STATE HOMESTEAD EXEMPTIONS AND THEIR EFFECT ON FEDERAL BANKRUPTCY LAWS

Real Property, Probate and Trust Journal, Spring 2004 by Rivera, Ryan P

Editors' Synopsis: This Article contains an overview of the history of the federal bankruptcy law and the federal homestead exemption. The author argues that varying state homestead exemption laws have created a chaotic and nonuniform system, and he discusses recent proposals to amend the federal exemption that will produce greater uniformity.

I. INTRODUCTION

An aphorism, paraphrased, is that "a debtor's homestead exemption is his castle."1 The significance of this aphorism should not be disregarded because lawmakers have linked the collapse of Enron Corp. to the homestead exemption.2 The exemption permits debtors in bankruptcy to keep expensive homes out of the hands of creditors.3 Texas, where Enron Corp. is located, allows homeowners to protect the full value of their homes in bankruptcy.4 As a result, Texas's homestead exemption protects several former Enron Corp. executives with multi-million-dollar mansions who might find themselves forced into bankruptcy by shareholder lawsuits or criminal charges.5

In five states the aphorism is particularly accurate. In addition to Texas, four other states allow homeowners to protect the full value of their home in bankruptcy. Florida, Iowa, Kansas, and South Dakota have adopted homestead exemptions that authorize debtors to protect an unlimited amount of equity from the claims of creditors. Unlike the five states just identified, homestead exemptions in the remaining forty-five states are considerably different because they impose some form of dollar limitation upon the debtor's exemption. While the majority of states have homestead exemptions that limit the dollar amount of equity a debtor may exempt, the dollar limitations that have been adopted are noticeably different.

What is the homestead exemption? It comprises two elements: the homestead and the exemption. Homestead signifies a dwelling house with customary appurtenances and includes outbuildings that are necessary for use where the family resides.6 The second element, the exemption, "[I]s an interest of the debtor carved out of the bankruptcy estate for the benefit of the debtor and thereby shielded from creditors' claims."7 The exemption provides the debtor with an asset that he can remove from the prebankruptcy estate to aid in the debtor's postbankruptcy rehabilitation.8 However, the homestead exemption is generally not available when a mortgage or other security interest is attached to the residential premises that a debtor seeks to exempt.9

Many states have constitutional or statutory exemptions that effectively negate any notion that "a debtor's homestead exemption is his castle."10 Consequently, the accuracy of the aphorism depends on the debtor's residency at the time of his bankruptcy filing. Even states within a similar geographic region have homestead exemptions that are afforded disparate treatment in federal bankruptcy proceedings. Despite this disparity, the homestead exemption's fundamental purpose of providing debtors with a source of protection in bankruptcy has remained constant since the mid-nineteenth century. The principal objective of the homestead exemption in the early twentieth century was to provide security for the family. The security afforded to the debtor's family provided a community benefit "to the extent that such security prevented] pauperism and provid[ed] the members of the family with some measure of stability and independence."12 Today, the principal objective of the homestead exemption is to secure a home for the householder.13 While the exemption is no longer exclusively focused on protecting the debtor's family, the exemption still has the same effect of providing debtors with a source of protection in bankruptcy.

In 1960, Professor Countryman stated one notable characteristic of state exemption laws is their extreme variety.14 This characteristic accurately describes the current condition of state homestead exemptions. While Florida, Texas, Iowa, Kansas, and South Dakota provide unlimited homestead exemptions, Delaware provides debtors with no homestead exemption whatsoever.15 Virginia's homestead exemption is exceptionally limited, providing debtors with a meager exemption of five thousand dollars.16 In addition to Virginia and Delaware, twenty other states have exemptions of fifteen thousand dollars or less.17 Besides the dollar limitation differentials, other peculiarities and unique priorities exist among state homestead exemptions.18 It has been stated that "[t]he only uniformity . . . found with respect to state exemption laws . . . is the universal academic discontent with the current condition of the law."19 Part I of this Article focuses exclusively on state homestead exemptions and will address different policies in various states.

Part II of this Article examines the history of federal bankruptcy and the federal homestead exemption. The classic goals of bankruptcy have been twofold: (1) to provide debtors with a "fresh start" from crushing debts, and (2) to ensure that creditors receive an equitable share of the debtor's bankruptcy estate.20 Accomplishing both of these objectives, while simultaneously enabling states to have control over their exemption laws, has produced a chaotic system of nonuniformity. It has been suggested that state homestead laws have resulted in a lack of equity and reasonableness. While this suggestion can be debated, it is indisputable that state homestead laws are far from uniform, and the "opt out" provision in federal bankruptcy has created the lack of uniformity that exists today.