DFW BANKRUPTCY CONFERENCE

Transcription

1 RECENT DEVELOPMENTS 0 DFW BANKRUPTCY CONFERENCE RECENT DEVELOPMENTS: TEXAS BANKRUPTCY COURT, TEXAS FEDERAL DISTRICT COURT, FIFTH CIRCUIT COURT OF APPEALS, UNITED STATES SUPREME COURT BANKRUPTCY DECISIONS Honorable Harlin D. Cooter Hale UNITED STATES BANKRUPTCY JUDGE FOR THE NORTHERN DISTRICT OF TEXAS 1100 Commerce Street, 14 th Floor Dallas, Texas (214) Telephone (214) Telecopier Gerrit M. Pronske 2200 Ross Avenue Suite 5350 Dallas, Texas (214) Telephone (214) Telecopier gpronske@pronskepatel.com October 21, 2013 BIOGRAPHICAL INFORMATION

2 RECENT DEVELOPMENTS 1 HONORABLE HARLIN D. COOTER HALE Born in Natchez, Mississippi. B.S., 1979, Louisiana State University. J.D., 1982, Paul M. Herbert School of Law, LSU, Order of the Coif , Law Clerk to the Honorable James L. Dennis, Associate Justice, Louisiana Supreme Court, now Judge on United States Fifth Circuit Court of Appeals , Private practice of law in Dallas, Texas. November 1, 2002, appointed United States Bankruptcy Judge, Northern District of Texas. Membership: Dallas Bar Association; Dallas Bankruptcy Bar Association; Louisiana State Bar Association; Texas Bar Association; American Bar Association; National Conference of Bankruptcy Judges; Master, John C. Ford American Inn of Court. GERRIT M. PRONSKE B.A., 1980, Texas Tech University, with High Honors J.D., 1983, Texas Tech University School of Law Shareholder, Pronske & Patel, P.C., Dallas, Texas Author, Pronske s Texas Bankruptcy, Annotated , (Thirteenth Edition), published by Texas Lawyer Press Chairman, Bankruptcy Section of the Federal Bar Association, 2007 to 2008 Chairman, Dallas Bankruptcy Bar Association Editor, Texas Bankruptcy Decisions to 2003 Editor, Texas Bankruptcy Court Reporter to 1995 Former Law Clerk to Honorable Robert C. McGuire, United States Bankruptcy Judge for the Northern District of Texas, Dallas Division Membership: Dallas Bar Association; Dallas Bankruptcy Bar Association; Turnaround Management Association; American Bankruptcy Institute; Master, John C. Ford American Inn of Court; Texas Bar Association; American Bar Association; Federal Bar Association Licensed in the States of Texas, Colorado and New Mexico Frequent author and lecturer at continuing legal educational programs

3 RECENT DEVELOPMENTS 1 RECENT DEVELOPMENTS: TEXAS BANKRUPTCY COURT, TEXAS FEDERAL DISTRICT COURT, FIFTH CIRCUIT COURT OF APPEALS, AND UNITED STATES SUPREME COURT BANKRUPTCY DECISIONS DISCHARGEABILITY Bullock v. Bankchampaign, N.A., 133 S.Ct (U.S. Sup. Ct., May 13, 2013) (Justice Breyer) Issue: Whether the term defalcation, as used in section 523(a)(4) of the Bankruptcy Code excepting from discharge a debt for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny, includes a culpable state of mind requirement involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior. Prior to the filing of a Chapter 7 bankruptcy by the petitioner, petitioner s father established a trust for the benefit of petitioner and his siblings, and made petitioner the (nonprofessional) trustee. The trust s sole asset was the father s life insurance policy. The petitioner borrowed funds from the trust three times; all borrowed funds were repaid with interest. His siblings obtained a judgment against him in state court for breach of fiduciary duty, though the court found no apparent malicious motive. The court imposed constructive trusts on certain of petitioner s interests in order to secure petitioner s payment of the judgment, with respondent serving as trustee for all of the trusts. Petitioner filed for bankruptcy. Respondent opposed discharge of petitioner s state-court-imposed debts to the trust, and the bankruptcy court granted respondent summary judgment, holding that petitioner s debts were not dischargeable pursuant to section 523(a)(4), which provides that an individual cannot obtain a bankruptcy discharge from a debt for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny. The Federal District Court and the Eleventh Circuit affirmed. The latter court reasoned that defalcation requires a known breach of fiduciary duty, such that the conduct can be characterized as objectively reckless. On appeal to the Supreme Court, issue was, essentially, whether the term defalcation contained a scienter requirement. In reversing the Eleventh Circuit, the Court held that the term defalcation in section 523(a)(4) includes a culpable state of mind requirement involving knowledge of, or gross recklessness in respect to, the improper nature of the fiduciary behavior. While defalcation has