Generally, a debtor in bankruptcy can use state law creditor protection exemptions. As explained by the Third Circuit Court of Appeals:
The Bankruptcy Code provides two alternative plans of exemption. Under § 522(b)(2), a debtor may elect the specific federal exemption listed in § 522(d) (“federal exemptions”) or, under § 522(b)(3), may choose the exemptions permitted, inter alia, under state law and general (non-bankruptcy) federal law (“general exemptions”)…. Debtors may select either alternative, unless a state has “opted out” of the federal exemptions category.[1]
If the debtor uses the general exemptions, the entirety property is exempt to the extent permitted by the non-bankruptcy law; the entireties shield is respected “to the extent that such [entireties] interest… is exempt from process under applicable non-bankruptcy law.”[2] The applicable non-bankruptcy law appears to be determined by the situs of real estate, not the domicile of the debtor. In In re Holland,[3] for example, the bankruptcy court used Florida law to fully exempt nonresidential property located in Florida when the debtor’s home state of Illinois would have denied exemption because the property was not a homestead.
In full bar states, of course, the property held by the entireties is immune from process and fully exempt if only one spouse is the debtor. Where, under applicable state law, the creditors of one spouse can reach the property, it is not exempt. The nature of applicable state law restrictions thus determines the degree of protection offered in bankruptcy:
“[In Massachusetts] [t]he debtor’s interest in her [statutory] tenancy-by-the-entirety is subject to attachment but not subject to levy or execution at this time and, so, the debtor’s right to possession cannot be interfered with unless and until the property is sold, or debtor and her present spouse are divorced, or she survives her spouse, in which event the trustee will be free to enforce his interest in the debtor’s real estate. The trustee has a real albeit contingent interest in the real estate, while the debtor has an exemption limited by the trustee’s expectancy.”[4]
Similarly, in Rhode Island a tenancy by the entirety is subject to attachment but not to levy and sale, which means that a debtor who chooses state exemptions can exempt entireties property to the extent that the debtor remains married or survives the non-debtor spouse. In Illinois, to the extent that a judgment creditor has a judicial lien against a debtor’s contingent interests in tenancy by entirety property arising out of a judgment against the debtor, these interests may not be immune from process and therefore may not be exempt under § 522(b)(3)(b). Similarly, in Tennessee because a debtor’s survivorship interest is not immune to execution, it remains in the bankruptcy estate even though the debtor’s interest in tenancy by entirety property is otherwise exempt under Code § 522(b)(2)(3).[5]
Any exemption removes property from the bankruptcy estate: “An exemption is an interest withdrawn from the estate (and hence from the creditors) for the benefit of the debtor.”[6] First, however, all property interests of the debtor come into such an estate, including a debtor’s interest in property held as a tenant by the entirety.[7] Accordingly, a pre-petition transfer can cause financial disaster. The bankruptcy courts in a majority of jurisdictions have held that the trustee can avoid any pre-petition transfer of otherwise exempt property.[8] The fraudulent conveyance provision of the Bankruptcy Code[9] permits the debtor’s interest in otherwise exempt entireties property that was transferred within two years of a bankruptcy petition to be returned to the bankruptcy estate. If returned, the property is likely no longer considered entireties property.[10]
If the debtor is not filing for bankruptcy voluntarily, the debtor is at risk of the creditor forcing involuntary bankruptcy within the avoidance period. Involuntary bankruptcy unravels an intra-spousal or third party transfer of entireties property. Involuntary petitioners, however, are not common:
Congress has made it quite difficult for creditors to bring a successful involuntary bankruptcy petition…. Courts have been quite reluctant to grant involuntary bankruptcy petitions, interpreting the already strict statutory requirements of involuntary bankruptcy “in a manner which vastly complicates creditors’ difficulties of proof and, therefore, increases the costs and risks associated with seeking bankruptcy relief….” Such decisions have made involuntary bankruptcy virtually useless to creditors seeking to collect from opportunistic debtors.[11]
Assuming a pre-petition transfer was not made, entireties property in a full bar jurisdiction will be exempted if none of the debts are joint debts: “A debtor’s individual creditors [can] neither levy nor sell a debtor’s undivided interest in the entireties property to satisfy debts owed solely by the debtor, because a debtor’s interest in tenancy by the entireties property is exempt from process under [the applicable state law].”[12] Exemption may be available even if both spouses file a petition jointly; the determinative factor is the nature of the debts.[13]
However, if the individual debtor-spouse files for bankruptcy and he or she has a joint debt with the non-filing spouse, the rule is markedly different. Remember: entireties property is exempt to the extent that “such interest … is exempt from process under applicable non-bankruptcy law.”[14] If one spouse files for bankruptcy and there are joint debts, the entireties property is not exempt to the extent of those joint debts.
The existence of joint debt permits the trustee to sell the entireties property under the Bankruptcy Code, section 363(h).[15] The power of sale permits the trustee to use the entireties property’s equity to satisfy the joint creditors.[16] To the extent that entireties property exceeds the joint debt in value, however, such equity continues to be exempt.[17]
In modified bar jurisdictions that permit creditor attachment of one debtor-spouse’s interest, the property may be in jeopardy of sale. The Code’s power-of-sale provision gives the co-tenant who has not filed for bankruptcy procedural rights to object.[18] Typically, if the creditor would not be prejudiced, courts will not permit sale of entireties property.[19]
[1] In reBrannon, 476 F.3d 170, 174 (3d Cir. 2007). If a state has opted out, the debtor must use the state exemptions.
