RUSSELL F. NELMS, Bankruptcy Judge.
The debtors sold their homestead after filing for bankruptcy under chapter 13. More than six months passed after the sale and the debtors did not reinvest the proceeds in another homestead. The debtors have moved to modify their plan to permit them to keep the proceeds.
The trustee objects to the plan modification. He argues that the proceeds are no longer exempt, and so the modified plan must provide for their distribution to unsecured creditors. The debtors argue that the homestead proceeds are exempt because their homestead exemption became final when no party timely objected to their claim of exemption. They say that the effect of the exemption is to forever withdraw the homestead and its proceeds from the estate. Alternatively, they argue that the trustee's objection is barred by res judicata because he failed to lodge his objection when the debtors sought this court's authority to sell the homestead.
The debtors filed a chapter 13 case in February 2011. Upon filing, they claimed an exemption under section 41.001(a) of the Texas Property Code for their homestead in Fort Worth, Texas. No party objected to the exemption and it became final on May 8, 2011.
The court confirmed a plan that required the debtors to pay $750.00 per month to the chapter 13 trustee. While most of this amount was directed to the reduction of pre-petition arrearages on the debtors' homestead, a small portion was to be distributed to unsecured creditors.
In September 2012 the debtors moved for authority to sell their homestead. In the motion, the debtors disclosed that the sale would net approximately $64,000, less certain additional expenses. The debtors claimed the proceeds as exempt and proposed that all equity be distributed to them. No party, including the chapter 13 trustee, objected to the motion. Instead, the trustee, the mortgage company and the debtors entered into an agreed order of sale. In the order the court approved the sale and ordered that the net proceeds "be disbursed to the Debtor(s) as their exempt equity in the home." The debtors closed on the sale of their homestead sometime in November 2012. While there is no evidence in the record of what the debtors did with the proceeds, they concede the proceeds were not used to purchase a new homestead.
Because the debtors' plan included monthly payments to reduce pre-petition mortgage arrearages and those arrearages were satisfied in full by the sale of their homestead, the debtors moved to modify their plan. As part of the modified plan, the debtors propose to keep the $64,000 in homestead proceeds.
The trustee objects to the proposed modification, arguing that it violates 11 U.S.C. § 1325(a)(4) because it fails to provide for the distribution of the amount of the homestead proceeds to unsecured creditors. The debtors contend that the proposed modification complies with section 1325(a)(4) because the proceeds are
Section 1325(a)(4) of the Bankruptcy Code requires as a condition to both plan confirmation and plan modification that chapter 13 debtors pay unsecured creditors at least the amount they would receive if the estate were liquidated in chapter 7. 11 U.S.C. §§ 1325(a)(4), 1329(b). To determine whether a plan modification satisfies this requirement, the court must consider what a hypothetical liquidation of non-exempt property of the estate would bring "as of the effective date of the plan." 11 U.S.C. § 1325(a)(4).
When dealing with plan modifications, courts are divided about whether the "effective date of the plan" refers to the effective date of the original plan or the date of the modified plan. Judge Robert Jones of this district addressed this issue in In re Moran, 2012 WL 4464492, 2012 Bankr.LEXIS 4426 (Bankr.N.D.Tex.2012). After analyzing each position, Judge Jones adopted the majority view that the "effective date of the plan" for purposes of section 1325(a)(4) is the date of the modified plan. Id. at *4, 2012 Bankr.LEXIS 4426, at *10. This court agrees with Judge Jones and follows Moran for the reasons stated in that decision. Consequently, the court must determine whether the liquidation test is satisfied as of the date of the debtors' modified plan.
Only property that could be liquidated to pay creditors in a chapter 7 — that is, nonexempt property of the estate — need be considered in the hypothetical liquidation test. See, Id. at *5, 2012 Bankr.LEXIS 4426, at *12 (failure to use the non-exempt portion of an asset to fund a plan modification results in failure to satisfy section 1325(a)(4)); 11 U.S.C. § 1325(a)(4)(only property that would be distributed under a plan need be valued); 11 U.S.C. § 522(c)(exempt property is not liable for most pre-petition debts). So, the court must consider whether the proceeds from the sale of the homestead are nonexempt property of the estate as of the date of the modified plan.
