The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, CD CA, ret.), analyzing a recent decision of interest:
The Bankruptcy Appellate Panel for the Ninth Circuit (the “BAP”) recently clarified what actions by a trustee are required in order for a chapter 7 debtor to lose his homestead exemption on recovered property under Section 522(g) of the Bankruptcy Code. Zamora v Perez, 628 B.R. 327 (9th Cir. BAP June 17, 2021).
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In 2010 debtor Thomas Perez (the “debtor”) and his wife recorded a Declaration of Homestead on their California residence (“Residence”). After encountering financial difficulties, the debtor consulted an organization called Legal Experts, which eventually advised him to file a bankruptcy one year after he recorded a third trust deed (“DOT)”) against the Residence in favor of his sister Maria for $200,000 based on loans she had made to him over time. The one-year delay was intended to avoid the DOT being a preference under Section 547. The DOT was recorded on May 30, 2019. In March 2020 the debtor signed his bankruptcy documents at Legal Expert’s office, which were to be held until one year after May 30, 2019. Legal Experts filed the petition early, on May 14, 2020.
On his schedules, the debtor listed the Residence with a value of $625,000 and encumbrances totaling almost $600,000, including the DOT. He did not claim a homestead exemption in Schedule C, instead protecting some equity with the wildcard exemption. He appeared at his 341(a) meeting of creditors with an attorney from Legal Experts, whom he had never met. The trustee asked him questions about the DOT and the underlying loan and told him she intended to have a realtor view the Residence. She did not say anything about a preference or her intention to avoid and recover the DOT for the estate. After filing a Notice of Assets, the trustee filed an application to employ a real estate broker but still did not mention the preference or avoidance.
Recognizing that he was in “trouble”, the debtor hired new counsel, who advised the debtor to have Maria reconvey the DOT. New counsel immediately filed amended schedules, valuing the Residence at $599,000 based on the broker’s value and including a notation that the DOT was an avoidable preference. New Schedule C claimed a homestead exemption of $175,000. The debtor’s attorney emailed the trustee to advise her that Maria would be reconveying the DOT within a week. The trustee responded that she intended to avoid the preference and, despite the assurance of prompt reconveyance, filed an adversary to do so. Maria’s reconveyance recorded within days.
The Trustee objected to the debtor’s homestead exemption, asserting that since the reconveyance occurred at her behest, he was not entitled to the exemption under Section 522(g). The bankruptcy court overruled her objection and the trustee timely appealed to the BAP, which affirmed.
The BAP looked at the criteria to prevail on an objection to an exemption under Section 522(g)(1) established by its case law, Hitt v Glass (In re Glass), 164 B.R. 759 (9th Cir. BAP 1994), aff’d. 60 F. 3d 565 (9th Cir. 1995): the trustee must present evidence that (1) the debtor transferred property in such a manner as to invoke the avoidance powers; (2) either the transfer was voluntary or the debtor knowingly concealed the transfer; and (3) the property was returned to the estate as the result of the trustee’s efforts. The BAP’s focus was on the third criteria: was the property returned as a result of the trustee’s efforts. Its answer was “no.”
The BAP surveyed cases which had denied the exemption, recognizing that they concluded that filing an adversary complaint and prosecuting such to judgment was not necessary for the trustee’s efforts to be sufficient. However, some action by the trustee must have caused the recovery. The BAP determined that its decision in Glass “established a floor for determining what constitutes a recovery by the trustee: an explicit statement by the trustee to the debtor that the trustee intends to recover the property interest for the estate. In other words, the debtor must be put on notice by an affirmative act or statement of the trustee that the transfer is avoidable and/or recoverable under the Bankruptcy Code and that the trustee intends to take action to recover the property interest.” The BAP noted that whether the floor had been met was a question of fact. The factual finding of the bankruptcy court that it had not been met was not clearly erroneous, as the transcript of the 341(a) indicated the trustee had not given the debtor any notice that she intended to avoid the preference and recover the property. The voluntary reconveyance was just that: voluntary. Therefore, the debtor was entitled to his homestead exemption.
This decision might be construed as the BAP dancing on the head of a pin. The inquiries by the trustee about the note and DOT were sufficient for the debtor to recognize he was “in trouble” and to hire new counsel to sort out the mess Legal Experts had caused. Yet, the case actually turned on the factual findings made by the bankruptcy court more than the new clarification of the Glass precedent quoted above. The statements of the trustee were not “notice” that the trustee intended to take affirmative steps. You can bet that in like circumstances all trustees in the Ninth Circuit are going to explicitly tell debtors of their intention to take affirmative action to comply with this technical clarification by the BAP.
Of greater interest to me, is footnote 7 where the BAP posits that because of the recorded homestead exemption, the DOT was not actually a preference because it did not remove from the estate equity which would have been recoverable by a hypothetical lien creditor. The BAP reasoned the debtor’s recorded exemption protected any unencumbered value in the Residence before the DOT was recorded and therefore the preference action would not have recovered any value for creditors. I am puzzled by this footnote, because under In re Kelley, 300 B.R. 11, 20-21 (9th Cir BAP 2003) and In re Anderson, 824 F. 2d 754, 757-59 (9th Cir. 1987), only the automatic homestead exemption is applicable in a forced sale or bankruptcy. The recorded homestead exemption in California protects equity when an owner voluntarily sells the exempt property. I wonder if the BAP considered the difference in the effect of the two homestead exemptions as described in Kelley. Full disclosure, I wrote the opinion in Kelley while sitting pro tem at the time on the BAP. I cannot reconcile footnote 7 with that opinion.
This submission was authored by the Hon. Meredith Jury (U.S. Bankruptcy Judge, CD CA, ret.) a member of the ad hoc group. The opinions expressed herein are solely those of the author. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.