been an exception to discharge in a bankruptcy statute since 1867, legal authorities have long disagreed about its meaning. Broad definitions of the term in modern and older dictionaries are unhelpful, and courts of appeals have disagreed about what mental state must accompany defalcation s definition. The Court has previously interpreted the term fraud in section 523(a)(4) to mean positive fraud, or fraud in fact, involving moral turpitude or intentional wrong, as does embezzlement; and not implied fraud, or fraud in law, which may exist without the imputation of bad faith or immorality. The Court found that the term defalcation should be treated similarly. Thus, where the conduct at issue did not involve bad faith, moral turpitude, or other immoral conduct, defalcation requires an intentional wrong. An intentional wrong includes not only conduct that the fiduciary knows is improper but also reckless conduct of

4 RECENT DEVELOPMENTS 2 the kind that the criminal law often treats as the equivalent. Where actual knowledge of wrongdoing is lacking, conduct is considered as equivalent if, as set forth in the Model Penal Code, the fiduciary consciously disregards, or is willfully blind to, a substantial and unjustifiable risk that his conduct will violate a fiduciary duty. The Court found that several considerations supported this interpretation, including statutory context, the fact that the Court s interpretation did not make the word identical to its statutory neighbors, Embezzlement, larceny, and fraud, and the fact that their the interpretation was consistent with the longstanding principle that exceptions to discharge should be confined to those plainly expressed. It was also consistent with statutory exceptions to discharge that Congress normally confines to circumstances where strong, special policy considerations, such as the presence of fault, argue for preserving the debt, thereby benefiting, for example, a typically more honest creditor. Next, the Court found that some Circuits have interpreted the statute similarly for many years without administrative or other difficulties. And Finally, the Court found that it was important to have a uniform interpretation of federal law. The Court therefore reversed the decision of the Eleventh Circuit. ATTORNEYS FEES Frazin v. Haynes & Boone, LLP, et al (In re Frazin), 2013 WL (5th Cir. October 1, 2013, Prado, J.) Issue: Whether the Bankruptcy Court has authority in light of Stern v. Marshall to enter final judgment on state law counterclaims of professional malpractice, breach of fiduciary duty, and DTPA in the context of professional fee applications under Section 330. Holding: The Bankruptcy Court has the authority to enter final judgment on state-law counterclaims for professional malpractice and breach of fiduciary duty in the context of professional fee applications under Section 330, but lacks the authority to enter final judgment on DTPA claims against estate professionals since determination of these claims is not necessary to enter a ruling on the fee application. Chapter 13 Debtor obtained court approval to employ state court litigation counsel and later appellate counsel as estate professionals to prosecute state-court litigation, a portion of the proceeds from which were intended to fund payment to unsecured claims under the confirmed plan. The professionals successfully obtained a multi-million judgment that was paid into the estate and sought Bankruptcy Court approval of payment of their professional fees from the estate under Section 330. In his objection to the professional fee applications, Debtor raised state-law counterclaims for negligence, breach of fiduciary duty, and violations of the Texas Deceptive Trade Practices Act ( DTPA ). After a six day trial, the Bankruptcy Court ruled against Debtor s state-law counter-claims and awarded the professional fee claims in the amounts requested. The District Court approved the judgment in all respects. On appeal, Debtor argued that the Bankruptcy Court lacked judicial authority to enter final judgment on the state-law claims raised in the objection to the professional fee applications under the precedent set by Stern v. Marshall. With respect to professional malpractice/negligence and breach of fiduciary duty claims, the Court reasoned that the award of professional fees and malpractice arise from a common nucleus of operative fact, looking to the Interlogic opinion and the res judicata effect of a final professional fee order with respect to malpractice claims. Osherow v. Ernst & Young, LLP (In re Interlogic Trace, Inc.), 200 F.3d 382 2

