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Bankruptcy News Flash: New Bankruptcy Ruling In Arizona May Affect Florida Debtor Homestead Property

Homestead Protection and the New Bankruptcy Law

Creditors have always feared states with large homestead protections. Florida,¹one of the five homestead-protective debtor states,² was considered by many to be the ultimate “debtor’s haven”³ and was the target of a great deal of criticism. Stocking cash into real estate has never been disdained in Florida. Florida’s homestead protectionism was succinctly described by Southern District of Florida Bankruptcy Judge A. Jay Cristol, who told the New York Times, “You could shelter the Taj Majal in this state and no one could do anything about it.” ⁴ The creditor community perceived this sheltering to be epidemic, especially in the Havoco decision, when the Florida Supreme Court allowed a debtor to deliver nonexempt cash to the homestead after a judgment creditor chased the debtor to Florida, where he avoided attachment by purchasing a large Florida homestead.⁵

Before April 20, 2005 – the date President Bush signed into law the, Bankruptcy Abuse Prevention and Consumer Protection Act⁶ (BAPCPA) – bankruptcy exemption law for debtor havens was relatively straightforward: If the state prohibited the federal exemptions, called “opt out” legislation, its state exemption would dictate what property was or was not exempt in the federal bankruptcy proceeding. The Bankruptcy Code allows a state to opt out of the federal scheme of exemptions in favor of state-established exemptions.⁷ For example, Florida, by virtue of §222.20, opted out of the federal scheme.⁸ Three of the four other homestead-protective states similarly opted out of the federal exemptions. ⁹

In 2005, the “opt out” states¹⁰ with large homestead exemptions were the concern of Congress, whose attention was alerted by the creditor lobbyists who perceived severe debtor abuse in the five homestead-protective states.¹¹ This concern spurred Congress to prevent the alleged bankruptcy abusers from being unrightfully protected.¹² Quasi-“opt-in”¹³ legislation ensued. Now, in the opt-out states, a debtor may be limited in his or her homestead if he or she has not resided in the homestead-protective state’s home for the prescribed time recited by Congress.

The post-April 20, 2005, the Code allegedly stamped out the ability to easily migrate from outside jurisdictions to homestead-protective states.¹⁴ The basic formula is that anyone who resides in a state less than 730 days prior to filing bankruptcy will not be entitled to the homestead-protective state’s exemptions.¹⁵ Debtors who reside in a homestead-protective state at least 730 days but less than 1,215 days may have an exemption limitation (cap) for their homestead of $125,000.¹⁶ The majority of debtors who have resided continuously in the homestead for 1,215 days will not be affected by the new legislation.

As of April 20, 2005, Florida’s Supreme Court’s protections recited in Havoco – where the homestead’s sanctity will not be disturbed irrespective of its purchase after creditor pursuit or even judgment – certainly should not apply in the bankruptcy forum if the debtor moved into a Florida homestead (as a resident) within 1,215 days.¹⁷

BAPCPA created a dichotomy between those who are in bankruptcy and those who are not. In the homestead-protective states, a nonfiler who moves to the state between one day and 1,215 days can enjoy the entire homestead to be exempt. Alternatively, a bankruptcy filer whose residency is also less than 1,215 days¹⁸ may be limited to a homestead of a certain amount.¹⁹ Federal law clearly hampers state homestead protections at least until the debtor’s residency reaches 1,215 days.

Just when the homestead-protective states were about to throw in the towel and allow the homestead cap to affect the unlimited homestead, an Arizona bankruptcy judge granted a reprieve. Judge Randolph J. Haines issued an opinion that Congress poorly drafted BAPCPA’s limit on the homestead exemption to $125,000 for those who resided in the state between 730 days and 1,215 days.²⁰

The argument is simple, but requires review of complex clauses of the Code. Judge Haines demands a reading of the statute as a whole as opposed to a narrow reading of the homestead-cap section.²¹ In Arizona, the limitations of homestead described above presently do not apply in “opt-out” states – including homestead-protective states. In re McNabb, 2005 WL 1525101 (Bankr. D. Ariz. 2005).

The McNabb court required the $125,000 exemption to be seen through the wording of the new bankruptcy provisions. First, the $125,000 cap on homestead refers to §522(b)(3)²² as incorporated by §522(p).²³ Before the cap of §522(p) applies, one must read §522(b)(2), which states: “Property listed in this paragraph is property that is specified under subsection (d), unless the state law that is applicable to the debtor under paragraph (3)(A) specifically does not so authorize” (emphasis added).

