“There’s no place like home…”

-Dorothy Gale

If a homestead interest in a residence is a separate vested property interest in and of itself, does a forced sale of that home without compensation beyond the division of proceeds guaranteed by the Bankruptcy Code violate the Fifth Amendment? That was the question underlying In re Thaw, a recent Fifth Circuit decision examining the interaction between the Bankruptcy Code, Texas property law, and the Fifth Amendment of the United States Constitution.

We’re not in Kansas anymore…

As we have covered on this blog in the past, section 522 of the Bankruptcy Code recognizes certain types of property as “exempt” from the bankruptcy estate. Among the listed exemptions is the “homestead exemption” in section 522(d)(1), which protects up to $22,975 in equity in the debtor’s residence. Despite this protection, the debtor may elect to forego the federal exemptions provided by the Bankruptcy Code in favor of exemptions under applicable state or local law. Debtors typically elect for the state law homestead exemption where the applicable state law exemption exceeds the $22,975 allowed under the Bankruptcy Code. One jurisdiction with a particularly generous homestead exemption, Texas, was the jurisdiction in In re Thaw.

Ding Dong The Witch is Dead: BAPCPA and the Mansion Loophole

In the Wizard of Oz, Dorothy’s farmhouse squashed the Wicked Witch of the East. Similarly, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), enacted in 2005, squashed the so-called “mansion loophole.” The “mansion loophole” allowed debtors living in certain states to shield from their creditors virtually all of the equity in their homes. Some debtors took advantage of the loophole by relocating to states with high or unlimited homestead exemptions and plowing all of their assets into large and expensive homes shortly before filing for bankruptcy protection. The BAPCPA closed the loophole by adding section 522(o), which reduced the homestead exemption by any amount invested or disposed of with the intent to hinder, delay, or defraud a debtor’s creditors, and 522(p), which, despite anything to the contrary in state or local law, capped a debtor’s exemptions at $155,675 for any property acquired within 1215 days before the date of filing.

“I’ll get you my pretty!”: A Quick Refresher on Forced Sales

Section 363 of the Bankruptcy Code contains express authorization to sell property of the bankruptcy estate, notwithstanding the fact that a third party, including a non-debtor spouse, may have an interest in that property. Third parties, such as a non-debtor spouse, are not left out in the cold though – section 363(i) of the Bankruptcy Code gives non-debtor spouses a right of first refusal to purchase the property subject to the forced sale, and section 363(j) directs the trustee to apportion and distribute the proceeds of a sale between the non-debtor owner and to the bankruptcy estate.

Landing in Munchkinland: How did we get to the Fifth Circuit?

The Fifth Circuit came to address these issues in In re Thaw following the bankruptcy of Dr. Stanley Thaw. In 2009, Dr. Thaw and his wife, Kernell Thaw, purchased a home for $2,150,000. Over the next two years, with a large monetary judgment against Dr. Thaw outstanding, the couple proceeded to make monthly payments on the property that were more than twice the contractually required amount while simultaneously refusing to pay the judgment. When Dr. Thaw filed for chapter 7 bankruptcy protection in 2011, the trustee objected to Dr. Thaw’s attempt to claim the equity in his home as exempt property on the basis that he had funneled money into the home with intent to hinder, delay, and defraud his creditors. Agreeing with the trustee, the court reduced Dr. Thaw’s homestead exemption to $0 pursuant to section 522(o) of the Bankruptcy Code. On the basis of this finding, the trustee sought to sell the Thaws’ home to raise money to pay Dr. Thaw’s debts.

There was no dispute about whether the court had the power to sell the home or whether Mrs. Thaw should be afforded the protections of section 363. The question before the court was whether she was entitled to compensation from the forced sale not just by virtue of section 363, but also for the unconstitutional taking of her homestead interest in the house. The “takings clause” of the Fifth Amendment of the United States Constitution provides that “private property [shall not] be taken for public use, without just compensation.” (emphasis added). On appeal to the Fifth Circuit, Mrs. Thaw challenged the bankruptcy court’s holding, and the district court’s affirmance, that her homestead interest was not a vested property right and therefore there was not a Fifth Amendment taking from a forced sale of the property. In particular, she argued that the lower court decisions should be overturned based on the recent Fifth Circuit decision in In re Kim, which clarified that a homestead interest may constitute a vested property right.

Follow the Yellow Brick Road: Analyzing Thaw’s claim

The court in In re Kim held that a homestead interest may constitute a separate vested property right, and that a non-debtor spouse could be entitled to compensation from the sale of a property to which a homestead right attached; however, the court limited its holding to cases where the real property in question was acquired before the BAPCPA was enacted. Applying the Supreme Court’s decision in United States v. Rodgers, a tax case about the power of a district court to order the sale of a family home in which a delinquent taxpayer had an interest, the court in In re Kim held that where a federal statute permits a person’s property to become liable for the debts of another, a Takings Clause objection cannot be successfully interposed if the property interest in question came into being after the enactment of the federal statute.

The court in In re Thaw distinguished the Thaws’ case on the basis that unlike in In re Kim, where the property interest in question pre-dated the BAPCPA, the Thaws acquired their property interest after the enactment of the BAPCPA. This fact meant that the couple was on constructive notice of how the Bankruptcy Code would operate in the event of the bankruptcy of one spouse. Furthermore, the court held that because of the protections built into sections 363(i) and (j) of the Bankruptcy Code, there was no gratuitous confiscation of Kernell Thaw’s homestead interest, and the sale was not so unreasonable or onerous as to compel compensation above and beyond the division of sale proceeds guaranteed by section 363 of the Bankruptcy Code.

Look Behind the Curtain: Conclusion

The takeaway from In re Thaw is simple: if you are a non-debtor with a homestead interest in a property purchased after the enactment of the BAPCPA, even if you tap your heels three times, you cannot seek additional compensation from the forced sale of that home based on the Takings Clause of the United States Constitution.