Ruling on a question of first impression, the Ninth Circuit Bankruptcy Appellate Panel held that a debtor who claims an exemption equal to “100% fair market value” is entitled to retain postpetition appreciation in the value of the property, even if the chapter 11 case converts to chapter 7.

The opinion is important for another reason: If adopted widely, the BAP’s analysis could end the split where courts disagree about a chapter 13 debtor’s right to retain postpetition appreciation in the value of a homestead. If followed, the BAP’s position regarding the finality of exemption claims would mean that debtors in cases that convert to chapter 7 from chapter 13 should retain post-petition appreciation regardless of whether the home was sold before or after conversion.

Typical Facts

The husband and wife debtors filed a chapter 11 petition in 2015. They scheduled their home as being worth about $165,000 and encumbered by a $130,000 mortgage. In the schedules, they claimed an exemption under Section 522(d)(1) for “100% of fair market value.”

At the time, the exemption was $45,900. No one lodged an objection to the exemption claim within the required time after the first meeting of creditors.

The bankruptcy court confirmed the debtor’s chapter 11 plan in 2017. The plan called for retaining the home and continuing to pay the mortgage until maturity.

According to the BAP’s November 2 opinion by Bankruptcy Judge Robert J. Faris, the plan was “muddled” but “appeared to claim [that] the entire fair market value of the home” was exempt. However, the plan recognized that the home would not be exempt until all creditors were fully paid under the plan.

The Dueling Motions

In 2018, more than one year after plan confirmation, the case converted to chapter 7. The debtors filed a motion to sell the home for $400,000 and allow them to retain all net proceeds because the home was exempt.

The debtor withdrew their motion to sell when the trustee filed an objection stating that only the trustee had the right to sell estate property. Instead, the debtors filed a motion to compel the trustee to abandon the home, because it was 100% exempt, and no one had objected.

The chapter 7 trustee countered with a motion to sell the property and contended that the debtors were only entitled to the statutory $45,900 exemption. All other net proceeds, the trustee said, should go to the estate and to creditors.

The bankruptcy court denied the debtor’s motion to compel abandonment and granted the trustee’s motion to sell. The trustee sold the home for $422,000, generating net proceeds of almost $225,000. On motion by the debtors, the bankruptcy court directed the trustee to hold the net proceeds pending resolution of appeals.

The debtors appealed to the BAP, successfully.

Mootness

The trustee argued that the appeal was statutorily moot under Section 363(m). The section provides that the “reversal or modification on appeal of an authorization . . . of a sale or lease of property does not affect the validity of a sale or lease . . . to an entity that purchased or leased such property in good faith, . . . unless such authorization and such sale or lease were stayed pending appeal.”

Judge Faris ruled that the appeal was not statutorily moot because the debtors were only challenging the amount of the exemption claim and the distribution of the proceeds. They were not contesting the validity of the sale, he said.

Likewise, Judge Faris said that the appeal was not equitably moot, because reversal would not result in an “uncontrollable situation” since the trustee was holding funds to pay the debtors if they were to win on appeal.

At the end of the discussion of equitable mootness, Judge Faris alluded to the idea that the distribution of sale proceeds would have necessitated dismissing the appeal. He said,

Even if the Trustee had fully distributed the sale proceeds, he has not shown that it would be impossible or inequitable to claw back those payments from administrative and unsecured creditors. Thus, the Trustee has failed to demonstrate that equitable mootness requires the dismissal of this appeal.

The dicta by Judge Faris implies that the BAP would not reflexively dismiss an appeal if sale proceeds have been distributed.

The Merits

On the merits, Judge Faris first addressed the question of whether the absence of an objection to the homestead exemption claim meant that the exemption was valid, “even though it is larger than the law allows.”

In sum, Judge Faris said that the answer was beyond “any debate” in view of Section 522(l), Bankruptcy Rule 1019(2)(B)(i) and Taylor v. Freeland & Kronz, 503 U.S. 638 (1992). The section says, “Unless a party in interest objects, the property claimed as exempt on such list is exempt.”

Judge Faris said that “Taylor holds that § 522(l) means what it says: if no one files a timely objection, an exemption claim is valid even if it had no ‘colorable basis’ in the law.”

