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Chapter 7 Debtors Permitted to Amend Schedules to Claim Homestead Exemption after Successful Avoidance Action by Trustee

The purpose of bankruptcy is to provide for an orderly process by which a debtor’s assets can be fairly divided and distributed among creditors.

It is also meant to ensure that debtors can start fresh. Not all of a debtor’s assets are available to creditors—the Bankruptcy Code allows a debtor to keep certain assets safe in bankruptcy through various asset exemptions available under both state and federal law. One such exemption is Michigan’s bankruptcy-specific homestead exemption.

In a recent opinion, the U.S. District Court for the Western District of Michigan (the “Court”) considered an appeal of a decision by the U.S. Bankruptcy Court for the Western District of Michigan in a case involving a husband and wife who filed for Chapter 7 bankruptcy protection.1

On appeal, the Court considered the question of whether the debtors could exempt their interest in property that was the subject of a pre-petition transfer that was subsequently avoided by the Chapter 7 trustee. The Court affirmed the bankruptcy court’s decision that the debtors are allowed to claim an exemption on the property.

Background and Procedural History

Three days before filing for bankruptcy, the husband and wife debtors executed and recorded a quit claim deed transferring the property, which they owned as joint tenants, to themselves as tenants by the entireties. The home at issue had equity in the amount of approximately $60,000. The practical effect of the pre-petition transaction was to increase the size of the debtors’ exemption in the home equity to the point where there was no equity left from this asset to satisfy creditor claims.

The Chapter 7 trustee successfully avoided this transfer as a fraudulent transfer, and the Court disallowed the debtors’ claimed Michigan tenancy by the entireties exemption. The debtors then amended their schedules to claim the property as exempt under Michigan’s bankruptcy-specific homestead exemption (which exempted all but approximately $3,000 in equity). The trustee objected to the debtors’ attempt to claim the exemption as joint tenants, arguing that once the pre-bankruptcy transfer was avoided it was improper, and prejudicial to creditors, to allow the subsequent exemption.

The bankruptcy held that the debtors’ second attempt to claim an exemption was proper, and the Court upheld the bankruptcy court’s decision on appeal.

The Court’s Analysis

On appeal, the trustee argued that the second exemption was improper under Section 522(g) of the Bankruptcy Code. Section 522(g) allows a debtor to claim an exemption in property that it did not possess when the bankruptcy began, and that the trustee recovers during the bankruptcy, as long as the transfer of the property out of the debtor’s possession was involuntary and the property was not concealed by the debtor.

As a result of the pre-petition quit claim deed, the debtors essentially transferred the property to themselves. Therefore, the Court found that there was no question that the prepetition transfer was a “voluntary” transfer. Less obvious was whether the trustee “recovered” the property so as to trigger the application of Section 522(g).

Ultimately, the Court sided with the debtors and allowed them to claim the new exemption because, under the facts of this case, there was no recovery under Section 522(g). The Court explained that the estate’s interest in the property was not enhanced as a result of the avoidance because the property was already property of the estate prior to the avoidance. In other words, because the property was never transferred outside of the bankruptcy estate, the trustee’s avoidance did not add property or its value back to the estate as a result of the trustee’s actions.

As the Court explained: “This result leaves creditors in exactly the same place they would have been had the transfer never occurred. The Trustee’s position, in contrast, would result in what amounts to a forfeiture of the equity the Mickens could otherwise have protected if they had stuck with the joint tenancy approach from the outset of the case.” The property, therefore, was not “recovered” for purposes of Section 522(g).

If you have any questions about this case, or bankruptcy issues in general, please contact Patricia Scott at 517.371.8132 or at pscott@fosterswift.com.

1. Hagan v. Mickens, Case No. 1: 17-cv-1013 (W.D. MI, Aug. 14, 2018)

Categories: Chapter 7, Financing, Personal Property Tax, Property Tax, Western District of Michigan

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 concentrates her practice in the areas of Bankruptcy, Finance, Collections, Real Estate, and Commercial Litigation. In the bankruptcy area she represents creditors and Chapter 7 Trustees in all aspects of bankruptcy. Patricia also represents small and mid-sized businesses to large corporations in multi-faceted litigation matters in state and federal court. Her work with financial institutions includes collections, loan workouts, foreclosures, receiverships and various complex banking and finance issues. 

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