Court Erroneously Requires that Exemption Attach to Equity

Posted by NCBRC - March 28, 2017

Because the debtor had no equity in her residential property to which it could attach, the Sixth Circuit found that the bankruptcy court properly authorized sale of the property and denied her claim for exemption based on her state law redemption rights. Brown v. Ellman (In re Brown), No. 16-1967 (6th Cir. March 20, 2017).

Susan Brown’s residence was valued at $170,000 and was secured for more than $200,000. When she filed her chapter 7 petition, she indicated her intent to surrender the property. The trustee sought an order allowing him to sell the property for $160,000 and use the proceeds to pay administrative costs and make distributions to creditors. Ms. Brown objected and claimed an exemption under section 522(d) based on her state law redemption rights. She did not seek a stay of the sale. The sale went forward and the bankruptcy court denied Ms. Brown’s exemption claim on the basis that she had no equity in the property. The district court affirmed.

On appeal, the circuit court began with the jurisdictional issues of mootness and standing.

With respect to the trustee’s claim that the appeal was moot, the court began with section 363(m) which provides that an appeal of an order authorizing the trustee’s sale of property is moot if the debtor failed to seek a stay of the sale and it was conveyed to a bona fide purchaser. While some courts have treated this as a per se rule, others have added the requirement that the person seeking a finding of mootness show that an order on appeal would “materially alter” the sale of the property. In re ICL Holding Co., 802 F.3d 547, 554 (3d Cir. 2015); C.O.P. Coal Dev. Co. v. C.W. Mining Co. (In re C.W. Mining Co.), 641 F.3d 1235, 1239 (10th Cir. 2011). The issue was unsettled in the Sixth Circuit. Official Comm. of Unsecured Creditors v. Anderson Senior Living Prop., LLC (In re Nashville Senior Living, LLC), 620 F.3d 584 (6th Cir. 2010).

The court adopted the reasoning expressed by the third and tenth circuits that, where an appeal of the order authorizing the sale will not affect the underlying transaction, the appeal is not moot. Here, the trustee, who carries the burden of showing mootness, failed to argue that a finding on appeal in favor of the debtor would alter the sale. Nor was the case moot under Article III principles because the appellate court would be able to issue effective relief.

The trustee next argued that Ms. Brown had no standing to appeal because she had no equity in the property and therefore no claim to any of the proceeds from the sale. The court disagreed with the trustee’s framing of the issue. Ms. Brown sought an exemption based on her state law redemption rights. If the bankruptcy court had granted her motion, she would have been entitled to the exempted portion of the proceeds. Therefore, she had standing as a party who was “affected adversely” by the court’s decision.

Turning to the merits, the court addressed whether the bankruptcy court erred in denying her exemption under section 522(d).

The circuit court agreed with the bankruptcy court’s finding that “that any exemption on the basis of the value of the debtor’s redemption rights must attach to some equity held by the debtor after satisfaction of the secured liens on the property. . . Absent such equity, the debtor had no interest to which the claimed exemption could attach.” The court rejected the argument that Law v. Siegel mandated reversal of the bankruptcy court’s decision. Rather, the court found that where Law dealt with the court’s power to surcharge a debtor’s exemption under section 105, it was faced with whether the exemption under section 522(d) applied at all. The court concluded that “Section 522 will not support an exemption on the basis of state-law redemption rights in a piece of property if the proceeds from the sale of that property are insufficient to satisfy the prior obligations owed to the secured creditors.”

In its amicus brief, NCBRC argued, among other things, that section 522(d) protects a debtor’s “interest” in property, as distinguished from “value,” and such interest may be possessory. The Code, which favors exemptions as furthering the debtor’s fresh start, does not require that an exemption attach to equity. Unfortunately, though the court deemed NCBRC’s brief “helpful,” it misconstrued, or otherwise failed to address, this argument.

Brown 6th Cir opinion March 2017

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