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Mar 19, 2018

Texas Law vs. Bankruptcy Law and the Texas Homestead: How Crazy Can Things Get?

By: Julie Koenig

It all began with Rodney Tow, a very creative Chapter 7 Bankruptcy Trustee for the Southern District of Texas, and the Zibmans[1].  The Zibmans sold their homestead in Texas on November 27, 1998, netting $120,665.23 in equity.  They placed these funds in a general, unsegregated account that already held approximately $8,500.00.[2]  Mr. Zibman then moved to Massachusetts to work while Ms. Zibman remained in Texas.  On February 9, 1999, the Zibmans filed a Chapter 7 Bankruptcy[3] in Houston and Tow was appointed their Chapter 7 Trustee.  On that same day, Ms. Zibman moved to Massachusetts and the Zibmans signed a six month lease on a townhome in that state.

On Bankruptcy Schedule C, the Zibmans elected the Texas exemptions and claimed all of the funds in the unsegregated account as exempt homestead proceeds.  At their creditors meeting, they stated they did not intend to use the funds to reinvest in a Texas homestead.

The Zibmans relied on the Texas Property Code, Section 41.001(c), providing “the homestead claimant's proceeds of a sale of a homestead are not subject to seizure for a creditor's claim for six months after the date of sale.”  Therefore, the six month period on the Zibmans’ exemption expired, according to the Texas Property Code, on May 26, 1999.  

On June 3, 1999, the Trustee objected to the Zibmans’ claim of exemption for the homestead proceeds, claiming that as the six month time period had expired and since the proceeds had not been reinvested in a homestead in Texas, the funds reverted to the Bankruptcy Estate for the benefit of their creditors.  The Zibmans responded with the “snapshot rule” - that a snapshot of their exemptions was taken on the date of filing and as the proceeds were exempt on that day, they remained forever exempt. 

Both the bankruptcy court and on appeal, the district court, denied the Trustee’s objection.  Tow appealed to the Fifth Circuit, which reversed the district court’s affirmance of the bankruptcy court’s judgment, rendered judgment for the Trustee, and remanded the matter to the bankruptcy court for continued proceedings consistent with the opinion.  The Fifth Circuit focused on the legislative intent underlying the exemption, which was solely to allow the debtor to invest the proceeds in another Texas homestead, not to protect the proceeds in and of themselves.  In doing so, the court appeared to have significantly altered the effectiveness to debtors of the longstanding bankruptcy “snapshot rule”.    The Fifth Circuit also changed the longstanding bankruptcy rule that a “snapshot” of a debtor’s assets was taken on the filing date and frozen in time.  This was a major victory for Chapter 7 Trustees in Texas.

Then things get frostier!  Mr. Frost[4] filed a Chapter 13 Bankruptcy Petition[5] and, using the Texas exemptions, claimed his homestead as exempt.  After his exemptions became final he sold his homestead and failed to reinvest the proceeds in another homestead within the statutory six month period.  After the expiration of the six months, the Trustee objected to Mr. Frost’s exemption arguing that the proceeds reverted to the bankruptcy estate once the six month period expired.  Both the bankruptcy court and on appeal, the district court, granted the Trustee’s objection and ruled the proceeds should be distributed to Mr. Frost’s creditors.  The Fifth Circuit, following Zibman, held that under the court’s precedent, (i) the sale of the homestead voided the homestead exemption and (ii) the failure to reinvest the proceeds within six months voided the proceeds exemption, regardless of whether the sale occurred pre- or post-petition.[6]  Therefore, the homestead proceeds had to be turned over to the Chapter 13 Trustee for distribution to Mr. Frost’s creditors.

