The Trustee’s Power to Sell the Debtor’s House over validly Perfected Homestead Exemption (Part Three)
By: John Lee

This is the third installment in my three part series on Trustee’s Avoiding Powers and Homestead exemptions.  If you have not read parts one and two of this three part series please go back and read them before you continue reading this one.

The First Circuit ruled (Traverse) that a Trustee could not sell a debtor’s home when she was current on her mortgage payments even though the trustee had successfully avoided the lien due to the mortgage companies failure to properly record.  The First Circuit also held that because the debtor’s exemption exceeded the value of the property, the property itself was exempt, not just the debtor’s monetary interest in the property.

The Fourth Circuit ruled (Calloway) that the Trustee could sell the debtors property even though the debtor properly claimed a homestead exemption in the property that exceeded any equity that was not encumbered by properly recorded liens.  Both the First and Fourth Circuits looked to the Supreme Court’s decision Schwab v. Reilly which holds that a Debtor’s exemption only protects the debtor’s monetary interest in a property, not the property itself, unless the exemption specifically states it is protecting the asset itself.

The facts of these two cases are very different and I believe the facts alone distinguish the two cases to the point where there is no conflict (yet) between the First and Fourth Circuits.  In Traverse the debtor had voluntarily entered into an agreement with the creditor (a Mortgage Company) where she agreed to allow a lien to be placed and agreed to make monthly installment payments.  In Calloway the debtor did not agree to have the lien placed, it was placed by the IRS and the debtor was not current on paying his taxes.  This fact alone is significant because in Traverse the would-be secured creditor had no right to sell the property because the debtor was current and not in default.  Whereas in Calloway the debtor was not current and the IRS was legally entitled to sell the property to collect the tax debt.  If the Trustee stands in the shoes of the secured creditor, he is in two very different situations with these two debtors.

But the differences do not stop there.  In Traverse the debtor was entitled to a $500,000.00 homestead exemption and in Calloway the debtor was only entitled to a $60,000.00 homestead exemption.  This is important because the Traverse case the house was only worth $223,500.00 and the Homestead exemption was for $500,000.00.  Which allowed the debtor to argue that because her homestead exemption far exceeded the actual value of the property that it was meant to exempt the entire asset itself and not just a monetary interest in the asset.  While in Calloway, the house was worth $325,000.00 and the exemption was only for $60,000.00.  There was no way Calloway could argue that the State intended his homestead to be an exemption for his entire house.  Also, because these are State specific exemptions, they can be written by the State legislatures in a manner in which they can be interpreted to be either for an entire asset or a monetary interest in an asset.  The Court in Traverse determined that Massachusetts State law intended for the $500,000.00 exemption to protect the asset itself when the asset was worth less than the allowed exemption.  The Court in Calloway determined that North Carolina State law intended for the exemption to be limited to a monetary interest in the asset and not in the asset itself.
Another major distinction between the two cases is that in Traverse the Trustee filed a Complaint to Avoid the Lien and persevere the interest for the unsecured creditors.  In Calloway the Trustee never avoided the IRS lien because it was properly perfected, he merely worked with the IRS to exercise the IRS’s right to sell the property.

Both courts looked to Schwab, the Court in Calloway found the exemption was a monetary interest in the property and the Court in Traverse found the exemption was protecting the entire asset based, in part, on the value of the asset compared to the value of the exemption.  In Calloway the debtor had an involuntary lien placed on his property for failure to pay taxes while in Traverse the debtor was current on her mortgage payments.   I wonder if the Court in Traverse based their decision in part on the fact that they felt it was unfair for a debtor to lose her home based on the mistake of a lender that she had absolutely no control over.
These two decisions, if relied on and expanded in future decisions, could lead to a conflict between the First and Fourth Circuits, but for now, I think there is enough differences that one can reasonably distinguish the two cases.

If you live in the Eastern District of Virginia don’t expect to be treated like the debtor in the Traverse case.  Massachusetts has a $500,000.00 homestead exemption while Virginia has a $5,000.00 once-in-a-lifetime exemption.  In Virginia, it would be almost impossible to argue that the State legislature intended the $5,000.00 homestead exemption to protect your entire house since most houses are worth far more than $5,000.00. If you live in Virginia and the Trustee avoids a mortgage lien because it was not properly perfected, you should expect the Trustee to be successful in his motion to sell the property for the benefit of your unsecured creditors.

The Appeals Court in Traverse ruled primarily on the fact that the Trustee stands in the shoes of the secured creditor and can not sell a house if the creditor could not sell it.  The Traverse Court explained that even if there were no homestead exemption at all, the Trustee could not sell a house where the debtor was current on the mortgage because the secured creditor could not have foreclosed on it.  The Traverse decision is fair and equitable to BOTH the Trustee and the debtor because it allows the debtor to stay in the house she is making payments on and allows the Trustee to sell the mortgage to another creditor.  This reasoning is not in conflict with Calloway because the Trustee was not seeking to sell a property where the lien was voluntarily placed subject to an agreed to installment loan.   I hope to see more courts following the Traverse line of reasoning in the future.

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