On January 4, 2013, the Ninth Circuit Bankruptcy Appellate Panel (the “B.A.P.”) held that a debtor cannot avoid a lien based on the California homestead exemption when the debtor has not maintained a continuous interest in the property. This holding will affect debtors who transfer property back and forth to other parties (including special purpose entities) before filing bankruptcy.
In Kuiken a creditor recorded a judgment lien on a debtor’s property. Two years after the creditor recorded the lien, the debtor transferred the property “for valuable consideration” to an LLC he owned. A short time later the LLC transferred this property back to the debtor as a “gift”. Less than a month later, the debtor filed for bankruptcy and then tried to avoid the creditor’s judgment lien.
Debtors can typically set aside a judgment lien if that lien impairs an exemption that the debtor is entitled to. In order to avoid a lien, under Bankruptcy Code Section 522, a debtor has to prove: 1) there was a “fixing”, or attachment, of a lien on an interest of the debtor in property; 2) such lien impairs an exemption to which the debtor would have been entitled; and 3) such lien is a judicial lien.
The creditor objected to the debtor’s lien-avoidance action arguing that the creditor’s lien had priority over the debtor’s homestead exemption. The creditor argued that the debtor’s conveyance of the property to the LLC resulted in a termination of the debtor’s previous interest in the property. When the debtor reacquired the property from the LLC, the debtor obtained a “new interest” in the property which came after the creditor’s lien had already attached on the property. Thus, under this reasoning, the debtor could not prove that there was an attachment of an “interest of the debtor in property”.
The B.A.P. agreed with the creditor, finding that when an interest once held by a debtor is entirely extinguished by a transfer, and a judicial lien that once attached when the debtor had that property interest cannot be now be extinguished when the debtor acquires a new interest in that property. Thus, the debtor’s own right to avoid the lien is terminated when that property is transferred to a third party. When the debtor reacquires this property, this is considered a “new interest” in the property that is already subject to the attached lien. Thus, the debtor cannot argue that the lien attached to the debtor’s property as the debtor acquired property that was already encumbered with the lien.
Under Kuiken debtors should be very careful in transferring, before bankruptcy, property that may be subject to lien avoidance, because debtors can lose their avoidance eligibility under Kuiken. Judgment lien holders, on the other hand, have very good authority for opposing an avoidance action on their judgment lien.
If you have questions about the subject of this article, or anything else relating to real estate law, please contact Brewer Offord & Pedersen LLP at (650) 327-2900, or visit our website at www.BrewerFirm.com.