Opinion ID: 4201280
Heading Depth: 2
Heading Rank: 3

Heading: Frost’s Applicability to Chapter 7 Cases

Text: Frost relied heavily on principles from Zibman, a Chapter 7 case. Nevertheless, the Hawks contend that Frost does not apply to their Chapter 7 case because Frost was a Chapter 13 proceeding. The Hawks note that the bankruptcy estate in a Chapter 13 case includes property “the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted.” 11 U.S.C. § 1306(a)(1). They contend that our decision in Frost effectively brought “proceeds that became nonexempt after the expiration of 9 Case: 16-20641 Document: 00514143347 Page: 10 Date Filed: 09/05/2017 No. 16-20641 the time-limited exemption back into the estate,” which was permissible under § 1306(a)(1) because the proceeds constituted a new property interest Frost acquired after the commencement of the case. Because Chapter 7 does not contain a provision like § 1306(a)(1), the Hawks reason that an unconditionally exempted property interest that is subsequently transformed into a new nonexempt property interest remains excluded from a Chapter 7 bankruptcy estate. We agree. As an initial matter, we note that the Trustee in this case did not object to the Hawks’ IRA exemption until well after the time for objections passed. This timing is significant in the Chapter 7 context. As noted above, 11 U.S.C. § 522(l) provides that “[u]nless a party in interest objects, the property claimed as exempt on [the schedules] is exempt.” Federal Rule of Bankruptcy Procedure 4003(b) also indicates that parties in interest must generally object to claimed exemptions within thirty days after the creditors’ meeting. In Taylor v. Freeland & Kronz, the Supreme Court held that a party in interest in a Chapter 7 case cannot “contest the validity of an exemption after the 30-day period,” even if “the debtor had no colorable basis for claiming the exemption.” 503 U.S. 638, 639, 643–44 (1992); see also In re Davis, 170 F.3d 475, 478 (5th Cir. 1999) (“If the exemptions are not objected to, the property becomes exempt and unavailable to be levied on by pre-petition creditors or managed by the trustee.”). The trustee in Taylor argued that such a strict interpretation of § 522(l) and Rule 4003(b) would “lead debtors to claim property exempt on the chance that the trustee and creditors, for whatever reason, will fail to object to the claimed exemption on time.” 503 U.S. at 644. Yet the Supreme Court noted that “[d]ebtors and their attorneys face penalties under various provisions for engaging in improper conduct in bankruptcy proceedings. These provisions may limit bad-faith claims of exemptions by debtors.” Id. (citations omitted). 10 Case: 16-20641 Document: 00514143347 Page: 11 Date Filed: 09/05/2017 No. 16-20641 In light of the Supreme Court’s decision in Taylor, it is somewhat difficult to understand how proceeds from the sale of the homestead in Frost could be brought into the bankruptcy estate “at a time when the homestead had already been declared exempt from the estate.” Frost, 744 F.3d at 387. However, as the Hawks suggest, Frost makes sense in the context of a Chapter 13 case. We stressed that it was “the land itself—not its monetary value—that [was] protected under Texas law and ‘exempted under [§ 522].’” Id. at 391 (quoting 11 U.S.C. § 522(c)). “Frost’s homestead was exempted from the estate . . . by virtue of its character as a homestead.” Id. at 387. But when Frost sold the homestead, his property interest “changed from an unconditionally exempted interest in the real property itself to a conditionally exempted interest in the monetized proceeds from the sale of that property.” Id. at 389. In other words, Frost obtained a new conditionally exempted property interest (the proceeds) when he sold his homestead. And in a Chapter 13 case, a new property interest “the debtor acquires after the commencement of the case” becomes part of the estate under § 1306(a)(1). Notably, in Frost, the bankruptcy court ordered the proceeds to be returned to the estate pursuant to § 1306(a)(1). The bankruptcy court noted that new property the debtor acquires after filing for Chapter 13 bankruptcy “comes in during the pendency of the case and becomes property of the estate.” Transcript of Confirmation Hearing at 9, In re Frost, No. 09-54674 (Bankr. W.D. Tex. Jan. 27, 2011). The bankruptcy court went on to explain: A [Chapter 7 case] would be a different situation. In a [Chapter 7 case], the property is the debtor’s, it’s exempted, it’s gone, and if he decides to sell it after that, it’s subject to only his postpetition creditors. But in a [Chapter 13 case], it’s different. And, so, I think it’s still subject to the Chapter 13 estate, if it’s not reinvested. Id. at 10–11. This reasoning is consistent with this court’s assessment that Frost’s property interest changed from an unconditionally exempted interest 11 Case: 16-20641 Document: 00514143347 Page: 12 Date Filed: 09/05/2017 No. 16-20641 in the real property to a conditionally exempted interest in the proceeds from the sale of his homestead. When Frost acquired the sale proceeds and did not reinvest them in another homestead within six months, this newly acquired property interest became part of the bankruptcy estate under § 