Section 541(a) of the Bankruptcy Code provides that property of the estate includes all legal or equitable interests in property held by the debtors as of the commencement of the case, including all proceeds from such property. 11 U.S.C. § 541(a)(1), (6). In a chapter 13 case, property of the estate includes all of the assets described in section 541 plus the same kinds of assets acquired by the debtor after the commencement of the case. 11 U.S.C. § 1306. Although all property of the estate vests in the debtor upon confirmation of a chapter 13 plan, this court has held that the estate continues to exist and, as such, assets acquired by the debtor post-petition are property of the estate. In re Hymond, 2012 WL 6692196, *3-4, 2012 Bankr.LEXIS 5861, *8-11 (Bankr.N.D.Tex.2012).
Initially, the proceeds from the sale of the homestead fall under the definition of property of the estate because (1) they
There is no question that the homestead was exempt when it was sold by the debtors. As permitted by 11 U.S.C. § 522(b), the debtors elected state exemptions when they filed their bankruptcy petition. The debtors designated their homestead as exempt pursuant to section 41.001(a) of the Texas Property Code. No party objected to the debtors' homestead exemption and, so, that exemption became final. 11 U.S.C. § 522(l); Taylor v. Freeland & Kronz, 503 U.S. 638, 643, 112 S.Ct. 1644, 118 L.Ed.2d 280 (1992). Still, the debtors have a problem. Section 41.001(c) of the Texas Property Code provides that when a Texas homeowner sells his homestead, the proceeds are exempt for only six months from the date of the sale. Tex. Prop.Code § 41.001(c). In In re England, 975 F.2d 1168, 1174 (5th Cir.1992), the court held that the purpose of the six-month exemption is to give Texas homeowners the opportunity to reinvest the proceeds in another homestead. More than six months have passed since the debtors sold their home and they have not reinvested the proceeds in another homestead. The trustee argues that the debtors' failure to timely reinvest the proceeds has caused them to lose their exempt status.
The debtors argue that because their homestead exemption has become final, the homestead is forever exempt. They say that no post-petition change in the nature of that asset (here, the conversion of the homestead to cash) can return it to the estate. Their argument finds support in Lowe v. Yochem (In re Reed), 184 B.R. 733 (Bankr.W.D.Tex.1995). In Reed, the debtors owned a ranch when they filed their chapter 11 bankruptcy petition. They claimed the ranch as exempt under Texas law and no party objected to the exemption. Later, the debtors sold the ranch and, as part of the consideration, received a $375,000 note. The debtors then purchased a new home and pledged the $375,000 note as security for the note on their new home. Later, the court converted the debtors' case to chapter 7. After the conversion, the obligors under the $375,000 note paid the note in full. The debtors' attorney disbursed some of the note proceeds to the sellers of the new home, paid other expenses, and transferred the remainder of the note proceeds to the debtors. The chapter 7 trustee sued the recipients of the note proceeds, arguing that the note was proceeds of the sale of the ranch and, as such, became property of the estate six months after the debtors sold the ranch.
In Reed, Judge Leif Clark held that the note was not property of the estate under section 541(a)(6).
Even though Judge Clark's reasoning is persuasive, this court does not follow it here for several reasons. First, because Reed did not involve a chapter 13 case, it did not require Judge Clark to address the question of whether the note constituted property of the estate under section 1306.
Second, this court questions whether the exemption of an asset "removes" it from the estate. The language of the Bankruptcy Code does not compel the conclusion that exempt property "leaves" the estate. Section 541(a) defines property of the estate broadly. Section 541(b) then excludes many kinds of property interests from that broad definition. But, section 541(b) does not purport to exclude from the definition of property of the estate an asset that has been finally exempted.
Depending on one's view, section 522(c) may clarify or confuse the status of property that has been exempted. That section does not define exempt property, but explains the effect of exemption. It says that property that is exempted is not liable either during or after a bankruptcy case for any pre-petition debt (with certain exceptions that do not apply here) so long as the case is completed and not dismissed. 11 U.S.C. § 522(c). One could, as Judge Clark did, take this language to mean that once property is finally exempted, it is removed from the estate, never to return. Alternatively, one could interpret section 522(c) to mean that exempt property continues to be property of the estate as long as an estate exists, but simply is not available for distribution to unsecured creditors.
The differing interpretations of section 522(c) are significant because if exempt property is removed from the estate, it is difficult to conceive of how it can re-enter the estate even if its character changes.
