Courts may disallow homestead exemption if property is put up for sale during case or within a year after

Discussing an issue that arises with some frequency in cases converted from chapter 13 to chapter 7, the court in In re: JEFFREY J. ROCKWELL d/b/a Rockwell Prods. f/d/b/a Rockwell Prods., Inc., Debtor., No. 15-20583, 2018 WL 4042859 (Bankr. D. Me. Aug. 23, 2018) found that if the property was properly exempted when the chapter 13 was filed, and the case was converted in good faith, the property remained exempt in chapter 7 even if the funds were not timely reinvested in a new homestead.  

   In this case, the Debtor, Rockwell, owned his residence and scheduled a $47,500 exemption of equity in the property as exempt under Maine law in his August 2015 chapter 13 bankruptcy filing.  The plan was confirmed in November 2015 providing for direct payments on the mortgage.  In January 2017 the bankruptcy court entered an order authorizing debtor to sell the property, paying the nonexempt portion to the trustee, as well as paying closing expenses and the balance of the mortgage.  Closing occurred in March 2017 with $47,500 distributed to Mr. Rockwell.  The chapter 13 trustee never objected to the exemption claim.  In August 2017 Rockwell converted to chapter 7.  As of that date Rockwell has spent $18,806.23 of the cash proceeds leaving a $28,693.77 balance.  The chapter 7 trustee objected to the exemption.  Mr. Rockwell moved out of the property in September 2017. 

  The court initially found that the trustee bears the burden of proof in establishing that the debtor is not entitled to the $47,500 proceeds exemption.  In examining the exemption, the court notes that when a bankruptcy is filed, an estate is created under §541 encompassing all of the debtor's property, including that which may be exempted.  Debtor may then exempt certain property from the estate pursuant to §522.  This section allows states to 'opt out' of the list of federal exemptions, and specify under state law which property may be exempt.  Maine opted out, and set a $47,500 exemption for homesteads.  The state exemption statute allows proceeds from the sale of exempt property to retain its exempt status for six months to allow reinvesting in a residence.

  Section 348(a) of the bankruptcy code discusses the effect of conversion from chapter 13 to 7.  The statute provides the conversion does not change the date of filing, the case commencement, or the order for relief for purposes of the converted case.  So, despite the conversion, the court still must use the 2015 filing date to determine the debtor's rights to exempt property.  §348(f)(1)(A) provides that unless a case is converted in bad faith 'property of estate in the converted case shall consist of property of the estate, as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion.'   The court noted no allegation of bad faith was made in the Rockwell case.  When the case was converted only $28,693.77 of the  proceeds of the sale remained in his control, and, before exemptions, on that amount was property of the estate.

  The court defined statutory schemes where state law sets a limited time to reinvest homestead exemption proceeds as 'vanishing exemptions.'  Court's have taken different approaches in dealing with such exemptions in converted cases.  One approach, defined as the 'partial snap-shot rule' requires that exemptions be determined by examining the exact scope of the exemption as of the time of filing, and if the proceeds are not timely reinvested, the exemption expires.1  Other courts reject this approach, finding that the snap-shot must be complete, and if the time frame requiring reinvestment has not expired prior to the filing of the chapter 7, the exemption is forever preserved, notwithstanding the post-petition passage of time and failure to reinvest. 2  The Rockwell court determined that the latter view more faithfully adheres to the Code and the practicalities of administering a chapter 7 case. 

  Determining that the exemption is frozen in time as of the filing date, notwithstanding the failure to reinvest the proceeds, is in accord with §522(c) and (k).  Under §522(c) property exempted is not liable during or after the case for any debt of the debtor that arose before commencement of the case.  The protection under §522(c) extends beyond termination of the case.  §522(k) provides that with the exception of certain avoidance costs set forth therein, property exempted is not liable for payment of any administrative expense.  Thus, under these sections, once property is exempted and is no longer part of the bankruptcy estate, the Code specifically insulates it from the reach of pre-petition creditors or administrative claimants.  The partial snap-shot rule violates these principles. 

  The partial snap-shot rule also runs counter to §541(a) and the framework of chapter 7.  The chapter 7 estate is captured at the commencement of the case, and exemptions are immutable despite post-petition events, other than specific exceptions defined in the statute.   

  The court allowed the exemption in the proceeds despite the debtor's failure to reinvest the proceeds.

Note that a very recent Arizona decision ruled to the contrary, finding that when the debtor sold their home with court approval but did not segregate the funds in a separate account, and used them for other purposes, the proceeds lost their exemption as homestead.  Flatt v. Mullen, 2018 U.S. Dist. LEXIS 189178, Case No CV-18-00914-PHX-DLR (D, Ariz., 6 November 2018).

1 In re Zibman, 268 F.3d 298 (5th Cir. 2001)↩

2 In re Thomas, BKY MER 17-43367, 2018 WL 3655654 (Bankr. D. Minn. July 31, 2018)↩

Michael Barnett www.tampabankruptcy.com