Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:
Last August, in Salven v. Galli ( In re Pass), 553 B.R. 749 (9th Cir. BAP 2016), the U.S. Bankruptcy Appellate Panel of the Ninth Circuit held that, where a chapter 7 debtor and her non-debtor husband legally separated and divorced postpetition, the debtor’s ex-husband could, on his own behalf, claim a homestead exemption in property of the estate. To read the full published decision, click here: http://bit.ly/2utaP5P.
In 2002, Frances Pass (“Pass”) and her then-husband, Aladino Galli (“Galli”), lived together in a home in Fresno, California (the “Fresno Property”). In 2002, they recorded a declaration of homestead (the “2002 Homestead Declaration”).
At some point, Pass and Galli decided to terminate their marriage.
In September 2009, Pass purchased a house in Coalinga, California (the “Coalinga Property”), and began refurbishing it. Early on December 30, 2009, Pass moved out of the Fresno Property with no intention of returning to reside there.
That very afternoon, Pass and Galli filed a joint chapter 13 petition. Thus, at the time they filed their joint petition, Galli resided in the Fresno Property and Pass resided in the Coalinga Property. They scheduled the Fresno Property as community property, and claimed a homestead exemption in the Fresno Property pursuant to California Code of Civil Procedure (“CCP”) section 704.730.
In September 2010, a state court entered a judgment of legal separation which incorporated a Marital Settlement Agreement and provided that the Fresno Property would be awarded to Galli as his sole and separate property.
In 2011, Galli executed and recorded a grant deed purporting to transfer the Fresno Property to Pass and Galli as joint tenants.
Subsequently, Pass filed a petition for a judgment dissolving the marriage. In April 2013, the state court entered a judgment of marital dissolution (incorporating a new Marital Settlement Agreement) under which Pass and Galli each retained a one-half joint tenancy interest in the Fresno Property.
Pass and Galli did not request relief from stay prior to making any of the purported transfers or obtaining any of the judgments purportedly affecting title to or their ownership of the Fresno Property. (As discussed below, the bankruptcy court later ruled that the purported transfers were void; Galli did not appeal that ruling.)
In September 2013, Pass requested that the bankruptcy court sever the joint chapter 13 case and convert her case to chapter 7. The bankruptcy court granted the request. Soon thereafter, Galli’s chapter 13 case was dismissed.
In Pass’ chapter 7 case, Pass amended her schedules to assert a $75,000 homestead exemption in the Coalinga Property instead of the Fresno Property. The chapter 7 trustee objected to Pass’ claimed exemption, alleging that Pass was not actually living in the Coalinga Property when Pass and Galli filed their joint chapter 13 petition. The bankruptcy court found that Pass had moved out of the Fresno Property, with no intention ever to return, hours before the petition was filed. Thus, the objection was overruled.
In the meantime, the trustee filed a motion for authority to sell the Fresno Property free and clear of liens and interests, as well as a complaint seeking to avoid the unauthorized postpetition transfers. In the adversary proceeding, the bankruptcy court entered summary judgment determining that the Fresno Property was community property (and therefore the entirety of the property was property of the estate), and that the postpetition transfers were void. However, the bankruptcy court also determined that Galli held a “homestead interest” in the Fresno Property by virtue of the 2002 Homestead Declaration, and the trustee could not sell the Fresno Property free and clear of Galli’s homestead interest without compensation to Galli. The trustee appealed.
ARGUMENTS PRESENTED TO THE BAP
In his appellate brief, the trustee argued that “it is the automatic and not the declared homestead that is needed to invoke the homestead [exemption] within bankruptcy.” The trustee also argued that exemptions are determined as of the petition date, even when the case has been converted from chapter 13 to chapter 7. Citing In re Homan, 112 B.R. 356 (9th Cir. BAP 1989), the trustee further argued that when only one spouse files, the choice of homestead exemption vests solely in the filing spouse. Because Pass and Galli were married on the petition date, and because Pass had chosen to claim an exemption in the Coalinga Property, the trustee argued that Galli was not entitled to claim an exemption in the Fresno Property.
Galli argued that he had “exemption rights” in the Fresno Property pursuant to the 2002 Homestead Declaration. He argued that those rights came into his bankruptcy estate when the joint chapter 13 petition was filed, and revested in him when his chapter 13 case was dismissed. Galli also argued that his right to an exemption was not lost when Pass amended her schedules to claim an exemption in the Coalinga Property because, among other things, after legal separation each spouse is “entitled to a homestead in his or her own right.” Galli also argued that Pass “abandoned” her rights in the Fresno Property when she amended her Schedule C, and that the trustee, as Pass’ successor, was estopped from asserting any interest in the property.
