ARE PROCEEDS FROM HOMEOWNER’S INSURANCE DISPUTE EXEMPT IN BANKRUPTCY

Let’s say that your house was partially destroyed by fire. You file a claim with your house insurance company for $200,000 for repairs. At the time of the fire, the value of your house was $300,000. You owed a mortgage on the house of $200,000. Thus, your equity was $100,000. The insurance company denies your claim. You file a lawsuit against the insurance company for breach of contract and everything else that you can think of. The insurance company settles the lawsuit for $100,000. The insurance company sends you a check for $100,000 which you deposit in the bank. Then, you file for Chapter 7 bankruptcy relief to get rid of $60,000 of credit card debt. In your bankruptcy petition, you claim the $100,000 as exempt under the homestead exemption. The trustee objects to your claim of exemption alleging that the homestead exemption does not apply to settlement proceeds of an insurance dispute. Who is correct?

 In Re Carlew, when the debtor filed for Chapter 7 relief on September 13, 2011, he scheduled insurance proceeds of $73,000 being held for home repair. This money came from the settlement of a lawsuit that the debtor filed in state court against the provider of his homeowner’s insurance. Mr. Carlew sued the insurance company based on the following: breach of insurance contract, violations of the Texas Deceptive Trade Practices Act, breach of common law duty of good faith and fair dealing, common law fraud, violations of the Texas Insurance Code, negligence, negligent misrepresentation, intentional infliction of emotional distress, and conspiracy to commit each of the foregoing claims. He forgot to include racketeering under the RICO act, drug dealing, illegal immigration, treason and bribery. Debtor asserted that this money was exempt pursuant to the homestead exemption under Texas Property Code §§41.001-.002.

The bankruptcy court sided with Mr. Carlew. “Admittedly, the matter at bar is not a typical homestead exemption dispute, but rather a dispute over whether the debtor may exempt all proceeds from the settlement of a lawsuit where the debtor sought relief on several separate and distinct ground, none of which can be exempt property. Nevertheless, because the dispute could not have arisen but for the existence of the debtor’s homestead, this Court believes that it should take into account the Fifth Circuit’s lengthy history of favoring homestead exemptions in concluding that the debtor will be allowed to exempt the entire $73,000 under Texas Property Code §§41.001-.002,” the court said.

“Under Fifth Circuit precedent, both proceeds from a lawsuit filed to recover damages on a homestead or from an insurance policy settlement become part of the bankruptcy estate and are potentially exemptible…Accordingly, the proceeds from the settlement of the State Court lawsuit, no matter what their characterization, are eligible to be exempted from the estate.” This conclusion was not changed by the fact that the lawsuit contained many counts. The court found that the debtor did not have the initial burden to break down the lump sum settlement into exempt and non-exempt proceeds. Once the debtor asserted the exemption, it was up to the trustee to provide specific proof that the exemption was not available. In other words, the trustee failed to carry the burden of proof to show that debtor did not qualify for the exemption claimed on the proceeds. In addition, the outcome was not changed by the fact that the debtor held on to the insurance proceeds for more than six months. The court found that the requirement that the money be reinvested within six months applied only when the homestead was sold.

Thus, at least in Texas, if debtor’s lawsuit against his homeowner’s insurance provider originates from a suit over insurance regarding the debtor’s homestead, the proceeds received from the settlement of the suit are exempt. It is safer, however, to use the proceeds to complete repairs on the house first, before filing for bankruptcy relief, to avoid tangling with the trustee over the insurance proceeds. Prevention is better than cure.