Court Rejects Trustee's Unique Homestead Attack

Some of the recent decisions on Texas homesteads coming out of the courts have people wondering just what John Wayne fought and died for at the Alamo.   The sanctity of the homestead along with the prohibition against garnishment of wages are two of the pillars upon which this State was founded.  While the news for Texas debtors has generally been depressing, Texas Bankruptcy Judge Tony Davis rejected a creative argument from an aggressive trustee in the case of In re Parsons, No. 12-12649 (Bankr. W.D. Tex. 12/12/14), which can be found here.

 

What Happened

The Debtors filed chapter 11 to deal with a large IRS liability.   At the time of the filing, they owed a small balance on their mortgage but the property was subject to a sizable tax lien.  No party objected to the exemptions during the chapter 11. 

 

The Debtors converted their case to chapter 7 after proposing a chapter 11 plan which drew no votes either for or against.    By the time of the conversion, the mortgage had been paid off but the IRS lien exceeded the value of the property.   Meanwhile the Debtors had negotiated a settlement of their IRS liability for a sum which was less than the value of the homestead.

The Debtors claimed Texas exemptions.    The Trustee objected on the basis that the Debtors had no equity in the property and that under section 724(b), the Trustee could sell the property and subordinate the IRS lien to pay administrative and priority claims.

 

The Court's Ruling

Judge Davis put his ruling at the beginning of the opinion for those not willing to wade through eight pages of discussion:

In this case, the Court concludes that a trustee may not collect administrative expenses by forcing the sale of a Texas homestead, encumbered by IRS liens but claimed as exempt, even if there is no equity in the property.

Opinion, p. 1.

The Debtors argued that the trustee's objection was untimely.   Under prior Western District case law, conversion to chapter 7 did not trigger a new period for objecting to exemptions.   In re Halbert, 146 B.R. 185 (Bankr. W. D. Tex. 1992).   Unfortunately for the Debtors, Fed.R.Bankr.P. 1019(2)(B) was adopted in 2010.   It says that when a case converts from chapter 11, 12 or 13, there is a new period triggered for objecting to exemptions unless either:  i)  a plan was confirmed at least one year prior to conversion; or ii) the case was previously in chapter 7 and the period for objections had expired.   The rule provision is probably a wise one.   In a reorganization case, creditors and parties are generally more focused on what they will receive under a plan.  As a result, they are less likely to focus on exemption questions.    The rule amendment closes the loophole.

The Court found that the argument under section 724(b) was premature.   In order for a trustee to invoke section 724(b), the property must be property of the estate.   Therefore, section 724(b) cannot be used to bring the property into the estate.

There is some debate between the parties as to the necessity or appropriateness of this section 724(b) maneuver by the Trustee, but that debate is irrelevant; because the exemption is valid, the Homestead is not property of the estate, and section 724(b) does not apply.

Opinion, p. 4.

Finally, the Court rejected the argument that the Debtors could not claim property which lacked equity as exempt under Texas law.   The Court distinguished cases in which the exemption is limited to a specific dollar amount and under which the Debtor might arguably need to have equity in order to have an exempt interest in the property.   The Court noted that under Texas law, it is the homestead itself which is exempt, not the value of the homestead.   The Court stated:

There is no dollar limit to the exemption because it is the homestead itself, rather than the debtor’s equity, that Texas law protects. (citations omitted). Even if the Debtors had no equity to exempt, they would still have a residence that is itself exempt under Texas homestead law.

Opinion, p. 8.    The ruling that the homestead itself is of intrinsic value under Texas law, as opposed to something as transient and impermanent as value, would have brought a smile to John Wayne's face.   

Why Were the Parties Fighting Over a Home With No Equity?

One question not answered by the opinion is why the parties were arguing over a home with no equity.   For the Debtors, the answer was straightforward.   They had lived in the house since 1983, long enough to pay off the first mortgage.   This was their residence rather than simply an investment.  The trustee's motivations were more complex.   While he knew that the property had no equity on paper, he was also aware that the Debtors were negotiating with the IRS.   If the Trustee could strike the same deal with the IRS, he could generate equity for the estate.   Thus, the Trustee was seeking to object to the exemption based on no equity and then create equity by compromising the IRS lien.   

Disclosures and Other Fine Print

 

My firm represented the Debtors and I tried the homestead issue for them.

 

John Wayne did not actually fight at the Alamo.   However, he did play Davy Crockett in the 1960 film version.   He also played Texans in many other films, including The Searchers (1956), Rio Bravo (1959), The Commancheros (1962) The Sons of Katie Elder (1965) and Rio Lobo (1970). John Wayne was not actually a Texan, but he is still the iconic Texan.