In a recently published decision, In re Masingale, 644 B.R. 530 (9th Cir. BAP 2022), the U.S. Bankruptcy Appellate Panel for the U.S. Court of Appeals for the Ninth Circuit (the BAP) held that in the absence of a timely objection, debtors who claimed a homestead exemption of “100% of FMV” in their residence had a valid exemption claim for the full fair market value of the property, including post-petition appreciation. The fact that the claimed exemption far exceeded the applicable statutory limit, or that the Chapter 7 trustee never had an opportunity to object, did not change the outcome as the BAP found that the lack of a timely objection barred any challenge to the exemption.

Background

In 2015, Mr. and Mrs. Masingale filed a Chapter 11 petition in the U.S. Bankruptcy Court for the Eastern District of Washington. The Masingales owned residential real property in Greenacres, Washington. In their schedules, the debtors listed their home as having a value of $165,430, with a mortgage lien against the property in the amount of $130,724. They also scheduled a homestead exemption in the property under Section 522(d)(1) of the Bankruptcy Code for “100% of FMV.” No creditor or interested party objected to this claimed exemption, let alone within 30 days after the conclusion of the Masingales’ November 2015 meeting of creditors, as required by the Federal Rules of Bankruptcy Procedure (the bankruptcy rules). Mr. Masingale later passed away in July 2016.

The bankruptcy court confirmed Mrs. Masingale’s Chapter 11 plan in August 2017. Over a year later, in November 2018, the bankruptcy court converted the case to Chapter 7. Mrs. Masingale filed a motion to compel the Chapter 7 trustee of her bankruptcy estate to abandon her home, arguing that “100% of FMV,” i.e., the entire fair market value of the property, was exempt because no one had objected to the scheduled homestead exemption. The trustee objected to her motion, arguing that the statutory basis for the exemption, Section 522(d)(1), capped the allowed exemption amount at $45,950, with any post-petition appreciation inuring to the benefit of the estate. The state of Washington, a creditor in the case, also objected, raising additional arguments. The trustee, in turn, filed a motion to sell the home, to which Mrs. Masingale objected.

The bankruptcy court determined that the outcome of both motions hinged on the value of the homestead exemption. If the exemption amount was unlimited, as Mrs. Masingale contended, then the estate would have no interest in the property, and the court would deny the sale motion and grant the motion to abandon. If, however, the exemption claim was capped at $45,950 as the trustee argued, then the court would grant the sale motion so that the trustee could recover the net equity for the estate.

Ultimately, the bankruptcy court held that: the lack of an objection to the homestead exemption only removed from the estate a “fixed interest” in the property equal to the value of the exemption; the Masingales’ exemption of “100% of FMV” was limited to $45,950 under Section 522(d)(1); and pursuant to Section 541 of the Bankruptcy Code, the post-petition increase in the home’s equity belonged to the estate. Accordingly, the court denied the motion to abandon and granted the trustee’s sale motion. Mrs. Masingale appealed.

While the appeal was pending, the trustee sold the home for $422,000, which was $256,570 more than its scheduled value. Sale proceeds, net of the senior lien and costs of sale, totaled $222,783.34. The bankruptcy court directed the trustee to hold the proceeds pending the appeal and further court order.

The BAP’s Analysis

Mrs. Masingale’s appeal raised two questions: in the absence of an objection, could the Masingales make a valid exemption claim that is greater than what the law allows?; and did the Masingales’ exemption claim encompass the full fair market value of the property at the time of sale (i.e., including post-petition appreciation) or just the value on the petition date? As to the first question, the BAP held that the Masingales’ exemption claim could not be challenged even though it exceeded the applicable statutory limit. In particular, the BAP found that Section 522(l) of the Bankruptcy Code, related provisions of the Bankruptcy Rules, and the Supreme Court’s decision in Taylor v. Freeland & Kronz, 503 U.S. 638 (1992) definitively answered the first question.

