by In chapter 7, an allowed, unconditional, exemption is removed from the bankruptcy estate and the property cannot be distributed to creditors even if the exemption loses its exempt status post-petition. Hawk v. Engelhart (In re Hawk), No. 16-20641 (5th Cir. Sept. 5, 2017).
Chapter 7 debtors, Gregory and Marcie Hawk, listed an IRA on their schedules and claimed an exemption for the account funds under Texas exemption law. The trustee did not object within thirty days and the court allowed the exemption. Over the course of several months, the Hawks withdrew funds from the account and did not roll them over into a new retirement account within sixty days as required under Texas law. The bankruptcy court found that the funds had lost their exempt status and ordered the Hawks to turn them over to the trustee. The district court affirmed.
On appeal, the Fifth Circuit began with two general principles. The “snapshot rule” takes into account the facts and law in effect when the petition is filed and says that property of the bankruptcy estate is determined at that time. Under section 522(l), once property is found to be exempt it is removed from the estate and may not be used to repay the debts of the debtor.
For guidance, the Fifth Circuit addressed how those rules have been applied to Texas’s homestead exemption in the context of both chapter 7, where the bankruptcy estate is frozen at the time of the petition, and chapter 13, where, under section 1306(a)(1), after-acquired property may enter the bankruptcy estate. Like the retirement fund exemption, Texas’s homestead exemption requires that when a homestead is sold, the proceeds must be reinvested in another homestead in order to maintain their exempt status.
In In re Zibman, 268 F.3d 298, 301 (5th Cir. 2001), the debtor sold his homestead prior to filing his chapter 7 petition, and failed to reinvest those proceeds in a new homestead within the required time. The court reasoned that if the snap shot rule were strictly enforced, it would change the homestead exemption from one that requires the debtor to reinvest within a specified time, to one in which the exemption is permanent without regard to reinvestment. Such result would be contrary to the purpose of the exemption which is to protect the homestead property, rather than the proceeds from its sale. The Zibman court, therefore, held that when the debtor failed to reinvest within six months, the exemption no longer applied to the proceeds and they became part of the bankruptcy estate.
In In re Frost, 744 F.3d 384, 386–89 (5th Cir. 2014), the chapter 13 debtor sold his homestead post-petition but during the pendency of his plan and failed to reinvest within six months. The court found that at the time of the petition, before he had sold his homestead, the debtor held an unconditionally exempt interest. When he sold the property, his exempt interest became conditional. Upon failing to meet the reinvestment condition, his interest changed to non-exempt and, as after-acquired property, it entered the estate. In so holding, the court relied on section 1306(a)(1), and the reasoning in Zibman.
Turning to the case before it, the Hawk court found that the fact that chapter 13 incorporates after-acquired property was an important distinction that governed its decision. When the Hawks filed their bankruptcy petition their IRA qualified as an exempt retirement account and was allowed without timely objection. Therefore, the property was removed from the bankruptcy estate. Because chapter 7 does not have a provision comparable to section 1306(a)(1) to capture post-petition property interests, the Hawks’ later use of the IRA funds did not impact their bankruptcy case.
The court distinguished Zibman on the basis that, in that case, the debtors sold their homestead prior to filing chapter 7. The “snapshot” of their property, therefore, showed a conditional interest in the homestead proceeds. In Hawk, there was no condition attached to the IRA funds at the time of their petition. Where the exemption was allowed without objection, those funds were permanently removed from the property of the estate.
The court acknowledged the trustee’s concern about abuse of exemptions, but noted that there are other provisions in the Code to address bad faith conduct.
The court withdrew its earlier decision affirming the bankruptcy court, and entered an order reversing and remanding for further proceedings.
Hawk 5th Cir opinion upon recon Sept 2017