Most of us would assume that a home owned by a married couple as tenants by the entireties would be exempt in all respects in all states. But no, that is not true in Illinois and states with similar laws, according to the Seventh Circuit.

In Illinois, a homestead owned as tenants by the entireties cannot be foreclosed and sold by a judgment lien creditor of one spouse, but the entireties interest is not entirely exempt, the Chicago-based appeals court says.

Consequently, a spouse cannot avoid a judgment lien on his or her contingent future interest in the home because that interest is not exempt in Illinois. In other words, a judgment lien that attached to one spouse’s contingent future interest in a homestead survives bankruptcy in Illinois.

In his August 5 opinion for the appeals court, Circuit Judge William J. Bauer warns that state laws vary dramatically on entireties property, so the result will not be uniform throughout the U.S.

The Death of the Wife

Years earlier, creditors filed a $1 million judgment lien against an attorney in the Illinois county where he owned a home with his wife as tenants by the entireties. The lawyer later filed a chapter 7 petition.

The lawyer-debtor claimed that his interest in the home was exempt under Illinois law and Section 522(b)(3)(B). He therefore sought to avoid the judgment lien as an impairment on his exempt property under Section 522(f).

After filing, the debtor’s wife died, terminating the tenancy by the entireties and vesting the debtor with fee simple interest in the home. Outside of bankruptcy, the creditors could have foreclosed the judgment lien after the wife’s death. Thus, it became imperative for the debtor to avoid the judgment lien.

Bankruptcy Judge A. Benjamin Goldgar of Chicago held that the debtor’s contingent future interest as a tenant by the entireties was not exempt under Illinois law. Therefore, Judge Goldgar ruled that the debtor could not avoid the judgment lien.

The district court reversed, but Circuit Judge Bauer reversed once again, focusing on the debtor’s contingent interest under Illinois law.

The Significance of State Law

The outcome turned on two sections of the Bankruptcy Code. Section 522(f) allows a debtor to avoid a judicial lien “on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled . . . .”

Section 522(b)(3)(B) determines whether the relevant property interest is exempt. The section allows a debtor to exempt “any interest in property in which the debtor had, immediately before the commencement of the case, an interest as a tenant by the entirety . . . to the extent that such an interest as a tenant by the entirety . . . is exempt from process under applicable nonbankruptcy law.”

Judge Bauer, of course, said that Illinois exemption law was the “applicable nonbankruptcy law.” He said that Illinois courts have not decided whether a judgment lien attaches to “the individual interests (in particular contingent future interests) of a tenant by the entirety.” So, he made a so-called Erie guess.

Parsing the Illinois statutes, Judge Bauer concluded that “interests held in a tenancy by the entirety or contingent future interests held by tenants by the entirety” are not exempt from judgment. He said that the statutes “merely exempt the tenancy interest from the attachment of a judgment lien.” [Emphasis in original.]

Judge Bauer therefore held that the judgment lien attached to the debtor’s “contingent future interest in the property.” Next, he said that the debtor’s interest as a tenant by the entirety would be estate property under Section 541(a), at least initially.

Judge Bauer then examined whether Section 522(b)(3)(B) exempted the debtor’s contingent future interest in the homestead. Although Illinois would exempt the tenancy interest, he said that “lesser interests” are not exempt in Illinois, such as the debtor’s “contingent future interest in the entireties property.”

Focusing on “such interest” in Section 522(b)(3)(B), Judge Bauer deduced that a debtor’s interest as a tenant by the entirety is “exempt to the extent that those interests the debtor holds as a tenant by the entirety are exempt under state law.”

Fitting the pieces together, Judge Bauer said that the creditor obtained a judgment lien on the debtor’s contingent future interest that existed on the petition date. Next, he said that Illinois does not make “all interests” immune from process that are held by a tenant by the entirety. Because Illinois does not exempt “contingent future interests,” he concluded that the debtor could not exempt his contingent future interest in the homestead.

Since the debtor’s contingent future interest was not exempt, Judge Bauer ruled that the debtor therefore could not avoid the lien on that interest. Although bankruptcy terminated the debtor’s personal liability, the creditor presumably could enforce the judgment lien.

Although a contingent future interest is not exempt, Judge Bauer said that the “main protection” in Illinois “is that a creditor is unable to force the sale of the property to collect a debt against only one of the tenants.”

Judge Bauer cautioned that laws around the country “are not uniform.” For example, he cited Indiana, where the law exempts “any interest” in property held by as a tenant by the entirety.

Another example is found in a decision in February by the Eighth Circuit. There, the appeals court held under Missouri law that a judicial lien is avoidable in Missouri as an impairment of the debtor’s homestead exemption. CRP Holdings A-1 LLC v. O’Sullivan (In re O’Sullivan), 914 F.3d 1162 (8th Cir. Feb. 1, 2019). To read ABI’s report on CRP, click here.