by Funds paid to the chapter 7 trustee out of the sale of debtors’ homestead could not be exempted where the sale did not fully satisfy outstanding liens. Baldridge v. Ellmann (In re Baldridge), No. 13-1700 (6th Cir. Feb. 3, 2014) (per curiam). The debtors’ residence was subject to two liens which, together, exceeded the value of the property. The bankruptcy court lifted the stay and permitted the trustee to sell the property for less than the value of the two liens. After paying off the senior lien in its entirety, the second lienholder took the remainder and, out of that, paid the trustee $28,000.00 in accordance with a “carve out” agreement settling the mortgagee’s objection to the trustee’s sale of the property free and clear of liens.
The debtors attempted to claim a portion of that amount as their homestead exemption under section 522(d)(1). The bankruptcy court found that, under section 506(d) which provides for the trustee to take from the sale of estate property, the reasonable, necessary costs and expenses of preserving, or disposing of, such property,” the trustee could take his costs from the proceeds from the foreclosure sale. Because the $28,000 did not represent equity in the residence, the debtors were not entitled to take their homestead exemption against that amount. The district court agreed. In re Baldridge, 2013 WL 1759365 (E.D. Mich. April 24, 2013) (2:12-cv-14612). The Sixth Circuit affirmed.
The debtors argued that the money paid to the trustee actually represented payment for the waiver of their state law right of redemption which was an equity interest in the property against which they could take their homestead exemption. The court rejected this argument as both factually and legally defective. As a factual matter, there was no evidence that the debtor’s right of redemption was a factor in the agreement between the trustee and the lienholder and the parties did not dispute that the trustee had authority to waive the debtors’ redemption rights. Moreover, the sale of the property left a deficiency of over $200,000 and the carve out agreement merely gave to the trustee funds from the junior lienholder’s recovery. There was, therefore, no residual equity upon which to base an exemption.
Referring to the opinion of the district court, the Sixth Circuit rejected the debtors’ argument that the $28,000.00 became property of the estate and was, therefore, subject to their exemption rights. Property of the estate under section 541(a)(1) is determined at the commencement of the case and the carve out agreement occurred post-petition. But more importantly, funds recovered by the trustee under section 506(c) are not converted to equity simply because they are paid to the bankruptcy estate, and therefore, could not support the debtors’ exemption claim.