Judgement Liens Homestead Exemptions and Involuntary Bankruptcies Who Gets What After BAPCPA

Judgement Liens Homestead Exemptions and Involuntary Bankruptcies Who Gets What After BAPCPA

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We've all heard the rationale for bankruptcy reform at cocktail parties and around the dinner table: Any deadbeat who runs up his bills can, before he pays up, run away and buy a house in Florida. The creditors can't touch his homestead. When the spendthrift files a chapter 7 bankruptcy, he gets both a discharge and a house loaded with equity. What a windfall! Alas, the poor creditors are left wringing their hands with no recourse but to charge off their receivables from this unscrupulous vagabond.1

Along comes the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) to prevent this injustice. BAPCPA places limits on the ability of debtors to exempt their homesteads in bankruptcy. The newly enacted §522(p)(1) of the Code, when effective, will limit the ability of debtors to exempt all but $125,000 of equity in their residences.2 True, there are a number of factors to consider, such as whether the debtors acquired their homesteads within the 1,215-day period preceding the filing of the bankruptcy, whether they transferred such interest from another residence in the same state during that period3 and whether an entireties exemption otherwise applies. For the purposes of this discussion, we will assume that our debtor's estate contains a personal residence in a state with an unlimited homestead exemption, and that the limitations of §522(p)(1) will apply. It is the educated opinion of some that this will lead to several other consequences that may not have been considered by Congress when it enacted BAPCPA.

How can a debtor with so much equity in his residence so stupidly wind up in bankruptcy to begin with? The obvious answer is that his creditors now can file an involuntary petition. Under the old Code, there was no incentive to file an involuntary petition. However, under BAPCPA, there is a prospect of realizing a distribution of proceeds from a trustee's sale of the debtor's homestead. Some will ask whether the new "means test" set forth in BAPCPA will result in the debtor's case getting converted to a chapter 13 or 11. However, the means test provisions of newly enacted §707(b)(2) of the Code only restrict the ability of debtors who file voluntary petitions to remain in chapter 7. Section 707(b)(1) of the Code, as amended under BAPCPA, reads: "After notice and hearing, the court...may dismiss a case filed by an individual debtor...or with the debtor's consent, convert such case to a case under chapter 11 or 13 of this title."4


Many states provide for homestead exemptions to some degree. However, while Florida garners all the fame and glory for its unlimited homestead exemption, four other states—Texas, Iowa, Kansas and South Dakota—have unlimited homestead exemptions as well.

So now, let's take another look at that classic scoundrel who ran up his credit cards and then moved to sunny Florida, throwing all he owns into what he thought was a safe homestead. What happens if his creditors get together and file an involuntary petition? Assuming that the limitations of §522(p)(1) will apply, it would appear that all but the first $125,000 of equity in this debtor's homestead would become property of the estate. The proceeds from a trustee's sale of this property would be available for distribution to unsecured creditors. Suppose, however, one of this deadbeat's creditors obtained a judgment against the debtor and properly perfected the judgment in the county where the debtor's homestead lies. Shouldn't that judgment creditor be satisfied in full from the proceeds of the bankruptcy trustee's sale of the debtor's homestead before the other unsecured creditors participate (assuming that the judgment and its perfection would otherwise not be subject to the trustee's avoidance powers)? After all, the extent of the homestead exemption has now been limited. In order to find your answer, further research and analysis are necessary.

Many states provide for homestead exemptions to some degree. However, while Florida garners all the fame and glory for its unlimited homestead exemption, four other states—Texas, Iowa, Kansas and South Dakota—have unlimited homestead exemptions as well. In order to address the issue posed in the previous paragraph—i.e., whether §522(p)(1) limitations on homestead exemptions will create windfalls for properly perfected judgment creditors—one must look to state law to determine whether the judgment creates a lien that attaches to the debtor's residence. See In re Watts, 298 F.3d 1077, 1080 (9th Cir. 2002). In most cases, states that have unlimited homestead exemptions apply the exemption to both attachment of a judgment lien to the homestead as well as to forced judicial sale of the homestead.

Starting with Florida, we need look no further than to the state's constitution. Art. X, §4(a)(1), Fla. Const. sets forth the infamous exemption:

There shall be exempt from forced sale under process of any court, and no judgment, decree or execution shall be a lien thereon, except for the payment of taxes and assessments thereon, obligations contracted for the purchase, improvement or repair thereof, or obligations contracted for house, field or other labor performed on the realty, the following property owned by a natural person...a homestead....

Thus, we see that our hypothetical judgment creditor has no lien on the hypothetical debtor's homestead. It would therefore follow that to the extent the judgment creditor could not be satisfied via a sale from other non-exempt property, such creditor is last in line and must participate in distributions with other creditors in the general unsecured class in the manner called for under §726 of the Code.

A less-publicized, but nevertheless unlimited, homestead exemption also exists in Kansas. Kansas, however, takes a different approach than Florida. Under K.S.A. §60-2202(a), "[a]ny judgment...shall be a lien on the real estate of the judgment debtor within the county in which judgment is rendered." However, the homestead exemption provided by Article 15 §9 of the Kansas Constitution provides that "[a] homestead...shall be exempted from forced sale under any process of law...."5 There is nothing in the constitution that exempts a judgment lien from attaching to homestead property, however. Thus, a judgment rendered in the county of the debtor's residence will result in the creation of a lien on the residence. To the extent that the residence constitutes the debtor's homestead—outside of bankruptcy, in most cases—the property would be exempt from a forced sale.6 However, in our hypothetical situation, in the case of an involuntary bankruptcy filed under BAPCPA, the proceeds of a forced sale of the debtor's homestead (i.e., over the $125,000 threshold and after satisfaction of senior liens) would probably have to be distributed to our hypothetical judgment lien creditor. Only after this creditor is satisfied may the unsecured creditors participate in a distribution.

