by Absent a statutory basis for doing so, a bankruptcy court may not deny a debtor’s homestead exemption based on bad faith or prejudice to creditors. Elliott v. Weil (In re Elliott), No. 14-1050, 14-1059 (consolidated) (B.A.P. 9th Cir. Dec. 10, 2014).
Prior to filing bankruptcy, the debtor transferred certain real property to the son of his business partner. He did not list the property on his bankruptcy schedules. After a series of subsequent transfers and after he obtained a chapter 7 discharge, the property made its way back to the debtor via a quitclaim deed from a company he organized and controlled. Upon learning of the existence of the property, judgment creditors of the debtor moved to reopen the bankruptcy. The debtor, for the first time admitted his interest in the property and sought to exempt it under the California homestead exemption.
In accordance with then-current Ninth Circuit law, the bankruptcy court denied the exemption on the basis that the debtor exercised bad faith in concealing the property during his bankruptcy.
While the debtor’s appeal was pending, the Supreme Court decided Law v. Siegel, 134 S.Ct. 1188 (2014), and the bankruptcy appellate panel looked first at whether that decision abrogated the law relied on by the bankruptcy court. In Law the Court held that a surcharge against an exemption based on debtor misconduct contravened the debtor’s exemption rights under section 522(b) and section 522(k)’s prohibition against use of exempt property to pay administrative expenses. Although Elliott involved denial of the exemption altogether rather than a surcharge against the exemption, the panel found that the reasoning of Law was controlling. A bankruptcy court does not have authority to create an exception to the homestead exemption based on a debtor’s bad faith.
The analysis did not end there, however. The trustee argued that whn the debtor transferred his property prior to bankruptcy, even though the transfer was fraudulent, it had the effect of destroying the debtor’s homestead exemption and the reconveyance post-discharge did not resurrect it under state law.
Turning to state law, the panel found that in California there are two types of homestead exemption: the Article 5 “declared” homestead, and the Article 4 “automatic” homestead exemption. The panel agreed with the trustee that because of the transfers the debtor did not have the benefit of the declared exemption, but found that the debtor could still enjoy the automatic homestead exemption. That exemption protects a debtor against forced sale without regard to continued ownership so long as there is both continued residency and an intention on the part of the debtor to use the property as his homestead. The bankruptcy court, having relied on then-current Ninth Circuit law to find that the debtor’s bad faith was sufficient cause to deny the exemption, did not consider facts to support application of the automatic homestead exemption and the record was not conclusive as to the issue. Thus, the panel vacated and remanded with instructions to the bankruptcy court to determine whether the debtor was entitled to California’s automatic homestead exemption.
Finally, the panel offered another avenue by which the bankruptcy court could deny the exemption based on the debtor’s misconduct. Section 522(g) “limits the ability of a debtor to claim an exemption where the trustee has recovered property for the benefit of the estate.” Section 522(g)(1) provides that a debtor may claim an exemption where the trustee has recovered property pursuant to section 542, so long as (1) the property was involuntarily transferred, and (2) the debtor did not conceal the transfer or an interest in the property. In this case, while the appeal was pending, the bankruptcy court granted the trustee’s motion for turnover of the property under section 542 based on fraudulent transfer. The panel concluded that section 522(g)(1) was applicable and that the bankruptcy court must take it into consideration upon remand.
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