Homestead Exemption Reduced when Mortgage Paid with Fraudulently Obtained Funds

Posted by NCBRC - May 6, 2020

The bankruptcy court properly reduced the debtor’s homestead exemption and imposed a constructive trust on the property where the debtor paid off her mortgage using funds from the sale of a vehicle she did not own and to which the creditor had the right of possession. Graybill v. Thomas (In re Bentley), No. 19-14758 (11th Cir. Apr. 22, 2020) (unpublished).

This case involved a 1930 Cord Phaeton automobile. Originally, the car was owned by the debtor’s son Lynford Bentley. Dr. Susan Kolb lent Lynford $50,000, which loan was secured by the car. Lynford stopped paying on the loan, then he died. Dr. Kolb sued Lynford’s girlfriend to obtain the car or its value. But Lynford’s mother, and the debtor in this case, Catherine Bentley, took possession of the car and removed it from Georgia to Florida. A Georgia judge issued an order giving Dr. Kolb the right to possession of the car, and Dr. Kolb informed Catherine of that order. Notwithstanding her knowledge of Dr. Kolb’s right to possession of the vehicle, Catherine sold it at auction, clearing $112,947.81. She used the majority of the funds to pay off her mortgage. Dr. Kolb sued Ms. Bentley for fraudulent transfer. Ms. Bentley filed for chapter 7 bankruptcy and claimed a homestead exemption under Florida law.

Finding that Ms. Bentley never owned the vehicle and therefore had no right to the funds she used to pay off her mortgage, the bankruptcy court sustained the trustee’s objection to the exemption claim, reducing the amount of the exemption by $112,947.81. The bankruptcy court also overruled the debtor’s objection to Dr. Kolb’s claim, and imposed a constructive trust on the debtor’s homestead property. On appeal, the district court affirmed.

[At some point prior to this decision, Ms. Bentley died and Mr. Graybill took over the case as the representative of her estate].

On appeal, the Eleventh Circuit court began with the debtor’s argument that the trustee’s objection to her homestead exemption was untimely. Rule 4003(b)(1) gives the trustee 30 days after the 341 creditor’s meeting to object, but the bankruptcy court found that that deadline was extended by Rule 4003(b)(2), which allows objection up to one year after the closing of the case if the homestead exemption was fraudulently asserted. The court relied on Whatley v. Stijakovich-Santilli (In re Stijakovich-Santilli), 542 B.R. 245, 255 (B.A.P. 9th Cir. 2015), and looked at whether there was a representation that the debtor asserted and that she knew was false. The court found that there was a knowing false representation when the debtor, by claiming a homestead exemption, implicitly represented that she was entitled to the funds used to pay off her mortgage. In addition, under Florida law, by filing for a homestead exemption, the debtor falsely asserted that she owned the home. Based on these findings, the court found that Rule 4003(b)(2) applied and the trustee’s objection was timely.

The court next rejected the debtor’s argument based on Law v. Siegel, 571 U.S. 415 (2014), that the bankruptcy court improperly surcharged her homestead exemption as punishment for bad acts. To the contrary, unlike in Law where the bankruptcy court relied on its inherent power, the lower courts here based the reduction of the debtor’s homestead exemption on application of section 522(o), which provides for the reduction in the amount of a homestead exemption in the event of fraud, and Florida homestead law.

The debtor next argued that Dr. Kolb’s claim of $133,141.12 was time-barred because it was based on a debt the debtor’s son owed to Dr. Kolb. But the lower courts found that, in fact, the debt was based on Dr. Kolb’s claim against the debtor based on Georgia Uniform Voidable Transactions Act (GUVTA), and the debtor’s fraudulent conveyance of the car when she knew that Dr. Kolb had a right to possess it. The court found that the debtor’s argument relied on there being a dispute as to the debtor’s right to possess the vehicle—a factual issue the court found was properly resolved against the debtor in the bankruptcy court. Finding that the claim was timely under GUVTA, the court rejected the debtor’s statute of limitations claim.

Finally, the court addressed the bankruptcy court’s imposition of a constructive trust with respect to the debtor’s homestead. Florida law allows an equitable lien against a homestead where the funds to purchase the homestead were obtained by fraud. The court reasoned that because the funds the debtor used to pay off her mortgage were from sale of the car which the creditor had a legitimate claim to, the bankruptcy court properly exercised its discretion in imposing a constructive trust and equitable lien on behalf of Dr. Kolb.

The court affirmed.

Graybill 11th Cir April 2020


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