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Fraudster Debtors Who Think Their Home Is Their Castle Might Want To Think Again

The maxim that one’s home is their castle goes at least as far back as the English common law of 1628: “For a man’s house is his castle and each man’s home is his safest refuge.” – Sir Edward Coke. Although today this maxim may not be as literal (or politically correct) as it once was, the courts still regard one’s homestead as practically the most sacred and impenetrable asset one can own.

Some creditors might ignore a debtor’s homestead – dismissing it as untouchable (“exempt”) property for debt recovery purposes – and those creditors would be correct in making that assumption under many circumstances. However, it’s worth the lender spending a little time scrutinizing the debtor’s financial situation concerning the house before it writes off a potentially lucrative source of repayment. This is especially true if the property was designated by the debtor as his or her “homestead” only recently, or the debtor’s liquidation of non-exempt property (such as a yacht) is followed by a large payment on the debtor’s home loan.

Minnesota law allows a creditor to pierce the “homestead” designation of real property if the debtor claimed a homestead exemption with actual intent to hinder or defraud creditors. Minnesota law provides an exemption for an individual’s homestead, currently, $420,000. See Minn. Stat. §§ 510.01-.02. However, under section 513.44 of the Minnesota Uniform Voidable Transactions Act (MUVTA), a debtor may not claim a homestead exemption when he or she transfers the property “with actual intent to hinder, delay, or defraud” creditors. See Minn. Stat. § 513.44(a)(1).

In the case Jensen v. Dietz (In re Sholdan), 217 F.3d 1006 (8th Cir. 2000), the debtor, a retired farmer 90 years of age with serious medical problems, prior to filing for bankruptcy, liquidated most of his non-exempt property and converted it into exempt property in the form of a house, which he listed in his bankruptcy petition as an exempt “homestead.” The bankruptcy court found that the debtor had converted non-exempt property to exempt property with the intent to defraud his creditors and upheld the bankruptcy trustee’s objection to the debtor’s homestead exemption. In agreeing with the bankruptcy court, the appellate court held that, although Minnesota law provides an exemption for an individual’s homestead, under MUVTA, a debtor may not claim a homestead exemption when he or she transfers (or converts non-exempt property) into the “homestead” property with actual intent to hinder, delay or defraud creditors. This legal principal not only applies to a debtor’s fraudulent purchase of a “homestead” using non-exempt property, but also under any circumstance where a debtor liquidates non-exempt property and transfers the proceeds into a legitimate “homestead” in order to put those proceeds out of reach of creditors. These principles apply in bankruptcy and non-bankruptcy situations.

However, notwithstanding the ruling in the In re Sholdan case, and those cases that came after it, the above principles are still only applicable in fairly narrow circumstances. The courts have ruled that the mere conversion of non-exempt assets to exempt assets (e.g., liquidating one’s boat and making a payment toward the homestead mortgage) is not by itself fraudulent and is perfectly acceptable, depending upon the timing and motivation involved. However, if additional facts constituting “badges of fraud” exist that indicate the debtor has converted non-exempt assets to exempt assets with the actual intent to defraud creditors, there is legal authority standing for the principle that those converted assets can be clawed back by the creditor and applied to the delinquent debt.

Although the concept of a virtually impenetrable homestead exemption may be a long-standing bedrock principle in our system of jurisprudence, it is not without its reasonable limitations. If an unscrupulous debtor thinks he or she can exploit the homestead protection with fraudulent impunity, they should first realize that Minnesota legal precedent includes another bedrock principle stretching back to the Minnesota Supreme Court in the 1890s (Esty v. Cummings): “While the homestead right is a valuable one … it was never intended, and it should never be permitted, to operate as a vehicle for fraud and rank injustice.”

About the Author

Jack Atnip III is an experienced litigator and creditors’ rights attorney who practices in the areas of Commercial Litigation, Financial Services, Collections/Creditors’ Rights, and Bankruptcy. Contact Jack by email or at (612) 305-1501.

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