03-3309 -- In re: Barbara E. Hodes, et al., Debtors; Lawrence S. Jenkins, et al., Appellants v. Barbara E. Hodes, et al.

U.S. 10th Circuit Court of Appeals
(October 6, 2004; morning docket)


SUMMARY OF ORAL ARGUMENT

Appellants' oral argument focused on the timeframe for when a court should apply the protections for a debtor under 11 U.S.C. 303(f) of the Bankruptcy Code and the plain language of the Kansas homestead statute. Appellants argued that the date of the filing of the bankruptcy petition should control. Judge Henry questioned Appellants about whether there were any cases in Kansas that addressed this timing issue and involved an involuntary bankruptcy proceeding. Judge Henry noted that Kansas cases do not seem to address this issue, and Appellants could not point to any cases that were tailored to the specific circumstances of this case. Despite the lack of specific case law, Appellants' strongest argument overall was that the debtors unfairly induced Appellants into a settlement agreement, which in turn led Appellants to forego making any motions available to them under 303(f).

Appellees directly attacked the contention that they manipulated the Bankruptcy process on the 'courthouse steps' by noting that no facts supported such an allegation of fraud and that the issue was not properly before the court. Appellees’ strongest argument was the contract issue, which Judge Hartz pursued with his line of questioning. Appellees agreed with Judge Hartz that their case was stronger because their intent to build an addition on to their home was demonstrated when they entered into a contract and delivered the money to the contractor. Finally, Appellees brought a Massachusetts Bankruptcy case to the court’s attention. The court was not impressed with Appellees failure to provide this in a supplemental document before the oral argument. Appellees advised listeners in the courtroom that this was a valuable lesson: start preparing for oral arguments early.

CASE SUMMARY (prepared at Washburn Law)

PROCEDURAL HISTORY

This case comes before the Tenth Circuit on appeal by the Creditor, Jenkins, and the Chapter 7 Trustee, Rajala, against the Debtors, the Hodes. On appeal, the Creditor objects to the homestead exemption allowed by the Bankruptcy Court for the District of Kansas and the State District Court.

FACTS

On November 17, 1997, the State District Court entered a judgment against the Debtors and twelve other co-defendants who were sued by creditors for breach of contract arising out of the sale of a business. The jury returned a verdict against all defendants, including the Debtors, for $4,000,000 plus interest and attorney’s fees. Thereafter, the Debtors liquidated nonexempt securities and used a portion of the proceeds to pay a $225,000 deposit for construction of an addition to their existing homestead worth in excess of $500,000. The Debtors claimed the addition was necessary to allow them to babysit their unborn twin grandchildren. After the deposit was paid, the Creditors filed an involuntary Chapter 7 petition against the Debtors on January 6, 1998. The parties attempted to reach a settlement agreement, but the Bankruptcy Court did not require the Debtors to comply with their agreement. In their Schedules filed on May 27, 1998, the Debtors claimed an exemption for the addition to their home pursuant to the Kansas Homestead Exemption. The Creditors and the Bankruptcy Trustee filed separate objections to the exemption. The Bankruptcy Court denied the objections, allowing the homestead exemption claimed by the Debtors.

ISSUE

Whether a cash deposit for construction of an addition to the Debtors’ pre-existing home qualifies under K.S.A § 60-2301 as exempt property in an involuntary bankruptcy proceeding.

ARGUMENTS

» Appellants’ Argument

The filing of a bankruptcy petition determines the date of the exempt status of the Debtors’ property. In this case, the involuntary petition was filed on January 6, 1998. The estate then created owns the Debtor’s property, including the cash deposit of $225,000 at issue in this case, subject to the allowance of an exemption in favor of the Debtor. Once the bankruptcy estate is established, the property cannot change from non-exempt to exempt status.

Neither the plain meaning nor the intention of the homestead exemption statute fit the specific facts of this case. The intention of the homestead exemption is to protect Debtors from a destitute lifestyle, not to protect non-exempt property. The Debtors seek to expand the plain language of the Kansas homestead law to encompass the cash deposit and improvements on real estate added with such cash after the date of filing the bankruptcy petition. However, the current homestead law exempts real estate, not cash. Further, the homestead law limits the exemption to an existing homestead and does not extend to an addition to a homestead.

Further, even if the exemption is allowed, only the portion of the cash deposit already used on the addition should be exempt. Therefore, the Creditors could collect on at least $216,000 of the cash deposit.

Shortly after the bankruptcy case commenced, the Debtors induced the Creditors into a post-bankruptcy settlement, persuading the Creditors to forego filing motions to block the Debtors from using the deposit. Therefore, the Debtors, in light of their actions, have either waived their right to seek an exemption or are estopped to assert the right.

The Appellants seek reversal of the District Court’s decision and an order disallowing the Debtors’ homestead exemption. If the Tenth Circuit does not reverse, the Appellants seek a remand for partial award of the cash deposit, specifically the amount unspent at the time the order for relief was entered.

» Appellee's Argument

The Kansas courts in the past have liberally interpreted and applied the homestead exemption. Both the Bankruptcy Court and the State District Court have continued the liberal interpretation of K.S.A. § 60-2301 in this case by extending the exemption to the cash deposit for construction of an addition to the Debtors’ homestead.

The Appellants arguments were not raised below and are without merit. The Bankruptcy Code sets the exemptions on the filing date. Under 11 U.S.C § 303(f), debtors are permitted to use and protect their property before entry of the order for relief but after the petition is filed. The Debtors’ homestead exemption in this case is not barred by waiver or estoppel, as those arguments were not raised below.

The Debtors ask the Court to affirm the District Court’s order denying the Appellants’ objection to the Debtors’ claimed homestead exemption.

WHY THIS CASE IS INTERESTING

If the Tenth Circuit upholds the District Court’s decision, debtors contemplating bankruptcy would be allowed to convert otherwise non-exempt property into an exempt asset. Thus, pre-petition bankruptcy planning would allow debtors to exercise wider latitude with their assets. Debtors’ assets in many cases would be free from creditor intrusion. Thus a decision upholding the District Court’s order would expand the already liberal Kansas Homestead Exemption. However, if the Tenth Circuit reverses the District Court’s order, greater protection will be provided to creditors’ rights to non-exempt property in bankruptcy proceedings.

INFORMAL CASE SUMMARY

Please Note: This informal case summary is not intended for official use and does not purport to be exhaustive of the issues or defenses presented by the parties.

In this bankruptcy appeal, the trustee and creditors appeal the order of the district court affirming the bankruptcy court's order denying their objection to the debtors' homestead exemption. The debtors were allowed to claim as a homestead exemption a $225,000 cash deposit paid to a building contractor for an addition to their home, even though the contractor had not expended any of the deposit before the involuntary bankruptcy petitions had been filed, and less than $9000 of the funds had been expended by the time the orders for relief were entered.

The appellants contended in the district court that the debtors were not entitled to claim the deposit as a homestead exemption because: 1) a cash deposit derived from the sale of nonexempt property does not constitute property which can qualify for a homestead exemption; 2) any improvements made to the homestead from the deposit must have been completed before the involuntary petitions were filed; 3) the Kansas exemption laws are intended to protect the destitute and the debtors are not destitute; 4) use of the deposit after the filing of the involuntary petitions violated the automatic stay; 5) the debtors engaged in fraudulent conduct; 6) the debtors should be estopped from asserting the exemption because of a settlement reached over a contested motion; and 7) the trustee had a special interest in the homestead. The district court rejected all of these contentions.