Opinion
Case No. 97-11639-SSM
December 4, 1997
Thaddeus Furlong, Fairfax, VA, of Counsel for the debtor
Andrew J. Terrell, Whiteford, Taylor Preston, L.L.P., Washington, DC, of Counsel for Quads Trust Company
MEMORANDUM OPINION
A hearing was held in open court on November 10, 1997, on the objection of Quads Trust Company to the debtor's claimed exemption of her interest in three limited partnerships. After receiving the evidence of the parties and hearing oral argument, the court took the matter under advisement to review the applicable law.
Facts
Mary Margaret Olexson Meyer ("the debtor") filed a voluntary petition under chapter 7 of the Bankruptcy Code in this court on March 7, 1997, and was granted a discharge on June 12, 1997. On her Schedule C ("Property Claimed as Exempt"), she claimed exempt under § 34-4, Code of Virginia, a 2.45% interest in each of three limited partnerships: 1110 North Kensington Street, L.P., 1117 North Kenilworth Street, L.P., and 1125 North Kenilworth Street, L.P. Two of the partnership interests — 1117 North Kenilworth and 1125 North Kenilworth — are shown as being subject to a lien in favor of Quads Trust Company ("Quads"). The "current market value" of the debtor's interest in each partnership was listed as being $1.00.
From the testimony at the hearing, it appears that debtor's estranged husband, Robert H. Meyer, Jr., also owns a 2.45% interest, and that the remaining 95.1% is owned by the debtor's father, Gerard J. Olexson, who is also the general partner.
The meeting of creditors was held on April 3, 1997, and on April 24, 1997, the chapter 7 trustee filed a report of no distribution. Quads Trust Company, which asserts it is the assignee of a promissory note originally payable to Dean and Mary Simonds, filed a timely objection to the debtor's claimed exemptions. On July 18, 1997, the debtor filed amended schedules, including an amended Schedule C. The amended schedules, however, made no change with respect to the claimed exemption of the three limited partnership interests.
Under F.R.Bankr.P. 4003(b), objections to a debtor's exemptions must be filed within 30 days of the conclusion of the meeting of creditors. On the 29th day, May 2, 1997, Quads filed a motion to extend the time. By order dated June 25, 1997, the time for objecting to exemptions was extended to July 7, 1997. Quads's objection was filed on that date.
The three limited partnerships each own an apartment building in Arlington, Virginia. The buildings now owned by 1117 North Kenilworth Street, L.P. and 1125 North Kenilworth Street, L.P. had previously been owned by Dean E. Simonds and Mary O. Simonds or by partnerships they controlled. At the time the Simonds sold the property, they made a loan of $184,815.00 to the debtor and her husband, Robert H. Meyer, Jr., as evidenced by a promissory note in that amount dated June 11, 1992. The note provided for interest on the unpaid balance at the rate of 10% per annum and required quarterly payments of interest only in the amount of $4,620.38 per month, with the principal due in full on June 11, 2002. The note was secured by a subordinate deed of trust against property owned by the debtor and her husband in Darnestown, Maryland, but was not secured by the apartment buildings in question. It is not clear from the evidence whether actual cash changed hands in connection with the loan or whether the note simply represented sums due the Simonds in connection with the purchase of the apartment buildings. The promissory note was subsequently modified in writing on August 23, 1993, to reduce the principal balance retroactively to $172,826. The liability of the debtor and her husband on the note to the Simonds was apparently treated as their "capital contribution" for their limited partnership interests in 1117 North Kenilworth Street, L.P. and 1125 North Kenilworth Street, L.P., and possibly — although the evidence on this point is far from clear — 1110 North Kensington Street, L.P. as well.
The focus of the evidentiary hearing was almost exclusively on the 1117 and 1125 North Kenilworth Street properties, and it is not clear whether the Simonds were the previous owners of the third property, 1110 North Kensington Street.
It appears that the Simonds made separate loans of $20,000 each which are secured by third deeds of trust against 1117 North Kenilworth Street and 1125 North Kenilworth Street. The Maryland property has apparently been foreclosed upon by the first deed of trust holder, leaving the $172,826 note totally unsecured.
For convenience, the court will refer to the note in question, as modified, as the $172,826 note.
On June 30, 1993, the Simonds assigned the promissory note and deed of trust to Quads Trust Company, as custodian for the benefit of John M. Jacquemin Quads Individual Retirement Account. Apparently the debtor and her husband stopped making payments in January 1994, and Quads sued the debtor and her husband in the Circuit Court for the City of Alexandria, Virginia. Quads was granted judgment on May 24, 1995 in the principal amount of $172,826, plus prejudgment interest in the amount of $27,012.94 and $5,000 in attorneys fees. Thereafter, Quads obtained from the Circuit Court on August 9, 1995, a charging order against the debtor's and her husband's interests in 1117 North Kenilworth Street, L.P. and 1125 North Kenilworth Street, L.P.
