Bankruptcy Trustees' Foot-Dragging In Closing Out Cases Leads To Screwing Over For Debtor-Homeowners Involving Homestead Exemption Claims

A Federal Appeals Court in San Francisco, California recently issued a ruling in a bankruptcy case that resulted in a serious screwing over for a pair of homeowners occurring after the passage of a significant amont of time subsequent to receiving discharges in their cases. (Note that the issue in this case was of significant enough importance that it caught the attention of the National Association of Consumer Bankruptcy Attorneys, which, as a "friend of the court," filed an amicus brief with the court in support of the position of the homeowners involved).

The issue involved was summarized by the appeals court as follows:

• These consolidated appeals present the question of how to construe the homestead exemption in bankruptcy. In both cases, the debtors filed for Chapter 7 bankruptcy at a time when the value of the equity in their homes was less than the amount they were eligible to claim under the state or federal homestead exemption.

• There was no value in the homestead properties that could be claimed by the bankruptcy estate, and the debtors therefore anticipated that they would be able to retain ownership of their homes, subject to the terms of their mortgages, after the bankruptcy closed. The value of the homes subsequently increased so that the debtors had equity in excess of the homestead exemptions.

• Our question is whether the bankruptcy Trustees may force a sale of the homestead properties in order to recover the excess equity, or whether instead the debtors should be allowed to retain any postpetition increase in the fair market value of their homes.

The facts involving the first homeowner, an Arizona resident, follow:

• On August 8, 2003, one, Gebhart, filed for Chapter 7 bankruptcy protection. As part of his bankruptcy petition, he claimed an exemption in the amount of $89,703 for the house he owned in Phoenix.

• According to the petition, the market value of the property at the time of filing was $210,000, and it was encumbered by mortgages in the amount of $120,297. The $89,703 figure represents the difference between the value of the homestead and the mortgages with which it was encumbered.

• Gebhart claimed the exemption pursuant to Ariz. Rev. Stat. § 33-1101(A), which at the time of the bankruptcy filing provided that an Arizona resident may hold as a homestead exempt from attachment, execution and forced sale, not exceeding $100,000 in value.

• On December 12, 2003 (four months after filing the bankruptcy petition), Gebhart received his discharge under 11 U.S.C. § 727. However, the case itself was left open.

• Gephardt continued to reside in his house and even refinanced his mortgage with a lender who apparently believed Gebhart owned the property free and clear of any claims by the bankruptcy estate, when, in fact, the bankruptcy case was not closed.

• On November 10, 2006 (almost three years after receiving his discharge), the Trustee asked the bankruptcy court to approve the appointment of a real estate broker to sell the home for the benefit of the estate. (The Trustee believed that the value of the house had increased substantially since the time of the bankruptcy filing, and that if it were sold, the estate would recover a great deal of money, even after paying off the mortgage and the expenses of the sale and paying Gebhart the value he had claimed for his homestead exemption).

The facts involving the second homeowner, a Washington State couple, follow:

• On June 30, 2004, Steven and Julie Chappell filed for Chapter 7 bankruptcy.

• They owned a home in Camano Island, WA, in which their equity at the time of bankruptcy—$21,511—was less than the $36,900 they were allowed to claim under the federal homestead exemption in bankruptcy.

• On October 21, 2004 (about 4 months after the filing of their bankruptcy petition), the Chappells received their discharge. However, the case itself was left open.

• On July 7, 2006, (over 20 months after receiving their discharge), the holder of the Chappells' mortgage moved for relief from the stay in order to foreclose on the homestead because the Chappells had fallen into default.

• The Trustee responded that he believed the fair market value of the homestead had increased substantially since the bankruptcy filing, and asked permission to attempt to sell the property and keep the excess recovered for the benefit of the estate.

The Federal appeals court concluded that, because the cases remained open and were never closed by the bankruptcy Trustee, it was appropriate for the Trustee to seek a sale of each debtor's homestead (despite the significant passage of time from when they received their discharges) and pocket the post-filing appreciation for the benefit of the unsecured creditors.(1)

See In re Gebhart, Nos. 07-16769, 07-35704 (9th Cir. September 14, 2010) for the entire ruling, and the court's analysis of the applicable law.

(1) The following excerpt from the opinion sets forth the concerns that any homeowner filing bankruptcy and claiming the applicable homestead exemption shorld have when a bankrupcy Trustee drags his/her feet when closing out a case (bold text is my emphasis, not in the original text):

• The debtors argue that the result we reach today will lead to uncertainty about the status of exempt property and abuses by trustees. The facts of the Gebhart bankruptcy suggest that some of these concerns are legitimate.

• Gebhart remained in his home for five years after filing for bankruptcy, paying his mortgage and believing that his bankruptcy was finished when he received his discharge.

• Gebhart may have been mistaken in this belief, but his misapprehension was shared by his mortgage lender, which refinanced his home, apparently unaware of any claims on the property by the Trustee. A Chapter 7 debtor will not be certain about the status of a homestead property until the case is closed (something that may not happen for several years after bankruptcy filing) or the trustee abandons the property.

• Gebhart argues that, even if the homestead is the property of the bankruptcy estate, the Trustee in his case intentionally left the case open longer than necessary and should be estopped from proceeding with the sale of the property.

• We do not decide whether estoppel might be available as a remedy in a bankruptcy proceeding, see Cannon v. Hawaii Corp. (In re Hawaii Corp.), 796 F.2d 1139, 1144 n.3 (9th Cir. 1986), because, even if it were, Gebhart has not met the requirement for estoppel to apply. rogue