Is Your Homestead Exemption Bulletproof under 11 USC 522(o)?

In Florida, your home is truly your castle.  We have Florida constitutional homestead equity protection in an unlimited amount.  This means that you can file bankruptcy with a two million dollar home (or more) with no mortgage and claim it as exempt, but this doctrine is subject to exceptions when a debtor files for bankruptcy protection.   11 U.S.C. 522(o) is one such exception.  Under this section, a debtor may not claim as exempt his or her homestead, or any portion of the homestead, that was acquired with non-exempt assets and actual fraudulent intent to defraud a creditor.  It is the second part of this test which sends chills down your spine.  What exactly is the requisite fraudulent intent?  This is the question that we will explore in this blog.

This  section of the bankruptcy code allows a trustee or creditor to challenge a debtor’s homestead exemption and provides a look-back period of 10 years.  In other words, we can look back 10 years to see where you obtained the money to purchase your homestead.  That is when the questions begin to fly fast and furious at the debtors.  Where did the money come from?  Did you cash in a 401K?  Why did you do that? Etc. Etc.

Before we get into the analysis of this section it is important to understand why this section exists.  If a debtor has a large amount of equity in their homestead and the bankruptcy trustee can get at that equity, then the amount of equity that the trustee can obtain will be distributed to the creditors.  If you are the largest creditor in a bankruptcy, this may be your only avenue to recover funds.  Likewise, the bankruptcy code was created and designed to level the playing field between the honest but unfortunate debtor and his or her creditors.  So, naturally, a debtor who takes inappropriate actions before filing for bankruptcy should be subject to a few questions.

While there are several cases across the country discussing 11 U.S.C. 522(o), they argument usually comes down to a simple question:  What was the intent of the debtor at the time of the purchase or pay down of the homestead.  Did they have an intention to defraud their creditors.  The court who have looked at this issue realized that Congress failed to define what fraudulent intent actually is.  So, the courts have looked to the traditional badges of fraud for assistance in determining the debtor’s state of mind at the time of the alleged misconduct.

Badges of Fraud include but are not limited to:

1. Whether a transfer was made to an insider.

2. The Debtor maintained possession or control of property after a transfer.

3. The transfer was concealed or the Debtor concealed other conversions.

4. Was the Debtor being sued at the time of the transfer?

5. Did the transfer or conversion occur after the entry of a large judgment against the Debtor?

6. The transfer was of substantially all of the Debtor’s assets.

7. The Debtor absconded.

8. The Debtor removed or concealed assets.

9. The value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred.

10. Was the transfer or conversion done on the eve of filing for bankruptcy?

11. Did the Debtor obtain credit to purchase the exempt asset?

12. The Debtor transferred the essential assets of the business to a lienor who transferred the asset to an insider of the debtor.

It is important to note at this point that the presence of one or two badges of fraud do not immediately establish an intention to hinder, delay or defraud a creditor at the time he or she purchased his or her homestead.  However, a confluence of badges can constitute the requisite intent to defraud a creditor.  These badges will need to be weighed along with all of the evidence in the case.

Interestingly, several courts have also mentioned an additional element that must be proven before the court will find a fraudulent intent.  In the case of Clark v. Wilmoth, 397 B.R. 915, the Court stated that there must be extrinsic evidence of fraud other than the badges of fraud.  This will vary from case to case.

Accordingly, for any debtor with a substantial amount of equity in a homestead, this discussion should take place between counsel and the Debtor.  In many states that have a much smaller equity exemption, this analysis may not be relevant; however, in states like Florida and Texas, the analysis comes into play quite often as many retirees have no mortgage on their homestead properties.