Bankruptcy Judge Jeff Bohm of the U.S. Bankruptcy Court for the Southern District of Texas, Houston Division, recently rendered an opinion that has the potential to significantly affect homestead rights. In re Presto, __ B.R. __, No. 06-33618, 2007 WL 2913316 (Bankr. S.D. Tex. Oct. 5, 2007). The opinion, which appears to be a matter of first impression, analyzes changes related to homestead rights under §522 of the Bankruptcy Code that were enacted under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). Judge Bohm held that where the debtor owed a debt arising from fraud committed while acting in a fiduciary capacity at the time his bankruptcy petition was filed, his homestead exemption was capped at $125,000. Importantly, there was no finding that the fraud was related to the homestead. Accordingly, it appears that if any debt arising from fraud that is committed while acting in a fiduciary capacity remains unpaid at the time the bankruptcy petition is filed, a debtor runs the risk of losing an unlimited homestead exemption (such as allowed in the state of Texas). Also interestingly, Judge Bohm ordered that the debtor was entitled to a cash exemption in the capped amount of $125,000 and found that the remainder of the value belonged to the estate, setting the stage for a sale of the property.
Relevant Factual Findings
Prior to filing bankruptcy, the debtor, Kevin Presto (Presto), a former executive at Enron, entered into an agreed divorce decree that stated each of the spouses was entitled one-half of any refund check issued by the Internal Revenue Service for overpayment of taxes for any year during which the parties were married. The decree also stated that if one of the spouses received a refund check, that spouse held the proceeds in constructive trust for the benefit of the other spouse to the extent of his or her share of the refund, and must pay that share to the other spouse within five days of receipt of the refund check.
In 2005, Presto prepared a tax return for the tax year 2002, a year in which he was married to Evelyn Presto (Evelyn) and signed her name to the return without her knowledge or consent. The Treasury Department issued a refund payable to “Kevin M. & Evelyn L. Presto.” Presto received the refund check, endorsed it with Evelyn's signature, again without her knowledge or consent, and deposited it into his own account.
Presto first notified Evelyn of the refund after he filed for bankruptcy and after having been served with discovery requests. Presto attempted to reach an agreement for payment of the amount due over 12 months, but that was rejected and he eventually paid her the full sum owing. The check to Evelyn paying off the debt was written on Feb. 10, 2007, the Unsecured Creditors’ Committee filed its objection to Presto’s claim for a homestead exemption on Feb. 16, 2007, and the check to Evelyn cleared Presto’s account on Feb. 20, 2007.
Presto asserted that he had written a check to Evelyn for her share of the refund shortly after he received the check but that it must have been lost in the mail. She had received three other checks from Presto around the same time but they were mailed in separate envelopes and two went through a state agency because they were child support payments.
Legal Analysis
Section 522(q) of the Bankruptcy Code, post BAPCPA, provides that “…a debtor may not exempt any amount of an interest in [its homestead] which exceeds in the aggregate $125,000 if … the debtor owes a debt arising from … fraud, deceit or manipulation in a fiduciary capacity….” 11 U.S.C. §522(q)(1)(B)(2). After first finding that the committee had standing to object to the homestead exemption, Judge Bohm stated that it must show (1) Presto owed Evelyn a fiduciary duty; and (2) he committed fraud, deceit or manipulation while acting in his fiduciary capacity.
The Fiduciary Duty
Judge Bohm first rejected the committee’s argument that the debtor’s homestead exemption must be limited to $125,000 if he has incurred a debt for any fraud, deceit or manipulation. Instead the debt must be incurred while the debtor was acting either in a fiduciary capacity or in connection with the purchase or sale of any registered security.
He also rejected the committee’s argument that the debtor was acting in a fiduciary capacity, based solely on the language of the divorce decree, when he received the tax refund. The language in the divorce decree was insufficient to create a fiduciary relationship because constructive trusts are equitable remedies and do not create actual fiduciary relationships. In contrast, traditional trusts create an actual fiduciary relationship.
Nevertheless, the court found that a fiduciary relationship existed based on provisions in the Texas Family Code, which provides that “the subsequent actual receipt by the non-owning party of property awarded to the owner in a decree of divorce or annulment creates a fiduciary obligation in favor of the owner and imposes a constructive trust on the property for the benefit of the owner.” Id. at *27 (emphasis in original). Accordingly, Presto owed a fiduciary duty to Evelyn upon his receipt of the refund check.
Acts of Fraud, Deceit and Manipulation
Judge Bohm also found that Presto committed fraud, deceit or manipulation while acting in his fiduciary capacity. He first found that fraud and deceit, although listed separately, are synonymous (per the Restatement of Torts) and both require “proof of six elements: (1) a material representation, (2) that was false, (3) that the speaker knew was false or was made recklessly without knowledge of its truth or falsity, (4) with the intent to have the other party rely, (5) actual reliance by the other party, and (6) damages.” Id. at *28. Judge Bohm noted that although the forgery of both the tax return and the endorsement of the check were “deplorable and patently fraudulent,” the relevant time frame to consider was after the refund check had been cashed because that is when he acted in a fiduciary capacity. Id. During this time frame there was an intentional concealment where a duty to disclose existed (per the divorce decree). Judge Bohm did not believe the debtor’s “trite” defense that the check was lost in the mail, and noted there was no persuasive evidence to support such an argument. He then held, in a rather conclusory fashion, that the concealment of the existence of the refund satisfied the first five elements of fraud and deceit. Id.
With regard to the sixth element—damages—Presto argued that “owes” as used in §522(q) requires that a debtor owe the debt at the time the objection to the exemption is filed and that because he had repaid Evelyn all amounts owing before the committee objected to the exemption, §522(q) did not apply. Judge Bohm rejected this argument finding that §522(q) “has both a deterrent and punitive effect.” Id. at *30. Under Presto’s interpretation, any debtor could “conceal such debts by not scheduling or otherwise disclosing them, and after such debts are uncovered, avoid the impact of §522(q) by simply paying off that debt.” Id. Instead, as held by Judge Bohm, “owes” means that the debt is owed on the date the petition is filed without regard to any payments on that debt that were made post-petition, which is also consistent with Fifth Circuit law holding that the right to exemptions is to be determined by the facts as they existed on the petition filing date. Id.
With regard to manipulation, Judge Bohm noted that there is no state or federal common law defining such a cause of action, so he looked to the common meaning of the word (found in Merriam-Webster’s dictionary). Id. at *31. It is “a change by artful or unfair means so as to serve one’s purpose,” a much lower standard of proof than common law fraud. Id. Because the standard is lower than that for fraud, the facts outlined within the fraud analysis above also make a sufficient case for manipulation.
Calculation of Homestead Interest
Judge Bohm concluded by granting Presto a $125,000 cash exemption in the homestead property, but held that the remainder of the value of the property belonged to the estate. In so ruling, he noted that the trustee could not simply be awarded a lien on the property for the value above the $125,000 because there would be an indefiniteness of recovery under §522(q). The recovery to the estate would be unknown until the property was sold and a lien must be given in a specific amount. Therefore, Judge Bohm found that the property was owned by the estate, not the debtor, setting the stage for a sale by the trustee. However, Presto was entitled to the first $125,000 of the sale proceeds as exempt property. Id. at *33.