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In
1998, WorldCom's founder, and former Chairman, John
Porter, purchased a 10,000 square-foot ocean-front
estate in Palm Beach, Florida. The home, featured
on the cover of the November 2004 issue of Luxury
Homes Magazine, was valued at nearly $17 million.
Yet, Porter owed more than $25 million for back taxes,
and, at the time, he was the defendant in several
multi-million dollar securities fraud lawsuits resulting
from WorldCom's failure. To avoid these liabilities,
Porter filed bankruptcy in May 2004 and sheltered
his lavish estate from creditors by invoking the Florida
homestead exemption.1
Abuse of the homestead
exemption is not uncommon. Several years ago, a General
Accounting Office study estimated that each year,
400 homeowners in Florida and Texas, all with over
$100,000 in home equity, profited from unlimited homestead
exemptions. While living in luxury, these homeowners
wrote off an estimated $120 million owed to honest
creditors.2 Such abuse of state homestead exemptions
was one of the targets of the Bankruptcy Abuse Prevention
and Consumer Protection Act ("BAPCPA") signed
into law by President Bush on April 20, 2005.
While the homestead
changes in BAPCPA were primarily directed to abuses
in Florida and Texas, the changes will significantly
impact the Arkansas homestead exemption. Arkansas
debtors can still elect to claim Arkansas' homestead
exemption; but, under BAPCPA, that election is now
subject to three important federal3 limitations for
debtors filing bankruptcy on or after April 20, 2005.4
First, a claimed homestead exemption can be reduced
to the extent that the value of the homestead is attributable
to non-exempt property that the debtor disposed of
within 10 years of filing with the intent to hinder,
delay, or defraud a creditor.5 Secondly, a debtor
may not exempt any amount of interest in the property
exceeding $125,000 that was acquired during the 1,215-day
period [3 1/3 years] preceding a bankruptcy filing
with the exception of any interest transferred from
a debtor's prior residence acquired in the same state
more than 1,215 days before filing.6 Finally, the
homestead is capped at a maximum of $125,000 where
the debtor owes debts arising from certain wrongful
acts.7 To understand the impact of these changes,
this article will examine the traditional application
of the Arkansas homestead exemption and potential
differing results under BAPCPA.
The
Arkansas Homestead Exemption
The Arkansas homestead
exemption has historically provided debtors with the
opportunity to retain their homestead without liability
to most creditors. Constitutionally based, the homestead
exemption was created in 1868 to "protect families
from dependence and want,"8 and provides:
The
homestead of any resident of this State, who is married
or the head of a
family, shall not be subject to the lien of any judgment
or decree of any court,
or to sale under execution, or other process thereon,
except such as may
be rendered for the purchase money, or for specific
liens, laborers' or mechanics'
liens for improving the same, or for taxes, or against
executors, administrators,
guardians, receivers, attorneys for moneys collected
by them,
and other trustees of an express trusts, for moneys
due from them in their
fiduciary capacity.9
Thus, a debtor, in dire financial straits, can seek
refuge from attacking creditors behind the seemingly
impenetrable walls of his home.
Utilizing the exemption,
married debtors facing insolvency typically liquidate
all of their non-exempt assets such as stocks and
bonds, commercial real estate, small business enterprises,
etc. and place the proceeds either in an existing
homestead or purchase a new homestead immediately
prior to filing bankruptcy.10 Under the Arkansas Constitution,
such debtors are able to claim the exemption, provided
they are married Arkansas residents and so long as
their home sits on no more than one-quarter of an
acre in the city or 80 acres in rural areas.11 Although
there is some discrepancy in the constitutional provisions
as to the value of the homestead, courts, recognizing
that homestead exemptions under the Arkansas Constitution
are to be liberally construed in favor of the exemption,
have uniformly found that there is no monetary ceiling
on the value of the homestead.12 As a result, homesteads
exceeding one million dollars in value are not uncommon,
and "wealthy married debtors with substantial
equity in their homes may refuse to pay their creditors
while sheltering their wealth in the homestead."13
This traditional protection, however, is now subject
to the new limitations of BAPCPA.