[2] Bankruptcy Code, 11 U.S.C. § 522(3)(B) (West 2008).
[3] 366 B.R. 825 (Bankr. N.D. Ill. 2007).
[4] The Honorable Alan M. Ahart, The Liability of Property Exempted in Bankruptcy for Pre-Petition Domestic Support Obligations After BAPCPA: Debtors Beware, 81 Am. Bankr. L. J. 233, 243-244 (2007), quoting In re McConchie, 94 B.R. 245, 247 (Bankr. D. Mass. 1988). The discussion of Massachusetts law involves law as applied to a principal residence.
[5] Id. (citations omitted).
[6] Owen v. Owen, 500 U.S. 305, 308 (1991).
[7] Brannon, 476 F.3d at 174 (quoting Napotnik v. Equibank & Parkvale Savings Assoc., 679 F.2d 316, 318 (3d Cir.1982)); In re Ford, 3 B.R. 559, 568 (Bankr. D. Md. 1980) aff’d, 638 F.2d 14 (4th Cir. 1981) (“[E]ven property held to be exempt will initially become property of the estate and will remain in the estate until such time as the exemption is taken.”).
[8] “The majority includes the Fourth, Sixth, Ninth, Tenth Circuits, lower courts in the Seventh and Eighth Circuits, and some lower courts in the First, Second, and Eleventh Circuits … The minority includes some lower courts in the First, Second and Eleventh Circuits.” Dana Yankowitz, “I Could Have Exempted It Anyway”: Can a Trustee Avoid a Debtor’s Prepetition Transfer of Exemptible Property?, 23 Emory Bankr. Dev. J. 217, 227 n.54, 55 (2006); see also Thomas E. Ray, Avoidance of Transfers of Entireties Property – No Harm No Foul?, 25 ABI J., Sept. 2006, at 12.
[9] 11 U.S.C. § 548. There are also additional provisions permitting avoidance by the trustee.
[10] See 11 U.S.C. § 522(g)(1)(A) (only involuntary transfers can be exempted); In re Swiontek, 376 B.R. 851, 865 (Bankr. N.D. Ill. 2007) (“A small number of courts that have analyzed this issue within the context of property transferred pre-petition out of a tenancy by the entirety estate, have permitted the trustee to avoid the transfer and have held that the property does not revert back into a tenancy by the entirety estate.”); In re Paulding, 370 B.R. 11, 17-20 (Bankr. D. Mass. 2007) (holding that Chapter 7 discharge can be denied when the debtor spouse transfers entireties property to the non-debtor spouse and then reverses transfer before filing the petition); In re Goldman, 111 B.R. 230, 233 (Bankr. E.D. Mo. 1990) (“The parties are mistaken when they assume that the property is conveyed back to the Debtor and his wife as tenants by the entireties.”); In re Rotunda, 55 B.R. 386, 388 (Bankr. W.D.Pa. 1985).
[11] Elijah M. Alper, Opportunistic Informal Bankruptcy: How BAPCPA May Fail to Make Wealthy Debtors Pay Up, 107 Colum. L. Rev. 1908, 1932 (2007), quoting Lawrence Ponoroff, Involuntary Bankruptcy and the Bona Fides of a Bona Fide Dispute, 65 Ind. L.J. 315, 351 (1990) (other citations omitted).
[12] In re Greathouse, 295 B.R. 562, 564 (Bankr. D. Md. 2003) (quoting In re Bell-Breslin, 283 B.R. 834, 837 (Bankr. D. Md. 2002)).
[13] Bunker v. Peyton, 312 F.3d 145, 152 (4th Cir. 2002).
[14] 11 U.S.C. § 522(3)(B).
[15] See 11 U.S.C. § 363(h).
[16] Greathouse, 295 B.R. at 565.
[17] In re Maloney, 146 B.R. 168, 171-72 (Bankr. W.D. Pa. 1992). Allowing the debtor-spouse’s share of the entireties property to be available to joint creditors only once that interest becomes subject to § 363(h) has been criticized. See, e.g., Lawrence Kalevich, Some Thoughts on Entireties in Bankruptcy, 60 Am. Bankr. L. J. 141 (1986) (arguing that the debtor-spouses’ entire interest in the entireties property should be generally available for creditors). Some courts have applied the excess funds to individual creditors. Steven Chaneles, Tenancy by the Entireties: Has the Bankruptcy Court Found a Chink in the Armor?, 71 Fla. B. J., Feb. 1997, at 22, 24 & n.16.
[18] See In re Wickham, 127 B.R. 9, 10-11 (Bankr. E.D. Va. 1990).
[19] See In re Monzon, 214 B.R. 38, 48 (Bankr. S.D. Fla. 1997) (“[A] single oversecured joint debt will not trigger administration of [the entireties property]. However, the presence of an unsecured or undersecured joint debt will subject entireties property to administration by a Trustee…”); Gary Norton, Sales and Co-owners: Cautionary Tales from the Cases, 24 ABI J., Nov. 2005, at 22 (discussing the balancing test employed by the courts in determining whether to permit a sale under § 363(h)). In one case highlighted in Norton’s article, In re Marks, the court found that § 363(h) could not apply without eviscerating the entire notion of a tenancy by the entirety. No. Civ. A. 00-524, 2001 WL 868667, at *3 (E.D. Pa. June 14, 2001). Other cases have been less protective of the notion of entireties or of the non-filing spouse.