A bankruptcy court in the Southern District of Texas, Houston Division was quick to apply the Frost rule to Chapter 7 proceedings, complicating debtor’s lives for awhile.  On March 20, 2012, Cody Smith filed a Chapter 7 Bankruptcy in the Southern District of Texas.[7]  He listed his homestead as exempt under Texas law and the exemption was allowed.  On April 25, 2013, Mr. Smith received a standard Chapter 7 discharge of all of his pre-petition debts.  On June 21, 2013, the Debtor and his non-filing spouse sold the homestead netting $813,935.77 in equity.  After the six month reinvestment period expired without the Debtor purchasing a new homestead, the Trustee filed a Motion for Turnover.  The Trustee argued that the holding in Frost should be applicable in a Chapter 7 Bankruptcy and that the remaining proceeds from the sale of the homestead should be turned over to the estate for the benefit of the Debtor’s creditors.  The court ordered the Trustee to bring the matter as an adversary proceeding which was duly filed.  The court ordered the proceeds to be deposited into the registry of the court pending the resolution of the adversary proceeding.  The bankruptcy court held that the decisions in both Zibman and Frost applied to Chapter 7 proceeds.  It further held that although the Debtor had received a discharge, his bankruptcy estate remained open as an “asset” case and therefore the remaining proceeds from the sale of the homestead belong to the bankruptcy estate.[8]  But, in a later opinion the same court held that if the Debtors requested and were granted a tolling of the six month reinvestment period during litigation, then the proceeds were protected beyond the initial six months from the date of the sale.[9]

And then the hawk struck - but it was a nice hawk!  On a petition for rehearing, the Fifth Circuit withdrew its initial opinion and found in favor of the debtors.  Gregory Hawk filed a Chapter 7 proceeding in the Southern District of Texas and claimed his IRA as exempt under the Texas exemptions.  The exemptions were allowed and he later withdrew funds from the IRA to live on.  The Trustee filed a motion seeking a turnover of the funds claiming they lost their exempt status when they were withdrawn from the exempt IRA and not rolled over into another IRA within 60 days.  The bankruptcy court granted the motion and on appeal the district court upheld the bankruptcy court.  On appeal to the Fifth Circuit, the Fifth originally upheld the district court’s decision but upon rehearing reversed and found in favor of the Debtors.[10]  Although Hawk involves IRA exempt funds and not homestead proceeds, the court discussed both in the opinion thereby distinguishing its rulings in Zibman and in Frost, a Chapter 13 case, from the outcome in a Chapter 7 case.  The Fifth Circuit reasoned that by filing a Chapter 13 proceeding, the debtor agrees that the property he acquires after filing for bankruptcy will become property of the bankruptcy estate under 11 U.S.C. §1306(a)(1).  Whereas a Chapter 7 debtor is able to make a “fresh start” by shielding from creditors his post-petition earnings and acquisitions.  “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.”[11]

Just this month life became even sweeter!   On March 7, 2018, in the case of In re DeBerry[12] the Fifth Circuit, following Hawk, held that the proceeds from the sale of an exempt homestead during an open Chapter 7 proceeding were also exempt because the debtor owned the homestead on the date of filing.

The lessons gleaned from these cases are simple:  In a Chapter 13 bankruptcy, never sell your homestead while your case is open unless you intend to reinvest the equity into a new Texas homestead within 180 days.  In a Chapter 7 bankruptcy, if you sell your homestead pre-petition and claim the proceeds as exempt under Texas law, make sure you reinvest those proceeds in another Texas homestead within 180 days or you will lose the money.   Or, in a Chapter 7 bankruptcy, if you claim your homestead as exempt under Texas law, don’t sell it until your exemptions are granted!


[1]  In re Zibman, 268 F.3d 298 (5th Cir. 2001)

[2]   They also sold some stock which was deposited into this same account.

[3]  Chapter 7 is considered “straight liquidation” and it takes approximately 90 - 120 days for a debtor to receive a discharge.

[4]    In re Frost, 744 F.3d 384 (5th Cir. 2014).

[5]   Chapter 13 is considered “individual debt adjustment” with payments made to a Chapter 13 Trustee over a three to five year period.

[6]   Frost, 744 F.3d at 388.

[7]   In re Smith, 514 B.R. 838 (Bankr. S.D. Tex. 2014)

[8]   The Western District of Texas declined to follow Smith in In re D’Avila, 498 B.R. 150, 159 (Bankr.W.D.Tex.2013) and In re DeBerry, No. 14-50406-CAG, 2015 WL 6528024 (Bankr. W.D. Tex. Oct. 28, 2015).

[9] In re Dinh, 562 B.R. 122 (Bankr. S.D. Tex. 2016)

[10]   Matter of Hawk, 871 F.3d 287 (5th Cir.2017) (also reasoning, in part, that the Trustee’s objection to the exemption was untimely),

[11]   Id. at 296.

[12]    In re Deberry, 2018 WL 1178353, (5th Cir. 2018).