Intent
To Defraud
While the ability to
attack pre-petition transfers is not new to the Bankruptcy
Code,14 under BAPCPA, an Arkansas debtor's homestead
exemption may now be reduced to the extent of the
value of any non-exempt property disposed of by the
debtor within 10 years of filing a petition of bankruptcy
with the intent to hinder, delay, or defraud a creditor.15
As a result, this 10-year reach-back period creates
fertile ground for the growth of homestead exemption
litigation and debtor-creditor attorneys should have
a working knowledge of what constitutes an intent
to defraud.
Merely converting non-exempt
assets into exempt assets, even on the eve of bankruptcy,
does not create the requisite intent to hinder, delay
or defraud a creditor.16 There must be indicia of
fraud beyond the mere use of the exemption.17 Unfortunately,
there is no clear-cut answer as to when the line has
been crossed, since the Eighth Circuit has refrained
from "setting forth either what fraudulent intent
is, as compared to the ordinary use of lawful exemptions,
or what extrinsic evidence might prove the existence
of fraudulent intent."18 Yet, it seems clear
that Congress, by using nearly identical language
in § 522(o), intended for the "intent to
hinder, delay, or defraud" language in BAPCPA
to be construed in exactly the same manner as the
fraudulent conveyance and discharge provisions of
11 U.S.C. § 548(a)(1) and § 727(a)(2), and
examination of the extensive body of case law under
this section provides guidance as to what constitutes
"intend to defraud."19
For instance, in In
re Hogan,20 the debtors attempted to convert their
non-exempt assets into a sheltered homestead exemption.
On the eve of bankruptcy, they liquidated non-exempt
assets, including, among other things, a recreational
home, farmland, and IRA accounts. In addition, the
debtors sold their principal residence for $99,445.20.
With these proceeds, they purchased a new home for
$229,000 and claimed the home as exempt. A creditor
attacked the transfers, claiming they were done with
the intent to hinder, delay or defraud creditors.
The bankruptcy court,
recognizing that a debtor rarely, if ever, admits
to fraudulent intent, noted that the objecting party
must generally rely on a combination of circumstances
which "suggest that the debtor harbored the necessary
intent."21 Considering these circumstances,
the court will then "draw an inference from this
evidence."22 Critical to this inference
is a consideration of the specific "badges of
fraud."23 These badges, which are
the same under both federal and Arkansas law, are
listed in the Uniform Fraudulent Transfer Act (UFTA),
and include: 1) the transfer was to an insider; 2)
the debtor retained possession or control of the property
transferred after the transfer; 3) the transfer was
concealed; 4) before the transfer occurred, the debtor
had been sued or threatened with suit; 5) the transfer
was of substantially all of the debtor's assets; 6)
the debtor absconded; 7) the debtor concealed other
assets; 8) the value received for the transfer was
not reasonably equivalent to the value of the asset
transferred; 9) the debtor was insolvent or became
insolvent shortly after the transfer was made; and
10) the transfer occurred shortly before or shortly
after a substantial debt was incurred.24
In addressing the creditor's
homestead objection, the Hogan court noted
that three of the six transfers made by the debtors
were made to members of their immediate family, and
a fourth transfer was made to the attorney advising
them. In addition, the transfers constituted virtually
all of the debtors' assets and rendered them insolvent
under the Code. Also, the debtors had been sued immediately
prior to the transfers. Moreover, the debtors continued
to maintain control over the transferred property.
The court also noted that it was questionable whether
the debtors had received a reasonably equivalent value
for some of the property transferred. The large number
of badges, coupled with the significant amount of
transfers and the debtors' deceitful nature, led the
court to hold that the creditor had successfully shown
an intent to defraud. Consequently, the debtors were
not permitted to claim any portion of the value of
their residence as exempt.
