Homestead: Equitable Lien and Loss of Bankruptcy Discharge

I recently read a case issued by the federal Court of Appeals which illustrated again the different treatment of homestead protection under Florida state law and in bankruptcy law..In this case a debtor obtained a money award through the settlement of her personal injury lawsuit to recover for personal injuries sustained in an accident. She never took possession of her share of the award. Instead, she directed her personal injury attorney to pay her award directly to the bank that held a mortgage on her homestead property. During the personal injury suit the debtor had been sued by American Express for her non-payment of credit card debt. The debtor stated that she had the personal injury award paid directly to her homestead mortgage in order to protect the award from American Express by virtue of Florida’s homestead protection laws.

A few months later the debtor filed bankruptcy. The bankruptcy trustee sought to put an equitable lien on her home. Under Florida law, paying extra money to reduce a mortgage, even if done to protect the money from current creditors, cannot be undone or reversed with one exception. If the money was invested in the homestead to protect it from creditors was the result of fraud or other egregious circumstances courts can give a creditor an equitable lien on the homestead for the amount of the creditor’s debt. This bankruptcy trustee argued that what this debtor did with her personal injury proceeds was either fraudulent or egregious and warranted the imposition of an equitable lien on the homestead.

There are separate rules in bankruptcy applicable to this transaction. In bankruptcy, if a debtor converts money to a homestead or other exempt asset within a year or two of filing bankruptcy in an effort to defraud creditors the bankruptcy court can deny the debtor its discharge of unsecured debts pursuant to Section 727 of the U.S. Bankruptcy Code.

The appellate court issued a split decision. The court said that the debtors assignment of her personal injury settlement to pay down her homestead mortgage did not warrant an equitable lien under Florida law. The money was not obtained by the debtor’s fraud or wrongdoing, and even if she intended to protect the money from creditors by using her homestead protection, her actions were not egregious. The court implicitly distinguishes pay down of a mortgage which may be a fraudulent conversion from actual common law fraud which is egregious and could warrant invasion of homestead rights.

In the bankruptcy case, the court said that the conversion of funds into the homestead did run afoul of Section 727 of the Code. Therefore, the court did deny this debtor its bankruptcy discharge of unsecured debts. In the end, the debtor kept the homestead free and clear of any liens, but the debtor got no relief from unsecured debt in bankruptcy.

About the Author

Jon Alper is an expert in asset protection planning for individuals and small businesses.

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