Laying the groundwork for a split of circuits, the Tenth Circuit Bankruptcy Appellate Panel built on Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017), and Law v. Siegel, 134 S. Ct. 1188 (2014), by holding that a chapter 7 trustee cannot scheme with secured creditors to sell a home out from underneath a debtor without paying the homestead exemption in full, even when there is little or no equity in the property above secured debt.
If there is another appeal and the Tenth Circuit rules the same way, there will be a split with the Sixth Circuit on the question of whether a debtor can claim a homestead exemption without having any equity in the property. A split would also enable the Supreme Court to decide whether a trustee can sell a home without paying a homestead exemption in full.
Unless the Sixth Circuit reverses course or the Supreme Court takes up the issue, individuals who file chapter 7 petitions in four states are at risk of losing their homes even if the sale price will not pay their exemptions in full. Homeowners in six states are shielded from the same fate unless the Tenth Circuit reverses the BAP.
The Trustee’s Scheme to Generate Fees at the Debtor’s Expense
In two chapter 7 cases filed about the same time, the debtors each owned homes, which they scheduled as having values somewhat less than the sum of mortgages and tax liens on the properties. The debtors claimed homestead exemptions, however.
The trustee appointed in both cases found buyers who were offering to pay about $5,000 more than the encumbrances on both properties. The trustee also negotiated a stipulation with the Internal Revenue Service where the government consented to the sale of the properties and agreed to carve out $10,000 in each case for distribution to unsecured creditors. In addition, the IRS agreed to a further $60,000 reduction in the government’s recovery on its tax liens in each case by allowing the trustee to pay his fees and the real estate broker’s commissions from the sale proceeds.
If the sales had been approved, the debtors would have received nothing for their homestead exemptions, while the trustee and broker together would have taken home more than $60,000 for their services in each case. Unsecured creditors would have recovered only $10,000 in each case.
For the debtors, the proposed deal was worse than simply losing their homes without anything for their homestead exemptions. The government’s agreement to carve out $10,000 for unsecured creditors and allow payment of the fees would have increased the debtors’ nondischargeable tax debts and left them with no equity to apply toward the purchase of new residences.
The future looking bleak, the debtors both prevailed on the bankruptcy judge to convert their cases to chapter 13. Conversion mooted the trustee’s incipient sale motions. In both cases, the bankruptcy judge upheld the debtors’ homestead exemptions, over the trustee’s objections. The conversion to chapter 13 mooted the trustee’s appeals from the homestead exemption rulings.
Following conversion, the chapter 7 trustee filed applications for allowances of more than $30,000 in compensation in each case for himself and his counsel. In an encyclopedic opinion on Dec. 14, 2016, Chief Bankruptcy Judge R. Kimball Mosier of Salt Lake City ruled that a trustee cannot sell an individual debtor’s home without paying the homestead exemption in full, in cash.
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 substance, he explained why he would not have approved the sales had the debtors not converted the cases to chapter 13. To read ABI’s discussion of Judge Mosier’s opinion, click here.
The trustee appealed to the Tenth Circuit BAP but lost again in a Nov. 30 opinion by Bankruptcy Judge Sarah A. Hall. The BAP reached the same result in barring a trustee from selling overencumbered property, albeit on somewhat narrower grounds than Judge Mosier.
Abandon, Don’t Sell Without Equity
To determine whether the trustee was entitled to compensation, Judge Hall analyzed Section 330(a)(4)(A), which bars the allowance of compensation if the services “were not reasonably likely to benefit the debtor’s estate [or] necessary to the administration of the case.”
Regarding the necessity of the trustee’s services, Judge Hall held that “abandonment of the homesteads would have better comported with a chapter 7 trustee’s ultimate duties and responsibilities.” The Bankruptcy Code, abundant caselaw, and the Handbook for Chapter 7 Trustees promulgated by the Office of the U.S. Trustee Program “emphatically” supported the bankruptcy court’s decision, Judge Hall said.
Judge Hall cited the Handbook for the proposition that a trustee should abandon property when liquidation would not produce a “meaningful” distribution for unsecured creditors. Similarly, she cited caselaw holding that a sale of fully encumbered property is generally prohibited, to prevent trustees from generating fees for themselves in a sale that produces nothing for unsecured creditors.
With regard to the Bankruptcy Code, Judge Hall said that equity for unsecured creditors “is what authorizes a trustee to exercise his powers of sale under Section 363 in the first place, because liquidation should not be for the benefit of the estate’s secured creditors.” Although a carve-out for unsecured creditors might be appropriate in some circumstances, she said that an agreement with a secured creditor to create equity “is suspect and presents opportunities for collusion.”
Since the proposed sale would have benefitted primarily the trustee and secured creditors, Judge Hall concluded that the services were not necessary in the administration of the estates.