Section 522(l) provides that “unless a party in interest objects, the property claimed as exempt [in the schedule of exempt property] is exempt.” Bankruptcy Rule 4003(b)(1), in turn, provides that a party in interest may object to a debtor’s claimed exemptions within 30 days after the conclusion of the Section 341 meeting of creditors. Furthermore, under Bankruptcy Rule 1019(2)(B)(i), when a Chapter 11 case is converted to Chapter 7, parties in interest have a new 30-day period to object to exemptions unless, as happened in the Masingales’ case, the case was converted to Chapter 7 “more than a year after the first order confirming a plan … .” In Taylor, the Supreme Court analyzed Section 522(l) and held that if no one timely objects, then an exemption claim is valid even if it has no “colorable statutory basis.”

In light of the foregoing, the BAP found that any right to contest the Masingales’ exemption claim expired 30 days after conclusion of their Chapter 11 meeting of creditors back in 2015. The fact that the trustee had no opportunity to object—because he was not appointed until 2018 when the case converted to Chapter 7, and Rule 1019(2)(B)(i) barred him from objecting post-conversion—did not change the result. The BAP commented that while it could “not fault the trustee for failing to object before he took office,” the foregoing authorities nonetheless prevented the exemption from being challenged.

As to the second question raised by the appeal, the BAP found that the Masingales had exempted the entire fair market value of their home. In reaching its conclusion, the BAP observed that the Supreme Court had “largely answered” this question in its decision in Schwab v. Reilly, 560 U.S. 770 (2010). In Schwab, the Supreme Court reaffirmed its holding in Taylor and found that when a debtor intends to “exempt the full market value of an asset or the entire asset itself,” the debtor should “declare the value of the claimed exemption in a manner that makes the scope of the exemption clear,” such as by listing the exempt value as “‘full fair market value (FMV)’ or ‘100% of FMV.’” The BAP noted that the Masingales followed the Supreme Court’s suggested course “to the letter.”

The fact that the Masingales cited to Section 522(d)(1) as the basis for the exemption did not change the outcome. Under Schwab, the act of listing the exempted value as “100% of FMV” made clear their intention to exempt the home’s full market value. Since no one timely objected, the exemption was valid even though it exceeded the statutory limit of $45,950. Addressing a matter of first impression, the BAP also held that an exemption claim of “100% of FMV” includes any post-petition appreciation and becomes incontestable if there is no timely objection. In so doing, the BAP found that the so-called snapshot rule did not change the outcome. Under the snapshot rule, the exemptions and the value therein that a debtor may claim are fixed on the petition date. As the BAP explained, if there is no timely objection, then a debtor can get the benefit of exemptions to which the debtor is not entitled and the snapshot rule never comes into play.

The effect of the BAP’s ruling on the bankruptcy estate in this case was not inconsequential, as the home had appreciated more than $250,000 since the case was filed in 2015. Notably, the BAP stated that it did not condone the Masingales’—or their counsel’s—conduct in making what it described as a “baseless” exemption claim, and suggested that sanctions and other penalties may be appropriate. The BAP also stated unequivocally that it published its decision “to reiterate that parties must timely object to any improper exemption claim, no matter how frivolous.”

The BAP reversed the portion of the bankruptcy court’s order determining the amount of the homestead exemption and remanded. The trustee and the state of Washington appealed the BAP’s decision and, as of the date of this article, these appeals are still pending.

Conclusion

As Masingale makes clear, the deadline to object to exemptions is a hard and unforgiving one— especially for trustees in converted cases who, for reasons beyond their control, had no opportunity to object to a frivolous exemption claim. Failing to bring a timely objection to an improperly claimed—or even ambiguous—objection may result in a significant economic loss for creditors and the estate. Trustees and interested parties should scrutinize a debtor’s schedule of exemptions (Schedule C) carefully and bring a timely objection if there is any question about whether a scheduled exemption amount is within the applicable statutory limit or is otherwise appropriate.

Lawrence J. Kotler is a partner and co-chair of the bankruptcy and fiduciary representations division of the business reorganization and financial restructuring practice group at Duane Morris.

Geoffrey A. Heaton, special counsel at the firm, practices in the area of business reorganization and financial restructuring, concentrating on representation of secured creditors, Chapter 11 and Chapter 7 trustees, creditors’ committees and unsecured creditors. 

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.