I have written several times about exempting assets in bankruptcy. The gist is that in a Chapter 7 bankruptcy, the debtor gets to keep all assets that are exempt using the appropriate exemption table, but the Chapter 7 Trustee assigned to the case is empowered to seize and liquidate the nonexempt assets for the benefit of the debtor’s creditors. And in other chapters the value of the nonexempt assets is one of the factors that are used to determine how much the debtor must repay the general unsecured creditors through the plan.
I have also written about the six-month reinvestment requirement for a homestead exemption after a debtor receives the exempt proceeds from the sale of the debtor’s primary residence. The idea here is that if the debtor has nonexempt equity in the primary residence, the Chapter 7 Trustee will sell the property for the benefit of the creditors, and write the debtor a check for the exemption amount; but the debtor must reinvest the proceeds in a new domicile within six months of receiving the check from the Trustee or else the Trustee can reclaim the money.
When the Trustee sells a nonexempt asset, the sale is, from the debtor’s perspective, an involuntary sale.
In this post I will discuss what happens to the homestead exemption when the debtor voluntarily sells the primary residence, either in bankruptcy, or outside of bankruptcy.
I. Voluntary Sale In Bankruptcy
A. Chapter 7
1. The Debtor Cannot Sell Property Of The Estate
In a Chapter 7 bankruptcy the debtor does not have the authority to sell any asset that is part of the bankruptcy estate because the assets in the bankruptcy estate are the responsibility of the Chapter 7 Trustee, who shall:
(1) collect and reduce to money the property of the estate for which such trustee serves, and close such estate as expeditiously as is compatible with the best interests of parties in interest;
(2) be accountable for all property received; . . .
11 U.S.C. § 704(a)(1) and (2).
The debtor cannot arrogate to himself the Trustee’s duties, such as selling estate assets. (I will use the male pronoun for linguistic simplicity ― it’s simpler and more felicitous to the flow than writing the awkward “himself/herself” ― with the understanding that I mean no slight to any women who are reading this post.)
2. The Debtor Can Sell Abandoned Property
Bankruptcy mavens reading this might counter that under 11 U.S.C. § 554 the Chapter 7 debtor might be able to get the authority to sell the property:
(a) After notice and a hearing, the trustee may abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit to the estate.
(b) On request of a party in interest and after notice and a hearing, the court may order the trustee to abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit to the estate.
(c) Unless the court orders otherwise, any property scheduled under section 521(a)(1) of this title not otherwise administered at the time of the closing of a case is abandoned to the debtor and administered for purposes of section 350 of this title.
(d) Unless the court orders otherwise, property of the estate that is not abandoned under this section and that is not administered in the case remains property of the estate.
In each of (a), (b), and (c) the abandonment is the result of a court order (in (c) the order is the order closing the case). Therefore, if there is no court order, there has been no abandonment.
This observation clears up a common misunderstanding about what happens when the Chapter 7 Trustee files a no-asset report after the meeting of creditors under 11 U.S.C. § 341(a). Some people are under the mistaken impression that once the Trustee files a report stating that there are no assets to be liquidated for the benefit of creditors, the debtor is free to dispose of them as he sees fit. However, as § 554(d) makes clear, unless the court orders abandonment, as long as the case remains open the Trustee can still go after assets that turn out to have greater value than the Trustee initially believed. See In re Gebhart, 621 F. 3d 1206 (9th Cir. 2010) for an example of a case in which the Debtor initially was able to exempt the equity in his primary residence, but ended up losing the property because the value increased above the equity exemption amount before the Bankruptcy Court closed the case.
3. Automatic Homestead Versus Recorded Homestead Exemption
Suppose the court ordered the Trustee to abandon the debtor’s principal residence because all of the equity was exempt, making the asset burdensome to the estate. If the debtor were to sell the property what would happen to the proceeds? To answer this question we need to know how the Chapter 7 debtor can exempt the equity in his primary residence.