The McNabb court showed that the Code, as a whole, reads differently than a section by itself. First, “the $125,000 cap applies only ‘as a result of electing under subsection (b)(3)(A) to exempt property under state or local law.’ Code §522(b)(1) allows debtors to elect to exempt property listed in either paragraph 2 [§522(b)(2)] or alternatively in paragraph 3 [§522(b)(3)].”²⁴ The McNabb court concluded that the limitations of §522(p) cannot apply because “the election ostensibly made available by §522(b)(1) may be taken away by a combination of state law and §522(b)(2).”²⁵ The McNabb court concluded that without the debtor’s ability to elect exemptions (Arizona is an “opt out” state where the debtor has no right to elect federal as opposed to state exemptions – the §522(b)(3)(A) election) the debtor cannot be limited to the $125,000 cab, which arises only “as a result of electing under subsection (b)(3)(A) to exempt property under state and local law”²⁶ (emphasis added).

The term “elect” arises in 11 U.S.C. §522(p) as well as §522(b)(3)(A). The prefatory language limiting the homestead to $125,000 in §522(p) specifically requires the debtor’s election, as it states that “as a result of electing under subsection (b)(3)(A) to exempt property under state or local law, a debtor may not exempt any amount of interest that was acquired by the debtor during the 1,215-day period preceding the date of the filing of the petition that exceeds in the aggregate $ 125,000 in value in [the debtor’s] residence.”²⁷ McNabb concludes that because opt-out states prohibit election, debtors in opt-out states cannot elect between federal or state exemption law. As Arizonans cannot elect, then neither §522(b) nor 522(p) can limit their exemptions.

Clear and unambiguous, this apparent glitch of the new Code may upset creditors as it appears §522(p) only applies in the minority of states that did not opt out. The McNabb court concluded that the statute cannot be second-guessed: “[H]ere there is no ambiguity nor absurdity in result. The language is unambiguous in stating that the cap is imposed only ‘as a result’ of an election, so if there is no election there can be no cap. And the result can hardly be deemed absurd when it is consistent with 163 years of bankruptcy law.” ²⁸

Just when homestead-protective states caught their breath after rejoicing over the McNabb ruling, Florida reviewed this issue and disagreed. Utilizing the “election theory” of McNabb, a Florida debtor sought to prohibit the imposition of a limitation on homestead to $125,000 under §522(p). The debtor received an opposite decision.

Judge Robert A. Mark, who strongly disagrees with McNabb, rules for the trustee in Kaplan and chastised the Arizona court’s McNabb decision.

As of November 2005, the courts could either side with Florida’s Kaplan or Arizona’s McNabb. In Nevada, where the court had to choose between the two conflicting decisions, the court sided with Judge Mark as it concluded that the legislative intent was to limit the homestead exemption: “Congress clearly intended to apply the provisions of [§522](p) to all debtors and not merely those citizens of states that permit the use of federal exemptions.”³¹ No other decisions had been entered as of November 2005.

At present, one can only speculate whether the other courts will agree with Judge Mark’s directive to cease litigation over this issue.³² If that happens, then the mansion loophole should finally be closed for the new residents of the homestead-protective states. Until then, this issue and the many other ambiguous clauses of BAPCPA will be the subject of future jurisprudence.

In the first published opinion interpreting a provision of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), Judge Randolph J. Haines of the District Bankruptcy Court, Phoenix Arizona, has held that the limitation on homestead exemption amounts contained in §522(p) is inapplicable in states that do not permit their residents to elect federal exemptions. In re McNabb, 326 B.R. 785, 2005 WL 1525101, Case No. 0-05-07495-RJH (Bankr. D. Ariz., June 23, 2005 ). In the context of an objection to the debtor’s claimed homestead exemption, Judge Haines was called upon to determine the applicability of several new provisions regarding exemptions contained in BAPCPA as well as interpret the $125,000 cap on homestead exemption contained in §522(p).

In this case, the debtor purchased a new home in Arizona just over one year prior to filing his chapter 7 petition there. He had previously lived in the state of California . He listed the residence on his Schedule A with a value of $330,000 and on Schedule D as being subject to a lien in the amount of approximately $205,500. The resulting equity would be completely exempt under Arizona law, which provides for a homestead exemption of up to $150,000. The debtor moved for an order compelling the chapter 7 trustee to abandon the residence as being exempt. Certain creditors objected to that motion on several grounds, as to one of which the trustee joined. The court quickly dispatched the creditor’s contention that, pursuant to §522(b)(3)(A), as amended by BAPCPA, debtor was required to claim exemptions under California law. The court noted that the new law or amendment does not become effective until 180 days after enactment, or October 17, 2005 . Accordingly, it did not govern the case before the court. The creditors also contended that the value of the debtor’s homestead was attributable at least in part to certain alleged fraudulent transfers and that §522(o), as added by BAPCPA, required that the homestead claim be adjusted accordingly. The court held that while that provision is one applicable to cases filed on or after the date of enactment, its effect could only be determined after an evidentiary hearing.