Even though the trustee had not been appointed when the debtors claimed their homestead exemption early in the chapter 11 case, Judge Faris said that “the rules make clear that he cannot now object.” Because there had been no objections to the exemption claim, he said it “is not subject to challenge.”

The FMV Claim

The second question, according to Judge Faris, was whether the debtors had claimed an exemption in the full market value of the home at filing or at the time of sale.

The Supreme Court’s decision in Schwab v. Reilly, 560 U.S. 770 (2010), “largely answered the second question,” Judge Faris said. He paraphrased Schwab as saying “that a debtor may claim ‘100% of FMV’ to put parties in interest on notice that he intends to claim the full value of the property as exempt.” Otherwise, the Court said, parties have no obligation to object if the debtor lodges an exemption claim in a dollar amount within the limits of Section 522(d).

Judge Faris said that the debtors followed Schwab “to the letter” by claiming an exemption in “100% of FMV,” or fair market value, and were entitled to the net proceeds even though the proceeds were in excess of the allowable exemption.

In addition to the chapter 7 trustee, the state had objected by contending that Schwab was mere dicta in counseling debtors to claim 100% of fair market value. Judge Faris said, “We do not agree that we can so easily reject language that the Supreme Court has approved for this very situation.”

The Snapshot Rule

Invoking the so-called snapshot rule, the trustee argued that the exemption was limited to the value of the property at filing and would not include appreciation. Judge Faris conceded that “postpetition appreciation of estate property inures to the benefit of the bankruptcy estate.”

Judge Faris described the workings of the snapshot rule as follows:

The snapshot rule fixes the point in time that defines the exemptions that a debtor is entitled to take. It says nothing about what happens when a debtor claims an exemption in postpetition appreciation to which the debtor is not entitled and no one timely objects. [Emphasis in original.]

To have the benefit of the snapshot rule, Judge Faris said that “a trustee or party in interest must object to an exemption claim that contradicts that rule.”

“As a matter of first impression,” Judge Faris said that the debtor’s “claim of an exemption equal to ‘100% of FMV’ includes postpetition appreciation and becomes incontestable if there is no timely objection.”

The BAP reversed the bankruptcy court’s order that had limited the exemption to the statutory maximum of $45,950 and remanded for the bankruptcy court to determine how to enforce the exemption “and what other remedies, if any, are appropriate.”

Observations

On a related question, the courts are split. Does a chapter 13 debtor retain the appreciation in the value of homestead, whether or not the case converts to chapter 7?

So far, only the Tenth Circuit has answered the question, but only in the context of a sale before conversion. The Tenth Circuit held that nonexempt appreciation in the value of a home sold after confirmation of a chapter 13 plan belongs to the debtor, not to creditors, if the case converts to chapter 7 after the sale. The appeals court specifically declined to opine on the result if the debtors were to remain in chapter 13 after the sale. See Rodriguez v. Barrera (In re Barrera), 22 F.4th 1217 (10th Cir. Jan. 19, 2022). To read ABI’s report, click here.

Answering an open question after Barrera, Bankruptcy Judge Joseph G. Rosania, Jr., of Denver ruled that a chapter 13 debtor retains appreciation in the value of nonexempt property that the debtor owned on the filing date but was sold in the course of the chapter 13 case. In re Klein, 17-19106, 2022 BL 310082, 2022 WL 3902822 (Bankr. D. Colo. Aug. 23, 2022). To read ABI’s report, click here.

Among judges holding otherwise, Bankruptcy Judge Marc Barreca of Seattle disagreed with the result later reached in the Tenth Circuit and with a fellow bankruptcy judge in the Ninth Circuit. Judge Barreca decided that the postpetition appreciation in the value of an asset belongs to the chapter 7 estate if the case converts from chapter 13. In re Castleman, 631 B.R. 914 (Bankr. W.D. Wash. June 4, 2021). For ABI’s report, click here.

The Ninth Circuit BAP’s notion of the finality of an exemption would seem to mean that chapter 13 debtors retain postpetition appreciation in exempt assets regardless of whether the sale is during the chapter 13 case, before conversion to chapter 7 or after conversion.

This writer has a question about the renewal of objection periods permitted by Bankruptcy Rule 1019(2). Does the rule permit objections to exemptions that were made final by Section 522(l)? If that’s so, is the rule invalid in some respect for contradicting the statute?