Not all cases involving
significant pre-petition conversion of assets, however,
will result in a finding of fraudulent intent. In
In re Bradley,25 Michael Bradley personally
guaranteed a $40 million commercial loan and personally
borrowed $5 million in order to purchase a flatbed
trucking company in 1997. In 1998, Mr. Bradley, realizing
his trucking company was failing, began selling a
substantial portion of his personal assets. Over the
next several months, he sold, inter alia, a
herd of cattle, a horse trailer, a rental home, his
personal residence, and 250 acres of land. He also
liquidated a 401(k) account. Overall, the net proceeds
from these sales amounted to $433,630.96. None of
the sales was to a relative or business associate,
all sales were public and all the sales were for fair
consideration. Bradley then used these proceeds to
purchase a new home, which he claimed as exempt in
his Chapter 7 bankruptcy proceeding filed shortly
after the home purchase. The trustee objected to the
debtors' homestead exemption, claiming the pre-petition
transfers were intended to delay, hinder or defraud
creditors.
Analyzing the 10 badges
of fraud, the Eighth Circuit Bankruptcy Appellate
Panel found that no such intent existed. First, the
court found that only two of the badges had been satisfied:
1) the transfers included substantially all of the
Bradleys' assets; and 2) the Bradleys were insolvent
at the time of the transfers. These badges alone,
however, were not enough to find the requisite intent.
Mr. Bradley had a credible explanation for the transfers.
He testified that he was concerned with tax obligations
associated with the release from liability for his
personal obligation on the $40 million loan. Based
upon advice from his counsel to purchase exempt property
to reduce his tax exposure, Bradley sold his assets
and purchased the homestead. Assessing the totality
of the circumstances surrounding the transfers, the
court found fraudulent intent lacking and affirmed
the bankruptcy court's decision denying the trustee's
homestead objection.
The debtor was not as
fortunate in In re Sholdan.26 In that case,
prior to filing a Chapter 7 bankruptcy, Sholdan liquidated
almost all of his non-exempt property consisting of
bank accounts, certificates of deposit and a mortgage
against his former farmstead, and converted it into
exempt property in the form of a house worth $135,000.
Sholdan claimed his new house as an exempt homestead
under Minnesota law, which, like Arkansas, has adopted
the UFTA and considers badges of fraud to determine
an intent to defraud. The trustee's objection to the
homestead exemption was sustained by the bankruptcy
court and affirmed by the district court.
On appeal, the Eighth
Circuit first gave its imprimatur on the use of the
UFTA badges of fraud analysis to assess the validity
of a homestead exemption objection.27 Recognizing
that the mere conversion of non-exempt assets to exempt
assets is not itself fraudulent, the Eighth Circuit
held that "there must appear in evidence some
facts or circumstances which are extrinsic to the
mere fact of conversion of non-exempt assets into
exempt and which are indicative of such fraudulent
purpose."28
Searching for the requisite
extrinsic evidence that would indicate an intent to
defraud, the court noted that the debtor was a retired
farmer, 90 years of age and afflicted with serious
medical problems. He had recently been named as a
defendant in a personal injury suit with damages well
in excess of his liability insurance coverage. At
the time of the purchases of his new home, the debtor
had been living in an assisted-care facility, and
prior to these living arrangements, he had resided
in an apartment for 13 years. Yet, in what the court
called "a radical departure from his previous
lifestyle," the debtor acquired approximately
$162,000 in cash by liquidating his assets and selling
his mortgage rights to his nephew's step-brother.
With that money, the debtor purchased and moved into
a newly-built house. As part of the home's purchase
agreement, the debtor's relatives requested that certain
additions be made to the house, such as a deck and
landscaping and specifically inquired as to the amount
by which the purchase price of the house would increase.
These actions, according to the majority, were sufficient
to find an intent to defraud creditors.
In a spirited dissent,
Judge Richard Arnold, disagreed with the majority's
analysis and argued that the facts "show only
that Mr. Sholdan, as allowed by law, purchased his
home with the purpose of putting his assets beyond
the reach of his creditors."29 Rejecting the
court's "radical departure from previous lifestyle"
approach, Judge Arnold noted that a debtor will always
make some sort of departure from his previous lifestyle
when he converts property to protect his assets, and
"it is not normally the business of judges to
decide what 'lifestyle' a citizen should choose."