Again unsuccessfully, the trustee contended that his services were nonetheless reasonably likely to benefit the estate.
On that issue, Judge Hall said that the bankruptcy court’s finding of lack of benefit to the estate was not reversible error, “regardless of whether its legal determinations were correct or incorrect.”
The trustee argued that his services benefited the estate, based on the notion that the debtors lacked equity and were not entitled to homestead exemptions.
Under Utah and federal law, exemptions must be liberally construed in favor of debtors, Judge Hall said. Under Utah law, she said that debtors are entitled to homestead exemptions even if they have no equity in their homes. The exemption, she said, arises from title and possession, although the exemption is limited in dollar amount.
Therefore, the trustee was not entitled to compensation under Section 330(a)(4)(ii) because there was no benefit to the estate, since the trustee should have abandoned the properties.
The trustee also argued there could have been benefit to the estate because he could have sold the properties under Section 363(f).
There was no bona fide dispute, and therefore no ability to sell under Section 363(f)(4), because, Judge Hall said, the bankruptcy court had upheld the debtors’ homestead exemptions, among other things.
Similarly, there was no right to sell under Section 363(f)(5), which would have applied were the debtors compelled to accept monetary satisfaction for their interests.
The Utah exemption statute does not permit a sale unless the price would pay the exemption in full. The trustee therefore could not have sold under Section 363(f)(5), thus shutting the door to the idea that the trustee could have conferred benefit on the estate.
Judge Hall upheld the denial of all the trustee’s requested fees by saying it made “no sense whatsoever to sell the homesteads and incur administrative expenses [of about $60,000 in each case] in order to get only $10,000 to unsecured creditors and at the same time deny debtors their homesteads.”
“All bankruptcy professionals,” she said, “must exercise billing judgment.”
Significant Circuit Splits in the Offing
If the trustee appeals again and if the Tenth Circuit affirms, there will be a split of circuits on two major issues.
In Brown v. Ellmann (In re Brown), 851 F.3d 619 (6th Cir. March 20, 2017), the Sixth Circuit decided a strikingly similar case with a diametrically opposite result. In Brown, the debtor had owned an overencumbered home, but she did not initially claim a homestead exemption. Instead, she originally signaled her intention to surrender the house.
The trustee in Brown cobbled together a deal to sell the home for less than the first mortgage. The first mortgagee agreed to take a haircut on the senior mortgage, carve out $6,000 for the second mortgagee, and leave a small surplus for unsecured creditors. The debtor later claimed an exemption and opposed the sale, unsuccessfully.
The Sixth Circuit upheld the sale, holding that the debtor was not entitled to claim a homestead exemption under Michigan without equity in the property. Aside from the distinction that the two cases arose under the exemption laws of different states, the Tenth Circuit BAP split with the Sixth Circuit on the validity of a homestead exemption in the absence of equity in the property.
More fundamentally, the Sixth Circuit allowed selling a home out from underneath a debtor without paying the homestead exemption in full, whereas the Tenth Circuit BAP would not allow a sale under analogous circumstances.
Brown also widened a split in its own right by holding that a sale order is not automatically mooted by Section 363(m) if the appellate court can grant some relief without affecting the validity of the sale.
The Tenth Circuit BAP cited to Brown in passing, but without addressing in depth how the two cases reached fundamentally different results.
To read ABI’s discussion of Brown, click here.
Jevic and Siegel Influence the BAP
The BAP buttressed its conclusions by referencing two recent Supreme Court decisions.
In a passing reference, the BAP said that “Jevic stands for the proposition that neither the parties, nor the courts, are free to circumvent the Bankruptcy Code’s rules and policies regarding priorities and distributions through manipulation of substantive and procedural protections.” The reference to Jevic in a footnote shows that the high court’s decision on limiting structured dismissal informs the result in other contexts, such as exemptions.
The BAP also cited Law v. Siegel for the idea that homestead exemptions are “sacrosanct” and can be denied “only on statutory bases enumerated in the Bankruptcy Code.”
Although the BAP case was not “strictly analogous” to Law v. Siegel, Judge Hall said the effect was the same: “to deprive debtors of their homestead exemptions on a basis other than one enumerated in the Code.”
Moreover, she said, the debtors had not been accused of any fraudulent behavior, like the debtor in Law v. Siegel. The “scheme” to sell the homes by negotiating with the IRS was “nothing more than an attempt to do indirectly what the Bankruptcy Code and Utah exemption statutes prevent him from doing directly.”
On behalf of the National Consumer Bankruptcy Rights Center and the National Association of Consumer Bankruptcy Attorneys, Tara A. Twomey submitted an amicus brief on behalf of the debtors.