The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA") capped the amount of a homestead exemption which could be claimed by a debtor that acquired a homestead within 1,215 days prior to bankruptcy. Currently, the amount of the cap, as set by 11 U.S.C. Sec. 522(p), is $160,375 in equity per debtor. This cap has resulted in a seismic shift in Texas where the unlimited homestead exemption is part of the State Constitution. Now debtors' attorneys must learn how to count to 1,215 and calculate the allowable equity before filing a bankruptcy petition. However, what of the case where only one spouse files? The short answer is that all community property enters the bankruptcy estate and that the cap is based on the one spouse that filed. This means that the non-filing spouse can be involuntarily divested of her otherwise sacrosanct homestead interest. The Fifth Circuit has now ruled on three different variations of this scenario and in each case, including the recent decision in Wiggains v. Reed (Matter of Wiggains), No. 15-11249 (5th Cir. 2/14/17), which can be found here, the non-filing spouse has come up short.
The Prior Cases
The first case of the trio was Kim v. Dome Entertainment Center, Inc. (Matter of Kim), 748 F.3d 647 (5th Cir. 2014). In that case, an involuntary petition was filed against Mr. Kim so that Mrs. Kim did not have a choice to file. When the homestead was sold, Mrs. Kim argued that she was entitled to compensation for the value of her homestead interest. However, the Fifth Circuit ruled that under Texas law, a spouse had a possessory interest in the homestead but not an economic interest. Once the homestead was sold, the non-filing spouse lost the benefit of the possessory interest and was not entitled to compensation.
Next up was Thaw v. Moser (In re Thaw), 769 F.3d 366 (5th Cir. 2014) in which the non-filing spouse claimed that she was entitled to compensation under the Takings Clause of the Fifth Amendment. The Fifth Circuit rejected that argument for cases in which the homestead was acquired after the adoption of BAPCPA. In other words, because BAPCPA was the law at the time the homestead was acquired, the homestead was acquired subject to that limitation and there was not a taking of a legal interest from the non-filing spouse.
Wiggains and the 11th Hour Partition
The most recent case, Wiggains, was published on Valentines Day 2017 but offered no love to the non-filing spouse. Mr. and Mrs. Wiggains purchased an expensive home in a Dallas suburb in 2012. In the summer of 2013, they began marketing the house which they had improved. Prior to a sale taking place, Mr. Wiggains filed bankruptcy. One hour before filing bankruptcy, he and his wife recorded a partition agreement in which they sought to convert their community property homestead into the separate property of each of them. The Chapter 7 Trustee sold the home, which netted equity of $568,000 and paid Mr. Wiggains his exemption in the amount of $130,675 (which was the amount of the cap at the time the case was filed).
Mrs. Wiggains then filed an adversary proceeding seeking a determination that she was entitled to one-half of the equity due to the partition agreement. The Trustee counterclaimed, seeking to avoid the partition as a fraudulent transfer. At trial, Mr. Wiggains testified that he executed the partition agreement on advice of counsel in order to maximize the couple's allowable exemption. The Bankruptcy Court ruled in favor of the Trustee. It found that Mr. Wiggain's "sole actual intent in entering into the Partition Agreement was to avoid the effect of the limitation placed on his homestead exemption by section 522(p) of the Bankruptcy Code." However, the Court did not determine whether Mrs. Wiggains was entitled to a share of the proceeds under 11 U.S.C. Sec. 363(j) which requires that a co-owner whose property is sold in bankruptcy be paid the amount of its interest. However, at the second hearing, the Bankruptcy Court found that the non-filing spouse was not entitled to any interest in the proceeds.
Mrs. Wiggains and the Trustee then requested that the Fifth Circuit allow a direct appeal to the Fifth Circuit which was granted.
The Partition Was a Fraudulent Transfer
The Fifth Circuit affirmed the Bankruptcy Court's rulings. The Court found that it was not necessary to engage in a contextual analysis of the circumstances surrounding the Debtor's intent in making the transfer when he had provided direct evidence of his intent. The Court said:
We agree with another court that held: "When a debtor admits that he acted with the [necessary] intent . . . there is no need for the court to rely on circumstantial evidence or inferences in determining whether the debtor had" that intent.