5 RECENT DEVELOPMENTS 3 (5th Cir. 2000). The Debtor s counter-claims for malpractice and breach of fiduciary duty were not independent of the federal bankruptcy law, but rather were necessarily resolvable by the Bankruptcy Court in the process of ruling on the professional fee applications and therefore fell constitutionally within the Bankruptcy Court s authority to enter final orders under Stern. With respect to the DTPA claims, however, the Court found that it was not necessary for the Bankruptcy Court to adjudicate the merit of the state-law claims to determine the allowance of the professional fees such that adjudication of the DTPA claims fell outside the authority of the Bankruptcy Court to enter final orders, although the Bankruptcy Court s factual determinations made in the course of analyzing the DTPA claims were within its constitutional authority because such underlying facts were necessarily resolved in adjudicating the fee applications. In a brief concurring opinion, Judge Owen added that a party objecting to a fee application should not reserve grounds for litigation in another forum simply because the grounds may also be at issue in a state-law cause of action, arguing that issues necessary to a fee application must be adjudicated in the Bankruptcy Court. Additionally, Judge Owen argued that, once those issues are finally adjudicated by the Bankruptcy Court, the court that adjudicates the state-law counter-claims outside of the Bankruptcy Court s judicial authority may apply issue preclusion principles to prevent wasteful and unnecessary relitigation of factual and legal issues. ESTOPPEL Axis Surplus Ins. Co. v. Flugence (Matter of Flugence), 2013 WL (5 th Cir., October 4, 2013) (Judge Jerry E. Smith) Issue: Whether, for purposes of establishing judicial estoppel, a debtor in a Chapter 13 case has a duty to disclose a postconfirmation personal injury claim. Issue: Whether, for purposes of establishing judicial estoppel, a Debtor can establish inadvertence for nondisclosure of a postconfirmation personal-injury claim where the Debtor knows the facts underlying the claim but does not know that disclosure is required. Issue: Whether application of judicial estoppel against a Debtor (but not against innocent creditors) recovery against a Defendant should be limited strictly to amount owed creditors. Debtor filed for Chapter 13 bankruptcy protection and a plan was confirmed. Following confirmation, Debtor was injured in a car accident, and she hired an attorney a month later. After that, an amended Chapter 13 plan was confirmed. In the following year Debtor sued Defendants for personal injury. After that, Debtor received her Chapter 13 discharge. During the pendency of the bankruptcy case and the plan, Debtor never disclosed to the bankruptcy court that she had been in an accident and might prosecute a personal-injury claim. When the Defendants discovered this non-disclosure, they had the bankruptcy case reopened and sought to have the Debtor judicially estopped from pursuing the undisclosed claim. The bankruptcy court declared that although Debtor was estopped from pursuing the claim on her own behalf, her bankruptcy trustee was not similarly estopped and could pursue the claim for the benefit of Debtor s creditors in accordance with Reed v. City of Arlington, 650 F.3d 571 (5th Cir.2011) (en banc). On appeal, the district court reversed, holding that Debtor did not have a potential cause of action prior to her initial application for bankruptcy protection, she relied on her attorney s advice as to whether she must disclose her potential cause of action to the bankruptcy court, and because of the flux in the 3

6 RECENT DEVELOPMENTS 4 law at the time regarding a debtor s duty to disclose in post-confirmation, Chapter 13 proceedings. On further appeal to the Fifth Circuit, the court reversed the district court, holdings that there is a continuing duty to disclose in a Chapter 13 proceeding, and that the Debtor had met all the elements of judicial estoppel. Judicial estoppel has three elements: (1) The party against whom it is sought has asserted a legal position that is plainly inconsistent with a prior position; (2) a court accepted the prior position; and (3) the party did not act inadvertently. Since those elements were met, the Fifth Circuit found that the bankruptcy court did not abuse its discretion by finding Debtor estopped. It may be uncertain whether a debtor must disclose assets post-confirmation, but this was a pre-confirmation non-disclosure. Here, the