The Simonds filed a voluntary chapter 11 petition in this court on January 26, 1993, Case No. 93-10335-DOT. Their chapter 11 plan was confirmed on January 18, 1995.
Stephen Kisska, an experienced real estate appraiser, testified at the hearing that the 1117 North Kenilworth Street property had a fair market value of $520,000 and that the 1125 North Kenilworth Street property had a fair market value of $510,000. No appraisal testimony was presented with respect to the 1110 North Kensington Street property, but the debtor testified that the partnership had purchased it in 1992 for $387,500. The debtor testified that the 1117 North Kenilworth property was subject to a first-lien deed of trust in the amount of $290,000, a second-lien deed of trust to the Virginia Housing Development Authority ("VHDA") in the amount of $125,000, a third-lien deed of trust to the Simonds in the amount of $20,000, and a financing statement in favor of Washington Gas Light in the amount of $45,000. In addition, she testified, the partnership owes $40,000 in loans to the general partner (her father). She testified that the 1125 North Kenilworth property is subject to a first deed of trust in the amount of $290,000, a second deed of trust to VHDA in the amount of $120,250, a third deed of trust to the Simonds in the amount of $20,000, and a financing statement in favor of Washington Gas Light in the amount of $33,000. She testified further that the partnership owes her father $40,000 in loans. There was no testimony concerning the debt structure of 1110 North Kensington Street, L.P. Finally, the debtor testified that she has received no income distributions from any of the three partnerships. She is, however, paid $1,000 per month by the partnerships as property manager.
The appraiser was not engaged to, and did not, appraise the value of the partnerships, as distinguished from the value of the partnerships' assets. The debtor testified that at one point she considered obtaining appraisals of her partnership interests but, after learning that such an appraisal might cost $6,000, decided not to. She testified that she valued the interests at $1 each because she was not sure what they were worth. When asked at what price she would be willing to sell her partnership interest, she said she would sell them for $1 each, but appeared to hedge, and it was clear from her testimony, taken as a whole, that she was not actually willing to sign over her interest to anyone for that price other than her father, and that there was no specific price at which she was willing to sell to a third party. She also testified that she was resisting Quads's objection because her father did not want "outside parties" involved in the limited partnerships.
Conclusions of Law and Discussion I.
This court has jurisdiction over the present controversy under 28 U.S.C. § 1334 and 157(a), and the general order of reference from the United States District Court for the Eastern District of Virginia dated August 15, 1984. Under 28 U.S.C. § 157(b)(2)(B), this is a core proceeding in which final judgments and orders may be entered by a bankruptcy judge.
Quads essentially raises two objections to the debtor's claimed exemption of her limited partnership interests. The first is that the interests are worth far more than the value at which they have been scheduled and exceed in value what the debtor is entitled to exempt under the Virginia homestead exemption. The second is that the debtor cannot claim a homestead exemption against the unpaid purchase price of the partnership interests. The court will address each objection in turn.
II.
Among the exemptions available to Virginia residents who file bankruptcy petitions is the homestead exemption set forth at Va. Code Ann. § 34-4 et seq. Under the homestead exemption, up to $5,000 of real or personal property may be held exempt from the claims of creditors by filing for record an instrument known as a homestead deed. Id.; In re Sherman, 191 B.R. 654, 656 (Bankr. E.D. Va. 1995). An additional $500 may be claimed for each dependent supported by the debtor, and a further $2,000 if the debtor is a disabled veteran. Va. Code Ann. § 34-4, 34-4.1. The homestead deed is required to contain a list of the property claimed exempt and the "cash valuation" of "each parcel or article" claimed exempt. Va. Code Ann. 34-14. In Addison v. Reavis, 158 B.R. 53 (E.D. Va. 1993), aff'd sub nom. Ainslie v. Grablowski (In re Grablowski), 32 F.3d 562 (table) (4th Cir. 1994), the District Court noted a long-standing practice in Virginia of listing only a nominal (typically $1.00 or $10.00) value for assets claimed exempt in bankruptcy and of amending the exemption upward "if and when the bankruptcy court determines that a higher value is more appropriate." 158 B.R. at 56. In Addison, as here, the debtor had listed the value of certain limited partnership interests at $1, and the District Court held that the debtor's exemption would be limited to the $1 claimed value unless the debtor amended the value stated for those interests upward within the $5,000 homestead exemption. Id. at 58.
