The following is an update of a recent case of interest prepared by retired bankruptcy judge Meredith Jury:
In a recent unpublished memorandum opinion, the United States Bankruptcy Appellate Panel of the Ninth Circuit (BAP) ruled that an interest of a debtor in a limited liability company which held title to the residence in which the debtor resided (the “Residence”) was not sufficient to support a homestead exemption in the Residence despite a state court ruling that the LLC was the reverse alter ego of the debtor. The BAP reasoned that to recognize a homestead exemption in the LLC’s property would reward the debtor for inequitable conduct. Schaefers v. Blizzard Energy, Inc. (In re Schaefers), 2020 WL 7043564 (9th Cir BAP 2020). To view the opinion, click here.
Debtor Bernd Schaefers and his estranged wife were the owners of a limited liability company known as BKS Cambria LLC (“the LLC”) which held title to the Residence in Cambria, California, where the debtor has resided since 2014. The debtor’s largest creditor, Blizzard Energy, Inc. (“Blizzard”), obtained a state court judgment against him for almost $4 million. In July 2019, Schaefers filed a chapter 11, which was converted to a chapter 7 in December 2019. Postpetition, the bankruptcy court granted relief from the automatic stay, allowing Blizzard to return to state court to seek to add the LLC as a judgment debtor. The state court ruled that the LLC was the reverse alter ego of the debtor and added it as a judgment debtor. The next day, Schaefers amended his Schedule C exemptions, claiming the California automatic homestead exemption found in Cal. Code of Civil Procedure (CCP) § 704.730 applied to his residence, in the sum of $175,000.
Blizzard objected to the claim of exemption, asserting that the interest the debtor held in the LLC was not an interest in real property that qualified as a dwelling under California law to support a homestead exemption. They further argued that the reverse alter ego finding by the state court was not sufficient for the debtor to claim ownership in the Residence. Opposing the objection, the debtor relied mainly on the fact that he had resided there since 2014, but he also submitted evidence of the state court alter ego ruling to bolster his claimed ownership of the Residence.
The bankruptcy court rejected the debtor’s arguments, reasoning that a separate entity, the LLC, owned the Residence, not the debtor. The debtor’s interest in the LLC was not an interest in real property; it was personal property. The reverse alter ego ruling did not change that outcome. The claim of exemption was denied.
The debtor timely appealed the order sustaining the objection to the BAP, which affirmed.
The BAP acknowledged that a person may claim a homestead exemption under CCP § 704.730 without holding a fee simple interest in the real property. Elliott v Weil (In re Elliott), 523 B.R. 188, 196 (9th Cir. BAP 2014). However, for a debtor to assert that his residence is a dwelling and qualifies for the homestead exemption, he must have some legal or equitable interest in the real property. Id. at 196. The debtor’s interest here was a personal property interest in the LLC, which is a separate and distinct legal entity from its owners or members. Limited liability company members have no interest in the company’s assets. Therefore, the debtor did not identify any beneficial or equitable interest in the Residence to support his exemption claim. The BAP easily distinguished cases cited by the debtor, all of which had identified an equitable interest in the real property. Referring to a popular estate planning tool, the revocable family trust, the BAP noted that debtors did not lose their homestead rights when they put legal title to their homes in such trusts because, as trustees, they retained the right to revoke the trusts, creating a sufficient equitable interest in the real property to support their homestead exemptions.
The BAP disposed of the unique twist in this case – that a state court had found the LLC was the debtor’s alter ego – on equitable grounds. First, they noted that an alter ego finding was a creditor’s remedy for the debtor’s inequitable conduct: “Alter ego principles almost never enable ‘the persons who actually control the corporation to disregard the corporate form.’ [citations omitted.].” Second, alter ego principles have been developed to prevent injustice. It would turn that whole concept on its head to reward the debtor here with a homestead exemption based on his own inequitable conduct that led to the alter ego finding in the first place.
California law has long held that a debtor may assert a homestead exemption in a residence absent fee title. Many cases have acknowledged an exemption where the debtors had some “equitable interest” in the property in which they resided on the relevant dates. (In bankruptcy, that is the petition date, plus the debtors must intend to remain in the property as their primary residence.) The real tussle turns on what is a sufficient equitable interest to support the claim of exemption. Although unpublished, this case adds to the general lexicon by illuminating what is not a sufficient equitable claim. A state court ruling that the entity which does hold legal title to the residence is the debtor’s alter ego does not create an equitable interest held by the debtor. The BAP’s reasoning is simple: an alter ego arises from the debtor’s inequitable conduct, which cannot be rewarded with an exemption he would not otherwise have.
I compare this case to the recently published bankruptcy court opinion In re Nolan, 680 B.R. 860(Bankr. C.D. CA. 2020)in which Judge Clarkson of the Central District found a debtor had a sufficient equitable interest in the home where he resided because he was the 50% beneficiary of his deceased father’s irrevocable trust, which held legal title to the home. Nolan is on appeal to the district court, but the debtor there certainly had a greater claim to an equitable interest in the real property than Schaefers. I predict that Nolan will be appealed to the Ninth Circuit. (Full disclosure: I wrote the appellee’s brief.) Perhaps after that journey, we will have a better understanding of just what is a sufficient equitable interest to support a homestead exemption.
These materials were written by retired bankruptcy judge Meredith Jury. Editorial contributions were provided by members of the ILC’s publications subcommittee. Retired Judge Meredith Jury is a member of the Insolvency Law Committee.
 A reverse alter ego finds an entity such as a corporation or LLC liable for an individual’s debts, as opposed to traditional alter ego where the individual is found liable for the corporation’s or LLC’s debt. See, Curci Invs., LLC v. Baldwin, 14 Cal. App. 5th 214, 221 (2017).