The United States Bankruptcy Court for the Western District of Michigan recently issued an opinion in a bankruptcy case involving a husband and wife who filed for Chapter 7 bankruptcy protection.

In re Douglas and Jeanette Mickens, Case No. BT 15-01872. (Bankr. W.D. Mich, Oct 20, 2017.) The case involves a complex procedural history, and lengthy legal analysis, all involving the question of whether the debtors could seek to exempt their interest in property that was the subject of a pre-petition transfer that was subsequently avoided by the Chapter 7 trustee. For the reasons discussed below, the Court ruled that the debtors are allowed to claim an exemption on the property.

Background and Procedural History

The property at issue in this case is the debtors’ home. Three days prior to seeking bankruptcy protection, the 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 trustee successfully avoided this transfer as a fraudulent transfer, and the Court disallowed the debtors’ claimed Michigan tenancy by the entireties exemption, which would have allowed the debtors to exempt the property from “property of the estate” that would have been otherwise available to creditors. The debtors then amended their schedules to claim the property as exempt under Michigan’s bankruptcy-specific homestead exemption, to which the trustee also objected.

The Court’s Analysis

At issue in this case was whether the trustee’s objection to the debtors’ second attempt to claim an exemption in the property, based on Michigan’s bankruptcy-specific homestead exemption, should be upheld or overruled.

The trustee’s objection relied upon Section 522(g) of the Bankruptcy Code. It provides an opportunity for 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.

Because the debtors in this case, in essence, transferred the property to themselves as a result of executing and recording the quit claim deed, the Court explained that there was no question the prepetition transfer was a “voluntary” transfer. The dispositive issue, therefore, was whether the trustee “recovered” the property in a manner that triggered application of Section 522(g).

Ultimately, the Court overruled the trustee’s objection and allowed the debtors to claim the new exemption. The Court explained that the Sixth Circuit Court of Appeals previously described the issues of avoidance and recovery as “distinct concepts and processes.” However, the trustee argued that the avoidance and preservation of the transfer under Section 551 of the Bankruptcy Code “is sufficient to bar the Debtors from claiming an exemption in the Property” in accordance with Section 522(g).

Section 551 provides that a transfer avoided under certain sections of the Bankruptcy Code, including Section 544, which was the basis of the trustee’s avoidance action in this case, “is preserved for the benefit of the estate but only with respect to property of the estate.” In other words, the trustee argued that because she avoided the transfer, the property subject to the avoided transfer should be preserved for the estate and not be capable of being exempted.

The Court explained, however, that while Section 551 is “automatically applicable to all avoided transfers” it is relevant “only where there is a transaction subsequent to the avoided transaction.” The Court further explained that in this case, “The transfer that was avoided by the Trustee was the transfer of the Property from the Debtors as joint tenants with rights of survivorship to themselves - the Debtors - as tenants by the entireties.” Therefore, the estate’s interest was not enhanced as a result of the avoidance because the property was already property of the estate prior to the avoidance.

The Court ruled in favor of the debtors because it found that, while the trustee successfully avoided the prepetition transfer of the property as a fraudulent conveyance, it did not “recover” the property for purposes of Section 522(g). 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, the avoidance “simply, but importantly, restricted the Debtor’s ability to claim an entireties exemption in Property that was unquestionably property of the estate before and after the transfer.” The property, therefore, was not “recovered” for purposes of Section 522(g).