Quads does not dispute that the debtor has two dependents and would be entitled to a total homestead exemption of $6,000. Although no evidence was offered that a homestead deed was properly filed, Quads does not assert any failure by the debtor to comply with the statutory procedure for perfecting a homestead exemption, and for the purpose of the present ruling the court assumes the proper procedure was followed.
Having carefully considered the sketchy evidence presented at the hearing, the court is unable to determine the true value of the debtor's partnership interest but finds that the value significantly exceeds the $1 value placed on it by the debtor in her schedules. Obviously, as the debtor's counsel argued, there is a difference between the value of a limited partnership interest and the value of that same partnership's assets. A limited partner does not have a direct property interest in the assets of the limited partnership and does not participate in the operation of the partnership, but rather is entitled, while the partnership is operating, to a pro rata distribution of income and, upon dissolution of the partnership, to a pro rata distribution of the partnership assets after all the partnership's debts have been paid. Va. Code Ann. §§ 50-73.34, 50-73.40, 50-73.44, and 50-73.52; Pischke v. Murray, 11 B.R. 913, 916-17 n. 2 (Bankr. E.D. Va. 1981). A partnership might therefore own valuable assets without the partnership itself being an attractive investment.
At the same time, the court is unwilling to accept the debtor's argument that the value of the partnership is measured solely by what could be obtained on an immediate liquidation. An on-going business often has a value to an investor that greatly exceeds the equity shown on its balance sheet. With respect to a single-asset real estate partnership, for example, if the operating cash flow is sufficient to service and to pay down the debt, and if the asset maintains its value over time, the property may be sold or refinanced after a reasonable holding period for an amount sufficient to produce a profit to the partners. In the present case, there is no evidence or even suggestion that anything has occurred that would make the partnerships worth less than they were when the debtor and her husband purchased their combined 4.9% interests seven years ago for $172,826.
A major problem here is that neither side has presented the court with the quality and kind of evidence — most of which appears to be in the hands of the debtor's father — that would permit the court to fix an accurate value on the debtor's interest in the three partnerships. Nevertheless, accepting the $172,826 note as representing the original purchase price of those interests only seven years ago, and the apparent appreciation in value of the real estate owned by the partnerships, the court is unable to credit the debtor's testimony that her interests are worth at most $1. The court, although it is unable to determine the actual value, finds that the value is well in excess of $1. Accordingly, the debtor's claim of exemption will be allowed only to the extent of $1 for each of the partnership interests and disallowed to the extent the interests exceed that amount, subject to the debtor's right to amend upward within the limits of the homestead exemption. Addison, 158 B.R. at 57-58, 61; Sherman, 191 B.R. at 657.
The appraisal report for 1117 North Kenilworth Street reflects a purchase price in June 1992 of $387,500, and a fair market value in July 1997 of $520,000, a 35% increase. The report for 1125 N. Kenilworth Street reflects that it too was purchased in June 1992 for $387,500. At a current fair market value of $510,000, this amounts to a 32% increase.
Since the trustee, as evidenced by his filing of a report of no distribution, appears to have no interest in administering the partnership interests, the value of the interests would become significant only in the event the debtor were to attempt to avoid Quads's judicial lien under § 522(f), Bankruptcy Code, as impairing an exemption. In such a proceeding, the debtor would have the burden of proving that the mathematical test of impairment set forth at § 522(f)(2)(A) was satisfied.
The debtor has claimed only $574.00 exempt under her homestead exemption and therefore has significant room to amend upward.
III.
Quads argues, however, that the debtor should not be allowed to claim any amount exempt because the claim Quads holds is one for the unpaid purchase price of the debtor's limited partnership interests. As Quads correctly points out, Va. Code Ann. §§ 34-3 and 34-5 do not permit a homestead exemption to be claimed "for the purchase price of any articles claimed as exempt or any part of the price thereof." Quads, of course, does not literally stand in the shoes of an unpaid seller, since neither Quads nor the Simonds sold the debtor the partnership interests in question. Quads cites, however, to In re Johnson, 179 B.R. 800 (Bankr. E.D. Va. 1995) (Shelley, J.) for the proposition that a exemption cannot be claimed in bankruptcy under the Virginia exemptions where the objecting creditor made a loan used to purchase the property that the debtor is attempting to exempt.
For reasons that are not clear, the exclusion is set forth, with only slightly different language, at two separate places in Title 34, Code of Virginia. Section 34-3 provides as follows:
The exemptions under § 34-4, 34-4.1, 34-26, 34-27, 34-29, and 64.1-151.3 shall not extend to . . . levy or distress for the purchase price of any articles claimed as exempt or any part of the price thereof. . . . If an article purchased and not paid for is exchanged or converted into other property of the debtor, such property shall not be exempt from payment of the unpaid purchase money debt.