Iowa law is more in line with that of Florida. I.C.A. §561.16 provides that a person's homestead is exempt from a judicial sale in most situations. As well, I.C.A. §624.23(2) provides that "[j]udgment liens...do not remain a lien upon real estate of the defendant, platted as a homestead...."7 In Iowa, judgment liens generally cannot attach to land used and occupied as a homestead. See Baratta v. Polk County Health Services Inc., 588 N.W. 2d 107, 110 (Iowa 1999). Therefore, as in Florida, our hypothetical judgment creditor would likely stand last in line with other unsecured creditors for purposes of participating in a distribution from a trustee's sale of the debtor's homestead under BAPCPA.

Texas, not surprisingly, has a super-sized constitutional homestead exemption—Tex. Const. Art. 16 §50. While the homestead provision is too large to cite here, there are cases interpreting its scope. In particular, there are at least two Fifth Circuit cases that contain seemingly contradictory rulings. In E.C. Henderson v. Belknap, 18 F.3d 1305, 1311 (5th Cir. 1994), the Fifth Circuit considered a case where chapter 7 debtors moved under §522 (f)(1) to avoid a judicial lien that purportedly impaired their homestead. Citing Exocet Inc. v. Cordes, 815 S.W.2d 350, 352 (Tex. App.—Austin 1991, no writ), the court concluded that a judicial lien did "fix" a liability on the debtor's homestead. It then concluded that the judicial lien "impaired" the debtor's homestead by placing a cloud on the debtor's title. However, later in U.S. v. Johnson, 160 F.3d 1061, 1064 (5th Cir. 1998), the Fifth Circuit stated that "[u]nder the Texas constitution, judgment liens on homestead property normally are not valid." In fact, the weight of authority in Texas appears to support the latter position. Therefore, Texas law appears to be more in line with that of Florida and Iowa. Accordingly, our hypothetical judgment creditor would probably stand last in line with other unsecured creditors with regard to distribution of proceeds from a trustee's sale of homestead property to the extent that his judgment lien is not satisfied from other nonexempt property.

Finally, South Dakota might just have the mother of all homestead exemptions—at least for those who are 70 years of age and older. South Dakota Article XXI §4 provides as follows:

The right of the debtor to enjoy the comforts and necessaries of life shall be recognized by wholesome laws exempting from forced sales a homestead, the value of which shall be limited and defined by law, to all heads of families, and a reasonable amount of personal property, the kind and value of which to be fixed by general laws.

South Dakota statutes define the breadth of this exemption broadly:

The homestead of every family resident in this state...so long as it continues to possess the character of a homestead is exempt from judicial sale, from judgment lien, and from all mesne or final process from any court... In addition, the homestead of a person 70 years of age or older and the un-remarried surviving spouse of such person, so long as it continues to possess the character of a homestead, is exempt from sale for taxes.

Thus, until enactment of BAPCPA, South Dakota's senior citizens could expect to reside in their homesteads safely beyond the reach of their creditors, and the property taxing authorities as well. For all South Dakota residents entitled to a homestead exemption, the hypothetical judgment creditor would not be entitled to a lien on the premises. Therefore, at a trustee's sale, the judgment creditor would stand last in line with other unsecured creditors, to the extent his judgment could not be satisfied from other non-exempt assets.

So at the end of the day, it looks as though all states with unlimited homestead exemptions but for Kansas, and with certain exceptions, prevent liens being placed on homesteads that may otherwise be attached from judgments. To the extent their liens cannot be satisfied from nonexempt property, the judgment creditors most likely are at the bottom of the pecking order—last in line to receive distribution of proceeds realized from a trustee's sale of the debtor's residence. As for judgment creditors in Kansas, the picture appears a bit rosier. While these creditors can't actually force a judicial sale under state law, indications are that they are ahead in the pecking order and need to have their claims satisfied before unsecured creditors are entitled to participate.


Footnotes

1 Of course, the conversation fails to address Florida's modest other exemptions as compared to those set forth in the Code. Return to article

2 See, also, newly enacted §522(q), which describes certain abusive situations that also limit homestead exemptions to $125,000. Return to article

3 See §§522(p)(1) and (2)(B) of BAPCPA. Return to article

4 Does this mean that a debtor who otherwise would not qualify for a chapter 7 discharge may enlist the help of friendly creditors to file an involuntary petition on his behalf to accomplish the trick? Return to article

5 The Kansas homestead exemption can also be found at K.S.A. §60-2301. Return to article

6 But, see, e.g., In the Matter of the Marriage of Johnson, 872 P.2d 308, 311 (Kan. App. 1994), holding that the homestead right that arises after a court-imposed lien is impressed on marital property is inferior to the court-imposed lien. Return to article

7 The statute does continue with a provision whereby a defendant can impair his homestead exemption upon service of a written demand upon the judgment holder. Return to article

Journal Date: 
Friday, July 1, 2005