The district court found that the “mansion loophole” cap on exemptions provided for in section 522(p) applies even in opt-out states where the debtor does not have the option to choose between state and federal exemptions. It also held that rule 4003(b)(4) does not impose a deadline on notice to the debtor of filing an objection to exemptions. In re Kane, No. 21-8209 (N.D. Cal. Sept. 2022).
One day prior to filing his chapter 7 petition, the debtor, a professional hockey player, purchased residential property from a limited liability company the debtor owned with his wife. The property was the sole asset held by the LLC. In his bankruptcy filings, he claimed a homestead exemption of $600,000 under California exemption law. The creditor, Lions Bancorporation, N.A., filed a timely objection to the exemption and served relevant entities, including the debtor’s bankruptcy counsel, but inadvertently failed to serve the debtor himself with the objection until approximately a month after the deadline for filing objections had passed.
After the bankruptcy court rescheduled the hearing on the objection to give the debtor more time, it found that section 522(p) applied to the exemption rather than the state exemption law. It therefore sustained the objection.
The debtor appealed to the district court on three issues: 1) whether the deadline for filing an objection to exemptions also governs notice to the debtor of the objection, 2) whether the debtor’s homestead exemption was subject to the cap in section 522(p), and 3) whether the bankruptcy court correctly applied the exemption cap.
Beginning with the question of service, Rule 4003(b)(1) requires the party objecting to an exemption to file and serve the objection within 30 days of the initial meeting of creditors. Rule 4003(b)(4) provides that a copy of the objection “shall be delivered or mailed to the . . . debtor and the debtor’s attorney . . .” but, unlike Rule 4003(b)(1), does not specify a deadline for delivery. The panel in In re Spenler, 212 B.R. 625, 630 (9th Cir. BAP 1997), described the purpose of the rule as “provid[ing] the debtor with timely notice that the trustee or other interested party objects to a debtor’s claimed exemption.”
The district court observed that Rules 4003(b)(1) – (3) all relate to filing objections to exemptions and all contain a deadline to do so. Only the notice provision, Rule 4003(b)(4), contains no such deadline. The court found that Spenler offered the relevant guidance. Where the purpose of the rule is to provide notice of the objection, strict adherence to a timeline takes a backseat to the question of whether the debtor had a reasonable opportunity to address the objection. In this case, where the debtor’s attorney had notice of the objection when it was filed, and the hearing on the objection was continued due to the late notice to the debtor, the court found the purpose of the rule was served and the bankruptcy did not err.
The court turned to the issue of whether section 522(p)’s cap on exemptions applied in opt-out states. That section provides: “(1). . . 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 1215-day period preceding the date of the filing of the petition that exceeds in the aggregate [$170,350].” The court found this section was enacted to close the “mansion loophole.”
In this case, the debtor did not elect to use the California exemptions as California is an opt-out state requiring bankruptcy debtors to use state rather than federal exemptions.
The court in In re McNabb, 326 B.R. 785, 787-91 (Bankr. D. Ariz. 2005), found that section 522(p) does not apply in opt-out states like California. As Zions pointed out, however, under McNabb’s reasoning, section 522(p) would apply to only two states, and Congress’s intent to close the mansion loophole would be essentially defeated.
In re Virissimo, 332 B.R. 201, 207 (Bankr. D. Nev. 2005), reached the opposite conclusion from McNabb. To do so, that court engaged in a tortuous reading of the word “electing” to find that when a debtor files a bankruptcy petition he “elects” which property he will claim as exempt. The Virissimo court found there was at least ambiguity as to the meaning of “electing” giving rise to the need to consult legislative history and effectuate congressional intent.
Finding that the language of section 522(p) was ambiguous, the court here agreed that congressional intent to close the “mansion loophole” would be better served if the statutory cap is applied to opt-out states. It affirmed the bankruptcy court’s order on that issue.
The next issue was whether appreciation to the value of the property was covered by the federal statutory exemption cap.
Resolution of the issue turned on when the debtor actually acquired his interest in the property. The debtor claimed that he acquired his interest when the LLC bought the property over two years before he filed for bankruptcy. Lions argued that he acquired his interest in the property one day before he filed for bankruptcy when the LLC quitclaimed the property to him.
The court found that under Ninth Circuit precedent, legal title is not necessary to a homestead exemption so long as the debtor resides on the property. Also, under state law, a limited liability company is a separate entity from its owners. Here, the court found the debtor failed to establish that he had an exemptible interest in the property prior to when he actually purchased it from the LLC one day before filing for bankruptcy. Although he claimed that he and his family lived on the property from the time the LLC purchased it, he presented no evidence of possession other than showing that he made the mortgage payments on the property. Specifically, the debtor failed to present evidence that he “possessed or exclusively used it, continuously resided there, or intended to reside there.”
In fact, the court found several points in the record suggesting that the debtor did not reside on, or intend to reside on, the property. He owned other residences, he worked and rented an apartment in another city, and he was in the process of restructuring his debts in the face of at least three cases of fraud and breach of contract when the LLC bought the property.
The court reiterated that while the exemption does not require the debtor to have title to the property he seeks to exempt, it does require that the debtor demonstrate some equitable interest including possession and the intent to reside on the property. The court concluded that the debtor acquired that interest one day before filing for bankruptcy and that any appreciation that accrued since the LLC purchased it two years before was part of the interest the debtor acquired.
The court affirmed the bankruptcy court’s order.
Tags: Exemptions
