11 USC 522(o) – Homestead Exemption Limitations in Bankruptcy

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In bankruptcy, creditors can allege that debtors should lose the part of their homestead exemption that is allegedly “attributable to” an “intent to hinder, delay, or defraud a creditor” under 11 U.S.C. § 522(o). This is particularly important given the recent increase in California’s homestead exemption effective January 1, 2021, which is now as high as $600,000. Debtors and creditors should carefully weigh the options when allegations under 11 U.S.C. 522(o) arise as the bankruptcy trustee may seek to sell the debtor’s house if the trustee or a creditor prevails on such a motion. This article provides guidance to help understand this rapidly expanding area of law.

The Meaning of 522(o) of the Bankruptcy Code

As the Supreme Court explained, Section 522(o) “prevents a debtor from claiming a homestead exemption to the extent he acquired the homestead with nonexempt property in the previous 10 years ‘with the intent to hinder, delay, or defraud a creditor.’” Law v. Siegel, 571 U.S. 415, 424 (2014).

“Section 522(o) has four essential components”—one of which is “that the disposition of the nonexempt assets was made with the intent to hinder, delay, or defraud a creditor.” In re Stanton, 457 B.R. 80, 91 (Bankr. D. Nev. 2011).

While “Congress did not provide any guidance regarding the construction of the phrase ‘with the intent to hinder, delay, or defraud’ when it enacted § 522(o), . . . [the] statutory language is similar, if not identical, to the language used in § 548 and § 727 of the Code.” In re Addison, 540 F.3d 805, 811 (8th Cir. 2008). As such, bankruptcy courts in multiple circuits, including within the Ninth Circuit, have “looked to the body of case law construing §§ 548(a)(1) and 727(a)(2) to determine the meaning of ‘with intent to hinder, delay, or defraud a creditor” in § 522(o).’” In re Addison, 540 F.3d at 811; see e.g., In re Craig, 2012 WL 6645692, at *3 (Bankr. D. Mont. Dec. 20, 2012) (“this Court has held that case law under 11 U.S.C. §§ 548(a)(1)(A) and 727(a)(2) provides instructive guidance with respect to § 522(o)”).

11 USC Section 522(o)

Under 11 U.S.C. Section 522(o), the Bankruptcy Code provides that:

For purposes of subsection (b)(3)(A), and notwithstanding subsection (a), the value of an interest in—

(1) real or personal property that the debtor or a dependent of the debtor uses as a residence;

 (4) real or personal property that the debtor or a dependent of the debtor claims as a homestead;

shall be reduced to the extent that such value is attributable to any portion of any property that the debtor disposed of in the 10-year period ending on the date of the filing of the petition with the intent to hinder, delay, or defraud a creditor and that the debtor could not exempt, or that portion that the debtor could not exempt, under subsection (b), if on such date the debtor had held the property so disposed of.

What this section added by the BAPCPA Amendment to the Bankruptcy Code in 2005 means is that creditors can allege that debtors should lose the part of their homestead exemption that is allegedly “attributable to” an “intent to hinder, delay, or defraud a creditor” under 11 U.S.C. § 522(o).

The Ninth Circuit Has Made Clear that Exemption Planning is Not Per Se Fraudulent

When parties are considering their rights under Section 522(o) of the Bankruptcy Code, it is important to remember that there is such thing as permissible exemption planning before bankruptcy.

The Ninth Circuit has ruled that “the purposeful conversion of non-exempt assets into exempt assets on the eve of bankruptcy is not fraudulent per se.” In re Stern, 345 F.3d 1036, 1044–45 (9th Cir. 2003) (“Stern”) (quoting Wudrick v. Clements, 451 F.2d 988, 990 (9th Cir.1971)). In Stern, “the principal evidentiary inference relied upon by the [moving party] is that non-exempt assets were converted to exempt assets immediately prior to bankruptcy. But, as Wudrick demonstrates, this inference is insufficient as a matter of law to establish a fraudulent transfer.” In re Stern, 345 F.3d 1036, 1044 (9th Cir. 2003). As the Ninth Circuit BAP also explained: “The Code presumes that creditors know the law and bear the risk that debtors will position their property to their best advantage.” In re Roosevelt 176 BR 200, 208 (9th Cir. BAP 1994).

Stern was cited in 2013 by the Hon. Margaret M. Mann of the Southern District of California Bankruptcy Court in finding that: “Ninth Circuit law even permits non-exempt assets to be converted to exempt assets immediately prior to bankruptcy, if no other circumstances of fraud are present.” In re Burke, No. ADV 12-90311-MM, 2013 WL 4431304, at *5 (Bankr. S.D. Cal. Aug. 8, 2013).

