HOME IMPROVEMENTS PAYMENTS CAN BE FRAUDULENTLY CONVERTED INTO HOME EQUITY ACCORDING TO FEDERAL APPELLATE COURT

The Federal Appellate Panel for the 8^th Circuit Court of Appeal recently held if a Debtor makes payments toward home improvements in an attempt to defraud a creditor, that those payments may not be exempt.  The issue for decision in this case was whether a debtor can claim home improvement payments as being exempt from the bankruptcy estate in a Chapter 7 bankruptcy case?

The facts in this case were actually quite typical and could apply to a number of people. The Debtors (Wife and Husband) made improvements to their principal residence over a period of time before filing for Chapter 7 Bankruptcy. During that time their daughter opened a bank account whereby Debtors began to make large deposits amounting to approximately $60,000.00 into their daughter’s bank account who then made payments toward the home improvements as well – in addition to other family members.

Debtor’s eventually filed for protection under Chapter 7 of the bankruptcy code after having engaged in this course of conduct for some time. In their Petition they attempted to take advantage of the homestead exemption by claiming that they had roughly $60,000.00 of equity in their home. The “homestead exemption” prevents the court from seizing and distributing that property to any creditors or the Court which may exist as equity in a personal residence. Using Title 11 of United States Code section 522(o) the Bankruptcy Trustee objected to the debtors’ exemption claiming that the improvements did not qualify under the homestead exemption since the money had come through their daughter’s account and was being claimed by the debtors as exempt to delay, hinder, and/or defraud their creditors.

In federal bankruptcy law a person filing for Bankruptcy protection has the option to choose which property s/he wants to claim as exempt from creditors. Essentially, this prevents a creditor from seizing and selling a person’s house when there exists enough equity in the residence that would satisfy the debts owed when they have a large degree of equity in his/her house. Each State gets to decide how much a debtor may claim as exempt. The Trustee or a Creditor is able to contest a claim for property exemption if at least some of the following conditions are satisfied: (1) Property had been disposed of within the last 10 years; (2) Property was not exempt at the time it was disposed of; (3) Debtors used proceeds from a sale to purchase a new home, improve and existing one, or make payments toward debt reduction on the present home; and (4) the filer had intended to delay, defraud, or hinder one of his/her creditors.

The Trustee essentially argued that the elements in contesting the exemptions claimed in this case had been satisfied and that the debtors’ supposed homestead exemption should be reduced by the money that was paid toward the home improvements over the preceding years from their daughter’s account. I believe the Trustee’s objection comes from what could be considered an argument for conversion. The fact that the Debtors’ daughter made the payments from her own bank account (even though parents were making deposits) was enough to raise some serious questions as to why the debtors chose to behave in this fashion. Of course, there may be a perfectly understandable explanation for such conduct, but in the case of a Chapter 7 bankruptcy, the Court, Trustee, and Creditor’s are going to examine a parties’ conduct before having filed a case. The moral of this case is that people need to be very careful with how they prepare the bankruptcy petition because everything a person does in the time before filing his or her petition will be under potential review.

As a Sacramento Bankruptcy Attorney I believe it is important to stay aware of the current trends and decision being made in all Courts across the country in order to best serve my clients and those who are in need of legal assistance. I have found that my clients are best served by an attorney who can modify his practice based on the change in information and circumstances that constantly change.  In addition to practicing bankruptcy law I am also highly experienced in filing divorce and other types of family law cases.

If you or someone you know is considering filing bankruptcy due to a pending divorce, or for other reasons, they should contact someone competent and with experience dealing with both issues to avoid complications that may develop.