Requiring the builder to make additions, in Judge
Arnold's opinion, was simply an attempt to protect
as much of the debtor's assets as the law allowed,
which is not evidence of fraud. Finally, Judge Arnold
reminded the majority that the "protection of
the homestead forwards important social policies of
its own" and is "as much a part of justice
as the protection of the rights of creditors."30
While cases like Hogan,
Bradley and Sholdan offer guidance on the
appropriate analysis of a homestead exemption claim,
they do little to define the line between legitimate
pre-petition planning and fraudulent conversion. Fraudulent
intent case analysis is reminiscent of the "we
know it when we see it" approach taken in certain
types of First Amendment cases and offers little comfort
to insolvency advisors. The divergent views are particularly
troublesome in light of the new 10-year reach-back
period in BAPCPA since forgotten transactions will
now be placed under the fraudulent intent microscope.31
It is therefore important for debtor and creditor
attorneys and trustees to carefully analyze pre-petition
transfers of non-exempt property under the UFTA badges
to determine whether a homestead challenge is appropriate.
Placing
A Cap On The Homestead Exemption
BAPCPA adds two significant
limitations to the ability to take advantage of Arkansas'
homestead exemption. First, a debtor must now reside
in Arkansas for 730 days prior to filing bankruptcy
to claim an exemption under Arkansas law.32 Secondly,
BAPCPA places a federal monetary cap on the amount
of the exemption which may be claimed for homestead
purchases within 1,215 days of filing bankruptcy.
Under BAPCPA, a debtor may not exempt any amount of
interest acquired by the debtor during the 1,215-day
period preceding the filing of a bankruptcy petition
that exceeds in the aggregate $125,000 in the value
of a claimed homestead plus the amount transferred
from a previous principal residence in the same state
if acquired more than 1,215 days before filing.33
The new cap does not apply to the principal residence
of a family farmer.34 As one court recently stated,
"in its first major shift in attitude since passage
of the 1978 [Bankruptcy] Code, Congress began to put
the brakes on the freedom in which states could protect
their state residents by providing generous homestead
protection laws."35
Operation of the new
cap can be illustrated by looking at how BAPCPA would
compel a different result in the Bradley case,
supra. In Bradley, the debtors liquidated
significant assets, including their existing home,
and purchased a $480,000 home on the eve of bankruptcy.
Under pre-BAPCPA law, the Bradleys were able to claim
their entire new home as exempt. Under BAPCPA, however,
any portion of the $480,000 purchase price which exceeded
the sales price of the Bradleys' prior principal residence
plus $125,000 would not be exempt from creditor claims
even though the transfers were not deemed fraudulent.
For example, if the Bradleys sold their prior principal
residence for $275,000 and used all the proceeds towards
their new home purchase, then $80,000 of the new home's
value would be available for creditors ($480,000 -
$275,000 - $125,000).
If the Bradleys' prior
residence was located outside of Arkansas, then the
exemption would be limited to $125,000 and $355,000
would be available to creditors as shown by Nevada
case decided under BAPCPA. In In re Virissimo,
the Bankruptcy Court for the District of Nevada considered
a case where two separate debtors purchased homes
in Nevada within 1,215 days of filing bankruptcy.
The debtors did not previously own homes in Nevada
and the equity in each home exceeded $125,000. Nevada's
homestead limitation is $350,000 and the question
was whether each debtor's exemption was capped at
$125,000. The trustee's objection to the exemptions
in excess of $125,000 was sustained.36
In Virissimo,
a critical factor in capping the exemption at $125,000
was that each debtor did not previously own another
home in Nevada. Under §522(p)(2)(B), the interest
acquired during the 1,215-day period preceding bankruptcy
does not include "any interest transferred from
a debtor's previous principal residence (which was
acquired prior to the beginning of such 1,215-day
period) into the debtor's current principal residence"
but only "if the debtor's previous and current
residences are located in the same state."37
A debtor moving to Arkansas from another state is
thus not entitled to deduct the equity from the prior
out-of-state residence for purposes of determining
the cap on the homestead exemption.
It is important to note
that to take advantage of the equity in a prior residence
in the same state, the prior residence must have been
"acquired prior to the beginning of such 1,215-day
period." Does the debtor completely lose the
benefit of the equity transfer exception provided
for in §522(p)(2)(B) if his previous residence
was also acquired within 1,215 days of filing bankruptcy?
