Texas Court Addresses Post-Petition Sale of Homestead in Chapter 7

Posted by NCBRC - November 23, 2016

A homestead that is exempt in chapter 7 is not part of the bankruptcy estate and, therefore, proceeds from its post-petition sale do not enter the estate for purposes of distribution to creditors. In re Montemayor, 547 B.R. 684 (Bankr. S.D. Tex. 2016) (Case No. 14-10031, Adv. Proc. No. 15-1003).

Juan Jose Montemayor filed for chapter 7 bankruptcy and claimed an exemption in a half-interest in real property as his homestead under Texas law. Post-petition he sold his interest in the property. With some of the proceeds, he bought land and commenced construction on a new residence. He deposited the rest of the proceeds into a bank account for use in building his new residence. When he had not invested all the proceeds in a new homestead within six months, as required by Texas homestead law, the trustee moved for an order requiring him to turn over the funds. The case was before the court on the trustee’s motion for summary judgment.

The court looked to Fifth Circuit law to determine what effect Mr. Montemayor’s failure to reinvest the homestead proceeds within the six-month time frame had upon his chapter 7 estate. The court considered the “proceeds rule,” which renders proceeds from the sale of a homestead subject to creditors if they are not reinvested in a new homestead within six months, and the “snapshot rule,” under which exemptions are determined by the status of the asset and the governing state law at the time of filing for bankruptcy.

In In re Zibman, 268 F.3d 298, 301-05 (5th Cir. 2001), the court applied the “snapshot rule” to find that the proceeds from the sale of the chapter 7 debtor’s homestead, which took place three months prior to his bankruptcy filing, were not entitled to exempt status because he failed to reinvest the proceeds within the six-month time frame. Because the homestead property was sold prior to bankruptcy and therefore never exempted, the court found that the exempt status of the proceeds was conditioned upon their reinvestment.

In In re Frost, 744 F.3d 384 (5th Cir. 2014), the court addressed a post-petition sale of homestead property in the context of a chapter 13 case and concluded “that the sale of a homestead voids the exemption and . . . proceeds not reinvested within the six-month statutory provision, regardless of pre or post-petition timing, become non-exempt.”

The question presented to the Montemayor court, then, was whether the rule in Frost applies in the chapter 7 context. The court conducted a survey of bankruptcy cases pre and post-Frost.

In Lowe v. Yochem (In re Reed), 184 B.R. 733 (Bankr. W.D. Tex. 1995), a pre-Frost case, the chapter 7 debtor sold his homestead post-petition and used the proceeds to pay off debts to creditors for which he had pledged the purchase note. The court rejected the trustee’s argument that the payments to creditors were unlawful transfers because the funds came from sale of property that, as an exempt homestead, was not part of the bankruptcy estate under the “snapshot” rule.

In a post-Frost case, In re Smith, 514 B.R. 838 (Bankr. S.D. Tex. 2014), the court found that Frost did not distinguish between chapter 13 and chapter 7, and therefore proceeds from the chapter 7 debtor’s post-discharge, pre-bankruptcy-closing sale of homestead property inured to the benefit of creditors.

Lowe v. DeBerry (In re DeBerry), Adv. No. 15-05054, 2015 WL 6528024 (Bankr. W.D. Tex. Oct. 28, 2015), on the other hand, held that Frost did not apply in chapter 7 and, because the homestead was exempted at the time of the petition, the proceeds from its sale never entered the bankruptcy estate.

The Montemayor court distinguished Frost finding that in Frost the six-month reinvestment period lapsed prior to plan confirmation and at a time when estate property had not revested in the debtor (in fact, under the rules of the bankruptcy court and the chapter 13 plan, estate property would not revest in the debtor until discharge). Under sections 541(a) and 1327(b), the proceeds were property of the bankruptcy estate because the homestead was still property of the estate when it was sold, and the debtor’s failure to reinvest the funds from the sale rendered them non-exempt.

Unlike chapter 13, where an exempt asset remains property of the estate until at least confirmation under section 1327(b), in chapter 7, exempt property is immediately removed from estate property. Therefore, the court found that the holding in Frost was not applicable. Rather, those cases applying the “snapshot rule” provided the answer to the issue. Where Mr. Montemayor’s homestead was exempted out of the bankruptcy estate without objection, the proceeds from its sale never became property of the estate. The court, therefore, denied the trustee’s motion for summary judgment and, sua sponte, found that Mr. Montemayor was entitled to judgment in his favor.

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