Avoiding Clouds on Homestead Exemptions[1]

We represent a debtor with a substantially younger, non-debtor spouse and equity in their home, exceeding the debtor’s homestead exemption. The home is owned as tenants in the entireties. This means that the surviving spouse inherits the property free and clear of the deceased spouse’s creditors. The spouse’s youth dissuaded the chapter 7 trustee from trying to sell the home free and clear of both owner’s interests.[2]

The trustee got creative. She tried selling just the debtor’s interest in the house. The buyer gets the right to live with the non-debtor. That right would never be used. The real deal is the right to sell the house if the spouse dies before the debtor dies. The buyer could sell the property provided the debtor was paid the homestead exemption on the property’s sale. That’s quite a windfall.

To us, this was diabolical.[3] The trustee can’t sell the debtor’s home in the bankruptcy case. So, they’re trying to sell the debtor’s future interest in their home which springs if the younger spouse dies prematurely.

The trustee could not sell the property free of the debtor’s homestead exemption. Instead, the trustee seeks to saddle the debtor’s homestead exemption with a third-party’s right. We saw this post-petition imposition on the debtor’s homestead as impermissible.

A Homestead Exemption with a Cloud

The proposed buyer’s interest would create a “cloud,” impairing the debtor’s homestead exemption.

Permitting the trustee’s proposed sale would prevent the debtor from selling their home. Who would buy or refinance the property knowing they would lose the property if the wrong owner died?

Clouds on homestead exemptions were addressed when debtors sought to avoid unenforceable judicial liens against their exempt homestead.[4]

Clouds on homestead exemptions are avoidable because they “[impair],” i.e., weakens, makes worse, lessens in power, diminishes, and affects in an injurious manner, their homestead exemption.”^[5] They “may leave debtor’s title to real property clouded, lead to future litigation, prevent a closing, preclude title insurance, require posting of a bond, or otherwise impair or impede a debtor’s right to deal with his real property post-petition in a free and unfettered manner.”^[6]

Sure sounds like our problem.

A Post-Petition Cloud?

Arguably, creating this cloud post-petition exempts it from Bankruptcy Code § 522(f)’s power to avoid pre-petition liens impairing exempt property.[7]

In Law v. Siegel, the U.S. Supreme Court rejected bankruptcy courts having equitable power to deny or impair exemptions based on debtors’ bad-faith conduct.[8] Recently, this logic was followed in In re Savino, which refused to impose an equitable lien on a debtor’s homestead.[9]

If bankruptcy courts may not impair debtors’ homestead exemptions for bad faith conduct, how can debtors be punished merely for surviving their spouse?

This matter is pending. We anticipate this situation’s resolution favoring the debtor. We are discussing it now due to its novelty and our belief that our readers want to be aware of this strategy.

As always, your comments and questions are most welcome.

References