• Third Circuit Defines Bankrupt's Exemption
  • June 3, 2003 | Author: Harris Ominsky
  • Law Firm: Blank Rome LLP - Philadelphia Office
  • The U.S. Court of Appeals for the Third Circuit has clarified a bankrupt debtor's exemption in commonly held property. Its interpretation avoided what it characterized as "an absurd result" of a literal interpretation of the Bankruptcy Code. In re Miller, PICS Case No. 02-1263 (3d Cir. Aug. 6, 2002). The issue arose in a Chapter 13 Bankruptcy proceeding in a case where the debtor, Gary M. Miller, owned an undivided, one-half interest as a joint tenant with a woman who was not a party to the bankruptcy and to whom he was not married. The issue arises under § 522(f) of the Bankruptcy Code, which authorizes the avoidance of certain liens "to the extent that such lien impairs an exemption to which the Debtor would have been entitled."

    Mathematical Puzzle

    The case will be of particular interest to puzzle fans who enjoy mathematical problems. The market value of the residence is $100,000, but there was an outstanding mortgage balance of $74,703, for which the owners were jointly obligated. Miller claims an exemption of $8,075 in the residence under the Code. Unfortunately, a creditor, Okmi Sul, held a judgment against Miller for almost $58,000.

    Miller argues that the judgment lien impairs his exemption and is entirely avoidable under the Code. However, according to Sul, additional equity remains to which her lien may attach, even after Miller's exemption is allowed in full. The Bankruptcy Court and the District Court agreed with Sul and held that her lien impaired only part of the exemption, and that $4,573 of the lien was unavoidable. On appeal the Circuit Court affirmed those decisions.

    To understand the puzzle that Congress has created, one must study § 522(f)(2)(a) which sets up the following formula to determine the extent that a lien impairs an exemption:

    1. For the purpose of this subsection, a lien shall be considered to impair an exemption to the extent that the sum of -

    1. The lien;
    2. All other liens on the property; and
    3. The amount of the exemption that the debtor could claim if there were no liens on the property.

    2. Exceeds the value that the debtor's interest in the property would have in the absence of any liens.

    Miller contends that, under the plain meaning of the statute, the proper calculation should be:

    Judgment Lien                   $ 58,000
    Entire Mortgage Balance  $ 75,000
    Debtor's Exemption             $ 8,000
    Total                                    $141,000

    For convenience these figures are rounded off but it is clear that this total exceeds what would be the value of Miller's one-half interest in the property absent any liens, $50,000, by $91,000. Therefore, Miller argues that the judgment lien must be avoided entirely, based on a literal application of the statutory formula. In rejecting Miller's calculations, Judge Greenberg maintains that Miller did not take into account in calculating "all other liens on the property," the fact that he owns the residence jointly so that the mortgage encumbers both joint tenants' interest in the property, not merely Miller's. Therefore, in round figures the value of the entire property, $100,000, less the mortgage debt of $75,000, leaves $25,000 in equity. By that analysis, as a co-owner, Miller's share of the equity is $12,500. Subtracting Miller's $8,000 exemption from his share of the equity leaves a surplus of $4,500 to which the judgment lien may attach.

    Judge Greenberg points out that this result would be reached if Miller's calculations are modified by using in the formula the portion of the debt the mortgage secures attributable to Miller's share of the property, $37,500, in place of the total debt secured by the mortgage, $75,000. Then, the total of subsections (ii) and (iii) under the "statutory provision" would be $103,500. That sum, $103,500 would exceed the value of Miller's $50,000 interest in the property in the absence of any liens, by $53,500, so that the lien would impair the exemption to that extent. Therefore, the lien would not impair the exemption to the extent that the amount of the lien, $58,000, exceeds $53,500, i.e. $4,500.

    Split of Authority

    Judge Greenberg pointed out that the Third Circuit Court of Appeals had not yet addressed this issue of the exemption and that there is a division of authority on this point. The Bankruptcy Appellate Panel of the Tenth Circuit has adopted Miller's approach, focusing on the literal meaning of the statute. However, the Courts of Appeals for the First and Eleventh Circuits and the Bankruptcy Appellate Panel of the Ninth Circuit follow the approach of this Court because a literal application of this section of the Code "would lead to an absurd result when a debtor owns property jointly with a non-debtor."

    He stated: ". . . it is illogical to net the total outstanding secured debt balance attributable to both a debtor and his joint tenant against the debtor's one-half interest in the property alone because Congress could not have intended that a debtor benefit under § 522(f)(ii)(A) by the use of what realistically should be regarded as someone else's debt even if the debtor may be liable personally to the creditor for the entire debt. Such a mechanical application of § 522(f)(ii)(A) would provide a windfall to the debtor at the expense of a secured creditor.

    "In our view, the correct approach is to view the debtor as owning one half of the property to which one half of the mortgage debt is thus attributable and, therefore, to regard 'property' in subsection (ii) to mean the debtor's interest in the property and then to allocate the lien among the interests in the property proportionately. In this case, in as much as Miller has a one-half interest in the property, one-half of the lien should be allocated to him. . ."

    The Third Circuit analysis would seem to be a logical approach to interpreting Congressional intent. If the purpose of avoiding liens is to assure an $8,000 exemption, any other interpretation could provide Miller with a windfall at the expense of the judgment creditor. For example, if the whole lien were avoided as requested by Miller, what would happen if the property were sold for the agreed value of $100,000, either in mortgage foreclosure or as a result of arm's length sale? Then, assuming that none of the figures change and we ignore costs and other expenses, the joint owners would receive a total of $25,000 cash. That would presumably be split equally between them, and in that case Miller would receive $12,500, instead of the $8,000 exemption intended by the Bankruptcy Code.