The principal focus of Judge Haines’s opinion is the creditor’s contention that pursuant to §522(p), added by BAPCPA, debtor’s claim of homestead was limited to $125,000 in value as it was acquired within 1,215 days of the date of the filing of the petition. The debtor claimed the cap was inapplicable because it applies only “as a result of electing under subsection (b)(3)(A) to exempt property under state or local law.” Section 522(b)(1) generally allows debtors to elect to exempt property pursuant to either paragraph 2 (federal bankruptcy exemptions) or paragraph 3 (state exemptions and federal nonbankruptcy exemptions). The Code also, however, authorizes states to prohibit their residents from claiming federal exemptions, an option selected by a number of states including Arizona . The result, the court observed, is that a debtor in Arizona has no right to “elect” state exemptions, because they are the only exemptions available to such a debtor. The court concluded that because the language of §522(p) applies only as a result of making such an election it can apply only in those states where such an election is available, that is those states that have not elected to opt out.

Applying principles of statutory interpretation, the court held that it could look to the legislative history only if the language was ambiguous or the interpretation adopted would lead to absurd results. In this instance, the court concluded that neither was the case. The election language used in the statute compels the conclusion that if there is no election, there can be no cap. Because the result is consistent with the statutory scheme that has existed under the Bankruptcy Code and its various predecessors for many years (that is, no uniform federal exemption), it is neither absurd nor clearly at odds with congressional intent. (Elsewhere in its opinion, however, the court does concede that the effect of this interpretation is to render this limitation applicable only in Texas and Minnesota—the only two states that have not chosen to opt out of the federal exemptions and permit exemption claims in excess of $125,000.) The court concludes that, even were it appropriate, reference to the limited legislative history available on BAPCPA would not be helpful in its interpretation, as it provides no insight as to the nature of the problem Congress was attempting to address in this section.

The court also reasoned that its conclusion was supported by the language of other provisions of BAPCPA, including another section at issue in the case, §522(o), which simply applies to all state exemption claims made pursuant to §522(b)(3)(A), without reference to an election. The court draws additional support for its conclusion from the interplay between §522(q) and new §727(a)(12), which requires denial of discharge if the court finds that §522(q)(1) “may be applicable” to the debtor and there is a proceeding pending in which the debtor might be found guilty of a felony or liable for a debt of the kind described in §522(q)(1). Specifically, subparagraph A of §727(a)(12) provides that the court must determine whether §522(q)(1) is applicable, indicating that it is applicable to some and not to others. The court concludes that the only function such a hearing might serve would be to permit the court to make a determination that the debtor had elected state exemptions where such election is available. Section 522(q)(2) does, however, offer another potential function for such a hearing in that it provides that §522(q)(1) is not applicable to the extent the amount claimed is reasonably necessary for the support of the debtor and any dependent of the debtor. Presumably, the court would need to hold a hearing to make such a determination.

Two other provisions of §522 may shed light on the court’s conclusions, one of which offers additional support for its holding, the other of which may support a different inference. In §522(b), Congress addresses the choice of exemptions in cases involving debtors who are husband and wife and provides that they may not split exemptions, with one choosing federal exemptions and the other state and nonbankruptcy federal exemptions. It further provides that if they cannot agree on the alternative to be elected, they shall be deemed to have elected the federal exemptions “where such election is permitted under the law of the jurisdiction where the case is filed.” In this provision, Congress clearly appears to use the term in a way that suggests that if such a choice is not permitted, there is no “election.” Another addition made by BAPCPA, to §522(b)(2), provides that if the effect of the new domiciliary restrictions is to render the debtor ineligible for any exemption, the debtor may “elect to exempt property that is specified under subsection (d).” Here, the word “elect” is used in a context in which the debtor essentially has no choice other than the one given by this new provision.

The court’s decision is amply supported by its inferences from statutory language and structure, but is not free from doubt and is sure to be controversial. In concluding, the court invites Congress, as part of the process of technical corrections now underway, to change the language of the statute if the interpretation adopted is inconsistent with its intent.

Another judge in the Southern District of Florida has weighed in on the effect of the BAPCPA amendments' caps on homestead exemptions. In re Wayrynen, 332 B.R. 479 (Bankr. S.D. Fla. 10/14/05). In Wayrynen, the trustee objected to a debtor's claim of exemption for a homestead with a $150,000 value which had been purchased a month prior to his bankruptcy filing. 11 U.S.C. 522(p) imposes a $125,000 cap on exemptions claimed for homesteads purchased within 1,215 days of the petition date. The debtor responded by contending that the cap did not apply in Florida, an "opt out" state which does not permit an election between federal and Florida exemptions, and furthermore that the cap did not apply because the equity in the homestead was derived from the sale of a previous home in Florida which had been owned more than 1,215 days prior to the filing date.