plan explicitly stated that the estate s assets would not revest in the debtor until discharge. Further, the court found that to prove that the Debtor did not know of the inconsistent position, she must show not that she was unaware that she had a duty to disclose her claims but that she was unaware of the facts giving rise to them. Here, the Debtor clearly knew of the facts underlying her personal-injury claim. The court further found that nothing in the Reed case required that recovery be limited strictly to the amount owed creditors. Reed requires only that, after a claim is prosecuted and the creditors and fees have been paid, any remaining recovery must be returned to the personal-injury defendants. The court therefore reversed the judgment of the district court and rendered, reinstating the judgment of the bankruptcy court. SANCTIONS In re Jones, Slip Op., Adv. No (E.D. La., March 18, 2013) Issue: Whether the bankruptcy court erred in failing to afford a creditor due process by imposing punitive damages and contempt sanctions for alleged conduct that occurred not only in the present case but also in other cases after the bankruptcy court's judgment. Issue: Whether the bankruptcy court erred in awarding any punitive damages and, even if punitive damages were awardable, in setting the amount of those damages, and in imposing any contempt sanction and, even if the court had the authority to impose such a sanction and the sanction was justified, in setting the amount of that sanction. Debtor filed an adversary proceeding in an effort to recoup overpayments made to lender on his home mortgage loan. The complaint requested return of the overpayments, reimbursement of actual damages, and punitive damages for violation of the automatic stay. At trial, the parties severed debtor's request for compensatory and punitive damages from the merits of debtor's claim for return of overpayments. At a hearing on sanctions, damages, and punitive relief lender agreed to implement several remedial measures designed to correct systemic problems with its accounting of home mortgage loans. These procedures were embodied in a judgment, and included $67, in compensatory sanctions for attorney's fees and costs, and implementation of the new procedures in lieu of punitive damages. In a reversal of its agreement with the court, the lender appealed the judgment to the district court, which affirmed the compensatory damages (with an increase) and remanded for the issue of punitive damages. At the remanded sanctions and punitive judgment hearing, the bankruptcy court imposed the original sanctions ordered (the accounting procedures) in lieu of punitive damages. Additionally, the bankruptcy court found that 4

7 RECENT DEVELOPMENTS 5 the lender had willfully violated the automatic stay when it charged debtor's account with unreasonable fees and costs; failed to notify debtor that any of these post-petition chargers were being added to his account; failed to seek court approval for same; and paid itself out of estate funds delivered to it for payment of other debt. The bankruptcy court imposed $3,171, in punitive damages on the creditor in connection with its violation of the automatic stay. On appeal of the $3 million punitive damage award, district court affirmed the award. Section 362 allows for the award of actual damages, including costs and attorneys' fees, as a result of a stay violation, and punitive damages "in appropriate circumstances." Cases interpreting the standard for "appropriate circumstances" have indicated that punitive damages can be supported when the conduct at issue is intentional and egregious, or when the defendant acted in "bad faith," or with actual knowledge that he was violating the federally protected right or with reckless disregard of whether he was doing so." The court found that the lender knew of debtor's pending bankruptcy and lender is a sophisticated lender with thousands of claims in bankruptcy cases pending throughout the country. The lender assessed postpetition charges on the loan while in bankruptcy. Despite assessing postpetition charges, lender withheld this fact from its borrower and diverted payments made by the trustee and debtor to satisfy claims not authorized by the plan or court. Lender admitted that these actions were part of its normal course of conduct, practiced in perhaps thousands of cases. Considering those facts, the bankruptcy court found that lender s conduct was willful, egregious and exhibited a reckless disregard for the stay it violated. The court found that punitive