A Pending Sale Contract Doesn’t Obliterate a Homestead Exemption in Chapter 7

Signing a contract before bankruptcy to sell a home will not destroy a chapter 7 debtor’s homestead exemption, according to Bankruptcy Judge Louis A. Scarcella of Central Islip, N.Y.

Before bankruptcy, the debtor signed a contract to sell her residence, which she claimed to be exempt under New York law. In that region of New York, the maximum homestead exemption was about $165,000 at the time. The debtor claimed a monetary exemption of about $125,000, representing the difference between her claimed value of the home and the encumbrances.

Were the house actually sold under the contract, the net proceeds would have been less than $150,000, still within the maximum New York homestead exemption.

The trustee objected to the exemption, contending that the state exemption did not apply because the debtor did not intend on living in the home indefinitely, as shown by the sale contract. The trustee also sought to be substituted as the seller so he could distribute the net proceeds to creditors.

As it turned out, the sale never closed. The debtor terminated the contract and returned the buyer’s deposit. On several grounds, the trustee persisted in objecting to the exemption.

In his December 27 opinion, Judge Scarcella overruled the exemption.

The New York Exemption

Judge Scarcella said that exemptions are determined in chapter 7 as of the filing date, citing the so-called snapshot rule. Because the debtor lived nowhere else, owned the home, and still resided in the home on the filing date, he said she was entitled to the homestead exemption.

The trustee contended that New York law requires an intent to live in the home indefinitely. According to the trustee, the debtor was not entitled to the exemption because the contract showed she did not intend on continuing to reside in the home.

Judge Scarcella said that courts in New York squarely disagreed with the trustee and have held that state law requires no intent to reside in a home permanently. Intent to reside is only a question, he said, when the debtor owns more than one home.

Judge Scarcella said the trustee’s argument was “reasonable but, in the end, unconvincing.” He said that “bankruptcy courts in this circuit have been steadfast in holding that a debtor is entitled to the homestead exemption despite having entered into a prepetition contract of sale so long as the debtor owned and occupied the homestead on the petition date.”

Judge Scarcella therefore held that the “existence of a prepetition contract of sale is immaterial if the debtor still owns and resides at her principal residence on the petition date.”

The Fourteenth Amendment Argument

The trustee argued that New York law violated the Equal Protection Clause of the Fourteenth Amendment, because debtors in different circumstances are treated differently. Someone who sells a home can exempt about $165,000, while a debtor who does not own a home may exempt only about $5,500 in cash.

Although invited to participate, the New York Attorney General declined to submit a brief.

To establish a Fourteenth Amendment claim, Judge Scarcella said that the trustee “must prove that this alleged disparate treatment is without any rational basis.” He proceeded to dismiss the constitutional argument, finding a “rational basis for any perceived difference in treatment” between someone who exempts the cash proceeds of a sale and a debtor who owns no home and only claims the minimal cash exemption.

The Voluntary Sale Argument

Because state law does not exempt proceeds from a voluntary sale outside of bankruptcy, the trustee contended the same result should apply when a debtor sells a home during bankruptcy. 

Again, Judge Scarcella disagreed, because the argument ignores the snapshot rule. He also relied on Section 522(c).

Unless the case is dismissed, that section provides that exempt property “is not liable during or after the case” for any debt incurred before filing.

Judge Scarcella therefore overruled the objection to the debtor’s homestead exemption.

The Dicta

In a statement that may be dicta at the end of the opinion, Judge Scarcella said that the debtor could exempt up to $165,000 in net proceeds if she were to sell the home voluntarily “during her bankruptcy case.”

However, the amount of the exemption may not matter. After discharge, the debtor would only be liable for any debts that were excepted from discharge. Thus, she theoretically could retain proceeds in any amount if she had no surviving claims.

For the amount of the exemption to matter, the trustee must have objected to the homestead exemption and prove there was equity in the property above $165,000. Assuming the trustee did not challenge the amount of the exemption in a timely objection, the trustee presumably could not claim excess proceeds if the debtor were to sell her home after bankruptcy, even if the case were still pending.

Relevant authority on the issue is found in Hawk v. Engelhart (In re Hawk), 871 F.3d 287 (5th Cir. 2017), where the Fifth Circuit held that an individual retirement account, exempt 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. Six months later, the Fifth Circuit expanded Hawk to protect proceeds of a homestead sold after a chapter 7 filing. Lowe v. DeBerry (In re DeBerry), 884 F.3d 526 (5th Cir. March 7, 2018). For ABI’s discussions of Hawk and DeBerry, click here and here.