At least one bankruptcy court has held that if a debtor
had equity in any in-state residence outside the 1,215-day
period, the debtor can use that equity for purposes
of the §522(p)(2)(B) exception.38
In In re Wayrynen,
the debtor purchased his current Florida residence
44 days before filing for $146,000 and claimed the
full amount as exempt under Florida's unlimited homestead
exemption. His prior residence had been purchased
966 days before filing and the Trustee sought to limit
the homestead exemption to $125,000 since the prior
residence had not been purchased greater than 1,215
days prior to filing. The debtor had, however, purchased
another Florida residence 5,824 days before filing
and sold that residence for $150,500 more than his
purchase price. The bankruptcy court for the Southern
District of Florida held that the equity from this
sale could be used for purposes of §522(p)(2)(B)
and since the equity of $150,500 exceed the value
of his current residence, the debtor was entitled
to completely exempt his homestead.
If a trustee or creditor
successfully caps a homestead exemption at $125,000,
how they reach property deemed above the cap is determined
by the bankruptcy court's application of state law.39
It is likely that a creditor is entitled to either:
1) a division of the property allowing the owner to
retain a homestead and the creditor to seek execution
on the remainder of the land or 2) the sale of the
property under execution with no bid to be received
unless it exceeds the amount of the homestead exemption.
If the partially exempt property is indivisible, such
as a home, then the latter option must be chosen.
Thus, a creditor can, and will, force an execution
sale of an indivisible homestead, and the exempt value
of the property will be paid to the debtor, while
the remaining non-exempt proceeds are available to
creditors.
The
Ultimate Cap For Bad Debtors
The final significant
homestead exemption change under BAPCPA applies to
those debtors who have engaged in certain types of
wrongful conduct. Under BAPCPA, the homestead limit
is capped at a total of $125,000 in two situations.
The first is where the debtor has been convicted of
a felony and the bankruptcy court determines
that the filing is abuse of Title 11.40 The cap also
applies where the debtor owes a debt arising from:
(a) a violation of securities laws; (b) fraud, deceit
or manipulation in a fiduciary capacity or in connection
with the purchase or sale of a security; (c) civil
RICO penalties under 18 U.S.C. § 1964; and (d)
any criminal act, intentional tort, or willful or
reckless misconduct that causes serious physical injury
or death to another within the 5 years preceding the
filing.41 The only exception to the foregoing cap
is where the property is "reasonably necessary
for the support of the debtor and any dependent of
the debtor."42
The intent of the foregoing
cap seems clear with cases like WorldCom and Enron.
Officers of entities like these will no longer be
able to shelter substantial sums in homesteads to
avoid the results of securities law and breach of
fiduciary duties litigation. Mr. Porter, WorldCom's
founder and former Chairman, would not be able to
keep his Florida ocean-front estate in the face of
securities fraud judgments.
Conclusion
Considering the new
limitations that BAPCPA has placed upon the Arkansas
homestead exemption, there is little doubt that a
homestead exemption no longer offers the broad protections
previously enjoyed by Arkansas debtors. It is thus
important for debtor and creditor attorneys as well
as trustees to:
• Determine what equity
exists in the homestead.
• Look for badges of fraud
in any transaction engaged in by a debtor in the 10-year
period preceding the filing of bankruptcy.
• Look for a debtor's conversion
of non-exempt assets exceeding $125,000 during the
1,215-day period preceding the filing of bankruptcy.
The practice of advising financially troubled individuals
to liquidate non-exempt assets may still be viable
with respect to homesteads that have existed for 1,215
days (absent other significant badges of fraud), but
the option of liquidating and purchasing a new home
is severely limited.
• Be aware of a debts arising
from securities/breach of fiduciary lawsuits, RICO
actions, or criminal, intentional torts or willful/reckless
acts that resulted in serious harm to another.
• If a debtor's current
homestead was acquired during the 1,215-day period
preceding the bankruptcy filing, determine whether
the debtor had equity in any prior in-state home purchase
that can be used to increase the $125,000 homestead
cap.
Endnotes
1. 151 CONG. REC. S2306, S2342 (2005).
