U.S. THIRD CIRCUIT

In re Messina

BANKRUPTCY

New Jersey Law Journal

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In re Messina, No. 11-1426; Third Circuit; opinion by Greenaway, U.S.C.J.; filed August 6, 2012. Before Judges Fisher, Hardiman and Greenaway. On appeal from the District of New Jersey. [Sat below: Judge Simandle.] DDS No. 42-8-xxxx [25 pp.]

Stergios and Renee Messina appeal from the district court order affirming the bankruptcy court's order granting the trustee's motion to value their exemption at zero and denying their cross-motion for an order requiring appellee-trustee to pay them the exemptions claimed in their Chapter 7 bankruptcy petition.

Renee Messina had obtained a loan from National Penn Bank (NPB), secured by an $118,000 mortgage on residential property owned by her and her husband. They later executed a second mortgage on the residence with Aames Funding Corporation for $118,000.

Four years later, they filed a voluntary Chapter 7. On Schedule A they listed their primary residence, which they valued at $230,000. On Schedule C, they claimed an exemption of $36,900 under 11 U.S.C. § 522(d)(1) and one for $250 under 11 U.S.C. § 522(d)(5), the maximum exemptions under these provisions. They did not list the mortgages on Schedule C.

Before expiration of Rule 4003's 30-day period to file an objection to claimed exemptions, the debtors informed appellee that the NPB mortgage had not been properly acknowledged by them when it was executed. Relying on N.J.S.A. 46:17-3.1, he then sought to avoid the NPB mortgage lien and his motion to sell the property free of all liens was granted. After the sale of the property, he filed a motion to value the debtors' exemption in their former residence at zero, arguing that they had no equity in the home to which the homestead exemption could attach, and because of the continuing validity of the NPB mortgage as to them, their claim of exemption in the residence was subordinate to, and did not extend to, his rights to the sale proceeds and, therefore, their exemption had no value.

The bankruptcy court granted the trustee's motion. The district court reversed, holding that his motion was barred because he failed to file a timely objection under Rule 4003(b). The trustee appealed.

Schwab v. Reilly, 130 S.Ct. 2652 (2010), was then handed down and the Third Circuit remanded the matter. On remand, the district court held that the trustee had no duty to object within 30 days under Schwab. It affirmed the bankruptcy court. The debtors appeal.

Held: The district court applied Schwab appropriately and correctly concluded that the 30-day time period in which to object to appellants' exemptions under Rule 4003(b) did not preclude the trustee from objecting and the trustee's objection is valid. Appellants did not provide sufficient notice through their disclosure in Schedule C that they intended to exempt the property's full value and the order granting the trustee's motion to value debtors' exemption at zero is affirmed.

The court says Schwab modified prior law, holding that Rule 4003's time limit applies only to objections based on the description of the exempted property, the code provisions governing the claimed exemptions and the amount listed in the column on Schedule C titled "Value of Claimed Exemption." When the objection is based on other elements, the time limit does not apply and a trustee has no obligation to object to an exemption claim unless the basis for that claim is found on the face of Schedule C.

The court says that under the code, a debtor is allowed to protect specific property from creditors because that property is exempt under federal bankruptcy law or under the laws of the debtor's home state. Both parties agree that the NPB mortgage was defective in acknowledgment and recording and is an "unregistered mortgage" under N.J.S.A. 46:17-3.1.

The court finds that the NPB mortgage was unsecured as of the date the petition was filed, as it was defectively acknowledged, and failed to perfect the bank's security interest. However, appellants are still obligated to pay the mortgage under state law and it was valid as to them.

The court rejects appellants' argument that they are entitled to the exemption they claimed in their residence since, through appellee's sale, equity was created in the residence, to which the exemption could attach. The court says filing for bankruptcy does not create new property rights or value where there previously were none. There was no equity in the property to exempt when appellants filed for bankruptcy because the two mortgages were greater than the value of the exemption and while a debtor may benefit from an avoidance if he files an exemption under 11 U.S.C. § 522(g), appellants very clearly stated that they had no intention of filing under 11 U.S.C. § 522(g). Thus, they are precluded from receiving anything from appellee's avoidance action.

The court says the district court correctly held that the avoidance of the NPB mortgage was a separate asset from that claimed as an exemption by appellants, as they claimed an exemption in the residence, not in the proceeds from its sale.

As to appellee's failure to timely object to their claimed exemption, the court says that the district court had to determine (1) whether the trustee's late objection is barred by Rule 4003(b) regardless of the merits of the objection itself; and (2) if, after Schwab, the objection is not barred under Rule 4003(b), whether the trustee's objection should be upheld on the merits.

In deciding the first question, the district court was required to determine whether the asset the debtors claimed as exempt on Schedule C is the same asset that the trustee was seeking to shield from them. It found that Schedule C claimed an exemption in only the equity in the residence when the debtors filed their petition. It concluded that the objection to applying the debtors' claimed exemption in the equity in their house to the separate asset of proceeds recovered by the trustee's voidance of the NPB mortgage falls outside of the three elements of Schedule C identified in Schwab, and is therefore not subject to Rule 4003(b)(2)'s 30-day limitation.

As to the second question, the district court agreed with the trustee that the NPB mortgage was valid against the debtors when they filed their petition and that the situation here, where the debtors are not acting pursuant to the voidance powers of a debtor in possession, is distinguishable from that of a Chapter 12 debtor in possession who possesses the avoidance powers of the trustee.

The district court concluded that the trustee had no duty to object to the debtors' effort to extend their claimed exemption in the equity of their residence to the separate asset of the recovered National Penn mortgage within 30 days, and that the bankruptcy court therefore properly considered trustee's objection. It also concluded that the bankruptcy court properly granted the trustee's motion to value at zero the debtors' claimed exemptions in their residence.

The Third Circuit concludes that the district court applied Schwab appropriately and that the trustee must prevail.

For appellants — David A. Kasen (Kasen & Kasen). For appellee — Steven R. Neuner (Neuner & Ventura).

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