In a Chapter 7 bankruptcy in California there are two ways to claim a homestead exemption. One way is to claim the automatic homestead exemption under Cal. Civ. Proc. Code § 704.730 if the debtor hasn’t recorded a homestead with the County Recorder’s Office.
The other way is to claim the homestead exemption under Cal. Civ. Proc. Code § 704.950, based on a homestead that was recorded with the County Recorder’s Office prior to filing for bankruptcy protection.
With that as a backdrop, here’s the Ninth Circuit’s position (emphasis added):
In California, however, the automatic homestead exemption protects a debtor only in the context of a forced lien sale. See Cal. Civ. Proc. Code §§ 704.720(b) & 704.740(a); Schwaber v. Reed (In re Reed), 940 F.2d 1317, 1321 (9th Cir. 1991) (“[T]he ‘homestead exemption’ in California is merely a debtor’s right to retain a certain sum of money when the court orders sale of a homestead in order to enforce a money judgment . . .”); Redwood Empire Production Credit Assoc. v. Anderson (In re Anderson), 824 F.2d 754, 757 (9th Cir. 1987). A debtor who seeks homestead protection in the context of a voluntary sale must record a declaration of homestead. See Cal. Civ. Proc. Code § 704.960; Anderson, 824 F.2d at 757. Under California law, should a forced lien sale occur, a debtor will receive his statutory homestead exemption before payment of the judgment lien because a debtor’s homestead exemption is senior in priority to a judgment lien. See Cal. Civ. Proc. Code § 704.850; see also Amiri, 184 B.R. at 63 (“In the event of a forced lien sale, the levying officer is required to distribute the proceeds to pay off all consensual liens and the debtor’s homestead exemption prior to satisfying any judgment liens.”).
(a) A Voluntary Sale And The Automatic Homestead Exemption
The Ninth Circuit’s holding in Wilson means that if the debtor has used the automatic homestead exemption instead of the recorded homestead exemption, and then voluntarily sells the property after court-ordered abandonment, the net proceeds of the sale are not exempt, and are fair game for the Trustee to seize.
You might counter that the proceeds are protected by the abandonment order. But that order protected the exempt home equity, not the nonexempt sale proceeds. Therefore, the safest thing to do is to wait until the case closes before selling the residence because once the Court closes the case the property and any subsequent sale proceeds belong to the debtor. 11 U.S.C. § 554(c)).
Practice Tip: If you’re a homeowner and haven’t already done so, record your homestead.
(b) A Voluntary Sale And The Recorded Homestead Exemption
Based on the Wilson decision, the proceeds from a voluntary sale are exempt if the homestead was recorded prepetition. However, the six-month reinvestment provision of Cal. Civ. Proc. Code § 704.720(b) still applies (emphasis added):
If a homestead is sold . . . the proceeds of sale . . . are exempt in the amount of the homestead exemption provided in Section 704.730. The proceeds are exempt for a period of six months after the time the proceeds are actually received by the judgment debtor, except that, if a homestead exemption is applied to other property of the judgment debtor or the judgment debtor’s spouse during that period, the proceeds thereafter are not exempt.
This means that if the case is still open and the debtor fails to reinvest the proceeds in another domicile within six months of receiving them, the Trustee can swoop on in like a bird of prey and seize the money. Again, it is safest to wait until the case closes to sell the property.
B. Chapter 13
Things are a bit more complicated in the Chapter 13 context.
As a prelude to selling the principal residence the debtor must file a motion for authority to sell real property. If the plan will pay less than 100% of the debtor’s prepetition debts, the Chapter 13 Trustee may insist that as a condition of the sale the debtor devote all net sale proceeds to the plan ― up to the point that the creditors are paid in full.
If the debtor used the recorded homestead exemption, then the debtor may successfully assert a claim to the exempt portion, with the six-month reinvestment caveat waiting in the wings.