Section 34-5 provides as follows:
The property exemptions created under this Code shall not be claimed against the following debts:
1. For the purchase price of such property or any part thereof. If the property purchased and not paid for is exchanged for or converted into other property by the debtor, such last named property shall not be exempted from the payment of such unpaid purchase price.
It is true that Johnson broadly read the "purchase price" exclusion of § 34-5 to apply not merely to the claim of an unpaid vendor but also to a third-party lender whose money was used to purchase the asset at issue. However, Johnson also involved a lender who had a security interest, albeit unperfected, in the automobile the debtor was claiming exempt. Because the security interest was not perfected by being noted on the certificate of title, it was subordinate to the claims of the bankruptcy trustee. Johnson, 179 B.R. at 804. The lack of perfection, however, did not prevent it from being enforceable against the debtor. Id. The precise holding of Johnson — which goes to great pains to distinguish two other bankruptcy cases that had declined to apply § 34-5 — was as follows: "This court holds that a third party creditor can prevail under § 34-5 if the creditor successfully shows that its loan proceeds were used to acquire the collateral, and that it has a valid purchase money security interest. " Id. at 805 (emphasis added). Here, there is no suggestion that the Simonds ever had or even negotiated for a security interest in the debtor's limited partnership interests. Thus the narrow holding of Johnson, as opposed to some of its broader dicta, simply does not apply.
Dominion Bank of Cumber lands, N.A. v. Nuckolls, 780 F.2d 408 (4th Cir. 1985), and Jones v. Kirsch (In re Kirsch), 93 B.R. 77 (E.D. Va. 1988).
More to the point, I have previously held that the exemption exclusions in Title 34, Code of Virginia, are unenforceable in bankruptcy to the extent that they conflict with the plain language of § 522(c), Bankruptcy Code. In re Scott, 199 B.R. 586, 592-94 (Bankr. E.D. Va. 1996). Accord, In re Conyers, 129 B.R. 470 (Bankr. E.D. Ky. 1991); In re Whalen-Griffin, 206 B.R. 277 (Bankr. D. Mass. 1997). As I held in that case, although Congress, in enacting the "opt out" provision embodied in § 522(b)(1), Bankruptcy Code, plainly intended to defer to the states in determining what property could be claimed exempt, Congress did not thereby permit the states to "opt out" of other exemption-related provisions of the Bankruptcy Code. In particular, § 522(c), Bankruptcy Code, expressly provides that property exempted by the debtor "is not liable during or after the case for any debt of the debtor that arose . . . before the commencement of the case," with only four exceptions. Those exceptions are as follows: (1) nondischargeable taxes; (2) nondischargeable alimony or child support; (3) debts secured by a lien that is not avoided in the course of the bankruptcy; and (4) embezzlement, theft, fiduciary defalcation, and conversion claims, but only where held by a Federal banking or thrift regulatory agency against an "institution affiliated party." Id. The claim held by Quads does not fall within any of those categories, except for the third — that is, it is a debt secured by a lien (the execution lien arising from the charging order) that, at least up to this point, has not been avoided. Unless avoided in the course of a bankruptcy, valid prepetition liens survive bankruptcy and may be enforced in rem after the debtor receives a discharge and the property is no longer property of the bankruptcy estate. Johnson v. Home State Bank, 501 U.S. 78, 82-83, 111 S.Ct. 2150, 2153, 115 L.Ed.2d 66 (1991); § 362(c), Bankruptcy Code. Whether the lien held by Quads can be avoided is not an issue presently before the court, and the court expresses no view on the matter. But //Quads is entitled to enforce its claim against the debtor's partnership interest, such right arises solely from its prepetition lien — which at this point has not been avoided — and not from the asserted "purchase price" character of its claim. Accordingly, Quads's objection, to the extent it challenges the debtor's right to an exemption in bankruptcy based on Va. Code Ann. § 34-3 and 34-5, is overruled.
Since Quads has no prepetition lien against the debtor's interest in the third partnership, 1110 North Kensington Street, L.P., it cannot enforce its judgment against that interest post-petition, because the debtor's personal liability on the claim has been discharged. Only the chapter 7 trustee and a creditor holding a nondischargeable claim may reach a debtor's non-exempt property post-petition. The trustee is free to administer such interest, however, to the extent it exceeds $ 1 in value, and Quads is free to make an offer to the trustee to purchase the interest.
IV.
A separate order will be entered allowing the debtor's claimed exemption in the limited partnerships to the extent, but only to the extent, of $1 for each partnership, subject to the debtor's right to amend upward to the extent of her unused homestead exemption.