ON APPEAL FROM AN ORDER OF THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF NEW JERSEY [Case No. 06-14240/GMB].
The opinion of the court was delivered by: Hon. Jerome B. Simandle
This matter is before the Court upon appeal from a Bankruptcy Court Order entered on March 6, 2007, which granted the belated motion by Trustee/Appellee Steven R. Neuner ("Trustee") to value at zero the exemptions that Stergios and Renee Messina ("Debtors") claimed in their residence. The principal issue in this appeal is whether that decision by the Bankruptcy Court ran afoul of Fed. R. Bankr. P. 4003(b) as interpreted by the Supreme Court in Taylor v. Freeland & Kronz, 503 U.S. 638 (1992), by permitting a late objection to an exemption. In Taylor, as discussed further herein, the Supreme Court held that a trustee's failure to timely object under Rule 4003(b) was fatal to a later challenge to the validity of a debtor's claimed exemptions. Because the Court finds that the Taylor precedent compels a different outcome than the Bankruptcy Court reached, the decision of the Bankruptcy Court shall be vacated and Debtors shall be entitled to their claimed exemptions, to which no timely objection was interposed.
On May 15, 2006 Debtors filed a Chapter 7 voluntary bankruptcy petition. On their Schedule D*fn1 , Debtors listed one secured mortgage creditor, Litton Loans, as holding a $113,657.68 secured interest in their home, which was valued at $230,000.
Debtors listed National Penn Bank as a disputed unsecured non-priority claim under Schedule F in the amount of $396,171.13. (Ex. A-9.)
"When a debtor files a bankruptcy petition, all of his property becomes property of a bankruptcy estate. See 11 U.S.C. § 541. The Code, however, allows the debtor to prevent the distribution of certain property by claiming it as exempt." Taylor v. Freeland & Kronz, 503 U.S. 638, 642 (1992). The Second Circuit explained this process as follows:
When an individual debtor petitions for bankruptcy he is entitled to claim certain property as exempt from the estate. See 11 U.S.C. § 522(b) (allowing debtor to elect to take exemptions provided by state or federal law); id. § 522(l) (requiring debtor to file list of property claimed as exempt); Fed. R. Bankr. P. 4003(a). Any creditor and the bankruptcy trustee may file objections to the debtor's list of property claimed as exempt. See Fed. R. Bankr. P. 4003(b). However, absent special circumstances, these objections must be filed "within 30 days after the conclusion of the meeting of creditors held pursuant to Rule 2003(a)." Id. If no objections are made, then "the property claimed as exempt ... is exempt." 11 U.S.C. § 522(l).
Debtors claimed an exemption under 11 U.S.C. § 522(d)(1)*fn2 in the amount of $36,900.00 and an additional $250.00 exemption under § 522(d)(5)*fn3 , seeking to exclude this money, allegedly equity in their home, from the bankruptcy estate. Trustee did not timely object to either one of the exemptions and no extension of time was granted by the Bankruptcy Court. (Tr. 5:14-15, Feb. 26, 2007) ("It is undisputed that the trustee did not object to the debtors' claimed interest in the homestead."). See Fed. R. Bankr. P. 4003(b) (requiring objection within 30 days).
The initial Meeting of Creditors was held on June 13, 2006. (See Docket Report of In re Messina, Ch. 7 Case No. 06-14240 (GMB) (Bankr. D.N.J. filed May 15, 2006).) Debtors informed the Trustee of specific defects in the National Penn Bank mortgage through correspondence on June 14, 2006 and June 21, 2006. (Debtors' Ex. A-4 at 3-4). Thereafter, Trustee initiated an adversary proceeding so that the estate could avoid the National Penn Bank mortgage lien, alleging that the mortgage was not properly acknowledged or recorded. Neuner v. National Penn Bank et al. (In re Messina), Ch. 7 Case No. 06-14240, Adv. No. 06-2013 (Bankr. D.N.J. filed July 5, 2006);(Trustee's Ex. A-10-1 at 5.) On August 21, 2006, Trustee submitted a motion for court approval of the sale of the residence. That sale was approved with liens, claims and interest to attach to all sale proceeds. Debtors did not object to the sale or the Order approving sale. On September 13, 2006 the sale produced net proceeds in the amount of $200,209.64.
On October 18, 2006, Trustee filed a Notice of proposed settlement reflected in the November 8, 2006 Consent Order, in which National Penn Bank consented to avoidance of its mortgage lien on the residence pursuant to 11 U.S.C. § 544(a)*fn4 and N.J. Stat. Ann. 46:17-3.1*fn5 , with the amount of the lien to be assigned and transferred to Trustee and preserved against Debtors pursuant to 11 U.S.C. § 551. (Trustee's Ex. A-3-1 at 4.) According to Trustee and the banks, the mortgage's defects in acknowledgment and recording made it defective as to subsequent purchases and creditors, but not as to Debtors, who were the original parties to the mortgage agreement. Debtors did not object to the November 8, 2006 Consent Order. As a result, the sale of the residence was free and clear of all liens. The remaining proceeds from the sale were placed into the bankruptcy estate.
