On an issue where the lower courts are split, a district judge on Long Island, N.Y., reversed the bankruptcy court by holding that a debtor is entitled to a homestead exemption in sale proceeds when the mortgage lender offers to buy the home and voluntarily takes a haircut designed to create an estate for unsecured creditors and the trustee’s commission.
The debtor’s mortgage was long in default. After judgment of foreclosure, the debtor filed a chapter 7 petition and scheduled the property as being worth about $2.2 million. She listed the mortgage debt as some $2.5 million. The lender filed a secured proof of claim for $2.9 million.
Conceding she had no equity in the property, the debtor claimed a New York homestead exemption of $170,825 but stated that she intended to surrender the property. The trustee abandoned the home and filed a report of no distribution. The debtor received a discharge.
Two weeks later, the trustee withdrew his report and filed a motion for permission to sell the home to the mortgage lender, which promised to pay the estate’s administrative expenses. To create grounds for selling over-encumbered property, the lender offered to give the trustee an undetermined amount of money to permit some distribution to unsecured creditors.
The trustee told the bankruptcy court that he could not value the property and quantify the amount of the give-up because the debtor was denying access to the property, perhaps based on the idea that the trustee had abandoned the home.
The debtor objected to the sale motion, arguing that she was entitled to payment of her homestead exemption from the sale. The bankruptcy court denied the objection, ruling that carve-outs were sometimes permitted and that the exemption did not apply. In re Stark, 20-70948, 2020 BL 368946, 2020 Bankr. Lexis 2520, 2020 WL 5778400 (Bankr. E.D.N.Y. Sept. 25, 2020). For ABI’s report on the bankruptcy court’s opinion, click here.
District Judge Eric Komitee of Central Islip, N.Y., reversed in an opinion on June 28. Presaging the result of his reversal, Judge Komitee said that the trustee “may . . . no longer to seek to sell the property through the bankruptcy process because he may decide that the secured creditors would not benefit.”
Appellate Jurisdiction
Appellate jurisdiction was an issue because the decision by the bankruptcy court did not resolve the entire controversy. The bankruptcy court had only denied the exemption but had not ruled on the proposed sale, for which no price had been given.
Judge Komitee cited the Second Circuit for holding that an order granting or denying an exemption is final. He said that every other circuit to reach the question has had the same conclusion.
Judge Komitee found appellate jurisdiction under 28 U.S.C. § 158(a)(1) to review a final order denying the claim of exemption.
The Merits Regarding the Homestead Exemption
On the merits, Judge Komitee said there were two issues. Whether carve-outs are ever permissible was the first. He said that “courts generally have found such arrangements permissible, though disfavored.”
Judge Komitee did not reach the issue because the debtor did not object to the sale as long as she recovered her homestead exemption from the proceeds.
Even if carve-outs are permissible, the second question asked whether the debtor would be entitled to her homestead exemption “before any creditors are paid.” Judge Komitee’s opinion explained that the debtor “would be entitled to her homestead exemption in a carve-out deal, because the value of the carve-out is ultimately derived from equity in the Property as defined by New York law.”
Judge Komitee quoted the New York law as providing a homestead exemption “in value above liens and encumbrances.” The statute, he said, “speaks to equity in the residence,” and the debtor had no equity on the filing date. But that wasn’t the end of the analysis.
Judge Komitee inquired as to “whether the give-up that the Trustee negotiates is extracted from ‘value’ in the ‘property’ that is covered by the New York homestead exemption.” If it does not come from the land and buildings, he said, then “where does it come from?”
The bankruptcy court had reasoned that the give-up derived from the trustee’s power to sell. Judge Komitee cited bankruptcy courts coming down both ways on the issue.
Judge Komitee said that the buyer was not giving value for the trustee’s sale power. Rather, the buyer was paying for the trustee’s ability to deliver ownership of the property more quickly and at a lower cost than through foreclosure.
Alluding to the time-value of money and the cost of foreclosure, Judge Komitee said:
[T]he correct answer, in my view, is that in exchange for the carve-out, the Trustee is delivering the sale of the Property outside a
foreclosure proceeding. Said differently, the Trustee is trading away, in exchange for the carve-out, [the debtor’s] right to remain in the
Property for an extended period without making mortgage payments; her right to exclude others during that period; and the like.
Describing the value in that manner, Judge Komitee said “it is clear that the value resides in the homeowner’s ‘property’ rights in the house, and is thus protected by the homestead exemption.” He elaborated:
When the Trustee trades away those rights via the section 363 sale process, he is trading away the same “property” referred to in the
New York homestead exemption.
Having decided that the trustee was selling value in the homestead belonging to the debtor, Judge Komitee next addressed the trustee’s argument that no homestead exemption existed on the filing date because there was no equity on the filing date.
Judge Komitee rebutted the trustee’s argument by citing to authority for the proposition that the value of exempt property is not frozen on the filing date. If a home’s values rises after filing, the debtor is entitled to the appreciation as part of the homestead exemption.
“By their very nature,” Judge Komitee said, “carve-out arrangements do the same thing; the secured creditor’s agreement to accept less money upon a sale creates equity in the home where none existed before.”
Judge Komitee reversed and remanded.
Observations
Judge Komitee’s opinion likely means there can be no short sales unless the price covers the entire homestead exemption or whatever smaller amount a debtor might permit. If the exemption is not fully covered, thus creating no estate for unsecured creditors, a bankruptcy court would presumably deny a sale motion on the principle that chapter 7 courts do not liquidate over-encumbered property.
We invite readers to compare the decision by Judge Komitee to the June 17 nonprecedential opinion by the Ninth Circuit Bankruptcy Appellate Panel in Babaee v. Marshack (In re Babaee), 21-1230, 2022 BL 211184 (B.A.P. 9th Cir. June 17, 2022). To read ABI’s report, click here.
In Babaee, the BAP held that the debtor had neither constitutional nor prudential standing to appeal an order selling an over-encumbered home. Notably, the BAP accorded no value to the debtor’s ability to prolong foreclosure or the possibility that the debtor could extract consideration from the lender in return for title.
Judge Komitee recognized the realities of litigation and foreclosure. Sometimes, theoretical rights like foreclosure are encumbered by the real world. The judge’s grounding in reality may have resulted from his service as the Chief of the Business and Securities Fraud Section in the office of the U.S. Attorney for the Eastern District of New York.
On an issue where the lower courts are split, a district judge on Long Island, N.Y., reversed the bankruptcy court by holding that a debtor is entitled to a homestead exemption in sale proceeds when the mortgage lender offers to buy the home and voluntarily takes a haircut designed to create an estate for unsecured creditors and the trustee’s commission.
The debtor’s mortgage was long in default. After judgment of foreclosure, the debtor filed a chapter 7 petition and scheduled the property as being worth about $2.2 million. She listed the mortgage debt as some $2.5 million. The lender filed a secured proof of claim for $2.9 million.
Conceding she had no equity in the property, the debtor claimed a New York homestead exemption of $170,825 but stated that she intended to surrender the property. The trustee abandoned the home and filed a report of no distribution. The debtor received a discharge.
Two weeks later, the trustee withdrew his report and filed a motion for permission to sell the home to the mortgage lender, which promised to pay the estate’s administrative expenses. To create grounds for selling over-encumbered property, the lender offered to give the trustee an undetermined amount of money to permit some distribution to unsecured creditors.
The trustee told the bankruptcy court that he could not value the property and quantify the amount of the give-up because the debtor was denying access to the property, perhaps based on the idea that the trustee had abandoned the home.