As a Bankruptcy Court in the Ninth Circuit stated: “In other words, debtors may maximize their exemptions, even when they do so shortly before the filing of a bankruptcy petition.” In re Thomas, 477 B.R. 778, 782 (Bankr. D. Idaho 2012). The court in Thomas quoted Congress as stating that: “As under current law, the debtor will be permitted to convert nonexempt property into exempt property before filing a bankruptcy petition. The practice is not fraudulent as to creditors, and permits the debtor to make full use of the exemptions to which he is entitled under the law.” Id. (citing House Report of Bankruptcy Reform Act of 1978, H.R. REP. NO. 95–595, at 361 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6317).

Judicial Discretion and Badges of Fraud under 11 USC 522(o)

Courts have “declined to define a bright-line rule on when the transfer of value from non-exempt to exempt assets is egregious enough to be proscribed, choosing instead to leave the discretion largely to the bankruptcy court.”  In re Wilmoth, 397 B.R. 915, 920 (B.A.P. 8th Cir. 2008); see, e.g., In re Oberst, 91 B.R. 97, 101(Bankr. C.D. Cal. 1988) (“the Court finds it very difficult to locate the exact line between bankruptcy planning and hindering creditors”).

Instead, “[i]n determining whether a debtor disposed of nonexempt assets with intent to hinder, with intent to delay, or with intent to defraud a creditor under Section 522(o), the traditional ‘badges of fraud’ employed in the fraudulent transfer context are often explored.” In re Tarkanian, 562 B.R. 424, 456 (Bankr. D. Nev. 2014); see e.g., In re Stanton, 457 B.R. at 93 (applying “badges of fraud” approach to section 522(o) claim). In In re Stanton, the bankruptcy court provided the following non-exhaustive list of “badges of fraud as ‘a set of objective criteria … use[d] as a basis for inferring fraudulent intent'”:

(1) the transfer or obligation was to an insider; (2) the debtor retained possession or control of the property transferred after the transfer; (3) the transfer or obligation was disclosed or concealed; (4) before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit; (5) the transfer was of substantially all the debtor’s assets; (6) the debtor absconded; (7) the debtor removed or concealed assets; (8) the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred; (9) the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred; (10) the transfer occurred shortly before or shortly after a substantial debt was incurred; and (11) the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.

In re Stanton, 457 B.R. 80, 93 (Bankr. D. Nev. 2011)

While the “badges of fraud” are helpful in assessing the intent of a debtor, “the existence of any or all of the badges of fraud is not dispositive of the issue of impermissible intent nor does it even create a presumption of such intent.” In re Tarkanian, 562 B.R. 424, 458 (Bankr. D. Nev. 2014). Notably, “there must be extrinsic evidence of fraud, other than the badges themselves, to support a finding of intent to defraud.” In re Wilmoth, 397 B.R. at 920; see In re Tarkanian, 562 B.R. 424, 458 (Bankr. D. Nev. 2014) (applying this rule); In re Coppaken, 572 B.R. 284, 304 (Bankr. D. Kan. 2017) (same).

Additionally, “[a]ny inference of fraud from these factors is de minimis in light of other factors negating fraud [and] [o]f primary importance is that fact that the exchange fulfilled a legitimate estate planning purpose.” In re Agnew, 355 B.R. 276, 286 (Bankr. D. Kan. 2006). The Central District of California Bankruptcy Court in In re Oberst, stated simply and directly that “[i]f the debtor is merely looking to his future wellbeing, the discharge will be granted.” In re Oberst, 91 B.R. 97, 101(Bankr. C.D. Cal. 1988) (analyzing intent to hinder, delay, or defraud under section 727(a)(2)).

Applying the “badges of fraud” approach, the bankruptcy court in In re Halinga found that despite the presence of several badges, the requisite intent for section 522(o) was not established for debtors, who prior to bankruptcy sold their unexempt liquor license and used the proceeds to pay down their residential mortgage. 2013 WL 6199152, at *3, 7. Specifically, the badges that were present included that “[debtors] were in dire financial condition when they made the Mortgage Payment, [] the liquor license was their largest or most significant nonexempt asset, [and] they ultimately stand to benefit from that transfer.” Id. at *6.

In coming to its conclusion, the court noted that the “[t]rustee presented no evidence that Debtors knew about or understood the effect of the Idaho homestead exemption statutes, [or]. . . that Debtors had been advised of the existence or extent of a homestead exemption by an attorney or anyone else,” especially given that the debtors were “revealed [] to be less than sophisticated in their financial dealings.” Id. at *7. Furthermore, the debtors presented a reasonable justification that they assumed the “[m]ortgage Payment would cut their future home payments in half.” Id.