This distinction is not merely academic. Several cases in this circuit have addressed debtors' failures to timely reinvest homestead proceeds under Texas law and have concluded that their failure to do so causes the homestead proceeds to lose their exempt status. Yet, none of these cases squarely addresses Judge Clark's analysis of section 522(c) or discusses how removed property can be returned to the estate.
The leading case regarding the impact of section 41.001(c) of the Texas Property Code on bankrupt debtors is In re Zibman, 268 F.3d 298 (5th Cir.2001). In Zibman the debtors sold their Texas homestead and kept the cash proceeds. Two months later they filed a chapter 7 bankruptcy case and claimed the proceeds as exempt under Texas law. They did not reinvest the proceeds in a new homestead within six months of the sale. When the debtors failed to do so, the chapter 7 trustee argued that the proceeds exemption had expired under Texas law.
The Fifth Circuit reached the same result in Studensky v. Morgan (In re Morgan), 481 Fed.Appx. 183 (5th Cir.2012). There, the debtor filed a chapter 7 petition but did not claim his homestead as exempt. After filing bankruptcy, he sold his homestead and used the proceeds to pay his brother, who claimed a lien on the homestead. When the trustee learned of the payment, he contested the brother's lien and demanded return of the proceeds. In response to the trustee's demand, the debtor, relying on Reed, amended his exemptions to claim the proceeds as exempt under section 41.001(c). The trustee objected to the exemption, arguing that the proceeds were not exempt because more than six months had passed since the sale of the home. The bankruptcy court and district court held for the debtor, but the Fifth Circuit reversed. Id. at 184, 186-187. In doing so, the court did not overrule Reed, but distinguished it by noting that the debtor in Morgan never claimed his homestead as exempt, but instead only claimed the proceeds as exempt. Id. at 185-186. The court then followed Zibman and held that the exemption of the proceeds was subject to the time limitation under Texas law. Id. at 187.
Even though the Fifth Circuit has not expressly rejected Reed, at least one court has held that the effect of Zibman is to do just that. In Frost v. Veigelahn (In re Frost), 2012 U.S. Dist. LEXIS 103268 (W.D.Tex.2012), the debtor filed a chapter 13 case and claimed his homestead as exempt under Texas law. He later sought permission to sell the homestead and retain the proceeds. The trustee objected to the motion to the extent that the debtor purported to retain the proceeds for more than six months without using them to acquire a new homestead. The bankruptcy court ruled for the trustee, holding that the sale proceeds initially would be exempt, but would only remain so if the debtor reinvested the proceeds in a new homestead within six months. Id. at *3. In his appeal to the district court, the debtor relied on Reed, arguing that because the homestead was exempt, it could not be brought back into the estate as proceeds. The district court affirmed the bankruptcy court's ruling. In doing so, it concluded that in Zibman, the Fifth Circuit had rejected Reed's approach. Id. at *7-8.
In a case similar to the one before this court, a bankruptcy court also found Zibman to be controlling. In In re Zavala, 366 B.R. 643 (Bankr.W.D.Tex.2007), the debtors filed under chapter 13, exempted their homestead, and then sold it. Eleven months after the sale, the trustee, relying on Zibman, moved to modify the debtors' plan to require them to pay unsecured creditors with the remaining sale proceeds. The debtors argued Zibman was distinguishable
Of the foregoing cases, only the district court in Frost specifically rejected Judge Clark's analysis in Reed. Even there, however, the court did not explain why Reed was wrong, but merely stated that in Zibman the Fifth Circuit rejected Reed's approach. That rejection, if it occurred at all, necessarily derived from shifting the analysis from section 522(c) to 522(b)(3)(A). That section allows debtors to exempt "any property that is exempt under ... State or local law that is applicable on the date of the filing of the petition...." Id. As Zibman notes, nothing in section 522(b) limits a state's power to restrict the scope of its exemptions. Zibman at 302 (citing Owen v. Owen, 500 U.S. 305, 308, 111 S.Ct. 1833, 114 L.Ed.2d 350 (1991)). So, according to Zibman, once a debtor elects Texas's homestead law, he elects the entirety of that law, not just that portion that benefits him. Id. at 304.
