Sunday, February 22, 2015

Exemptions Continue to Feel Frost's Bite

The rift in the bankruptcy universe created by Viegelahn v. Frost (Matter of Frost), 744 F.3d 384 (5th Cir. 2014) continues to widen, drawing more exemptions into its vortex in seeming disregard of Supreme Court precedent.   The latest opinion to come down is  In re Hawk, 2015 Bankr. LEXIS 309 (Bankr. S.D. Tex. 1/30/15) which holds that the Debtor in a chapter 7 proceeding forfeited his IRA exemption when he liquidated the account after the deadline to object had expired.   

The Debtors filed their chapter 7 proceeding on December 15, 2013.   On this date, they held an IRA in the amount of $164,902.   Over the period from December 11, 2013 to July 14, 2014, the Debtors withdrew the funds from the IRA. The Trustee filed a no asset report on April 3, 2014.  The deadline to object to exemptions expired on April 28, 2014.  No party filed an objection.

A creditor objected to the Debtors' discharge.   At a deposition on November 18, 2014, the creditor learned of the liquidated IRA in a deposition.   The Trustee then made demand for the Debtors to turn over the IRA proceeds because they had not been reinvested within sixty days.   The Trustee then filed a motion for turnover of the funds.

The Bankruptcy Court granted the Trustee's motion for turnover, finding that the failure to file a timely objection was not material.   The Court stated:
(T)he Court finds that the pertinent threshold question is whether property deemed exempt under state law loses its statutory protection at any point during the pendency of a Chapter 7 case. Here, the Liquidated IRA Funds lost their exempt status under state law while the Debtors' bankruptcy case was open. Once the Liquidated IRA Funds became non-exempt, the Funds automatically became property of the estate and the Chapter 7 Trustee was immediately entitled to them.
Opinion, at *9.    The Court emphasized the Fifth Circuit's language in Frost that

a change in the character of the property that eliminates an element required for the exemption voids the exemption, even if the bankruptcy proceedings have already begun.

Frost at 388.   The Court found that it was significant that the IRA exemption under the Texas Property Code included a provision allowing proceeds to retain their exempt character if reinvested within sixty days.   As explained by the Court:
(A)pplication of the 60-day rule here is merely applying the entire IRA exemption statute and should not turn on whether a party in interest lodged an objection to the claimed IRA exemption In fact, the imposition of an objection condition when applying either the Texas homestead or IRA exemption statute would violate state law. There is no objection requirement in either sections 41.001 or 42.0021. Construing an extratextual objection requirement would preclude application of the reinvestment provisions--thereby contravening the intent of the Texas legislature.  (emphasis added).
Opinion, at *20-21.   Thus, according to the Court, in order to give effect to the intent of the Texas legislature, proceeds from an IRA must be timely reinvested to retain their exempt status.

While the Court may be correct as to the intent of the Texas legislature, why is this relevant?   Exemptions in bankruptcy are a matter of federal law.  When a Debtor claims exemptions under Texas law, he does so as a matter of federal law.    In re Dyke, 943 F.2d 1435 (5th Cir. 1991).  Federal bankruptcy law very definitely does contain an objection requirement.  Under bankruptcy law, any property claimed by the Debtor as exempt leaves the estate absent a timely objection.   According to this term's opinion in Law v. Siegel, 134 S.Ct. 1188 (2014), "a trustee's failure to make a timely objection prevents him from challenging an exemption."   Under the previous Supreme Court opinion in Taylor v. Freeland & Kronz, 503 U.S. 638 (1992), a clearly invalid claim of exemption could not be challenged once the objection period had passed.    According to the Court:
We reject Taylor's argument. Davis claimed the lawsuit proceeds as exempt on a list filed with the Bankruptcy Court. Section 522(l), to repeat, says that "unless a party in interest objects, the property claimed as exempt on such list is exempt." Rule 4003(b) gives the trustee and creditors 30 days from the initial creditors' meeting to object. By negative implication, the Rule indicates that creditors may not object after 30 days "unless, within such period, further time is granted by the court." The Bankruptcy Court did not extend the 30-day period. Section 522(l) therefore has made the property exempt. Taylor cannot contest the exemption at this time whether or not Davis had a colorable statutory basis for claiming it.
 Taylor, at 643-44. 

There seems to be a clear conflict here.   The Supreme Court has stated that once property becomes exempt, it remains exempt.   It has now said this for over twenty years.   However, under Frost, as interpreted by Judge Bohm, property must retain its exempt character at all times during the pendency of the case or be subject to turnover.    It does not seem possible to reconcile the Supreme Court opinions in Taylor and Law with Frost and Hawk.  If property could be claimed by the trustee at any time that it lost its exempt character, then property which was never exempt could be challenged at any time.    However, the Supreme Court expressly rejected that proposition.   To reiterate, if we protect property claimed as exempt with no colorable basis, as the Supreme Court did in Taylor, how can we fail to protect property which was legitimately exempt on the date of filing?

With any luck, this issue will eventually make its way back to the Fifth Circuit, or if necessary, the Supreme Court.   Until then, the watchword is debtors beware:  your exemptions are less secure than you might think.

Hat tip to Steve Roberts.


Valerie said...

Really enjoyed reading your perspective on this issue. It'll be interesting to see what the ruling on this issue is and how far in the judicial system this issue gets.

John Mclaughlin said...

I'm very rusty when it comes to the law with bankruptcy. This really brought back the thoughts about what it can take to ensure that the proper proceedings are being taken to ensure that someone is getting the most out of their bankruptcy. I would have to agree with Valerie though that it will be very interesting to see how far down this will go down the rabbit hole. Thank you for sharing.