Accordingly, litigants should look to facts suggesting whether something unusual happened, as opposed to ordinary exemption planning.

Courts Must Weigh The Importance of the Homestead Exemption with 522(o)

In evaluating claims under 522(o), bankruptcy courts must also consider the purpose of the homestead exemption. “The object of all homestead legislation is to provide a place for the family and its surviving members, where they may reside and enjoy the comforts of a home, freed from any anxiety that it may be taken from them against their will, either by reason of their own necessity or improvidence, or from the importunity of their creditors.” Thorsby v. Babcock (1950) 36 Cal. 2d 202, 204. “The homestead law is not designed to protect creditors, but protects the home against creditors . . . thereby preserving the home for the family.” Amin v. Khazindar (2003) 112 Cal.App.4th 582, 588.

Burden of Proof on Section 522(o) Bankruptcy Code Objections

Most importantly, it is axiomatic that “[e]xemption statutes in bankruptcy law should be construed liberally in favor of the debtor.” In re Tober, 688 F.3d 1160, 1163 (9th Cir. 2012); see In re Roberts, 527 B.R. 461, 473 (Bankr. N.D. Fla. 2015) (“this Court must view the evidence in the light most favorable to the Debtors. The homestead exemption should be carried out in a liberal spirit in favor of those entitled to the exemption. Exceptions to the exemptions should be strictly construed against the party challenging the exemption.”).

“The party objecting to a debtor’s claimed homestead and seeking a reduction in amount pursuant to 11 U.S.C. § 522(o) has the burden of proof using a preponderance of the evidence standard.” In re Corbett, 478 B.R. 62, 69–70 (Bankr. D. Mass. 2012) (citing FRBP Rule 4003(c), which provides that: “In any hearing under this rule, the objecting party has the burden of proving that the exemptions are not properly claimed. After hearing on notice, the court shall determine the issues presented by the objections.”); see In re Lacounte, 342 B.R. 809, 813 (Bankr. D. Mont. 2005) (burden on party objecting under Section 522(o)).

“Since the purpose of the [section 522(o)] is to prevent the conversion of non-exempt into exempt property, [section 522(o)’s] restriction does not apply to the proceeds of property that would have been exempt if it were retained by the debtor.” Homestead in bankruptcy—Restrictions on homestead in bankruptcy—Section 522(o) conversion of nonexempt assets into homestead, Fraudulent Transfers, Prebankruptcy Planning and Exemptions § 14:10; see In re Enloe, 542 B.R. 414, 428–429 (Bankr. S.D. Tex. 2015) (debtor used “$195,000.00 of non-exempt assets … and $110,000.00 of exempt assets” to acquire the homestead so that “only 63.9% of the homestead’s value is properly ‘attributable’ to the non-exempt assets,” and as such “the exemption was limited to 36.1% of the proceeds from the eventual sale”).

Can a Debtor Fraudulently Transfer Property that is Exempt Under the Homestead Exemption?

There remains an unanswered question of whether a debtor can fraudulently transfer property that is exempt from collection. As the California Court of Appeal explained, transferring an exempt asset cannot “be with intent to defraud a creditor not having a lien upon the [asset], for a creditor is not entitled to complain of the transfer by the debtor of an asset which he could not have reached, had the debtor retained it . . . leav[ing] the creditor in the same position in which he would have been before it was done.” Tassone v. Tovar, 28 Cal. App. 4th 765, 768 (Cal. App. 1994).

Contact a Skilled Bankruptcy Attorney to Consider Your Rights Under 522(o)

Bankruptcy law is hardly clear about what constitutes permissible planning for bankruptcy exemptions in California as opposed to fraudulent conduct under Section 522(o). Further complicating matters, bankruptcy laws are constantly evolving. That is why it is important to contact an experienced bankruptcy attorney in California familiar with Section 522(o) of the Bankruptcy Code. For a free, 15 minute consultation, contact the bankruptcy attorneys at Talkov Law today at (844) 4-TALKOV (825568) or at info(at)talkovlaw.com.

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About Scott Talkov

Scott Talkov is a real estate lawyer, business litigator and bankruptcy lawyer in California. He founded Talkov Law Corp. after of experience with one of the region's oldest law firms, where he served as one of the firm's partners. He has been featured on ABC 7, CNN, KCBS, and KCAL-9, and in the Los Angeles Times, the Orange County Register, the San Diego Union-Tribune, the Press-Enterpise, and in Los Angeles Lawyer Magazine. Scott has been named a Super Lawyers Rising Star every year since 2013. He can be reached about new matters at info@talkovlaw.com or (844) 4-TALKOV (825568). He can also be contacted directly at scott@talkovlaw.com.

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