Judge Friedman noted in Wayrynen, like Judge Haines in McNabb, that the "as a result of electing" language in 522(p) could be construed as meaning that a Florida resident (who, as a result of state law, does not have the option of electing between federal and state exemptions) is not subject to the cap. However, like Judge Mark (the Chief Judge of the Southern District of Florida), Judge Friedman found that such an interpretation would be contrary to the intention of the Reform Act's drafters. He reconciled the language with the legislative intent by finding that a Florida resident who claims a homestead exemption under state law has made an election by having chosen to reside in Florida, having chosen to purchase a residence in Florida, having chosen to make it his or her permanent residence, and having availed himself or herself of bankruptcy relief.

Nonetheless, the debtor prevailed on his second argument that the equity in his current homestead in excess of the cap was still exempt because it was derived from a previously owned Florida homestead owned more than 1,215 days prior to the petition date. 522(p)(2)(B) provides a "carve-out" from the cap which excludes the amount of any "interest transferred from a debtor's previous principal residence (which was acquired prior to the beginning of such 1215-day period) into the debtor's current principal residence" if they are both in the same state.

The debtor had initially purchased a Florida residence in 1989 for slightly less than $100,000. He sold that property in August 2002 (within 1,215 days of the petition date) for $250,000, realizing a little more than $150,000 in equity. He then purchased another Florida residence the next month for about $175,000. The second homestead was then sold in March 2005 for $271,500, and a new homestead purchased for $146,000. Judge Friedman found that the "interest transferred" from the debtor's previous residence (the first property) amounts to $150,000 (the built-up equity realized upon its sale) which was reinvested in the subsequent homesteads, and that since the amount of that "interest" is excluded from the interest being claimed as exempt, the debtor was entitled to claim the entire $150,000 present value of his current homestead as exempt.

In so holding, Judge Friedman rejected the trustee's argument that the reference in the "carve-out" to the Debtor's previous principal residence" should be construed as referring only to the particular property owned by the debtor immediately prior to the own being claimed as exempt. Instead, he extended the protection of the carve-out to prior homesteads owned by the debtor as well, on the basis that the safe harbor appears to have been intended "to afford protection to individuals like the Debtor who, rather than seeking to take advantage of Florida's exemption provisions to shelter illicitly- or improperly-obtained funds, simply have benefited as a result of their ownership of Florida real property and the general appreciation of property values attributable to previous intra-state transactions."

Another Case

A bankruptcy judge in Nevada has joined Judge Mark of Florida in concluding that the 522(p) homestead exemption cap applies in all states, and not just those which permit residents to elect between the federal and state exemptions. In re Virissimo, 332 B.R. 201 (Bankr. D. Nev. 2005). As previously discussed here, at least one judge in Arizona has held that the language used by Congress in 522(p) to create a $125,000 cap on exemptions for homesteads purchased less than 1,215 days prior to bankruptcy does not apply in states where the state legislature has prohibited debtors from selecting the federal rather than state exemptions. In re McNabb, 326 B.R. 785 (Bankr. D. Ariz. 2005). A Florida court has held to the contrary that 522(p) can and should be interpreted consistently with legislative intent to impose the cap on all state homestead exemptions. In re Kaplan, 2005 WL 2508151 (Bankr. S.D. Fla. 2005). The different results center on the interpretation of the phrase in 522(p) which renders the cap applicable "as a result of electing under subsection (b)(3)(A) to exempt property under State or local law," and the extent of reliance on legislative history. Judge Riegle in Virissimo joins the Kaplan court in applying the cap broadly.

In divining the plain meaning of 522(p), Judge Riegle concludes that there is an "election" for purposes of 522(p) when a debtor elects to claim property as exempt, and "elects" to do so under 522(b)(3). She suggests that a debtor always "elects" between exemptions under the federal provisions under 522(b)(2) and the state or local provisions under 522(b)(3), even if an "election" to use 522(b)(2) might be ineffective if the state law prohibits use of the federal exemptions and a timely objection is made.

Alternatively, Judge Riegle finds the statute ambiguous in that it is susceptible to multiple interpretations and, like Judge Mark, concludes that legislative history can be relied on when the clearly expressed legislative intent is contrary to the strict language. Also like Judge Mark, the Nevada court had no difficulty discerning Congressional intent to apply the cap to all debtors and not solely those who reside in states that permit the use of federal exemptions.

With three notable decisions already issued, the homestead cap -- which was one of the most frequently discussed BAPCPA changes -- is proving to be a continuing subject of debate and dispute.