The courts are split on allowing a trustee to sell a home with no equity over an objection by the chapter 7 debtor. Without resolving the ultimate question, Bankruptcy Judge Robert E. Grossman of Central Islip, N.Y., ruled that the debtor’s homestead exemption does not by itself prevent the trustee from selling.
The debtor had been in mortgage default for years. After the entry of a judgment of foreclosure, she filed a chapter 7 petition and scheduled the property as being worth about $2.2 million. She listed the mortgage debt for some $2.5 million. The lender filed a secured proof of claim for $2.9 million.
The debtor conceded that she had no equity in the property. She claimed a homestead exemption but stated that she intended to surrender the property. The trustee filed a report of no distribution and abandoned the home. The debtor received her discharge.
After discharge, the trustee filed a motion for permission to sell the home to the lender, who would pay the estate’s administrative expenses. In addition, the lender would give the trustee some undermined amount of money “to enable some distribution to unsecured creditors of the estate,” Judge Grossman said in his September 25 decision.
The trustee said he was unable to peg the give-up by the lender because the debtor had not allowed access to the property for performing a valuation.
The debtor objected to the sale motion, contending that the give-up belonged to her in satisfaction of her homestead exemption.
Judge Grossman might have denied the sale motion without prejudice because the trustee as yet had no agreement to sell. Instead, he treated the debtor’s objection like a motion to dismiss and denied the motion because, in his view, a homestead exemption alone does prevent the sale of overencumbered property.
Courts indeed are split over a trustee’s right to sell overencumbered property. In Brown v. Ellmann (In re Brown), 851 F.3d 619 (6th Cir. 2017), the Sixth Circuit allowed a sale with no recovery by the debtor on her homestead exemption. To read ABI’s report, click here.
On the other side of the fence eight months later, the Tenth Circuit Bankruptcy Appellate Panel refused to allow a sale of property when the debtor’s homestead exemption was not being paid in full, even though the lender would have made a carveout for unsecured creditors. Jubber v. Bird (In re Bird), 577 B.R. 365 (B.A.P. 10th Cir. 2017). To read ABI’s report, click here.
Judge Grossman identified the issue as whether “the proceeds of a short sale of a debtor’s residence that a mortgagee gives up to the estate pursuant to an agreement negotiated by a chapter 7 trustee [is] subject to the debtor’s homestead exemption and payable to the debtor.”
Judge Grossman acknowledged the “general rule” that a trustee should not administer fully encumbered property “only for the benefit of a secured creditor.” On the other hand, he said there was “no per se prohibition against a trustee using his statutory power to create new value for unsecured creditors.”
Selling short with a carveout for unsecured creditors falls “squarely within the trustee’s principal duty to maximize a return for unsecured creditors,” Judge Grossman said. Before bankruptcy, the debtor had the same ability to permit foreclosure in return for a payment from the lender, he said.
Although the trustee could sell, would the proceeds belong to the debtor in view of her homestead exemption?
Judge Grossman decided that the carveout did not arise “from any equity in the Property but from an agreement essentially monetizing the Trustee’s power under the Code to dispose of the Property utilizing the section 363 process.” He added that the deal with the lender “creates value for the estate where none existed.”
Judge Grossman therefore held that “the Trustee has the authority to negotiate a give-up with a mortgagee for the benefit of the estate. The Court further finds that those funds are not properly characterized as proceeds of the sale of real property, but rather are attributable to the rights and powers of the trustee granted to him under the Code and exercised by him for the benefit of the estate.”
The decision does not mean that the trustee can sell under any terms. Not yet knowing the “net benefit to the estate,” Judge Grossman said he was not deciding whether the eventual agreement with the lender “will ultimately be approved by the Court considering the salient terms of the agreement.”
In other words, Judge Grossman said at the end of the opinion that his discretion “will be exercised with fairness and compassion.”
The courts are split on allowing a trustee to sell a home with no equity over an objection by the chapter 7 debtor. Without resolving the ultimate question, Bankruptcy Judge Robert E. Grossman of Central Islip, N.Y., ruled that the debtor’s homestead exemption does not by itself prevent the trustee from selling.
The debtor had been in mortgage default for years. After the entry of a judgment of foreclosure, she filed a chapter 7 petition and scheduled the property as being worth about $2.2 million. She listed the mortgage debt for some $2.5 million. The lender filed a secured proof of claim for $2.9 million.
The debtor conceded that she had no equity in the property. She claimed a homestead exemption but stated that she intended to surrender the property. The trustee filed a report of no distribution and abandoned the home. The debtor received her discharge.
After discharge, the trustee filed a motion for permission to sell the home to the lender, who would pay the estate’s administrative expenses. In addition, the lender would give the trustee some undermined amount of money “to enable some distribution to unsecured creditors of the estate,” Judge Grossman said in his September 25 decision.