In a remarkably short time, a panel of the Fifth Circuit saw the error in its ways, vacated an opinion handed down on July 19, and held that exempt property on the filing date does not lose its exempt status even if it is converted to nonexempt property after the filing of a chapter 7 petition.
The per curiam opinion on Sept. 5 removes a cloud of perpetual uncertainty that had been hanging over chapter 7 debtors in the Fifth Circuit. For seven weeks, when the July opinion was good law, a chapter 7 debtor who liquidated exempt property was in peril even if the case had been closed and the time for objecting to exemptions had long since passed.
The new opinion establishes two principles in the Fifth Circuit. As we will discuss later, the holding in In re Frost, 744 F.3d 384 (5th Cir. 2014), is now limited to chapter 13 cases, and In re Zibman, 268 F.3d 298 (5th Cir. 2001), does not apply to cases where the time for objecting to exemptions has elapsed.
The Facts
The case involved a couple who filed a chapter 7 petition with about $130,000 in an individual retirement account, or IRA. They scheduled the IRA as exempt under Texas law. There were no objections to the claimed exemption, and the trustee eventually issued a no-asset report.
Starting a few days before filing and continuing for seven months, the couple withdrew all the money from the IRA, spent most of it on living expenses, and did not reinvest any proceeds in another IRA.
Learning that the IRA had been liquidated and not reinvested, the trustee demanded that the couple turn over the IRA proceeds, because Texas law provides that withdrawals from an IRA must be reinvested in another IRA within 60 days to retain their exempt character. When the trustee made her demand, the debtors still held about $30,000 in proceeds from the IRA.
The bankruptcy judge ruled in favor of the trustee and required the couple to turn over the $130,000. The district court affirmed.
The Original Panel Opinion
The original panel opinion from July was based largely on Frost, where a couple owned a home when they filed a chapter 13 petition. Later, they sold the home but did not reinvest the proceeds in another exempt homestead. Without saying in the opinion whether the case was in chapter 7 or 13, the Fifth Circuit held in Frost that the proceeds lost their exempt status, relying in part on Zibman, discussed below.
Lower courts were divided on whether Frost also applied to chapter 7 cases. Some courts believed that Frost should apply only in chapter 13 cases because Section 1306(a)(1) brings after-acquired property into the estate. Since there is no counterpart in chapter 7, those courts would not invoke Frost in chapter 7 cases.
The original panel opinion in July, written by Circuit Judge Edward C. Prado, resolved the issue by holding that Frost applied equally in chapter 7. The appeals courts developed the notion of conditionally and unconditionally exempt property.
Unconditionally exempt property, like an IRA or a homestead, could become conditionally exempt on being sold or liquidated. If proceeds were not reinvested in exempt property within the time permitted by state law, the conditionally exempt money would lose its exempt character.
Arguably splitting with every other circuit and seemingly abandoning the snapshot rule, the original panel opinion in effect held that exemptions never become final even if the time for objection has run out.
The original opinion was important because it meant that debtors in Texas and perhaps elsewhere could not take money from an IRA until after the chapter 7 case was closed. It also meant that a chapter 7 debtor in Texas could not sell an exempt homestead after filing because it would lose the exemption if the proceeds were not reinvested in a new homestead within six months.
Even after the chapter 7 case had been closed, a trustee could reopen the case and demand turnover. Following the July decision, it was unclear how long debtors were required to hold exempt property even after a chapter 7 case was closed.
The Motion for Rehearing
On August 2, the husband moved for panel rehearing and rehearing en banc, supported by an amicus brief filed by Prof. Christopher G. Bradley of the Univ. of Kentucky College of Law, retired Bankruptcy Judge Leif M. Clark, and attorneys Stephen W. Sather and Michael Baumer, both of Austin.
The last brief on the rehearing petitions was filed on Aug. 21. Without holding oral argument, the panel issued its 14-page per curiam opinion on Sept. 5, withdrawing the prior opinion, reversing the bankruptcy court, remanding the case, and denying the petition for rehearing en banc. In effect, the panel reversed its prior opinion and allowed the debtors to retain all proceeds from the liquidated IRA.
The Rationale after Rehearing
Originally mandated by the Supreme Court in White v. Stump, 266 U.S. 310 (1924), and largely ignored in the prior opinion, the new opinion reaffirmed the snapshot rule, which in substance provides that exemptions are fixed on the filing date. The appeals court then examined Frost and Zibman, ultimately limiting the holdings of both.
Zibman, which predated Frost, concerned debtors who sold their exempt homestead two months before filing a chapter 7 petition but did not reinvest the proceeds in another home. The appeals court held that the proceeds lost their exempt status because the Texas statute protects only a homestead, not proceeds of a homestead.
The new opinion then did what Frost did not do: It limited the holding to chapter 13 because after-acquired property is not brought into a chapter 7 estate. The new opinion characterized the IRA proceeds as a newly acquired property interest.
Since the time for objecting to exemptions had expired, the new opinion said “there was no means by which the [debtors’] newly acquired property interest [in the IRA proceeds] could become part of the chapter 7 estate.”
The new opinion emphasized how Zibman dealt with debtors who had sold their home before filing, giving them only a conditional exemption on the filing date. The new opinion thus limits Zibman to situations where an exempt asset is sold before bankruptcy but not reinvested in another exempt asset within the time allowed by state law.
Finality of Exemptions Emphasized
The new opinion helps debtors generally because the appeals court emphasized the finality resulting from the lack of objections to exemptions.
The debtors had liquidated some of the IRA before filing, thus giving the trustee an opening to demand turnover of those moneys, based on Zibman. Nonetheless, the new opinion allowed the debtors to retain even those proceeds. Because the trustee “did not timely object to the claimed exemption,” she “could not contest the exemption’s validity after the time for objection passed,” the opinion says.
Consequently, the new opinion also limits Zibman to cases where the time for objection to exemptions has not elapsed.
The new opinion emphasizes the differences between chapters 7 and 13. The per curiam opinion says the two chapters “are not meant to always yield the same results.”
With regard to after-acquired property, the opinion holds that “a new property interest the debtor acquires after filing for bankruptcy becomes part of the estate in a chapter 13 case but does not become part of the estate in a chapter 7 case, even if the debtor acquires the new property by transforming a previously exempted asset into a nonexempt one.”
The debtor was represented by William P. Haddock from Pendergraft & Simon LLP in Houston.
To read ABI’s coverage of the July opinion and the motion for rehearing, click here and here.