Post Petition Divorce Property Settlement May Not Impact Spouses’ Homestead Exemptions in Bankruptcy Court

In two related cases involving property settlement before the United States Bankruptcy Court for the District of Connecticut, the Bankruptcy Court upheld a debtor-wife’s right to claim a homestead exemption in the primary residence that she owned and occupied as of the bankruptcy petition date, even though the post-petition divorce decree required the debtor-husband to buy out her interest in the residence.

In April 2011, the debtor-husband and debtor-wife jointly filed a petition for bankruptcy protection under Chapter 7 of the Bankruptcy Code, 11 U.S.C. §§ 701 et seq.  The debtors listed their jointly owned marital residence as a real property asset.  Pursuant to 11 U.S.C.§ 522(b)(3), they claimed personal exemptions in accordance with Connecticut state law, including a homestead exemption of $125,900 for the unencumbered fair market value of marital residence.  See Conn. Gen. Stat. § 52-352b(t).

The Property Settlement

In May 2011, after filing the bankruptcy petition, the debtors divorced.  The property settlement under the state court judgment of dissolution provided that the debtor-husband obtain financing and pay the debtor-wife $62,950 for the value of her one-half interest in the marital residence and, upon payment, the debtor-wife quitclaim her interest in the property to the debtor-husband.  The settlement further provided that if the debtor-husband was unable to obtain financing, the couple would sell the property and divide the proceeds.

In August 2011, the Chapter 7 trustee filed an objection to the debtor-wife’s claim of a homestead objection.  The trustee also filed a motion to compel filing of a supplemental schedule by the debtor-wife to capture the cash payment from her husband that was ordered in the property settlement to liquidate her interest in the residence.

Homestead Exemptions Under Connecticut Law

In Connecticut, any “natural person” is entitled to claim an exemption for his homestead up to $75,000, which is calculated based on the fair market value of the property less the amount of any statutory or consensual lien.  Conn. Gen. Stat. § 52–352b(t) (2009).  A “homestead” is defined as “owner-occupied real property … used as a primary residence.” Id. at § 52–352a (e) (2005)

Case law has further refined this definition to establish three requirements for real property to constitute an individual’s statutory homestead: (1) the individual must “own[ ]” the subject real property within the meaning of Section 52–352a as of the relevant time; (2) the individual must “occup[y] ” the subject real property within the meaning of Section 52–352a as of the relevant time; and (3) the subject real property must be “used as a primary residence” within the meaning of Section 52–352a as of the relevant time. In re Kujan, 286 B.R. 216, 220–21 (Bankr.D.Conn.2002); see also KLC, Inc. v. Trayner, 426 F.3d 172, 175 (2d Cir. 2005) (citing Kujan as “setting out ‘homestead’ requirements for invocation of homestead exemption”).

The Bankruptcy Court established that the “relevant time” for determining entitlement to an exemption is the date that the bankruptcy petition was filed.  At that time, the debtor-wife owned the property, occupied the property, and used the property as her primary residence.  Therefore, her interest in the property satisfied the requirements for her to be entitled to a homestead exemption.  Because this entitlement existed as of the petition date, the Bankruptcy Court overruled the Chapter 7 trustee’s objection to the debtor-wife’s homestead exemption.

Bankruptcy Court

The Chapter 7 trustee also argued that the cash payment to the debtor-wife required by the property settlement after the petition date was a new asset and, therefore, must be included in the debtor-wife’s estate.  According to the federal bankruptcy code, the estate subject to bankruptcy proceedings includes any interest in property that would have been property of the estate “if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date…as a result of a property settlement agreement with the debtor’s spouse, or of an interlocutory or final divorce decree.  11 U.S.C. § 541.

However, the Bankruptcy Court concluded that the cash payment that the debtor-wife received to liquidate her interest in the marital residence was not a new asset acquired after the initiation of bankruptcy proceedings; the court characterized this payment as the proceeds of her exempt interest in the marital residence, which had been included and subsequently withdrawn from the estate.  The property settlement did not alter the net value of the debtor-wife’s post-petition assets and liabilities, only the form of such interests.

The Court’s Decision

The Bankruptcy Court concurred with the majority of courts, holding that property exempted from the estate after the petition date does not re-enter the estate as a result of having changed form, even if the property in its new form may not be entitled to a state law exemption.  Although the Connecticut exemption statutes initially determine whether, as of the petition date, a debtor’s interest in property is exempt from the claims of pre-petition creditors, the federal bankruptcy code protects the exempt property from these claims. 11 U.S.C. § 502.  Because the settlement agreement did not add assets to the debtor-wife’s estate, the Bankruptcy Court denied the Chapter 7 trustee’s motion to compel a supplemental filing.

Based on common law, Connecticut statutory law and federal bankruptcy law, the Bankruptcy Court determined that the debtor-wife’s ownership, occupation and use of the marital residence prior to filing the bankruptcy petition was sufficient to entitle her to a homestead exemption for this interest and, once exempted from the bankruptcy estate, this interest could not re-enter the estate even if it changed form from real property to cash.

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