BAP’S RULING AND REASONING
First, the BAP examined whether the 2002 Homestead Declaration precluded the trustee from selling the Fresno Property without compensating Galli.
The bankruptcy court had concluded that because a trustee’s “powers to liquidate estate assets are derived from those of a creditor who holds a judgment lien,” the 2002 Homestead Declaration shielded the Fresno Property from the trustee’s reach in the same way that a homestead declaration shields property from the attachment of judgment liens. Pass, 553 B.R. at 758 (quoting Salvi v. Galli ( In re Pass), Adv. No. 14-01056 at 12 (Bankr. E.D. Cal. Oct. 14, 2015)); see also Cal. Civ. Proc. Code § 704.950. The BAP rejected this conclusion because a trustee’s power to sell estate property is derived from Section 363, not from the trustee’s rights as a hypothetical lien creditor under Section 544.
The BAP also rejected the bankruptcy court’s suggestion that the trustee’s proposed sale of the Fresno Property could be considered a voluntary sale because it “‘is property of the estate over which the Trustee is effectively the owner.’” Pass, 553 at 759 (quoting Salvi v. Galli ( In re Pass), Adv. No. 14-01056 at 10 (Bankr. E.D. Cal. Oct. 14, 2015)). The BAP stated, “We must reject this proposition as inconsistent with our previous decisions holding that the filing of the bankruptcy petition itself constitutes a ‘forced sale’ for exemption purposes.” Id. (citations omitted).
Thus, the BAP concluded that the 2002 Homestead Declaration did not prevent the trustee from selling the Fresno Property.
Second, the BAP examined whether Galli was entitled to assert an “automatic” homestead exemption in the Fresno Property. This required the BAP to answer two questions: “First, whether Galli, as a non-debtor, may assert any exemption in property of the Pass bankruptcy estate; and second, whether Galli is entitled to a homestead exemption under California law.” Id. at 759.
As to the question of whether a non-debtor may claim an exemption in estate property, the BAP noted that there is a lack of case law addressing this issue. In Homan, the BAP had ruled that a non-debtor spouse could not assert an exemption in a home where the debtor had chosen to exempt other property. But the BAP distinguished Homan because “[w]hat is true of spouses . . . is not necessarily true of ex-spouses.” Id. at 760. The BAP stated that, by precluding non-debtor spouses from claiming exemptions in estate property, Congress designed the exemption provisions to encourage spouses to file jointly (something ex-spouses cannot do). The BAP also noted that Galli would not benefit from the community property discharge, which Homan had “identified as a counterbalancing advantage to the otherwise ‘hard result’ of denying non-debtor spouses any say in the selection of exemptions.” Id. (quoting Homan, 112 B.R. at 360). The BAP limited Homan’s holding to situations in which non-filing current spouses of the debtor attempt “to assert exemptions to which he or she would not be entitled as a joint debtor.” Id. The BAP concluded, “The mere fact that Galli is not the debtor does not prohibit him from asserting a state law exemption in property of the bankruptcy estate.” Id.
As to the question of whether Galli was entitled to an “automatic” homestead exemption under California law, the BAP rejected the trustee’s argument that because a debtor’s entitlement to claim exemptions is determined as of the petition date, and because Pass and Galli were married when they filed their joint chapter 13 petition, their exemption rights were limited to those that they enjoyed as a married couple on the petition date. The BAP stated,
The principle that exemption rights are determined as of the petition date cannot be stretched so far as to require that a debtor’s marital status on the petition date is fossilized for the duration of the case. Even less should former joint debtors whose cases have been severed and dismissed be yoked, for state-law exemption purposes, to their ex-spouses who remain in bankruptcy. To hold otherwise would flout the well-established principle that “bankruptcy courts [should] avoid incursions into family law matters….”
Id. at 760-61 (alteration in original) (citations omitted). Therefore, the BAP ruled that Galli’s homestead rights must be determined with reference to his current marital status, not his marital status on the petition date. The BAP stated that, under California law, after a judgment of dissolution or legal separation, each former spouse qualifies for the “automatic” homestead exemption for property in which he or she resides. Thus, the BAP concluded that Galli was entitled to claim a homestead exemption in the Fresno Property, and affirmed the bankruptcy court’s conclusion that the trustee could not sell that property without compensating Galli.