Debtors pursued the difference between the net proceeds of the sale and sums paid out by Trustee. In response, Trustee filed a motion seeking an Order to value the Debtors' exemption in the residence at zero and to deny Debtors any exemptions to the proceeds from the sale of the home. Debtors subsequently cross-moved seeking an Order requiring Trustee to pay the claimed exemption of $36,900.00 pursuant to 11 U.S.C. § 522(d)(1) and $250.00 pursuant to § 522(d)(5). Debtors argued that Trustee's valuation motion was out of time and that, in any event, they were entitled to the exemption on the merits because the mortgage was void at the time of filing.
There is no dispute that the Trustee's motion was an objection to the exemptions beyond the thirty days normally permitted by Fed. R. Bankr. P. 4003. On July 5, 2006, as noted above, Trustee commenced adversary proceeding against the improperly acknowledged mortgage lien holder to avoid the lien. (Br. in support of Trustee's Mot. for Summ. J. in Ex. A-10-1 at 2.) Debtors filed their amended Schedule C on August 30, 2006. (Ex. A-9.) Under Rule 4003(b), "a party in interest may file an objection to the list of property claimed as exempt only within 30 days after the meeting of creditors . . . is concluded or within 30 days after any amendment to the list or supplemental schedules is filed, whichever is later." Because the date of the amended Schedule C came later than the first creditors' meeting, the Trustee had thirty days from the amendment date, August 30, 2006, to file an objection to any claimed exemptions. The Trustee's deadline for objection under Rule 4003(b) expired on September 29, 2006, without action being taken. By that time, the sale of the residence was complete and had produced net proceeds of over $200,000, as noted above. On November 16, 2006, forty-seven days after the deadline for objection, Trustee filed his motion to value Debtors' residence at zero or in the alternative to declare that it does not extend to sale proceeds. (Ex. A-3-1).
Debtors argued that at the time of filing the petition, the mortgage was automatically void under N.J. Stat. Ann. § 46:17-3.1, which provides: Every mortgage or conveyance in the nature of a mortgage of and for any lands, shall be void and of no effect against a subsequent judgment creditor, or bona fide purchaser, or mortgagee for a valuable consideration, not having notice thereof, unless such mortgage shall be acknowledged or proved according to law, and be recorded, either by registry as hereinbefore provided or by recording in full, or lodged for that purpose with the county recording officer of the county in which such lands are situated, at or before the time of entering such judgment or of recording or lodging with said county recording officer, the said mortgage or conveyance to such subsequent purchaser or mortgagee, provided nevertheless, that such mortgage as between the parties and their heirs shall be valid and operative.
According to Debtors, as of the commencement of the bankruptcy case, Trustee became a bona fide purchaser, and as a result, the mortgage was void as to the Trustee. Therefore, once the lien was avoided there was equity in the residence to be exempted. Trustee did not dispute that he had the powers to become a bona fide purchaser and avoid the lien, but argued that Debtors had no equity to the residence at the time of filing, did not acquire a new interest in the sale proceeds as a result of his avoidance action on the unperfected mortgage lien, and therefore could not validly claim an exemption.
In the February 26, 2007 oral decision, the Bankruptcy Court granted Trustee's motion to value Debtors' claimed exemptions as to the residence at zero. The Bankruptcy Judge ruled that although the Trustee failed to timely object to the Debtors' claimed exemptions to the residence, Trustee was not barred under Fed. R. Bankr. P. 4003(b) from contesting the matter because "the Bankruptcy Rules provide that the schedules must accurately describe the debtor's claimed exemption in order for the parties to be put on notice." (Hr'g Tr. at 6, Feb. 26, 2007.) The Bankruptcy Court held that because the provision of the Code Debtors identified pertained to equity in the residence and not to the proceeds of the sale of the recovered property, the exemption did not put Trustee on sufficient notice. (Id. at 7.) The Bankruptcy Court held that Debtors should have claimed an exemption under 11 U.S.C. § 522(g)*fn6 in order to seek recovery from the proceeds of the sale after the Trustee's successful avoidance action. (Id. at 9.) However, the Bankruptcy Court held, even if Debtors had claimed exemptions under § 522(g), these exemptions would have been denied on the merits because that provision requires an involuntary transfer of property, which is not what happened in this case. (Id. at 10.) In other words, the Bankruptcy Court held that because there was no basis for the exemption claimed there was not proper notice and if an exemption ...