1306(a)(1). The situation is different in the Chapter 7 context. Section 1306(a)(1) is applicable only in Chapter 13 cases; no similar provision applies to Chapter 7 cases. Here, the Hawks filed for Chapter 7 bankruptcy and subsequently claimed an exemption for funds held in an IRA. No party in interest objected. The funds were unconditionally exempted because of their essential character as “assets held in . . . an individual retirement account.” TEX. PROP. CODE § 42.0021(a); see 11 U.S.C. § 522(l). Moreover, the Trustee could not “contest the validity of [that] exemption after the 30-day period.” Taylor, 503 U.S. at 639, 643–44. When the Hawks withdrew funds from the IRA, the Hawks’ property interest changed from an interest in assets held in a retirement account to an interest in “[a]mounts distributed from a [retirement] account.” See TEX. PROP. CODE § 42.0021(c). But because § 1306(a)(1) applies only in Chapter 13 cases and no similar provision applies in a Chapter 7 case, there was no means by which the Hawks’ newly acquired property interest could become part of the Chapter 7 estate. Lower courts have debated whether Frost applies in Chapter 7 cases. One bankruptcy court held that “Frost’s core holding is based on factually distinguishable underpinnings and, as such, is distinguishable in a chapter 7 where, such as here, the debtor sells a properly exempted homestead postpetition.” In re Montemayor, 547 B.R. 684, 713 (Bankr. S.D. Tex. 2016). Other courts have held that Frost controls when a Chapter 7 debtor sells a homestead after filing for bankruptcy. Lowe v. DeBerry, No: 5:15-cv-1135, slip op. at 19 (W.D. Tex. Mar. 10, 2017); In re Smith, 514 B.R. 838, 850 (Bankr. S.D. Tex. 2014). In one such case, a district court noted that allowing a Chapter 7 debtor 12 Case: 16-20641 Document: 00514143347 Page: 13 Date Filed: 09/05/2017 No. 16-20641 to retain proceeds from a postpetition homestead sale that were not reinvested within six months would “produce inequitable results, particularly when Chapter 13 debtors in identical situations are not permitted to retain such proceeds.” DeBerry, slip op. at 19. But Chapter 7 cases and Chapter 13 cases are not meant to always yield the same results. Chapter 13 is a “wholly voluntary alternative to Chapter 7,” which permits a debtor “to retain his property if he proposes, and gains court confirmation of, a plan to repay his debts.” Harris, 135 S. Ct. at 1835. By filing under Chapter 13, the debtor agrees that the property he acquires after filing for bankruptcy will become property of the bankruptcy estate under § 1306(a)(1). Id. On the other hand, “Chapter 7 allows a debtor to make a clean break from his financial past.” Harris, 135 S. Ct. at 1835. A Chapter 7 debtor “is able to make a ‘fresh start’ by shielding from creditors his postpetition earnings and acquisitions.” Id. It follows logically that a new property interest the debtor acquires after filing for bankruptcy becomes part of the estate in a Chapter 13 case but does not become part of the estate in a Chapter 7 case, even if the debtor acquires the new property interest by transforming a previously exempted asset into a nonexempt one. Lower courts have also suggested that the approach we take today will “effectively read the [time] limitation out of the statute in Chapter 7 cases.” DeBerry, slip op. at 19. But limitations on exemptions still apply to property interests debtors hold when they file for Chapter 7 bankruptcy. See Zibman, 268 F.3d at 304. For example, in Zibman, we noted that “‘freezing’ the exemption for the proceeds simply because it was in effect at the date the petition was filed, [would] effectively read the 6–month limitation out of the statute.” Id. Therefore, we held that when the debtors “failed to reinvest the proceeds in another Texas homestead within the statutory time period, those proceeds lost their exemption.” Id. at 305. Yet in that case, the debtors already 13 Case: 16-20641 Document: 00514143347 Page: 14 Date Filed: 09/05/2017 No. 16-20641 held proceeds when they filed for bankruptcy, and state law provided only a conditional exemption for those proceeds. If the debtors had still owned the homestead at the time of filing, their homestead would have been subject to an unconditional exemption under Texas law. Likewise, if the Hawks held amounts recently distributed from their retirement account when they filed for bankruptcy, those funds would be subject to the applicable sixty-day limitation on the exemption. See TEX. PROP. CODE § 42.0021(c). The Trustee could have objected to the exemption if the liquidated funds were not rolled over into another retirement account within sixty days. 1 But the Trustee did not timely object to the claimed exemption, and under Taylor, the Trustee could not contest the exemption’s validity after the time for objecting passed. 503 U.S. at 643–44. The property interest was “withdrawn from the estate” when the exemptions were allowed, Owen, 500 U.S. at 308, and there was no provision under which the Hawks’ subsequently acquired interests in amounts distributed from the IRA could become part of the estate. Accordingly, we hold that the bankruptcy court erred in ordering the Hawks to turn over the liquidated funds to the Trustee. 2