In the author’s view, the BAP correctly rejected Galli’s argument that the 2002 Homestead Declaration precluded the trustee from selling the Fresno Property. A homestead declaration prevents the attachment of a judgment lien unless there is equity in excess of the amount of the homestead exemption, but it does not diminish a co-owner’s interest in the property. In Pass, the entirety of the Fresno Property was property of the estate. Therefore, the trustee was entitled to sell the property pursuant to Section 363, and to distribute the net sale proceeds in accordance with Sections 724 and 726.
The validity of the BAP’s other two primary rulings is less clear given the paucity of authority on the subject.
First, an analysis of whether a debtor (or anyone else) is entitled to exempt property from property of a bankruptcy estate should begin with Section 522. Section 522(b) allows a debtor to exempt property from the estate. If a debtor fails to file a list of exemptions, “a dependent of the debtor may file such a list, or may claim property as exempt from property of the estate on behalf of the debtor.” 11 U.S.C. § 522( /) (emphasis added). There is nothing in the Bankruptcy Code to suggest that a non-debtor is entitled to exempt property from the estate on his or her own behalf.
There is also nothing in CCP section 704.710, et seq. to suggest that the “automatic” homestead exemption applies when a separated or ex-spouse (as opposed to a judgment lien creditor) seeks to sell a community property homestead. In this regard, footnote 6 of the BAP’s decision is noteworthy:
The Trustee’s counsel further conceded at oral argument that the Trustee’s proposed sale should be treated as involuntary, hence capable of triggering the automatic homestead exemption. . . . [A]s the issue is not disputed, we need not decide it and will treat the proposed sale as an involuntary or forced sale under California law.
Id. at 761 n.6.
Mainly in two contexts, courts have stated that the filing of a bankruptcy petition is the functional equivalent of a forced or involuntary sale: (1) when determining whether California’s “automatic” homestead exemption (as opposed to the declared homestead exemption) applies in bankruptcy cases; and (2) when determining that the petition date is the correct date for determining a debtor’s eligibility to claim an exemption. See, e.g., In re Cole, 93 B.R. 707 (9th Cir. BAP 1988); In re Herman, 120 B.R. 127 (9th Cir. BAP 1990); In re Morgan, 149 B.R. 147 (9th Cir. BAP 1993); In re Kelley, 300 B.R. 11 (9th Cir. BAP 2003). But it does not necessarily follow that a trustee’s Section 363 sale of estate property is the same thing as a judgment creditor’s execution sale of a judgment debtor’s property. In light of footnote 6, courts and practitioners should be careful not to read Pass as definitively holding that a trustee’s Section 363 sale is, in fact, an involuntary sale triggering a non-debtor’s right to claim an exemption in his or her own right.
Second, even if non-bankruptcy law can/does give a separated or ex-spouse an independent right to exempt community property from property of the estate, the BAP’s willingness to look at Pass and Galli’s current marital status (rather than their marital status on the petition date) is questionable. There was no dispute that Pass and Galli were still married on the petition date. Indeed, although not reflected in the record on appeal, a petition for a judgment of legal separation was not even filed until June 2010 (over five months after they filed for bankruptcy). Also, the state court’s September 2010 judgment of legal separation incorporated a Marital Settlement Agreement in which Pass and Galli agreed that the date of legal separation was January 1, 2010 (two days after they filed their joint chapter 13 petition).
The BAP was rightfully reluctant to interfere in family law matters. For example, courts have been hesitant to interfere with a state court’s award or modification of spousal support. See In re Allen, 275 F.3d 1160 (9th Cir. 2002); In re MacDonald, 755 F.2d 715 (9th Cir. 1985). However, it is unclear whether that policy should apply when a non-debtor spouse legally separates from the debtor postpetition and then seeks to exclude property from the estate by exercising exemption rights that did not exist on the petition date.
These materials were written by John N. Tedford, IV, of Danning, Gill, Diamond & Kollitz, LLP (email@example.com). Editorial contributions were provided by Michael J. Gomez of Frandzel Robins Bloom & Csato, L.C. in Fresno, California.
Thank you for your continued support of the Committee.
Insolvency Law Committee
Radmila A. Fulton
Law Offices of Radmila A. Fulton
John N. Tedford, IV
Danning, Gill, Diamond & Kollitz, LLP
Marcus O. Colabianchi
Duane Morris LLP
Rebecca J. Winthrop
Norton Rose Fulbright US LLP