The maxim that one’s home is their castle goes 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 these days that maxim may not be as literal as it once was, the courts still hold one’s homestead as practically the most sacred and impenetrable asset that exists.
Some banks may tend to disregard a debtor’s homestead, considering it an untouchable asset when it comes to sources for delinquent loan recovery. And they would be correct in making that assumption under most circumstances. However, it’s worth it for the lender to spend a little time scrutinizing the specific circumstances surrounding a debtor’s homestead before they write off a potentially lucrative source of repayment, especially if the property was designated by the debtor as his or her “homestead” within the last several years, or the liquidation of non-exempt property is followed by a large pay down on the homestead loan.
Minnesota law allows a creditor to pierce the “homestead” designation of real property, if the debtor claims a homestead exemption with the actual intent to hinder or defraud creditors. In the case Jensen v. Dietz (In re Sholdan), 217 F.3d 1006, prior to filing for bankruptcy, the debtor 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 the Minnesota Uniform Fraudulent Transfer Act, a debtor may not claim a homestead exemption when he or she transfers the property with actual intent to hinder, delay or defraud creditors. This legal principal not only applies to a fraudulent debtor’s purchase of a “homestead” using non-exempt property, but also under any circumstance where a debtor liquidates an amount of non-exempt property and transfers it into a homestead in order to put it out of reach of creditors. And it applies in bankruptcy and non-bankruptcy situations.
However, notwithstanding the ruling in the Jensen case and its progeny, the above doctrine is 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 speed boat and making a large payment toward the homestead mortgage) is not in itself fraudulent. However, if there are additional facts indicating that the debtor has done so with the actual intent to defraud creditors, there is legal authority standing for the principal that those converted assets can be clawed back by the creditor and applied to the delinquent debt.
Although the saying that “a man’s home is his castle” may be a time-honored bedrock idea, before the unscrupulous debtor thinks he or she can exploit that maxim with fraudulent impunity, they may realize – courtesy of the diligent lender – that Minnesota legal precedent has its own time-honored principles stretching back to the 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.”