Opinion, p. 9. When asked whether his intent was to keep property out of the bankruptcy estate, the Debtor had testified:
"I guess that's semantics. At the time we honestly felt like it was more preserving [Mr. Wiggains's] own rights."
Based on this testimony, the Fifth Circuit said "Keeping property in the hand of his wife is the mirror of keeping property out of the hands of creditors." It also noted that "If not for the creditors who could make claims on the net proceeds, there was no stated need for the partition." As a result, the Fifth Circuit found that the Bankruptcy Court's factual finding that the Debtor had acted with intent to hinder or delay creditors was not clearly erroneous.
The Spouse Was Not Entitled to Compensation Under Section 363(j)
The Fifth Circuit also rejected the argument that Mrs. Wiggains was entitled to compensation under section 363(j), an issue not reached by the Kim or Moser cases. At first blush, section 363(j) seemed to offer some hope to Mrs. Wiggains. It states:
After a sale of property to which subsection (g) or (h) of this section applies, the trustee shall distribute to the debtor’s spouse or the co-owners of such property, as the case may be, and to the estate, the proceeds of such sale, less the costs and expenses, not including any compensation of the trustee, of such sale, according to the interests of such spouse or co-owners, and of the estate. (emphasis added).
However, there still had to be a right covered by section 363(g) or (h). Section 363(g) relates to dower and curtesy, which are "inchoate rights that do not vest until a spouse's death." Thus, they were not applicable. Section 363(h) applies to “the interest of any co-owner in property in which the debtor had, at the time of the commencement of the case, an undivided interest as a tenant in common, joint tenant, or tenant by the entirety . . . .” Had the partition not been set aside, section 363(h) would have entitled Mrs. Wiggains to a share of the proceeds as a co-tenant. Unfortunately, under section 541(a)(2), all joint community property held by the couple entered the bankruptcy estate. Because 100% of the joint community property interest entered the estate, Mrs. Wiggains was not a co-tenant and section 363(h) did not apply.
Using a unique analogy, the Fifth Circuit explained why the non-filing spouse's homestead interest was not entitled to economic compensation.
Opinion, pp. 18-19. There you have it. In community property states such as Texas, 11 U.S.C. Sec. 541(a)(2) operates to empty the safe, leaving the non-filing spouse without any sticks or any compensation.As previously stated, there is no doubt that a homestead interest “gives protective legal security rather than vested economic rights.” To explain the nature of this protection, we borrow from a common idiom of property law that describes property as a “bundle of sticks.” Rather than being another stick in the bundle, a party’s homestead interest “is a protective safe in which the bundle is put.” If the safe is empty, as is the case here and in other community-property states where the entire homestead property is brought in as a part of the bankruptcy estate, it can hardly be argued that an otherwise voluntary sale of a homestead entitles a non-debtor spouse to compensation for the contents of her empty safe. (internal citations omitted).
How to Maximize the Homestead
Following this string of cases, the score is Trustees 3 - Non-Filing Spouse 0. So what is a couple with a valuable Texas homestead to do? None of the options are wonderful.
One possibility is to partition the homestead at the time it is acquired and before financial distress has set in. Unfortunately this option is generally not available by the time bankruptcy counsel has been contacted. The parties could also get divorced and place an owelty lien against the debtor's interest, reducing the equity. This only works if it is a real divorce and not a sham one. A divorce finalized the day before the bankruptcy is filed might be a red flag.
Another option is not to file bankruptcy within 1,215 of acquiring a homestead subject to section 522(p). If a debtor comes to see you 1,000 days after acquiring a homestead that would be subject to the cap, it would be malpractice to tell the debtor to do anything other than to wait. However, that might not be within the debtor's control since creditors could file an involuntary petition as happened in the Kim case.
A couple could also down-size into a homestead fitting within the cap and use the excess proceeds to negotiate settlements with troublesome creditors. If this option works, the couple avoids bankruptcy. If it doesn't work, at least they have a home. $320,000 won't buy a very fancy home in Austin or Dallas, However, it would buy a 3 bedroom, 3 bath, 3,200 sq. ft. home in Tahoka or 100 acres in Commanche. It would even buy a nice condo on South Padre Island.
Perhaps the only practical option is to maximize the capped exemption by having both spouses file and timing the case after the triennial adjustment of the cap (it last was adjusted in April 2016 so there are two more years to go).