Volume XV, Number 1 – May 2006
Confusion Under The 2005 Bankruptcy Act
On April 20, 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Act”) was enacted into law. The stated purpose of the Act is to “improve bankruptcy law and practice by restoring personal responsibility and integrity in the bankruptcy system and ensure that the system is fair for both debtors and creditors.” Although the Act generally applies to bankruptcy cases filed on or after October 17, 2005, the provisions limiting the homestead exemption were made effective on the date of enactment.
The greatest perceived abuse of the federal Bankruptcy Code was the unlimited homestead exemption available under the laws of some states (Texas and Florida are the most notable). These state law exemptions permitted a debtor to exempt the entire value of their expensive homes from the federal bankruptcy proceeding, thereby allowing the debtor to retain his/her home (and its substantial equity) rather than have any of it available to his/her creditors.
THE 2005 LAW. To claim a state’s property exemptions other than the homestead exemption, the Act imposes a new 2-year residency requirement (was 6 months). However, a debtor must reside in the homestead property sought to be exempted for 1215 days (about 3 years, 4 months) prior to filing the bankruptcy petition, and may only claim as exempt the value of the homestead interest owned for such 1215 day period. Otherwise, the Act provides a maximum homestead exemption of $125,000. Notwithstanding that the 1215-day residency and ownership requirements are met, the exemption will be limited to $125,000 where the court finds that an abuse of the bankruptcy law occurred or that debts arising from certain criminal or fraudulent conduct of the debtor were involved.
Value transferred from a previous principal residence in the same state is grandfathered into the value of the residence sought to be exempted, however, value resulting from a conversion, within 10 years of filing the bankruptcy petition, of nonexempt property into homestead property with the intent to hinder, delay, or defraud a creditor will not be exempted. For example, a debtor gets sued, and then liquidates his (non retirement) brokerage account to pay down the mortgage on his homestead. Three years later, after an adverse judgment is entered against the debtor, he files for bankruptcy protection. Under the described “conversion” limitation, even assuming all the residency/ownership requirements are met, the value of the homestead exemption will be reduced by the amount of the earlier mortgage paydown (conversion).
In the relatively short time since the homestead limitations of the Act became effective, several cases have interpreted key language of the homestead provision. These cases arose because of a conflict between the specific “black letter” of the law and the more generalized language of the congressional committee reports. Ordinarily, when such a conflict arises, the courts will follow the language of the statute if it is clear, and will refer to the committee reports if the statute is not clear.
The language of the statute specifically states that the above 1215 day and $125,000 limitations apply only if “as a result of electing … to exempt property under State or local law,…[the debtor is seeking to exempt an amount greater than $125,000]”. Thus, the law clearly indicates that an election must be made under state law. Some states, like Florida, Nevada, Arizona, and Texas, do not give their residents the option of making such an election, but rather require them to use the state provided exemptions in a federal bankruptcy filing. Thus, one would expect that in those states which do not permit a debtor to make such an election, the homestead limitations of the Act would not be applicable based upon a reading of the clear language of the statute.
In the first case to interpret the above language, the Arizona Bankruptcy Court in In re McNabb held that a debtor in Arizona (which has a $150,000 homestead exemption), did not “elect” under Arizona law, since that law required the debtor to use the state’s exemptions and thus deprived him of any election. Thus, the court held, the new limitation did not apply. The court also concluded that the statutory language was unambiguous, and therefore resort to the legislative history was not only unnecessary, it was impermissible.
Subsequent to the McNabb decision, all decided cases have reached an opposite result, showing us yet again that “result oriented courts” are still thriving in this country. The court in In re Kane, even though in a back-handed recognition that the statutory language was plain and unambiguous, stated that it could not be given such plain and unambiguous meaning.
It remains to be seen how all of this will end up when the dust clears. Congress may very well enact a “technical corrections” bill to clear up this (and numerous other issues in the poorly drafted legislation).
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