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Exemption Policy: Sometimes it Doesn’t Pay to be Debt Free

posted by Nathalie Martin

We have two married 60-something friends who are artists in Santa Fe and own a very simple home with a rental house in the front. The house is tiny by all but New York City standards, and since their income is always in flux (some months several grand, many months nothing at all), they live very close to the bone. No credit card debts, no car payments, no mortgage.  The only fixed expenses they have are their $1,000 a month health care policy and a few utility bills. Generally, they get along just fine, but last month, when he ended up in the hospital for 5 days for literally swallowing wrong. 

Somehow, they now allegedly owe $30,000, despite the expensive health care policy. I know, there is supposed to be a $5,000 deductible limit per person, but there is something about a pre-existing condition etc. etc. She called to ask:  “they can’t take our house to pay a hospital bill, can they?” Given its location, this property is worth a lot, so we all know the answer. 
Now I know that no one exemption scheme can work for everyone, but these people have done everything right. They have lived a Dave Ramsey debt-free life, and while they could have saved more in traditional retirement vessels, they relied on Santa Fe’s outrageous real estate values to set them up for life. So I ask you, are our exemption policies out of sync with reality? Do they work for most people most of the time? I am suddenly dubious.      

Comments

Exemptions are strange little creatures that have a sometimes tenuous relationship to reality.

For example:
In WA, where I practice, our car exemption is $2,500 per car up to $5,000 for the marital community. It doesn't matter in state practice, because judgment creditors don't pursue used cars unless they're very high end. However, our chapter 7 trustees will try to sell any car with more than about $2,000 in equity. This puts clients in a tough spot, because virtually no car that sells for $2,500 is worth $2,500; and, they can't trade the car in while it's being administered, and they don't have money for a down payment otherwise. Provided they don't have equity in their house, you can select federal exemptions and use the wild card. If they have equity in their house, then they're going into chapter 13. Unless of course, they don't have regular income, then they're stuck losing something that they desperately need in the chapter 7: their car or large chunks of home equity.

The problem is that the current uses exemption statutes with lists of fixed values for assets with frequently fluctuating values. Legislatures are not always up to the task of adjusting the lists on a timely basis in response to market conditions.

One solution would be to switch to a progressive exemption system that uses percentages of equity for high dollar assets such as houses and cars, i.e. 100% of homestead equity up to $100,000, then 30% of the equity between $100,001 up to $200,000, etc. This creates a system where these high value assets such as houses and cars are exempted in relationship to their market value and reflects that people depend on them for transportation or have invested their future in real property instead of traditionally fully exempt assets like IRAs and 401(k)s.

Massachusetts now has a very generous homestead law, $500k, and applicable to pre-existing debts.

But Mass. has also outlawed denials of coverage for pre-existing medical conditions. Given the high read of bk related to medical expenses, NM might look at that source of financial hardship for its residents.

Otherwise, you're going to have an epidemic of middle-aged folks leaving their high school chemistry gigs to cook meth to cover healthcare costs.

:-)

great comments, both of you! And that Breaking Bad reference really made my day!

I was recently thinking about a similar issue here in Illinois in the context of liquidation analysis. Basically, someone has to pay in a 13 (or 11) the same amount as would be distributed to unsecureds in a 7. But in doing the analysis, you have to factor in broker's commission and fees as well as the Chapter 7 liquidation fees.

So if you have married debtors with the home being their only non fully exempt asset, $100,000 in equity in a $500,000 home, $40,000 (8%) goes to the broker, then $1,500 to the Chapter 7 Trustee, then $4,500 to the Chapter 7 Trustee, then $20,500 to the Chapter 7 Trustee. Then $400,000 for the secured debt. Then $30k exemption. The LA says that the amount to be received is about $3,500. Basically, they get to keep their $100k equity.

If they had $100k in equity in a $400,000 house, it's 400k - $32k - 1,500 - 4,500 - 15,900 - 300k - 30k = $16,100.

Same amount of equity, similar debtors, but a $12,600 difference in the minimum amount that has to be paid in an Illinois 13. And they get to keep $83,900 of their equity basically. But it's still clearly regressive in that you get to keep less of the same amount of equity depending on how valuable your house is.

Exemptions tend to be haphazard, all the more so because Congress has never been willing to take the decision away from states for bankruptcy purposes. Thus homestead exemptions vary from minimal to unlimited, setting the stage for sad cases such as you describe. However, even with the best of intentions, creating an "always fair" scheme would be a daunting challenge. For example, the extremely generous pension protections in current law seem non-controversial, and if there is anything which few would allow to be exempted, it is large amounts of cash. But suppose you and I are both in our 50's, have closely parallel situations, and need consider bankruptcy. I am employed, and have accumulated $500,000 in protected retirement accounts. You are self-employed, and have acquired a similar retirement reserve, but to maintain flexibility in your business have felt compelled to keep the funds in unrestricted accounts. Where is the "fairness"? How could there be "fairness"? But, yes, based on my 30+ years as a bankruptcy lawyer, the exemption laws do work for most people most of the time.

The problem is not with the exemption scheme, but with a healthcare system which forces people into bankruptcy because they get sick.

Sometimes Bankruptcy is not the answer. Sometimes, one needs to shell out the money to pay a lawyer to litigate.

For example, with a medical emergency, there really is no contract. You go to the ER and perhaps are admitted to the hospital. But there is no discussion of costs and fees prior to services being rendered.

So the courts are asked to fill in a price term. Now, Courts don't like doing this. They really are not set up to do this and don't have the tools to do it. And the whole thing really ends up sounding in equity, as a form of quasi-contract.

So the answer to your friends, in part, is to make the hospital prove up their claims. I suspect that most people would find $30,000 for a six day stay to be excessive and unreasonable. Especially since people on Medicare or who have good insurance policies pay far less. The reality is, your friends are being asked to subsidize the healthcare costs for other people.

Meanwhile, your friends need to get their house sold, and move next door to Texas or Oklahoma, where there are 100% homestead exemptions.

Any litigator worth his salt should be able to tie up the hosptial's case long enough to accomplish this.

Besides, the hospital might have a hard time even bringing suit because disclosing this information is probably a violation of HIPPA.

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