Addressing the same question now before the Sixth Circuit, Chief Bankruptcy Judge R. Kimball Mosier of Salt Lake City wrote an encyclopedic opinion concluding that a trustee cannot sell an individual debtor’s home without paying the homestead exemption in full, in cash.
Judge Mosier’s opinion explains why the Bankruptcy Code prevents collusion between a trustee and a secured creditor from stripping away a debtor of a homestead exemption even when the encumbrances exceed the value of the property.
The Sixth Circuit Case
In Brown v. Ellmann (In re Brown), 16-1967 (6th Cir.), the Sixth Circuit is reviewing a decision by a district judge in Detroit who held in May that a debtor can have a homestead exemption only if there is equity in the property. Even though the debtor got nothing, the decision allowed the trustee and unsecured creditors to obtain a recovery from the sale of the debtor’s home, although the homestead exemption was otherwise valid.
In the Sixth Circuit case, a woman filed a chapter 7 petition while owning a home worth $170,000 that was encumbered with mortgages totaling almost $220,000. With consent from the lenders, the trustee sold the home for $160,000.
The holder of the first mortgage agreed to take about $148,000 in full satisfaction of the debt and allowed the trustee to distribute $6,000 to the holder of the second mortgage. After paying the brokerage fee and closing costs, the trustee would have money left over for distribution to unsecured creditors.
The debtor objected, raising her homestead exemption as reason for not selling the home. The bankruptcy court ruled against her, and the district court affirmed, holding there is no homestead exemption without equity in the property for the debtor.
The briefs having been filed, Brown awaits oral argument. Because the underlying principles are the same, the Cincinnati-based appeals court might withhold ruling until the Supreme Court decides Czyzewski v. Jevic Holding Corp., on which oral argument took place on Dec. 7. Jevic will decide whether a settlement can distribute proceeds in violation of statutory priorities. To read ABI’s discussion of the implications of Jevic on the outcome of Brown, click here.
The Salt Lake City Case
In Judge Mosier’s case, a couple filed a chapter 7 petition while owning a home they scheduled as being worth $351,000. The home was encumbered with $300,000 in mortgage debt and an IRS tax lien for about $115,000. The couple claimed a $51,000 homestead exemption under Utah law.
After Judge Mosier overruled the trustee’s objection to the homestead exemption, the trustee responded by locating a purchaser willing to pay $425,000 for the property, or enough to pay off the liens and cover expenses of sale, generating about $7,500 of equity. The proposed sale was not that simple, because the trustee intended for the debtors to get nothing.
As part of the sale, the IRS agreed to subordinate its secured claim by enough to generate $10,000 for the estate. The deal would also allow the trustee to pay his fees and costs from the sale proceeds.
Faced with the possible loss of their home, the couple converted the case to chapter 13 and removed their claim of a homestead exemption. After conversion, the trustee and his counsel filed fee applications for about $31,000.
Ruling on the fee applications in his Dec. 14 opinion enabled Judge Mosier to explain in detail why the chapter 7 trustee could not have sold the home without paying the debtors’ homestead exemption in full.
Reasons for Denying the Fee Application
Citing Section 330(a)(4)(A), Judge Mosier denied the fee applications because the trustee’s services were not necessary, did not benefit the estate, and “could work a substantial harm on the debtors if they were approved.” In effect, his opinion explained why he would not have approved the sale had the debtors not converted the case to chapter 13.
Judge Mosier said that allowing the sale would have had “devastating consequences for the debtors.” He explained that the debtors “would lose their home without any funds in return with which to acquire a new place to live, and proceeds from the sale of the home would go to the trustee and his counsel instead of toward the IRS’s claim.”
But that was not all. By paying the trustee, the IRS would have a smaller recovery, saddling the debtors with a larger nondischargeable tax claim even though the debtors would have no sale proceeds to apply toward tax debts.
And there’s more. Judge Mosier said the debtors in effect would have been paying the costs of administration from an increase in their nondischargeable tax debt.
“This is hardly the fresh start that the Code contemplates,” Judge Mosier said.
Why the Code Bars Selling a Homestead with No Equity
The bulk of Judge Mosier’s opinion is a dissection of several provisions of the Bankruptcy Code, all leading to the conclusion that a trustee cannot sell someone’s homestead without paying the homestead exemption in full. He also discusses concepts raised in Jevic without addressing that case by name.
The judge began with the proposition that Section 554 was included in the Bankruptcy Code to prevent trustees from selling fully encumbered property and “bringing no value to the estate.” He cited the U.S. Trustee’s Handbook as saying that “‘a trustee should not sell property subject to a security interest unless the sale generates funds for the benefit of unsecured creditors,’” nor should a trustee sell an asset where the proceeds “‘will primarily benefit the trustee or the professionals.’”
The Handbook, according to Judge Mosier, explains why trustees are not “to act as liquidating agents for secured creditors,” a concept in bankruptcy law dating from the former Bankruptcy Act.
To show that the trustee’s services would not have benefitted the estate, Judge Mosier first cited the Supreme Court’s 1991 Owen decision for the proposition that exemptions are not limited by liens. At the time of filing, he said, the liens presumptively exceeded the value of the home. Consequently, the debtors were basing their homestead exemption on legal title, which he said Owen permits.
Even though it turned out that the property was worth more than the liens, a sale was still not permissible, for reasons Judge Mosier explained.
Under Utah law, the judge said that the debtors were entitled to an exemption even if the property were worth less than the encumbrances, contrary to the trustee’s contention. Since it turned out that there indeed was equity for the debtors, he said the trustee could not contest the validity of the homestead exemption.
Judge Mosier said that Utah law does not allow a forced sale of a homestead unless the proceeds would pay the exemption in full, in cash. He then went on to explain why the purported carveout for the trustee was nonetheless exempt proceeds that the debtors were entitled to receive.
Even if the trustee could have sold the property, Judge Mosier would have paid the carveout to the debtors on account of their homestead exemption before distribution to unsecured creditors.
In a comment reminiscent of the issues in Jevic, Judge Mosier said that the trustee and the IRS cannot by agreement “defeat junior lien interests or the debtors’ homestead exemption.” He then went on to explain why he disagreed with cases where a secured creditor uses debt to purchase property and leaves a “tip” for unsecured creditors, bypassing junior liendholders or holders of priority claims. He explained why he disagreed with the notion that a “tip” or carveout is not proceeds of estate property.
Judge Mosier went on to explain in depth why neither Sections 724 nor 506(c) provide a basis for carveouts that disregard statutory priorities.
The extent to which the result stemmed from Utah law is not immediately apparent. Arguably also, much of the opinion is dicta and may have different or no application in chapter 11 cases where exemptions are not in play. Nonetheless, the thrust of the opinion arguably stands for the proposition that Section 507’s priorities cannot be ignored in a sale, the very question at issue in Jevic.
To read ABI’s discussion of Jevic’s oral argument in the Supreme Court, click here.