Fall House Cleaning Recent Developments in Avoiding Liens on Exempt Homesteads

Fall House Cleaning Recent Developments in Avoiding Liens on Exempt Homesteads

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To enable a fresh start, debtors often seek to avoid judicial liens that impair a claimed homestead exemption. With adjustable-rate mortgages, rising credit costs and increasing delinquencies, there is likely to be more activity in this motion practice. Debtors will be engaged in "cleaning house" this fall to preserve their stake in a homestead.

11 U.S.C. §522(f) provides:
(1) [T]he debtor may avoid the fixing of a lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled...if such lien is—(A) a judicial lien...
(2)(A) For the purposes of this subsection, a lien shall be considered to impair an exemption to the extent that the sum of—(i) the lien; (ii) all other liens on the property; and (iii) the amount of the exemption that the debtor could claim if there were no liens on the property; exceeds the value that the debtor's interest in the property would have in the absence of any liens. (B) In the case of a property subject to more than one lien, a lien that has been avoided shall not be considered in making the calculation under subparagraph (A) with respect to the other liens.

A judicial lien is defined in 11 U.S.C. §101(36) as a lien obtained by judgment, levy, sequestration or other legal or equitable process. Because any judicial lien is subject to the existing law at the time it is "fixed" on the property interest, there is not an unconstitutional taking.1 The purpose of the statute is to preserve the exemptions created under federal and state law. In the process, judicial liens are entirely avoided.2

Lien avoidance is commenced by a motion to avoid. Such a motion can be brought at any time, even after the bankruptcy is closed or after the property in question is sold.3 But a pre-judicial delay in bringing the motion may support a denial of the relief sought.4

Debtor Must Own the Property

Debtors engage in exemption planning, and this process may involve the use of various trust entities. The U.S. Bankruptcy Court for the Eastern District of California has found that where the homestead in question is owned by a revocable trust, the debtor beneficiaries may not avoid any judicial liens under 11 U.S.C. §522(f).5 In that case, the debtors transferred their homestead into a revocable trust several years prior to filing for bankruptcy. The debtors were both the settlers and beneficiaries of the trust. Prior to the bankruptcy, judicial liens attached to the property. The court allowed the debtors' exemption claim of the beneficial interest in the homestead.6 The court denied the motion to avoid the lien because the trust owned the real estate in question, stating that "on the date debtors filed their bankruptcy petition, the trust owned the property...debtors may not utilize §522(f)(1)(A) to avoid a judicial lien that encumbers property owned by another."

Calculation under the Code

Under the 1994 Bankruptcy Amendments to 11 U.S.C. §522(f)(2), impairment is defined by means of a calculation. In many bankruptcy cases, there are a series of liens arising out of judgments that affect or otherwise impair an exemption claim. It should be noted that consensual liens are preferred over judicial liens because all liens are included in the calculation.7 Aside from the issues of attachment, priority and ownership, the application of the statute requires a determination of value and a calculation.

The elements of the application are detailed in In re Cox.8 The Cox court summarized the statutory elements of lien avoidance under §522(f): (1) a fixing of a lien on an interest of the debtor in property, (2) such lien impairs an exemption to which debtor would have been entitled, and (3) such lien is a judicial lien. Citing the Ninth Circuit in In re Chiu,9 the Cox court focused first on the debtor's property rights at the time of bankruptcy and what liens were "fixed" on the homestead at that time.

The "fixing" of the lien is the critical element. The U.S. Supreme Court discussed the fixing of a lien in Farley v. Sanderfoot.10 There, the lien was created by a divorce decree. The Supreme Court found that the lien and the property interest were created at the same time, so the lien was not "fixed" on the debtor's pre-existing interest. Some courts create a preemptive exception, which essentially means the lien is not "fixed." The U.S. Bankruptcy Court for the Southern District of Florida has determined that the homestead exemption created by Florida's Constitution prevents the attachment of a judicial lien to a homestead.11 Most recently, that court again denied a lien-avoidance motion affecting a judicial lien because the lien could not attach to a homestead.12 In taking the analysis one step further, the Fifth Circuit, applying Texas law, held that even where a forced sale cannot be compelled, the bare existence of the lien is an impairment if proceeds can be seized and there is a cloud on the title.13

But impairment must also be found. Impairment became the primary issue in In re Cox. The court's analysis focused upon whether the debtor's property would have been exempt "but for the lien," citing Owen v. Owen.14 Concluding that the nonavoidable liens must be included in the calculation even if they are junior in priority, the court granted the motion to avoid the lien, finding that the exemption was impaired.

The BAPCPA amendments of 2005 enlarged the carve-out of 11 U.S.C. §522(f)(1)(A) for alimony, maintenance and support judgments. If the judicial lien impairing the exemption is for a domestic-support obligation (DSO) specified in 11 U.S.C. §523(a)(5), it may not be avoided. This exception also applies if the DSO has been assigned to another entity.

Lien avoidance was a significant change in bankruptcy law when enacted by the Bankruptcy Act. Those powers granted to debtors continue to be of great benefit in protecting exemptions and a great detriment to a creditor who won the race to the courthouse.

 

Footnotes

1 In re Snyder, 231 B.R. 437, aff'd and modified, 249 B.R. 40 (B.A.P. 1st Cir. 2000).

2 140 Cong. Rec. at H10, 769 (daily ed. Oct. 4, 1994).

3 In re Kai-Ming Chiu, 304 F.3d 905 (9th Cir. 2002).

4 Matter of Bianucci, 4 F.3d 526 (7th Cir. 1993).

5 In re Bogetti, No. 01-23174-A-7, 2006 WL 2422810 (Bankr. E.D. Cal. Aug. 18, 2006).

6 Other courts continue to allow a homestead exemption when property is held by a trust if requisite intent is met. In re Szwyd, 346 B.R. 290 (Bankr. D. Mass. 2006). The same argument was made unsuccessfully for a life estate in In re Stenzel, 259 B.R. 141 (B.A.P. 8th Cir. 2001); rev'd and remanded, 301 F.3d 945 (8th Cir. 2002).

7 In re Kolich, 328 F.3d 406 (8th Cir. 2003).

8 In re Cox, No. 05-11772006 WL 2422817 (Bankr. E.D. Cal. Aug. 17, 2006).

9 Supra note 3.

10 Farley v. Sanderfoot, 500 U.S. 291 (1991).

11 In re Epstein, 298 B.R. 917 (Bankr. S.D. Fla. 2003); In re Potter, 320 B.R. 753 (Bankr. M.D. Fla. 2005).

12 In re Pearlstein, 2006 WL 2398767 (Bankr. S.D. Fla. Aug. 17, 2006).

13 In re Henderson, 18 F.3d 1305 (5th Cir. 1994), cert. denied, Belknap v. Henderson, 513 U.S. 1014 (1994).

14 Owen v. Owen, No. 05-30700500 U.S. 305, 311 (1991).

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Journal Date: 
Wednesday, November 1, 2006