So, while Zibman and its progeny may reject Reed's approach, they do not address its fundamental tenet, that being that once property is finally exempted under the Bankruptcy Code, that property leaves the estate, never to return. In this court's opinion, Zibman, by which this court is bound, must be reconciled with section 522(c) by a two-step analytical process. First, one must conclude that exempt property is not withdrawn from the estate, but remains property of the estate insulated from the claims of creditors for as long as the asset enjoys exempt status under state law. Second, one must conclude, as the court did in In re Davis, 170 F.3d 475, 481-3 (5th Cir.1999), that section 522(c) does not preempt Texas's homestead laws. In a chapter 13 case, the effect of this construction is to place the debtor in the same position with regard to exemptions as he would have been in had he not filed for bankruptcy. The pendency of the bankruptcy case neither expands nor reduces his exemption rights. So, once an asset no longer enjoys exempt status under state law, that asset becomes vulnerable to claims and, hence, distributable to creditors.
Here, it has been more than six months since the debtors sold their homestead. Accordingly, the homestead proceeds were non-exempt property of the estate as of the date of the debtors' plan modification and, as such, are necessarily part of any hypothetical liquidation analysis under the best interests test. Because the plan fails to provide for the distribution of the sale proceeds to creditors, it does not comply with section 1325(a)(4).
The debtors alternatively argue that any objection to the exemption of the proceeds should have been raised when they sought authority from this court to sell the homestead and receive the proceeds as their exempt equity. Because no party objected to the motion and the order approving the sale is now final, the debtors argue that any such objection is barred by the doctrine of res judicata.
To determine whether this matter involves the same cause of action as the sale order, the court must apply a transactional test. Id. at 1053. In that test the important inquiry is whether the two causes of action are based on the same "nucleus of operative facts." Travelers Ins. Co. v. St. Jude Hosp., 37 F.3d 193, 195 (5th Cir.1994). If two causes of action arise from the same transaction, res judicata bars not only any claim that was adjudicated in a prior action, but any claim that could have been adjudicated. Id. In effect, the first judgment extinguishes all rights between the parties with respect to "all or any part of the transaction ..., out of which the action arose." Id.
The sale motion and order implicated several matters including (1) the debtors' request to sell the homestead, (2) the application to apply the proceeds to certain obligations and expenses, and (3) the debtors' claim to the exempt equity. The debtors phrased the last of these claims as follows in their sale motion:
No party objected to the motion, but because the debtors and their mortgage lender disagreed on the amount owed on the mortgage, they negotiated a form of order, which the trustee approved and this court signed. The order has become final. That order provides in pertinent part:
Each side now points to these provisions as conclusive proof that it should prevail. Ultimately, the question boils down to the placement of burdens. The trustee contends that it was the debtors' burden to disclose their intent to exempt the proceeds beyond section 41.001(c)'s time limitation. The debtors argue that it was the trustee's burden to object to their retention of the proceeds beyond the time limitation.
Although a persuasive case can be made for either side, the facts here favor the trustee. In this regard, Republic Supply Co. v. Shoaf is instructive. In Shoaf, a
Id. at 1054.
Shoaf suggests that a key ingredient of the transactional test in circumstances such as these is the debtor's disclosure of his intent to take an act that arguably deviates from controlling law. The clarity of the order in Shoaf is in sharp contrast to the vagueness of the order in this case. Here the order approving the sale merely ordered that the sale proceeds "be disbursed to the Debtor(s) as their exempt equity in the home." It did not order that the equity would remain exempt for more than six months after the date of sale. Indeed, neither the motion nor the order disclosed any such intent by the debtors.
Moreover, creditors might also have been confused by that portion of the motion that said that "Debtor(s) propose that all of the equity in the property be distributed to the Debtors(s) from the sale proceeds with any remaining balance being paid to unsecured creditors." (emphasis added). Although the court construes this language as a typographical error, it is possible that creditors could have construed it as the debtors' intent to distribute at least part of the sales proceeds to unsecured creditors.
Under these facts, any creditor reviewing the motion to sell could have concluded that the debtors intended to retain the proceeds subject to the time limitation of section 41.001(c) or, perhaps, to abandon the exemption as to some of the proceeds. If the debtors intended to retain all of the proceeds beyond the time limitation of section 41.001(c), they should have made that intention clear in their motion and the order they negotiated with the trustee. Because they did not do so, the trustee's objection to the plan modification cannot be said to involve the same transaction. Consequently, the trustee's objection is not barred by res judicata.
For the reasons stated herein, the court finds that the debtors' proposed plan modification does not satisfy section 1325(a)(4) and, as such, must be denied.
