The “Vanishing” Homestead Exemption—Before The U.S. Supreme Court (Wells v. McCallister)

Vanishing?

By: Donald L Swanson

The case is Wells v. McCallister, Case No. 21-1448 in the United States Supreme Court. 

The question presented is:

  • whether a debtor’s homestead exemption, existing on the date of bankruptcy filing, can vanish if the debtor sells the homestead during the bankruptcy and does not promptly reinvest the proceeds in another homestead.

The Petition for writ of certiorari explains:

  • This case is about the homestead exemption;
  • Nearly every state provides some type of homestead exemption that protects a portion or all of a homeowner’s equity in the primary residence; and
  • Many states also exempt the proceeds of a homestead sale, so long as those proceeds are reinvested in another homestead within a certain period of time.

Homesteads in Bankruptcy

Here’s how a homestead works in bankruptcy:

  • A debtor who retains the homestead throughout the bankruptcy benefits from the homestead exemption; and
  • A debtor who sells the homestead just before filing bankruptcy but quickly reinvests the proceeds in a new one also benefits from the proceeds exemption.

Recurring Question/Divided Courts

But a recurring question has divided the federal courts where:

  • a debtor is entitled to a homestead exemption upon bankruptcy filing; but
  • sells the homestead during the bankruptcy without reinvesting the sale proceeds within the statutory window; and
  • the question is, “Do the proceeds remain exempt?

Circuit Split

Here’s where the circuit courts, who have addressed the question, stand:

  • Ninth Circuit adopts and applies the “vanishing” exemption rule that a debtor “forfeits” the exemption by selling the homestead after bankruptcy and failing to reinvest the sale proceeds in a new homestead within the allotted time (see, In re Jacobson, 676 F.3d 1193 (9th Cir. 2012));
  • First Circuit disagrees—expressly rejecting In re Jacobson’s “vanishing” exemption rule (see, In re Rockwell, 968 F.3d 12, 23 (1st Cir. 2020)); ; and
  • Fifth Circuit says, sometimes the exemption vanishes and sometimes it doesn’t, applying the “vanishing” exemption rule in Chapter 13 cases (see In re Frost, 744 F.3d 384 (5th Cir. 2014)) but rejecting the rule in Chapter 7 cases (see In re DeBerry, 884 F.3d 526 (5th Cir. 2018)).

Importance

The Wells v. McCollister Petition declares that the “vanishing” homestead question is “profoundly important,” explaining:

  • Each year, thousands of homeowners face difficult decisions about whether to sell their homes during their bankruptcies and what to do with the proceeds:
    • For some, purchasing a new home while in bankruptcy may be impossible; and
    • For others, the sale proceeds may have a higher and better use—like settling with creditors, dealing with unplanned medical expenses, or finding a less expensive vehicle or housing solution;
  • In the First Circuit, debtors can make “healthy financial choices, knowing what property is out of the reach of the pre-petition creditors”; but
  • In the Ninth Circuit, debtors must hold on to their homesteads until the bankruptcy proceedings conclude—or risk losing their homestead exemptions altogether; and
  • In the Fifth Circuit, debtors must choose between the benefits of proceeding under Chapter 13 and the drawbacks of the “vanishing” exemption rule; and
  • In jurisdictions that have yet to adopt a definitive rule, uncertainty abounds.

“Vanishing” Exemption Rule is “Wrong”?

The Wells v. McCallister Petition proposes that there is no good reason for debtors to confront these difficult choices, because the “vanishing” exemption rule is “wrong”:

  • The text of the Bankruptcy Code makes clear that “the commencement of the  case” is the moment at which an exemption is adjudged (§ 541(a)(1)); and
  • The “vanishing” exemption rule undermines the “principal purpose of the Bankruptcy Code”—to provide debtors a path to a “fresh start.”

Additionally, the “vanishing” exemption rule yields peculiar results, such as: debtors in jurisdictions that protect homestead sale proceeds are better off than those in jurisdictions that do not.

Ninth Circuit Context

In Wells v McCallister, the Ninth Circuit Court’s opinion:

  • Recognizes that Jacobson’s “vanishing” exemption rule is an “outlier”;
  • Identifies contrary rulings by the First and Fifth Circuits;
  • Acknowledges that Jacobson’s “vanishing” exemption rule has “been criticized, questioned, and rejected by many”—including “a number of bankruptcy judges” and “a prominent bankruptcy practice guide”;  
  • Finds “no justification in federal law, state law, or logic” for the rule’s “peculiar” results; but
  • nevertheless, the Ninth Circuit feels bound by Jacobson and refuses to reconsider the “vanishing” exemption rule en banc.

Persistent and Entrenched Split

So, the Petition contends, the division of authority will persist, and only the Supreme Court can resolve this entrenched circuit split.  For example:

  • In 2021, the Supreme Court denied a petition for writ of certiorari arising from the First Circuit’s decision in Rockwell;
  • The overarching theme of the opposing brief in that case is that a Supreme Court review is unnecessary because the case involves “a weak and eroding conflict that will eventually resolve itself”—there is “every reason to believe the Ninth Circuit [will] eventually eliminate the conflict on its own”;
  • Such prediction has been proven wrong: since then, the Ninth Circuit has doubled down on Jacobson and dug in its heels; and
  • Accordingly, the split is entrenched, and the Supreme Court’s intervention is necessary.

Soliciting Solicitor General’s Input

The U.S. Supreme Court’s latest action in Wells v. McCallister reads:

  • “October 11, 2022, The Solicitor General is invited to file a brief in this case expressing the views of the United States.”

Here are observations about this October 11, 2022, entry:

  1. It suggests that prospects for granting the Petition in Wells v. McCallister are substantial;
  2. The Solicitor General’s yet-to-be-declared position in Wells v. McCallister is entirely predictable: the Solicitor General, on behalf of our largest-ever creditor (i.e., the United States of America), will take the position that is most-favorable to creditors—regardless of what’s best for the bankruptcy system or for the overarching goal of providing a “fresh start”—and on the Wells v. McCallister question, that means siding with the Ninth Circuit; and
  3. The U.S. Supreme Court tends to give substantial weight to the Solicitor General’s positions.

Conclusion

It will be interesting to see how the Wells v. McCallister case progresses.

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