   Current law tries to give each spouse something approximating a life estate.   The legislature could make this explicit so that each spouse would have a separate vested economic interest in the property.   This wouldn't stop sale of the property, since section 363(h) would still be there.   However, it would ensure that the non-filing spouse received a financial consolation prize.

Finally, when faced with a bankruptcy within 1,215 days after acquiring a homestead, it might make sense for both spouses to file.   Section 522(m) says that homestead exemptions are calculated per debtor.   If two debtors file, the cap is twice as much as if one had filed.   Generally, the conventional wisdom is to keep the other spouse out of bankruptcy if she has limited exposure on the debts (such as when the husband is sued on debts from his business for which the wife is not liable).   However, if the homestead exemption is capped, then two spouses filing means 2x the exemption.    There may have been other reasons why it didn't make sense for Mrs. Kim to join her husband's filing.   However, from here on out, it is a topic that bankruptcy counsel should broach with both spouses.



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