Appellate Court Rules Increased Property Value Belongs to the Bankruptcy Estate

The 9th U.S. Circuit Court of Appeals, which has jurisdiction over all Sacramento area residents who file Chapter 7 or Chapter 13 bankruptcy, ruled yesterday that a Chapter 7 bankruptcy trustee may be able to sell a debtor’s house if its value increases during the bankruptcy, even though the debtor’s equity was fully exempt at the time of filing. The 9th Circuit consolidated two bankruptcy appeals within their jurisdiction in the case, In re Gebhart, No. 07-16769.

Debtors from Arizona and Washington each argued that the Chapter 7 trustee’s failure to object to a homestead exemption claim within the prescribed time frame permitted to contest the property’s value results in the property being withdrawn from the bankruptcy estate.

Gebhart focuses on a debtor who filed for Chapter 7 in Arizona in 2003 and claimed the full value of his home as exempt. The trustee assigned to the case did not object to the exemption when the debtor claimed it. However, the debtor’s case remained open and in 2006 the trustee attempted to sell the house as property values increased in order to reclaim the appreciated value for the debtor’s creditors. The debtor lost in the district court when he objected to the sale arguing the homestead exemption covered the full value of his home when he filed for Chapter 7. Oddly, a court in Washington with facts almost identical to the case filed in Arizona held that the original exemption did in fact cover the inceased value of the debtor’s home.

By hearing Gebhart the 9th Circuit resolved the discrepancy between the District Court’s opposite treatment of debtors involved in a similar situations within the jurisdiction. The three judge panel rejected the debtors’ joint arguments and found that a homestead exemption that caps the exemption at a particular dollar amount only applies to the amount claimed exempt, not the entire property. This means that the bankruptcy trustee may sell the debtor’s home if the value of the property increases during the bankruptcy in order to claim the excess value on behalf of creditors. The 9th Circuit relied heavily on the Supreme Court’s decision in In re Reilly, 130 S. Ct. 2652, which holds that an exemption that names a specific dollar amount exempts only an interest in property, not the entire property.

California requires debtors to use a specific dollar amount exemption which caps claims for equity in homesteads. Therefore, this recent decision means, in California, the bankruptcy estate is entitled to appreciation in the value of partially exempt property so long as the bankruptcy case remains open.

As long as real estate values remain flat the decision in Gebhart should have little practical impact on the average Chapter 7 debtor. What makes this decision even more dubious is the fact that the Arizona debtor’s case remained open for over 3 years. For undisclosed reasons, the Trustee failed to close the original debtor’s case, which resulted in debtor’s property increasing in value. Typically, a chapter 7 bankruptcy lasts several months and would therefore unlikely affect the value of real property.

However, this case demonstrates that future filers as-well-as bankruptcy practitioners need to take an active role in terminating the bankruptcy case once the debtor has received his discharge to prevent this situation from happening to them. You should contact a Sacramento bankruptcy attorney familiar with these issues if you are dealing with extreme debt and/or are behind on your mortgage payments. The Law Offices of Matthew D. Roy helps people navigate the legal channels to secure a more stable economic future.