But if the debtor used the automatic homestead exemption, then the Trustee may appeal to the Wilson holding and claim that the nonexempt proceeds of the voluntary sale belong to the bankruptcy estate and should be devoted to paying creditors.
In either case the debtor might be able to retain all of the net sale proceeds if the Court accepts the holding in In re Burgie, 239 B.R. 406 (B.A.P. 9th Cir. 1999).
In the first sentence of its opinion the Burgie Court identified the issue at hand:
In this case we must decide whether the unreinvested proceeds from the sale of the debtors’ homestead after the confirmation of the chapter 13 plan constitute “disposable income” that must be used to pay creditors pursuant to a motion by the trustee to amend the plan.
In re Burgie, 239 B.R. at 407.
The Court held that the proceeds did not constitute disposable income within the meaning of 11 U.S.C. § 1325(b)(1) and (2), and therefore didn’t have to be devoted to the plan. This meant that the debtor could retain all of the net proceeds regardless of any homestead exemption, automatic or recorded.
The only problem with appealing to Burgie is Bankruptcy Appellate Panel (“BAP”) cases are not binding on bankruptcy judges, other than the judge from whom the appeal was made. See, e.g., In re Silverman, 616 F. 3d 1001, 1005 (9th Cir. 2010) (It is not Ninth Circuit law that all bankruptcy courts are bound by BAP decisions.) See also, Ozenne v. Chase Manhattan Bank, No. 11-60039 at 14 (9th Cir. March 25, 2016) (“Our court, recognizing the BAP’s narrow jurisdiction, has even concluded that the BAP’s decisions are not binding.”)
This means that if you have a judge who doesn’t find Burgie persuasive, you might not be able to keep the sale proceeds. Of course, you could always appeal an adverse ruling to the BAP, which is bound by its own decisions. But that could lead to expensive litigation, with the potential for the Chapter 13 Trustee to appeal to the Ninth Circuit.
C. Chapter 11
Things are a bit different in a Chapter 11 because the debtor serves as a quasi-trustee called the debtor-in-possession (“DIP”) (No jokes about the way dip is sometimes used as a vulgar pejorative.)
The DIP must get court approval before selling estate assets outside of the ordinary course of the debtor’s business. Unless the sale serves to benefit the estate, i.e., the creditors, the Court might not permit the debtor to retain the nonexempt sale proceeds unless the creditors are all getting paid in full. (This follows from the recent Ninth Circuit holding that the absolute priority rule applies to individual Chapter 11 cases in which the plan is confirmed in spite of the existence of a nonconsenting class.) However, the individual Chapter 11 debtor might appeal to the reasoning in Burgie because of the condition for plan confirmation found in 11 U.S.C. § 1129(a)(15)(B):
In a case in which the debtor is an individual and in which the holder of an allowed unsecured claim objects to the confirmation of the plan — . . . the value of the property to be distributed under the plan is not less than the projected disposable income of the debtor (as defined in section 1325(b)(2)) to be received during the 5-year period beginning on the date that the first payment is due under the plan, or during the period for which the plan provides payments, whichever is longer.
Thus, if the plan is confirmed over the objection of an unsecured creditor and the debtor is devoting all of his disposable income to the plan, he might argue, à la Burgie, that the sale proceeds aren’t disposable income that must be devoted to the plan.
II. Voluntary Sale Outside Of Bankruptcy
If you have no creditors, you’re free to sell anything you want ― other than the usual contraband such as marijuana, heroin, cocaine, Ross Perot campaign Kool-Aid, etc.
However, if judgment creditors have claims against you, then the Wilson holding applies to the voluntary sale of your home: You get to keep the exempt portion of the net sale proceeds (with the usual six-month reinvestment caveat) if you recorded the homestead with the County Recorder’s Office; but if you didn’t record the homestead, all of the net sales proceeds are fair game for your creditors.
If you’re a debtor in the Central District of California who is considering using bankruptcy to deal with your debts, call an attorney who is a board-certified bankruptcy law specialist to represent you.