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Labor & Economy

Bankruptcy: Fixing California’s Homestead Exemption Law

Bill Raden

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It’s not news that it is tougher to buy a home in the U.S. than it was 40 years ago. But what may come as a surprise to the roughly 7. 7 million Californians financially secure enough to own their homes is how the state’s inadequate and loophole-riddled bankruptcy protections too often make it impossible to hold onto that piece of the American Dream, just when it’s needed most. The problem lies with the law’s “homestead exemption,” a provision intended to shield a core amount of a bankrupt debtor’s home equity, when a court forces the sale of the house, in order to allow that debtor to land on their feet with a roof over their head and start afresh.

When Congress enacted the 1978 federal bankruptcy code, which is the basis for California’s and the other 49 states’ widely varying laws, the state’s homestead exemption was set at $40,000. Back in 1975, when Sacramento wrote the state’s original exemption under the previous federal law, that was the median price of a California home. This meant that when a court ordered the sale of a house, the debtor could essentially take the exemption and buy another home outright. But four decades of steeply rising home prices have made the exemption’s provisions woefully obsolete.

Jenny Doling, a Palm Desert bankruptcy attorney and debt-relief advocate, told Capital & Main that she regularly sees first-hand what in her practice has become a distressingly familiar scenario: families that lose their homes and equity in the face of unexpected medical expenses, bad luck or worse. 

One recent case involved a retirement-age couple — clients who had come to Doling seeking bankruptcy protection because of crippling hospital bills incurred when the husband fell gravely ill. Two days before Doling could file, however, the man suddenly died from his illness.

“He was over 65 and she’s under 65,” Doling said. “And that distinction is very important, because when he was alive, they qualified for a $175,000 homestead exemption. When he passed, her homestead exemption dropped all the way down to $75,000 for a single person. And so that put her house in jeopardy, and made it so she couldn’t file bankruptcy.”

Stories like that led California State Senator Bob Wieckowski (D-Fremont) to add bankruptcy reform to last year’s Economic Equity and Financial Stability Initiative, the three-bill package he authored to help low- and middle-income families escape the crushing burden of consumer debt. Senate Bill 501 and SB 641, which spelled out reforms to the state’s wage garnishment system, were signed into law last fall.

The third, however — SB 308 — passed the Senate only to stall in the Assembly. The legislation, which seeks to modernize the homestead exemption, failed to clear the Assembly when 20 fellow Democrats caved in to pressure from the state’s powerful banking and debt-collection lobbies by “taking a walk” during the final floor vote. That defeat set the stage for what is already proving a contentious rematch in the new session for a bill that is perhaps closest to Wieckowski’s heart.

“I have a bankruptcy practice,” Wieckowski explained to Capital & Main. “Exemptions are supposed to reflect our values and what we want to protect for consumers from creditors forcing a sale or a liquidation. … And the exemptions schedule is supposed to say, ‘Hmm, we’re going to exempt this much of the value of [a debtor’s] house. We’re trying to protect the average person because you, creditor, have other options.’”

Although California’s original exemption was adjusted in 2009 to its current three-tiered levels ($75,000 for individuals; $100,000 for married couples; $175,000 if the debtor is age 65 or older, is disabled, or is on a limited income), the median California home now costs $437,000. That’s nearly six times the individual exemption and well over twice the $176,200 that the 1975 amount would have been had it simply kept pace with inflation. SB 308, which originally called for a single $700,000 across-the-board exemption, has been amended down to relatively modest adjustments of $100,000, $150,000 and $300,000, respectively.

“In the big picture, this is nibbling,” Wieckowski noted. “And the banks are full-metal jacket — they just say, ‘We can’t have this done. We can’t raise these exemptions, because we need to liquidate these houses to get these people out of there” — displacing otherwise hardworking Californians that live for that American Dream to actually own a home.”

The bill’s other major provision redresses an obscure 2012 bankruptcy court ruling that tilted the playing field lopsidedly in favor of banks and collectors. Called In re Jacobson, the case dealt with a rarely invoked provision of 2005’s creditor-friendly federal bankruptcy law signed by George W. Bush called a “six-month look-back.” The landmark ruling essentially meant that California debtors were now required to reinvest their exemption lifeline in a new house within six months or have it seized by the court trustee.

“It turned the reinvestment protections that California had enjoyed for a hundred years upside-down,” Wieckowski recalled. “And it really allowed the trustees in bankruptcy to not only sell the debtor’s house but then wait six months and come back and grab their homestead exemption because they hadn’t reinvested, because there was nothing for them to buy [in that time]. Freddie Mac and Fannie Mae require two years after bankruptcy to give them the money. It just seems so unfair, so inequitable that I said, ‘We’ve got to fix that.’”

SB 308 would eliminate the six-month look-back rule entirely and free up the equity for more pressing needs.

“A lot of people at 82 years old don’t want to buy another house,” Jenny Doling noted. “They need to pay for medical care and to live on [the equity]. It makes no sense. A lot of them need to go into long-term care facilities, and that’s right around the corner. But that wouldn’t be a reinvestment of the homestead exemption.“

The bill also addresses some rather bizarre anachronisms in the current law. Not the least of which is the requirement that estranged spouses must sign a waiver approving of their former mate’s choice of exemptions. That, said bankruptcy attorney Erik Clark, who is also serving as legislative liaison on SB 308 for the Central District Consumer Bankruptcy Attorney Association, makes little sense given the toxicity that can surround couples going through a bitter divorce.

“You can just think about how that works,” he reflected. “And even worse, one of the issues that I brought up is a situation where you have domestic violence, where it’s all about power and manipulation, and you have the single mother running away from the abusive ex and [who] now has to go and beg him to approve or choose the exemptions so she can protect her measly assets. It’s just ludicrous. … We’re just trying to live up to what the law was originally intended to be in California, and undo some of the perversions that have come along since.”

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