2. For example, O.J. Simpson moved to Florida after
losing a $33 million lawsuit in California
and explained to a reporter that the unlimited homestead
exemption would allow him
to protect a multi-million dollar house. 151 CONG.
REC. H1993, H2054 (2005).
3. Traditionally, the scope of a state-created property
exemption has been determined
by reference to state law and not federal law. Panuska
v. Johnson (In re
Johnson), 880 F.2d 78, 79 (8th Cir. 1989).
4. Bankruptcy Abuse Prevention and Consumer Protection
Act of 2005, Pub. L. No. 109-8,
§ 1501(b)(2), 119 Stat. 23 (2005).
5. 11 U.S.C. § 522(o) (2005).
6. 11 U.S.C. § 522(p).
7. 11 U.S.C. § 522(q).
8. Tisha M. Bartlett, Note, Middleton v. Lockhart:
Rule 41(b), a Fraudulent Transfer,
a Homestead, and a Homicide-Did This Hard Case Make
Bad Law?, 56 ARK. L. REV.
113, 129 (2003).
9. ARK. CONST. ART. 9, § 3.
10. Robert Laurence, Attacking the Acquisition
and Forcing the Sale of an Indivisible
Arkansas Homestead, 55 ARK. L. REV. 473, 474 (2002).
11. Robert Laurence, Mobile Homesteads, and in
Particular the Exempt Status of Mobile
Homes Located on Rented Lots: The Laws of Arkansas,
Mississippi, Nebraska,
and Utah Compared and the Principle of the Liberal
Construction of
Exemption Statutes Analyzed, 57 ARK. L. REV. 221,
222 (2004).
12. In re Kimball, 270 B.R. 471, 478 (Bankr.
W.D. Ark. 2001).
13. Laurence, supra note 11, at 225.
14. See, e.g., 11 U.S.C. §§ 727(a)(2)
and 548.
15. 11 U.S.C. § 522(o).
16. In re Holt, 894 F.2d 1005, 1008 (8th Cir.
1990).
17. In re Johnson, 880 F.2d at 82.
18. Id. at 81.
19. In re Maronde, 332 B.R. 593, 599 (Bankr.
D. Minn. 2005).
20. In re Hogan, 214 B.R. 882, 885 (Bankr.
E.D. Ark. 1997).
21. Id.
22. Id.
23. Id.
24. Id.
25. In re Bradley, 294 B.R. 64 (8th Cir. 2003).
26. In re Sholdan, 217 F.3d 1006, 1008 (8th
Cir. 2000).
27. Id. at 1009.
28. Id. at 1010 (quoting from Norwest Bank
Nebraska, NA v. Tveten, 843 F.2d 871 (8th
Cir. 1988))
29. Id. at 1011 (Arnold, R., dissenting).
30. Id.
31. It is worth mentioning that "intent to hinder,
delay, or defraud a creditor" should
apparently be read in the conjunctive. According to
the Eighth Circuit, "courts generally
view this language as establishing a single test,"
and thus, the court will
not "endeavor to separate out the terms fraud,
hinder and delay." In re Johnson,
880 F.2d at 80 n.1.
32. 11 U.S.C. §522(b)(3).
33. 11 U.S.C. § 522(p).
34. 11 U.S.C. § 522(p)(2)(A).
35. In re Maronde, supra note 19, at
598.
36. In re Virissimo 332 B.R. 201 (Bankr. D.
Nev. 2005).
37. 11 U.S.C. §522(p)(2)(B)
38. In re Wayrynen 332 B.R. 479 (Bankr. S.D.
Fla. 2005).
39. See In re Hyman 123 B.R. 342 (Bankr. Fed.
App. 1991); In re Bronner, 135 B.R.
645 (Bankr. Fed. App. 1992); In re Gitts, 116
B.R. 174 (Bankr. Fed. App. 1990);
In re Duffy, 240 B.R. 60 (Bankr. D. Nev. 1999);
r, 611 N.W.2d 458 (Wis.
2000).
40. 11 U.S.C. § 522(q)(1)(A).
41. 11 U.S.C. § 522(q)(1)(B).
42. 11 U.S.C. § 522(q)(2).
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