damages serve a function broader than compensatory damages - "they are aimed at deterrence and retribution." Punitive damages may properly be imposed to further a State's legitimate interests in punishing unlawful conduct and deterring its repetition. The Supreme Court has established three factors for courts to consider when reviewing punitive damages: (1) the degree of reprehensibility of the defendant's misconduct; (2) the disparity between the actual or potential harm suffered by the plaintiff and the punitive damages award; and (3) the difference between the punitive damages awarded by the jury and the civil penalties authorized or imposed in comparable cases. In determining reprehensibility of the behavior, the court found that heavier punitive awards have been thought to be justifiable when wrongdoing is hard to detect (increased chances of getting away with it), or when the value of the injury and the corresponding compensatory award are small (providing low incentives to sue). The lender took the position that every debtor in the district should be made to challenge, by separate suit, their own stay issues with the lender. The court disagreed, finding that over eighty percent of chapter 13 debtors in this district have incomes of less than $40,000 per year. The burden of extensive discovery and delay is particularly overwhelming. Finding that there is a strong societal interest in deterring such future conduct through the imposition of punitive relief the court found that the bankruptcy court was correct in deeming lender s behavior reprehensible and finding that an award of punitive damages was appropriate. With respect to the ratio between the punitive damages and the actual harm, the court found that these were not excessive. Exemplary damages must bear a "reasonable relationship" to compensatory damages. The proper inquiry for this factor is whether there is a reasonable relationship between the punitive damages award and the harm likely to result from the defendant's conduct as well as the harm that actually has occurred. High awards are justified where a particularly egregious act has resulted in only a small amount of economic damages and in cases in which the injury is hard to detect. Potential harm to others should also be considered. Additionally, size of the corporation 5

8 RECENT DEVELOPMENTS 6 is a factor. The court finally found that the lender was on notice that its actions were impermissible and could incur significant penalties and assessing punitive damages at ten times the amount of compensatory damages was within the constitutional limits. The court therefore affirmed the decision of the bankruptcy court. DISCHARGEABILITY Kinkade, v. Kinkade, 707 F.3d 546 (5 th Cir., February 6, 2013) (Judge Jennifer Walker Elrod) Issue: Whether the discharge exception of section 523(a)(15) for divorce-related debts not in the nature of support, applies to both community debts and separate debts. Issue: Whether a portion of a judgment debt reflecting a sum of money that judgment creditor loaned the debtor before the parties marriage fell within the subject discharge exception of section 523(a)(15). In the debtor s Chapter 7 bankruptcy case, a judgment creditor, who was debtor s exwife, filed adversary complaint seeking determination that debt arising from the parties state-court divorce proceedings was nondischargeable. The issue before the bankruptcy court was whether the debtor owed his ex-wife was dischargeable in bankruptcy. The bankruptcy court, and the district court on appeal, held it was not. On appeal to the Fifth Circuit, the court found that the ex-wife had loaned the debtor two sums of money: some before the parties marriage, and some during the marriage. Both amounts came from exwife s separate property. During the ensuing divorce proceeding, the state-court judgment awarded the ex-wife certain debts. After the debtor filed for Chapter 7 bankruptcy, ex-wife initiated an adversary proceeding to contest discharge of the debt pursuant to section 523(a)(15). The central question on appeal was whether section 523(a)(15) applied to the debt. Ex-wife contested the bankruptcy court s decision on two grounds. First, she argued that section 523(a)(15) applies only to community debts, not separate obligations. The Fifth Circuit disagreed, finding that the bankruptcy statutory text suggested no such distinction. The statutory language requires only that the debt be incurred by the debtor in the course of a divorce or separation. The debtor next argued that section 523(a)(15) did not apply to the sum