Questions Remain After Enactment of “Perfect” Bankruptcy Code

Mark Bosco,  |  March 16, 2017

The arrival of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“The Reform Act”) was introduced with a great deal of doomsday prophesy.Practitioners, scholars, and jurists that reviewed The Reform Act prior to its passage all came up with the same conclusion:that the new law was not a model of clarity.This conclusion was reached despite testimony before the Senate Judiciary Committee suggesting that The Reform Act was “perfect.”

In spite of the apparent perfection of The Reform Act, judges, attorneys, and parties who have sought relief in bankruptcy court after October 17, 2005 have struggled with a myriad of issues arising from the inconsistencies raised by The Reform Act.One of these issues is The Reform Act’s attempt to close the “Mansion Loophole.”

Under bankruptcy law prior to The Reform Act, debtors living in certain states could shield from their creditors virtually all of the equity in their homes.In light of this, some debtors actually relocated to these states just to take advantage of their “Mansion Loophole” laws.

The Reform Act attempted to put an end to the “Mansion Loophole.”With The Reform Act there is now a $125,000 cap on homestead that is imposed on debtors, even if applicable state exemptions allow greater or unlimited protection.In what is believed to be the first published decision regarding The Reform Act, an Arizona court analyzed the statute to determine whether the cap applied in Arizona.See In re McKnabb, 326 B.R. 785 (Bankr. D. Ariz. 2005).

In McKnabb, the court held that the $125,000 cap in new Sections 522(p) and Section 522(q) of the Bankruptcy Code only apply in non opt-out states, that is, states in which a debtor may choose between state or federal exemptions.More than two-thirds of the states have opted out of the federal exemptions.If McKnabb is followed, these new caps would only apply in Texas and Minnesota, not in states like Arizona or Florida, in which debtors must utilize state exemptions.Because Arizona is an opt-out state, according to McKnabb, the $125,000 cap of Code Section 522(p) is not implicated.

The applicability of Section 522(p) in opt-out states has been extensively litigated since the decision in McKnabb.Bankruptcy courts that considered this issue have uniformly rejected the decision of McKnabb.In rejecting McKnabb, these courts have ruled that the $125,000 cap should apply nationwide, not just in Texas and Minnesota.

Is the statute “perfect” as promised?The answer is obviously no.On this specific issue did Congress choose the best language to accomplish its intended purposes?Once again, the answer is no.The McKnabb decision read narrowly and mechanically may find support, but other decisions taking into account the clear legislative intent to apply the homestead cap in all states seem to be more plausible.

Alas, this is just one of many issues that will be faced by the courts and litigants in the future as we week to make sense of the “perfect” Code.