In re Oliver, ___ B.R. ___, 2023 WL 2620032 (Bankr. E.D. CA. 3/23/23)

Dear constituency list members of the Insolvency Law Committee the following is a case update written by Meredith Jury, retired bankruptcy judge, analyzing a recent case of interest:

SUMMARY

A recent published opinion from the Eastern District of California Bankruptcy Court (the Court) denied a debtor’s motion to abandon an exempt homestead, concluding that pending adversary proceedings which asserted claims that debts were excepted from discharge under 11 U.S.C. § 523(a)(2) and (4) could result in decisions which would limit the debtor’s homestead exemption under 11 U.S.C. § 522(q)(1)(B)(ii).  Therefore, abandonment was premature.  In re Oliver, ___ B.R. ___, 2023 WL 2620032 (Bankr. E.D. CA. 3/23/23). 

To view the opinion click here.

FACTS

In his chapter 7 bankruptcy, debtor Todd Oliver exempted his residence in the amount of $626,400 under the applicable automatic homestead exemption Cal. Code Civ. Pro. § 704.730, as amended in 2021.  He valued the property at $825,000 and scheduled a first mortgage of $379,155.  The sum of the mortgage and the homestead exemption exceeded the value of the property, so there was no available equity for administration in the bankruptcy estate.  After avoiding two judicial liens under 11 U.S.C. § 522(f), the debtor moved the court to abandon the property pursuant to 11 U.S.C. § 554(b) as being of inconsequential value and no benefit to the estate.  He reasoned that since the 30-day deadline to object to exemptions provided by Bankruptcy Rule 4003(b)(1) had expired, his homestead exemption was deemed allowed.

The Court noted that two adversary proceedings alleging that debts were excepted from discharge under §523(a)(2) (fraud) and § 523(a)(4) (fraud or defalcation while acting in a fiduciary capacity) were pending against the debtor.  To the Court that meant the provisions of § 522(q) could come into play.  Because the time to object to exemptions asserting a § 522(q) challenge is extended to case closure by Bankruptcy Rule 4003(b)(3), allowing abandonment before the adversaries were resolved would be premature; the Court denied the motion.

REASONING

The Court briefly reviewed Congress’s enactment of three federal limitations on state exemptions included in BAPCPA in 2005, the additions of §§ 522(o), (p) and (q), with the pertinent one here being (q).  It characterized that subsection as addressing “misconduct issues” and noted that if a debtor fell within its provisions, his homestead exemption would be capped at $189,000, notwithstanding the more generous exemption under California law.  The Court summarized five circumstances in § 522(q) that would result in the cap: (1) abusive filing of a bankruptcy case after being convicted of a felony; (2) debt from any violation of federal or state securities laws; (3) debt from fraud, deceit or manipulation in a fiduciary capacity or in connection with the purchase or sale of any registered security; (4) civil debt from racketeering; and (5) debt from criminal, intentional, willful or reckless misconduct resulting in serious physical injury or death to another individual within the last five years.  The relevant subparagraph in the case was § 522(q)(1)(B)(ii), which is the fraud in fiduciary capacity provision.  Because the two pending adversaries asserted fraud and breach of fiduciary duty claims, the Court deemed it possible that debtor’s homestead exemption would be limited to $189,000, freeing up equity for the estate.

The Court acknowledged the paucity of case law interpreting § 522(q)’s subparagraphs, citing only one case 16 years ago about the debt from fraud and deceit limitation.  It also noted the “saving clause” in § 522(q)(2) which can be used to modify the cap if sums exceeding it are “reasonably necessary for the support of the debtor and any dependent of the debtor.”  The Court declined to interpret the meaning or breadth of the language contained in § 522(q)(1)(B)(ii) and whether it could apply to the debtor because the “[a]nswers to those questions must await decisions made in the usual case-by-case adversary manner.”

The Court, however, did make definitive rulings on procedures and burdens.  The deadline to object under § 522(q) is case closure under Bankruptcy Rule 4003(b)(3).  Any party in interest has standing to assert a § 522(q) objection.  Under California law, the burden falls on the debtor to prove entitlement to an exemption.  However, once that burden is met, the objector has the burden to prove the § 522(q) predicate for capping the exemption, here proof of fraud, deceit or manipulation in a fiduciary capacity.  Finally, if the debtor then asserts a defense under § 522(q)(2), he bears the burden to establish the reasonable necessity of modifying the cap.

AUTHOR’S COMMENTS

It appears that the Court raised these arguments and concerns on its own when considering the abandonment motion.  The opinion makes no reference to a trustee’s or creditor’s assertions.  In addition, the opinion contains no reference to legislative history which might indicate that Congress intended this section to apply to the “ordinary” breach of fiduciary duty claims which proliferate the numerous § 523(a)(2) and (4) adversary proceedings filed daily in bankruptcy courts around the country.  I would note that other than the felony provisions of § 522(q)(1)(A) and the criminal and intentional or willful tort claims in § 522(q)(1)(B)(iv), this section pertains to Securities violations and civil RICO claims.  Were those the primary target of Congress?

My primary concern is the logistical impact of this approach on our bankruptcy courts and the debtors anxious to get on with their lives.  Does this mean that every time an adversary with a § 523(a)(2) or (4) claim is filed, the courts will delay closing the main case until the conclusion of those adversaries in case some “party in interest” wants to challenge a homestead exemption under § 522(q)?  Wouldn’t that pose an administrative nightmare for the clerks’ offices?  My additional concern for debtors is what happens if in the two to three years it might take to conclude the adversaries, the residence appreciates in value beyond the applicable homestead, even if at the end § 522(q) does not cap it?  Is this now fair game for trustees to delay closings indefinitely so that they can capture that appreciation later? (I am aware that California recently passed legislation which purports to attribute any postpetition appreciation to the debtor, but until that new statutory provision is tested in the courts, its application might be questionable; there are reasonable arguments that federal law preempts it.)  Finally, does this mean that during this long delay, debtors will be prohibited from refinancing or selling their homes?  I will be watching the impact of this decision closely in the near future.

These materials were written by Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.). Editorial contributions were provided by Meredith King, attorney at Franklin, Soto, Leeds, LLP in San Diego, California (mking@fsl.law).