Should the Widow Win? Part 1

Consider the following facts followed by two scenarios and three options.

Widow of ne'er-do-well late husband files Chapter 7 bankruptcy with one asset--her home--valued at $180,000 subject to the following liens: a $52,000 mortgage, a $113,143 tax lien in favor of the IRS, and a $47,942 lien in favor of the Deportment of Taxation of North Carolina. Our widow is left with negative "equity" of nearly $34,000. In other words, the property is underwater, financially speaking. 

North Carolina law also affords our impoverished widow a homestead exemption of $55,000. Regrettably for her, however, the same law subordinates the homestead exemption to mortgages and tax liens.

How would bankruptcy help our widow? In the first place, it discharges her legal obligation to pay all three debts. This is important because her only significant income is from Social Security.

But what of her home?

Scenario 1: The mortgage must continue to be paid. Bankruptcy discharges debts; it does not, generally speaking, discharge liens securing those debts. The mortgage lender will foreclose if she doesn't continue to pay.

What about the IRS and the NC Department of Revenue? While the judicial opinion from which these facts are taken doesn't explain why they wouldn't foreclose their liens, the tax authorities appear to be content to wait until the widow herself dies before collecting.

In short, in Scenario 1, the widow stays in her home.

Scenario 2: Consider an enterprising Chapter 7 bankruptcy trustee who suggests the following to the two tax authorities: "If you reduce your liens to 60% of what is owed, I will sell the home and pay off the mortgage. I'll then pay each of you your reduced liens (a bird in the hand ...), pay myself my statutory fees and reimburse myself for my out-of-pocket expenses (of say, about $30,000), and give the remaining $38,000 to other creditors of which the unpaid 40 of your claims are the largest part, and pay the remainder of about $2000 to the widow."

In short, in Scenario 2, all creditors are better off while the widow is on the street.

What's a court to do?

Option A: Let the widow keep her home in the spirit of equity? Or,

Option B: Let the bankruptcy trustee sell the home by following the letter of the law? Bankruptcy Code section 724(b), to be precise. Or,

Option C: "Interpret" the letter of the law in the spirit of equity and let the widow keep her home?

If you picked Option C you'd have on your side the authority of the the federal District Court for the Western District of North Carolina. You can read the opinion of the District Court in Summerlin v. Turnage (March 14, 2023) here where it affirmed the decision of the lower Bankruptcy Court.

Since leaving the practice where I generally represented commercial creditors in Chapter 11 corporate bankruptcy cases, I've come to appreciate better the plight of the many Americans caught in the maw of our financialized society. Leaving the widow Turnage in her home to the end of her days strikes me as good a result as can be expected.

On the other hand, there's the pesky Bankruptcy Code that appears to authorize what the Chapter 7 bankruptcy trustee proposed to do. For what it's worth, I am not persuaded by the District Court's opinion. It mischaracterizes what the trustee and two tax creditors agreed to do, misapplies the SCOTUS decision in Law v. Siegel (2014), and unnecessarily impugns the integrity of the trustee.

For a better explanation of why the trustee might be wrong, one can turn to the opinion of the lower Bankruptcy Court here. I hope to post my thoughts about it soon.