of money that the ex-wife loaned him before the parties marriage, and that her right to reimbursement was a contractual one, not a marital one, and cannot suddenly gain additional status by being included in a petition for divorce and partition. The Fifth Circuit disagreed, finding that in the present case the debtor and his ex-wife did marry, and the state court resolved their obligations to one another including the debt in the course of their divorce proceeding. This made the debt nondischargeable under section 523(a)(15) of the Bankruptcy Code. The court therefore affirmed the judgment of the bankruptcy court. AUTOMATIC STAY In re Law, 2013 WL (Bankr. N.D. Tex., August 29, 2013) Issue: Whether a post-petition pre-discharge letter mailed by motor vehicle lender to Chapter 7 debtor was in nature of willful violation of automatic stay of section 362(a)(6), as an improper attempt to collect prepetition debt, warranting award of actual damages in amount of $1,000, punitive damages in amount of $10,000, and reasonable attorney fees of 6

9 RECENT DEVELOPMENTS 7 $5,880, together with injunction against mailing out such letters in future. After the filing of a Chapter 7 bankruptcy case, after the debtor filed a statement of intention, indicating her intention to surrender the vehicle, and prior to the discharge, a car lender sent the debtor letter (and not also to debtor s counsel), which notified the debtor in repeated fashion of the AMOUNT NOW DUE and LAST DAY FOR PAYMENT on the Debtor s account, and indicated where the Debtor should send payments to cure her defaults. The vehicle in question was in the possession of debtor s estranged husband, who was not a joint debtor in the Chapter 7 case. The debtor and her counsel believed that, under the circumstances, the letter from the lender was an improper attempt to collect on a prepetition claim against the debtor, since the automatic stay had terminated as to the vehicle (but not to the debtor ), and there was nothing preventing the lender from repossessing the vehicle. The court held a hearing to determine whether the letter constituted a willful violation of the automatic stay. The court found that there was no dispute that the lender had notice of the bankruptcy. Among other things, the court found that the letter left an uncomfortable concern that the precise business strategy of the lender may have been to send the letter and see if possibly the debtor would send in a payment. The debtor testified that left her confused and anxious. The court held that the letter constituted a willful violation of the automatic stay, and awarded the debtor, pursuant to section 362(k), (a) $1,000 in actual damages; (b) $10,000 in punitive damages; and (c) reimbursement of attorneys fees to Legal Aid of Northwest Texas (the debtor s pro bono counsel) of $5,880. The court also enjoined the lender, pursuant to section 105(a) of the Bankruptcy Code, from sending further letters in the style and format of the letter to any other debtors in the Northern District of Texas. The court found that lenders should not send letters to debtors, who are represented by counsel, and who have filed Statements of Intention to surrender their vehicles, with words screaming (in all capital letters) AMOUNT NOW DUE and LAST DAY FOR PAYMENT. Even so-called bankruptcy disclaimer language (which was not in all capital letters) was found to be somewhat ambiguous to a debtor like the one in the caseat-bar. The problems with the letter were that: (a) it went to the debtor only and not her attorney, while she still had an open case and no discharge yet; (b) the lender had received full notice of the debtor s bankruptcy case; (c) the debtor filed a timely Statement of Intention indicating she desired to surrender the vehicle; (d) the debtor conspicuously stated in her Schedules that she did not have possession of the vehicle; (e) the time had passed where the automatic stay no longer applied to the vehicle and the lender was free to exercise in rem relief as to it; (f) there was nothing in Texas law that required the lender to send to the debtor any notice of the lender s intention to repossess the vehicle. Based on this, the court found that the letter crossed the line into being a stay violation. It looked and smelled like a collection attempt or other attempt to put pressure on a debtor who quite plainly expressed an intention to surrender the vehicle and who, quite plainly, was still in a bankruptcy case and represented by counsel. EXEMPTIONS In re Garcia, Slip Op, Case No rfn- 13 (Bankr. N.D. Tex., September 27, 2013) (Judge Russell Nelms) Debtors sold their homestead after filing for bankruptcy under chapter 13. During the six months that passed after the sale, the debtors did not reinvest the proceeds in another homestead. Instead, the debtors moved to modify their plan to permit them to keep the proceeds. The trustee objected to the plan modification, arguing that the proceeds were no 7

10 RECENT DEVELOPMENTS 8 longer exempt, and so the modified plan must provide for their distribution to unsecured creditors. Debtors argued that the homestead proceeds were exempt because their homestead exemption became final when no party timely objected to their claim of exemption. Alternatively, they argued that the trustee s objection was barred by res judicata because he failed to lodge his objection when the debtors sought this court s authority to sell the homestead. The bankruptcy court held that (1) the homestead proceeds lost their exempt status after six months from the date of sale and (2) the trustee s objection was not barred by res judicata. The court therefore denied the requested plan modification pursuant to the best interest of creditors requirement of section 1325(a)(4), which requires as a condition to both plan confirmation and plan modification that chapter 13 debtors pay unsecured creditors at least the amount they would receive if the estate were liquidated in chapter 7. The court found that proceeds from the sale of the homestead fall under the definition of property of the estate because (1) they are the proceeds of the homestead, an asset held as of the commencement of the case, or (2) the proceeds themselves are an asset acquired by the debtors post-petition. Under section (c) of the Texas Property Code, when a Texas homeowner sells his homestead, the proceeds are exempt for only six months from the date of the sale. The leading case regarding the impact of section (c) of the Texas Property Code on bankrupt debtors is the 2001 Fifth Circuit case of In re Zibman, where the the debtors sold their Texas homestead and kept the cash proceeds two months prior to filing Chapter 7. In that case, the Fifth Circuit held that the case was filed with the 6 month time clock running on the exemption, and the bankruptcy trustee was therefore entitled to the proceeds if they were not reinvested into another homestead. The Fifth Circuit reached the same result in Studensky v. Morgan in There, the debtor filed a chapter 7 petition but did not claim his homestead as exempt. After filing bankruptcy, he sold his homestead and used the proceeds to pay his brother, who claimed a lien on the homestead. When the trustee learned of the payment, he contested the brother s lien and demanded return of the proceeds. In response to the trustee s demand, the debtor amended his exemptions to claim the proceeds as exempt under section (c). The trustee objected to the exemption, arguing that the proceeds were not exempt because more than six months had passed since the sale of the home. The Fifth Circuit found in that case that the debtor never claimed his homestead as exempt, but instead only claimed the proceeds as exempt. The court then followed Zibman and held that the exemption of the proceeds was subject to the time limitation under Texas law. The court found that Zibman had to be reconciled with section 522(c) by a two-step analytical process. First, one must conclude that exempt property is not withdrawn from the estate, but remains property of the estate insulated from the claims of creditors for as long as the asset enjoys exempt status under state law. Second, one must conclude that section 522(c) does not preempt Texas s homestead laws. In a chapter 13 case, the effect of this construction is to place the debtor in the same position with regard to exemptions as he would have been in had he not filed for bankruptcy. The pendency of the bankruptcy case neither expands nor reduces his exemption rights. So, once an asset no longer enjoys exempt status under state law, that asset becomes vulnerable to claims and, hence, distributable to creditors. The court held that since it had been more than six months since the debtors sold their homestead, the homestead proceeds were non-exempt property of the estate as of the date of the debtors plan modification and, as such, were necessarily part of any hypothetical liquidation analysis under the best interests test. Because the plan failed to provide for the distribution of the sale proceeds to creditors, it did not comply with section 1325(a)(4). 8

11 RECENT DEVELOPMENTS 9 9